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ASSET SERVICING IN 2020: THE IMPACT OF GEN Y ISSUE 21 • SEPTEMBER/OCTOBER 2007

The ruck with private equity club deals Business is brisk for transition managers Does German real estate need a wake-up call?

DTCC: MOVING WITH THE

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FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2007

strong whiff of paradigm shift has hung in the markets this year. Without in any way minimising the impact of recent market volatility, truth be told, it is something of a sideshow. If that sounds controversial, think again. Much bigger changes are afoot and the boom market of the last three years has lulled many into a false sense of security about the long term viability of the global market order. The once high tides of liquidity that floated all boats seemingly distracted investors from the longer term trends and appropriate risk management mechanisms and unwise lenders from appropriate credit control practices. Apparent during late July and early August was the growing maturity of Asia and Latin American emerging markets, many of which suffered belated but chesty coughing fits as America and other developed markets caught something akin to viral pneumonia. It’s a small, but noteworthy directional change. More significant yet, over the medium to long term, is the gradual passing of the baby boomer generation and the ascendance of Generation Y.This segment of the workforce will invariably shape the future success of the global economy. The question for the fund management industry is how well it is preparing for this particular market shift. Generation Y, or less formally Gen Y, is broadly defined as comprising those born over the 15 years from June 1976 to June 1991. They are the children of the baby boomers and are today’s 20-somethings. This ascending generation will develop into tomorrow’s accumulators of wealth. The fund management industry has boomed over the last 15 years of baby boomer dominance—propelled by extended economic prosperity in most developed nations. The growth in the depth and range of investible products made available during this time is directly related to baby boomers morphing into middle age. Many had prepared for retirement for more than a decade. However, those same baby boomers are now on the cusp of retirement. The demographic momentum that underpinned the rising pool of retirement funds will decelerate during the next ten years. As boomers move out of the workforce, many fund managers will be left with a shrinking pool of wealth. Some fund managers will continue to manage the remaining wealth of the boomers; yet others will establish a dialogue with Gen Y and have to deliver against a new set of demands and expectations. Right now, despite rising population numbers in many emerging markets, the tipping point has not quite been reached. However, it is coming soon enough. In future, fund managers will be much more focused on Asia, central and eastern Europe and Latin America than the mature markets of North America and western Europe. It is not only the fund management industry that is in flux: all global and regional financial structures are in a state of change. Consolidation, cross-border acquisitions and changing patterns in the sources of market liquidity are all signal indications of this dynamic. The interplay between Gen Y and the evolution of global markets will nonetheless pose as many challenges as opportunities. Buying patterns in many emerging regions, such as the GCC and the Far East are much more speculative and short term than many western manufacturers have been used to. For products to sell in emerging markets they have to be innovative, provide consistent short-term returns and have credible branding. Additionally, funds will have to try alternative distribution channels; some of which have not even been thought of yet. It is not an easy cocktail to mix. As ever, we will be reporting on the changing dynamics with keen interest.

Francesca Carnevale, Editorial Director August 2007

Contents COVER STORY ..Page 68 “Since the start of the millennium, the organisation has kind of outfitted itself for the third millennium,” says Donald F Donahue, chairman and chief executive officer (CEO) of The Depository Trust & Clearing Corporation (DTCC). Pretty soon, the DTCC will become—whether it will admit it overtly or not—a lynchpin of a globalised securities markets. How will it handle change?

COVER STORY: DTCC: MOVING WITH THE NEW WORLD ORDER

DEPARTMENTS MARKET LEADER

DO PRIVATE EQUITY CLUB DEALS ALWAYS MAKE SENSE? ..Page 6 Neil O’Hara explains the pitfalls and the challenges

SUSTAINING GROWTH IN US ETFS ....................................................Page 10 Neil O’Hara looks specialised funds that track narrower equity market sectors

FUND PROFILE: CLAYMORE INVESTMENTS................................Page 16 Francesca Carnevale profiles a firm that has made ETFs a particular specialty

IN THE MARKETS

WHAT NEXT FOR PROJECT TURQUOISE? ....................................Page 18 Lynn Strongin Dodds wonders when the new trading platform will open for business

THE RISK RACE ....................................................................................................Page 24 Xenomorph CEO Brian Sentance asks if trading risks are properly understood

MANAGING THE CLIMATE AND DEVELOPMENT ..................Page 28 Ian Williams looks at the way the markets balance environmental and economic needs

INDEX REVIEW

ALL SWINGS AND NO ROUNDABOUTS ........................................Page 30

ISSUER PROFILE

AFT REVIEWS NEW ISSUE VOLUME FOR 2007 ........................Page 32

Simon Denham, managing director, Capital Spreads, looks at the main indices Andrew Cavenagh profiles the borrowing plans of Agence France Trésor.

................Page 36 John Rumsey outlines the prospects for Brazil's pension fund industry

BRAZIL’S PENSION FUNDS SPREAD THEIR WINGS

BRAZIL CHANGES CORPORATE ACCOUNTING RULES ......Page 40

REGIONAL REVIEW

John Rumsey examines the impact on corporate borrowing

THE RISE OF INDIA’S DISTRESSED DEBT MARKET ................Page 42

Simon Watkins looks at an emerging asset class .

................................................................................Page 44 The JSE’s patient play for a broader regional role

JSE: THE WIDER VIEW

REAL ESTATE BANK PROFILE

IT’S BETTER TO BE BIG THAN HUGE ................................................Page 98

ALTERNATIVES

MIND OVER MATTER ..................................................................................Page 101

INDEX REVIEW 2

CAN ANYONE REAWAKEN GERMANY’S PROPERTY MARKET?......Page 94

Tread carefully says Mark Faithfull of the unevenly recovering market.

Why Brown Brothers Harriman (BBH) thinks capital is not the be-all and end-all

Neil O’Hara charts the shifting landscape of the prime broker

Market Reports by FTSE Research ............................................................................Page 104 Index Calendar..............................................................................................................Page 112

SEPTEMBER/OCTOBER 2007 • FTSE GLOBAL MARKETS

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Contents FEATURES THE MIDDLE EAST REPORT

THE ADDED ATTRACTION OF EGYPTIAN BANKING ..........Page 46 Foreign banks are pouring into Egypt, tempted by the potential of a nascent retail market that could service the Middle East’s largest single population grouping. You can almost feel the temptation. However, as domestic banks can testify, you need brains as well as brawn in this competitive and challenging market

GCC BANKS LOOK ABROAD FOR NEW BUSINESS ..............Page 50 Flush with funds and profits the banks and major financial institutions of the Gulf Cooperation Council (GCC) countries are beginning to feel constrained by the size of their domestic markets. With a growing array of retail and investible products, GCC banks are beginning to flex their confidence and are actively looking for acquisitions overseas. What next?

HIGH OCTANE GAS-FIRED FUNDING ................................................Page 56

Demand outstrips supply for Middle East securities. While a credit crunch threatens elsewhere, lending remains strong in the GCC countries and even more big ticket deals are in the pipeline. How long can the boom in local infrastructure spending, real estate and corporate fund raising last? Quite a long time it seems. Francesca Carnevale reports on a growing asset class ..............................................Page 60 With the continued expansion of the global markets comes a growing need for both borrowing and lending of securities. Beneficial owners seem to want more information, greater transparency and better risk-management than ever before—just a few of the challenges facing custodians and third-party providers alike. Dave Simons reports

US SECURITIES LENDING LIVES IT LARGE

TRANSITION MANAGEMENT

THE EVOLUTIONARY IMPERATIVE ....................................................Page 72

Transition management is growing at a heady pace and handles at least $2trn in assets annually. The relationship between client and transition management provider is changing as, in the words of one provider, “it becomes more a solution-based consultative business”. Francesca Carnevale reports on the trends and the transformation of a global industry

EFFICIENT FIXED INCOME EXECUTION ..........................................Page 79

THE 2020 ASSET SERVICING REPORT ..............................................Page 81 The gradual ascendance of Generation Y will alter the products developed and the distribution systems used by fund managers. Who will win and who will lose out in the coming revolution?

Hot Licks: the trends to watch ........................................................................................Page 82 Generation Y in the ascendant ........................................................................................Page 83 Changing the pitch in fund administration ..................................................................Page 86 Will the buyside get what the buyside wants? ..............................................................Page 88 The trouble with technology ..........................................................................................Page 91 Will custody ever be the same again? An Asian perspective ......................................Page 92

SEPTEMBER/OCTOBER 2007 • FTSE GLOBAL MARKETS

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The Globe logo, CME, Chicago Mercantile Exchange, and CME Group are trademarks of Chicago Mercantile Exchange Inc. CBOT and Chicago Board of Trade are trademarks of the Board of Trade of the City of Chicago. Copyright © 2007 CME Group. All rights reserved.

Market Leader THE LIMITATIONS OF PRIVATE EQUITY CLUB DEALS

DO CLUB DEALS ALWAYS MAKE GOOD MUSIC? Club deals have become popular among the largest private equity firms, but some investors and club members worry what will happen if one of these mega-transactions turns sour. Even if club deals do not go awry, market analysts think that in future they will remain the exception rather than the rule. Neil Oâ&#x20AC;&#x2122;Hara outlines their possible pitfalls and their natural limits. T IS EASY to see the appeal of club deals. A couple of early delivered have transactions spectacular returns. The current craze took hold in August 2004 when Kohlberg Kravis Roberts & Co. (KKR),

I 6

The Carlyle Group and Providence Equity Partners put up $548m in equity for a $4.4bn leveraged recapitalisation of satellite operator PanAmSat. Two months later, the club members took out a dividend of

Although partnership documents in club deals include a governance term sheet, informal understandings about who plays what role are often the key to success, according to Colin Blaydon, professor of management and director of the Center for Private Equity and Entrepreneurship at the Tuck School of Business at Dartmouth College in Hanover, New Hampshire. Photograph by Mindrift, supplied by Dreamstime.com, July 2007.

$245m. In March 2005, PanAmSat went public and paid an additional $200m to the club. Then, in August 2005, Intelsat agreed to buy PanAmSat for $25 per share, which valued the club's stake at $1.8bn. All told, the club quadrupled its money in a year. Emboldened by that success, clubs began to tackle targets too big for any one firm to buy on its own. In December 2005, Clayton Dubilier & Rice, The Carlyle Group and Merrill Lynch Global Private Equity put up

SEPTEMBER/OCTOBER 2007 â&#x20AC;˘ FTSE GLOBAL MARKETS

$2.3bn of equity in a $15bn leveraged buyout of Hertz, the car rental company. Hertz paid a $991m dividend in June 2006 and another $260m from the proceeds of an initial public offering (IPO) in November 2006 that left club members with a stake then valued at $3.8bn and now worth $5.3bn. For members of the club, it was a tripling of return. Even bigger deals followed. In short, order HCA, Equity Office Properties and TXU, all club deals, successively claimed the title of largest leveraged buyout ever. So why does Caroline Aboutar, a senior consultant at Mercer Investment Consulting, see fewer club deals in the future? “The mega-buyout firms

can write larger checks and they need to put their funds to work,” she says, “They are not going to need to team up as much together.” If sponsors do step back from clubs, investors in private equity funds won't object, notwithstanding the spectacular returns on PanAmSat and Hertz. “How well will these consortia work if really tough decisions are needed to keep the business solvent?” asks Trey Thompson, formerly managing director of private markets at the Austin, Texas-based University of Texas Investment Management Company (UTIMCO). Thompson left UTIMCO in April to become a partner in Perella Weinberg, the boutique investment bank.

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Private equity firms accustomed to calling the shots by themselves will have to work together when hard decisions have to be made about layoffs, plant closures or personnel changes. Blackstone acknowledged the risk in the preliminary prospectus for its own IPO. “Consortium transactions generally entail a reduced level of control by Blackstone … we may not be able to control decisions relating to the investment, including decisions relating to the management and operation of the company and the timing and nature of any exit.” The experience in venture capital, where consortium deals have long been the norm, will not necessarily apply to buyout clubs. Venture capital

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FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2007

Market Leader THE LIMITATIONS OF PRIVATE EQUITY CLUB DEALS

commitments are smaller and the “Informal understandings are going to sponsors do not always charge full same firms often compete in one deal be the real test of how well it works,”he fees on that money. “Investors have while they co-operate on the next.“It says,“Governance formalisms are only become a lot more aggressive in moderates the severity of the going to have effect when things are so trying to get co-investments,” Kelly conflicts,” explains Richard Phillips, a nasty that people are jockeying for says,“Sponsors see it as a way to keep partner in the San Francisco office of position vis-à-vis each other to get out the capital within the family.” In a recent example, Providence Equity lawyers Kirkpatrick & Lockhart,“They of a bad situation.” Clubs often coalesce around Partners and Madison Dearborn do not end up in court except in personal relationships as a result, says teamed up with Ontario Teachers extreme circumstances.” Plan and Teachers Paul Gajer, a partner in the New Michael Kelly, a managing director Pension York office of Sonnenschein Nath & responsible for due diligence on private Private Capital as co-investors for the Rosenthal LLP points out that venture equity sponsors at the specialist proposed buyout of Canadian capital deals typically are not financial advisor Hamilton Lane, based telecommunications giant BCE. The potential for leveraged either. Equity conflict among members owners who disagree do exists even if a club deal is not have to act, but in the successful. Buyout firms buyout world if the debt like to schedule goes into default the If sponsors do step back from clubs, realisations to coincide lenders can force a investors in private equity funds won't with their fund raising resolution. Buyout object, notwithstanding the spectacular cycle so that investors get investors also do not money back from one expect multiple rounds of returns on PanAmSat and Hertz. “How fund just in time to financing, so some well will these consortia work if really subscribe to the next.“You sponsors may be reluctant tough decisions are needed to keep the might have one group to put up more capital. “I business solvent?” asks Trey Thompson, arguing to sell the have seen situations where formerly managing director of private business prematurely just one private equity firm will because they need to put take out the senior lender markets at the Austin, Texas-based some points on the board and assume control over University of Texas Investment to raise their next fund,” the situation to break a Management Company (UTIMCO). says Thompson, who stalemate,”Gajer says. ranks this risk second Although partnership only to how clubs will documents in club deals cope with transactions include a governance term that go sour. In extreme informal sheet, cases, pressure for an exit may understandings about who plays what in Bala Cynwyd, Pennsylvania. Although complementary firm override the desire to maximize the role are often the key to success, according to Colin Blaydon, professor expertise is important, partners at return on an investment. Despite their reservations about of management and director of the competing firms who have worked Center for Private Equity and well together on past deals are more club deals, private equity investors in practice have little choice except to Entrepreneurship at the Tuck School likely to repeat the experience. The nature of private equity clubs play along. Competition to get into of Business at Dartmouth College in may be changing in any case. In the the top funds is so intense that if Hanover, New Hampshire. Blaydon, who is a director of both main, this is because sponsors do not limited partners scale back their venture capital and private equity firms like giving away part of a deal to their allocation to control consortium risk, (including Merrill Lynch Global Private competitors. Firms would rather the general partners may exclude Equity), says clubs use members’ augment their capital through co- them from future funds altogether. specialist teams to focus on particular investment by existing participants in “Those are some of the hardest aspects of a company—Bain Capital’s their funds, an opportunity some decisions limited partners have to operations group, for example. investors are keen to exploit because make,”says Thompson.

SEPTEMBER/OCTOBER 2007 • FTSE GLOBAL MARKETS

In the Markets THE PROLIFERATION OF QUANT BASED ETFS IN NORTH AMERICA

Sustaining growth in US ETFs The exchange traded fund (ETF) industry in the United States grew up on the back of institutional demand for funds that mimic broad-based indices. In recent years, the number of ETFs has proliferated as sponsors responded to demand from registered investment advisors (RIAs) for specialised funds that track narrower sectors of the equity market as well as commodities, fixed income, currencies and real estate. Neil O’Hara reports. 2006 STUDY by the Bostonbased Financial Research Corporation projected that US exchange traded fund (ETF) assets would grow 29% per year compound to hit $1.4trn by 2011. Assets have just passed $500bn, putting the industry on track to meet or beat that forecast. With ETFs already blanketing the market, what will sustain the growth? In a crowded field, it is becoming harder for ETF sponsors to hit home runs, after all. According to Gus Sauter, chief investment officer at Valley Forge, Pennsylvania-based The Vanguard Group, 10 new ETFs came to market in 2002 and four of those took in more than $250m of assets in their first year. In 2006, sponsors launched 166 new ETFs, but so far, only seven have reached $250m within 12 months. “The low hanging fruit has already been picked,” Sauter says, “ETFs for municipal bonds may be the last big frontier—but it is very difficult.” Leading players, such as Barclays Global Investors (BGI), State Street Global Advisors (SSGA) and Vanguard, are now so well entrenched in broad based ETFs that new entrants have resorted to more arcane products to differentiate themselves.

In 2003, PowerShares pioneered ETFs based on the American Stock Exchange’s Intellidex methodology that constructs “intelligent” indices using quantitative screens of fundamental data intended to pick stocks with investment merit. That same year, Rydex took a different tack when it launched a series of ETFs based on equal-weighted indices that contain all the components of Standard & Poor’s traditional indices but in identical proportions instead of weighted by market capitalisation. Moreover, in 2006, Wisdom Tree introduced ETFs that track indices based on dividend payments. Sauter regards these “fundamental” ETFs as a triumph of marketing over common sense. A commitment to low cost passive investment products propelled Vanguard to become the largest US money manager, and Sauter says its research shows the quantitative screens carve out a segment of the market—growth or value, for example—but do not deliver any excess return, or alpha. If investors want style exposure, they can get it at lower cost from ETFs offered by the major sponsors. Sauter dismisses as hype claims that fundamental ETFs, which are typically mid-cap value

Gus Sauter, chief investment officer at Valley Forge, Pennsylvania-based The Vanguard Group, 10 new ETFs came to market in 2002 and four of those took in more than $250m of assets in their first year. Photograph kindly supplied by The Vanguard Group, August 2007.

weighted, beat the broader market, too. “Investors are being told this is something that beats the Standard & Poor’s 500,”he says,“Academic research shows that value and small-cap stocks have outperformed the broader market over the past 40 to 50 years. The comparison is wholly inappropriate.” In their quest for a foothold, newer entrants account for a disproportionate share of recent ETF issuance. Anthony Rochte, senior managing director and co-head of the ETF business at SSGA in Boston, says more than 200 new ETFs came to market between the beginning of November 2006 and early July. SSGA, which accounts for 24% of US ETF assets, launched 19 ETFs in that period—9% of the total—but those funds attracted 23% of net asset flows into new ETFs. “We are very thoughtful about new product launches,” Rochte says, “We have a responsibility not only to potential new shareholders but to existing holders as well.” Even veterans such as Rochte, who has worked in the industry since the

SEPTEMBER/OCTOBER 2007 • FTSE GLOBAL MARKETS

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In the Markets THE PROLIFERATION OF QUANT BASED ETFS IN NORTH AMERICA

early 1990s and on ETFs for the last seven years, cannot always predict how well new products will do. For example, in December 2006, SSGA launched the SPDR DJ Wilshire International Real Estate ETF, which tracks an index of real estate securities outside the US. Based on SSGA’s research, Rochte knew there was pent-up demand from investors but “did not have huge expectations.” By early July, though, assets exceeded $1bn, a spectacular success that revealed an unmet need in the market. Rochte says the money came not only from institutions but also from RIAs who wanted to keep clients’ exposure to real estate but felt that after a long bull run US real estate investment trust valuations had become stretched. RIAs recognised early on that low expense ratios make ETFs an attractive proposition for a business in which revenues based on a percentage of clients’ assets encourage them to seek maximum performance at minimum cost. Many RIAs have adopted a core-satellite portfolio structure, which uses index products like ETFs for beta, the core market exposure, and tries to capture excess returns, or alpha, through specialised vehicles like actively managed mutual funds, commodities and real estate. ETFs also work well for another RIA tactical allocation staple, the programme—a fancy name for market timing based on sector rotation. Retail brokers dependent on commissions have little incentive to use passive investments such as ETFs, whose low fees leave no room for the revenue sharing they enjoy when clients buy actively managed mutual funds. As the big brokerage firms push more clients into fee-based accounts, however, brokers have begun to see the light. The latest innovation—feebased unified managed accounts that

Noel Archard, head of iShares product development at Barclays Global Investors (BGI), says his firm is looking at both fundamental and active ETFs but will not launch new products unless it is sure they can deliver the promised results. Photograph kindly supplied by Barclays Global Investors (BGI), August 2007.

Anthony Rochte, senior managing director and co-head of the ETF business at SSGA in Boston, says more than 200 new ETFs came to market between the beginning of November 2006 and early July. Photograph kindly supplied by SSGA, August 2007.

allow clients to hold stock, bonds, mutual funds, ETFs and separately managed accounts all under one umbrella—will accelerate the trend, aided by support from the brokerdealers. “Virtually all the major firms are rolling out ETF wrap portfolios,” says Rochte, who believes the major firms’ marketing muscle will drive incremental ETF asset growth for the near future. RIAs and fee-based brokers could use index mutual funds, but Joseph Keenan, managing director and head of investor services at The Bank of New York Mellon (BNYM) in New York, points out that advisors dislike revealing clients’ identities to mutual fund sponsors in case the latter try to lure other client assets away. The ETF structure avoids the risk of disintermediation; ETF sponsors don’t even know who the advisor is, let alone the underlying client. In addition, while some advisors worry that if they rely too much on index funds clients may decide they don’t need an advisor, Keenan’s experience suggests otherwise.“People are willing to pay advisors to pick the right ETFs for their portfolio in the right percentage and decide when to sell or buy,”he says. BNYM does not sponsor ETFs itself but as the largest third party service provider to ETFs—it handles over 200 funds and works with 19 sponsors around the world—the bank has a unique perspective on where asset growth is coming from among existing ETFs and what new products are in the pipeline. Keenan confirms that sponsors have shifted their attention from institutions to the retail market, which has led to the proliferation of sector, commodity and fundamental ETFs.“The trend toward asset allocation models and sector rotation means there needs to be a breadth of product,”Keenan says.

SEPTEMBER/OCTOBER 2007 • FTSE GLOBAL MARKETS

In the Markets THE PROLIFERATION OF QUANT BASED ETFS IN NORTH AMERICA

Although ETFs are attracting the lion’s share of net asset flows into the mutual fund/ETF market, Keenan does not expect ETFs to supplant the $10trn-plus mutual fund industry. He credits BGI and others with aggressive campaigns to educate advisors on how to use passive products in actively managed portfolios, but notes that ETFs and mutual funds complement each other in the coresatellite structure. For all the inroads ETFs have made so far, they have yet to penetrate personal retirement savings plans [employer-sponsored 401(k) and 403(b) plans, individual retirement accounts, etc], which account for about a third of US mutual fund assets. Keenan says ETFs face two big obstacles: how to pay plan administrators from a low margin product, and administrator batch processing systems built around the once-a-day pricing of mutual funds that are ill-equipped to handle products like ETFs that trade continuously. Solutions that Keenan has seen rely on unitised funds that bundle ETF trades for the day in return for a fee

out of which the record keeper is paid, or a brokerage window within the retirement account that allows participants to trade individual stocks as well as ETFs. Neither is perfect, but Keenan says ETFs may get a boost from the Pension Protection Act of 2006, which requires full disclosure of fees within retirement plans. Historically, participants often could not tell how much they paid the record keeper or what the mutual fund sponsor paid to have its funds offered in the plan. A low-margin ETF has nowhere to hide those costs. Any plan that embraces ETFs will enjoy complete fee transparency, which may appeal to plan trustees worried about their enhanced disclosure obligation. Keenan sees the 401(k) market as the Holy Grail for the ETF industry.“If plan participants start to demand access to these products, that could be the tipping point,”he says,“It could increase the annual asset growth of ETFs well above the 35% we have seen.” For the near term, though, ETFs will have to get their assets from elsewhere. Bruce Bond, chief

executive officer (CEO) of Wheaton, Illinois-based PowerShares Capital Management, believes that fundamental ETFs will drive growth in the near term. Following the success of its original products based on the Intellidex indices, PowerShares has launched several ETFs based on the FTSE RAFI Index Series, which weight components according to cash dividends, free cash flow, total sales and book value instead of market capitalisation. Bond cites research showing that fundamentallyweighted indices outperform the equivalent capitalisation-weighted benchmarks. He’s philosophical about true believers who reject a result that implies market pricing is imperfect, too. “The efficient market folks have not given it the big bear hug yet,”he observes.” PowerShares, which was bought by Invesco last September, now has $12.5bn under management in its fundamental ETFs. The PowerShares precedent opened the door to anyone else who could reduce a fundamental investment theme to an algorithm. A

ETF Asset Managers in the US ranked by AUM as of June 29, 2007 Year End 2006 MANAGER

# ETFs

AUM

YTD 2007 % Total

# ETFs

(USD Bn)

Market Share

# ETFs

AUM

AUM Change

AUM

Change

% Change

(USD Bn)

% Change

2007

% Change

Barclays Global Investors

117

$248.30

61.0%

134

14.5%

$287.49

$39.19

15.8%

61.2%

0.2%

State Street Global Advisors

$92.60

22.8%

38.1%

$92.40

-$0.20

-0.2%

19.7%

-3.1%

Vanguard

$22.26

5.5%

18.5%

$32.22

$9.96

44.7%

6.9%

1.4%

Powershares

$8.47

2.1%

21.7%

$31.25

$22.78

269.0%

6.7%

4.6%

Bank of New York

$27.17

6.7%

-5

-83.3%

$9.43

-$17.74

-65.3%

2.0%

-4.7%

ProFunds

$2.16

0.5%

333.3%

$6.48

$4.32

199.7%

1.4%

0.8%

WisdomTree

$1.52

0.4%

23.3%

$4.00

$2.47

162.2%

0.9%

0.5%

Rydex

$2.59

0.6%

0.0%

$3.25

$0.66

25.4%

0.7%

0.1%

Van Eck Associates Corp

$0.52

0.1%

66.7%

$0.91

$0.39

74.1%

0.2%

0.1%

Claymore Investments

$0.36

0.1%

188.9%

$0.88

$0.52

142.7%

0.2%

0.1%

First Trust Advisors

$0.70

0.2%

230.0%

$0.91

$0.20

29.0%

0.2%

0.0%

Fidelity

$0.13

0.0%

$0.15

$0.02

15.1%

0.0%

XShares Advisors LLC

$0.00

0.0%

100.0%

$0.07

100.0%

0.0%

0.0% 0.0%

Ziegler Capital Management LLC Total

$0.00

0.0%

100.0%

$0.00

100.0%

0.0%

343

$406.81

100.0%

499

156

45.5%

$469.45

$62.64

15.4%

100.0%

Source: Bloomberg, Morgan Stanley Investment Strategies, supplied by Morgan Stanley, August 2007.

SEPTEMBER/OCTOBER 2007 • FTSE GLOBAL MARKETS

flood of new ETFs followed, most based on different investment approaches rather than additional sectors or asset classes, and Bond expects more to follow.“That is where you are going to see the growth in the ETF market in the US over the next five years,”he says. For Rockville, Maryland-based Rydex Investments, ETFs tracking equal-weighted indices were not a fundamental play but a natural outgrowth of a mutual fund business built on leveraged, inverse and other quantitative index-based models targeted at the RIA market. ETFs now account for $5bn of Rydex’s $15bn assets under management. In June, Topeka, Kansas-based Security Benefit agreed to buy Rydex in a transaction expected to fuel growth by providing better access to retirement plan administrators. Tim Meyer, ETF Business Manager at Rydex, believes demand for equal weighted and fundamental ETFs will come at the expense of traditional actively managed mutual funds. Active managers use various criteria to pick stocks and over- or underweight sectors, but investors never know exactly what is in the fund and may be exposed to the risk that managers don’t adhere to their investment guidelines. Fundamental ETFs avoid both problems. “You know exactly what you are getting,” Meyer says, “You are not going to have style drift.” Efforts to take fundamental ETFs a step further and launch funds that track actively managed portfolios have so far failed to satisfy regulators at the Securities and Exchange Commission (SEC). The obstacle is transparency. Active managers do not want to disclose their holdings in real time for fear that investors will front run their trades. Sponsors have proposed trading based on risk measures and

correlation statistics, a procedure long used when institutional investors solicit blind bids for baskets of stocks, but the SEC has balked. Bid-offer spreads will widen to reflect the added risk of imperfect information even in normal markets, while in times of stress the ETF price could wander far from the underlying net asset value. Noel Archard, head of iShares product development at Barclays Global Investors (BGI), says his firm is looking at both fundamental and active ETFs but will not launch new products unless it is sure they can deliver the promised results. “There has to be some substance there and not just spin,” he says, “It is nice to have something that theoretically provides alpha for a client but it is much more difficult to deliver that to the market.” Archard says BGI tries to develop products that meet specific investor needs, and will innovate when necessary to achieve the result. Faced with investor demand for commodity and currency products, for example, BGI introduced its iPath exchange traded notes (ETNs) to provide access to asset classes difficult or even impossible to package in a conventional ETF. It used the ETN structure to launch a well-received buy-write product, too. With more than $300bn under management, BGI’s iShares brand has an enviable market position the firm defends through an extensive program of education and support to help financial advisors understand how ETFs work and the role they can play in clients’ portfolios. Archard expects to launch more products that track international markets and feels BGI has barely scratched the surface in fixed income. “As well established as ETFs have become in the US, it is still early days for the product overall,”he says.

Joseph Keenan, managing director and head of investor services at The Bank of New York Mellon (BNYM) in New York, points out that advisors dislike revealing clients’ identities to mutual fund sponsors in case the latter try to lure other client assets away. Photograph kindly supplied by Bank of New York Mellon, August 2007.

Tim Meyer, ETF Business Manager at Rydex, believes demand for equal weighted and fundamental ETFs will come at the expense of traditional actively managed mutual funds. Photograph kindly supplied by Rydex, July 2007.

ETFs Listed in the US - Assets by Type of Exposure as of June 29, 2007 Exposure

# ETFS

AUM (USD Bln)

% TOTAL

International

$138.06

29.4%

Large-Cap

$123.14

26.2%

Sector

194

$54.86

11.7%

Value

$34.25

7.3%

Growth

$29.27

6.2%

Fixed Income

$25.52

5.4%

Broad Market

$23.53

5.0%

Mid-Cap

$20.30

4.3%

Small-Cap

$17.73

3.8%

Custom

$2.18

0.5%

Commodities Total

$0.63

0.1%

499

$469.45

100.0%

Source: Bloomberg, Morgan Stanley Investment Strategies, supplied by Morgan Stanley, August 2007.

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2007

In the Markets FUND PROFILE: CLAYMORE INVESTMENTS

THE FUTURE OF ETFs?

It’s fundamental It would be difficult to find a fund management house quite so dedicated to exchange traded funds (ETFs) as Claymore Investments Inc., the wholly-owned Canadian subsidiary of Lisle, Illinois based Claymore Group Inc. Som Seif, its chief executive officer, acknowledges that Claymore is an “aggressive manufacturer, producing ETFs for the US and Canadian markets, with a core product around the FTSE RAFI Index Series.” Claymore Investments is the second largest player in the Canadian ETF market, and is now keen to export its ETF manufacturing expertise overseas. Francesca Carnevale reports. OM SEIF started Claymore Investments, Inc in Toronto, Canada back in January 2005, with a mission. Leading the implementation of Claymore’s business development and corporate strategies, Seif believed and still maintains,“ETFs are the future way to invest.”Seif holds that while there has been a pick up of ETFs in the North American markets by both retail and institutional investors, “the product is just on the cusp of its true potential.” Seif has an almost messianic fervour for ETFs. “I’m a big fan; they are efficient and really designed for the end investor. At the retail end they are better than mutual funds, and are lower cost and at the institutional end provide a flexible and better tool for managing exposure in a portfolio.” The index providers that Claymore uses “design indices based on sophisticated quantitative models with independent and academic research,” says Seif. “Relative to industry benchmarks, the indices we work with are designed to offer the potential for return by isolating significant factors that have

contributed to superior investment performance historically. We favour specialists in quantitative methods of stock selection, and have designed strategic indices that provide unique baskets of securities for ETFs to track.” Seif is intense and focuses his talk with a clear client-buying perspective. In part, this is likely due to the strong client focus he honed as an investment banker with new product development experience. Prior to joining Claymore, Seif worked at high-touch house RBC Capital Markets, where he played a key role in developing the bank’s structured products group in both Canada and the US, and where he structured and raised capital for both Canadian and US asset managers. With that in mind, Seif’s insistence on an investment strategy that “delivers consistent returns” is understandable. Claymore believes that a strategy-driven, quantitative process provides a disciplined investment approach that offers the potential for superior performance over market cycles. Drilling down, he explains, “research or strategy based

investment approaches are a more intelligent way of managing assets.” In other words, Seif is a strong believer in the value of fundamental investing.”Although Seif explains his preferences in rich terms: “It is an intuitive and intelligent approach,” he firmly asserts the applicability of fundamental investment strategies on a sustained basis. “It is a better way to invest in down markets,” he maintains. Seif explains that there are three essential market conditions: “down, average and boom”. In down and average markets, he says, fundamental investing will “invariably see good outperformance. In a boom market, it will keep pace with the market, but this strategy works best in a normal or down market.” Consequently, the house has favoured a core product range built around the FTSE RAFI Index Series. In February last year, Claymore Investments began using the FTSE RAFI Canada Index as the underlying benchmark for its first Fundamental Index ETF for the Canadian market. Claymore subsequently launched a raft of ETFs based on fundamental indices, including a version for the US market and its innovative Claymore Oil Sands Sector ETF that gives investors exposure to Canadian Oil Sands, one of the world’s largest reserves of oil. Based on the Sustainable Wealth Oil Sands Index, “it uses a fundamental approach weighting constituents based on their current Oil Sands production output, future expected growth in oil sands production and a percentage of total company production which is oil sands related,”says Seif. Most recently, in July, parent Securities Claymore company launched its Claymore/SWM Canadian Energy Income Index ETF that tracks an equity index called the

SEPTEMBER/OCTOBER 2007 • FTSE GLOBAL MARKETS

Sustainable Canadian Energy Income Index. The ETF is listed on the American Stock Exchange (AMEX). The Index comprises of 30 stocks from a universe of companies listed on the Toronto Stock Exchange (TSX), AMEX, NASDAQ or NYSE. Now Seif says that the firm is planning to expand overseas,“We are looking at a variety of options and are in the early stages of strategic planning in selected markets in Asia, Europe and the Middle East.” Claymore will be adopting a variable approach to opening new markets. In some, it will launch and list new product; in others it will either work with or establish joint operations with individual investors and market makers, in yet others, it will open offices. “We are at the development stage of the strategy and are tiering {sic] the opportunities available and responding accordingly,”says Seif. Seif acknowledges that the challenge of developing new markets is as great as the opportunities. “Each market presents its own peculiar requirements. You simply cannot impose a North American product on the rest of the world. It has to have resonance in the local market. Now that may involve harnessing local buying patterns, or it may involve developing new product entirely. You cannot, for instance, market an ETF with China exposure in Taiwan; however elsewhere it is a different story. We are mindful of investors and what they are looking for.” Claymore is not a one-trick pony however, and has a range of closed end funds, that diversify its client offerings. At the end of July, the Claymore/Guggenheim Strategic Opportunities Fund, a new closedend fund, raised $182m from its initial public offering on the New York Stock Exchange. The Fund invests in a wide range of fixed-income and other debt

Som Seif, chief executive office, Claymore Investments. Photograph provided by Claymore Investments, August 2007.

and senior equity securities selected from a variety of sectors and credit qualities and other equity investments that the Fund’s sub-adviser believes offers attractive yield and/or capital appreciation potential. This includes employing a strategy of writing (selling) covered call and put options on such equities. As Seif has it, Claymore has a consistent manufacturing strategy, whereby it’s closed end funds, ETFs and other products are closely correlated, that “appeal to different buyers. Some investors want principal protection,

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2007

some do not. Yet others want a broad strategy, with ETFs at the core.” The important thing is to understand changing client requirements, stresses Seif in both domestic and overseas markets and “tailor product offerings accordingly.” As volatility returns to the markets, “which we think is a positive trend,” says Seif, he thinks a common thread among investors is that they are seeking “reliable low cost investment options with some intelligence in them, at both institutional and retail levels. On that we aim to deliver.”

In the Markets THE OUTLOOK FOR PROJECT TURQUOISE

It was almost a year ago that seven investment banking powerhouses joined forces proclaiming their intent to launch a pan-European trading platform. Dubbed Project Turquoise, the plan was to provide an alternative trading venue to the large European bourses. Some investors cheered at the promise of cheaper trading costs and stayed tuned for more information. They are still waiting. Lynn Strongin Dodds reports.

