FTSE Global Markets

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COMPETITIVE PRESSURES VIE WITH A SECURITIES LENDING BOOM I S S U E N I N E T E E N • M AY / J U N E 2 0 0 7

Can Freddie Mac make a comeback?

Emerging private equity in the GCC BarCap’s play in the US super league

TXU: DUSTBOWL OR PAYDIRT?

PORTFOLIO TRADING ROUNDTABLE: THE BUYSIDE BITES BACK

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Outlook EDITORIAL DIRECTOR:

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F T S E G L O B A L M A R K E T S • M AY / J U N E 2 0 0 7

o you remember the old 1990s parlour game that showed that everyone, exalted or humble, could track seven degrees of separation from actor Kevin Bacon? Well, that is what this issue is all about. Not Kevin Bacon, but the increasingly globalised nature of the markets that means that in any sphere these days, the same names go round and round.

I will show you what I mean. With just a week to go before exclusive negotiations between Barclays Bank and ABN AMRO came to an end, speculation was rife that Royal Bank of Scotland (RBS) would enter a bid for the Dutch bank. RBS has adopted an aggressive global growth strategy of late and by February of last year ranked eighth in the world and third in Europe by market capitalisation. That’s true also of the Barclays Group and its high octane investment banking arm, Barclays Capital which, unusually for a foreign bank, has taken the US capital markets by storm over the last few years.

With such dominant market positions, it is ironic then that both Barclays and RBS have come under fire for allegedly undercutting margins on loan syndications Gulf Cooperation Council (GCC) capital markets. Once the preserve of a few select houses, such as Arab Banking Corporation, HSBC, Deutsche Bank, BNP Paribas and Standard Chartered, the GCC loan market is now a free-for-all, with a stream of foreign and new local banks opening offices in Dubai, Abu Dhabi, and Bahrain, eager to win mandates supporting the region’s massive infrastructure and energy-related development programmes. In those same GCC markets a massive deepening of the financial markets is underway, with private equity an increasing feature in the region.

Talking of private equity, Goldman Sachs, which is reportedly advising RBS on its bid for ABN AMRO has regularly advised Kohlberg Kravis Roberts & Co (KKRs) on its acquisition of various firms, including the Dollar General Corporation and some of the other groundbreaking leveraged buyouts (LBOs) of the first quarter of 2007. That same LBO market is in its zenith, with at least fifteen transactions finalised during the last six months with a deal value ranging between $19bn and $44bn.

In this super league table of acquisitions, the outstanding deal by value alone is that of KKR’s intended purchase of Texan energy giant TXU. KKR meantime felt it politic to promise support for climate change initiatives, including cap and trade, in order to get shareholder and regulatory approval for the acquisition. It joined with ten big US corporations that recently founded the Climate Action Partnership to lobby the While House on climate change, cheered along by Wall St luminaries such as Paul Volcker, the former Federal Reserve chairman.

That same White House is coming under increasing pressure to tackle the growing crisis in the US sub-prime mortgage market, which aside from threatening the very existence of a number of lending institutions, is severely undercutting the efforts by many low paid workers to get on and stay on the US housing ladder. That is calling into focus once more the role of special status organisations such as Fannie Mae and Freddie Mac, to come to the rescue, even though they are recovering from self-inflicted wounds which seriously impaired their central status in the US retail mortgage industry. But it is not the only area of sub-prime lending that is looking to be in crisis. In early April, the sub-prime credit unit Monument was sold to American credit card issuer CompuCredit for some £390m. Reportedly, the gross book value of the business is around £490m, including a tranche of accounts that are in arrears. The seller? Barclays. Good job we managed to get it all in then.

Francesca Carnevale, Editorial Director April 2007

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Contents COVER STORY COVER STORY: TXU – DUSTBOWL OR PAY DIRT?

..............Page 47 What does everyone think about KKR’s buyout of TXU? One good indicator may be Troy Fraser—a stalwart Republican who is chairman of the Texas Senate’s committee on business and commerce. He sponsored three bills that would adversely impact the deal. All were passed in the Senate by 30 to 0 margins and were sent to the House of Representatives.

Art Detman examines the brouhaha surrounding the year’s largest buyout to date.

REGULARS MARKET LEADER

FIGHTING CLIMATE CHANGE ........................................................................................Page 6

INDEX REVIEW

WHY THE FTSE 100 IS FINDING IT HARD TO TOP 6450 ......Page 12

IN THE MARKETS

THE OUTLOOK FOR ASEAN ETFS................................................................................Page 14

Ian Williams reports on the upswing in climate care among American’s leading corporates.

Capital Spread’s Simon Denham examines this market limit

Why the ASEAN region is beating expectations

THE RISE OF PRIVATE EQUITY IN THE MIDDLE EAST ........Page 16 Fund raising for private equity in the GCC states is at an all time high

DIFC’S ASSET MANAGEMENT CHALLENGE

................................Page 24 Dubai’s ambitious plans to create a global asset management centre

GCC BANKS TURN EASTWARDS

..................................................................Page 28 Infrastructure finance and Asia provide new business

REGIONAL REVIEW

HAS SARBANES OXLEY DONE TOO MUCH OR TOO LITTLE? ..Page 34 Ian Williams reassesses the impact of Sarbanes Oxley legislation

RISING DERIVATIVES TRADING ON RUSSIAN DR INDEX........Page 38 Diversifying exposure to Russian DRs listed on the LSE’s IOB

THE APPEAL OF RUSSIAN IPOS

............................................................Page 40 Forget worries about Russian politics, it’s all about the corporate growth story

BRAZIL’S PRIVATE BANKS WAKE UP TO CHANGE ......................Page 43 Wealth management, the primary driver as banks fight for market share

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HIGH YIELD DEBT STILL ON THE UPSWING

DEBT REPORT

........................................Page 75 Fuelled by an unprecedented volume of leveraged buyouts Europe’s high yield market is booming. Andrew Cavenagh reports.

REAL ESTATE

................................................................................Page 110 Could problems in the US’s sub-prime retail market offer hopes of a comeback to Fannie Mae and Freddie Mac?

INVESTMENT SERVICES

........................................Page 89 Global giants now demand a greater breadth of services from their sub custody clients, writes Dave Simons. Can the sub custodians respond?

INDEX REVIEW

Market Reports by FTSE Research ..............................................................................Page 114 Index Calendar ................................................................................................................Page 128

TIME FOR A COMEBACK?

SUB CUSTODIANS FLEX THEIR MUSCLE

JANUARY/FEBRUARY 2007 • FTSE GLOBAL MARKETS

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Contents FEATURES BARCAP’S TEAM-PLAY TRIES FOR A TOUCHDOWN ..........Page 54 American banking history is littered with failed efforts by foreign banks to break into a business long dominated by American bulge bracket firms such as Morgan Stanley and Goldman Sachs.

In less than seven years, armed with a focused strategy, an unusually cohesive corporate culture, and a little luck, Barclays Capital has emerged at the forefront in a range of products from debt underwriting to commodities and derivatives. Neil O’Hara explains why concerted teamwork has driven the bank up the investment banking league tables.

PORTFOLIO TRADING REPORT

BETTER WAYS TO CUT A CAKE

..........................................................................Page 59 Increasingly complex requirements from the sell side have redefined portfolio trading services and the technology and trading algorithms that support the business. Regulatory requirements have also made their mark. What now?

THE PORTFOLIO TRADING ROUNDTABLE

............................................Page 63 “Portfolio trading has evolved over many years and these days a good portfolio trading desk has to have excellence on the operational side and excellence in its execution capability. Portfolio traders have to be good at everything, because the trades we see are diverse in their complexity and we have be able to provide an equal level of service and equal quality of execution across the spectrum,” says Phil Hodey, managing director and head of portfolio trading at UBS. Did the roundtable agree?

SECURITIES LENDING REPORT

THE RUNAWAY RACE FOR MARKET SHARE ............................Page 78 While the bulk of the business still remains with the custodian lenders, there are new routes to market that offer lenders and borrowers more opportunities to match their requirements.

Will the custodian lenders finally meet their match? Lynn Strongin Dodds reports.

EQUILEND LOOKS TO ASIA FOR GROWTH ................................Page 88 Equilend’s changing market geography.

WHY OFFSHORE BUSINESS IS REALLY ONSHORE NOW......Page 93 With the new focus on quality of expertise and with a growing diversity of product, what really separates onshore financial services centres from offshore centres these days? Can we continue to distinguish between offshore and onshore, particularly when some financial centres, such as Dublin and Luxembourg stretch definitions to the absolute limit?

ALL THE FUN OF THE FAIR ........................................................................Page 99 These are luminous times for alternative fund administration providers. Enjoying consistent growth across the spectrum of business, the number of firms providing specialist administration services is on the up. The good news is, there is little sign of market overcrowding and in the short term, this will encourage more firms to establish niche positions. How long can the good time last?

HEDGE FUND IPOS ........................................................................................Page 106 In February, private equity and hedge fund manager Fortress Investment Group became the first US manager to issue shares, which immediately traded at a 70% premium to the offering price. Private equity behemoth Blackstone Group, which runs $17bn in hedge funds alongside its better-known private equity portfolios, plans to follow suit, and more are sure to follow. Neil O’Hara reports.

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M AY / J U N E 2 0 0 7 • F T S E G L O B A L M A R K E T S

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Market Leader CARBON TRADING

Photograph supplied by Dreamstime.com, April 2007.

PRESSURE BUILDS FOR CLIMATE CARE The United States has still not ratified the Kyoto Protocol to the Climate Change Convention that posits an international mechanism for emissions trading. With the White House’s frosty attitude to the whole concept of global warming, one might have thought that the prospects for carbon trading in the US itself were bleak—indeed black. However, this year, the corner has been turned. Following the publication of the Intergovernmental Panel of Climate Change, the White House—under pressure at home and abroad—is more agnostic these days. Ian Williams reports on the upswing in climate care.

N EARLY APRIL the US Supreme Court ordered the Environmental Protection Agency to change its White House inspired policy against regulating auto emissions of Greenhouse gases. More and more US states and Canadian provinces are signing up with the seven

I 6

northeastern states in the Regional Greenhouse Gas Initiative.

Industry has jumped with no small degree of alacrity on the accelerating bandwagon. The private equity acquirers of the giant Texan utility TXU felt it politic to promise support for climate change initiatives, including

cap and trade, in order to get shareholder and regulatory approval.

They joined ten big US corporations that recently founded the Climate Action Partnership to lobby for government action on climate change, cheered along by Wall St luminaries such as Paul Volcker, the former Federal Reserve chairman.

Chicago maintains a tradition of running a market in almost every product, tangible or otherwise, so hosting a hot-air futures market should not be too surprising. In fact, the Chicago Climate Exchange (CCX), whose holding company is listed on London Stock Exchange’s Alternative Investment Market (AIM), has been trading greenhouse gas emissions since 2003. This February, trading

M AY / J U N E 2 0 0 7 • F T S E G L O B A L M A R K E T S

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Market Leader CARBON TRADING

new business reached its highest opportunities and a volume since its competitive advantage. foundation in 2003, 3.7m More and more tons of CO2 for its shareholders, investors Carbon Financial and regulators are Instrument™ (CFI) looking for climate contracts which each change disclosure from represent a 100 tons of companies, and CCX CO2 or its equivalent. It can act as an immediate also owns the disclosure mechanism.”

Netherlands-based Sandor adds, “The European Climate bottom line is that how a Exchange (ECX) whose corporation manages its turnover, backed by carbon exposure can intergovernmental create or destroy its regulation, exceeds its shareholder value.

American parent with Therefore, more 60m tons at prices of up The political power of corporations, and shareholders and to €15, which are the political allergy to taxes, reinforce the analysts now keep an considerably higher than suspicion that the US input to this model exact eye on what those in the voluntary will be based around the CCX, which is corporations are doing US market. in the climate change Dr Richard Sandor, already trading in offsets in the and carbon area.”

CCX’s founder, points to international markets, not least with the Supporting Sandor’s its previous experience membership announced in March of thesis, CCX’s founding in the acid rain Australian power generator AGL—as well as members include some emissions markets, holding the European ace. of the US’s largest which currently trades greenhouse gas $5bn a year of emissions. emitters: such as “We are both designers DuPont, American and practitioners in the Electric Power, Ford, and SO2 market and many of Photograph supplied by Dreamstime.com, April 2007.

Motorola—not to those lessons can be applied to a carbon market. At that gases and they are doing so on a mention the city of Chicago itself. The time, many people said that it would voluntary basis. Sandor once again members made a binding, voluntary to reduce their never work and that it would cost too calls in the experience of the acid rain commitment much, potentially bankrupting the market.“At the time, one of the things emissions by 4% from an average of stressed with the US their 1998 to 2001 emissions by 2006. electricity sector, and creating price we In the absence of national legal spikes. The opposite happened and Environmental Protection Agency was the program has proved to be a great the importance of data integrity, in standards, membership of CCX offers success from both an environmental terms of monitoring, verification and agreement on the start date, and economic perspective. At a cost of distribution to the public. The same independent benchmarking for the $1bn the programme yielded $45bn applies for the success of any market.” level of corporations’ and institutions’ In fact, he relates the issue to emissions, and accurate metering of to $80bn in reduced health costs,” corporate relations, “Having your their subsequent levels of emission. says Sandor.

One of the key issues for emissions emissions data audited by a third- Big emitters can sell directly as trading is the difficulty of measuring party with the reputation and integrity “Offset Providers,” while smaller intangibles. In effect, people are of the NASD helps a member to better users using less than 10,000 tons can their energy use “Offset Aggregators,” but those selling promises not to produce understand carbon dioxide or other greenhouse consumption, which translates into offset deals are checked by a CCX

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Market Leader CARBON TRADING

approved verifier. They need not be in the USA, since offsets can be bought in Mexico and Brazil. Industrial polluters can buy emission rights based on renewable energy practices, ranging from landfill methane collection to forestation projects.

There are green dissidents, who believe the cap and trade system does not give enough incentives to industry to reduce emissions. Dan Rosenblum of the Carbon Tax Center counters that “The sulphur model worked when it involved a few dozen electric utility companies but it is ill-suited when the stakeholders—essentially every business and household in the country—number 100m or more.

Moreover, electric generators seeking to reduce sulfur emissions had a variety of technological alternatives available.

There are no comparable methods available to reduce carbon emissions other than fuel-switching and, perhaps sometime in the future, sequestration.”

The Center suggests a combination of carbon tax and credits, which would give serious economic incentives to a much broader mass of consumers and producers. “A carbon tax actually provides more precise and timely price signals, in a more understandable and transparent fashion,”Rosenblum avers.

Only a “trajectory of rising energy prices will provide the incentives necessary,” he claims, adding, “A phased-in carbon tax allows this, but cap-and-trade will do little to level the price roller-coaster that discourages emissions-minimising investment.”

He also warns that the “inherent complexity”of carbon trading, leaves it open to exploitation by special interests, “not to mention perverse incentives to ‘bank’ pollution now against future credits. Carbon taxes are relatively immune to manipulation.”

However, tax is a four letter word for much of US business, which is one

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reason, apart from Sandor’s point about investor relations, why so many are racing to embrace the CCX. As Duke Energy CEO James Rogers, told the Wall St Journal earlier this year: “If you are not at the table when these negotiations are going on, you’re going to be on the menu.”

Corporations would prefer to have a system that they have shaped rather than one designed and imposed by legislators and civil servants.

The board of Puget Sound Energy (PSE) a recent recruit to CCX, was already interested enough in climate change to hold a retreat on the issue, from which emerged a decision to support“regional and national efforts” on the issue – hence their two wind farms, 150 and 250 Megawatts, and CCX membership.

Steve Secrist, Director of Environmental Policy and Sustainability for PSE explains that “phase one” of its membership involved demonstrating a reduction in emissions over a five-year period.“We discovered that we’d achieved some significant reductions over and above the CCX requirements.” Awaiting CCX’s audit to confirm PSE’s own findings, he says “Joining gave us a unique opportunity to learn more about the emissions trading markets at a time when both Washington State and the national governments are looking closer and closer at the issue.

It helps us to develop a more diversified generation portfolio at a time when we are increasing our renewable generation capacity.”

Interestingly it did not take shareholder pressure to force the board to take the step. In fact PSE already has two wind farms generating a total of 350 Megawatts capacity, and that was in advance of legislation now working its way through Washington State government senate that would restrict the use of non-renewable

energy sources. “There is some financial benefit, some social and some political, but it is not our style to trumpet that. We set out on this, and our participation in the market is part of that,”says Secrist.

Looking to the future, he reports, “We have been discussing with Congress, and we support a marketbased mechanism, whether it is cap and trade or tax, because certainty in standards is vital, and for that we need national leadership for energy utilities to provide responsible and reliable service and still make a profit.

The lack of national leadership is frustrating, but it’s heartening the way cities, states and corporations have stepped up.” Sandor, prominent among those who stepped up modestly says, “We are professional inventors of markets and with the help of our members, are building the institutions that will be necessary for a market to properly function in a way that can cost-effectively address the issue of climate change.”

Internationally, he predicts that “environmental markets will likely follow a similar pattern to cotton markets in the late XIX century. They took off in different places, Liverpool, New Orleans, and Mumbai, using different standards. Eventually the world’s markets coalesced and became a global market, with commonly accepted standards. We believe, and have been advocating for a number of years, that carbon markets will follow a similar pattern.”

The political power of corporations, and the political allergy to taxes reinforce the suspicion that the US input to this model will be based around the CCX, which is already trading in offsets in the international markets, not least with the membership announced in March of Australian power generator AGL—as well as holding the European ace.

M AY / J U N E 2 0 0 7 • F T S E G L O B A L M A R K E T S

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Index Review UK MARKET UNCERTAINTY SLOWS FTSE100 CLIMB

FTSE100 unlikely to top 6450 in short term My last message drew attention to the fact that, among other things, the Volatility Index (VIX) was flirting with all time lows, which could be seen as a harbinger of some extreme (probably negative) price activity. The best that can be said is that a few spread betters faced the right way round on the slide down. The majority, unfortunately, were not and the whole sorry saga was compounded by a fatal tendency to try to ‘bottom pick’ falling markets. That said, we stand in mid-April with the markets back up near their highs.

The DAX is actually 150 points higher than the closing level on the 26th February, as though nothing had happened. This performance is truly astounding. Last May the FTSE100 took six long months to make up the losses of that ‘correction’. This time round a month and a half is all that was needed. Simon Denham, managing director of spread betting firm Capital Spreads tells us what he expects for the FTSE100 in the coming months.

HE MAIN UK index continues to under-perform its European counterparts. It has rallied some 3.5% since the turn of the year, but the DAX has done better, climbing 8.5%, compounding the 9% versus 22% moves of 2006. For all of ‘Merger Mania’ and ‘Private Equity Asset Strippers’ headlines, the facts are rather more mundane. The top end of corporate UK is weighed down with high taxes, mountains of red tape and, in the main, products that rely too much on price appreciation to generate additional revenue. Growth in the mining and oil sectors on a volume basis is almost static and in many cases actually falling—there is just not that much more to be discovered that is not already signed up to one of another of the major producers.

T

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Telecommunications firms look to be feeding off themselves in a frenzy of customer sniping and the cost of signing those new (hardly loyal) clients is making for ever-thinning margins.

The belief that better returns will be available in newer markets around the globe flies in the face of what has happened over the past few years in Europe and the States. Add to this the fact that some of the banking sector members may be mired in a bit of a credit crunch over Sub Prime lending in the States. The Bank of England seems almost certain to raise rates once more —while the more politically influenced European Central Bank may be forced

by France and Italy to hold steady.

Growth for 2007/08 is being reassessed downwards and the overall outlook does not look wonderful.

Simon Denham, managing director, Capital Spreads. Photograph kindly provided by Capital Spreads, December 2006.

That was the bad news!

The good news is that all the bad does not actual add up to enough to form a basis for an actual return to a bear market. While the winds of global slowdown continue to blow, they are only marginally stronger than last year and the US consumers seems somehow to keep on buying, even with a housing market that has the potential to make the UK fallout of 1989 to 1994 seem like small beer. It might seem strange to have a whole list of bearish pointers and very few bullish ones, but that is often the way with financial markets.

The long drawn out ‘Death Aria’ of Tony Blair continues as he milks ever more desperate encores, and the premier-in-waiting ‘Our Gordon’Brown must be tempted to do a Macbeth, as this is probably the only chance he will ever get for that short hop to power.The pensions time bomb, whose fuse he lit 10 years ago, has blown up just a bit too quickly to make his elevation to Number 10 quite such a foregone conclusion. The sound of knives being drawn along the Westminster corridors is deafening and recent polls might well tempt a ‘stalking horse’ to challenge Gordon Brown who has never been popular with much of his party.

Markets do not like uncertainty and I fear the best that the FTSE100 can hope for may be to cling to the current levels or grind a little higher.The 6450 level seems to meet heavy resistance and the current environment suggests it is too heavy to overcome in the short term.Traders seem to be happy to sell at any levels above 6400. Poor performances tend to have a reason and markets are not prone to“we have done badly for two years so it must be due for a bit of turn up”thinking.

M AY / J U N E 2 0 0 7 • F T S E G L O B A L M A R K E T S

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In the Markets ASEAN: HOW AN INDEX HELPS ATTRACT REGIONAL INVESTMENT INFLOWS

ASEAN ENCOURAGES CAPITAL INFLOWS It was inevitable that competition for investment dollars was going to heat up in 2007, as the BRIC economies and the Middle East continue to the be the focus of emerging market investors. The Association of Southeast Asian nations is the latest organisation to enter the fray, wanting to create a free trade ASEAN zone by 2015 and instigating moves to deepen the region’s capital markets. A meeting of ASEAN finance ministers in Chang Mai, Thailand, in early April underscored this point.

SEAN FINANCE MINISTERS have agreed to establish an ASEAN Bond Portal that will provide a centralised platform containing information on the ASEAN bond market. “We would explore further measures to enhance liquidity and efficiency of our bond markets including developing appropriate instruments and issuing longer duration bonds,”they said in an official communiqué in early April. According to a draft communiqué obtained at the meeting ministers said "this will be the first step towards facilitating deeper bond market linkages as more ASEAN bond markets adopt an electronic bond trading platform.” Additionally, the Thai and Singaporean finance ministers also stated their intention to move ahead with bilateral cooperation on establish e-bond trading linkages between them. At the same meeting, ministers stressed pan-ASEAN efforts to enhance the profile of the region as an investment destination.

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According to the Institute of Developing Economies, at the Japan External Trade Organisation, the combined growth rate for the ASEAN 5 (Singapore, Indonesia, Malaysia, Philippines and Thailand in 2006 was 5.4%,. Indonesia, despite stagnant investment growth, is estimated to grow by 5.2% this year. Buoyant external demand has compensated for slower domestic demand in Thailand, where 4.8% growth is expected. Malaysia meanwhile is estimated to grow at 5.7%, due to expanding investment, while Vietnam is predicted to grow at 8.2%, led mainly by the country's industrial and services sectors. The Philippines, despite weak investment, is estimated to grow by 5.5%, on the back of thriving external demand and consumption, while Singapore’s growth is estimated to range between 5.9% and 6.1%.

Part of the debate at the finance ministers’ meeting centred on ways in which the region could build on the success of the FTSE/ASEAN 40 index and trading activity in the FTSE/ASEAN 40 Exchange Traded Fund (ETF) which listed on the Singapore stock exchange last September. There are now 12 ETFs listed on the exchange, half of which were listed during the last nine months. Tan Sri Nor Mohamed Yakcop, Malaysia’s second finance minister noted at the time that “our efforts to promote ASEAN as an asset class have come to fruition with the launch of products such as the FTSE/ASEAN 40 ETF. … The ASEAN finance ministers will continue to play our part, in collaboration with leading private sector players, such as CIMB and

Singapore skyline at dusk. Photograph by Yong hian Lim, supplied by Dreamstime.com, April 2007.

FTSE, to promote the proliferation of products and growth of funds investing in ASEAN.” The FTSE/ASEAN 40 ETF is the first ETF that offers investors a way to access the growing ASEAN economies, tracking the FTSE/ASEAN 40 Index, which comprises the 40 top stocks by market capitalisation and adjusted for free-float across Indonesia, Malaysia, Philippines, Singapore and Thailand.

The ETF is managed by CIMB-GK Securities Pte Ltd with CIMB Principal Asset Management Berhad as the submanager. The fund advisor is Barclays Global Investors and the market maker is Citigroup. The benchmark index, FTSE/ASEAN 40, provided Total Returns of 110.61% over the last 5-year period and 22.70% returns over the last 12-month period. The combined GDP of the ASEAN-5 nations accounts for 91% of ASEAN GDP. While it appears strange for ASEAN ministers to talk in this context about the importance of one regional index and an ETF based upon the same index, it should be remembered that in the ETF space there are actually very few ETFs offering regional exposure. iShares Emerging Markets Index and Vanguard Emerging Markets ETF have a broad, generic reach, while iShares S&P Latin America 40 Index provides Latin American exposure. That’s about it. It is an entirely different case with country exposure, where you find a range of plenty, for example iShares FTSE/Xinhua China 25 Index and iShares MSCI Brazil Index.

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Regional Review MIDDLE EAST REPORT: PRIVATE EQUITY GROWTH

According to the Emerging Markets Private Equity Association (EMPEA), some 162 private equity funds focused on investing in the emerging markets of Asia, Eastern Europe, Latin America, the Middle East and Africa raised $33.2bn in capital commitments in 2006—a 29% increase year on year. The Middle East saw a 54% growth year on year in total funds raised through 2006.

Francesca Carnevale reports on a rising asset class.

Not everything in the Middle East garden is entirely rosy.

There is not and in the short term, there never will be, wholesale commitments to privatisation of what are essentially strategic upstream energy and infrastructure assets in the region.

Photograph of Dubai City, by Styve Reineck, supplied by Dreamstime.com, April 2007.

Private equity makes its mark MERGING MARKET PRIVATE equity funds are growing at an accelerating rate and while most are generalist, new funds tend to be increasingly multiform, either by geography, by deal diversity or by sector. What is true for the emerging markets right now is also true for the Middle East. “Private equity is expanding to new markets with no or, at best, a limited history of private equity,” acknowledges EMPEA president Sarah Alexander, who marks out Jordan and Libya in the region for special mention. Alexander also notes that the industry is “seeing growth in funds focused on specific sectors such as infrastructure and clean technology.”

According to the Gulf Venture Capital Association (GVCA), more than $10bn was raised by Middle East private equity funds in 2006, up from $5.7bn in 2005. Fund raising and private equity investments in the region through 2007 threatens to outstrip this performance, with the activities of local firms being supplemented by overseas private equity firms looking either to establish

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operations or invest directly in the region. Even the United States’ specialist overseas direct investment agency, the Overseas Private Investment Corporation (OPIC) has gotten in on the act. At the start of the year Robert Mosbacher Jr., OPIC’s president and chief executive officer, announced an allocation of $566m in three separate funds to provide private equity financing to support new projects in Jordan and its neighbouring countries.

OPIC will support three private equity investment funds, with a minimum of $230m to be invested in Jordan. By focusing investments on sectors such as affordable housing, small business and regional companies, “we intend to spread the developmental benefits widely,” Mosbacher said at the time. The Jordan Fund II, will commit $150m for investments in private, small and medium sized Jordanian firms and is—typically for the region—multisectoral and will focus on telecommunications, information technology, financial services, aviation, education and medical

and/or pharmaceuticals companies.

The two other funds will dedicate some 30% of their investments in Jordan, and the rest elsewhere. The $113m EuroMENA Fund, will focus on middle market companies in Egypt, Lebanon and Morocco and the $300m Emerging Markets Housing Fund, will focus on Jordan and South Africa, with a secondary focus on other countries in Africa and the Middle East. It is expected to generate 87,000 units of affordable housing, and invest 15% of its total capitalisation in Jordan (equivalent to around $45m). OPIC selected International Housing Solutions, a joint venture between MuniMae, a Baltimore-based real estate company, and the principals of Howard Eurocape, a real estate developer based in Ireland as the fund sponsor, and the general partner is the Emerging Markets Housing Fund Management Company, based in Luxembourg.

The rush to leverage private equity returns by local institutional and high net worth investors is picking up pace through 2007, and fund raisings in the region, although modest by current private equity standards of

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Regional Review MIDDLE EAST REPORT: PRIVATE EQUITY GROWTH

investors from around the GCC, the US and Europe, with both institutions and family consistently outperform offices represented”. The investor expectations. Recent fund base also includes strategic raisings typify the trend. In investors who have “a broader November 2006 Millennium interest in the telecom sector, and Private Equity (MPE), who will invest alongside the controlled by the Dubai fund in certain opportunities holding company Dubai World, where there is room for coand the governmentinvestors to participate.” controlled Dubai Islamic Bank, Delta Capital’s fund will focus launched two $1bn private on investments in already equity funds and plans a total established companies where of seven, raising a further $5bn there is a significant potential this year. Reportedly over across the MENA region on “an $1.5bn of the next $5bn has opportunistic basis,” said Morten already been secured. In Kvammen, head of private equity combination, funds committed at Delta Capital when the Fund have set a new benchmark for was launched. Delta Capital will private equity firms working in also leverage parent company the region.

Delta Partners’specific experience MPE’s first two funds will Iyad Duwaji, chief executive officer of investment bank in the Middle East focus on energy and SHUAA Capital, which manages $2.3 billion including telecommunications industry, telecommunications, media and two regional private equity funds remain bullish of which is currently estimated to be technology (TMT) and will buy future of financial services and investments in the region worth a conservative $50bn and is either controlling or minority In fact, downstream energy and infrastructure one of the fastest growing sectors stakes, invest in buyouts or investments in the GCC are a something of a no-brainer in the region, with compounded privatisations and acquire right now. The surge in construction levels and annual revenue growth of equity-related instruments, population numbers in the Middle East, particularly in approximately 12% a year. such as convertible bonds. To the fast growing markets of Dubai, Abu Dhabi, and Delta Capital has great ensure success, MPE hired Qatar, means that local demand for goods and services expectations of both the fund wholesale a specialist TMT continues to rise. Photograph kindly supplied by and the industry, which it investment team from the ShuuaCapital, April 2007. expects to more than double in European Bank of More latterly, Delta Capital, the size over the next seven years. The Reconstruction and Development private equity arm of Dubai-based firm claims that companies in which (EBRD).

In December 2006, NBK Capital, the Delta Partners, raised $100m in late the Fund will target its investments investment and merchant banking February, for its Middle East and North are expected to grow their market subsidiary of the National Bank of Africa (MENA) Telecom Fund. Investor share by a factor of at least seven over Kuwait (NBK) announced the first demand encouraged the firm to up the the life of the Fund, garnering closing of its NBK Capital Equity size of the Fund from $75m to $100m, revenues somewhere between $15bn Partners Fund, focused on investing in having secured $75m in commitments and $20bn by 2014. The seven year, companies seeking expansion or well before the fund raising cut off $100m fund targets an annual rate of restructuring capital in the Levant, date. Even the partners and employees return in excess of 25% (net of fees) Turkey, Egypt and the Gulf of Delta Capital and Delta Partners and focuses on taking majority or Cooperation Council (GCC) states. By invested in the fund, raising a significant minority stakes in target early December NBK Capital had combined $7.5m between themselves. companies, investing on average $8m already secured a planned $200m in As the Fund launched, Nezar Al Saie, to $12m per investment. SHUAA funds, and by the end of the year, the chairman of the MENA Telecom Fund Partners, the private equity arm of Fund finally closed with $300m in explained that the fund’s investor base SHUAA capital, has also raised a represents “a select group of blue-chip $100m for The Frontier Opportunity committed capital.

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Regional Review MIDDLE EAST REPORT: PRIVATE EQUITY GROWTH

Fund, which aims to invest primarily in Syria. Iyad Duwaji, Chairman of SHUAA Partners explains that,“ this is a first of its kind for Syria, it is a high risk high return proposition were we target IRR over 30%, but Syria in our view could be seen as the Vietnam of the Middle East” A number of trends have contributed to the rise of private equity in the GCC and wider Middle East region. Not least is today’s marked volatility in the region’s equity markets, which began to take something of a beating in May last year, after an uninterrupted three year bull run. In a market where stock prices are unreliable, investing in private equity appears to be a more reliable medium term alternative.

Moreover, “anticipated market deregulation ahead of WTO, increased intra regional flow of money, expansion into neighbouring markets, and the ongoing rise in demand for energy and infrastructure are also presenting deal flow for private equity”, says Iyad Duwaji. In fact, downstream energy and infrastructure investments in the GCC are a something of a no-brainer right now.

The surge in construction levels and population numbers in the Middle East, particularly in the fast growing markets of Dubai, Abu Dhabi, Bahrain, Qatar and Kuwait, means that local demand for energy continues to rise.

Added to that is the rise of long term off-take agreements contracts that Abu Dhabi and Qatar are signing with Asian, US and European energy buyers. In turn, the region is awash with cash looking for an investment home that promises reliable returns over the medium term. SHUAA Capital’s private equity funds “have targeted sectors such as oil and gas, retail and hospitality,” says Duwaji, who acknowledges that SHUAA’s funds have a stake in two very

20

Abraaj Capital’s AbdelWadood acknowledges that in these volatile times, a new challenge for the private equity firms is finding the right opportunity to exit a deal.

Going public has become a realistic exit option. In its brief history, Abraaj Capital has engineered two IPOs, with internal rates of return in excess of 60% according to Abdel-Wadood. Exit via a trade sale is another exit option which, he notes, is becoming more frequent and has been the case in Abraaj’s most recent exit.

successful companies namely Damas and Rotana hotels “two of the top brands in the Middle East,”he adds.

Keeping with the energy theme, another private equity funds that has successfully capitalised on the sector’s growth is GCC Energy Fund, launched back in 2005 and run by chief executive officer, Adil Toubia.

Since November 2006, the firm has announced strategic investments in Maritime Industrial Services; the purchase of a 50% stake in Stellar Energy (MENA); the acquisition of a controlling interest in Oman’s Dhofar Power Company; and the purchase of a 33% equity stake in The Gulmar Offshore Group.

However, not everything in the Middle East garden is entirely rosy.

There is not, and in the short term, there never will be, wholesale commitments to privatisation of what are essentially strategic upstream energy and infrastructure assets in the region. Invariably then, many of the

better investment opportunities will remain in state hands. Where private sector opportunities do exist, such as the liberalised water and telecommunications sectors, there are already plenty of private companies at work. Remember too that MPE is itself is a state controlled entity, and that investors in MPE funds will also have taken into account the ‘Dubai economic miracle story’ and Dubai’s sovereign rating before making that investment decision—in other words, in the short term, another no-brainer.

Moreover, the competence and availability of human capital is not ubiquitous throughout the region.

Dubai, Bahrain and Kuwait have discrete, yet substantial professional populations, but that is not the case in many Emirates, Saudi Arabia and Oman, where much of the real wealth is concentrated in too few hands. In addition, regional standards of corporate governance present a major hurdle to private equity investment.

Can due diligence be successfully completed on companies with family ownership structures—especially for large scale investments? Informal ownership structures are not good enough for private equity due diligence, neither are ones where the state remains the real controller of a deal.

Additionally, local companies find it hard to cede decision making to a third party such as a private equity fund—meaning one of three things.

One, private equity investments in local firms have, on the whole, tended to be minority stakes, cashing in on an upward business boom, rather than taking majority stakes, taking all the key marketing and sales decisions and then leveraging the business into fast growth. Two, even with substantial equity and seats on the board, some private equity firms have found it hard to change corporate mores and culture,

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Regional Review MIDDLE EAST REPORT: PRIVATE EQUITY GROWTH

especially in family dominated companies, though few will go on record with that acknowledgement.

Three, it has encouraged local private equity firms to look further a-field in the short term, to begin to diversify their exposure and achieve a substantial history of successful deals under their belt.

Dubai-based Abraaj Capital, which has $4bn under management and is one of the largest dedicated private equity institutions in the region, is one such firm and does not limit its investments to the GCC states.

Instead, the firm prefers a Middle East North Africa and South Asia (MENASA) regional designation, where it sees “historical commercial and business ties” explains Abraaj Capital managing director Mustafa Abdel-Wadood. The buyout firm’s commitment to a broader crossregional geography is also illustrated

by Abraaj’s recently established joint venture in India, Sabre Capital, which it established with the Sabre Group, raising some $300m for private equity investments in the country.“The head start we had in the region,” acknowledges Abdel-Wadood, “gave us an enviable and all-important track record, which has allowed us to spread out from the region, albeit there remains immense opportunity at home as well as abroad.”

Abdel-Wadood sees the real estate sector as particularly attractive. “One of our early dedicated property funds is almost fully invested and we have been looking at some good and consistent returns, particularly from our investments in the GCC and Pakistan. We think it important to remain diversified, even in a sector specific fund.”

Abdel-Wadood acknowledges that in these volatile times, a new challenge for the private equity firms is finding the right opportunity to exit

22

Abraaj Capital’s managing director Mustafa Abdel-Wadood. The buyout firm’s commitment to a broader cross-regional geography is also illustrated by Abraaj’s recently established joint venture in India, Sabre Capital, which it established with the Sabre Group, raising some $300m for private equity investments in the country.“The head start we had in the region,” acknowledges Abdel-Wadood,“gave us an enviable and allimportant track record.” Photograph kindly supplied by Abraaj Capital, April 2007.

a deal. Going public has become a realistic exit option. In its brief history, Abraaj Capital has engineered two IPOs, with internal rates of return in excess of 60%, according to AbdelWadood. Exit via trade sale is another exit option which, he notes, is becoming more frequent as has been the case in Abraaj’s most recent exit.

While opportunity beckons, and the likelihood remains that private equity fund raising and investment will once again outstrip expectations this year, the fact remains that the capital markets are still relatively immature in the GCC states and more so in the wider Middle East region, thereby capping both exit opportunities and the ability of private equity firms to introduce significant leverage into the

firms they invest in.“We are seeing the evolution of acquisition financing but it is still far from where it could be,” acknowledges Abdel-Wadood, noting that “mezzanine financing remains virtually unknown in the MENA region”. Corporations looking for expansion“have been restricted to seek bank loans to meet their requirements for growth, but now are tapping into the capital market, and we have helped the past five years engineer many landmark transactions and new structures” says SHUAA Capital’s Duwaji, and the current explosion of the region’s IPO’s, underscores this fact. For private equity funds to work most efficiently however, the right mix of debt and equity is required, with debt usually outstripping equity by at least a factor of three.

Up to now, the region’s key players have had the market almost to themselves. But that will not last for long. Competition is surely on the way, and the mighty Carlyle Group and other international firms now work in the wider MENASA region.

Competition will force everyone to work harder, but the local firms welcome new participants, says SHUAA’s Duwaji, who maintains “that the presence of well-regarded international firms will raise the bar for everyone.” The particular understanding of local firms of the region’s capital markets culture will always give them an edge— particularly with regard to the growth of Islamic financing as a source of capital. Bahrain-based Arcapita, for example, which launched a $200m fund back in October 2005, offers a broad range of financing options including several that comply with Islamic rules. The likelihood is that private equity in the Middle East will evolve its own mores, forms and adopt its own risk management techniques.

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Regional Review MIDDLE EAST REPORT: FUND MANAGEMENT IN DUBAI AND BAHRAIN

The DIFC goes global Following the enactment of collective investments and trust laws last year, the Dubai International Financial Centre (DIFC) is now keen to establish itself as a global centre for asset management.

Sandy Shipton, head of asset management at the DIFC. Photograph kindly supplied by the DIFC, April 2007.

WO IMPORTANT PIECES of legislation were passed by the Dubai Financial Services Authority (DFSA) last year which provide two important building blocks for the DIFC’s aspirations to establish itself as a global asset management hub. The regulations were designed to facilitate the establishment of real estate investment trusts (REITS) and to remove unnecessary impediments to the marketing and selling of foreign funds in and from the DIFC.“Collective investments, in the broadest sense, covers all funds including mutual funds, property funds, Islamic funds, hedge funds, fund of funds and private equity funds,” says Sandy Shipton, head of asset management at the DIFC.“The enactment of this law is the final piece in the jigsaw that creates a world class domicile for the funds industry here in Dubai.”

Shipton maintains that the funds sector is “central to the financial services industry and to the global economy. The DIFC and its regulator, the DFSA, “have worked extremely hard to create the right environment for the industry to come to the DIFC, and we believe that now we have achieved this, we maintain that both fund managers, custodians and administrators will see the unique benefits of the DIFC and the region.”

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Although the funds industry is still in its infancy in the Middle East, Shipton says the DIFC has larger aspirations:“We are looking to establish ourselves as a global centre for the funds management industry and are not confining ourselves by a regional perspective.”

The “DIFC’s funds offering differs from other centres, and in particular offshore locations, in that we offer an institutional wholesale environment that is backed by regulation that meets international standards,” explains Shipton. Regulatory supervision is provided by the DFSA, which operates entirely independently of the DIFC. “The DFSA has been established as a world-class regulator from the outset.

