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Japan vows to support US in opposing ‘coercion’ from China

Japanese prime minister Yoshihide Suga said the US and Japan would “oppose” coercion or force in the South and East China Seas, in unusually blunt remarks about China after his summit with Joe Biden.

Speaking alongside the US president at the White House on Friday, Suga said the two leaders had held “serious” discussions about China and the “severe security environment” in the Indo-Pacific region.

“We agreed to oppose any attempts to change the status quo by force or coercion in the East and South China Seas and intimidation of others in the region,” Suga said.

The US and Japan are concerned about Chinese military activity near Taiwan in the South China Sea. They are also worried about Chinese actions around the Senkaku Islands in the East China Sea that are administered by Tokyo but claimed by Beijing, which calls them the Diaoyu.

Suga said the leaders also stressed the importance of peace in the Taiwan Strait, in language that highlighted growing concern in the US and Japan about rising Chinese military activity around the island.

He said the two leaders had also “reaffirmed” the recent statement that their top defence and foreign policy officials had made in Tokyo about “the importance of peace and stability of the Taiwan Strait”.

Michael Green, a Japan expert at the Center for International and Strategic Studies in Washington, said Suga’s comments on Taiwan were the most assertive from a Japanese leader since the US and Japan both switched diplomatic recognition of China from Taipei to Beijing in the 1970s.

“There was a lot more nodding to the Taiwan problem than we have seen in a US-Japan summit since 1969,” he said, referring to the summit Richard Nixon held with prime minister Eisaku Sato.

Green added that Suga’s statement about opposing unilateral efforts to change the status quo mirrored a phrase that the US has used about Taiwan since the George W Bush administration.

At the press conference, Biden said the US and Japan were “committed to working together to take on the challenges from China” including the East and South China Seas.

Earlier this week the Chinese air force flew 25 fighter jets, bombers and surveillance aircraft into Taiwan’s air defence identification zone, a record intrusion.

Japan is concerned has become increasingly worried about Taiwan since any US-China conflict over the island would draw in Tokyo because of its mutual defence treaty with Washington.

A senior US official recently told the Financial Times that Washington was worried that China was flirting with the idea of invading Taiwan, which Beijing claims as part of its sovereign territory. 

In addition to Suga’s comments at the news conference, the leaders reiterated their concern in a joint statement issued after the summit, the first time such language has been included since the Nixon-Sato meeting.

In the statement, the leaders said they also shared “serious concerns regarding the human rights situations” in Hong Kong where China has cracked down on the pro-democracy movement and also in the northwestern province of Xinjiang.

The White House had pushed Suga to voice support for Taiwan ahead of the summit but Japanese officials were divided over whether he should agree to refer to the island during his visit to the US. Some argued that the recent statement in Tokyo had sent a strong enough signal to China, while others said Japan should demonstrate a united front with the US.

Suga was the first foreign leader to visit Biden since he entered the White House in January, underscoring the importance the US is putting on relations with Japan as part of his broader strategy to counter China.

Ahead of the summit, China had warned Japan to avoid getting involved in the “confrontation” between Washington and Beijing.

As well as taking aim at China, Suga said he would push to reinforce Tokyo’s defence capabilities and bolster US-Japan deterrence.

“China has engaged in a massive military build-up in Japan’s backyard — while increasingly menacing territory that Japan sees as its own. Yet Japanese defence budgets have remained at a remarkably low level, at 1 per cent of gross domestic product,” said Jennifer Lind, an Asia security expert at Dartmouth College in New Hampshire. “The dangers from China mean that Japan simply must do more. And Suga’s statement suggests that it will.”

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Hainan ‘on fire’ as luxury’s centre of gravity tilts to China

When poets, literati and courtiers fell out of favour with China’s emperors, they were banished to the island of Hainan to fend for themselves among wild jungles and indigenous tribes. 

Today, the tropical resort destination known as China’s Hawaii has become a rare bright spot in the global luxury market, which has been hit hard by the coronavirus pandemic.

“Hainan Island is on fire,” John D Idol, who heads Capri Holdings, owner of the Michael Kors and Versace brands, told analysts in February. 

To boost domestic consumption, the Chinese government has turned the island into a duty-free shopping hub. Visitors can indulge in fashion from Gucci and Prada, jewellery from Cartier, beauty products from Estée Lauder or premium whisky from The Macallan.

Hainan became even more popular when Covid-19 travel restrictions meant Chinese consumers, who have driven luxury sector growth in recent years, could no longer go on shopping trips to Paris, London, Milan or Hong Kong.

The island is a powerful symbol of how luxury’s centre of gravity is tilting towards China, mirroring the “repatriation” trend in earlier decades of Japanese shoppers who used to buy Louis Vuitton and Balenciaga abroad but now do so at home.

Nowhere is this clearer than at sector leader LVMH, whose accelerating recovery has been fuelled in large part by China. The company said on Tuesday that its first-quarter sales in Asia excluding Japan were 26 per cent higher than in the corresponding period of 2019, before the pandemic.

Even when Chinese shoppers can travel again, analysts expect they will continue to buy at home as brands open bricks-and-mortar stores and expand ecommerce offerings, such as virtual stores on Alibaba’s Tmall Luxury Pavilion

The share of Chinese consumers’ high-end purchases within the country soared from 32 per cent in 2019 to more than 70 per cent in 2020, according to consultancy Bain, and is expected to be about 55 per cent by 2025 once the pandemic effect fades.

Amy Dai is emblematic of the consumer those brands have been able to attract. The 30-year-old resident of Chongqing used to make pilgrimages to Europe to buy luxury goods, one of China’s 170m annual overseas travellers whose spending accounted for more than a third of all global luxury sales before the pandemic struck.

But last year, Dai took a two-hour flight to the Hainan city of Sanya to shop, and to do so turned to online platforms. Her spending on luxury items topped Rmb1m ($150,000) last year, more than in 2019.

“Before the pandemic, I did prefer going abroad or occasionally I would buy from overseas purchasing agents,” she said. “Since the pandemic started I’ve switched to domestic retailers, because otherwise I can’t get the latest editions in time.” 

