FTSE Global Markets

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US TRANSITION MANAGEMENT RAISES THE BAR ISSUE 23 • JANUARY/FEBRUARY 2008

Deep sea mining plumbs the depths to reach the stars Will Europe’s REITs scale the heights?

Liability driven investing moves into the mainstream

AON LEADS THE NEW MARKETS CHALLENGE THE NEW DRIVE IN EMERGING MARKETS PRIVATE EQUITY

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Outlook EDITORIAL DIRECTOR:

Francesca Carnevale, Tel + 44 [0] 20 7680 5152, email: francesca@berlinguer.com STAFF WRITER:

Julia Grindell CONTRIBUTING EDITORS:

Neil O’Hara, David Simons, Art Detman.

SPECIAL CORRESPONDENTS:

Andrew Cavenagh, John Rumsey, Simon Watkins Lynn Strongin Dodds, Ian Williams, Mark Faithfull.

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Mark Makepeace [CEO], Imogen Dillon-Hatcher, Paul Hoff, Andrew Buckley, Jerry Moskowitz, Fran Thompson, Andy Harvell, Sandra Steel, Sylvia Mead, Nigel Henderson.

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FTSE GLOBAL MARKETS • JANUARY/FEBRUARY 2008

his edition is a strange brew of gloom and bloom. Dampening the upcoming end of year festivities, London’s Cantos City Panel Survey, a monthly survey of leading fund managers, buy-side and sell-side analysts in the UK, have issued their latest market missive, holding that the downturn in the housing market and consumer spending will continue. Eight out of ten City of London experts believe house prices will drop in 2008, with more than 64% now also predicting a drop in consumer spending over the next quarter up from 43% in November. There is no doubt that mortgage misery and the continuing stresses falling out of the US sub prime market will continue to haunt bank balance sheets through the early part of 2008. Both Dave Simons and Mark Faithfull touch on how these underlying trends will affect real estate around the world in this edition, with a transatlantic review of the real estate investment trust (REIT) markets.The magazine will continue to follow the global real estate market through 2008, as a useful barometer of the eventual global spread of the impact of sub prime on both corporate fund raising and property values (industry, office and retail) for better or worse.

The bloom meanwhile is distinctly focused on the rise of private equity in emerging markets, the increasing sophistication of the fund administration and outsourcing business—all topics covered in this issue. The real spotlight is on Chicago’s insurance giant Aon. The insurance industry is undergoing something of a makeover and it is emerging as a catalyst for increasingly relevant risk management product for the financial services industry. Aon has made this imperative a cornerstone of its own restructuring, which it is still undergoing, to take account of the changing global financial dynamics and the firm provides a fascinating template into the way that global super-institutions are adapting to new 21st century dynamics. If you do not believe in the increasing crossover between the financial markets and the insurance industry, consider the impact of Warburg Pincus’investment of up to $1bn in MBIA, the monoline insurer. However Warburg may yet come to regret its eagerness to join the fray as MBIA announced in late December that $8bn of its $30bn complex mortgage insurance exposure is of a type viewed as most risky. MBIA now needs a further injection of capital if it is to stave off a ratings downgrade.

The news also puts into question MBIA’s stated plans for a $500m rights issue in 2008. It will be interesting to see how it all plays out, as the monoline depends entirely on its triple-A credit rating. In addition to shares worth $31 a share, Warburg received warrants that will allow it to buy an additional 16.1m of common shares of MBIA at $40 a share over the next seven years. Warburg will be a winner if MBIA weathers the storm, but a storm it is.

In spite of MBIA’s immediate problems, insurance will become an investor play and a key provider of new investible product. The latest innovation is ICAP-JLT’s insurance joint venture, which claims to have taken catastrophe risk mitigation to a new level, with the first catastrophe swap transaction.

Catastrophe swaps are designed to cover a pure form of risk linked to a single catastrophic event: either windstorms or earthquakes for example.

Counterparties who buy catastrophe swaps are effectively buying insurance for the eventuality that such an event takes place and industry wide insured losses reach a specified threshold. Products such as catastrophe swaps are attractive as a hedge for the reinsurance industry, or as a way for investors to gain access to a risk category that has low correlation with other asset classes.

With climate change becoming increasingly a concern, the emergence of catastrophe bonds and swaps looks almost prophetic, but certainly timely.