Significantly, its framework is free from the confines and complexities that can develop when old systems are forced to fit new circumstances. The DFSA has been created specifically to suit the environment within which it operates,” he says.

Shipton explains that the DFSA has been created using “principle-based primary legislation modelled closely on that used in London and New York, and its regulatory regime works to the same standards in those centres. It has been done deliberately, taking the best from each and provides a regulatory regime that is also familiar to the financial institutions who locate in the DIFC, providing necessary legal certainty.”

The DIFC, which opened in September 2004, is a 110-acre free zone and was designed as a “gateway for capital and investment,” explains Shipton. Firms operating in the DIFC are eligible for benefits such as a zero

tax rate on profits, 100% foreign ownership, no restrictions on foreign exchange or repatriation of capital, operational support and business continuity facilities.

The DIFC encompasses, banking services, capital markets, asset management, fund registration, insurance, Islamic finance, business processing operations and ancillary services. Shipton says that the DIFC’s global aspirations are natural, given “Dubai’s location, the DIFC can bridge the financial centres of London and New York in the west, with Asia’s rising markets in the East.

The collective investments law and the Investment Trust Law, of August last year, which permitted the operation of real estate investment trusts (REITs) within the DIFC are two valuable pillars on which the DIFC’s aspirations rest. Says Shipton,“REITs provide a convenient for listed and tradable property ownership, backed by transparent pricing and liquidity. We are seeing a major pipeline build up in this regard.”

He explains that Dubai hopes to become a centre both for REITs based on local Dubai assets and assets outside the country, with listings on the Dubai International Financial Exchange (DIFX). He also points to the experience gained through the Islamic bond (Sukuk) market, “where the DIFX has the largest number of listed Sukuks,” says Shipton, as a pointer to the potential of REITs. The DIFC will also have to compete with Bahrain, which has also overhauled its collective investment and trust legislation in recent months. Shipton is sanguine about Bahrain’s initiatives,

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Regional Review MIDDLE EAST REPORT: FUND MANAGEMENT IN DUBAI AND BAHRAIN

which he stresses are focused on “a regional, rather than a global context.”

Right now, acknowledges Shipton, there are other considerations to have to factor in. The current zone occupied by the DIFC is virtually full because, “we are two years ahead of where we planned to be”. Enlargement of the free zone is the only option and the DIFC is now near to completing 18 additional buildings—eleven of which will come on stream between now and September,“in a construction plan that encompasses 65 buildings in all. To provide space for incoming firms, we have also annexed buildings outside the DIC to cover excess demand,” he explains.“To date we have achieved 15%

of the overall business growth plan, but put that in context, that the original plan stretched out to 2020, now that has been accelerated to 2015, and likely that will be accelerated again,”he adds.

Now there is talk of the DIFC exporting its brand overseas, although Shipton is wary of discussing the plans in any detail. The likelihood is however, the DIFC will base new operational centres in Asia, London and perhaps even the United States.“It is very early stage, but we are in dialogue with Beijing on a number of interesting projects. We are keen to encourage the export of capital.” It makes sense. Dubai has the largest Chinese population in the Middle East and more Chinese are

moving to the region as China secures its long term hydro-carbon supplies from the states comprising the United Arab Emirates (UAE).

There are other indicators also that support Shipton’s growing conviction that Dubai will become the world’s fourth largest financial centre.

Halliburton, the world’s largest oil servicing company recently relocated its global headquarters to Dubai, and says Shipton, more global companies are following suit. “We are now a global play and financial institutions see the opportunities here. We are now a viable global hub and we carry hardly any baggage. Dubai is now a star attraction.”

BAHRAIN’S CB’S NEW ALTERNATIVE INVESTMENT REGULATIONS

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he Central Bank of Bahrain (CBB) is finalising new regulations that will spawn the development of a regional industry of hedge funds, derivatives and other alternative investment instruments. Rules supporting hedge funds and alternative investments are contained in a new regulatory framework for collective investment undertakings (CIUs).

The new collective investment undertaking framework, updates regulations governing mutual funds, and will also incorporate, for the first time, rules allowing CIUs targeting professional investors. According to Abdul Rahman Al Baker, executive director, financial institutions supervision at the CBB, the new rules distinguish between three different types of investor.

The CIU rules cover retail investment schemes, which have specific disclosure requirements and where the investor needs a high degree of protection; experienced investor investment schemes, where the investment risk is higher but which are targeted at “medium sized or professional and sophisticated investors, with a net worth of up to $1m,” expands Al Baker. Finally, the CIU also distinguishes exempt collective investment schemes, such as hedge funds, leveraged funds and derivatives funds, and which specifically address the funds industry, which says Al Baker, is “a critical, growing and highly dynamic segment of Bahrain’s financial sector and which perfectly understands the risks involved in alternative investments.”

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Bahrain currently leads the region as a funds centre, with over 2,000 authorised funds, including over 100 locally domiciled funds. The new CIU regulations will further enhance and develop the market, by allowing a much broader range of CIU to be domiciled and offered in Bahrain, all within a credible regulatory framework.

The new framework will create a new category of ‘exempt’ schemes. These schemes will be required only to register with the CBB, rather than be authorised, and will not be subject to on-going supervision. They will furthermore not be regulated, but may only be sold to a restricted investor base (those able to make a minimum investment of $100,000, and with at least $1m in financial assets, and subject to verification by the institution selling the product that the investor fully understands the risks involved).

The rules for exempt schemes will allow hedge funds and other higher risk alternative investment vehicles to be legally domiciled and/or sold in Bahrain, within an appropriate regime that recognises the sophistication of this limited investor base. “This new category will significantly facilitate the development of products totally different from plain vanilla products and aimed at professional investors, who are high net worth individuals or institutions,” says Al Baker. “Currently, Middle East investors have to look overseas for such products. The CBB regulations, however, will enable regional access to such instruments.”

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INFRASTRUCTURE & OVERSEAS GROWTH FUEL MIDDLE EAST BANKS

??

HE TASI INDEX, the principal benchmark of the Saudi market has had a rough time of late.

Lower oil prices and the on-going worries over Iran and Iraq seem to have affected the Saudi stock market and financial sector more than any other in the GCC region. Investor confidence was further shaken by the Saudi Capital Markets Authority (CMA), the official regulator’s decision earlier this year, to suspend two firms, Anaam International Holding Group and Bishah Agriculture Development, after accumulated losses had wiped out their capital. Nonetheless, investors were also reassured at the growing confidence of the CMA and its willingness to tackle trouble quickly and ruthlessly.

2007 is however, a reality check for most Saudi banks. The outstanding

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2007 opened on a mixed note for many banks in the Middle East, as different countries reacted differently to volatility in the stock markets over the last twelve months. Saudi Arabian banks have been most and immediately affected. In the main, the pain of a drop in profit growth is largely expected to be short term, particularly for banks with interests outside the stock market. Even so, the region as a whole is building its banking business on infrastructure growth and a growing diversity of financial instruments, in both the investment and debt markets. The only way is up.

profit growth recorded in 2005 and a large part of 2006, when many banks were recording growth in excess of 70%, was simply not sustainable over the long term. The profits of a number of institutions were directly tied to the performance of the stock market and everything was on an upswing, while the stock market index was on an upward trajectory. Inevitably, though, bank profits were always likely to dip once the equity markets around the region started to dip and dive in February last year. The surprise was that the effect of the stock market downturn took so long to wash through the banking sector’s result. Finally, it has and most of that downturn was depicted in the first quarter results of this year.

John Coverdale, managing director of SABB, said when the bank’s results were announced, that, “Although we have not been able to match the high

levels of profits seen in the first three months of 2006, the bank achieved an increase of SAR31m in profits compared to the fourth quarter of 2006.

This growth demonstrates the underlying momentum that SABB has maintained and will build upon during the rest of 2007."

Even so, Coverdale acknowledged that,“Operating income for the quarter, compared with the same period in 2006, was down 27.7% as a result of significantly lower fees from brokerage and mutual fund business, although this was offset by improved balance sheet driven income, including higher levels of loans and deposits. We have continued to grow our card and consumer loan book, and loan provisions have increased commensurately. However, overall credit quality remains sound. The very liquid market conditions have kept

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deposit levels high and SABB's challenge for 2007 will be to ensure that these funds are channelled towards further quality asset growth.” The bank's capital and liquidity positions remains strong, stressed Coverdale.

Riyad Bank, Saudi Arabia's fifthlargest lender by market value, also provides a paradigm for the sector. Net profit fell 25% in the first quarter of this year, because of lower commission income from stock market-related activities. Earnings were below the average 5.6% decline analysts had forecast. "Riyad Bank's first-quarter profits were affected by a decline in fees from activities linked to the stock market," explained chairman, Rashid Al Rashid, who added that the bank would now focus on developing its core banking operations.

Saudi Arabia’s banks had posted exceptional earnings growth in the first quarter of 2006. In these more straightened times, it is natural that there is a tightening of lending and with continued stock market volatility, initial public offerings have naturally but temporarily dried up in the country.

Eventually, sustained new lending will return, particularly attached to Islamic issuance and the real estate sector, but the upswing will take much longer to realise. Mortgage lending still has substantial lebensraum both in Saudi Arabia and the wider Middle East region; but these developments are for subsequent market reviews.

Like many banks in the country, however, Riyad Bank has relied on stock market commissions, which last year accounted for around one third of the bank’s revenue. Most affected has been Al Jazira. Some 70% of its income last year came from stock market commissions. That degree of concentration is not true of all Saudi banks however, Al Rajhi, for instance, one of the larger banking operations in the Gulf region reported that stock

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market commissions accounted for less than 17% of its total revenue.

Small indications of a possible turnaround in the fortunes of the stock exchange appear to be emerging however. In March five Saudi Arabian insurance firms launched IPOs. The firms issued shares worth a total of $60.3m, or 38% of their total combined capital. The IPO of the month however was the $9.3m public share offering of

Like many banks in the country, however, Riyad Bank has relied on stock market commissions, which last year accounted for around one third of the bank’s revenue.

Most affected has been Al Jazira. Some 70% of its income last year came from stock market commissions.

That degree of concentration is not true of all Saudi banks however, Al Rajhi, for instance, one of the larger banking operations in the Gulf region reported that stock market commissions accounted for less than 17% of its total revenue.

Saudi-based Islamic insurer SABB Takaful in an offer involving 35% of its capital. HSBC Group will keep a 32.5% stake. Shares were offered at 10 riyals each, with a minimum of 50 shares and a maximum of 100,000 per subscriber.

HSBC Saudi Arabia was the financial adviser for the IPO and SABB the subscription manager. Although the IPOs were small scale, they have been widely welcomed as a confidence building exercise, particularly SABB

Takaful’s IPO, which was six times oversubscribed and attracted $66m worth of bids.

Despite continuing market volatility throughout the GCC, elsewhere in the region, the performance of the banking sector has generally remained buoyant in the first quarter. National Bank of Kuwait (NBK), Kuwait’s largest bank, for instance, announced net profits of $221.5m, up 13%. The Bank also reported a return on average assets of 3.2% and a return on average equity of 29.3%. According to Ibrahim Dabdoub, NBK’s chief executive officer, the results “represent solid growth across all of the bank's business lines.” NBK says Dabdoub is investing heavily “in building our capacity to meet future customer needs, as well as serve new customers and markets.

Our investments in people and systems have been thoroughly reviewed to ensure a solid platform that will enable NBK to compete effectively and efficiently in more open markets." Added to that " is regional expansion,”says Dabdoub. "In March 2007, we were granted a license to operate in the UAE. This complements recent additions to our international business.”

Ahli United Bank, which recently won Global Finance magazine’s “Best Bank in the Middle East for 2007” award, meantime reported a 14% increase in net profits, to $68.9m for the first three months of this year. This start to the year was repeated with few exceptions across the Gulf Cooperation Council (GCC) states, underpinned by strong regional economies and relatively high oil prices. Growing client deposits is also a strong feature. Ahli United, for instance, reported a massive $1bn upswing in customer deposits over the quarter.“Last year, we made significant progress in pursuing our strategy of organic and acquisition growth. This year, we aim to build on [that] successes,”says Fahad Al- Rajaan, Ahli

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Regional Review GCC BANKING

United Bank’s chairman. National Bank of Bahrain joined this regional trend, with earnings growth rising by 20.24% to $31.9m, according to Hassan A Juma, managing director and chief executive officer.

Positive results for the last five consecutive quarters or more has spurred the region’s leading banks to broaden their international reach and, depending on current business focus, it is a case of different banks, different strokes. Qatar National Bank (QNB), for example, which has a strong focus on the Middle East and North African region, has most recently has invested in expanding operations in Libya, where it has just opened a representative office. Ali Shareef Al Emadi, QNB’s acting chief executive stresses that the move builds on “emerging opportunities [that] will boost the business trade between Qatar and Libya”.

In a related development, it appears that GCC based Islamic banks are focusing much of their international expansion on the Malaysian market, attracted by the country's legal and regulatory structure, and its efforts to establish itself as an Islamic financing hub. More pertinently, Malaysia offers a ten year tax break on sukuks issued in the country, and it is also seen as a gateway to other markets, including China. In April, Qatar Islamic Bank opened a subsidiary operation, Asian Finance Bank, in Malaysia with a capital of $100m.

It is, however, in the area of infrastructure, capital goods and trade finance however that banks in the Middle East are really proving their mettle. Ahli United Bank recently signed an agreement with the Arab Trade Financing Program (ATFP) that will allow the bank to extend ATFP’s credit facility worth $30m to its customers to support foreign trade flows. Under the terms of the new

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agreement ATFP will refinance the credit extended by Ahli United to its eligible customers in Bahrain. Abu Dhabi- based ATFP, is a specialised financial institution launched by the Arab Monetary Fund, has done extensive work to develop and promote trade in Arab countries. ATFP appoints designated national agencies, or financial institutions through which they can operate, thereby extending their services to a wider audience. “The partnership between AUB and the ATFP will help exporters to manufacture and market goods abroad efficiently. Our hope is that the resulting increase in foreign trade will have a ripple effect; and positively affect all aspects of the local economy,” says Adel El Labban, Group Chief Executive Officer and Managing Director, Ahli United Bank.

Equally, Ahli United Bank’s $186m Pan Asian Industrial Fund has completed its initial closing. MIF is a private real estate fund, managed and sponsored by Mapletree Investments Pte Ltd, an Asia-focused real estate firm in the Temasek group of companies.

MIF is focused on investing in manufacturing facilities, business parks, industrial parks, research and development facilities, IT and software parks, and industrial offices in various Asian countries. The key objective of MIF is to tap the shift in production and research and development processes to Asia by creating a diversified portfolio of good quality industrial real estate assets with a stable return profile.

Fellow Bahrain-headquartered ABC meanwhile has closed a succession of syndicated loans for the infrastructure sector of late, including a $350m Sukuk Al Ijara Facility closed for Sharjah Electricity & Water Authority Sharjah Electricity and Water Authority (SEWA).

ABC Islamic Bank was joined by

Gulf International Bank, Kuwait Finance House (Kuwait) and Sharjah Islamic Bank in lead managing the deal, a signal indication of the growing confidence among the region’s leading banks to go it alone on major syndications these days.

SEWA is the first Sharjah government owned entity to approach the syndication market for a long-term Islamic financing facility. ABC also closed a seven year €55m project financing facility for the Palm City Residence in Libya. On a much larger scale is the $485m financing for Batelco, Bahrain’s telecommunications major, which ABC jointly arranged with Standard Chartered Bank. The transaction was oversubscribed by 60% and the size of the facility was increased from an original $300m to $485m. Equally buoyant was Bahrain's Arcapita Bank five year syndicated Murabaha facility that was increased in size to $1.1bn in April, up from $500m, following investor demand for some $1.3bn in allocations. The proceeds of the facility will be used to re-finance Arcapita's outstanding $210m multicurrency sukuk and for general corporate purposes. Underwriters for the issue included Barclays Capital, DBS Bank, the European Islamic Investment Bank, Standard Bank, Standard Chartered Bank and WestLB. The pipeline of deals originating from the region is building steadily for the rest of this year and corporations in the GCC, like the banks, are showing willing to work in and out of nearby markets. In April Emaar announced that Emaar MGF, a Joint Venture of Emaar Properties and India's MGF Developments, intends to raise around $ 3bn through an IPO in India. The issue is likely to set a new issue benchmark in the region, particularly as Emaar recently announced its financial results for 2006 showing a 35% increase year on year.

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Regional Review NORTH AMERICA: SARBANES OXLEY ACT UNDER FIRE

Listening to some American business leaders, you might suspect that the Sarbanes Oxley Act (SOX) was some form of genetically engineered plague, that is designed to hamper American business competitiveness and disadvantage American financial markets.

Three recent studies, including one commissioned by Mayor Bloomberg, have emphasised growing foreign competition to New York’s financial industry, partly capitalising on the increased requirements imposed by SOX. Moreover, the influential US Chamber of Commerce has called for reforms to the act to counter “perceptions that the US risks losing its global pre-eminence in the capital markets.” Ian Williams reports on the growing tussle over the efficacy of the Act.

SOX IN THE SPOTLIGHT

Photograph by Milosluz, supplied by Dreamstime.com, April 2007.

HERE ARE A growing number of complaints about the record number of earnings restatements, and postponements of results announcements—Sony being one of the latest. All the focus of that blame is on the exigencies of SOX. There is surprisingly little commentary pointing out that restatements are only necessary when there has been a previous mis-statement! However, once away from the corporate executives, whose collective depredations after all provoked the act, the picture changes completely. In fact, the number of restatements from larger corporations has dropped by 20% this year because, as the first affected by the Act, they have begun to adjust to the new demands for accuracy. Supporters

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of the Act wonder what exactly is wrong with having precise numbers.

One of these, Charles Niemeier, a vociferous Board member of the Public Company Accounting Oversight Board (PCAOB), points that the restatements are much smaller than they used to be. “If you look at the largest scandals, Enron, WorldCom etc [sic] none of them started out to be the largest in the world. They started out small, and then in one quarter they got off track by a penny or two, and then got in deeper and deeper. Now, every time you see a small restatement, what you see is a company getting back on track.You see an Enron thwarted.”

The PCAOB was a crucial player in the passing of the Sarbanes Oxley Act,

and established a statutory body, relatively free of the political pressures that sometimes dog other financial services institutions such as the Securities and Exchange Commission, (SEC) the official markets regulator, for example. This body has replaced the reliance on the previous practice of self-regulation of the accountancy profession and its purpose is to “protect the interests of investors and further the public interest in the preparation of informative, fair and independent audit reports.”Following the series of scandals where major accountancy firms had signed off on what were later shown to be mostly fictional books from managements, the Board (naturally) has been pressing stricter regulatory standards.

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Regional Review NORTH AMERICA: SARBANES OXLEY ACT UNDER FIRE

Its opponents meantime have been trying to litigate it out of existence, but their latest law case failed.

The tussle between reformers and the regulators is like a Sumo wrestling match, with much grunting and groaning, but little or no sign of movement. Nor is there likely to be.

Reform is unlikely and repeal is impossible. “Not with Democratic control of the Congress,” says Steve Davis of corporate governance consultants Davis Global. “With dozens of companies caught backdating options, executives awarding themselves record bonuses for doing badly, and trials of managers caught playing fast and loose with the books, there is no political momentum in Washington to cut back on oversight.”

Niemeier is a staunch proponent of the SOX reforms, whose downside he strongly feels has been exaggerated and whose benefits have been ignored. His position precludes him from commenting on the political climate in Washington, but he exudes confidence that the reforms passed in 2002 will last. To begin with, he points out the recent studies lamenting the lack of competitiveness allegedly caused by SOX do not go as far as calling for repeal. “There is not much appetite [in Washington] for opening up Sarbanes Oxley, there are much better chances for tweaking the few areas where regulators can meet genuine objections.” Much of the criticism focuses on the cost of compliance, particularly with internal controls, and he agrees, “There has been a substantial cost.”However, he notes that, “since 1977 companies have been mandated to do this—but they [have not], so this is a sort of deferred maintenance cost.”

Niemeier maintains that Sarbanes Oxley is not innovative.“Was it really

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so absurd for boards to be engaged, or for management to stand behind the reports they made to the public?” he asks. “For analysts to be free from conflicts? For companies to have adequate internal controls?

Everyone was supposed to do this before. What changed was that Sarbanes Oxley says ‘this time it’s different – you really do have to do these things!’” He also says that managers have found it “really easy to forget where their money comes

The tussle between reformers and the regulators is like a Sumo wrestling match, with much grunting and groaning, but little or no sign of movement. Nor is there likely to be. Reform is unlikely and repeal is impossible. “Not with Democratic control of the Congress,” says Steve Davis of corporate governance consultants Davis Global.

from. They do not really see shareholders on a daily basis. They were supposed to have accountability, but they did not really. That is why Sarbanes Oxley and in particular the internal controls parts of it are here to stay.”

Against the rising number of complaints that board members are more difficult to recruit nowadays, because of the increased responsibilities of board members encased within SOX, Niemeier has little patience. Not only is there no evidence of any general reluctance,

but he also thinks that management boards are more “engaged” than ever.

“If you really just want to hang out with your friends, then this is not the time to be on a board. But if you really want to have some influence, and make difference, now is the time, because boards are more important than they have been for some time,” says Niemeier.

As for international competitiveness, by any measure, the US markets are defying gravity, and have done so fairly consistently since the introduction of the Sarbanes Oxley Act. Admittedly, in 1996 New York accounted for 60% of the world’s IPOs – but dot.com mania is not, perhaps, the best reference point for such matters. However, Christopher Dodd, the new Democratic senate banking chairman, pointed out to Sarbanes Oxley critics in March that no less than 34 foreign IPOs listed on US exchanges last year, the highest percentage in the US in two decades.

Some of the creative dissonance shows in the double complaints from New York, that Sarbanes Oxley is driving IPOs to London and elsewhere to avoid its rigorous standards, but that at the same time, London’s standards, particularly in the AIM market are too low.

In fact, claims Niemeier, “Many of the companies in the AIM market would not be allowed in the US at all.” He adds “However, if we are going to compete we should be doing it on the basis of higher standards of governance and reporting. High liquidity is not going to last forever, and when it dries up capital is going to seek safer markets.

We have the lowest cost of capital in the world and with Sarbanes Oxley, the safest in the world. We should build on that improvement, not roll them back.”The improvement will be contested but it does look as if going back is not an option.

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THE FTSE GLOBAL EQUITY INDEX SERIES. AHEAD OF THE CROWD. FTSE adds emerging markets to the global universe with the inception of the FTSE All-World FTSE introduces free float adjusted indexes

2000

2001

The FTSE Multinational Index Series is launched

FTSE extends the global universe to 98% with the launch of the FTSE Global Equity Index Series

The FTSE4Good Index Series is launched

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Regional Review RUSSIAN DEBT

Trading futures and options on the Russian IOB Index

There are 37 countries and 100s of Depositary Receipts (DRs)—negotiable certificates representing ownership of a given number of a company’s shares, which can be listed and traded independently from underlying securities—on the London Stock Exchange’s (LSE’s) International Order Book (IOB). In 2006, trading on IOB exceeded $289bn in 2006—up 121 % on 2005 and there were 918,049 trades—up 91% on 2005. Of those totals, the 20 or so Russian DRs account for around 70% of trading. The next logical step was to create a specific index to help meet investor demand for futures and options based on the most liquid Russian DRs.

In addition to futures and options on the index, EDX offers exchange-traded contracts on the four most liquid DRs included in the FTSE Russia IOB index, currently Gazprom, Lukoil, Surgutneftegas and MMC Norilsk Nickel. A clearing service is also available for bilaterally negotiated deals on all ten of the DRs in the index as well as for futures and options on the index itself.

EDX London has also recently expanded the clearing service to include another 15 “ HE MASSIVE EXPANSION in DRs, ten of which are Russian DRs and trading in Russian DRs on the five of which are Kazakh firms.

IOB is a success story,” says Lee According to Betsill the pick up of Betsill, managing director at EDX futures and options based on both London, the derivatives exchange single DRs and on the index has managed by the LSE and owned exceeded expectations. From a jointly by the LSE, with a 76% share standing start on launch, some 1000 and the OMX Group (which owns futures were traded daily in 24%). “It shows how much interest December. The figure doubled in there is in trading these companies,” January and doubled again in he adds. EDX London was set up in February 2007 and then shot up to 2003 to combine the liquidity over 10,000 per day in provided by the LSE with 3 Year Performance of FTSE Russia IOB Index in US$ Terms March. By mid-April EDX OMX’s derivatives trading London had traded a technology and offers 300 further 45,000 contracts. access to equity and index 250 With the exception of derivatives from both the Sistema, which is a Nordic and Russian 200 telecommunications firm, markets.

150 the other nine companies Betsill says that EDX in the index are in strategic London had “observed a 100 commodities, which means growing over the counter 50 that the index not only (OTC) derivatives market provides exposure to the based on [the] Russian most liquid Russian DRs, DRs.” According to EDX FTSE Russia IOB Index FTSE Russia Index FTSE Emerging Index but also allows a London, banks commodities play. participating in OTC Source: FTSE Group and Datastream, data as at 31 March 2007.

Russian derivatives trading were also interested in the advantages of onexchange trading: EDX London developed the Russian IOB Derivatives Service, giving its members access to both futures and options on single ADRs and on a newly developed index, created with FTSE Group, the FTSE Russia IOB Index.The FTSE Russia IOB Index is a market-cap weighted index designed to measure the performance of the ten biggest and most liquid Russian DRs trading on the LSE’s IOB. The index had a starting value of 1,000 points and now stands at 1208. The index is calculated in US dollars and is published both on a real-time basis (in US dollars), and at the end of each trading day (in US dollars, Sterling and Euros). The index is reviewed quarterly, and the list of companies may alter depending on company trading volumes.

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GROW WITH US IN CENTRAL AND EASTERN EUROPE. www.ri.co.at

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Regional Review TURNING UP THE HEAT ON RUSSIAN IPOS

CAN LUKOIL UNLOCK INVESTOR TORPOR Last year, combined, Russian corporations raised some $17.5bn through domestic and foreign initial public offerings (IPOs) in 2006 against some $5bn in 2005. By the end of last year, eager Russian brokerages anticipated another banner year, but over the first quarter of 2007, it became plain that the year is not living up to expectations. What’s the problem?

FTER a dynamic upturn in both equity and bond issues by Russian corporations last year, 2007 is looking decidedly dull. Some analysts still think that it could take a turn for the better, pointing to the optimism of Russian brokerages at the beginning of the year. Analysts at Alfa Bank, for example, anticipated the Russian IPO market would exceed the 2006 total within the first half of this year. In a March report, Alfa Bank stated that Russian companies have already raised $10.6bn through IPOs and other share placements since the beginning of the year. Troika Dialog, was also upbeat projecting equity issuance would top $30bn. A recent Renaissance Capital report also predicted that some 43 IPOs would emerge from Russian companies this year, raising a combined $31.24bn. Not only that, it also anticipated that MDM-Bank, Alfa-Bank and URALSIB Financial Group would follow in 2008.

Other houses, notably Citigroup, expect total issuance volume to be significantly down year on year. Either way, a number of tempting firms and, some say, teasers, in the second quarter will likely provide a signal indication of the remainder of the year.

Among the current crop of international debutants is Magnitogorsk Iron and Steel Works (MMK).

Russia's third-largest

A

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steelmaker set the price range for its international share float at $12.25$15.50 per global depositary receipt (GDR) in mid-April. The company, which already has a small free float in Russia, intends to issue GDRs, each equivalent to 13 ordinary shares, in London and ordinary shares, with a price range of $0.94 to $1.19, in Russia, aiming to raise $1bn or so in total. ABNAmro, Morgan Stanley and Renaissance Capital are acting as lead managers for the GDR. A recently issued research note by Alfa Bank stated that MMK was trading at 5.7 times enterprise value to earnings before interest, tax, depreciation and amortisation (EBITDA), in line with the Russian steel sector average.

The reception to Magnitogorsk is expected to provide an important bellwether to investor sentiment towards Russian issuers (equity and debt) through the second quarter of the year. That sentiment has been increasingly subdued, due in part perhaps to a period of growing political tension between Russia and the West and in response to continuing uncertainty over oil prices.

In February, telecommunications equipment supplier Sitronics, a unit of Russian conglomerate AFK Sistema raised around $350m for acquisitions and debt amortisation through a dual listing in Moscow and London,

This year will either light up Russia’s corporate issue calendar, or it will end as a damp squib.Photograph of the Moscow skyline at night. Photograph by Alexander Avdeev, supplied by Dreamstime.com, April 2007.

though the final figure fell well below the company's original target of $550m. Credit Suisse, Goldman Sachs and Renaissance Capital acted as joint global coordinators and book runners for the offering. HSBC was co-lead manager. First quarter issuance volumes were also marred by the decision of GV Gold, Russia's seventh-largest gold miner, to pull its planned IPO, while metals company OAO Polymetal debt also priced toward the tail-end of its range. The lack of investor demand was telling.

Polymetal is the biggest silver producer in Russia and ranks fifth in the world. The company had expected to raise $800m.

In mid-April that perennial market teaser, Lukoil, announced that it was planning a $500m Eurobond before the end of June—the company’s first issue in four years. If Lukoil does actually come to market with a new bond, it is likely that it might shakeout investor torpor. After all, the company, which is majority owned by Russian ING Bank Eurasia (which holds a 63% stake) holds 1.3% of the world’s total oil reserves and accounts for 2.1% of global production of oil. In

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High Rise.

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by FTSE under licence. Neither FTSE nor PriBIL nor their licensors shall be liable (including in negligence) for any loss arising out of use of the FTSE Private Banking Index Series by any person. Distribution of FTSE index values and the use of FTSE indices to create financial products requires a licence with FTSE.

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Regional Review TURNING UP THE HEAT ON RUSSIAN IPOS

Russia, it accounts for 18% of total oil output and 18% of the country’s oil refining volume. Lukoil has also been outperforming other oil majors listed on the MICEX Stock Exchange of late, which have also been experiencing some market volatility.

Reportedly, Deutsche Bank and Credit Suisse will take the lead arranging roles for the issue. However, some market watchers say that Lukoil has been promising to return to the Eurobond market for the last two years, yet has found reasons to delay any bond issues. Lukoil already has a GDR listed on the London Stock Exchange (LSE). If Lukoil does come to market it will be cosmetic. The last time the company approached the Eurobond market was back in 2002, with a relatively small five year bond, worth $55m. It had already issued two bonds previously, worth $350m and

$230m, but these were pre-paid well ahead of maturity.

So what is there to look forward to?

There’s a whiff of change in Russian issuance expected during the rest of this year. For one, there is a notable shift towards companies outside the commodities sector.

Banking (Sberbank and VTB), territorial generating companies (TGK), communications (Sitronics) and the chemical industry will continue to provide investors with alternative investment choices, though most market watchers expect individual issue sizes to become somewhat smaller. Even with some major Russian names having come to market over the last year or so (including the mega debut of Rosneft), it is worth remembering that Russian equity issuance is still in its infancy.

Although London remains the preferred destination for Russian company DRs, with a 45% share of both number of IPOs and issue volume, increasingly larger corporations are looking to support the Russian capital markets. VTB’s intended $4.5bn issue, for instance, will split its IPO between London and Russia, with at least 50% listed on the MICEX Exchange.

Among the companies expected to come to market within the coming six to nine months include Krasnoyarsk Nonferrous Metals Plant (Krastsvetmet), which is Russia's most important precious metals refinery; Pharmstandard, the country's largest drug maker, which is expected to float up to 40% of its shares in both London and Moscow, PAVA Agricultural Company and Nutrinvestholding, a baby foods group.

NEW BARING VOSTOK FUND SEEN AS FILLIP FOR EMERGING MARKETS

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aring Vostok Capital Partners has launched a new private equity investment fund worth $1bn in committed capital, focused on Russia, Ukraine and Kazakhstan. Although a mid-sized fund, the announcement was regarded as an indirect fillip for Russian equities in the wake of the series of market corrections in March that saw some fund managers re-examine their exposure to emerging market risk.

According to Michael Calvey, co-managing partner of Baring Vostok, "Russia and the CIS remain challenging markets in many respects, but the returns on investment are very attractive and compare favourably with most other countries or regions." The fund is a limited partnership registered in Guernsey.

The sponsor is Baring Private Equity Partners, part of the ING Group; the investment adviser is a subsidiary, Baring Vostok Capital Partners.

"The medium-sized businesses on which we focus are growing fast, generating strong profit margins, and are generally not exposed to the political risks that have impacted some of the country's largest companies," adds Calvey. The fund, which will be one of the biggest dedicated equity funds in Eastern

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Europe, is the fourth for Baring Vostok, which has invested in financial services, consumer products, media, telecoms and oil and gas since founding its first fund in Russia in 1994 and which helped develop companies such as Golden Telecom, CTC Media, Borjomi, Yandex, Gallery Group and Bank Caspian.

Private equity fund raising is rapidly picking up pace in Russia. An estimated $2.5bn (€1.9bn) was raised in Russia last year by funds using mainly foreign institutional money, and the government recently announced plans for a $1bn venture capital fund to stimulate investment in technology start-ups.

Russia’s private equity market is dominated by local investors. Last year, Russian investment banks Troika Dialog and Renaissance Capital raised almost $300m and $200m for their respective private equity funds. However, there are signs that foreign buyout firms are beginning to look at the potential of Russia. Guernsey-based Aurora raised £75m (€114m) on the Alternative Investment Market to invest in Russian mid-market companies and which quickly bought a stake in Unistream, a money transfer bank.

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BRAZIL: PRIVATE BANKING

Photograph by Milosluz, supplied by Dreamstime.com, April 2007.

WEALTH CREATION BUOYS BRAZIL’S PRIVATE BANKS It is the best of times and the worst of times for private banks in Brazil. There is a growing and rather big pool of high net worth (HNW) individuals which is more predisposed to keeping its money in the region, rather than sending it overseas. Second, this same group is beginning to reach out to a far greater range of asset management choices available to them, as domestic interest rates fall. Private banks are also building onshore service teams, as scrutiny from local regulators and the tax authorities increases. That spells a big long overdue shake up for the business. John Rumsey reports from São Paulo.

HREE TAKE-OVERS last year changed the face of Brazilian banking. One was local and two were by Swiss banks. All were at least in large part driven by a desire to build a private banking and wealth management presence in the country’s burgeoning wealth management sector.

Banco Itaú’s acquisition of BankBoston’s Brazilian operations from Bank of America in April last year increased Itaú’s clients by 300,000

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at a stroke and upped its assets by R22bn. In return, Bank of America took a near 6% stake in Itaú. The deal catapulted Itaú into first place in Brazil’s domestic private banking market—taking the crown from Bradesco.

Then, UBS took over Banco Pactual, which paid an initial $1bn and— under a formula that factors in the performance of the Brazilian bank and ensures that key staff are locked in— will buy the bank for $2.6bn with a

$500m retention pool. Pre-takeover, Pactual’s asset management business had $18.6bn under management with a range of funds including equity, fixed income, private equity and hedge. Its wealth management business ran to a further $4.6bn.

The latest major deal was Credit Suisse’s purchase of 50% and one share of Hedging-Griffo. The $294m cash acquisition was signed in December at 9.5 times HedgingGriffo’s annual earnings. It had been a widely rumoured deal for some time and, reportedly, was complicated by the need to retain Luis Stuhlberger, the firm’s founder, to ensure the deal’s success and whose name is intimately bound up with the group. Hedging Griffo, originally a private bank, is now a heavyweight asset manager with some $8.3bn under management and a particularly strong focus on hedge funds—one of the key growth areas of

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the Brazilian asset management market. The bank manages some $7.6bn worth of private assets. Over the last three years the firm claims that assets under management have increased by an average annual growth rate of 38.5%. The acquisition adds significant scale to Credit Suisse’s onshore asset management and private banking businesses. The bank also opened offices recently in Sydney and Moscow.

Under the terms of the transaction, the parties have entered into an option arrangement whereby Credit Suisse may acquire, and the current shareholders may sell, the remaining stake in Hedging-Griffo after five years. The transaction is still subject to final approval by the Central Bank of Brazil and is expected to close by the middle of 2007. Once the transaction is finalised, Hedging-Griffo will operate as Credit Suisse Hedging-Griffo and it is reported that all the partners of Hedging-Griffo have now signed longterm contracts with the Swiss bank.

Credit Suisse built an investment banking franchise in Brazil when it acquired Banco Garantia back in 1998.

The acquisitions then, are part of a bigger trend to build up muscle in private banking both globally and in Brazil in particular. In February, Morgan Stanley announced it was hiring a fivestrong team to serve Latin institutions and Brazilian high net worth clients.

The new team, headed by Jon Mallon, will be based in the firm’s new private wealth office in Miami.

Citigroup meanwhile expanded its private banking team in Brazil by 30 last year, an increase of nearly 30%, says Robin Liddle, managing director at Citigroup. Hiring was concentrated in equity brokerage, fund of funds, and real estate. The team only serves clients that have more than $5m in investable assets. The bank decided that with the complex financial advice

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required, particularly in areas such as asset management, where an allocation may include private equity, real estate and hedge funds, it needed to focus on service.“We did not want to run the risk of diluting our service by taking on smaller clients,” he says.

That meant a team of staff that have or are working to get MBAs. He estimates there are at least 40,000 Brazilian families that would fit the bank’s $5m plus criteria.

The frenzied pace in building up a local presence points to an upheaval that is partly local and partly global.

Rapid worldwide growth in high net worth individuals and buoyant capital markets are piling up the profits for global private banks. They are looking for the growth markets of the future to keep profits heading north.

The frenzied pace in building up a local presence points to an upheaval that is partly local and partly global.

Rapid worldwide growth in high net worth individuals and buoyant capital markets are piling up the profits for global private banks. They are looking for the growth markets of the future to keep profits heading north. Emerging markets are the current vogue with their huge potential for rapid growth and clients that are branching out and demanding more services.

As a middle-income country that enjoyed an industrialisation-led boom in the 1960s, Brazil has had time to develop a sizeable and well-

established high net worth (HNW) market. The unevenly skewed wealth distribution among its 185m people means there are some truly rich people. The two richest men in Latin America are both Brazilian and both bankers, according to Forbes magazine in 2006. Joseph Moises Safra of Safra Bank, who incidentally comes 69th worldwide, is first with $7.4bn and Aloysio de Andrade Faria, in charge of Banco Alfa second.

There are estimated to be 100,000 high net worth individuals in Brazil out of a total of 300,000 throughout Latin America, according to Merrill Lynch’s World Wealth Report. The Brazilian figure is increasing rapidly, at 11.3% per year. Not only that, but in Brazil high net worth individuals are generally wealthier in comparison to other countries. Many of them have assets of more than $30m and the World Wealth Report estimates that these ultra-high net worth individuals make up 2.4% of the total. The number of billionaire families in the country doubled last year alone from some seven to 15, says Liddle.

The next layer down is huge and growing too. There are 15m Brazilians with savings accounts and 2.5m of them invest in funds, providing a large base of customers for domestic banks.

Mutual fund products are ever more widely distributed by banks that have a private banking arm to clients with less resources.

Changing dynamics Despite its propitious wealth profile, Brazil’s onshore market has been sleepy because onshore most Brazilians simply put money into money market instruments. That stymied growth in other asset classes and generated a dull and complacent asset management industry. However, the industry is getting a welcome shake up as rates come down. The

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HEAD TO HEAD WITH THE CBLC In a rapid fire Q&A John Rumsey talks to Amarílis Prado Sardenberg, chief operating officer, and Monique Moura de Almeida, head of the development division, at the Brazilian Clearing and Depository Corporation (CBLC). The CBLC is a forprofit corporation, independent of the Bovespa, and run by its own board, although Bovespa still retains a 20% strategic stake.

How does CBLC handle clearing and settlement of trades?

We are totally dematerialised and we have retained the book entry format. That has enabled us to gain efficiency in execution, and transparency with realtime price dissemination. Trades are posted for investors to see through our own network and that of the major news agencies. We have two settlement systems. We use a netting system for the daily trading of equities with settlement taking place on a T+3 basis and provide cross-settlement for fixed-income bonds and initial public offerings. We have around 200 custodians in the market, although within international markets we have far fewer (around 10 to 15), which is comparable to the US. These custodians link in to our system. Brazilian law obliges them to identify their final customers. Our accounting system records the name of the owner, which is a significant factor in ensuring that we have strong know-yourcustomer (KYC) standards. It also enables us to issue a monthly statement directly to the beneficial owner.

The process of supplying a monthly statement started in 1989. About five years ago, we introduced a compulsory registration system that gives investors direct access to statements over the Internet.

We are linked directly and automatically to the exchange. There is no matching process as all trades come ready matched. The intervention of participants in the electronic trading system is minimised and we have been developing this for 10 years.

What are the most unique features of your systems?