The luxury sector is counting on Chinese consumers to fuel the recovery after a difficult 2020 in which sales contracted by roughly a fifth to €217bn globally, according to Bain.

Locator map of Hainan, China

China’s comparatively successful suppression of the virus and rapid economic recovery — gross domestic product growth returned to pre-pandemic levels in the fourth quarter — played a pivotal role in maintaining optimism.

The recovery was initially spurred by “revenge shopping”, or indulging after the world’s most populous country emerged from a nationwide lockdown, but has since given way to something more durable.

“There are plenty of rich people who have benefited from the pandemic as they work in high-growth industries or own well-performing stocks,” said a Beijing-based employee of a European brand. High-end jewellery, the person added, was “selling like crazy”.

The pandemic also accelerated shifts that were under way in China’s luxury market, such as the expansion of ecommerce, lower import duties and tighter controls over the grey market driven by daigou, professional shoppers who buy watches, jewellery, clothes and cosmetics overseas on behalf of mainland Chinese. Brands had already begun narrowing the price differential that had made goods sold in China more expensive than those stocked in Europe or the US. 

Hainan duty free sales to grow sevenfold by 2030

Such trends have prompted luxury brands to invest more in China.

A report from Jefferies analysts found that only Louis Vuitton, Burberry and Gucci had stores in all of China’s 25 biggest cities, suggesting that others might need to expand their footprints. 

Planting a flag in Hainan could be an effective way to get in front of more Chinese consumers. 

Shiseido, the Japanese beauty brand, plans to double its sales counters on the island to 60 by the end of the year. Estée Lauder also said it was experiencing strong demand.

Beauty and cosmetics products account for almost half of all duty free sales in Hainan, according to Bernstein Research, while luxury goods make up about one-third of sales. But the latter are growing rapidly with the number of luxury brands on the island up 80 per cent in the past six years. “We expect more are going to come,” Bernstein analysts wrote.

Tourists purchase bags at a duty-free shop in Haikou, Hainan
Tourists purchase bags at a duty-free shop in Haikou, Hainan © Luo Yunfei/China News Service via Getty

Chen Xin, an analyst at UBS, said Hainan’s duty free sales more than doubled in 2020 from the previous year to Rmb30bn, and she forecast a compound annual growth rate of 40 per cent from 2019-25.

Further underpinning this growth were policy changes intended to build up duty free shopping on the island.

Last year, the Chinese government tripled the amount that consumers could buy annually duty free in Hainan to Rmb100,000 and scrapped a cap of Rmb8,000 for a single item. It also issued three licences to companies to operate duty-free shops, a significant increase from the seven licences that had previously been given since the 1980s.

But some luxury brands were wary of betting too much on Hainan, given that they could only sell there via wholesale agreements with state-backed companies and cannot open their own stores. That gives brands less control over pricing and customer experience.

Others worry that the island risks being abused by daigou.

“We believe the development of Hainan is positive but we must remain careful and work together to ensure that it does not become a hub for the grey market in China,” said Jean Jacques Guiony, chief financial officer of LVMH, the world’s biggest luxury group.

“If consumers travel to Hainan and come to our boutiques, then we are ready to serve them. But if it is to buy in bulk and then resell to intermediaries, then no.”

Despite those concerns, LVMH has expanded on Hainan via DFS, its travel retail division. The company has partnered with Shenzhen Duty Free Group on a duty free mall called Haikou Mission Hills located in a popular resort. It opened in January but will be expanded over the next two years to reach more than 30,000 sq m of retail space.

Such destinations could help alleviate the crowds that Sharron Zhou, a 35-year old marketing executive from Shanghai, ran into during her trip to Hainan over the lunar new year. She was so put off she did not buy anything. “You couldn’t find salespeople . . . People were stepping on my feet,” she said.

Additional reporting by Xueqiao Wang in Shanghai, Sun Yu in Beijing, and Alice Woodhouse in Hong Kong

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SpaceX wins $2.9bn Nasa contract to land Americans on the moon

Elon Musk’s SpaceX is set to return American astronauts to the surface of the moon, beating rival tech billionaire Jeff Bezos to one of the most prominent prizes in the commercial space race.

Nasa on Friday named SpaceX as the sole contractor to build its next lunar lander and carry out a single demonstration visit to the moon, potentially as soon as 2024.

SpaceX offered to build and operate its lander for $2.9bn, which was “significantly” less than a rival bid from Bezos’ Blue Origin, according to a Nasa document obtained by the Washington Post. A third company, Dynetics, had submitted a bid that was higher still.

The selection of a sole contractor breaks with recent Nasa practice of picking two rival projects for the most important elements of its space programme, and reflects the severe budgetary pressure the agency has been operating under as it tries to return to the moon for the first time since 1972.

“We awarded the contract to SpaceX given what we believe are realistic budgets in future years,” said Mark Kirasich, a Nasa official.

The choice of SpaceX threatens to widen the gap with other commercial space concerns, and leaves Nasa increasingly dependent on Musk’s private space company. Besides pioneering a new era of fixed-cost commercial space programmes for Nasa, SpaceX was the first to carry cargo to the International Space Station, and last year brought human space flight back to US soil for the first time since 2011 when it took Nasa astronauts to the ISS.

Nasa officials said they were launching a review into how they can maintain competitiveness in the development of human landers, including a round of consultations with the rest of the commercial space industry. The discussions were designed to lead to a “sustainable” series of visits to the moon, following in the wake of the single SpaceX demonstration landing, they said.

Bezos had sought to align himself with some of the traditional powers of the US space industry, fronting a project to build a lunar lander alongside Lockheed Martin, Northrop Grumman and Draper.

SpaceX will use its Starship, which is under development, for the demonstration lunar landing. Despite the company’s plans to eventually use the craft for a complete journey between the Earth and Mars, its role in the landing announced on Friday will only be to take two astronauts from orbit around the moon down to the surface before returning them.

The mission is part of Nasa’s Artemis programme, which will use the giant SLS rocket being developed by Boeing, along with the Orion spacecraft from Lockheed Martin, to fly astronauts to and from a “gateway” in lunar orbit. Despite Starship’s potential to replace both of these programmes, Kirasich said Nasa had “no plans to change our architecture” and would stick with its existing plans to reach the moon.