However, it is not only the risk of climate related catastrophe that requires mitigation. If anything should emerge from the malaise that has infected the developed markets in the second half of 2007, it is that a more thorough approach to risk management across the financial and investment spectrum is required. Perhaps insurers such as Aon might point the way: and perhaps there’s more to look forward to in 2008 and beyond that the current market gloom originally suggests.

T

Francesca Carnevale, Editorial Director December 2007

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Contents COVER STORY ........................................Page 52 Since the autumn of 2005 the Aon Corporation has undertaken a sweeping restructuring of its business to face head on the challenges of a changing insurance market and the increasing convergence between insurance and the global capital markets. Francesca Carnevale talks to Greg Case, Aon’s president and chief executive officer, about the corporation’s 21st century new business drivers.

COVER STORY: AON: FACING UP TO CHANGE

DEPARTMENTS MARKET LEADER

......................................................................................Page 6 Neil O’Hara explains why LDI is now a mainstream portfolio management tool.

WHY LDI IS A FREE LUNCH

ETFS BACK IN THE LIMELIGHT ..............................................................Page 11

IN THE MARKETS

INDEX REVIEW

REAL ESTATE REPORT

ETFs just keep on multiplying. How do you choose the best from the rest?

......................................................Page 14 Neil O’Hara on the dynamics of the current liquidity crunch

THE FED EASING THAT WASN’T

........Page 17 Simon Denham, managing director, Capital Spreads, looks at the main indices

WILL EQUITIES BUCK ECONOMIC TRENDS IN 2008?

HAVE EUROPE’S REITS TOUCHED THE HEIGHTS? ......................................Page 19 Mark Faithfull asks whether European REITs have yet to come into their own?

....................................................................................Page 24 Andrew Cavenagh explains why covered bonds are the best way to fund mortgages.

THE LURE OF FOREIGN REITS

DEBT REPORT

THE RESILIENCE OF THE COVERED BOND ..................................Page 27

REGIONAL REVIEW

........................................Page 33 Kuwait’s banks now look overseas for new growth: where do they see opportunity?

STOCK EXCHANGE REPORT

KUWAITI BANKS’ DASH FOR GROWTH

INVESTORS DIG DEEP FOR BOVESPA ..............................................Page 36 John Rumsey reports on Bovespa’s explosive IPO and what it signifies

BERMUDA BANKS ON RECOGNITION ............................................Page 40 It’s a time of promise and change for the Bermuda Stock Exchange.

BLAST OFF OR MELT DOWN FOR METALS? ....................................Page 80

COMMODITIES

INDEX REVIEW 2

Dave Simons reviews the effects of a volatile market in metals

REACHING FOR THE STARS BY PLUMBING THE DEPTHS ....Page 83 Simon Watkins reports on a future trend

Securities Lending Market Overview ........................................................................Page 86 Market Reports by FTSE Research ..............................................................................Page 88 Index Calendar ..............................................................................................................Page 96

JANUARY/FEBRUARY 2008 • FTSE GLOBAL MARKETS

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TRANSITION MANAGEMENT. BE PREPARED. WE ARE. At BlackRock Merrill Lynch Transition Management, we bring together the world-class asset management capabilities of BlackRock with the direct market access and global execution infrastructure of Merrill Lynch, one of the world’s largest broker-dealers. It’s a powerful combination.

Because we constantly share our local knowledge and global experience, we’re better prepared to tailor innovative transition solutions to our clients’ changing needs.

Put our sharp minds, proven track record and transition insight to work for you.

Visit blackrock.com or call: London: +44 (0)20 7743 2704 New York: +1 212 449 8627 Melbourne: +61 3 9657 3213

Issued by BlackRock Investment Management (UK) Limited (authorised and regulated by the Financial Services Authority). Registered office: 33 King William Street, London EC4R 9AS. Registered in England No. 2020394. Assets under Management as at 30 June 2007. Tel: 020 7743 3000. For your protection, telephone calls are usually recorded. Past performance is not a guide to future performance. The value of investments and the income from them can fall as well as rise and is not guaranteed. You may not get back the amount originally invested. BlackRock is a trading name of BlackRock Investment Management (UK) Limited. The Merrill Lynch name and logo are trade marks of, and are used under licence from, Merrill Lynch & Co., Inc.

