Is Poland next?

A deformed perception of reality

President Putin’s troops are making slow progress in Ukraine but the lack of speed in no way detracts from what military minds see as a foregone conclusion: the physical destruction of a European nation.

In 2017, with a headline-dominating North Korea looking like the biggest threat to global stability, Ben Hodges, then Commanding General of US troops in Europe, told Karina’s Column: “Of course Russia, and its behaviour over the last three years [with invasions of Crimea and Ukraine] is the only nation that really possesses the ability, the capability, to destroy a European country or the United States with their nuclear weapons.”

“So in terms of an existential threat, that’s Russia,” he said, quickly adding a reassuring sentence: “Now it’s not likely, but that’s a part of it.”

Ukrainian bravery cannot stop, only delay, a war criminal with a superior arsenal and armed forces. Negotiations, unless Putin has changed his form, are but a cover for regrouping and keeping his opponents off balance.

We can only speculate at what the ultimate aim of the former KGB spy might be, but a devastated nation, living in fear of the Russian bear next door, is likely to be a satisfactory outcome. There is no need for an occupation, which would drain funds from state coffers. NATO becomes a de jure impossibility for Ukraine – as opposed to a de facto one, which had long been the case. The EU will not, and cannot take on, a country reduced to rubble with a desperate need for a Marshall Plan equivalent.

One of the outcomes of the war is that Russia, despite acquiring pariah status, has slotted back into the top echelon of nations. No more is China the only story.

As the West desperately tries to understand Putin’s motivations and where these will lead, one man who dealt with him as first a President and supporter, to then discover an implacable enemy, says the leaders in the West have never understood and will never understand that Putin has the “mentality of an exponent of organised crime,” Mafia boss rather than statesman.

Mikhail Khodorkovsky, the former owner of petrol company Yukos, worked in parallel with the Russian President until his forays into political opposition landed him in jail for a decade.

In a recent interview with Italian newspaper Corriere, the London-based exile dismissed Putin apologists’ theory that his fear of Ukraine joining NATO led to the invasion.

“He hates NATO but does not fear it. Rather, he is now taken with a messianic mission. He is possessed, and you can see that in his having placed a [17.5m high] statue of Vladimir the Great [Prince of Novgorod, Grand Prince of Kiev, and ruler of Kievan Rus' from 980 to 1015] in front of the Kremlin.”

Khodorkovsky has no doubt the aggression against Ukraine is the fruit of a “deformed” perception of reality. After over two decades in power, the Russian President is surrounded by advisers who through fear dare not tell him the truth.

Putin has already threatened the use of nuclear weapons against the West, turned Belarus into a vassal state, and sent troops to Kazakhstan to quell anti-government unrest in January – it is unclear whether they have all returned home. The Russian Ministry of Defence says they have. At the very least, President Kassym-Jomart Tokayev is entirely in his debt.

The West, anxious about a Third World War, has been very clear that unless a NATO nation is attacked, they will not fight. Only two weeks ago, Russia bombed a military facility in Ukraine close enough to Poland for those on the border to see the flashes.

What would NATO do if Putin bombed some of the exported arms from NATO countries building up on the Polish side of the border? That is one of the few ways into Ukraine and into the hands of its army. Would the West prevaricate, arguing that the attack was about the weapons, not the country? That would be a mistake.

Khodorkovsky is not alone in believing that the West’s military inaction is encouraging Putin. He envisages a scenario where the Russian President will conquer Ukraine - guerrilla warfare will continue - and as the Russian economy worsens, he will launch a war against Poland, a similar distraction to the wars he launched in 2008 and 2014, but more in line with his Vladimir the Great-like ambitions.

At least one Polish mother has already contacted her London-based sister for assistance in extracting her conscription-aged son from the country as quickly as possible.

Putin’s heart-breaking and unprovoked war on Ukraine has had the welcome effect of uniting the West – Sweden is likely to announce it will join NATO by the spring. But the effects on his own country - turning Russians into pariahs, devastating the domestic economy on the back of sanctions and a brain drain, eliminating the last vestiges of a free society – sets the scene for more wars.

