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FTSE’S NEW COUNTRY CLASSIFICATION BREAKDOWN ISSUE 22 • NOVEMBER/DECEMBER 2007
Countrywide Financial tries to find its feet The future of electronic exchange trading The attraction of 130/30 investment strategies
CHINA’S NEW INVESTMENT FUND - A LONG TERM BLOW TO THE DEBT MARKETS?
SECURITIES LENDING ROUNDTABLE: TRANSPARENT GROWTH
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FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2007
hey said it could not be done; but it has. Some 22 transition management specialists have signed the T-Charter, the voluntary code of practice that governs the way that transition managers win and perform portfolio transitions. Inalytics chief executive, Rick Di Mascio, who chaired the discussions, notes the T-Charter has “real value to clients when selecting and engaging transition managers.,” and will help beneficial owners identify the key issues to consider when transitioning their assets. The T-Charter has been a consistent theme in our coverage, but always with the underlying caveat that it might be difficult to get the global transition management community, and their compliance officers, around a table to put ink on paper that binds them to a voluntary code of best practice. Any doubts have been roundly smashed. We send our congratulations to a forward thinking community that took the initiative to ensure clients enjoyed best practice.“It was imperative for the industry to reach an agreement to improve transparency and reassure pension funds that transitions are being managed properly and in a cost efficient way,” says Di Mascio, who was instrumental in bringing all parties to agreement. Honourable mentions should also go to Graham Dixon of Credit Suisse, who was the intellectual driver behind the T-Charter, Tim Wilkinson of Citigroup, Jody Windmiller of UBS and Lachlan French (previously of State Street, and who has just moved to Barclays Global Investors), who consistently lobbied the press and, in fact, market practitioners to sign up to the document. When we commented on the credit markets in the July/August edition, spreads on corporate-debt instruments were still comfortably tight, corporate bond purchases among foreign investors remained strong, and, despite worsening conditions within the US housing market, the stock market roared ahead, closing above 14,000 for the first time ever in July. That was then. This is now. The speed with which the sub-prime loan debacle spread throughout the general credit markets has been astonishing, to say the least.“The balance of risk to the economy seems to have shifted,”admits Atlanta Federal Reserve Bank President Dennis Lockhart. Read David Simons’s US overview and Andrew Cavenagh’s report on the asset-backed market for an update on the key inhibitors that have stymied the debt capital markets these past weeks. Art Detman meantime looks at the summer woes of Countrywide Financial Corporation (CFC), which developed so rapidly that it surprised many in the American home mortgage industry. As sub prime loans made by other lenders defaulted in large numbers, home prices softened, and interest rates rose CFC remained optimistic, because common wisdom said the home mortgage industry’s problems were restricted to sub prime loans. At CFC, sub primes comprised no more that 10% of loan originations. However,“What got Countrywide and others into trouble was their financing strategy,” says Michael McMahon, a former commercial banker turned security analyst who is now a private investor. As one star wanes, another rises and our cover story this month highlights the remit and potential impact of China’s new investment corporation, whose coffers are being fuelled by China’s surging foreign exchange reserves “This stockpile of cash is a source of excess liquidity in the economy, a low-yielding asset base, as well as a major political issue,” says Jing Ulrich, managing director and chairman of China Equities at JPMorgan. Julia’s Grindell’s incisive article hints at the explosive power the fund will wield. There is no doubt that it is a time of change. Some would even say a paradigm shift in the nature and drivers of the global financial markets is underway. What role emerging and heavily capitalised Chinese financial institutions will play in that new world order is just emerging.
T
Francesca Carnevale, Editorial Director October 2007
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Contents COVER STORY COVER STORY: CHINA TURNS CORNER IN FOREX MANAGEMENT Page 47 In March, China reached a turning point in the management of its foreign exchange reserves. The National People’s Congress announced it would sponsor a new state foreign exchange investment corporation with a mandate to look beyond the safe haven of government securities markets and reap higher returns on its burgeoning forex stockpile. China Investment Corporate Ltd. (CIC). What will it do? Julia Grindell reports.
DEPARTMENTS MARKET LEADER
WHAT NOW FOR THE US SUB PRIME MARKET? ..............................Page 6
INDEX REVIEW
KICKING OFF ANOTHER BULL RUN? ................................................Page 10
Dave Simons looks at the fallout from the summer’s crunch in the credit markets
Simon Denham, managing director, Capital Spreads, looks at the main indices
NORTHERN TRUST ITALIAN TAX INITIATIVE ..............................Page 12 Northern Trust adds to its expertise in pan-European pension pooling
TARGET FUNDS FIND THE BULLSEYE
............................................Page 14 Dave Simons reports on the new ways of optimising wealth while minimising upkeep
IN THE MARKETS
WHAT DOES ‘BEST EXECUTION’ MEAN? ........................................................Page 18 It means different things to different people, even under MiFiD. Dave Simon explains.
WHAT NOW FOR THE RATINGS AGENCIES?..............................Page 24 Are ratings agencies misguided or misunderstood? Neil O’Hara finds out.
IN A CLASS OF THEIR OWN ......................................................................Page 27 FTSE Group’s new country classification rulings and their impact.
STOCK EXCHANGE REPORT
TASE BASKS IN THE SUNLIGHT..............................................................Page 29
FACE TO FACE
THE DIFC DASH FOR GROWTH ..................................................................................Page 31
TASE CEO Ester Levanon on the dynamics of growth.
Francesca Carnevale talks to Dr Omar bin Sulaiman, chairman of the DIFC
ISLAMIC FINANCE: WAITING FOR THE UPSURGE ................Page 34 John Rumsey examines the impact on corporate borrowing
REGIONAL REVIEW
THE QUESTION OF QDII ..............................................................................Page 38 QDII is coming into its own in 2007, Stuart Leckie, CEO, Stirling Finance explains why.
THE SELLING OF SINGAPORE ..................................................................Page 44 The Singapore authorities play for high stakes as the city-state becomes a regional hub
ALTERNATIVES INDEX REVIEW 2
THE ATTRACTION OF 130/30 INVESTING
....................................Page 73 Neil O’Hara charts the rise of hedge-fund lite investment strategies. Securities Lending Market Overview ........................................................................Page 87 Market Reports by FTSE Research ..............................................................................Page 88 Index Calendar ..............................................................................................................Page 96
NOVEMBER/DECEMBER 2007 • FTSE GLOBAL MARKETS
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Contents FEATURES COUNTRYWIDE IN THE SPOTLIGHT ..................................................Page 51 From a single office in Calabasas — a former stagecoach stop just north of Los Angeles — Countrywide grew into the world’s largest home-mortgage company, originating $463bn in loans last year and servicing a $1.5trn portfolio of home loans. The company’s success made cofounder and chairman Angelo Mozilo a very wealthy man. Now, both his fortune and his company may be in jeopardy because of a deadly combination of rising interest rates, falling home sales, and a worldwide liquidity crisis. Art Detman reports
THE FUTURE OF SECURITIES LENDING ROUNDTABLE
..........Page 57 There are now fund managers who traditionally shunned securities lending and left it to be dealt with in a back office manner by back office people who are now borrowing securities for the first time. Not only 130/30 investment strategies, but also new regulations and deregulation have encouraged investment managers to recognise that borrowing securities and shorting them is actually good investment management practice and not just something that “evil people” do, says Mark Faulkner, CEO, Spitalfields Advisors. To find out what other attendees had to say, join the roundtable
AUTOMATING THE OTC DERIVATIVES MARKET
..........................Page 69 Efforts to automate trade processing have come a long way since regulators leaned on the industry to cut the volume of outstanding confirms on credit default swaps two years ago. Yet despite the enormous information technology investment already made, the summer surge in trading revealed that more is needed to handle the market's continuing exponential growth. Neil O’Hara reports
ABS ISSUANCE INHIBITED ..........................................................................Page 80 Asset-backed bonds appeared to have become a highly liquid option for financial market investors. Yet within a period of six weeks, the abrupt seizure in short-term borrowing around the world—driven by concerns over exposures to the worsening US sub prime mortgage crisis?turned the market on its head. Funding problems experienced by many ABS investors sent valuations spiralling downwards. Bond spreads in the secondary market quadrupled across the ratings spectrum in some cases, forcing prospective new issuers to abandon their plans indefinitely. How did this happen, and where does the market go from here? Andrew Cavenagh reports
ECNS RING CHANGES IN THE TRADING LANDSCAPE........Page 83 Although regulation in the US and Europe is often written about as a catalyst for change, the trading landscape in both regions has already been altered thanks to direct market trading, algorithmic trading, a sharpened focus on best execution and banks’ internalising their own orders. Legislation has and will only accelerate the trends set in motion. New electronic players have emerged while existing incumbents and regulated exchanges are busy reconfiguring their models. Who will survive, of course, is another question. Lynn Strongin Dodds reports
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Market Leader DEBT MARKETS REVIEW
WHERE NOW WHEN ALL ROADS LEAD TO THE US HOUSING BUBBLE? Economists worry that the unwinding of the debt markets has only just begun, though few are surprised at the ferocity of the pullback, given the dangerously high levels of debt in excess of income growth that underscores every facet of the US economy. Can Federal Reserve rate cuts and other government interventions have any meaningful impact? From Boston, Dave Simons reports. N SEPTEMBER, SECURITIES firms and leading leveraged buyoutbackers Morgan Stanley and Lehman Brothers both revealed losses related to the decline in the debt markets. Stateside, barely $23bn in new M&A deals were issued in early September, says Dealogic. Strategic deal volume, a measure of corporatebuying activity, plunged to $10.7bn, from $52.6bn a year ago. Some commentators say the unwinding of the debt markets has only just begun, though few are surprised at the ferocity of the pullback, given the dangerously high levels of debt in excess of income growth that underscores every facet of the US economy, from the record number of home-equity borrowers to the mother of all debtors, the US government (currently $9trn in the hole). Since President George W. Bush took office in 2001, the ratio of debt to GDP has risen from around 250% to 339% at the end of the first quarter, according
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to CorporateOne’s September Economic and Financial Digest. All roads lead back to the bursting US housing bubble, which pulled the rug out from under the mortgagesecurities market as institutional investors withdrew their long-held support. Lenders responded by closing down once readily available avenues of credit, in the process exacerbating an already precarious situation. With mortgage-equity withdrawals seemingly tapped, corporations, which have long relied on the growth in mortgage debt to sustain profits, will likely watch their own growth dissipate—particularly as housing prices continue to fall, say analysts. Though the Federal Reserve’s 50 basis points (bps) rate cut in September was welcome news, the markets have already priced in several more cuts through year’s end, with many analysts thinking that a recession could be triggered if cuts do not materialise.
Luigi Spaventa, professor of economics at the University of Rome, calls the current crisis an extreme version of the credit risk transfer process, which is largely due to the prevailing “originate and distribute” business model, in which banks originate the loans and then distribute the underlying risk to outside investors, theoretically reducing the susceptibility to the kind of systemic shocks that have since impacted the debt markets. Obviously this is not what happened, says Spaventa. “Though the credit underlying all kinds of asset-backed securities and of credit derivatives should no longer be on the balance sheet of the originating banks, the collapse of one segment of those securities has affected and is affecting the banking system.” Namely the market for structured investment vehicles (SIVs), which invest mainly in high-yield asset-backed securities. Because SIVs do not appear above the line on a bank’s balance sheet, information related to the banks’ commitment to such products is limited at best—which is precisely the problem, says Spaventa.“As the prices and market liquidity of the collateral collapsed, refinancing by rolling over the outstanding commercial paper has become almost impossible. This is why the committed banks and financial institutions have been required to provide emergency liquidity. In this way, some of the credit risk that was transferred to the market by the banking system has re-emerged on the banks’ books, straining capital requirements to an extent depending on the size of the commitment relative to the assets of the bank.” Most troubling to market watchers has been the rapid pullback in volume and tenure of asset-backed commercial paper (ABCP). In the month of August alone, commercial paper fell nearly 12%, or nearly two times the previous
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20.10.07 20 10 07 FTSE Global Gl b l Markets M k t 1
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Market Leader DEBT MARKETS REVIEW
largest decline occurring 37 years ago. seems likely that net capital inflows, securitisation—the conversion of nonInterest rates on commercial paper have which are needed to finance the gaping marketable assets into marketable risen a full percentage point since late current account surplus, will weaken assets—that swept across the financial summer, creating further problems for further, thereby putting downward world in recent decades…this flood of corporate borrowers looking to dish off pressure on the dollar. Indeed, we marketable assets not only has eroded debt to an increasingly smaller pool of project that the greenback will traditional concepts of liquidity, it has available investors. At the same time, depreciate further vis-à-vis most major stimulated risk appetites and fostered a belief that credit usually is available at maturities have been reduced from currencies in the quarters ahead.” reasonable prices.” months to weeks or even Consider the massive days in some instances. By market for credit default late September, questions swaps (CDSs), which act as remained as to whether Luigi Spaventa, professor of insurance against default on companies could properly economics at the University of Rome, an underlying debt dispense with an calls the current crisis an extreme instrument. Since 2001, accumulated $959bn demand for CDSs has grown worth of asset-backed version of the credit risk transfer from $1trn to nearly $36trn paper. Banks that provided process, which is largely due to the today. Because they do not financing for the most prevailing “originate and distribute” appear on an exchange, little vulnerable segments of the business model, in which banks is known about the extent of market, including monooriginate the loans and then distribute CDS ownership among the line debt products as well major financial firms. The as structured investment the underlying risk to outside investors, problem, say experts, is that vehicles, may be left theoretically reducing the susceptibility CDSs require substantial holding the bag as a result to the kind of systemic shocks that liquid backing in order to of the debt-market have since impacted the debt markets. make good on any potential volatility, say observers. Obviously this is not what happened, liabilities—and in a market as The dislocations in the says Spaventa. over-leveraged as this, such credit markets have backing may, in some caused issuance of instances, be non-existent. structured fixed-income Again, liquidity—or lack of products to decline Traditional economics defines it—underscores the new reality. “The significantly, notes Jay Bryson, global economist for Wachovia. “Although liquidity as available cash against total assumptions…upon which many of new issuance will not likely remain at liabilities, yet the historically low interest these vehicles have been structured and today’s depressed levels forever, few rate environment of recent years has rated have come into question,” notes observers expect it to return to the fostered the notion that easily accessible Maureen Coen, global head of assetheady pace of early 2007 anytime credit is just as good as cash. As backed commercial paper origination at soon,” says Bryson. While not consumer borrowing peaked in early Credit Suisse.“It was never assumed that predicting a mass exodus, Bryson 2006, the average rate of US household market liquidity would be so restricted believes that the reduction in available savings went negative for the first time for so long for these types of vehicles.” The highly complex, enormously structured products, combined with since the Great Depression. In short, the the relative unattractiveness of entire infrastructure of the US economy leveraged trading practices of hedge alternative vehicles like government through the middle part of the decade funds is also significant, say critics like bonds, may have a substantial negative depended on the continued price Robert Bruner, co-author of the book effect on US currency going forward. appreciation of American homes. In a The Panic of 1907: Lessons Learned from “Foreign investors—avid buyers of US recent Wall Street Journal opinion piece, the Market’s Perfect Storm. Bruner structured products over the past few Henry Kaufman, former chief suggests that many of the same years?will not have as many fixed- economist for Salomon Brothers, mused elements that preceded the crash 100 income securities to purchase in the how “this new mindset has been years ago are evident today, namely too US,” asserts Bryson. “Therefore, it abetted by the tidal wave of much debt and not enough information.
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The announcement by Bear Stearns last May that it had sustained substantial hedge-fund losses through the use collateralised debt obligations (CDOs) was not that unusual; two months later, the company sent shock waves through the investment community when it admitted that it didn’t know exactly how much money it had lost. “Complexity creates information asymmetry,” observes Bruner.“For anyone nowadays, it is very difficult to know what is really going on.” Obviously feeling some measure of responsibility as the situation worsened, on September 18th the Federal Reserve exceeded expectations
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by knocking a half-point off the fund rate, the first such reduction in more than four years. Most analysts believe the tipping point was September’s jobs report, which indicated that corporations were likely postponing new hires due to tightening credit markets. The Federal Reserve was handed a convenient fall-back: it was cutting due to bona fide concerns about the economy, rather than providing a safety net for debt-addled homeowners and cocky investors. Time will tell whether its intervention has a lasting impact or is merely a short-term panacea. “The sub prime mortgage losses that triggered uncertainty about
structured products more generally have reverberated in broader financial markets, raising concern about the consequences for economic activity,” admitted a somber Federal Reserve chairman Bernanke, as government officials began a concerted effort to key in on the mystery and complexity that is at the center of today’s debt market woes. “If there is one field where something ought to be done, even before damning the sins of rating agencies,”adds Spaventa,“it is to find a way to deal with the off-balance sheet operations of banks and achieve greater transparency of their effective exposure to risk.”
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Index Review THE IMPACT OF MARKET VOLATILITY
Why is the FTSE 100 pressing to hit all time highs? The answer to this is the continued gains in profitability on the less heralded portions of the markets. While all the headlines focused on the trials and tribulations of the banking sector, the reporting season actually showed the best performance ever from the rest of Britain’s corporate base. The credit crunch might make for good headlines but it does not alter the fact that actual money is increasing at around 12% year on year. This money must go somewhere. Simon Denham, managing director of spread betting firm Capital Spreads reports. ITH MY SPREAD betting hat, I can only smile at all this volatility as this begets business. However, substantial damage may be done by the continued chaos. British public finances are in a precarious position that the Labour administration dare not continue the cycle of borrow and spend. It must hold back wage expectations in the public sector. However, the number of state employees is huge and any reduction in state spending is almost certain to force, if not a recession, then at least a near approximation of one. Moreover, politicians are so fearful of the electorate’s dependency on the drug of government largesse that even the opposition Conservative party cannot bring themselves say“spending cuts”. Instead, they come up with tiny palliatives such as death duty changes, first-time home buyer bribes and taxes on wealthy non-domiciled foreigners. In August, the average price to earnings (P/E) ratio of UK top 100 plc was an attractive mid 12. With better
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KICKING OFF ANOTHER BULL RUN? than expected results in pockets of the market the market, another 400 points higher, is still in the mid-12’s, but now with the potential of further interest rate cuts, it all looks even more attractive. The FTSE 100 Index has managed to rally some 17% since the end of 2005, compared with over 25% for the S&P, almost 50% for the DAX and well over 100% for the BRIC markets. In the great global scheme of things, UK plc is standing still and with the prospect of a tighter public sector spending round and more cautious bank lending regime to put a firmer brake on growth. On the plus side, the increasing strength of the Euro has given the UK a distinct advantage over its continental competitors. As sterling most likely weakens, combined with the potential for lower rates, the export manufacturing sector is at its most optimistic in years. One area of obvious expectation for investors is the mining sector but these revenues are dependant to a great extent on the ‘goodwill’ of the country in which they are operating and in the current political environment must surely come with a health warning. What has happened to the oil industry could very well become a blue-print for resource extraction companies in the years to come. Oil has quadrupled in recent years but the share price of the
oil majors has gone almost nowhere. A huge percentage of what should have been a massive profits boost has been swiped by greedy governmental use of windfall taxes (UK) or, in some cases, virtual sequestration or/nationalisation (as in Russia,Venezuela and, Bolivia for example). As precious and base metals become ever more valuable, politicians will find it increasingly difficult to stand in the way of popular movements to take back natural assets ‘for the people’— especially in poorer nations where the glamour of communism still exerts its beguiling influence. An estimated 70% of the FTSE 100 Index companies income comes from outside the UK and it is this revenue stream that is holding up valuations. With the expected fiscal tightening in the UK public sector likely to affect the whole growth, potential of the country investors will be sifting through portfolios to shake out companies with too great an exposure to solely UK revenue. Of course, all this plays against a global valuation level far in advance of the plodding FTSE 100 and FTSE 250. China trades on a P/E of 50 (with inflation near to 7%!), the Hang Seng and the S&P at 19 and Europe at around 15. If something can be done about the appalling level of UK corporation tax then, potentially, we may be at the start of yet another bull run.
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In the Markets NORTHERN TRUST SECURES ITALIAN TAX RULING
NORTHERN TRUST LEADS THE WAY ON ITALIAN TAX TRANSPARENCY RULING Following a recent, landmark ruling from the Agenzie delle Entrate, the Italian tax authority, Northern Trust is the first custodian to be able to secure reduced withholding tax rates for investors holding Italian equities through a tax-transparent, cross-border pooling vehicle. The reductions are in respect of dividend income arising from investing in Italian stocks, which could (potentially) increase total return for investors in Italian equities via such vehicles by over 40 basis points a year. ORTHERN TRUST IS the first asset service provider to obtain a positive Italian tax ruling covering tax-transparent pooling vehicles. The specific ruling pertains to one of Northern Trust’s client’s Irish Common Contractual Fund (CCF) that invests in Italian stocks. Northern Trust would not be drawn into the specifics of the ruling, claiming (naturally) some intellectual property in the terms of the ruling. However, according to Aaron Overy, pooling business development manager in Northern Trust’s asset servicing sales team,“While the ruling at this stage is only binding on the specific CCF, it sets a precedent, which we can then utilise for other clients interested in leveraging the ruling. Each of our taxtransparent pooling clients that invest in Italian stocks could achieve a positive outcome from the Italian tax authority and potentially retain more of their investment returns.” The fact that the new ruling covers Italy is important, notes Overy,“as it is a high yielding market of around 3.11%. Compare and contrast with others, for instance: The US offers a 2% yield, France 2.74%, Germany 2.36% and Switzerland 1.6%. As part
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of a long term strategy, there will always be substantial interest in the Italian market.” Overy explains that, “in the European context, many countries are bound by agreements that allow the charging of the same rate of withholding tax, irrespective of the country you are domiciled in. To achieve this a fund requires supportive tax rulings in at least three places: in the domicile of the fund (for example Luxembourg or Dublin), the country from where the original investment is made (through a tax transparent fund, such as a CCF in Dublin) and the country in which the assets are bought (in this instance, Italy).” Northern Trust has consequently developed a methodology for other clients with Italian equity investments using the CCF fund structure, to guide them through the process of approaching the Italian tax authority on the issue of tax transparency. “For us it was essential to ensure that the way the fund is structured precisely meets the requirements of the Italian tax authorities. The wording has to be absolutely precise,” notes Overy. He adds that,“We now think that we have
the correct constituting documentation that will allow other clients to benefit.”Overy is anxious to stress however, that rulings from Italy are not now automatic. “Because we have a precedent, it is now easier for us to go back and get a similar ruling. We understand the processes better and the people involved and what they require. It is not that easy to begin that process from scratch.” Claims to intellectual property aside, at the same time, Northern Trust is also urging other pooling clients, including those using the Luxembourg Fonds Commun de Placement (FCP) and the Dutch Fonds voor Gemene Rekening (FGR) structures, who have an interest in Italian equities, to consult their tax advisers on this topic. Northern Trust is among the pioneers of cross-border pooling and claims to be the first to support fully tax-transparent funds, created to pool the assets of investors with multiple tax rates, investing in multiple jurisdictions. The bank even has a patent pending with the United States’ Patent and Trademark Office (USPTO) and World Intellectual Property Organisation (WIPO) to protect the innovative methods and systems it has developed to support cross-border tax-transparent pooling vehicles. Onto a winning formula, by August this year, the bank has more than doubled its cross-border pooling assets under custody over the previous year to over $24bn.
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“The appetite for cross-border pooling continues to grow, driven by the need for platforms that can support our clients’ diverse business needs and global investment strategies,” notes Overy.“Our pooling services offer both tax-transparent and non-taxtransparent funds with multiple countries of investment and multiple countries of investor. The structures have allowed multinationals to pool their assets, gaining improved oversight of their pension funds as well as offering economies of scale. Cross-border taxtransparent pooling also has a particular appeal to investment managers, who can realise 30 basis points or more of additional return through the
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elimination of ‘tax drag’when compared with a traditional pooled vehicle.” According to Overy, the confirmation of tax-transparency by tax authorities is pivotal for cross-border pooling, enabling investors within a “pool” to obtain the same withholding tax treatment as though they were investing directly. In this particular case, it means that the underlying investors in the pooled investment fund are subject to the same withholding tax rates as if they had invested directly in Italian equities. However, notes Overy, investors enjoyed: “all the added benefits of investing via a pooled fund – for example, tighter governance, better risk management, economies of scale
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and access to new asset classes”. Overy explains that the ruling is a “milestone and “significant development in the pooling arena owing to the fact that, for some time, it has been understood that Italian domestic law would not typically recognise such structures as tax transparent. This has not been an issue in the majority of other major investment markets.” The next objective, notes Overy, is to achieve a similar ruling for France, which together with Italy, have been notoriously difficult markets to pin down on tax transparency rulings. “It is now however, only one objective among many.”
At UBS we give you direct access to our own advanced crossing technology. With our crossing rates reaching 15% in Europe alone*, direct interaction with our liquidity has never been easier or more effective. Get into the flow. www.ubs.com/ directexecutionservices
* UBS figures, percentage of notional executed, eligible flow, May 2 2007. Issued in the UK by UBS Limited, a wholly owned subsidiary of UBS AG, to persons who are not private customers. In the U.S., securities underwriting, trading and brokerage activities and M&A advisory activities are conducted by UBS Securities LLC, a wholly owned subsidiary of UBS AG that is a registered broker-dealer and a member of the New York Stock Exchange and other principal exchanges and SIPC. © UBS 2007. All rights reserved.
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In the Markets TARGET MATURITY FUNDS
TARGET DATE FUNDS GAIN GROUND Experts estimate that a possible $300bn in US employer-backed defined-contribution assets will be gradually transferred over the next ten to 15 years as baby boomers exit the workforce. An opportunistic mutual fund industry has responded by offering an array of so-called target-date retirement fund products, aimed at optimising wealth preservation while minimising upkeep. Dave Simons reports. O DATE, ONE of the most popular retirement-investment vehicles has been the targetdate asset-allocation fund, also known as target maturity or lifecycle funds. Typically constructed as fundof-funds products that invest in the portfolios of a number of existing mutual funds, target-date funds are specifically designed to capitalise on the most basic of investment tenets: to maximise exposure to equities during the early stages of one’s savings career, and, conversely, to mitigate risk once the person nears retirement age. The chief benefit of this approach, obviously, is that all asset adjustments are made automatically, relieving the investor (and plan administrator) of such tedious duties. Target fund specialists say that target funds are stimulating debate in four key sectors. There is a growing debate on the relative merits of the US system versus the UK system
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The passage of the United States’ Pension Protection Act of 2006 (PPA) paved the way for employers to automatically enrol employee earnings into 401(k) accounts unless directed otherwise. Moreover, companies are now mandated to opt for the low-maintenance target-date funds. The result has been a monumental leap in the number of target-date funds, from 145 two years ago, to 223 through the first half of 2007, according to Morningstar. Target-date fund assets have nearly doubled since the beginning of 2006, and now total over $150bn worth of assets under management, notes Boston-based Financial Research Corporation. Fund leaders include Fidelity,— which originated the target-date concept with its Freedom Fund in 1996 and remains the largest targetdate provider—Barclays, T. Rowe Price and Vanguard.
The passage of the United States Pension Protection Act of 2006 (PPA) paved the way for employers to automatically enroll employee earnings into 401(k) schemes unless directed otherwise. Moreover, companies have increasingly mandated the low-maintenance target-date fund as the default option. The result has been a monumental leap in the number of target-date funds, from 145 two years ago, to 223 through the first half of 2007, according to Morningstar. Photograph © Elder Salles, Agency: Dreamstime.com, supplied October 2007.
On the right glidepath Key to the success of any target-date fund is the establishment of a proper “glidepath”; a variable asset-allocation formula that is gradually adjusted based on risk levels appropriate for a participant’s target retirement date. The strategy is partially what distinguishes target-date funds from ordinary balanced funds, says Susan Czochara, senior product manager of defined contribution solutions for Northern Trust Global Investments (NTGI). The firm recently introduced a series of target date collective funds in five-year increments beginning 2010 through 2050.“Typical balanced funds have a set allocation to bonds and equities or other asset classes that remain static over time except for occasional rebalancing,” says Czochara.“Whereas a target date fund does change over time based on a glidepath becoming more conservative as the investor approaches their target
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In the Markets TARGET MATURITY FUNDS
date, which typically represents their date of retirement.” If a plan participant were to invest in a balanced fund with a current allocation of 70% equities and 30% bonds, in ten years that allocation will not have changed in terms of risk and return profile. By contrast, a target date fund with the same equity-bond mix will have shifted its allocation to 60% equities and 40% bonds at the end of the ten-year period, reflecting a more conservative risk and return profile, says Czochara.
Finding the right mix With life expectancies on the rise, individuals need all the help they can get to ensure sufficient funding throughout the retirement years. Which is precisely why some targetdate funds remain in force well beyond the individual’s traditional cash-out date. However, such a strategy increases the individual’s risk of losing significant amounts of capital post-retirement, with no chance to offset such losses through additional contributions. “Blindly lengthening the investment horizon without due consideration of the risk associated is a possible invitation to a very frugal retirement,” notes Cleo Chang, vice president and head of the Investment Research Group at Wilshire Funds Management and author of the report The Evolution of Target Maturity Portfolios. Surveys show that more than 80% of participants exit their plan on retirement day anyway, says Doug Murray, director of client delivery services at Wells Fargo Institutional Trust Services. “We do not believe that participants will stick to an approach that results in losses in principal, no matter what modern portfolio theory says.” Murray points to a recent industry survey indicating that 68% of participants
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with either five years prior to or after retirement were concerned about the impact of a stock decline on their portfolio. “A quarterly account statement that shows loss of principal will trigger participant reaction,” cautions Murray.“The best target date funds need to be designed with this in mind.” Additionally, target-date funds often fail to take into account the reallife investment behavior of plan participants. According to a recently issued white paper from JPMorgan Asset Management entitled Ready! Fire! Aim?, the industry assumes that all participants make adequate account contributions, receive annual salary increases, never borrow from their accounts and make withdrawals in a timely manner come retirement. However, in many instances the opposite may be true on all counts. Richard Shaw, president of Connecticut-based QVM Group LLC, says that there are other variables that can skew a target-date fund’s longterm results.“For example, what a 50year-old retiree should do is probably different than what a 65-year-old retiree should do,” notes Shaw.“What a wealthy retiree and a struggling retiree should do is completely different. What a retiree with a pension income should do is not the same as what a retiree without a pension income should do. How one retiree can cope emotionally with volatility is not the same as how another can cope.” While foreign equities currently account for more than half of the world’s market capitalisation, targetdate funds tend to have a much stronger domestic orientation, with as much as a four to one US to non-US equity bias. As such, investors seeking a strong exposure to foreign stocks would not be well served by such allocations, says Shaw.