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Contents FEATURES THE EMERGING MARKETS PRIVATE EQUITY ROUNDTABLE ..Page 43

“If you have a medium to long term point of view, and you can withstand certain levels of volatility relative to more developed markets, these are in our opinion some of the most attractive risk reward ratios you can obtain globally,” notes Andres Rubio, head of Morgan Stanley Private Investment EMEA. With variable returns in developed markets, private equity investments in emerging markets has never looked so good. However there are risks a plenty to avoid while picking through the plethora of firms anxious to attract private equity investment. Participants in the roundtable explain the pitfalls and how to avoid them and secure optimum returns

A BETTER CASE FOR FUND ADMINISTRATION ................................Page 56

In spite of recent market turbulence, demand for administration services, from US mutual funds to private equity and hedge funds, remains unusually buoyant, as investment managers continue to see the benefits of outsourcing a host of operations in order to meet their objectives. For the industry’s leading fund administrators, that is a very bullish sign. Dave Simons reports from Boston

THE APPEAL OF HIGH MARGIN MENUS....................................................Page 62

Component outsourcing has moved up a level. As service providers offer an ever more generous menu of services, the choice on offer for clients has never been so good. How do clients now choose between service providers and how do service providers ensure that they capture the most profitable business lines? Lynn Strongin Dodds highlights the new relationship patterns emerging between client and securities service providers

THE EMERGING ASIAN MODEL OF FUND DISTRIBUTION..Page 66

The largely European drive towards higher levels of automation of funds processing has not yet travelled to the Far East. Faxes and paper instructions remain a feature of the market. Simon Shapland, of RBC Dexia Investor Services, explains why global asset managers need to take a fresh approach to fund sales if they want to win in Asia

COLLATERAL MANAGEMENT IN THE SPOTLIGHT ....................Page 68

The recent upheaval in financial markets has dragged collateral management out of the closet on to centre stage. As the credit markets have unravelled, the purported benefit of structured debt instruments—the dispersion of risk to those most willing to accept it— became a fatal weakness. Neil O’Hara highlights the role of collateral in keeping the credit and derivatives markets sane

US TRANSITION MANAGEMENT ROUNDTABLE ..........................Page 71

Xerox transitioned $3.6bn out of a $5bn defined contribution/401(k) plan in 2007. The firm lacked legacy in-house experience with transitions and had to come up to speed extraordinarily quickly as it only had seven months or so to complete the transition.

Xerox acknowledged it needed the expert guidance of both consultants and transition managers to complete their project successfully. A distinguished panel of transition managers, consultants and the CFO of Xerox discuss the salient trends in transition management, and how the relationship between client and providers is becoming ever closer.

4

JANUARY/FEBRUARY 2008 • FTSE GLOBAL MARKETS

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It’s all about results.

To learn more about how we can help you with your next asset restructuring please contact:

Mellon Transition Management Services (MTMS)

David Hanlon US East Coast Sales Boston, MA – (617) 382-1048

assists clients in controlling risks and protecting returns during transitions and provides valuable oversight throughout the transition process, from pre-trade planning to post-trade analysis. MTMS combines deep expertise in transition trading and derivatives with an extensive global network—delivering

Patrick Hughes, CFA US West Coast Sales San Francisco, CA – (415) 975-2331 Jamie Cashman, CFA US Consultant Relations Philadelphia, PA – (215) 553-4436

customized solutions to meet client needs and flexible strategies to respond to changing market environments.

http://www.mellon.com/transitionmanagementservices

John Egar Canadian Sales Toronto – (416) 643-5137

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Market Leader THE DEEPENING OF THE LDI MARKET

WHY LDI IS A FREE LUNCH

Photograph © Simone Van Den Berg, November 2007.

A serendipitous combination of strong equity markets and rising interest rates over the past three years has boosted defined benefit pension plan asset values and cut the present value of liabilities. The moves have reversed much of the damage inflicted from 2000 to 2002, when corporate sponsors, plan trustees, regulators and beneficiaries watched in horror as typical funding ratios for defined benefit pension plans at companies in the Standard & Poor’s 500 Index plummeted from 130% to 80%. For many sponsors, the nightmare is over now that their plans have recovered fully funded status. To keep them that way, sponsors are turning to liability driven investing (LDI). Neil O’Hara reports.

ROMPTED BY A desire never to repeat the bear market experience—and a not-sogentle push from regulators—plan sponsors have started to move the goalposts. In the traditional model, sponsors used an asset-liability study to determine the optimum allocation between equities and fixed income.