GETTING THE GET-GO HE BANKS BACKING Project Turquoise say their goal is to offer fund managers and other market participants trading in Europe’s top 300 stocks dramatically reduced costs. Turquoise is a hybrid system that will allow transactions both on-exchange as well as in dark liquidity pools, where firms buy and sell large blocks of shares away from the public limelight. If successful, Turquoise could have a significant impact. Together, for example, the bank’s in the Turquoise consortium account for about 50% of the volume traded on the London Stock Exchange (LSE). Right now though, market watchers still wait on promised developments. The only significant announcement to emerge to date was back in April with the appointment of EuroCCP, a division of US based Depositary Trust & Clearing Counterparty (DTCC), as the pan-European clearing and settlement house for the project. EuroCCP, in turn, named Citi’s global

transaction services business as its settlement agent. EuroCCP, intends to act as the central counterparty for Turquoise, providing netting, a full range of risk management services and enabling anonymous post-trade processing. Positions will then be passed to Citi's global transaction services business for settlement in the respective central securities depositories. Citi is one of the seven banks involved in Turquoise, including Credit Suisse, Deutsche Bank, Goldman Sachs, Merrill Lynch, Morgan Stanley and UBS. In the summer, BNP Paribas took a 3% stake in the project. The lack of news has prompted some industry participants to ask whether more should have been achieved by now. However, the consortium is still on the lookout for a chief executive officer (CEO) as well as a technology provider and in that context, a hiatus is only to be expected. Headhunter Armstrong International will conduct the search

and an announcement is expected by the end of the summer. At the same time, a shortlist of potential technology providers has been assembled. OMX, the Nordic and Baltic exchange operator that also runs a technology business, as well as Chi-X, the newly minted platform developed by Instinet, are believed to be strong contenders. There was also talk of Plus Markets, formerly known as Ofex, being in the mix, but the firm was recently granted formal stock exchange status and it is now leading its own competition against the LSE over listing and trading charges. Nonetheless, there is a sense of déjà vu about Turquoise. Few have forgotten the aborted Jiway (launched in 2000) or, more recently, the LSE’s own Dutch equities trading service of 2005 that was intended to inject competition into the European trading NASDAQ Equally, landscape. launched an ambitious European venture back in 2003, which ultimately failed to ignite fund managers’

SEPTEMBER/OCTOBER 2007 • FTSE GLOBAL MARKETS

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In the Markets THE OUTLOOK FOR PROJECT TURQUOISE

Bob Fuller, chief executive of Equiduct, notes, "It is difficult yet to say how successful in moving liquidity Project Turquoise, or any other new venue, will be.You have to create a marketplace and then get firms to want to use it. It is not just the participants who are involved but also their customers who will ultimately decide how successful any new venue will be. Moving liquidity in the past has not been that easy and requires convincing clients to stop requesting the use of the major exchanges." Photograph kindly supplied by Equiduct, July 2007.

imaginations. However, perhaps the biggest disappointment was Tradepoint, which had the backing of many of the same Turquoise players: including Deutsche Bank, Morgan Stanley, Goldman Sachs and Merrill Lynch. The platform did not make a dent into the liquidity of any established exchange and later merged with the Swiss Stock Exchange to create virt-x at the beginning of this century. The head of derivatives and dealing at the Scottish Widows Investment Partnership Tony Whalley’s notes,“There has been a wall of silence except for the news about EuroCCP and Citi. I would like to see it [Turquoise] happen but so far I do not have any facts or figures to suggest that it will.”Stephen Kingsley, financial services partner at BearingPoint, a UKbased management and technology

consultancy is also tentative. “Turquoise can pose a threat to the established exchanges if the seven banks can get their act together. However, in order for the challenge to be real, Turquoise has to be operational and until they find a CEO I do not believe that will happen,”he says. Duncan Higgins, chief operating officer, equities execution at UBS Investment Bank, acknowledges that even if Turquoise does not debut at the same time as the Markets in Financial Instruments Directive (MiFID) in November, he dismisses talk of the project failing to materialise. “Project Turquoise will definitely happen. It is also important to remember that it will be a pan-European Trading platform. In order to have competition Turquoise must be a permanent feature of the market. We are taking our time because we want to find the right technology provider and chief executive. We are in discussions with a number of potential candidates and are looking for someone who not only has experience in the industry but also can be inspirational and drive the business forward because we are a small start up company.” The hope is to go live by the end of the year although many industry pundits believe that the platform will not be operational until 2008. Kevin Covington, head of strategy & proposition, BT Global Financial Services, who believes that the project will not meet the MiFID deadline, is nevertheless optimistic that the project will see the light of day. He notes, “I think there is quiet determination to make it work. The dynamics of the business and the environment is also very different to the one when Tradepoint and Jiway were launched. Back then the technology was not in place plus there were no algorithms or dark pools of liquidity.” UBS’s Higgins agrees,

Kevin Covington, head of strategy & proposition, BT Global Financial Services, who believes that the project will not meet the MiFID deadline, is nevertheless optimistic that the project will see the light of day. He notes,“I think there is quiet determination to make it work. The dynamics of the business and the environment is also very different to the one when Tradepoint and Jiway were launched. Back then the technology was not in place plus there were no algorithms or dark pools of liquidity.” Photograph kindly supplied by BT Global Financial Services, July 2007.

adding, “The early initiatives such as Tradepoint were ahead of their time. As executing brokers, [we] could not easily interact with more than one venue. Today [however,] advances in technology such as smart order routing, which we use, has and will make a huge difference. It is one reason why multi-lateral trading facilities today have a better chance of being successful than in the past.” There is no doubt that the spread of smart-order routing systems to automatically direct trades to the best price on the lowest-cost venue will only intensify the competition between all the different players — banks, trading venues and stock exchanges. The other impetus, of course is MiFiD, which is ushering in a new world order for investment services throughout Europe. MiFiD’s

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In the Markets THE OUTLOOK FOR PROJECT TURQUOISE

Tony Whalley, head of derivatives and dealing at the Scottish Widows Investment Partnership notes, “There has been a wall of silence except for the news about EuroCCP and Citi. I would like to see it [Turquoise] happen but so far I do not have any facts or figures to suggest that it will.” Photograph kindly supplied by Scottish Widows Investment Partnership, July 2007.

focus on best execution and the elimination of concentration rules prevalent on the Continent should mean that investors will be spoilt for choice in terms of trading venues. In the meantime, European exchanges are not resting on their laurels. The LSE, for instance, has introduced a new and lower fee structure that cut the average tariff by about 10% and encouraged banks to turn to its electronic order book. The changes, phased in from April 1st this year, include lower fees for transactions executed directly by private investors. Then in June, the LSE launched TradElect, a new high speed trading system, which it claims is the fastest in Europe. The platform allows the exchange to handle 3,000 messages a second, up from 600, and it cuts the time to process an order from 140 milliseconds to about 10 milliseconds. The new platform along with a buoyant merger and acquisition

market and a healthy appetite for initial public offerings contributed to the exchange beating analyst forecasts for its first quarter ending on the 30th June. Revenues for the period jumped 19% to £100.1m from £84.3m a year ago. Also in the works is the £1.1bn proposed merger between the LSE and Borsa Italiana. It is too early to say whether Turquoise might seriously affect the LSE’s business volumes. According to a recent survey of 200 UK analysts conducted by IR magazine, 40% believe that Project Turquoise does not pose a serious threat while 22% feel that the LSE could lose business. The bottom line today, though, is that Project Turquoise for now remains on the drawing board. Bob Fuller, chief executive of Equiduct, notes,“It is difficult [right now] to say how successful in moving liquidity Project Turquoise, or any other new venue, will be. You have to create a marketplace and then get firms to want to use it. It is not just the participants who are involved but also their customers who will ultimately decide how successful any new venue will be. Moving liquidity in the past has not been that easy and requires convincing clients to stop requesting the use of the major exchanges.” Jim Gollan, chairman of virt-x echoes these sentiments.“If history is anything to go by, liquidity is sticky. Project Turquoise may be successful in lowering fees of the tariff refusniks but its offering must be overwhelmingly different to change fundamentally the landscape in Europe. Absent new ground, it is unlikely to be successful in shifting liquidity from the established marketplaces. “After all, it will be the clients of Project Turquoise who control most of the volumes and not the participating banks. Under MiFiD best execution rules, hedge funds and other active institutional

Jim Gollan, chairman of virt-x says.“If history is anything to go by, liquidity is sticky. Project Turquoise may be successful in lowering fees of the tariff refusniks but its offering must be overwhelmingly different to change fundamentally the landscape in Europe. Absent new ground, it is unlikely to be successful in shifting liquidity from the established marketplaces. Photograph kindly supplied by virt-x, July 2007.

investors may only divert their volumes to a new platform if it can offer the same or better stock quotes. “Turquoise and other new venues have to ensure that if you trade blue chips on their platform market impact will be less than on an established exchange,”adds Gollan. Perhaps the greatest challenge for Turquoise lies in whether the seven banks can work together effectively. Alasdair Haynes, chief executive officer of ITG's international operations, explains: “I have had a change of heart. Nine months ago, Project Turquoise was seen as cage rattling exercise to get the LSE to lower its tariffs. If it was just that, though, then they would not still be talking about it. They need to get the pricing, positioning and technology right to attract the buyside but even if they do that there is a lingering question as to whether you can herd seven cats.”

SEPTEMBER/OCTOBER 2007 • FTSE GLOBAL MARKETS

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THE EUROPEAN EXCHANGES SUMMIT

15th & 16th October 2007

Driving liquidity and efficiency in a competitive environment

One Whitehall Place, London www.marketforce.eu.com/exchanges

Positioning for dynamic change Building on the long-standing relationship between the Institute of Economic Affairs and the Financial Services sector, ‘The European Exchanges Summit’ presents a fantastic opportunity to debate the rapidly changing landscape in capital markets across Europe. From the growth of competition and the impact of evolving technologies on the industry, to the new opportunities presented by recent regulatory developments, this inaugural conference will ask how exchanges can compete effectively to add value for users, to drive liquidity and to promote efficiency. The event will bring together senior decision-makers from exchanges, the buy and the sell side, clearing and settlement houses, as well as new trading platforms across Europe to discuss and debate new ideas and business opportunities.

Top-level speakers include: ROLAND BELLEGARDE Executive Director NYSE Euronext

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SIMON BRICKLES Chief Executive Officer PLUS Markets

ALASDAIR HAYNES Chief Executive Officer ITG International

DAVID PITMAN Director of Marketing London Stock Exchange

RAINER RIESS Managing Director Deutsche Börse

LUDWIK SOBOLEWSKI President of the Management Board Warsaw Stock Exchange

DAVID LESTER Chief Information Officer London Stock Exchange

BOB FULLER Chief Executive Officer Equiduct

@ conferences@marketforce.eu.com

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In the Markets RISK MANAGEMENT & AUTOMATED TRADING

THE RISK RACE Algorithmic and automated trading currently dominates the headlines, with low latency execution of trades becoming a technological tussle. Is end-of-day risk management keeping up with (or, indeed, is it appropriate) for this age of automated, high volume intra-day trading? In other words, will the slow moving, intellectual tortoise of risk management still manage to keep up with the fast-moving, energetic trading hare? Brian Sentance, chief executive officer of Xenomorph examines the chase. LGORITHMIC TRADING IS hot news right now.You can see why. Few other topics present equal opportunities for scaremongering. In this instance, the brouhaha focuses on the “rise of the machines”to replace human intervention in financial markets trading. Setting aside the hype and sometimes over-marketing of this topic, the recent and continuing growth in algorithmic trading does mark a fundamental change in the markets. Moreover, its effects will be wideranging, as new markets and assetclasses move to electronic trading. In this hullabaloo, however, trading’s less glamorous partner, risk management, appears to have been forgotten. In the days of electronic, submillisecond trading execution, is a oncea-day ‘snapshot’ calculation of the level of market risk sufficient or indeed prudent? Alternatively, should risk management take on the challenge of moving towards intra-day real-time measurement and management of risk?

Certainly, the risk management profession has enough on its plate. The credit and operational risk requirements of Basel II come into force in 2008. Compliance with Basel I requirements for market risk continues to be challenging for many institutions. The recent sub-prime lending crisis and the level of exposure to credit derivatives are cause for concern. Moreover, innovative structured products present new modelling challenges, particularly exposure to private equity and high yield debt. Putting aside all the articles that could and have been written on these topics, how is risk management responding to the rapid expansion in automated trading?

Speaking the same language It is probably worth starting with some definitions.‘Algorithmic trading’is often used to describe a whole range of activities, from electronic execution to any kind of trading activity where human intervention is minimised. From

speaking to practitioners in this market area, there seems to be consensus that algorithmic trading is more specifically concerned with the optimal (usually lowest cost) execution of a buy or sell request on behalf of a client. In other forms of automated trading—let’s call it automated proprietary trading—no client is involved, and an institution’s own capital is being put at risk during the day in order to profit from intra-day profit opportunities. Driven by the 1996 amendment to the Basel I Accord, market risk management involves the calculation of Value at Risk (VaR). This calculation provides an indication to senior management and regulators of what level of loss may be exceeded by an institution under normal market conditions at a given level of probability. For example, a VaR of $50m with a confidence level of 99% means that an institution could expect to suffer a loss of over $50m at a frequency of around one day in one hundred, assuming normal market behaviour. Calculating VaR is both a computationally and data intensive process. Consequently, it is typically run as an end-of-day (EOD) batch process, often taking an hour or two of computations before results are ready for examination. When calculating VaR, equities are a simple asset class to deal with, having none of the non-linearities or multiple risk factors of more complex derivative asset classes. Putting aside the modelling of private equity portfolios, for most risk managers equities are easy to model, requiring only relatively basic positional data and statistical analysis of historical market prices. Even so, in a world of intra-day automated equity trading, does such EOD risk measurement remain valid and simple to understand? Is this snapshot approach leaving financial institutions open to intra-day risk that is not observable through EOD processes?

SEPTEMBER/OCTOBER 2007 • FTSE GLOBAL MARKETS

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In the Markets RISK MANAGEMENT & AUTOMATED TRADING

Murphy’s Law While there is no positional risk exposure when undertaking algorithmic execution of orders on behalf of clients, how should risk managers deal with intra-day positional risk arising from intra-day proprietary trading models? Are the levels of net positional exposure intraday significant when compared to EOD levels? How is a trading desk to be appropriately charged internally for the capital it uses, if the measurement only takes place at some arbitrary time of day? I am sure that for most institutions this is not a big issue yet. However, Murphy’s Law (whatever can go wrong will go wrong) is nowhere more at home than in financial markets. Even prior to the advent of computer-driven automated trading, the markets have enough bad experiences of what can go wrong with intra-day trading without adequate controls in place.

The data deluge Automated trading, penny trading and regulations such as the Markets in Financial Instruments Directive (MiFID) in the European Union and Regulation NMS (RegNMS) in the United States are the engines behind the dramatic increase in transactional and market data that risk managers must deal with each day. It is a gargantuan job. According to the Tabb Group, to capture and store the entire world’s market data would take a database that is growing at around 3.5 terabytes every day. Even if the markets continue to use ‘snapshot’EOD risk management, it will still need to ‘snap’market prices globally to ensure consistency of data and consistency of the risk numbers calculated. While it appears straightforward in practice, closing prices for markets in Asia, Europe and America do not happen at the same time, and are not suitable (or even available) for a single once-a-day global risk calculation.

MiFID and RegNMS are also driving an increase not only the number of trades, but also in the number of trading venues available (and therefore the number of sources of data that may need to be captured and stored). At best this looks like an opportunity for data aggregators such as Reuters and Bloomberg to sell more data. At worst it could become a data management nightmare for risk management departments that are often far more involved in data cleansing and validation than they would like to be. In addition to having to establish what now represents a ‘good’ market price (closing or otherwise) across many trading venues, liquidity risk also needs to be accounted for. Even if an institution does move to the calculation of risk three times a day, for example, is this sufficient? Alternatively, would intra-period (rather than simply intra-day) risk become the next problem? Put another way, does risk management need to move from a snapshot, post-trade process to a realtime, pre-trade compliance process? Certainly some of the algorithmic trading vendors are seeing the beginnings of this approach. However, this development may require much greater co-operation between risk management, trading and compliance departments. We can also expand the point. If, for example, risk management did move to being a realtime process, then would there be any conflict of interest where risk managers would have knowledge of risks/exposures caused by trading conflicts between algorithmic trading desks (acting for clients) and proprietary trading desks (risking institutional capital)? In these instances, a firm would have to question whether it owes a duty of care to each separate trading desk, the institution as a whole or the regulator. In order for risk management to

keep up with the recent advances in trading, I would suggest that firms ask themselves and apply answers to the following questions. • Is snapshot EOD risk management sufficient from a regulatory point of view, from a business risk point of view or both? • What is the justification for the choice of the ‘EOD’ snapshot time and is time-consistency maintained for the global market data used? • Are our intraday exposures monitored? If still running EOD VaR calculations, could this data be supplemented by maximum intraday exposure data? • How can we best leverage the massive amounts of data now needed for trading, risk management, and regulatory compliance purposes? • Can we leverage this need for data and technology to bring trading, risk management and compliance departments closer together organisationally? • Are our data management systems supporting and adding value to risk management, and are they realtime capable? • Should risk management encompass both real-time pre-trade calculations as well as post-trade snapshot VaR and should this be approached? • Can we leverage technologies such as clustering/grid and high-performance databases used in automated trading to do more intra-day and be more responsive to market events? Perhaps the risk management tortoise needs to apply more of its undeniable intellectual ability to keep up with the energetic trading hare. The proper application of data and technology are vital in this regard. In addition, I would venture that risk management must become less conservative in adopting the high performance technology that is making these advances in trading possible.

SEPTEMBER/OCTOBER 2007 • FTSE GLOBAL MARKETS

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In the Markets CARBON TRADING & DEVELOPMENT

CLIMATE CHANGE VERSUS GROWTH When the Kyoto Protocol was being negotiated, some of the most hotly debated issues related to ways in which developing countries could be ‘persuaded’ not to emulate the carbon-spewing path to development of industrialised countries. Then, arguments arose over the nature and extent of ‘compensation’ for countries that might opt for a more carbon friendly growth path. Needless to say, the emerging markets argued strongly that they were being asked to pay an unreasonable price to offset climate change. Not least, they said, because developed markets were responsible for the vast majority of past emissions, plus cleaner technologies would be more expensive. Equally, they remain unconvinced that any efforts on their part would dent the polluting output of the industrialised world with per capita carbon emissions many times greater than theirs. Ian Williams discusses the implications of an unresolved tussle. HE KYOTO PROTOCOL negotiations raised important questions on how nations should take responsibility for carbon emissions. Some developed countries (the United States and Australia for example) and many emerging economies strongly articulated their reluctance to inhibit the activities of their carbon emitting industries and, by implication, limit growth. The emerging markets complained that they were being asked to pay an unreasonable price to help fend off further climate change and, at the same time, stoke the flames of the industrialised world’s continued prosperity. One potential solution would have been carbon taxation with transfers of capital for overseas development aid to the needier emerging economies.

However, a market-based, rather than tax solution was the favoured approach. The clean development mechanism (CDM) that Kyoto’s negotiators ultimately opted for was based firmly on the operation of the US sulphur emissions market, and combined global social planning and market mechanisms. The first phase runs from 2008 to 2012, coinciding with its extension to all greenhouse gases. Carbon trading—especially the way that it is implemented in the European Union—is generating a big demand for credits from users. Unlike the voluntary trading system in use in the US, and which is centred on the Chicago Climate Exchange, emissions’ trading forms part of the mandatory system to reduce emissions in Europe. In effect this allows European companies to buy

Carbon trading?especially the way that it is implemented in the European Union?is generating a big demand for credits from users. Unlike the voluntary trading system in use in the US, and which is centred on the Chicago Climate Exchange, emissions’ trading forms part of the mandatory system to reduce emissions in Europe.The funds that this market generates could, if directed properly, take significant amounts of capital and technology to the developing world, allowing countries to leapfrog to cleaner technologies past the smog and smokestack hurdle to industrialisation by selling their carbon credits. Photograph supplied by Istockphoto.com, July 2007.

carbon reductions from emerging markets. The funds that this market generates could, if directed properly, take significant amounts of capital and technology to the developing world, allowing countries to leapfrog to cleaner technologies past the smog and smokestack hurdle to industrialisation by selling their carbon credits. Without some such transfers, the world’s ability to meet the Millennium Development Goals (MDGs) will be sorely tested. Set for the year 2015, the MDGs are an agreed set of goals that can be achieved if all actors work together and do their part. Poor countries have pledged to govern better, and invest in their people through health care and education. Rich countries have pledged to support them, through aid, debt relief, and fairer trade. The UNDP is working with a wide range of partners to help create coalitions for change to support the goals at global, regional and national levels, to benchmark progress towards them, and to help countries to build the institutional capacity, policies and programmes needed to achieve the MDGs. It has been estimated that an annual $60bn to $90bn is needed just to deal with the environmental issues that hamper the alleviation of poverty in the developing countries. The UNDP’s Oliver Waissbein contrasts that with the actual $3bn to $5bn in overseas development assistance targeted at environmental issues.

SEPTEMBER/OCTOBER 2007 • FTSE GLOBAL MARKETS

What’s more, Waissbein complains that hitherto the beneficiaries of this process—both in terms of selling credits and carbon-saving investments—have been the larger developing countries, such as Brazil, China and India and on what he calls “end of pipe industrial gas facilities,” that do little for development objectives In response, the UNDP set up the “MDG Carbon Facility,”that would use the programme’s network of offices, and environmental projects, that cover almost every developing country in the world to spread the benefits. Its role was to start up the projects and develop access to the markets. Waissbein points out that the CDM should lead to a transfer of technology as well as foreign direct investment (FDI), leading to developmental benefits in addition to reducing carbon usage in the developing world. “Not all projects are capital intensive, like wind farms. We can spread out to less capital intensive developments—for example, collecting and using landfill gas is relatively simple, and the earning are greater than simple carbon saving schemes since methane is 21 times as potent as carbon dioxide as a greenhouse gas,”notes Waissbein. Specifically excluded from the scheme are the traditional macro-energy projects, large hydropower and nuclear, whose environmental benefits have of course been questioned in the past. The intention is to distribute both finance and technology to more countries and more deeply inside them, building on UNDP’s existing $5bn energy and environmental project portfolio. It also covers much more diverse project types, ranging from building efficiencies, co-generation of electricity from industrial processes, to thermal solar energy and biomass. Waissbein gives as an example; simply switching a building from incandescent to fluorescent lamps not only pays for itself very quickly but can attract credits as well. He also points out that many of

the projects will have collateral developmental impacts; for example, bio-gas or solar cooking facilities relieve girls and women from the task of searching for firewood for cooking, which would allow them to go to school. UNDP’s role is to use its networks to both canvass for, and then screen projects for feasibility. After that, it will help develop projects and secure financing from local sources based on a future commitment to buy the credits tied to a timeline for implementation of the project. “We can show the local banks that the company, municipality or whatever has a buyer for the carbon credits, which can unleash local bank finance,”says Wassbein. In June, the UN Development Programme and Fortis, the BelgianDutch bank, announced a carbontrading partnership that would facilitate the transfer funds and expertise to the emerging markets and, admits the bank, make a few Euros on the side. Seb Walhain of Fortis says that the bank, which has sixteen traders on its Amsterdam carbon trading desk (probably the largest in the world), is hoping to do well by doing good. “It was definitely not philanthropy or charity. Emissions are a liability and we had hundreds of clients short on carbon credits.” When the European Commission introduced emissions trading in 2003, Fortis says Walhain, “had to consider the consequences. We had €12bn in energy stocks and so we had to analyse what the carbon emissions would do for the clients. We set up a European trading position, but by 2008 the market goes global and all our clients were looking for cover, they need to buy carbon credits.” Walhain points out that 30bn worth of carbon credits traded last year. That figure will treble this year, and double again next year, bringing it to 200bn. “UNDP is only a small fraction of that but we hope to scale it up. We have a double

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2007

digit share of the market and we intend at least to keep it that way.”In fact, Fortis has signed up for projects that generate only 15m carbon credits during the first phase of Kyoto from 2008 to 2012. UNDP chose Fortis out of fifteen banks in competitive tender to partner the MDG Carbon Facility, because of its expertise both in Europe and because it already had a presence in Brazil, Russia, India and China. “We liked it with the MDG facility. It has wide range of forms of credit, very green, very top quality assets, with a diversified portfolio,”says Walhain. One of the key elements of the carbon trading is certification. Does the project being financed really reduce emissions? UNDP and Fortis will work together to ensure certification, both in advance for investment purposes and subsequently for payments for the credits. The partnership offers one-stop shopping for developers interested in selling carbon credits with UNDP helping with technical, legal and financial advice for which it will expect payment once the credits start rolling. Both Fortis and UNDP will engage third party agents for verification of the credits. Fortis guarantees the credit price and commits to buy at least 80% of them until the end of 2012, while holding open the possibility of buying more. It is important to note that there was a collapse of carbon prices for the 20042008 phase when it was revealed how the caps set by the EC had been rather too generous. For the 2008-12 Kyoto phase that has been remedied with the EC setting tougher caps leading to carbon prices rising dramatically. The stage is now set for an exciting and dynamic carbon market that will mature over the coming years. A key factor for those players wanting to tap emerging markets will be the credibility and independence of on-site monitors. Fortis and UNDP are well placed for this growing market.

Index Review LIVING WITH VOLATILITY THROUGH 2007

All swings and too few roundabouts For all the rushing around of recent weeks there seems to be no closer idea of where we are or what the future holds. Valuations seem to indicate that the markets are a raging buy, with the FTSE 100 trading at around 12 times earnings. Once the current volatility is worked out private equity merchants will be licking their lips at what is now available. Lest it be forgotten 12 times earnings generally equates to 10% or 11% return pre-tax. With interest rates anywhere between 4% and 6% a nice bit of fat is left on the bone for those with available liquidity. By Simon Denham, managing director, Capital Spreads. HE FTSE 100 has had something of a torrid time as markets have come under pressure. While we are seeing continued weakness in the various financial markets we are not actually getting much in the way of shorting. Investors seem to be concentrating on closing out riskier positions and just staying out. The lack of long term investors buying the limited amount of position liquidation is forcing the markets lower as brokers hunt for any takers. Those with a mind for purchases know that it has now become a buyer’s market. Add to this the well reported failure of the banks to get away much of the debt associated with recent acquisitions. The piling up of, nominally good value, but still risky private equity paper on books of many an investment bank will have risk control officers in a frenzy. While the absolute safety of the loan is generally assured BIS lending rules mean that unless the debt can be offloaded the banks will be unable to participate in further deals. It could, potentially, create a domino effect where the ability to support paper values will be submerged in the rush to get out. The same thing happened to Scandinavian debt in the

early 1990s where Japanese banks just sold at any price rather than hold on. This commentator remembers buying Nokia prime (un-subordinated) debt at 750 basis points (bp) over US treasuries. Although we hear a good deal about sub-prime problems we hear less about the fact that the classic junk bonds sector is actually at almost historic lows for defaults. This poses something of a quandary. How can the housing sector be doing so badly when the corporate sector is doing so well? Actually, you would have thought there was some link between the two. Even so, there appears to be a looming sense of doom that the one will bleed into the other. Analysts and economists cannot put their fingers on it; but many of them are just waiting for the next bombshell. The recent reporting season in the UK and US has passed with no major casualties. In fact, the banking sector in the UK has rather outshone expectations—though you might be forgiven for thinking otherwise when you look at their recent stock price performance. All this seems to be being lost in the wash of ‘market sentiment’. With the lack of buyers affecting trading markets are almost certainly looking at

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

volatile behaviour all the way through to the winter months. The support in the FTSE 100 at around 6200 seems to be pretty well established but on the other hand we are back below 6450 that took so much effort to defeat back in February. The current environment seems curiously detached with long term investors watching from the sidelines, waiting for an opportunity to get in on the bottom floor. Short term traders meantime are looking to see how weak the underlying market is and continually probing to the downside. Market watchers will now be looking eastwards to see whether there is any indication that demand in the West is waning. If cracks appear in the highly leveraged East then the markets may well suffer even further into the year. While Indian and Chinese equities show strong potential there is no denying that much of the production is built on debt. If the flow of business from Western consumers slackens then the sub-prime loan crisis in the US will look like small potatoes. Loans to new manufacturing units in hard to pronounce parts of the world have been running at all time highs and for many it will just take a small push to send them over. All in all the markets are too violent for many. With volatility apparently increasing investors will sit back, pick off cheap value and watch the chaos unfold. As ever, place your bets ladies and gentlemen.

SEPTEMBER/OCTOBER 2007 • FTSE GLOBAL MARKETS

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Issuer Profile AGENCE FRANCE TRÉSOR SETS LIMITS ON NEW BORROWINGS

AFT REVIEWS 2007 NEW ISSUE VOLUME Agence France Trésor, the agency responsible for raising France’s sovereign debt in the capital markets, may well cut its planned issuance for this year, as it appears likely that the government will generate better-than-expected revenues from other sources. Andrew Cavenagh reports. GENCE FRANCE TRÉSOR (AFT) will not make a final decision on exactly how much it is going to issue during the remainder of the year until September, at the earliest. By the end of June, it had issued €70.2bn of different types of medium-term and long-term bonds out of the €102.5bn total that it had provisionally planned to issue by the end of 2007.“We have additional tax receipts that could be up by at least €3bn to €5bn on the forecasts at the start of the year and potentially [from] the privatisation programme. Although, at this stage, the proceeds from that are a little hard to predict,” explains Benoît Coeuré, chief executive of AFT. At the end of June, the Finance Ministry sold a further stake in France Telecom for €2.65bn, and this revenue will be used to reduce the debt of the central government or the public administration. Whether the government intends to sell a further stake in the state telecoms company before the end of 2007 is not clear right now. Coeuré says that if the cash increase is marginal, the AFT is more likely to cut issuance of short-term TBills: with maturities of six to 12 months instead. “It is a question of magnitude, but we will not know that until September.” The French Government’s plan to

bring the national debt to within the 60% of GDP limit prescribed by the European Union’s Growth and Stability Pact by 2010 (or by 2012 at the latest) appeared to encounter a setback in the first half of this year after a significant Benoît Coeuré, chief executive of AFT. At the end of June, the reduction in the Finance Ministry sold a further a stake in France Telecom for percentage in 2006 from €2.65bn, and this revenue will be used to reduce the debt of 66.2% to 63.9%. At the the central government or the public administration. Whether end of the first quarter, the government intends to sell a further stake in the state the figure had climbed telecoms company before the end of 2007 is not clear right again to 65%. now. Coeuré says that if the cash increase is marginal, the However, Coeuré AFT is more likely to cut issuance of short-term T-Bills: with explains that this was maturities of six to 12 months instead. Photograph kindly not as negative a supplied by AFT, July 2007. development as it might seem. The figure reflected the usual accounted for 17% of the total in the seasonal discrepancy, he notions, as first half of 2007 against 15% the the AFT's issuance of its Obligations previous year.“Recently we have seen Assimilables du Trésor (OATs) was a continuing increase in demand for always heavily loaded into the first six inflation-linked bonds. It is a market months of the year. This is in part that has matured a lot,” Coeuré because the agency does not issue in observes. “People need more and August and December. Coeuré adds more long-dated assets - and more that the final percentage target for and more index-linked bonds,”adds a 2007 will be part of the budgetary banker at one of the AFT’s primary discussions in September, but he dealers. “We believe clients—both expects that it will be close to the end- real-money accounts and hedge funds—are now looking for trades in 2006 figure. One feature of OAT issuance this products that are inflation-linked.” The AFT has long enjoyed a year has been another increase in the volume of index-linked bonds, which reputation for being innovative and

SEPTEMBER/OCTOBER 2007 • FTSE GLOBAL MARKETS

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www.aft.gouv.fr Reuters <Tresor> Bloomberg Tresor <go>

Regional Review AGENCE FRANCE TRÉSOR SETS LIMITS ON NEW BORROWINGS

Moreover, within The AFT could meet further 2001 until September 2002 but responsive. prudent limits of the volume of long- demand for long-dated instruments dropped when falling interest rates dated securities that the French with a tap of its 50-year bond. Coeuré invalidated its strategy of buying longgovernment, like any other, might observed that the current issuance of term exposure and selling short-term want to issue at any one time, the $12.9bn is “not the definitive size”. risk. “Now that long-term rates are agency is trying to satisfy this demand However, he does not anticipate that higher, we are moving closer to the with new offerings. “It is a really France will issue either a 40-year comfort zone where it would make sense to resume the professional issuer,” says OATs and BTANs issues and cumulative total on June 30, programme under the one of its primary dealers. 2007 (EUR billion) agreement of the Finance “There is real contact with Minister,” Coeuré all the primary market acknowledges. He added makers, and there is a this could take place before major, major demand for the end of the year “along this type of product.” the same lines as what we At the end of the first have done earlier” but week of March, the AFT stresses that it would be launched the longestimportant for the AFT to maturity bond yet to give the market a clear idea be linked to the of its policy ahead of time. harmonised Euro-zone The secondary platform index of consumer prices for retail investors that the (excluding tobacco) with AFT set up last year with the $4bn OAT 1.8% 25th Source: Agence France Trésor. Supplied August 2007 Euronext and eight banks July 2040 issue in a acting as Specialistes en syndicated transaction. The type of holder first in %)first quarter 2007 OAT by ownership byquarter type2007of(structure holder Valeur du Trésor (SVTs) to agency is now looking at aOAT ownership (structure in %) provide liquidity has long-dated instrument meanwhile more than linked to the French 26 doubled the participation of consumer index.“The next Insurance companies such buyers in the market, step would logically be to Credit institutions albeit from a small base. introduce a new long UCITS The initiative, which French linker with a other enables individuals to buy maturity of 15 years or 58 7 and sell OATs as simply as more," confirms Coeuré.“It non-resident investors institutions do at auctions would certainly be possible 7 at marginally wider to do it before the 2 produced a spreads, beginning of next year.” Source: Banque de France. Supplied August 2007 turnover $364m in 2006 While current marketSource: Banque de France compared with the $250m speculation places the that the largely unsuccessful special likely maturity of the instrument at bond, or one denominated in dollars. Meanwhile issuance of T-Bills pricing programme that preceded it anywhere between 15 and 32 years, Coeuré says a final decision will be seems likely to fall between now and had achieved in 2005. “The idea was made nearer to the issue date. “It is the year end. “Given the current that we wanted retail investors to on Government access a more liquid secondary something we can adjust according to information investor demand at the time.” He revenues, it is more likely that we will market,”explains Coeuré.“Participation added that this long-term French adjust slightly downwards rather than is much higher than under the old programme, although it is still small in index-linked instrument was also upwards,”said Coeuré. It is possible, however, that the AFT the wider picture." In the longer term, likely to be sold through a syndication among the AFT’s primary dealers and could re-open the swap programme the AFT should become noticeably less that it operated from the beginning of active in the market as the French be sized accordingly.

SEPTEMBER/OCTOBER 2007 • FTSE GLOBAL MARKETS

economy continues to strengthen and the government’s borrowing requirement lessens. “The general environment is improving. We see debt and deficits reducing all over Europe, and we are part of that movement,” maintains Coeuré. “We are certainly going to cut down the issuance over the next few years.” Whether this happens over the next two to three years is less certain.“It is not that clear that the current government is going to be that aggressive on reducing the deficit, so it's difficult to say,” commented a source at another of the primary dealers. Heavy levels of sovereign bond redemptions across all the larger European countries in 2008, 2009, and 2010 should also ensure a relatively 077_VDP-Az_185x125e_FTSE 31.07.2007 high level of new issuance to refinance

the retired debt. But how rapidly the overall level of outstanding debt comes down is not so certain. “That will depend on political decisions,” says the dealer. At the same time, the AFT is going to have to address a more international audience with its road shows and marketing effort on future issues, as foreign investors account for an ever larger slice of France’s outstanding sovereign debt. Overseas buyers now own 61% of it against just 13% a decade ago.“It’s also a challenge for the future because we have to keep in touch with an increasingly diversified investor base,”said Coeuré. The AFT’s network of 20 primary dealers is of considerable assistance here, as they are all significant banks with widespread operations around 9:49 Uhr Seite 1 the world. “When you have an

international presence like we have, that is not really an issue,”said one. Coeuré says the AFT will also attempt to woo back more “end investors” such as pension funds and insurance companies, which have increasingly shied away from buying bonds directly in preference to taking exposure to them through the swap market.“We need to find a new way to appeal to end investors,” confirmed Coeuré. “We do not want to talk only with banks!” Dealers observe that this probably reflects the fact that it is now relatively expensive for such investors to participate in the primary bond auctions—unless they want to acquire a particularly large holding of a given instrument—and they are consequently more active in the secondary market.

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Regional Review LATIN AMERICA: THE RAPID GROWTH OF BRAZILIAN PENSION FUNDS

BRAZIL’S PENSION FUNDS SPREAD THEIR WINGS

Photograph © Io Foto: Agency: Dreamstime.com, August 2007.