New Approaches Though the fund-of-funds strategy remains the most common approach for target date investing, blended or hybrid vehicles, which combine both active and passive management styles, are beginning to make inroads. Because they reduce volatility and provide an optimal risk/return tradeoff, hybrids are widely considered to be more potent and efficient than the standard FoF model, says NTGI’s Czochara. “Enhanced strategies also are more cost-effective than actively managed components, with fee structures that tend to be about half that of active strategies.” In an effort to improve the targetdate prototype, several firms have begun offering target-date funds aimed at addressing the specific needs of the participant. Wilshire Funds Management’s Payden/Wilshire Longevity funds, a series of four target-date funds (2010, 2020, 2030 and 2040) launched in conjunction with Los Angeles-based fund company Payden & Rygel, holds assets through retirement using a blended strategy, but with a twist: individuals who are still in the early stages of the savings cycle are treated to a more aggressive asset-only efficient frontier, while those nearing retirement fall into a surplus frontier category, which aims to minimise capital loss while maximising the goal of a retirement surplus. Others include BMO Fund’s LifeStage Plus, which allows participants to lock in gains on a daily basis so long as they stay committed until maturity, as well as Eaton Vance Corp.’s Supplemental Retirement Account (SRA), a web-based programme for systematic retirement savings outside of a standard qualified retirement plan.
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In the Markets MIFID: WHAT BEST EXECUTION MEANS TO YOU
Paul Kennedy, vice-president of product management at GoldenSource, a provider of enterprise data-management solutions.“The point is, best execution really means different things to different people. Even if you asked the regulators in the European Union, most of them would probably struggle to tell you the correct definition.Yes, there is the knee-jerk, obvious, ‘cheapest-fastest-best price,’ but that doesn’t always make sense given the particular situation, because there are overriding issues such as market impact, timing, and so forth,” says Kennedy. Photograph kindly supplied by GoldenSource, October 2007.
BEST EXECUTION, OR WORST NIGHTMARE? Coming to grips with best execution has been far and away the most challenging aspect of Markets in Financial Instruments Directive (MiFiD) in the years and months leading up to its November implementation. Now with MiFiD in play, it is still not completely clear whether everyone in the investment community is on the right track. From Boston, Dave Simons reports. HREE-AND-A-HALF years in the making, the Markets in Financial Instruments Directive (MiFID), came into effect on November 1st this year. MiFiD seeks to
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provide increased protection to investors by harmonising the rules of conduct applicable to investment services providers, while improving market efficiency and streamlining
communications processes. Key to the successful deployment of MiFiD is an all-encompassing best execution policy, requiring financial services firms on both the buy and sell side of the market to provide the best execution arrangements possible for their clients, taking into account a number of factors including price, cost, speed, likelihood of execution/settlement and size. “Best execution has been the most discussed area of MiFiD since the directive was first proposed,” noted Rob Nieves of KPMG during a recent meeting of the London-based Financial Services Discussion Club. “Liaising between the buy-side and the sell-side and documenting policy adherence will require significant process changes and re-training across departments if this element of MiFiD is to be successful.” Indeed, getting a handle on the new best-execution requirements has been the most challenging aspect of MiFiD in the years and months leading up to its November implementation. As recently as late summer, a survey conducted by SunGard, a software and processing-solutions provider for the financial-services industry, found that one in two financial services firms weren’t completely certain that their reading of best execution under MiFiD will pass the test.
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THE FTSE I WANT TO INVEST MORE INTELLIGENTLY INDEX FTSE. It’s how the world says index. Because investors always want superior returns, FTSE has developed a range of investment strategy indices that are designed to offer an enhanced risk / return profile. Alongside traditional indices, we offer indices that use alternative weighting criteria, which include sales, cash flow, book value and dividends, instead of market capitalisation. www.ftse.com/invest_intelligent © 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.
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In the Markets MIFID: WHAT BEST EXECUTION MEANS TO YOU
“It is like a philosophy paper—‘best execution, define it in 100 words,’” says Paul Kennedy, vice-president of product management at GoldenSource, a provider of enterprise data-management solutions.“The point is, best execution really means different things to different people. Even if you asked the regulators in the European Union, most of them would probably struggle to tell you the correct definition. Yes, there is the knee-jerk, obvious, ‘cheapest-fastest-best price,’ but that doesn’t always make sense given the particular situation, because there are overriding issues such as market
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impact, timing, and so forth. While we are edging towards a clearer definition of best execution within Europe, I think the more interesting thing is the recognition that execution, advice and trading are three essential component activities that all have to be treated as separate services.” Now, as MiFiD comes into play, it is still not completely clear whether everyone in the investment community is on track due to the wide-ranging implications of the directive, admits Alain Lesjongard, head of international compliance at the Bank of New York Mellon.“Like most large organisations, we are investing a lot of time in
contacting our clients about how we are going to achieve best execution,” says Lesjongard. “In time, the MiFiD goals will be realised and it will have a positive impact. However, November 1st is just the start of MiFiD and 12 to 18 months post-MiFiD implementation will be equally important in highlighting the benefits and impact to the industry across Europe.”
Into the fast lane Just as the electronic communications networks (ECNs) helped revolutionise American trading during the 1990s, the new EU regulations are designed to encourage the proliferation of high-
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speed alternative trading systems and other advanced distribution processes necessary to meet the multi-platform demands of best execution. “With MiFiD in mind, all trading venues must have a technology infrastructure that ensures that all steps are taken to deliver efficiency and meet best execution requirements,” says Markus Gerdien, president of business area market technology for EU data-centre operator OMX. “In order to be competitive, trading venues must constantly be able to assure investors best execution. Here the focus is no longer strictly on price—other factors, such as cost, speed, likelihood of
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execution and settlement are equally important. Any trading venue will have to earn its business in the future.” MiFiD is also prompting an almost complete renewal process in the STP arena, according to Jason Nabi, head of financial intermediaries in the UK for BNP Paribas.“You look at the increased volumes, the complexity, the numerous additions in terms of execution points, the ongoing changes around the various settlements engines, and so forth—the whole architecture is constantly evolving. As a service provider, we have spent a lot of time and investment capital making sure that we’re up to speed not only with what the markets
FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2007
are up to today, but what they’re likely to do moving forward.” Looking at the long-term impact of MiFiD on the broker/dealer community and the stock exchanges and alternative venues in which they trade, Lesjongard believes there will be increased competition for business between the traditional exchanges and new alternative venues. “Brokers/dealers will have to increase their awareness of what trading facilities are available as they will have to justify having obtained ‘best execution’ for their retail and professional clients. In the longer term this will result in further efforts by the
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In the Markets MIFID: WHAT BEST EXECUTION MEANS TO YOU
exchanges and other venues to reduce trading costs, and this will make Europe a more attractive place in which to perform business.” The extent to which traditional exchanges will be adversely impacted by alternative platforms such as Project Turquoise—the pooling of collective trading-data resources by a consortium of investment banks including Merrill Lynch and Deutsche Bank with the goal of bypassing the main exchanges—is also the subject of much debate, says Karel Lannoo, chief executive for the Centre for European Policy Studies (CEPS). “Of the large European exchanges, the London Stock Exchange is probably the most exposed to the effects of MiFiD, as nearly 80% of its income is derived from equity trading and related market data, areas that have been opened up to competition under the new directive.” Like US firms scrambling to comply with newly implemented tax codes and accounting regulations, EU companies may have to wait for the first round of legal decisions to come down to know whether or not they are on the right track. “Part of the problem with best execution is that the wording in the directive is not very specific,”says Greg Kilminster of the research group Complinet Regulatory Insight, echoing the sentiments of a survey of financial services professionals. “The whole point of MiFiD is the implicit piece about removing the national barriers,” says GoldenSource’s Kennedy,“which implies that we do not really need 26 stock exchanges in Europe, for instance. I do not think anybody who really works on [a] stock exchange has seriously got their head around that concept just yet. Going forward, Kennedy sees the world post-MiFiD as a battle of liquidity pools being spread across a growing number of trading venues. “And those
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liquidity pools are all going to have to offer a number of things: ease of access via electronic means; quick execution in nanosecond increments, thereby meeting the algorithmic trading needs of the market; as well as transparency from the customer point of view, i.e., that the price they received was truly a fair one.” What are the implications for nonEuropean institutions that work or have strategic shareholdings in European institutions that invariably fall under the directive? Naturally, US companies, with or without EU domiciled divisions or subsidiaries, will have to comply with MiFiD to be able to fully participate in EU markets. Additionally, domestic firms with significant European clientele will have to make the proper modifications in order to provide the protections afforded by MiFiD. “NonEuropean institutions with stakes in European institutions should already be aware of the changes and be taking them into account when formulating strategy,”says BK’s Lesjongard.“But as the implications become clearer over time, they may well see greater opportunities to do more business in Europe. The opportunities should develop from the reduced trading costs and the regulatory consistency between EEA member states.” Speaking at a recent Washington conference, SEC Commissioner Roel C Campos highlighted the need for EUUS harmonisation in light of the MiFiD best-execution requirements. “In MiFiD there is neither a Trade-Through Rule, nor the private electronic linkages that connect individual US exchanges into a network of trading venues as exists now as a result of Reg NMS…Reg NMS works in the US because of the investment in linkage, among the markets and the ECNs. The time to establish such linkages in Europe will be an important matter.
Alain Lesjongard, head of international compliance at The Bank of New York Mellon. “Like most large organisations, we are investing a lot of time in contacting our clients about how we are going to achieve best execution,” says Lesjongard. Photograph kindly supplied by The Bank of New York Mellon, October 2007.
Also, the enforcement and selfreporting of best-execution rules will be of critical importance to the future of MiFiD. These are details, in my view, that need some study.” Though it may be a bumpy road ahead, Keri Smith, director of network management for RBC Dexia Investor Services, believes the end result will make today’s initiatives well worth the effort. “MiFiD legislation will add to monitoring mechanisms and tighter controls,” says Smith, “but it is important to continually introduce and enhance legislation with an eye toward fostering further growth, rather than hindering it. To be successful, there must continue to be dialogue with all parties involved. Doing so will allow us to learn and contribute to builds that make the industry much more vibrant.”
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In the Markets CREDIT RATINGS UNDER THE MICROSCOPE
HANDS UP: WHO’S FAULT IS IT ANYWAY? Credit rating agencies have become everyone's favourite whipping boy in the aftermath of the sub prime mortgage meltdown. Congress has scheduled hearings; the Securities and Exchange Commission (SEC) and the International Organization of Securities Commissions have launched investigations into rating agency policies, procedures and potential conflicts of interest; and Arthur Levitt, a former SEC chairman, has called for additional oversight and transparency. What next? Neil O’Hara reports. CHORUS OF complaints threatens to drown out the plaintive cries of ratings agencies that they were only doing their job— giving an opinion about the probability of default. Is that enough when the market uses ratings for so many other purposes? Andrew Chow, a portfolio manager at SCM Advisors in San Francisco, has seen it all before. When the high yield bond market collapsed in the late 1980s, he recalls vitriolic accusations that the rating agencies were just after the fees, facilitated the bust, and helped uncreditworthy companies to borrow huge sums. Time passed, the market bounced back and everyone—politicians, regulators and investors included—forgot about it. “The rating agencies behave pretty much the same way they did before and nobody complains about it,”Chow says, “Everybody understands that the rating agencies are not a magic bullet.”
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Actually, Chow has little sympathy for investors who rely on credit ratings and do not do their own fundamental research.The corporate bond market has long understood that rating changes are a lagging indicator of creditworthiness. Investors who outsource their due diligence to the agencies will find out about credit problems, but only weeks or months after people who roll up their sleeves and pore over financial statements.“That is not the way to be a sophisticated investor, is it?” Chow scoffs. He acknowledges that investors unfamiliar with novel debt instruments may prefer to follow third party recommendations but says investors often expect too much from the rating agencies, especially in relation to structured debt. A credit rating addresses the probability of default, not market prices or volatility, after all. When the agencies confer their highest rating, AAA, it
A credit rating addresses the probability of default, not market prices or volatility, after all. When the agencies confer their highest rating, AAA, it means that although default is highly unlikely it will nevertheless occur on rare occasions. Investors who interpret an AAA rating as a guarantee against default do so at their peril; even more so if they extrapolate from a low default probability to assume a stable market price. Photograph © Igor Nikolaev, supplied by Dreamstime.com, October 2007.
means that although default is highly unlikely it will nevertheless occur on rare occasions. Investors who interpret an AAA rating as a guarantee against default do so at their peril; even more so if they extrapolate from a low default probability to assume a stable market price.“That is completely outside of the scope of the agencies,” says James Jockle, senior director, corporate communications at Fitch Ratings. Like the other major rating agencies, including Moody’s and Standard & Poor’s, Fitch publishes default studies that track the performance of bonds it rates. Fitch’s results appear to validate the agency’s methodology. – default rates do increase as the rating decreases. The agency has a better track record on corporate bonds than structured debt, though. The average cumulative fiveyear default rate for the past 15 years was 3.30% for structured debt vs. 3.04% for corporate bonds. Defaults among AAAand AA-rated structured debt are noticeably higher than among equivalent corporate bonds, but the rates are still quite low. Credit ratings may be good predictors of default probability but they play a much bigger role than that implies. The arbitrary designation that bonds rated BBB- or higher qualify as investment grade has long created a discontinuity in the market because so many institutions are not permitted to own sub-investment grade paper. Implementation of the Basel II
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In the Markets CREDIT RATINGS UNDER THE MICROSCOPE
framework for regulatory capital will accentuate the divide. Banks, brokerdealers and other regulated entities subject to the new rules have to set aside significantly more capital against high yield bonds, which means in practice they will not hold them. If the rating agencies downgrade a credit below investment grade, regulated entities will be forced to sell. Banks are among the largest investors in AAA- and AA-rated tranches of collateralised debt obligations and residential mortgage backed securities, including bonds backed by U.S. sub prime mortgages. Rating agencies face the prospect that wholesale downgrades of sub prime paper will cause market participants to sell at a loss, which could reinforce whatever credit impairment the agency was
worried about in the first place. SCM’s Chow argues that rating agencies should focus on credit fundamentals, not their impact on the market. “They are supposed to disregard that feedback loop,” he says, “It should not be the rating agencies’burden.” Jockle says an agency’s reputation is its premier asset, so Fitch can not afford to take into account how its assigned ratings might affect market prices, which are influenced by many other factors besides the rating.“The onus is on us to make the appropriate credit call,” he says, “The issue of potential forced selling is independent of us.” It is not just bond ratings, either. Chow points out that if a rating agency downgrades a commercial paper program from A1 to A2, the issuer will find it almost impossible to roll over
Fitch Ratings Structured Finance Average Cumulative Default Rates 1991-2005 (%)
Average
Average
Average
Average
Average
One-Year
Two-Year
Three-Year
Four-Year
Five-Year
‘AAA’
0.02
0.06
0.1
0.14
0.14
‘AA’
0.07
0.18
0.36
0.53
0.58
‘A’
0.11
0.42
0.95
1.42
1.95
‘BBB’
0.41
1.51
3.11
4.65
5.75
‘BB’
1.13
3.1
4.97
6.36
7.01
‘B’
3.11
6.73
9.79
11.65
12
‘CCC’
24.87
38.57
47.4
50.65
50.21
Investment grade
0.13
0.46
0.95
1.43
1.75
High yield
3.4
6.51
8.78
9.95
10.24
All structured
0.7
1.54
2.37
3.01
3.3
Fitch Ratings Global Corporate Finance Average Cumulative Default Rates 1990-2006 (%)
Average
Average
Average
Average
Average
One-Year
Two-Year
Three-Year
Four-Year
Five-Year
‘AAA’
0
0
0
0
0
‘AA’
0
0
0
0.03
0.06
‘A’
0.03
0.16
0.32
0.48
0.73
‘BBB’
0.26
0.87
1.61
2.53
3.47
‘BB’
1.24
3.64
5.78
7.82
9.84
‘B’
1.47
3.66
6.16
8.59
11.16
‘CCC’ to C
43.41
22.93
30.72
35.64
41.63
Investment grade
0.1
0.34
0.64
0.96
1.31
High yield
2.94
5.75
8.25
10.74
12.72
All corporates
0.61
1.27
1.89
2.51
3.04
Source: Fitch Ratings, October 2007.
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any outstanding paper. Of course, the market can freeze up before the rating agencies take any action, as issuers of asset backed commercial paper have just discovered.“If the rating agencies look at credit fundamentals slightly slower than the market does, well, that’s the way it is,”Chow says. Investors, regulators and politicians are focusing on the potential conflicts of interest embedded in a business model where issuers pay the rating agencies. Is the relationship between underwriters and rating agencies too cosy? Standard & Poor argues that in structured finance a dialogue is essential so that issuers and underwriters know in advance whether their proposed tranches will meet the agency’s requirements for a particular rating, and if not how they should modify the structure. “We will never tell an arranger what it should or should not do. We merely react to the proposals made by arrangers”the agency wrote in a recent paper describing its structured finance rating process. Market participants remain sceptical because issuers have so much at stake. The margin by which total sale proceeds exceed the value of the underlying sub-investment grade assets hinges on the size and ratings awarded to the investment grade tranches of a structured debt pool. “If it turns out that a lot of paper was not rigorously rated then the usual cycle of outrage, investigation and legislation will occur,” says one New York-based hedge fund manager. Investigators may be on the wrong track, however. What if the agencies have clean hands? Nobody can blame them if the market relies on ratings for more than their ostensible purpose. The key question may not be how well the rating agencies did their job, but what the scope of ratings should be given how regulators and investors actually use them.
NOVEMBER/DECEMBER 2007 • FTSE GLOBAL MARKETS
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FTSE GLOBAL CLASSIFICATION CHANGES
A Question of Class In September, global index provider FTSE Group announced the results of its annual country classification review, which designates countries into either developed, advanced emerging or secondary emerging market categories. In an era of change in the way that investors approach overseas investment, global classification takes on a greater importance. Francesca Carnevale discusses the significance of this latest batch of changes to the global classification categories. ACH YEAR FTSE Group, working with an expert committee of market practitioners, reviews quality of market criteria for all stock markets included in the FTSE Global Equity Index Series (FTSE GEIS). The expert committee reviews analysis of the market quality of each country in FTSE GEIS, which is undertaken by FTSE throughout the year. The recommendations of the expert committee are presented to the FTSE Policy Group each September. The process includes a thorough review of issues such as ease of market access, the cost of investing and the security of underlying investment transactions by international investors in all countries. The major criteria used to evaluate countries in the FTSE indices include economic size, wealth, market quality, and market depth and breadth. All together, roughly 25 factors are considered. Ultimately, the resulting assessment reflects the country’s level of investability for foreign investors and an upgrade in status materially affects investment inflows. Equally, the internationalisation of many industry sectors is revitalising interest in global benchmarking and benchmarks, as provided by FTSE GEIS, are moving from being utilised as a comparative tool to being actively managed as a performance lever.
E
As well, each year any number of countries is placed on a special Watch List. These countries come under particular scrutiny, as they can move either up or down the country classification scale and the committee and FTSE closely liaise with international investors and stock markets working in Watch List countries in reviewing the overall investment environment and collaborate in trying to eliminate any impediments to the establishment of a healthy investment market. According to Lindsay Tomlinson, vice chairman, Barclays Global Investors and chairman of the FTSE Policy Group, “The FTSE engagement process on country classification is of enormous value to the industry. It brings together asset managers, investment banks, exchanges and regulators to improve knowledge and understanding of the issues and barriers to trading efficiency across markets. The dialogue is facilitating major improvements in market practice with real benefits to all participants.” This year’s results have come under particular scrutiny, as changes have been substantive. On the upscale, Israel will be promoted to developed status in June 2008; while Hungary and Poland will be promoted to advanced emerging status from secondary emerging at the same time. Poland is significantly larger than Hungary in terms of market size, with a total market capitalisation of
FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2007
Watch List countries will be assessed again at the next country classification review, which is expected in September next year. These countries will remain on the list for a full year before any change is made to their status and FTSE gives investors at least six months notice of any changes that will be introduced into its indices as a result of a country classification review. Photograph supplied by Istockphotos.com, October 2007
roughly $150bn (as of December 2006) with over 260 companies listed on the Warsaw Stock Exchange. Hungary, meantime, is the smallest of the emerging markets in FTSE’s EMEA region, with a total market capitalisation standing at somewhere in the region of $42bn, with a much smaller number of companies (about 40 or so) listed on the Budapest Exchange. Israel now meets all the quality of markets criteria for a developed market, and according to FTSE Group, has actually done so since being included on the Watch List in 2006. In addition, a new FTSE Index for developed markets in Europe, the Middle East and Africa (EMEA) will be introduced for investors wanting to integrate Israel within their existing developed Europe
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In the Markets GLOBAL CLASSIFICATION
portfolios. Equally, Hungary and Poland meet all the eligible quality of markets criteria for developed markets, however they will carry advanced emerging status for a while longer until their World Bank gross national income (GNI) per capita rating classification is upgraded to high. With 600 or so listings on the Tel Aviv Stock Exchange and a total current market cap of about $160bn, it will represent just a small percentage of FTSE’s All-World Developed Index. Nonetheless, it underscores consistent efforts by Israel to upgrade its investment regime to compete on an equal footing with other developed markets. By the by, Dow Jones Indexes and Russell Indexes classify Israel as developed, while S&P and MSCI still classify it as emerging. On the downscale, Pakistan will now be removed from the FTSE GEIS in June of next year. The Pakistan stock market has not achieved the minimum entry requirements for the FTSE Policy Group’s quality of markets criteria. However, mindful that investors may still want to trade the market, FTSE Group has announced that it will maintain a separate country index for Pakistan and will engage with the market authorities to seek improvements in trading practices and surveillance which will allow Pakistan to be reinstated at some future point. Additionally, Greece remains on the Watch List. Classed as developed, the country will continue to be assessed for demotion from developed to advanced emerging. It was a tough decision for the Policy Group, however key financial institutions in Greece acknowledge that some aspects of the market remain restricted and although progress has been made, overall
28
most market commentators acknowledge that the country continues to fall short of the standard requirements of a developed market. Nonetheless, the Athens Stock Exchange and the Greek Capital Markets Commission reportedly remain committed to working with FTSE to agree and implement viable solutions to issues such as delivery free of payment for transferring securities between accounts, allowing off-exchange transactions, making omnibus custody account facilities available to international investors, lifting restrictions on short sales and creating a liquid stock lending market. It is expected that substantial progress will be made over the next 12 months, particularly as some of these issues are addressed by the Market in Financial Instruments Directive (MiFiD), which comes into force in early November this year. FTSE’s expert committee will assess the status of progress in September next year, when a final decision will be made as to Greece’s designation. However, Greece is not the only country to remain on the Watch List until the next review. South Korea and Taiwan are also on the list and will be assessed again in September 2008 for promotion from advanced emerging to developed status. While significant changes have been made to South Korea’s investment procedures and regulations, and the country has made moves to lift restrictions on the free delivery of securities between accounts and offexchange transactions,. South Korea also needs to add greater freedom to foreign exchange trading, allowing investors to separate Won transactions from the underlying Korean securities. Consequently, it cannot yet move into the developed
segment. Similarly, Taiwan still has to meet all the developed country free market access criteria before it too can move up a grade. Meantime, the China A share market, will also remain on the Watch List for possible inclusion in FTSE GEIS. A substantial increase in QFII investment and the removal of foreign investment restrictions are required however, to meet the criteria laid down for entry into FTSE GEIS and these have yet to be implemented.. The inclusion of the China A market on the Watch List is perhaps initially surprising, as it is still largely uninvestable by foreign investors. However, it should be seen as an indicator that China is a global phenomenon because of its size and rapid growth and is under intense scrutiny by investors seeking new investment opportunities. Being on the Watch List is therefore more a quantitative indicator and China’s “A” share market will move depending on how quickly and freely the market evolves and opens up to free foreign investment flows. The consensus is that the market will remain on the Watch List for some time. All Watch List markets will be assessed again at the next country classification review, which is expected in September next year. These countries will remain on the list for a full year before any change is made to their status and FTSE gives investors at least six months notice of any changes that will be introduced into its indices because of a country classification review. To allow investors to anticipate the impact of turnover, investment flows and country weightings that the changes outlined in this article, will have on FTSE indices, a set of FTSE Watch List Indexes are available, which reflect current market conditions, but with the changes outlined above already implemented.
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Stock Exchange Review TEL AVIV S/E RAISES ITS GAME
BUILDING CONFIDENCE
Ester Levanon, chief executive of the Tel Aviv Stock Exchange (TASE), Photo kindly supplied by the Tel Aviv Stock Exchange, October 2007
The Tel Aviv Stock Exchange has had a banner year. Dividend yield for 2006 increased to 3.6%, a record level in the Exchange’s history and the array of indices offered on the exchange have been systematically enlarged and upgraded. Now, Israel has been awarded developed status by FTSE Group, which says Ester Levanon, chief executive of the Tel Aviv Stock Exchange (TASE), ups the stakes to a new benchmark. Francesca Carnevale reports.
HETHER GOOD TIMING, or good management, since Ester Levanon became TASE’s chief executive in May last year, the exchange has been on a roll. Levanon has enjoyed a number of beneficial events that will inevitably mark her tenure as a successful leader. In June, for instance, TASE announced that dividend payments by companies traded on the exchange reached a benchmark $5bn (compared with $3.6bn in 2005) and that the dividend yield for the exchange increased to 3.6%, a record in its history and up on the 3.4% in 2005. Put that in a better context. The number put TASE ahead of some of the world’s leading exchanges: Tokyo yielded 1.1% last year, London 3.1%, Paris 3.2%, Italy
W
3.3% and Toronto 2.4%. TASE enjoys a market cap of some $161bn in equities and $99bn in fixed income, with daily trading volume of $326m and $382m respectively. In an effort to build on this positive trend, the exchange has embarked on a number of new initiatives and interventions which are designed to encourage liquidity, enhance the exchange’s product range and its profitability, allowing it to compete effectively for inward investment dollars in a global marketplace. Levanon explains the raison d’etre. “We have worked hard to establish TASE as a one stop shop, for T-bills, corporate bonds, and sophisticated index products. We are always mindful of striving to provide our clients with
FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2007
sophisticated products in order to attract new business,”she notes. In May, for instance, TASE upgraded the stock exchange’s indices to conform with international standards. The changes will come into affect from the beginning of January 2008. The exchange will change the method of weighting stocks on the index. Instead of weighting them according to market capitalisation, as is the practice today, the weighting will be on the basis of public holdings of stocks (in other words, the free float). In addition, stock weightings will be updated quarterly. The change is in line with TASE’s efforts to increase the free float on the exchange. According to Levanon, “Adapting TASE indices to international standards will make the
29
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Stock Exchange Review TEL AVIV S/E RAISES ITS GAME
7
p0
Se
n07
Ju
7
M ar -0
6
c-0
De
p06
Se
n06
Ju
6
M ar -0
5
c-0
De
Se
p05
Index rebased (30 Sept 2005=100)
market much more accessible to foreign prerequisites for inclusion in the index markets criteria for a developed market investors. At the same time, changing (such as the ratio of free float and the and has done so since being included on the method of weighting will market value of the free float). The the FTSE Group Watch List in 2006. A encourage the companies to take action exchange has also launched new new FTSE Index for developed markets to increase public holding of stock.” In indices, such as the Yeter-120, which in Europe, Middle East and Africa will be applying these measures to specific replaced the Yeter-150 index in February introduced for those investors wishing indices, TASE authorised a further this year. The Yeter-120 includes 120 to integrate Israel within their existing increase (from 22.5% to 25%) in the broad market stocks with the highest Developed Europe portfolios.“For Israel, ratio of free float, required of companies market capitalisation outside of the it is a very important event,” notes Levanon. “Watching a country growing to be included in its headline indices, a exchange’s TA-100 index. Specific indices were also upgraded. up from cradle to the status of a move which comes into effect in December this year. The minimum The TA-Mid cap 30 Index, for instance, developed country is meaningful for all public holding be also be raised in the has been expanded to 50 stocks, with Israelis. It makes us believe that we truly TA-25 index, from NIS500m to an appropriate name change to the TA- stand shoulder to shoulder with the NIS600m. Explains Levanon,“the move Mid cap 50 index. Levanon explains global investment community. But this is is important, increasing the potential that the change was due to a number an emotional charge, and the market liquidity of shares and enhancing of factors.“The relative high turnover of should acknowledge that we have trading. Public holdings, historically, in the index population during semi- concrete achievements behind us, a high Israel, are lower than in many other annual updates sometimes affected the level of GDP growth, a surplus in the countries. We wanted to find ways to index’s appeal. The expansion of the balance of payments, less than 3% increase public participation in Israel’s index’s ranks should have the effect of inflation and a strong currency. We also growth story. We also realised that reducing the impact of the changes on have an immensely valuable natural many companies had been working the stocks contained within the index,” resource: the quality and ingenuity of towards increasing their free float, and she notes. But there were other our people.” Levanon acknowledges the change we were keen to encourage them to reasons. “In light of increased listings issue more shares, but also, the move is on the exchange and increased trading will have a significant uptick in interest consistent with our efforts to bring activity on the exchange it was a in the Israeli market,“and why not. We about the growth of share liquidity and natural move,” says Levanon. have worked hard to help establish a make the shares more attractive to both “Increasing the ranks of the index to 50 viable Israeli capital market, not just in stocks allows broader representation of equities, but also in bonds and in real foreign and local investors.” The exchange also took the bold TA-Mid cap stocks and also increases estate. It really is a very interesting time to become involved in the market. We move of revisiting some of its the market value of the index.” Levanon is now basking in the have done much to encourage new benchmark indices and revamping them. In March, the exchange decided limelight as Israel moves to developed listings and dual listings, backing our to admit shares with very high market status from advanced emerging as of initiatives at home with a number of capitalisation to the main indices by June 2008. Israel meets all quality of initiatives with other exchanges, such as the New York Stock means of a fast track FTSE Developed including Israel Index 2-year Performance Exchange and the London process. These shares will (USD total return) Stock Exchange (we signed be admitted to appropriate 150 an memorandum of indices (namely the TA-25, 140 understanding in February TA-100, Tel-Tec-15. TA130 this year). Now we are Real Estate-15 and the TAlooking at new initiatives: Financial-15 indices) prior 120 such as exchange traded to the official semi-annual 110 funds, and working with updates. To qualify for the 100 other exchanges to facilitate fast track process, shares 90 dual listings for Israeli have to have a market value 80 companies in varied greater than 33% of the countries. It is a positive smallest share in the index growth story.” and also meet the precise FTSE Developed incl. Israel Index Source: FTSE, October 2007
30
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Face to Face DIFC: THE NEXT PHASE OF GROWTH
His Excellency Dr Omar Bin Sulaiman, governor of the Dubai International Financial Centre (DIFC). Photographs kindly supplied by the DIFC, October 2007.
In a special Face to Face interview, FTSE Global Markets has undertake a Q&A with His Excellency Dr Omar Bin Sulaiman, governor of the Dubai International Financial Centre (DIFC) and the representative for DIFC affairs for His Highness Sheikh Mohammed Bin Rashid Al Maktoum, vice-president and prime minister of the UAE and ruler of Dubai. The DIFC is one of the world’s fastest growing financial centres and now home to more than 270 companies. Dr Omar Bin Sulaiman, who was earlier the Director General of Dubai International Financial Centre Authority (DIFCA) has driven the development of the DIFC and talks about the range of initiatives now employed by the DIFC to take the centre to its next stage of growth.