Then they devoted all their attention to finding managers who could beat the benchmarks for the chosen asset classes. In effect, sponsors assumed

P

6

that if they maximised the return on gross assets, the liabilities would take care of themselves, at least for the three year interval between successive asset-liability studies.

The collapse in funding ratios revealed a logical flaw in this model. If a plan’s purpose is to pay pensions, the critical measure is not gross assets but rather the surplus or deficit of assets relative to liabilities, i.e. its net asset value. Viewed in that light, the traditional allocation of 60% to 70%

equities and 40% to 30% fixed income incorporates a monumental mismatch in duration between assets and liabilities as well as a leveraged bet on the riskiest asset class: namely equities.

LDI tries to correct that imbalance.

In its simplest form, it involves little more than extending the duration of the fixed income portfolio, often by switching benchmarks from the Lehman Aggregate Index (duration 4.5 years) to the Lehman Long Government Credit Index (11 years).

While still less than the average US plan duration of 12 years, it is a lot closer; and if the yield curve is upwardsloping the switch boosts the return on assets, too. “It is the proverbial free lunch,” says James Moore, product manager for long duration and pension products at Pacific Investment Management Company (PIMCO) in Newport Beach, California, “You are not sacrificing anything on expected return and you reduce your tracking error to liabilities.”

JANUARY/FEBRUARY 2008 • FTSE GLOBAL MARKETS

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Market Leader THE DEEPENING OF THE LDI MARKET

Netherlands and now the No wonder it is a popular United States, legislators and move. Moore says a fully regulators have created funded 12-year duration plan incentives for sponsors to can cut tracking error from focus on their plans’ funding about 14% to 12.5% just by status. The Pension Protection pushing out duration on the Act (PPA), which Congress existing fixed income enacted in 2006, forces portfolio. He estimates that sponsors to address funding among plans that have deficits faster and eliminates embraced LDI more than most contribution holidays 70% have taken this step, for over-funded plans. which he calls LDI-light.

Meanwhile, the Financial After all, a duration match on Accounting Standards Board 30% of assets leaves a gaping (FASB) issued FAS 158, which mismatch on the other 70%. already requires corporate The next step in a sponsors to show the pension comprehensive LDI solution plan surplus or deficit on their adds an interest rate swap balance sheet and will oblige overlay, which extends them to run the dollar duration further to provide a amount of changes in funding dollar match for the whole status through the income plan. That does not eliminate statement from 2012. all investment risk, but it The new rules have confines tracking error Dan Tremblay, an institutional portfolio manager at Boston, dragged pension plan against liabilities to the risk Massachusetts-based Pyramis Global Advisors, a division of funding ratios from the on the equity portfolio.

Fidelity Investments, noticed a shift in the tenor of client relative obscurity of an Suppose market volatility is meetings away from education toward identifying specific assistant treasurer’s office 15%, a plan with 70% in objectives and making plans to implement LDI. Pyramis expects straight to the CFO’s desk. equities will still have a 10.5% a majority of US plan sponsors to take a hard look at LDI in the Senior executives are paying tracking error. The final stage next year or two and that most will at least extend duration in attention to the pension in LDI tries to pare that risk their fixed income portfolio. Photograph kindly supplied by surplus or deficit as never through diversification into Pyramis Global Advisors, November 2007. before, according to Lee commodities, real estate, hedge funds and other alternative says Moore. It’s a cash management Freitag, product manager for LDI at asset classes that deliver returns challenge already familiar to plans Northern Trust in Chicago. “Whether uncorrelated to equities. Some that use other leveraged overlays like or not plan sponsors adopt an LDI strategy, they will be measured in a sponsors prepared to accept a lower currency swaps or portable alpha.

How far a particular plan will go framework that looks at asset risk and overall expected rate of return increase the allocation to fixed income as well. toward LDI often depends on the return relative to liabilities,”he says.

In a 2006 survey, Northern Trust Moore notes the interest rate attitude of the people who manage it. overlay adds leverage to the portfolio, Moore estimates only 10% to 15% of found that only 5% of US pension so a plan’s gross asset value will be LDI adopters have implemented a plans had implemented an LDI more volatile even though it will comprehensive solution, and in those solution; another 9% were planning better track liabilities. Managers cases, the key decision makers often to do so. Freitag says many sponsors therefore must be prepared for margin have a background in enterprise risk have not yet absorbed the full calls by the swap counterparty. “If management. “They are trying to implications of the PPA and although rates go up you can’t monetise the tackle risk in a holistic manner,” he they know more about LDI than they gain as your liabilities go down. You says,“They think like risk managers as did a year ago, they are still trying to figure out whether it makes sense for need to have liquidity in your asset opposed to asset allocators.”