Meanwhile, the prognosis for the West’s economy, already suffering from inflationary forces, is dire. Wheat prices at record highs are bound to stay there. There will be no new planting in Ukraine. Oil prices are 70% higher than twelve months ago. with Western leaders like Boris Johnson going cap in hand to unseemly leaders of oil producing states to beg for increased production or deals. Saudi Arabia’s Prince Mohammed bin Salman reportedly refuses to take President Joe Biden’s calls, with the latter having been critical of MBS’s human rights record. Autocracies have been strengthened by Russia’s actions.

The erosion of social cohesion and livelihood crises were two of the top five 10-year risks in the 2022 World Economic Forum Global Risk report. The effects of the invasion can but exacerbate these. Governments will need to tread carefully, and apply support, as a toxic cost of living increase feeds into society.

What might happen if Putin does take the war into Poland? We don’t know. But we do know what a previous invasion of Poland I 1939 led to.

Quantum Matters: The Good, the Bad and the Ugly of Quantum Cybersecurity

With a US inteligence report confirming that President Putin authorised a pro-Trump influence campaign in the latest election, China and the US in a stand-off, and the recklessness of ransomware groups tolerated, and at times abetted, by state actors, geographical risk is at its highest in a long time. See my latest column in The Quantum Daily on how we are skirting the edge. And what steps can be taken to mitigate risk.

An assassination in Sarajevo. The subsequent chain of events ultimately leads to a world war. An estimated 20 million people die.

A small US bank succumbs to a cyberattack. Amidst carefully placed misinformation campaigns, bank runs and riots, the repercussions start to drag down the financial system. The US blames Russia, calls on NATO under Article 5, where an attack on one is an attack on all, and step-by-step the world explodes into the Third World War.

What unifies these two scenarios is that we are living in an era reminiscent of pre-World War I: the seeds of conflict are sown, irrigated by mistrust, and one spark can start a wildfire.

Last month at their Geneva summit Joe Biden made clear to Vladimir Putin where the US red lines in cybersecurity lie. “Certain critical infrastructure should be off-limits to attack, period,” said the US President.  One of the 16 sectors mentioned was financial services. It is a given that the message was also aimed at China, Iran and other hostile states with a track record of cyberattacks.

The US government has been in contact with American banks this year to chivy them into increasing their cyber defences, while Federal Reserve Chairman Jerome Powell stated that cyberattacks are the biggest risk to the system. They can trigger a liquidity run and lead to solvency issues.

One of the most worrying possibilities is a supply chain attack. In a little-publicised paper published by the New York Federal Reserve, Cyber Risk and the US Financial System: A Pre-Mortem Analysis, the authors note that an attack on a significant service provider which connects small and medium sized banks has the potential to cause a systemic event. The concentration of banks using the few existing cloud providers, like AWS or Microsoft’s Azure, for instance, is a clear risk.

The authors also note that in a five-day cyber attack, nearly half of US financial institutions would run out of reserves by day five.

The top concern is not so much a provocation, as a misjudgement, ultimately leading to WWIII. Take the recent Colonial Pipeline attack by DarkSide. They planned to attack the business side, not the operational side, which is responsible for transmitting roughly 45% of East Coast fuel. They knew the latter would be perceived as an attack on infrastructure, bringing the might of the US intelligence services down on them for straying into the political arena.

“We are apolitical, we do not participate in geopolitics, do not need to tie us with a defined government and look for our other motives,” they swiftly posted on their Dark Web page, as they sought to excuse their error and distance themselves from suspicions of links to the Russian government.

There is no easy solution to the uncertainty of who is behind a cyber attack, nor to mishaps prevalent in a digital world.

But there is a clear need for key sectors to take a big step up in cybersecurity. Not least with China – which just celebrated the 100th anniversary of the Communist Party amid Taiwan fly-overs – on what looks ever more likely to be a collision course with the West.