SpaceX has suffered a number of fiery crashes this year in its first efforts to prove it can safely land the Starship. Lisa Watson-Morgan, Nasa’s programme manager for the lunar lander, said of the glitches: “As we have areas to work through, we will work through those. But right now, everything looks good.”

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EY’s Wirecard audits suffered serious shortcomings, German probe finds

EY’s audits of defunct payments group Wirecard suffered from serious shortcomings over a period of years, a German investigation has found.

The Big Four firm is said to have failed to spot fraud risk indicators, did not fully implement professional guidelines and, on key questions, relied on verbal assurances from executives.

A special investigator who scrutinised the EY audits came to a damning verdict about the quality of the work, according to people with first-hand knowledge of the report. The investigator was commissioned by the Bundestag parliamentary committee in Berlin looking into the accounting scandal and had access to internal EY documents.

The report, filed to the Bundestag late this week, will significantly increase the woes of the accountancy firm. EY is already facing lawsuits from Wirecard shareholders and creditors. Legal action by Wirecard’s administrator is also likely to follow.

EY partners who signed off Wirecard’s accounts are already under criminal investigation over potential violations of rules on carrying out professional duties. Earlier this year, the accountancy firm replaced its leadership in Germany and announced an organisational reshuffle.

“The report outlines failures during the EY audits as professional standards were not met,” Matthias Hauer, an MP for the conservative CDU/CSU parliamentary group, which suggested appointing the special investigator, told the FT. He added the report confirmed “EY has significant responsibility for the scandal not being uncovered earlier”.

Wirecard received unqualified audits from EY for a decade and was once hailed as one of Germany’s rare technology success stories. It collapsed into insolvency last summer after revealing that €1.9bn in cash did “not exist”.

A team from auditors from Rödl & Partner led by Martin Wambach, the parliamentary special investigator, dug through 90 gigabytes of EY data that included internal working papers and 40,000 emails.

The review found that EY did assess in detail Wirecard’s outsourced operations in Asia, which sit at the heart of the fraud. However, the auditor did not take issue with the fact that the day-to-day operations in the so-called third-party acquiring business (TPA) “deviated substantially from contractually-defined business processes”.

Moreover, EY failed to spot a series of fraud risk indicators, among them unusually close links to its Asian partners as well as high and rising margins in a business that had lower value-added than Wirecard’s core business. Rödl & Partner dismisses Wirecard’s argument that higher profitability reflected the TPA business carrying a higher risk; it points to the fact that the higher risk never led to financial losses.

“From our perspective, there were numerous fraud risk indicators with regard to the TPA business which could have increased the critical attitude and could have triggered further audit acts,” the special investigator concludes.

Rödl & Partner, like KPMG in its special audit last year, also takes issue with the fact that the money deposited in escrow accounts in Asia was treated as Wirecard cash. It notes that EY’s assessment of the matter was “contradictory” as internal documents showed the firm initially wanted to treat the money as “other financial assets”.

EY later changed its mind based on the argument that Wirecard could access the funds within three months on condition it could get a bank guarantee. The accountancy firm stated internally that, thanks to its financial strength, Wirecard could obtain such a bank guarantee at any time — but EY did not check that proposition during its audits.

Rödl & Partner also noted balance confirmations for the escrow accounts repeatedly suffered from inconsistencies, such as different Wirecard subsidiaries attributed to the same accounts.

“The [Rödl & Partner] report about EY is the equivalent to the KPMG report about Wirecard. Its language is technical, but its content is devastating,” said Jens Zimmermann, an MP for the Social Democrats.

Fabio De Masi, an MP for the leftwing Die Linke, said: “EY had a deep understanding of the TPA illusion and to some extent even was its mastermind,” adding that it was unsurprising that the business was not properly audited. “For me, the question is if EY did not want to uncover anything.”

Rödl & Partner did not immediately respond to FT requests for comment.

EY said its German arm had not been provided a copy of the Rödl & Partner report and so was unable to comment on its contents.

“The collusive acts of fraud at Wirecard were implemented through a highly complex criminal network designed to deceive everyone — investors, banks, supervisory authorities, investigating lawyers and forensic auditors, as well as the auditors,” EY said

“We have supported the parliamentary inquiry committee (PIC) throughout and will continue to do so. We also welcomed the PIC’s decision to consult auditing experts and fully co-operated with the special investigators in their work.

“Based on our information, the EY Germany auditors performed their audit procedures at Wirecard professionally, to the best of their knowledge and in good faith.”

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Netscape 2.0: Coinbase stock debut rekindles memories of web breakthrough

For cryptocurrency enthusiasts, this week’s blockbuster US stock market listing for Coinbase is the modern equivalent of the Netscape debut that thrust the internet on to the mainstream of finance a quarter of a century ago.

The initial public offering of the web browser — then a Silicon Valley start-up — came well before Microsoft bundled Internet Explorer into its best-selling PC software. It was the moment to get in on the ground floor of a life-changing technology.

Still, the 1995 launch left some fund managers scratching their heads: how do you value this company? Is it really a game-changer?

A similar conversation is taking place across Wall Street today after more than 120m Coinbase shares — worth $43bn — changed hands on Wednesday and Thursday, pushing its valuation to $65bn, just below that of Intercontinental Exchange, the owner of the New York Stock Exchange.

The public-market launch of the company, which holds digital assets for 56m retail customers and operates the largest digital coin exchange in the US, was the latest in a long line of examples of how bitcoin and other digital assets are moving from the fringes to the main stage.

The Netscape IPO “was the moment it was printed on the public psyche: ‘What is the internet? What is the web?’,” said Tom Jessop, the president of Fidelity Digital Assets. “This transaction is probably that significant.”

Several asset managers have filed plans to launch bitcoin exchange traded funds with the Securities and Exchange Commission. Goldman Sachs is restarting a crypto derivatives trading desk as institutional money managers warm to the market. The chief executive of the New York investment bank, which advised Coinbase on its flotation, told investors this week that he wanted to “look for ways to expand our capabilities” in crypto.