In the United Kingdom, the their particular plan. pool to meet mark to market calls,”

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Talk is beginning to turn to action, surplus, but they are still on the hook if they have a three to five year horizon however. This past summer, Dan the funding ratio deteriorates.The risk is and an inappropriate asset mix they Tremblay, an institutional portfolio particularly skewed for plans in a“hard could find themselves significantly manager at Boston, Massachusetts- freeze” (closed even to existing under-funded.”

Sponsors do not always realise how based Pyramis Global Advisors, a participants) where no further benefits division of Fidelity Investments, noticed will accrue and the liabilities are quite much risk is lurking in their pension a shift in the tenor of client meetings predictable. “As these plans approach plan, according to Chittim’s colleague away from education toward full funding, the risks of different Peter Austin, managing director of strategies become Standish Mellon’s products solution identifying specific objectives and investment making plans to implement LDI. increasingly asymmetric to the group. Austin’s team runs models that compute the probability a sponsor Pyramis expects a majority of US plan downside,”Senoski says.

It is hardly a novel idea to lock in considering LDI will have to put cash sponsors to take a hard look at LDI in the next year or two and that most will funding for a known future liability, into a plan based on different asset allocations.“We try to help at least extend duration in sponsors understand what their fixed income portfolio. they have, what they face It is not a “one size fits and the options available,” all” game, however.

Austin says. The optimum Bringing liabilities into the LDI solution sometimes analysis highlights the It is not a “one size fits all” game, involves a big transition: differences between however. Bringing liabilities into the one Standish Mellon client pension plans, so analysis highlights the differences flip-flopped from an comprehensive LDI tends between pension plans, so equity-to-fixed income to generate a bespoke comprehensive LDI tends to generate a ratio of 65:35 to 25:75. solution for each plan.

Some sponsors choose to Demographics play a part, bespoke solution for each plan. roll the dice anyway. Joe but so do the financial Demographics play a part, but so do the Moody, head of liability strength of the sponsor financial strength of the sponsor and driven investing at SSGA in and the size of the plan. the size of the plan.

London, says under-funded Companies plagued by plans are often willing to weak balance sheets, aging chase the excess return on beneficiary populations risky assets in order to and pension obligations bridge the funding gap. At that far exceed the market value of the corporate parent—the but common sense does not always the other extreme, he has one client major US auto manufacturers, for prevail. David Chittim, a senior vice that has“quite an appetite”for risk even example—embrace LDI because they president at Standish Mellon Asset though its plans are all in surplus. “Its need to avoid top-up contributions if Management, recalls that a friend’s market cap is huge in comparison to the funding ratio dips. Cash rich daughter got engaged in May 2001 the pension plan,” Moody says, “It can companies with younger beneficiaries but set a wedding date 18 months afford to take the risk.”

LDI forces sponsors to make tradeand market capitalisations that dwarf later. He asked the father whether he their pension plans—such as Big had moved money to cover the offs between risk and return. Although Pharma—can afford to take more risk. expected cost out of his company’s a wholesale transition into fixed A plan’s status also plays a part. stock into a money market fund. He income would provide the best match Michael Senoski, LDI investment hadn’t, and did not intend to, hoping between assets and liabilities, few director at Pyramis Global Advisors, that a rising stock price would defray sponsors can tolerate the lower says sponsors are reluctant to adopt LDI the expense. Instead, the stock expected return on assets such a move until plans are close to fully funded. A dropped by 50% and he had to sell implies. Sponsors therefore have to set combination of excise and income taxes twice as much stock.“A company with a budget for how much risk they will leaves US plan sponsors with little a fully funded frozen plan is in exactly take and then decide where to spend it. incentive to accumulate a significant the same position,” says Chittim, “If Moody says plans often measure risk

FTSE GLOBAL MARKETS • JANUARY/FEBRUARY 2008

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Market Leader THE DEEPENING OF THE LDI MARKET

Lee Freitag, product manager for LDI at Northern Trust in Chicago. Freitag notes that senior executives are paying attention to the pension surplus or deficit as never before, according to “Whether or not plan sponsors adopt an LDI strategy, they will be measured in a framework that looks at asset risk and return relative to liabilities,” he says. In a 2006 survey, Northern Trust found that only 5% of US pension plans had implemented an LDI solution; another 9% were planning to do so. Freitag says many sponsors have not yet absorbed the full implications of the PPA and although they know more about LDI than they did a year ago, they are still trying to figure out whether it makes sense for their particular plan. Photograph kindly supplied

by Northern Trust, November 2007.

through DV01, the dollar value by which a plan’s liabilities change for a one basis point move in interest rates.