Paradoxically, the quantum industry may be the answer to cybersecurity, while also being its biggest threat. The creation of quantum keys which are certifiably random – unlike the current RSA encryption and other standard ones – could provide hacker-free security. At least eleven global banks are exploring quantum safe protocols for security, ranging from JP Morgan to BNP Paribas and RBC of Canada, as reported here by The Quantum Daily (TQD). Around thirty-five quantum companies in countries ranging from Poland to Singapore are working on quantum cybersecurity products.

A handful of years down the line powerful quantum computers may be able to decrypt the data already being harvested by ransomware gangs and hostile nation states – yet another reason to experiment with current quantum cryptography.

Although information is hard to come by, China reportedly has quantum key distribution technology over fibre optic cable between Beijing and Shanghai. In essence, a quantum internet, providing hundreds of kilometres of totally secure communications.

The West is intent on catching up, with governments and companies spending large sums. Germany, for instance, announced in May a €2bn investment in quantum and related technologies, while a month later British start-up Arquit announced a link with defence company Northrop Grumman to explore its own end-to-end quantum encryption.  Meanwhile, the US Department of Energy last year unveiled a blueprint for a quantum internet.

The Cold War arms race mostly involved creating weapons of destruction, the so-called Mutually Assured Destruction (MAD) doctrine which, arguably, kept the peace over many decades. In the 21st century, the most important advance in keeping world peace will be security and protection: Mutually Assured Defence – not as MAD.

Power to the People

The merging of business and politics

GLOBAL TRENDS AND WHAT THEY MEAN FOR BOARDS OF DIRECTORS

This column was first delivered as a webinar to Z/Yen Group and the Financial Services club, which you can listen to here

Firstly, many thanks to my dear friend, Alderman, Professor and Sheriff Michael Mainelli for asking me to share some thoughts with you.

INTRODUCTION

Covid-19 and its economic effects are not going away anytime soon. We will be seeing a reconfiguration of our systems, ranging from geopolitical relations to the power of national governments, from company accounts to working patterns.

Some say the new paradigm is but an acceleration of existing trends. I wouldn’t disagree, but there is a point at which acceleration leads us into a new world, one where we must change our outlook. One where the responsibilities of Boards of Directors broaden out into the wider world. THAT is what I will focus on today.

For simplicity’s sake, I have divided this speech into three.

• THE RISK COMMITTEE

• THE NOMINATION AND REMUNERATION COMMITTEES

• THE AUDIT COMMITTEE 

What I am saying for each one equally applies to executives and entrepreneurs and, naturally, to the main Boards. 

RISK COMMITTEE

Black Swan Events

That famous phrase used by author Nassim Nicholas Taleb. Arguably a pandemic is not a Black Swan event when Bill Gates publicly – publicly! – talked about how unprepared governments were in a video a few years ago. But let us not quibble about definitions.

What matters is that Risk Committees need to expand the subjects on their agenda.

There will be other pandemics. There will be unseasonal flooding and bush fires like those in Australia. Climate change is a given and its effects on natural resources and economies are key. Take a recent catastrophe in Russia where the thawing permafrost lead to 20,000 tons of diesel spilling into the Norilsk River.

Geopolitically we are in a world of increasing nationalism and maverick leaders where the web of US-led, post-war institutions no longer function. Where does the dialogue and the negotiating happen now?

I will just mention three key countries.

RUSSIA. President Putin’s poll numbers are plummeting; Covid-19 deaths are more than the government’s corrupt statistics office will reveal; the oil-dependent Russian economy has been battered by record-low oil prices. Putin will need to engineer a distraction, this year or in 2021 – another invasion, perhaps Belarus? Or cutting off electricity supplies in some small corner of the West? Or a cyberattack in a port area…they (or perhaps another country like North Korea or Iran) have done it before in Rotterdam. 

CHINA – it is too large a subject to deal with in this webinar! Let me just say that China was never the West’s best friend, an assumption held by the government of David Cameron, but neither is China our worst enemy, President Trump’s current assumption. Bringing those supply chains back from China, the new ‘localism’, ain’t that easy!