A handful of companies, including Tesla and payments group Square, have bought bitcoin to hold on their balance sheets. And this week hedge fund Brevan Howard moved to invest up to 1.5 per cent of its main fund in cryptocurrencies, according to a person briefed on the matter.

Sceptics note that cryptocurrencies have yet to achieve widespread adoption in payments and other core areas of the financial system. Jay Powell, chair of the Federal Reserve, on Wednesday called cryptocurrencies “vehicles for speculation”, reflecting a view that is still prevalent among key policymakers around the world.

GM170428_21X_Coinbase read

Cryptocurrencies have also drawn the ire of prosecutors and regulators, concerned over money laundering and risks to the investing public given their high volatility, as well as alarm over the environmental damage caused by bitcoin mining. In 2018, Bank for International Settlements head Agustín Carstens said “cryptocurrencies are, in a nutshell, a bubble, a Ponzi scheme and an environmental disaster”.

Though the Coinbase debut marks a critical juncture for crypto markets, the company had to put some of its more ambitious plans on hold. A sale of tokens, a type of digital asset that would have formed a class of Coinbase stock, was ultimately cancelled after the company struggled to find a large enough pool of brokers licensed to trade them, according to people involved in the process.

The Coinbase listing, which raised at least $3.4bn for shareholders who sold at the opening trade on Wednesday, does not guarantee a solid trajectory for the exchange or for cryptocurrencies. The rally in bitcoin prices has helped drive investor interest in the digital currency, and a reversal could prove damaging to its prospects. Already, the surge in retail trading that captivated Wall Street and the investing public in January and February has begun to fade.

Bitcoin and other assets have appeared to be on the verge of mainstream adoption before; in one high-profile setback in 2019, the derivatives exchange Cboe pulled the plug on bitcoin futures due to a lack of investor interest.

Line chart of Daily median bitcoin transaction fee ($)  showing Trading crypto is proving to be lucrative as transaction fees climb

Still, more crypto listings are in the pipeline. Bakkt, the Intercontinental Exchange-backed provider of crypto wallets, is going public through a merger with a shell company. The chief executive of Kraken, a Coinbase rival, has also laid out his ambitions to go public. Shares in the company have recently changed hands at prices that would give it an implied valuation of $10bn to $15bn, according to people briefed on the trades.

Coinbase has already shown it is profitable, recording net income of at least $730m from about $1.8bn in revenue during the first quarter. That suggests that, compared to the fees that established brokers and exchanges can earn from processing much larger volumes of stocks trades, this is a lucrative business. Coinbase’s regulatory filings, including quarterly and annual reports and investor presentations, will now offer a peek into the business in a way not seen by the public before.

“It’s now a phenomenon traditional institutions cannot ignore,” Jessop said, noting the company’s large user base. “Clearly that’s an attractive pool of revenue.”

For the wider cryptocurrency ecosystem, the Coinbase listing “legitimises the industry in a new way”, said Stephen Wink, a partner at law firm Latham & Watkins, which advised banks on the transaction. “Folks understand that the SEC process for becoming a public company is a rigorous one, and that gives some comfort that what they’re doing is on solid ground. That lends real credence to do all this.”

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Fed urges Texas to ‘winterise’ grid after $130bn storm damage

February’s Arctic blast inflicted as much as $130bn in economic damages on Texas, making the hundreds of millions of dollars in annual investment needed to protect the state’s power grid from freezing temperatures worth the cost, the Dallas Fed said in a report on Friday.

The storm dealt a devastating blow to the state, knocking out power for nearly a week, killing at least 100 people and causing widespread damage to homes, businesses, crops and infrastructure. The Dallas Fed put the economic toll at an estimated $80bn to $130bn.

The storm also exposed a fragile power grid and natural gas supply system that was not able to withstand sustained freezing temperatures — critical equipment at gas and coal power plants failed, wind turbines seized up and gas wells and pipelines froze, resulting in the loss of about half the state generation capacity.

“The cost of annual preparations for extreme and relatively infrequent weather events has proven difficult for policymakers and industry to justify,” said the team of Dallas Fed economists. “Our analysis indicates winterising for extreme winter weather events appears financially reasonable.”

The Texas legislature is debating proposed rules in response to the storm that would require power plants to winterise their facilities and provide funding to cover the cost, with penalties for not doing so escalating to as much as $1m a day.

The newly proposed regulations, part of a sweeping response to the storm, are similar to those that were recommended by federal officials after a similar cold snap caused widespread blackouts in 2011, but were never taken up by Texas state lawmakers or regulators.

The “shocking aftermath of the February freeze and the widespread power outage demand” another look at the investments, the Dallas Fed said, estimating the total cost of hardening measures at as much as $430m a year.

Winterising the state’s 162 gas-powered plants, many of which were knocked offline during the storm as pipes and other equipment froze, would cost around $95m.

Installing internal warming equipment at the state’s 13,000 wind turbines would be “infeasible”, says the Dallas Fed, but upgrading cold-weather coatings on turbine blades and having more de-icing drones ready to deploy would make them more resilient. Newly drilled oil and gas wells would be more expensive to upgrade at up to $200m a year in added costs, the Dallas Fed estimates.

Texas lawmakers so far have not taken up similar measures that would require the oil and gas industry to protect their equipment from the cold weather, which critics say is a major gap in the state’s storm response.

Natural gas production plunged 45 per cent during the storm as many wells and pipelines were knocked offline by the freezing temperatures and others lost power, creating a “death spiral for electricity generation”.

Many have urged Texas authorities to strengthen the grid as climate change threatens to bring more intense storms to the state.

“Without question, these extreme weather events are coming with greater frequency and intensity and with rising costs and loss of life” Sylvester Turner, the mayor of Houston, Texas’ biggest city, told a US House hearing on the storm last month.

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Israel’s shadow conflict with Tehran moves into the light

A mysterious explosion that caused a blackout at Iran’s nuclear enrichment facility last weekend prompted suggestions from the Islamic Republic that its old foe Israel was responsible.

Israel is usually tight-lipped after an unexplained attack, whether the November assassination of a leading Iranian nuclear scientist, cyber attacks designed to slow Tehran’s enrichment ability or assaults on Iran-linked ships travelling in international waters.

