COMMENT : Major sets the scene for a roller coaster ride

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The Independent Online
On the face of it, John Major's resignation has little if any relevance for financial markets, despite the frantic futures trading that took place on Liffe last night. Certainly it is not an event that seems fundamentally to alter the investment landscape. Reaction, in London at least, was muted; the view from the trading floor was that nothing could be worse than the present Tory infighting and that yesterday's development should therefore be viewed positively.

That, however, is very much a domestic City reaction. The view from overseas is rather different. To overseas investors, a prime minister's resignation highlights something that those not plugged into national events might not fully have appreciated - a deeply unstable political situation. Markets hate uncertainty and this is clearly an uncertain situation.

Furthermore, to write this off as without significance is to assume that a similarly minded Tory inherits the position. The succession of a tax- cutting rightwinger could have very dramatic implications for economic policy, as equally could that of a one-nation Tory like Michael Heseltine. Watch out for a roller coaster ride for the pound, stocks and shares as the contest develops.

The shift is from equities to gilts

For a good 30 years, institutional investors in Britain have pursued the cult of the equity. Their reward has been superior returns and protection against inflation that ravaged returns on conventional gilts. But times are changing, judging by new figures released yesterday.

In the first quarter of 1995, institutional investors disinvested in UK company securities for the first time since 1974. The net disinvestment in ordinary shares amounted to pounds 1.6bn. Pension funds were the principal force at work, cutting their holdings of UK company securities by pounds 3bn - this at a time when they stepped up their net investment in gilts to over pounds 3bn.

One swallow doesn't make a summer, but this is almost certainly more than a temporary aberration. Pension funds are maturing, but their distribution of assets has not yet adjusted to take account of this. They are overweight in high-return but high-risk equities at a time when attention is focusing on liabilities to the increasing number of retired in schemes.

A further incentive for change is the effect of current pension legislation, which will introduce minimum funding requirements. In broad terms, the principle is that equity yields can still be used to value schemes' liabilities to active members but gilt yields must now be used to value at least three- quarters of the obligations to retired people.

The effect, one leading fund manager suggests, is to create a benchmark portfolio - and one that is markedly out of line with the average UK pension fund.

A strong statutory impetus is thus given to a strategic shift away from equities to gilts. This impetus is given further force by the stipulation that valuations be conducted every year. The annual volatility in returns on long bonds is much less than that of equities, leaving managers who stick to the cult of the equity more exposed.

The effect of this shift in priorities could well be profound. The new funding requirements are not expected to come fully into force until 2002, but they are likely already to be colouring institutional investors' thinking.

One interpretation of all this is that the Government is cynically creating a structure in which its huge borrowings will have to be digested by institutional investors.

Another is that the Government is creating a powerful constituency for low inflation, since there will be a much more direct relationship between funds' ability to honour their commitments to retired people and the performance of gilts.

Whichever is true, the 1990s are likely to continue being the decade of gilts.

Guarantees required in telecoms deal

British Telecom is right to be suspicious of anything that enhances the increasingly serious romance between its two main European counterparts - France Telecom and Deutsche Telekom. Our own privatised utilities have got nothing on these two monoliths when it comes to monopolistic practice.

Though the affair is not yet fully blown, its ultimate purpose is already obvious - to create a partnership of such force and power that it is capable of dominating even a deregulated European telecommunications market, bulldozing all significant competition before it. US and European regulators would therefore be daft to approve the proposed link with Sprint until satisfactory assurances can be obtained about opening up the German and French markets not just to European competition, but to American as well.

Germany has made some of the right noises, announcing plans to deregulate its voice telephony market by the target date of 1998 and unveiling details of Deutsche Telekom's impending privatisation. But words are not as strong as deeds, and there is plenty of scope to worry that commitment to deregulation in Germany is not yet firmly rooted.

In France, the signals are equally mixed. The government has recently agreed to abide by the European Commission's call for the liberalisation of "alternative infrastructures" - Eurospeak for the telecommunications networks of utilities and railways, as well as cellular systems. But there is still little progress on the privatisation of France Telecom, even if the company itself has spent the past year getting ready for commercial status.

As long as these concerns persist, the European Commission is likely to hold up approval of the Atlas joint venture between the two European telecoms operators. Atlas is meant to be a harmless enough enterprise to offer big business customers global one-stop telecommunications services. As with the joint venture with Sprint, however, the suspicion is that it is a precursor to much closer ties, perhaps even a merger.

On the US side, the concern is a little different. The Federal Communications Commission and the Department of Justice want to ensure that US companies get the same open treatment in France and Germany as the two telecoms companies can expect in the US. They, too, are pushing for rapid deregulation and liberalisation of the European market, and have put reciprocity firmly on the agenda. In the short term, as unusual as it may seem, Washington and Brussels therefore have common interests.

For competitors such as BT, approval of the transatlantic link would be worrying in the extreme. BT is scrambling to forge its own European links but is presently locked out of France. Germany looks a better bet but even here, progress is slow.

There is an opportunity in all this, however. With a bit of luck, Brussels will attempt to use the leverage that approval for these two joint ventures gives to win real concessions out of Germany and France. What is needed is further, concrete proof of Franco-German commitment to telecoms liberalisation. Rubber-stamping deals like this one is certainly not the way forward.