On July 18, the monetary policy committee of the Central Bank of Brazil top-sliced the country’s benchmark interest rate again, bringing it down another half percent to 11.5%. The decision marked both the continuity of the policy of loosening monetary policy and the end of an era. Brazil which had long had the highest real rates in the world lost that dubious honour to Turkey. At the same time, regulations governing pension funds are being liberalised. Combined, the measures are seeing a surge of interest by funds to move out of government debt and into equity and other higher-yielding, higher-risk investments. The process may prove protracted. John Rumsey reports from São Paulo. HE BRAZILIAN PENSION fund market is becoming a force to be reckoned with. It already has assets of R400bn (around $239bn, just under the volume of assets under management by CalPERS) and is growing at a steady clip of 15% to 20% per year, according to Raphael Santoro, at Towers Perrin in São Paulo. That said, the sophistication of funds varies enormously and some are too small to have very developed investment strategies. There are about 370 funds in Brazil although some 100 of them have assets of less than R100m, notes Fernando Lovisotto at consultancy Risk Office in São Paulo. Experts are now wondering if more new funds will be launched. Some four years ago, industry associations were allowed to start up

their own funds. Lawyers and the trade federation have done so, points out Lovisotto. The move is beneficial for tax reasons, he notes. Still, the take-up has not been great as there is not yet a great acknowledgement of the importance of pensions in the country and association pension funds do not receive copayment from sponsors. The other question mark is how quickly pension funds will change their allocations, which are still very much geared to state and Federal debt. They are allowed to invest up to 50% in equities under Brazilian rules. Very few do. With the exception of Previ (see case study), Brazilian funds are a conservative lot: typically they invest just 16% and 17% in equities on average, Lovisotto notes. Consultants

are puzzled by just how slow funds have proved at moving into equities. “It is happening, but it has not been as quick as we had believed. We really thought that funds were going to be more aggressive,” says Lovisotto. “When real rates reach 5%, we will see a rush to equities,”he predicts. The conservatism of many funds means that they have missed out on the last four years of sizzling performance and this may be reinforcing their reluctance to invest now: many funds are telling consultants that they are afraid that equity markets are now starting to look over-valued. Still, many funds are rewriting investment policies, according to José of Arsenal Luiz Fagundes Investimentos. Fagundes has met some ten funds in the last couple of months who are actively looking to update investment policies. Changes will allow funds a larger allocation to equities and investments in new categories of assets such as corporate debt and alternatives. Funcef, the third largest fund in Brazil, agrees that pension funds are proving slow to adjust to the new reality in Brazil. “Growth in investing in the stock exchange has been very

SEPTEMBER/OCTOBER 2007 • FTSE GLOBAL MARKETS

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Regional Review LATIN AMERICA: THE RAPID GROWTH OF BRAZILIAN PENSION FUNDS

In the past, slow. Fagundes Arsenal’s Brazil’s pension funds are increasingly allocations were was much meanwhile believes that being scrutinised by equity market greater than they are smaller, boutique firms today, says Guilherme have the most to gain from players. Some analysts believe that they Lacerda, president. Funcef, the change. They have been are starting to play a role in smoothing mostly serving employees at the cutting edge of the out volatility. For now, Brazilian equity of giant state-owned bank multi-market industry and markets continue to be so heavily Caixa Econômica Federal, have a strong lead over the dependent on fleet-footed foreign is ahead of the pack. With larger managers who have money with 60% to 80% of the latest assets of R27bn and tended to focus on catering 84,000 participants, the to conservative investors, wave of initial public offerings being bellwether fund already he says. snapped up by foreigners, mostly from invests a healthy 25% of Pension funds are also North America. assets in equities—up 7% increasingly looking to in just four years. Lacerda other asset classes, such as is pursuing a policy that private equity and venture will push that figure up further and it regulator, passed Regulation 3456. It capital. Funcef is starting to invest in is slated to reach 30% by the end of makes two important changes, private equity, according to Lacerda. next year, he says.“The normalising of explains Santoro. Pension funds are “The participation of private equity is the Brazilian economy means that it now able to invest 20%, up from 10%, very low in Brazil, compared to other will win share within global markets. in credit funds. These funds typically countries. We are on the way to Stock markets should continue to post include securitised assets, such as car enjoying solid economic growth of good performance. Although clearly loans and personal loans that are about 5%. That will open up many there will be fluctuations, we expect deducted from borrowers’ payroll. more possibilities for investment,” he there to be good growth on a two to Pension funds are also now allowed to says. Most of the funds in Brazil invest four year basis,”he predicts. invest 3% in multi-market funds, in infrastructure, energy, transport, Certainly, pension funds are which typically have aggressive logistics and basic sanitation. Funcef is increasingly being scrutinised by performance targets, high allocations also looking at earlier stage deals equity market players. Some analysts to equities and the ability to use long- through venture capital funds, for believe that they are starting to play a short tactics as well as invest in illiquid example in technology and software role in smoothing out volatility. For assets. The onerous requirements for development as well as in food now, Brazilian equity markets disclosure to regulators has also been industries, notes Lacerda. The fund continue to be so heavily dependent loosened giving funds more will be co-operating with the asset on fleet-footed foreign money with autonomy in their decisions, Lovisotto managers on the selection of 60% to 80% of the latest wave of points out. companies. “We had many problems initial public offerings being snapped Finally, the new laws allow defined with managers in the era of telecoms up by foreigners, mostly from North benefit funds to exceed the limits and infrastructure privatisations. Now, America. That makes guessing the established by the CMN, if they are we want to keep a closer eye on speed of the re-allocation of pension sufficiently well funded (a funding them,”he says. Finally, a portion of the funds into equities vital. ratio of more than one), points out fixed-income portfolio is likely to be It is not only changes in interest Santoro. The new regulations while switched out of Federal and state rates but a gradual thawing of not being as far-reaching as some issues into corporates. At the end of restrictive legislation that is would have liked are a start say 2006, funds were investing some 17% encouraging funds to consider consultants who reason that the CMN in corporate bonds and expected to investing in other assets. After intense plans to make further, incremental increase this to 25% by the end of discussions with representatives of changes. The multi-market industry 2007, according to Santoro. Funcef, the pension fund industry and has welcomed the idea: Claritas which has a lower allocation to fixedAbrapp, the national association of the Investimentos for one has already income than many at 65% is almost pension fund industry and Conselho hired a person to build relations with exclusively invested in government Monetário Nacional (CMN), the pension funds, points out Lovisotto. debt at 95%.

SEPTEMBER/OCTOBER 2007 • FTSE GLOBAL MARKETS

FT GLOBAL CONFERENCES & EVENTS

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Regional Review LATIN AMERICA: BRAZIL ADOPTS IFRS

Brazil firms up on accounting rules Brazil is finally getting serious with its commitment to adopting international accounting standards. About time too. The country has lagged behind most of the rest of the world in dragging its accounting norms into the modern world. The individual cost for companies is likely to be high but it should anchor foreign investors to the capital markets. If authorities fluff this opportunity to harmonise the country’s accounting rules with international norms, analysts and investors will get deeper, better research on companies in other parts of the world. The consequences for the future of the country’s thriving stock markets could be far-reaching. John Rumsey reports. RAZIL HAS FALLEN far behind other countries in synchronising its accounting norms. The European Union adopted the International Financial Reporting Standards (IFRS) at the end of 2005. Other developed nations, including Australia, Canada and New Zealand are moving rapidly in that direction. Many emerging market countries, including in Latin America alone Peru, Ecuador, Honduras and Guatemala have already adopted underlying IFRS standards and Brazil’s main competitors, including Russia and China, are moving fast to adopt international standards, says Ivan Clark, partner in the global capital markets practice for Latin America, at accounting and financial services firmPricewaterhouseCoopers (PWC) in São Paulo. The magnitude of the change can be seen in the numbers. By April, 79 countries had opted for international standards last year, and the number of companies using international standards passed the

10,000 mark. A signal indication of the unstoppable progress of international standards is the decision by the US market authorities to accept them. The International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) have agreed to converge their two gold standards: the American Generally Accepted Accounting Principles (GAAP) with the IFRS. To that end, the two boards have signed a memorandum of understanding that commits the US authorities to accept statements of companies adhering to the international standards by the end of 2008. Although international and emerging market investors are not focused on the issue yet (they are too busy bringing home the very plentiful bacon) that will change. As more countries fall into line with international norms, those that have dragged their heels, such as Brazil, are likely to be punished, accountants reason.

Photograph supplied by Istockphoto.com, July 2007.

Brazilian nonchalance ends It looked as if Brazil was set to drift endlessly on the issue of adopting international standards after a burst of activity at the beginning of the decade. Law 3,741 to push international standards had first been proposed in 2000, but then languished. As so often in Brazil, inertia and a rag-tag of improbable lobby groups undermined the initiative. One of the main beneficiaries of Brazil’s accounting standards has been local printing firms as Brazilian legislation requires notification of key corporate events in major journals. That proved a boon for papers and printers who filled papers with lengthy announcements. Adopting international regulations cuts that perk. That led to the bizarre spectacle of printers seeking to prevent the adoption of international accounting standards. In spite of such lobbying, there have been signs of life recently. In May, Armando Monteiro, the of the legislation, promoter

SEPTEMBER/OCTOBER 2007 • FTSE GLOBAL MARKETS

submitted the bill to Congress. The matter is waiting for approval from the commission of the constitution and justice, Comissão de Constituição e Justiça and the Chamber of Deputies and will then be sent up to the Senate. Meanwhile, the private sector has been showing the way forward. The Comissão de Valores Mobiliários (CVM), Brazil’s equivalent to the United States’ Securities and Exchange Commission, has recognised that international investors may discount the price of Brazilian securities if others adopt international standards and Brazil does not. It has set the start of 2010 as the date for the adoption of international norms for companies listed on Bovespa through proclamation 14,259 last year. The move is considered vital for the continued revival of the exchange, especially as it has become steadily more dependent on foreign participation. Some 60% of shares listed on Bovespa are held by foreigners, predominantly north Americans.

Current moves At the same time that legislators are working towards making Brazilian more international, standards Brazil’s federal accounting body, the Conselho Federal de Contabilitdade (CFC), has composed a committee to harmonise a plethora of industry groupings and try to reach greater consensus on regulations, says PWC’s Clark. Under its auspices, a committee of accounting practices, Comitê de Pronunciamentos Contábeis (CPC), has been founded. The CPC is composed of members of the other bodies involved in influencing legislation related to accounting. These bodies—Abrasca (the association of Brazilian listed

companies), Apimec (the association of analysts and investment professionals in capital markets), Bovespa (the stock exchange), Fipecafi (the foundation institute of accountancy, actuary and financial research) and Ibracon (the institute of independent auditors of Brazil)— each had differing aims and differences in views. The CPC started operating last year and its aim is to bring Brazilian accounting norms into line with the rest of the world. Clark believes that over time the new CPC will make a very large difference and become a focal point for the industry. For now, Brazilian companies cannot use IFRS because it would render them ineligible for various tax breaks, Clark says. If introduced, the IFRS would make three sweeping changes to current Brazilian legislation. It would allow companies to record journal entries that are consistent with IFRS, require large companies to be audited in Brazil, which is one of the few countries in the world that does not have statutory audit compulsion (except for companies that are regulated by the central bank or listed) and would simplify disclosure standards. It’s been estimated that it may take companies 18 months to complete the conversion because of the complex nature of the changeover. One of the difficulties is going to be finding accountants with the right background and the necessarily deep knowledge of international accounting norms. The Brazilian accounting industry is just starting to grapple with the issue. “We have a huge education process at the moment and are putting our Brazilian accountants through IFRS courses. It can take two to three years to come up to speed,” says Clark. There needs to be a shift in what is taught in the

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2007

universities. Much more basic requirements exist too such as the need for a translation of the international rules into Portuguese. There are other complicating factors. Brazilian companies that have carried out market activities in the US have already adopted the American GAAP. As north Americans continue to dominate investments in Brazil, would it not make more sense to adopt US standards? The CVM decided finally that US rules were both designed with particular reference to the US market and would be on balance more expensive than international rules. Even so, the cost for adopting the cheaper international standards is estimated to be high with some estimates that it could be as much as BR1m for some companies. For the flood of companies selling equity on Bovespa this year, the decision on whether to adopt US or international standards is something that they need to grapple with now. They are increasingly aware of the dilemma. Lawyer Alexandre Gossn Barreto of Souza, Cescon Avedissian, Barrieu e Flesch in São Paulo, says that these companies usually defer to their advisers in the decision. With the US set to accept international legislation, most are plumping for international standards. One of the principal differences is that the IFRS is based on principles while the US GAAP is based on rules. That means that the IFRS is more flexible. Still, one of the criticisms levelled at international standards is that it is practiced unevenly in different jurisdictions around the world, undermining its claim to be a universal standard. Furthermore, US GAAP is a well known and well tried system whereas the international version is new and untested.

Regional Review ASIA: HOW TO HANDLE INDIAN NON-PERFORMING ASSETS

With a booming Indian economy, not many investors spare a thought for Indian non-performing assets (NPA). However, this market has seen a quiet and very effective transformation. PriceWaterhouseCoopers estimates over $1bn will be spent buying NPAs from Indian banks this year. In early July, Isle of Man-registered Dhir India Investments (Dhir) plc floated on AIM raising £25m via a 16.67m share placing at £1.50 per share. The firm is the first listed fund in the UK to invest in the $50bn Indian NPA market, an area which larger players have typically avoided due to regulatory, logistical and operational requirements. Simon Watson reports. CCORDING TO ALOK Dhir, managing director of Dhir, the firm is targeting an annualised return of 25% to 30% gross of management fees, once the proceeds of its IPO placing are fully invested. Dhir is looking at four types of investments: turnarounds, the resale of assets or companies, break-ups and straight sales and bridge financing. The company says it expects to be fully invested within a year, having made about six investments already. Most of the NPAs sold by India’s banks to date have been bought by a handful of Indian financial institutions and a select few international investment banks and funds—for example, JP Morgan, Citigroup, Deutsche Bank, Standard Chartered Bank, WL Ross, Spinnaker, Eight Capital, Clearwater Capital, and Kotak Mahindra Bank. These investors generally target transactions with a value of over $20m, or the acquisition

The budding appeal of Indian NPAs “Most of India’s NPA stock consists of companies with significant assets and business fundamentals that find themselves over-leveraged and in hock to creditors, but like Michael Milken showed in the US in the junk bond market, these are great assets that you’ll never see priced here again,” says Sam Barden, chief executive officer for SBI Fund Management, in Moscow. Photograph supplied by iStockphoto.com, July 2007.

of large portfolios. Dhir, on the other hand, will focus on small and medium-sized transactions valued between $5m to $10m. Dhir also raised a further £25m through a private placing, marketing the newcomer as an income and capital growth play offering Western fund managers exposure to Indian NPAs. Evolution Securities is the nominated adviser and broker to the company. “Most of India’s NPA stock consists of companies with significant assets and business fundamentals that find themselves over-leveraged and in hock to creditors, but like Michael Milken showed in the US in the junk bond market, these are great assets that you’ll never see priced here again,” says Sam Barden, chief executive officer for SBI Fund Management, in Moscow. “Distress was created during a period of high interest rates and poor industrial growth in India in the 1990s

which hit a large number of Indian companies, despite their strong assets and solid fundamentals, but things are different now,”explains Barden. Indeed, the stock of NPAs in India is estimated to be approximately $50bn, built up primarily as result of the transformation of the Indian economy from a centrally regulated economy during the 1990s to a more free market economy. NPA resolution strategies adopted by Indian lenders in the 1990s were limited to debt restructuring—jointly through the Board for Industrial and Financial Reconstruction (BIFR) or independently by individual lenders— and legal action under the Debt Recovery Tribunal (DRT) Act. One Time Settlement (OTS) options were constrained by the dual problem of lender constraints in accepting aggressive discounts and the inability of the companies to find alternate funding. Both recovery and turnaround efforts were hampered by

SEPTEMBER/OCTOBER 2007 • FTSE GLOBAL MARKETS

the lack of effective bankruptcy laws and, more important, the absence of a distressed debt market which could provide an exit route for lenders or allow corporates to raise revival and/or growth finance. Since then, of course, the Indian economy has recorded real GDP growth averaging 8.1% for the last three years. This has created an opportunity to invest in NPAs, which are typically over-leveraged capital structures with insufficient liquidity and in default of their obligations to creditors. Often these companies have significant assets and/or solid underlying business fundamentals, which are not being fully utilised. In such circumstances, Dhir believes that the resolution of the existing debts, and in some cases a turnaround of the underlying business, can lead to substantial profits on exit from the investments being generated in the short and medium term. Encouraged by new central bank rulings that allow cash-based NPA portfolio transactions, several leading banks such as ICICI Bank, State Bank of India (SBI), HSBC and Punjab National Bank (PNB) have offloaded NPAs to distressed debt investors. Principal debt has been transacted through portfolio auctions involving multiple bidders as the acceptance of cash-based NPA sales as a resolution option for banks has grown. However, further growth in developing and deepening this market is being hampered by foreign investment restrictions. A recent central bank ruling allowing only 49% foreign direct investment (FDI) in asset reconstruction companies (ARCs), and the cap on single foreign institutional investment (FII) of 10% (aggregate 49%) in instruments issued by ARCs, does not allow the investor to control and drive

workouts. This is essential, given the relative risks of such investments. NPA sale regulations also favour banks, further restricting the flexibility of distressed asset investors, who may prefer to operate through a foreign investment fund or ‘‘local servicer” model, reducing the costs associated with maintaining large local balance sheets. This has prevented many focused nonbanking distressed asset investors from coming into India. Most other countries have a very active distressed asset bond market, which facilitates timely restructuring based on economic realities. Despite these glitches, the distressed asset market has evolved significantly. With at least an estimated 5% to 6% of GDP still trapped in under-utilised assets, a pragmatic and open approach towards foreign investment in distressed debt may help unlock value from these assets and put them back to efficient productive use once again. Against this backdrop, Dhir is taking advantage of growing investor appetite for Indian assets as the $775bn economy expands at a record pace. The country’s growth has pushed up the value of the plants, machinery, land and buildings used as collateral by borrowers now in default, making the task of recouping the loans easier. “Some of the laggards have become hot properties,” says Alok Dhir, managing partner of Dhir Investments, in Mumbai, “and I’m telling investors that this is a great time to enter the market. If you come in now, you'll ride the wave.” Dhir thinks that the growth in loans in India could mean that as much as $3bn a year is added to the bad loan tally. Moreover, the Central Bank of India says that commercial bank credit rose by a record 36% to R3.96trn ($88.3bn) in the year ended March 31. Tapping

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2007

into management’s experience in the Indian distressed assets market and local knowledge, Dhir’s strategy is to fully invest float proceeds within 15 months, resolving target company debt problems and in many cases turning businesses around, making substantial profits on exit. Annualised returns of 25% to 30% are being targeted through four types of investment – turnarounds, company or asset sales, break-ups and the sale of assets, and bridge financing. To mitigate risk, investments related to any one single company will not exceed £7.5m. “Investors have a huge appetite for India's non-performing loans,” says Roger Nightingale, head of research, for Millennium Asset Management, in London, adding that “there’s a large non-performing loan pool with the banking and financial institution community that is witnessing a silent turnaround along with the economic boom, and this has created enough traction and investment opportunities for investors.” Dhir’s estimate of India’s bad loans includes soured credits at cooperative lenders, non-bank finance companies and loans written off by banks. That is more than the central bank’s estimate of $12.3bn, which includes only loans overdue for more than three months at commercial lenders. In comparison, most Chinese bad loans are in companies that have ceased to operate, explains Denys Firth, a partner in Asia Debt Management Hong Kong, a buyer of bad credits in Asia. “The opportunity is limited to realising or liquidating assets, mostly real estate,”he adds. In India however, “the opportunity is to restructure the balance sheet, reduce debt, add some working capital and revitalise the operations of the company,”says Firth. “While more risky, this can be more rewarding in terms of total return.”

Regional Review AFRICA: THE JSE EMBARKS ON A NEW GROWTH PHASE

Keeping pace with the JSE There’s a popular view in South Africa that in recent years the JSE has done everything but walk on water. No wonder. In the near final phase of comprehensive movement from a legacy IT infrastructure into a next generation technology solution, the JSE has been through demutualisation, and successfully established an expanding and popular derivatives market (and in particular a single stock futures market). Current market volatility aside, the JSE has enjoyed a protracted period of substantive growth. Now the focus is on new products, the encouragement of more listings as well as some understated international initiatives. ICKY NEWTON-KING, the JSE’s deputy Chief Executive Officer (CEO) is readying for a holiday. It’s understandable. It has been a prolonged hectic period in the life of JSE Ltd. Even so, during the market turmoil of the past couple of weeks, the JSE as a listed company has been hit harder than its own all share index, with its market cap dropping by almost R2bn and its share price plummeting close to 20% in early August. “Nobody is looking at the fundamentals,”noted a local broker and nervousness and uncertainty as to how big the US sub prime problem is aside, the extent of the fall off in the South African markets has been something of

a surprise Even in simplistic terms: the JSE is a monopoly and there was no news in the market that might destabilise opinion about the exchange. Moreover, while JSE’s price to earnings (PE) ratio is sitting at 39 ; above the South African market average of about 15, one consequence of current market turbulence is that JSE’s business is enhanced, “as more trades go through the exchange, each trade giving the JSE fee income. Market volatility is good for us,”acknowledges Newton-King. The JSE’s all share index meantime ended at 25,991.800 by the 16th August. Resources lost 5.42%, the gold mining index tumbled 3.05% and the platinum mining index retreated 2.67%. Banks weakened 3.74%, financials dipped 2.88%, and industrials shed 3.14%. The rand was bid at 7.46 to the US dollar from 7.31 when the JSE closed on August 15th, while gold was quoted at $654.25 a troy ounce from $668.55/oz at the JSE’s last close. Before the current turmoil, the JSE had been enjoying a long bullish run. According its own statistics, the number of trades, including off-order book trades, were up 27% on the year by the end of July. Volumes were down 14%, but value was up 26%. Foreign trading was holding fairly steady, just 5% firmer year on year with net purchases of R58.3bn. Its consolidated revenue for the six months to June is some 31% higher than for the same period last year, with cash from operations up by 67%. “It is well ahead of what analysts were expecting,”acknowledges Newton-King.

The average daily number of deals for the first six months of this year are up 31%, according to the latest half year report issued by the exchange. JSE noted a strong growth in equity derivatives, with average monthly contracts up 200%, single stock futures were up 299%, while index futures rose 6%. “there is also continued appetite for Can-Do Options, while the daily average number of agricultural derivatives contracts has grown by 35%. We are delighted with the overall growth of the exchanges derivatives business and the pace has been cracking,” says Newton-King. The overall uptick has been pleasing for JSE’s shareholders, which have seen the share price treble over the year, with some local analysts maintaining, that the exchange itself remains under-priced. The JSE is the world’s 16th largest equities exchange, with a total market capitalisation of some R3.9trn (around $620bn).The JSE operates three markets across multiple products namely: equities, derivatives and agricultural derivatives and in early 2005 it launched a comprehensive interest rate exchange, Yield-X. Last year was probably the most exciting year in the history of the JSE. A milestone was reached in early June 2006 when JSE Ltd listed on its own exchange after 118 years as a mutual society. The exchange was on an upward curve. “There were 37 new listings in 2006, up from 19 in 2005, of which 18 were main board listings and 19 on AltX, the alternative exchange,” says Newton-King. Total listed companies were up from 388 in 2005 to 401 in 2006, with 364 of these on the main board and 37 on AltX. AltX now has over 50 listings. Though the JSE’s good times are not all in the past.“The pipe line for new listings over the next few months looks very exciting,”she adds. It all adds up in JSE’s ambitious growth strategy that encompasses both

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and development companies. and global pan-regional One of the biggest problems with elements;“we have a number of the local investment market is new products underway which that there are relatively few listed we expect to announce later this junior miners and very few retail year.”The exchange is noted for investors buy into junior mining its considered and detailed stocks as the the risks and planning and project fundamentals associated with management. Most recently exploration differ from those this has encompassed a massive associated with the traditional infrastructure modernisation miners with which local investors programme, with the moniker are more familiar. Project Orion, which will be As a result, the JSE has been finally completed in 2008. The and will be hosting free JSE is in the process of educative sessions throughout completing full implementation the year where retail investors of a next generation technology will be taught specific valuation solution, which can be used as a techniques relating to Nicky Newton-King, deputy chief executive officer, of the base from which to provide new exploration and will be able to JSE.Photograph supplied by the JSE, August 2007. business services and engage with mining companies operations as may be required Newton-King is also optimistic about listed on the local bourse. by the JSE’s users (both internal and Many analysts believe that external), current customers and the future of the JSE to attract more potential new customers. The JSE’s companies as a result of the economic regionalisation is inevitable for business model has not changed. “Once growth that South Africa is experiencing; African stock markets as they struggle Orion is completed all out technology however, she is reticent to nominate to overcome poor liquidity and to will be on next generation technology specific examples of detailed regional attract more foreign investment. The enabling us to keep and even keener initiatives. “You can say we are path has been cleared for dual listings control on this aspect of our costs.” progressing in our discussions with on southern Africa’s stock markets regional institutions and that we hope following several meetings of the explains Newton-King. Apart from the technology being that in the near future we will have some regional stock exchanges. This is upgraded through Project Orion, the concrete initiatives in place.” Part of that essential if the JSE is to become a JSE’s equities market uses TRadElect the unstated strategy is to establish the JSE competitive stock exchange in the London Stock Exchange’s new trading as a viable regional hub and in the past, modern world. It should provide a system and will continue to do so says the JSE has indicated that it wants to natural attraction, for example, for Newton-King. As well, the JSE utilises attract more interest from African mining companies seeking to list, as the Swiss settlement system, via a Sega companies and is likely to remain a key the majority of juniors have often inter-settle system, which Strate, (the objective over the long term. Since 2004, plumped for exposure on the Toronto CSD in which the exchange has a large 14 African mining companies have listed Stock (TSX), the Australian Stock shareholding) bought off the shelf and on the JSE and have, subsequently, Exchange (ASX) and London’s received considerable investment Alternative Investment Market (AIM) customised for its own requirements. Newton-King acknowledges that the support. The JSE is likely then to as markets for raising exploration and JSE probably “tries harder” than other continue with its initiative of hosting development capital. For Newtonmainstream exchanges. “South Africa is specialised showcases for mining King, the flexibility to take account of still an emerging market, therefore to companies listed on the JSE and its evolving market conditions is stay in the mainstream, our regulations alternative bourse, AltX. Another, and paramount. “The overall story is and operations often exceed accepted locally pioneering, strategy the JSE has positive and we are focused being international standards. We are always introduced is a separate mining able to provide innovative and trying to offer more because we need to showcase initiative designed to educate intelligent solutions to our clients. make sure investors are as comfortable South African retail investors on the We feel confident about our as possible to transact in South Africa .” fundamentals of investing in exploration tomorrow,”she says.

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BANKING IN EGYPT: THE PROFIT MOTIVE

HONING A COMPETITIVE EDGE Egypt’s banks are living with change. By and large the country’s banks have a future of powerful consolation before them. The government’s infrastructure reforms are improving incomes and living standards and the banking sector has benefited from consolidation and a clean up of non-performing loans. Now foreign banks are entering the Egyptian market with brio, anxious to capitalise on a fast growing sector. You bet they can.

Photograph © David Campbell. Agency: Dreamstime.com, August 2007.

HE EGYPTIAN GOVERNMENT’S wholesale plan of introducing infrastructure reforms, involving its tax, trading and foreign exchange regimes, strengthening monetary policy and encouraging reform and privatisation of the financial sector has largely worked. GDP growth touched 6.8% in the fiscal year ending June 2006, and this year will likely top that figure. Exports grew by just over 18% in 2005/2006, to reach $15.9bn while imports rose 21% to $26.3bn. [Export growth is driven in large part by non-oil exports, which are up 42.4%, while non-oil imports are up by 30.3%. However oil-imports are down by 23.7%. An increase in foreign exchange reserves, tourist receipts of $6.2bn and $3.1bn in Suez Canal revenue have created a balance of payments (BOP) surplus of some $3bn]. Egypt’s banking sector has benefited from consolidation, improvements in solvency and the quality of products and services offered by the local banking market. Reform is ongoing in Egypt, backed by a Unified Banking Law introduced in 2003 which did four things. First it encouraged consolidation. In the 1990s, the sector was overblown, comprising 60 foreign and domestic banks. That has been whittled down to 30 and the government is still chary of issuing new banking licences. Two, financial institutions had to ensure they had a minimum of LE500m (about $90m) in paid up capital. In other words, banks had to have a serious and purposeful attitude, backed by sufficient funds. Three, a number of banks were slated for privatisation [of which, more later] and finally, banks were encouraged to tackle non-performing loans. The law was backed by a government intent on change and also by outside support, such as a recent World Bank 20-year assistance programme on soft terms, worth around $500m,

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covering the next five years, providing supporting huge non performing loans portfolio, estimated to make up infrastructure development, financial sector reform, and 73% of the banks gross loans. Despite vast holdings, Egypt’s public sector banks are non-lending operations. The government’s latest drive is to divest most of its joint venture stakes in Egypt’s private notorious for non-performing sweetheart loans made to banks by year 2007/2008 to help to cover the country’s connected businessmen, a practice prevalent in the 1990s. One local business magazine estimated that Banque du balance of payments deficit. In early July, the government took everyone by surprise Caire is burdened by around $2bn worth of nonby announcing it would sell an 80% stake in Banque du performing assets. That aside, most likely a persuasive Caire to a strategic investor. Most shocked of all was Bank point for the government was the successful sale, last Misr, whose executive had been preparing to merge with October of Bank of Alexandria, the country’s fourth largest bank, to Italy’s SanPaulo IMI for Banque du Caire (which has a $1.6bn (six times its book 6% share of the domestic value). Five Middle Eastern and market) for nigh on two years. European banks had been in Government opposition parties the running, with an 80% stake also had a field day, voicing in the bank up for grabs. concerns about the growing Candidates had included level of foreign ownership in Egypt’s own Commercial Egyptian assets. Government International Bank (CIB), ministers and the Central Bank France’s BNP Paribas, a joint of Egypt (CBE) insist that such venture of Jordan’s Arab Bank fears are overblown. Youssef and Saudi Arabia’s Arab Boutros Ghali, the minister of National Bank, and a Dubaifinance, said in a press based partnership. The revenues conference that the decision from the sale were allocated to followed detailed cost analysis restructuring Banque Misr, of the merger with the input of Banque du Caire and the international consultants. “The National Bank of Egypt, branches of both banks are in announced the central bank at close proximity, which means the time of the acquisition. we would either have to shut Earlier, bank sales were largely down these branches or let confined to Egyptian private them negatively effect Bank banks: with MIBank having Misr operations,” Ghali told been purchased by Societe local press. He also motioned a Generale and Egyptianstrategic sale was a cheaper American Bank by Calyon. option overall: the total cost of Sahar El Sallab, vice chairman and managing director of A panel consisting of combining the two banks was Commercial International Bank (CIB). Sallab explains members of the planning and “around $2.4bn against $1.6bn that the bank has invested heavily in new systems, budget committee and the for restructuring the two banks training and developing an effective cross-selling strategy. economic committee of the separately”. Not only that, a “Egypt is to all intents and purposes a greenfield market, People’s assembly requested strategic sale could net the retail banking is still in its infancy and mortgage lending have formal investigation into government up to $2.4bn in has yet to find its feet. Market penetration is still less the Banque du Caire sale. In proceeds, which in turn could than half the average in Europe. The potential of this recent months, a small but be used to pay back public market is clear to both foreign and domestic banks, so it is vociferous opposition group sector debts to the Bank of important to develop your edge,” she adds. Photograph opposed to what they see as the Alexandria and the National kindly supplied by CIB, August 2007. selling of Egypt through Bank of Egypt, the country’s largest bank by far (with LE132bn in assets) and help clear privatisation schemes that hand over Egyptian assets too their loan portfolios by the end of the 2007-2008 fiscal year. easily to foreign companies. Some have called for Egyptian The bulk (80%) of Banque du Caire shares will be sold to companies only to be allowed to bid for the bank. Central a private investor in 2008, says the government, 15% will be Bank governor, El Okda has publicly insisted however that listed on the Cairo and Alexandria Stock Exchange (CASE) even if Banque du Caire were to be bought by a foreign and 5% will be held by employees. According to Ghali, the company, domestic banks would still enjoy the lion’s share sale will take place in a similar format to the sale of Bank of (around 71% of the sector is held in Egyptian hands. Alexandria last year. The eventual winner of the bid will Middle Eastern banks control around 10% and foreign inherit a bank with a 6% share of the market and over 200 banks (mainly European) control the rest. Jordan’s Arab branches but also an over-sized employee roster and a Bank, the National Bank of Kuwait and HSBC are some of

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the banks that have already expressed interest in the sale. Of late, the talk in Cairo is of CIB joining forces with Arab African International Bank (AAIB) to bid for Banque du Caire. The possibility has also been raised that eventually the CIB might even acquire the Central Bank’s 49% stake in AAIB. CIB’s management has not officially commented, however, unofficially, CIB is keen to use the synergies in AAIB (in which the Kuwait Investment Authority also holds 49%). AAIB has a strong retail and project financing franchise and has a decent sized branch network, which was expanded when it acquired Misr American International Bank in 2005. CIB has been making a significant play for greater market share in recent years. Historically, CIB has been strong in the corporate sector, acknowledges Sahar El Sallab, vice chairman of CIB, “but the emphasis now is on deepening our retail franchise.” Sallab explains that the bank has invested heavily in new systems, training and developing an effective cross-selling strategy. “Egypt is to all intents and purposes a greenfield market, retail banking is still in its infancy and mortgage lending has yet to find its feet. Market penetration is still less than half the average in Europe. The potential of this market is clear to both foreign and domestic banks, so it is important to develop your edge,”she adds. Egypt’s banking has long been dominated by four public sector behemoths which held half the assets of the country and more than 57% of its deposits, and had been immune to experts’ calls for their privatisation. October’s sale of 80 percent of the Bank of Alexandria, the smallest of the four, to Italian bank Sanpaolo IMI for $1.6bn in the country’s largest privatisation deal showed Egypt’s new determination to reform. There is a lot of foreign interest in buying Egyptian banks; tempted by a nascent retail sector in the Middle East’s most populous market. Most recent, was the acquisition in early August of Al Watany Bank by the National Bank of Kuwait, for $516m. Al Watany has a 22 branch network, spread through Egypt and assets of almost $2bn. NBK won the tender after submitting a price equal to 4.16 times book value and 17 times earnings. NBK submitted a price of LE77.01 per share. Nearest competitor, an alliance bid by Commercial Bank of Kuwait and Al Noor Financial Investment Company amounted to LE75 per share. The deal is expected to be finalised by the end of this year after obtaining both Egyptian and Kuwaiti relevant regulatory approvals and changing Al-Watany Bank’s current name to reflect its acquisition by NBK. NBK’s chief executive officer, Ibrahim Dabdoub says the deal “constitutes a significant step within NBK’s expansion strategy in the region,” and highlights the country as “one of the most promising markets in the region”. Not only that, Dabdoub explains that some 400 Kuwaiti companies and organizations work closely Egypt; with some 400,000 Egyptian expatriates living in Kuwait itself, “who are in need of various financial and banking services”. In spite of political talk-talk about national assets, the fact is there is a paradigm shift at work in the Egyptian

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NBK’s chief executive officer, Ibrahim Dabdoub says the deal “constitutes a significant step within NBK’s expansion strategy in the region,” and highlights the country as “one of the most promising markets in the region”. Not only that, Dabdoub explains that some 400 Kuwaiti companies and organizations work closely Egypt; with some 400,000 Egyptian expatriates living in Kuwait itself,“who are in need of various financial and banking services”. Photograph kindly supplied by National Bank of Kuwait, August 2007.

banking market. The realisation is that market liberalisation and foreign inward investment in the financial sector has helped other Middle East markets boom and now, both the government and the country at large want a share of that new financial order. Moreover, they are prepared to work for it and adopt a new outlook and approach to business development. El Sallab sums up the new paradigm neatly. In her view, the development of the country’s banking sector is a microcosm of the larger economy. “Banks have an important role in Egypt,” she stresses.“It is not just about profit and opportunity. I think there is a new realisation that we have to take the long term view: invest in training, lifting professional and living standards, investing in infrastructure through appropriate financings and have a hand in the consolidation and deepening of the sector itself. This is not an ad-hoc approach. In fact, it is our financial duty, as an integrated institution, to develop the country and still make a profit.”