DIFC: BUILDING TOMORROW’S WORLD W
HAT HAS BEEN the role of the DIFC in encouraging the regional asset management sector? In this regard, specifically what has been the most salient effect of the Collective Investments Law? Long term, how will the law help deepen the asset management industry? Until recently there was no real asset management sector in the Middle East. This situation, however, is rapidly changing, in large part to the efforts of the DIFC. What is
FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2007
becoming increasingly clear is that a successful financial services industry needs the backing of a strong fund management sector. Middle East investors are now looking for specialized expertise to help them invest strategically in diversified portfolios, and so we see a need for asset management firms. To this end, the DIFC has devoted a good deal of its time and energy into developing this sector, and has attracted an increasing number of fund management firms, including Ansbacher, SHUAA Capital, Franklin Templeton, Mellon Global, Merrill Lynch, Man Investments and Permal. The advent of these institutions has
31
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Face to Face DIFC: THE NEXT PHASE OF GROWTH
raised the bar considerably in terms of providing an enhanced level of service to a wider range of clients and bringing international best practices to the region. For example, by passing the Collective Investment Funds Law, the DFSA has, for the very first time in the industry made fund administration a regulated activity. As with all activities at the DIFC, this means that fund management firms operate in an environment that is secure, transparent and subject to an internationally recognised regulatory framework. The introduction of the Collective Investment Funds Law already has had a significant impact on asset management in the Middle East and, consequently, the financial services industry here. Moreover, thanks to this law, the region is now poised to lead the way in the asset management sector, which has until now been traditionally dominated by US and European firms. Has the Collective Investments Law encompassed hedge funds and Shari’a compliant funds? Along with providing investors with security and instilling confidence, the new law allows for the operation of various types of ‘alternative’ investments, such as property funds, Islamic funds, hedge funds, and funds of funds including Real Estate Investment Trusts (REITS) —all of which are playing a larger role in regional finance. How might the DIFC expand upon the Law over the near term? This is still to be determined based on industry requirements and the evolution of the practice. For example, our REITS legislation has only recently been enacted and has resulted in significant interest from that sector. The first REIT was recently authorised by the DFSA. How has the DIFC worked to encourage the development of the investment services industry: in particular custody and fund
32
administration services? Does the DIFC have a role as a catalyst in this regard? In terms of custody and fund administration, key global centres are Dublin, followed by Luxembourg and London. This is relatively specialized and the DIFC is actively encouraging its development. Several firms have moved into the centre providing this service. In addition, as this happens, regulation becomes increasingly important, which is why we introduced the Collective Investment Law to regulate the fund industry. In particular in other markets, firms are regulated by their respective authorities but not specifically regulated for this activity. However, in the DIFC it is an authorized activity and we may see other offshore financial centres following this approach in the near future, for example Bermuda. As such, we believe we are acting as a catalyst in this industry and setting standards for others to follow. What has been the role of the DIFC in deepening the nascent Islamic Finance sector? How might this role evolve over the near term? Islamic finance is an area that has grown to become an increasingly important segment within the global financial market, gaining considerable ground as a viable and alternative model to conventional finance. Today, the size of the Islamic finance market is estimated to be in excess of US$ 300 billion and is forecast to grow at a rate of 12% to 15% per annum over the next ten years. The future growth and development of the Islamic finance industry largely depends on the degree of innovation introduced in the market. Although the industry has increasingly demonstrated that it can match the sophisticated range of product and service offering of its conventional counterpart, there has been a slow pace of new products introduced in the market.
The DIFC aims to become the centre of product innovation by helping fuel the development and structuring of more complex, liquid and long-term Islamic products that will satisfy the broad needs of investors and issuers. We have also established an Islamic Finance Advisory Council that will play a key role in providing strategic advice on the Islamic finance industry and market place as well as highlight the impact of the legal and regulatory initiatives locally and internationally, thereby contributing to the development of the industry in general and within the DIFC in particular. Through its international stock exchange, the DIFX, the DIFC also offers a liquid, transparent and efficient platform for the primary listing, and secondary trading of sophisticated Islamic finance instruments, thereby providing an active market where Islamic finance can continue to grow meaningfully. The DIFX is playing a key role in the rapid growth of Sukuk as a prominent asset class, because of its location and its international standards and has now acquired 44% of the world’s Sukuk by listed value, making it the world’s largest market for Sukuk. Owing to its supervision and regulation, the DIFC will also play an active role in the broader acceptance of Islamic finance products and services in international markets. By promoting sound accounting procedures and standards, the DIFC will provide a significant boost to the levels of transparency, accountability and credibility of Sharia’a -compliant products, helping to integrate Islamic financial markets with global markets. What in your view is the significance of the Real Property Law and the Strata Title Law within the DIFC? Why were the laws enacted at this time? The Law combines the benefits of guaranteed
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title under the Real Property Law with an administrative structure designed to handle the day-to-day management of buildings. It will help overcome the complexities of co-owners association constitutions, master community declarations, and the like, by introducing a simple but comprehensive system of rights and responsibilities. It incorporates many of the key concepts of existing co-owners association arrangements already in use in Dubai, but simplifies them and adds a title guarantee to the properties within DIFC. These laws can and only apply for property within the designated centre. We chose to enact the law at this time as a continuation of our quest to make the DIFC the number one financial hub in the region. It is a part of a long line of regulations and laws designed to further enhance recognition of the DIFC as a place where business is conducted smoothly and in an ethical manner. The DIFC has established a number of initiatives with specific countries to encourage business development. What have these initiatives accomplished to date? What has the DIFC learned from initiatives such as these? Are they but one way forward? What other kind of cross-border initiatives does the DIFC have in mind? To date, we have been involved in many international initiatives and have worked with a number of governments, organisations and
Page 33
capital and full convertibility of the Dirham, Dubai has proved to be a highly attractive destination for foreign direct investment. The World Investment Report ranked the UAE as 22nd among the countries considered attractive to foreign investment. Some 150 of the Fortune 500 companies (including all of the top 10) have established a presence in Dubai, and the UAE’s 23 free zones are now host to numerous multinational and regional companies. In addition to what Dubai can offer, the DIFC in particular can offer yet more. Companies from all over the world are recognizing the highly attractive investment environment advantages the DIFC has to offer, such as: 100% foreign The DIFC by night. Photograph of The Gate in Dubai. ownership, zero percent Photograph kindly supplied by DIFC, October 2007. tax rate on income and institutions across the Middle East, profits, a wide network of double US, Europe and Asia. We have taxation treaties available to UAE explored opportunities with other incorporated entities, no restrictions on exchanges such as Euronext and foreign exchange or capital/profit partnerships with financial repatriation in a dollar-denominated institutions such as Deutsche Bank. environment, a transparent operating One of the things that we have taken environment with high standards of strict from these business development rules and regulations, initiatives is the importance of cross- supervision and enforcement of money border relationships and the benefits laundering laws, ultra modern office state-of-the-art they can bring to Dubai and to the accommodation, sophisticated region as a whole. We are always open technology, to ventures which are in line with our infrastructure, data protection/security, international focus and which fit with operational support and business continuity facilities of our ambitions for growth. Looking ahead what are the key uncompromisingly high standards. It is opportunities that offer you leverage? hard for any business to turn down A market-orientated economy with such an attractive proposition, which is complete freedom of movement of why we have become so successful.
FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2007
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Regional Review PICK UP IN ISSUANCE EXPECTED
Moreover, the sale of Sukuks in the Gulf region has overtaken those in Malaysia for the first time, according to statistics in a report by Moody’s Investors Services. The Gulf region had seen $13.2bn worth of Islamic bonds sold by the end of August, substantially higher than the $9.7bn sold in Malaysia to date. As a rule, the GCC Islamic market accounts for 55% of global sales. There are signs that the Islamic financing market is gaining additional traction through the establishment of special investment funds that will widen Analysts think that issuance volumes in the Islamic bond market investor appeal in Islamic securities. (Sukuks) to rise substantially following the Eid holidays and Barclays Capital plans to launch a group remain strong throughout the rest of the year. It’s been a quiet of hedge funds that will be managed issuance season up to now; but market watchers are consoled by according to Islamic law. Barclays a growing trend towards increased sukuk issuance, driven in Capital and its partner, US-based large part by attractive pricing for Islamic notes and wider Shariah Capital, say that investors in the spreads. Elsewhere, the need for continued investment in hedge funds will be able to choose infrastructure is feeding new issuance pipelines, though new precisely which fund they want to invest in, which makes them quite unlike equity issuance will likely remain subdued until year end. typical fund of hedge funds. However, forward the company’s Barclays Capital staff in the bank’s T HAS BEEN a summer of turmoil in drive the Middle East markets, as the international expansion plans. More Middle East market solutions group are effects of religious festivals such as recently, in September, Kuwait’s Mobile unwilling to explain exactly how the Eid and Ramadan, uncertainty in the Telecommunications Company (MTC) hedge funds would comply with Shari’a global credit markets and a depressed signed two Shari’a compliant syndicated law, explaining that it is their intellectual issuance season, has affected volumes. loan deals worth a total of $7.4bn. MTC property and for the time being at least, is giving them a sales edge. Nonetheless, market It is a significant move by watchers believe that it is a a western player in the lull before a storm of new market, which intends to issuance, particularly in the The Gulf region had seen $13.2bn worth sell the securities to Islamic finance sector. of Islamic bonds sold by the end of August, western investors. To date, Companies expected to substantially higher than the $9.7bn sold in investment in Islamic issue sukuks over the next finance structures and quarter include Omniyat Malaysia to date. As a rule, the GCC Islamic funds have been Holdings, the holding market accounts for 55% of global sales. dominated by local firms. company for Omniyat Saudi Arabian investors Properties, and Amlak have provided 50% of the Finance. Despite a quiet summer, the UAE’s Dana Gas sold has reportedly agreed a two year $40m raised by British Islamic $875m worth of convertible Sukuk, after murabaha facility worth $4.9bn to help Insurance Holdings (BIIH), a UK increasing the size of the issue from pay for its successful $6.1bn capture of based Takaful firm, in a private. The $750m following strong interest in the Saudi Arabia’s third mobile licence. BIIH also hopes to raise $160m via an bonds. The Islamic bonds have been MTC has also signed a $2.5bn IPO with a similar amount via a structured as Sukuk al Mudarabah and murabaha facility to help refinance a second tranche at a later date taking they will mature in 2012. The funds previous $1.2bn Islamic loan set up the capitalisation to around $360m. However, in other corporate generated from the sale will be used to last December.
Islamic issuance rebounds after a quiet summer
I
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Regional Review PICK UP IN ISSUANCE EXPECTED
The quiet summer came as borrowing sectors, increasing caution is signed a $6.1bn loan agreement, as being noted, though in pockets issuance part of a consortium of international something of a surprise to the wider volumes remain robust, particularly in and regional banks, for the benefit of region, as it had noted a surge of the steel and oil sector. However, news SABIC Innovative Plastic, a subsidiary activity in the first half of the year, in has emerged that Industries Qatar, for of Saudi Arabia’s SABIC company. The both the debt and equity markets. The example, has temporarily halted its plan loan will be used to finance 70% of a Middle East region had exceptional to borrow $1.3bn for the expansion of a deal under which SABIC will acquire initial public offering (IPO) activity steel plant due to turmoil in global credit the US General Electric’s General during the second quarter of 2007, markets. The company says the project Electric Plastic. The Arab Bank is posting the second biggest surge in the past five years. Some 20 firms issued is“still viable,”and talks with contractors mandated lead arranger in the deal. At the sovereign level, Dubai is set to equity worth a total of $3.9bn, are continuing even though the financing has been delayed. Elsewhere follow Abu Dhabi in receiving a credit according to a report issued in Japan’s Yamato Steel Company and a rating this year as part of its plans to September by Ernst & Young. By consortium of Gulf firms continue in sell government bonds. It is believed comparison, in 2006, $8bn was raised talks with banks to raise $1.2bn for a ratings agency Fitch is presently through 45 IPOs in the Middle East, steel plant in Bahrain. The Arab working on the rating, while JPMorgan whereas the region recorded $4.8bn raised in IPOs through 33 consortium, called Foulth, separate offerings in the includes steel and chemical first half of this year. Saudi maker Industries Qatar and Arabia ranks first in terms Kuwait-based Gulf Moreover, the sale of Sukuks in the Gulf of funds raised, followed by Investment Corp. The firms region has overtaken those in Malaysia for the UAE and Qatar. Saudi are talking to lenders the first time, according to statistics in a Arabia’s Capital Market including HSBC, Arab report by Moody’s Investors Services. The Authority (CMA) has now Banking Corp and BNP Gulf region had seen $13.2bn worth of reportedly given approval Paribas to act as arrangers Islamic bonds sold by the end of August, to five firms to launch on the project. Meanwhile, initial public offerings Bahrain’s Ahli United Bank substantially higher than the $9.7bn sold in (IPO), with a total of and Arab Banking Malaysia to date. As a rule, the GCC Islamic around 38.9m shares on Corporation recently signed market accounts for 55% of global sales. offer. The subscription a $480m facility agreement period will be from with Damietta International October 27th to Port Company to finance the and the five development of a new container is offering advice on the bonds issue. November 12th terminal, set to be the largest of its kind Abu Dhabi received an ‘AA’ rating in companies are the Commercial Union in the Middle East, within the Port of July prior to selling a $1bn five year for Cooperative Insurance, Al Saqr for Cooperative Insurance, Arabian Damietta on Egypt’s Mediterranean sovereign bond. The relative quiet of the market Cooperative Insurance, Al Khaleej coast.The new container terminal is part of DIPCO’s plans to transform the port continues to feed oversubscription in Training and Education and Middle into a major transhipment hub in the the quality issues. Qatar Telecom’s East Specialised Cables. Elsewhere, (Qtel’s) recent $2.5bn five year term Dubai-owned DP World, the world’s eastern Mediterranean. Saudi Basic Industries (Sabic), Saudi loan syndication, for instance, was third-largest container port operator, Arabian Mining, and Chevron Phillips oversubscribed. The funds will be used plans to sell as much as 30% of its Chemical are all seeking investment to refinance an existing $2.5bn loan shares, worth up to $3.5bn, to help for major projects in the Kingdom which Qtel arranged in March to fund expansion in an IPO that will totalling $6.25bn. Market watchers say support its purchase of a controlling begin in November. Once the sale is that the fact that all these projects are 51% stake in Kuwait’s National approved by the Dubai government, Telecommunications the shares would be listed on the approaching the market at the same Mobile International Financial time, means that they are competing (Wataniya). Qtel’s $2bn revolving Dubai credit, which it signed for last Exchange and may also be offered on with each other for limited funds. the London Stock Exchange. Additionally, Arab Bank Group has November, continues uninterrupted.
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Regional Review CHINA: QDII DEEPENS CHINA’S FINANCIAL MARKETS
QDII PROMOTES MARKET GROWTH
Photograph supplied by Istockphoto.com, October 2007.
2006 was a milestone for China’s financial markets. Domestic stock markets rose by more than 130%, but more significantly perhaps, the year marked the implementation of the Qualified Domestic Institutional Investors (QDII) system, under which institutional investors are granted permission by the Chinese government to invest abroad. Stuart Leckie, chairman of Stirling Finance Ltd, argues that the expansion and involvement of market participants will lead to increased investment outflows from mainland China, but that QDII will deliver many additional benefits, including the strengthening of China’s financial sector as participants increasingly adopt international standards and facilitate China’s integration into the global financial markets. INCE APRIL 2006, Chinese regulators have given the green light to various domestic financial institutions to invest abroad. By the 14th October this year, a quota of $16.1bn had been granted to commercial banks for overseas investment, $18.5bn to fund managers, and $3.5bn to insurance companies. Then, the National Social Security Fund (NSSF) awarded its first international investment mandates in November last year. Moreover,
S
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regulatory approval has been given to securities companies and trust companies to invest abroad. Qualified Foreign Institutional Investors (QFII), which are foreign investors that can invest in China’s domestic market and QDII represent China’s partial capital account liberalisation efforts. Its government understands that a fully-convertible currency and free capital flow is necessary in the long term. However, in the short to medium term it
carefully controls which foreign investors can invest in China and which Chinese investors can invest abroad through the granting of QFII and QDII licenses and by allocating a foreign exchange quota. QFIIs and QDIIs can only invest up to the quota limit. By October 2007, the market regulator, the CSRC had granted 52 QFII licenses to overseas banks, securities companies, fund managers and endowments. In total QFIIs have been awarded a $9.945bn quota. QDII was formally established in April 2006 by a People’s Bank of China (PBoC) Notice No 5, which gave categorical permission to three types of entity to invest abroad; namely banks, fund management companies and insurance companies. Precise implementation rules however, were left to each of the country’s industry regulators (including the China Banking Regulatory Commission [CBRC], the China Securities Regulatory Commission [CSRC] and the China Insurance
NOVEMBER/DECEMBER 2007 • FTSE GLOBAL MARKETS
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Regional Review CHINA: QDII DEEPENS CHINA’S FINANCIAL MARKETS
Regulatory Commission [CIRC]) to implementation rules as early as April movements. In a sense, these were not formulate.These entities, combined with 2006, the first among its peer true investment products, as they two special government funds, the regulators after the central bank offered little value for the Chinese NSSF and the recently established Notice, and has been quick to grant investors to obtain real international China Investment Corporation (CIC), QDII licenses. As of 14th Oct. 2007, exposure and risk diversification. form the universe of QDIIs in China. In there are 21 QDII banks, including the Perhaps as a result, the uptake of the the past, only selected entities, such as Industrial and Commercial Bank of first batch of QDII products was anything but enthusiastic. By the NSSF and some year end, only $380m of insurance companies with QDII products had been existing foreign exchange sold—less than 3% of the holdings, could hold foreign total quota. ICBC, the largest assets through special Chinese bank with the government approvals. widest distribution network, These were exceptions reportedly only sold $60m of rather than the norm. its first QDII product. Then, The timing of QDIIs in February this year, the was not random, rather Bank of China had to scrap inevitable. From 2001 to its first US Dollar Enhanced 2005, Chinese stock Cash Management Product markets were in a as the low annualised return prolonged decline and (1.3% after converting back China’s regulators worried to RMB) triggered massive that allowing domestic redemptions. institutions to invest The initial lack of investor overseas would further interest was in part due to weaken investors’ the timing of QDII product confidence in the launches, which coincided domestic stock markets. with the biggest bull run in By 2006 though, the The timing of QDIIs was not random, the Chinese domestic situation had changed. rather inevitable. From 2001 to 2005, equity markets (which rose The domestic equity China’s regulators worried that allowing 130% last year). Believing market had already domestic institutions to invest overseas that the domestic market started to stage a would weaken investors’ confidence in the offered better return convincing rebound and domestic stock markets. opportunities, few investors China had accumulated were willing to invest circa $1trn in foreign internationally. Moreover, exchange reserves. By the expectation of allowing some capital RMB appreciation outflow, the authorities could begin to China and Bank of China, and continued relieve international pressure for the international names such as HSBC dampened investors’ enthusiasm to and Citibank. Together, they have invest abroad. As the RMB was (and remnimbi to revalue. Regulated by the CBRC, banks are been granted $16.1bn of quota, the still is) widely expected to appreciate among the largest and most active largest sum given to any particular by 3%-5% each year against the US dollar, any return obtained from US QDIIs in China. Their dominance in group of QDII investors. Initially, the CBRC allowed QDII dollar fixed income investments is the QDII field was overtaken by fund management companies only very banks to invest only in fixed income and likely to be significantly eroded, or recently. To some extent, banks’ head structured products. Many bank QDII even become negative after currency start was possible because of a products had relatively short maturities conversion. As this view on RMB proactive stance taken by the and some appeared to be speculative, appreciation is widely held, the cost of hedging is also regulator. The CBRC issued QDII based on the foreign exchange market currency
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commensurately high. In addition, many early products were complicated structured products and had limited appeal to relatively unsophisticated Chinese retail investors. The lack of training of bank sales staff also led to a risk of mis-selling. Given the challenges facing bank QDIIs, the CBRC proved receptive to market feedback and became proactive in introducing changes. After some initial reluctance to allow QDII banks to offer equity exposure to investors, the CBRC revised the rules in May 2007 to include overseas listed equities, equity funds and equity structured products, provided that the overseas stock exchange and the overseas regulator have each signed a memorandum of understanding with the CBRC on QDII cooperation. Although there are still many restrictions, for instance, the total amount of stock investment is capped at 50% and investment in one single stock is capped at 5% of the QDII product’s total net assets, while the minimum subscription for each customer needs to exceed RMB300,000, the move represents a major step forward. QDII banks wasted no time in offering products linked to Hong Kong equities and global equities. In June 2007, at least 5 new bank products were launched. The products appear to be quite diverse, from ICBC’s pure Hong Kong stock theme to HSBC’s more diversified global theme, to the Standard Chartered Emerging Markets infrastructure theme. Market feedback was much warmer. According to Chinese media, the Oriental Pearl product offered by ICBC raised a total of RMB4.45bn ($585m), the largest amount raised for any QDII product at that time. Indeed, it equals is the entire amount raised for QDII in 2006. Compared with the quick response from the CBRC to QDII, it took the
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CSRC, China’s asset management regulator, more than a year to issue implementation rules. Before its release CSRC had allowed only one fund manager—Hua An—to invest abroad on a pilot basis. As China’s first QDII fund manager with $500m quota granted by SAFE, Hua An launched the Hua An International Balanced Fund in September 2006 (jointly managed by Hua An and Lehman Brothers) which invests in global equities, global fixed income, US REITs and commodities. Investors responded more enthusiastically to the Hua An Fund than the bank QDII products. Hua An ended up with $200m in subscriptions—a 40% quota utilisation rate. It was impressive compared with the QDII bank products at the time. After waiting for more than one year, on the 20th June this year, the CSRC issued a trial rule for QDII fund managers and securities firms to invest abroad. To be eligible, a fund manager needs to have net assets of no less than RMB200m and a minimum of 2 years experience in equity investments. According to market estimates, about 20 fund managers are eligible. The permitted investment products under the new trial rule are expansive, ranging from bank deposits, money market products, government bonds, corporate bonds, convertible bonds, MBS, ABS, for example, to ordinary shares, preferred shares, ADRS, and REITS. Since the trial rule was in place, the fund management QDII market has taken off dramatically. As of 14 October, 9 fund managers have obtained QDII licenses, and 5 of them have been granted a total of US$18.5bn quota. In September and October 2007, 4 fund managers including China Southern, Huaxia, Harvest and China International launched extremely successful QDII funds, offering investors exposure to
FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2007
QDII Banks and Their Quotas QDII Bank
Quota (US$bn)
Bank of China
2.5
ICBC
2
China Construction Bank
2
Bank of Communication
1.5
China Merchants Bank
1
HSBC
0.5
Agricultural Bank of China
1
Citic Bank
0.5
Ming Sheng Bank
0.5
Citibank
0.5
Standard Chartered Bank
0.5
Industrial Bank
0.5
Everbright Bank
0.5
Bank of East Asia
0.3
Hang Seng Bank
0.3
Bank of China (Hong Kong)
0.3
Credit Suisse Shanghai Branch
0.3
Beijing Bank
0.3
Shanghai Pufa Bank
0.5
Deutch Bank
0.3
Nanyang Commercial Bank
0.3
Total
16.1
Source: FTSE Xinhua , Oct. 14th 2007
QDII Fund Management Companies and Their Quotas QDII Fund Manager Hua An (pilot programme)
Quota (US$bn) 0.5
China Southern
4.0
Huaxia
5.0
Harvest
5.0
China International
4.0
Fortis Haitong
TBD
Fortune SGAM
TBD
ICBC-CS FMC
TBD
Changsheng Total
TBD 18.5
Source: Stirling Finance
Hong Kong, Asia Pacific, and global equity markets. Investor enthusiasm have been overwhelming, with the all these funds (typically US$4bn in size) fully subscribed on the first day of marketing. It seems like that after an initial year and half of stagnation, various factors, including an increasing perception of the A share “bubble”, a recognition of the arbitrage opportunity in Hong Kong, a desire to diversify overseas, a more
41
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Regional Review CHINA: QDII DEEPENS CHINA’S FINANCIAL MARKETS
M ay Ju -05 nJu 05 l Au -05 g Se -05 pOc 05 t No -05 v De -05 c Ja -05 nFe 06 b M -06 ar Ap -06 r M -06 ay Ju -06 nJu 06 l Au -06 g Se -06 pOc 06 t No -06 v De -06 c-0 Ja 6 nFe 07 b M -07 ar Ap -07 r M -07 ay Ju -07 nJu 07 l-0 7
P/E Ratio
liberal set of QDII rules, and improved listing abroad, as well as investment underestimated. The agency also won fund/product design, have all returns. By the end of 2006, the NSSF praise from international managers and converged to the breakthrough of the had accumulated some $42bn in total observers for its professional approach assets, and is regarded as a leading in undertaking the manager selection, QDII scheme. and in setting a new standard of The third category of QDII is institutional investor in China. Following government approval of its governance for Chinese government insurance companies. In the past, insurance companies were allowed to QDII status, the NSSF invited bids for agencies. As a pension fund, the NSSF use only existing foreign exchange five international fund mandates. More has an advantage in that it can focus on holdings to invest in high-grade fixed than 100 fund managers responded to long term strategic allocation. Notwithstanding the stellar income products or shares performance of the domestic issued by Chinese market in 2006 and 2007, the companies only in a few Following government approval of its NSSF has steadily increased currencies. Under the old QDII status, the NSSF invited bids for five its international allocation system, only China Life, international fund mandates. More than and now holds Ping An and PICC approximately $5bn, or 12% received approvals on an 100 fund managers responded to the call. of its overall portfolio in individual basis with a After interviewing a short-list of 25 international investments. combined quota of managers, the agency finally picked 10 The newly established approximately $3.5bn. international fund managers to manage China Investment On 25 July 2007, the approximately $1bn of initial overseas Corporation (please see our CIRC issued a new set of investments in November 2006. Cover Story) is a special QDII rules allowing governmental fund charged insurance firms to invest with the investing a portion up to 15% of their total assets (with either existing or the call. After interviewing a short-list of of China’s $1.4trn foreign reserves. In addition to the QDIIs outlined purchased foreign exchange) abroad. 25 managers, the agency finally picked The permitted investments have also 10 international fund managers to above, in April the CBRC gave a been expanded to include money manage approximately $1bn of initial green light to trust companies in market products and fixed income overseas investments in November China to apply for QDII status. To be products, as well as equities and 2006. The mandate total was further eligible, a trust company must have funds. If insurance companies invest increased to $1.6bn by April 2007. The registered capital of no less than the maximum permitted amount sum is not large by global standards, but RMB1bn and have been profitable in abroad, they will likely become the it is the first time that foreign fund the past two years. Finally, in June 2007, the CSRC QDIIs with the largest investment managers began to manage money for a outflow ($38bn based on total 2006 QDII and the impact cannot be allowed securities companies to become QDIIs. The year-end insurance assets P/E levels of FTSE/Xinhua China A50 Index vs. FTSE/Xinhua eligibility criteria for of $252bn). China 25 Index. securities companies are The NSSF is perhaps 40 relatively stringent, China’s most high-profile including minimum net QDII. Established in 2000 30 capital of RMB800m, a ratio as a strategic reserve to of net capital to total assets help China cope with its 20 of at least 70%, and ageing population and minimum AUM of rising pensions, the 10 RMB2bn. It is estimated agency is funded by a that around ten Chinese fiscal budget allocation, 0 securities companies lottery proceeds and a currently meet these criteria. portion of initial public FTSE/Xinhua China A50 Index FTSE/Xinhua China 20 Index The rich set of offering (IPO) proceeds international investment from Chinese companies Source: FTSE/Xinhua.
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opportunities that becomes available through QDII will naturally complement the existing investment channels for domestic investors, offering exposure to new markets, new asset classes, and meaningful risk diversification. International investment should make sense especially for institutional investors such as pension funds and insurance companies, which have long time horizons and a risk profile that calls for diversification. In the case of life insurers, to match the duration of their long term liabilities, they need to invest in long term fixed income instruments. The lack of a deep, liquid long term bond market in China means that insurers will choose to turn abroad. Given China’s overheated domestic stock markets, international equities could become an attractive choice for tactical allocation. A particular case in point is the comparison between A shares in China and H shares in Hong Kong. H shares are shares issued in Hong Kong by Chinese companies such as China Life and ICBC. As of June 2007, the P/E ratio (against 2007 estimated earnings) of A share companies is approximately 33, while the same measure for H share companies is only 19. This represents a significant price discount for H shares. The anomaly in pricing exists because the capital controls in China have prevented arbitrage between the two markets. However with the QDII system, the pricing anomaly between the two markets could potentially narrow or even disappear over time. The likely convergence in pricing makes Hong Kong’s H shares an attractive investment opportunity for Chinese domestic investors. A few QDII banks and fund management companies have already started to exploit this anomaly, offering Chinese investors exposure to Hong Kong equities including H
Page 43
shares. Such strategies will likely yield significant long term returns to Chinese domestic investors, even after currency conversion. A comparison between the price to earnings levels of FTSE/Xinhua China A50 Index and the FTSE/Xinhua China A25 Index illustrates the price divergence. The former represents the largest 50 A share companies listed in China, while the latter comprises the 25 largest and most liquid H shares as well as red chip stocks listed in Hong Kong. Chinese investors, both retail and institutional, however, will be the biggest beneficiaries from more liberal investment policies. Benefits come in the form of potentially higher returns and lower risks through diversification. In addition, gaining exposure and experience in the international market will also help Chinese retail and institutional investors to mature. The interactions that domestic institutions have with global players will help them understand and adopt best international practices and improve governance. QDII will also create significant opportunities for international fund managers, custodians, index providers, and other participants in the financial services industry. As Chinese investors turn their attention to global, they will need relevant advice and services from international fund managers and other service providers.
In terms of products, while most types of traditional international investment products will have a chance of gaining some QDII business, index products such as ETFs should be especially favoured. The reason is simple: as Chinese investors lack the knowledge and research capacity to analyze individual stocks or bonds in foreign markets, ETFs that track the broad indices will become an effective way of obtaining market exposure without incurring high tracking error. The low cost of ETFs and other index products should also be a plus. Finally, in terms of countries/regions that will benefit from QDII most, Hong Kong is emerging as a winner. Hong Kong was the first to reach a memorandum of understanding with the CBRC on QDII collaboration. Mainlanders’ familiarity with Hong Kong listed companies, which include many mainland firms, plus the significant price discounts (averaging 40%) of H shares to A shares, as well as the rich and diverse offerings of Hong Kong funds (about 2,000, many with global exposure) should all create an advantage for Hong Kong in winning QDII business. The recent performance of the FXI China 25 Index seems to suggest that the market is anticipating a positive impact of mainland China capital flow on the Hong Kong stock market.
QDII Fund Offerings in Sept/Oct 2007 QDII Fund Manager
Funds Launched in Sept/Oct 2007
China Southern
Global Select Allocation Fund: an equities fund investing in both mature and emerging markets that have been approved by the CSRC. A blend of indexing and active management strategies will be used.
Huaxia
Global Select Equity Fund: actively managed equities fund with >60% exposure to global equities.