This time, however, in officially sanctioned leaks to local media and the US press, Israel all but claimed credit for last weekend’s attack.

Its public embrace of a shadow conflict with Tehran is aimed at complicating the US-brokered talks over Iran’s nuclear programme that have been given new life by Joe Biden’s presidency, according to Israeli, European and US officials and analysts who spoke to the Financial Times.

“Israel wants to make the position [over nuclear talks] harder for the American administration and send the message to the Iranians that we’re stronger and we don’t need to hide when we’re doing something,” said Eldad Shavit, an Israeli army reserves colonel and former intelligence officer.

For Benjamin Netanyahu, Israel’s veteran prime minister, the escalation is part of a decade-long rejection of the idea that Iran’s ambitions can be tamed by diplomacy.

His position, say people familiar with his thinking, is both politically expedient — Iran is a potent symbol in Israeli politics — and driven by a deeper fear of the existential threat posed by Tehran. In his assessment, Israel’s own undeclared covert nuclear weapons programme — active since the 1970s and operational since the 1980s — is not a sufficient deterrent.

Netanyahu sacrificed his relationship with President Barack Obama by aggressively courting Republicans opposed to the nuclear accord signed with world powers in 2015. While Netanyahu was vindicated when Donald Trump ripped up the deal in 2018 and imposed crushing sanctions on Iran, the Israeli leader now fears a return to Obama-era rapprochement.

Israeli PM Benjamin Netanyahu alleges that Iran always intended to renege on the nuclear deal © Debbie Hill/EPA/Shutterstock

Netanyahu has in the past few years authorised hundreds of air strikes on Iranian-linked targets in Syria, and more recently stepped up covert actions. An assessment from the US intelligence community this week described a pattern of “iterative violence between Israel and Iran”.

“If you put together all the things Israel’s doing, what they’re saying . . . is that going back to [the nuclear deal] isn’t going to stop us, we don’t believe in it and you’re going to have to go further,” said Elliott Abrams, the Trump administration’s former Iran envoy. Israel believes that without “additional limits on the Iranian nuclear programme or on Iranian support for terrorist groups we will have to act in our own self defence”, he added.

Israel has always said the Iran deal is insufficiently broad because it does not include curbs on Iran’s pursuit of ballistic missiles and its regional ambitions, including backing Shia militia groups in Iraq, Lebanon and Syria.

Netanyahu has also alleged that Iran always intended to renege on the deal, trumpeting a secret nuclear archive that Mossad agents spirited out of a warehouse in Tehran.

“Israel has had a long-running war with Iran, even if it has been a secret war with a low-profile,” said Sima Shine, a former Mossad official and head of the Iran programme at the Institute for National Security Studies. “Now, there’s an interest in Israel to deter Iran, and to make them think we can penetrate any place every time they jeopardise our national security.”

Iran responded to the blackout by this week stepping up its uranium enrichment to 60 per cent, its highest ever level. Weapons-grade uranium is enriched to 90 per cent.

“These are our responses to your viciousness,” Iran’s president Hassan Rouhani said on Wednesday, even as nuclear talks with world powers were restarting in Vienna. “You wanted to make our hands empty during the talks but our hands are full.”

Iranian officials agree in private that Netanyahu’s intention is to derail the talks, while covert actions delay the nuclear programme.

“Israel has a record of destroying Iraqi and Syrian nuclear programmes and has the self-defined mission to do the same with Iran’s but not through bombardment rather sabotage,” said an Iranian hardliner. “It’s sending a message to the Americans that they don’t need to contain Iran through the talks and hence no need to lift the sanctions.”

A US National Security Council official said Washington and Tehran had a “common objective” of returning to the nuclear accord. The Vienna talks were the best way to limit Iran’s nuclear ambitions and to “address the full range of concerns that we have with Iran’s activities in the region and beyond”, the person added.

Mike Eisenstadt, a former US government military analyst now with the Washington Institute think-tank, argued Israel’s covert actions could give the Biden team leverage. “It kind of puts daylight between the US and Israel and buys time for negotiations,” he said.

European diplomats have expressed dismay at the tit-for-tat conflict and its capacity to damage the Vienna talks.

One described it as a “vicious circle” and said Iranian retaliation through moving to 60 per cent enrichment “could seriously complicate things” in the Austrian capital. Another European official said there was “one actor who is not interested in the talks” and was attempting to “undermine the diplomatic efforts” — a clear reference to Israel.

But the official also expressed hopes that other parties wanted the nuclear deal “back on track”, including Iranian hardliners who need sanctions lifted to bring economic benefits and ease domestic political pressures.

“In the end it will be about what kind of compromise will be found . . . and which they can sell as their win and show they were not the ones who have backed down,” the official said. 

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Pipeline pressure and Elliott’s stake have GSK in a spin

When Emma Walmsley announced the bold move to break-up British drugmaker GlaxoSmithKline in 2018, she said spinning off its toothpaste-and-vitamins unit would allow the company to focus on delivering “breakthrough medicines”.

But as the split looms, with GSK due to reveal more detail on its plans for the £9.8bn consumer health joint venture with Pfizer in June, shareholders fear the cupboard of innovative drugs is almost bare. Elliott Management, the activist hedge fund, has taken a multibillion-pound stake to push for change, sending GSK’s share price up 6 per cent after the Financial Times reported the position this week.

Yet it is far from clear whether GSK’s lagging research and development productivity is bad luck or poor planning — and whether another leader could have tackled the challenge more quickly. Walmsley has pledged to carry on as chief executive of the drugmaker after the split but some shareholders would prefer her to lead the consumer business, where she has more experience. 

One top-30 shareholder said: “The natural [CEO] change that might have happened organically — Emma will have been in the role five years in 2022 — could be forced through by Elliott, who see this, plus the uplift from crystallising the disposal of the consumer healthcare business, as the medium-term upside in their plan.”

Elliott’s stakebuilding — led by Mark Levine and Sebastien de La Riviere — caught GSK off guard. The pharma group had not prepared a defence against any potential activist investors or held formal discussions with the hedge fund, according to people briefed on the matter.

Elliott declined to comment. But one person familiar with the activist group’s general approach argued it would not have become involved unless it planned to agitate for a sale of at least part of the business ahead of the demerger — most likely consumer health — with pharma and vaccines likely to be put on the bloc later.

