Opinion
Financial and Monetary Systems

5 things I learned on the future of global finance at Davos 2024

view over davos ahead of the World Economic Forum's 2024 Annual Meeting in a blog about what we learned about finance

Oliver Wyman's Huw van Steenis outlines his five takeaways about global finance from this year's Davos. Image: World Economic Forum/Marcel Giger

Huw van Steenis
Vice-Chair, Oliver Wyman
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Financial and Monetary Systems

  • Leaders at the World Economic Forum's 2024 Annual Meeting in Davos were cautiously optimistic on the global economic outlook.
  • But while AI and geopolitics dominated the agenda, major transitions emerged and the reordering of global trade was also debated.
  • Having sat across more than 35 private meetings and panels, Oliver Wyman's Huw van Steenis came to better understand the mindset of businesses, investors and policy-makers – here are his 5 takeaways.

The mood at the World Economic Forum's 2024 Annual Meeting in Davos was one of cautious optimism on the economic outlook, but it was overshadowed by a surfeit of geopolitical risks.

Economic optimism is percolating because several macro scenarios are not playing out as feared: inflation is coming down faster and central banks are pivoting; soft landings (US) or shallow recessions (Europe) now look plausible; and much of Europe has navigated the abating energy crisis (for now).

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Artificial intelligence (AI) and geopolitics dominated the agenda – even crowding out discussions on climate change. But in the private sessions and corridors the major transitions were also keenly debated: the macro regime shift, energy transition, reordering of global trade and the rewiring of credit extension.

Sitting across more than 35 private meetings and panels, I came to better understand the mindset of businesses, investors and policy-makers.

Here are five of my takeaways from Davos 2024:

1. Artificial intelligence remains between hopes and fears

Alongside geopolitics, the most discussed topic at the World Economic Forum’s Annual Meeting was artificial intelligence. How transformational will it be? Will it run rogue? What does it mean for jobs? Will it concentrate power into fewer hands? And how will its business model play out?

OpenAI CEO Sam Altman was trying to rein in fears, saying: “It will change the world much less than we all think and it will change jobs much less than we all think.” Nonetheless, the call for “responsible” AI was loud.

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Take financial institutions as one test case. Based on my bilateral conversations, the leading banks are investigating use cases with roughly 10% improvement in efficiency over the next three to five years and a stretch case of up to 20%.

But while many want to experiment and gain efficiency, the lack of road-tested experience at scale, internal capabilities and regulatory approvals will all slow down progress.

“It’s going to be an evolution, it’s not going to be a revolution … because we have to be very prudent about how we do it," argued UBS CEO Sergio Ermotti in the 'Are Banks Ready for the Future?' session.

One investor told me he had trimmed his fund’s AI-related investments – arguing that the technology was genuine, but the returns might not be as great as expected.

“Maybe we have hit a kind of peak hype for this moment,’ argued Inflection AI Co-founder and CEO Mustafa Suleyman, who also co-founded Deep Mind.

2. The shift to private credit is accelerating

The structure of credit intermediation is changing apace – with a secular shift from banks to private credit – and there was much discussion, both public and private, about two possible accelerants to this major rewiring.

The first is bank regulations. US proposals – dubbed the ‘Basel Endgame’ – call for a 20% to 25% increase in capital requirements for the largest bank. I argued in the Financial Times on the eve of Davos this would likely have unintended consequences. Pretty much every bank boss and investor wanted to discuss the potential impacts.

For instance, the proposed rule would increase by fourfold the capital required for a crucial source of funding for solar or wind farms, rendering them prohibitively expensive for many banks. Already, some banks are pausing. The private credit market could pick up some, or perhaps all, of the slack over time.

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Another proposal suggests loans for small and medium-sized companies should have a risk weighting (which drives capital) three times higher than the actual loss experience. Again, this would penalize their cost of funding and encourage them to seek finance outside of the banking system.

The second accelerant is a sea change in capital allocation to credit and this was likely to be the largest growth in asset allocation over coming years. The rates or return are appealing and, moreover, many asset owners aren’t as quite as bullish as the market on rate cuts.

So where are the risks to this, as no trend goes unchecked? The primary pushback was frothiness in the leveraged lending market and credit dynamics as firms manage a more than doubling in the cost of interest (private credit is mostly floating rate, while a typical corporate bond is fixed at issuance). But a second was whether sub-scale players may push the envelope to grow their way out of trouble.

3. Energy security and end of free money shifting the green transition investment narrative

The tone of conversations around decarbonization were both more measured but deeper than at any previous Annual Meeting. That’s not just due to the green-hushing and “strategic silence”; rather there is a frank discussion about the cost and complexity of such a large transition.

The end of free money and energy security have profoundly changed the investment narrative. For instance, last year the global clean energy index (ICLN) was down 21%, while the S&P was up 24% and Nasdaq 55%. And this year it has fallen further, down almost 12% while the S&P is up 1.5%.

There is a huge rethink taking place about what this means for investment strategies and portfolios. What’s more, some funds are having large outflows or closing from such heavy underperformance. And overly prescriptive European fund rules are having to be rethought, though too slowly for many.