One interesting feature of the market is the different roles borne by us in our key role as the CCP. These include credit risk and delivery versus payment. To deal with this, we have a very sophisticated, safe and well-tested infrastructure. We set trading limits for all parties and control it on a real-time basis. That is

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supported by collateralization, marked-to-market on a daily basis. We also manage a clearing fund composed by clearing members’ contributions that are in line with the share of risk. And in our settlement system it doesn’t matter if trades are being settled through netting or cross, we have delivery versus payment, that is simultaneous final and irrevocable. We also carry out very strong risk analysis, looking for example at risk concentration.

What are the main features of transparency and dissemination policies?

There is a list of information that it is mandatory to deliver to the market which is controlled by Brazilian law.

As far as issuer dissemination is concerned, we have a very strong regulatory framework in Brazil. It is compulsory for companies to deliver detailed information to the securities commission and exchange.

The Comissão does Valores Mobiliários, and Bovespa have specialised people that track the information that companies release. If the information is not clear, they can go back to the company and ask for more information. They developed a system to input that information and share it. The CBLC has an agreement with Bovespa to pick up information and this allows us to keep users up to date with company actions, such as dividends and subscriptions. This system can be accessed by anyone through the Bovespa site. The information is put straight on the site to make it fair to all investors and delivered to news vendors at the same time. It’s a very efficient and consolidated system.

What is your investor profile?

Nowadays we are very happy with the distribution of investors. It’s well balanced between foreign, institutional and retail funds. We would like to increase the participation of pension funds, of course, but they are growing fast. The programme “Bovespa vai até você” (Bovespa goes where you are) has worked to spread the profile of investors and to attract in individual investors. It promotes the exchange and has been making access easier. Longterm programmes such as that have attracted retail investors and are reaping rewards. Retail participation has been vital in improving politicians’ perception of Bovespa. Congress increasingly recognises that the stock market is a good for the economy and is not a speculative tool used only by foreigners. They see that capital markets are important for the overall economy.

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benchmark Selic peaked at 26.5% in 2003 and is down to 13%.

For now, Brazil still has the world’s highest real rates but real rates are set to be in single digits and possibly as low as 6% or 7% by year-end. The realisation that the money market investment tactic that has served them so well is drawing to a close has coincided with a period of a rapid increase in prices in other markets.

Equities enjoyed their fourth year of superb performance, with the key Ibovespa index climbing 32.9% in 2006. Equity managers have been able to ride this wave. What Brazilians call hedge funds (which can be better defined as multi-asset funds) returned an average 19.01% in 2006 and 19.54% in 2005%. That number was dragged down by the large number of ‘hedge funds’ that invest almost all but a tiny percent of assets in money markets.

The combination has breathed some life into the lacklustre asset management industry as a whole.

Still, even though equity markets (excepting the few volatile weeks at the beginning of March) have been on fire, HNW clients are not necessarily making plain vanilla choices. Citigroup sees clients opting increasingly for real estate and private equity funds. Liddle explains that despite the lack of liquidity in the latter, Brazilian ultra high net worth investors are willing to invest as part of a balanced portfolio. Indeed, he sees his clients actually moving away from multi-asset funds, which invest in more traditional equity and debt markets. Still, Citigroup is targeting a very rarefied group of clients: multiasset funds are growing fast and spawning a whole host of new boutiques and investment strategies.

Additionally, there is now a seachange in family succession and planning. Family-owned companies increasingly consider other succession

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an IPO to set up other enterprises, such as a family office or real estate, notes Lacerda. The proceeds of IPOs are also creating immediate fortunes for families and individuals that need to be managed.

The flipside

Citigroup sees clients opting increasingly for real estate and private equity funds. Liddle explains that despite the lack of liquidity in the latter, Brazilian ultra high net worth investors are willing to invest as part of a balanced portfolio. Indeed, he sees his clients actually moving away from multi-asset funds, which invest in more traditional equity and debt markets. Photograph of Sao Paulo, by Alexandre Fagundes, April 2007.

models than just passing the company on to the next generation and they are also becoming accustomed to selling parts of the company on the equity markets. Ricardo Lacerda, a mergers and acquisitions specialist at Citigroup, sees this change in mindset when he deals with family members considering tapping the markets.

Previously, families feared a loss in prestige from selling the family’s crown jewels. Pioneer families are starting to change the way Brazilian company owners think. For example, the decision by the Rabinovitch family to sell their stake in CSN; moves by the Zogbi family to sell their stakes in Ripasa and Banco Zogbi; and the Beldi family’s choice to sell their stake in Tele Centro Oeste.

Families can use the proceeds from

The flipside for private banks is that they and their clients are being scrutinised much more closely. Money laundering, terrorist financing and the rise in corporate governance has seen regulators tighten the screws worldwide and the tax man and police gain new powers to compel private banks to divulge details on their clients.

Difficulties with drug smuggling from neighbouring Bolivia and piracy and possible terrorist cells in Paraguay have seen Brazilian police step up investigations of complex crimes.

Brazil has been vigilant on antimoney laundering as a whole. The Brasilia-based COAF (Conselho de Controle de Atividades Financeiras), a central body set up to collect and report data, is embedded in the Ministry of Finance and requires that banks report all unusual transactions.

Regulators have been carrying out extensive checks. They started with the largest and are now looking at mid-sized and small banks.

Increasingly, private banks recognise that they need local offices not only so they can be near clients but because of legal regulations. That could explain why Swiss banks, in particular, have been so keen to secure onshore assets. They depended for too long on the country’s secrecy laws to run the highly lucrative business of offshoring, moving the assets of rich individuals into Switzerland and into anonymous accounts. The end of that business model is in sight as Switzerland and other former tax havens increasingly adjust to international norms.

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DUSTBOWL OR PAY DIRT?

TXU:

CORPORATE PROFILE: KKR’S BID FOR TXU

Will it be the world’s biggest leveraged buyout (LBO) or nothing but a washout? The long drawn out proposed $45bn takeover of TXU, the largest electrical utility in Texas, is beginning to look like a soap opera on afternoon television. Kohlberg Kravis Roberts (KKR) and Texas Pacific Group are jointly seeking TXU, although the Blackstone Group may yet challenge them for the honour.

Meanwhile, the credit-rating agencies are in a snit. And if some miffed Texas lawmakers have their way, the entire story may change from drama to farce. Art Detman explains why.

Frederick M. Goltz, right, with Kohlberg Kravis Roberts & Co., waits his turn to testify as he sits with Michael MacDougall, left, before a hearing held by the House Committee on Regulated Industries, Tuesday, February 27th 2007, in Austin, Texas.

MacDougall is an investor with Texas Pacific Group of New York. Mr. Goltz aims to purchase TXU. Photograph taken by Harry Cabluck for Associated Press. Photograph supplied by paphotos, April 2007.

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HANCES ARE THAT neither Henry R. Kravis, a founding partner of Kohlberg Kravis Roberts (KKR), nor David Bonderman, co-founder of Texas Pacific Group, expected to be reduced to appearing before the Texas state legislature to make their case for buying the TXU Corporation. Yet there they were in Austin, testifying just like ordinary human beings. Ignore the skeptics, they urged. By taking TXU—originally Texas Utilities Company —private, the moneymen would work wonders. Plans for eight of 11 planned coal-fired power plants would be scrapped, yet TXU would continue to meet the power needs of its growing and energy-hungry market. Stockholders would receive a 25% premium on their shares, electrical rates would be cut 10% for more than half of its residential customers, and $400m would be invested in wind power and other environmentally friendly technologies. Even with that impressive round of payouts potential buyers expected that TXU would continue to pay its bills, including interest on a whopping $37bn in debt—involving some $24bn in new debt and the assumption of $13bn in existing debt. They also pleaded not to have the Public Utilities Commission power review the deal but instead depend on the buyers to protect the public interest.

Not lost on the legislators was the fact that Texas Pacific Group is based in Fort Worth and that James A Baker III— yes, that James Baker—will serve as advisory chairman of the new company. Moreover, William Reilly, former head of the federal Environmental Protection Agency and chairman emeritus of the World Wildlife Fund; Donald L Evans, former US Secretary of Commerce; and Lyndon L Olson Jr., a former Texas state representative and US ambassador to Sweden, will also be directors.

Some lawmakers seemed satisfied with the testimony, which veered from earnest entreaties to wounded innocence to veiled threats. Others, Republicans and Democrats alike, were more sceptical. None however suggested killing several bills under consideration in the state Senate that, if enacted, could torpedo the deal. As Kravis and Bonderman knew, it would not be the first time that a proposed big utility transaction went down in flames. Just last year a $12.5bn merger between two Maryland energy companies collapsed because state regulators feared rising prices. In New Jersey, a $17bn acquisition of one power company by another met a similar fate.

If the TXU deal goes through, it will have a total value of $45bn, of which only $7bn would be in hard cash. KKR and TPG each will contribute $2bn in cash, and some of Wall Streets biggest investment banks—Goldman Sachs and Lehman Brothers among them—will likely pony up a total of $3bn. The debt to equity ratio could be as much as 6.4 to 1. Even so, neither Kravis nor Bonderman seemed in the least perturbed by this dramatic level of leverage. Not so the credit rating agencies. Standard & Poor’s, for one, promptly downgraded most of TXU’s debt to junk status and put all of the company’s debt on CreditWatch with

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negative implications. Standard & Poor’s credit analyst Terry Pratt is blunt: “If the acquisition is successful and the capitalisation plan defined by management is established, we expect to further downgrade TXU.” He additionally chided the company’s managers for even considering the buyout.“They have clearly sent a message that they have little allegiance to the current bondholders.”

Why is there such turmoil over a business so mundane as an electrical utility? After all, nothing is more fungible than electricity. Quite true, but also irrelevant since deregulation of the power markets, which changed power companies from plodding but safe utilities to, well, to companies that can be more like other companies—which is to say neither plodding nor safe.

As Samuel Brothwell, senior analyst at Wachovia Capital Markets, notes,“TXU is not a utility. Risks include failure of the buyout proposal, gas price volatility, political opposition to coal, sensitivity to high retail power prices, an margin erosion from retail customer churn, punitive legislation, or both.”

Deregulation in Texas began in 1999, when the state legislature enacted a law to phase out regulation and phase in competition. The power of the marketplace, lawmakers believed, would empower all users to force electrical providers to vigorously compete against one another. Of course, it did not work out that way. “As always, deregulation benefits only the largest users,” says Barbara Shook, Houston bureau chief for Energy Intelligence Group.“The problem for residential and small business customers in Texas is that the market is controlled by giant industrial users. As a result, the industrial market is highly competitive, so if power companies are going to make a profit, it is going to have to be off of residential and small commercial users.“Depending on your supplier,”she continues,“you are going to pay between 12 and 16 cents per kilowatt hour. That is a lot more than it was prior to deregulation.”Indeed, it is well above the US average of 9 cents per kilowatt hour (kWh).

What happened? In Texas, over time power generation was deregulated, along with power transmission. Only power delivery to individual users—the electric lines that reach houses and commercial buildings—remains regulated. The theory is that each ratepayer can direct the power delivery company to use whichever power generator is cheapest.“Say you live in the Dallas area,”says Terry Hadley, a spokesman for the Public Utilities Commission of Texas. “You have a choice of some 50 different offers by retail electric providers.” True enough, but Hadley concedes that nonetheless the goal of lower prices has not been met.“Prices went down at first. Since then they have increased substantially.”

One villain is the price of natural gas, which is the most common fuel used to generate electricity in Texas but one that TXU hardly uses. (TXU is primarily coalpowered but also has one nuclear power plant and is the state’s largest buyer of electricity produced by winddriven turbines.) Natural gas demand and prices in

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America shot up in the past few years, driving up the price of electricity produced by natural gas. As noted by Peter Hartley, a professor of economics at Rice University, the wholesale price of electricity is set by the highest-cost producer. “Given the current price of coal, if the price of electricity is set by those firms using natural gas, the firms that have a lot of coal-fired capacity will earn extra money.”

And certainly that is exactly what TXU has done. In 2006, it posted record results: $2.52bn in net income for common shareholders, an increase of 49%. Because of a vigorous share buyback programme, per-share results were even better, up 118%. What’s more, the stellar results were achieved despite a mild winter, which reduced the use of electric space heaters.

Credit where credit is due: the results are also a testimony to the efforts of C John Wilder, TXU’s chairman and chief executive. When he joined the company in 2004, TXU was struggling under the burden of misguided expansion.

Deregulation had enabled it to make big mistakes, and Wilder quickly and wisely set a new course. He sold off the natural gas business and an energy subsidiary in the UK and improved productivity in TXU’s core business. The stock zoomed from under $12 in 2004 to more than $60.

Wilder is expected to stay on after the Jim Burke, CEO with TXU Energy, answers a question during a hearing held by the House buyout. Even if he leaves, he will not Committee on Regulated Industries, Tuesday, February 27th 2007, in Austin, Texas. Burke, lose. Reportedly, he will receive between 38, is chairman and CEO of TXU Energy, TXU’s retail business. Burke was recruited in $100m and $200m should he depart— 2004 as senior vice president of TXU Energy’s consumer markets, where he led the and likely the same amount if he stays. consumer segment through fundamental change in the marketing and operations areas for The proxy statement, say the analysts, is both incumbent and growth markets. Prior to joining TXU, Burke was president and chief ambiguous in this regard, which operating officer of Gexa Energy. Gexa Energy was a rapidly growing startup electric suggests that the lawyers who wrote it provider based in Houston that was acquired by FPL in 2004. Gexa Energy served both did their job well. residential and commercial accounts. Prior to Gexa Energy, Burke was senior vice president Whatever the amount, Wilder is of consumer operations with Reliant Energy, responsible for all customer care, billing and being rewarded for his operational transaction management. Photograph taken by Harry Cabluck for Associated Press. expertise, not his strategic savvy. When Supplied by paphotos, April 2007. he announced that TXU planned to build 11 generating plants powered by By then, Kravis and Bonderman were in the hunt. coal, he was beset with objections from environmentalists and politicians alike. Wilder refused to Goldman Sachs, their principal investment banker, meet with the head of Environmental Defense, which counseled a green approach: reach an agreement with went to court to block the new plants and set up a Web some major environmental organisations, then announce site—stoptxu.org—that rallied environmentalists across your takeover plan. Bill Reilly—renown for his work in the country. During this time, Wilder never even met implementing the Clean Air Act—headed the buyout with the mayor of Dallas, who organised protests outside team of negotiators, who met with the very lawyer suing TXU on behalf of Environmental Defense. After ten days TXU’s headquarters.

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KKR’S KEY DEALS TO DATE IN Q1 2007 Private equity firms provide equity dollars and borrow money to buy companies that are either struggling, or which are not optimising their market potential, fix them up, and sell them off, generating huge returns for stakeholders. Buyout giant Kohlberg Kravis Roberts & Co’s (KKR’s) acquisition strategies can take many forms and the firm has taken publicly listed companies private, acquired divisional assets through corporate divestiture transactions, partnered with family-owned businesses and strategic buyers, and purchased and grown companies through industry-consolidation strategies. Through its listed specialist investment fund, KKR has also provided convertible debt financing through private placements, illustrating the increasingly diversified investment armoury of the firm.

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KR, LIKE OTHER buyout specialists, looks for businesses with predictable cash flows, that are in growing business sectors and have capable management. KKR then places its own staff on the management board and assists in improving sales, marketing and corporate growth strategies. When investments are sold, profits are distributed to investors, which include corporate and public pension plans, financial institutions, insurance companies, and university endowments.

It has certainly been a busy first quarter for KKR and since the beginning of 2007, the firm has been involved in buyout deals either directly or indirectly, via an affiliate or in consortium, worth an aggregated value of over $84bn. The range of deals covered here show the diversity of sectors that KKR invests in and varied approaches to investments adopted by the buyout firm so far this year. As the year opened, KKR joined a consortium including Citigroup Private Equity; SAC Capital Management, LLC; SPG Partners; Bregal Investments; Caisse de dépôt et placement du Québec; Sterling Capital; Makena Capital; Torreal SA; and Southern Cross Capital in a $3.8bn acquisition of Baltimore, Maryland-based, Laureate Education, Inc., an international higher education firm. The deal is expected to close by the end of June, subject to the usual closing conditions for transactions of this type.

Citigroup and Goldman Sachs provided the debt financing, while Morgan Stanley and Merrill Lynch & Co. advised Laureate’s Board.

In late January KKR Private Equity Investors LP, KKR’s publicly traded fund, which is listed on Euronext Amsterdam, invested in Sun Microsystems through a $700m private placement of senior convertible notes. The investment will be in the form of $350m of convertible senior notes due in 2012, and $350m of convertible senior notes due in 2014.

A nominee of KKR was appointed to the Sun Microsystems Board of Directors shortly after the transaction closed.

Also in January, a consortium of funds advised by KKR and the mid-market and large company

European buyout specialist CVC Capital Partners (CVC), bought the outstanding share capital of the Van Gansewinkel Groep, a specialist waste disposal firm, with an annual turnover of €600m. The consortium will combine Van Gansewinkel with AVR (which turns over roughly €500m a year) which was bought by the same from the Municipality of Rotterdam a year earlier. The merged firm, will become a fully integrated waste management company covering the entire waste chain from consultancy through collection, to recycling and endtreatment. Van Gansewinkel has diversified its operations outside of Benelux, its home market, to become active in other markets such as the Czech Republic, Poland, France, Portugal and the UK. By early March KKR announced that its affiliates were buying Dollar General Corporation, the Fortune 500 discount retailer, in a deal worth $7.3bn, including approximately $380m of net debt. Dollar General shareholders will receive $22 in cash for each share of Dollar General common stock they hold, representing a premium of approximately 31% over Dollar General’s closing share price of $16.78 on March 9th 2007 and a premium of approximately 29% over the average closing share price during the previous 30 trading days. The transaction is expected to close in the third quarter of 2007 though it is subject to shareholder and regulatory approvals. Debt financing for the transaction has been committed by Goldman Sachs and Lehman Brothers, subject to customary terms and conditions.

Lazard and Lehman Brothers are financial advisors to Dollar General and Wachtell, Lipton, Rosen & Katz is its legal counsel. Goldman Sachs is acting as financial advisor to KKR. Only a month later the buyout firm reported that its affiliate intended to buy First Data Corporation, the electronic commerce and payments firm, with a total transaction value around $29bn, making it one of the world’s top six buyout deals of the last six months, including the $44bn TXU transaction. Many US stock market analysts had predicted a takeover of the

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A fountain sprays water over a pond at the Millennium Campus of the First Data Corporation headquarters in Greenwood Village, Colorado., south of Denver. First Data Corp. reported in early April that it is being acquired by an affiliate of private equity firm Kohlberg Kravis Roberts & Co. for about $25.6bn in cash. Picture by: Ed Andrieski and supplied by Associated Press/PA Photos, April 2007.

2005 and $7.1bn after Greenwood Village, In late January KKR Private Equity the spin-off. The firm Colorado-based company Investors LP, the KKR’s publicly processes checks, debit since it separated from cards and credit card the faster-growing traded fund which is listed on transactions. According to Western Union paymentEuronext Amsterdam, invested in Sun a report in The Wall Street transfer business last Microsystems through a $700m Journal and the company’s year. Since the spin off private placement of senior STAR Network offers PINfrom Western Union, convertible notes. The investment will secured debit acceptance various news reports at 2m ATM and retail have stated that the firm be in the form of $350m of locations. First Data was has struggled to find a convertible senior notes due in 2012, split off from American chief executive officer to and $350m of convertible senior Express Co. in 1992 as an succeed Henry C (Ric) notes due in 2014. A nominee of information-processing Duques who is currently KKR was appointed to the Sun company that would both chairman and chief Microsystems Board of Directors handle billions of creditexecutive officer of First card and other Data, who returned to shortly after the transaction closed. transactions for third run the company back in parties, The Wall Street 2005. He first served as Journal reported, adding that the company has First Data chairman from April 1989 to January 2003 struggled in recent years to organise its international, and as chief executive officer from April 1989 to commercial and retail-processing units. An investment January 2002. in the company’s initial public offering, adjusted for the First Data shareholders will receive $34 in cash for recent spin-off of Western Union, would have each share of First Data common stock they hold, generated 18% compounded annual returns for First representing a premium of approximately 26% over Data’s shareholders versus 9% for the S&P 500.

First Data’s closing share price of $26.90 on March Citigroup, Credit Suisse, Deutsche Bank, HSBC, 30th 2007 and a premium of approximately 34% over Lehman Brothers, Goldman Sachs and Merrill Lynch the average closing share price during the previous 30 have committed to provide debt financing for the trading days. Since its initial public offering in 1992, transaction subject to customary terms and conditions, First Data has grown from $1.2bn in annual revenue and are acting as financial advisors to KKR. to $10.6bn prior to the spin-off of Western Union in

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For the first time in history, a major business transaction was predicated on approval from environmentalists. A huge business transaction tacitly validated the concept of global warming and the need to balance environmental concerns with the demands of commerce.“The culture is going green,” Reilly told the press. Indeed, just a couple of months earlier the CEOs of ten major US companies called for mandatory caps on carbon emissions. Photograph of old and new wind power machines, kindly supplied by TXU, April 2007.

of talks in San Francisco, capped by a marathon 17-hour session, an understanding was reached. If the TXU buyout went through, only three of the 11 planned coal-fired plants would be built (plans for these three, Reilly argued, were too far along to abandon). More wind power would be bought.

And other environmentally friendly technologies and goals (such as a cap on carbon emissions) would be adopted. Both Environmental Defense and the Natural Resources Defense Council would endorse the proposed buyout.

The announcement was electric, so to speak. For the first time in history, a major business transaction was predicated on approval from environmentalists. A huge business transaction tacitly validated the concept of global warming and the need to balance environmental concerns with the demands of commerce. “The culture is going green,” Reilly told the press. Indeed, just a couple of months earlier the CEOs of ten major US companies called for mandatory caps on carbon emissions.

Alas, the warm and fuzzy feeling lasted only a day or two. Other environmental organisations complained that Environmental Defense and the Natural Resources Defense Council—both of which are considered far more business-friendly than, say, Greenpeace—settled for too little. Of the 11 proposed coal plants, TXU’s board had already decided to scuttle six. The three that ED and NRDC signed on to were probably the dirtiest of the bunch.

Then, too, some of the language in the agreement came under attack. After the buyout, TXU would not build any coal plants beyond the three on the drawing board... unless there was no other way of meeting the energy needs of its customers. In other words, we will not build them unless we need to.

Aside from the environmental concerns, it appeared that the buyout people had made irreconcilable promises. No, TXU would not build additional coal-fired plants beyond the three planned. Yes, TXU would have enough power even as the population of Texas in general and the DallasFort Worth area continues to grow. Of course, if TXU reneges on its promise not to build more coal-fired plants, it earns additional revenue; if it honors that pledge, which would restrict the supply of electricity and thus drive up the price, it earns additional revenue.

Even the pledge not to place acquisition-related debt on TXU’s lone PUC-regulated operation, TXU Electric Delivery, is in doubt. Clever accountants can find ways to redefine debt, and if it is defined as being not being related to the acquisition but to Electric Delivery, it will qualify for a boost in rates.

If the proposed buyout does go through at the $45bn price, it will eclipse the former record-setting LBO of $39bn, which was what Blackstone Group paid to acquire Equity Office Partners Trust, America’s largest owner of office buildings. But what if Blackstone’s CEO, Stephen A Schwarzman, decides to bid for TXU? It would be the first time a major private equity firm has bid against another private equity firm. For a while, analysts were speculating that Schwarzman might indeed offer more than $70 per share, compared with the $69.25 offered by his arch rival Kravis.Yet at the same time they were saying that, because so many investment banks were either funding the KKR/TPG deal or acting as advisors to it, Blackstone would not be able to raise sufficient funding.

Not to worry. Just weeks after denouncing public markets as “overrated” and “not really worth it,” Schwarzman trotted out a proposed initial public offering

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TXU FACTS AND FIGURES

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XU IS ONE of the leading energy companies and energy retailers in North America. The firm’s business is divided into four main segments: TXU Energy, TXU Power, TXU Wholesale and TXU Electric Delivery.

TXU Energy is reportedly the largest competitive energy retailer in the US, with 2.4m customers and 70 terawatt hours in retail sales plus 48 terawatt hours in wholesale sales in 2004.

TXU Power has over 18,300 MW of generation in Texas, including 2,300 MW of nuclear and 5,800 MW of coal-fired generation capacity. TXU Wholesale optimises the purchases and sales of energy for TXU Energy and TXU Power and provides related services to other market participants. TXU Wholesale and its affiliate, TXU Renew, are the largest purchasers of

wind-generated electricity in Texas and fifth largest in the United States. In addition, TXU Power Development Company and its affiliates are involved in a power generation development programme in Texas and are evaluating opportunities for additional development outside of Texas.

TXU Corp.’s regulated segment, TXU Electric Delivery, is an electric distribution and transmission business that complements the competitive operations, using superior asset management skills to provide reliable electricity delivery to consumers.

TXU Electric Delivery operates the largest distribution and transmission system in Texas, providing power to three million electric delivery points over more than 100,000 miles of distribution and 14,000 miles of transmission lines.

of stock that would pour $4bn into Blackstone’s coffers. In PUC released a report, prepared by an independent return, investors would receive just a piece of the consulting firm, that said TXU reportedly abused its market management firm, not any of the individual investments power in the summer of 2005. According to the report, TXU that have made Schwarzman and his partners fabulously allegedly failed to muster sufficient wholesale competition wealthy. But at least investors would have the opportunity during a four-month period, and as a result its pass-along to fund additional investments that would add to that prices to customers increased by $70m, resulting in a windfall profit for TXU of $19.6m. The PUC’s proposed fabulous wealth.

Does the market think Schwarzman will try to outbid remedy was that TXU should refund $70m to wholesale Kravis and Bonderman? Evidently not. In fact, the market power buyers and pay a $140m penalty. TXU responded hardly believes that Kravis and Bonderman will succeed in strongly, condemning the report as “flatly wrong” and buying TXU. Although the stock price jumped 13% on the promised to fight. Meanwhile, in a separate case, the PUC’s staff told commissioners day the TXU deal was that TXU may have earned announced, it has never as much as $80m more reached the $69.25 target than permitted by price. One good reason may In 2006, TXU posted record results: regulations in 2006. be Troy Fraser, a stalwart All this has only Republican who is chairman $2.52bn in net income for common intensified opposition to of the Texas Senate’s shareholders, an increase of 49%. the buyout. In the Texas committee on business and Because of a vigorous share buy-back House, Representative commerce. He sponsored programme, per-share results were Phil King, also a three bills that would even better, up 118%. What’s more, Republican and a adversely impact the the stellar results were achieved committee chairman, proposed buyout of TXU; all wants TXU to sell some were passed in the Senate by despite a mild winter, which reduced generating plants so it 30 to 0 margins and were the use of electric space heaters. won’t dominate its sent to the House of market. And Joe Barton, a Representatives.

Fraser Republican member of the claims, not entirely US House of convincingly, that he is not opposed to the buyout. “This is legislation that I had laid Representatives and a long-time TXU ally, has repeatedly out months ago before the KKR buyout proposal was even criticised TXU’s rates. In Texas, Barton pays 16.56 cents per on the table,” he says. “We believe that TXU has clearly KWh; at his condominium in Arlington, Virginia, a suburb been over-earning on retail, over-earning on wholesale, of Washington, he pays 5.96 cents.

If Fraser’s legislation passes, it will force TXU to divest and over-earning on their lines charges. What we are trying to do it bring down the cost of each one of those itself of some major operations and subject the buyout to functions so we can lower electric rates, which we think PUC approval. In other words, it will almost certainly kill the deal. So the TXU story might go from high drama to low are too high in Texas.”

The position of pro-regulation forces was strengthened farce. On the other hand, if the buyout is successful, many when a week prior to the Kravis/Bonderman testimony the small ratepayers might yet view the entire thing as tragedy.

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BANK PROFILE: BARCLAYS CAPITAL

According to figures released in late February the rate of profit growth at Barclays Capital more than doubled last year as surging trading powered pre-tax profits at the investment bank up to a record £2.2bn (€3.3bn) and left the unit on track to meet chief executive Bob Diamond’s profit target three years early. Profit performance is not Barclays Capital’s only fruit. The investment bank has muscled its way into US investment banking based on a commitment to financing and risk management rather than a full service business model. The British bank is riding high where so many others have stumbled. American banking history is littered with failed efforts by foreign banks to break into a business long dominated by American bulge bracket firms such as Morgan Stanley and Goldman Sachs. In less than seven years, armed with a focused strategy, an unusually cohesive corporate culture (and a little luck) Barclays Capital has emerged at the forefront in a range of products from debt underwriting to commodities and derivatives. Neil O’Hara explains why concerted teamwork has driven the bank.

BarCap’s team-play tries for a

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Photograph by Cameron Collingwood, supplied by Dreamstime.com, April 2007.

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hen Barclays sold its cash equities and merger advisory activities to Credit Suisse First Boston in 1997, the market derided the remaining fixed income business as a rump investment bank. Nobody— except perhaps Bob Diamond, the then newly appointed chief executive of Barclays Capital—foresaw that the ugly duckling would morph into a swan able to challenge the market leaders.

The transformation began on Barclays’ home turf in the United Kingdom and Europe. As recently as 2000, Barclays Capital had “no business in the US that was world class” according to Grant Kvalheim, co-president of Barclays Capital responsible for investment banking and credit products worldwide and regional head of Barclays Capital in the Americas. Kvalheim joined Barclays in May 2001 after six years with Deutsche Bank, where he was head of global debt origination. He held the same position during an earlier nineyear stint at Merrill Lynch; prior to that, he spent seven years at JP Morgan, where he cut his teeth in the capital markets.

Starting from such a low base, Barclays recognised that it could not do everything at once and expect to do it well.

Instead, Diamond and Kvalheim targeted client segments and specific products, hired the best people they could find to build a revenue base and only extended coverage to other client and product areas when the existing businesses reached critical mass. Kvalheim admits luck played a part.

Barclays went on a hiring spree at a time when its competitors were trying to staunch losses in their cash equity operations. “We were able to get a relatively large number of what I consider incredible talents,”he says,“If we were trying to do the same thing today it would be a lot more difficult.” Congress lent a hand as well. When legislators repealed the Glass-Steagall Act, which had prevented US commercial banks from underwriting securities since the 1930s, it upset the old order in debt underwriting as emerging universal banks such as

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Marsh knew FirstEnergy JPMorgan Chase, Citigroup had to get the deal done and Bank of America right but the effort Barclays elbowed aside the bulge was willing to make bracket investment banks. persuaded him to take a “Banks win in financing chance. “This was a very and risk management vis à important deal for us and vis the investment banks,” the execution on it went very says Kvalheim, although he well,”he says,“At the end of insists that, while a big the day we were vindicated.” balance sheet is a preThe FirstEnergy deal condition, capital alone epitomises Barclays’ does not guarantee strategy: focus on a success. “We realised early promising industry on it was also about having (utilities rely on the debt the best possible people markets more than most), you could find and hire the right people and marrying that with a leverage existing superior business model, relationships. To Marsh, that is, being a bank.”

Barclays’ willingness to Kvalheim scored an early devote resources for the win in 2001 when Barclays Grant Kvalheim, co-president of Barclays Capital responsible for long term distinguishes it landed a slot as joint book investment banking and credit products worldwide and regional head from banks that are here runner on a $4bn debt of Barclays Capital in the Americas. Kvalheim joined Barclays in May today, gone tomorrow offering by FirstEnergy, an 2001 after six years with Deutsche Bank, where he was head of global based on market electric utility with debt origination. He held the same position during an earlier nineconditions or their latest operations from the Midyear stint at Merrill Lynch; prior to that he spent seven years at JP strategic thinking.“It is a bit West to the East Coast. At Morgan, where he cut his teeth in the capital markets. Photograph like being Avis,” he says, the time, it was the largest kindly supplied by Barclays Capital, April 2007.

“Sometimes when you are utility financing ever in the United States, and Barclays was nowhere in the US debt not number one you work a little harder.”

Barclays has handled numerous transactions for underwriting league tables. [see Table 1] It did not happen in a vacuum, however. Michael FirstEnergy in subsequent years and is among the Brennan, who runs Barclays’ utility business on the company’s top five credit providers. On occasion, commercial banking side, had a longstanding relationship FirstEnergy has pushed Barclays to reach a little and they with FirstEnergy. So did Jim Glascott, managing director have always come through, which has helped cement the and head of US debt capital markets origination, who had relationship. “When your partners do that for you, you just joined Barclays Capital from Deutsche Bank. Glascott remember it down the road,”says Marsh.

The FirstEnergy bond deal was a crucial transaction for had worked on financings for FirstEnergy and its predecessors during an earlier 14-year career at Morgan Barclays, too. “For Barclays to be there with Citibank and Stanley. Barclays also hired fixed income research analyst Morgan Stanley certainly turned some heads,” says Kevin Roche, who came from Deutsche Bank but had Glascott. Within two years, Barclays catapulted to number followed FirstEnergy as a credit analyst in his days at four among debt underwriters for utilities in the US and Morgan Stanley, too.“FirstEnergy felt comfortable that we has ranked third for the last two years. [see Table 2] A strong banking relationship paired with newly-hired had capital markets execution capability and that we had respected and proven fixed income research support,” top notch capital markets talent—in this case, Peter Goettler, managing director and head of debt capital explains Glascott.

Richard Marsh, chief financial officer (CFO) of FirstEnergy, markets and investment banking, Americas—earned admits that picking Barclays for the role was controversial at Barclays a lead manager slot alongside Bank of America the time, but he was impressed by the calibre of the people and Citibank in October 2001 for a $1bn debt issue by they had brought on board. “They were really making a Honeywell, the company’s first offering since the proposed strong commitment to the utility space in terms of being merger with General Electric fell apart.

In February 2002, Goettler proved the Barclays formula there as a credit partner and building the capital markets function so they could compete with traditional top tier could work for new clients, too. When General Mills bought players here,” he says. Barclays had helped finance Pillsbury from Diageo in 2001, Barclays’commercial bankers, FirstEnergy’s purchase of GPU, a Pennsylvania-based utility who had no previous relationship with the company, won a that owned the Three Mile Island nuclear power plant; the place in the seven-bank syndicate that provided bridge financing. That experience so impressed General Mills that bond issue refinanced the acquisition bank debt.

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BANK PROFILE: BARCLAYS CAPITAL

avid basketball player and Goettler’s pitch for a lead fan since his childhood in role in bond issues to Southern California, refinance the debt fell on displays an extensive fertile ground. Against collection of Los Angeles fierce competition among Lakers memorabilia in his the seven banks for the glass-walled digs cachet of handling the first overlooking Barclays offering for an infrequent trading floor in New York. but prominent issuer, Team spirit infuses the Barclays shared the lead product development manager role with Citibank process as well. Although and Deutsche Bank on a Barclays has a brain trust $3.5bn transaction, the that builds models and largest deal General Mills applies them to create had ever done. new products, Kvalheim These early successes finds some of the best created momentum on Peter Goettler, managing director and head of debt capital markets and ideas come from bankers, which Barclays was quick to investment banking, Americas—earned Barclays a lead manager slot capital markets people or capitalise. “The most alongside Bank of America and Citibank in October 2001 for a $1bn salesmen who pick up prestigious borrowers in the debt issue by Honeywell, the company’s first offering since the proposed intelligence from clients market were entrusting to merger with General Electric fell apart. In February 2002, Goettler about problems they need us some of the most proved the Barclays formula could work for new clients, too. When to solve. Cohesion like important corporate General Mills bought Pillsbury from Diageo in 2001, Barclays’ that is rare at investment financing transactions they commercial bankers, who had no previous relationship with the banks, where research, had ever executed,” says company, won a place in the seven-bank syndicate that provided bridge capital markets, sales and Goettler. The relationships financing. Photograph kindly supplied by Barclays Capital, April 2007. trading often waste time have flourished, too.

Barclays was joint lead manager for a $1bn Honeywell debt fighting for a bigger share of the spoils rather than trying to offering in March and a $1.5bn General Mills deal in January. win more business for the firm as a whole.

“It is a culture of easy and fluid cooperation across the Building relationships on solid ground lies at the heart of Kvalheim and Goettler’s strategy. The pair, who firm and it’s created and maintained in so many ways that worked together at Deutsche Bank and Merrill Lynch, are mutually reinforcing, it’s a beauty to behold,” says expects Barclays to win capital markets or risk Kvalheim, who credits Diamond and other founders of management business on merit—because it can deliver, Barclays Capital for laying the foundation. Every not because the commercial bank already lends money to investment bank claims to value teamwork, respect the a potential client. “We do not want to do just one deal individual and so on, but Barclays means it and rewards and go away,” Kvalheim says, “We want to do a lot of people accordingly. “We will pay for the right behaviour, deals. Lending money is part of an overall relationship which is not only doing the business but doing the and we think it qualifies us to talk about risk business the right way,” Kvalheim says, “We have zero tolerance for aberrant behaviour. Zero.” management and other things.”

The strong personalities who rise to the top in The approach demands people who are not only at the top of their game but also team players willing to put the investment banking do have disagreements, of course, but bank’s strategic goals first. It comes as no surprise from an when everyone has aired their views and management organisation led by ardent sports fans. CEO Diamond’s makes a decision Barclays’ culture demands respect for it. office in Canary Wharf is festooned with Boston Red Sox “People do not go outside and say, ‘Forget that, I’m going and New England Patriots emblems, while Kvalheim, an to do what I want anyway’,” Kvalheim says. The prima

Table 1: Barclays Capital U.S. Investment Grade Bonds - All Industries Year 2001 2002 2003 2004 2005 2006

$m 2,453.3 3,476.3 7,514.0 4,821.5 9,867.2 6,009.7

% Market Share 1.0 2.1 4.3 3.6 7.0 5.4

Rank 12 13 10 10 5 7

Source: International Financial Review league tables. Supplied by Thomson Financial, April 2007

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donnas who hold sway over independent fiefdoms at some of its competitors have no place at Barclays. Effective bonus management also plays its part. In a period of rapidly expanding US headcount – up from 1,285 to 2,612 in the last five years – Kvalheim has reassured existing staff that their bonus expectations will not be impaired by guarantees paid to new hires. The parent bank agreed to absorb any unearned sign-on compensation costs so the bonus pool reflects the underlying profitability of Barclays Capital, a policy that dispels any fears and encourages staff to focus on the incremental opportunities new hires create through access to additional clients and products.

Despite the success Barclays has enjoyed in the US, the client base is still not as big as Kvalheim would like. He does not have fixed parameters for a target client, but Barclays will not chase one night stands and shies away from clients who just want access to its balance sheet. The substantial resources required to serve big clients— whether they be hedge funds, corporations, financial institutions or government agencies—are only justified if Barclays sees a chance to build a relationship and sell multiple products. Kvalheim nevertheless recognises the need to deliver research and other services that may not cover their costs in isolation but provide essential support to clients, traders and capital markets bankers.

Larry Kantor, who joined Barclays in April 2003 as managing director and co-head of research, has drawn on his experience on the buy side earlier in his career to concentrate on servicing unmet client needs in crossproduct research. As a portfolio manager, he chafed at the lack of integration between research on, say, oil prices and what those forecasts implied for yields on US treasuries or emerging markets bonds. He encourages his senior oil analyst to work with the people who cover Mexico and Venezuela, for example, or the chief US economist to talk to the head of asset-backed securities research when looking at the mortgage market. Barclays has a significant presence in sub-prime mortgages, but only as a manager of securitisations: it handled over $25bn of sub-prime deals in 2006. Credit exposure is limited to an inventory of loans purchased pending securitisation, parts of which may be pre-sold. Last summer, Barclays bought HomEq, a subprime servicer, and it completed the purchase of EquiFirst, an originator, at the end of March. Kvalheim expects to have a bigger presence in a business he believes will be more profitable in the future. “Half the sub-prime

Bob Diamond, chief executive of Barclays Capital. Diamond made it his business to ensure that Barclays Capital morphed from an ugly duckling into a swan able to challenge market leaders in the difficult US investment banking market. Photograph kindly supplied by Barclays Capital, April 2007.

origination capacity has evaporated in the last couple of months,”he says,“We don’t expect the market to be down that much. By owning a quality originator and servicer, we stand to be a beneficiary.”

Looking forward, Kvalheim sees “tremendous opportunities” to expand its commodities franchise in the US. Barclays is already giving Morgan Stanley and Goldman Sachs a run for their money in the rest of the world and a stronger US presence would enable it to mount a global threat to the long dominant duo. In credit derivatives, where Barclays was late to the party, he expects to grab a bigger share of a fast-growing market.

Securitisation will grow, too, including commercial mortgage-backed securities as well as sub-prime.

Kvalheim also sees growth in equities, a business many people do not associate with Barclays. Although the firm is

Table 2: Barclays Capital US Investment Grade Bonds: Energy & Power Year 2001 2002 2003 2004 2005 2006

$m 1,130.8 2,148.5 4,899.2 1,907.7 3,472.4 2,347.3

% Market Share 1.7 3.8 9.6 5.3 11.1 8.8

Rank 10 9 4 7 3 3

Source: International Financial Review league tables. Supplied by Thomson Financial, April 2007

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BARCLAYS CAPITAL LEVERAGED FINANCE GROUP BUILDS US MARKET FRANCHISE

I

will continue to jointly serve as the administrators of n early March, Barclays Capital announced the LandSource and will be responsible for its day-to-day closing of a $1.55bn financing for LandSource operational management.