THE US – Trump is embattled. There are major doubts that he can win the November election. Creating more division inside the US – the enemy within - isn’t enough. I would expect some new narrative and action around “the enemy without” – new tariffs, new trade wars, take your pick.

Rising Inequality

Pope Francis in his Urbis & Orbis Easter homily spoke about a “dignified life”. We are going to have millions…and millions… and millions… of unemployed. Whether the US unemployment rate is 13% or higher – you are all aware of the recent controversy about the numbers - it is bound to head up vertically. As will our numbers.

And the so-called full employment we had in much of the West was a lie, with zero-hour contracts, no ability to save, no margin for error. We left too many people behind on the back of globalisation and automation. Re-incorporating them (plus all those who falling headlong into unemployment now) into working society and a dignified life is an enormous challenge. If the corporate sector is not part of the solution, it will be perceived as part of the problem.

The divide on economic policy between left and right is fast disappearing. The evidence? President Macron of France spoke about the need to transform our capitalist societies due to their environmental and social inequality failures. A discussion about the Universal Basic Income is now mainstream. British trade union Unison saw a net increase of 16,000 in their members, which is 18% higher than in the same period last year.

I urge you to read a dystopian 1952 novel by Kurt Vonnegut, Piano Player.

Government

After the financial crisis, the pendulum of power for financial services and banks swung back towards government and the regulators. Even more so now. Big government is back.

To keep businesses like airlines going they will be forced to turn loans into equity stakes. After all loans, even at low rates, don’t do the trick when the revenues aren’t there.

Circumstances, not ideology, have put government in the ascendant at the expense of the private sector. With the best will in the world, they won’t be able to sell those shareholdings anytime soon, and so they will influence how companies are run, how they interact with their suppliers, how they deal with their financials.

Of course, the biggest risk and opportunity is Quantum Computing. I am no expert, but as a shareholder in a quantum computing company, I have been exposed to some of the mind-blowing possibilities and would urge any board to be constantly updated on advances.

THE NOMINATION AND REMUNERATION COMMITTEES

People

This section is really about people. How do you attract the most talented people? Speaking mainly to a City audience, let me point out we have a problem – and this is relevant for financial and professional services in other OECD countries.

The City was where the best and the brightest in my generation headed. Now, they more generally head to Google or start-ups, they join NGOs or set up their own.  Former City Minister Mark Hoban chaired a Financial Services Skills Taskforce which found a skills and talent crisis in the sector, issues with purpose and culture and not enough continuous education.

Attracting the best and the brightest is one problem. But the unemployed are also your problem. The deprived are your problem. Racism is your problem. There is no longer a separation between politics and business.

In the words of Martin Luther King: “In the end we will remember not the words of our enemies but the silence of our friends.”

From Larry Fink of BlackRock to UK CEOs, companies have spoken out on the back of the Black Lives Matter movement. Some have announced special schemes or are looking anew at their recruitment. Those that haven’t are probably making a mistake. Because if you consider the demonstrators, and those who have spoken up on social media – all races, including a lot of whites.

A larger proportion of companies’ workforces are made up of millennials and Generation Z, and they CARE. They look for work/life alignment, where they can be the same person at work and at home, and they want to be proud of the company they work for.

Diversity & Inclusion

Look at it like ESG (Environmental Social Governance). That ‘E’ no longer sits in some far-off office and is trotted out once a year. Mark Carney, the former Governor of the Bank of England first highlighted the financial risk from stranded assets and, in parallel, the opportunities. The Norwegian Sovereign Wealth Fund recently sold its Glencore shareholding for breaching it guidance on coal use.

Similarly, the ‘S’ in ESG, or Diversity & Inclusion, is now central. It is about risk and it is about innovation. To mitigate risk and think laterally we need diverse opinions which are encouraged and listened to.

That is why I am the Co-founder of the newest institute at the London School of Economics, The Inclusion Initiative, which uses behavioural science and data to improve innovation and the bottom line. My Co-Founder Professor Grace Lordan and I are in conversation with financial and professional firms about their becoming partners in this endeavour.

Do please get in touch if you think it might be of interest to you.