Harvest
Overseas Chinese Equity Fund: invests in stocks and preferred stocks of companies that have main business in China, and are listed in Hong Kong, Singapore, NASDAQ and NYSE.
China International
Asia Pacific Advantage Fund: Invests in Asia Pacific (ex. Japan) blue chip companies that have international competitative advantages.
Source: Stirling Finance
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Regional Review SINGAPORE: ASEAN’S FINANCIAL POWERHOUSE EMERGES
SINGAPORE BUILDS ASSET MANAGEMENT EXPERTISE In early October, BNP Paribas Securities Services announced it was establishing an office in Singapore. The move is timely. Asset servicing providers are increasingly finding rich pickings in the Singapore market, leveraging a string of government led initiatives to create a tax-efficient investment centre, with a minimum of bureaucracy. Singapore is now benefiting from long standing efforts to establish the city-state as one of Asia’s key asset management centres, even in the alternative asset management space.
Neil Daswani global head of securities services and managing director of transaction banking at Standard Chartered in Singapore. Photograph kindly supplied by Standard Chartered, October 2007.
A recent arrival in the hedge fund sector was Deutsche Bank, which is opening capital introduction and prime finance desks in Singapore to help serve the hedge fund industry there. Deutsche Bank is now part of a club of prime broking specialists that includes Citibank, Morgan Stanley and Merrill Lynch, which have all strengthened their prime brokerage desks in Singapore this year. A number of developments have encouraged the deepening of the Singapore market. The relatively short time taken to register a fund in the city-state, as well as a growing array of asset service provider that can support a widening range of investment strategies, are combining to act as strong incentives to establish alternative investment operations on the island. Concessionary tax rates are levied on profits earned by financial services companies in respect of
income earned billing clients for investment services rendered. Profits distributed as dividends are also granted a concessionary tax status. Moreover, since June of last year the Singapore Stock Exchange (SGX) has accepted listings of hedge funds. SGX listing rules for hedge funds require that a fund must be authorised or recognised under section 286 or 287 of the Securities and Futures Act; or be offered only to institutions and/or accredited investors, and have a minimum asset size of at least S$20m or $20m for Singapore and foreign currency denominated funds respectively. Fund managers must have a proven independent risk management function. There are also strict requirements on the personnel side; with the investment management team of a hedge fund is expected to have at least one principal with a minimum of five years relevant investment management experience.
CCORDING TO HEDGEFUND Intelligence, the London-based alternative assets data provider, some 100 hedge funds managing assets worth $16.5bn have now been established in Singapore, leading some commentators to predict that the centre will ultimately cement its position as one of Asia’s leading asset management centres. That outlook is predicated on the trend that has picked up speed in the first half of 2007, when hedge fund assets more than doubled in the city-state. The Monetary Authority of Singapore notes that the hedge fund industry in the city-state grew 76% last year and the pace picked up substantially this year. Some 20 hedge funds set up operations in the first six months of this year and even established funds in the capital report that the size of their funds now exceeds $1bn.
A
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Even Closer We are bringing our top rated securities services to Singapore. By establishing an operational and client servicing base in the heart of the Asia-Pacific, we are committed to helping our clients grow worldwide.
Closer to markets, closer to clients.
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Regional Review SINGAPORE: ASEAN’S FINANCIAL POWERHOUSE EMERGES
Hedge funds are not Singapore’s only fruit. The asset servicing business is growing apace, and BNP Paribas is the latest large custodian house to set up significant regional operations in the city state. BNP Paribas’ local play is strategic; serving its global clients in multiple locations, the situation in Singapore speaks volumes. As does its new management team. Marcel Weicker (subject to the approval of the regulators) will be appointed local head for the Singapore office reporting to Jean-Marc Pasquet, who is currently head of the bank’s Asia-Pacific operations. Mr Weicker joins BNP Paribas from RBC Dexia, which is itself establishing a substantive beachhead in the wider region and brings to BNP Paribas expertise in supporting “European clients for their fund administration and custody needs in Asia.” Pasquet notes that, “Having a local presence in Asia means we can offer an expanded product range and servicing capability to our global clients with local expertise and knowledge.” Some of the groundwork which is now focusing attention on the asset management market in Singapore was laid down last year when premier and finance minister Lee Hsien Loong announced a range of tax and other initiatives aimed at spurring growth in the financial services sector. Among the measures introduced were enhanced tax incentives for asset and wealth management, capital and treasury markets, and captive insurance. With a view to encouraging the growth of financial services companies the government has introduced a raft of liberalising measures. Capital gains and income made by financial service companies trading investments for and on behalf of their non-resident clients are, for example, often tax exempt (both in the hands of the financial services company and in the hands of the non-resident client). In
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consequence, Singapore has become an attractive location for foreigners to base their investments. According to Neil Daswani global head of securities services and managing director of transaction banking at Standard Chartered in Singapore maintains that: “An aging population, rising income and high saving rate in Asia all present new opportunities for the asset management industry as asset management companies look to launch more products to tap into this pool of funds. We are also seeing that the changing appetites of investors has resulted in asset management companies looking to switch their asset allocation from plain vanilla products of equities and fixed income to other structured products that include Islamic products and even various hedge funds. In order to obtain better returns for their investments, fund managers are also looking towards more structured products and products that offer absolute returns on investment to increase the overall performance of their funds.” There is more to come as the government seeks to deepen Singapore’s regulatory regime. The Monetary Authority of Singapore (MAS) has released a policy consultation paper on proposed amendments to the Securities and Futures Act (SFA) and the Financial Advisers Act (FAA). This is the third in a series of policy consultations MAS is conducting following a review of the SFA and FAA that commenced in 2006. The current policy consultation paper sets out proposed amendments in a number of areas, including perpetual licensing for holders of corporate licences; regulatory assistance to foreign regulators; licensing exemptions relating to fund management, leveraged foreign exchange trading and advising on corporate finance; and definitions of
“securities”and “futures contract”in the SFA and the FAA. These amendments aim to enhance MAS’ supervisory oversight of capital markets services and financial advisers’ licence holders, and the responsiveness of MAS’ regulatory framework to market innovation. MAS has also released the draft Amendment Bills to the SFA and the FAA, the Draft Securities and Futures (Licensing and Conduct of Business)(Amendment) Regulations 2007 and the Draft Financial Advisers (Amendment No.2) Regulations 2007, which seek to implement the policy changes proposed by MAS in various consultation papers issued through last year and this year. The Amendment Bills are targeted for first reading in Parliament in the first quarter of 2008. The moves are significant in that they describe Singapore’s efforts to establish itself as a regional powerhouse. Until recently the asset servicing business in SE Asia has been dominated by subcustody service, but that is changing rapidly. Explains Daswani at Standard Chartered: “The last two years have seen substantial increased flow of international investments into Asia which has resulted in significant resurgence of the capital markets business in Asia. This has been further fuelled by the growth of the domestic fund industry within Asia. From a securities services provider perspective, this has meant a significant growth in transaction volumes and assets under custody. The securities services providers have therefore had to significantly ramp up their processing capacities to cater to this growth.” “Across Asia, Standard Chartered Bank has seen significant growth in our inbound sub-custody business,” adds Daswani. “Given the liberalisation across markets in Asia and the growth of the local funds; we continue to expect significant demand for outbound custody services.”
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CHINA TURNS CORNER IN FOREX MANAGEMENT In March, China reached a turning point in the management of its foreign exchange reserves. The National People’s Congress (NPC) announced it would sponsor a new state foreign exchange investment corporation with a mandate to look beyond the safe haven of government securities markets and reap higher returns on its burgeoning forex stockpile. China Investment Corporate Ltd. (CIC), the country’s long-awaited state forex investment company set up to make better use of its huge foreign exchange reserve, was inaugurated at the end of September. Managed by former vice minister of the Ministry of Finance (MOF), Lou Jiwei, it will receive between $200bn and $300bn from the MOF in start-up capital. Given the break-neck speed of China’s foreign exchange growth, industry observers predict that CIC could be entrusted with as much as $1trn within 5 to 10 years. No wonder that the spotlight is now on Beijing. What impact will the fund have on the global financial markets? Julia Grindell reports.
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POTENTIAL CLUE of what to expect came in May, when the CIC jumped into action with a $3bn investment in a pre-initial public offering (IPO) stake of US private equity giant Blackstone Group, before the fund was even formally established. The deal was enabled by Central Huijin Investment Corporation, the state policy vehicle set up to recapitalise China’s large domestic banks and which was merged with the CIC prior to its launch as a wholly-owned subsidiary. “We will maintain transparency of company operations on the premise of safeguarding our commercial interests,” Lou Jiwei, the company’s newly-appointed board chairman, told the Xinhua news agency. Lou is also deputy secretarygeneral of the State Council, or the cabinet. Other CIC board members include two executive directors Gao Xiqing, who is vice chairman of the National Council for China’s Social Security Fund and is CIC’s general manager. Zhang Hongli is CIC’s second executive director. Zhang Xiaoqiang, Li Yong, Fu Ziying, Liu Shiyu and Hu Xiaolian are non-executive directors. Liu Zhongli and Wang Chunzheng are independent directors and an additional director will be elected from the company’s employees. Zhang Xiaoqiang
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CHINA’S NEW STATE INVESTMENT CORPORATION
"We will maintain transparency of company operations on the premise of safeguarding our commercial interests," Lou Jiwei, the company's newly-appointed board chairman, told the Xinhua news agency. Lou is also deputy secretary-general of the State Council or the cabinet. An old photograph of Lou Jiwei, talking at a 2003 Euromoney conference. Photograph kindly supplied by Associated Press/PA Photos, supplied October 2007.
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and Wang Chunzheng are vice-ministers of the National quarter of this year, China’s US Treasury holdings increased Development and Reform Commission (NDRC), the a mere 5.8%. They actually declined by 3% in April and nation’s top economic planner. Fu Ziying is an assistant to May of this year, to $407bn as of May.” In other words, despite China’s continual buy-in to Tthe minister of commerce. Liu Shiyu is a central bank vicegovernor, Hu Xiaolian head of the State Administration of bonds, these investments are accounting for proportionally Foreign Exchange (SAFE) and Liu Zhongli was former less of their US dollar reserves over time. In light of this, a finance minister. Xie Ping and Wang Jianxi were appointed senior economist of Henderson Global Investments, as deputy general managers. Xie Ping is now the general Nicholas Brooks, predicts in a recent report “in the longmanager of the Central Huijin Investment Corporation and term the developed economy bond markets will be losing Wang Jianxi a vice board chairman of the Central Huijin. Hu an important source of support.” Professor Zhong however, iterates that “regardless of the Huaibang, Commissioner of Discipline Inspection with the China Banking Regulatory Commission, has taken up the introduction of CIC, the stocks of T-bonds held by the Chinese government will not reduce, China will not sell any post as chief supervisor. No doubt, “the establishment of this CIC is a positive T-bonds, and there will just be an incremental portfolio step in China’s financial reforms,” says Anthony Chan of adjustment whereby China will very gradually diversify global asset managers Alliance Bernstein. China has funds away from T-bonds and into higher yielding markets.” “The goal of [CIC] is to maximise return on investment,” accumulated foreign reserves of $1.3trn, which are growing in excess of approximately $40bn a month, and starting to says Zhong.“The focus will be on equity markets, commodity have adverse effects on China’s macroeconomic stability. markets and industries which are important to China’s “This stockpile of cash is a source of excess liquidity in the sustained economic growth,” highlighting that CIC’s investments will be economy, a lowpredominantly profityielding asset base, as oriented with room to well as a major political include some strategic issue,” says Jing Ulrich, How will this newly moulded forex portfolio elements as well. managing director and impact government bond markets? Will it lead Accordingly, financial chairman of China to an eventual sell-down of China’s T-bond experts are citing Equities at JPMorgan. portfolio? “There are signs that diversification Singapore’s Government Up to CIC’s launch, Investment Corporation the majority of China’s out of traditional dollar holdings such as US T(GIC) as a potential forex reserves had been bonds is already taking place,” says Jing. model for the CIC. managed by the State “China’s holdings in US treasuries jumped “Singapore’s GIC Administration of 28% in 2006, in line with the 30% increase in operates along similar Foreign Exchange foreign exchange reserves holdings over the lines to most private (SAFE) on behalf of the investment management People’s Bank of China year. However, such holdings have undercompanies, investing (PBOC), the central paced the build-up in foreign reserves thus far government reserves bank. “SAFE has been in 2007. In the first quarter of this year, across a range of asset focusing its forex China’s US Treasury holdings increased a mere classes and regions,”says investments on US T5.8%. They actually declined by 3% in April Brooks. However, to bonds and other highallow for the more and May of this year, to $407bn as of May.” rating, low-risk, fixed strategically placed income tools,” explains investments, “there has Zhong Wei, professor been some speculation of finance at Beijing Normal University.“The new company will be responsible that China’s CIC may ultimately look more like a hybrid of for managing a portion of China’s forex and diversifying GIC and Temasek Holdings, the Singapore government’s away from T-bonds to more moderate risk and moderate strategic investment arm,”Brooks continues.“Temasek takes long-term strategic stakes in companies and tends to take a return equity markets.” How will this newly moulded forex portfolio impact more activist approach to its investments.” Zhong adds that,“the risk of investing in emerging markets government bond markets? Will it lead to an eventual selldown of China’s T-bond portfolio? “There are signs that is comparatively high, so I don’t think CIC will be in any diversification out of traditional dollar holdings such as US hurry to put money into neighbouring countries.” Though T-bonds is already taking place,” says Jing. “China’s Jing notes,“the fund will also likely seek direct stakes in key holdings in US treasuries jumped 28% in 2006, in line with sectors, with natural resources and energy potentially at the the 30% increase in foreign exchange reserves holdings top of the list, along with high-tech, financial and major over the year. However, such holdings have under-paced consumer names. Private equity and property real estate the build-up in foreign reserves thus far in 2007. In the first investment trusts are also on the agenda.”
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Up to CIC’s launch, the majority of China’s forex reserves had been managed by the State Administration of Foreign Exchange (SAFE) on behalf of the People’s Bank of China (PBOC), the central bank.“SAFE has been focusing its forex investments on US T-bonds and other high-rating, low-risk, fixed income tools,” explains Zhong Wei, professor of finance at Beijing Normal University.“The new company will be responsible for managing a portion of China’s forex and diversifying away from T-bonds to more moderate risk and moderate return equity markets.” Photograph of a dragon and tower in Beijing. Photograph © David Huo, supplied by Dreamstime.com, October 2007.
The shape that CIC’s strategic investments might take, if at all, is still unclear, but in light of past events China will likely be trying to keep things out of the limelight to avoid political controversy. “The Chinese authorities are all too aware of the political implications that more active investments can have, and obviously the China National Offshore Oil Corporation deal is widely discussed and analysed,” says Green, citing China National Offshore Oil Corporation’s failed bid for Californian rival Unocal in 2005 due to US Congress intervention. As the debate in the US and Europe shifts from not ‘if’but ‘how’to regulate the purchase of controlling stakes in these regions’key sectors by sovereign wealth funds (SWFs) such as China’s CIC, things aren’t getting any easier. “The challenge is to imagine checks at the EU level that are light enough not to become a barrier to healthy investment, but adequate to limit foreign state-based investment that poses a risk to our long term interests,” said EU Commissioner Peter Mandelson in a statement in early summer. Whether this is fair or not should be left for another time, and another magazine, but China must be all too aware by now of the obstacles in the way of notoriously opaque government-owned investment vehicles with their sights set on controlling stakes in vital or politically sensitive sectors in the west. Before CIC really starts stirring up global equity markets, there are still a number of structural challenges to overcome. Firstly, CIC has to fully absorb Central Huijin Investment Corporation and the exact nature of this move has yet to be disclosed. Established in 2003 and owned by the central bank, Huijin was set up to create an organisational structure by which the Chinese government
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could operate as a shareholder for the “big four” state owned banks by drawing on China’s forex reserves for their recapitalisation. In accordance with this, “Huijin has investment authority over China’s forex reserves,” explains Arthur Kroeber, Director of Dragonomics, a Beijing based financial research firm. “I can see why this forex-related function will be absorbed by CIC, but to the extent of which Huijin will continue to be involved with the domestic economy and as a shareholder in China’s large commercial banks has yet to be revealed.” “The details are still unclear,” says Jesse Wang vice chairman of Huijin and a key facilitator in the Blackstone deal. In the meantime, there are also some technical issues affecting the process by which MOF will raise the funds prior to their transfer to CIC. Due to central bank regulations, PBOC is not permitted to give the money directly to MOF. Because of this, and in an attempt to curb excess liquidity, the NPC has given MOF approval to issue RMB1.55trn of special ten-year bonds as part of the financing programme. “Earlier proposals were that these bonds would be issued directly to PBOC and after converting the proceeds to $200bn in a foreign exchange swap with SAFE (part of PBOC), MOF would assign the funds to CIC as start-up investment capital,” explains Alliance Bernstein’s Chan. Nevertheless, the buzz now circulating in China says that an intermediary will now be brought into the equation. Zhong reveals, “MOF will now issue these bonds to the Agricultural Bank of China, which will sell these bonds to PBOC in return for money that will be passed to MOF. MOF will then use this money to buy forex reserves from the central bank. “This should not have any direct impact
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expertise by requesting to place their staff in these companies. “When Singapore’s GIC was getting started it was not unknown for them to take stakes in fund management and other kinds of financial companies in order to learn the business. I think this was part of the reason for the investment in Blackstone,” suggests Kroeber. As one might expect, CIC has been seeking the expertise from financially-accomplished overseas Chinese, including Chen Zhiwu, professor of finance at Yale University who holds a place on CIC’s internal advisory committee, in order to accelerate the Although Zhong comments that,“the risk of investing in emerging markets is comparatively high, so I learning process. It is clear don’t think CIC will be in any hurry to put money into neighbouring countries.” Jing adds that,“the fund that CIC must surmount a will also likely seek direct stakes in key sectors, with natural resources and energy potentially at the top of number of hurdles before the list, along with high-tech, financial and major consumer names. Private equity and property real becoming operational. “It estate investment trusts are also on the agenda.” Photograph of Beijing’s night snack market. Photograph may [have been] formally © Bertrandb, supplied by Dreamstime.com, October 2007. set up with a name plate on on liquidity in the domestic market because the the door in September, but I don’t think CIC will be RMB1.55trn of bonds held by PBOC will be released into operating in a meaningful way until the beginning of next year. Given CIC’s long-term goals, a few months here or the market gradually.” Coordinating this transfer programme therefore looks set there doesn’t really matter, but from a financial markets to take some time, applying further limitations to the speed standpoint, it would be nice to know when they are going at which CIC can diversify its forex portfolio to higher- to begin stirring up the waters,”comments Kroeber. There is no denying that the establishment of CIC is a yielding targets. The mechanism by which future CIC bonds will be issued, or indeed the continued magnitude of funds step in the right direction in terms of China’s forex reserve going to CIC, is still to be made apparent. “Given that management. The opportunity cost of not shifting a chunk China’s monthly forex reserves accumulation was an average of this rapidly-growing forex stockpile away from lowerof $45bn in the first quarter of 2007, we could expect CIC’s yielding fixed income instruments has now become too future bond issuance to average about $10bn a month,” great. CIC’s own capabilities combined with its expressed predicts Chan.“China’s CIC could therefore, easily become a desire to keep investments low-key - in light of experiences and a growing protectionist sentiment in the west - will $1trn investment corporation in less than a decade.” Despite China’s CIC possessing the potential to become likely limit the shape of any near-term investment the world’s largest SWF in years to come,“the question is portfolio. The technical challenges that have arisen in CIC’s really about whether China has the management financing programme will potentially limit the speed at capabilities to run a really professional investment which China can diversify its forex reserves away from corporation on a global scale and I think that this will affect lower yielding government securities such as T-bonds. These considerations taken together would suggest initial how drastic China’s impact will be in the immediate future,” says Chan. It is therefore probable that CIC will investments should not rock global markets in the shortdraw on a variety of strategies in managing its funds. term. In the long-term however, global bond markets could “There is no doubt that CIC will place a large chunk of its eventually lose out as developed and emerging market fund with global managers and one would expect that over equities become an increasingly attractive target for capital time China will take back more and more of the money to flows. Given China’s obvious desire to sustain its economic growth, as CIC develops expertise and increases its fundmanage themselves,”says Green. In order to develop CIC’s internal expertise, Kroeber says base, over time, a more activist higher-risk approach to it is possible that it will make investments, which are outbound investment could result. Further, bolder strategic designed in part to help Chinese fund managers gain stakes should not be ruled out.
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From a single office in Calabasas — a former stagecoach stop just north of Los Angeles — Countrywide grew into the world’s largest home-mortgage company, originating $463bn in loans last year and servicing a $1.5trn portfolio of home loans. The company’s success made cofounder and chairman Angelo Mozilo a very wealthy man. Now, both his fortune and his company may be in jeopardy because of a deadly combination of rising interest rates, falling home sales, and a worldwide liquidity crisis. Art Detman reports from California.
COUNTRYWIDE:
PROFILE: COUNTRYWIDE FINANCIAL
Photograph supplied by iStockphoto.com, October 2007.
UP CLOSE & PERSONAL? HE NEAR-DEATH experience of Countrywide Financial Corporation (CFC) in recent months developed so rapidly that it surprised perhaps even Angelo R Mozilo, the company’s brash and supremely confident chief executive officer. Throughout late 2006—as sub prime loans made by other lenders began defaulting in large numbers, home prices softened, and interest rates rose — Mozilo exuded confidence at his company’s prospects. At a conference of bond investors in September of 2006, he asserted that CFC’s “proprietary technology” and “prudent underwriting guidelines”would win the day. His optimism seemed justified because common wisdom said the home mortgage industry’s problems were restricted to sub prime loans. While those loans were made to borrowers with weak credit they comprised no more than 10% of CFC’s business (even so, enough to rank
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Countrywide third among all sub prime lenders). Mozilo castigated other mortgage companies for incompetence, said Countrywide would grow by hiring its competitors’ castoffs, and predicted that 2007 would be the trough in the home lending cycle. By 2008 business would be humming again. Actually, business hummed in 2006 for CFC, which reported record revenues of $11.4bn, record per share earnings of $4.29, and net profits of $2.511bn (down a hair from $2.528bn in 2005). In March this year, New Century — a major sub prime lender — suspended operations. By this time, more than two dozen sub prime lenders had closed up shop. But there were signs that the mortgage industry’s problems weren’t confined to sub prime loans. CFC, for example, reported that during 2006 the delinquency rate on its prime loans rose to 2.93% from 1.57% in 2005.
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Financial company executives testify on Capitol Hill in Washington, Thursday, March 22nd, 2007, before the Senate Banking Committee hearing on sub prime mortgages. From left are, WMC Mortgage chief executive officer Laurent Bossard; Countrywide Financial executive managing director Sandy Samuels; HSBC Finance Corporation chief executive officer Brendan McDonaugh; Janis Bowdler; and First Franklin Financial Corporation President L. Andrew Pollock. Photograph by Dennis Cook, supplied by Associated Press/PA Photos, October 2007.
In July two hedge funds managed by Bear Stearns suddenly collapsed, mainly because they were unable to determine the value of their sub prime loans. Fear rippled through credit markets around the globe. The entire worldwide credit system threatened to freeze up. Some put the blame upon Alan Greenspan, who as chairman of the Federal Reserve System (the Fed) flooded the financial system with liquidity after the dot-com collapse in 2000 and lowered short-term rates to just 1%. This stabilised markets and softened the 2001 recession. However, in driving down interest rates, the Fed enabled more people to buy homes and thus fueled an unprecedented run up in housing prices. An unsustainable cycle had gotten under way. Lenders gladly allowed buyers to overextend themselves by making loans with below-market rates during the first two or three years, the expectation being that homeowners could refinance before the higher rate kicked in. Besides, the reasoning went, rising home prices would enable even buyers who were paying only interest to build equity. To yield-hungry investors — aggressive hedge funds and cautious pension funds alike — packages of these mortgages appeared to be super-safe investments with higher returns than those of other collateralised securities. Bundling thousands of mortgages into a single tradable security dates to the late 1970s, when Solomon Brothers invented the idea. Until then, companies like Countrywide either sold their loans to the Federal National Mortgage Association or the Government National Mortgage Association, both of which had dollar limits on each loan and strict underwriting standards, or kept nonconforming loans on their own books. Securitisation freed loan volume from the anchor of in-house capital. US mortgage companies were transformed from long-term lenders into mere originators.
What’s more, as consumer credit companies became more sophisticated in assessing the creditworthiness of individuals, what had been an exhaustive underwriting process became little more than a clerical procedure to obtain credit scores. Meanwhile, agencies such as Standard & Poor’s and Moody’s began rating the individual mortgages that comprised the collateralised debt obligations. Mortgage originators, says Peter S Cohan, head of his own consulting firm, “gave the business to the agency that provided the highest rating. Basically, they were buying the ratings.” With the risk transferred in large part to investors that bought mortgages, rather than the companies that originated them, a classic moral hazard had been created. Soon marketing, not underwriting, was the key to success in the mortgage business. No one did this better than Countrywide. Its loan origination officers became the industry’s most effective, winning prospects with this assurance: “I want to be sure you are getting the best loan possible.”Even so, there was a flaw in the business model.“What got Countrywide and others into trouble was their financing strategy,”says Michael McMahon, a former commercial banker turned security analyst who is now a private investor.“They finance medium and long term assets with short and medium term borrowings.” Even though CFC sells most of its loans to institutions, it holds several billion dollars in mortgages on its books and needs to roll over short-term loans that finance those mortgages. Without ready cash to fund new mortgages for sale, it would be essentially out of business. As industry-wide defaults and foreclosures rose and home sales dropped, Mozilo sought to reassure investors by claiming a line of readily available credit that totalled almost $50bn. Liquidity, he assured the market, was not a problem for Countrywide.
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Kenneth Bruce, a highly regarded analyst at Merrill Lynch $2bn in CFC. BofA, the nation’s leading consumer bank with who, for 13 years, worked in the banking industry (including assets of $1.46trn, had romanced CFC for six years or more, two years at Countrywide), agreed and reiterated a buy rating. according to reports. In return for BofA’s ready cash, CFC gave Two days later, in mid-August, Bruce reversed himself and up 20,000 shares of preferred stock, which pay an annual issued a sell rating, warning that Countrywide could go dividend of 7.25% (more than double the rate similar CFC bankrupt if it could not continue borrowing money to fund securities paid just a month before) and are convertible into its portfolio. Neither his upbeat note nor sell rating was 111m shares of common at $18. BofA CEO Kenneth Lewis intended for the public. “Those notes were proprietary for had secured the right to buy 16% of Countrywide for not only our clients,”says a Merrill Lynch spokeswoman. “We did not less than market price but for 20% less than book value. BofA send them to any media.”Bruce’s alarm triggered a sell-off in cannot sell the preferred shares for 18 months, but in return not only Countrywide stock, which fell 13% one day and gets the right of first refusal on any offer to acquire all of CFC. An enigmatic phrase in the agreement says that the then 11% the next, but in mortgage-related securities of all conversion price “may be kinds. There was a adjusted upon the week-long run on occurrence of certain Countrywide Bank, In March, New Century—second only to CFC events.” Neither CFC’s wholly owned in making sub prime loans—suddenly company would thrift that has about 100 elaborate, but reasonably offices across the US. suspended operations, just a week after a translated it means that if The $50bn in ready favourable analyst’s report from Bear Stearns. CFC’s financial condition credit that Mozilo By this time, more than two dozen sub prime declines beyond a certain touted had evaporated. lenders had either failed or closed up shop. point, the conversion He scrambled to pull However, there were signs that the mortgage price also declines. together a financing Analyst Paul Miller’s package. One report industry’s problems were not confined to sub prediction had come to said he was offered 30prime loans. CFC, for example, reported that pass. An analyst at S&P day money at 12.5%, during 2006 the delinquency rate on its prime says the preferred stock the financial equivalent loans rose to 2.93% from 1.57% in 2005. sale signaled distress on of hara-kiri. Pundits the part of Countrywide, opined that CFC was and Frederick Cannon of too big to fail — after all, it originated one in six home mortgages in the US. The Keefe, Bruyette & Woods (KBW) agrees. “From a stock traded as low as $15. On August 17 Mozilo shareholder’s viewpoint, it was very expensive, but it would announced he had secured a financing of $11.5bn from a appear that it was also extremely necessary.” Mozilo put forward the best face possible, calling it a vote consortium of 40 banks. This failed to ease market fears. Every month Countrywide made $41bn in mortgage loans, of confidence and portraying the transaction as a win-win and to finance these it relied upon turning over $13bn in deal for both companies. BofA’s Lewis was more detached. commercial paper. The new funding fell short of “We hope this investment will be a step toward a return to Countrywide’s needs. Paul J Miller, an analyst at Friedman, a more normal liquidity in the mortgage market,” he said. Billings, Ramsey & Co., predicted that if the liquidity crunch Alas, investors weren’t persuaded that Countrywide had lasted more than a month, Countrywide would be forced to been saved. They concluded that the $2bn BofA investment was really too small to make a real difference. Interest rates sell assets at a deep discount to remain in business. As we’ll see, he was right. First though, Mozilo announced were rising, home values were falling, and an that Countrywide Bank—the company’s wholly owned undetermined number of CFC borrowers would be unable federal savings bank—would speed its expansion in order to to continue making payments as the interest rates on their fund home loans with deposits. As McMahon notes, this is loans reset to market rates. One clue: fully 60% of CFC’s relatively easy because Countrywide Bank branches are just sub prime loans made in 2005 and 2006 and scheduled to kiosks inside Countrywide Home Loan offices, not branches reset in 2008 have not been refinanced. Mozilo himself as defined by the Fed. By this time, according to one source, spoke despairingly of a “sudden and severe and deep examiners from the Office of Thrift Supervision (which deterioration”in home values. In August Mozilo announced that 500 jobs would be cut. regulates federally chartered savings banks) had set up shop inside of Countrywide’s headquarters and were monitoring In early September he announced that an additional 900 events on a real-time basis. Countrywide had staunched the employees would be let go. Two days later he said the total outflow of funds with newspaper ads offering above-average would reach 10,000 to 12,000 over the next three months, up interest rates. By the end of September, Countrywide Bank to 20% of Countrywide’s total headcount. A week later, was attracting $50m in deposits each day. As the industry almost buried in a press release, was news of a new financing continued to deteriorate, Mozilo made a surprise of $12bn secured by liens against mortgages held in announcement: Bank of America (BofA) had agreed to invest Countrywide’s own portfolio. Over 30 days, Countrywide
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had obtained three financings: first a bank financing of $11.5bn, then the sale of $2bn in convertible preferred stock, and finally a mystery funding of $12bn. Meanwhile, layoffs of 500, then 900, and ultimately 12,000 had been announced. It appeared that Mozilo no longer had a firm hand on events but rather was improvising almost day to day. In fact, the announced layoffs may not be enough. Nonconforming loans accounted for 40% of CFC’s loans in 2006. Mozilo wants to reduce that to 10%, which means he likely will have to reduce headcount by a total of 30% or even 40%. Meanwhile, lawsuits are piling up. “It’s not atypical to have a number of lawsuits occur when you see a stock price drop the way this stock price has dropped,”says Cannon of KBW. “Whether or not they have meaningful merit from an equity investor’s point of view is hard to say. But I would put those lawsuits as one of those off-balance sheet risks that we try to be aware of.” Cannon is right, of course. Furthermore, one suit goes to the very heart of Countrywide’s problems. Filed by the San Francisco law firm of Liner Yankelevitz Sunshine & Regenstreif as a class action on behalf of everyone enrolled in the company’s employee pension plan, the suit maintains that the administrators of the plan—all company insiders—knew or should have known that Countrywide was about to encounter conditions that would drive down the price of its stock (which fell more than 50% during the first nine months of 2007). Ronald S Kravitz, the lead attorney in the action, will surely ask jurors this key question: “Why did the administrators of the pension plan offer CFC stock as an investment option, and why did they fund the company’s share of employee contributions solely with CFC stock, when they themselves were selling their
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Countrywide bank customers wait in the lobby of a Los Angeles branch, Monday, August 20th 2007. Countrywide Financial Corp. tries to reassure customers that the liquidity problems dogging its mortgage lending business are not affecting its banking unit, Countrywide Bank FSB, even as people worried about their savings converge on bank offices. Photograph by Nick Ut, supplied by Associated Press/PA Photos, October 2007
own shares, month after month after month?” Indeed, it appears that Mozilo himself has not bought a share for his own portfolio since 1987, and that no officer or director bought a share in 2006 or 2007. Insider trading, as reported on the SEC’s website, amounts to 23 pages of transactions, but every transaction is a sale, not a purchase. Mozilo himself allegedly has reaped more than $400m in stock options that he has exercised over the years. Many of these sales were, it has been reported, made under Rule 10b5-1, which permits executives to establish plans for the regular sale of stock. The idea is that, as long as these sales were executed under a predetermined plan, the executive is protected from any accusations of insider trading. But this may prove a challenging argument for Mozilo to make. According to filings in late 2006 and early 2007 ( as the liquidity crisis was becoming evident but before CFC stock reached its low point) he allegedly adopted a new plan, added a second plan, and then revised it. The net effect was to permit him to sell shares at far higher prices than if he hadn’t instituted the new plan (which allowed him to sell up to 350,000 shares a month), or adopted a second plan (which allowed him to sell an additional 115,000 shares a month), or filed a revision that allowed the sale of 580,000 shares a month (just as CFC stock reached its all-time high of $45.03).