Communities LLC, a joint venture of Lennar Corp.

Loan proceeds will be used to recapitalize the (Lennar), LNR Property Corporation (LNR) and MW venture for future opportunities, finance a special Housing Partners (MWHP). Barclays Capital was the distribution to Lennar and LNR, and pay down sole lead arranger and sole lead book runner of the existing debt. The loan is concurrent with the financing, which consisted of a $1.106bn six-year First contribution of cash and property by new investor Lien Term Loan B initially priced at Libor plus 275 basis MWHP in exchange for a 68% interest. Lennar and points (bps), a $244m seven-year Second Lien Term LNR will each retain a 16% interest in LandSource Facility priced at Libor plus 450bps and a $200m following the contribution and financing. undrawn five-year Revolving Credit Facility initially Since its inception in 2004, Barclays Capital’s US priced at a rate of LIBOR plus 300bps. The pricing on Real Estate Capital Markets Group has brought the Revolving Credit Facility and Term Loan B Facility several innovative deals to market. Notable may be reduced based on certain events. The deal was transactions include: ENSEC Home Finance Pool I, closed as a result of a team effort involving Barclays the first-ever asset based securitisation from the Gulf Capital’s US Real Estate Capital Markets, US Leverage Region; the securitisation of the Torre Mayor Loan, Finance and US Investment Banking operations. the first Mexican property to be securitised in a US While Lennar is one of the largest homebuilders in fixed rate CMBS transaction, and the TERRA LNR I, the US, LNR is one of the nation’s leading real the first homesite land securitisation ever completed. estate, finance, management and development Meanwhile the bank’s US Leveraged Finance Group, companies. MWHP is co-managed by MacFarlane established less than a Partners, a leading US Barclays continues to outperform its peers year ago, has been real estate investment involved in over 40 management firm, and 200 leveraged transactions includes the California 180 totalling more than Public Employees’ 160 $75bn. The group has Retirement System 140 been chosen by (CalPERs), which has 120 Chesapeake Energy for more than $230bn in 100 its €600m and by assets under 80 MGM Mirage to lead management. As a 60 $750m bond issues. result of the financing, The bank was also a MWHP will have a 68% lead arranger for Delta financial interest in Barclays ABN Amro JP Morgan Chase Airlines’ senior secured LandSource and 50% Citigroup Bank of America FTSE All-World Developed Banks credit facilities (worth voting control of the $2.5bn). entity. Lennar and LNR Source: FTSE Group and Datastream, data as at 31 March 2007.

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BANK PROFILE: BARCLAYS CAPITAL

30%. All this without increasing risk, too; Barclays expects to increase revenues faster than either value at risk or riskweighted assets, which should boost returns from an already impressive 41% on economic capital and 26% on regulatory equity in 2006. More should come from the Barclays Group’s anticipated tie-up with ABN AMRO, a move announced in early 2007, that if completed will result in the world’s fifth largest banking group by market capitalisation. ABN AMRO’s investment banking divisions are its global clients and capital markets businesses, as well as its private equity and asset management units. Up to now, Barclays Capital has eschewed corporate finance and equities since it was launched but a merger with the Dutch bank may see Barclays begin to take its first steps in those arenas as well. What is sure: the one-time rump investment bank is primed to kick its competitors’butts in the US for some time to come.

not in cash equities or research, it has a thriving business in equity derivatives and equity-linked notes. It has a strong convertible bond franchise in Europe and Asia as well, which it plans to bring to the US “in the not too distant future.”

After a year in which Barclays Capital’s pretax profits jumped 55% to more than $4bn, market analysts anticipate a less spectacular 2007. Last year’s growth consolidated Barclays Capital’s position as the second-biggest profit driver in the Barclays group and cut the gap to the top profit centre, UK banking, where profits rose 17% to £2.6bn. The investment bank generated £560,000 in revenues per member of staff last year, up from £498,000 the previous year as the ratio of compensation to net revenues improved to below half. Longer term, Kvalheim expects US profits to grow faster than the rest of the world while the entire investment bank maintains a compound annual growth rate close to

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The portfolio trading market then is being spliced and diced whichever which way fits buy side and sell side requirements. Brams, Jones and Klamler looked at cakes, land and property divisions as means to find evidence to support their proposition. Perhaps what they should have been looking at instead was today’s portfolio trading market. Photograph provided by Istockphotos.com, April 2007.

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BETTER WAYS TO CUT A CAKE

GLOBAL PORTFOLIO TRADING

Today’s portfolio trading market is being sliced and diced. For one, the relationship between the buy side and the sell side in portfolio trading is changing, as the client side increasingly accesses the market themselves. Moreover, as investment strategies become more complex, there is a flight to quality, with the large, global houses concentrating business around them as both client and sell side provider seek to find comfort in an increasingly complex and dynamic trading world. In turn, increased client requirements are placing particular demands on portfolio trading houses, which are now redefining the provision of portfolio trading services in a much broader context. How far can portfolio traders stretch and still claim the name?

Can portfolio traders really become all things to all men? Francesca Carnevale reports.

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AN YOU HAVE your cake and eat it too? No, but you matured rapidly in this respect:“Now, in terms of electronic can slice up an object in such a way that it maximises trading, all the asset classes are on an even keel for the satisfaction of all parties who receive a piece of accessibility. If you want to, within your hedge fund, you it—and this seems to be true of most things, as long as it is can trade FX traded derivatives and equities, and you can not actually a pie. At least that is what a mathematician, a access those with a similar level of maturity,”he maintains.

Banneville thinks that the integration of traditional silos political scientist and an economist posit in a paper for the December 2006 issue of the Notices of the American in both sell-side and buy-side organisations is a natural Mathematical Society, entitled Better Ways to Cut a Cake. consequence of this complexity. Société Générale itself has Specifically, Steven J Brams, Michael A Jones and Christian combined it’s derivates and cash trading businesses into Klamler analysed “cake-cutting algorithms that use a one group where, he says,“there is a lot more knowledge It’s a demand-pull business now, he minimal number of cuts (n-1 if there are n people), where a sharing.” cake is a metaphor for a heterogeneous, divisible good, acknowledges, and provides an indication of changing demand.“If you are a hedge fund, you want to be able to whose parts may be valued differently by different people.”

As a portfolio trader, does it sound familiar? Let’s trade electronically in such a way that fits your business underscore the point through another analogy, Zaphod process. It might be something as simple as trading an Beeblebrox, the de-facto president of the universe in the equity and hedging it. Perhaps it is denominated in a foreign currency, so you Douglas Adam’s sci-fi want to hedge it with an classic, The Hitchhiker’s foreign exchange (FX) Guide to the Galaxy, could As Banneville hints, the most trade; perhaps you want to never suffer from insecurity. dramatic change brought about by hedge it with a future. You Beeblebrox knew his place technology is the rise of dark pools would have to make those in the universe (he ran it) separate processes and and was happy with it. That’s of liquidity. In the United States access different parts of not necessarily true of alone, some 40 to 50 “different perhaps multiple sell-side today’s portfolio traders. iterations of non-explicit liquidity brokers. That makes it very Their universe is being, if not centres have arisen,” notes disjointed. Clients want one turned upside down, then at Blumberg. In Europe as well, person, one screen and one least shaken up, by a algorithm that will access confluence of trends, in changes are being brought about by all liquidity sources, which their role relative to MiFiD, which takes effect in particularly among hedge the buy side is being November 2007. funds.” He concedes that redefined constantly. the requirement is still in Invariably then, old the top quartile of definitions of programme trading are a busted flush. Once one-dimensionally defined sophisticated buy side trading desks, “Right now, it’s a as the trading of at least 15 stocks worth a combined $1m by small number, but it will grow.”

Bank of New York went a step further last October, with the New York Stock Exchange, the market these days is infinitesimally more “complex and no longer defined by one the establishment of BNY ConvergEx Group, joining with model, but rather by a broad definition of different services,” Eze Castle Software and private equity firm GTCR Golder says Ken Kane, managing director and head of programme Rauner to establish an entirely new company, bringing trading at Credit Suisse.“Our trading desk provide a menu together BNY Securities Group trade execution, of pricing options to clients from pure agency to blind risk commission management, independent research and and structures that help our clients achieve their transition management with Eze Castle’s trade order implementation goals. Other clients want us to handle management technology. The global agency brokerage emerging markets and global trades and yet another client provides the spectrum of pre-trade, trade and post trade will carve out 80% of a portfolio that carries 20% of its value solutions and since the start of this year has been and keep the rest on their blotter and trade it all out as single establishing the new brand moniker. Explains Blumberg, stocks.” Adds Anthony Blumberg, president of ConvergEx “What was BNY Brokerage is now BNY ConvergEx Global Markets,“years ago portfolio trading was the domain Execution Solutions, and G-Port, the element of the business which specialises in programme trading has of long only funds, but today it is used by everyone.”

That one trend has had broad repercussions. According become ConvergEx Global Markets. Blumberg thinks that to Francois Banneville, co-head of global programme market positioning is a key element of tomorrow’s portfolio trading at Société Générale, notes that from now on, the trading environment. “You cannot be all things to all men.” buyside “will always need a global footprint and access to BNY ConvergEx is “agency only, with our own proprietary all markets.” Not only that, Banneville also notes that research, with no proprietary trading desks and no internal programme traders are required to provide liquidity across hedge fund products.” Blumberg points to Regulation multiple asset classes, and that the European market has NMS and the European Union’s Markets in Financial

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Instruments Directive (MiFiD) as key influences on the market, particularly unbundling, “which continues to reverberate through the markets, though much less so in the United States,” he notes. The most dramatic and obvious of these changes is the adoption of newly ratified commission sharing arrangements (CSAs) by European institutions. In particular, the implementation of CSAs into the UK equity marketplace is taking place so quickly that it is difficult to keep up.“An increasing number of institutions in the United Kingdom and Europe have established CSAs,” says Credit Suisse’s Kane and that figure is rising.

“Clients now have the flexibility to use execution houses for best coverage. We see it as an evolving relationship.”

In such a complex market, Blumberg stresses that differentiation is a market imperative. “Additional market differentiators for us include strength in emerging markets and the way in which the group is structured: it’s a 24 hour group, with a 24 hour dealing centre, working out of Bermuda, which backs up each of the sales and trading desks in New York, London, Hong Kong and North Asia, providing continuity.”He also points to the importance of a global reach with regard to access to emerging market assets. “Frontier markets are very much in vogue in the search for performance and yield, and we are now expected to provide strength in esoterics, such as Middle Eastern assets, or even assets in sub-Saharan Africa.”

The spread of technology within the trading industry also redefining the tools and methods of execution, acknowledges Blumberg, and in the case of BNY ConvergEx explains in large part, “the tie up with Eze Castle.” Banneville stresses the point, “Clients want to be able to have one view of the market which will allow them to access all the available market venues and then make their choice. It may be based upon best price, fastest execution, or where the most liquidity is.”

As Banneville hints, the most dramatic change brought about by technology is the rise of dark pools of liquidity. In the United States alone, some 40 to 50 “different iterations of non-explicit liquidity centres have arisen,” notes Blumberg. In Europe as well, changes are being brought about by MiFiD, which takes effect in November 2007.

Credit Suisse’s Kane thinks that one effect of MiFiD will result in an increase in the number of alternative trading venues and thereby a concurrent increase in liquidity pools.

The largest growth in our algorithms has been our dark strategies primarily Guerrilla and Sniper. They exploit liquid opportunities without ever displaying orders in the market.

Fast completion of large trades with extremely low impact.

Like all portfolio trading services providers, BNY ConvergEx now has its own“dark pool”, specifically VortExSM, a patentpending process in which ConvergEx streaming orders intersect with dynamic indications of interest (IOIs) from a broad network of liquidity providers, including electronic market makers, alternative trading systems and exchanges.

Dark pools, or “dark books” as the TABB Group sometimes describes them, are limit order books or trading networks that do not publish a quote in the open market.

F T S E G L O B A L M A R K E T S • M AY / J U N E 2 0 0 7

Ken Kane, managing director and head of programme trading at Credit Suisse.“Our trading desks might be required to provide risk pricing to a client, who needs a incremental price at a particular point in a trade, while another client might want us to handle emerging markets and global trades and yet another client will carve out 80% of a portfolio that carries 20% of its value and keep the rest on his blotter and trade it all out as single stocks.” Photograph kindly supplied by Credit Suisse, April 2007.

By attempting to create a safe environment where large liquidity providers can locate large liquidity seekers without the risk of being traded ahead of, crossing networks try to minimise market impact and information liquidity and simplify the trading process.

Dark pools can be divided into two types, those that have emerged through broker-owned systems (that is crossing possibilities provided by a brokers trading book) and specialised utilities. The larger broker owned systems continually stream their cash equities and algorithmic flow through the pool, where that flow can match up with larger resting orders. Specialist systems are owned by exchanges and broker consortia. They take their members from the sellside, charging them only token fees for executions. Both types of crossing and trading systems are anonymous and fully automated and allow a broad range of order types, and customers are able to establish parameters around their executions, such as discretionary orders, for instance, or pegging an order to a particular price point. According to Boston-based TABB Group, the combined crossing network volume in the marketplace has grown to 9% of total equity trading volume and is projected to increase by 3% a year for

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(MTF), which is fuelling the next several years. the explosion of panAgency brokers with European platforms. crossing systems include Investment Technology firms such as BNY Group's (ITG) POSIT, the ConvergEx Group, Instinet, anonymous crossing ITG, Liquidnet, NYFIX, network, and Liquidnet Pipeline and River Cross.

Europe, the buy-side Full-service sell side b l o c k - t r a d i n g providers that have marketplace, are the major crossing platforms players in Europe, meanwhile include newcomers are jumping in Citigroup, Credit Suisse, the market to stake out a Fidelity Brokerage position. Last November, Company, Goldman Sachs, Instinet, the global agency Knight Capital Markets, broker, formed Chi-X as an Lehman Brothers, Merrill electronic alternative to Lynch, Morgan Stanley and the exchanges. Chi-X, UBS. Specialised utilities, which went live in January, whose members are has attracted large sellsellside firms, are BIDS, ISE side firms, such as Lehman Stock Exchange, LeveL, Anthony Blumberg, president of ConvergEx Global Markets. Blumberg Brothers and Goldman NASDAQ and NYSE. points to Regulation NMS and the European Union’s Markets in Sachs, to post two-way Up to now, most of these Financial Instruments Directive (MiFiD) as key influences on the bids and offers. Then liquidity pools have been market, particularly unbundling,“which continues to reverberate there's Project Turquoise, a established in the United through the markets, though much less so in the United States,” he consortium of seven global States, but an explosion of notes. The most dramatic and obvious of these changes is the adoption investment banks that different liquidity pools will of newly ratified commission sharing arrangements (CSAs) by banded together to form soon “be a driver in Europe European institutions. In particular, the implementation of CSAs into their own alternative for portfolio trading firms to the UK equity marketplace is taking place so quickly that it is difficult electronic trading provide tools such as to keep up. Photograph kindly supplied by BNY ConvergEx, April 2007. platform.“If they do not act algorithms and front ends which will enable traders to get a grip on that development as ECNs, then they will go against the spirit of MiFiD,” and control trading within it,” says Kane. Credit Suisse warns Banneville.

“MiFID is also raising questions about how fund developed Pathfinder, a smart routing algorithm that “places orders on a market where price and volume discovery can be managers will check the quality of execution. It is not optimised, while preventing signalling.” In other words, always obvious, for example, when there is no unbundling Pathfinder will trawl through multiple liquidity pools to find in place, it may not be best executed. It may be cheaper to the other side of a trade, without affecting the market.“It is buy the services elsewhere. The funds will have to an indication of the complexity required of both “portfolio demonstrate that they have put in place all the tools and traders and the algorithms they offer and an indication of systems to get best execution,”he adds.

Kane says: “There’s a plethora of issues around best what will be required on a daily basis going forward,” says Kane.“Smart routing technology is being rolled out by the execution, but a lot of it lies in the ability to look to multiple major houses,”says Banneville,“but to be effective, there has destinations and see what prices are available in multiple scenarios. Therefore, you need to have technology that has to be alternative liquidity.”

Paul Miller, a consultant at financial services consultancy the ability to bring in multiple price feeds and analyse that Morse (which until the beginning of April was known as data at high speeds. You need to see the representation of CSTIM) questions whether MiFiD will affect the number of those price feeds, or you need to have a strategy engine liquidity pools out there. “What is certain is that MiFiD will that’s listening to them, and can react to an event.”Morse’s negate what everyone now refers to as ‘dark pools’, under Miller agrees,“From the client side there is a considerable MiFid you have to show transparency through the entire overhead in proving best execution, and it is no longer just trading process.”Altering the rules that require all trades to about achieving the best price.”

The portfolio trading market then is being spliced and go through a stock exchange, MiFID allows investment banks to trade shares internally, but requires them to diced whichever which way fits buy side and sell side publish pre-trade prices of intended trades beforehand. In requirements. Brams, Jones and Klamler looked at cakes, addition, by eliminating rules that require foreign stocks to land and property divisions as means to find evidence to be traded through local markets and local brokers, MiFID support their proposition. Perhaps what they should have introduces the concept of a multilateral trading facility been looking at instead was today’s portfolio trading market.

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Global Portfolio Trading

Roundtable

Participants:

Supported by:

Left to right back row: DOUG HAMPTON, head of global trading, State Street Global Advisors BRIAN BIELINSKI, head of quantitative portfolio management, Trafalgar Capital Management MARY McCAVE, senior dealer, Legal & General FRANCESCA CARNEVALE, editor, FTSE Global Markets Left to right front row: MARK WHEATLEY, managing director, portfolio trading, Merrill Lynch SCOTT COWLING, European head of trading, Barclays Global Investor PHIL HODEY, managing director and head of portfolio trading, UBS RICHARD EVANS, managing director, head of portfolio trading, Citigroup

F T S E G L O B A L M A R K E T S â&#x20AC;˘ M AY / J U N E 2 0 0 7

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GLOBAL PORTFOLIO TRADING ROUNDTABLE

WHAT MAKES A GOOD PORTFOLIO TRADER? SCOTT COWLING, EUROPEAN HEAD OF TRADING, BARCLAYS GLOBAL INVESTORS: What comes to mind is

operational efficiency. The capacity to efficiently return executions, confirm the time and manner of trades and settle them, without any problems or breaks, is an extremely high requirement.

MARY McCAVE, SENIOR DEALER, LEGAL & GENERAL:

The ability of the sales trader to fully understand the requirements of the client. Having somebody who really focuses on your account, and who understands the ins and outs of your approach is imperative. Basically someone who gets the job done.

BRIAN BIELINSKI, HEAD OF QUANTITATIVE PORTFOLIO MANAGEMENT, TRAFALGAR CAPITAL MANAGEMENT: Technology makes a good portfolio trader

and desk. I think this technology encompasses broker efficiency and trading algorithms as well as a bit more exposure of the entire portfolio trading process to the client.You are seeing more and more brokers provide more technology solutions all the way down to the client desktop level and it is becoming an increasingly important aspect of the client’s relationship with the broker.

SCOTT: Once that is in place, do you think that it should cost you more or less than the basic vanilla portfolio desk service?

BRIAN: You could argue either way, but putting technology in client’s hands does, in many ways, make the job easier for the broker. Concerning efficiency gains for the client, you may argue that some brokers should bill for it. On the other hand, you don’t pay for receiving monthly statements, and you don’t pay for receiving fills via email. Many times these platforms are just a more efficient way for the broker to receive orders from and transmit fills to the client.

DOUG HAMPTON, HEAD OF EUROPEAN DEALING, STATE STREET GLOBAL ADVISORS: Added to what

everyone else says, it is the breadth and understanding of the market offered by a bank. If I have an issue about Polish settlement say, and they can handle that, then all well and good. Alternately, if I have an issue about a swap and they understand how the swap structure works, that is important too. We look at portfolio trading as a route to get into an investment bank, which is then expected to handle all our various settlement and operational issues. I do not want a bank that just wants to execute trades and which cannot handle the specific issues that come up for us.

FRANCESCA CARNEVALE, EDITOR, FTSE GLOBAL MARKETS: Is the relationship then about value-added and

not just order execution?

MARK WHEATLEY, MANAGING DIRECTOR, PORTFOLIO TRADING, MERRILL LYNCH: Yes, that is clear. Order

execution has become commoditised to a degree—both in terms of the real-time service level that clients require and operational efficiency. Doug’s point is valid. Programme trading teams on the sell side have generally attracted people that do not want to be compartmentalised and

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therefore they offer, and have an understanding of, a much broader area of the business. This is true of all the firms I have worked for. At Merrill Lynch, we have a portfolio team that is very much at the centre of the floor and is connected to every other area of the business.

PHIL HODEY, MANAGING DIRECTOR AND HEAD OF PORTFOLIO TRADING, UBS: Portfolio trading has evolved

over many years and these days a good portfolio trading desk has to have excellence on the operational side and excellence in its execution capability. Portfolio traders have to be good at everything, because the trades we see are diverse in their complexity and we have be able to provide an equal level of service and equal quality of execution across the spectrum. Moreover, we follow that up with an efficient back office and operational process.

FRANCESCA: Are your clients increasingly giving you the harder parts of the business, the very high-touch trading requirements, or the most illiquid part of a portfolio to trade out?

PHIL: When you speak to people about portfolio trading there is an assumption that it is very much a low-touch, vanilla way of getting a lot of business done quickly. Today that could not be further than the truth. The level of complexity in what our clients are trying to achieve, and what they expect from portfolio houses is extensive. The use of technology and the use of experienced traders on the desk will all combine to give clients the level of complexity they require to achieve their objectives, but it is far from being the vanilla business that most people assume it to be.

MARY: One needs to have a certain degree of security.

Direct market access (DMA) is obviously becoming more the norm for people, but some buy side players do not quite have the technology that they need, even though many houses are working to upgrade their systems.

However, if you have a difficult portfolio that you want to trade on an agency basis—such as an emerging markets portfolio, then you are more likely to want to utilise the skills of sell side experts. That process will continue until we build up our skills on the buyside. The buyside is going through a transition. We are upgrading our skill sets and trading is migrating over to our side now.

PHIL: Portfolio trading has always been considered a cheap way to execute. It is interesting that when you now look at the prices of DMA and algorithms, they do not necessarily reflect what they should do relative to portfolio trading.

With portfolio trading, you are getting people managing your trade as well as machines. I do not think a premium has been priced in to the marketplace, so that either DMA prices go down or portfolio trading prices go up. We have found on more than one occasion that for the difficult trades, clients are willing to pay us more to look after their trades. They recognise the benefits of selecting a capable broker and are willing to pay the right price for it.

SCOTT: A definition of a difficult order is very simply that you have a high volume requirement, a high liquidity requirement and therefore rationally you are best placed to find the other side of your order. Theoretically a client through its many

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broker relationships (with, in turn, their many client relationships) should give you a better chance of finding the other side than one broker and their client relationships.

PRE-HEDGING: RIGHT OR WRONG? RICHARD EVANS, MANAGING DIRECTOR, PORTFOLIO TRADING, CITIGROUP: There was a big focus on pre-

hedging a few years ago where it was the norm to allow the sellside to pre-hedge client orders. Following the investigations that took place, we have seen a change in the way some clients are happy for you to pre-hedge and others are not. This has certainly caused a difference in pricing. Everyone is very specific about whether you can or can not pre-hedge. In the past it was ambiguous, which then resulted in a very wide spread of principal prices. The spread of prices is much closer now, as everyone is upfront and clear about how they expect you to interact around the strike price of the trade. From a Citigroup perspective our stance has been never to pre-hedge unless it has been explicitly agreed by the customer. What we have seen is that we have now become more competitive in the marketplace in terms of our principal quoting, because other houses have tended to move their prices further away. The investigations that took place has been a positive thing for transparency in the marketplace. However, as Phil says, it could become much more difficult going forward following the Markets in Financial Instruments Directive (MiFiD) in terms of the transparency and the protection that is allowed to the sellside in terms of how immediate the publication of that trade is likely to be.

MARY: We do not allow pre-hedging, but it really comes down to whether a buy-side dealer decides to give a broker the names and direction upfront and if they choose to do that then surely they automatically presume that the brokers are going to pre-hedge. We tend to deal on a blind basis, so we do not allow brokers to pre-hedge.

RICHARD: Pre-hedging is very much interacting with the official price around the time that you are executing the trade. If you are able to source liquidity at or around that price by making an assumption about what the customer is likely or not likely to be trading then I guess that is the risk that you are taking yourself.

SCOTT: When trading, either principally or agency, one is required to look at the total costs. Pre-hedging will affect the implicit part of the transaction and the commission is obviously very explicit. Historically, some clients perhaps were only concerned with the explicit part and wanted to see a low explicit charge and did not really care about the implicit part. However, that is a very naĂŻve thought process.

It is necessary to consider the total and if one were to allow pre-hedging, which Barclays Global Investors (BGI) does not, you would have to give consideration to would that act change the sum total costs.

BRIAN: We monitor our portfolio trades and the market action of the trades from before we request the bids to well after the time when the whole thing should have been

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BRIAN BIELINSKI, head of quantitative portfolio management, Trafalgar Capital Management

executed. We do pay attention to the fact that there is a chance that someone might try to pre-hedge the trade. We try to educate our brokers about the nature of our underlying strategies. These strategies are not necessarily very short term, so the brokers are not taking the other side of a very short term trade or a very short term strategy. As such, we look for more aggressive risk pricing from our brokers. Nevertheless, we do not allow pre-hedging.

PHIL: The issue for banks that run risk on an inventory basis is that it works very well in stable markets but as volatility increases, the appetite to run the inventory tends to reduce. I am sure you all found two weeks ago when volatility did increase, that risk prices came out. Generally, the risk parameters that you have been running your inventory from become much less attractive in times of high volatility and you are forced to close out risk. When this happens, the risk prices not only move higher but also brokers are potentially sitting on some large losses. There are definitely arguments for running inventory type of risk management and an unwind type of risk management where you do not want to build an inventory. Getting the balance between those two elements is the important part of understanding what risk you are comfortable running, and what risk you do actually want to unwind.

ACCESSING THE RIGHT DARK POOLS OF LIQUIDITY FRANCESCA: How do you guarantee clients that you can access the right dark pools?

MARK: In the end it is about the absolute performance that you give clients in terms of their total execution cost. It is difficult for a client to work out whether you are accessing

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you can actually source inventory direct from a client is a significant part of our job. In addition, one of the points that Doug made about the risk systems that the sell side use now, is that they allow them to run much more inventory. What we have seen is that this inventory has actually become more centralised. Previously, when banks had a trading floor with a separate cash business, a separate portfolio business, a separate derivatives business etc, you were not really looking holistically at that risk. That has now changed. There is no-one out there though that wants to become a long-term fund manager on the trading floor, and people always need to reduce risk at some stage, so eventually that is going to require going to either an exchange or finding the other side.

TECHNOLOGY AND ITS IMPACT

SCOTT COWLING, European head of trading, Barclays Global Investor

a dark pool, whether you are internalising, whether you have other clients flow to cross that business against, or whether simply you are going to the first price point of liquidity on an exchange. The end performance that you give them is actually what they are looking at and how they will judge the result. Most clients do not mind where that liquidity comes from. If you have access to an alternative liquidity pool that is improving their performance then that is the real end game for them. It essential therefore to have access to any meaningful liquidity sources that arise.

PHIL: Brokers by their very nature are looking to match buyers and sellers whether that is from their own order flow, or from other clients in the market place. It is actually brokers being able to find the other side and not just going to one of the different electronic venues, but knowing either by their trading history or knowing what the clients are interested in. Being able to make the right call for the right person to find the other side of those difficult trades is what dark pools are all about.

FRANCESCA: Is there a high level matching board, or is it just experience that lets you know where a particular group of say European Mid Cap stocks resides?

MARK: You can rely heavily on some of the systematic flow and inventory tools, but they do not replace the relationships that we have with our clients in the market.

You are never going to know where every piece of stock resides, but the ability to maintain a relationship such that

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DOUG: Technology has brought down costs and will keep bringing costs down. What the sell side needs to do is to go back to the stage where service is the important thing. I do not think that technology can sell you anymore. It is the quality of people that they have in place to provide that technology.

RICHARD: It is a combination of both actually. A big part of it is the service, but it is service that you provide with a better toolkit. For example, an airline pilot provides a great service, but he can only provide that service because he has a dashboard with relevant information that is readily available to him. If you compare that to the Wright brothers when they originally flew their aeroplane, they just had enough to get them 120 feet along the ground. Whereas, today a modern airline pilot needs to have the available technology to allow him to do a job that may involve intercontinental travel and do it well. I think technology still continues to be a differentiator, and it is how you interpret information that allows you to give your client a better quality service.

PHIL: Going forward, the successful broker is the one that understands that every customer is different. That their investment objectives and styles are different; and if these are different, you clearly are going to have a different trading style to achieve these objectives. A lot of focus over the past few years has just been providing product for clients without necessary understanding what those clients require. For the next few years, the business will be about fine tuning product for different client bases, making sure that we put the right things in front of the right clients to help them to succeed.

FRANCESCA: Mary, how much is new technology driving the growing expertise that you were talking about earlier and the confidence in your DMA strategies?

MARY: Because of the way the markets used to work, and the way we once relied on brokers to do all of our trading for us, the buy side has not invested in technology in the way that the sell side has. Technology is their bread and butter and by pumping money into technology, it helps the sell side differentiate themselves. Now that the markets have opened up and you can have DMA, and clients are beginning to realise that they can get cheaper transaction

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costs by executing themselves, then they are beginning to chase technology as well. The important thing is to secure a sufficient budget to fund it all.

FRANCESCA: Are you chasing the technology or is the technology chasing you?

MARY: It is probably a bit of both really. There are times you could argue that there is not much mileage in being one of the first movers, so it suits that the ‘tried & tested’ technology that has been around for the sell side, can be used by the buy side as well.

BRIAN: Technology is obviously improving. It is also improving the quality and level of interaction between the client and the broker, giving the client more ‘say’ over what is done through the broker and how it is done. This is a process of constant improvement and I believe it is a result of clients wanting more hands on control of their portfolio executions.

FRANCESCA: Phil, do clients consult with you more about execution strategies?

PHIL: Definitely. I would point out first that technology has been responsible for the market fragmenting more than anything else to date does. As algorithms are executing more of the daily flow, the average trade size on exchange has decreased significantly. This has made it much tougher to get large orders completed quickly in the market itself. I

RICHARD EVANS, managing director, head of portfolio trading, Citigroup

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am not saying that that is a good or bad thing, it just means that we have to have the technology in place to manage this fragmented flow and free up the trader to focus on the high-level strategy. On the portfolio side, it is a case of looking at the overall risk characteristics of the trade and using risk management techniques to achieve our clients’ objectives. This is usually an ongoing two-way dialogue with the customer.

FRANCESCA: Richard, do you think technology has changed the relationship between the sell side and the buy side?

RICHARD: It has led to significantly more transparency between the person executing the order and the person placing the order. Five or six years ago about 25% of the business that we received as an entity came in by FIX. That is over 50% now. If you look to the US market, it is over 90%. Inevitably when you connect up the buy and sell sides it leads to real-time execution monitoring, real-time analytics, and immediacy of information back to the buyside rather than relying on someone sitting and monitoring the portfolio performance on the sell-side and making a phone call every 30 minutes or so. Having the buy side have that level of information at its fingertips frankly makes the sell side slightly nervous, because you always have somebody looking over your shoulder and second guessing what you are doing. Even so, it also has led to openness in communication and, as Brian says, if you understand fundamentally, what your customer is trying to do, it helps you achieve better execution for that type of transaction.The other thing about technology is that now we are actually building the tools, systems and software to provide immediately to the buy-side. What the buy side has is just as good or if not better than what the sell side has. It just comes down in how much you are prepared to invest in the technology. This is not for everybody, because certain dealing desks—depending on the way that they are structured—still ought and need to outsource their execution capabilities to someone who has all the capability.

These clients are not able to invest in every single piece of tool kit that would enable them to execute their business.

SCOTT: Just to clarify who uses programme trading. As I see it would be passive funds or quantitatively managed funds generally. These are the types of strategy that are not picking securities because they think that they are going to double in price. They are going for either no alpha because they are trying to track an index or they are doing something because they believe there is a small margin to be made. As a result of this, all of these investors are very concerned with the cost incurred—therefore technology is very important to them. Bear in mind that a fund manager is paid as a proportion of the assets—and that is obviously based on their success at gathering those assets—whereas technology is a fixed cost. Until you get above a certain threshold it won’t make economic sense, so those at the lower end rely on those value added services of the brokers.

Once you get above a threshold, I guess you would have less reliance on the services and you would expect to do more yourself to minimise the shortfalls and the cost.

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DOUG: Technology is going to change the market in the sense that if you look at other technologies it tends to be ‘winner takes all’ and you can dominate that market once you have a dominant position within it. One needs to get desk top space in one space, and once you get comfortable with that, you are going to start putting more business through it. All of a sudden it is a very concentrated sales side with four or five dominant brokers and I am not sure whether that is good or bad, but that is the risk that we are faced with technology.

COMPRESSION MARK: We have been talking about compression and about

the number of brokers out there for more years than I care to think about. The cost of technology will drive to a certain extent the compression of business. The cost of building this technology and compiling all the data that is required is not cheap. If you do not have the ability to pay those costs it becomes difficult to compete, and you out-source or cease offering the service. If it is a good thing or not it depends on which side of the equation that you end up on.

MARY: We signed CSA’s with all of our brokers, which is at odds with a lot of the street; we did not want to actively concentrate the number of counterparties with whom we mainly deal. However, although we have signed with everyone, we are seeing a natural concentration to some of the bigger players really. At the moment this number is probably eight, but again you can see that shrinking even more. Quite a lot of buy side players have only signed CSA’s with a few core brokers, which I find quite interesting.

FRANCESCA: Is there a flight to quality Mark?

MARK: Yes, certainly we have no worries at present but have seen the situation over the past ten to 15 years where very significant names have changed their model, failed to keep up with the market, or predict where the market place is going, and suffered accordingly. You cannot ever be complacent and that is where the understanding of the clients, and what we need to provide them, is crucial. As Richard points out, in terms of the speed with which information passes today, there is also now a high speed of execution that causes its own problems to the buy side dealer’s ability to manage it. For example you have a certain type of buy side trading desk that is going to get a continuous flow of orders from any number of fund managers, but at what stage do they cut that flow off and address how they are trading it in terms of portfolio verses DMA etc? It is actually very difficult to do, so it is crucial that we understand exactly how the dealers are set up and how they interact with the people who are making the investment decisions. Again, when Mary spoke about the emerging markets earlier, obviously technology does not yet help you at many levels in those markets, so there is still a long way to go to provide the full scale service that clients need, and that in itself will delay full-scale broker compression.

PHIL: It is true, technology is not the solution to everything.

If you look at the changing relationship between the buy and the sell side—does it mean that the brokers that succeed will be the ones who look at how they operate and interact with their clients and understand where they add value? Or effectively decide where we should let the buy side trade themselves? Those considerations are crucial to whoever succeeds. There is the general opinion that liquidity will concentrate towards the bigger houses, and here are more reasons to believe that this will happen now than at any time in the past, but at the same time, you can not just assume that it will happen. Arguably the blue chip liquid names will go to a DMA platform and we will be left with difficult names. Arguably it could mean that you are going to end up going to boutiques and specialist brokers. I do not think it is safe to assume that liquidity will concentrate towards the big houses. How those houses interact with clients and understand their needs and deliver upon those; is really going to dictate the success of an investment bank going forward.

RICHARD: The industry is a lot more efficient now than in the past. A big driver of that is commission sharing arrangements (CSAs) allowing the buy side to execute with a more concentrated group of brokers without reducing the amount of research that they have available to them.

Therefore, that is creating efficiency in the market place, where you do not have to execute with a broker in order to pay a research bill and compromise on liquidity access. As Phil says, you are never going to get to the point where all liquidity goes to a certain number of bulge brackets, because from an efficiency perspective those local broker dealers still have more access to the local investors than global firms are likely to have. Regulation is often a source of frustration, but in this respect I think it is becoming very positive to the industry.

SCOTT: I was interested in establishing whether commission sharing arrangements have led to increases in business for the houses that are represented here today. I was under the impression that perhaps there had been an increase but that had subsequently reverted somewhat.

PHIL: I am not sure they have reverted, I can say that where we have signed a CSA there is evidence that those accounts have grown at a greater rate than those that have not.

MARY: I think that some houses went down the line of signing just a few CSA’s but they have realised this is slightly too restrictive and that they need to sign a few more, in order to satisfy their best execution requirements within the CSA framework.

DOUG: Part of the job on the sales side is to gather information about the market and I think technology allows us control that information ourselves. That is a big change in the market from five years ago. The sales side has to look at ‘how do they make money from their clients?’The relationship has changed. The key thing with the technology for us is to have the people on the sell side get the best out of it as possible. I think a few people have that but across the board there are not enough people providing that to the buy side. From our perspective they really add

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value to our processing. We can use our technology to make sure that we do not cause disruptions in the market.

MARK: The idea of expecting the buy side to use all the available tools straight away does not wash—though to be fair we have seen buy side trading desks get to terms with them very quickly. We have an execution consulting desk that effectively does some of what Doug just described. The desk analyses what the customers own trading style is, and tries to help them fine tune it. In the execution process we are not trying to intervene at the PM level, because the actual investment decision will always be the client’s own.

However, how they choose to implement that decision through their own trading desk is extremely important and it is where we try to help minimise slippage.

FRANCESCA: Doug, who is policing your performance?

DOUG: We trade with the broker and the broker then provides capital. It is hard to measure that and say whether that was a good job or not. We really are looking to measure performance of our traders not so much the broker’s performance anymore. We will try to compare our algorithms. We are not at the point where we can compare the different tools that they provide to us. In the old days of complaining to the broker are gone, it’s now more the case that the complaints come to us now. We do not have anyone to turn around to blame anymore. The calls are on us.

MARY: I agree. We use transaction cost analysis but it is more to look at how we have performed, rather than broker performance. We are in control of our orders –and so we are directing where the flow is going anyway; and we are asking the broker to trade in a certain way. Having said that, we have no offices outside the UK, so we trade global equities from our desk. In markets where we are not trading in live time then there is potentially more reason for using TCA to analyse broker performance. Going back to MiFid we are forced to examine how we trade and to come up with an execution policy. At the beginning of discussions about MiFid there was a lot of worry from the sell side that the buy side wanted to pass responsibility for best execution on to the sell side in all situations., however we are happy to stand by our execution policy and happy to be measured and monitored on that basis.

RICHARD: From a transaction cost analysis perspective the time horizons have changed in terms of what is being measured. If I think about short term as being within five minutes for example; mid term being the day, long term meaning multiple days; the long term decision about executing which security to invest in is typically the fund manager’s decision. The more mid- term decision (hours to a small number of days) is more the buy side dealer’s decision. Whereas in the past the buy side would measure the sell side in terms of the timing of their decision as to when to execute an order, that timing is now being done by the buy side dealer, and it is the implementation after that decision has been made that the sellside are being measured on. So back to Doug’s point about measuring specific algorithms, you may measure the sell side algorithms against each other in terms of the performance

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MARY McCAVE, senior dealer, Legal & General

after the decision has been made, but when that decision is made is what is being measured on the buy sides dealing desk?

MARY: Some houses on the buy side already work in the kind of way that others aspire to. With MiFiD coming in, it will be a catalyst for a lot more firms to sharpen up their processes. More people are using pre-trade models, and then they will be using the post trade to compare this with the actual execution.

FRANCESCA: Phil, how do you think MiFiD will effect performance measurement?

PHIL: Irrespective of how individuals are being measured, the fact is that there is now a regulatory requirement to do so. It is also more than just a quantitative exercise; it is actually starting to qualify what is a good job and what is a bad job. This is a key problem; there has never been a qualitative overview that let us really understand whether a trade was executed well or poorly.

BRIAN: Algorithms can make everyone a lot more efficient.

Currently they’re great at the easy orders, straightforward stuff where there’s the liquidity and the trade frequency that the algorithms can work with effectively. Nevertheless, you need an algorithm, or a more intelligent process by which to separate out the easy orders verses the more difficult orders. Right now, most of these decisions are being made by the brokers and portfolio trading desks.

However, as technology improves the ability to make more of those decisions will be available to the client. Although I am not saying that all clients will want to use it.

SCOTT: There are many people working very hard to pick the right stocks. However, ultimately a client does not really make its money from picking stocks, but rather from its assets. Asset allocation is the true driver. Therefore, how one performed versus a close or a volume weighted average is fine, but the big question is should you really have been executing in that manner? MiFiD is a big concern. Although there is the opportunity to have volume data printing in many different venues, if that cannot be effectively consolidated, then you will not be able to measure performance effectively, and that is worrying.