A few last words on people. Communication and collaboration are key skill sets. Empathetic leadership and the ability to understand what drives your many different stakeholders is something that no leader can do without. Chose them wisely.

“Build back better” is a phrase you may have heard. Understand what the impulse behind it is, for it will affect the future of companies.  

THE AUDIT COMMITTEE

Resilience

In the financial crisis, the banks were bailed out by the government. The regulators then forced them to increase their capital and work on changing their culture. That is why we are not facing a financial sector crisis, at least at the moment.

The corporate sector is different. Companies are being run in an “efficient” way. Cut costs to a minimum, carry as little capital as possible, get that ROE up.

That’s finished.

For two reasons. One, the realisation that the Black Swan world we live in demands higher capital sums and more focus on cash, or cash equivalents. The amplitude of the events we are facing is such that this is necessary.

Two. Treating employees as contractors, or outsourcing to India, and then focusing excessively on shareholders, is a discredited model. It now turns out to be a very risky one. One bank CEO said to me she thinks differently about employees in India whose circumstances mean lockdown and isolation aren’t possible.

And, as mentioned earlier, government and regulators will be much more powerful and involved in the private sector than before. They also don’t like that model. The new Stewardship Code, for instance, calls for more high-quality integrated reporting.

Costs still need to be cut, but automation, robotics and AI are now the focus, plus having 30% or more of your workforce on agile working, depending on your business, which will also save on real estate fixed costs – with  huge implications for commercial real estate.

Fraud

I have only one word. It’s going to be HUGE. I presume accountants are more than aware of this. Anecdotally I already know about one private equity-held company that took government furlough money in a month when it had no right to. When you have convulsions in funding, opportunities for misbehaviour increase.

Taxes

Look out for windfall taxes on some of the corporate sector. Governments are desperate for funds. They will hit individuals – a wealth tax perhaps, getting rid of the vestiges of the Non-Dom regime, a rise in income tax – but they can’t raise VAT as consumption needs to come back. That leaves the corporate sector in their crosshairs.

I hope, and perhaps this is more hope than reality, this crisis will lead to the proper taxation of the Googles and Amazons of this world. And not just taxes. Elon Musk, the Tesla and Space X entrepreneur, recently called for the break-up of Amazon. And I just read a convincing case for a digital advertising monopoly suit against Google, co-written by a Yale professor who’d been in the Anti-Trust unit of the US’s Department of Justice a few years ago.

Maybe, just maybe, the employees of the Facebooks and the Twitter’s will be the impulse behind proper corporate taxes on their employers? It is far-fetched as a theory, I will grant you that, but they aren’t afraid to be heard. In 2018, for instance, 20,000 Google employees – yes, 20,000 – walked out in protest at their company’s handling of sexual harassment.

CONCLUSION

In 2015 a client for the Robinson Hambro CEO Advisory service who was the Executive Chairman of a bank asked me to give a talk to his Global Advisory Board. My theme was that globalisation had peaked. Very prescient, if I say so myself, coming before Trump and Brexit. In case you think I have a crystal ball, let me say I also predicted Putin would be out of power in Russia. You can’t win them all!

The point of this story is that we cannot predict the future. But executives and non-executives can consider trends and responsibilities within Boards, within the Risk Committee, the Nominations and Remuneration Committees, and the Audit Committee, and act accordingly.

Thank you for listening. And now, the fun bit for me, I much look forward to your comments and questions.

UK General Election 2019

Safeguarding the country

This edition of Karina’s Column is based on an interview with James Arbuthnot, a long-standing Conservative politician who now sits in the House of Lords. It is not representative of the views of Robinson Hambro Ltd.

With the UK’s momentous General Election a day away, yet another respected career politician is joining the chorus lead by former Prime Ministers Sir John Major and Tony Blair in calling for moderates to vote across parties, be it the Liberal Democrats in some cases, or a “sensible Conservative or a sensible Labour person.”

James Arbuthnot, a Conservative peer whose career encompassed the role of Chief Whip, Minister for Defence Procurement and a decade as Chairman of the influential Defence Select Committee, has a one-word answer when asked if he is still a member of the Party: “No.”