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But finance also needs to go where emissions are: It’s more about financing emissions reductions than just reducing financed emissions. Private equity is increasingly taking up the mantle to build out transition funds at scale and frameworks for public investing are in flight, too.

And the scale is there. UN Special Envoy on Climate Action and Finance Mark Carney spoke of the $1.8 trillion of climate-related finance last year at a Bloomberg-hosted salon.

Given the shift in rates, infrastructure projects are now more appealing, too: Ones that used to earn a paltry low- to mid-single-digit return are now in the high single digits. But it’s clear permitting, technology, supply chains and public policy are all critical and finance can’t get far ahead of this and still make good returns.

“Energy transition was always going to be messy and volatile”, argued Jason Bordoff, Dean of the Columbia Climate School. The handoff between fossil fuels and renewables is incredibly complex and full of inertia, given our current infrastructure, but is also propelled by fabulous innovation.

Geopolitics and energy security are key factors in how quickly or slowly we transition, and this has been an underdiscussed topic at United Nations’ COPs, Davos meetings and boardrooms alike.

4. Macro regime change a key issue and central banks still need to adapt

The base case for many investors I met at Davos is for fewer than the six US Federal Reserve rate cuts the market has priced in. They think the Fed is likely to be cautious given the asymmetry in payoffs for a central banker. No-one wants to cut and then have to backtrack.

Also some fear things like how the impact on trade from Houthi attacks could add costs. Hence many worry about equity markets being priced to perfection and instead are adding to credit allocations. That’s in contrast to some of the Wall Street optimism about deals and initial public offerings, which counts on borrowing costs coming down.

European Central Bank (ECB) officials were also making clear they would be reactive to watching Eurozone wage data – and the Fed – and signalled that June is the most likely scenario for the first rate cut. Given expectations for no growth across Europe, some financiers felt this was too far off.

Many investors I met also fretted that there may still be trouble in store in pockets of the economy that boomed the most from free money. Venture capital stood out – investors felt fully allocated to venture capital and worry that there are further markdowns to come.

Quite a few are running their own estimated “marked to market” accounts in parallel to official ones to guide cash flows and allocations. Others worried about credit hits to companies getting refinanced. It’s more a queasiness of unfinished business than high-conviction shorts.

Finally, after the world’s largest banks showed resilience through COVID and the fastest rise in interest rates in 45 years without too much difficulty, it feels odd that central bankers haven’t taken more comfort over the performance of post-financial crisis reforms.

It was faulty risk management practices and poor supervision at a handful of second-tier banks that tripped those banks up, and they were absorbed by large banks smoothly. This was the key debate at a private meeting between a global central banker and bank bosses.

The conclusion: there is reason for caution on pushing ahead the Fed’s Basel Endgame, and central bank models still need to adapt to today’s economy and credit extension system.

5. The reordering of global supply chains is accelerating

The pace of friendshoring is accelerating – benefiting India, Vietnam, Mexico and, to some extent, Canada – if the private panels and corridor conversations are a good steer.

Disinvesting from China was a dominant theme in talks between one of the world’s largest asset owners and companies. Some US funds spoke to political pressure to flatten risks in Chinese securities.

One CEO of a mammoth industrial said they will undertake maintenance capital expenditure only for their operations in China and a roughly 35% increase in capital spending in 2024 to enable a major new plant in a friendshoring move.

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Meanwhile, macro investors are more worried about the balance sheet recession in China stemming from the bust of the property bubble. Given this now feels like an embedded trend, it is making China feel a need to reach out more constructively, one keen watcher argued to me.

Previous summits have been a flashpoint for US and European Union disagreements – whether over who pays for NATO, the US Inflation Reduction Act, the foolhardiness of Russian gas dependence or unlevel financial regulation. But such issues have been deprioritized while hot (and cold) geopolitical conflicts continue to rage.

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For instance, there was far less finger wagging at the US over the Inflation Reduction Act by the Europeans than last year. This industrial policy so far has been a great success – a recent MIT study shows it’s running twice ahead of the Congressional Budget Office’s base case. So it’s not a lack of effectiveness.

Rather it appears more to be with European fiscal worries, which mean Europeans fret that they compete at the scale of the US, while some modifications in the rule writing softened some of the sharpest edges. As one said, Europe has an uneasy choice: If it wants to go green at an acceptable cost to society, it will have to buy Chinese – and risk falling out with the US.

Meanwhile, in the context of a fragmenting world, the UK’s Brexit bet on global trade deals to offset the large loss of trade with Europe has never looked more out of the money.

Where next for the global finance?

So what about this year’s unusual mix of economic optimism and geopolitical apprehensiveness?

One highlight this year was getting my hands on an extremely rare copy of the new Stripe edition of “Poor Charlie’s Almanack” – which sold out in the hours following Berkshire Hathaway's Charlie Munger’s death aged 99 – through a chance meeting with Stripe CEO John Collison.

Munger argued one must: “Recognize reality even when you don't like it. Especially when you don't like it.” The Fed pivot continues to provide succour to equities. But given the uncertain geopolitical outlook, investors should run scenarios even for unpalatable outcomes – and manage their bets accordingly.

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