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TO BUY OR NOT TO BUY The summer of 2007 will be noted for two events: a shaky US sub-prime market and a somewhat likely kick-off in the Middle East banking market of a spate of mergers and acquisitions. The Gulf region has yet to produce a truly regional bank with the size and range to compete head to head with the major international banks. Any deals of significant size, such as the National Bank of Dubai/Emirates Bank merger could change all that. Francesca Carnevale reports. T WAS ONLY a matter of time that with cash to burn banks in the Middle East would be prime targets for predatory acquirers at home and abroad. What better time to cement growth than through the acquisition of market share in the wider Middle East and North Africa (MENA) region? The most high profile pairing to date, that would have set a new benchmark for acquisitions in the Gulf Cooperation Council states would have been International Bank of Qatar’s offer to buy Ahli United Bank for up to $6.1bn in cash and stock. Bahrain’s largest lender by market value, Ahli United is a prize catch. International Bank of Qatar’s offer came just weeks after Ahli United Bank bought a 35% stake in Alliance Housing Bank, Oman’s largest mortgage lender for $132m. It also has a stake in Al-Ahli Bank of Qatar. International Bank of Qatar, an affiliate of National Bank of Kuwait was reported to be offering between $2.05

and $2.25 per share in cash for a 55% stake and the rest in stock. Investor in Ahli United, Tamdeen Investment Company, appeared to have reached an initial agreement to sell its 13% stake in Ahli United at a price of $2.25 per share; however, the deal has stalled. Some reports have it that Tamdeen changed its mind; others that the vendor and buyer could not agree the precise terms under which preacquisition due diligence would be conducted. Ahli United’s stock was trading at $1.39 as late as the 10th July this year. However, its shares were suspended on the Bahraini exchange because of takeover rumours. At the time of taking this magazine to press, no news emerged as to either Ahli United returning to the stock exchange, or that any progress had been made between buyer and potential sellers of Ahli United stock. The bank is a natural target, with an upward profit profile and with $21bn plus in assets. Ahli United announced net profit of $150.7m for the first

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daily basis. In mid-August, local press reports that a half of this year, up 39.7 % over the same period in 2006. Bigger now looks to be better in a region where the size number of Kuwaiti investors were interested in buying the of a balance sheet is an important marker for a local bank’s Commercial Bank of Kuwait’s (CBK) share of just fewer ability to participate in the region’s near term project than 20% in the Bank of Bahrain and Kuwait (BBK). CBK finance market, which is currently estimated to be worth in ended up denying the rumours after less than a week of excess of $1bn. Moreover, banks in the Gulf are growing in speculation. The bank issued the statement in response to confidence and it can only be a matter of time before a reports that it had signed a deal to sell its shares. Equally, sizeable merger or acquisition propels a major Gulf bank National Bank of Abu Dhabi, the largest bank by assets in the United Arab Emirates, is said to be on the lookout for into the global banking league. Not right now, however. Deal or no deal for Ahli United, an acquisition and market rumour says the bank has Abu acquisition fever is infectious. In March, Abu Dhabi Islamic Dhabi Commercial Bank in its sights. Again, this appears to Bank accepted a takeover offer from Emirates International be unconfirmed. National Bank of Abu Dhabi, will hold a shareholder meeting in Investment, a company early September to vote controlled by the on a bond sale plan, country’s ruling family. worth as much as Then in July, Emirates $1.75bn. Bank International The bank is (EBI) and National A recent McKinsey report noted that the proposing to sell as Bank of Dubai (NBD) much as Yen40bn completed an $11.3bn region will likely also receive a boost from ($348m), $861m worth (€8.2bn) merger to international banks wanting to grow in the of Malaysian ringgit and create one of the largest region. However, both the Emirates Dir2bn ($545m) worth banks by assets in the Bank/National Bank of Dubai merger and the of bonds by year end. Gulf. The Emirates stalled Ahli United transaction have illustrated The convertible bonds Bank/National Bank of are expected to come to Dubai merger is that valuations are sky high and there are few market with a ten year perhaps a step in the obvious targets in the region available to maturity, and will fuel right direction if a banks in the West that are in the middle of a speculation that the number of Gulf banks credit crunch. bank will use the funds are to play in the global to help finance league. The merger will acquisitions. create the region’s In Dubai, the state’s largest bank with assets ruler reportedly made an of $45bn. “The offer to buy a 32% stake proposed transaction brings together the UAE’s second and fourth largest banks in SHUAA Capital, the largest investment bank in the UAE by assets. As a combined entity, we believe the company will in June, but it came to little. Interest in SHUAA is be well positioned to grow and to deliver outstanding value understandable, as the discrete investment bank is pulling in to its shareholders, customers, and employees,” says business. In July, the bank posted modest profits of $20.3m, Douglas Dowie, chief executive officer of the National Bank but nonetheless, a sizeable increase on the same period last year when the figure was below $1m. Revenues for the same of Dubai (NBD). Each EBI share will be exchanged for one share in the quarter were $44.9m, as opposed to $7.6m in 2006. SHUAA combined Emirates NBD, valuing the EBI shares at AED9.30 said 19% of its revenue came from investment banking, 14% per share. Each NBD share meantime will be exchanged for from brokerage and almost 50% from associate companies 0.95 shares in Emirates NBD, valuing the NBD shares at and principal trading. SHUAA Capital itself rushed to AED8.84 per share. The exchange ratio of 0.95 equates to a market in late August with a strong denial that it was part of 14% premium to NBD’s share price in early March, when consortium bidding for Ahli United. On a more concrete footing however, Malaysia’s trading in the bank’s shares ceased (standard practice in the Middle East during merger talks to protect shareholders). Employees Provident Fund (EBF), the state pension fund, Merger negotiations aside, NBD also managed to grow says it will begin talks regarding the possible sale of the business substantially in the first half o this year, recently RHB Bank, part of the RHB Group, to the Kuwait Finance announcing a 29% rise in half-yearly profit to $177.3m, House (KFH). The EBF bought the RHB Group earlier this compared with $137.2m in the first half of last year. The year for $3.6bn, edging out the KFH and EON Capital. No bank’s assets were worth around $22bn at the end of June financial details on the possible sale of the RHB Bank have yet been revealed. The Commercial Bank of Qatar (CBQ) 2007, 17% more than at the start of the year. In a frenzied market, rumours of strategic sales and has also confirmed that it has received initial approval to mergers are being rumoured and counter-rumoured on a buy an undisclosed stake in the UAE’s United Arab Bank

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acquisiti o n o r new ppo rtu nit

MIDDLE EAST BANKS ON THE ACQUISITION TRAIL

(UAB). The bank has been given the go-ahead by ‘major’ this trend, National Bank of Kuwait (NBK), most recently, shareholders in the UAB to buy a sizeable stake and also to signed an agreement to buy a 40% stake in Turkish Bank. Ibrahim Dabdoub, NBK’s chief executive officer, explains manage the lender. Qatar National Bank (QNB) meantime has raised that the Turkish economy,“will continue its strong growth $1.75bn through a syndicated term loan in late July, in one over the long term on the back of continued economic of the Gulf’s largest syndications to date, signalling its reforms, political stability and favourable demographic intent to use the funds to acquire banking assets in the trends; this will have a positive effect on the banking sector wider MENA region. The facility was priced at 19.5 basis in the coming years”: a growth story that NBK is anxious to leverage. Established points over Libor. The only in 1982, Turkish bank will use the funds Bank is rated as the to support expansion 12th fastest growing plans and for general A recent McKinsey report noted that the bank in Europe by The purposes. Ali Shareef Al region will likely also receive a boost from Banker magazine and Emadi, QNB’s Group has a network of 20 CEO the loan “will be international banks wanting to grow in the branches. utilised to support region. However, both the Emirates NBK is planning a further the aggressive Bank/National Bank of Dubai merger and the scrip issue to raise its growth of QNB”. stalled Ahli United transaction have illustrated capital base by some Emadi explains that that valuations are sky high and there are few 20% to help finance its QNB’s international recent acquisitions of presence is rapidly obvious targets in the region available to Turkish Bank and expanding to include banks in the West that are in the middle of a Egypt’s Al Watany new locations in Oman, credit crunch. Bank, in recent weeks Kuwait and Yemen, as well as helping the “supplementing bank expand its project existing branches in financing activities. London and Paris and representative offices in Libya, Singapore and Iran”. Intent NBK is also building a franchise in Syria and is expected on its international expansion plans, QNB made on to announce the establishment of a strategic stake in a acquisition this year, buying a 20.6% strategic stake in Syrian venture shortly. A board meeting, scheduled for Jordan’s Housing Bank for Trade and Finance (HBTF) for late September is expected to rubber stamp approval of the rights issue at a premium of 900 fils per new share over $442m. issued, over and above the par value of 100 fils A recent McKinsey report noted that the Middle East ban ks a per share, after obtaining the necessary region will likely also receive a boost from re loo approvals from the appropriate international banks wanting to grow k regulatory authorities. “The in the region. However, both the subscription procedures will be Emirates Bank/National Bank of issued in advance in order to make Dubai merger and the stalled the process as easy as possible for Ahli United transaction have our shareholders,” says illustrated that valuations are Mohammed Abdul Rahman Alsky high and there are few Bahar, NBK’s chairman. obvious targets in the region While some of the Middle East’s available to banks in the West financial institutions are on the that are in the middle of a credit acquisition trail, others are cashing crunch. Foreign banks entering in on strategic investments made the market will acquire market some time ago. Shamil Bank of share either through a strategic Bahrain announced that is has lowered shareholding or through an outright its stake in Karachi-based Meezan Bank purchase of a relatively small franchise, from 26 to 7. Shamil Bank’s sale of 19% according to the report. Gulf banks have ownership of the institution, Pakistan’s first licensed been more willing to look at alliances with western banks and Citi, Deutsche Bank and HSBC have set Islamic bank, netted a 17% internal rate of return and an average annual return of 46% for the past 10 years. Shamil up partnerships with established Gulf players. Equally, leading banks in the Gulf are looking intently at said the time was right to dispose of part of its holdings in potential acquisitions and strategic investments in both the institution. That may be unusual in a year that may local banks and banks in hinterland countries, such as mark a new confidence among Gulf banks, armed with Jordan, Turkey, Syria, Egypt, Libya and Algeria. Typifying cash on the acquisition trail.

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BIG TICKET FUND RAISING IN THE GCC

Demand outstrips supply for Middle East securities. The region’s debt capital markets sector has grown rapidly, driven by corporate takeovers, private equity transactions and infrastructure deals. While a credit crunch threatens elsewhere, lending remains strong in the GCC countries and even more big ticket deals are in the pipeline. Moreover, GCC firms are increasingly active in Asia, particularly China. How long can the boom in local infrastructure spending, real estate and corporate fund raising last? Quite a long time it seems. Francesca Carnevale reports on a growing asset class.

HIGH OCTANE GAS- I FIRED FUNDING

Photography © Mszumlas, Agency: Dreamstime.com, August 2007.

N A DEAL that accentuates Qatar’s role as the world’s top producer of liquefied natural gas (LNG), the $4bn financing of the Qatargas 4 LNG project was signed in late July—the second largest financing for Qatar Petroleum projects after Qatargas II. The four Qatargas projects are the largest series of sequential LNG project financings to come to market, worth a combined $30bn. They involve construction of seven LNG trains, with the resultant gas shipped out by a fleet of 44 tankers. Qatargas 4’s financing consists of various 15.5-year commercial tranches, as well as a co-financing tranche provided by a Shell subsidiary. When completed, the Qatargas’yearly production capacity of 7.8m metric tonnes of LNG will be sold to mainly North American buyers. The Qatargas projects“really pushed back the boundaries of LNG financings, not just in terms of the scale of the four deals, but also in terms of their complexity and innovation. Qatargas II was the largest-ever energy financing in its own right and also the first LNG project to be funded right through the LNG chain; [while] Qatargas 3 was the first LNG financing based entirely on sales to the US alone,” explains Philip Stopford, head of White & Case’s energy, infrastructure, project and asset finance legal practice in London. Qatargas 4 has sealed a summer of big ticket fund raising in the Gulf, marked by a growing diversity of financing structures. Syndicated lending is particularly strong. Traditionally syndicated lending is principal way corporations raise debt in the Middle East. Debt capital markets however have been seeing more issuance of late. High liquidity means there is plenty of cash to invest and banks are willing lenders. Not only that, there are new sources of liquidity available. Increasingly, the market is harnessing institutional fund money—a big change from even one year ago. However, it is debatable whether the current market shake out will dent this trend. Oversubscription is typical. Damas Group, for example, the Dubai-based jewellery retailer raised $255m in July through a syndicated loan to finance the expansion of its stores. The four year facility was co-arranged and underwritten by BNP Paribas and Gulf International Bank (GIB). Initially valued at $140m, it rose to $255m at a pricing of the London interbank offered rate (Libor) plus 1.3% per annum.

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Second, a crop of smaller deals is coming to market. Notable among these is investment grade-rated BankMuscat International’s (BMI’s) maiden syndicated term loan, worth $75m. The three-year loan was mandated to book runners BankMuscat, Commerzbank Aktiengesellschaft and Mizuho Corporate Bank and includes Arab Banking Corporation, Bayerische Landersbank, GIB, Lloyds TSB Bank and National Bank of Dubai as lead arrangers. The loan received commitments from investors from the Far East, Australia, Europe and Middle East. Big ticket deals are the order of the day however. The biggie in the banking sector was ABC’s June $1bn syndicated loan facility, led by a host of banks including ABN AMRO Bank, Arab Bank, Bank of Tokyo-Mitsubishi UFJ, Barclays Capital, BNP Paribas and others. The funds will be used for general funding purposes including refinancing. Exceptionally finely priced, ABC’s five year term loan pays a margin of 0.25% per annum over Libor, the lowest ever for a five year financing in the Gulf. According to John McWall, head of syndication at ABC in Bahrain, the succession of deals running through the market this year amplifies a growing trend.“There is a far greater pool of banks operating in the region and in many syndications 70% to 80% of syndicate members are coming from overseas. European banks are key drivers, but we also see participations from banks in Asia, China and Taiwan in particular, which are looking to diversify their own loan book,” he says. McWall has been monitoring syndication activity in the Gulf for some years and says that ten years ago, syndication volume was around $10bn, in 2003/4 it was $26bn; in 2005, it rose to over $40bn and reached $65bn in 2006. “2007 will be way beyond that figure,” he says. Historically, says McWall, project financings have been the key source of loan syndications, “and corporate lending was very shallow. Now it is a completely different story. Telecommunication-related issuance was a feature earlier this year, he adds, with Batelco, MTC, Q-Tel and Wataniya having approached the markets. “Right now, mergers and acquisitions and expansion activity is driving issuance and more small and medium sized companies are using syndicated lending.” Islamic financings have also featured strongly, particularly in Qatar, where Barwa Real Estate Company QSC raised a $600m murabaha in early August, financed by a syndicate led by Gulf International Bank (GIB), ABC Islamic Bank, Islamic Bank of Asia, Samba Financial Group and Raffeisen Zentralbank Österreich Aktiengesellschaft. Barwa has an option to extend the one year facility for a further two years. Initially launched at $500m, syndication raised over $750m and Barwa decided to retain part of the oversubscription. Established in 2005 by the state owned Qatari Diar Real Estate Investment Company, which now owns 45% of the firm, Barwa is one of the country’s largest publicly listed real estate developers and is among the region’s top 20 firms in the sector.

Sukuk are typically backed by physical assets, from which returns are paid to bondholders instead of interest. The two most popular types of Islamic deals in the market are leasing (ijara) transactions and sale (murabaha) structures. In ijara deals, a group of banks buy an asset that belongs to the borrower, give the borrower the funds and then lease the asset back to the borrower. In a murabaha, the bank group will purchase a specific asset for the borrower and sell it back at a fixed profit margin. However, the variety of Islamic structures is growing. A recent example of this diversity is Dana Gas PJSC’s debut issue of Exchangeable Trust Certificates under a Sukuk structure, worth $1bn, issued in mid July. Structured as a muharaba, the Sukuk will mature in 2012 and holders have the right to exchange their certificates into ordinary shares of Dana Gas, subject to certain (undisclosed) conditions. Sales of Sukuk have surged as more large and conventional banks based outside the Middle East enter the market to gain exposure to booming Gulf economies, and as investors become more comfortable with the security. According to the most recent Sukuk Market Report covering the first half of 2007, compiled by the Islamic Finance Information Service (IFIS), the global Sukuk market has hit an all-time high, with a market value now totalling $24.5bn in the first six months of this year—75% higher than last year. Even in the Islamic bond sector though, size counts. Nakheel, a member of Dubai World, listed the world’s largest Sukuk on the Dubai International Financial Exchange (DIFX) in July. Barclays Capital and Dubai Islamic Bank PJSC were joint lead managers and book runners for the $1.5bn, five-year syndicated ijara facility, which achieved record participation totalling $3.52bn. It also comes with specific subscription rights to invest in any future share offerings by Nakheel. The monies will help Nakheel finance offshore real estate developments, through a new subsidiary, Nakheel International. The subsidiary is expected to launch within the next six months and will help the firm compete with other UAE-based companies such as Emaar and Damac, which are developing projects in the Middle East, India and China. DP World itself listed both a traditional bond worth $1.75bn and a $1.5bn Sukuk on DIFX earlier the same month, making it the first issuer to list both conventional and Islamic debt securities on the same exchange. The listings also confirm the DIFX as the largest exchange in the world for Sukuk by listed value. Big ticket issues are evident across the board. Saudi property developer Dar al-Arkan upped the size of its own Islamic bond from $800m to $1bn. Dar al-Arkan’s five-year Sukuk was structured as ijara (leases) priced at 225 basis points over three month Libor and will finance residential construction projects in Saudi Arabia. The Sukuk was sold mainly to investors from Europe (40%) and the Middle East (38%) and “demonstrates the demand that exists globally for well-structured Shari’a-compliant investment opportunities,” noted Majid Al Sayed Bader Al-Refai, managing director and CEO of Unicorn Investment Bank at the time of the issue.The five-year Sukuk is the second Islamic bond issued by Dar Al-

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Arkan. The real estate developer raised a $600m Sukuk in February this year—the first Sukuk issued by a Saudi company in the international capital markets. While real estate development is a constant in capital raising activity in the Gulf, it is also true in the wider region. EMKE Group, for instance, announced in August that it will invest $200m to build a shopping centre in Yemen. The Yemeni government has allocated 20 acres of prime land in capital SANAA for the project and is now aggressively promoting foreign inward investment. Equities also continue to be popular, particularly among the retail sector. Almost 1.3m Saudi investors applied for shares in Kingdom Holding Company’s (KHC’s) $860m IPO, which closed in the late July. Heavily over-subscribed, the IPO was 264% covered with around $2.3bn worth of applications from 1.251m potential subscribers. The IPO offered 315m shares, or a 5% stake, in Kingdom and valued the firm at $17.2bn. KHC’s shares now trade on Tadawul Services Sector. Commenting on the IPO, HRH Prince Alwaleed, chairman of KHC said, “The response has been strong [and the] IPO marks the next stage of KHC’s growth. The company’s approach will always be based on a sharp, bold investment approach that will continue to be the HRH Prince Alwaleed, chairman of Kingdom Holding Company (KHC). Photograph foundation on which we build and kindly supplied by KHC, August 2006. develop KHC in the future.” The benign environment in the GCC countries is also being Eisa Al Eisa, managing director and CEO of Samba Financial Group, the financial advisor, lead manager and exported. First in the wider Middle East region. Kuwait’s underwriter of the KHC IPO announced the completion of Global Investment House, the company’s largest shareholder the allocation of share refunds for all the retail subscribers, and co-lead manager for the offer, has recently closed the First where a minimum of 50 shares were allocated for every Jordan Investment Company’s (FJIC’s) IPO, with the offering retail subscriber. The rest of the shares were allocated based around four times oversubscribed. A consortium of local and on a ratio basis. Eisa Al-Eisa notes: “With large, mature regional institutional and individual investors, with Global stable companies such as KHC coming onto the Tadawul taking a majority share, had already covered 60% of FJIC’s and the outlook for the Saudi market looks very $213.2m capital. The remaining 60m shares were bought up encouraging. The economic fundamentals for Saudi’s by almost 68,000 investors who generated around $317m. economy remain sound and the stock market is broadening Second, Gulf firms are consistently figuring in Asian and deepening while investment sentiment and activities developments. A letter of intent was signed between the are maturing – the future of equities in this country is a very management committee of Yanjiao Economic and Technology Development Area and a Middle East consortium including exciting prospect.” GCC stock markets are expected to suffer the least Gulf Finance House and Gulf Energy in early August, worth among emerging markets because of the impact of the sub approximately $5bn. There is more to come. Equally, the prime credit market losses in the US. Saudi Arabia and forward pipeline remains strong for the late summer with Kuwait have proved especially resistant to the global Saudi Basic Industries Corporation (SABIC) commencing the decline due to extremely low levels of western institutional marketing for its second Sukuk, appointing HSBC Saudi investment, according to an analyst report by EFG- Arabia Ltd as joint lead manager and book runner and HSBC as the sole regional GCC coordinator. Hermes, the Egypt based investment bank.

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US SECURITIES LENDING

With the continued expansion of the global markets comes a growing need for both borrowing and lending of securities. Beneficial owners who increasingly view securities lending as a generator of alpha require more information, greater transparency and better risk-management than ever before—just a few of the challenges facing custodians and thirdparty providers alike. Dave Simons reports.

LIVING LARGE WITH LENDING

HE TRANSITION OF securities lending from basic back-office function to full-on asset management and trading tool continues full throttle, and the numbers certainly support that claim. Global assets on loan currently total $3.6trn, with combined worldwide assets available reaching an estimated $16trn, according to Boston-based research group Celent. As a bellwether for the global marketplace, securities lending has greatly benefited from the continued optimism both at home and abroad. “We are very bullish on the fundamental growth potential of the business over the next several years,” says Mark Van Grinsven, head of global securities lending for Northern Trust.“Even if market levels sag or interest rates go the wrong way, I think we’re seeing a continuation of the trend that has been happening over the last few years. Obviously, there is an increased comfort with shorting from the investment-management side, which reflects the number of players who have added a short component to their approach. There is also increased client sophistication and knowledge, and globally we are seeing more clients wanting to participate in lending which is also a plus.”

The expansion of alternative investments continues to propel securities lending, particularly as a greater number of beneficial asset holders become acclimated to using hedge funds, fund of funds and hedge-like products. © Photographer: Jamey Ekins/Agency: Dreamstime.com, July 2007.

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US SECURITIES LENDING

things really work in these markets over a number of years, which we can then capitalise on for the benefit of our clients,” says Van Grinsven. “It is a very good example of how a strong custodial relationship can be helpful in this environment.” The upward trend in securities finance is indicative of the overall health of the global-capital markets, which remain quite ebullient, notes Tim Douglas, global head of securities lending at Citi. “The markets have weathered a lot of turbulence over the past year, and securities finance has been one of the key beneficiaries of the expansion. As the markets increase in both size and dollar value, that just increases the need for both borrowing and lending of securities.”

Emerging opportunities Deregulation within the emerging markets is also seen as very favourable for securities lending over the near term. JPMorgan views these new markets as strategically important to its securities lending operations,“particularly because the yields and spreads are at a higher premium early on,” says Paul Wilson, global head of client management and sales for securities lending at JPMorgan. “From our perspective, places such as Mark Van Grinsven, head of global securities lending for Northern Trust.“Even if market Korea in the past and Taiwan more levels sag or interest rates go the wrong way, I think we’re seeing a continuation of the trend recently have been very good markets to that has been happening over the last few years. Obviously, there is an increased comfort get into.” Wilson also points to the with shorting from the investment-management side, which reflects the number of players continually evolving infrastructure and who have added a short component to their approach. Photograph kindly supplied by tax regimes in the BRIC countries. Northern Trust, July 2007. “Obviously Russia, India and China are The expansion of alternative investments continues to high on our watch-list right now. In addition to accessing propel securities lending, particularly as a greater number these markets directly, we’re also looking at ways that we of beneficial asset holders become acclimated to using can gain entrance synthetically via a swap-transaction or hedge funds, fund of funds and hedge-like products.“Five synthetic transaction.” Craig Starble, senior managing director and global head to 10 years ago when these types of clients were long-only, some had a view that securities lending was risky business of securities finance at State Street, underscores the because of the affiliation with shorts,” says Van Grinsven. benefits of building a diversified lending platform.“At State “You do not see that as much anymore. And that is very Street, we lend in both US and international equity and fixed-income markets on a fairly equal basis,”says Starble, good for this industry.” Having a strong custodial presence certainly doesn’t hurt, “which provides us with a very balanced lending portfolio. either—and despite the continued trend towards As our clients gravitate toward the purchasing of assets in unbundling, Northern Trust and other large institutions have the emerging markets such as Turkey, Hungary, Taiwan and been able to rely on the advance work of their custody Mexico, we have provided support in the form of tax, legal divisions to evaluate new markets from both an opportunity and sub-custodial due diligence—in short, everything you and risk perspective.“For instance, emerging markets are an need to be comfortable lending in those markets. From a important piece of the growth plan. Because of our custody lending perspective, those markets generally see some very presence, we are fortunate to have a large amount of in- attractive spreads, mainly because the demand for the house knowledge that can give us some insight into how securities is so great, and also because very few people are

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terms of what it will protect, it also has the capital base to support it.” On the cash-reinvestment side, clients need to completely understand the risks involved in the areas of credit, interest rates and liquidity, notes Wilson, and as such, having the ability to customise the way the client’s cash is managed is a key element of proper risk management. “Allowing them to make sure that the programme they have is specific to their needs is absolutely the right way to deal with this,”he adds. These days, beneficial owners require much more information about lending activities than in the past, including the identity of the loan recipients, the nature of the loan, what kind of return was achieved and so forth. All of which points to the increased expectations for securities lending as a generator of revenue. Says Wilson,“Historically, clients simply looked at lending as a way to cover the costs of custody, but today the more common question is, ‘How much alpha can I generate from securities lending?’ In short, clients are increasingly seeking additional ways to add additional alpha from their lending activities and are more willing to consider taking on the added risk in order to reach that goal.” Moreover, being able to provide the right kind of information whether it be realPaul Wilson, global head of client management and sales for securities lending at JPMorgan. time, daily, weekly, monthly, or quarterly, “From our perspective, places like Korea in the past and Taiwan more recently have been or perhaps for certain clients, all of the very good markets to get into.” Photograph kindly supplied by JPMorgan, July 2007. above, is paramount. “The information lending in these markets at present.” Like its competitors, needs of the risk manager can be different to those of the getting in the queue early is a major objective at State fund manager, who in turn may want something different Street. “When these markets do finally open up from a from the operations head, and so forth,” says Wilson. lending perspective, we want to be among the first to “Obviously, maintaining this kind of specialized capitalize on that opportunity for our clients,”says Starble, informational process is crucial in order for us to be successful “rather than at the middle or the end of the chain— and meet the needs of our securities-lending clients.” because as you can imagine, the ones who are closest to the front will be afforded the best spreads.” Benefits of unbundling Mitigating risk is yet another area of importance to sec- The separation of custody and lending services among lend leaders. On the lending side, most of the major beneficial owners continues to grow, particularly as providers offer clients some form of indemnification, unbundling is perceived to improve transparency, increase protecting them against losses from collateral shortfall returns and allow for greater control. “Many lenders have should a borrower default.“This is crucial, because it helps recently unbundled their custody and lending contracts to align the interests of both the provider and the client,”says gain a better understanding and control of their fees, and JP Morgan’s Wilson. “However, as this business continues to more properly align the interests of their service to grow and the risks become potentially greater, the providers,” says Chris Jaynes, president of eSecLending. question becomes, are there agents out there who may be “Transparency is also increasingly important for senior writing checks that their client won't be able to cash?” management and boards to ensure that their fund assets Clearly, this points to the significance of the firm’s are earning the full and appropriate returns for any risks capitalisation, says Wilson. “And with a balance sheet of taken and to ensure that objective criteria were used to $125bn as a firm, not only is our indemnification broad in award asset mandates.”

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ECURITIES LENDIN S G The ORIGINAL industry-wide conference sponsored and developed by securities lending and borrowing professionals for securities lending and borrowing professionals.

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US SECURITIES LENDING

Kathy Rulong, executive vice president and executive director of BNY Mellon Global securities lending.“As the demand for pricing transparency intensifies and new routes to market develop, we will continue to modify and enhance the Bank of New York Mellon I-Bid platform,” she says. Photograph kindly supplied by Bank of New York Mellon, July 2007.

Tim Douglas, global head of securities lending at Citi.“The markets have weathered a lot of turbulence over the past year, and securities finance has been one of the key beneficiaries of the expansion. As the markets increase in both size and dollar value, that just increases the need for both borrowing and lending of securities,” he says. Photograph kindly supplied by Citi, July 2007.

“A significant amount of our book is done on a third- claims over $1.1trn in total assets auctioned to date. party basis,”says Citi’s Douglas.“So we tend to take a very “Lenders are increasingly using auctions and third party agnostic approach to third-party versus bundled services. specialists to enhance returns on their most attractive Our goal here is to make sure we have a best-in-class assets while continuing to utilise their custodian to lend securities-finance product offering, that our clients can their general collateral assets via the agency queue,”notes buy either bundled or unbundled.”Douglas points to Citi’s Jaynes. “Beneficial owners have been utilising multiple recent acquisition of fund administrator Bisys Group Inc., providers for many years for investment management, a move intended to help the company better position itself brokerage execution, foreign exchange, etc., [sic] even though these are all in the fast-growing services typically world of alternativeprovided by custodian asset servicing. “Here The merger with Bank of New York gives banks or their affiliates. was a company that Mellon the opportunity to use its own auction As many beneficial was a third-party platform, Mellon I-Bid, for the benefit of a owners are now provider of fund beginning to services, and Citi’s combined client base. The web-based, singleunderstand that intention is to bundle security platform was recently upgraded to securities lending that capability with its handle discrete portfolios of stocks when is primarily a trading other offerings, clients want to limit loans to one or a few and investment including global exclusive borrowers in exchange for a management function, custody, direct custody guarantee of earnings or return. they are choosing to and securities finance,” optimise results by says Douglas. “When utilising specialists.” we approach the The merger with Bank of New York gives Mellon the market, we believe there are very good opportunities, both bundled and unbundled, and it is incumbent upon us to opportunity to use its own auction platform, Mellon I-Bid, have high-quality, full-service product offerings that can for the benefit of a combined client base. The web-based, be incorporated either way—and create a platform from single-security platform was recently upgraded to handle discrete portfolios of stocks when clients want to limit which the client can choose.” Auction platforms continue to gain favor throughout loans to one or a few exclusive borrowers in exchange for the market, as evidenced by the steadily increasing a guarantee of earnings or return. “Clients want pricing number of portfolios supported by eSecLending, which flexibility and to know that they are getting the most

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competitive rates available for their securities in the current market environment,” says Kathy Rulong, executive vice president and executive director of BNY Mellon Global securities lending. “As the demand for pricing transparency intensifies and new routes to market develop, we will continue to modify and enhance the BNY Mellon I-Bid platform.” Going forward, increasingly sophisticated technological solutions designed to further reduce operational risks and improve operational efficiencies will continue to raise the viability of third-party lending programs, says eSecLending’s Jaynes. “Enhanced communication protocols, trading systems, and custody systems, combined with the industry’s ongoing efforts to help standardise and automate back-office functions to achieve straight through processing, have allowed third-party providers to efficiently and safely administer client programmes. The increased operational efficiencies have allowed for the safe growth of third-party agency and directlending programs over the last decade and provided beneficial owners with greater choice and control over their securities lending programmes.” State Street’s Starble agrees that some of the most important technology will centre on thirdparty lending capabilities. “A bilateral link must be established between the custody bank and the lender in order for the lender to keep track of availability, buy-sell activity and all the traditional custodial reporting and analysis duties,”says Starble. Moreover, he says, “we are gong to see a significant effort on the part of the industry to develop these kinds of technologies, mainly because lending is becoming much more portable. In three years, we will probably see clients who will be quite willing to give their lending agent a one-year mandate and then put the mandate up for bid the following year. It is going to become more like a capitalmarkets transaction, as opposed to what has long since been a custody-related transaction only.”

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As such, look for custodians such as State Street to beef up their third-party capabilities in order to meet the challenge of increased competition within that space. “While we will always be a major custody lender,”says Starble,“at the same time we know that we need to continue to improve our thirdparty business, with the idea that we can then introduce those clients to the custody side of the bank—the same way they have introduced their clients to the lending side of the business. In other words, it is a mutually beneficial situation.”

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DTCC: PREPARING FOR 2010

Donald F Donahue, chairman and chief executive officer (CEO) of The Depository Trust & Clearing Corporation (DTCC), the world’s largest post trade financial services organisation, appears fond of quoting Darwin. At a SIFMA conference in late April this year, he noted: “It is not the strongest of species that survives, nor the most intelligent, but the one most responsive to change.” A bon mot or an evolutionary truism not lost, it seems, on the DTCC, which over the last few years has undergone a steady yet revolutionary—or is that evolutionary?—overhaul of its procedures and systems. By 2010, the DTCC says it wants to be the leading provider of service solutions to the financial markets. Francesca Carnevale writes about the how and the why.

THE SHAPE OF THINGS TO COME Donald F Donahue, chairman and chief executive officer (CEO) of The Depository Trust & Clearing Corporation (DTCC). Donahue quotes the invariable drivers of change: global competition, the need to serve new investor classes, and the inevitable and interminable application of cost and risk controls. For its CEO, these days DTCC is about leading change and not responding to change in a dynamic marketplace.“We are a different organisation nowadays, and our aim is not only to serve our customers but also to exceed their expectations.” Photograph kindly supplied by the DTCC, August 2007.

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Overall, the upgrading of the DTCC’s services involves a INCE THE START of the millennium, the organisation has kind of outfitted itself for the third three-pronged tactical approach. The first is redesign of millennium,” says Donald F Donahue, urbane some of its core services.“Last year, we returned more than chairman and chief executive officer (CEO) of The $580m in rebates, discount and interest to our customers, Depository Trust & Clearing Corporation (DTCC); the and we continue to reduce transaction fees, and expect to largest financial services post-trade infrastructure lower them by more than $81m this year.”The concepts of organisation in the world. The DTCC is on a mission.“We client service and value resonate clearly in Donahue’s realised going into the turn of the millennium that the thinking: “Fractions of a penny make a trade viable or not,” industry was going through a series of inflection points and he notes, “so we have to constantly seek efficiencies and that we had to undergo an overhaul.”That realisation has drive down costs. At the same time, we have to earn involved the DTCC in a “six-plus years re-engineering enough to handle millions of transaction sides. Managing project that will bring significant new efficiencies to the those dynamics have to be mastered.” That carefulness and attention to detail has earned industry,”he says. Donahue quotes the invariable drivers of change: global Donahue an enviable reputation as a master strategist, competition, the need to serve new investor classes, and combined with a tactician’s attention to detail. In part, that the inevitable and interminable application of cost and ability to break down the market to its essential components risk controls. For its CEO, these days DTCC is about and rebuild it to suit particular times and circumstance leading change and not responding to change in a comes from Donahue’s long standing employment at the dynamic marketplace. “We are a different organisation DTCC, where he worked his way up through merit to nowadays, and our aim is not only to serve our customers running the organisation. His sometimes low-key approach to high-brow problems, has meant, say DTCC insiders, that but also to exceed their expectations.” he has retained the That leadership ability–sometimes lost in approach is nowhere senior management–to more apparent than in cut the heart of the the DTCC’s acceptance matter, while of Turquoise’s Donahue’s sometimes low-key approach to understanding the invitation to provide high-brow problems, has meant, say DTCC mechanics that make the clearance, settlement insiders, that he has retained the application of strategy and risk management possible. Donahue is a services, via its ability–sometimes lost in senior man of many levels, one EuroCCP subsidiary, to management–to cut the heart of the matter, of which is a nice line in the new planned, panwhile understanding the mechanics that make self-deprecating European trading the application of strategy possible. humour: “I am the platform.“We see it as a original man in black,” vote of confidence in he smiles. our ability to deliver a No surprise then that large-scale, crossattention to detail across border project within a specified timeframe.” However, Donahue stresses that the the spectrum of DTCC’s business range has been a strong Turquoise announcement is but one of“many recent signals characteristic of its overhaul of its core services. Among its that integration of global securities markets is now a given, most recent initiative is a programme of overhauling legacy and a trend that will only accelerate in the immediate term: systems to ensure capacity to handle trading volume look at the NYSE/Euronext deal, or the way Latin American surges.“Because of upgrades, we can handle at least 283m countries are striking deals among themselves and the sides per day through the clearing system and even more Iberian markets. Our strategy is to be in place to support through our risk systems. There are no longer any application level constraints, and current applications have these developments.” DTCC and LCH Clearnet are in the early stages of been designed to accommodate even higher volumes.” According to Donahue, the system was tested on July discussing an interconnection of clearing systems to support trading between the markets as regulations evolve 26th this year, the largest trading day in its history. DTCC’s to allow freer cross-border trading. DTCC has also National Securities Clearing Corporation (NSCC) consulted with the United States Securities and Exchange subsidiary handled a new record of nearly 93m Commission (SEC) to ensure that the changes the transactions from all major US exchanges, regional stock organisation implements are in line with regulators and the exchanges and electronic communications networks market.“Ensuring that the regulatory apparatus evolves in (ECNs), “without even blinking,” he notes. Other line with market integration is vital,” notes Donahue.“We developments include a new data replication process for think the market efficiencies that global integration the Fixed Income Clearing Corporation’s (FICC’s) data. The new process more effectively aligns FICC procedures promises will be a key driver of our efforts in this regard.”