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Typically, executives file a plan and stick with it for years. But Mozilo filed plans that allowed him to sell stock at an ever-increasing rate even though his options did not expire until June 2011. Mozilo also began selling shares he had held for years. As October drew to a close, it appeared that soon Mozilo would own no shares of his company, a remarkable situation for a CEO. Because Mozilo is ultimately the responsible officer for the company’s pension plan, and because he sold so much stock within the past two years, litigants may demand he give up some of those gains. Kravitz goes further than simply alleging that CFC stock was an unlucky investment for the pension plan. “Countrywide stock became an imprudent investment based in part on the misconduct going on in the company that, once disclosed, could lead to a drop in the price of the stock.” This alleged misconduct has been reported in various news articles, which describe a variety of practices that exploited Countrywide borrowers by charging them interest rates that were higher than their credit scores merited and overcharging them for a variety of fee-based services, such as appraisals and credit reports. Mozilo has angrily denied the allegations, although he has not specifically rebutted any particular one. Meanwhile, the state treasurer of North Carolina wrote to the SEC complaining that Mozilo “apparently manipulated his trading plans to cash in” even as the sub prime debacle was unfolding. And the Louisiana Municipal Police Employees’Retirement System persuaded the Delaware Chancery Court to order Countrywide to provide confidential information about the operation of its stock-option program. Countrywide was also told to provide any related information that it may have already given to the SEC, the New York Stock Exchange, or the US Department of Justice. Clearly, both actions lay the foundation for lawsuits. Kravitz expects that at some point all the suits will be consolidated into a single action and a lead attorney will be appointed by the court to prosecute the action. The lawsuits present a possible impediment to what is likely the most logical solution to the problems facing Countrywide, which would be its acquisition by Bank of America. BofA now holds nearly 10% of all US bank deposits, which is the limit set by the government. If BofA is to grow, the mortgage market presents a natural path. Already BofA ranks fifth, with a 7% market share, but experts say that its mortgage operation is not managed nearly as well as Wells Fargo’s (the number two mortgage company) or CFC’s. Mozilo has proposed that BofA outsource its entire mortgage business to Countrywide, which presumably would put its own people at home mortgage desks in BofA branches and which certainly would act as BofA’s back office for all mortgage transactions. BofA CEO Lewis has not publicly responded directly to this idea, but he has said that he has never been involved in a successful joint venture. Indeed, suppose that BofA had hired Countrywide to run its mortgage business, and then Countrywide was hit with these lawsuits, unfavorable press
articles, and equally unfavorable comments by various politicians. Lewis would have little if any control over the situation, hardly the position a conscientious (or ambitious) CEO wants to find himself in. Mike McMahon, the former banker, notes one potential downside. Mortgage banking is a volatile, cyclical and seasonal business, and therefore mortgage banks command a low price/earnings multiple. CFC, for example, traded below 10 times earnings (recently, the p/e ratio was 5). Even so, CFC might still make sense for BofA. Like other commercial banks, BofA expects to cross-sell services to its mortgage customers. Besides, even with the book of CFC mortgage business, BofA would not be primarily a mortgage bank but rather a consumer bank with a big mortgage business. Will it happen? It might, provided that Mozilo and Lewis find a way to settle the lawsuits quickly and at a reasonable cost. But there is still another potential problem. Generally, institutional investors who buy mortgage-backed securities have no recourse if those mortgages default. The exception is fraud — whether it is committed by the mortgage originator or the borrower. Here lies the rub: it is an unquantifiable hazard for CFC or any company that acquires it. In the freewheeling days of 2003 to 2005, it was easy for loan officers and borrowers to bend the facts to their advantage. If an institutional investor can substantiate enough such instances, it may force Countrywide to take back an entire package of loans — a potentially devastating event. Meanwhile, the housing market continues to deteriorate and so does Countrywide’s financial results. For September, the company reported that total loan fundings fell 44% from September 2006. Delinquencies as a percentage of unpaid principal balances rose to 5.85%, up from 4.04%, and pending foreclosures climbed to 1.27%, up from 0.51%. A few days later CFC announced that layoffs and office closings will require a pretax charge of $125m to $150m. Analysts projected third quarter losses of as much as $1.3bn after loan loss provisions. What does Mozilo have to say about his company’s predicament? Very little (phone calls from the press, including FTSE Global Markets, are rarely returned). However, in an effort to combat an increasingly poor public image, Mozilo hired a major public relations agency with substantial experience in crisis management. Now, employees are provided with rubber wristbands that proclaim “Protect Our House.” In a meeting with employees, a senior executive reportedly told them that“it’s gotten to the point where our integrity is being attacked. NOW IT’S PERSONAL! . . . And, WE’RE NOT GOING TO TAKE IT!” In other words, if anyone has suffered during the recent mortgage lending crash, it is Countrywide, not its customers or shareholders. The events of the past two years have resulted in a grim outlook for nearly every aspect of the US housing industry. But the industry will bounce back and once again the American housing market will be robust and growing. For now, it’s too soon to say the same about Countrywide Financial.
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THE SECURITIES LENDING
Roundtable TRANSFORMATION & TRANSPARENCY
COMMENTATORS:
Supported by:
Left to right back row: MICK CHADWICK, head of trading, securities finance, Morley Fund Management DAVID RULE, chief executive officer, International Securities Lending Association (ISLA) MARK FAULKNER, chief executive officer, Spitalfields Advisors CHRIS JAYNES, president, eSeclending Left to right front row: RICHARD STEELE, head of product development for securities lending, JPMorgan Worldwide Securities Services FRANCESCA CARNEVALE, Editor, FTSE Global Markets JOHN POOLE, chief operating officer - Europe, Mercer Investment Management
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TRENDS TO WATCH CHRIS JAYNES, PRESIDENT, eSECLENDING: There is an increasing demand for lending in emerging market countries. It been a growing trend for a number of years and agent lenders are more actively looking at different ways to structure trades to gain access to these markets. As well, beneficial owners continue to unbundle securities lending from custody and utilise multiple providers and different routes to market to optimise their programmes. Institutions increasingly view lending as an investment decision and now use multiple providers across different parts of their lendable asset base. This allows the beneficial owner to choose the provider with the greatest expertise and ability to add value in each market, asset class or route to market and enables them to better benchmark performance against other providers. MARK FAULKNER, CHIEF EXECUTIVE OFFICER, SPITALFIELDS ADVISORS: The big trend? There are now
fund managers who traditionally shunned securities lending and left it to be dealt with in a back office manner by back office people who are now borrowing securities for the first time. Not only 130/30 investment strategies, but also new regulations and deregulation have encouraged investment managers to recognise that borrowing securities and shorting them is actually good investment management practice and not just something that “evil people do”. A problem the industry faces is that it is still built upon the same operational foundations that it always has been. The good news is that some of these traditional fund managers will wake up to this fact and actually make things better and move securities lending closer to their front offices. That will happen when they realise how much money they have to pay to borrow securities, how much money they can make as lenders, how inefficient the market is, and how opaque the pricing is. This trend is welcome, forceful and positive. RICHARD STEELE, HEAD OF PRODUCT DEVELOPMENT FOR SECURITIES LENDING, JPMORGAN WORLDWIDE SECURITIES SERVICES: The market is definitely evolving.
Until quite recently the industry was pretty segmented— some might say almost regimented. There were people who lent their own portfolios on a directed basis, and then there were agent lenders (typically custodians). We also see new third party providers coming in and offering more unbundled services. Traditional providers recognise this development and have responded accordingly by providing a much broader product range. At the same time, our more sophisticated clients now look to us to provide more flexible solutions than may have been the case before. In particular, traditional long only managers are looking to utilise their portfolios in different ways and asking service providers to accommodate that change. Faced with this unprecedented level of demand some providers find that their platforms may need to be overhauled, so they can
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provide the flexibility that clients require and it is interesting that prime brokers are looking at this space as well. DAVID RULE, CHIEF EXECUTIVE, ISLA: Big regulatory changes are underway. For example, the introduction of Basel II, with dealers in particular having to obtain more information from agent lenders about the underlying principals to their loans and the allocation of collateral among them. Mark has talked about securities lending moving towards being a front office activity and part of that is going to be more price transparency. We have already seen the growth of an interdealer market with the introduction of ICAP’s platform recently, which further encourages price transparency. JOHN POOLE CHIEF OPERATING OFFICER - EUROPE, MERCER INVESTMENT MANAGEMENT: UCITs III
considerably increases the flexibility of what we can do in our core funds. We can now adopt shorting strategies, so the challenge for us is to find a cost effective way to implement 130/30 within a UCITs structure, which involve some additional regulatory restrictions. With our long only funds on the one side, and hedge type funds on the other, one of the things we want to do longer term is borrow securities from one of our long only funds and lend them to one of our long short funds. There are some huge compliance issues in that. Nonetheless, we want to cut out some of the people who would normally be in that kind of structure. Why should our long only funds lend to a third party only for our long short funds to borrow from them? The lending fund gets a lower return, and the borrowing fund pays a higher financing cost. We want to get rid of those costs to our funds. We need to find somebody to work with, to achieve this and ensure that we behave in a way that is fair to both funds. MICK CHADWICK, HEAD OF TRADING, SECURITIES FINANCE, MORLEY FUND MANAGEMENT: I echo John’s
sentiment about the convergence between traditional long only fund management and the long/short space and that the compliance hurdles are significant. However, even if we cannot go so far as to disintermediate prime brokers altogether, the mere existence of both strategies under the same roof can at least keep the prime broker honest. I also strongly echo Mark’s sentiments. There has been a debate about where the product should actually sit. Is it an operations function? Alternatively, is it (to use fund management jargon) a potential source of alpha? We are now able to benchmark performance in a way that we were not able to five or ten years ago. Practitioners can now judge the performance of a programme in both absolute and relative terms. Moreover, as the industry becomes more competitive, securities lending becomes an increasingly important source of revenue. In the overall market, two trends dominate. In relatively mature, commoditised markets, where price discovery is less of an
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issue, anything that moves is being automated. It’s all about scale; it’s all about operational efficiency. Then, at the other end of the spectrum you have some of the emerging markets where traditionally, standard securities lending has not been possible, and there you see the development of synthetic products that allow participants to generate returns in those markets. This is where it helps to work under the same roof as the fund manager who ultimately controls those assets, since such structures will typically involve the outright purchase and sale of the underlying securities. FC: I get a sense of a market in transition and becoming
increasingly complex. How is that affecting the provision of your services Richard? RS: As the custodian and lending agent to a very broad and diverse client base we have had to develop flexibility as well as scale in our business for many years now. That is something that we have become very adept at and, at the same time, we are in a constant dialogue with our clients about their requirements and what they are trying to achieve. There are now many different routes to market and we all know that lending can be very portable nowadays. Above all, you must remember that it is not over when you have been awarded the portfolio mandate. In fact, that is where the relationship really begins. Clearly then in the final analysis if we are in the business, and also growing our book at a significant rate, we must be doing something right.
130/30 STRATEGIES & THEIR IMPACT MF: Recent headlines suggest that there is about $60bn in 130/30 dedicated investment right now, which manifests itself at ratios of $18bn worth of shorts, which is a drop in a bucket frankly. Looking forward, we are talking about something that could be much more important. If there is a take-off along the lines of that in exchange traded funds (ETFs), 130/30 could become very important, very quickly. It is interesting to see that many of the funds and firms that are focusing on this strategy are the same funds and firms that made a success out of ETFs. They were right last time and maybe they will be right again. We think that they are backing this horse. Therefore, it could be much more significant than it currently is, but it isn’t all that significant yet. RS: This sort of thing requires a long lead time and people need to decide where they are going to start investing in the cycle. With some of the deals that are going around at the moment, questions come up such as: “Can you support discretionary lending? Can you support directed lending? Can you support it in a pooling environment? Can you support a long short type structure?” I am not sure that everyone can tick all those boxes yet, and that is where it starts to get very, very interesting.
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CHRIS JAYNES, president, eSeclending FC: Chris, do you think that eSecLending can tick all those boxes? CJ: Absolutely. Each client will need to evaluate the various options presented to them. Mark’s point is pertinent in that long short 130/30 portfolios are not a significant part of the market yet, but it still is an important component for clients. No matter how small a component these new strategies may be to any client’s overall asset base, it is the first time many have been borrowers of securities and there is a need for education on the legal, regulatory and operational issues involved. There is a concern about how to manage this process most efficiently and to make sure that they are being charged fair and reasonable fees. Whether you are managing $100m in shorts or $5bn you still need to be able to answer all these questions. All of the agents are working on solutions in different ways to help clients determine how they migrate from a long only manager to a long short manager and the trend is clearly going in that direction. I do not think any of us can predict how big it will ultimately become but the trend is clearly happening and I do not see it stopping any time soon. JP: Do we see 130/30 being adopted across the board, across all equity asset classes? Or, will it be market specific? I can’t see us going down the 130/30 route in the short term in every asset class, but we are seeing a definite change in attitude to this strategy. The impression I have is that it has already been adopted quite strongly in US equities, and other asset classes are now catching up. I’m not sure of all the reasons for this, but certainly the relaxation provided by UCITs III, especially now we can physically short, makes the operational aspects of implementing 130/30 far less of a barrier. Clearly UK and European equities are more important asset classes here, and the UCITs III changes are now making the implementation of strategies like this easier for us.
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and long/short, inevitably there are going to be come into play. What will attempts by both the be the investment path investment banks and the taken? Established markets custodians to drive their first and then more tanks onto the other’s lawn emerging markets? It is and try to erode the other likely to be the established guy’s franchise. The market markets first. Will 130/30 follow the ETF model? is sufficiently diversified that one cannot easily pick Only now, for instance, are a winner.There are going to you seeing really esoteric emerging market ETFs. It be funds and strategies for which the custodian is the must be remembered that shorting is not that easy. It natural provider. is not as easy as just selling Conversely, the prime broker will be best placed to securities that you do not like. Take the S&P 500, the provide the relevant service ‘bottom” or most shorted for other funds, other strategies. The beauty from 10 securities are already a beneficial owner’s over 60% utilised, trading at a massive premium in perspective is that there’ll MARK FAULKNER, chief executive officer, Spitalfields Advisors the securities lending be choice. Greater market, difficult to borrow and keep short. Moreover, the transparency will facilitate the unbundling of these various role of your prime broker(s)—and/or your custodian(s) who products and services, and you don’t have to put all your eggs are increasingly becoming competitors in this space—will in one basket.You can do certain activities with one provider be critical in getting sustainable access to securities, for the and others with another. newer borrowers to base their strategies around. If, say, I ring up a major prime broker or custodian and I am a FC: Chris is there is room for everybody? relatively new fund and I say that I would like some hard to borrow stock, they will more than likely say,“You know, you CJ: There will always be room for providers who can add aren’t borrowing billions of dollars of general collateral value. It is a huge market that is controlled by a small (GC) securities from me. I cannot give it to you. I am going number of significant players so there is absolutely room to give it to the guys that I have an historic, balance-driven for providers offering a differentiated product or a new relationship with.” It is going to be very difficult to break approach. Increasingly though, with the shift that Mark into those more obvious trades and those hard to borrow talked about earlier regarding the move from a back office stocks if you are a relative newcomer. to a front office function, there will be different expectations placed upon providers and there will be an increased demand for performance measurement and PRIME BROKERS & CUSTODIANS: A other data that did not exist a few years ago. As Beneficial MERGING OF INTERESTS? Owners continue to un-bundle securities lending they are demanding a higher service level and specialized FC: David how do you see this dynamic evolving? capabilities, based on each provider’s specific competencies and expertise. It does not need to be a one-stop shop or DR: One of the differences between prime brokers and custodians is the leverage that they provide and that prime one size fits all approach like it was year’s ago. brokers lend against the assets. One reason why prime brokers have never been disintermediated by the RS: We have very good relationships with the prime custodians with hedge funds is because they would not brokers. However, I can’t see them ever wanting to get into take the credit risk. Actually, to be precise, they could not the core custody space, because it is not going to be manage the credit risk in the way that the prime brokers remunerative enough. You have to be able to offer both can and whether they will be able to provide that kind of scale and customisation at the same time, and on a very leverage to asset managers, I don’t know. That said some cost effective basis. However, they are going to try to big hedge fund managers now are beginning to look more cherry-pick the best relationships if they can. like traditional asset managers. Fundamentally, custodians and prime brokers have radically different business models and so as you have seen convergence, arguably between hedge funds and long only MC: Prime brokerage has long been to the hedge fund industry what global custody has been to the long only side. managers, it is interesting to understand where the With the blurring of the boundaries between the long only interface is going to be between the different providers. MF: A number of issues
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MF: That’s a good point. I predict, though, that within a year
we will see a major acquisition or transaction in the financial markets along the lines of custodian and broker dealer getting together. Moreover, one of the primary reasons cited behind the transaction will be to do with financing and servicing the growing section of the investment management community that go long and short. There will be headline announcements and some of the words in those headlines will be will be ‘long/short’, ‘prime brokerage’ and ‘global custody’. Like Richard says, prime brokers are reluctant custodians and very few dominant custodians if any of them, have a prime brokerage capability or prime broking operations worth talking about. The capabilities shouldn’t be mutually exclusive but in practice they seem to be. However, some of the custodians do have the capital to service this growing segment of the market, so there is an opportunity there for somebody to actually go out and do some financial re-engineering on a massive scale. The timing is now right. Prices are more realistic and the profile of the financing business has increased. Fortune favours the brave. MC: That will raise some interesting questions.
I don’t dispute any of that logic; but at the risk of playing devil’s advocate, you already have institutions such as JPMorgan and Citibank who in theory could do precisely that already—offer both sides of the service under the same roof. However, whether the issues are cultural, operational or compliance, there hasn’t been much convergence to date. DR: They will also have an issue about how they offer best
execution to both sets of customers. To a pension fund who wants to make sure that its securities are being lent to the best deal in the market and to the hedge fund who wants to make sure that it is getting its securities on the best terms.
FAIR & TRANSPARENT PRICING JP: Basically we disintermediate relationships over which we have no control and limit ourselves to dealing with a party we have appointed allowing us better control over programme costs and greater transparency of information. I have an issue. I actually think that custodians are conflicted already and I don’t think they actually know who is really their client in their securities lending programmes. I suspect they make way, way more money from their big broker dealer relationships in terms of the cash balances that they maintain with them than they do from me, and so I have never felt comfortable with the idea that we get a disinterested service from the custodians.
MF: The problem that custodians often face is that they have clients that want to lend that quite frankly should not be lending and all too often an overhang of easy to borrow securities in their lending pools. They don’t say “no” as easily as they should. The lending departments are very accommodating of their custody colleagues, because lending offsets the expense of custody for their clients. This has fuelled the third party lending business as they can afford to be more discerning in the selection of their clients and the securities that enter their lending pools. RS: Actually, we do manage the book much more rigorously than that and do turn away business that is not profitable. Sometimes it seems as if people are happy to take the aggregation benefits of using a custodian when it comes to all the products and services, but expect the custodian to invest the same amount in the supporting infrastructure when they want to cherry-pick the bits of business that make the most revenue. MC: To be honest you pass on those costs to your clients. The cost of settling a trade in CREST is what? 50 pence? The volume discounts available to custodians mean that it’s even lower than that. Meanwhile, many fund managers get charged between £10 and £15 a ticket. Now obviously there are fixed costs to cover, but custody is an inherently good business in which to be.The barriers to entry for any potential new entrant are huge, so effectively what you have is an established cartel, for want of a better word. If greater transparency facilitates unbundling and the potential for ‘cherry-picking’as you call it, perhaps the way forward is for custodians to charge a sensible price for each component of the service they provide, rather than one product effectively subsidising another within the current ‘bundled’service offering. MF: There has to be a catalyst for unbundling.You are absolutely right, something has to happen and what is happening is that fund managers are effectively popping up on both sides of the debate right now that they are both long and short—add in the hedge funds who are long and short as well and you have a heady mix. So the catalyst is people actually recognising the significance of this business, which is a good start. But then, what happens next to encourage change? Regulators, possibly, have a significant role to play because industries typically change slowly unless they are forced to. There may well be regulatory change forthcoming that will drive this business to take steps regarding transparency and best execution that this industry would not necessarily volunteer for. MC: Anyone who is making a living as an intermediary is
RS: I don’t think you will necessarily get a completely
disinterested service from any service provider. However, custodians sign agreements with their clients who they represent as agents and they will get the best deal they possibly can on the terms that are agreed, which include your investment guidelines and any other risk/reward parameters that you choose to adopt.
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hardly incentivised to promote greater transparency and greater efficiency. It has to come either from one end of the chain or the other, or it has to be imposed by regulation. The way to ameliorate any potential compliance issue is via the mechanism of price. There should be a transparent price for a product, or a transaction, or a service.This industry, despite the best efforts of guys such as Mark, is still bedevilled by its relative opaqueness.
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DEFINING BEST EXECUTION DR: In general terms, my understanding is that for agent lenders, best execution mean looking to get the best deal for customers, having policies setting out how you do that and being transparent with customers. Most people have behaved that way and we have a well regulated and fair industry in that respect in any case. MF: And shame on the industry for lobbying as they did
and getting off the hook on this one. DR: I do not think that they did get off the hook, because I don’t think there was a hook in the first place MF: But there is no obligation to provide best execution. There was discussion as to whether it would be relevant and extended into the world of securities lending and the industry got together and wrote a letter, which quite frankly shocked me in terms of its contents and got off the hook. So, typical clients who spend very little time thinking about securities lending, would reasonably expect to be protected by MiFiD and best execution and they aren’t. DR: They will be actually, because many agent lenders are concluding that they actually do have to offer best execution to their clients, because they are going to be treated as professionals and depending on your interpretation of the runes from the European Commission, securities lending may or may not be—and some people are concluding that it is—an execution of client orders MF: That would be very welcome. I am heartened to here
that, the clients will be too and that will be a winning strategic decision. DR: The question is what does best execution amount to? What it doesn’t amount to is that you have to execute at this market price, which is on a ticker tape, because that does not exist in securities lending and securities lending transactions are not as simple as equities sales. There are different dimensions to the transaction, and therefore acting in the client’s interest does not necessarily mean dealing at one particular price—it also depends on the client’s collateral needs and tax status, etc. So what the best execution will amount to is in effect having a policy that says to the customer that we will act in your best interests. RS: The debate has actually moved on. Looking at the latest guidance provided by the FSA and the response of the European Commission to CESR, a client will always need to be properly protected whether retail, professional or eligible counterparty. Every lending provider has to look at this in the context of the firm’s overall approach to best execution and JPMorgan has written a best execution policy which outlines very clearly how we would operate on behalf of our clients to obtain the best possible outcome. The challenge is
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that securities lending is not a business that fits very neatly into a trade by trade disclosure regime and people arguing for that are potentially going to do the industry a disservice by leveraging a huge cost base on it, which frankly it is not in a position to support at the moment. CJ: I would come back to the issue raised earlier about pricing and so called cherry-picking. It is a strange concept in this industry where some view that there is something bad about a beneficial owner choosing to take their assets and lend through a different route or a different provider. They feel that it is somehow unfair to a custody provider who now only has to charge transaction fees for supporting the custody function of lending. Securities lending is not an entitlement of custody providers so their pricing should just be set according to what service they provide. The industry should stop utilizing opaque pricing structures where the clients do not know how much they are actually paying for the different services being provided. These bundled arrangements prevent beneficial owners from evaluating all options and making proper informed decisions. JP: Until recently, I had never seen an RFP response from a custodian that did not include the condition that this pricing structure is conditional on them getting more securities lending. MC: When I asked this question of a custodian in a similar forum earlier this year, they told me that increasingly they were being asked to strip that out and quote separately for securities lending and ‘core’ custody. Because of the rise of third party lending agents, auction platforms, alternative routes to market, there is a desire on behalf of the ultimate customer to see that transparency and the custodians simply do not have a choice here. JP: That is very true but they used to just ignore it. In RFP exercises before I joined Mercer, we were absolutely explicit. The actual phrase used was: “You should assume that you will get none of our lending business”. We still got fee quotes that assumed a level of lending income. Then, there was then surprise when we lent the most lucrative asset classes through a third party. MF: I am asking for some adoption of standards that apply across the industry, not more information that is part of this kind of gentle obfuscation of pricing and information and bundling together of everything. Those days should be and are slowly going away, but this is just is just another subtle example of just more obfuscation. RS: Many of us use independent data providers to report to our clients on their programme performance. However most clients do not want to be called every day, preferring to look at it over a period of time and my second point is: what would the benchmark be, and could it have been implemented effectively in time?
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MF: No idea. It would not have been beyond the wit of this industry to meet this challenge head on rather than duck it. That is a hypothetical question really and one for about 18 months ago and not for today. What I am responding to is a call for clarity from a client of the global custody industry; a client of the securities lending industry. When they asked for clarity of pricing they were ignored—so they took their valuable assets away and their provider got upset. That seems like a logical response by the client to an illogical act by the provider to me. It seems almost deliberate the way that some providers ignore the clients’ requests for information. This is not a recipe for long term success.
BUNDLING & UNBUNDLING CJ: I’d like to dispute the notion that something was taken away. The provider should not feel entitled to a client’s business, so nothing was taken away from them. Rather, the beneficial owner just chose a different provider to perform a specific service. No one has the entitlement to be a client’s sole provider so it should not be seen or accepted as a takeaway if a Beneficial Owner decides to transfer a portion of their business to another firm who they feel can add value JP: One of the problems with custodians, is that they have
not got their heads around the fact that lenders became better educated and more knowledgeable. If you go back 15 years, the choice of a custodian was an obvious solution because nobody on the lending side, or few people on the lending side really understood the risks and the rewards and the nature of securities lending. As you become more knowledgeable, you become more sophisticated and better able to choose the best provider, which goes back to what Chris was saying earlier, different asset classes, different structures lend themselves to different ways of accessing the best risk/reward trade off. It is not always the custodian, and the problem today is that the custodian sometimes seems to think that it is almost theirs by right and it isn’t. MC: In defence of the custodian, there will always be a role for the custodian. The overwhelming volume of assets that are made available to the Street are in fairly fiddly, administratively and operationally intensive clumps,and the custodians should be given credit for mobilising those assets. They are and will remain a permanent feature in the landscape; no-one is trying to disintermediate them out of existence. From our perspective, there are certain markets and asset classes where we don’t think we add any value for the client, so we let the custodian do the lending. On the other hand, there are markets where we do have the scale and the expertise, the revenue potential is there, so we handle the lending ourselves.Then there are other portfolios that maybe lend themselves to auctions or exclusives. There is enough money on the table in this product for various different types of provider to make a living.
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RICHARD STEELE, head of product development for securities lending, JPMorgan Worldwide Securities Services
JP: A handful of basis points can make a huge difference to how performance is perceived and therefore it is almost an obligation on us, to certainly give the service that we sell and claim to be providing to our clients. We don’t just claim to find the best managers to deliver alpha. We also claim that, we are offering more challenging of service providers generally. This includes indentifying better ways of delivering peripheral returns on things like securities lending CJ: Another important development that has helped facilitate more choice in providers is technology and the improvements in communications and settlement platforms. It was more difficult to operate in a third party environment ten years ago than it is today. Some of the inherent advantages that custodians had when it was more difficult to transact outside of a custody framework have now disappeared due to these technological advancements. It is now an efficient process for everyone, regardless of where they are located. MC: Custodians have historically relied on client inertia, because it was always incredibly difficult and complicated to switch providers. That said, just as in UK retail financial services, people can now switch providers in a way that they never used to be able to. To be fair, that has forced the custodians to raise their game. I can remember years ago, a custodian pooh-poohing the concept of third party lending, saying it was never going to fly. Nowadays custodians not only accept the existence of third party lenders, but they are also establishing third party lending programmes themselves.
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Management, back in 1998. That whole episode spurred the development and improvement of collateral management in terms of its robustness, pricing methodology etc. It is only in times of crisis that any flaws or weaknesses in the system become apparent. It is too soon to say whether we will see any in our little subset of the overall market universe. The area of the securities finance industry that is probably most exposed to a potential credit loss is the cash reinvestment business, run predominantly by the US global custodian agency lending programmes. Over the course of the history of this industry, any credit losses have been on the cash reinvestment side rather than on the actual lending side of the business. We do have some cash reinvestment business but ours is all fully collateralised and pretty low risk.