“This is the end of GSK,” the person added. 

Early successes

Walmsley was an unexpected choice to lead the company. As the process of finding a successor to former chief executive Sir Andrew Witty began, then-chair Sir Philip Hampton assured shareholders he was looking for “an external candidate steeped in pharma”, said one person briefed on the conversations.

Walmsley, appointed in September 2016, had no background in that area — and was already on the GSK payroll as chief executive of the consumer health division, having joined the company after a long stint at L’Oréal.

One person familiar with the search said the strongest of three external candidates who all had solid pharma experience was excluded over a $25m golden handcuff payment that would have been met with “substantial shareholder resistance”. 

Walmsley, one of three internal candidates shortlisted, had in any case been the preferred choice of all directors on her merits, the person emphasised.

A senior portfolio manager in the City of London, who holds GSK shares, said Walmsley had made a good early impression. She won praise for surrounding herself with experienced scientists, such as Hal Barron, the president of R&D who also sits on the board and has done innovative deals, investing in new ways to find drugs; and Luke Miels, a former AstraZeneca executive who leads pharmaceuticals. 

“When she first came in, she hired some very good people around her, the ex-HSBC chief financial officer, a new head of pharma, a new head of R&D. She didn’t overpay for the Pfizer consumer assets — and ended up doing the joint venture which was good for both parties,” he said. 

Another top-30 shareholder said the decision to split the company, ending the diversified model that Witty had assiduously defended, was a “brave move”. “It also shines a light on pharma, which has to be strong enough to prosper on its own,” the shareholder said. 

But now some shareholders worry that the fresh attention could expose GSK’s failure to refill the drugs pipeline. Investors sometimes compare Walmsley to rival AstraZeneca’s Pascal Soriot, who had a career in pharma including leading Genentech before taking the helm of the Anglo-Swedish company and turning it into a scientific leader.

GSK’s drugs pipeline has lagged behind its rivals

“The best people in the pharma industry tend to have deep roots in science and can really fully contribute to the strategic decisions on R&D direction,” said Jo Walton, an analyst at Credit Suisse.

Before Elliott’s approach, shares in GSK had fallen 14 per cent since Walmsley took up the post in 2017, compared with a rise of 49 per cent at AstraZeneca over the same time, and a 16 per cent increase at US-based Pfizer.

Out of the vaccine race

Concerns over GSK’s pipeline have been brought into sharper focus during the pandemic.

The company is notably absent from the frontrunners that have a Covid-19 vaccine on the market. It decided to focus on supplying an adjuvant to boost the efficacy of vaccines made by others — including in a partnership with Sanofi that is far behind, after problems with an early-stage trial. 

While investors may be glad GSK has escaped the scrutiny that AstraZeneca is suffering, it has missed out on the billions of dollars of revenue forecast by Pfizer and Moderna.

GSK has been playing catch-up with a deal with German biotech CureVac and a partnership with Vir, which has created a promising Covid-19 drug. It also has an earlier stage project on self-amplifying mRNA on vaccines.

GlaxoSmithKline employees
GlaxoSmithKline is focusing on supplying an adjuvant to boost the efficacy of Covid-19 vaccines made by others © Kenzo Tribouillard/AFP via Getty

But its position could be further damaged as vaccine executives and scientists are leaving the company, resenting being left on the sidelines when they could have made the biggest contribution of their careers, according to people familiar with the matter.

Rebuilding oncology

Even before Elliott’s stake was revealed, this week had been disappointing for GSK. The company had been reinvesting in oncology — a lucrative market where novel drugs can fetch high prices and trials are shorter — reversing Witty’s move to exit the area. But on Wednesday, GSK scrapped two trials for cancer drug feladilimab. 

It was only a small setback, but comes after others earlier in the year. In January, one oncology drug failed in late-stage trials, and another had its US regulatory approval delayed by restrictions related to the pandemic. The drug has received a positive recommendation in the EU. 

Failures are common in drug development, with some experts estimating as many as nine out of 10 do not get approved. GSK does have 14 assets in oncology now, including Zejula, from its acquisition of Tesaro, which is on the market. Overall, it had nine major approvals in 2020 and new and speciality drugs made up half of pharma revenue.

Poor productivity has been compounded by “bad luck” with some assets, said Walton, but she added: “You need a big enough portfolio to be able to absorb a few failures.” 

Line chart of Share prices rebased showing Shares in GSK have underperformed its peers

GSK forecasts a mid-to-high single-digit percentage decline in earnings per share this year, compared with 2020. Sales of Shingrix, the shingles shot, have been disrupted by the pandemic. Others are likely to be more permanent shifts, as revenues from drugs such as the asthma treatment Advair are eroded by generic competition.

Geoffrey Porges, an analyst at SVB Leerink, said investors are questioning the attempt to reestablish a cancer business. 

“It’s a highly competitive category with huge companies that have large portfolios,” he said. “So to rebuild that from a standing start is a challenge in the best of times.”

He said the company could have given more attention to its world-leading vaccines business, which he estimates could be worth £25bn to £30bn. He said the programme for a shot for RSV, a respiratory virus that hits infants and the elderly, is “pretty promising”. 

“The sense one gets is the vaccine business is being built to fund the ambitions in oncology,” he said. 

Buyers in the wings

While there could be many buyers for the consumer business, it might be tough to find someone willing to snap up the drugmaker.

“It’s not at all clear that anyone would be interested in the entire entity, at what would probably be a $70bn acquisition price,” Porges said.

The UK government could also be reluctant to allow a foreign buyer to purchase GSK. After the pandemic and Brexit, it is concerned about ensuring it has homegrown vaccine-making capacity. 

GSK will have to impress investors at the “absolutely critical” capital markets day in June, the portfolio manager said. It is their opportunity to show what drugs may be hiding in the cupboard.

Credit Suisse’s Walton said: “I would imagine Emma and the board are trying to make the company as attractive as possible with a clear long-term standalone proposition so it isn’t taken over come August next year. With Elliott in the background, maybe that is more difficult to do.” 