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DOUG HAMPTON, head of global trading, State Street Global Advisors FRANCESCA: Data management will be really important once it comes in to play. Have you invested in the systems?

I am sure your clients will rely on you even if they want to run their trade strategy themselves. Have you prepared for that Richard?

RICHARD: We have been forced to invest just by the fact that the regulations have changed. Having to be in a position where we are able to justify how we have executed the transaction means that we have to store pretty much every market data tick and transaction. A lot of behind-thescenes work takes place from a technology perspective, which does not result in a new front end system. In terms of benchmarking, as Scott says, it is a concern. Many people target a couple of specific benchmarks at the moment, but when you get to multiple liquidity pools it is going to be very difficult to monitor what you are executing, what you are targeting and what your customer wants you to target.

I can envisage a lot of ambiguity creeping in. Let me be specific. A few years ago, many closing methodologies were very different, depending on the index that you were benchmarked against. The best example of that is in Italy where they had two different closing benchmarks, depending on the index that you were benchmarked to.

Liquidity is likely to fragment across Europe from multiexchanges and you could end up with ten different closing prices. When you are trying to target a specific benchmark this is going to become very difficult, not only to execute against, but also measure a performance against. That is one

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of the current unsolved MiFID mysteries.

MARY: Is there a consensus from the sell side to on how to establish the closing price (post MiFID)?

RICHARD: If you look at the US as an example, the two primary markets are losing share on a daily basis. The current official closing prices still tend to be what is deemed as the primary market. I do not know if that will change once the primary market actually falls below a certain percentage of market share- or whether it will stick to the primary exchange listing of that security. I have no easy answer for it because if you think about a number of solutions, whether you take the weighted average of a number of exchanges, or whether you take the last tick from which ever exchange closed the latest, one thing for certain is that there will be more ambiguity.

MARK: There is always likely to be some sort of benchmarking, whether it is to the close or some other agreed point. As liquidity fragments there is a tipping point beyond which there is no easy monitoring solution.

Everybody has thought about various potential outcomes and some of the technology needed is already built, as we all have experience gained from the US markets. We already have to store most of the information anyway. Therefore, I am not worried that it is not going to be available, it is more a matter of collation and dissemination. Another interesting point about MiFiD relates to Scott’s comment about explicit and implicit costs. The drill down in to the absolute cost of a trade now includes differing venues, and also looks at settlement/clearing charges etc. Without technology, this is almost impossible. If you look at the job of a trader in an investment bank, you are asking him to not only make a decision where the liquidity and best price is; but actually make a split second decision adjusting that for the settlement and clearing costs. Technology is really the only solution for some of those issues.

FRANCESCA: Will MiFiD put back the onus of technology onto the bulge bracket houses simply because you have the resources to fund the necessary developments?

PHIL: It is clear that there is an enormous investment to be made. To be fair, the majority of the collating of data is not difficult. However, there is an enormous amount of investment required. In fact I read a report this morning that said 25% of all servers bought globally are bought by investment banks. It is a very good signal that we spend a lot of money on technology. We have to, because our customers’ requirements are so sophisticated. If investment banks stopped making money, and with pricing based around portfolios and DMA and the exchange cost of trading, there is the possibility that this enormous investment will not recoup its costs. If that should happen, then that is going to change the structure of the marketplace again. Therefore, technology is a key differentiator in the success or the potential success of a broker.

DOUG: Do you think if you were starting your own business you could afford this technology? Maybe that is why we don’t see many agency brokers out there because they can not afford to be in the market place?

RICHARD: It is becoming more difficult because to

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maintain a competitive edge—which these days is more and more about technology— you have to continue to invest in it. It is a continual challenge for the agency-only brokers to maintain a competitive position in this regard.

There are however a small number of clients who are still concerned about the mix of business within an investment bank between agency and principal business.

PHIL: A cash execution business on its own may not be as attractive a prospect as one aligned to other investment banking services. For example, 30% of the programme trades that we execute at UBS now are not booked as cash trades but are in fact part of derivative transactions, so there is opportunity to provide alternative solutions to clients. That is actually where a real opportunity lies for investment banks, starting to align those products in such a way that the cash business supports a much bigger business. Cash on its own is still a good business, but in a standalone business, it is less of an opportunity than what you get can offer elsewhere. It is interesting that Scott mentions the multi-asset side as well. One of the key areas that we are looking at the moment is developing a portfolio trading facility that covers both a fixed income and equity.

FRANCESCA: Brian does that not encourage you to outsource all your trading?

BRIAN: That is part of the discussion about fragmentation of market information. It is more difficult for individual clients to aggregate all the market information and access they require, so in some sense that does make the portfolio trading product more desirable. Brokers are already doing the work to aggregate this information. They achieve better efficiencies of scale having to do it for multiple clients.

FRANCESCA: We have big and sophisticated players around this table who can make their own trading decisions. There must be many asset managers who simply cannot access multiple markets themselves. Doesn’t that ultimately mean more business for the big investment banks?

PHIL: Most of that becomes a question of scale—probably something one of my colleagues across the table should answer. At what size team does a central dealing desk on the buy side actually have the capacity to trade well in all situations? We have 19 people in portfolio trading at UBS in London alone. It makes sense for the large buy side institution to build a trading operation themselves. What size of assets under management does it then become unrealistic to be able to achieve that scale, instead of using a third party i.e. a broker?

BRIAN: I think it is a lot easier for us to evaluate, because we are much more focussed on a broker’s execution services, rather than its research services. For a research purchaser value can be much more difficult and subjective to evaluate. For us, there are still some subjective measures, for example, settlement issues. However, while these subjective criteria are important, we consider them secondary to execution performance and consistency.

RICHARD: It is nice to hear that there is going to be continued reliance on the large bulge bracket banks. That is no different in any other industry. The players in the

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industry with the bigger market share tend to be the most successful at innovating and coming up with new products.

They have the resources behind them to be able to do that.

BRIAN: I have seen some brokers change objectives over time. For example, some may increase focus on risk business today, then six months later they lose some of that focus. So we cannot say to one broker ‘today you guys are doing well, you’ll be our only broker’. We have to maintain relationships with several different brokers in order to protect our clients from a particular broker’s possible change in business focus.

UNBUNDLING FRANCESCA: Can we talk a little about unbundling, and

the long term impact of that.

DOUG: It has less effect on us than many others. We do

not require so much market research. However, to say we have no research, that is not true either. We do. What is forcing us down the rut is more towards the commission sharing rate. We also need to pay people who provide us services that can not provide the quality of execution.

Therefore, for us, it is the commission sharing that has happened that probably would not have happened to us two or three years ago.

MARY: We have both sides to our business; our passive side is purely execution only, so it never comes in to the unbundling discussion really. On the active side we are seeing benefits in that we are being able to use our commission payments a lot more effectively to target firms that provide the most useful research while still getting the business done with the houses that provide the best execution.

PHIL: Portfolio trading is already an execution-only service so unbundling should have little impact on our business.

So, will it affect portfolio trading? In theory, it should not, however, I am sure that it in some places it will. Looking at how the portfolio trading model operates is the correct way of understanding unbundling in the broader context of the equities business as a whole.

MARK: I agree. Portfolio trading has always been a service used by execution-only clients, and yet many others also need research because they have a different side to their business. The ability to face-off to clients in differing ways across multiple businesses is absolutely crucial. If you look at the execution-only charge, where should that end up coming out? Currently there is a disjoint between what classifies as the execution component of a high touch cash order versus where a portfolio trade is priced, and following on where a DMA or algo trade is priced. Can you take from that there is a problem with the value of the execution piece, or does that simply mean overall commission rates are wrong? Potentially not, but the right balance has yet been to be found. You will also get to the stage where the research and the provision of service are difficult for some of the smaller brokers to provide due to costs. Coming back to Doug’s point, if you are looking at

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the initial outlay, it is very expensive to start up a technology programme. However it is significantly more expensive to set up a full scale research product. The smaller brokers who do not necessarily have that will be forced to compete on execution price alone, and therefore there could be some compression due to that.

MARY: How do you feel about the pricing level of the execution component, because now in the UK for example, the talk was that component would be seven or eight basis points for high touch. That is going to come down as technology advances, and so should bring the total commission down.

MARK: You had to start somewhere, and in terms of the analysis, most people came out with the same sort of price.

We manage our client relationships holistically by looking at the amount of resource we provide, whether it is research, execution, corporate access or capital, and from that look at the overall profitability of that client. If that execution component goes down significantly, the amount of revenue we are getting may not actually net off with the value of the service we are giving out. Then, most likely, the overall service level will be pulled back. We have a very open dialogue with all our clients on the analysis we put in, and make sure they understand what we are giving them in resource and how we account for it, so it never becomes a surprise if resources are re-directed. It is a business after all and we do want to make money. In terms of technology cost and investment, if it starts not to make any sense because we are not getting any pay back for it, then it becomes an issue. Likewise, if you get to a stage with a client relationship where the overall picture no longer makes financial sense, then you have to look at allocating your resources where somewhere it will.

FRANCESCA: The first part of this discussion was about all the benefit services that portfolio traders had to offer to clients to keep their business- how do you effectively price that value added service? –Surely you can not do it for nothing…

RICHARD: Quite often some of the services that we provide are seeded from our internal requirements anyway.

Then it is looking to monetise what we have, by selling it to someone else; and whether that is implicitly selling it in terms of receiving feed back; or in terms of effectively in exchange for order flow if that’s applicable and allowed. It is difficult to be specific about the price of a particular algorithm for example, and inevitably we determine an average cost relative to the flow and set-up cost of the product. Client profitability has become much more prevalent over the last couple of years and is moving much more form an art into a specific quantitative scientific process. In a similar way- loss ratios and retention have become more standard because communication within the industry has become a lot more open about it; that the same thing will happen to client profitability.

FRANCESCA: Does that give you comfort Scott? That it is all going to be scientific.

SCOTT: Yes it does. All the people here today like to look at

the world in a quantitative manner, so ultimately yes. Mary said the sell side suggested an average execution rate as maybe in the region of eight basis points. The cost of building the technology is huge, but to a large extent is a fixed cost once it is done. Then you have exchange costs, which are maybe in the region of half a basis point. There is therefore 7.5 basis points left to cover the cost of the value-add services. Will it become a more scientific process? If people know how much something costs then they are going to be more aggressive about what margin they are going to pay on top of that and that is possibly a dangerous place.

FRANCESCA: Is that why you keep it as an art Phil?

PHIL: I found the whole cost conversation over the last few years is quite interesting, I can’t remember walking in to a shop and asking how much something costs before I bought it. The cost of executing business is something that we have to be focused on. However, should Doug, or Scott, or Brian choose to trade with UBS because it happens that our internal cost of doing business is different and that means that they can pay less? Well, I think it is more than that. If I go to look at two TV’s; I am not going to just base my decision on which is the cheapest. My decision is going to be based on the size, sound and vision quality and so on.

There are so many different things around portfolio trading that you cannot necessarily quantify purely as a cost. This is a problem for the buy side to understand. How do they effectively measure what things they value from their broker and what value they attach to that? They should look at that and not how much it costs the broker to a trade. That is the difference, and people will pay more for a service that gives them more.

FRANCESCA: Doug, if you measure your brokers’ performance against what you value, then why wouldn’t you just concentrate all of your business towards one or two of the best providers?

DOUG: First, it is not practical; secondly, risk. I like to spread my risk across a number of brokers rather than having all on one. Thirdly, one broker can not provide you with everything- you can not get the coverage that you need. I do not want one broker seeing all the informationthat is a lit that you are giving. I do not want to see 5 global brokers either. It is too much information to be giving out to the market. If I could see 5% of the market, I knew a lot was going on. If you give someone 20%, then they know a significant of what is going on and that is too much information.

WHAT MAKES A GOOD PLATFORM? FRANCESCA: Phil, What makes a good platform for you?

PHIL: Probably the clearest measure that I would use

would be how much time a portfolio trading individual spends processing a trade verses making decisions as to how to execute a trade. It has to be connected to all of the markets that you trade in. It is basically the automation of the process and over-laying that with the technical analysis

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that you need to make the decisions. My focus on technology is not to make the tools make the decisions for me- it is to show me the decisions that I need to make. That is certainly a key area.

FRANCESCA: Scott are alternative trading systems and new trading alliances important factors in deciding who to work with?

SCOTT: We want to access everything that helps us optimise our shortfall. That covers it really.

ILLIQUID TRADES FRANCESCA: Is everything accessible? Have you ever been

given a request that you cannot deliver?

MARK: I did my first Moroccan trade a few years ago in a

previous job, where we actually managed to execute for the client, but realised after the event that we had no agent bank in place. A year later we cancelled it as it was still not settled.

RICHARD: Smaller firms have less access to those execution venues or asset classes.

FRANCESCA: There must be some assets that are totally illiquid.

RICHARD: Brokers are always happy to say that there is a price for everything, but that may not fit with the expected alpha for the lifecycle of the holding.

FRANCESCA: But you would never go back to your client and say there is no way I could get this?

RICHARD: If you look at some of the larger transactions there is a time line that you are looking through to reach your objective. Depending on the risk and the return of those names, you get to the end of that trading period and then you make the decision. One thing that is often missed is an understanding the time in terms of executing your transaction. You may often get an order from a customer and just naturally assume that it needs to be completed by the end of the day, just because that’s the way the majority of orders are. If you understand more of what your client’s underlying objectives are, you may have four or five days to execute that order. That kind of information is something that needs to become more open between the buy side and the sell side and it comes back to the quality of the partnership between broker and client.

automate. If you are trading in an OTC market such as Europe, the opposite is the case. As we integrate more of the trading of different assets it will be interesting to see whether on-exchange business and ease of visibility prevails and whether any other assets in Europe follow the cash equities model. I certainly don’t believe that technology solves everything, and when you are looking at an OTC market it is far less helpful and lack of visibility is the crux of that. However, that’s how the ability to trade dark pools evolved, and Portfolio trading has always been at the forefront of such technology innovation, and I believe it will continue to be there for the foreseeable future.

SCOTT: In the long term, you have to be flexible to changing conditions. If, in terms of our liquidity and trading requirements, they break down into a portion that will be executed on an electronic platform and a portion that will be executed ‘upstairs’. There is a lot that goes on ‘upstairs’. If we think about the UK market, somewhere in the region of 50% occurs off SETS. That is probably the case for many markets especially across Europe. There will be increased numbers of venues and liquidity pools and we have talked about whether you would want to access them all. I would suggest that yes, you would like to access them all, but with the capacity to subsequently look at ‘was that a sensible choice’? Then you can come and back and say ‘No, perhaps in that particular venue I am incurring negative selection’, but at least you would know that. In summary it is about flexibility and being clear as to what one is going to be doing on and off exchange and how one is going to be doing it.

PHIL: Our focus is going to be on continuing to build a large scalable platform that will reliably facilitate our customers’business—whether that be a choice of executing directly or using one of our traders. We will also focus on

THE OUTLOOK FOR PORTFOLIO TRADING FRANCESCA: How will portfolio trading evolve over the next five to ten years, and how you are preparing for that change?

MARK: One of the changes we have been pursuing is the integration of all types of execution that exist within equities, and how technology helps. Different banks have approached integrating businesses at varying rates and levels. It might involve fixed income and equity, or cash and derivatives, or looking at maybe a region through all assets classes. Take, for instance, the evolution of the options markets in the US, where almost 95% of the business now is listed and dealt on-exchange and it is very easy to

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PHIL HODEY, managing director and head of portfolio trading, UBS

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GLOBAL PORTFOLIO TRADING ROUNDTABLE

MARK WHEATLEY, managing director, portfolio trading, Merrill Lynch

providing execution advice, whether that is on implementing a particular strategy or other client needs. A significant area for us is going to be re-aggregating that diverse liquidity pool. We are going to have react quickly to the significant changes that we face in the marketplace over the next few years.

BRIAN: Sources of market information and access are increasing rapidly. So is the necessity to rely more on technology in order to quickly take advantage of that information. It boils down to technology. The increases in technology which we have seen over the last few years is almost nothing compared with what is going to happen in the future. In addition to improvements in the brokers’ abilities in portfolio trading and execution algorithms, there will be massive improvements in getting clients more involved in the portfolio trading and execution process to whatever level they desire.

RICHARD: Undoubtedly, it will be more difficult to differentiate for the sell side and for the buy side also. It is becoming more of a level playing field in terms of access to the tool kit available and liquidity pools. More data is going to be more available i.e. post-MiFiD in terms of market data. This will make peoples’ jobs more difficult and we are going to continue to rely on technology. From a pricing perspective, I expect risk pricing to go up, and agency pricing to come down. The reason for that is risk will be more focused on the more difficult trades. The cost of capital may not necessarily go up, but the make-up of the

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capital that is being requested of the sellside is going to become more expensive. Finally, there will be more partnership between the buy side and the sell side.

Technology allows that to happen, everybody is able to see what the other side is executing and transacting and the conversations that take place. In the past that transparency may have been on an hourly or half hourly perspective but now it will be much more in real time.

DOUG: Everyone will adopt diverse strategies to stay ahead of the game and there will not be as clear a distinction between groups—on both the buy side and the sell side— in the future.

MARK: As everyone says, the key point is flexibility. The rate of change in technology has sped up dramatically.You can plan a certain amount, but you also have to plan flexibility. It would be great to understand exactly where the market is going to be in five years time, but it is impossible to know for sure. You have to make certain assumptions and the plans that you put in place have to be flexible enough to adapt.

FRANCESCA: Portfolio trading accounts for about 30% of total trading. Do you expect that to increase over the next few years?

RICHARD: Measuring portfolio trading as a percentage is subjective. It depends at which point you are actually measuring it. The London Stock Exchange has a definition of portfolio trades as does the New York Stock Exchange, but their definitions are actually different. The way that I tend to measure it is the percentage of our overall cash businesses within Citigroup excluding exchange for physicals. So, taking into account customer generated portfolio trades as a proportion of the over all cash business, that has increased by about 30% over the last two and half years. Do I expect it to continue going up? Not really. It is getting to a point where it is going to start to reverse. As more of the buy side get electronic tool kits, straightforward trades will be executed via DMA or algo routes. However, there will continue to be a need for portfolio desk to evolve to take more complicated transactions. A multi-billion dollar, multiple-day, multiasset type trade is something that the buy side are not going to be doing on a weekly basis, so they need to partner with an experienced broker to get the best result.

PHIL: The average size of a portfolio trade is going to up significantly, but the absolute number of portfolios or proportion of business getting executed by portfolio trading is possibly going to fall. If you compare that to the US there is an interesting statistic that comes out from the New York Stock Exchange (NYSE) on a monthly basis that says that the proportion of business comes in from portfolio trades. But that is often electronic business that goes down a portfolio trading line and may include single stock trades.

RICHARD: I would suggest that number in the US is much less than the 70% reported by the NYSE, but instead may more accurately be around the 40% level.

FRANCESCA: Thank you all very much.

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HIGH YIELD

HIGH YIELD DEBT

The European market for high-yield bonds is still going from strength to strength. Fuelled by an unprecedented volume of leveraged buyouts in a benign environment of low interest rates and corporate defaults, a growing base of investors seems ready to snap up almost anything on offer.

This bull market looks set to reach a record level of issuance this year after virtually doubling in 2006. Andrew Cavenagh reports.

STILL ON THE

UPSWING ROWTH IN THE European high yield market was spectacular last year. European companies issued €37.5bn worth of non-investment-grade bonds last year—about a third of which were dollar denominated— against €19.1bn in 2005, and the early signs certainly suggest an even bigger market in 2007. According to the inaugural quarterly report from the European High Yield Association (EHYA) published in mid-April, issuance in European highyield bonds the first three months of 2007 totalled the equivalent of $9.3bn—an 18.3% increase on the $7.9bn recorded in the same period of the year before. The association advised that this figure could increase as further deals were reported, and investment banks are already putting the total higher.“To date we have had €7.5bn against €7.2bn for the same period last year,”says Youssef Khlat, cohead of European high-yield at BNP Paribas in London.

An additional boost to the market in 2007 will come from an unusually high level of redemptions, as up to €8bn of outstanding high-yield bonds are due to mature during the year. On top of that, there are companies with call options on high-coupon bonds that they issued between 2002 and 2004 that may well take advantage of current interest rates to refinance their debt at lower cost. “They can certainly save 3% to 4% if they issued [with coupons] above 10%,” explains Axel Potthof, senior vice-president and portfolio

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A continuing pick-up in credit quality of new issues was also evident in the first-quarter figures from the European High Yield Association (EHYA), a trade association representing participants in the European high yield market, as a considerably higher majority of the bonds issued in the first three months of 2007, at just over $6.6bn, achieved double-B ratings than in the first quarter of 2006, where the figure was just under $4.6bn.The total of single-B bonds by comparison was down from just under $3bn to just over $2.6bn, while triple-Cs fell away from $318m to $300,000.

Photograph by SolarSeven, provided by Dreamstime.com, April 2007.

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A general improvement in the credit quality of nonmanager in the Munich office of the specialty fixed-income investment grade companies across Europe over the last 18 fund manager PIMCO.“They can issue at 7.5% today.”

Leveraged buy-outs remain the big engine for growth in months has attracted more categories of investor to the the market. They accounted for around 60% of the total high-yield market, as low interest rates have reduced the European high-yield issuance in 2006, and as the size of returns on investment-grade bonds. By contrast, European acquisition that private-equity firms seem prepared to high-yield bonds delivered overall average returns of about contemplate expands further and further into 11-figure 10% in 2006—similar to those of US high yield market— territory, so inevitably will their requirements from the having outperformed the much larger market on the other high-yield market. “About 65% of high-yield bonds in side of the Atlantic in the two previous years. As a Europe currently stem from leveraged buyout (LBO) consequence, traditional high-yield funds now face financings where bonds are issued to finance a takeover by increasing competition on new issues from hedge funds, private equity,” says Potthof. “They are the driving force CDO managers and “cross-over” investment-grade investors such as insurance companies and pension funds, behind the volume of issuance.”

Last year’s £8bn acquisition of Thames Water in the UK, and this expanding investor base has greatly improved the for example, should lead to a high-yield bond issue worth outlook for issuers.

“Demand for high-yield bonds is very high in Europe the equivalent of about £1.2bn within the next few months.

The Kemble consortium, led by Australia’s Macquarie and new issues are frequently several times Bank, that bought Thames has signalled its intention to oversubscribed,” says Potthof.“Many investors are moving refinance part of the £4bn bank loan it raised for the into the high-yield market in the search of higher returns.

Pension funds are certainly acquisition along with the increasing their exposure.” water company’s £3.2bn of While higher valuations existing debt through the An additional boost to the market meant the market would capital markets. Kemble has in 2007 will come from an unusually struggle to match last year’s told the industry regulator high level of redemptions, as up to returns, he says 6% to 7% The Water Services €8bn of outstanding high-yield bonds should be achievable given Regulation Authority are due to mature during the year. stable interest rates and no (Ofwat), the economic deterioration in corporate regulator for the water and On top of that, there are companies profitability. The credit sewerage industry in with call options on high-coupon outlook also remains strong, England and Wales, that it bonds that they issued between with default rates at plans to raise about 75% of 2002 and 2004 that may well take historical lows. According to Thames Water’s regulated advantage of current interest rates to Moody’s, only 1.75% of asset value of nearly £6bn companies in the high-yield from a securitisation-type refinance their debt at a lower cost. market went bankrupt over structure and a further 20% the last 12 months (a figure of the company’s regulatory asset value (RAV) as subordinated debt at the holding well below the historical long-term average of 4.5%) and company level. As the latter will have no recourse to the market consensus is that the number will not rise Thames Water’s revenues—although they will be the only above the low 3% level in the year ahead—a move that will means of servicing the debt—the bonds will not be able to have little impact on investor appetite.“Going from 2% to secure an investment-grade rating and should command a 3% is not a big deal,”confirms Richards at SSGA. A continuing pick-up in credit quality of new issues commensurately healthy coupon.

The sheer volume of money that is still pouring into was also evident in the first-quarter figures from the private-equity funds means that such LBOs should carry EHYA, the trade association representing participants in on dominating European high-yield issuance for the the European high yield market, as a considerably foreseeable future. “You would certainly expect that to higher majority of the bonds issued in the first three continue now given the amount of private-equity capital months of 2007, at just over $6.6bn, achieved double-B that is unspent,” observes Scott Richards, senior portfolio ratings than in the first quarter of 2006, where the figure manager in State Street Global Advisers’ fixed-income was just under $4.6bn. The total of single-B bonds by group in Boston. However, at the same time there has been comparison was down from just under $3bn to just over an increase in the number of large corporate transactions $2.6bn, while triple-Cs fell away from $318m to from companies seeking to raise additional funding or $300,000. Potthof points out that most of the double-B refinance existing debt — including some emerging issuers rated companies in Europe were so-called fallen angels, from Eastern Europe.“Some of those have very good credit which the rating agencies had downgraded from qualities,” says Potthof.“I think, for example, that we have investment grade during the last credit crunch in the had only good experiences with the mobile telecoms 2001 to 2003 period, and that many of them have now recovered to the point where the market is pricing in a companies in Eastern Europe so far.”

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rating upgrade. Ahold and Alcatel are two examples of companies whose bonds were trading at particularly narrow spread levels as a result.

The development of a wider range of high-yield bonds over the past five years has also made the market more attractive to issuers. Khlat at BNP Paribas pointed out that floating-rate and payment in kind (PIK) bonds, in particular, offer private-equity firms much more flexibility in their financing strategies than the traditional fixed-rate instruments and within a short space of time they have begun to account for a substantial portion of the market.“I think around 30% of the issuance in Europe (€11.5bn) in 2006 was in the form of floating-rate notes, which is pretty significant when you consider it was practically zero six years ago,” he explains. “There was also €6bn of subordinated PIKs.” At the same time, he pointed out that the private mezzanine and second-lien markets were offering companies an attractive alternative to the public high-yield markets. With the dynamics of the market working so forcefully in the favours of issuers, it is not surprising that there has been a compression of spreads across corporate sectors that previously commanded significant differentials. Companies with stable cash flows and tangible assets no longer price the bonds significantly tighter than those without either.“The difference between the best and the worst sectors is much tighter than it used to be,”confirms Richards at SSGA. The issuers’ market has also driven a trend towards looser covenants, as these — like spreads — are subject to ‘pricing’ in the market. Several issues over the last year, for example, have not had the standard high-yield covenant package. Khlat at BNP Paribas observes that a relaxation of covenant protection is an inevitable part of the cycle in a bull market, along with companies pushing out the boundaries of leverage. Meanwhile, he acknowledges that some deals are now “getting stretched”, he says. “Default rates remain extremely low, and there is no sign yet that a lot of credits are starting to under-perform seriously. But I think one needs to be more careful and selective,”he adds.

Potthof says there is a distinction in the market between “seasoned” issuers, who have demonstrated the ability to grow profits and pay down debt, and some of the more recent LBO-led transactions where the companies still had to demonstrate that they could repay higher levels of gearing. “The marginal deal is pretty highly levered these days,” he says.“Some of the newer issuers are very highly geared and those are the first that will face a problem if there is a downturn.”He adds that PIMCO is not investing in these transactions.

Despite these concerns about deals on the margin of the market, however, the overall view remains optimistic. At the EHYA’s meeting in February that reviewed 2006 and made its forecast for 2007, most of the speakers expected primary volumes of high-yield bonds to struggle to keep pace with demand against the projected background of low interest rates and default risk. In this environment,

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sponsors are likely to take advantage of the market liquidity to drive even more aggressive structures, covenants, terms and pricing through further convergence of the loan and bond markets.

Taking into account his caveats over the most aggressive deals, Potthof believes the current bull market in European high yield could continue well beyond 2007. “The fundamentals are pretty stable, and this cycle could continue for another two to three years,”he says.“We think it could well be comparable to that of the mid-to-late 1990s, which ended in 2002.”

There is also a general recognition that the economic environment is bound to get tougher at some point—floor rates can hardly go any lower—but how severe a correction this induces in the European high-yield space is a moot point.“Clearly this has to re-adjust,”says Richards at SSGA. “But when that happens and how severely it happens is something we could argue about all day long.”

A recession in the US economy or an oil-price could clearly hit the profitability of certain sectors hard, while the liquidation of one or more hedge funds could impair financial liquidity — which Richards says ultimately represented the biggest threat to the high-yield investor. “If high-yield companies can’t access the equity market to delever, or lose the ample liquidity that the banks are currently providing. That would be a problem,”he says.

The ability to restructure companies with high-yield debt is a pressing concern of the EHYA at present. Gilbey Strub, executive director at EHYA, says the association expected the next cycle of corporate restructurings to be a challenge under the current insolvency regimes in the UK and Europe due to the explosive growth in European leverage lending and the greater complexity of deal structures since 2001.

She says the presence of more subordinate debt holders in typical corporate financings meant the traditional receivership approach (as in the UK) – which favoured secured creditors to the virtual exclusion of all others - was too inflexible. “Leveraged deals have become a lot more complicated since the last cycle because the US hedge funds have really fuelled demand for more variety in subordinated high-yield debt products such as PIKs, hybrids and second-lien deals.”

Such investors would be disadvantaged by the current practice that did not always allow all creditors a say in restructurings and was problematic in other ways – such as basing plans on liquidation values that did not take account of “going-concern” values of enterprises. The EHYA’s European Insolvency Working Group is drawing up a proposal for the UK government to amend existing legislation to promote instead the use of court-appointed administration procedures, as the 2002 Enterprise Act— which was designed to do just that—had clearly not gone far enough in its reforms to do so.“The longer-term effect of restructurings that don’t treat subordinated debt creditors fairly will be to dry up liquidity in corporate finance,”she warned.

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Once considered a back office function, securities lending has come of age and moved to the front of the line. Business is booming, thanks to surging hedge fund activity and the quest for enhanced returns from pension funds. The custodian banks are still major players but they now have to prove their mettle against a growing band of new third party lending and electronic participants.

While the bulk of the business still remains with the custodian lenders, there are new routes to market that offer lenders and borrowers more opportunities to match their requirements. Will the custodian lenders finally meet their match? Lynn Strongin Dodds reports.

THE RUNAWAY RACE FOR MARKET SHARE N THE NOT too distant past custody and securities lending went hand in hand. It was seen as a relatively mundane, straightforward activity which was parcelled out to an institution’s custodian. In the past seven years, the dynamics have changed significantly with the hedge fund community making its larger than life impact. Their voracious appetite for stock has pushed securities lending to new lofty levels. Data Explorers put total lendable assets at $19trn globally, with $4.3trn on loan at any time.

In addition, many traditional fund manager have stepped up their pace in an attempt to squeeze out those extra rates of return. Although securities lending can generate between ten to 20 basis points depending on the programme, it does not take that much to enhance performance. As John Arnesen, managing director, securities lending Europe for Bank of New York, notes “Generating an additional couple of basis points in the equities market, for example, may not sound like a great deal but it is enough to differentiate between returns being in the top or bottom quartile.”

I

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Crowded Pool or Exclusive Access?

Crowded Pool or Exclusive Access? The choice is yours.

or

eSecLending takes an active approach to securities lending by managing customized programs for institutional investors. Unlike the traditional agency approach, where many lendersâ&#x20AC;&#x2122; portfolios are grouped together and their securities sit in a pool waiting to be borrowed, eSecLending markets each clientâ&#x20AC;&#x2122;s portfolio individually and awards lending rights to the optimal bidders.

Our clients receive more lending revenue compared to traditional programs, because eSecLending introduces objective competition via a blind auction process. eSecLending clients achieve all this while maintaining conservative risk parameters, retaining close control over their lending programs and receiving superior, customized client service.

United States +1.617.204.4500 Europe +44 (0) 207.469.6000 info@eseclending.com www.eseclending.com

eSecLending provides services only to institutional investors and other persons who have professional investment experience. Neither the services offered by eSecLending nor this advertisement are directed at persons not possessing such experience. Securities Finance Trust Company, an eSecLending company, performs all regulated business activities. Past performance is no guarantee of future results.

Our services may not be suitable for all lenders.

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INVESTMENT SERVICES: SECURITIES LENDING

John Arnesen, managing director, securities lending Europe for Bank of New York, notes “Generating an additional couple of basis points in the equities market, for example, may not sound like a great deal but it is enough to differentiate between returns being in the top or bottom quartile.” Photograph kindly supplied by Bank of New York, April 2007.

SECURITIES AVAILABLE AND ON LOAN AS OF END MARCH 2007

Securities Available for Lending Securities On Loan Securities Transactions

Number of Value of Securities Securities ($bn) 206,827 12,808 34,741 3,059 1,743,890 Source: Data Explorers, April 2007

Not surprisingly, the increasing level of activity has spawned a new generation of providers hoping to win a piece of the action. Custodial firms not only had to contend with competition from non custodial rivals but also technological US based upstarts such as Equilend, a screen-based securities lending trading platform started in 2001 by 10 leading banks and ESecLending, an electronic auction based securities lending manager.

SecFinex, a European electronic trading platform for securities lending was launched in 2000. Although the human touch is still preferred and relationships are valued, the electronic path has gained traction in the last three years. According to a report published last November by US based research and consulting firm Celent, securities lending via electronic platforms was negligible in 2003 but it now accounts for 10% of all securities lending in 2006. By 2009, this figure is predicted to jump to 20%.

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Faced with a smorgasbord of options, beneficial owners such as pension plans, insurance and life companies have became much more proactive in deciding how and with whom to conduct business. They are carefully scrutinising their portfolios in much more detail in terms of the risk and returns profile as well as corporate governance parameters.

Gone are the days when they would simply respond to borrowers’ demand and just accept the proposed price without comparing and contrasting.

Beneficial owners also appear to have the upper hand when it comes to fees. In the past the typical split was 60/40 between themselves and the providers, but today, the rate is more in the 80/20 range. As one industry participant put it,“We have to spin our wheels a lot more to get to the same place we were a few years ago. There is more competition and it is important to look for new opportunities and products.”

Although the custodial path continues to be welltrodden, beneficial owners may use one firm for its custody and another for securities lending. They are also turning to a lending intermediary such as a securities lending desk at a broker dealer, which typically has a prime brokerage link to the asset hungry end user hedge fund community. An increasingly popular route is the exclusive arrangement.

This is when a lender agrees to lend all or a designated part of a portfolio on an exclusive basis to a borrower selected by it. Despite the hype though, the exclusive market accounts only for about 11% to 12% of activity, according to figures from Data Explorers.

Other avenues being pursued include auctioning off part of the portfolio or using a specialist, for perhaps, the Spanish equities or US fixed income component of the portfolio. A beneficial owner may also decide to create its own securities lending desk. In reality, though, this is only viable for the larger pension funds that have deep pockets and resources to set up the infrastructure. The organisation also has to be willing to take the risk as taking the independent route means not being able to fall back on a custodial indemnification contract.

As Fred Francis, head of global markets for RBC Dexia, notes, “In the past five years, we have seen the business increasingly move from beneficial owners lending directly to them using the agency model.This is because the investment needed in technology and risk management required to run such an operation has become much more complex. The market has grown and spreads have fallen, and managers do not want to take time away from their core focus of fund management. Agents, on the other hand, are geared up to deal with many clients. They have the experience and have been exposed to all facets of the industry.”

Custodians may still be dominant but the majority of beneficial owners are increasingly adopting a best of breed approach and use a combination of venues. Chris Jaynes, president of ESecLending notes, “What we have seen is beneficial owners unbundling the securities lending piece from the custody business. They are using multiple providers for different parts of their business. This is

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AT STATE STREET, WE INSIST ON DOING THINGS IN A VERY SPECIFIC WAY. YOURS.

State Street has been providing securities lending services since 1974, making it one of the most expert lending agents serving the market today.

We’ve put that experience to work to achieve significant returns for our customers without compromising our conservative approach to risk.

With a global presence, a top-quality team and hundreds of lending and borrowing customers worldwide, we are proud to be the industry leader in securities finance.

For more information, please visit www.statestreet.com/securitiesfinance.

INVESTMENT SERVICING

INVESTMENT MANAGEMENT

This advertisement is not directed to any person in any jurisdiction where the publication or availability of such services are prohibited by reason of that person’s nationality, residence or otherwise.

INVESTMENT RESEARCH AND TRADING © 2007 STATE STREET CORPORATION. 07-STT00920107

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INVESTMENT SERVICES: SECURITIES LENDING

A SNAPSHOT VIEW OF THE SECURITIES LENDING MARKET AS OF APRIL 1 2007 Top 10 Equities By Total Balance—showing the scale of activity in these equities

Top 10 Equites By Change in Balance (Total Balance > 10m)

Rank Stock description Change on Previous Mth (%) 1 DaimlerChrysler AG 54.66 2 Roche Holding AG -17.45 3 Novartis AG -19.75 4 Total SA 0.21 5 HSBC Holdings PLC -62.39 6 Nestle SA 26.46 7 AXA SA 2.61 8 Banco Bilbao Vizcaya Argentaria SA 22.44 9 RWE AG 14.20 10 BNP Paribas -0.70

Rank Stock description 1 Kier Group Plc 2 Willis Group Holdings Ltd 3 Bovis Homes Group PLC 4 Laird Group Plc 5 Commvault Systems Inc 6 First Data Corp 7 FMC Corp 8 Dow Chemical Co/The 9 United Dominion Realty Trust Inc 10 Dean Foods Co

Top 10 Corporate Bonds By Total Balance—illustrating the scale of activity in these bonds

Top 10 Corp By Change in Balance (Total Balance > 10m)

Rank Stock description Change on Previous Mth (%) 1 European Investment Bank (6% 07-Dec-2028) 5.71 2 Hipototta Plc (3.181% 30-Sep-2048) -0.54 3 European Investment Bank (5.625% 07-Jun-2032) -8.89 4 Kreditanstalt fuer Wiederaufbau (3.5% 17-Apr-2009) -0.62 5 European Investment Bank (4% 15-Oct-2037) 4.22 6 Freddie Mac Gold Pool (4.5% 01-May-2036) -0.32 7 Freddie Mac Gold Pool (4.5% 01-Oct-2035) -0.14 8 General Motors Corp (8.375% 15-Jul-2033) -5.45 9 European Investment Bank (5.5% 15-Apr-2025) -10.97 10 Kreditanstalt fuer Wiederaufbau (3% 15-Nov-2007) -3.59

Rank Stock description Change on Previous Mth (%) 1 European Investment Bank (4.125% 15-Apr-2024) 2859.66 2 Ayt Cedulas Cajas Global (3.5% 14-Mar-2016) 769.07 3 Eurohypo AG (4.5% 21-Jan-2013) 578.39 4 AyT Ced Cajas Fondo d T'zacion de Activos (4% 07-04-14) 488.83 5 European Investment Bank (3.75% 24-Nov-2010) 366.15 6 Beazer Homes USA Inc (6.875% 15-Jul-2015) 357.84 7 Deutsche Genossenschafts-Hypobk (5.5% 01-04-10) 319.51 8 Bank Nederlandse Gemeenten (5.125% 20-Oct-2011) 301.80 9 Beazer Homes USA Inc (8.375% 15-Apr-2012) 284.43 10 Banco Sabadell SA (4.25% 24-Jan-2017) 255.28

Change on Previous Mth (%) 490.00 465.29 448.36 284.26 281.25 258.37 253.94 253.69 235.07 232.20

The amount of security out on loan as a percentage of the amount available is another indicator of popular stocks. Data from Performance Explorer Lenders by Data Explorers.

Top 10 Equities By Utilisation and Balance

Top 10 Corp Bonds By Utilisation then Balance

Rank Stock description Change on Previous Mth (%) 1 TC Pipelines LP 0.00 2 Cosmo Securities Co Ltd -3.68 3 First Capital Realty Inc not available 4 Frontline Ltd 3.04 5 3D Systems Corp 12.82 6 National Bank Of Canada (5.85% Undated) -1.57 7 Parkervision Inc 11.75 8 Sakata Seed Corp -0.32 9 American Superconductor Corp 0.98 10 WCI Communities Inc 28.61

Rank Stock description Change on Previous Mth (%) 1 Freddie Mac Gold Pool (4.5% 01-May-2036) 2 Fannie Mae REMICS (6% 25-Mar-2037) 3 Bayerische Landesbank (4.785% 23-Jun-2009) 4 Freddie Mac Gold Pool (5.5% 01-Feb-2037) 5 Structured Adjust Rate Mtg Loan Trust(5.955% 25-06-36) 6 Freddie Mac Gold Pool (5.5% 01-Feb-2036) 7 GE Capital UK Funding (5.28656% 01-Aug-2011) 8 Ctywid MtgTrust(4.72% 9-01-34) (SEDOL:12669EG67) 9 Ctywide MtgTrust(4.72% 19-01-34) (SEDOL:12669E3D6) 10 Freddie Mac REMICS (5.5% 15-Sep-2031)

The following tables detail the top securities by fee within two bands of total balance out on loan.