DAVID RULE, chief executive officer, International Securities Lending Association (ISLA)
COPING WITH MARKET VOLATILITY FC: How does current market volatility play out? Does it
favour custodians or third party lenders? RS: One of the things that helps players better differentiate
themselves is: did their performance track the rising market or did they actually outperform it? This is where more transparency of data can help. When it comes to the more volatile markets we are seeing at the moment, it’s really time to revisit your lending programme parameters such as cash investment guidelines to determine that they are appropriate given the concerns we are seeing. In this sense you have to step back and say that although people may be looking for alpha, they are not willing to risk their portfolio in a market like this and are looking now to manage risks accordingly. CJ: Many beneficial owners have under taken reviews of
their programs in response to recent market events and are evaluating their approach and reviewing the risks and returns within their program. Some beneficial owners have made changes to certain parameters or guidelines where appropriate, while others have reaffirmed their existing structures. This is not unique to custodians, third parties or direct exclusives. It’s a client issue related to their specific goals, return expectations and risk profile. MC: As the old saying goes, return of your capital is more
important than return on your capital. I suspect that what is happening in the market at the moment will probably be, in the medium to long term, healthy for the industry. The closest thing most people can remember that compares to this in recent times is probably Long Term Capital
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MF: The key questions that Mick partially addressed there was, “How much of my lending revenue actually comes from lending? How much of my lending revenue comes from cash reinvestment? And these are going to be the questions that people are going to be focusing on, if they aren’t already doing so, now and in the coming weeks. There are lots of different ways to make money from cash reinvestment, as we know. Invariably, the strategies employed by certain re-investors of cash will come under scrutiny and the clients will ask themselves and their providers,“was that a good strategy or a bad one for me the client who is at risk?” I don’t think for one minute that anybody engaged in securities lending has deliberately breached client guidelines. Everybody in securities lending knows that they cannot do that. Nonetheless, there are providers who, if you ask them, will say: “We always operate well within or right in the centre of our clients’ guidelines. We actually do take less risk than our clients would allow us to take on their behalf because we have got tremendous understanding of the money markets and strong internal controls. ”I believe many of them when they say that. However, they also privately allude to there being providers that are out there trading on the edge of client guidelines a little bit and we may find that those might have some issues. This could be sour grapes at losing business to high income projections from competitors—but if it isn’t the clients, the market will find out very soon. In the Financial Times recently, Deutsche Bank said something of vital relevance. It had to do with confidence and banking and noted that crucial questions in the next days and weeks include “How do you mark your positions to market? What price are you putting on the securities that you have invested in?” It is a question that investors want answered by their cash reinvestment providers and I would really encourage anyone who is a lender who takes cash as collateral, to consider asking them now. Some will take great comfort from the responses – others may not. FC: What role can ISLA play in encouraging that dialogue? DR: One of the things that ISLA has been doing is
developing operational best practice guidelines, including
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interestingly on mark to market. ISLA has facilitated it but it is really market practitioners who are doing it. Developing standards for how the operations of the industry work is important and part and parcel of that is greater automation of processes. MF: Does that mark to market best practice extend beyond
the lent securities and the price at which they are marked?. Does it follow through and actually address the mark to market of the instruments purchased via the cash reinvestment? DR: It does not really focus on cash reinvestment. It is more about what price sources people would use for marking to market securities.
MC: I am not saying there is zero risk. We are a direct
lender, in a sense that we are part of the Aviva Group, but it is an agency model. Our clients are predominantly the group life and pensions companies. We do VaR analysis for these clients in our programme- funnily enough, we use some of the tools that Mark sells. The problem is that the numbers look almost too good to be true. You have gross outstandings in a programme of tens of billions and then, because everything is done with creditworthy counterparties, fully collateralised and marked to market daily, you end up with a VaR figure that is maybe in the low millions. Some clients have raised a sceptical eyebrow. Is that your experience as well?
CJ: Having ample short term liquidity within collateral portfolios was critical in July and August to avoid any unnecessary sales of securities into a difficult market. With few buyers for many short term products during this time the normal liquidity in the market froze up. This happened broadly in the market across asset classes unrelated to sub prime so collateral managers managed through the period by keeping sufficient overnight cash to meet any redemption needs.
DR: It is a real strength of the industry that risks are managed well and kept low. Fair enough lenders are looking again at their collateral guidelines and they should do that. But heaven help us that they don’t panic because they do not need to and if they did you would see how important securities lending is to the liquidity of the capital markets. In the sterling money markets for instance we’ve seen a flight from unsecured to secured, and the repo market would not work without the securities lending market because banks don’t own gilts any more, they borrow them all. And that is just one corner. Equity markets, bond markets, credit markets, they all rely at the end of the day on securities borrowing, because the people that own the securities are the institutions and it really is vital that they continue to lend and there is no sign, so far that I can see, that they have stopped. One other point I would like to make is on people now talking of lending as a form of alpha. That is not particularly healthy, because alpha is about excess returns from skill in investing. There can be an element of that with securities lending but it does not account for the bulk of the lending income. Part of lending is the market return, that you are missing out on if you do not lend, and part of the return is from taking credit risk and leverage, which is what you do with the cash reinvestment. Telling investors that they are getting alpha is misleading frankly.
MC: For
MC: I dispute the assertion that there is not a component
MF: I think it would really be helpful to take that best practice one step further so that clients can ask “how is the traded and OTC inventory that I own in my reinvestment portfolio marked to market?” That is where their risk associated with lending is greatest. But it is important to note that we are not talking about those kinds of hard to price OTC instruments being a large component of a typical securities lending collateral portfolio. That type of reinvestment trading is a very different type of activity and it is important that readers of a stock lending article do not think that it is typical for there to be assets in a securities lending collateral pool that might be unpriceable. If there are any concerns they should liaise with their provider and review their positions.
the lion’s share of European lending programmes, non-cash collateral is the norm, so you don’t have the outright unsecured exposure to credit product that goes with most cash reinvestment programmes.Your primary risk is your counterparty credit exposure. If it is a well managed programme, you are only dealing with reputable, creditworthy entities. Everything is done under industry standard documentation, with exposure marked to market daily. If you are prudent in your collateral criteria, and you have a sufficiently sensible policy on haircuts and over-collateralisation, the quantum of risk in a securities lending programme is actually very small. That cannot be over-stated.
MF: I can tell you that we regularly review about $1trn worth
of cash reinvestment and non-cash collateral. We see risk.
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of alpha in the equation, particularly in the current environment. There has been a flight to quality where there is a premium on government bond collateral, and we have been able to make considerable additional revenue. Liquidity, whether it is in the form of cash or government bonds, which until recently was cheap and plentiful has suddenly become scarce and expensive. Because we like to think we know what we are doing, we’ve been able to capture that value in the additional returns we have been able to generate in our programme. I am not sure of the extent to which that has occurred elsewhere. Mark can confirm that between similar lending programmes, with similar collateral profiles and similar mandates, there is considerable variance in the performance of those programmes. The fact is that some firms are better than
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others at extracting value from this product- I’d call that Alpha. It is not just about what your collateral mandate is and what the size and composition of your portfolio is. It is also about the expertise and capability of the people doing the business. MF: Broadly, to go back to the point about the collateralised
nature of the markets, right now most people’s fixed income business is going like gangbusters. To put some numbers around this, there is $3trn to $4trn a day being generated as cash collateral (mainly in the US dollar) looking for a home. Typically some of it is out there on the yield curve, some of it is nearer the front end. Today, it is nearly all at the front end. One of the biggest challenges for the re-investors of such large pools of cash is finding a home for the money on a daily basis. The supply of commercial paper has dried up and the risk appetite of the re-investment agents and their underlying principal clients has dramatically reduced. The scale of this daily activity and its importance to the global money markets is quite stunning. The sub prime crisis is very different than say the LTCM crisis. This time, things are different because the risk has effectively been syndicated through hundreds of hedge funds, funds and broker dealers. In the LTCM crisis the risk was concentrated in the hands of about ten to 12 significant known counterparts. People do not know who owns the risk positions today and it is only going to be as we go through the results season that we will begin to see where the damage lies. However, the importance of the securities lending markets to the cash markets is enormous. Without it, it is almost difficult to see how they would efficiently function.This is the time when the old stock lending cliché “that it is the liquidity that helps the global machine of capitalism function”comes to the fore. It happens to be true. It is the oil that keeps the machine going. RS: With quarter end coming up as well that will exercise everybody’s minds. FC: Is the securities lending industry very skittish then? JP: Unfortunately only a few people really understand all
the reasons why people borrow securities and most borrowing is perceived as being done by a bunch of guys who want to take a punt on Stock A going down 20% in the next month, so what we don’t want to see is a blow up which causes lending to be at the forefront of the client’s mind, when really they ought to have other things to challenge them than our lending programme.
THE USE & ABUSE OF VOTING RIGHTS DR: There is a risk to the industry of unintended
consequences if regulators intervene to try to prevent borrowing to vote. It is important that the industry presents its case well to prevent that, but also that the industry keeps its own house in order so that we don’t get abuses of people borrowing securities in order to vote. I do think
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though that this whole issue is going to get more complicated with the introduction of long: short funds alongside long-only funds in fund management houses. And what we talked about earlier of an index fund lending to another fund in the group that has a short position, who decides how they vote? It is quite tricky and it is not primarily a stock lending issue. Rather it is an inherent issue of shorting becoming a more normal part of investment management, which effectively separates out the two functions of taking a position in a share and owning a company. People are going to have to wrestle with how those things are combined. FC: What role is ISLA playing in encouraging good practice? DR: ISLA can only go so far. I don’t think that ISLA can set
standards for how fund management houses should manage themselves. MC: A lot of equity borrowing is driven by dividend trading
strategies, and that confuses the issue from a corporate governance perspective when you have a dividend and a vote happening at the same time. MF: It makes the charts look very spiky. MC: Is there not merit in maybe decoupling those two and
having the dividends paid at a different time in the calendar from the votes? Wouldn’t that make it easier to spot voting or other corporate governance abuses? DR: Yes, and we have said that that is more desirable. But
that is really down to the individual companies and again it may not be at the top of their list of priorities. MF: A contentious vote is obviously also a trading or arbitrage
opportunity for a trader. A vote for something that is contentious is most likely to take the company in one direction or another – positive or negative.That is a good opportunity for a trader to take a position - be it long or short. So again, if it really is a hot issue, you may get a lot of borrowing around that time, not to actually secure a cheap vote, but to actually take advantage of a market trading opportunity to the short side. So it is very unfair of people that look at corporate governance in a vacuum to say,“Another big spike around a vote! Surely, another abuse of lending” These people would do well to remember that there are dividends and there is legitimate trading and the facts simply do not support the fiction on the alleged charges in corporate governance. One of the best industry responses to this wrong-headed attack is the detailed data based research that ISLA and the London Business School Hedge Fund Studies Group are doing with Data Explorers. The objective is to get some independent research concluded and facts established. To date the debate has been hijacked by people who do not understand securities lending and want to sensationalise it for their own benefit. I believe that the facts will set the record straight.
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DR: It remains true nonetheless that there are very few empirical cases that you can show. However, it may only take one high profile one to bring the politicians down on this industry like a ton of bricks and what I have been saying to everyone, is: “Do not be tempted to facilitate this type of trade.” JP: There are some commercial reasons why this wouldn’t happen. Our target market, for instance, is pension schemes and their sponsoring companies and many of these will be quoted PLCs . We would not want to see anybody borrowing our stock effectively for no other reason than to vote against the management of the companies who are one step removed from our clients. There have been examples recently, where hedge funds have taken what are really very small positions for a short time simply to facilitate challenging incumbent management, and it isn’t clear they have any long-term interest in the companies involved. We simply would not want to facilitate that. Long-term shareholders challenging incumbent management is one thing, but we do not see short-term stock borrowing as an appropriate way to do so.
MC: Actually, we are frequently lending it to an investment bank who is lending it on to someone else in any case. It may therefore be impossible for a lender to determine who is ultimately trying to borrow stock and why.
MC: If you feel that badly about it you simply recall the
DR: Prime brokers may be able to police it in a limited
stock. There is no inherent contradiction between good corporate governance and securities lending. What you need is a clearly articulated and understood policy on the subject, plus a good working relationship between the respective areas. Sorry for mentioning this again but there is an advantage to having securities lending run out of the fund manager, because we are just 20 yards away from our corporate governance people.
sense, but even they can’t fully control it, because a firm may use multiple prime brokers and in any case they are not running the hedge funds.
JP: Just a quickie on spikes close to contentious votes. That
suggests a lack of responsibility. In our programme, we say we reserve the right to recall stock when there are contentious votes and I can imagine scenarios where we will exercise that right. We regard voting as part of our stewardship of our clients’ assets. If there is a contentious vote, we should be voting. We have a fiduciary responsibility to our clients. FC: A naive question. Does no one ask why some firms want to borrow particular stock at crucial times? MF: Typically borrowing motivation is not questioned by the
lenders – be they principal or agents. It is the difference between an agency relationship were you have a fiduciary responsibility to protect someone and a principal relationship where motive is not necessarily questioned and therefore cannot necessarily be understood. There are many reasons to borrow a specific security at any given time and it would be imprudent and inappropriate to assume what the motive was. In the principal world caveat emptor applies and it does not in the agency or fiduciary world. Couple that with the adage that no borrower likes a smart lender and there you have it.
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JOHN POOLE, chief operating officer - Europe, Mercer Investment Management
RS: This was discussed some years ago by the UK Takeover
Panel. They were reviewing whether there was a requirement for every stock lending transaction in an offeree company to be disclosed to them during a takeover situation, and after taking soundings in the industry they concluded that because all offeree and offeror positions were already being disclosed there was no requirement to extend the reporting to all transactions.
CONCLUDING REMARKS FC: Either from a regulatory standpoint, or a market
standpoint, what should people be looking out for? RS: We are seeing the final confluence of a range of
regulatory issues that the industry has been getting to grips with, in particular in the European space. MiFiD comes into force in November and will continue to occupy the industry in the coming months. Basel II is coming in January next year and that speaks to the European agent lender disclosure issue that people are also engaged with at the moment. The industry is coping with a lot of things that have hit at the same time and it is difficult to keep all these things in check, but from what I have seen from JPMorgan’s perspective and having been on the ISLA board, we are certainly bringing things to a satisfactory conclusion. From a market standpoint, the industry will continue to see more of the same, but also some transformation, particularly in the
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130/30 space with more active participation of the front office in what has been a largely back office business for many clients. Those are the things to look out for next year.
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their exposure to each underlying principal from the agent lenders and they will have to credit assess all those principals. ISLA will be doing work to facilitate that disclosure from the agent lenders and we will be planning a survey of the industry in the next few weeks.
CJ: There is certainly more scrutiny from a regulatory perspective. In the coming months we will see more on MiFiD and best MF: Eighty percent of the execution and Beneficial revenue in this industry Owners are expecting more comes from emerged transparency in their markets and that the bulk programs. From a client of the energy of the perspective, more industry will be consumed beneficial owners want to in making those markets see where returns are being more efficient and to grow MICK CHADWICK, head of trading, securities finance, Morley Fund generated from, what risks those and get more Management they are taking to generate supply. Battle lines are returns, and want to ensure that earnings are being allocated increasingly drawn between the prime brokers and the appropriately and not subsidising other accounts. custodians who want to be prime brokers and this will be interesting to see play out, and the extent to which JP: For us the next 12 to 18 months, the important areas will they park tanks on each other’s lawns. I actually think be assistance in helping us come up with products that performance attribution will be the next big thing. Much allow us to take full advantage of the new UCITs III like they choose an asset manager, beneficial owners will freedoms, in particular allowing us to find efficient ways of ask “How do you do it?” and everyone will have to financing short trading. In the very short term what we articulate where the money comes from. The buzz is don’t want to see is for one result of the current liquidity about optimisation, not maximisation. I also think this crisis to be a blow up in someone’s lending programme, mark to market issue is huge, and Richard mentioned especially on the reinvestment side, which causes fear quarter end. It will be an interesting end of the year, but across the lending industry generally. Lending really is I do predict that there will be a major M&A event next year in the banking world that at its core will have relatively safe. finance as its logic. DR: I agree with some of that and certainly one of the things I want to do with ISLA is to make people outside MC: In terms of the growth and development of the industry, the industry understand the importance of the industry to it may sound prosaic but I see more of the same. In mature the capital markets, because I don’t think it is widely markets there will be increased volume accompanied by the understood by regulators, central bankers, chief automation necessary to handle that volume. Across all executives, and so on. The risk to the industry is that for markets I see increasing convergence between synthetic and most beneficial owners stock lending is no 59 in their list traditional lending, given that they are driven by the same of things that they care about. Nonetheless, the goal. As far as the overall industry landscape is concerned, importance of well-functioning stock lending markets to within the fund management sector there will be an wider market liquidity has grown significantly over the increasing recognition that securities finance is very much a last decade? in particular with the growth of the front office discipline. My own background is on the sell derivatives markets, the expansion of hedge funds and side. Back when I started there, securities finance was the changes in banks’ balance sheets. The stock lending regarded as a quasi back office function. Now, securities industry has come out of the recent market turbulence finance and prime brokerage sits at the heart of an with a good story to tell. Lending volumes actually grew investment bank’s dealing operation. For most fund and that helped to sustain liquidity in the repo markets managers it will never be as core as that- unless a fund needs and the cash bond and equity markets. More narrowly on to use leverage, securities finance will remain a ‘bolt-on’yield what regulation is coming up in Europe, Basel II is going enhancement strategy. However, given the competitiveness to be a big change, particularly for the dealers, in the way of the industry, the revenue contribution from this activity that they are going to have to calculate their capital on will become ever more important, and it will attract stock loans, they will have to get granular information on appropriate management time and attention as a result.
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THE MOVE TO AUTOMATION
AUTOMATING OTC DERIVATIVES
Efforts to automate trade processing have come a long way since regulators leaned on the industry to cut the volume of outstanding confirms on credit default swaps two years ago. Yet despite the enormous information technology investment already made, the summer surge in trading revealed that more is needed to handle the market’s continuing exponential growth. Neil O’Hara reports.
IKE THE BATTLE of Waterloo, this summer’s turmoil was a near-run thing for the over the counter (OTC) derivatives market. “If what happened in July and August had happened a year ago or two ago the consequences could have been catastrophic,” says John LaVecchia, director of US credit markets at the Jersey City, New Jersey office of TradeWeb, an electronic trading platform for fixed income derivatives. Although derivatives dealers declined to comment, market participants say back office staff had to burn the midnight oil and work weekends to keep up when volume exploded. It is not unusual for dealers’ staff to handle fluctuations around the average transaction flow during normal business hours; not two or three times that amount. Nevertheless, some firms found their operations side was not as scalable as they anticipated, according to Mark Beeston, president of T-Zero, a London-based electronic affirmation service. The immediate crunch was in booking trades and executing documents, but the whole operations function was swamped.“You cannot borrow bodies out of your other areas,”Beeston says,“At the time you need those resources they are exceptionally busy doing their own thing.” Error rates tend to rise when people are working under stress, too, which makes the processing backlog worse. Markit’s Quarterly Metrics Report for June 2007 shows a rapid increase in electronic trading and a steady decline in non-electronic trading of credit derivatives over the past
L
So far, automation has helped back offices stay one step ahead of the game. They have moved away from processing every trade toward handling exceptions, but that function isn't scalable. If it takes 50 people in a dealer's back office to sort out 20% of today's trades it will take twice as many when volume doubles – and qualified staff are hard to find. At some point, the industry has to tackle the error rate, through either greater reliance on affirmation or electronic trading. Photograph supplied by Istockphotos.com, October 2007.
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Henry Hunter, chief marketing office for SwapsWire in London, an electronic processing platform for OTC derivatives, says the low level of automation in interest rate swaps reflects a buy side that includes a large number of participants who trade so infrequently they aren't concerned about operational overload from manual confirmations. Those trades still flow through the two dozen major dealers, however, where they cause real headaches. Photograph supplied by SwapsWire, October 2007.
Janet Wynn, general manager and managing director of DTCC Deriv/SERV, says the firm's electronic platform and data warehouse have already proved their worth. For example, when a troubled hedge fund is taken over, the entire credit default swaps portfolio can be assigned to an acquirer through DTCC's platform in just a few days. In the past, a buyer had to print out and pore over thousands of pages of documentation just to see what was in the portfolio and how to handle the assignments, a process that could take several weeks. Photograph kindly supplied by the DTCC, October 2007.
two years. The volume of outstanding confirmations shrivelled between September 2005 and December 2006, but crept back up in the first half of 2007 as the market expanded even faster than before. It’s a safe bet the third quarter report will show backlogs ticked up over the summer for both credit derivatives and other contracts. T-Zero tackles the problem by trying to squelch errors up front. It receives trade details directly from dealers’ trade capture systems and transmits it to buy-side counterparties for affirmation, then allocates the trade among the various sub-accounts. In effect, counterparties have an obligation to spot errors before dealers do any further processing. The system shifts responsibility for allocations over to the buy side, too. “It makes the middle office more accurate and scalable,” says Beeston, “It also removes the source of operational errors before errant trade data flows downstream to cause them.” Many market participants expected Depository Trust & Clearing Corporation’s (DTCC) electronic matching and documentation services to eliminate all their processing problems. It hasn’t worked out that way in practice. Although a huge improvement over manual confirmations, DTCC’s services do not eradicate settlement risk because matching still does not occur until one or more days after the trade date. By the time an error shows up in the documentation process, it may have already caused a payment break and possibly a bad margin call as well as an incorrect calculation of counterparty risk exposure.
“Electronic matching addresses a symptom,”Beeston says, “We address the disease, which is inaccurate trade data.” It is a disease of epidemic proportions. According to the International Swaps and Derivatives Association’s (ISDA’s) 2007 Operations Benchmarking Survey, 20% of credit default swaps, 20% of equity derivatives and 18% of interest rate derivatives executed by large dealers have to be rebooked. The ISDA speculates that efforts to cut confirmation backlogs may have inflated the numbers somewhat, but it is a huge burden on the back office because every break requires manual intervention. The sheer complexity of OTC derivatives provides many more opportunities for breaks to occur than in conventional transactions. Cash market trades have just three fields: price, security identification number and volume. In addition to those, a derivatives trade has to specify the precise legal counterparties, margins, collateral arrangements and fees. Multimillion dollar novations can be held up over differences as small as $50 because firms use a different number of decimal points to convert fees the traders express in basis points into a dollar amount the back office must enter into DTCC’s system. For cash instruments, fixing errors a day or two after trade date inflicts a mark to market gain or loss but no counterparty risk. In OTC derivatives, which are typically more volatile than cash securities, participants have to accept counterparty risk, too. John La Vecchia, director of credit sales for Thomson TradeWeb LLC, says the failure of
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several hedge funds this summer left some dealers stuck LCH.Clearnet. Once SwapsWire has processed a trade, it with open confirmations that could have caused severe feeds the details into SwapClear, which acts as a post-trade losses if other players had not stepped in to take over the clearing house for cash flow movements, margin calls and collateral management. “For trades done through the stricken funds. Although electronic affirmation shortens the time errors dealers in the interbank market the whole thing is that are outstanding from days to minutes or hours, completely automated,”Hunter says,“All the ops guys need somebody still has to enter the trade details and the is another reel of paper to spew out of the printer saying ‘No counterparty has to check them. LaVecchia says dealers have Exceptions’. That’s stunning scalability.” Some dealers who taken steps to automate the process all the way from trade are SwapsWire clients have just one back office person who capture through matching and confirmation, but except for a keeps an eye on their entire SwapsWire/SwapClear flow. A back office that incorporates state of the art few large firms the buy side has been slow to adopt electronic processing. He believes—not surprisingly—that electronic automation does not solve all the problems, however. trading is a better solution.“It creates an accurate record at the Stephen Bruel, an analyst in the securities and capital markets practice at time of execution that Tower Group, a market can be used to feed all research firm based in the downstream Needham, Mass., says systems,”LaVecchia says. According to the International Swaps and the inability to value Markit’s quarterly some structured debt Derivatives Association’s (ISDA’s) 2007 report found that instruments caused far electronic execution Operations Benchmarking Survey, 20% of more trouble than trade now accounts for credit default swaps, 20% of equity derivatives processing backlogs almost 90% of credit and 18% of interest rate derivatives executed during the market derivatives trading by large dealers have to be rebooked. The turmoil. He volume, double the ISDA speculates that efforts to cut acknowledges that back proportion in office operations still September 2005. Equity confirmation backlogs may have inflated the need work but pricing derivatives are less numbers somewhat, but it's a huge burden on OTC derivatives is a automated, although the back office because every break requires front office function. the proportion is manual intervention. “The dangers relate to growing, especially proprietary risk that among the major banks and hedge funds dealers. For interest have taken and not so rate derivatives, conventional trading still represents more than 60% of the much the operational risk associated with these instruments,”says Bruel. total, however. The back office does need price information, of course. Henry Hunter, chief marketing office for SwapsWire in London, an electronic processing platform for OTC Margin calculations, collateral movements and quarterly derivatives, says the low level of automation in interest rate payments all depend on valuations, and, as so many swaps reflects a buy side that includes a large number of investors discovered to their cost, the theoretical price a participants who trade so infrequently they aren’t computer model spits out bears no relation to what a concerned about operational overload from manual willing buyer will pay a forced seller in a volatile market. confirmations.Those trades still flow through the two dozen Bruel suggests the exchanges, which facilitate liquidity and major dealers, however, where they cause real headaches. provide a consistent pricing mechanism, may have a role to Hunter says dealers are encouraging more clients to switch play. OTC derivatives represent a potential source of over to SwapsWire’s electronic system, which requires no revenue; indeed, Eurex has already listed futures on some iTraxx credit default swaps indices. technology integration and is free to the buy side. Karel Engelen, policy director and head of FpML at The large sell side firms have a strong incentive to improve back office scalability because they account for ISDA, says the summer volume surge spilled over into most of the volume whether the market is quiet or novations, which are much less automated than regular frenzied. Sell side clients have flocked to SwapsWire’s fully trades. A novation allows a new legal entity to substitute automated interface that feeds interest rate swaps for one of the original counterparties to a bilateral transactions into their trade capture systems already derivative contract, so it requires the consent of all three confirmed. “The back office has nothing to clear up,” says parties. The market has adopted standard language in Hunter, “It is already being done. They have almost emails relating to novation but people still have to look up the details and give their consent. Once terms are agreed unlimited scalability with the operations department.” For interbank transactions, dealers can take automation a by the front office, the back office completes the novation step further with SwapClear, a product offered by through an automated confirmation process.
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Karel Engelen, policy director and head of FpML at ISDA, says the summer volume surge spilled over into novations, which are much less automated than regular trades. A novation allows a new legal entity to substitute for one of the original counterparties to a bilateral derivative contract, so it requires the consent of all three parties. Photograph kindly supplied by ISDA, October 2007.
Mark Beeston, president of T-Zero, a London-based electronic affirmation service. The immediate crunch was in booking trades and executing documents, but the whole operations function was swamped, notes Beeston.“You cannot borrow bodies out of your other areas,” he says,“At the time you need those resources they are exceptionally busy doing their own thing.” Photograph kindly supplied by T-Zero, October 2007.
Novations caused much of the paperwork backlog that drew regulators’ attention to credit default swaps in the first place two years ago. In response, ISDA developed its Novation Protocol to standardise and speed up the procedure. That helped the industry get backlogs under control, but the process still requires manual intervention. “There is a renewed focus on looking for electronic solutions for novation consents,”says Engelen. Up to now, automation has focused on immediate posttrade processing but market participants are starting to explore electronic solutions for the entire product life cycle, including novations, portfolio reconciliation and collateral management. Engelen expects the spread of electronic processing to facilitate the introduction of new products, too. A higher degree of automation makes it easier to handle new products and shifts the point at which automated processing is economic earlier in the product life cycle. Manual processing will never disappear, though. It takes time for market participants to agree on standard terms for new products and until they do automation is virtually impossible. Janet Wynn, general manager and managing director of DTCC Deriv/SERV, says the firm’s electronic platform and data warehouse have already proved their worth. For example, when a troubled hedge fund is taken over, the entire credit default swaps portfolio can be assigned to an acquirer through DTCC’s platform in just a few days. In the past, a buyer had to print out and pore over thousands of pages of documentation just to see what was in the
portfolio and how to handle the assignments, a process that could take several weeks. Wynn notes that although backlogs increased over the summer they were nowhere near as bad as when regulators sounded the alarm in September 2005. She points out that back office staff had enough capacity to handle other projects over the summer as well. The big firms finished loading their historical portfolios into DTCC’s data warehouse and participated in a test of payment calculations for the settlement system DTCC will launch later this year.“There is no paralysis out there,”Wynn says, “Everybody is working very hard. There are a lot more exceptions to handle but it is very much under control.” The industry cannot afford to sit still, however. Automation frees up back office resources to focus on novations and breaks, but if OTC derivatives keep up their breakneck volume growth the need for staff is bound to increase, too. “Without DTCC’s platform the volume of trades could not have happened,” says Wynn, “And they could never have handled this surge.” So far, automation has helped back offices stay one step ahead of the game. They have moved away from processing every trade toward handling exceptions, but that function isn’t scalable. If it takes 50 people in a dealer’s back office to sort out 20% of today’s trades it will take twice as many when volume doubles – and qualified staff are hard to find. At some point, the industry has to tackle the error rate, through either greater reliance on affirmation or electronic trading.
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Interest in 130/30 strategies is setting off. An estimated $50bn to $60bn is already invested in 130/30 strategies and this value is expected to grow rapidly. Some market watchers predict that up to 20% of the money invested in US large-cap core long-only strategies will move to short-enabled strategies during the next decade. The current level of investor interest is leading some commentators to posit that 130/30 investing could be the makings of a new investment paradigm rather than a passing fad. Neil O’Hara tests the waters.
130/30 portfolios are not hedge funds though. That is because the risk controls overlaid by 130/30 strategists on Jones’ model keep the target market exposure at 100%. It is then a relative value play, not an absolute return strategy. The appropriate risk gauge is therefore tracking error rather than standard deviation; after all, if net market exposure is 100%, volatility should track the market, too. Photograph supplied by iStockphotos.com, October 2007.