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with those in other DTCC subsidiaries, ensuring “that all our subsidiaries are positioned to meet the two-hour recovery procedures we are held to under regulatory standards,”explains Donahue. However, perhaps its most significant activity has been the development of its over the counter (OTC) derivatives support system, DTCC Deriv/SERV. Deriv/SERV was expanded in the past year to include credit default swap index, CDS on loans and CDS on single name asset-backed securities. Automated support of lifecycle events, such as assignments, amendments, terminations and exits, for OTC interest rates derivatives went live last October. The service has also expanded its European and North American equity derivatives coverage to accommodate equity derivatives products, such as Asia ex-Japan share and index options and swaps and Japanese index variance swaps. With these additions, Donahue expects the service will support more than 60 OTC equity, interest rates and credit derivatives products by the autumn of this year. “We focused initially on credit default swaps,” he says , “but we designed the platform so that it could be expanded to support other OTC derivative instruments. We also worked in close tandem with customers to test trade confirmation and matching systems.” He also notes that DTCC also launched a payment reconciliation service in February 2004 which now handles over nearly 2m Donald F Donahue, chairman and chief executive officer (CEO) of The Depository Trust & payments each quarter. One benefit for Clearing Corporation (DTCC). Photograph kindly supplied by the DTCC, August 2007. customers, adds Donahue is that “we have reduced the operating risk of handling OTC derivatives OTC derivatives products including rates, equities, and contracts.” The upshot is that the DTCC now confirms commodities—the timing of which will be determined more than 90% of all credit derivatives contracts traded through collaboration with warehouse customers. The third element, alluded to earlier, is overseas globally and its customer base now spans more than 960 clients in 31 countries. “Last year we processed 2.6m expansion: either through the establishment of new offices, Deriv/SERV transactions and are now averaging around or through collaboration agreements. In February this year, it opened a new City of London office. The London office 20,000 transactions each day,”he says. The DTCC has since strengthened the Deriv/SERV serves as the regional customer centre for its global infrastructure by launching its Trade Information services, including EuroCCP, DTCC Deriv/SERV and the Warehouse, which provides an automated and Trade Information Warehouse for OTC derivatives, the standardised global central registry of derivatives contracts. Global Corporate Action Validation Service (GCA VS), and “To ensure global settlement service efficiency, we are a new service being developed for the alternative partnering with CLS Bank, thereby offering settlement in investment product (AIP) market. The new office will 15 currencies and a strong foreign exchange provide “a critical liaison to DTCC’s European counterparts infrastructure.” The partnering of these two industry- and industry organisations, as well as global hedge funds. owned organisations will provide an integrated global Since nearly half of our customer base are firms that payment processing infrastructure for the OTC derivatives operate globally, we opened in London to meet the market, linking the Trade Information Warehouse with a customers, who are looking to us to help them reduce central settlement facility. Initially supporting credit operational costs, streamline processing and manage risk derivatives, the solution is designed to be extended to other wherever they operate,”explains Donahue.

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In its search for a global identity, the DTCC is expanding municipal bond issues in real time to the industry. Current its reach through information sharing and collaboration notification practices on bond issues are decentralised and agreements with overseas depositary and clearing involve a variety of formats and manual processes providers. In December last year, the DTCC signed with including phone calls, faxes and emails. NIIDS was developed by DTC to help broker/dealers the state owned China Government Securities Depository Trust & Clearing Co., Ltd. (CDC), the central depository meet regulatory requirements for the prompt reporting of system for China’s bond market, to exchange information bond trades and will do away with paper and move and explore opportunities to promote cross-border customers into real time. With NIIDS, underwriters will investment. More lately, in June this year, the DTCC send new-issue information electronically to DTC, as followed it up with a similar agreement with the China well as any follow-up adjusted information. Data needed Securities Depository and Clearing Corporation Limited for trade reporting, matching and master file set up will be transmitted to DTC (SD&C). It is a neat by an underwriter or an move, given that entity acting on behalf “China is a country In December last year, the DTCC signed of the underwriter, with dramatically with the state owned China Government such as a book running increasing stock system. Book running market participation, Securities Depository Trust & Clearing Co., or book building and as the financial Ltd. (CDC), the central depository system vendors compile “the industry becomes for China’s bond market, to exchange book” on bond and more and more a information and explore opportunities to security issues. They global business, China promote cross-border investment. More track pricing, will play a major role. regulatory compliance, Our goal is to create an lately, in June this year, the DTCC followed issuance information environment that will it up with a similar agreement with the and other financial foster an open sharing China Securities Depository and Clearing investor data, which is of information and Corporation Limited (SD&C). submitted to them by ideas, and finding the underwriters. ways that we can work Acting on instructions together to address market challenges and opportunities,” says Donahue. from their underwriting customer, the book running Donahue notes that similar initiatives have been agreed vendors are then responsible for submitting data to DTC and continue to be discussed around the globe, though to complete requirements for DTC eligibility and NIIDS. acknowledges that one cannot extemporise in today’s Once DTC has all the required reporting information, market. For Donahue, careful preparation is everything. and acting on the instruction of the underwriting “How do you stitch something together that supports the customer, it will send the data to information vendors, evolution of equity and interconnecting infrastructure and dealers and other market participants. Data vendors are performance guarantees, without focused, careful and responsible for taking the NIIDS information from DTC and distributing it to customers and other market strategic thinking? It cannot be done,”he says. DTCC has also undertaken a major re-engineering of its participants so they can match, confirm and report underwriting and corporate actions systems. The single, trades in a timely and accurate fashion. The role DTCC plays in the capital market system is new platform, called. the Securities Origination Underwriting & Reliable Corporate Actions Environment growing and evolving. Up to now, the DTCC has (SOURCE), will replace and consolidate the asset services concentrated on processing the trading volume on US legacy systems that have been in place for decades, stock exchanges, regional exchanges and ECNs. Pretty “bringing major new efficiencies and straight-through soon, the DTCC will become—whether it will admit it processing benefits,” notes Donahue. While the re- overtly or not—one of the lynchpins of the globalisation of engineering of the corporate actions will be implemented the securities markets. Historically, the DTCC’s principal in phases through 2009, the new underwriting system is remit has been to protect the safety and soundness of the scheduled to go into production for customers in early system, by ensuring trade data is processed, ownership September. Through July and August, a group of 25 records are changed and financial obligations between customer firms and several information vendors have trading parties are settled. DTCC’s avowed mission by 2010 participated in a coordinated test of the new system that is to be the acknowledged world-class provider of servicing will streamline the process by which underwriters submit solutions to financial markets through leadership, new-issue eligibility requests to The Depository Trust innovation, technology, risk management and strategic Company (DTC), a DTCC subsidiary. It also will introduce alliances. One cannot help thinking that the organisation the New Issue Information Dissemination Service (NIIDS), will become more than that. And why not? In Donahue’s a service that will disseminate information on new world, the shape of things to come is evolving.

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TRANSITION MANAGEMENT: KEY TRENDS

Next generation

TRANSITIONS N

What now for transition management? The industry is growing at a heady pace and is now reported to handle at least $2trn in assets annually. As it enjoys a sustained period of plenty and diffuses across the globe, transition management is evolving at different rates and in different ways in different regions. Both North American and European transition managers note increasing complexity in the product offering. As well, the relationship between client and transition management provider is changing as, in the words of one provider, “it becomes more a solution-based consultative business”. In Asia meanwhile, transition managers dance to an entirely different beat. Francesca Carnevale reports on the trends and the transformation of a global industry.

Photograph supplied by Istockphoto.com, August 2007.

OWHERE IS THE growing diversity of the global asset management industry reflected more clearly than in transition management. Ever more apparent is the changing timbre in both the application and practice of transition management as the product offering diffuses around the globe. Growing demand for transition services in frontier markets in Asia, the Middle East, southern Africa and Latin America is building additional volume for global providers, across the spectrum, and taking transition management to a new level. Moreover, mounting business volumes and progressively more sophisticated asset allocation strategies in mature markets in the United States and Europe now add to the complexity of the overarching transition management offering. Transition management houses have responded with speed. New York-based Charlie Shaffer, managing director and joint global head of transition management of the BlackRock Merrill Lynch hybrid, for instance, nowadays also specialises in 130/30 hedge fund-lite product services, “where there is massive upswing in business volumes”. Their growing popularity is understandable as “hedge funds are better understood these days,” explains Tim Wilkinson, global head of transition management at Citi in London. “Several institutions are now incorporating 130/30 strategies as part of a shift towards implementing a Core-Satellite investment strategy. Lower management fees for the passive Beta component result in lower aggregate fees, in part aided by increased securities lending revenues. Core-Satellite involves keeping say 80% of the Fund’s assets in an Optimised Index Portfolio, while making the remaining 20% work hard via high alpha strategies,”Wilkinson explains. It is a far cry from olden days in which clients made the simple choice of transiting (predominantly) an index-based equities portfolio into another equity long only portfolio. After choosing to move between asset managers, the client had a relatively straightforward choice between a buy side (with in-house index and/or custodian credentials) and a sell side provider (acting as an independent broker/dealer). Not only that: today a broader range of clients have themselves a widening array of service providers to choose from; including independent agent providers, such as BNY

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Graham Dixon, managing director, transition management, Credit Suisse, London. Photograph kindly supplied by Credit Suisse, August 2007.

Convergex, and new hybrid providers such as BlackRock Merrill Lynch that have successfully melded both buy side and sell side offerings into a comprehensive service package. For Bill Stush, head of transition management, at BlackRock Merrill Lynch in New York, it is a straight choice between “full service provider versus a specialist boutique.” While clients are more commonly looking for a full service provider at a firm level,“It is important that the level of focus and expertise is in no way diluted at the product level. We believe this focus is of particular importance in transition management, where the client is entrusting the provider with the performance of their entire portfolio during the period of the restructuring,”says Paul Marchington, head of transition management at Lehman Brothers in London. Even so, in today’s patchworked market, the traditional competition between buy side providers—such as Barclays Global Investors (BGI), BlackRock Inc (formerly Merrill Lynch Investment Managers) and State Street, and sell side providers, such as BNY Convergex, Lehman Brothers, Citi, Credit Suisse, Morgan Stanley and JPMorgan, has resurfaced once again. In this latter day rematch, David Edgar, head of transition management at BGI in London believes that the day’s demanding business climate means houses with buy-side capability are in the ascendance once more. Edgar thinks the buy side model has the edge because of “the greater opportunities it provides in crossing networks, direct market access, the spread of broker relationships and market knowledge.”Stush meanwhile stresses the fiduciary element, as clients increasingly utilise the transition manager as a“caretaker of assets, handling multi-broker relationships, modelling portfolios and utilising derivatives to mitigate risks.” It is a particular feature as clients,“look to protect historic returns as they move assets from one manager to another,”he adds. On the other hand, Graham Dixon, European head of transition management at Credit Suisse in London and one of the founding fathers of transition management as a business, thinks that as the market evolves, the broker/dealer model is gaining ascendancy. “As asset allocations become more complex and more funds deploy sophisticated overlay strategies, the modern transition manager needs the capabilities of a securities firm, asset manager and custodian

within a single transition management service.” Though there may be an increasing element of market specialisation creeping in. As Citi’s Wilkinson notes, “Logic would surely argue in favour of appointing an experienced provider deploying an impartial operating model. Even today however, some clients are still inclined to trust those they know best, whether or not these criteria are fulfilled.” The question of business model runs deeper than simply type of transition provider, but raises core, and often counter intuitive questions on the protection and risk control provided to the client. “By allowing the transition provider to outsource execution to thirdparties not only does the client relinquish their contractually protection on execution control but also reduces the effectiveness of intra-day risk control,” claims Marchington at Lehman Brothers. Whatever the business model in play however, everyone reports a serious up-tick in both the volume and value of transited assets. BGI, State Street and Russell, for instance. Each claim between 800 and 900 transitions over the last twelvemonth span, according to recent surveys by Plan Sponsor and Euromoney’s Global Investor magazine—a phenomenal number and one which points to some degree of commoditisation in the transition management offering in some markets. As Ed Pennings, managing director, transition manager at State Street in London notes: “Growing complexity aside, transition management today is something of a scale business. It’s a fact, the more transitions you do, the more experience you gain and the more efficient it becomes and you can pass on that efficiency to the client in terms of cost.” Moreover, the uptick has occurred in what historically looked like a crowded market, but which today appears to support an increasingly diverse array of transition management providers. As a result, thinks Wilkinson, there is increasing selection on both sides of the coin.“The wheat is beginning to be sorted from the chaff. It is an intuitive development, as clients better recognise their own needs and which transition managers can actually deliver,”he says. In that climate, diversity in supply is essential. The buzz right now is around fiduciary responsibility; multi-asset capability; project management skills and a range of valueadd services that increasingly stretch the job-definition of a portfolio transition specialist. Today’s successful transition manager is a man for all seasons: psychiatrist, problemsolver, project manager, trader, liquidity provider, asset manager, risk manager and not least—in those markets dominated by consultants—consummate politician. In addition, all this is available at a competitive price. Credit Suisse’s Dixon acknowledges the increasingly segmented structure of the transition management business. “The rapid growth in the number of transitions is evidence that the transition managers are providing a useful service. Clients are finding it easier to change asset managers and this may be making them less tolerant of poor performance. Some clients view transition management increasingly as something of a commodity,” he says.“You are seeing a clear

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PEACE

MIND

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do it yourself

choose wrong partner

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Transition management assignments needn’t throw your life into upheaval. At Northern Trust, our dedicated Transition Management team crafts a tailored approach to your trade. In short, your goals are our goals: information leakage prevention, efficient trade execution, and cost minimisation — both explicit and implicit. Because we act as a fiduciary, you get greater transparency. You know what we’re doing and when we’re doing it. That way, you can focus on those things that really matter — like getting a good night’s sleep. If you’d like to find out exactly how we can help, call +44 (0)20 7982 2000 or visit northerntrust.com.

Asset Management | Asset Servicing | Wealth Management

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to be concentrated in transiting distinction between plain vanilla portfolios between fired and transitions, and more complex hired asset managers. portfolios and client requirements, Nowadays we see more where the emphasis is on problem portfolio liquidations, either to solving and project management,” pay benefits or to generate cash adds Credit Suisse transition for use in either private equity or manager Karin Russellinfrastructure projects,”he adds. Wiederker.“At the complexity end, While providing transition cost is less of a consideration,”she managers with new business notes. It is a theme picked up by opportunities, the move away Hari Achuthan, director, pension from long only equity exposure strategies and transition means that, not only is the management at Credit Suisse in client “spoilt for choice as the New York. “Because of the John Minderides, global head of transition number of transition houses is increased complexity of portfolios management, JPMorgan. Photograph kindly supplied by on the rise again, but also and the need for better risk JPMorgan, August 2007. clients are becoming more management services, no explicit fee transitions are definitely less popular. People are discerning as they understand the possibilities inherent in nowadays more prepared to pay for good service. Look, one the product offering. As a consequence,“we see the same simply does not generate alpha from a transition, so let’s keep few faces in the race for particular mandates. There is definitely a flight to quality,”says Marchington. it all in perspective.” Not everyone is competing for the same bit of business What they are meant to do is something of a mix. Scale does not necessarily dictate complexity comments Citi’s in the same way every time.” Spreadbury at Morgan Wilkinson, “You get $100m transitions that are complex Stanley notes that selection works both ways, “We are relative to $500m events which are fairly vanilla. Transitions much more discerning about the work we take on, upwards of $5bn tend to err towards the complex side concentrating on higher value business,” he says. In part, however.” Gary Spreadbury, managing director, transition says BGI’s Edgar, increasing selection is the result of a management at Morgan Stanley expands the theme. “So switch in relationship between client and service provider. much of what is defining the market these days is outside Transition managers are becoming more involved with the old universe. The transitioning of assets might now their clients and providing a broader service range: and employ an interim portfolio, exchange traded funds (ETFs) Spreadbury acknowledges that, “nowadays, the client or index futures that give the client exposure to their provider relationship is often something of a partnership.” preferred benchmark until they finalise the destination It happened for a variety of reasons explains Edgar.“but I guess we really began to see it after the mutual fund affair.” management contract.” Back in 2003 Putnam admitted to allowing its portfolio Furthermore, as John Minderides, global head, transition management at JPMorgan points out,“the portfolios we are managers and some investors to market time its funds. now building are much more concentrated. There are many Under agreements with the United States’ Securities and more high alpha mandates with fewer securities in them. Exchange Commission (SEC) and the Office of the Secretary We recently transitioned a portfolio with a global mandate of the Commonwealth of Massachusetts, Putnam paid that had fewer than 60 stocks in it.”As a consequence, he $110m in penalties and restitution to settle charges with the explains that the underlying analytics are very different.“In state and federal regulators. Total assets at Putnam dropped these instances, you are not having to worry about selling substantially as a consequence. [It should be noted that since an illiquid tail. Liquidity problems are on the buy side, not then Since Putnam has implemented reforms and appointed on the sell side right now. It is altogether a different play.” new senior management. It is also the first mutual fund Moreover, “we now work directly with a number of asset company to implement“Mutual Fund Protection Principles”, managers, which changes the complexion of client an industry standard for compliance and investor protection]. Equally, when it comes to choosing transition managers requirements and encourages specialisation and longer the market is dividing into “panels and standalones,” notes term relationships with key clients,”he adds. In the United States, a number of developments have Dixon.“The key selection shift over the past 18 months has influenced the structure of the market of late. First is the been the move from single transition contracts to retained diversification away from equities. “Historically, pension service agreements,”adds Marchington. In the United States, funds used transition managers to manage portfolio changes this distinction is particularly acute. According to Kal Bassily, from one equity manager to another. Over the last 18 global head of BNY Convergex’s transition management months we have noted a tremendous growth in business, in the US the market is clearly segmented.“What transitioning fixed income assets,”Kal Bassily, global head of you find is that because the larger funds have frequent asset transition management at BNY Convergex in New York says. movements they have, or in some cases are in the process of Second, one-sided transitions are on the rise.“Business used putting together, panels of transition managers with which

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ROCKET SCIENCE. IT’S NOT TRANSITION MANAGEMENT. Moving billion-dollar portfolios can be an incredibly complex process. At BGI, our goal is to quickly and seamlessly execute your transition. We specialise in managing the risks while seeking to preserve the value of your assets. This expertise in transition management comes from our being one of the world’s largest asset managers.1 But if it’s more credentials you’re after, BGI has been ranked one of the top transitions managers in Global Investor Magazine’s survey for the last two years running.2 You can contact us at: transitions@barclaysglobal.com or telephone: Europe +44 (0)20 7668 8600 US +1 415 267 7523 Canada +1 416 643 2923

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For Institutional Investors only This advertisement has been issued by Barclays Global Investors Limited (BGI) which is authorised and regulated by the Financial Services Authority in the United Kingdom. Please note that transition management in the US and Canada are provided by Barclays Global Investors, N.A. (BGINA) and Barclays Global Investors Canada Limited (BGICL) respectively. BGI, BGINA and BGICL are affiliates of Barclays Bank PLC. Registered address, 1 Churchill Place, London E14 5HP. © 2007 Barclays Global Investors. All rights reserved.

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they work on a regular basis. A consultant also tends to be involved. At the mid-tier level, the panel is an anomaly. In those instances, clients look at the history and performance record of the transition manager. Invariably, these clients tend to gravitate towards providers where transition management is a core business and where there is substantial investment in technology and risk management platforms.” Access to the pension fund client is still “very consultant driven,”explains Minderides at JPMorgan.“It is very true in the United Kingdom. It is still largely the case in the United States, but it depends on the beneficial owner. In the public pension fund space, there is a formal request for proposal structure. In the private sector space meanwhile, clients often have their own advisory arrangements. In continental Europe, consultants have by and large, much less of a hold on the business. In Holland, where there is a finely tuned fiduciary management space, specialist consultants are often on hand to advise clients. In Germany, for instance, there is still scope to sell directly to the client, without an intermediary.” In the Middle East, is it is a different model again, notes Dixon at Credit Suisse. “You are often dealing with sophisticated government organisations with professional staff that have researched the transition management market in depth. They work with a panel and decide which providers to put forward for which task.” As Asia and Latin America come into the transition management mix, a new layer of requirements is being laid down. Tom Clapham, director, transition management, at Deutsche Bank in Hong Kong notes: “In terms of strategic asset allocation, it is fair to say that the global average still remains 60% equity, 30% fixed income and 10% other asset classes. In Asia, it is the opposite. Institutional clients still tilt towards bonds and defensive asset classes, with a small level of exposure to equities and an even smaller exposure to international assets.The question asked by pension funds and insurance companies in Europe is ‘which transition manager do I use?’In Asia, the question is often,‘should we use a transition manager at all?’.” Nonetheless, in Asia as elsewhere opportunity still beckons. “Whilst relatively new to certain parts of AsiaPacific, transition management is already well-entrenched within Australasia, and clients right across the region are inevitably looking towards the more established and recognised providers in that region,” notes Citi’s Wilkinson, whose Australasian operations come under the auspices of Michael Jacket-Simpson and his team, based in Sydney. Clapham notes that“Asian institutional investors are growing in number and their asset base faster than elsewhere”. Moreover, “asset allocations are increasingly diversifying across markets and those investors in fixed income are beginning to invest in equities and derivatives,”he says. Over in Japan, Justin Ballogh, senior managing director and head of transition management at State Street Global Markets, Asia Pacific, further colours the market’s complexion: “This shift in allocation strategies is driving much of the activity in transition management in Asia and is a sea-change from

what was driving mandates four or five years ago.Then it was all about moving between passive and active strategies.” In spite of local market anomalies which sometimes make the going difficult, Bassily, Pennings, Balogh and others acknowledge that the wind of new business opportunity is flowing Australasia’s way.“Right now there are pockets of strong activity in places such as Hong Kong and Singapore, Australia and New Zealand,” says Bassily. While a growing market, Asia nonetheless presents its own particular challenges. Notes Bassily, “the Asian market, while undergoing rapid transformation, remains fragmented. In Japan, for instance, transition management is still in its infancy, in part because of legal complexities. Over there, trust banks decide on transition managers, not the asset owner.”Additional complexity rolls out across the wider region because,“the institutional investment base is different in Hong Kong and Singapore than it is in Korea and Taiwan and it is different again in Malaysia and Thailand,”adds Deutsche Bank’s Clapham. In the relatively mature markets of Europe meanwhile, “Southern Europe is opening up,” notes Wilkinson, in addition to the established markets in the United Kingdom, Scandinavia and Benelux. In Germany you have a sophisticated clientele, but it remains a “deep and still relatively untapped market,”he says. Irrespective of the opportunities, competition remains strong, with BGI’s Edgar seeing little change in the rush for market share. Although successful, Edgar acknowledges that the provider market is notoriously opaque. “We do not always know who we are competing with for new business. I suspect that every transition manager has a set of key clients that provide consistent and repeat business. It could be some have more than others, or that houses have particular regional or fund specialisations.” For the time being, transition management providers are buoyed by a rising tide which is floating all boats. It won’t always be that way though.“Some of the larger asset management houses and beneficial owners are gaining confidence and handling some of the portfolio transitions in-house; pushing out harder and more demanding transitions to a one or more trusted providers,”notes State Street’s Ed Pennings, and the market patchwork is becoming more complex still. Pennings indirectly highlights a challenging truth. Not all transition managers will be able to compete on an equal footing on a consistent basis over the long term: for various reasons (either they cannot offer scale, a full service offering, or multi-asset capability). At the high end—eventually— business will coalesce around key global houses, leaving a phalanx of smaller, specialist players to solve particularly knotty problems in moving a set of securities from one portfolio manager to another. There are signs of it happening already and the trend can only gain ground. That old Chinese proverb about the perils of living in interesting times may yet come to bite some of the current crop of transition management providers. Right now however, in an increasingly fast-moving and sophisticated marketplace, the winds of opportunity remain firmly set in their direction.

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Increasing fixed income allocations within client portfolios has focused transition managers on the specific challenges of trading the asset class. One particular area of focus has been the effect of odd lot trade size on execution price. By John Minderides, global head of transition management, JPMorgan DD LOTS ARE defined as trade sizes which are below the normal market standard traded in that asset. What constitutes an odd lot can vary significantly across asset type and global markets. For example, a corporate bond odd lot in the US is normally regarded as a trade size of less than $1m, but in Europe $100,000 is the norm. It is commonplace in some markets for market makers to widen bid/offer spreads for odd lots. This price adjustment is known as the differential. It is applied for compensating a trader for taking a small position onto their books which may be difficult to sell and to ensure they cover their ticketing cost on the trade. There are various reasons why odd lots exist. One reason is the size of assets a client has under management. Managers need to diversify their portfolios in order to reduce risk. For smaller funds this means that holdings might be held in odd lot sizes. In addition, asset managers whose funds are designed to track benchmarks often create odd lots. At the end of each month a passive fund needs to rebalance holdings against their benchmark, the result is often a list of odd-lot trades which bring the passive fund into line with the benchmark. Odd lot holdings also arise when asset managers buy a bond for a number of client funds at the same time. The bond will then be allocated to individual accounts on a prorata basis, often resulting in odd lot allocations. While odd lot size definition are fairly consistent, the pricing (i.e. bid/offer spread) and mark ups can vary dramatically with credit rating, issue size, industry sector and certain market conditions. The key factor is the liquidity of the bond and the greater the liquidity, the tighter the bid/offer spreads.

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As fixed income trades in an over-the-counter (OTC) market, and because dealers have different niches within the market, bond liquidity is dealer specific, depending on the market penetration each trader seeks. Some dealers for example will not trade in any size less than $1m, whereas some will happily provide liquidity on even the smallest flow. Most dealers are prepared to put a competitive bid on the more liquid bonds.Transition managers are often able to get better bids due to the volume of trades they execute.They can also leverage their dealer relationships to ensure their clients receive competitive pricing even for smaller trades. Photograph supplied by Istockphoto.com, August 2007.

The main issues that affect bonds’ liquidity include: • Credit Rating: as the bond moves across the credit rating spectrum, the liquidity is affected; there is usually more appetite (and lower costs) for investment grade domestic corporate bonds than non-domestic speculative lower grade bonds. • Buyside versus sell-side: offer side is normally tougher as holders willing to sell can be hard to find. Dealers often are happy to bid a bond but will not offer unless they already hold a short position of bond in a small size. • Issue Size: if a bond issue is small or the issuer has already repurchased some of the bonds it will be more expensive for client to trade especially in odd lots. • Time since Issuance: bonds are most liquid for the first few months of issuance and practice suggests that newer bonds are usually less expensive to trade than wellseasoned ones. • Size of the market maker: the mark up for odd lots is also dealer specific as any trader needs to cover his/her own transaction costs, it would be fair to assume that with large established liquidity providers supported by a sophisticated infrastructure, and these cost mark-ups would be less due to the economies of scale. • Market Maker’s Inventory: the offer also depends heavily on the individual dealers’ position. If a trader does not hold a position or is short a bond he may apply a larger mark up for an odd lot offer. In some circumstances where the bond is illiquid dealers will refuse to even offer the bonds.

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TRANSITION MANAGEMENT: ODD LOT TRADES

As fixed income trades in an over-the-counter (OTC) market, and because dealers have different niches within the market, bond liquidity is dealer specific, depending on the market penetration each trader seeks. Some dealers for example will not trade in any size less than $1m, whereas some will happily provide liquidity on even the smallest flow. Most dealers are prepared to put a competitive bid on the more liquid bonds. Transition managers are often able to get better bids due to the volume of trades they execute. They can also leverage their dealer relationships to ensure their clients receive competitive pricing even for smaller trades.

Figure 2. Historical fixed income trading costs versus trade size. Equity Trades Cost (Bps) 90 80 70 60 50 40 30 20 10 0 10%

Data Analysis

30%

4 0%

50%

6 0%

70%

80%

% ADV

In analysing the relationship between bid/offer spread and odd lot sizes, it is interesting to make a comparison to equity trading spreads and how they vary with trade size. For fixed income, order size is a major component of liquidity; the corresponding measure for equity trading is average daily volume. Figure 1 shows the relationship between quoted spreads and trade size. Cost in this case is calculated as an effective half-spread. Research by Amy K Edwards, Lawrence E Harris, and Michael S Piwowar, Corporate Bond Market Transparency and Transaction Costs (2005), estimated transaction costs using a time-series regression model. It used prices of all NASD corporate bond trades reported to TRACE in 2003 (over 252 trading days). The equity graph (Figure 2) shows trading cost estimates compared to trade size measured in terms of average daily volume. The data was constructed using JPMorgan’s proprietary risk management system OnSite for a portfolio of 40 US small cap stocks and calculated expected trading costs for various levels of liquidity. The percentage of average daily volume was used as the relative liquidity factor for the portfolio. The equity graph displays a characteristically upward slopping shape, reflecting that costs of trading increase with trade size (less liquidity) to reflect the market impact caused through trying to trade larger volumes. Conversely, the fixed income graph shows completely different characteristics, exhibiting the wider spreads that have to be paid in order to execute smaller odd lot trade Figure 1. Historical fixed income trading costs versus trade size. Fixed Income Trades

90 80 70 60 50 40 30 20 10

1 0 ,0 0 0

20%

1 0 0 ,0 0 0

1 ,0 0 0 ,0 0 0

1 0 ,0 0 0 ,0 0 0

sizes. The data clearly illustrates that trading cost patterns differ significantly across asset classes. In contrast to equity trading costs, fixed income trading costs generally decrease with trade size. This is especially the case for small trades / odd-lots that might face significant liquidity problems.

Electronic Trading Electronic trading plays a key role in facilitating the execution of odd lot trades. In order to provide clients with a competitive odd lot trading service the ‘sell-side’ needs to keep their cost base to a minimum. One way they achieve this is through electronic trading and the benefits it provides such as automated execution and straight through processing. The electronic order systems that have been established to introduce efficiencies in execution have evolved into the tool of choice for odd lot execution. The majority of private banking trades and small orders from institutional investors are handled more efficiently through electronic systems rather than by voice. Electronic trading platforms such as Bloomberg, MarketAxess, TradeWeb and Reuters bypass the salesperson and provide clients with the ability to execute odd lot trades directly with the market maker. Some sell-side firms, such as JPMorgan and others have set up ‘flow desks’ that utilise technology and focus purely on trading odd lots across the fixed income spectrum. The increasing involvement of transition managers in building fixed income portfolios has increased the focus on reducing the costs for small and odd lot fixed income trading. Unlike most equity markets, fixed income trades over-the-counter where accessing liquidity can be more challenging than in an order driven market. When selecting a transition manager for fixed income, it is important to use one that has an established electronic trading infrastructure for effectively facilitating execution. Leveraging these capabilities, transitions clients should look to receive transparent, efficient and cost effective execution across the spectrum of fixed income products independent of size. ………………………………………………………………............... Special thanks to Renata Guobuzaite and Paul Butcher for their contribution to this article.

Trade size (USD)

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TABLE OF CONTENTS INTRODUCTION ............................................................................PAGE 82 CHALLENGE & OPPORTUNITY: DEALING WITH GENERATIONY ..................................................PAGE 83 CHANGING CLIENT APPROACHES TO FUND ADMINISTRATION........................................................PAGE 86

THOUGHT LEADERSHIP REPORT

PREPARING FOR GENERATION ‘Y’ BACK TO THE FUTURE: THE BUY SIDE/SELL SIDE ROUND-ROBIN ..................................PAGE 88 TECHNOLOGICALLY SPEAKING ..................................................PAGE 91 ASIA’S CHANGING CUSTODY MARKET......................................PAGE 92

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Rob Wright, chief operating officer, RBC Dexia Investor Services. Photograph kindly supplied by RBC Dexia, August 2007.

Securities servicing is at a crossroads. Regional trends are stretching the definition of asset or securities servicing across a broad spectrum from plain vanilla custody to fund administration, securities lending and a host of other services encompassing the back, middle and front office of investment managers Cross-asset or multiple asset securities servicing is more common nowadays, swept along by ever-increasing volumes of business from alternative asset managers. Moreover, as asset owners and fund managers in Asia, Latin America and the Middle East are now added to the client lists of global service providers, the industry is changing shape and feel as their particular demands are brought to bear on providers. Nothing will be the same again. Francesca Carnevale talks to Rob Wright, chief operating officer and managing director, RBC Dexia Investor Services, about the salient trends. ERHAPS SURPRISINGLY, NOTES Rob Wright, chief operating officer, RBC Dexia Investor Services, the pace of change in securities servicing is being set in Australia of all places, where “a high percentage of fund managers are in full outsourcing mode and well ahead of the industry curve. The trend for outsourcing in the UK and North America, on the other hand, tends to revolve more around the outsourcing of specific components. The tendency toward a fuller outsourcing model is gaining momentum, however, and other geographies such as Europe are following suit.” Looking forward, Wright points to three industry trends that he says have“staying power”in the years ahead.The first is continued growth in derivatives, where the primary driver here is complexity.“A number of manufacturers are moving into derivatives in a big way. As a result, you’ll see some funds combining strategies, bringing together 130/30 strategies, mixing bonds, equities and so forth.”Accordingly, providers are now confronted with the numerous challenges associated with bringing it all together in a cohesive, comprehensive service package that meets the needs of the individual clients.”

“One of the new challenges we’re also seeing is a new pricing dimension entering the business, as it becomes increasingly complex to price OTC derivatives,” he notes. Wright suggests that even traditional sources, such as Standard & Poor’s, Reuters and Bloomberg, are challenged by client requirements, putting service providers in the hot seat.“We are doing a significant amount of work developing pricing models to provide an independent third-party opinion on the value of OTC instruments for major funds. It is an important and valuable step for both the buy and the sell side – creating an inviolable source of transparent and independent pricing. If you don’t consider that a mission critical activity, then just look at the challenges facing some of the biggest hedge fund managers with today’s sub prime mortgage crisis.” This is particularly important as hedge funds are using multi-asset trading, allowing them to apply their complex strategies across foreign exchange, fixed-income, options, futures and equities.To keep up with this sector’s interest and lower elements of risk and boost their marketability, custodians and fund administrators have provided complementary systems at their end. Wright says his own firm benefits from bringing all its service offerings onto an integrated platform. “The key driver now is linking that platform to the middle office.That means a number of checks and balances and compliance-related functions are incorporated into the overall service offering.”In the simplest of terms, the requirements of alternative fund managers have further pushed demands for platforms that can deliver better functionality and lower costs. “The securities services industry has developed more into cross-product support as the hedge fund industry has developed,” he says, noting a second trend of “end-to-end data processing and the greater use of technology in servicing client requirements. There are more multistrategies surrounding FX and fixed-income, for example, especially with more sophisticated hedge fund strategies. People therefore look for ways to effectively handle the complexities of market and infrastructure needs simultaneously.” In that regard, custody and fund administration are synergic to these developments, he notes. Service providers must now truly earn the mantle of global custodian and offer a precise blend of “local and global knowledge, says Wright.“Global money managers are at the forefront of outsourcing, although we’re seeing increasing demand from boutique and some mid to large domestic managers as well, driving the outsourcing of non front-end business,” he says. “Globally, you’re bringing your best practices to the client and then supplementing that with local market expertise, where you can help clients with specific tasks.” To that mix is added a third trend of new clients emerging from Asia and Eastern Europe. “Understanding your client,”is Wright’s catchphrase. Whatever the trend, he says, “ultimately, the key to success is the ability to service your client in the same consistent manner, no matter what product or service they’re using, or in which country they’re using it.”

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generation Y There is a paradigm shift required in understanding the motivations for Generation Y. Following behind the baby boomer generation is a group of individuals marked by a fundamental shift in values and attitudes to work, reproduction and savings. Not only does that mean fewer younger people feeding their savings into the retirement pot; but also Generation Y looks to be a harder generation to sell pensions to in the first place. Photograph supplied by Istockphoto.com, July 2007.