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Wall Street stocks on track to close week at new record highs

US stocks and bonds rallied this week, leaving Wall Street’s main equities barometer at a record peak, as the latest signs of the country’s economic recovery sparked a shift into American assets.

Economic reports pointing to a quickening improvement in the labour market and a stimulus-fuelled jolt in consumer spending bolstered both foreign and domestic investor appetite for US securities.

The rise of both stocks and bonds in tandem runs against typical market dynamics, but a confluence of factors provided both markets a boost this week, analysts said. The blue-chip S&P 500 stock index has gained 1.2 per cent over the period, leaving it up more than 5 per cent from the end of March, in what would be its third-straight monthly advance.

Economically sensitive S&P 500 sectors such as energy, financials and industrials have led the way since the end of January, with each up around a fifth. 

“As the economic reopening accelerates in the coming months, we believe the bull market remains on a solid footing,” Mark Haefele, chief investment officer at UBS Wealth Management said. “We maintain a cyclical bias and prefer US consumer discretionary, energy, financials and industrials.”

The group, which manages the money of wealthy individuals, on Friday increased its S&P 500 target to 4,400, indicating it expects the gauge to build on its record highs and rally another 5 per cent by the end of 2021. 

This sense of economic enthusiasm sparked a heavy retreat in long-term US government bonds during the first quarter of this year. However the direction of travel has begun to shift over the past two weeks. 

The 10-year Treasury yield, a key benchmark for fixed income markets, has fallen 0.14 percentage points over the past fortnight to 1.58 per cent, marking the biggest drop over any such two-week period since last summer. The yield, which moves in the opposite direction of the price, had reached above 1.77 per cent on March 30. 

The recent pick-up in demand has left some investors and analysts scratching their heads, particularly since it has come even as data released on Thursday showed US retail sales jumped last month by the most in 10 months while the number of Americans filing for first-time jobless benefits fell to its lowest level since the start of the coronavirus crisis. Typically, such positive news would push investors away from this haven debt.

However investors pointed to rising foreign demand for Treasuries, which still yield more than many other global peers, as one reason for the sharp rally.

A strong sale of 30-year Treasury bonds on April 13 helped instil confidence in the market since there had been concerns leading up to it over whether investors demand would be sufficient to absorb a big wave of newly issued debt. Investors are expected to closely watch a $24bn auction of 20-year notes on Wednesday for further insight.

Subadra Rajappa, head of US rates strategy at Société Générale, pointed out that the dramatic sell-off on the first three months of this year had left the market prone to a sudden rally. “US Treasuries’ immunity to ever-stronger data is proof that a positive growth and inflation outcome is priced to perfection,” she said

“We do not detect a major change in the message the Treasury market is sending us, but we also wouldn’t think that yields are likely to resume an endless climb as they are about in line with their ‘fundamentals,’” added Roberto Perli, an economist at Cornerstone Macro.

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The David Cameron scandal: just how sleazy is British politics?

“We all know how it works. The lunches, the hospitality, the quiet word in your ear, the ex-ministers and ex-advisers for hire, helping big business find the right way to get its way.” So said David Cameron in 2010, in a speech on lobbying shortly before he became prime minister.

A decade on it has become painfully clear that the former leader did indeed know how it worked. In recent weeks Cameron has seen his reputation savaged amid details of his lobbying efforts on behalf of the financier Lex Greensill. Each day has brought new revelations about the relationship between the government and Greensill Capital, the supply chain finance company which collapsed last month. 

As premier, Cameron allowed Greensill to work from Downing Street — where he styled himself a senior adviser — on a scheme of no clear value to government. Then, after leaving politics, he joined Greensill as a paid adviser and in that role lobbied ministers for the now collapsed business.

His private texts to the chancellor Rishi Sunak would have been worse had Treasury officials not ultimately rejected the appeals. Former officials have been stunned to hear that a senior civil servant in charge of government procurement was allowed to work for Greensill while still in Whitehall. Facing mounting pressure, the government said this week it would launch an inquiry into the affair.

One Tory MP publicly described Cameron’s behaviour as “a tasteless, slapdash and unbecoming episode for any former prime minister”.

Former UK prime minister David Cameron, left, with the current premier Boris Johnson. Both leaders have made efforts to change the culture in Whitehall © Getty Images

And yet perhaps the most disturbing aspect is that it is not certain anyone has broken any rules. As with previous scandals the affair has exposed gaps in regulations. And while the details have shocked, the underlying behaviour exists almost in plain sight. A primary purpose, after all, of putting a senior politician or official on your payroll is the doors they can open. 

Keir Starmer, the leader of the opposition, seeing a chance to tie Boris Johnson to the misconduct of his predecessor, said the scandal is “just the tip of the iceberg”. He added: “Dodgy contracts, privileged access, jobs for their mates, this is the return of Tory sleaze.”

So how deep is the malaise? Most British leaders like to congratulate themselves on the general cleanliness of the country’s politics, especially when they glance across the Channel at the illustrious list of French politicians with criminal convictions or look at the vast sums of money spent in American election campaigns.

Yet the UK’s record is good rather than great. On Transparency International’s global corruption rankings the UK is just outside the top 10 cleanest nations, ranking joint 11th out of 180, behind New Zealand, Singapore and a number of European nations including Germany, the Netherlands and the Scandinavian countries. For Bernard Jenkin, the Tory MP and former head of the Public Administration Committee: “Eleventh is good, but we want to keep improving”.

Last year Robert Jenrick, communities secretary, intervened to approve a housing development after sitting next to the scheme’s backer at a dinner

On the current scandal, he told the BBC: “It’s been a culture in Whitehall that’s been building up for a long time . . . this very informal way of conducting relationships about very important matters and the distribution of public money.” 

Duncan Hames, a former MP now policy director of Transparency UK, says: “When you look at integrity in public life there are a number of indicators around the relationship between money and politics — lobbying, the revolving door and political donations. Britain has problems in all three of these.” 

Slow progress

Ever since the 1994 cash-for-questions scandal, when a lobbyist paid MPs to ask parliamentary questions, helped sink John Major’s government, the UK has incrementally updated the previously informal rules but progress has been faltering. That affair led to the creation of the Committee on Standards in Public Life and tougher regulations on lobbying.