DV01 is also used to price derivatives and swaps through which plans can transfer that risk to third parties.

Another measure looks at the expected tracking error against liabilities, which plans try to minimise without impairing returns. As more plans approach fully funded status, Moody expects to see increasing interest in LDI. “Sponsors would like to control that tracking error risk,”he says.

How well does LDI work in practice?

Nathan Dudley, head of LDI at

10

Tacoma, Washington-based Russell Investment Group, says anecdotal evidence indicates that plans using LDI came through the recent dislocation in the credit markets relatively unscathed.

He notes that LDI fixed income portfolios do not include mortgage backed securities (MBS) or asset backed securities (ABS), the worst affected sectors, because the durations are too short. In addition, although a flight to quality drove interest rates on US treasuries lower, corporate credit spreads blew out so interest rates for AA credits—used to discount corporate pension liabilities—were little changed.

Plans that have not adopted LDI benefited from strong equity markets, however, and their fixed income benchmark, the Lehman Aggregate Index, has outperformed the Lehman Long Government Credit Index that LDI plans use in 2007 so far.“Those who did not shift their portfolios to be more in line with the liabilities are not feeling the pain at this stage,”Dudley says.

The turmoil may have hurt a few plans, however. Alan Brown, chief investment officer at money manager Schroders plc in London, says sponsors following LDI often allocate part of their risk budget to boost returns on the cash collateral that supports the interest rate swap portfolio. Instead of investing in LIBOR-matching strategies, they place the cash in short term bond funds or similar vehicles designed to deliver a margin over LIBOR. In reaching for yield, some of these had significant exposure to mortgage backed securities whose value collapsed in July and August.

Notwithstanding dramatic short term volatility, Brown notes that August, as a whole, was a non-event for equities.“If you had been away for the month you would have wondered what people were talking about,” he says. Schroders

David Chittim, a senior vice president at Standish Mellon Asset Management, recalls that a friend’s daughter was engaged in May 2001 but set a wedding date 18 months later.

He asked the father whether he had moved money to cover the expected cost out of his company’s stock into a money market fund.

He hadn’t, and did not intend to, hoping that a rising stock price would defray the expense.

Instead, the stock dropped by 50% and he had to sell twice as much stock.“A company with a fully funded frozen plan is in exactly the same position,” says Chittim,“If they have a three to five year horizon and an inappropriate asset mix they could find themselves significantly under-funded.”

Photograph kindly supplied by Standish Mellon Asset Management, November 2007.

adopted LDI for its own pension plan three years ago but the summer’s events have not changed its target asset allocation. When it made the switch, Brown says the firm was able to cut its value at risk in the pension plan by one third, or £25m, without impairing the expected return on assets.“At the time it represented 10% of pre-tax profits,” he says,“It was huge.”

With potential savings like that up for grabs, unfunded pension liabilities showing up on the face of financial statements and plans close to fully funded, CFOs may find LDI hard to resist.

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Photograph supplied by istockphoto.com, December 2007.

Only three years ago, exchange traded funds (ETFs) were the new kids on the block. ETFs are index-based funds that trade on exchanges like stocks and which offer investors exposure to a sector or market without the holder having to own the underlying asset. Nowadays investors are increasingly spoilt for choice as the broadening array of ETFs brings the investment vehicle firmly into the mainstream. ETFs are also moving into the arena of Islamic financing and branching out into even more specialised investment areas. Moreover, ETF producers are expanding their reach, listing rafts of new specialist ETFs in new markets. Here’s a quick roundup of some of the latest offerings.

ARCLAYS GLOBAL INVESTORS (BGI) has launched the UK’s first Shari’acompliant exchange-traded funds (ETFs) has established a specialist panel of Islamic scholars to supervise the evolution and development of further Islamic ETFs. Shari’a law forbids Muslims receiving interest payments and from investing in companies involved in the production or sale of pork, alcohol, tobacco, pornography, gambling and nonIslamically structured finance or life insurance. Barclays Global Investors (BGI) says the panel has issued a

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‘fatwah’, or edict, on the three new ETFs, which will track MSCI indices of Shari’a-compliant companies. These are the iShares MSCI World Islamic, which consists of 793 stocks; the iShares MSCI Emerging Markets Islamic, tracking an index of 306 stocks; and the iShares MSCI USA Islamic, with 276 stocks.