By the middle of the first decade of the 21st century, the baby-boomer generation (aged between 45 and 60) spanned middle age. With many baby-boomers having saved diligently for retirement for more than a decade, the fund management industry has enjoyed a sustained period of extraordinary growth. That demographic momentum will now begin to decelerate and a new paradigm will come into play—the demographics of Generation Y. New relationship and work patterns will invariably revolutionise the geography and structure of savings, fund management and asset servicing in the second decade of the 21st century says a new KPMG report. Francesca Carnevale talks to its author, KPMG partner Bernard Salt. HE PREMISE OF a just published KPMG report Beyond the baby boomers: the rise of Generation Y is that it is a strategic imperative that the fund management industry begins to engage with the future accumulators of wealth. The KPMG report considers the results of a survey of fund management businesses in 17 countries; focus groups involving Generation Y participants held in London, New York, Tokyo, Frankfurt and Sydney and one-on-one interviews with senior fund management executives in the United States, the United Kingdom and Germany. According to KPMG partner Bernard Salt, the 125 valid responses from the fund management industry covered 18% of assets under management globally. The results of the survey must be of concern to the fund management industry, says Salt, adding, “Up to now the fund management industry has focused on servicing people in the wealth accumulation stage, which fits between the ages of 45 to 59 and largely to the exclusion of emerging market segments such as Generation Y.” Salt explains that between 1990 and 2005 the number of people falling into the wealth accumulation stage in the United

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States alone grew 51% and encompassed some 81m people. Not only that, over the next 15 years, growth in the 40 to 59 age group in the US will drop to 1% in total. Other quarters of the US lifespan grew less rapidly over the same period. Significantly, the population aged 20 to 39 (Generation Y) contracted by 3%. The fund management industry’s response to the “turning off of the demographic tap is to continue to focus on the boomers by managing the drawdown of their asset base. However, there is another strategy that many in the fund management industry appear reluctant to embrace; namely, engagement with the ‘wealth inheritors’of the future, Generation Y who right now appear less likely to opt for the savings strategies of their parents,”he notes. In KPMG’s survey, Salt acknowledges that the fund management industry appears to be reluctant to pick up the trend, highlighting that:“At best the proportion of managers who actively have an interest in Generation Y is around 22%. Additionally we found that 28% had not been focused on Generation Y but intended to focus on it in the immediate future, which suggests that industry wide, some 50% of fund management professionals will be looking

THE IMPACT OF GEN Y ON FUND MANAGEMENT

the paradigm shift of

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in the labour market in many developed countries: “Growth in the labour market population aged 15 to 64 is slowing and in Japan and Russia, for instance, it is visibly contracting. In the 15 years up to 2005 population growth in the wealth accumulation lifecycle (aged 45 to 60) ranged from a relatively low 10% in Germany to a phenomenal 145% in Singapore. Equally, the movement of population into the draw-down (pension income earning phase of 61 to 75) neatly parallels the wealth accumulation trends. Then again, at the Generation Y level, Japan, the UK, Australia, New Zealand, Italy, Germany, Canada and Korea and even China report a decline in the labour market. “The exceptions are India, Vietnam, Islamic nations and the Christian Latino countries of Central and South America. But the question is whether they have the wealth and spending at the individual level and the savings drive to provide substantial alternative marketplaces for the fund management industry,”notes Salt. “People will either have to dedicate more resources to their pensions, or the pool will contract,”he adds. Moreover, there is a paradigm shift required in understanding the motivations for Generation Y. Following behind the baby boomer generation is a group of individuals marked by a fundamental shift in values and attitudes to work, reproduction and savings. Not only does that mean fewer younger people feeding their savings into the retirement pot; but also Generation Figure 2 Percentage change in 40-59 population for selected Y looks to be a harder generation to sell countries, past and present pensions to in the first place. 150 “This generation moves in tribes, it values relationships, it thinks globally. It is different 120 to previous generations and the fund 1990-2005 2005-2020 management business must establish 90 credibility with this generation to become a 60 ‘trusted advisor’ as well as an employer of choice. These are not responses that can be 30 credibly manufactured and delivered quickly by any industry.” 0 Generation Y says Salt has “only ever -30 known a world of gently ascendant prosperity. They have no recollection of the Source: UN Population Database, 2007 excesses of the 1980s or of the stock market crash of 1987. Moreover, they are supported either directly or indirectly by a parental Figure 3 Factors that make FM products attractive to Gen Y customers safety net, sometimes called the Bank of 2% 1% 2% Easy to get started with little maintenance 2% Mom and Dad, but which makes them Top tier performance 4% 23% fearless of the future”. Additionally, Easy to understand 5% Generation Y are also often single children Flexibility Low fees/inexpensive in a family, with well developed negotiation 8% Time horizon to realise returns skills, “particularly if their parents are Funds are managed for them divorced or separated; and are used to Enables a level of self control dealing with authority figures from a very Element of self management 8% early age and these negotiation skills are No-load products also taken into the workforce, hence they Low risk investments 19% are hungry for achievement and success, Other 11% but at a very rapid rate and they are having Note: Ranked responses weighted Source: KPMG International 2007 fewer children and if they do they are 16% having them at a relatively late age.” intently at the requirements of Generation Y within the next five years and that this ratio might rise as high as 70% by 2015.” One reason for the current dissonance is that perhaps, “the fund management industry is so far undecided on the ways in which it can engage Generation Y as customers”, he notes. By way of explanation Salt’s points out that when fund management survey respondents were asked which factors made fund management products attractive to Generation Y they highlighted concepts such as ‘easy to start’ (mentioned by 23% of respondents) and ‘toptier performance’(an answer given by 19% of respondents). Concepts such as ‘low risk’ and ‘self management’ barely received acknowledgement by 2% of respondents, yet in focus groups Generation Y respondents reportedly gave these considerations very high scores.“In other words, this is an industry that knows its products far better than it knows its future customers,” says a rueful Salt. He articulates two key questions that he says the fund management industry should “consider carefully. Has this industry had such success that it is now incapable of viewing issues objectively? Or is this industry simply focused on short term results?” Salt acknowledges that the Generation Y phenomenon has a strong geographic delineation. He notes a contraction

Japan

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viral marketing campaigns that Salt believes that a number of use popular websites such as changes need to occur in the YouTube and “existing fund management industry if it relationships with Generation is to tap successfully into these Y’s baby boomer parents are long term changing also untapped opportunities. demographics. Right now, Salt For example, one FM business appears ambivalent, mainly in the survey said they offer because he says the industry, discounts to children of their “has a culture of thinking short existing clients: which builds up term. Remuneration is based on the relationship between the immediate results as opposed to industry, the baby boomer long term positioning. It is now generation and Generation Y.” time to think longer, harder, and Salt also believes that the more strategically about market fund management industry issues such as positioning must take stock and strategise institutions for the next decade. for the long term. After all, he This also has a wider implication points out, strategic industry than simply fund management.” (such as the oil and KPMG’s survey also looked at pharmaceutical sectors) has the approaches and attitudes KPMG partner Bernard Salt, the 125 valid responses from long used 25 year business Generation Y adopted towards the fund management industry covered 18% of assets under modelling to help plan employment and in particular, management globally. The results of the survey must be of investment and business employment in the fund concern to the fund management industry, says Salt, adding, growth plans.“That level of long management industry. “Up to now the fund management industry has focused on term thinking is now required in The results are challenging. servicing people in the wealth accumulation stage, which fits the fund management and asset Career expectations are between the ages of 45 to 59 and largely to the exclusion of servicing industry if it is to preternaturally high, while emerging market segments such as Generation Y.” adjust and prepare for the feelings of loyalty and Photograph kindly supplied by KPMG, July 2007. demographic changes ahead.” responsibility towards employers are preternaturally low. Generation Y entered the Finally, he notes, the fund management industry needs to workforce early this decade and while the working clearly “differentiate brands and address Generation Y’s population continues to expand in countries such as the US negative perception of independent advisors.” Equally, what comes across strongly from the KPMG survey and Australia, it is expanding at a reducing rate. “If that Generation Y worker does not measure up, you cannot reach is the dismay of many fund management professionals with into the workforce bucket to get a replacement, because the Generation Y; an approach that will have to change if the bucket is shallower. It has important consequences for the industry is to engage successful with the next generation of way that employers hire and utilise Generation Y employees, asset owners. One industry respondent noted: “The reason who are more focused on loyalty to peers than to companies. that Generation Y is not a market for investment products is This also has consequences for the fund management because people prefer to push off pain … they want instant industry itself, as it will redefine staff engagement and gratification of the senses today.”Salt agrees that perceptions retention packages in future: after all, the survey found that and approaches must change and that the industry cannot employee turnover rate in excess of 30% were common and rest on its laurels, motioning that a rising tide has floated this is not sustainable over the longer term, particularly in almost all boats,“the industry has enjoyed such success over the fund management industry”thinks Salt.“when I look at the last 20 years that it has attributed this success to corporate the results, the next decade will be marked by turmoil and a strengths and agility. However, it could be that years of positive financial results have led the fund management shift in the rules.” For Salt, the work has to start at a fundamental level in industry into a false sense of security about its ability to defining effective approaches to Generation Y. Right now, respond to the pressures for change, which will surely come.” On a positive note, all interviewees and survey he notes, the industry does not see Generation Y has especially requiring the capacity to control, tailor and correspondents agree that Generation Y is hungry for monitor its investments. “If this is truly the industry view education and information about financial planning. It is then later focus group results suggest that on this issue, the incumbent then on the industry and its distributors to industry has got it wrong. Trust is an important factor to provide that education and create trust and belief in the Generation Y and when asked they say they will refer to industry’s savings and investment products over the long, their parents and their friends when making investment long term. The cry is out there: “We need Finance 101 on decisions, not independent sources.” He points out that the school curriculum,”said one focus group respondent in the industry must look to peer-to-peer marketing, utilise the survey. Will the industry listen?

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LEVERAGING

GLOBAL GROWTH The pace of outsourcing over the last four or five years has been frenetic. The speed with which some deals came to market, has caused regret to both client and provider with some subsequently unhappy divorces. For outsourcing both parties need to consider carefully how in the future they can ensure that these alliances will work to both sides benefit. Enjoying continued growth, fund administration is still on the upswing. The market shows little sign of overcrowding and new clients and business is coming on stream, particularly in newer markets in Europe, Asia and the Americas. In the short term, this will encourage more firms to establish niche positions. Peter Fairweather, director, sales and relationship management at RBC Dexia reports. Photographer © Stasys Eidiejus. Agency Dreamstime.com, August 2007.

HE GROWTH CYCLE in fund administration will continue for some years and for the time being at least, there is plenty to go around. More consolidation in the fund administration business is more than likely in the medium term, as custodian houses merge and newer entrants are acquired by larger players seeking market dominance. As fund managers grow larger and more global through organic or acquisitive means, they expect to have greater buying power when outsourcing. Their expansion has been matched by the manner in which asset servicers have also grown. These developments will be fed by a number of underlying trends, including the ‘globalisation’ of larger investment houses and funds, which have invested in establishing a global footprint; a larger number of institutions seeking alternative investment solutions; and more alternative asset managers outsource non-trading operations. For established houses however, niche expertise is not enough. 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. In coming years, buy side clients will increasingly look at the global footprint and ambition of their service provider, the breadth of current and planned services, the core competences of individual providers (particularly if they favour component outsourcing), any value added specialist services that are available and whether these attract premium fees. Additionally, as providers increasingly partner with their clients in expanding their reach across the globe, clients will

increasingly assess whether their provider is a relationship based supplier, that seeks to build mutually beneficial services, or whether their definition of client relationship means the client has to fit in with an extensive, but ultimately commoditised range of services. The outsourcing question Has the failure of some recent large and complex deals blunted the appetite for outsourcing? The answer is certainly no, but more complex deals may now be broken up into smaller components over a longer and more thoughtful transition period. This development naturally will mean that in some cases clients will opt to work with more than one supplier. As technology improves and the ability to provide better management information for control and reporting purposes increases, then the ability to handle multiple relationships become easier. However, the collation and consolidation of data from various inhouse and external systems remains an issue for many fund managers and centralising this through a common data warehouse is for many still a pipedream and this fact may put the brakes on some component outsourcing. Nonetheless, component outsourcing is becoming more attractive as the both clients and providers begin to focus on the provision of quality service, rather than on cheaper cross-subsidised deals in a bundled format that results in some demonstrably weaker parts. Larger complex deals are not always supported by influential relationship management. Therefore, when issues arise the closeness of the relationship is not strong enough to get around problems, tactical or strategic.

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Fund managers need to include suppliers as partners they can entrust with tactical and strategic planning so that decisions can be made in unison. The merging of interests (globally) of both fund managers and administrators will continue. Both developments are a sign that large global players will continue to exert a dominant influence on the overall provision of services. However, as more funds become global, expertise in specific markets or the provision of smaller more specialist players will mean that clients will continue to have a choice and both approaches will co-exist, developing their own unique selling points to attract and retain business. It is a basic lesson from evolution, that no one species will dominate. Nonetheless, despite the clamour for customisation, certain services across all of the players regardless of size, will become commoditised. The provision of basic global custody is a good example of this in operation. Even so, services such as foreign exchange and securities lending will be seen as a standard service requirement as more sophisticated investment strategies become the norm. As the administrators gain scale and are seen to be focusing on asset servicing as a core business division, they will be able to invest more heavily and readily thus attracting outsourcing opportunities from those fund managers not willing to make such an investment or who see processing as being outside their core activities. Where a middle or back office is complex, then a whole outsource is less likely and specific services will be considered for delegation. This means that administration services will need to be adaptive and may have to be compatible with a variety of partners, including competitors. As custody becomes less of a specialized service and easier to transition, many databases and data warehouses will have to be agnostic in their fit and communication protocol. Fund managers and administrators need to work more closely regarding future asset classes and services. The growth of derivatives, real estate and private equity has highlighted how unsuitable certain legacy systems are for recording, controlling and reporting. By the nature of the new investment strategies and products, some of the underlying investments are more difficult to price. There are complex management fee structures to be calculated and risks have to be identified and appropriately valued. It makes full automation of the administration process difficult. Fund managers also need to understand the limitation of the existing systems, both in-house and external, and work to develop processing support in sensible tandem with their own product development demands. From a provider perspective, we acknowledge that securities traded, the structures, and the fee calculations can be complex. In this changing market however, it is not simply a question of people on the job; the efficiencies in reporting or even the reach that allows efficient pricing across a broad range of assets. What it ultimately involves is a commitment to understanding the client’s overall strategy and growth plans and having the right people in place to handle accounts and provide

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Peter Fairweather, director, sales and relationship management RBC Dexia Investor Services. Photograph kindly supplied by RBC Dexia, August 2007

support services, wherever it is necessary. In that sense, checking that your provider has a commitment to providing its staff with proper account handling and product training is vital. It becomes particularly important, given the fact that some asset classes are complicated and automation has yet to effectively manage the administration, control and reporting needs. Manual intervention puts a strain on the intellectual capital that administrators have, both in traditional centres and in the emerging global processing geographies. However, it must always be understood that fund administrators these days have a much greater role to play than just cost efficient processing. It is and will continue to develop as a closer client services management industry and that service range will increasingly support the global distribution of fund management products. It’s a fact. Administrators need to be visionary in understanding how markets are moving. Increasingly, they should be working with practitioners and industry change agents to have an influence and input on regulatory change and the development of best practice. In the future with there being a wider choice of outsourcing partners to consider, looking for a partner who has empathy with your business and views the relationship as just that, a long term commitment for mutual benefit, will be more satisfying than just the cheapest deal. When choosing an administration partner therefore, a fund manager should look for someone who understands and promotes “buy side” concepts and someone who will construct not obstruct creativity. That is a given in a fast changing marketplace where investment and distribution strategies are in flux to take into account a new stream of investors, with different cultural mores. That fact alone will ultimately change the nature and scope of the provision of securities services. The question for both fund managers and providers is: are we ready for change?

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Participants: NORIPAH KAMSO, CEO, CIMB-PRINCIPAL JIM CONNOR, PARTNER, MORSE

BACK TO THE FUTURE

EMMA CRABTREE, HEAD OF MULTI MARKET SALES & RELATIONSHIP MANAGEMENT, RBC DEXIA FRANCIS JACKSON, EMEA, HEAD OF NEW BUSINESS DEVELOPMENT, JPMORGAN

Photograph kindly supplied by Dreamstime.com, August 2007.

If you know what is going to happen in the future, do you adapt to it, or do you mould that future to your own designs? One thing is for sure. Asia is tomorrow’s market and Generation Y will be leading the charge in terms of savings and investment patterns. Will the fund management industry cleave to its current manufacturing parameters, or will it structure its investible products for a new type of retail investor? Equally, will custodian and fund administration specialists cling to their service structures, or will they meld their services to better fit changing client requirements? When crystal gazing, it is useful to get a panoramic view. That is why we grouped a fund manager, two asset service providers and one consultant to supplement new perspectives on the issues. Then we asked them slightly different questions, to provide you with a rounded thought piece. CIMB-Principal, Malaysia’s leading asset management firm responded to questions covering the long term expectations of Asia’s nascent fund management industry of today’s asset servicing firms. Emma Crabtree, head of multi-market sales & relationship management RBC Dexia and Francis Jackson JPMorgan’s head of new business development, head up the provider side, give their view of the evolution of customer services and the ways in which their firms are preparing for the changes ahead. In conclusion, the key threads of the discussion are brought together by Jim Connor, partner at Morse, the specialist consulting agency, to put a final and glossy patina on everyone’s predictions. NORIPAH KAMSO, CEO, CIMB-PRINCIPAL

What guided your choice in your asset services provider? Do you have more than one? Knowing what you know now, would you make the same choice(s) again? The selection of an asset services provider will be based on their global capabilities or partnerships with global counterparts in order to provide that global reach. In the context of the appointment of a trustee for a fund with foreign exposure, for example, it is crucial that the trustee has established offices in those foreign countries. It is crucial for us to appoint a reputable asset service provider that has the specific expertise in a particular area, such as exchange-traded funds to give an example, with the

necessary resources and with a good track record. Other criteria that we consider include efficiency, fast responses and flexibility on the part of the trustee to facilitate our operational processes. Lastly, although local custodian fees, for example, are quite standard, the cost of global custodial services can vary and this of course can also be a factor in our selection. How will your asset servicing requirements change over the coming years? How are you preparing for those changes and are you discussing/working with your asset servicing providers(s) to ensure your support services are in line with your long term goals and strategies?

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Our asset servicing requirements will change as the asset management industry evolves into a more competitive and innovative landscape in the next 10 years. We expect to increase our assets under management and be in a better position to obtain more favourable rates based on the increased volume. How do you lever competition to get improved services from your asset servicing provider? Do you think competition between service providers will increase or decrease over the coming decade? As the asset services providers increasingly compete with each other, we are better able to negotiate for lower rates and at the same time expect improvements in the services rendered. For example, the service providers are more eager to meet our expectations including requests for seamless access to information and announcements. The competition has also hastened the move towards electronic transactions (where previously these were faxed), hence cutting the operational processing time and improving efficiency. We have no doubt that competition will be even more intense in future as fund houses increasingly innovate and create sophisticated investment products for an increasingly sophisticated investment public. This will spark a requirement for asset service providers to support their fund management functions more effectively. Do you expect the quality and cost of overall service provision to increase or decrease as a result of consolidation between service providers? The consolidation of service providers will result in improvements in the quality of services and we stand to gain from the combined expertise as a result. Already, many local banks are feeling the pressure to establish strategic alliances or better tie-ups with global partners in order to compete with certain foreign banks that are offering various services, such as trustee and custodial services under one roof. How important is it that your asset servicing provider gives you value-added services, such as securities lending/risk management services/ fund pooling services/as part of the overall services portfolio? We are not involved in securities lending activities. Risk management is at the core of our investment process and we have a team to oversee the risk management strategies and techniques employed. However, we do attach importance to the value-added services provided and this includes cash and stock reconciliation facilities. We have also been successful in negotiating for lower fees for fund transfers. EMMA CRABTREE, HEAD OF MULTI MARKET SALES AND RELATIONSHIP MANAGEMENT, RBC DEXIA INVESTOR SERVICES

Do you discuss your client’s requirements for both fund administration and asset servicing on a regular basis? What are the key requirements of the service you provide to your clients?

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Yes, because everyone is changing their buying behaviour. Clients now look to providers for intellectual capital: particularly when it comes to entering new markets, and they will expect that we provide them with the required understanding of that market. Equally, clients no longer accept being shoe-horned into a one-size fits all service. In some of the more developed markets perhaps you could say there is more homogeneity, but elsewhere, our clients are increasingly diverse, with varied requirements and we note a definite shift to relationship driven business and component outsourcing. Clients are more selective and aware of the different strengths and abilities of their service providers. With the rise of multi-asset investment strategies, and more sophisticated portfolio investment strategies, what are the key challenges going forward for the investment services providers? From a product complexity standpoint, there is increasing usage of derivatives and structured funds. Investment banks and asset managers are blending and producing more creative products by the day. Right now, the demand for Alpha is key and the role of the provider is to give intellectual capital surrounding the operational management of these new asset types and funds In terms of challenges: many of the new asset management structures are proprietary. Moreover, many derivatives and new fund structures are not prescriptive, therefore one of the biggest challenges is actually being able to value some of these assets. Providers have an important role in helping clients achieve proper valuations. How will fund manufacture change over the coming decade? Further, how will business change in Asia, or the Middle East? How are you positioning yourself to leverage these changes? One of the biggest challenges in Asia is “sticky money”. Put crudely, once Asian investors make their 20% profit, there is a tendency to cut and run. It is a completely different buying culture and manufacturers and investor services providers will need to adapt accordingly. FRANCIS JACKSON, EMEA HEAD OF NEW BUSINESS DEVELOPMENT, JPMORGAN

How will the Y Generation affect manufacturers over the coming decade? Generation Y is all about distribution, branding and having a range of products that are flexibly delivered.Y Generation flow is in and out of the market and yet they are conscious that they will have to save for their retirement. We’ve undertaken studies and find that Generation Y tends to gravitate to trusted names, so branded insurance companies and banks are in a strong position to capitalise on this preference. But we do not underestimate the fact that there is a big change ahead. Insurer Standard Life, for example, has exceeded expectations in its development of self-invested pension funds. It’s a system much more like those available in the US. However, the US retirement system has been designed around the baby boomer

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generation, which saved in a consistent and uninterrupted way and which are very different to Generation Y’s requirements. Manufacturers will have to structure products that allow the next generation of savers much more flexibility, greater savings options and savings holidays. Moreover, the expectations of Generation Y is much greater—they appear to have zero tolerance of poor performance. How are asset service providers responding to these long term trends? Over the medium term, the asset management industry will polarise into those managers that are specialist in an asset class, and those which are multi-specialist, with capability across global equity, corporate bonds, alternatives, private equity and real estate. We believe both will gravitate to the global model, because of the ability of global providers to service any geography, any asset, support multi-clients and handle, if required, massive demand. Equally, manufacturers will be looking to gain traction and encourage their service providers to provide a single platform that can handle both back and middle office, transfer agency, on a sound platform. Again, we believe that will encourage manufacturers to gravitate to a branded global provider, backed by appropriate infrastructure. JIM CONNOR, PARTNER, MORSE

Will market consolidation result in better services for clients over the long term? Scale can be a good thing. The US market, for example, is mature and growth via acquisition makes sense. Like all consolidation trends, too few providers means choice is compromised, but we are not there yet. Some consolidation is about market share and synergy, such as Bank of New York and Mellon Corporation. Others such as Citi and Bisys is about the convergence between hedge fund and traditional trading technologies, and will eventually offer a single platform converged offering: which is good for the client and good for providers too. How will the asset servicing market evolve then? After some analysis, we concluded that three broad strategies will emerge. There will be a Universal Provider model offering a broad range of services across many geographies. Not everyone will go the distance however. Then we anticipate functional specialisations will appear, servicing a segment of the market where middle and back office services are harder and more complex. Here the service will not easily lend itself to automation or scale, but it will offer a more sophisticated and customised service to a specialist customer with high-touch needs. The other development will be geographic specialisation, servicing asset owners and managers with a specific focus and providing expertise in a particular market or set of markets. However, this specialisation over the longer term is not sustainable as investment management becomes a truly

Emma Crabtree, head of multi market sales and relationship management, RBC Dexia Investor Services. Photograph kindly supplied by RBC Dexia, August 2007.

global business. It is an interim stage development and ultimately the markets will polarise between the large global providers and specialist asset boutiques. Will prime broking compete more and more with custodianprovided hedge fund administration? There are two schools of thought. Some believe in a onestop theory, where prime brokers serve all the needs of their hedge fund clients. Others think that prime brokers make more money from execution and lending and therefore should stick to that business. Proprietary asset managers tend to shy away from having their prime broker see all their portfolio and to avoid information leakage will deal with two or more prime brokers as a minimum. That creates a problem, because there can only be one administrator. Therefore, the trend of having a specialist hedge fund administrator and two or three prime broking relationships is most sustainable. However, that will not stop some prime broking houses providing a one-stop shop for those managers who appreciate an all-inclusive arrangement. Why should clients expect providers to proffer a bundled custody, fund administration and transfer agency offering? It doesn’t have to be bundled. If you are a small fund however, then the ability to buy specialist services is more costly and the added operational complexity may not be justified. The added cost and complexity of specialisation will tend to drive asset managers to a bundled service. Additionally, global players can take bundling to a different level with the ability to support internationalised investing and cross-border investor servicing.

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Fund administration remains a relationship driven business and technology is vital to servicing. What now for a market in which competition appears to be driving platform development?

SPEAKING...

ONE-STOP SHOP solution, backed by a seamless technology platform has come into its own as manufacturers look for the full spectrum of services from providers – even specialists, upping the ante for everyone. Clients enjoy the efficiencies of working with a single platform interface that allows them to use separate administrators, custodians and finance lenders as and when specific circumstances require. However, a new set of challenges and opportunities are being thrown up. Providers are coming up against new competition, from prime brokers, whose services increasingly overlap with fund administrators in the hedge fund space. This presents fund administration providers with an imperative to develop “a full products cross system – able to handle fixed-income, equity, foreign exchange, all consolidated on one platform in real time, that can provide net margins, collateral efficiency and consolidated reporting,” says Eric Mansuy, chief information officer at RBC Dexia. “The development of these cross-asset platforms has been driven by a demand found across the investment spectrum.” The size and diversity of the alternative investment market continues to grow at a steady pace. According to an October 2006 Celent Communications report, The Burgeoning Business of Prime Brokerage, global hedge fund assets will double to $2.1trn by 2009. That means opportunity, but also growing competition for this business. Moreover, as hedge funds move into more-complex instruments in search of higher returns, middle and back office functions also are becoming more complex and cumbersome. The upshot, says Denise Valentine, analyst with Celent and author of report, is increasing overlap between prime broking and fund administration service models. Prime brokers offer a growing list of additional services, including portfolio systems, partnership accounting, portfolio risk analytics, margin and cross margin, and aggregated reporting. However,Valentine notes:“Many of these additional services can be duplicated by fund administrators, technology providers and even outsourcing firms.” “Actually, the world was not that simple four or five years ago. We already had NAV, reconciliation processes and also a few derivatives. What is new is intra-day and OTC pricing, multiple NAV calculations through the day, internationalisation of the business and an impressive increase in derivative instruments,” says Mansuy. “The market is also moving up the value chain with the request of some customer to cover some middle office functions, such as trade matching.”

Pressure on hedge funds to comply with corporate actions regulations, regulation (such as Sarbanes-Oxley) and the adoption of multi-asset investment strategies by traditional fund managers means that outsourcing of middle and back office functions remains a key trend. The question is how much and where. Custodians and fund administrators have had to recognise, in turn, that they must demonstrate a commitment to investing in both flexible technology and innovative thinking to harness new money flows into hedge funds and varied asset classes. Equally, as institutional and hedge fund clients work and invest globally, the challenge for service providers and their technology is acting global, but thinking local. It is not an easy marriage; particularly as fund administrators are also taking on middle as well as back office responsibilities, such as servicing corporate actions. It can be a difficult administrative process to complete. Says Mansuy,“It can be a risky process.”Customers can struggle with it, which is why it is one of the components of our service.” The ability to distribute to any geography, is service critical, says Nick Rowley, managing director and chairman of Oceanus, the document and case management solutions provider. It becomes particularly important for firms servicing time sensitive transactions for one customer, while having a different service level agreement for another, says Rowley:“the technology platform you provide must offer cost effective and timely solutions to both.” Being competitive in this space means having the scale and resources to develop and support an ever expanding range of services—which is where market consolidation comes in. To date, a number of traditional administration firms have moved into the hedge fund space, buying up specialist providers with hedge fund administration expertise: BISYS has acquired Hemisphere and RK Consulting and has in turn been acquired by Citi; Mellon Financial bought DPM and in turn was merged with The Bank of New York, which had earlier snapped up International Fund Administration; State Street purchased International Fund Services and has now bought Investors Trust; RBC’s asset servicing business merged with Dexia Investor Services, HSBC bought Bank of Bermuda and JPMorgan bought Tranaut Fund Administration. “Having an alternative-investment capability is a key component in the mainstream fund administrator’s offering, while having a large parent, particularly with expertise in custody, provides fund administrators with a lot of additional clout and, hopefully, seamless technology,”says Mansuy.

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COMPETITION DRIVES TECHNOLOGY

TECHNOLOGICALLY

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ALL CHANGE IN ASIAN CUSTODY As the big asset servicing providers target subcustody business in Asia, they bring both an established template for success and local expertise. One of the biggest shifts in recent years is the growth in domestic business. Traditionally, agent banks have focused on cross-border business, but the rise of hedge funds, private equity funds and the deepening of the Asian mutual fund industry makes the domestic market equally attractive to a variety of players. In a highly competitive market what types of service providers will win the battle for market share? HE BULK OF business in Asia’s custody market is servicing traditional pension funds and government pools of money, though that dynamic is fast changing. The rise of alternative investment strategies is one new business driver, thinks Lawrence Au, Asia Business Executive at Northern Trust, based in Singapore. Moreover, he says, “Asian funds are themselves changing in their perspectives, as they increasingly invest overseas and in a wider array of assets”. Scott McLaren, chief executive officer, RBC Dexia Trust Services Hong Kong Limited explains: “Take the example of Taiwan, where they now allow domestic funds to invest overseas. The traditional structure involving domestic custody services to a fund investing only in the local market is gone. Now they are investing internationally and looking for global capability from providers. Equally, on the other side of the coin, we see large fund management firms, with funds focused on single country strategies, such as Vietnam, and that calls for a clear domestic focus.” Both global providers and sub-custodians are enjoying rising demand for their services, albeit in an increasingly competitive market where they are butting up against each other where their business lines overlap. That irony is clearly evidenced by a top down analysis of the market. The three largest sub-custodians in Asia, for instance, are three global operations, namely HSBC, Citi and Standard Chartered. All are present and compete in every Asian market and their expertises (or market strengths) are actually quite similar. They have the support of a global parent, yet are also armed with in-depth knowledge of Asia’s varied markets— key factors when it comes to providing sub-custody services to

global custodians.“Asia is a highly competitive space but it is still dominated by domestic interests,” says Liao Chong-Jin, head of custody and fund administration, Asia-Pacific, in Singapore at Bank of New York Mellon, who notes that 98% of the bank’s business is servicing customers with global assets. In the context of Asia, this involves central banks, “where the bulk of foreign assets lie”, insurance companies and pension funds, “where only a very limited number of pension funds in the region can invest overseas,”he notes. As James Hogan, global head of HSBC Custody and Clearing, notes, “the definition of our business is changing. Scale is an obvious consideration. We have people in many locations, for example, working on keeping our platform ahead of developments. That represents an investment and you have to question whether single providers in single regions will be able to compete with that level of service over the long term.”Global custodians group sub-custodians into networks, which allow them to concentrate on serving asset managers (traditional or alternative) in the financial markets. Beyond trade settlement and safekeeping of securities, subcustodians look after rights offering notifications, dividend collections, market and regulatory information, and taxreclamation services. The relationship between global custodian and sub-custodian is strictly vertical. In Asia, apart from a few countries where there are strong local sub-custodian banks, such as Mizuho in Japan, DBS Bank in Singapore and Maybank in Malaysia, the global providers with a multi-market presence in the region hold sway. One indigenous Asian sub-custodian that is hoping to break the mould is DBS Bank, which provides sub-custody and clearing services in Hong Kong and Singapore. DBS is pursuing an ambitious strategy of building a pan-Asian subcustody presence on the back of the regional retail and commercial banking network that the bank is building. It has to in order to compete and survive. The threat to local providers from the global providers is real and lasting; and the global providers show every inclination, this time, of playing a long game. Eventually, single market sub-custodians might find they are marginalised in terms of expertise, scale and product offerings. Clients tend to select providers based on credit ratings and in that fact, global players enjoy the advantage. In most cases, says Au, while the choice of provider is not determined by price,“service quality

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The evolution of asset services in and range of products invariably Asia is then a story of two halves. influences prices”. Single market The success of international players sub-custodians are compelled to in the sub-custody field is invest larger amounts in services intrinsically linked to the concepts of and people. Local sub-custodians scale and risk. The development of on the other hand say they compete systems able to cope with the at local level, even with lower credit increasing complexity of the industry ratings; although many puts those with global resources and acknowledge that they rarely service networks in a better position to foreign institutions, which usually compete. On the other hand, since opt for a named global player. one of the reasons for people to use HSBC’s Hogan thinks the current sub-custodians is to mitigate risk, trend for global custodians is to US and European investors tend to move towards a business model feel more comfortable dealing with where they use fewer agent banks, international sub-custodians that appointing instead a core bank for James Hogan, global head of HSBC Custody and can offer similar services in other their emerging markets Clearing, notes “the definition of our business is parts of the globe. transactions. This is where RBC changing. Business in Asia has grown from A few other long term Dexia and other specialist players covering six markets to close to 40. Scale is an developments are noteworthy, with are making their presence felt. “We obvious consideration. We have people in Brazil, longer term repercussions for asset are supporting our clients as they for example, working on keeping our platform servicing providers. The first is work globally, utilising a network of ahead of developments, aided by teams in Goa. inflows of US and European money sub-custodians in specific markets. That is a massive investment and you have to into Asia is nowadays augmented by It means we can concentrate on the question whether single providers in single intra-regional flows, particularly value added business for our regions will be able to compete with that level of from Korea and more recently Japan clients,”says McLaren. service over he long term.” Photograph kindly (though still in limited quantities). Increasingly specialisation is seen supplied by HSBC, August 2007. China too, is about to make a large as a value-added offering. HSBC, for example, has enjoyed success in winning additional qualified institutional play with its new state run overseas foreign institutional investor (QFII) mandates. The Qualified investment fund, due to launch later this year. Sustained Foreign Institutional Investor (QFII) program, which allows levels of liquidity emanating out of these markets will foreign investors access to the Chinese domestic A-share eventually change the overall pattern of asset service market, is still very restrictive, while the Qualified Domestic provision, which is currently working to normative rules Institutional Investor (QDII) program, which allows Chinese established in the West. Long term, look for uniquely investors access to foreign markets is yet to properly take off. Asian responses. Third, there is a growing relationship The domestic sub-custody space is dominated by the so called between the Middle East and Asia, which is creeping up on ‘Big Five’ state owned Chinese banks, including the Bank of largely complacent North American and European banks China (BOC), the China Construction Bank (CCB), the that have so far (with the exception of HSBC) which have Agricultural Bank of China (ABC), the Industrial and dominated service provision in Asia. Again, long term, look Commercial Bank of China (ICBC), and Bank of for the emergence of some Middle Eastern names in the service mix. Asia is also offering new markets, such as Communications (BoCom). McLaren, Au and Hogan mention South Korea,Taiwan and Vietnam, though “It is a small market with a relatively India as three other major growing markets. Both Korea and modest economy to date, but it is evolving quite rapidly. Taiwan have securities borrowing and lending product Vietnam is introducing debt and equity and other capabilities as part of the market infrastructure, which has instruments in the market,”says Hogan. Finally, the shock of the new is an imperative in Asia. opened up these markets to the prime broker business and broker dealers.“They are attractive but complex markets and Innovation is critical for both global custodians and subthe global custodians require quality sub-custodians who are custodians seeking to gain market share in the region. well plugged into these markets to both understand their Following a trend present in other markets around the needs and to help influence their future direction and world, there has been a focus on developing and offering evolution,”says Hogan. McLaren goes further,“emerging asset solutions for derivatives clearing. The same applies to classes such as real estate investment trusts, hedge funds and treasury and cash management areas. “In five years time, I pension funds with 130/30 strategies and permutations of expect the market to look and feel differently,”acknowledges those strategies are determining new investments in the McLaren. “Right now you still get a sense of people feeling overall service offering. If the trend is outbound investment, their way. That won’t last for long. Given the relaxation of that has to play to the advantage of the global houses over the regulations, Asian asset owners are keen to leverage their assets globally. That’s when it will get really interesting.” long term.”

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EUROPE: REAL ESTATE UPDATE

Fabian Hüpher, managing director of Berlin-based CBRE Germany explains that “Traditionally, German property was very difficult to buy because the domestic institutions were prepared to pay high prices for it.” He adds that in the past two or three years they have been sellers and a lot of international money has moved in. Photograph kindly supplied by CBRE Germany, August 2007.

CAN , GERMANY S PROPERTY MARKET REAWAKEN? Three years ago the fiercely loyal German investment institutions gave up on their own domestic property market and looked further afield for investment growth, making way for an unprecedented number of international investors sniffing out bargains. A post World Cup economic upsurge and the go ahead for real estate investment trusts have left domestic and international institutions fighting for a slice of the German property pie. However, writes Mark Faithfull, buyers should tread carefully in an unevenly recovering market. N THE FACE of it, it would seem that investors simply cannot get enough of German property right now. While the exclusion of residential property from this spring’s Real Estate Investment Trust (REIT) legislation has disappointed investors—especially acquisitive foreign speculators and institutions—both domestic and international investors are circling an everdwindling supply of assets. Traditionally, the German real estate market has been an almost closed shop, with domestic institutional investors, owner occupiers and property funds monopolising investments. These same investors have been prepared to

pay high prices to exclude foreign investors, which tend to be more financially prudent about overseas acquisitions. However, as Germany’s economy limped through the opening years of this century and consumer spending resistance maintained a gloomy economic outlook, local institutions seemed simply to fall out of love with property, an attitude exacerbated by issues with open-ended funds and lingering consumer pessimism. Indeed, the climate precipitated a big sell off during the past three years and foreign buyers (attracted by keen prices and comparatively high yields for commercial property by European standards) swept in.