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NSTITUTIONS IN SEARCH of alpha are shovelling money into 130/30 portfolios, which aim to extract the maximum value from active equity managers’ research. Is it a new paradigm or another passing fad? The underlying concept isn’t exactly new. Alfred Jones created the first hedge fund in 1948 on the premise that if he levered a long portfolio and took short positions in stocks expected to lag he could improve performance and cut market risk at the same time. 130/30 portfolios are not hedge funds though. That is because the risk controls overlaid by 130/30 strategists on Jones’model keep the target market exposure at 100%. It is then a relative value play, not an absolute return strategy. The appropriate risk gauge is therefore tracking error rather than standard deviation; after all, if net market exposure is 100%, volatility should track the market, too. Not all 130/30 programmes are the same, of course. At one end of the spectrum, managers view 130/30 as a small step beyond enhanced indexing. For example, Warren Chiang, managing director responsible for active equities strategies at Mellon Capital, a division of The Bank of New York Mellon Corporation, restricts variance from benchmark weight for individual stocks to ±1% and keeps a tight rein on factor risks to eliminate any bias toward growth, value or momentum. Such constraints deliver low tracking error (between 2.5% and 3%) and a modest excess return target of 2.5%, which is about 1.5% higher than for the equivalent long only portfolio.“We market 130/30 as a substitute for a low volatility core equity manager,” Chiang says,“we think that is where you maximise the alpha given the risk.” Mellon Capital uses quantitative models to construct both long only and 130/30 portfolios. The firm is not trying to shoot the lights out, but aims to earn a bit more than the
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benchmark return from diversified portfolios that minimise risk.“We are not one of those 130/30 managers that have really concentrated bets that are highly deviated from the benchmark,” says Chiang. Rather than a separate asset class, he sees 130/30 as a tool that can be applied to, say, large capitalisation or international equity mandates, which accounts for differences in how managers construct the portfolios and what fees they charge. Among the top 130/30 managers this year is UBS, which has pursued a fundamental price to intrinsic value investment approach for more than 25 years. The firm’s analysts have always run discounted cash flow models on the companies they cover, according to Scott Bondurant, capability head for long-short equity products at UBS Global Asset Management. UBS stock rankings all the way back to 1980 show that the most under-priced names outperformed the market by about 5% and the most overvalued underperformed by about 3%. UBS targets an excess return of 200 basis points (bps) for a long only portfolio benchmarked to the Russell 1000 Index, but for a similar 130/30 portfolio the firm expects its leveraged stock selection to deliver 250bps-500bps over the benchmark. Leverage can cut both ways, of course. “We believe in active management,” says Bondurant, “if you have a manager that doesn’t have that skill in the first place 130/30 is giving him another shot at getting it wrong.” To proponents, the 130/30 structure frees managers to make more money from stocks they expect to underperform. In capitalisation weighted equity indices, a few large names dominate the list followed by a long tail of stocks with trivial weights. For example, Bondurant says more than 80% of the stocks in the Russell 1000 have a weighting of less than 15bps. Long only mandates that contemplate a maximum 100bps variance from the benchmark weighting in individual
Brad Taylor, global head of investment finance and hedge fund services at RBC Dexia, says institutions are happy to pay for alpha but not for strategies that only deliver repackaged beta.“Institutions are looking for the benefit of a long-g- short approach but they are increasingly seeking this exposure in a more modest cost structure,”Taylor says. Institutions like the transparency and controlled risk profile 130/30 portfolios offer, too. Photograph kindly supplied by RBC Dexia, October 2007.
Warren Chiang, managing director responsible for active equities strategies at Mellon Capital, a division of The Bank of New York Mellon Corporation, restricts variance from benchmark weight for individual stocks to ±1% and keeps a tight rein on factor risks to eliminate any bias toward growth, value or momentum. Such constraints deliver low tracking error (between 2.5% and 3%) and a modest excess return target of 2.5%, which is about 1.5% higher than for the equivalent long only portfolio. Photograph kindly supplied by The Bank of New York Mellon, October 2007.
stocks don’t give managers the flexibility to make that bet against the smaller names: they can only go to zero, no matter what the weight. “If you have a 15bps you identify as 50% overvalued and it underperforms by 50% then you have added 7.5 bps,” Bondurant says, “It is no big deal. However, if you can go to 85bps short—100bps less than the benchmark—you add 50bps. That is very meaningful.” Charles Shaffer, managing director and product manager for 130/30 in Merrill Lynch’s global markets and investment banking division, says quantitative managers have taken an early lead in snagging 130/30 mandates, accounting for more than 70% of the assets under management. It is a natural extension of their investment process, which relies on factor models to rank stocks from best to worst. For a long only mandate, managers buy the top stocks, but they have a ready-made list of losers to populate the short side of a 130/30 portfolio. Like quants, long only fundamental managers focus on picking winners, but they have no incentive to devote scarce resources to losers. If a company doesn’t pass muster, most fundamental analysts drop it and move on; unlike quants or shops like UBS, they don’t rank their entire universe. Fundamental managers who want to offer 130/30 products have to reorient their research to generate ideas for the short book. Shaffer says sceptics once claimed that only hedge fund managers, who know how to handle shorts, and quants, who employ rigorous risk management and a ready ranking of stocks, would be able to run 130/30 money well. Experience has proved the naysayers wrong, however: fundamental 130/30 managers have beaten the quants hands down in 2007. “The conventional wisdom, particularly in the early days of product development, is often backwards,” says Shaffer, whose
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THE VALUE PLAY OF 130/30 STRATEGIES
Ric Thomas, a senior managing director of State Street Global Advisors (SSgA) and department head of the US enhanced equity group, estimates that at any particular time only 10 or 15 names in the Russell 1000 are specials subject to higher borrowing costs. Even for the small capitalisation Russell 2000 Index, he reckons 85% of the names are general collateral. With so much scope for shorting general collateral stocks, 130/30 managers either avoid specials altogether or take small positions in just a few names.
Leverage can cut both ways, of course. “We believe in active management,” says Bondurant, “If you have a manager that doesn’t have that skill in the first place 130/30 is giving him another shot at getting it wrong.”
team provides advice, analysis, prime broker and securities lending services to managers who run 130/30 portfolios. Although Darrell Riley, head of global institutional marketing at T. Rowe Price, accepts the logic behind 130/30 structures he remains leery of its practical application, particularly for fundamental managers who often lack the quantitative tools and risk management systems needed to handle a short book. He notes that short positions
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consume a disproportionate share of a manager’s emotional energy, too. “It’s the exception rather than the rule that people are good at it,” Riley says. T. Rowe Price does not offer 130/30 portfolios today and has no immediate plans to do so. Riley sees 130/30 products positioned as high conviction long strategies with selective use of shorts to capture the full benefit of a manager’s research knowledge. On the quant side, it works remarkably well for as long as the quantitative model works.“Quants are fine when there is good factor stability and when you combine that with 130/30, it’s fantastic,” Riley says, “But when there is a turning point, they may really suffer.” It’s no secret that quantitative 130/30 managers hit a rough patch during the market turmoil in July and August. Track records in 130/30 are still short, but so far, UBS, which has $2.25bn under management, has delivered about double the excess return of its long only portfolios. From inception in September 2005 through the end of June, its institutional 130/30 product is up 17.93%, compared to 15.76% for the equivalent long only portfolio and 14.32% for the Russell 1000, the benchmark for both. At 4.33%, the tracking error has come in at the low end of the 4%-8% target range, which Bondurant attributes to unusually low market volatility through most of the period. Investors don’t get a free lunch, however. 130/30 portfolios bear incremental transaction costs because they deploy 60% more capital and have correspondingly higher portfolio turnover. Managers charge higher fees, too. For its retail 130/30 product, UBS charges 150bps—about 35bps more than for the equivalent long only vehicle. Institutional fees are lower, of course, but 130/30 products still command a 45% premium over long only fees. The portfolios incur stock borrowing and financing costs, too, which Bondurant estimates at 15bps provided almost all the shorts come from the general collateral pool. On balance, a retail UBS investor pays an extra 50bps for a shot at up to 300bps of excess return. Borrowing from the hedge fund world, institutional 130/30 fees often include a performance element although it typically doesn’t kick in unless the manager beats the benchmark return. Brad Taylor, global head of investment finance and hedge fund services at RBC Dexia, says institutions are happy to pay for alpha but not for strategies that only deliver repackaged beta. “Institutions are looking for the benefit of a long- short approach but they are increasingly seeking this exposure in a more modest cost structure,” Taylor says. Institutions like the transparency and controlled risk profile 130/30 portfolios offer, too. So far, most 130/30 products are benchmarked to broad indices, including the MSCI World, the Standard & Poor’s 500 and the Russell 1000. For large capitalisation indices like these, even the smaller names a 130/30 manager might want to sell short are usually available in the general collateral pool.
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Nevertheless, Taylor says liquidity dried up in some names during the recent upheaval, which caused problems for a few funds. “In times of market turmoil, managers need access to the widest possible array of securities and large inventories of those securities to reduce the likelihood of a loan being recalled,” says Taylor, who notes that RBC Dexia has a large pool of securities available to borrowers from its $2.6trn of assets under custody. Ric Thomas, a senior managing director of State Street Global Advisors (SSgA) and department head of the US enhanced equity group, estimates that at any particular time only 10 or 15 names in the Russell 1000 are specials subject to higher borrowing costs. Even for the small capitalisation Russell 2000 index, he reckons 85% of the names are general collateral. With so much scope for shorting general collateral stocks, 130/30 managers either avoid specials altogether or take small positions in just a few names. Thomas also points out that the emphasis on smaller stocks on the short side does not Charles Shaffer, managing director and product manager for 130/30 in Merrill Lynch’s global markets necessarily introduce a and investment banking division, says quantitative managers have taken an early lead in snagging capitalisation bias to the overall 130/30 mandates, accounting for more than 70% of the assets under management. It is a natural portfolio because the extension of their investment process, which relies on factor models to rank stocks from best to worst. For incremental 30% in long a long only mandate, managers buy the top stocks, but they have a ready-made list of losers to populate positions are often smaller the short side of a 130/30 portfolio. Photograph kindly supplied by Merrill Lynch, October 2007. names, too.“People think this is only a way for you to take advantage of negative managers to compete for core equity mandates rather than information,” he says,“If your model works down the cap scarce allocations to alternative investments. Merrill Lynch distribution, you will take more overweights among small estimates that US public and private pension plans alone cap names, not just underweights. Net-net, you are not hold $3trn in long only equity, about 10 times their allocation to alternatives. For institutional investors unwilling to seek taking any size bet.” Thomas acknowledges that leverage and short selling or unable to get board approval for a higher alternative ratchet up the risk of 130/30 portfolios relative to long only, allocation, 130/30 portfolios provide access to a key source of but in a way that benefits investors as long as managers hedge fund alpha: short selling.“The key to this product is pick stocks well. “None of the increase in risk is due to precisely the fact that it does keep beta at one,”says Shaffer, uncompensated factor exposure such as a size bet or a who expects the explosive growth in assets under sector bet,” he says, “It’s hard to make the case that long management to continue. “If these products’ early only is a better structure than 130/30.”SSgA now manages performance is any indication our $1trn estimate [of the potential market] could be quite conservative.” By any more than $10bn in its Edge brand 130/30 portfolios. As a substitute for long only equity, 130/30 products allow measure, that’s more than a flash in the pan.
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THE 130/30 PRIMER: WHAT YOU NEED TO KNOW & A LITTLE BIT MORE What is 130/30 investing? The idea is simple. Start with a long portfolio tied to a benchmark, but give managers room to exploit stocks identified as dogs by selling short up to 30% of the portfolio and let them reinvest the proceeds in expected winners. The net market exposure remains 100% (130% long and 30% short), explains Jeremy Baskin, global head of active quant strategies at Northern Trust Global Investors (NTGI) in Chicago. A successful stock picker should deliver better performance relative to a benchmark while still subject to the constraints typical of a long only mandate, including maximum variance from benchmark weightings by sector, industry and individual security. “I think that 130/30 has become a category reference that includes funds that similarly net to 100% long,” notes Baskin, “it may not be right for every investor.” Even so, for the right investor, 130/30 strategies offer investors a lot of flexibility. “130/30 removes the constraint on shorts,” he says.
Is this a new strategy? It has been around for three or slightly more years and is sometimes referred to as active extension or short extension strategies. It is picking up in popularity quite quickly though and as of March this year it is estimated that between $50bn and $60bn worth of assets are invested in 130/30 strategies.
Why 130/30 funds are popular There is a significant demand from the institutional market. Pension funds, for example, show a growing need for alpha-based returns to help solvency levels. 130/30 strategies also offer an alternative to those institutions for which pure hedge fund plays are a little to rich for their liking. 130/30 strategies are attractive because they work around the usual constraints placed on managers by long only mandates. “Most managers in this regard have a benchmark and benchmarks are cap weighted,” says Baskin, adding, “By definition, if you have a long only mandate, you simply cannot short. Therefore, the moderate leverage and shorting that 130/30 allows means that it is attractive to beneficial owners, which might be wary of jumping on the hedge fund bandwagon. The appeal of 130/30 is augmented by the fact that they are cheaper than hedge funds as well.”
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While many beneficial owners are looking to alternative investments, such as hedge funds and private equity funds for some of this alpha, up to now actual allocations to these types of investments as a percentage of overall assets under management are still very low. The biggest bulk of corporate plan assets (over 41%) and public plan assets (over 45%) are in domestic equities. Most of these investments are in large cap stocks, which cuts to the heart of 130/30 investing, as it is principally centred in the large cap segment. Additionally, UCITs III provide investment managers with an opportunity to package these funds for retail investments. While UCITs III funds do not borrow stocks to sell, they do use derivatives to gain the same effect. Baskin says plans can replicate 130/30 exposure with equitised long/short strategies, such as investing in market neutral hedge funds and combining that exposure with a swap on the S&P 500, or a futures contract to gain particular market exposure.
Why 130/30 and not 140/40 or 150/50? It is worth noting that 130/30 is not necessarily a set ratio. Some managers prefer anything from 120/20 to 140/40 or range between. However, in a 130/30 fund the active risk is similar to traditional long only fund, although the overall exposure to an investment manager’s investment process is 160%. However, as NTGI’s Baskin notes, “130/30 strategies are about getting more alpha per unit of risk. However, if you look at the maximum value of going short, after 140/40 and 1510/50, the benefits generally diminish, so you have to have the right balance that works for your process, benchmark and level of active risk.”
Why are so many investment banks beginning to offer 130/30 support? Not everyone who wants to launch a 130/30 fund will have the appropriate technology, operational processes or culture to support the strategy (strange though it may appear, not all fund managers are adept at shorting stock, for example). Prime brokers, for example, while expensive, do offer constructive help in this regard offering both broking and custodial services. Equally, banks offering quant services can help the asset manager identify over or under priced stocks.
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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.
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DEBT REPORT: ASSET BACKED SECURITIES
ABS ISSUANCE INHIBITED
After the first six months of 2007, European securitisation was set to break all records. Analysts were confidently expecting that new issuance for the year would exceed €500bn for the first time, as asset-backed bonds appeared to have become a highly liquid option for financial market investors. Yet within six weeks, the abrupt seizure in short-term borrowing around the world—driven by concerns over exposures to the worsening US sub prime mortgage crisis—turned the market on its head. The consequent funding problems experienced by many ABS investors sent valuations spiraling downwards. Bond spreads in the secondary market quadrupled across the ratings spectrum in some cases, forcing prospective new issuers to abandon their plans indefinitely. How did this happen, and where does the market go from here? Andrew Cavenagh reports.
T While no mass sell-offs had taken place by late September, some initial casualties emerged at the end of August. Among the first was the Cheyne Finance SIV, which was established in August 2005 and whose $9.7bn of assets included an unusually heavy exposure to the US sub prime market through both direct investments and CDOs. Photograph © pmphoto, supplied by Dreamstime.com, October 2007.
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HE IRONY OF the collapse in the value of European asset-backed securities market is that—excepting those assets with US sub-prime exposure—it has nothing to do with the performance of their underlying assets. It is entirely down to the way a large chunk of the investor base has chosen to fund its investments. They are the conduits and structured-investment vehicles (SIVs) that are sponsored by banks and others. Worldwide they are reckoned to hold asset-backed securities worth the equivalent of $1,400bn. They finance these investments to a large extent by issuing asset-backed commercial paper (ABCP), which typically has a maturity of between three and six months. While rates on ABCP were low—flat or close to inter-bank rates such as three-month Libor and Euribor—this model provides a significant arbitrage opportunity as the ABS investments pay spreads above Libor.
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In an announcement to the Irish Stock Exchange on The strategy depends crucially, however, on the ability to “roll over” the commercial paper as it falls due. As August 28, the Dublin-listed vehicle said that mark-tomounting fears over banks’ sub-prime exposures (both market losses in its investment portfolio had breached one direct and indirect through collateralised debt obligations of its key triggers—the major capital loss test—and that it [CDOs]) cause them to stop lending to each other in the had sold off assets to raise enough cash to meet its short-term markets, appetite for CP dried up and left those projected liabilities for the next few months. Cheyne added who relied on it for funding exposed. While the bank- that it would “continue to sell assets to meet out liabilities sponsored conduit programmes have liquidity facilities as they come due” while it attempted to negotiate a re(put up by their sponsors) that cover 100% of the CP they capitalisation to extend the maturity of its debt. The same day the €10bn Rhinebridge SIV, sponsored by have issued—which enables them to refinance any debt that falls due for a period of at least 90 days—the liquidity the troubled IKB Deutsche Industriebank, sold $176m of facilities in SIVs are not so large. Consequently their only bonds to meet its immediate debt obligations rather than attempt to draw on alternative to meet liquidity facilities, debts falling due (if they conceding that further cannot refinance it) is support from IKB and to sell off assets, and it While banks in most cases can be its owners “cannot be is the scale of these expected to provide the additional expected at this stage”. potential fire-sales that liquidity necessary to prevent the vehicles The impact of these has had such a they sponsor from having to dispose of enforced disposals— detrimental impact on and the threat of a lot ABS valuations. large volumes of securities at significant more to come—on The Moody’s rating discounts, those set up by hedge funds bond valuations was agency estimates that and others do not have such an “in savage. By midSIVs held $400bn of house” liquidity provider. To say the September, the spreads various asset-backed least, they consequently face an uphill on triple-A residential bonds at the beginning struggle to find an external source of mortgage-backed of September, and that securities (RMBS) vehicles without bank such funding in the current environment. issued by the big UK sponsors accounted for master trusts—up to $90m of this total. July the tightest priced While banks in most bonds in the European cases can be expected to provide the additional liquidity necessary to prevent the market—had shot out to 50 basis points on the 3-month vehicles they sponsor from having to dispose of large Libor benchmark from a level of 11bp just two months volumes of securities at significant discounts, those set up before. The secondary market spreads on triple-A bonds on by hedge funds and others do not have such an “in house” all other asset classes widened by between 175% and liquidity provider. To say the least, they consequently face 400%, which quickly strangled the primary market. Spain’s an uphill struggle to find an external source of such Banco Pastor, for example, confirmed on September 20 that it was postponing a planned €600m issue indefinitely until funding in the current environment. Their situation is exacerbated by their high gearing of conditions improved, and one banker estimated that at the vehicles, which obliges them to maintain mark-to- least €20bn of deals out of the country would now be market valuations and other triggers that—if breached— shelved until 2008. The only deals of any size that did emerge in September can also force them to sell off assets. As the values of assetbacked bonds have plunged, more SIVs have faced —like the £5bn Granite 2007-8 issue out of the Northern enforced asset sales for this reason, and such disposals can Rock RMBS master trust that will be used as collateral for only drive market prices further down and spread the the beleaguered bank’s emergency loan facility from the malaise to other vehicles.“The problem is that one fund’s Bank of England—were those that issuers wanted to retain forced liquidation depressing prices would be the next for repo purposes. One or two smaller deals, such as the fund’s trigger point to liquidate, as net asset values €750m Sound BV 2 and €250m E-MAC BV issues out of decline,”explains Chris Greener, credit research analyst at the Netherlands (where in both cases the underlying assets are covered by NHG guarantees) also came out, Société Générale in London. While no mass sell-offs had taken place by late where the issuers managed to pre-place the senior classes September, some initial casualties emerged at the end of of triple-A notes but were obliged to retain the mezzanine August. Among the first was the Cheyne Finance SIV, which and junior ones. In the secondary market, meanwhile, several of the large was established in August 2005 and whose $9.7bn of assets included an unusually heavy exposure to the US sub-prime repeat issuers began to buy back their own bonds at a substantial discount.“It makes sense for them to do that,” market through both direct investments and CDOs.
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DEBT REPORT: ASSET BACKED SECURITIES
observed Greener at Société Générale. Most asset-backed analysts are not expecting the situation to change much before the end of October, as lack of liquidity some SIVs to sell off more assets. Priya Shah, structured credit strategist at Dresdner Kleinwort, says the vehicles that did not have bank sponsors were looking particularly vulnerable and while all the SIVs are looking for temporary liquidity lines to enable them to dispose of their assets in a more orderly manner not all would succeed in the current climate. “If you have half of those non-bank vehicles having to sell their assets, then that’s going to be a pretty big number,” she pointed out. Shah added that the $12bn of assets held in the recently established SIV-lites would undoubtedly have to be sold. These riskier variants of the SIV structure do not have bank sponsors (they have been issued by CDO managers), have larger capital note structures below the issued debt, and their collateral is much more concentrated into a single asset class. Four of the five launched to date have funded themselves exclusively in the CP market, where they have no chance of rolling over the debt in the necessary timeframe. “There’s no one now that going to buy that commercial paper,”she says. The shadow of these disposals looks set to inhibit new issuance for at least another two months, as the triple-A
spreads on prime RMBS will need to halve from the midSeptember levels before the big serial issuers (who dominate European RMBS) return to the market. This is because the margins on the mortgages average 55-75bp over Libor, and they need 40-50bp of excess spread to cover reserve funds, servicing costs and potential losses. “That’s the only point at which the arbitrage really starts to work,”explained Laila Kollmorgen, head of secondary ABS trading at BNP Paribas in London. By the end of September, however, there were signs that the market was turning as triple-A secondary spreads came in 10bp in the final week of the month. Kollmorgen said that indicated primary market should come back within six weeks.“At the latest it’s going to be mid-November.” While the European bank-sponsored conduits, which hold the equivalent of around $300bn of asset-backed securities will not be able to start buying again until ABCP margins come back to at least 10bp over inter-bank rates as in the US, there are fledgling signs that real-money investors (insurers, pension funds and rational asset managers ) are setting up funds to acquire discounted ABS, as PIMCO and others have done on a large scale in the US. These buyers should then account for a larger share of the investor base going forward in as European securitisation gets back on track—albeit with risk re-priced from the spread levels that prevailed before July—in 2008.
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:
Paul Spendiff Tel:44 [0] 20 7680 5153 Fax:44 [0] 20 7680 5155 Email:paul.spendiff@berlinguer.com
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KEEPING AN EYE ON THE FUTURE OF ECNs HE ONE CERTAINTY is that the securities exchange marketplace will become even more crowded and not every player will make it to the finishing line. Many believe that Europe will follow a similar pattern to the US, which has seen a proliferation of participants in the wake of the Regulation for National Markets (Reg NMS), which was introduced in 2005 and came into force earlier this year. Under the new rules, the onus is put on the exchange to pass on an order if it cannot provide the best price when the order is executed. The Markets in Financial Instruments Directive (MiFiD), which finally sees the light of day in November this year, is a broader framework. Under MiFiD, the obligation firmly rests on an investment firm’s ability to find the best trading venue. MiFiD also provides for the creation of multi-lateral trading facilities (MTFs), which allows parties to trade among themselves away from the exchanges, much like crossing networks in the US. While the two sets of regulation may differ, their main objectives remain the same - to protect the investor by ensuring best price on every execution. Moreover, they are both designed to level the playing field. One of the challenges, though, is that the lines of distinction seem to be blurring between the various electronic participants, the exchanges and their value propositions. For example, in the past three years, the New York Stock Exchange (NYSE) bought Archipelago Exchange. NASDAQ meantime, which had bought Brut in 2004, purchased Instinet a year later. With this growing market complexity and blurring, often times the
T
While there is confusion over the precise definition of an ECN, at its most basic level it is an electronic marketplace that facilitates the buying and selling of stocks by lining up brokers and market-makers that trade on behalf of institutional and retail investors without sending the order through an exchange for execution. In Europe, under MiFiD, ECNs and crossing networks are mostly referred to as MTFs, which can offer a displayed market as well as dark orders and quotes. They all differ from the established stock exchanges in that they do not trade their own list of stocks nor do they hold initial public offerings. Photograph © Rolffimages, Agency: Dreamstime.com, supplied September 2007.
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Although regulation in the US and Europe is often written about as a catalyst for change, the trading landscape in both regions has already been altered thanks to direct market trading, algorithmic trading, a sharpened focus on best execution and banks’ internalising their own orders. Legislation has and will only accelerate the trends set in motion. New electronic players have emerged while existing incumbents and regulated exchanges are busy reconfiguring their models. Who will survive, of course, is another question. Lynn Strongin Dodds reports.
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characteristics and terminology used to describe these trading venues and liquidity will coalesce around a small different platforms can be confusing. In simple terms then, number of platforms just as it happened in the US.” Right now, there is a great deal of buzz around the how do alternative trading systems (ATS), electronic communication networks (ECN), crossing networks, MTFs advent of dark pools. These are electronic trading venues that match buyers and sellers anonymously, without and stock exchanges differ from each other? The common thread is that most are electronic trading quoting prices. For institutional investors, these deals are platforms. Breaking it down further, in official parlance, an usually done at the mid-point of the underlying market ATS across in North American markets is a networked price, which saves half the bid-offer spread. Another application that electronically connects potential buyers advantage is that market impact, which can account for up and sellers of securities, matching their trades on to 80% of transaction costs, is eliminated. Although it has been touted as a recent phenomenon, predefined criteria. This can include call markets, matching systems and crossing networks as well as electronic dark pools are not a new concept, according to Joseph Cangemi, managing director of BNY ConvergEx, the communications networks (ECNs). While there is confusion over the precise definition of an agency brokerage, research and technology affiliate of Bank ECN, at its most basic level it is an electronic marketplace of New York Mellon. In the old days of floor based trading, that facilitates the buying and selling of stocks by lining up if a broker had received a large order, he would not show brokers and market-makers that trade on behalf of his full hand. Instead, they would work it in smaller pieces institutional and retail investors without sending the order while disclosing the least amount of information possible and only to those they through an exchange trust. for execution. In Dark pools have Europe, under MiFiD, mushroomed in the ECNs and crossing In Europe, under MiFiD, ECNs and crossing US with estimates networks are mostly networks are mostly referred to as MTFs, which having it that around referred to as MTFs, can offer a displayed market as well as dark 40 to 45 are in which can offer a operation, although displayed market as orders and quotes. They all differ from the the types of liquidity well as dark orders and established stock exchanges in that they do not pools vary quotes. They all differ trade their own list of stocks nor do they hold dramatically. There are from the established initial public offerings. agency brokers that stock exchanges in only handle client that they do not trade orders and cross their own list of stocks those, where possible. nor do they hold initial These include ITG, which pioneered the dark liquidity public offerings. It is no surprise, perhaps, that industry participants often model, Instinet and relative newcomers, Pipeline Trading refer to all of these different types of platforms, except the Systems and Nyfix Millenium. On the independent front, exchanges, as electronic venues. As Alasdair Haynes, chief Liquidnet is the most prominent player, catering to the executive officer and head of ITG’s international business, buyside. This means that institutions can trade with each points out,“You need a dictionary to understand what the other without using a broker. Investment banks, on the other hand, offer crossing market looks like and I think there needs to be more clarification. For example, some might ask what is Chi-X networks that match their own proprietary orders with (the first order-driven pan-European equities alternative those of institutional, hedge funds and retail clients. Many trading system launched by Instinet this past March). Is it household names have also banded together to create an ECN, MTF, ATS or quasi-exchange? The exchanges are Block Interest Delivery System Trading (Bids) in an attempt looking at what the MTFs are doing and visa versa in terms to increase competition and liquidity in equities trading. of offering different value products. No one wants to be left These include Citigroup, Goldman Sachs, Lehman behind and they are encroaching on each other’s territory.” Brothers, Merrill Lynch, Morgan Stanley and UBS and Alan Jenkins, European head of MiFiD at BearingPoint, a more recently, Bank of America, Bear Stearns, Credit UK based consultancy, agrees, adding,“It does seem that all Suisse, Deutsche Bank, JP Morgan and Knight Capital the acronyms are becoming synonyms for each other. In Group have invested in the system. In addition, broker-dealer-owned platforms have started Europe, ECNs now have a new name - MTFs - although they do not get off that lightly and have similar obligations to link with other broker-owned and/or independent dark as fully fledged exchanges under MiFiD. The result, though, liquidity pools, which again can distort the dividing lines. will be that liquidity will fragment further and we will see For example, Credit Suisse has linked its CrossFinder with a proliferation of new data and execution venues in the first Instinet CAB, Fidelity CrossStream, Lehman LCX, 12 to 18 months of MiFiD. Then in the next two to three Liquidnet and others. Merrill Lynch and ITG, on the other year period, people will start to work out which are the best hand, have joined forces to launch Block Alert, a global
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Joseph Cangemi, managing director of BNY ConvergEx, the agency brokerage, research and technology affiliate of Bank of New York Mellon. In the old days of floor based trading, if a broker had received a large order, he would not show his full hand. Instead, they would work it in smaller pieces while disclosing the least amount of information possible and only to those they trust. Photograph kindly supplied by BNY Convergex, October 2007.
John Barker, head of Liquidnet believes “the next four years will see several new entrants coming into the European market with both mainstream and niche offerings. As players such as ITG, Chi-X and Liquidnet have demonstrated, there is market share to be gained although I think in the end Europe is smaller than the US and will only be able to sustain three to four different models.” Photograph kindly supplied by Liquidnet, October 2007.
block trading service using agency broker ITG’s Posit crossing network. Overall, the new contenders and incumbents have been successful in wrestling liquidity away from the established exchanges in US equities. A recent study conducted by Aite this past autumn revealed that exchanges currently account for about 75% of domestic equity trade volume, compared to 25% for ATS’. By the end of 2011, this figure is expected to be whittled down to about 62%. Sang Lee, managing partner of Aite, along with others, believes consolidation is inevitable.“Today, the US equities market is highly fragmented and it is not easy to navigate in the short term as liquidity migrates from one location to another. The displayed platforms have been more successful, with the four largest – NYSE, NASDAQ, BATS and Direct Edge - accounting for about 85% to 90% of all trading in US equities. Market consolidation seems to be inevitable, and while the share of the four largest players may fall, I believe they will continue to dominate.” Cangemi of BNY ConvergEx, which recently launched a dark liquidity trading venue called VortEx, notes,“I do not think that the US market can support all these varieties of liquidity pools. There are about 45 registered ATS/ECN in the US but that does not mean that they are all having a critical impact on the market. Looking ahead, I think there is room for eight to ten but they may be totally different
than the ones that are currently in the market.” As for the growth of dark liquidity pools, Lee believes that their potential is limited despite the hype. “They currently occupy about 12% to 15% of the US market and while some predict they will grow to account for 50% of trading, I think that is unsupportable. First, their growth creates a credibility problem because by definition they do not offer displayed quotes and instead rely on the publicly available quotes to determine crossing points. As the public market shrinks, the credibility of the public price will come into question and as a result, trade execution quality in the dark liquidity pools may come into question as well. Also, their growth may be curtailed because of the regulators emphasis on transparency.” This is unlikely, though, to stop electronic upstarts and exiting players in the displayed and dark pool space from trying their luck in the post MiFiD world. At first glance, Europe may be a harder market to crack. The efficiency of the exchanges’ electronic order books, where average order sizes remain substantially greater than in the US, has made it difficult for competitors to win liquidity in Europe. However, as Peter Randall, director, Chi-X Europe Ltd, notes, “It is difficult to speculate about how many players there will be but I think the pie will get bigger as more liquidity is generated.The platforms that will win are those that can offer access to new liquidity, better pricing and sophisticated technology.”