“I cancelled my subscription when Boris Johnson became leader, for two reasons,” he adds. “First, because I didn’t believe the policies the Conservative Party was following over Brexit. And the second because I didn’t have faith or belief or respect for Boris Johnson.”

Martin Wolf, Chief Economics Commentator of The Financial Times, argues that a hung Parliament would be the best result of the December 12th election, as it would make the major parties realise the damage arising out of their extreme positions and force them to rediscover their moderate souls.

“It definitely resonates with me,” says Lord Arbuthnot. “The country is being sold a type of Brexit that it was promised it would not have. We were told that we would get millions of extra money a week to spend on things. We weren’t told that it was going to cost us billions, the billions that it is now going to cost us in terms of lost growth, lost productivity and lost friendships with our closest allies.”

“I’m appalled at the notion that we ought to be doing things alone rather than with our closest friends,” he adds, speaking at a breakfast hosted by the Worshipful Company of International Bankers, a livery company in the City of London. 

A number of moderate members of Parliament from both major parties are not standing in this election. On the Conservative side it includes former Home Secretary Amber Rudd and veteran MP Sir Nicholas Soames. “A Conservative Party that has no room for [former Minister of State for Digital and the Creative Industries] Margot James, [Tory grandee] Ken Clark, [former Chancellor] Philip Hammond doesn’t strike me as the Conservative Party that I joined and worked for, for all of my life,” says Lord Arbuthnot, who calls the Labour Party “unacceptably Marxist, if there is an acceptable Marxism.” 

The father of four, married to Emma Arbuthnot, the Chief Magistrate for the UK and Wales, calls for curbs to the laddish culture that has become prevalent in Parliament, which he points out is awful for most men too.

“I must say I’m so thankful to be in the relative sanctuary of the House of Lords. My old people’s home. I bring the average age down, by the way,” he says with a twinkle in his eye.

Since stepping down as a politician, Lord Arbuthnot has taken on Non-Executive and consultancy roles that leverage his knowledge of the defence industry. At one point he was a Director of SC Strategy, whose directors include Sir John Scarlett, former head of MI6. He is currently Chairman of the Advisory Board of Thales UK, the defence and technology company and Chairman of Electricity Resilience Ltd.

He concurs with national security advisers like Lord Evans of Weardale, a former MI5 director general, that a parliamentary report into alleged Russian interference in the UK democratic process should be released to the public before the General Election. The government insists that it will take much longer to redact confidential information in the report.

“It’s a worry to me that the Intelligence and Security Committee (ISC) has produced a report about Russian potential interference in the referendum results and in the 2017 election. It was seen by the security services in March of this year, cleared by them, probably with some redactions and it’s been with the Prime Minister for some time. He appears to show no interest in publishing it before the election,” notes Lord Arbuthnot. “I think that it is relevant to the voters. I think they might like to see what Russia has been doing.”

In the summer of 1996, the IRA planned to blow up enough of the UK electricity grid to leave London and the South East in darkness for months. Their plot was foiled. However, since then our dependence on electricity has grown exponentially.

“I believe that if the Chinese or the Russians wanted to switch off our electricity grid, they have enough capability in place to be able to do it within the next 20 minutes, if they wanted to,” says Lord Arbuthnot. “But they don’t want to because if they did that, they would collapse the world economy and along with it, they would collapse their own economy. What I think they do want to do is make it impossible for that to be an existential threat against their country.”

He suppresses a smile while declining to respond to a question about whether we have the capability to close down the Russian, Chinese or Iranian grids: “I couldn’t possibly comment.”

As this interview is published, a Conservative majority is looking most likely. However we are living in unprecedented times, not only in the moderates deserting the two major parties, but in a new, hate-filled political tribalism. What is unquestionable is that the exodus of moderate politicians is already causing great harm to the British political system. May the winner move to heal the wounds of society and the body politic.

Lord Arbuthnot was interviewed as part of the Worshipful Company of International Bankers Talk & Toast power couple series sponsored by Streets Consulting.