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Controversially, private equity investors also swooped on multi-tenant residential properties which were being enthusiastically sold off by cash-strapped city councils, in the belief that they would be able to sell these on to REIT funds this year; a hope dashed by the politicallymotivated final stipulations for German REITs (known as G-REITs). German investors offloaded a record €61.5bn of commercial real estate globally (up 275% on 2005) during 2006, according to the Moving Further and Faster report by property agency Jones Lang LaSalle. German domestic sales of commercial real estate totalled €39bn of that record figure and the bulk of sales activity came from both German open-ended and closed-ended funds, followed by large corporate and government disposals. “Many German funds had a tumultuous year in 2006 with net outflows from German open-ended funds totalling almost €7.5bn, although net inflows have now resumed,” says Robert Orr, European head of Jones Lang LaSalle’s International Capital Group.“Other German funds have taken advantage of the overwhelming appetite for German real estate from crossborder investors and taken the opportunity to sell non-core assets. Funds were also preparing for German REIT legislation, re-weighting and diversifying their portfolios.” Dr Martin Braun, partner, corporate finance with the Frankfurt office of Cushman However, German investors are now Wakefield, says: “We are beginning to see higher demand for office space in the investing heavily back into their home important CBDs, Frankfurt being a good example. I think G-REITs will give corporate market and this trend will remain very investors a good opportunity to invest in this market across a diverse portfolio.” evident for the rest of 2007, says Orr. Photograph kindly supplied by Cushman Wakefield, August 2007. “Recent months have seen a remarkable turnaround in German fund activity. A number of funds are where you invest, in the East you need to look at the now cash-rich, and are scouring the globe for investment microclimate, or land a great deal.” Tony Smedley, head of Continental European opportunity,”he adds. “I would take exception to the proposition that Investment Funds for Invista Real Estate Investment Germany’s economy is re-emerging,”adds Herbert Quelle, Management, also cautions that investors must buy head of economic affairs for the German Embassy in prudently and is concerned at a dash to property grab.“At London.“We clearly have a broad and profound recovery. If the moment it is a very competitive market and something you look at the medium- and long-term prospects then of a herd mentality has emerged, with some investing for the sake of investing,” he says. “There are also a lot of Germany is somewhere you would want to go.” Thomas Demmel, partner with Field Fisher Waterhouse private sellers and that can mean more challenges for Deutschland, adds that although there has been a lot of buyers. Closing deals is not always easy and German focus on REITs, there are plenty of other investment tax/property rules mean that there is quite a lot of leakage opportunities. “REITs are not the only way forward,” he from gross to net returns. Faced with two identical reflects.“There is plenty of potential in rental growth and investments yielding 5%, one in France, one in Germany, there is a lot of restructuring in former Eastern Germany, I would generally favour the French investment because where standards are going up. But you have to be careful net returns will be higher.”

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Demmel believes that the exclusion of residential properties from G-REITs is the result of a political compromise carved out as the Social Democrats in the governing coalition got their way. The finance ministry argued that allowing homes to be held within REITs could have a negative impact on tenants, as well as causing problems for sustainable city development and social housing policies with private equity houses as landlords. The debate has weakened the concept of G-REITs but market makers say these investments can be brought to market by other methods. However, the financial fallout was demonstrated by US investor Cerberus which is looking to exit its purchase three years ago of Hanover-based vehicle Baubecon Holding, a portfolio of 20,000 apartments previously owned by trade unions. Cerberus has been frustrated by its performance, with expectations of fast-rising rents and quick returns on sales to tenants disappointing with rent hikes capped by law in Germany and investors not achieving the anticipated margins they expected to achieve by selling properties to individual tenants. Private equity houses believed that they could persuade home renters to buy at prices discounted from prevailing market rates but which would still provide them with lucrative profits in much

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Thomas Demmel, partner with Field Fisher Waterhouse Deutschland, explains that although there has been a lot of focus on REITs, there are plenty of other investment opportunities.“REITs are not the only way forward,” he reflects.“There is plenty of potential in rental growth and there is a lot of restructuring in former Eastern Germany, where standards are going up. Photograph kindly supplied by Field Fisher Waterhouse Deutschland, July 2007.

Tony Smedley, head of Continental European Investment Funds for Invista Real Estate Investment Management, also cautions that investors must buy prudently and is concerned at a dash to property grab.“At the moment it is a very competitive market and something of a herd mentality has emerged, with some investing for the sake of investing,” he says. Photograph kindly supplied by Invista Real Estate Investment Management, July 2007.

the same way as the Conservatives sold off social housing to UK residents in the 1980s. However, Germany’s notoriously ownership-shy population has not been enthusiastic and Cerberus, which had initially planned a stock market flotation for the portfolio, cancelled the plans. Italy’s Pirelli Real Estate is eyeing Germany and is a potential buyer for Baubecon. Fortress, the US hedge fund and private equity group, bought a €3.5bn portfolio in 2004 and floated it on the stock market but share prices have slumped significantly since then. Last October, Fortress spun off the 150,000 homes in a Luxembourgbased REIT, selling 20% of its holding for €853m. UK fund Terra Firma took over Viterra, the housing arm of utility Eon, in 2005 for €7bn in a deal that was expected to change the face of German domestic home ownership and folded its 135,000 apartment-portfolio into Deutsche Annington, another portfolio of 64,000 apartments acquired in 2001. In addition to the portfolio now up for sale, Cerberus jointly owns 65,000 properties with investment bank Goldman Sachs. Quelle adds of the issues surrounding residential property investment: “Yes the current rules are set in stone but we can be assured of continuous revision and if people can be persuaded then this may change. The current government coalition is in

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place until 2009, but for REITs this is just the start; they may not meet the maximum demands and expectations now but in five years from now that may be different.” Instead, the biggest market concern should be Germany’s dwindling population, warns Ulrich Hoppe, director general of the German-British Chamber of Commerce and Industry. “In the next 40 years the population is expected to decline between 10% and 12% and the economically active population by nearer 20%,”he says.“That needs to be addressed by higher birth rates and higher immigration, but the decision to restrict immigration from the newest EU states shows that Germany as a society is not yet ready for that. What we need now is 15 years of strong economic growth to give the current population confidence over immigration.” What will drive the market is the increasing competition for a dwindling number of available property assets says Fabian Hüpher, managing director of Berlin-based CBRE Germany.“Traditionally, German property was very difficult to buy because the domestic institutions were prepared to pay high prices for it,” he says. “In the past two or three years they have been sellers and a lot of international money has moved in. Now German GDP growth is strong and everyone is active in the property market. However, construction has not kept pace and despite the liquidity in the market new office construction is running at less than

1% of the total for the first time. So there is very high demand and low supply.” Data from Cushman Wakefield concurs with this view and it cites the record-breaking €47.7bn of property transactions recorded in 2006, driven principally by “huge levels of foreign investment”, particularly in the retail sector, which accounted for around half of transaction volumes. Office deals were up on 2005, but were largely driven by eagerness by German corporate investors and institutions to diversify portfolios away from Germany and the office sector in particular. “There are still high vacancy rates in the office market but some investors are now betting on a recovery,”says Dr Martin Braun, partner, corporate finance with the Frankfurt office of Cushman Wakefield. “We are beginning to see higher demand for office space in the important CBDs, Frankfurt being a good example. I think G-REITs will give corporate investors a good opportunity to invest in this market across a diverse portfolio.” He also believes that the G-REIT market is important for the Frankfurt stock market in maintaining its position against rival exchanges such as AIM or Amsterdam.“There is so much demand for liquid indirect investment and problems with the liquidity of open ended funds triggered an opportunity for international investors to pick up some very well priced properties,”he says.

Don’t work in the dark, who knows what you might find Emerging Markets Report provides a comprehensive overview of the principal deals, trends, opportunities and challenges in fast-developing markets. For more information on how to order your individual copy of Emerging Markets Report please contact:

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PROFILE: BROWN BROTHERS HARRIMAN

BBH:

In its core custody business, BBH boasts end-to-end STP rates in the low-90% range. While Tucker admits that there are fixed costs associated with maintaining that level of efficiency,“the fact that we have not made acquisitions and then had to do things like migrate clients [sic] from one system onto another, or that we have grown organically and have one single integrated platform, makes it easier for us to achieve scale at much lower levels of asset value or transaction volume.” © Photographer: Nicemonkey/Agency: Dreamstime.com.

While some degree of scale is needed in order to maintain a competitive edge, the guiding lights at Brown Brothers Harriman (BBH) believe that the quest for capital is not the be-all and end-all. By specialising in a smaller number of defined market segments—rather than being all things to all men—BBH continues its goal to achieve economies of scale while growing its business organically. Dave Simons reports from Boston. NE COULD ARGUE that the bonding involved in the mergers of State Street-IBT and of Bank of New York Mellon has put the pressure on the remaining field of leading asset servicing banks to join forces or lose business. At the same time, there is the equal and opposite view. Namely, that the spate of mergers among the sector’s majors has resulted in a smaller, easier to manage playing field, which is precisely how Andrew Tucker, partner and head of investor services Europe for Brown Brothers Harriman chooses to look at it. “I do not really see business diminishing. If anything, the pool of assets gets bigger and bigger every year—particularly as we continue along in this golden age of asset and wealth creation,” says Tucker. “In reality, the number of services

WHY SOMETIMES BIG BEATS HUGE

available to the institutional asset-manager community is becoming limited, and I do not believe there is anyone who wants to see a market shrink to just a handful of providers, even under the best of circumstances.” The bank views the spate of consolidations as a real opportunity. “I think there were a number of clients who were with IBT, for instance, simply because they were a niche alternative to State Street.” Not surprisingly, says Tucker, in the months since the merger was announced, “The phone has been ringing, particularly as people begin to weigh their options. Of course, that is not to say that many of them will not decide to stay with State Street, since they are a very credible competitor in this business. But for others, an alternative like BBH may be the way to go.” Though its $2trn in assets under custody represents roughly one-tenth of industry leading Bank of New York Mellon (post merger) in percentage terms BBH has grown its business at least as fast as its top-tier peers. Does this mean that scale really is not that important? “One could make the argument that if we are doing well we must be doing something right,”says Tucker.“Of course, scale is an important feature, but I also believe that you can get to a point where you are too big to manage. We have had a very successful limited market-segment strategy, focusing on

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investment managers in general and their collective investment schemes on the one hand, and dealing with a large number of financial institutions that have been historically concentrated in Europe and Far East on the other. So I think that one can achieve scale and efficiency at an asset size that is significantly less than what the conventional wisdom might have you believe.” In its core custody business, BBH boasts end-to-end STP rates in the low-90% range. While Tucker admits that there are fixed costs associated with maintaining that level of efficiency,“the fact that we have not made acquisitions and then had to do things like migrate clients [sic] from one system onto another, or that we have grown organically and have one single integrated platform, makes it easier for us to achieve scale at much lower levels of asset value or transaction volume.” The merger of State Street and IBT, in particular, underscores the increasingly popular notion that hedgefund administration represents one of the most significant avenues for growth over the long haul. By contrast, BBH has yet to fully commit itself to this line of business.Yet another example of the bank’s reluctance to be all things to everybody everywhere, says Tucker.“Where the hedge-fund industry is considered, the only thing a classic custodian can really do is fund administration. Whereas the prime broker effectively controls the assets in terms of foreign exchange, lending, and all these other aspects. Consequently, it is our view that doing hedge administration on a standalone basis isn’t that strategically important.” Besides, says Susan Livingston, Boston-based BBH partner and head of investor services for Offshore and Asia/Pacific, servicing hedge funds does not always guarantee a big paycheck. “If it’s a Merrill Lynch, PIMCO, Fidelity, that is a different story—and our strategy is to work with the leading asset managers and very large banks,”says Livingston. “Unfortunately, a lot of the hedge funds today are run by a couple of guys in a garage in Connecticut. Sure, one could take on their business, but really, what is their potential for growth? This is the reason why we have been hesitant to take on some of these books of business.” By comparison, Livingston points to real-estate funds and private-wealth management as areas “where people know that the services you are providing are truly valuable and are willing to pay for them.”Tucker agrees. “In Europe, people are looking to put their real-estate funds into the crossborder facilities that Luxembourg has to offer, for instance, and that segment has been growing enormously,”he says. “The fund of fund and fund-of-hedge-fund business, as opposed to pure hedge-fund administration, has also been quite strong for us.”Additionally, BBH has been leading the charge in derivatives-processing capability. Along with Barclays Global Investors, in July BBH became the first service provider to exchange Financial products Markup Language (FpML) based contract notifications over SWIFTNet, as part of an ongoing effort to increase efficiency through automated over-the-counter (OTC) derivative post-trade processing. “Of course, it is a highly

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manual process for the industry at the moment,” says Tucker,“which is why we are looking to help pioneer some of the efforts to bring straight through processing (STP) into that equation.” Having witnessed countless mergers in her 25 years with BBH, Livingston is nonplussed by the latest round of bank bonding. “From Brown Brothers’ perspective, every one of them has resulted in our obtaining very large pieces of new business?and not typically middle market, but from the top end of the market, mainly,” says Livingston. “Ironically, it has often been the kind of business that might have been harder to obtain otherwise. This is because when these situations arise, very often the trustees just do not like being told which custodians they now have to use. They may stay for a while, but over time, it becomes an RFP opportunity for us. Following the last merger announcement, I received a call from the president of one of our clients, who was worried that we would be overly inundated with business from all the disaffected clients.” Of course, mergers not only affect clients, but also the employees of the merged companies. “That is something that tends to get overlooked. People tend to focus mainly on the business part of the story,” says Livingston. “Coincidentally, we held a series of employee open houses shortly after the State Street-IBT story came out, and over 300 people showed up in the first hour. Naturally, these companies are trying very hard to retain their top talent, but as the number of mergers increases, employees become increasingly distrustful of the situation. You hear stories about executives exchanging high fives when the mergers are announced, when many jobs are going to be eliminated, and you wonder how that kind of scenario affects some people who have families. Moreover, I think that is part of what differentiates our culture. Having a privately owned, family-oriented structure is something that cannot easily be dismissed. [That is] because when you come right down to it, it is not just about the analysts’ perspective on things.” In 1995, nearly two-thirds of BBH’s revenue came from within the United States. Today, the situation has completely reversed. Some 70% of BBH business exists across the pond. With many of the larger custodians increasing their domestic focus, BBH’s emphasis on Europe and other overseas markets becomes yet another dividing point. “I read the reports of our competitors, and they talk about how they’re going to be growing their overseas revenues because that is where they see better margins and more opportunity. [Moreover,] I think,‘Great, we’re already there!’ The thing is, we have found this formula overseas that is working for us, which is to have top-notch, local client service that can deliver the product via a highly integrated and efficient operational hub, one that allows us to have exactly the same systems and reports delivered worldwide,” says Livingston. In Japan, one of the hardest markets to break into culturally, BBH’s reliance on localised partners has resulted in a robust 73% market share in mutual funds, globally invested.“Our goal is to get the front

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end in place, so that the client’s overseas experience feels very much like a comfortable local experience,”she adds. Hence the importance of becoming a truly global entity, says Livingston.“I recently took a course at Harvard Business School called Getting Global Strategy Right, and they were going through the various business models that showed how different companies adapt overseas. What was interesting was the shortsighted and somewhat arrogant opinion among many US companies that the American way is the only way. I think a lot of our competitors have taken sort of an IBM largecompany approach to the foreign markets: a guy from Boston comes over to China, he is there for two years, he then moves over to Australia, then to London, and so forth. I mean, you can certainly push the American model, but that does not always work everywhere. We feel that kind of approach is very difficult for the client, mainly because the client ends up having to adapt to the vendor, rather than the other way around.” Several years ago, BBH considered the possibility that UCITS III might encourage a redomiciliation of the fund business into individual markets, “so that if you were a UK-based investment manager, you would use UK Open Ended Investment Companies (OEICs) as your global distribution vehicle,”explains Tucker. OEICs are hybrid investment funds that have some of the features of an investment trust and some of a unit trust. Like investment trusts, OEICs issue shares on the London Stock Exchange and use the money to invest in other companies. Unlike investment trusts, they are openended?as demand for the shares rises; the manager just issues more shares. “Or, if you were a German fund manager you’d use a German Kapitalanlagegesellschaft (KAG, a German capital investment company), and so on,” he

Andrew Tucker, partner and head of investor services Europe for Brown Brothers Harriman.“I do not really see business diminishing. If anything, the pool of assets gets bigger and bigger every year—particularly as we continue along in this golden age of asset and wealth creation,”says Tucker.“In reality, the number of services available to the institutional asset-manager community is becoming limited, and I do not believe there is anyone who wants to see a market shrink to just a handful of providers, even under the best of circumstances.”Photograph kindly supplied by Brown Brothers Harriman, August 2007.

Susan Livingston, Boston-based BBH partner and head of investor services for Offshore and Asia/Pacific, servicing hedge funds does not always guarantee a big paycheck.“Our strategy is to work with the leading asset managers and very large banks,” says Livingston.“Unfortunately, a lot of the hedge funds today are run by a couple of guys in a garage in Connecticut. Sure, one could take on their business, but really, what is their potential for growth? Which is the reason why we have been hesitant to take on some of these books of business,” she notes. Photograph kindly supplied by Brown Brothers Harriman, August 2007

continues. Instead, UCITS III appears to have accelerated the trend towards the use of crossborder domiciles as the place where funds can be registered for distribution in multiple global markets, including Asia. Tucker explains that: “As Europe becomes more of a unified territory from a fund-manager’s perspective, in our view fund managers are increasingly gravitating toward the cross-border domiciles, primarily of Luxembourg, but also Dublin, and Cayman as well, particularly for alternative vehicles. They are using these fund domiciles to not only distribute throughout Europe, but around the world. It is an interesting development.” Having a controlled marketsegment strategy has allowed BBH to properly position itself in Europe and other foreign markets, particularly where cross-border activity is concerned. “A lot of our attention has been aimed at Luxembourg and Dublin, where we currently have 10% market share respectively, and we have very good growth opportunities elsewhere that again are coming to us organically, either from successful clients who are expanding their fund offerings or with new clients coming on board who are looking for an alternative to the Big Four.” Going forward, Livingston understands the importance of maintaining a relevant business model, particularly in an evolving industry where people sometimes mistake “big” to be synonymous with “best.” “We try to be careful about the kind of business we take on, knowing what is a good fit and what is not. [That] means saying ‘no’ sometimes—and in our business, that is not always common.” Adds Tucker, “We are interested in going where our traditional clients want us to go, and also being selective in terms of where we think the best risk-reward opportunities lie. It is a very simple concept—but it is one that has brought us great success over time.”

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The shifting landscape A of the prime broker Single strategy hedge funds are becoming an endangered species. When the merger business collapsed after 9/11, merger arbitrage specialists broadened their horizons to encompass capital structure, distressed securities and special situations. The bloodbath in convertible arbitrage two years ago killed off almost all the pure plays there, too. The survivors still trade convertibles but dabble in credit, capital structure and event-driven arbitrage, too. Meanwhile, the big multistrategy hedge funds keep getting bigger and push into ever more exotic investments. For prime brokers it is a challenge to keep up and an opportunity for new entrants to build market share. Neil O’Hara reports.

The big banks, which dominate the debt underwriting league tables, have better access to securities the hedge funds want to buy, too. "Financing is a bank business, not a brokerage business," Pesce says, "Hedge funds that use the traditional prime brokers for leverage are increasingly concerned about the amount of resources dedicated to competing with their prime brokerage customers."© Photographer: Rolffimages/Agency: Dreamstime.com.

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S RECENTLY AS 2000, Goldman Sachs and Morgan Stanley had a commanding lead in prime brokerage. Although reliable data is hard to come by, their combined market share was close to 75%, and while they are still the market leaders today industry sources say their share has dropped below 50% of a financing revenue pool expected to hit $10bn for 2007. Bear Stearns, long a clear number three, now finds itself in a three-way scrap for third place against upstarts, such as Deutsche and UBS. Bank of America and Citi have elbowed their way into the game, too, along with niche players—for instance, Credit Suisse. Why are the traditional brokers losing out to the universal banks? Christopher Pesce, managing director and global head of prime brokerage at Banc of America Securities in New York, has a simple explanation: size matters. Prime brokers make most of their money from financing clients’ positions and fierce competition ensures little difference in pricing among the major players. As borrowers, hedge funds can source their credit from either A-rated traditional prime brokers such as Morgan Stanley and Goldman Sachs, or universal banks rated AA or better. If a fund can get higher quality for the same price, it is an easy choice. That is not all, however. The traditional investment banks have committed increasing amounts of their capital to proprietary trading in direct competition with their hedge fund clients. The prime broker side sees every trade a hedge fund clears through that firm, raising fears that the prop desk may sneak a peek even though a Chinese wall should keep the two apart. Universal banks do proportionately far less proprietary trading, so hedge funds have greater confidence their prime broker will not piggyback their positions, or trade against them. The big banks, which dominate the debt underwriting league tables, have better access to securities the hedge funds want to buy, too.“Financing is a bank business, not a brokerage business,”Pesce says,“Hedge funds that use the traditional prime brokers for leverage are increasingly concerned about the amount of resources dedicated to competing with their prime brokerage customers.” Pesce, who joined Banc of America five years ago from Goldman Sachs, has presided over a five-fold increase in prime broker revenues and reckons BofA now ranks fourth among prime brokers in the United States. Bear Stearns, Merrill Lynch, Deutsche and UBS—who all believe they are number three—might dispute that. However, BofA has grabbed a significant piece of the pie. The combination of high credit quality, access to product and cross margin

PRIME BROKING

MIND OVER MATTER

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capability among different asset classes is a compelling proposition for hedge funds looking to diversify their funding sources. Beyond a certain dollar amount, a hedge fund gets no benefit from spending more money at its existing prime brokers. Therefore, Pesce argues it should use the excess to build a new relationship that brings additional access to products like bank debt, leveraged loans and investment grade or high yield bonds. The universal banks have taken different approaches to building market share. For example, Deutsche targets established funds, while UBS likes to work with start-ups as well. Credit Suisse prefers to service a small number of large funds, while Citi goes after a broader swathe. Some have developed particular product expertise. Jon Hitchon, head of global prime services at Deutsche Banks claims the bank is widely recognised as a leader in the swaps market, and has earned a reputation for doing difficult transactions well.“We thrive on complexity,”he says,“We find that many of the traditional prime brokers have lived off the fat of wide spreads for many years.” Deutsche often gets a first look at new financial products as a result. Deutsche's forte keeps its risk managers on their toes, however. The bank taps its credit department to vet potential clients in advance, checking out the principals' reputations as well as the stability of the capital, including lockup periods and any rights the manager has to suspend redemptions. A 16-strong risk team drills down to the individual positions clients hold and runs stress tests every day to see how portfolios would perform in volatile markets conditions. “We assume that one day we might have to own some of these assets,”Hitchon says,“We look at things [such as] liquidity. Models come up with a valuation but when you try to liquidate you may find the price is a fraction of that.” The secondary market for exotic products such as structured notes and collateralised debt obligations is limited at best, as two hedge funds run by Bear Stearns found out to their cost. The funds owned leveraged portfolios of AAA-rated and AA-rated CDO tranches backed by sub-prime mortgages, but when margin calls forced them to sell the bids came in well below what the models predicted. In a letter to clients, Bear Stearns revealed that by June 30th this year, one fund had “effectively no value” and the other had “very little value” left for investors. Hitchon says Deutsche aims to wrest market share away from Goldman Sachs and Morgan Stanley, but it will take time to close the gap. He estimates a $650m “revenue opportunity” in today's market. To get there, Deutsche has its eye on larger funds that demand more from their prime brokers, the 350 funds that control about 85% of hedge fund assets.“Prime brokers are becoming what I would call prime financiers, or banking relationship driven,”Hitchon says. Everybody wants a piece of the top funds, of course, but Credit Suisse has put them front and center of its entire prime broker strategy. Philip Vasan, managing director and global head of prime services and capital services, cares far

more about who becomes a Credit Suisse client than how many he has. He wants to build a partnership with funds that can develop into dominant asset managers, supported by the highest ratio of prime broker staff to clients in the industry.“It’s a function of quality and fit,”Vasan says,“We offer high touch service that helps our clients innovate as their needs become more complex.”His select client roster numbers about 400 across asset classes including equities, fixed income, foreign exchange and commodities. These sophisticated clients expect lenders to recognise offsetting positions across different asset classes and countries. The demand for cross-margin capability has forced prime brokers to reorganise and integrate their financing of different products. Like other universal banks, Credit Suisse finds its global footprint a critical competitive advantage, too. Hedge funds need a broad supply of securities they can borrow in multiple jurisdictions, as well as synthetic access to markets from which they are excluded. "Prime brokers need to have greater breadth and greater integration than ever before," says Vasan. The administrative hassle makes hedge funds reluctant to switch prime brokers so new entrants stand a better chance in pitching for fresh business. In addition to start-ups and hedge funds who want to diversify their funding sources, prime brokers are picking up accounts from traditional asset managers. The latter are rolling out 130/30 investment programmes. These strategies use an index portfolio as collateral to support an extra 30% long commitment to stocks expected to outperform the index that are offset by a 30% short position in stocks expected to underperform. In head to head competition against Morgan Stanley and Goldman Sachs, Credit Suisse recently won a mandate from the Florida State Board of Administration as sole prime broker to its new 130/30 product family. While Credit Suisse is pursuing a niche strategy, it is still based on full-service prime brokerage. The demand for integrated reporting, valuation and cross-margin financing requires a huge investment in information technology, according to Edward Hawthorne, a partner in the New York office of financial services research and consulting firm Capco who is co-lead of its institutional and alternative asset management services in North America. At first, firms tried to meet the need through service alone, offering clients a point person to coordinate among the product groups. “That only gets you so far,” Hawthorne says. “The heavy investment taking place now is in aligning and synthesizing the whole data architecture across different products,”he adds. The infrastructure cost is so high that some players have chosen to specialise in particular products or services. Hawthorne cites as an example the French banks, which dominate the market for financing structured products, especially in Europe, but offer little in the way of clearing or other services. He also sees players such as Citi going after smaller hedge funds that don’t interest the market leaders. Small funds tend to rely on their prime brokers for more services, including risk management software, investment

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analytics and trading algorithms, so the revenue potential is disproportionate to the assets under management. These tools are now so widely available that they no longer confer a significant competitive advantage, however, which has encouraged others to feed at the trough. “Some administrators have moved into offering execution services, leveraging their presence as an administrator to move up the chain,”says Hawthorne. Denise Valentine, a senior analyst at Aité Group, a financial market research and consulting firm based in Boston, Massachusetts, says fund administrators are starting to offer financing and even capital introduction services, too. Moreover, while the big players want to be everything to everyone, the burgeoning market leaves room for firms such as Neuberger Berman and Jefferies to service small funds whose financing needs are better suited to their modest balance sheets. Besides financing capability, Valentine sees capital introduction and securities lending as critical to prime brokers’ competitive success. Hedge funds need to know that if the prime broker does not have a security in inventory it knows where to go to get it. Advisory services can give prime brokers an edge as well, helping clients develop disaster recovery plans or select software packages. Valentine says the jockeying for position has triggered enormous employee turnover at fund administrators as prime brokers, who pay more, poach their employees. Although skill shortages exist in several areas, they are most acute in derivatives where dramatic growth has outpaced the available operational expertise, pushing up salaries and employee retention costs. “Administrators are giving them expense accounts, having parties every month and taking them to dinner to try to keep them,”Valentine says. They are trying to prevent the loss of institutional knowledge, but the competition isn't just prime brokers; hedge funds will pay up for qualified back office staff, too.

Alex Ehrlich, global head of prime services at UBS, says the traditional firms have to consider how they want to interact with hedge funds across the board, not just in prime brokerage. "How do they deliver the firm?" he asks, "A big global multi-strategy firm may be a good client in equities, fixed income, commodities, foreign exchange, banking and prime brokerage. All those products could have multibillion dollar relationships." Photograph kindly supplied by UBS, July 2007.

Jon Hitchon, head of global prime services at Deutsche Banks claims the bank is widely recognised as a leader in the swaps market, and has earned a reputation for doing difficult transactions well. "We thrive on complexity," he says, "We find that many of the traditional prime brokers have lived off the fat of wide spreads for many years." Deutsche often gets a first look at new financial products as a result. Photograph kindly supplied by Deutsche Bank, July 2007.

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2007

The largest hedge funds are invading the traditional Wall Street firms’ turf on other fronts, including investment banking and private equity, in effect becoming competitors as well as customers. Alex Ehrlich, global head of prime services at UBS, says the traditional firms have to consider how they want to interact with hedge funds across the board, not just in prime brokerage.“How do they deliver the firm?” he asks, “A big global multistrategy firm may be a good client in equities, fixed income, commodities, foreign exchange, banking and prime brokerage. All those products could have multibillion dollar relationships.” UBS has spent the five years since Ehrlich joined (from Goldman Sachs) upgrading its technology platform to integrate its prime broker service across the different products to cover the full range of hedge funds’ needs. “We need to know the breadth of what clients are doing and for them to know we service across that breadth.” For a bank such as UBS, balance sheet capacity is not in question but Ehrlich says the traditional investment banks must decide whether to focus their business on trading or client service, and if it is both, how to resolve the potential conflicts of interest. Banc of America’s Pesce is more explicit. He does not believe the investment banks can keep up. If hedge fund assets double (which could happen within five years) the traditional prime brokers do not have the balance sheet capacity to double their exposure to the largest funds even if they wanted to. And as firms direct more capital to proprietary trading, they won’t want to; if anything, they will pull capital away from customer financing to earn higher returns on trading—a direct challenge to their hedge fund clients. “It is a unique situation,” Pesce says, “The dynamic is shifting very clearly toward the universal banks, which have the richest natural resources to support ongoing hedge fund growth.”

103

Al lF Wo FT TSE rld SE W Ind FT or D ex SE FT eve ld FT Ad SE lop Ind SE va Em ed ex In e Se nce co d E rgin de x nd g m FT ary erg Ind FT SE Em ing ex SE G In e FT De lob rgin de al SE x F g v In Ad TSE elo All de C va E pe x nc me d A ap In ed rg ll F Ca de FT TSE Em ing x p SE In Se erg All c Ca de Gl i x ob ond ng A p FT al G ary ll C Ind F ov Em ap ex FT TSE SE e E SE In rn er E P EP PRA RA me gin dex RA /N /N nt g I AR nd A / B F FT TSE NAR REI EIT ond ex SE In EP EIT T G Gl d o EP lo R RA A/N Glo ba bal ex In /N A ba l R AR RE l D EIT de M x M acq EIT IT G ivid s I ac lo en nde G qu uar ba d+ x ar ie lob lR In a G ie Gl lob l No ent de x ob al n- al In In R al In fra ent de x fra st al st ruc In ru de F tu x FT TSE ctu re In SE 4G re FT SE FT 4G oo 100 dex RA SE ood d G In FI GW G lob de x De A lob al In ve De al d 1 lo v pe elo 00 ex FT d In p de SE ex me RA US nt I x FI 10 nd Em 00 ex I er gi nde ng x In de x % Change

Al lF Wo FT TSE rld SE W Ind FT or D ex SE FT eve ld I S A FT dv E lop nde SE Em ed x a In e Se nce co d E rgin de x nd g m FT ary erg Ind ex in FT SE E g SE Gl mer I FT gi nde De ob n a SE x F g v l In Ad TSE elo All va Em ped Cap dex nc In ed erg All F Ca de FT TSE Em ing x p SE In Se erg All c Ca de Gl i x ob ond ng p A FT al G ary ll C Ind F ov Em ap ex FT TSE SE SE EP EP ern erg Ind EP RA RA me in ex g R n /N /N FT A/N AR AR t Bo Ind FT SE AR EI EIT nd ex SE EI T I E G EP PR T G Glo lob nde x al RA A/N lo ba l b I /N A R n a AR RE l D EIT de M x I M acq EIT T G ivid s I ac n Gl lob end de qu uar x o + al ar ie In G ba R ie Gl lob l No ent de x ob al n- al In In R al In fra ent de x fra st al st ruc In ru de F tu x FT TSE ctu re I r 4 S FT E4 Go e 1 nd SE FT Go od 00 ex o RA SE In G FI GW d G lob de x De A lob al In a D ve l lo eve 10 dex pe 0 l FT d opm In de SE ex e RA US nt I x FI 10 nd Em 00 ex I er gi nde ng x In de x

FT SE

104 % Change

l-0 7

Ja n07

l-0 7

12:16

Ja n06

l-0 5

Index Level Rebased (31 Jul 02=100)

22/8/07

Ja n05

l-0 4

Ja n04

l-0 3

Ja n03

l-0 2

MARKET DATA BY FTSE RESEARCH

FT SE

MARKET REPORTS 21.qxd:MARKET REPORTS 21.qxd

Page 104

Global Market Indices

5-Year Total Return Performance Graph 800

700

FTSE All-World Index

600

FTSE Emerging Index

500

FTSE Global Government Bond Index

400

FTSE EPRA/NAREIT Global Index

300

200

FTSE4Good Global Index

100

Macquarie Global Infrastructure Index

FTSE GWA Developed Index

-5

FTSE RAFI Emerging Index

2-Month Performance

Capital return

-10

Total return

-15

-20

1-Year Performance

Capital return

Total return

SEPTEMBER/OCTOBER 2007 â&#x20AC;˘ FTSE GLOBAL MARKETS

MARKET REPORTS 21.qxd:MARKET REPORTS 21.qxd

22/8/07

12:16

Page 105

Table of Capital Returns Index Name

Currency Constituents

FTSE All-World Indices FTSE All-World Index FTSE World Index FTSE Developed Index FTSE Emerging Index FTSE Advanced Emerging Index FTSE Secondary Emerging Index FTSE Global Equity Indices FTSE Global All Cap Index FTSE Developed All Cap Index FTSE Emerging All Cap Index FTSE Advanced Emerging All Cap Index FTSE Secondary Emerging Fixed Income FTSE Global Government Bond Index Real Estate FTSE EPRA/NAREIT Global Index FTSE EPRA/NAREIT Global REITs Index FTSE EPRA/NAREIT Global Dividend+ Index FTSE EPRA/NAREIT Global Rental Index FTSE EPRA/NAREIT Global Non-Rental Index Infrastructure Macquarie Global Infrastructure Index Macquarie Global Infrastructure 100 Index SRI FTSE4Good Global Index FTSE4Good Global 100 Index Investment Strategy FTSE GWA Developed Index FTSE RAFI Developed ex US 1000 Index FTSE RAFI Emerging Index

Value 2 M (%) 6 M (%) 12 M (%) YTD (%) Actual Div Yld (%)

USD USD USD USD USD USD

2876 2458 2015 861 443 418

256.32 450.12 243.59 549.72 503.27 658.84

-1.3 -1.9 -2.5 10.4 8.0 14.1

6.3 5.6 4.5 24.2 24.5 23.5

20.8 19.6 18.2 48.8 45.1 54.9

7.2 6.6 5.7 22.7 22.8 22.4

2.18 2.20 2.19 2.08 2.37 1.66

USD USD USD USD USD

7943 6203 1740 926 814

432.15 413.06 786.78 735.21 903.68

-1.4 -2.6 11.2 9.6 13.6

6.5 4.6 26.3 27.3 24.6

21.6 18.9 52.5 48.9 58.1

7.6 5.9 24.9 25.2 24.3

2.09 2.10 2.00 2.27 1.62

USD

721

108.06

1.4

1.7

0.7

0.0

3.68

USD USD USD USD USD

310 196 231 251 59

2442.85 1076.49 2179.47 1219.23 1484.36

-11.0 -13.5 -10.5 -13.8 -2.9

-10.8 -15.3 -11.7 -15.5 4.3

11.4 3.5 9.0 4.9 32.6

-6.6 -11.3 -7.3 -11.5 9.1

3.46 4.41 4.23 4.10 1.80

USD USD

230 100

9765.21 9544.87

-4.7 -5.5

5.5 4.6

22.4 21.0

5.4 4.4

2.95 2.98

USD USD

710 105

6842.23 5844.63

-2.7 -3.1

3.1 1.4

17.2 12.5

4.0 1.8

2.48 2.79

USD USD USD

2015 1011 350

4185.32 7066.16 6407.92

-2.9 -0.4 12.3

4.4 8.1 27.2

18.5 23.9 53.5

5.3 9.0 25.2

2.43 2.66 2.55

Table of Total Returns Index Name

Currency Constituents

Value 2 M (%) 6 M (%) 12 M (%) YTD (%) Actual Div Yld (%)