Equity by Fee: more than $10m but less than $100m

Equity by Fee: more than $100m

Rank Stock description 1 Hufvudstaden AB 2 Neurochem Inc 3 Home Solutions of America Inc 4 Imergent Inc 5 Midway Games Inc 6 Cell Therapeutics Inc 7 Eurotunnel SA 8 Sulphco Inc 9 Parkervision Inc 10 Medis Technologies Ltd

Rank Stock description 1 Dean Foods Co 2 NYSE Group Inc 3 Fairfax Financial Holdings Ltd 4 Elisa OYJ 5 OKO Bank plc 6 Fortum Oyj 7 Zoltek Cos Inc 8 Tietoenator Oyj 9 Pre-Paid Legal Services Inc 10 La-Z-Boy Inc

Corporate Bonds by fee: more than $10m but less than $100m

Corporate bonds by Fee: more than $100m

Rank Stock description 1 Dura Operating Corp (8.625% 15-Apr-2012) 2 Georgia Gulf Corp (10.75% 15-Oct-2016) 3 Northwest Airlines Corp (10% 01-Feb-2009) 4 DJ TRAC-X NA (6.05% 25-Mar-2009) 5 Calpine Corp (7.75% 15-Apr-2009) 6 Hawaiian Telcom Communications Inc (12.5% 01-May-2015) 7 Technical Olympic USA Inc (10.375% 01-Jul-2012) 8 MagnaChip Semiconductor Finance Co (8% 15-Dec-2014) 9 Movie Gallery Inc (11% 01-May-2012) 10 WCI Communities Inc (9.125% 01-May-2012)

Rank Stock description 1 Delta Air Lines Inc (8.3% 15-Dec-2029) 2 Argentina Govt International Bond (8.28% 31-Dec-2033) 3 Beazer Homes USA Inc (8.125% 15-Jun-2016) 4 General Motors Corp (8.375% 15-Jul-2033) 5 Sherwood Copper Corp (5% 31-Mar-2012) 6 Turkey Govt International Bond (11.875% 15-Jan-2030) 7 K Hovnanian Enterprises Inc (8.625% 15-Jan-2017) 8 Gaz Capital for Gazprom (8.625% 28-Apr-2034) 9 General Motors Corp (7.125% 15-Jul-2013) 10 France Telecom SA (1.6% 01-Jan-2009)

Source: Data Explorers, 2007

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because no one provider can be the best in every asset class for every client. I think that most beneficial owners will have between two to four providers as opposed to one. In many ways they are applying the same principles they use for fund management to securities lenders. This means choosing providers who can add value in particular asset classes and markets.”

Rob Coxon, head of international securities lending at ABN AMRO Mellon, adds: “There is no doubt that the days of the bundled service are long gone. The business is much more portable and pension funds will more readily move from one provider to the next. Accountability and automation are big themes, and there is much more transparency than there used to be due to the rise of industry consultants and independent benchmarking services. Beneficial owners today are much more engaged and the degree of scrutiny has increased significantly, and that leads to greater competition. It is of course also a more competitive marketplace, particularly in respect of agency lending, due to the emergence of new players such as ESecLending. That has shaken any complacency there may have been out of the industry.”

Paul Wilson, head of sales and client management for securities lending at JP Morgan Worldwide Securities Services, adds, “Up until a few years ago it was almost

Ed Oliver, securities lending product manager for Europe at Northern Trust Global Investments, reflects the industry view when he notes, that “most large custodian banks operate a third party lending service. We can’t always satisfy borrower demand from our custody portfolio and we have added assets to lend in order to become more competitive and to win business.” Photograph kindly supplied by Northern Trust, April 2007.

“I EquiLend.”

At JPMorgan, we leverage the EquiLend platform to increase automation, so that our trading and operational experts can focus on value added services for our lending clients and borrowers.

By using EquiLend's AutoBorrow trading service, our on-loan balances have increased significantly. AutoBorrow increases our scalability, while we believe EquiLend's post-trade services improve efficiency and mitigate risk.

Born leaders choose EquiLend.

Sandie O’Connor Global Head, Securities Lending and Execution Products * JPMorgan

North America +1 212 901 2200 Europe +44 (20) 7743 9510 www.equilend.com * Foreign Exchange, Transition Management, Futures and Options, Commission Recapture EquiLend LLC and EquiLend Europe Limited are subsidiaries of EquiLend Holdings LLC. EquiLend LLC is a member of the NASD and SIPC. EquiLend Europe Limited is authorized and regulated in the United Kingdom by the Financial Services Authority. All services offered by EquiLend are offered through EquiLend LLC and EquiLend Europe Limited using EquiLend proprietary technology and software. © 2001-2007 EquiLend Holdings LLC. All Rights Reserved.

F T S E G L O B A L M A R K E T S • M AY / J U N E 2 0 0 7

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The volume of securities lending transactions traded electronically has increased five fold since 2003 and is expected to double over the next three years. Certainly electronic trading platforms that specialise in securities lending are picking up pace. In Europe at the end of last year, the history of electronic trading of securities lending started to be re-written. In December, Euronext bought a majority (51%) stake in SecFinex, enabling it to compete effectively with rival Deutsche Börse's Eurex platform, allegedly following an unsuccessful bid by interdealer broker ICAP plc for the firm. Not one to take things lying down, ICAP has now launched its own platform. Francesca Carnevale reports.

THE AGE OF ELECTRONIC TRADING FINALLY DAWNS I

CAP INTENDS TO introduce i-Sec, its new electronic trading platform for securities lending in late April.

With i-Sec, ICAP joins a growing band of independent firms that facilitate screen-based access to the securities lending markets. Roy Zimmerhansl, head of electronic securities lending at ICAP explains that: “The strong growth in securities lending and continued pressure on spreads in the market mean that our customers are looking to increase securities lending efficiency and reduce cost.” Moreover, he says, “commoditisation of many transactions is impacting profitability and driving the case for greater automation across the industry”. The firm is well positioned to cater to these trends,” maintains Zimmerhansl, who points to ICAP’s experience in repo, which he says puts the firm in a good position to translate client needs into an essential industry tool.

ICAP’s move is timely. While other vendors in the European sphere, such as Secfinex and Eurex, have provided electronic securities lending trading platforms for a number of years, growth in their market share has been patchy to date. For two reasons, lenders and borrowers are conservative and have tended to stick with tried and trusted relationships. Second, electronic trading platforms, as alternative routes to market, have had to compete with the rise in securities lending auction providers, such as ESecLending.

Interest in European electronic trading platforms took something of an upturn in December however with Euronext’s acquisition of 51% of SecFinex. Reportedly, the platform had sought an investor for some time,

Roy Zimmerhansl, head of electronic securities lending at ICAP explains that: “The strong growth in securities lending and continued pressure on spreads in the market mean that our customers are looking to increase securities lending efficiency and reduce cost.” Photograph kindly supplied by ICAP, April 2007.

and came close to selling itself to ICAP earlier in 2006, but allegedly other major shareholders in the platform, eventually demanded too high a price. Launched back in 2000, SecFinex provides securities lending traders with secure access to a live price-driven marketplace.

Euronext’s acquisition will invariably broaden SecFinex’s potential client based to include members of Euronext and Euronext.liffe. Euronext clients will enjoy a more efficient, cost effective and automated access to the fast-growing securities lending market and the panEuropean exchange now (finally) has an electronic securities trading platform that competes effectively with Deutsche Börse’s Eurex platform. Société Générale Corporate & Investment Banking and Fortis Merchant Bank, have joined Euronext in committing to develop SecFinex's market position. Some market watchers now say that the merger negotiations between SecFinex and Euronext purchase have in fact slowed down SecFinex’s expansion, leaving the door open for ICAP develop and then enter the market with its i-Sec product.

Electronic trading on ICAP’s i-Sec enables market participants to improve their distribution and leverage their relationships by bringing together “multiple

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sources of supply and demand,” says Zimmerhansl.

The i-Sec platform has been designed by traders for traders,” he adds, offering “functionality not available elsewhere in the market.” i-Sec is based on ICAP’s BrokerTec platform, and allows traders active in securities finance to borrow or lend equities via an electronic platform that combines the leading order matching system with a high-speed, high capacity network. Traders enjoy full anonymity until execution, as well as price transparency with full price levels and market depth display. Trading electronically on i-Sec will allow users to manage a wider range of pre-existing counterparty relationships more efficiently, enhancing both distribution and access to securities.

This increased diversity of counterparties will further add to the liquidity in the market. Initially, equities from France, Germany, Italy, Spain, the United Kingdom and Japan will be available for lending and borrowing on the i-Sec platform.

“With our existing client network and strong presence in electronic broking, ICAP is well positioned to add real value to the securities lending market,” says Zimmerhansl. “Widely available blue chip stocks

certain that the custodian would get the lending contract.

Today, that is no longer the case and many clients are making separate decisions regarding lending and custody, albeit they may still select the same organisation for both.

With so many different routes to market we realised we need to provide a platform which can support them all. We want to be a one stop shop and not a one size fits all.”

JP Morgan is not alone. All its rivals have been raising their collective bar and are now falling over themselves to provide the full gamut of services. This ranges from deal negotiation and auctions to the added value of cash or collateral re-investment and customised solutions. As a result, the lines of distinction are blurring between the custodians and the third party agents.

Ed Oliver, securities lending product manager for Europe at Northern Trust Global Investments, reflects the industry view when he notes, that “most large custodian banks operate a third party lending service. We can’t always satisfy borrower demand from our custody portfolio and we have added assets to lend in order to become more competitive and to win business.”

The one threat that applies to all is that against the backdrop of industry consolidation, there could be a concentration of flows into fewer hands. In the past year, State Street announced its intentions to acquire Investors Financial Services (IFS) from Investors Bank & Trust Company while the Bank of New York and Mellon deal rocked the custodial world. According to Bill Cuthbert, chairman of Spitalfields Advisors,“the bulk of the business still goes to 10 custodians. However, the 80%/20% rule applies and the lion-share is captured by the [top] six. This

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lend themselves well to a trading platform, that delivers the best price for stock, while the platform will also bring much needed transparency to the special stocks that are traded.” Additionally, ICAP historically has enjoyed a strong history and market share in the fixed income market, where “all the infrastructure and support are in place,” he adds, “and we will be able to leverage this network to roll out i-sec. Additionally, there is now real convergence between equity and fixed income in many firms.”

With Euronext’s backing, SecFinex will have a new lease of life and Eurex will undoubtedly double its efforts to maintain and grow market share. ICAP’s Zimmerhansl is not fazed by the invariable rise in competition. ICAP’s track record in the bond market and the firm’s long established relationships in the prime broking and repo markets, should provide the firm with the necessary fillip to sustain and grow its i-Sec business, he stresses. If he is right, the launch of ICAP Securities Lending could herald a serious pick-up in the use of electronic trading platforms by securities borrowers and redraw routes to market for a substantial portion of the industry.

Fred Francis, head of global markets for RBC Dexia, notes,“In the past five years, we have seen the business increasingly move from beneficial owners lending directly to them using the agency model.

This is because the investment needed in technology and risk management required to run such an operation has become much more complex. The market has grown and spreads have fallen, and managers do not want to take time away from their core focus of fund management. Agents, on the other hand, are geared up to deal with many clients. They have the experience and have been exposed to all facets of the industry.” Photograph kindly supplied by RBC Dexia, April 2007.

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a significant amount of will now be the top five activity in real money after the BoNY/Mellon terms in the short to merger.

In all but medium term.” exceptional cases, small to One area that does have medium sized pension potential for growth is funds believe it is much synthetics. Chris Taylor, more efficient to use their head of European custodians for their securities securities lending at State lending programmes.”

Street, notes, “We are Not surprisingly, industry seeing and believe that participants have mixed there will be further views on how growth in using synthetics consolidation will impact to enter markets where securities lending and the traditional stock lending is custody world overall. not permitted due to Those that have found regulatory issues. This is partners, of course, are the especially true in the Asian most optimistic about the emerging markets.” benefits for their customer For the foreseeable bases. Others, however, are future, industry participants hoping there might be an believe that hedge funds opportunity to pinch a will continue to drive the client or two during what growth in securities lending. can often be often be a Activity will also stem from period of uncertainty. As traditional long only one custodian put it, “One managers taking a leaf from of the reasons to merge is the hedge fund investment to create a single platform. hymn book. According to However, acquisitions can Chris Jaynes, president of ESecLending notes,“What we have seen is Oliver of Northern Trust, be a painful transition and beneficial owners unbundling the securities lending piece from the “We are definitely seeing an there is a period of custody business. They are using multiple providers for different parts increase in historically long instability from a client and of their business. This is because no one provider can be the best in only managers using employee perspective. It every asset class for every client. I think that most beneficial owners portfolio strategies such as also takes up a great deal of will have between two to four providers as opposed to one. In many the 130/30 which involves management time and ways they are applying the same principles they use for fund shorting 30% of the money and in some cases, management to securities lenders. This means choosing providers who portfolio. I think in the they may take their eye off can add value in particular asset classes and markets.” Photograph future we will see an the ball. Although mergers kindly supplied by ESecLending, April 2007. increase in client using create opportunities to attract new clients, some may also leave during this period.” some capabilities that are typically used by hedge funds and All concur though, that for now there is plenty of this will fuel growth in securities lending.”

There is still some reluctance, however, in certain business to go around. The mature markets including US, Canada, UK and the Netherlands continue to contribute a pension fund quarters over the practice of securities steady flow, while participants have seen more activity lending. This is due to a concern that hedge funds would from Belgium and Spain which have relaxed their use borrowed stock to wield influence on important proxy regulations to allow securities lending. Countries in votes such as mergers and acquisitions. Voting rights are emerging Europe such as Poland, Hungary and the Czech transferred to the borrower when shares are lent.

Industry participants, however, believe that there is a Republic are also expected to bring more supply to the table as is Asia, especially China, India and Malaysia which need for more education across the fund management all have been reported to be interested in opening their spectrum on the finer points of securities lending. Taylor of State Street, adds, “In most jurisdictions, for the markets to securities lending.

However, as Cuthbert points out, these markets may be majority of proxies there is clear evidence the majority of relatively small in the securities lending world.“Despite the shareholders don’t vote. They majority of owners of increased interest in countries such as Russia and India, shares don’t lend them either and when stock is on loan, you still need active borrowers and active lenders and there the majority isn’t always being lent over the proxy dates. is currently not a lot of evidence that they are present. As a Put that all together and it is unlikely that the practice of result, I am not sure whether these countries will generate securities lending will influence a critical proxy vote.”

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That said, Taylor adds,“one can cite examples but with seen as a low risk way of generating reasonable returns.”

Looking ahead, as the market matures and develops, more than 15 years in the market, I can think of only a dozen or so contentious cases where there has been technology no doubt will play an even larger role in clear evidence of a vote being manipulated through automating the industry. Moreover, industry participants that the Markets in Financial Instruments stock on loan.”

A 2005 report by The Securities Lending Committee of Directive (MiFID) and its focus on best execution will the International Corporate Governance Network (ICGN) also have an impact as fund managers take a closer look supports this view. The group found that despite the at how they trade and the best ways to extract value. In prevalence of share lending, most lenders did not recall addition, an increase in regulation and compliance will shares for the purpose of voting them. So far, the force asset managers to monitor their programmes on a regulatory bodies do not seem unduly worried. Currently, more regular basis and understand in even greater the US Securities and Exchange Commission has no firm detail how securities lending can impact their asset plans yet while the UK’s Financial Services Authority, is management activities. currently examining whether to introduce rules requiring investors to report interests in companies held through borrowed shares or contracts for difference. Hermes, one of the country’s largest pensionfund managers has called for regulators to outlaw voting Innovation. altogether by borrowers of Dedication. shares. Meanwhile in Hong Satisfaction.

Kong, the Securities and Futures Commission said it is As a premier provider of global custody studying “issues relating to services, our commitment to delivering borrowed shares and voting.” high-quality tailored solutions and Overall, Wilson believes the excellence in relationship management noise surrounding the proxy continues to be recognised by the voting issue was much louder a leading independent industry surveys. few years ago. This is because Through strong partnerships with our there is not only more clients and a creative entrepreneurial transparency and information culture, we ensure institutional available in the market but also investors can successfully address the beneficial owners are complex challenges they face today. increasing their use of securities lending.

He adds,“Although there have been worries that hedge funds will borrow securities to vote at annual general meetings, in our experience, this has typically not been the case. Many clients look at every situation and determine whether it makes economic sense for them to recall the shares or keep them on loan. It is important to remember that this is a relatively new area for To discover how we can help you achieve your pension funds. Only in the last goals in 2007 and beyond, please contact: couple of years have we seen many of the largest pension Brian Leddy funds lending for the first time.

Head of Sales This is because they are under +44 (0)20 7163 5907 pressure to find new sources of brian.leddy@abnamromellon.com alpha and securities lending is

A passion for results

www.abnamromellon.com

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SUB CUSTODIANS

FLEX THEIR

MUSCLES The business of sub custody, like so many other facets of the market, has turned into survival of the fittest, with the biggest players flexing their financial muscle in order to secure a greater share of territories once claimed by the smaller, regional provider. As competition heats up and clients clamor for more services at lower cost, the trend towards scale is unmistakable. Dave Simons reports from Boston.

NSTITUTIONAL PLAYERS HAVE made clear their desire to utilise as few sub custody agents as possible with the goal of containing costs and streamlining operational processes. More than ever, global giants are demanding from their sub custody clients a greater breadth of services to include everything from fund administration and derivatives processing to streamlined corporate-actions messaging. As has been discussed in recent times, such conditions would appear to signal the ultimate elimination of the mono-market local agent, particularly as super mergers continue to close the ranks of the world’s foremost custody players. Still, many smaller, local agents continue to hang tough, and can be admired for their tenacity.

Still, well-established agents such as Standard Chartered Bank and HSBC have used their intrinsic understanding of the various indigenous markets to good advantage, and today these companies have a clear advantage in a diminishing field of sub-custodians. With technology paving the way for a more efficient brand of custody worldwide, increased competition will ultimately force subcustodians to tweak their business model the same way they have elsewhere, by increasing their client base and bolstering their product line. Technological enhancements continue to emerge at a rapid pace, providing network managers with the tools they will need to minimise risk and widen the communications pipeline going forward.

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SWIFT Strides Key to the continued enhancement of sub-custody services is a fast and efficient communications system, and to that end, SWIFT is currently preparing its XML-based ISO 20022 proxy-voting message standards, which will support end-to-end automation and transparency of the voting process aimed at improving automated meeting notification and cancellation, voting, vote status, confirmation and results.The new message set is slated for release by year’s end.“We continue to see good progress with SWIFT,” remarks Andrew Osborne, head of worldwide network management for Chicago-based Northern Trust, a buyer of sub-custody services.“I think we are all in pretty good shape in terms of the settlement, reconciliation and payment types of messaging. And of course there is a lot of effort currently being focused on corporate-actions messaging, I believe there’s been a nearly 20% increase in the use of CA messaging across the SWIFT network within the past year alone, which is a pretty positive sign.”Still, Osborne believes there is plenty of room for improvement in terms of corporate-action messaging standards. “At a recent SWIFT seminar, it was noted that out of 116 different local sub custodial agents, there were 116 different variances on the use of the SWIFT messages! Obviously that is the kind of thing that needs to be addressed, going forward.”

SUB-CUSTODY & THE SEARCH FOR SCALE

Key to the continued enhancement of sub-custody services is a fast and efficient communications system, and to that end, SWIFT is currently preparing its XML-based ISO 20022 proxy-voting message standards, which will support end-to-end automation and transparency of the voting process aimed at improving automated meeting notification and cancellation, voting, vote status, confirmation and results. Photograph by James Nemec, supplied by Dreamstime.com, April 2007.

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Northern Trust is one of several Seeking scale global custodians working with The recent acquisition of Westpac’s SWIFT to develop a validation Australian sub custody business by service that will allow other HSBC, which followed closely on members to test messages going the heels of the addition of the Abu forward. “At that point, I think we Dhabi Middle East Stock Exchange will have taken the current 15022 to HSBC’s global custody and message format to its fullest clearing network, underscores the extent,” says Osborne, “and we are seemingly insatiable appetite for now looking forward to the 20022 scale among the industry’s biggest Kevin Smith, managing director of global custody message standard, which will players. “And we are likely to see at Bank of New York (BNY) continues to see good provide an opportunity for more further consolidation,” notes BNY’s progress being made in the area of SWIFT flexible and faster data and Smith. “We’ve sort of adopted an utilisation and messaging as it relates to the sub content.” SWIFT maintains a fairly approach over the last several years custody side.“All of the attributes that SWIFT aggressive target of having the where we’ve been less reliant on has had in this space continue to be relevant— industry converted by 2015, says our network and therefore less the performance of the messaging has been firstOsborne,“which, though we here at reliant on local, individual country class, it is independent, reliable and secure, which Northern Trust believe is providers, and thus we’ve adopted is absolutely critical in this area,” says Smith. achievable, may be more difficult a strategy to utilise multinational Photograph kindly supplied by Bank of New for other members in the industry. global-type firms that certainly York, April 2007.

And of course, maintaining have an extensive regional, multiadequate investment in the current 15022 standard is very market capability. Clearly, this is a scale business, says important, even while we are working on converting to the Smith. In Europe we’re already seeing consolidation on a new standard. As such, one of the roles of our group is cross-border basis, and that’s something that’s going to staying on top of our sub custodians in terms of managing continue to evolve over the next several years.” their technological development. And naturally the transfer Says IBT’s Gallagher,“A year ago we had 29 relationships agent is such a critical part of the system, and if we can get covering 92 markets, and this year we are at 21, and our them fully integrated into the electronic-communications stated objective was to get to 15. The point is, any sub chain, everybody wins.” custodian that can handle only one or two markets is going Kevin Smith, managing director of global custody at The to have a real tough time competing long term. Because the Bank of New York (BNY), continues to see good progress world is consolidating, and I think the institutions that being made in the area of SWIFT utilisation and messaging cover the 10-plus markets—such as Standard Chartered, as it relates to the sub custody side. “All of the attributes HSBC, Citibank—are already dominating [the space] and that SWIFT has had in this space continue to be relevant— will really squeeze the individual providers right out of the the performance of the messaging has been first-class, it is market. Last year alone we terminated with six different independent, reliable and secure, which is absolutely single-market providers, and we have another four or five critical in this area,” says Smith.“And it has also been very that we have currently targeted. Moreover, it is not because well utilised from a geographical standpoint—for instance, of service issues—it is just that if there is another provider of the 103 markets we now have in our sub custodian in the same market who we also use for other markets and network, there’s only a single market in Latin America that who can do an equally good job, we can then leverage our does not actually have SWIFT deployed as yet, but that is services, contracts and fee schedules. It is a clear trend.” mainly a country issue. It has been a cash mechanism for BNP Paribas, which oversees a multi-market European 30-plus years and has been used extensively as part of our sub-custody network, has been picking up more trade-processing and reconciliation side, and now it’s mandates in markets that have typically been provided for moving into the asset-servicing messaging space on or supported by some of the mono-market subcorporate actions, dividends and the like.” custodians, says Jason Nabi, head of financial “At this point, on your plain vanilla products, SWIFT is intermediaries in the UK. “In the past, the Tier-1 working quite well,”adds Bob Gallagher, senior director of investment banks and even some of the Tier-2 banks have global network management, Investors Bank & Trust (IBT), been the main clients of some of those mono-market the Boston-based custodian recently purchased by State providers. For the most part, that client base remains the Street Corp.“I think where corporate actions is concerned, same, although there has been some consolidation across the issue is to get SWIFT more ingrained, starting with the that segment of the financial intermediaries market to issuers and all the way through to the custodians, similar harmonise their relationships and their providers. In Italy to the way an STP might work on a securities trade. Of and the UK, for instance, there have been strong local course, getting the issuers on board remains a challenge— providers that have not necessarily had a European they have different priorities. So I think that is still a high network, and recently there has been a switch to include risk area.” those markets as part of a wider arrangement.”

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Bob Gallagher, senior director of global network management, Investors Bank & Trust, the Boston-based custodian recently purchased

by State Street Corp.“I think where corporate actions is concerned, the issue is to get SWIFT more ingrained, starting with the issuers and all the way through to the custodians, similar to the way an STP might work on a securities trade. Of course, getting the issuers on board remains a challenge—they have different priorities. So I think that is still a high risk area,” he says. Photograph kindly supplied by Investors Bank & Trust, April 2007.

Andrew Osborne, head of worldwide network management for Chicago-based Northern Trust, a buyer of sub-custody services.

Osborne notes that: “We are all in pretty good shape in terms of the settlement, reconciliation and payment types of messaging. And of course there is a lot of effort currently being focused on corporate-actions messaging, I believe there’s been a nearly 20% increase in the use of CA messaging across the SWIFT network within the past year alone, which is a pretty positive sign.” Photograph kindly supplied by Northern Trust, April 2007.

Additionally, there is considerable demand for integrated services and products from the more medium-sized Tier-3 banks and brokers, who are looking for someone who can offer them execution DMA with integrated clearing on a wide range of markets and who can support them in their middle- and back-office processes. “We think all of that puts pressure on the mono-market providers,” says Nabi.

“The ability to bring together execution with clearing, settlement and with other services is where we are seeing the requirement going.”

Still, how does one replicate the “personal”attribute that regionals have long touted? For one thing, by maintaining a “localised” approach to custodial services, says Nabi.“All of our main markets across Europe are covered by a branch set-up, so that we have local-market employees, as well as local-market interfaces with the CSDs, the CCPs, the exchanges, the regulators and the central banks, which allows us to have the same arrangement we have in the UK as we would in Italy, France or Spain. In that way we can deliver local expertise, but because it is part of a global or at least pan-European set up, we provide a degree of integrated scale.”

While the adoption of technology and standards have seemingly pushed the mono-market provider one step closer to extinction, opportunity still exists for enterprising smaller-scale players through the use of personalised services.“We all to a greater or lesser extent make demands of our sub custody providers beyond the plain vanilla offering,”says Keri Smith, director of network management for RBC Dexia Investor Services.“You could look at the old

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Jason Nabi, head of financial intermediaries in the UK at BNP Paribas.“In the past, the Tier-1 investment banks and even some of the Tier-2 banks have been the main clients of some of those mono-market providers.

For the most part, that client base remains the same, although there has been some consolidation across that segment of the financial intermediaries market to harmonise their relationships and their providers,” he says. Photograph kindly provided by BNP Paribas, April 2007.

adage,‘One person’s meat is another person’s poison.’What we may consider to be a personalised service may be a standard offering for others. This is one of the reasons why, when on paper so many sub custody providers can offer similar services, the global custodians may select different providers. Unless the markets evolve to the point where there is only one effective provider, then there will always be choice. That choice means there is an opportunity for the local providers to distinguish themselves by aligning personalised services to clients. I do not see this form of ‘value-added’ servicing disappearing from sub custody relationships any time in the foreseeable future.”

Looking ahead While there has been extensive interest in the emerging markets in the past several years—and this appears to be continuing—sub custody providers are being cautious with their expansion efforts, still mindful of the market collapses which affected places like Kazakhstan, Ecuador and Bolivia of the late ‘90s, says RBC Dexia’s Smith. “As we branch forward and the investments in emerging markets continue to grow at such unprecedented levels, many of the sub custody providers have begun assessing and introducing offices to support the business in some of these markets.

However, the trend to do so certainly appears to be done based on the historical lessons learned in the past, and not solely on the ‘push’ from clients or investors. With that being said, as long as the hot markets continue to draw investment interest, sub custody providers will continue to introduce their support as well.”

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points, the ongoing changes around In Europe, the single-currency the various settlements engines, and platform presents the opportunity so forth—the whole architecture is to consolidate and to eliminate constantly evolving. As a service cross-border roadblocks, and provider, that’s part of our value looking ahead, many believe the proposition to clients—they look for TARGET2-Securities (T2S) us to take the lead in these areas in initiative gives the EU industry its an aligned operating model that will best hope of achieving such not cause them or their clients any universality. Under the current problems. So we spend a lot of time scenario, TARGET2-Securities and investment capital making sure could provide settlement, with Keri Smith, director of network management for that we’re up to speed not only with depositories like Euroclear and RBC Dexia Investor Services. “You could look at what the markets are up to today, Clearstream fulfilling the assetthe old adage, ‘One person’s meat is another but what they are likely to do servicing piece. However, obstacles person’s poison.’ What we may consider to be a moving forward.” remain. “The proposal only covers personalised service may be a standard offering Political changes in the securities Euro currencies,” notes IBT’s for others. This is one of the reasons why, when industry will always affect sub Gallagher,“which cuts out the UK, on paper so many sub custody providers can custody services in one way or Switzerland and other non-Euro offer similar services, the global custodians may another, adds Smith of RBC Dexia. trading countries. The real concern select different providers,” says Smith.

“MiFID legislation will add to here is that even if this is Photograph kindly provided by RBC Dexia monitoring mechanisms and tighter established as a cost-saving Investor Services, April 2007. controls, but the Code of Conduct venture, the for-profit depositories, in an effort to continue to provide shareholder value, are and Target2 will require introductions of additional requirements as well. It is important to continually going to raise prices on another part of their business.”

Initiatives such as Europe’s forthcoming Markets in introduce and enhance legislation with an eye toward Financial Instruments Directive (MiFID) are prompting an fostering further growth and not hindering it. To be almost complete renewal process in the STP arena, successful, there must continue to be dialogue with all according to Nabi.“You look at the increased volumes, the parties involved. Doing so will allow us all to learn and complexity, the numerous additions in terms of execution contribute to builds that make the industry more vibrant.”

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OFFSHORE CENTRES SQUARE UP TO COMPETITION

IS OFFSHORE STATUS UPDATED?

Offshore centres face the dual challenge of having to compete with onshore and fellow offshore jurisdictions. Onshore, financial centres such as Dublin and Luxembourg, have managed to blur the boundaries between offshore and onshore designations. Offshore, competition is stepping up as centres seek to make dealing in their jurisdiction cheaper and more cost effective than elsewhere, while offering root and branch service provision that competes directly with onshore providers. Are descriptions such as onshore and offshore now in need of an overhaul?

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PAULA COX, DEPUTY premier and minister of between London and New York. Wojciechowski points out finance for Bermuda was on a road show in London at that in sectors such as insurance; Bermuda has now the end of March, under the auspices of the Bermuda outstripped London and New York. It is a duality explains International Business Association (BIBA). Armed with the Wojciechowski, offshore investments are coming back into consummate charm of a seasoned and successful politician, vogue and the island “is the beneficiary of flexible, lighter Cox is frank about the pressures the island centre has been touch regulation that does not burden shareholders but still offers protection”. labouring under. “Bermuda The BSX he says has certainly took a beating a developed on “those lines few years ago from the as well, and is now looking Cayman Islands in the area at listing a variety of of fund administration. products, such as US nonNow we have a good registered 144a turnaround story. We placements, hedge funds listened to firms who had and special purpose seriously considered vehicles – many of which coming to Bermuda who are structure and pointed out that we were administered onshore.” bureaucratic and that the Both Cox and island’s due diligence Wojciechowski agree that process was onerous. Now what is happening in we have turned that Bermuda, and they around.” Cox thinks there venture other jurisdictions are four key elements: the as well, is that business is existence of a strong no longer traditional and partnership between the commercial benefits of government and the private an offshore designation is sector, an island wide being adapted to suit new commitment to providing market conditions. As quality service, the Wojciechowski would development of a local, have it, “it is about qualified and strong seriousness and the level professional sector and the of regulation that gives establishment of a investors all the comfort regulatory regime that is fair they require, and yet being and consistent. commercially flexible.” As Cox was in London to Tamara Menteshvilli, chief executive officer of the CSX explains that Cox has it, it is providing sell the island’s updated the easing of regulations governing funds listing in Jersey “is a “regulatory credibility fund legislation package proactive set of regulations that allows the fast-tracking of both the with a competitive edge. because, she says, establishment of a fund and the listing of it.” Menteshvilli also points Increasingly it is a story “complacency has no place out that although the initiative was introduced by the Jersey about efficiency and in the new world order. regulator, CSX will the first port of call for funds intending to list. effectiveness.”

Clients walk with their Photograph supplied by Berlinguer Ltd, April 2007.

The Channel Island feet.”

Moreover, Cox jurisdictions of Guernsey acknowledges, these days clients have a lot of places to walk to, as a key impact of and Jersey have also been active in easing the bureaucracy of globalisation has been to result in the establishment of funds listing, without sacrificing quality of standards. Recent centres of expertise in varied financial centres around the figures show that the value of funds under administration in globe, including Dublin, Luxembourg, the Cayman Islands, Jersey, now at a record high of £179.1bn, has risen by 30% the British Virgin Islands, Dubai, Guernsey, Jersey, the Isle over 2006. The hedge fund sector along, with private equity and property, has been the catalyst for much of the growth of Man and Labuan.

Competition between offshore jurisdictions has helped that began in 2004 when the Expert Fund Guide, the new raise the bar for local regulatory standards and improve the streamlined authorisation regime for alternative investment image of offshore centres worldwide. Greg Wojciechowski, funds, was introduced by the Jersey Financial Services president and chief executive officer of the Bermuda Stock Commission (JFSC). Since then, the momentum has shown Exchange (BSX) says that the overhaul of Bermuda’s no signs of slowing. In the last 12 months, expert funds regulatory regime means that “all the pieces are there” to registered in Jersey have more than doubled to 274, while leverage the benefits of Bermuda’s strategic location the net asset value of such funds now stands at £29.5bn.

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U n i q u e l y

Established in 1971 the Bermuda Stock Exchange (BSX) is today the worldâ&#x20AC;&#x2122;s fastest growing offshore securities market.

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The BSX is internationally recognised as an attractive venue for the listing of: Hedge Funds Investment Fund Structures Equities Fixed Income Structures Derivative Warrants

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The BSX is a full member of the World Federation of Exchanges.

Bermuda is a British Overseas Dependent Territory and is part of the UK for the purpose of OECD membership.

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GUERNSEY STREAMLINES FUND REGISTRATION regulation and due diligence to the licenced Guernsey service provider (fund administrator), than the individual investment funds themselves.

The Guernsey Financial Services Commission (GFSC) amended its regulatory framework and streamlined the consent process for registered closed-end funds as of the beginning of February this year. The GFSC will grant the required fund consent within three working days, if the Guernsey licensed service provider can show that it has carried out ver the last two years, Guernsey like many offshore sufficient due diligence to be satisfied that the regimes, has undertaken a root and branch review promoter and associated parties are fit and proper. of the jurisdiction’s legal and regulatory regime to Second, that effective procedures are in place to enable it to compete effectively in an increasingly ensure that the fund is not offered to the Guernsey globalised market in which new financial centres are public directly by the issuer and that the status of emerging. In Guernsey’s case, a working party led by the registered closed-end fund is specifically referred Guernsey advocate Peter Harwood, undertook a to in the prospectus or offering document. comprehensive review of the island’s investment According to Ben Morgan, partner at Carey Olsen in regime and issuing a number of recommendations in a Guernsey, the process of self-certification “has worked report, published in the summer of last year. Over the well with QIFs and there is remainder of this year, it every reason to believe is expected that most if this process will work just not all of Harwood’s The GFSC will grant the required fund as well.” Morgan explains recommendations will be consent within three working days, if the that it now takes up to enacted, a move which Guernsey licensed service provider can show three business days for has been described as that it has carried out sufficient due diligence the GFSC to approve a vital for Guernsey, as to be satisfied that the promoter and fund, though it “must other offshore have a Guernsey jurisdictions, such as the associated parties are fit and proper. Second, administrator and all the Cayman Islands, continue that effective procedures are in place to disclosure requirements to benefit from ensure that the fund is not offered to the laid out in the APC form streamlined fund approval Guernsey public directly by the issuer and that must be met. There is processes that can take the status of the registered closed-end fund is now an onus on the as little as 48 hours. specifically referred to in the prospectus or administrator to undertake Key elements of the due diligence and, let’s be report’s recommendations offering document. clear, there are no included the introduction changes in the actual due of a new Prospectus Law, diligence requirements, but now the responsibility shifts which provided new guidelines for disclosure for all to the administrator, rather than the regulator.” Morgan Guernsey domiciled entities raising capital, a new adds that the GFSC will still carry out limited checks and funds law to cover open and closed ended investment will still review all filings. “There is no dumbing down of funds and the categorisation of funds into ‘regulated’ regulation, the process of regulation is by no means and ‘registered’ funds. Regulated funds will consist of diminished by the new rules,” stresses Morgan. traditional UCITs-type funds as well as Guernsey’s The remainder of the proposals can only be existing class B schemes, which are commonly used implemented when legislation is enacted and these for alternative investment funds. The funds will be will therefore come on-stream during the year. required to have their administration carried out in However, the Harwood report is only one of a Guernsey and fund promoters and managers will be number of initiatives being undertaken in the subject to full diligence once the funds are set up.

Bailiwick through 2007. A working group for the The report’s also recommended the removal of fiduciary sector has already published proposal that regulatory obstacles that could make it difficult for are set to introduce the civil law concept of Guernsey service providers to administer or provide foundations into the Guernsey legislature. The move services to non-Guernsey funds. Finally, Harwood offers a counterpoint to Switzerland’s adoption of the proposed that the consent process for registered common law of trusts in 2005. funds should be streamlined by shifting the focus of Following last year’s publication of the so-called Harwood Report on the Guernsey’s regulatory and legal regime, the island’s independent financial services regulator streamlined the consent process for registered closed-ended funds at earlier this year, simplifying procedures and cutting back the time needed to domicile funds in the jurisdiction. There’s more to come however.

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At the start of the year Jersey’s funds industry received their alternative investment vehicles. “Jersey’s legal and a boost as the regime achieved recognition by the Dutch fund professionals can compete even more effectively as a Financial Markets Authority (AFM) and introduced the result of these measures,”says McArthur.

“The launch of the light touch, fast track regulatory Listed Fund Guide. The decision by AFM to add Jersey to the short list of jurisdictions whose regulation is considered regime for listed closed ended funds will help the Island to sufficient to allow a light touch by the Dutch regulator acquire more alternative funds business, taking advantage enables Jersey funds to be listed on the Euronext exchange of the current upswing in permanent capital vehicles for private equity and hedge fund managers,”he adds.“Finally, without the need for a licence in the Netherlands.

Yatra Capital Limited, an Indian property fund, advised by there is considerable interest from private equity funds and law firm Carey Olsen, was the first fund to take advantage other alternative investment vehicles in listing on of the recognition, raising £100m through a placement on Euronext, so the timing of the AFM’s recognition of Jersey the exchange. Jersey’s new listed fund guide ensure that is ideal in such a buoyant market.”

Undoubtedly, Jersey’s moves was a competitive response closed ended investment funds that are listed on European and other leading stock exchanges including the London, New York, Dublin, Channel Islands Stock Exchange (CSX), the Alternative Investment Market of the London Stock Exchange and Euronext, can be subject to a streamlined 72-hour approval process.

Although similar to Jersey’s Expert Fund regime in terms of a streamlined approach, the Listed Fund regime is not restricted to ‘expert investors’and appeals to fund managers and hedge fund service providers. The principal benefits are certainty of the process and the timing - which are both critical in any fund launch. According to Tamara Menteshvilli, chief executive officer of the CSX“It is a proactive set of regulations that allows the fasttracking of both the establishment of a fund and the listing of it.

Maintaining the list of recognised exchanges for that purpose is conducive to our exchange, because our rules are linked to that regime.

The first port of call will be to consider a listing on our exchange.”

The regime is available to private equity, property and other alternative investment funds, such as hedge funds and funds of hedge funds. The move is widely regarded as a means to increase Jersey’s competitiveness in the UK REITs sector, which has been slow to pick up to date, but which is now picking up steam.

Graeme McArthur, representing the Jersey Funds Association, described the developments as important in P.O. Box 623, One Lefebvre Street, St Peter Port, making the jurisdiction an even more Guernsey GY1 4PJ Guernsey T +44 (0) 1481 713831 attractive option for fund promoters Jersey T +44 (0) 1534 737151 F +44 (0) 1481 714856 www.cisx.com seeking the appropriate location for

We aim higher.

The CISX A more personal Stock Exchange delivering professional services efficiently and responsibly to the global marketplace.

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Greg Wojciechowski, president and chief executive officer of the Bermuda Stock Exchange.

Both Cox and Wojciechowski agree that what is happening in Bermuda, and they venture other jurisdictions as well, is that business is no longer traditional and the commercial benefits of an offshore designation is being adapted to suit new market conditions.