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announced. The group So far, the recipe has has said it will be fit for worked for Chi-X. purpose by the first or Instinet claims that second quarter of 2008 trading on Chi-X is on but industry pundits average 90% cheaper remain sceptical. John than on the main Barker, head of European markets. In Liquidnet believes “the August, the trading next four years will see platform took a several new entrants significant minority of coming into the trading in the largest European market with shares listed on the both mainstream and Dutch and German niche offerings. As stock exchanges – two players such as ITG, countries where Chi-X and Liquidnet domestic law does not have demonstrated, require that all share there is market share trading be routed to be gained although I through the local think in the end exchange. Europe is smaller than A promising start the US and will only be no doubt but the jury able to sustain three to is out over its long four different models.” term performance as For now, all the the European Alan Jenkins, European head of MiFiD at BearingPoint, a UK based attention is on marketplace has yet to consultancy, agrees, adding,“It does seem that all the acronyms are becoming equities, but looking become crowded. synonyms for each other. In Europe, ECNs now have a new name – MTFs farther down the line, Now, Nyfix intends to although they do not get off that lightly and have similar obligations as fully there could be limited launch Eurofledged exchanges under MiFiD. The result, though, will be that liquidity will opportunities in the Millennium, an MTF fragment further and we will see a proliferation of new data and execution over the counter for pan-European venues in the first 12 to 18 months of MiFiD. Then in the next two to three year space. Paul Winter, listed cash equities in period, people will start to work out which are the best trading venues and global head of OTC the fourth quarter liquidity will coalesce around a small number of platforms just as it happened derivatives, at Fortis while Liquidnet is in the US.” Photograph kindly supplied by Bearing Point, October 2007. Investments, says,“If it continuing to enhance happens we could see its product offering in electronic trading in Europe. Equiduct, the simpler products which was borne out such as plain vanilla of the old Easdaq A recent study conducted by Aite this past interest rate swaps or trading platform, autumn revealed that exchanges currently forward rate recently struck a deal account for about 75% of domestic equity trade agreements where with Börse Berlin volume, compared to 25% for ATS’. By the end there is a lot of formerly known as the of 2011, this figure is expected to be whittled liquidity. I think it Berlin Stock down to about 62%. would be harder to Exchange. Few details create an electronic of their precise trading platform in the offering are currently more complicated available and there are concerns that Bob Fuller, head of the venture, is leaving at products such as collaterised debt obligations where there are more problems with pricing and valuations.” the end of October. As Richard Balarkas, head of advanced execution All eyes are still sharply focused on the fate of Project Turquoise, the pan-European exchange being set up by a services at Credit Suisse, puts it, “An exchange type of consortium of investment banks, including Credit Suisse, mechanism may encourage more liquidity in some of the Deutsche Bank, Goldman Sachs, Merrill Lynch, Morgan OTC derivatives markets but by definition, they are OTC. Stanley and UBS. It has already selected the DTCC There is a lack of uniformity and I think the new venues subsidiary EuroCCP to provide clearing and settlement will be focusing more on developing products for the services; however, a management team is yet to be equities market.”
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Top 10 Equities By Daily Total Return
Top 10 Corp Bonds By Daily Total Return
Rank Stock description
Rank Stock description
1
Groupe Eurotunnel SA
1
Rotech Healthcare Inc (9.5% 01-Apr-2012)
2
Imergent Inc
2
Fremont General Corp (7.875% 17-Mar-2009)
3
Home Solutions of America Inc
3
Magnachip Semiconductor Finance Co (8% 15-Dec-2014)
4
Medis Technologies Ltd
4
Tembec Industries Inc (8.625% 30-Jun-2009)
5
Alitalia - Linee Aeree Italiane Spa
5
K Hovnanian Enterprises Inc (8.875% 01-Apr-2012)
6
Raser Technologies Inc
6
K Hovnanian Enterprises Inc (8.625% 15-Jan-2017)
7
Dendreon Corp
7
Dollar General Corp (10.625% 15-Jul-2015)
8
Delta Financial Corp
8
Beazer Homes Corp (8.125% 15-Jun-2016)
9
Sulphco Inc
9
Burlington Coat Factory Warehouse Corp (11.125% 15-Apr-2014)
10
InterOil Corp
10
Freescale Semiconductor Inc (10.125% 15-Dec-2016)
Equity by Fee > 10 < 100 Mln
Equity by Fee > 100 Mln
Rank Stock description
Rank Stock description
1
Groupe Eurotunnel SA
1
Dendreon Corp
2
Imergent Inc
2
Corus Bankshares Inc
3
Home Solutions of America Inc
3
Cree Inc
4
Medis Technologies Ltd
4
Force Protection Inc
5
Alitalia - Linee Aeree Italiane Spa
5
Thornburg Mortgage Inc
6
Raser Technologies Inc
6
Indymac Bancorp Inc
7
Delta Financial Corp
7
USANA Health Sciences Inc
8
Sulphco Inc
8
La-z-boy Inc
9
InterOil Corp
9
Mueller Water Products Inc
10
Interoil Corp
10
Utstarcom Inc
Corp by Fee > 10 < 100 Mln
Corp by Fee > 100 Mln
Rank Stock description
Rank Stock description
1
Rotech Healthcare Inc (9.5% 01-Apr-2012)
1
Dollar General Corp (10.625% 15-Jul-2015)
2
Fremont General Corp (7.875% 17-Mar-2009)
2
Burlington Coat Factory Warehouse Corp (11.125% 15-Apr-2014)
3
Magnachip Semiconductor Finance Co (8% 15-Dec-2014)
3
Freescale Semiconductor Inc (10.125% 15-Dec-2016)
4
Tembec Industries Inc (8.625% 30-Jun-2009)
4
Ford Motor Co (4.25% 15-Dec-2036)
5
K Hovnanian Enterprises Inc (8.875% 01-Apr-2012)
5
Realogy Corp (12.375% 15-Apr-2015)
6
K Hovnanian Enterprises Inc (8.625% 15-Jan-2017)
6
Calpine Corp (8.5% 15-Feb-2011)
7
Beazer Homes Corp (8.125% 15-Jun-2016)
7
Bon Ton Stores Inc (10.25% 15-Mar-2014)
8
Calpine Corp (7.75% 01-Jun-2015)
8
Pilgrims Pride Corp (8.375% 01-May-2017)
9
Trac-x North America 2 March 2009 Tr 1 (6.05% 25-Mar-2009)
9
Spectrum Brands Inc (11.25% 02-Oct-2013)
10
Dura Operating Corp (8.625% 15-Apr-2012)
10
General Motors Corp (8.375% 15-Jul-2033)
Govt by Fee > 10 < 100 Mln
Govt by Fee > 100 Mln
Rank Stock description
Rank Stock description
1
Philippines, Republic Of The (Government) (6.375% 15-Jan-2032)
1
Federal Home Loan Mortgage Corp (5.5% 23-Aug-2017)
2
Turkey, Republic Of (Government) (11.875% 15-Jan-2030)
2
United States Treasury (0% 15-Nov-2011)
3
Indonesia, Republic Of (Government) (6.875% 09-Mar-2017)
3
Federal Home Loan Mortgage Corp (5.5% 20-Aug-2012)
4
Mexico Government International Bond (5.875% 15-Jan-2014)
4
Canada Mortgage And Housing Corp (4.3% 01-Apr-2009)
5
Italy, Republic Of (Government) (2.25% 01-Feb-2010)
5
Federal Home Loan Mortgage Corp (5.5% 20-Aug-2012)
6
Argentina, Republic Of (Government) (1.33% 31-Dec-2038)
6
Federal Home Loan Banks (3.875% 14-Jun-2013)
7
Italy, Republic Of (Government) (5.25% 20-Sep-2016)
7
Kfw Bankengruppe (0.5% 03-Feb-2010)
8
Resolution Funding Corp (0% 15-Jul-2019)
8
United States Treasury (0% 10-Jan-2008)
9
United States Treasury (0% 15-Aug-2021)
9
United States Treasury (0% 18-Oct-2007)
10
Turkey, Republic Of (Government) (4.75% 06-Jul-2012)
10
Italy, Republic Of (Government) (2.2% 01-Jul-2009)
SECURITIES LENDING DATA
A SNAPSHOT VIEW OF THE SECURITIES LENDING MARKET AS OF OCTOBER 10 2007
Source: Data Explorers, 2007. All figures kindly compiled by Data Explorers, October 2007.
FTSE GLOBAL MARKETS â&#x20AC;˘ NOVEMBER/DECEMBER 2007
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4
ar -0
Se p-
M
03
3
ar -0
Se p-
M
02
Se p-
MARKET DATA BY FTSE RESEARCH
FT SE
MARKET REPORTS 22.qxd:MARKET REPORTS 22.qxd Page 88
Global 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
0
FTSE GWA Developed Index
40
30
FTSE RAFI Emerging Index
2-Month Performance
12
10
8
6
Capital return
4
Total return
2
0
1-Year Performance
80
70
60
50
Capital return
20
Total return
10
0
NOVEMBER/DECEMBER 2007 â&#x20AC;˘ FTSE GLOBAL MARKETS
MARKET REPORTS 22.qxd:MARKET REPORTS 22.qxd
22/10/07
14:34
Page 89
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
2883 2465 2022 861 443 418
268.48 470.32 254.38 590.09 529.70 727.29
4.7 4.5 4.4 7.3 5.3 10.4
10.1 9.2 8.2 29.1 25.4 34.5
22.2 20.8 19.2 54.6 48.8 63.6
12.3 11.4 10.4 31.7 29.2 35.1
2.15 2.18 2.17 2.02 2.36 1.55
USD USD USD USD USD
7892 6155 1737 923 814
450.93 429.84 839.97 767.85 995.08
4.3 4.1 6.8 4.4 10.1
9.7 7.7 30.2 26.7 35.2
22.6 19.5 56.8 51.1 65.5
12.3 10.2 33.4 30.8 36.9
2.07 2.09 1.95 2.28 1.51
USD
719
112.02
3.7
3.5
4.4
3.7
3.56
USD USD USD USD USD
302 193 236 245 57
2647.73 1171.46 2398.27 1307.82 1650.25
8.4 8.8 10.0 7.3 11.2
-4.1 -6.4 -1.5 -8.6 9.0
14.5 7.1 14.3 7.2 37.8
1.2 -3.4 2.0 -5.1 21.3
3.26 4.12 4.01 3.94 1.62
USD USD
226 10398.57 100 10170.23
6.5 6.6
6.7 5.6
25.6 24.0
12.2 11.2
2.86 2.89
USD USD
698 105
7116.23 6106.07
4.0 4.5
7.0 7.4
16.7 13.0
8.2 6.3
2.54 2.83
USD USD USD
2022 1002 351
4343.07 7320.11 6965.29
3.8 3.6 8.7
7.3 8.2 33.9
18.8 24.9 62.6
9.3 12.9 36.1
2.44 2.68 2.43
Table of Total 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
2883 2465 2022 861 443 418
311.54 732.18 294.62 711.65 642.51 869.52
5.1 4.9 4.8 7.8 5.8 10.7
11.6 10.6 9.7 30.9 27.1 36.5
24.9 23.5 21.9 58.2 52.6 66.7
14.4 13.5 12.4 34.3 32.1 37.4
2.15 2.18 2.17 2.02 2.36 1.55
USD USD USD USD USD
7892 6155 1737 923 814
499.56 475.43 954.52 878.69 1116.95
4.7 4.5 7.2 5.0 10.4
11.1 9.0 32.0 28.5 37.0
25.2 22.1 60.3 54.8 68.6
14.3 12.2 35.9 33.6 39.1
2.07 2.09 1.95 2.28 1.51
USD
719
151.40
4.3
5.5
8.3
6.6
3.56
USD USD USD USD USD
302 193 236 245 57
3720.14 1253.61 2511.81 1399.15 1703.31
9.1 9.7 10.9 8.1 11.5
-2.4 -4.3 0.6 -6.6 9.9
18.2 11.5 18.9 11.2 40.4
3.7 -0.5 4.9 -2.4 22.7
3.26 4.12 4.01 3.94 1.62
USD USD
226 11830.08 100 11600.95
7.0 7.0
8.7 7.6
29.4 27.9
14.9 13.9
2.86 2.89
USD USD
698 105
8163.90 7046.08
4.5 5.0
8.6 9.2
19.6 16.2
10.5 8.8
2.54 2.83
USD USD USD
2022 1002 351
4578.66 7720.03 7087.80
4.2 4.1 9.3
8.8 10.2 36.1
21.7 28.2 67.5
11.5 15.6 38.9
2.44 2.68 2.43
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;˘ NOVEMBER/DECEMBER 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
89
% 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 n id de 10 Sm x 00 al l 1 Ind ex 50 0 In de x
90 % Change
p07
ar -0 7 Se
M
p07
14:34
Se
ar -0 6
Index Level Rebased (30 Sep 02=100)
22/10/07
M
p05
ar -0 5
Se
M
p04
ar -0 4
Se
M
p03
ar -0 3
p02
Se
M
Se
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 22.qxd:MARKET REPORTS 22.qxd Page 90
Americas 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
50
FTSE GWA US Index
0
FTSE RAFI US 1000 Index
2-Month Performance
12
10
8
6
Capital return
4
Total return
2
0
1-Year Performance
90
80
70
60
50
40
Capital return
30
20
Total return
10
0
NOVEMBER/DECEMBER 2007 • FTSE GLOBAL MARKETS
MARKET REPORTS 22.qxd:MARKET REPORTS 22.qxd
22/10/07
14:34
Page 91
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
872 737 135
614.99 640.14 881.81
5.5 5.3 8.3
9.3 8.5 30.3
17.7 16.0 67.8
10.2 9.1 38.2
1.80 1.78 2.17
USD USD USD
2766 2565 201
390.68 378.35 1327.76
5.3 5.1 7.8
8.9 8.1 30.0
18.1 16.5 68.3
10.3 9.2 38.1
1.72 1.70 2.13
38 3338.50 15 4954.80 13 13148.70
8.8 2.9 10.5
35.9 23.2 43.4
67.4 51.5 82.3
44.1 31.1 52.8
na na na
USD USD USD USD USD
155 135
110.92 108.34
2.2 1.8
2.1 1.3
1.6 1.1
2.4 1.6
4.53 4.59
USD USD USD USD
122 98 118 4
2681.25 2121.28 1230.56 1341.77
10.1 10.3 10.1 9.5
-8.1 -9.2 -8.7 -2.0
2.5 0.9 1.9 8.0
-5.2 -6.8 -5.7 -0.5
4.05 4.11 4.16 3.03
USD USD
98 91
8679.55 8623.83
4.8 4.8
1.6 0.6
16.6 16.2
8.0 7.7
2.79 2.75
USD USD
145 101
5667.27 5430.04
5.0 5.5
6.7 7.0
11.4 11.3
5.4 5.3
2.04 2.07
USD USD USD
679 986 1344
3853.97 6274.06 5518.03
4.3 3.6 2.5
6.2 4.9 0.9
13.8 13.3 -
6.6 6.2 3.7
1.97 2.06 1.28
Table of Total 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
872 737 135
929.97 1026.02 1095.34
5.9 5.7 8.7
10.3 9.4 31.9
19.8 18.1 71.9
11.7 10.6 40.6
1.80 1.78 2.17
USD USD USD
2766 2565 201
424.19 410.22 1542.23
5.6 5.5 8.2
9.8 9.0 31.6
20.2 18.5 72.4
11.7 10.6 40.5
1.72 1.70 2.13
USD USD USD
38 15 13
na na na
na na na
na na na
na na na
na na na
na na na
USD USD
155 135
163.71 159.28
3.0 2.6
4.4 3.6
6.4 5.9
5.9 5.1
4.53 4.59
USD USD USD USD
122 98 118 4
4043.58 2220.96 1318.66 1423.67
10.9 11.2 11.0 10.4
-6.2 -7.4 -6.9 -0.4
6.5 4.8 5.9 11.4
-2.5 -4.2 -3.0 1.9
4.05 4.11 4.16 3.03
USD USD
98 91
9826.38 9755.92
5.5 5.5
3.1 2.0
20.0 19.5
10.3 10.0
2.79 2.75
USD USD
145 101
6287.28 6044.96
5.4 5.9
7.8 8.1
13.6 13.5
7.0 6.9
2.04 2.07
USD USD USD
679 986 1344
4031.38 6547.21 5630.98
4.7 4.0 2.8
7.2 6.0 1.5
16.0 15.7 14.4
8.1 7.8 4.7
1.97 2.06 1.28
FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2007
91
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
De
% Change
De
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
92 % Change
p07
ar -0 7 Se
M
p07
14:34
Se
ar -0 6
Index Level Rebased (30 Sep 02=100)
22/10/07
M
p05
ar -0 5
Se
M
p04
ar -0 4
Se
M
p03
ar -0 3
p02
Se
M
Se
MARKET DATA BY FTSE RESEARCH
FT SE
MARKET REPORTS 22.qxd:MARKET REPORTS 22.qxd Page 92
Europe, Middle East, Africa Indices (EMEA)
5-Year Total Return Performance Graph 400
350
FTSE Europe Index (EUR)
300
FTSE All-Share Index (GBP)
250
FTSEurofirst 80 Index (EUR)
200
FTSE/JSE Top 40 Index (SAR)
150
FTSE Gilts Fixed All-Stocks Index (GBP)
100
FTSE EPRA/NAREIT Europe Index (EUR)
50
FTSE4Good Europe Index (EUR)
0
FTSE GWA Developed Europe Index (EUR)
0
-2
0
FTSE RAFI Europe Index (EUR)
2-Month Performance
10
8
6
4
2
Capital return
-4
Total return
-6
-8
1-Year Performance
50
40
30
20
10
Capital return
Total return
-10
-20
NOVEMBER/DECEMBER 2007 â&#x20AC;˘ FTSE GLOBAL MARKETS
MARKET REPORTS 22.qxd:MARKET REPORTS 22.qxd
22/10/07
14:34
Page 93
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 ex UK All Cap 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
595 2011 391 528
477.65 139.45 258.88 250.35
-0.4 0.7 0.4 -0.4
1.6 3.1 2.5 1.6
10.9 14.4 13.5 10.9
4.0 6.6 5.7 4.0
2.82 2.47 2.81 2.88
EUR EUR EUR EUR
1782 867 1186 1661
426.11 455.16 458.68 420.58
-0.9 0.0 -0.2 -1.0
0.9 2.2 1.8 0.7
11.7 14.7 14.2 11.4
3.7 6.3 5.5 3.6
2.73 2.83 2.72 2.78
GBP GBP EUR EUR EUR SAR SAR USD
692 3316.89 102 6466.79 81 5605.33 101 4934.95 313 1550.89 41 27267.58 160 29959.19 10 1287.88
0.8 1.7 1.8 0.6 0.1 5.5 4.9 5.6
1.0 2.5 4.8 3.6 2.3 10.9 9.9 7.1
8.7 8.5 14.2 10.0 11.1 33.0 33.9 23.8
3.0 4.0 7.6 4.9 4.5 20.6 20.2 5.2
2.89 3.05 3.16 3.19 2.93 2.21 2.36 0.95
EUR EUR GBP
236 416 29
97.49 105.33 145.36
0.3 0.2 0.3
-1.6 -1.7 -0.9
-4.0 -3.5 -4.4
-2.5 -2.3 -3.0
4.49 4.79 4.82
EUR EUR EUR EUR EUR
99 37 47 85 14
2353.30 971.59 2621.10 1124.09 1319.13
-3.7 -1.9 1.0 -3.6 -6.0
-22.9 -22.0 -18.3 -23.2 -17.5
-8.6 -12.3 0.1 -9.4 5.7
-21.6 -21.4 -12.2 -22.1 -12.3
2.89 3.04 3.92 3.01 1.10
USD
52 13601.79
8.8
13.5
36.4
18.3
2.98
EUR EUR
294 55
5106.46 4426.07
-0.7 -0.3
0.6 1.6
7.7 4.2
1.9 0.8
3.13 3.46
EUR EUR
528 468
4129.01 6295.08
-0.8 -0.2
26.9 2.1
38.7 13.3
29.3 5.2
3.20 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 ex UK All Cap 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
595 2011 391 528
891.98 176.72 312.68 307.34
0.0 0.8 0.5 0.0
3.7 5.6 4.8 3.7
14.2 17.7 16.7 14.2
6.7 9.4 8.4 6.7
2.82 2.47 2.81 2.88
EUR EUR EUR EUR
1782 867 1186 1661
491.35 524.41 524.33 485.42
-0.6 0.1 -0.1 -0.7
2.9 4.6 4.0 2.7
14.9 18.0 17.2 14.5
6.3 9.0 8.1 6.2
2.73 2.83 2.72 2.78
GBP GBP EUR EUR EUR SAR SAR USD
692 102 81 101 313 41 160 10
3952.04 3734.40 6537.36 5803.05 2015.04 2905.22 3160.72 1303.08
1.6 2.5 2.0 1.1 0.4 6.3 5.7 6.2
2.7 4.3 7.6 6.0 4.5 12.3 11.3 8.3
12.2 12.2 17.9 13.9 14.4 36.4 37.4 25.2
5.7 6.9 10.8 8.1 7.4 23.2 22.8 6.2
2.89 3.05 3.16 3.19 2.93 2.21 2.36 0.95
EUR EUR GBP
236 416 29
155.74 178.74 1966.08
1.0 0.9 1.5
0.6 0.3 1.6
0.3 0.5 0.6
0.7 0.8 0.9
4.49 4.79 4.82
EUR EUR EUR EUR EUR
99 37 47 85 14
3092.54 1037.49 2829.40 1181.70 1348.81
-3.4 -1.5 1.2 -3.21 -5.9
-21.3 -20.1 -16.1 -21.61 -16.8
-6.2 -9.3 3.9 -6.89 6.7
-19.8 -19.3 -9.4 -20.24 -11.6
2.89 3.04 3.92 3.01 1.10
USD
52 15719.09
8.9
16.4
40.9
21.6
2.98
EUR EUR
294 55
6147.50 5374.54
-0.3 0.3
2.8 4.0
11.1 7.9
4.7 4.0
3.13 3.46
EUR EUR
528 468
4416.32 6672.45
-0.4 0.1
3.3 4.4
13.9 16.7
5.8 8.1
3.20 3.06
FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2007
93
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
94 % Change
07
7
ar -0 Se p-
M
07
6
ar -0
14:34
Se p-
M
05
5
ar -0
Index Level Rebased (30 Sep 02=100)
22/10/07
Se p-
M
04
4
ar -0
Se p-
M
03
3
ar -0
Se p-
M
02
Se p-
MARKET DATA BY FTSE RESEARCH
FT SE
MARKET REPORTS 22.qxd:MARKET REPORTS 22.qxd Page 94
Asia Pacific 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
0
2-Month Performance
30
25
20
15
10
5
Capital return
0
Total return
-10 -5
1-Year Performance
300
250
200
150
Capital return
100
Total return
50
0
NOVEMBER/DECEMBER 2007 â&#x20AC;˘ FTSE GLOBAL MARKETS
MARKET REPORTS 22.qxd:MARKET REPORTS 22.qxd
22/10/07
14:34
Page 95
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
1276 803 473
305.07 532.24 110.85
4.9 10.3 -4.9
14.4 31.7 -5.1
28.4 56.2 1.3
17.5 35.5 -3.7
1.86 2.35 1.22
USD USD USD
3148 1821 1327
538.56 1199.85 392.06
4.3 15.9 -5.2
14.8 52.8 -5.4
29.2 75.6 0.7
18.2 52.1 -3.8
1.85 2.29 1.23
USD USD MYR TWD CNY CNY
151 467.14 40 9188.52 100 8697.89 50 6646.84 995 12504.01 25 26121.81
3.1 1.7 -3.5 3.2 21.8 25.1
18.8 15.5 6.1 17.7 89.7 67.1
53.7 45.2 39.1 27.6 268.0 117.4
30.4 22.9 22.1 16.3 173.4 57.3
2.79 2.95 2.85 3.38 0.46 1.30
USD
257
86.63
4.5
2.6
2.7
3.4
1.62
USD USD USD USD USD
81 41 54 42 39
2488.26 1860.50 2990.99 1463.56 1706.78
11.1 12.6 13.1 9.4 12.3
9.3 6.7 18.2 4.9 12.6
39.0 34.2 44.4 29.8 46.3
20.8 17.2 24.1 11.9 28.1
2.66 4.7 3.91 4.48 1.42
IRP IRP
63 30
1336.01 1401.38
12.1 14.0
61.1 67.9
97.0 98.4
59.9 65.1
0.49 0.60
JPY
192
5938.05
-4.8
-5.6
0.7
-5.3
1.22
USD MYR JPY
100 30 100
6544.11 9781.76 1752.93
5.7 2.2 -2.0
12.6 17.7 -1.3
23.9 57.1 9.0
13.2 36.0 -0.2
1.67 2.67 1.21
JPY AUD AUD SGD JPY JPY HKD
473 113 55 19 344 1008 50
4262.96 4716.79 6834.23 8413.46 5965.57 6304.90 8096.76
-5.0 7.2 5.6 2.8 -4.2 0.8 23.4
-6.4 10.6 6.7 16.0 -5.9 5.7 55.0
1.5 27.3 23.7 48.0 3.6 17.9 na
-3.9 16.3 12.7 24.5 -2.2 7.2 na
1.27 3.78 4.02 2.98 1.32 2.61 1.78
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
1276 803 473
348.54 660.07 132.36
5.5 11.1 -4.4
15.7 33.9 -4.6
31.0 60.5 2.6
19.5 38.7 -2.6
1.86 2.45 1.17
USD USD USD
3148 1821 1327
593.14 1395.95 414.20
4.9 17.2 -4.7
16.2 55.7 -4.8
31.8 81.5 2.0
20.3 57.0 -2.7
1.84 2.37 1.17
USD USD MYR TWD CNY CNY
151 569.64 40 10032.76 100 9114.36 50 7933.71 995 13496.30 25 31827.01
4.1 2.8 -2.7 4.1 21.8 25.7
21.4 18.3 8.1 21.7 90.8 70.1
58.7 49.9 43.8 32.0 270.4 121.5
33.8 26.1 25.1 20.2 175.1 60.2
2.71 2.81 2.50 3.38 0.55 1.49
USD
257
101.02
4.8
4.0
4.9
5.2
1.62
USD USD USD USD USD
81 41 54 42 39
3251.70 2025.91 3141.80 1594.88 1751.78
11.7 13.3 14.0 10.7 12.5
10.8 8.3 20.5 7.4 13.4
43.1 38.4 50.3 35.9 48.7
23.3 19.7 27.5 15.7 29.3
2.85 5.0 3.86 4.66 1.53
IRP IRP
63 30
1339.48 1405.58
12.2 14.1
61.5 68.4
98.3 100.0
60.8 66.2
0.51 0.66
192
6337.31
-4.3
-4.9
2.0
-4.2
1.24
100 6767.01 30 10378.35 100 1837.23
6.1 3.1 -1.6
13.7 20.2 -0.6
26.1 63.0 10.4
14.9 39.5 1.0
1.73 2.59 1.24
-4.6 8.5 7.1 4.3 -3.7 1.2 24.2
-5.8 12.7 9.0 19.1 -5.3 7.4 58.36
2.8 32.4 29.4 53.1 5.0 21.0 na
-2.8 19.9 16.8 28.0 -1.1 9.5 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 • NOVEMBER/DECEMBER 2007
473 113 55 19 344 1008 50
4384.91 5181.86 7485.93 8953.05 6120.19 6583.17 8281.84
95
GM EDITORIAL 22.qxd
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Page 96
CALENDAR
Index Reviews November – December 2007 Date
Index Series
Review Type
Effective Data Cut-off (Close of business)
9-Nov
Hang Seng
Quarterly review
7-Dec
28-Sep
14-Nov
MSCI Standard Index Series
Quarterly review
30-Nov
31-Oct
Early Dec
CAC 40
Quarterly review
21-Dec
30-Nov
Early Dec
ATX
Quarterly review
31-Dec
30-Nov
Early Dec
IBEX 35
Semi-annual review
2-Jan
30-Nov
Early Dec
OBX
Semi-annual review
21-Dec
30-Nov
Early Dec
OBX
Quarterly review
21-Dec
30-Nov
5-Dec
DAX
Quarterly review
21-Dec
30-Nov
6-Dec
FTSE Global Equity Index Series (incl. FTSE All-World)
Annual review / North America
21-Dec
28-Sep
7-Dec
S&P BRIC 40
Annual review
21-Dec
16-Nov
7-Dec
S&P / ASX Indices
Quarterly review
21-Dec
11-Dec
NZSX 50
Quarterly review
31-Dec
30-Nov
12-Dec
FTSE/JSE Africa Index Series
Quarterly review
21-Dec
7-Dec
12-Dec
FTSE UK Index Series
Annual review
21-Dec
11-Dec
12-Dec
FTSE techMARK 100
Quarterly review
21-Dec
30-Nov
12-Dec
FTSE Euromid
Quarterly review
21-Dec
30-Nov
12-Dec
FTSEurofirst 300
Quarterly review
21-Dec
30-Nov
12-Dec
FTSE EPRA/NAREIT Global Real Estate Index Series
Quarterly review
21-Dec
7-Dec
12-Dec
FTSE eTX Index Series
Quarterly review
21-Dec
30-Nov
14-Dec
FTSE NAREIT US Real Estate Annual review
21-Dec
30-Nov
Index Series 14-Dec
FTSE NASDAQ Index Series
Annual review
21-Dec
30-Nov
14-Dec
NASDAQ 100
Annual review
21-Dec
30-Nov
18-Dec
FTSE Bursa Malaysia Index Series
Annual review
21-Dec
30-Nov
15-Dec
PSI 20
Semi-annual review
2-Jan
30-Nov
Mid Dec
VINX 30
Semi-annual review
25-Dec
30 Nov
Mid Dec
OMX C20
Semi-annual review
25-Dec
30-Nov
Mid Dec
OMX S30
Semi-annual review
29-Dec
30-Nov
Mid Dec
OMX N40
Semi-annual review
29-Dec
30-Nov
Mid Dec
Baltic 10
Semi-annual review
29-Dec
30-Nov
18-Dec
S&P MIB
Quarterly review - shares & IWF
27-Dec
17-Dec
19-Dec
S&P US Indices
Quarterly review
21-Dec
19-Dec
S&P Europe 350 / S&P Euro
Quarterly review
21-Dec
19-Dec
S&P Topix 150
Quarterly review
21-Dec
19-Dec
S&P Asia 50
Quarterly review
21-Dec
19-Dec
S&P Latin 40
Quarterly review - shares & IWF
21-Dec
19-Dec
S&P Global 1200
Quarterly review - shares & IWF
21-Dec
19-Dec
S&P Global 100
Quarterly review - shares & IWF
21-Dec
19-Dec
DJ STOXX
Quarterly review
21-Dec
13-Nov
21-Dec
Russell US Indices
Quarterly review - IPO additions only
31-Dec
30-Nov
Sources: Berlinguer, FTSE, JP Morgan, Standard & Poors, STOXX
96
NOVEMBER/DECEMBER 2007 • FTSE GLOBAL MARKETS
GM EDITORIAL 22.qxd
22/10/07
14:40
Page IBC1
Jim wondered if there was an easier way to get his own copy of FTSE Global Markets...
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GM EDITORIAL 22.qxd
22/10/07
14:40
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