USD USD USD USD USD USD

2876 2458 2015 861 443 418

296.29 697.99 281.02 660.34 607.53 785.52

-1.0 -1.6 -2.3 11.0 8.6 14.6

7.7 7.1 5.9 26.0 26.3 25.2

23.5 22.3 20.9 52.4 48.9 58.0

8.8 8.2 7.2 24.7 24.9 24.1

2.18 2.20 2.19 2.08 2.37 1.66

USD USD USD USD USD

7943 6203 1740 926 814

476.97 455.17 890.55 837.24 1011.69

-1.1 -2.4 11.8 10.2 14.1

7.9 6.0 28.0 29.1 26.2

24.3 21.5 56.0 52.8 61.2

9.1 7.4 26.8 27.3 26.0

2.09 2.10 2.00 2.27 1.62

USD

721

145.21

2.4

3.6

4.4

2.3

3.68

USD USD USD USD USD

310 196 231 251 59

3410.97 1142.61 2265.73 1294.51 1527.95

-10.5 -12.8 -9.8 -13.2 -2.7

-9.3 -13.6 -9.9 -13.9 5.2

15.0 7.8 13.3 8.8 35.1

-5.0 -9.3 -5.3 -9.7 10.1

3.46 4.41 4.23 4.10 1.80

USD USD

230 11061.12 100 10840.11

-4.2 -4.9

7.4 6.6

26.2 24.8

7.5 6.5

2.95 2.98

USD USD

710 105

7815.80 6712.19

-2.5 -2.9

4.7 3.1

20.1 15.6

5.7 3.6

2.48 2.79

USD USD USD

2015 1011 350

4393.31 7419.53 6487.58

-2.7 -0.1 12.9

5.9 10.1 29.0

21.3 27.2 58.4

7.0 11.1 27.2

2.43 2.66 2.55

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

FTSE GLOBAL MARKETS â&#x20AC;˘ SEPTEMBER/OCTOBER 2007

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

105

% Change

F FT TSE SE Am N e FT orth rica SE Am s I FT La er nde S FT t x SE E A in A ica m In m N e FT orth rica eric dex a SE s A In La me All Ca dex ric tin p FT Am a A In SE ll d e LA rica Cap ex TI In BE All de C FT X x FT Al ap SE SE In lAm FT LAT Sha de x S r I e er B E In ica LA EX F TI TO dex s FT TS SE E U Gov BEX P I SA ern E Br nd ex a m FT PRA FT G en sil SE /N ov F T SE t B Ind EP AR ern SE EP ex o EP RA RA EIT men nd /N RA /N t B Ind No /N AR AR e o r th x nd EI M ARE EIT A T ac No US me Ind qu IT ex ric r N D t ar a iv ie orth h A In m ide No A nd dex rth me eric + ric a R In A M a d e ac me No nta ex ri qu ar ca I n-R l In ie de nf en US ra x st tal A In ruc Ind tu fra ex re s FT tru In FT SE ctu dex re SE 4G In 4G oo oo d U dex d S U In FT F S FT TSE SE 10 dex RA SE GW 0 I nd RA FI A ex US FI U US S I M id 10 nde Sm x 00 al l 1 Ind ex 50 0 In de x

106 % Change

l-0 7

Ja n07

l-0 7

12:16

Index Level Rebased (31 Jul 02=100)

22/8/07

Ja n06

l-0 5

Ja n05

l-0 4

Ja n04

l-0 3

Ja n03

l-0 2

MARKET DATA BY FTSE RESEARCH

F FT TSE SE Am N e FT orth rica S s I FT E L Am er nde at S FT x SE E A in A ica m In m N e FT orth rica eric dex a SE s A In La me A l l Ca dex ric tin FT Am a A p In SE ll d e LA rica Cap ex TI In A BE ll de C FT X x FT Al ap SE SE In l-S L ha de AT Am FT x re IB er SE In ica LA EX F TI TO dex s FT TS G B E P SE US ove EX I E Br nd rn A FT PRA FT Go me asi ex l S / n v FT SE N E t B Ind EP AR ern SE EP ex o EP RA RA EIT men nd /N In RA /N t No B d A A /N ex o rt RE R IT h A nd M ARE EIT ac No US me Ind qu IT r r ica ex N Di t ar v ie orth h A In m id No Am er end de x rth + er ica A ica Re Ind M ac me e n N x ta ri qu o ar ca I n-R l In ie de nf en US ra x st tal A In ruc Ind ex fra tu re s FT tru In FT SE ctu dex re SE 4G In 4G oo oo d U dex d S US In FT F FT TSE SE 10 dex RA SE GW 0 I nd R FI A A ex US FI U US S I M id 10 nde Sm x 00 al l 1 Ind ex 50 0 In de x

MARKET REPORTS 21.qxd:MARKET REPORTS 21.qxd

Page 106

Americas Market Indices

5-Year Total Return Performance Graph 350

300

FTSE Americas Index

250

FTSE Americas Government Bond Index

200

FTSE EPRA/NAREIT North America Index

150

FTSE EPRA/NAREIT US Dividend+ Index

100

FTSE4Good USIndex

FTSE GWA US Index

FTSE RAFI US 1000 Index

2-Month Performance

-5

Capital return

-10

Total return

-15

-20

1-Year Performance

Capital return

Total return

-10

SEPTEMBER/OCTOBER 2007 • FTSE GLOBAL MARKETS

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22/8/07

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Table of Capital Returns Index Name

Currency Constituents

FTSE All-World Indices FTSE Americas Index FTSE North America Index FTSE Latin America Index FTSE Global Equity Indices FTSE Americas All Cap Index FTSE North America All Cap Index FTSE Latin America All Cap Index Region Specific FTSE LATIBEX All-Share Index FTSE LATIBEX TOP Index FTSE LATIBEX Brasil Index Fixed Income FTSE Americas Government Bond Index FTSE USA Government Bond Index Real Estate FTSE EPRA/NAREIT North America Index FTSE EPRA/NAREIT US Dividend+ Index FTSE EPRA/NAREIT North America Rental Index FTSE EPRA/NAREIT North America Non-Rental Index Infrastructure Macquarie North America Infrastructure Index Macquarie USA Infrastructure Index SRI FTSE4Good US Index FTSE4Good US 100 Index Investment Strategy FTSE GWA US Index FTSE RAFI US 1000 Index FTSE RAFI US Mid Small 1500 Index

Value 2 M (%) 6 M (%) 12 M (%) YTD (%) Actual Div Yld (%)

USD USD USD

873 739 134

582.95 607.80 814.22

-4.3 -4.6 3.6

2.9 2.1 25.7

16.4 15.0 58.0

4.5 3.6 27.6

1.85 1.83 2.27

USD USD USD

2813 2613 200

371.18 359.88 1231.79

-4.5 -4.9 3.7

3.1 2.2 26.2

16.9 15.4 59.7

4.8 3.9 28.2

1.76 1.74 2.22

38 3067.70 15 4813.20 13 11900.70

5.4 2.0 9.4

29.3 24.0 34.2

52.9 47.3 56.8

32.4 27.4 38.3

na na na

USD USD USD USD USD

154 133

108.48 106.39

0.7 0.7

0.9 0.4

1.2 1.0

0.1 -0.3

4.89 4.97

USD USD USD USD

125 97 120 5

2436.18 1923.04 1117.37 1225.59

-16.5 -17.2 -17.1 -11.5

-20.4 -22.2 -21.2 -12.3

-1.7 -3.8 -2.3 3.1

-13.9 -15.6 -14.4 -9.1

4.45 4.57 4.55 3.53

USD USD

99 92

8280.49 8228.10

-7.9 -8.5

3.4 2.7

11.5 10.9

3.0 2.8

2.89 2.86

USD USD

157 101

5396.87 5149.23

-5.6 -5.6

-1.1 -1.6

14.2 13.6

0.4 -0.2

2.04 2.08

USD USD USD

681 990 1383

3695.18 6056.31 5381.31

-5.5 -5.7 -7.5

0.9 0.5 -0.9

13.7 14.1 -

2.2 2.5 1.2

2.00 2.12 1.30

Table of Total Returns Index Name

Currency Constituents

Value 2 M (%) 6 M (%) 12 M (%) YTD (%) Actual Div Yld (%)

USD USD USD

873 739 134

878.42 970.78 1007.73

-4.1 -4.4 3.8

3.8 3.0 27.2

18.5 17.1 61.8

5.5 4.6 29.4

1.85 1.83 2.27

USD USD USD

2813 2613 200

401.68 388.88 1425.79

-4.3 -4.6 3.9

3.9 3.1 27.8

18.9 17.4 63.5

5.8 4.9 29.9

1.76 1.74 2.22

USD USD USD

38 15 13

na na na

USD USD

154 133

158.89 155.22

0.9 1.5

3.2 2.7

5.9 5.8

2.8 2.4

4.89 4.97

USD USD USD USD

125 97 120 5

3645.11 1997.15 1187.98 1289.95

-16.0 -16.6 -16.5 -11.5

-19.0 -20.8 -19.7 -11.3

2.0 -0.1 1.5 6.3

-12.1 -13.8 -12.6 -7.7

4.45 4.57 4.55 3.53

USD USD

99 92

9315.41 9250.64

-7.7 -8.2

4.9 4.1

14.8 14.1

4.6 4.3

2.89 2.86

USD USD

157 101

5964.31 5709.99

-5.4 -5.4

-0.2 -0.6

16.4 15.9

1.5 0.9

2.04 2.08

USD USD USD

681 990 1383

3850.57 6293.92 5478.85

-5.3 -5.5 -7.3

1.8 1.5 -0.3

15.9 16.5 15.7

3.3 3.6 1.8

2.00 2.12 1.30

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2007

107

FT ve S l F E FT ope TS Eu E ro S d FT E E p De Eur uro e I SE De FT vel ope blo nde SE op ex c I x ve F n e FT lope TS Eu d E UK de SE d E E rop ur In x o E u e p De ur ro A e de ve op blo ll I x lo e A c Ca nde pe l A p l l I x l d Eu Cap Ca nde ro e p I x x p FT e U nde SE All S I x Al Ca nde l-S p x FT FT ha Ind SE SE re ex In FT u 1 SE rof 00 de x FT uro irst In SE fir 80 de FT uro st 1 In x FT d SE FT SE/ firs 00 ex SE JS t 3 In Eu /J E T 00 de ro S zo F E op In x ne TS A 4 d Go E R ll-S 0 I ex FT ve us har nd FT s SE r n ia e ex S EP FT FT E G FT me IO Ind RA SE SE ilt SE nt B ex s /N EP E F Pf Bo Ind AR R PR ixe an nd ex A A d d FT FTS EIT /NA /N Al bri Ind SE E E RE AR l-S ef ex u EP EPR ro IT EIT toc Ind RA A pe Eu E ks ex I / /N e r u M NA AR x U ope rop nde ac R E K e x qu EI IT D RE In ar T E Eu ivi ITs de ie u ro de I x Eu rop pe nd nd + e ro e pe No Ren In x I n t de FT F FTS nfr -Re al I x SE TS E4 ast nt nd GW E4 Go ruc al I ex G o n A oo d E ture de x De d u ve Eu rop Ind r l FT op op e I ex SE ed e 5 nd RA Eu 0 I ex FI rop nd Eu e ex ro Ind pe e In x de x

% Change

FT ve S l F E FT ope TS Eu SE d E E rop FT De Eur uro e I SE De FT vel ope blo nde c x S o ve F E pe ex In FT lope TS Eu d E UK de SE d E E rop ur In x De Eur uro e A ope de ve op blo ll I x lo e A c Ca nde pe l A p x d l C ll C In Eu ap a de ro e p I x x F T pe U nd SE All S I ex Al Ca nde l-S p x FT FT ha Ind S S re ex FT Eu E 1 In SE rof 00 de x FT uro irst In SE fir 80 de x st u I F FT T ro 1 nd SE FT SE/ firs 00 ex SE JS t 3 In Eu 0 de / E ro zo F JSE Top 0 In x ne TS A 4 d l l E Go R -S 0 I ex FT ve us har nd FT SE rn sia e ex S EP FT FT E G FT me IO Ind RA SE SE ilt SE nt B ex s /N EP E F Pf Bo Ind AR RA PR ixe an nd ex A d d FT FTS EIT /NA /N Al bri Ind SE E E RE AR l-S ef ex ur E EP PR o IT EIT toc Ind RA A pe Eu E ks ex I / /N e r u M NA AR x U ope rop nde ac R E K e x qu EI IT D RE In T I ar E iv T d ie Eu uro ide s I ex r n Eu op pe nd d + e ro e pe No Ren In x I n t de FT F FTS nfr -Re al I x SE TS E4 ast nt nd GW E4 Go ruc al I ex G o n A oo d E ture de x De d u ve Eu rop Ind FT lop rop e I ex SE ed e 5 nd RA Eu 0 I ex FI rop nd Eu e ex ro Ind pe e In x de x

FT SE

108 % Change

l-0 7

Ja n07

l-0 7

12:17

Ja n06

l-0 5

Index Level Rebased (31 Jul 02=100)

22/8/07

Ja n05

l-0 4

Ja n04

l-0 3

Ja n03

l-0 2

MARKET DATA BY FTSE RESEARCH

FT SE

MARKET REPORTS 21.qxd:MARKET REPORTS 21.qxd

Page 108

European Market Indices

5-Year Total Return Performance Graph 400

350

FTSE Europe Index

300

FTSE All-Share Index

250

FTSEurofirst 80 Index

200

FTSE/JSE Top 40 Index

150

FTSE Gilts Fixed All-Stocks Index

100

FTSE EPRA/NAREIT Europe Index

FTSE4Good Europe Index

FTSE GWA Developed Europe Index

-5

FTSE RAFI Europe Index

2-Month Performance

Capital return

-10

Total return

-15

-20

1-Year Performance

Capital return

Total return

-10

SEPTEMBER/OCTOBER 2007 â&#x20AC;˘ FTSE GLOBAL MARKETS

MARKET REPORTS 21.qxd:MARKET REPORTS 21.qxd

22/8/07

12:17

Page 109

Table of Capital Returns Index Name

Currency Constituents

FTSE All-World Indices FTSE Europe Index FTSE Eurobloc Index FTSE Developed Europe ex UK Index FTSE Developed Europe Index FTSE Global Equity Indices FTSE Europe All Cap Index FTSE Eurobloc All Cap Index FTSE Developed Europe All Cap ex UK Index FTSE Developed Europe All Cap Index Region Specific FTSE All-Share Index FTSE 100 Index FTSEurofirst 80 Index (FTSEurofirst 100 Index) FTSEurofirst 300 Index FTSE/JSE Top 40 Index FTSE/JSE All-Share Index FTSE Russia IOB Index Fixed Income FTSE Eurozone Government Bond Index FTSE Pfandbrief Index FTSE Gilts Fixed All-Stocks Index Real Estate FTSE EPRA/NAREIT Europe Index FTSE EPRA/NAREIT Europe REITs Index FTSE EPRA/NAREIT Europe ex UK Dividend+ Index FTSE EPRA/NAREIT Europe Rental Index FTSE EPRA/NAREIT Europe Non-Rental Index Infrastructure Macquarie Europe Infrastructure Index SRI FTSE4Good Europe Index FTSE4Good Europe 50 Index Investment Strategy FTSE GWA Developed Europe Index FTSE RAFI Europe Index

Value 2 M (%) 6 M (%) 12 M (%) YTD (%) Actual Div Yld (%)

EUR EUR EUR EUR

571 2003 369 504

479.36 138.49 257.92 251.25

-4.0 -4.6 -4.4 -4.0

2.3 3.7 2.8 2.3

16.3 20.6 19.9 16.3

4.3 5.8 5.3 4.3

2.84 2.48 2.82 2.90

EUR EUR EUR EUR

1760 841 1169 1639

430.15 455.04 459.72 424.71

-3.6 -4.6 -4.4 -4.1

2.6 3.8 3.0 2.4

17.8 21.8 21.2 17.7

4.7 6.3 5.8 4.6

2.72 2.81 2.70 2.77

GBP GBP EUR EUR EUR SAR SAR USD

688 3289.12 102 6360.11 79 5504.44 101 4904.74 314 1549.92 41 25846.41 164 28561.81 10 1219.40

-4.3 -3.9 -4.5 -3.5 -3.8 0.6 -0.2 13.4

2.4 2.5 3.6 2.6 2.3 12.7 12.2 7.5

9.5 7.3 18.7 12.7 15.8 35.1 36.8 12.3

2.1 2.2 5.7 4.3 4.5 14.3 14.6 -0.4

2.87 3.05 3.23 3.29 2.94 2.16 2.30 1.26

EUR EUR GBP

237 416 26

97.20 105.11 144.87

0.1 -0.3 1.2

-2.0 -2.0 -1.9

-3.1 -3.0 -4.5

-2.8 -2.5 -3.3

4.49 4.11 5.30

EUR EUR EUR EUR EUR

101 35 38 86 15

2444.68 990.71 2593.92 1352.93 1627.83

-16.2 -16.1 -17.0 -15.3 -7.2

-18.1 -18.2 -15.3 -14.2 -6.2

0.4 -1.5 6.8 7.0 21.6

-18.5 -19.9 -13.1 -16.1 -3.2

2.70 3.06 4.09 2.82 1.03

54 12506.21

-4.2

10.1

35.1

8.8

3.12

USD EUR EUR

293 54

5144.60 4437.40

-3.9 -3.3

0.6 -0.4

12.9 6.8

2.6 1.1

3.08 3.45

EUR EUR

504 472

4162.07 6310.08

-4.3 -3.8

1.9 3.3

16.7 19.2

3.7 5.5

3.15 3.06

Table of Total Returns Index Name

Currency Constituents

FTSE All-World Indices FTSE Europe Index FTSE Eurobloc Index FTSE Developed Europe ex UK Index FTSE Developed Europe Index FTSE Global Equity Indices FTSE Europe All Cap Index FTSE Eurobloc All Cap Index FTSE Developed Europe All Cap ex UK Index FTSE Developed Europe All Cap Index Region Specific FTSE All-Share Index FTSE 100 Index FTSEurofirst 80 Index (FTSEurofirst 100 Index) FTSEurofirst 300 Index FTSE/JSE Top 40 Index FTSE/JSE All-Share Index FTSE Russia IOB Index Fixed Income (FTSE Eurozone Government Bond Index) FTSE Pfandbrief Index FTSE Gilts Fixed All-Stocks Index Real Estate FTSE EPRA/NAREIT Europe Index FTSE EPRA/NAREIT Europe REITs Index FTSE EPRA/NAREIT Europe ex UK Dividend+ Index FTSE EPRA/NAREIT Europe Rental Index FTSE EPRA/NAREIT Europe Non-Rental Index Infrastructure Macquarie Europe Infrastructure Index SRI FTSE4Good Europe Index FTSE4Good Europe 50 Index Investment Strategy FTSE GWA Developed Europe Index FTSE RAFI Europe Index

Value 2 M (%) 6 M (%) 12 M (%) YTD (%) Actual Div Yld (%)

EUR EUR EUR EUR

571 2003 369 504

892.23 175.28 311.19 307.42

-3.7 -4.2 -4.1 -3.7

4.6 6.2 5.3 4.6

19.8 24.2 23.3 19.8

6.7 8.5 7.9 6.7

2.84 2.48 2.82 2.90

EUR EUR EUR EUR

1760 841 1169 1639

494.50 523.63 524.99 488.66

-3.3 -4.2 -4.1 -3.7

4.8 6.2 5.4 4.6

21.2 25.3 24.5 21.1

7.0 8.8 8.2 6.9

2.72 2.81 2.70 2.77

GBP GBP EUR EUR EUR SAR SAR USD

688 102 79 101 314 41 164 10

3889.15 3642.23 6410.03 5740.19 2006.89 2732.04 2990.27 1227.47

-4.1 -3.7 -4.0 -3.1 -3.5 0.7 0.0 13.9

4.3 4.5 6.4 5.1 4.7 14.1 13.7 8.0

12.9 10.9 22.6 16.6 19.4 38.4 40.2 13.0

4.0 4.3 8.6 6.9 6.9 15.8 16.2 0.1

2.87 3.05 3.23 3.29 2.94 2.16 2.30 1.26

EUR EUR GBP

237 416 26

154.18 177.15 1936.87

0.8 0.4 1.3

0.1 0.0 0.7

1.1 1.0 0.5

-0.3 -0.1 -0.6

4.49 4.11 5.30

EUR EUR EUR EUR EUR

101 35 38 86 15

3201.11 1052.86 2795.69 1416.88 1664.24

-15.8 -15.6 -16.4 -14.8 -7.0

-16.6 -16.5 -12.8 -12.5 -5.5

3.0 1.7 10.9 9.9 22.9

-17.0 -18.1 -10.5 -14.5 -2.4

2.70 3.06 4.09 2.82 1.03

54 14431.12

-3.3

12.7

39.6

11.7

3.12

USD EUR EUR

293 54

6167.14 5360.13

-3.6 -3.0

3.0 2.2

16.5 10.6

5.0 3.7

3.08 3.45

EUR EUR

504 472

4433.74 6666.31

-3.9 -3.5

4.2 5.7

20.4 22.8

6.2 8.0

3.15 3.06

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2007

109

F As TS ia E FT Pa As SE F cif ia As TS ic Pa ia E e c Pa As F x J ific cif ia TS ap In ic Pa E an de e cif Ja I x FT x Ja ic A pan nde SE pa ll I x Ja n A Cap nde pa ll x I n Ca nd FT SE F FTS All p I ex n C T E Bu S /A ap de rs E/A SE I x n a FT M SE A d FT T al AN N I ex SE n a S S y As E E s 4 de ia FT Xi C T ia 0 In x Pa SE nh aiw 10 de cif /X ua a 0 I x n n i FT ic G nhu All- 50 de FT F SE T SE ov a Sh In x EP SE EP ern Chi are de R E R m n I x FT FT A/ PR A/ en a 2 nd SE SE NA A/N NA t B 5 I ex EP EP REI AR REI on nde R RA T E T d x F A/ /N As IT As Ind FT TSE NAR AR ia As ia ex SE I E EI Div ia 3 Ind ID DFC IT A T A ide 3 I ex FC I si sia nd nd In ndia a N Re + I ex o di n FT a In n-R nta de In fra e l I x SE fra st nt nd Bu a r F e s u l rs FTS TS tru ct In x u E a M E S 4G ctu re dex al G oo re In FT ays X S d 30 de SE ia ha Jap In x Sh Hijr ria an de ar ah h 1 In x ia 0 d F h S h a 0 ex FT TSE Jap ria Ind SE G an h I ex FT G WA 10 nd S W 0 e FT E R A Jap In x SE AF Au an de RA I A stra In x d FT FT FI iust lia I ex SE SE Sin ra nd l RA R ga ia I ex FT FI AF por nd SE K I J e ex a RA aiga pa Ind FI i 1 n I ex Ch 00 nd in 0 I ex a n 50 de In x de x

% Change

F As TS ia E Pa As cif ia F As TS ic Pa ia E e c A Pa s F x J ific i cif a TS ap In ic Pa E an de e cif Ja I x FT x Ja ic A pan nde SE pa ll I x Ja n A Cap nde p a ll x I C n FT a nd SE F FTS All p I ex Bu TS E/A Cap nde rs E/A SE I x n a FT M SE A d FT T al AN N I ex SE SE SE ays 4 nd As e ia FT Xi C T ia 0 In x Pa SE nh aiw 10 de cif /X ua a 0 I x n n i i F c G nh All 5 de FT SE FT TSE ov ua -Sh 0 In x EP SE EP ern Chi are de R E R m n I x FT FT A/ PR A/ en a 2 nd SE SE NA A/N NA t B 5 I ex R R EP EP EI AR EI on nde R RA T E T d x F A/ /N As IT As Ind FT TSE NAR AR ia As ia ex SE I E EI Div ia 3 Ind ID DFC IT A T A ide 3 I ex FC I si sia nd nd In ndia a N Re + I ex o di n FT a In n-R nta de In fra e l I x SE fra st nt nd Bu F s r a e rs FTS TS tru uct l In x u E a M E S 4G ctur re dex al G oo e In FT ays X S d 30 de SE ia ha Jap In x Sh Hijr ria an de ar ah h 1 In x ia 0 d FT h J Sha 0 I ex FT SE ap ria nd SE G an h I ex FT G WA 10 nd S W 0 e FT E R A Jap In x SE AF Au an de s I t RA A ra In x d FT FT FI iust lia I ex SE SE Sin ral nd i ex g a R R a FT AFI AF por Ind SE K I J e ex a RA aiga pa Ind FI i 1 n I ex Ch 00 nd in 0 I ex a n 50 de In x de x FT SE

FT SE

110 % Change

Ju l-0

Ja n0

Ju l-0

12:17

Ja n0

Index Level Rebased (31 Jul 02=100)

22/8/07

Ju l-0

Ja n0

Ju l-0

Ja n0

Ju l-0

Ja n0

Ju l-0

MARKET DATA BY FTSE RESEARCH

FT SE

MARKET REPORTS 21.qxd:MARKET REPORTS 21.qxd

Page 110

Asia Pacific Market Indices

5-Year Total Return Performance Graph 1600

1400

FTSE Asia Pacific Index

1200

FTSE/ASEAN 40 Index

1000

FTSE/Xinhua China 25 Index

800

600

FTSE Asia Pacific Government Bond Inde

400

FTSE IDFC India Infrastructure Index

200

2-Month Performance

Capital return

-5

Total return

-10

-15

1-Year Performance

250

200

150

100

Capital return

Total return

-50

SEPTEMBER/OCTOBER 2007 â&#x20AC;˘ FTSE GLOBAL MARKETS

MARKET REPORTS 21.qxd:MARKET REPORTS 21.qxd

22/8/07

12:17

Page 111

Table of Capital Returns Index Name FTSE All-World Indices FTSE Asia Pacific Index FTSE Asia Pacific ex Japan Index FTSE Japan Index FTSE Global Equity Indices FTSE Asia Pacific All Cap Index FTSE Asia Pacific ex Japan All Cap Index FTSE Japan All Cap Index Region Specific FTSE/ASEAN Index FTSE/ASEAN 40 Index FTSE Bursa Malaysia 100 Index TSEC Taiwan 50 Index FTSE Xinhua All-Share Index FTSE/Xinhua China 25 Index Fixed Income FTSE Asia Pacific Government Bond Index Real Estate FTSE EPRA/NAREIT Asia Index FTSE EPRA/NAREIT Asia 33 Index FTSE EPRA/NAREIT Asia Dividend+ Index FTSE EPRA/NAREIT Asia Rental Index FTSE EPRA/NAREIT Asia Non-Rental Index Infrastructure FTSE IDFC India Infrastructure Index FTSE IDFC India Infrastructure 30 Index SRI FTSE4Good Japan Index Shariah FTSE SGX Shariah 100 Index FTSE Bursa Malaysia Hijrah Shariah Index FTSE Shariah Japan 100 Index Investment Strategy FTSE GWA Japan Index FTSE GWA Australia Index FTSE RAFI Australia Index FTSE RAFI Singapore Index FTSE RAFI Japan Index FTSE RAFI Kaigai 1000 Index FTSE RAFI China 50 Index

Currency Constituents

Value 2 M (%) 6 M (%) 12 M (%) YTD (%) Actual Div Yld (%)

USD USD USD

1291 808 483

290.90 482.53 116.55

4.1 8.7 -3.2

11.9 23.6 -0.9

24.6 48.4 9.2

12.0 22.9 1.3

1.86 2.45 1.17

USD USD USD

3171 1831 1340

516.14 1035.08 310.15

4.7 13.3 -2.9

13.2 38.3 -0.9

26.2 45.2 9.0

13.3 31.2 1.4

1.84 2.37 1.17

USD USD MYR TWD CNY CNY

152 452.88 40 9035.82 100 9015.03 50 6443.58 995 10267.31 25 20888.16

4.5 2.6 1.8 9.8 10.0 24.0

20.8 18.3 15.6 14.5 90.3 34.0

56.1 49.5 49.1 33.6 227.8 80.2

26.4 20.9 26.6 12.7 124.5 25.8

2.71 2.81 2.50 3.38 0.55 1.49

USD

257

82.86

1.9

0.5

-3.5

-1.1

1.75

USD USD USD USD USD

84 43 61 45 39

2239.95 1652.94 2643.76 1337.58 1520.16

-6.3 -9.1 -2.4 -9.9 -3.4

4.2 -0.4 6.6 -1.5 8.8

32.3 25.5 32.2 21.8 41.2

8.8 4.1 9.7 2.2 14.1

2.85 5.00 3.86 4.66 1.53

IRP IRP

63 30

1192.12 1229.54

14.1 15.9

37.0 40.3

111.8 107.8

42.7 44.8

0.51 0.66

JPY

194

6237.79

-4.2

-1.9

7.9

-0.5

1.24

USD MYR JPY

100 30 100

6193.42 9574.6 1789.32

4.5 1.7 -0.5

9.1 23.2 1.1

20.7 58.7 15.8

7.1 33.1 1.9

1.73 2.59 1.24

JPY AUD AUD SGD JPY JPY HKD

483 117 58 19 346 1014 50

4489.00 4401.05 6469.19 8187.59 6224.98 6255.99 6564.02

-3.8 -2.4 -4.0 1.6 -3.1 -5.5 16.6

-1.4 6.2 4.6 16.6 -0.8 3.5 na

9.6 22.9 21.2 50.3 10.7 25.7 na

1.2 8.5 6.7 21.2 2.0 6.4 na

1.23 3.77 4.14 2.96 1.26 2.65 2.05

Table of Total Returns Index Name FTSE All-World Indices FTSE Asia Pacific Index FTSE Asia Pacific ex Japan Index FTSE Japan Index FTSE Global Equity Indices FTSE Asia Pacific All Cap Index FTSE Asia Pacific ex Japan All Cap Index FTSE Japan All Cap Index Region Specific FTSE/ASEAN Index FTSE/ASEAN 40 Index FTSE Bursa Malaysia 100 Index TSEC Taiwan 50 Index FTSE Xinhua All-Share Index FTSE/Xinhua China 25 Index Fixed Income FTSE Asia Pacific Government Bond Index Real Estate FTSE EPRA/NAREIT Asia Index FTSE EPRA/NAREIT Asia 33 Index FTSE EPRA/NAREIT Asia Dividend+ Index FTSE EPRA/NAREIT Asia Rental Index FTSE EPRA/NAREIT Asia Non-Rental Index Infrastructure FTSE IDFC India Infrastructure Index FTSE IDFC India Infrastructure 30 Index SRI FTSE4Good Japan Index Shariah FTSE SGX Shariah 100 Index FTSE Bursa Malaysia Hijrah Shariah Index FTSE Shariah Japan 100 Index Investment Strategy FTSE GWA Japan Index FTSE GWA Australia Index FTSE RAFI Australia Index FTSE RAFI Singapore Index FTSE RAFI Japan Index FTSE RAFI Kaigai 1000 Index FTSE RAFI China 50 Index

Currency Constituents

Value 2 M (%) 6 M (%) 12 M (%) YTD (%) Actual Div Yld (%)

USD USD USD

1291 808 483

330.45 594.38 138.51

4.4 9.3 -3.1

13.1 25.5 -0.3

27.1 52.7 10.4

13.3 24.9 1.9

1.86 2.45 1.17

USD USD USD

3171 1831 1340

565.22 1191.26 326.07

5.0 13.6 -2.8

14.4 41.2 -0.2

28.8 50.7 10.2

14.6 34.0 2.1

1.84 2.37 1.17

USD USD MYR TWD CNY CNY

152 547.27 40 9757.95 100 9369.32 50 7620.55 995 11078.10 25 25319.46

4.9 2.9 2.0 12.5 10.4 24.3

22.8 20.1 17.4 17.3 91.4 35.8

61.1 53.9 53.9 39.1 230.1 84.1

28.6 22.7 28.6 15.5 125.8 27.4

2.71 2.81 2.50 3.38 0.55 1.49

USD

257

96.39

2.9

1.9

-1.4

0.4

1.75

USD USD USD USD USD

84 43 61 45 39

2909.98 1787.91 2756.01 1441.09 1557.26

-5.7 -8.5 -1.6 -9.1 -3.1

5.7 1.0 8.6 0.8 9.6

36.3 29.4 37.8 27.7 43.5

10.3 5.7 11.8 4.6 15.0

2.85 5.00 3.86 4.66 1.53

IRP IRP

63 30

1193.66 1231.35

14.3 16.1

37.6 41.0

113.4 109.6

43.3 45.6

0.51 0.66

194

6621.93

-4.1

-1.2

9.2

0.1

1.24

100 6375.35 30 10062.15 100 1866.51

4.9 2.0 -0.5

10.2 25.1 1.8

22.9 64.9 17.3

8.3 35.2 2.6

1.73 2.59 1.24

-3.7 -2.0 -3.6 1.6 -3.1 -5.2 16.9

-0.8 8.2 6.8 18.0 -0.2 5.2 na

10.9 28.0 26.8 55.3 12.1 29.0 na

1.8 10.5 9.0 22.7 2.7 8.2 na

1.23 3.77 4.14 2.96 1.26 2.65 2.05

JPY USD MYR JPY JPY AUD AUD SGD JPY JPY HKD

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2007

483 117 58 19 346 1014 50

4594.36 4777.61 6986.56 8581.35 6352.54 6504.35 6666.79

111

GM EDITORIAL 21.qxd

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Page 112

CALENDAR

Index Reviews September – November 2007 Date

Index Series

Review Type

Effective Data Cut-off (Close of business)

Early Sep Early Sep Early Sep 1-Sep 4-Sep 5-Sep 7-Sep 7-Sep 10-Sep 12-Sep 12-Sep 12-Sep 12-Sep

ATX CAC 40 S&P / TSX SMI Index Family Nikkei 225 DAX S&P MIB S&P / ASX Indices NZSX 50 FTSE UK Index Series FTSE / JSE Africa Index Series FTSE Asiatop / Asian Sectors FTSE Global Equity Index Series (incl. FTSE All-World)

Semi-annual review / number of shares Annual review of free float & Quarterly Review Quarterly review - constiuents, shares & IWF Semi-annual review Annual review Quarterly review/ Ordinary adjustment Semi-annual constiuents review Quarterly review - shares, S&P / ASX 300 consituents Quarterly review Quarterly review Quarterly review Semi-annual review

28-Sep 21-Sep 21-Sep 30-Sep Late Sept/Early Oct 21-Sep 24-Sep 21-Sep 28-Sep 21-Sep 21-Sep 21-Sep

31-Aug 31-Aug 31-Aug 30-Jun

Annual review / Developed Europe

21-Sep

29-Jun

12-Sep 12-Sep 12-Sep 12-Sep 12-Sep 12-Sep 12-Sep 12-Sep

FTSE techMARK 100 FTSEurofirst 80 & 100 FTSEurofirst 300 FTSE Euromid FTSE eTX Index Series FTSE Multinational FTSE Global 100 FTSE EPRA/NAREIT Global Real Estate Index Series FTSE4Good Index Series FTSE NAREIT US Real Estate Index Series FTSE NASDAQ Index Series NASDAQ 100 S&P MIB DJ STOXX DJ STOXX DJ STOXX Blue-Chip S&P US Indices S&P Europe 350 / S&P Euro S&P Topix 150 S&P Latin 40 S&P Asia 50 S&P Global 1200 S&P Global 100 Russell US Indices FTSE Xinhua Index Series TSEC Taiwan 50 OMX H25 FTSE / ATHEX 20 Hang Seng MSCI Standard Index Series

Quarterly review Annual Review Quarterly review Quarterly review Quarterly review Annual review Quarterly review

21-Sep 21-Sep 21-Sep 21-Sep 21-Sep 21-Sep 21-Sep

31-Aug 31-Aug 31-Aug 31-Aug 31-Aug 29-Jun 31-Aug

Quarterly review Semi-annual review

21-Sep 21-Sep

7-Sep 31-Aug

Quarterly review Quarterly review Quarterly review / Shares adjustment Quarterly review - shares & IWF Quarterly review Style Review Annual review Quarterly review - shares & IWF Quarterly review - shares & IWF Quarterly review - shares & IWF Quarterly review Quarterly review - shares & IWF Quarterly review - shares & IWF Quarterly review - shares & IWF Quarterly review - IPO additions only Quarterly review Quarterly review Quarterly review - share in issue Semi-annual review Quarterly review Quarterly review

21-Sep 21-Sep 21-Sep 24-Sep 21-Sep 21-Sep 21-Sep 21-Sep 21-Sep 21-Sep 21-Sep 21-Sep 21-Sep 21-Sep 30-Sep 19-Oct 19-Oct 31-Oct 30-Nov 7-Dec 30-Nov

31-Aug 31-Aug 31-Aug 17-Sep 14-Aug 1-Sep 1-Sep

13-Sep 14-Sep 14-Sep 14-Sep 18-Sep 19-Sep 19-Sep 19-Sep 19-Sep 19-Sep 19-Sep 19-Sep 19-Sep 19-Sep 19-Sep 21-Sep 10-Oct 11-Oct Mid Oct Mid Oct 9-Nov 14-Nov

31-Aug 17-Sep 31-Aug 11-Sep 3-Sep 31-Aug

31-Aug 24-Sep 28-Sep 28-Sep 28-Sep 31-Oct

Sources: Berlinguer, FTSE, JP Morgan, Standard & Poors, STOXX

112

SEPTEMBER/OCTOBER 2007 • FTSE GLOBAL MARKETS

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Page IBC1

THE FTSE I WANT THE WORLD INDEX FTSE. It’s how the world says index. Global markets grow more complex and interconnected every day.To stay abreast, you need a comprehensive index that can slice and dice markets the way you do. The FTSE Global Equity Index Series was the first benchmark to cover the world seamlessly with a single consistent and transparent methodology. Because FTSE indices are independently verified by a panel of market practitioners, you can be sure that they will always be in line with investors’ needs. Wherever you invest, FTSE gives you the clearest view of how you are doing. www.ftse.com/invest_world © FTSE International Limited (‘FTSE’) 2007. All rights reserved. FTSE ® is a trade mark jointly owned by the London Stock Exchange Plc and The Financial Times Limited and are used by FTSE under licence.

GM EDITORIAL 21.qxd

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