As Wojciechowski would have it, “it is about seriousness and the level of regulation that gives investors all the comfort they require, and yet being commercially flexible.” Photograph kindly supplied by the Bermuda Stock Exchange, April 2007.

to the success of neighbouring Guernsey’s success in having Guernsey registered private equity funds, list in Euronext and reach a broader investor audience. When it floated on Euronext Amsterdam last May, Kohlberg Kravis Roberts’ landmark listed fund, the Guernsey-based KKR Private Equity Investors LP, provoked euphoria among the private equity industry. Heralded as a new way of financing, the IPO targeted $1.5bn (€1.15bn), but ultimately, following immense appetite from investors, more than tripled its goal, raising a massive $5bn. KKR Private Equity Investors IPO was swiftly followed by a similar listing from Apollo, which in August last year priced $1.5bn-worth of shares through a global private placement for AP Alternative Assets LP — again based in Guernsey and listed on Euronext. More recently, 3i announced that it was seeking to raise £1.3bn (€1.9bn) for a listed infrastructure vehicle, amid rumours that the FTSE 100 firm is looking to shift its fundraising to the public markets. The Carlyle Group is also understood to be preparing to float a $1bn fixed-income securities vehicle in London or Amsterdam.

Competition between offshore exchanges looks likely to accelerate over the coming years as each jurisdiction strives to create a 360 degree service level that not only encourages registration, but also local listing and by

Graeme McArthur, representing the Jersey Funds Association, described the developments as important in making the jurisdiction an even more attractive option for fund promoters seeking the appropriate location for their alternative investment vehicles. “Jersey’s legal and fund professionals can compete even more effectively as a result of these measures,” says McArthur. Photograph kindly supplied by the Jersey Funds Association, April 2007.

extension, the establishment of a liquid trading environment. For all offshore centres, this is a particular sticky issue, as they increasingly compete, in a post Regulation NMS and Markets in Financial Instruments Directive (MiFiD) defined world. What it means is that not only do they compete directly with the main exchanges in onshore markets but also now with the rise of specialist trading pools and dark pools. In response, offshore centres can lose as much or as little of the bureaucracy and due diligence (without sacrificing quality and the international standards they mirror) in order to make it more attractive for funds and firms to register in their jurisdictions and list on their exchanges. How the different centres will respond to these ongoing challenges is only now emerging. The likelihood is that business will eventually coalesce around centres of excellence, such as the Channel Islands and Bermuda, which can boast a multiplicity of expertise, in areas as diverse as alternative fund administration, real estate funds, Islamic finance, special purpose vehicles (SPVs), and the trading of fungible securities, such as 144a placements. Some responses will be suprising. Expect at least one or more offshore centres to develop a strategic tie-up with a leading mainstream exchange. Expect others to respond with initiatives in Asia. As Bermuda’s Cox emphases,“we are constantly reinventing ourselves to the benefit of our customers and we have yet more to do.”

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ALL THE FUN OF THE FAIR HESE ARE DAYS of wine and roses for alternative fund administrators and there is still much more to look forward to. According to the December 2006 HFMWeek Hedge Fund Administrator Survey, of 57 hedge fund administrators, some $2.1trn of hedge fund assets were under administration (AUA), as of the end of October last year. Over the six months up to November 2006, the number of single and fund of hedge funds under administration grew by 7%, to number 18,817, with the number of fund of hedge funds under administration growing by 20%.

Celent senior analyst Denise M Valentine, points out that, most likely, the US market share of hedge fund managers will tail off from 63% of the global market, to around 50% over the next two years, as hedge fund growth continues outside North America. In particular, she thinks European hedge fund assets will grow fastest, increasing their share of the global hedge fund market from 27% last year to 35% by 2009, while Asia’s market share will also increase from a little under 5% to around 9% over the same period.

Crucial to today’s alternative fund administration business is the continuing propensity of hedge funds, real estate investment firms and private equity funds to outsource their back office operations to focus on asset building instead. Additionally, Bob Donahoe, director of business development at BISYS in New York thinks a number of cross-trends add new layers of complexity.“Size is definitely a growing phenomenon, funds are getting bigger with diverse requirements,”he explains.

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While in some markets, such as Dublin, competitive pressure is being eased by consolidation (Bank of New York’s planned merger with Mellon and State Street’s purchase of Investors Bank & Trust) , globally competition to provide independent fund administration services continues to thrive.

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ALTERNATIVE FUND ADMINISTRATION

Enjoying refulgent growth, the alternative fund administration business is still on the upswing. The good news is, there is little sign of market overcrowding and in the short term, this will encourage more firms to establish niche positions.

Ultimately, the alternative fund administration market will become a mirror image of the custodian market, where the top ten firms dominate the business by a country mile, but that is really a consideration for the future. In the meantime, as they used to say in the 1960s, it’s a happening. Francesca Carnevale reports.

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ALTERNATIVE FUND ADMINISTRATION

Second, Donahoe points to the fact that more mainstream institutional investors (pension funds and endowments) now allocate assets to alternative fund managers. A record $126.5bn of new money flowed into the hedge fund industry last year, nearly tripling the $46.9bn in new money they attracted in 2005, according to Hedge Fund Research, which tracks more than 10,500 hedge funds. This trend is unlikely to diminish for over the short term, particularly where pension funds are looking to shore up shortfalls. Local developments also add to the mix. As Peter Heaps, managing director of RBC Dexia Fund Services in Dublin, “as a consequence of UCITs 3, mainstream funds can invest in a broader range of instruments, allowing traditional clients to migrate into alternatives.” These particular trends play directly to the house of specialist administrators.

According to the Bank of New York and specialist research firm Casey, Quirk and Acito’s seminal paper on Institutional Demand for Hedge Funds: New Opportunities and New Standards the two most popular answers to the question, “what makes for an attractive hedge fund firm? [sic]” were outstanding risk management and operational and structural excellence. Appositely, included in operational excellence were independent checks and balances on asset valuations. The follow on is, “A flight to quality,”says Rachel Turner, head of client services, at Bank of New York’s fund administration centre in Dublin. “It gives institutional investors comfort to know there is a capable third party administrator involved. As more institutional investors invest in alternative assets, hedge funds are much more likely to choose an administrator with an extensive track record.”

Equally, says Donahoe at BISYS the assortment of client requirements is becoming increasingly diverse.

In the midst of plenty however, challenges remain.

Globally over 70 separate fund administrators already compete for business—albeit growing business.

According to Celent’s Valentine, current market growth rates will only spur more firms to enter the fray.“Venture capital and investment banking firms are actively pursuing fund administration business,” she states. “In some cases, encouraging experienced staff in the major houses to set up on their own, bringing one or two clients along with them. You need expert staff, a high end accounting management system that you can buy for a few million dollars and the establishment of a particular niche offering and perhaps superior technology.” At the time this edition went to press, news was emerging that six ex-PFPC staff in Dublin were about to do just that, starting a new company Quintillion. BearStearns is also rumoured to have a share in it. “A number of established houses are still working with old, legacy systems,“ notes Valentine, who points out that regular investment in new technology is de rigueur for administrators these days, pointing to as an example, CITCO’s teamwork with Smartstream to upgrade its platform.

For established houses however, niche expertise is not enough. They live in a demand-pull world, where fund administrators must continually invest in their businesses, extend their global reach, and generally upgrade services across the board while keeping costs to a minimum.

It is not as easy as it sounds, even for well established operations. “Our clients are constantly trading new investment strategies and products. As a result, many

MERGERS & ACQUISITIONS IN HEDGE FUND ADMINISTRATION AQUIRING FIRM Bank of New York State Street Fortis Prime Fund Solutions Mourant Mellon Northern Trust Butterfield Fund Services JP Morgan Citigroup HSBC SS&C Technologies

Bank of New York BISYS State Street BNP Paribas

ACQUISITION Mellon Group Investors Bank & Trust Hedge Fund Services (HFS) BVI* AIB Fund Administrators (Jersey) DPM Baring Fund Administration Deerfield Fund Services Tranaut Fund Administration Forum-Financial Group Bank of Bermuda Amicorp Fund Services, Eisnerfast Cogent Management International Fund Administration Hemisphere, RK Consulting International Fund Services Cogent RBS International Fund Services

YEAR 2007 2007 2006 2006 2005 2005 2004 2004 2003 2003 2003 2005 2006 2002 2002 2005 2002 2002 2007

Source: Celent, Trends in Hedge Fund Administration, August 2006. Various market reports & interview notes, March/April 2007

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ADMINISTRATION OF SINGLE HEDGE FUNDS: ASSETS UNDER ADMINISTRATION AS OF NOVEMBER 2006 FUND ADMINISTRATOR CITCO FUND SERVICES HSBC ALTERNATIVE FUND SERVICES BISYS INVESTORS BANK & TRUST STATE STREET (IFS) GOLDMAN SACHS FORTIS PRIME FUND SOLUTIONS GLOBE OP CACEIS INVESTOR SERVICES SS&C FUND SERVICES Total number of firms in HFMWeek survey: 57

TOTAL ASSETS UNDER ADMINISTRATION (AUA) ($bn) 310.0 174.4 151.47 144.6 142.5 142.0 123.0 100.1 85.79 71.0 Total of AUA (Single Funds) $1788.46bn

% CHANGE (APR-NOV 2006) 29% 17% 13% 19% 2% 14% 19% 25% 3% 34% Overall growth in period: 17%.

Source: Source: HFMWeek Hedge Fund Administrator Survey, December 2006.

ADMINISTRATION OF FUND OF HEDGE FUNDS: ASSETS UNDER ADMINISTRATION AS OF NOVEMBER 2006 FUND ADMINISTRATOR FORTIS PRIME FUND SOLUTIONS CITCO FUND SERVICES HSBC ALTERNATIVE FUND SERVICES UBS FUND SERVICES SEI BISYS EURO-VL (SG SS) STATE STREET (IFS) PFPC OLYMPIA CAPITAL Total number of firms in HFMWeek survey: 57

TOTAL ASSETS UNDER ADMINISTRATION (AUA) ($bn) 134.0 105.0 84.4 77.07 53 51.62 51.6 42.6 30.8 25.0 Total of AUA (Fund of Funds) $954.09bn

% CHANGE (APR-NOV 2006) 20% 17% 17% 21% 13% 12% 64% 22% -1% 0% Overall growth in period: 20%.

Source: HFMWeek Hedge Fund Administrator Survey, December 2006.

instruments are difficult to price and require operational expertise in understanding cashflows, resets and other contract terms. Management and performance fee structures are becoming bespoke and therefore more complex,” acknowledges Meliosa O’Caoimh, chief operating officer, at Northern Trust’s fund administration centre in Dublin. The nature of the business renders 100% STP virtually impossible, especially in areas like Fund of Funds and derivative processing. Our approach is to automate as much as possible, to surround the business with talented resources and to maintain focus on simple control measures that ensure good overall operational results,” says O’Caiomh. BISYS’s Donahoe expands on the theme. “Some people do view alternative fund administration and hedge fund administration in particular as something of a commodity,” he says, “but the securities traded, the structures, and the fee calculations can be complex. It is not simply a question of people on the job, following things through; it is having the right people.”

Business growth from over-the-counter heavy funds, derivatives-driven vehicles and credit-based entities has been particularly robust of late and Donahoe specifically mentions that BISYS is seeing a lot more derivatives—both

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over-the-counter and exchange traded—and “a lot more distressed debt and swaps”.

Alternative fund administration then remains an uneasy mix of commoditised and customised operations, which means that houses are heavily dependent on the quality of inhouse expertise. In a specialist alternative fund administration centre, such as Dublin, this has created its own peculiar problems (please see box: Ireland seeks competitive cost advantage). Phil McGowan, managing director of Investors’ Bank & Trust’s Dublin office, acknowledges the underlying dynamics.“As hedge funds do not lend themselves to a commoditised offering we must look at overall value when assessing the price premium of specialised administration services.” Bob Donahoe, at BISYS is blunt,“some administrators are competing on cost, and we tend not to, because it is not economic to do so.”

Gavin Nangle, managing director, State Street’s Investment Fund Services centre in Dublin agrees it is an industry-wide challenge and ventures that as the fund administration business per se is becoming more varied it makes more sense not to differentiate product, but the overall service offering. “Progressively, more alternative fund administration services have expanded out from

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TOP TEN HEDGE FUND ADMINISTRATORS (SINGLE FUNDS AND FUND OF HEDGE FUNDS)

BY GROWTH OF AUA BETWEEN APRIL AND NOVEMBER 2006.

FUND ADMINISTRATOR JP MORGAN HEDGE FUND SERVICES RBC DEXIA FUND SERVICES SS&C FUND SERVICES CITCO FUND SERVICES GLOBE OP FORTIS PRIME FUND SOLUTIONS BANK OF NEW YORK EURO-VL (SG-SS) HSBC ALTERNATIVE FUND SERVICES INVESTORS BANK & TRUST

TOTAL ASSETS UNDER ADMINISTRATION (AUA) ($bn) 39.40 37.24 96.0 415.0 123.4 257.0 83.7 60.9 258.8 164.7

% CHANGE (APR-NOV 2006) 159% 30% 28% 26% 25% 20% 19% 18% 17% 16%

Source: HFMWeek Hedge Fund Administrator Survey, December 2006.

traditional fund accounting, net asset value (NAV), secretarial services and investor relations, to full business process outsourcing,” says Nangle. That includes the trade support provided by front office operations, the operational support of mid-to-back office operations as well as the traditional fund administration package.

State Street has built a dominant franchise in the Dublin market, based on its comprehensive service range that encompasses both alternative and mainstream alternative fund administration for both onshore and offshore businesses. “About 80% of that is Irish domiciled funds, 20% is non-Irish, some of which might be domiciled in the Cayman Islands or Bermuda, and some of that is alternative business, but not all.” What is important says Nangle is that State Street “engages closely with the client so we can anticipate the precise product cycle of its various funds, be they long-only or hedge based”.

Then again, some alternative hedge fund administrators are moving away from either providing hedge fund only or private equity fund only administration services. Many now provide the whole gamut. BNP Paribas, is one house that has adopted an integrated approach. “Our view is that we service the underlying asset, whatever the fund type, with the primary driver of getting right solution. Some of that is automated, some, in the case of OTC derivates for instance, is not, which still remains a fax and document based operation,” explains Malcolm Pobjoy, head of UK institutional investors, at BNP Paribas in London. “Our view is that it has to be more integrated, as assets become more mainstream.”

Right now, however, Pobjoy acknowledges that the business remains specialised, with the bank operating out of geographic centres, such as Luxembourg, Dublin and King of Prussia in Pennsylvania, which have their own particular expertise.

JP Morgan, on the other hand, has distinct hedge fund and private equity focused businesses. Like JP Morgan, Northern Trust has a split team approach. Northern Trust’s Head of Private Equity Fund Administration Paul Guilbert, counts some of the United Kingdom’s major buyout houses amongst their client base.

With regards to the desire for many funds to be domiciled offshore: “Historically this was driven by tax considerations,”acknowledges Guilbert, though he stresses this is no longer such a strong case.“The biggest reason for private equity firms domiciling offshore is for VAT structuring purposes and there are still some tax break benefits to be enjoyed, but one of the other main principal determinants is quality of service. Some of the quality players such as ourselves are not onshore and in these days of real-time technology this is not seen as a deterrent by prospective clients who don't actually need to come offshore for their administration services.”

Guilbert says that the bank signed up a record $13bn (AUM) in new private equity fund administration business last year, into its Guernsey office.“It has also been a record year in property as well,” he adds. Private equity fund administrators enjoy not only rising business volumes, but a degree of market stickiness, that other business sectors would envy. Relationships between administrator and private equity funds tend to be long term. Northern Trust for one, boasts that it has not lost a private equity client in this millennium.

Hedge funds are similar to private equity funds in some respects, but not others. Both are lightly regulated, private pools of capital that invest in securities and compensate their managers with a share of the fund's profits. However, most hedge funds invest in highly liquid assets and their investors can readily enter or leave the fund. Private equity funds, on the other hand invest in illiquid assets (private sector firms on the whole, although increasingly buyouts involve listed companies) and their limited partners tend to commit their investment for the full life of the fund. “There is some blurring around the edges, as these days hedge funds often invest in private equity companies' acquisition funds,” notes RBC Dexia’s Heaps.

Joe Patellaro, senior vice president of BISYS Private Equity Services, notes the rise in LBO activity globally has occurred at the same time as an increase in the level of sophistication in services and reporting that limited partners require for the

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funds they invest in. Although BISYS is retained by private equity fund sponsors, the firm spends considerable effort providing “institutional grade solutions that limited partners are comfortable with,” says Patellaro. It is particularly pertinent with private equity funds,“because limited partners cannot liquidate their positions, therefore limited partners are particularly focused on fair value”, he says. Equally, sponsors are “hesitant to move valuations without a substantive change based on a subsequent round of financing or material changes in operation.” Notes Patellaro, “the end game for them is the exit.” Additionally, says Patellaro, US reporting rules have been refocused and new technical guidance “has been issued on privately held illiquid assets, which will likely result in more frequent adjustments to fair value from initial cost”. It is a vital consideration in a business, which Patellaro acknowledges is almost entirely transaction driven.

While in some markets, such as Dublin, competitive pressure is being eased by consolidation (Bank of New York’s planned merger with Mellon and State Street’s purchase of Investors Bank & Trust) , globally competition to provide independent fund administration services continues to thrive. To further complicate matters for the global fund administration community, a new breed of third-party administrators are emerging, some of them prime-broker affiliated, others hedge funds themselves, such as New York-based LaCrosse Global Fund Services, created by Cargill's Black River Asset Management arm, which is building a niche franchise to service hedge funds around the globe.

BISYS remains unmoved by growing competition in both its market specialisations. Patellaro and Donahoe believe alternative investments are on an up-cycle and that this will continue for some years to come, albeit the geographic spread of that business will change.

BISYS, following the requirements of its clients, was moved to expand its alternative fund administration business into Asia at the beginning of this year, adding to its existing operations in US, Ireland, the Cayman Islands and Bermuda.

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RBC Dexia’s Peter Heaps thinks the upward cycle will continue for some years.“For the time being at least, there is plenty to go around. Further consolidation in the fund administration business as a whole is likely in the medium term, as more custodian houses merge, as in our own case, and newer entrants are bought out by larger players seeking market dominance, but that won’t stop the underlying trend that more institutions are seeking alternative investment solutions and more alternative asset managers outsource non-trading operations.”

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Phil McGowan, managing director of the Dublin officer of Investors Bank & Trust. Photograph kindly supplied by Investors Bank & Trust, April 2007.

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IRELAND’S COST EFFECTIVE GEOGRAPHY OF FUND ADMINISTRATION Dublin made its name in the early 1990s as a low-cost alternative to the high salary and property costs of Europe’s principal financial centres, onshore and offshore. That advantage has disappeared as rising salaries and property values are now, in turn, redrawing the map of financial services provision in Ireland.

ew conversations with Dublin’s fund administration experts fails to touch on the issue of staff, their availability and cost and the effort that individual firms are going to retain staff.

Now there is a new twist. Dublin’s very success has meant that a large concentration of fund services providers has developed in the city, pushing up retail and staffing costs. In response, fund administrators have hived off back office operations to other centres in the country. “I do think there is still a strong story for Dublin,” maintains Phil McGowan, managing director of the Dublin officer of Investors Bank & Trust. “Everyone talks of cost and retention, and while it makes sense in many instances for institutions to set up operations outside of Dublin, but people should not discount the value of experience provided in the city.”

Industry professionals acknowledge there is a danger of competition for skills turning into an inflationary spiral that starts to make Ireland less attractive for administrators and their clients. Rachel Turner, head of client services at Bank of New York in Dublin. “It is definitely an employee's market. We have known staff to leave for a year to go travelling, and then come back and walk straight into a high paid position because of the competition for experienced staff. In the short term, market consolidation will ease some of that pressure, but not for long.”

Gavin Nangle, head of business development at State Street in Dublin acknowledges that staffing is a challenge, “for everyone, but it can be tackled.”

Nangle points to the provision of comprehensive staff training programmes and career opportunities that provide an attractive “work-life balance,” he says.

State Street was one of the first of the global administration providers to open offices outside of Dublin. State Street chose Kilkenny. Now the financial services provider employs more than 1500 people in Ireland, some 300 of which work out of its

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regional operations at the Loughboy Business and Technology Park near Kilkenny. State Street had looked at a number of sites, explains Nangle, and chose Kilkenny "because it has a good, educated, population base and is also close to pools of labour in Carlow, Clonmel and Waterford".

There is also the added attraction, concedes Nangle, that it is very near Dublin, which means that staff can come into the Dublin offices easily and, of course,. "Kilkenny offers a more relaxed way of life, which can be a consideration when you are competing to retains staff.” It is a strategy supported by Ireland’s economic development promotion body, the Industrial Development Agency (IDA Ireland). IDA has played a leading role in encouraging some of the biggest administrators in the market, such as CITCO, BISYS, PFPC, as well as State Street, to create satellite offices not only in the hinterland of the capital but in regional centres such as Cork, Drogheda, Galway, Kilkenny, Waterford and Wexford. Firms have been able to tap into pools of labour and to forge links with local educational institutions in order to ensure that the skills and qualifications they need are readily available. Now the IDA is encouraging the financial services provider to help establish Ireland as a centre for training and thought leaders. HSBC recently opened offices in an outlying suburb of Dublin called Sandyford, which provides training for its European staff. If the IDA has its way, it is a signal indication of things to come. In the meantime, service providers are learning to live with the price of Dublin's success by efforts to increase their levels of staff retention through training and career development programmes, and also by channelling expansion efforts into satellite offices in other towns and regions around Ireland, which not only keeps cost levels down but offers access to a broad range of potential new recruits provided by Ireland's much-admired education system.

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Traditionally secretive hedge funds are beginning to lose their stage fright. Managers long accustomed to flying under the regulatory radar and avoiding publicity have started to tap the public markets. The trend emerged in Europe, where in recent years hedge fund managers have floated closed end feeder investment funds as well as hedge fund management companies. Initial public offerings (IPOs) aside, hedge funds continue to attract more money, having reportedly raised a further $44.5bn in the third quarter of last year alone, according to Hedge Fund Research in Chicago. With so much continued interest in hedge funds, Neil O’Hara looks at the key reasons why some hedge fund firms feel the need to tap the capital markets.

Why hedge funds

Investors in a hedge fund manager get a chance to participate in the lavish management and incentive fees for which the industry is famous. Everybody wins — or do they? In most public offerings, investors expect a significant portion of the proceeds to finance the company’s future growth.

Successful asset management companies generate surplus cash, however, so the proceeds from a hedge fund management company IPO typically end up in the principals’ pockets. Photograph by Susan Findlay, provided by Dreamstime.com, April 2007.

float N FEBRUARY, PRIVATE equity and hedge fund manager Fortress Investment Group became the first US manager to issue shares, which immediately traded at a 70% premium to the offering price. Private equity behemoth Blackstone Group, which runs $17bn in hedge funds alongside its better-known private equity portfolios, plans to follow suit, and more are sure to follow.

For hedge fund managers, public offerings of the management company crystallise the value of the firms they have created and allow them to take some cash off the table, says Nigel Farr, a partner at Herbert Smith in London. Publicly-traded shares also provide a currency managers can use to finance acquisitions or for executive compensation schemes. Herbert Smith advised management companies on two recent flotations: Polar Capital on the Alternative Investment Market, London’s junior listing venue, and Blue Bay on the main market. The firm also handled closed end fund offerings on Euronext for Marshall Wace (MW TOPS) and Boussard & Gavaudan.

Investors in a hedge fund manager get a chance to participate in the lavish management and incentive fees for which the industry is famous. Everybody wins — or do they? In most public offerings, investors expect a significant portion of the proceeds to finance the company’s future growth. Successful asset management companies generate

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surplus cash, however, the proceeds from a hedge fund management company IPO typically end up in the principals’ pockets.

For example, Fortress raised $533m, of which the prospectus says $250m was used to repay a term loan that financed a $250m distribution to the five principals. Total distributions to the principals in the normal course amounted to $446.9m in 2006 and $409.2m in 2007 before the offering; they received a further $888.0m from the sale of a 15% interest in Fortress to Nomura in January 2007.

It is not unusual for successful hedge fund managers to earn large distributions, but privately-held firms do not receive a capitalised multiple of future cash flows in exchange for a reduced economic interest. David Friedland, president of the Hedge Fund Association and president of Magnum Funds US, a $500m fund of hedge funds manager based in Aventura, Florida, believes that every successful manager eventually reaches a point where he or she has less incentive to focus all day every day on making money for the fund.“There is always a potential conflict of interests and it’s something that investors have to consider,” Friedland says.

The highly motivated people who run successful hedge funds have a big piece of their wealth tied up in the firm even after going public, of course. The principals of Fortress

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still own 77.7% after the Nomura transaction and the IPO, a stake worth $8.9bn at the current market price ($28.38), while Blackstone’s founders will retain about 90% ownership after its proposed $4bn offering.

The potential conflict has not deterred major Wall Street firms such as JPMorgan Chase, Lehman Brothers and Morgan Stanley from buying minority interests in hedge fund managers, either. Unlike public offerings, however, those deals often include lock-in agreements and deferred payout arrangements designed to keep the key people motivated, according to Talbot Stark, global hedge fund relationship manager at BNP Paribas in London. A minority partner can help a hedge fund attract additional assets, too: Highbridge Capital, which had $6.5bn under management when JPMorgan Chase bought in two and a half years ago, now manages $17bn. “I think the combination has been far more successful in asset growth than most people anticipated,”Stark says.

Although an IPO does not provide access to a dedicated distribution channel, it can still attract additional assets to the manager’s funds through enhanced name recognition.

It is an avenue open only to a few, however. In today’s market, Stark believes a firm must have at least $5bn under management, multiple investment strategies to diversify the revenue stream, a robust infrastructure, a 10-year plus track record and (critically) principals with impeccable reputations in the financial community. “Success in the public markets will be dictated by the perception of the inner circle of the City or Wall Street,”Stark says,“If people do not respect them, it will taint that success.”

For some people the opportunity to cash out will not be worth the price. Hedge fund managers, many of whom fled the bureaucracy of large financial institutions, have to create a robust regulatory and compliance regime to meet the standards of oversight expected at public companies.

They must tolerate intense public scrutiny from analysts and the media, too, including disclosure of fees and executive remuneration. Stark sees large hedge funds becoming more institutionalised as the industry matures, but for some managers “it’s nice to have secrecy and lack of transparency.”

Those who do not want the hassle of a management company flotation can still tap the public markets, at least in Europe where the rules governing investment companies are less restrictive than in the US. Hedge fund and private equity managers have started raising permanent capital through public offerings of closed end funds that feed into the managers’ existing funds. In November 2006, BNP Paribas helped underwrite a €440m deal for Boussard & Gavaudan listed on Euronext. One month later, in the largest closed end hedge fund offering to date, Britain’s Marshall Wace raised €1.5bn through MW TOPS, a vehicle that will invest alongside other investors in the firm’s open end hedge funds. The London-based company sold shares of MW Tops, a closed-end investment company, for €10, or $13.27 each which on the first day of trading on Euronext Amsterdam, the share price rose by a cent to finish at

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Talbot Stark, global hedge fund relationship manager at BNP Paribas in London. A minority partner can help a hedge fund attract additional assets, too: Highbridge Capital, which had $6.5bn under management when JPMorgan Chase bought in two and a half years ago, now manages $17bn.“I think the combination has been far more successful in asset growth than most people anticipated,” Stark says.

Photograph kindly supplied by BNP Paribas, April 2007.

€10.01. Marshall Wace, founded in 1997 by Paul Marshall and Ian Wace, has about $10bn under management following the public offering. Before setting up the hedge fund manager, Wace was head of equity and derivatives trading at Deutsche Morgan Grenfell. Marshall previously worked at Mercury Asset Management, which was bought

by Merrill Lynch in 1997. Marshall Wace found that by listing it could reach a broader church. Hedge funds in Europe have been able to bypass rules restricting the sale of the investments to less affluent individuals by listing their funds as companies on the stock market and selling shares.

MW Tops will aim for an annual return of 12% to 16% after fees and expenses. The Marshall Wace funds it will invest in use a computer programme to gather and select investment ideas and take bets on declining and rising stocks. By the time Marshall Wace led its IPO, it was treading a somewhat worn track. American private equity firms got in on the act even earlier; Kohlberg, Kravis & Roberts raised $5bn on Euronext in May 2006 and Leon Black’s Apollo Management launched a $1.5bn fund last August. The buyout firms had found that a European public vehicle allows managers to tap investors who cannot otherwise – for lack of financial resources or legal authority — invest in their open end hedge funds.

Permanent capital also enables managers to invest in less liquid instruments with greater confidence because they no

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HEDGE FUND IPOS

Nigel Farr, a partner at Herbert Smith in London. Publicly-traded shares provide a currency managers can use to finance acquisitions or for executive compensation schemes. Herbert Smith advised management companies on two recent flotations: Polar Capital on the Alternative Investment Market, London’s junior listing venue, and Blue Bay on the main market. The firm also handled closed end fund offerings on Euronext for Marshall Wace (MW TOPS) and Boussard & Gavaudan.

Photograph kindly supplied by Herbert Smith, April 2007.

although some have longer have to worry about incorporated governance redemptions, according to mechanisms intended to Quentin Nason, managing The highly motivated people who run minimise the risk of director for equity capital successful hedge funds have a big persistent large discounts. markets and head of piece of their wealth tied up in the firm In theory, investors have European permanent even after going public, of course. The daily liquidity, too. In capital at Deutsche Bank. principals of Fortress still own 77.7% practice, large hedge fund That was an important after the Nomura transaction and the investors who cannot buy or consideration for Marshall sell a position without Wace in the MW TOPS IPO, a stake worth $8.9bn at the moving the market may find offering managed by current market price ($28.38), while the redemption right in an Deutsche Bank, Merrill Blackstone’s founders will retain about open end fund more Lynch and UBS. To reach 90% ownership after its proposed attractive despite its fragmented distribution $4bn offering. limitations. channels throughout For private equity Europe, Deutsche worked investors, lack of liquidity is through intermediaries Nason calls “client rich, product poor” to access different a fact of life in both public and private entities. Again, types of investor. “It takes a lot of time but can be quite traditional open end vehicles have an edge: they permit rewarding,”he says,“It’s very powerful if done right.”From investors to fund commitments only when the manager a marketing perspective, investors in closed end vehicles needs money to finance a transaction. “It is funding on a must be seen to rank pari passu with other investors in the just in time basis,”explains Prakash Mehta, a partner in the underlying hedge funds. Nason finds the market more Washington, DC office of lawyers Akin Gump Strauss receptive if managers absorb the offering expenses, too, Hauer & Feld,“Permanent capital investors do not get that which avoids immediate dilution of the fund’s net asset benefit because all their money goes in at the beginning.”

The burgeoning popularity of closed end hedge fund value. Marshall Wace capped MW TOPS expenses at 1% of the offering price, for instance, while Boussard & feeders in Europe is unlikely to spill over to the US any time Gavaudan and Brevan Howard defrayed the entire cost for soon. Public offerings of these vehicles fall under the Investment Company Act of 1940 (ICA), which regulates their funds.

However advantageous permanent capital is for mutual funds. For“a host of reasons”an offering governed by managers, it’s a different story for investors. Like any closed the ICA is not practical, Mehta says. He points out that some end fund, these vehicles can trade below net asset value, entities — insurance companies, for example – are exempt

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fund raised €770m, a from the ICA, but this respectable sum but only avenue raises other half the €1.5bn target.“Some complications. The principal Permanent capital also enables managers have pulled away disadvantage of permanent managers to invest in less liquid because they didn’t want to capital from the managers’ instruments with greater confidence risk reputation damage by perspective is additional because they no longer have to worry not having subscriptions disclosure about their largest from the public,” says Stark, holdings, according to Ana about redemptions, according to “From a public relations Haurie, group managing Quentin Nason, managing director for perspective, it’s much better director of Dexion Capital, a equity capital markets and head of to double the book than cut London-based hedge fund European permanent capital at it in half.” advisory firm best known for Deutsche Bank. That was an important Equity deals, whether for its stable of publicly traded consideration for Marshall Wace in the hedge fund managers or funds of hedge funds. Its permanent capital funds, $1.5bn flagship, Dexion MW TOPS offering managed by have grabbed the headlines Absolute, is managed by Deutsche Bank, Merrill Lynch and UBS. but hedge funds are Harris Alternatives in beginning to tap the debt Chicago, Illinois. For a markets, too. In November, primary listing under Chapter 15 of the London Stock Exchange (LSE) rules, a fund Citadel Investment Group, a $13bn hedge fund based in must publish its ten largest holdings on a quarterly basis. Chicago run by Ken Griffin, launched a medium term note Managers who find that obligation too onerous can choose a programme for up to $2bn, a continuous offering under secondary LSE listing or they can go to AIM or Euronext, which it raised $500m in December. The deal, which earned which do not require equivalent disclosure but lack the a BBB+ rating from Fitch and BBB from Standard & Poor’s, gives Citadel an alternative to conventional hedge fund prestige of a primary LSE quote.

The regulatory environment is in flux as the LSE and financing through prime brokers and the flexibility to seize Euronext vie to attract new hedge fund listings. Herbert market opportunities, like its purchase of a 4.5% stake in Smith’s Farr explains that the Financial Services Authority sub-prime mortgage originator Accredited Home in rules for a primary listing now say the directors of a feeder March. “They are starting to run Citadel like a normal fund whose assets pass through to another investment corporate where they are looking at the capital structure,” vehicle must comprise a majority of the board of the says Stark. If a fund the size of Citadel can shave a few basis underlying master fund. In a structure like MW TOPS, a points off its funding cost, it will be worth it — and it will requirement for upstream control of the master by a keep a leash on what the prime brokers charge, too.

The public markets—debt and equity—are bound to play smaller listed feeder fund is unrealistic.

Proposals to amend the listing rules have been in a bigger role in the hedge fund industry in the years ahead. circulation since March 2006 with implementation by Q3 2007 And while US hedge funds do not have access to at the earliest. Farr says the proposed revisions as drafted do permanent capital in their domestic market, it’s only a not go far enough. They drop the board majority rule but still question of time before the most prominent emulate the require the listed feeder to control the master fund, he says.“In success of their private equity brethren and launch feeder order to be attractive as a primary listing venue for hedge funds in Europe. funds this requirement should be dropped and the portfolio disclosure obligations modified to preserve legitimate confidentiality concerns,” Farr adds. Meanwhile, the LSE announced that Chapter 14, a little-used secondary listing For a reprint of this or any other that has neither the disclosure obligations nor the governance article in FTSE Global Markets provisions of Chapter 15, is available to non-UK investment companies.The LSE doesn’t want to lose lucrative new listings please contact Paul Spendiff on: to AIM or Euronext, neither of which has a comparable +44 (0)20 7680 5153 or by email at: governance rule. Brevan Howard’s feeder fund, BH Macro, became the first fund of hedge funds to obtain a London paul.spendiff@berlinguer.com listing this way.

No matter how the regulatory dust settles hedge fund managers will try to tap the market for permanent capital.

Ever since the Boussard & Gavaudan deal, BNP Paribas’s Stark says the bank has been approached by a stream of managers, including some it declined to help. The recent BH Macro experience gave the market pause, however: the

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TIME FOR A

By the time the air went out of the sub prime lending balloon, the popularity of such ‘exotic’ loans had already helped shift the balance of power that once much-favoured longstanding mortgage giants Fannie Mae and Freddie Mac, the two largest buyers and guarantors of home mortgages in the US. With opportunistic firms such as Countrywide, Lehman Brothers and Bear Stearns pushing ahead in the mortgage-backedsecurities business, what does the future hold for both Fannie and Freddie? From Boston, Dave Simons reports.

COMEBACK? S ANOTHER SEASON of baseball got underway in Arlington,Texas this past April, the Texas Rangers—the major league team once under ownership of one George W Bush—took to the field in the park formerly known as Ameriquest Field, now referred to under its previous moniker, The Rangers Ballpark in Arlington. The switcheroo was not so much the result of fans ruminating over a corporate moniker, but rather management’s effort to distance itself from the problems plaguing its financier, Ameriquest Mortgage Company, the result of an abrupt shift in the prevailing winds blowing over the US lending landscape.

Ameriquest is just one of numerous upstart companies that profited during the boom in so-called sub prime lending that began during the latter part of the previous decade and re-wrote the rules governing loan origination. Devised mainly for otherwise non-qualified homebuyers, sub prime loans initiate with a so-called low ‘teaser’ rate of interest but then quickly escalate to a higher than average rate after just a few years. Because the overall interest charged is considerably higher than conventional 30 year mortgages, sub prime loans have been highly attractive to the investment community, and in particular hedge funds, speculate observers.

However, in the wake of the Federal Reserve Bank’s 17 consecutive prime-rate adjustments, foreclosures began to touch epidemic levels, bank regulators began tightening the screws and the result has been a lending market shakeout of historic proportions.

Ameriquest—owned by ACC Capital Holdings, the largest prime sub lender by volume—had lots of company in firms such as New Century Financial and Accredited Home Lenders. Many of these are now teetering on the brink of financial ruin, or have already met their demise.

By the time the air went out of the sub prime-lending balloon, the popularity of such‘exotic’loans had already helped shift the balance of power that once favoured the longstanding mortgage giants Fannie Mae and Freddie Mac, the so-called government-sponsored enterprises (GSEs) and the two largest buyers and guarantors of home mortgages in the US.

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blemished credit records Supported by the Federal who would otherwise have government, Fannie and been unable to meet Freddie secure mortgages criteria of ‘prime’ lenders. from loan originators, The trend allowed holding some and private-label lenders to securitising others for the cruise past the GSEs for the investment market. Created first time ever. Despite

by Congress (in 1938 and recent woes within the sub 1970 respectively), Fannie prime industry, the and Freddie’s ultimate goal ongoing presence of was to provide the mortgage nontraditional loan market with a steady stream opportunities continues to of capital by purchasing threaten the GSEs’ home loans from lending traditional business model. institutions, with the For the fourth quarter of ultimate goal of making 2006, Freddie Mac reported home ownership affordable a loss of $480m, versus a to the low- to middleprofit of $684m in the same income wage families. period during 2005.

Not that their mission Moreover, Fannie Mae has been altogether and Freddie Mac will have altruistic, and during the to contend with an early part of the decade William Poole, president of the Federal Reserve Bank of St. Louis, who uncomfortably restrictive the explosion in home believes that GSEs business model should be confined to areas “with a set of governmentbuying helped clear public purpose” by removing inherent Federal guarantees as well imposed guidelines while substantially bolster the as imposing portfolio size limits should they keep their governmentthey attempt to find their fortunes of the GSEs, backed positions, thinks Poole. Photograph kindly supplied by the groove. The Office of much to the consternation Federal Reserve Bank of St. Louis, April 2007.

Federal Housing of some lawmakers, who Enterprise Oversight claimed that they had (OFHEO), under the grown to far and too fast. … in the wake of the Federal Reserve leadership of director But Fannie & Freddie’s Bank’s 17 consecutive prime-rate James Lockhart, currently period of earnings success adjustments, foreclosures began to touch requires that Fannie and came to a screeching halt Freddie maintain a 30% beginning in 2003, when it epidemic levels, bank regulators began capital surplus above a was revealed that alleged tightening the screws and the result has 2.5% minimum capital accounting discrepancies been a lending market shakeout of requirement. Additionally, helped inflate the historic proportions. the GSEs have agreed to numbers, leading to a restrict portfolio growth to prolonged bout of 2% annually. In a series of executive house-cleaning recent comments, Federal Reserve Chairman Ben Bernanke at both agencies.

While the two companies were struggling to regain said that the GSEs’ investment objectives “should be credibility, opportunistic firms such as Countrywide anchored to a clear and well-defined public purpose…an Financial Corp., Lehman Brothers and Bear Stearns began obvious and worthy candidate is the promotion of whittling away at the GSEs’ long-held dominance in the affordable housing.” Meanwhile, the House of Representatives has proposed legislation that would create mortgage-backed-securities business.

By 2006, Fannie and Freddie’s combined market share an independent GSE regulatory group called the Federal had dropped to less than 34%, down from nearly 60% at Housing Finance Agency (FHFA), which, among other the start of the decade, according to National Mortgage things, seeks to place limits on how Fannie and Freddie News figures. A factor in the GSE retreat was the manage their profit-making operations. The bill has governmentally imposed affordable-housing limits placed received bipartisan congressional support.

For its part, Freddie Mac announced that beginning in on loans available for repurchase by both Fannie and Freddie (currently $417,000). But the real culprit was the September it would no longer purchase riskier home explosion in the sub prime lending markets. In 2005, nearly mortgages in an effort to combat the rapidly rising rate of 37% of all mortgage-backed securities came from sub foreclosures, and will initiate tougher standards for the prime loans, mainly marketed to consumers with mortgages that it continues to buy. The company is also in

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THE OUTLOOK FOR FANNIE MAE & FREDDIE MAC

Until very recently, Freddie the process of rolling out a Mac and Fannie Mae set the set of new fixed-rate and standard and played the hybrid adjustable-rate dominant role in the mortgages to appeal to mortgage backed securities lenders with sub prime(MBS) market. Over the past type clients. few years, however, loans While conceding that a that were originated outside period of reckoning was of the regulated system long overdue for the began to be packaged GSEs, at the same time together in private-label Freddie Mac chief securitisations and funded in executive officer Richard the capital markets. “Which Syron suggested that too has created a very different much oversight could kind of environment,” says have a detrimental Schnure. “A lot of this was impact. “The loudest because of the intense voices in the debate have demand that had built up been those demanding over a number of years. not only to tighten What has happened is that oversight of the Freddie Mac has gone GSEs…but to diminish back to providing capital our tools and shrink the to the market for the box within which the higher-quality standards GSEs can operate,” said of these mortgages.”