Rules on MPs’ personal expenses were tightened after a 2009 scandal which revealed widespread abuse — again this was largely unquestioned in Westminster where the expenses were seen as compensating MPs for their largely stagnant salaries. 

A floating duckhouse is towed past the Houses of Parliament as part of protests over the MPs’ expenses scandal in 2009. One MP’s claim for a duckhouse for his pond became totemic

Regulations on political donations and electoral spending have been tightened several times, including after the so-called Bernie Ecclestone affair which saw Tony Blair’s Labour party abruptly exempt Formula 1 from a 1997 ban on tobacco advertising, just months after Labour received a £1m donation from the motorsport magnate, and shortly after a meeting between the two men. Mr Blair and his close team faced a police inquiry in 2007 — though it ended without charges — over the “cash-for-honours” affair in which several men nominated for peerages were discovered to have lent money to the Labour party. 

Yet, while selling honours is a crime, the elevation of donors and allies to the House of Lords (where financial disclosure is less rigorous) continues. As recently as last December, Johnson overruled a scrutiny committee after it opposed a peerage for Peter Cruddas, a former Tory party treasurer. Johnson’s most recent honours list also included peerages for two former editors and a newspaper proprietor. 

Political donations remain a weak spot. “It is common practice among political parties to raise funding through opportunities to get close to senior politicians and this is even formalised in dinner clubs or events at party conferences,” says Hames. “It is basically cash for access. Those involved consider it worth their while.”

Boris Johnson’s former chief strategist Dominic Cummings promised a ‘hard rain’ would fall on Whitehall © Charlie Bibby/Financial Times

The notion of cash for access was highlighted last year when Robert Jenrick, the communities secretary, intervened to approve a housing development after sitting next to the scheme’s backer, and a Tory donor, at a dinner. He was later forced to reverse his decision.

All sides agree that businesses and interest groups must be allowed to put their case but, while Cameron did tighten up the rules on lobbying, his reform was narrow enough not to include his later self. (As Cameron was employed by Greensill, rather than working as an outside consultant, he was not required to register as a lobbyist.)

While ministers are expected to maintain records of meetings with lobbyists and interest groups, records are not kept of the informal text messages and calls — the method Cameron himself often used. 

Other age-old political practices remain common. Johnson has attracted renewed criticism for channelling government money to areas of electoral benefit, most recently over a £3.6bn fund for towns for which the criteria appear to heavily favour Conservative constituencies. 

John Major, left, lost the election in 1997 partly due to allegations of sleaze surrounding his MPs. His successor Tony Blair faced a police inquiry in 2007 over the ‘cash-for-honours’ affair, though there were no eventual charges © Getty Images

Change in values

But the most pressing issue now is the revolving door between government and the private sector, an issue afflicting many nations, but which has been made more complex by the changing nature of public service.

Civil servants increasingly are encouraged to gain business experience while ministers’ careers often end well before retirement age, leaving them searching for a more lucrative second act. Lord Eric Pickles, chair of the Advisory Committee on Business Appointments, which vets moves of senior politicians and civil servants, warned this week of a culture where “the existing cohort looked after the cohort that just left, on the assumption that the cohort coming up would look after them”. Acoba is widely seen as toothless and Pickles noted that last year it vetted 108 people out of 34,000 civil service departures.

The genesis of the current scandal lies in efforts started by Cameron and continued by Johnson to change the culture in Whitehall. The moves to bring in outsiders to shake up what was seen as an inefficient and obstructionist Whitehall were led by Francis Maude, a cabinet office minister under Cameron. The background was the era of austerity and the need to find substantial savings. 

There is nothing to suggest any wrongdoing in this aim, but in the words of one senior civil servant from that period: “Those brought in to shake things up did not have the same values as long-term civil servants and the culture of contempt towards Whitehall generated within the civil service a defensive crouch and low self esteem which made them unwilling to challenge actions they felt were wrong.”

The cowing of the civil service has accelerated under Johnson. His former chief strategist, Dominic Cummings, promised a “hard rain” would fall on Whitehall, while allies drew up hit lists of leading officials. 

Change has also led to a new class of public figure, neither civil servant nor even traditional political adviser, brought in often without reference to rules on outside interests. This has led to charges that Johnson has succumbed to what critics call a “chumocracy” in which jobs, contracts and public funds are awarded to friends and allies. This trend accelerated during the pandemic when ministers had the defence that life and death decisions had to be made at speed. 

Former civil servant Jill Rutter © Wikicommons

Jill Rutter, a former senior civil servant and ex-head of the Institute for Government, notes the risks: “The cronyism debate has subsided a bit because of the success of the vaccines task force, but you do have these jobs — the crown representatives, ad hoc roles, department non-execs, and unregulated appointments — and at the very least we need to look at how you manage conflicts of interest.”

This is seen as key because the lead set by the prime minister and his close ministers is central to standards of government. One former official notes of both Cameron and Johnson: “There is a sense of entitlement from them that these rules are fine but they are for others.” 

Concern over process, appointments and contracts has powered the creation of the Good Law Project, a group which challenges what it sees as abuse of process in the courts. Its founder Jolyon Maugham, a fierce government critic, says: “The UK has no rules to protect it from venal politicians. We have a set of cultural norms overseen by the civil service. But the civil service feels disempowered and so its ability to oversee these norms is diminished.” 

Each day seems to bring new revelations about the relationship between the government and Greensill Capital, the supply chain finance company run by Lex Greensill, which collapsed last month © Ian Tuttle/Shutterstock

Johnson has flouted numerous conventions, including during the Brexit negotiations when he sanctioned legislation to violate an international treaty. More recently he has been found to have privately been seeking donations to fund the refurbishment of his Downing Street flat.

It all reinforces a point made by Bob Kerslake, a former head of the home civil service: “Our current model depends to a large degree on the prime minister following, understanding and respecting the rules and maybe in the light of recent experience we might want to ask the question of whether a system that depends on that is sufficient.” 

One can overstate the depth of the malaise. But British politics is not as spotless as its practitioners would wish. The first step towards cleaning it up might be to take a closer look at behaviours which are, too often, in plain sight.