Syron recently. Syron Nela Richardson, senior economist with Freddie Mac. Going forward, The pronounced shift defended Freddie Mac’s the evolving market conditions may prompt some recovery in the away from the traditional desire to maintain a wellperformance of the GSEs, says Richardson.“The yield curve will 30-year fixed rate product capitalised portfolio, always play a big role in determining how the market moves.” that the GSEs specialised saying it would allow the Photograph kindly supplied by Freddie Mac, April 2007. in—the result of steadily company to properly respond in the event of a sudden market pullback. “Our falling interest rates—coincided with a rapid increase in the charters specify that we must be a continual presence in the use of adjustable-rate mortgage products (or ARMs), which mortgage market, providing affordability, liquidity and were typically marketed to lower-income families to stability. All of which begs the question—why overly hamper purchase homes that might not have been affordable otherwise. Beginning at the start of the decade, us just when you’re going to need us most?”

“When talking about market share, regulatory issues and so nontraditional products such as “2-28” loans (in which the forth, it’s really important to remember that, just as the housing interest rate is fixed for the first two years, after which it can market has always been a really central part of the real adjust every year to the index value plus the margin) began economy, over the past decade mortgage products have taking up a much larger piece of the overall market, rising become more important to the financial markets than ever from roughly 5% of private-label ARMs to over 37% over a before,”says Calvin Schnure, director of economic analysis at four-year period. But with interest rates ticking back up, Freddie Mac.“While there has been a diminishing supply in combined with a flattening of real-estate values,“we have seen a swing back to the the number of top-quality STRESSES IN THE SUB-PRIME LENDING MARKET SHOW traditional sweet spot for assets, at the same time we THEIR IMPACT the GSEs, which is the have had an increase in 160 fixed-rate product,” says demand for them. With the 140 Nela Richardson, senior growth of things like hybrideconomist with Freddie investment funds outside of 120 Mac. Going forward, the the banking system, the 100 evolving market market has searched for 80 conditions may prompt ways to create a high60 some recovery in the quality, stable product. And performance of the GSEs, perhaps the most suitable 40 says Richardson.“The yield investment to fit that need is curve will always play a big a quality mortgage product, Freddie Mac Fannie Mae role in determining how and that is where Freddie FTSE USA Index – General Financial FTSE USA Index – Mortgage Finance the market moves.”

Mac comes in.”

Source: FTSE Group and Datastream, data as at 31 March 2007.

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The original purpose of the GSE—to provide liquidity in good and bad markets using quality products—is more important now than ever before, says Schnure. “We have had a huge expansion of sub prime credit, which has caused a lot of concern. You hear about it daily—analysts speculating about the broader impact on credit. Our presence in the market ensures that qualified mortgage borrowers or the mortgage-securities markets will not be affected. Before the GSEs were created, such a spillover effect could actually occur. As bad as the sub prime problem has been, financing has still been readily available, and the mortgage-securities markets will not freeze up due to these concerns. We’re not reinventing ourselves at all.

We are saying that our traditional role, even now in the 21st century, is still quite important to the economy.”

However, while a GSE uptrend is not out of the question, the bottom line, say many observers, is that the days of Fannie and Freddie controlling the MBS market are over.

“You will see less pressure on Fannie Mae and Freddie Mac, and I think [they] will have some breathing room, but I do not think they are going to be what they ever were before,” remarks Countrywide Financial Corp. chief executive officer Angelo Mozilo.“I think what has been demonstrated over the last 24 months is that there is another market out there, that is ready, willing and able to, and is very liquid, to accept the kind of product that Fannie and Freddie generally dominated. So Fannie and Freddie are going to have to fight like hell to get their market share back.”

Extending GSE operations into market segments “already well served by existing private firms will not enhance the efficiency of mortgage markets or reduce costs to mortgage borrowers,” notes William Poole, president of the Federal Reserve Bank of St. Louis, who believes that GSEs business model should be confined to areas “with a clear public purpose” by removing inherent Federal guarantees as well as imposing portfolio size limits should they keep their government-backed positions.

The problems that have befallen the sub-prime market have not been limited to the crop of smaller “specialist” players. Should they take effect, proposed Federal standards could have a significant impact on much larger firms that include mortgage company Countrywide.

Speaking at a Raymond James Financial Inc. conference in Orlando in March, Countrywide chief financial officer Eric Sieracki noted that possibly 60% of Countrywide’s customers seeking hybrid adjustable-rate mortgages such as “2-28” loans would fail to qualify under the new guidance, which would place far greater emphasis on a buyer’s ability to repay at the highest possible rate.

While the jury is still out, analysts believe it is possible that the current situation could have a more serious impact on investment banks such as Bear Stearns & Co. and Lehman Brothers, that have profited from the purchase of sub prime loans as well as the packaging and re-selling of higher-yielding securities backed by such loans.

“We see the sub-prime situation as being relatively contained,” said Chris O’Meara, Lehman’s Chief Financial

F T S E G L O B A L M A R K E T S • M AY / J U N E 2 0 0 7

Where to now for Fannie Mae and Freddie Mac? By the time the air went out of the sub-prime lending balloon, the popularity of such ‘exotic’ loans had already helped shift the balance of power that once favoured the longstanding mortgage giants Fannie Mae and Freddie Mac, the so-called government-sponsored enterprises (GSEs) and the two largest buyers and guarantors of home mortgages in the US. Photograph by Nsilcock, supplied by Dreamstime.com, April 2007.

Officer, in a conference call following the company’s firstquarter earnings announcement. Though sub prime only accounted for roughly 3% of Lehman’s revenues during the past six quarters, according to O’Meara, shares of Lehman have fallen nearly 16% since February as investors fretted over the company’s sub prime involvement.

How does this affect the GSEs, in light of increased competition and the exceedingly volatile mortgage environment? “We continue to support oversight legislation that would strengthen market confidence and promote the company’s mission,” says Schnure, adding, “but we do not have a crystal ball, and cannot predict the prospects of future events. That said, continue to improve customer focus, and we believe our renewed focus on mission and customer service will broaden our overall mix of lenders securitising our mortgage securities. In a continued tight spread environment, it is increasingly important for us to innovate and improve efficiency in order to provide attractive returns in our mortgage investment business. One way we have capitalised on the funding environment was through increased issuance of structured debt products, and through opportunistic use of debt repurchases. Essentially, we have a disciplined approach to investing that allows us to keep risk low, while taking advantage of market opportunities as they become available.”

Additionally, says Schnure, Asian investors—including central banks, which have increasingly turned to Freddie Mac bonds and securities for extra return over US Treasuries—are likely to stay large buyers in an effort to maintain their well-diversified portfolios.

The ability to respond to market changes in a timely fashion has made the GSEs “a Congressional success story,” argues Syron. But, says Syron, that story can only remain positive“if we have the right capital and operational flexibility to respond quickly to market transitions. Business cycles will come and go. But these economic realities should not keep families from achieving their dreams of homeownership.”

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MARKET REPORTS BY FTSE RESEARCH

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FTSE Global Equity Index Series – Global

31 March 2006 to 31 March 2007

FTSE All Cap Regional Indices (USD)

140

130

FTSE Global AC

120

FTSE Developed Europe AC

110

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100

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90

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80

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70

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FTSE All Cap (AC) Regional Indices – Capital Returns (USD) 40

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Key: AC = All Cap, LC = L arge Ca p, MC = Mid Cap, SC = Small Cap, LC/MC = L a r g e a n d M i d C a p

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FTSE All-Emerging Country Indices – Capital Returns 100 80 60

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2-Month Stock Performance Best Performing FTSE All-World Index Stocks (USD/%) Partygaming UK International Nickel Indonesia INDO COFCO International (Red Chip) HK MAR BMCE Leighton Holdings AU

Overall Index Return (USD) FTSE Global AC Index FTSE Global LC Index FTSE Global MC Index FTSE Global SC Index FTSE All-World Index 12% FTSE Asia Pacific AC ex Japan Index FTSE Latin America AC Index 10% FTSE All Emerging Europe AC Index FTSE Developed Europe AC Index 8% FTSE Middle East & Africa AC Index FTSE North 6% Americas AC Index FTSE Japan AC Index 4%

75.8 64.3 63.8 59.2 58.9

Worst Performing FTSE All-World Index Stocks (USD/%) Health Management Associates A USA -44.1 Banco Nossa Caixa SA BRAZ -36.9 LG Card KOR -29.9 ACC IDA -26.8 Catcher Technology TWN -26.7

No. of Consts

Value

2 M (%)

8,092 1,198 1,684 5,210 2,882 1,841 203 113 1,666 207 2,702 1,360

411.19 389.09 570.02 518.12 243.81 539.62 1021.55 897.48 482.86 667.37 350.06 416.63

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6 M (%) 12 M (%)

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14.3 13.7 15.0 14.9 14.2 24.2 30.5 17.3 23.9 8.3 9.8 -0.5

YTD (%) Actual DIv Yld (%)

2.4 1.6 4.3 5.2 2.0 3.2 6.3 1.3 3.8 7.0 1.1 2.6

2.01 2.18 1.67 1.45 2.10 2.58 2.74 1.55 2.51 2.75 1.72 1.06

Key: AC = All Cap, LC = L a rge Cap, MC = Mid Cap, SC = Small Cap, LC/MC = L a r g e a n d M i d C a p

2% 0% F T S E G L O B A L M A R K E T S • M AY / J U N E 2 0 0 7 -2% -4% 8%

115

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ar -0 7

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MARKET REPORTS BY FTSE RESEARCH

O

MARKET REPORTS 19.qxd Page 116

FTSE Global Equity Index Series – Developed ex US

31 March 2006 to 31 March 2007

140 140

FTSE Developed Regional Indices – Large/Mid Cap (USD) FTSE Developed (LC/MC)

130 130

FTSE Developed Europe (LC/MC)

120 120

FTSE Developed Asia Pacific (LC/MC)

110 110

FTSE All-Emerging (LC/MC)

100 100

FTSE Developed ex US (LC/MC)

FTSE Developed Regional Indices – Capital Returns (USD) 40

30

20

10

0

FTSE North America AC (US$)

FTSE Developed ex US Sector Indices (LC/MC) – Capital Returns (USD)

50

40 40

30 30

20 20

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10

10

Total Return

Total Return

0

0

-10

-10

Key: AC = All Cap, LC = L arge Ca p, MC = Mid Cap, SC = Small Cap, LC/MC = L a r g e a n d M i d C a p

M AY / J U N E 2 0 0 7 • F T S E G L O B A L M A R K E T S

MARKET REPORTS 19.qxd

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17:43

Page 117

2-Month Stock Performance Best Performing FTSE Developed ex US Index Stocks (USD/%) Partygaming UK 75.8 COFCO International (Red Chip) HK 63.8 Leighton Holdings AU 58.9 SI 56.4 Hotel Properties Eiffage FRA 49.3

Overall Index Return (USD)

Worst Performing FTSE Developed ex US Index Stocks (USD/%) Metrovacesa SP -26.0 Round One JA -25.0 Culture Convenience Club JA -24.1 Techtronic Industries HK -21.6 Katokichi JA -20.0

No. of Consts

Value

2 M (%)

FTSE Developed ex US Index (LC/MC) 1,340 FTSE USA Index (LC/MC) 690 FTSE Developed Index (LC/MC) 2,030 FTSE All-Emerging Index (LC/MC) 852 510 FTSE Developed Europe Index (LC/MC) FTSE Developed Asia Pacific Index (LC/MC) 772 FTSE Developed Asia Pacific ex Japan Index (LC/MC) 288 FTSE Developed ex US AC Index 3,892 FTSE Developed ex US LC Index 569 FTSE Developed ex US MC Index 1,684 FTSE Developed ex US SC Index 5,210

281.60 590.92 235.05 457.11 284.93 255.00 453.82 478.63 435.80 591.61 649.31

2.8 -1.1 0.9 3.3 2.8 2.9 5.2 3.1 2.5 4.3 5.2

6 M (%) 12 M (%)

13.5 6.8 10.2 19.8 14.7 11.8 23.9 14.6 12.7 17.7 22.0

17.6 10.0 13.8 18.7 22.4 9.0 31.4 18.2 16.8 21.6 22.9

YTD (%) Actual Div Yld (%)

3.4 0.5 2.0 2.1 3.3 3.8 6.5 3.8 3.0 5.4 6.8

2.32 1.81 2.08 2.28 2.63 1.74 3.14 2.23 2.44 1.67 1.45

FTSE Global Equity Index Series – Asia Pacific 31 March 2006 to 31 March 2007

FTSE Asia Pacific All-Cap (AC) Regional Indices (USD) 140

FTSE Global AC

130

FTSE Developed Asia Pacific (LC/MC)

120

FTSE Developed Asia Pacific ex Japan (LC/MC)

110

FTSE Asia Pacific (LC/MC) FTSE All-Emerging Asia Pacific AC

100 90

FTSE Japan (LC/MC)

7

7

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F T S E G L O B A L M A R K E T S • M AY / J U N E 2 0 0 7

117

MARKET REPORTS 19.qxd

13/4/07

17:43

Page 118

40

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% 20 10

As ia

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MARKET REPORTS BY FTSE RESEARCH

FTSE Asia Pacific Regional Sector Indices – Capital Returns (USD)

2-Month Stock Performance Best Performing FTSE Asia Pacific Index Stocks (USD/%) International Nickel Indonesia INDO 64.3 COFCO International (Red Chip) HK 63.8 Leighton Holdings AU 58.9 Hotel Properties SI 56.4 TWN 53.5 Faraday Technology

Worst Performing FTSE Asia Pacific Index Stocks (USD/%) LG Card KOR -29.9 ACC IDA -26.8 Catcher Technology TWN -26.7 Round One JA -25.0 Hindalco IDA -24.8

Overall Index Return (USD) No. of Consts

Value

2 M (%)

8,092 FTSE Global AC Index 3,201 FTSE Asia Pacific AC Index FTSE Asia Pacific Index (LC/MC) 1,289 FTSE Asia Pacific LC Index 528 761 FTSE Asia Pacific MC Index FTSE Asia Pacific SC Index 1,912 FTSE Developed Asia Pacific ex Japan Index (LC/MC) 288 FTSE Developed Asia Pacific Index (LC/MC) 772 FTSE All-Emerging Asia Pacific Index (LC/MC) 517 FTSE Japan Index (LC/MC) 484

411.19 468.93 266.76 451.78 515.91 525.41 453.82 255.00 315.93 156.56

1.3 2.8 2.6 2.4 3.9 4.3 5.2 2.9 1.9 1.7

6 M (%) 12 M (%)

11.8 12.5 12.3 12.3 12.3 14.1 23.9 11.8 13.7 6.8

14.3 10.4 11.0 11.6 7.9 5.9 31.4 9.0 17.6 0.7

YTD (%) Actual DIv Yld (%)

2.4 2.9 2.7 2.3 4.6 4.9 6.5 3.8 -0.4 2.5

2.01 1.83 1.84 1.87 1.66 1.77 3.14 1.74 2.12 1.06

Key: AC = All Cap, LC = L arge Ca p, MC = Mid Cap, SC = Small Cap, LC/MC = L a r g e a n d M i d C a p

118

M AY / J U N E 2 0 0 7 • F T S E G L O B A L M A R K E T S

8% 6%

il

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MARKET REPORTS 19.qxd Page 119

FTSE Global Equity Index Series – Europe

31 March 2006 to 31 March 2007

FTSE European Regional Indices Performance (EUR)

120

115

FTSE Global AC

110

FTSE Developed Europe ex UK LC/MC

105

FTSEurofirst 300

100

FTSE Developed Europe AC

95

90

FTSEurofirst 100

85

FTSE Eurobloc AC

80

FTSEurofirst 80

FTSE Europe All Cap Indices – Capital Returns (EUR)

25

20

% 15

10

5

0

FTSE North America AC (US$)

FTSE Developed Europe All Cap Sector Indices – Capital Returns (EUR)

60

50

40

30

20

Capital

10

Total Return

0

-10

Key: AC = All Cap, LC = L a rge Cap, MC = Mid Cap, S C = Small Cap, LC/MC = L a r g e a n d M i d C a p

119

MARKET REPORTS 19.qxd

13/4/07

17:43

Page 120

MARKET REPORTS BY FTSE RESEARCH

2-Month Stock Performance Best Performing FTSE Developed Europe Index Stocks (EUR/%) Partygaming UK 75.8 Eiffage FRA 49.3 Volkswagen Pfd GER 38.5 ABN Amro Hldgs.

NETH 34.7 Volkswagen GER 34.7

Overall Index Return (EUR) FTSE Global AC Index FTSE Europe AC Index FTSE Europe LC Index FTSE Europe MC Index FTSE Europe SC Index FTSE Developed Europe AC Index FTSE All-Emerging Europe AC Index FTSE Eurobloc AC Index FTSE Developed Europe ex UK AC Index FTSEurofirst 300 Index FTSEurofirst 80 Index FTSEurofirst 100 Index

Worst Performing FTSE Developed Europe Index Stocks (EUR/%) Metrovacesa SP -26.0 H. Lundbeck DEN -18.1 Public Power Corp GRC -15.1 Outokumpu FIN -14.0 Natixis FRA -13.6

No. of Consts

Value

2 M (%)

8,092 1,779 244 330 1,205 1,666 113 853 1,187 300 80 100

355.70 422.28 444.41 572.72 626.17 417.70 776.37 445.34 450.70 1515.65 5349.96 4763.48

-1.1 0.7 -0.1 2.5 3.1 0.7 1.8 1.6 1.0 0.1 0.7 -0.4

6 M (%) 12 M (%)

6.4 10.7 7.8 16.3 21.1 10.6 14.4 12.3 12.2 8.5 9.0 6.2

YTD (%) Actual Div Yld (%)

3.9 12.5 9.8 19.3 22.4 12.6 6.6 13.4 13.6 10.6 10.4 7.8

1.4 2.8 1.8 5.0 6.4 2.9 0.3 4.0 3.7 2.2 2.7 1.3

2.01 2.48 2.72 1.97 1.68 2.51 1.55 2.48 2.33 2.69 2.88 3.09

FTSE UK Index Series 31 March 2006 to 31 March 2007

FTSE UK Index Series (GBP) 120 120

FTSE FTSE100 100

115 115

FTSE FTSE250 250

110 110

FTSE350 350 FTSE

105 105 100 100

FTSESmallCap SmallCap FTSE

95

FTSEAll-Share All-Share FTSE

95

90

90

FTSE Fledgling

85

FTSE Fledgling

80

FTSE AIM All-Share

85

7

M M ar a -0 r70

Fe F b- eb 07 -0 7

Ja J n- an 07 -0 7

De D c-0ec 6 -06

No N v- ov 06 -0 6

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6

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6

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6

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FTSE AIM All-Share

M M ar a -0 r60

80

FTSE techMARK

FTSE techMARK

Key: AC = All Cap, LC = L arge Ca p, MC = Mid Cap, SC = Small Cap, LC/MC = L a r g e a n d M i d C a p

FTSE North America AC (US$)

120

M AY / J U N E 2 0 0 7 â&#x20AC;˘ F T S E G L O B A L M A R K E T S

FTSE North America AC (US$)

-6%

F T S E G L O B A L M A R K E T S • M AY / J U N E 2 0 0 7

-6%

Steel & Other Metals

Aerospace & Defence

Diversified Industrials

Electronic & Electrical Equipment

& Other Metals

ace & Defence

ified Industrials

nic & Electrical quipment

Capital

Health

rmaceuticals & iotechnology

Total Return

121

Telecommunication Services

12.51 18.49 13.17 39.37 13.49 0.00 779.37 -

communication Services

2.62 2.78 2.64 1.51 2.61 -0.29 0.34 -

Food & Drug Retailers

3.05 1.94 2.88 1.69 2.84 1.73 0.38 1.32

Drug Retailers

1.4 4.6 1.9 2.8 1.9 4.1 8.7 6.1

Transport

P/E Ratio

Transport

Net Cover

Support Services

Actual Div Yld (%)

pport Services

YTD (%)

Entertainment Media & Entertainment

Leisure & Hotels

0

10

0

isure & Hotels

K

0

General Retailers

Ar

M

ch

10

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te

g

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Fl

ar e

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10

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FT SE

FT SE

FT SE

lC ap

20

Tobacco

Pharmaceuticals & Biotechnology

re & Household Personal Care & Household ducts Products

Health

Food Producers & Processors

5.8 18.7 7.6 11.1 7.7 12.2 -4.4 7.9

d Producers & Processors

5.8 16.9 7.4 13.3 7.6 14.9 12.8 13.2

Beverages

Value 2 M (%) 6 M (%) 12 M (%)

Beverages

1.7 5.3 2.2 1.7 2.2 2.5 6.3 4.3

Household Goods & Textiles

100 6308.03 250 11689.30 350 3334.50 338 4013.53 688 3283.21 243 4571.37 1,202 1146.40 100 1605.30

ehold Goods & Textiles

No. of Consts

Automobiles & Parts

8% Overall Index Return (GBP)

75.4 58.6 42.6 34.2 33.0

obiles & Parts

Best Performing FTSE All-Share Index Stocks (GBP/%) Partygaming Alizyme MyTravel Group UK Coal Pendragon

ing & MachineryEngineering & Machinery

Forestry & Paper

al

Sm

0

35

17:43

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FT SE

FT SE

0

25

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13/4/07

ction & Building Construction & Building aterials Materials

Chemicals

Oil & Gas

FTSE 100 Index FTSE 250 Index8% 4% FTSE 350 Index 2% FTSE SmallCap6% Index FTSE All-Share Index 0% FTSE Fledgling 4% Index FTSE AIM Index -2% 2% FTSE techMARK 100 Index 6%

Chemicals

Oil & Gas

-4%

Mining

-2%

Mining

0

10

O il

%

FT SE

FT SE

MARKET REPORTS 19.qxd Page 121

FTSE All-Share Sector Indices – Capital Returns (GBP) 50

40 40

30 30

20

Capital

Capital

Total Return

Total Return

-10

-10

-20

-20

FTSE UK Indices – Capital Return (GBP)

20

10

0

-10

2-Month Stock Performance

Worst Performing FTSE All-Share Index Stocks (GBP/%) Jessops -86.5 Emblaze -41.7 Erinaceous Group -41.5 Agcert International -41.2 Queens Walk Investment -39.9

-4%

0%

Key: AC = All Cap, LC = L arge Cap, MC = Mid Cap, SC = Small Cap, LC/MC = L a r g e a n d M i d C a p

MARKET REPORTS 19.qxd

13/4/07

17:43

Page 122

31 March 2006 to 31 March 2007

FTSE Xinhua Index Series (CNY/HKD) 280

FTSE/Xinhua China 25 (HKD)

240

FTSE Xinhua All-Share (CNY) FTSE Xinhua Small Cap (CNY)

200

FTSE/Xinhua China A50 (CNY) 160

FTSE Xinhua 600 (CNY) 120

FTSE Xinhua China Government Bond Total Performance Index (CNY) 7 M

ar -0

7 Fe b0

7 Ja n0

6 c-0

No

De

v0

6

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Ju

g-

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06

6

06 nJu

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6

6 r-0 Ap

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6

80

M

MARKET REPORTS BY FTSE RESEARCH

FTSE Xinhua Index Series

FTSE Xinhua Index Series Index Name

Consts

FTSE/Xinhua 25 Index (HKD) 25 FTSE/Xinhua China 50 Index (CNY) 51 FTSE Xinhua All-Share Index (CNY) 1,003 FTSE Xinhua 600 Index (CNY) 600 FTSE Xinhua Small Cap Index (CNY) 403 FTSE Xinhua China Government Bond Total Performance Index (CNY) 31

Value 2 M (%) 6 M (%) 12 M (%) YTD (%)

15634.92 11247.64 6592.92 7055.27 4930.98 96.12

0.3 9.3 22.2 19.6 44.4 -0.2

30.2 104.3 94.0 94.8 89.0 0.3

41.2 156.9 171.2 167.6 193.9 1.4

Actual Div Yld (%)

-5.8 22.2 44.2 40.1 82.3 0.2

1.73 0.73 0.75 0.81 0.31 3.18

FTSE Hedge Index Series FTSE Hedge Management Styles (USD) – 5-Year Performance 140

FTSE Hedge

130

FTSE Hedge Directional

120

FTSE Hedge Event Driven

110

FTSE Hedge Non-Directional

100 90

7 ar -0 M

06 Se

p-

6 ar -0 M

05 pSe

5 ar -0 M

04 Se p-

4 ar -0 M

3 -0 Se p

3 ar -0 M

2 -0 Se p

M

ar -0

2

80

Based upon indicative index values as at 28 February 2007 and 30 March 2007

Key: AC = All Cap, LC = L arge Ca p, MC = Mid Cap, SC = Small Cap, LC/MC = L a r g e a n d M i d C a p

122

M AY / J U N E 2 0 0 7 • F T S E G L O B A L M A R K E T S

MARKET REPORTS 19.qxd

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FTSE Hedge – Management Styles & Strategies (NAV Terms) FTSE Hedge Index Directional Equity Hedge Commodity Trading Association (CTA) / Managed Futures Global Macro Event Driven Merger Arbitrage Distressed & Opportunities Non-directional Convertible Arbitrage Equity Arbitrage Fixed Income Relative Value

Index Level*

2M (%)

6 M 12 M (%) (%)

YTD 5-Year Ann 3-Year (%) (%) Volatility (%)

5350.72 3260.25 2286.70 2062.19 1988.61 3294.72 2102.82 2281.62 3063.90 1987.37 2072.07 2040.72

-3.5 -3.4 -5.7 -5.5 -1.2 -6.4 -4.9 -7.5 -2.3 -4.6 -3.5 -0.5

0.2 1.6 0.0 1.2 -0.1 -2.0 -2.8 -1.3 -1.3 -3.7 -1.5 -0.5

-2.4 -2.7 -5.0 -3.8 -1.5 -4.7 -3.7 -5.2 -1.5 -3.9 -2.4 0.2

0.0 -0.1 0.1 -0.2 -0.6 0.0 0.3 -0.1 -0.1 0.0 0.0 -0.1

4.3 5.8 5.7 8.0 4.1 3.7 1.1 5.9 2.3 4.3 2.6 1.0

3.4 5.0 6.8 10.0 5.9 5.3 4.9 6.2 2.1 4.4 2.9 1.6

* Based upon indicative index values as at 28 February 2007 and 30 March 2007

FTSE EPRA/NAREIT Global Real Estate Index Series FTSE EPRA/NAREIT Global Real Estate Indices – 5-Year Performance (Total Return Basis) 400

EPRA/NAREIT Global Index (USD)

350

EPRA/NAREIT North America Index (USD)

300

EPRA/NAREIT Europe Index (EUR)

250 200

EPRA/NAREIT Eurozone Index (EUR)

150

EPRA/NAREIT Asia Index (USD)

100

7 ar -0 M

06 Se p-

6 ar -0 M

05 Se p-

5 ar -0 M

p04 Se

4 ar -0 M

03 Se p-

3 ar -0 M

02 Se p-

M

ar -0

2

50

FTSE EPRA/NAREIT Global Real Estate Indices (Total Return) Index Name

EPRA/NAREIT Global Index (USD) EPRA/NAREIT North America Index Index (USD) EPRA/NAREIT Europe Index (EUR) EPRA/NAREIT Euro Zone Index (EUR) EPRA/NAREIT Asia Index (USD)

Consts

Value

2 M (%)

316 131 100 47 85

3811.99 4313.07 3931.17 4341.73 2933.95

1.3 -4.1 2.4 4.4 6.5

6 M (%) 12 M (%)

21.1 13.6 19.2 22.7 29.1

32.7 24.0 29.3 33.6 38.9

YTD (%)

Actual Div Yld (%)

6.2 4.0 2.0 8.0 11.2

2.92 3.64 1.97 2.24 2.65

Key: AC = All Cap, LC = L a rge Cap, MC = Mid Cap, SC = Small Cap, LC/MC = L a r g e a n d M i d C a p

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FTSE Bond Indices – 5-Year Performance (Total Return Basis) FTSE All-Eurozone Government Bond Index (EUR) FTSE Euro Corporates Bond Index (EUR) FTSE USA Goverment Bond Index (USD) FTSE Pfandbrief Index (EUR) FTSE Gilts Index Linked All-Stocks Index (GBP) FTSE Japan Government Bond Index (JPY)

180

160

140

120

100

ar -0

7

06 p-

M

M

Se

ar -0

6

05 pSe

ar -0

5

04 p-

M

M

Se

ar -0

4

03 Se

M

p-

3 ar -0

pSe

ar -0

2

02

80

M

MARKET REPORTS BY FTSE RESEARCH

FTSE Bond Indices

FTSE Euro Emerging Markets Bond Index (EUR) FTSE Gilts Fixed All-Stocks Index (GBP)

FTSE Bond Indices (Total Return) Index Name

Consts

Value

2 M (%)

241 400 36 329 12 28 132 245 31

154.84 178.17 215.86 145.18 2058.88 1934.44 153.69 111.33 96.12

0.5 0.6 0.8 0.7 1.0 0.6 1.7 0.4 -0.2

FTSE All-Eurozone Government Bond Index (EUR) FTSE Pfandbrief Index (EUR) FTSE Euro Emerging Markets Bond Index (EUR) FTSE Euro Corporates Bond Index (EUR) FTSE Gilts Index Linked All Stocks Index (GBP) FTSE Gilts Fixed All-Stocks Index (GBP) FTSE USA Government Bond Index (USD) FTSE Japan Government Bond Index (JPY) FTSE China Government Bond Index (CNY)

6 M (%) 12 M (%)

-0.3 0.2 2.0 0.7 -0.3 -1.0 2.2 0.8 0.3

1.9 2.1 3.4 2.7 3.0 0.6 5.8 2.3 1.4

Annual Redemption YTD (%) Yld (%)

0.2 0.4 0.8 0.7 -0.5 -0.7 1.4 0.6 0.2

4.23 4.29 5.08 4.64 1.61* 4.67 4.81 1.54 3.18

* Based on 0% inflation

FTSE GWA Index Series FTSE GWA Index Series – 5-Year Performance (Total Return Basis) 250

FTSE GWA Developed Index (USD) FTSE GWA Developed ex US Index (USD) FTSE GWA Developed ex Japan Index (USD) FTSE GWA Developed Europe Index (EUR) FTSE GWA UK Index (GBP)

200

150

100

ar -0 7 M

06 pSe

6 ar -0 M

05 pSe

5 ar -0 M

04 pSe

4 ar -0 M

03 pSe

3 M ar -0

02 pSe

M

ar -0

2

50

Key: AC = All Cap, LC = L arge Ca p, MC = Mid Cap, SC = Small Cap, LC/MC = L a r g e a n d M i d C a p

124

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FTSE GWA Indices (Total Return) Index Name

Consts

Value

2 M (%)

2030 1340 1546 510 693

4206.90 4638.78 4184.25 4274.69 4030.89

1.4 3.2 1.2 0.5 2.5

FTSE GWA Developed Index (USD) FTSE GWA Developed ex US Index (USD) FTSE GWA Developed ex Japan Index (USD) FTSE GWA Developed Europe Index (EUR) FTSE GWA UK Index (GBP)

6 M (%) 12 M (%)

11.8 15.0 12.1 10.2 8.9

18.2 22.2 19.8 15.2 10.9

YTD (%)

Actual Div Yld (%)

2.4 3.8 2.2 2.4 2.0

2.25 2.49 2.38 2.81 3.06

FTSE RAFI Index Series FTSE RAFI Index Series – 5-Year Performance (Total Return Basis) 250

FTSE RAFI US 1000 Index (USD) FTSE RAFI Developed ex US 1000 Index (USD)

200

FTSE RAFI Kaigai 1000 Index (USD) 150

FTSE RAFI Europe Index (EUR) FTSE RAFI Eurozone Index (GBP)

100

ar -0 7 M

p06 Se

M ar -0 6

05 pSe

5 ar -0 M

Se

p-

04

4 M ar -0

p03 Se

3 ar -0 M

p02 Se

M

ar -0 2

50

FTSE RAFI Indices (Total Return) Index Name

FTSE RAFI US 1000 Index (USD) FTSE RAFI Developed ex US 1000 Index (USD) FTSE RAFI Kaigai 1000 Index (USD) FTSE RAFI Europe Index (EUR) FTSE RAFI Eurozone Index (EUR)

Consts

Value

2 M (%)

1005 1017 1021 478 274

6179.19 7005.40 6035.56 6394.02 6576.50

-0.4 4.0 1.5 1.4 2.3

6 M (%) 12 M (%)

9.2 16.4 12.6 11.8 13.2

15.6 23.4 21.3 16.9 18.2

YTD (%)

Actual Div Yld (%)

1.7 4.9 2.9 3.6 4.5

2.13 2.50 2.54 2.85 2.75

Key: AC = All Cap, LC = L a rge Cap, MC = Mid Cap, SC = Small Cap, LC/MC = L a r g e a n d M i d C a p

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31 December 2003 to 31 March 2007

FTSE LATIBEX Index Series (EUR Terms) 350

FTSE LATIBEX All-Share Index

300

FTSE LATIBEX Top Index 250

FTSE LATIBEX Brasil Index 200

FTSE Latin America Index 150

FTSE Brazil Index 100

M

ar -0 7

c-0

6

06

De

pSe

6

n06 Ju

5 c-0

ar -0 M

05

De

pSe

05 n-

5

Ju

M

ar -0

4 c-0 De

p04 Se

04 nJu

ar -0 4 M

c-0

3

50

De

MARKET REPORTS BY FTSE RESEARCH

FTSE LATIBEX Index Series

FTSE LATIBEX Indices (EUR Terms) Index Name

FTSE LATIBEX All Share Index FTSE LATIBEX TOP Index FTSE LATIBEX Brasil Index FTSE Latin America Index FTSE Brazil Index

Value

2 M (%)

6 M (%)

12 M (%)

YTD (%)

2455.90 4021.70 9168.20 585.59 505.30

3.5 3.6 3.4 2.0 2.6

23.1 23.0 27.1 22.6 24.2

17.7 14.5 10.9 17.6 12.4

6.0 6.4 6.5 5.1 5.2

FTSE UK Commercial Property Index Series FTSE UK Commercial Property Index Series – 5-Year Performance (Total Return Basis) 250

FTSE All UK Property Index

200

FTSE UK Retail Property Index FTSE UK Office Property Index

150

FTSE UK Industrial Property Index

100

ar -0 7 M

6 Se p0

ar -0 6 M

5 Se p0

5 ar -0 M

4 p0 Se

ar -0 4 M

3 p0 Se

ar -0 3 M

2 p0 Se

M

ar -0 2

50

Key: AC = All Cap, LC = L arge Ca p, MC = Mid Cap, SC = Small Cap, LC/MC = L a r g e a n d M i d C a p

126

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FTSE UK Commercial Property Indices (GBP Terms) Index Name

FTSE All UK Property Index FTSE UK Retail Property Index FTSE UK Office Property Index FTSE UK Industrial Property Index

Value

2 M (%)

6 M (%)

12 M (%)

YTD (%)

5603.84 5544.53 5634.64 5634.64

0.9 0.5 1.0 1.0

6.6 5.1 7.1 7.1

14.1 13.5 13.8 15.4

2.7 1.0 5.1 5.1

YTD (%)

Annual Volatility (%)

5.3 8.8 11.7

2.4 4.3 6.1

FTSE Private Banking Index Series 120

Low Risk 115

Medium Risk

110

High Risk

105

100

ar -0 7

6

M

Se

De

c-0

p06

06 nJu

M

De

c-0

ar -0

5

6

95

FTSE Private Banking Index Series (USD Terms) Index Value (31 Dec 2005=100)

3 M (%)

106.66 110.59 113.63

1.3 1.6 1.8

USD Low Risk USD Medium Risk USD High Risk

6 M (%) 12 M (%)

3.2 5.2 6.6

5.7 7.3 8.4

FTSE Research Team contact details Andy Harvell Head of Research andy.harvell@ftse.com +44 20 7866 8986

Andreas Elia Research Analyst andreas.elia@ftse.com +44 20 7866 8013

Kamila Lewandowski Research Analyst kamila.lewandowski@ftse.com +44 20 7866 1877

Sandra Jim Research Manager, Asia Pacific sandra.jim@ftse.com +(852) 223 0-5814

Key: AC = All Cap, LC = L a rge Cap, MC = Mid Cap, SC = Small Cap, LC/MC = L a r g e a n d M i d C a p

F T S E G L O B A L M A R K E T S â&#x20AC;˘ M AY / J U N E 2 0 0 7

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CALENDAR

Index Reviews May – August 2007 Date

Index Series

Review Type

Effective Data Cut-off (Close of business)

10-May 11-May 16-May Early Jun Early Jun Early Jun Early Jun Early Jun Early Jun 1-Jun 1-Jun 1-Jun 4-Jun 5-Jun 6-Jun 6-Jun

FTSE Med 100 Index Hang Seng MSCI Standard Index Series ATX KOSPI 200 IBEX 35 CAC 40 OBX S&P / TSX S&P BRIC 40 S&P / ASX Indices DJ Global Titans 50 OMX S30 DAX FTSE UK Index Series FTSE Global Equity Index Series (incl. FTSE All-World) FTSE techMARK 100 FTSEurofirst 300 FTSE eTX FTSE/JSE Africa Index Series FTSE EPRA/NAREIT Global Real Estate Index Series NASDAQ 100 NZSX 50 S&P MIB FTSE Bursa Malaysia Index Series DJ STOXX S&P US Indices S&P Europe 350 / S&P Euro S&P Topix 150 S&P Asia 50 S&P Global 1200 S&P Global 100 S&P Latin 40 Russell US Indices VINX 30 OMX S30 Baltic 10 OMX C20 OMX N40 TOPIX New Index Series FTSE Xinhua Index Series TSEC Taiwan 50 PSI 20 OMX H25

Semi-annual review Quarterly review Annual review Quarterly review Annual review Semi-annual review Quarterly review Semi-annual review Quarterly review Semi-annual review - constituents Quarterly Review Annual review of index composition Semi-annual review Quarterly review Quarterly review Annual review - Emgng Eur, ME, Africa, Latin America Quarterly review Quarterly review Quarterly review Quarterly review

18-May 1-Jun 31-May 29-Jun 8-Jun 2-Jul 15-Jun 22-Jun 15-Jun 15-Jun 15-Jun 15-Jun 30-Jun 15-Jun 15-Jun

27-Apr 30-Mar 30-Apr 31-May 31-May 31-May 31-May 31-May 31-May

15-Jun 15-Jun 15-Jun 15-Jun 15-Jun

30-Mar 31-May 31-May 31-May 1-Jun

Quarterly review 15-Jun Quarterly review/ shares adjustment 15-Jun Quarterly review 29-Jun Quarterly review, IWF 15-Jun Semi-annual review 15-Jun Quarterly review 13-Jun Quarterly review 15-Jun Quarterly review 15-Jun Quarterly review 15-Jun Quarterly review 15-Jun Quarterly review 15-Jun Quarterly review 15-Jun Quarterly review 15-Jun Annual / Quarterly review 30-Jun Semi-annual review 25-Jun Semi-annual review 29-Jun Semi-annual review 29-Jun Semi-annual review 25-Jun Semi-annual review 25-Jun Semi-annual review 27-Jul Annual Review 20-Jul Quarterly & annual review 20-Jul Semi-annual review 30-Jul Semi-annual review - consituents, Quarterly review - shares in issue 31-Jul Quarterly review 7-Sep Quarterly review 31-Aug

1-Jun 31-May 31-May 8-Jun 31-May 15-May

30-Jun 29-Jun 31-Oct

21-Sep 21-Sep

29-Jun 24-Aug

6-Jun 6-Jun 6-Jun 6-Jun 6-Jun 8-Jun 11-Jun 12-Jun 12-Jun 13-Jun 13-Jun 13-Jun 13-Jun 13-Jun 13-Jun 13-Jun 13-Jun 15-Jun Mid Jun Mid Jun Mid Jun Mid Jun Mid Jun 1-Jul 11-Jul 12-Jul Mid July Mid July 10-Aug 15-Aug 28-Aug 29-Aug

Hang Seng MSCI Standard Index Series FTSE Global Equity Index Series (incl. FTSE All-World)_ Annual Review / Japan FTSE Goldmines Index Series Quarterly review

31-May 30-Apr 31-May 31-May 5-Jun

31-May 31-May 31-May 31-May 31-May 31-May 16-Jun 18-Jun 29-Jun 31-May

Sources: Berlinguer, FTSE, JP Morgan, Standard & Poors, STOXX

128

MARCH/APRIL 2007 • FTSE GLOBAL MARKETS

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Page IBC1

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GM EDITORIAL 19.qxd

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