The panel, which comprises Islamic scholars Dr Mohammed Elgari, Sheikh Nizam Yacuby and Dr Abu Ghuddah, will certify that products are Shari’a-compliant, provide advice on fund operations and investment methods, and carry

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ETFS BACK IN THE LIMELIGHT

SHARI’A COMPLIANT ETFS LEADS NEW PRODUCT DIVERSITY

out overall supervision of funds’ compliance with Shari’a principles.

“This allows Barclays to operate more efficiently and more proactively in the Islamic finance space at a time when Islamic investors are increasingly moving assets from nonShari’a to Shari’a investments,” said BGI Europe vice-chairman Lindsay Tomlinson.

“Islamic finance represents a very big opportunity for the London market, with a growth rate of around 10% to 15% and a market size of £250bn ($505m).”

The globalisation of the ETF market is also growing apace, with new markets getting in on the act through 2008. The Taiwan Stock Exchange Corporation (TSEC) is to develop exchange-traded funds (ETFs) with the Abu Dhabi Securities Market (ADSM), with the ETFs traded on both exchanges. The two exchanges signed a memorandum of cooperation in mid December to strengthen ties and work together in developing new investible products that will be listed on both exchanges. Dr Rong-I Wu, chairman of TSEC, told a press conference announcing the venture in

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In the Markets ETFS BACK IN THE LIMELIGHT

Dubai: “We agreed to study the ETF product for dual listing, especially for Islamic funds.” This is the first memorandum of cooperation that TSEC has signed with a Middle East exchange; although it reportedly has also held talks with Dubai International Financial Exchange (DIFX) and Dr Rong-I says TSEC has other agreements in the pipeline. Dr Rong-I explains that the jointly developed ETFs will be based on listed stocks either from the ADSM, the Taiwan Stock Exchange, or a mixture of stocks from the two, with the first of the ETFs being launched in the first quarter of this year. The first ETFs to be launched will likely be based on either stocks of technology companies or Shari’a compliant stocks. However, Dr Rong-I acknowledged that the Taiwanese market was new to Islamic finance and that it may take some time to develop and understanding and appetite for Shari’a compliant investible instruments in the country.

ADSM has repeatedly stated its intention to broaden the range of securities available on the exchange and in particular its desire to develop a framework for the trading of ETFs. The agreement between the two exchanges also opens the possibility of dual listing of companies in Taiwan and Abu Dhabi, which Dr Rong-I said could happen by the middle of 2008 if the exchanges were able to resolve legal and regulatory issues.

In a separate development, Victoria Bay Asset Management announced in mid-December that it has launched a new ETF that will reflect changes in the price of light sweet crude oil. The United States 12 Month Oil Fund, LP ETF, will track changes in percentage terms of the price of light sweet crude delivered to Cushing, Oklahoma, using changes in the average of the prices of twelve crude oil futures contracts—namely the lead month

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and the following eleven months, with each month receiving equal weight. Oil price ETFs are not new and Victoria Bay’s ETF will join an array that includes the Claymore MACROshares Oil Up Tradeable ETF, PowerShares DB Oil Fund ETF and the United States Oil Fund ETF. “Having the portfolio consist of a number of contracts in the same commodity, but spread out across a year, is expected to produce different results for investors than if all the contracts were in the same month,” John Hyland, the fund’s director said.

“This new approach would be impacted differently by the prices of the futures market and the effect of contango and backwardation.

Back now to BGI, which continues to expand the reach of its iShares ETFs. Already listed in ten countries, the fund manufacturer has listed eight of its iShares ETFs on the Australian Securities Exchange (ASX). The first tranche of iShares began trading on the ASX last week and further releases are expected in the year ahead. The eight existing iShares are cross-listed from the New York Stock Exchange and consist of A$125bn in total assets under management. In a formal release, announcing the move BGI Australia chief executive officer, Morry Waked noted that, “The listing of international iShares on the ASX will offer Australian institutional intermediary and individual investors a new, simple and cost-effective way to obtain immediate, diversified exposure to the world’s investment markets.” with just one trade’, he said. Last financial year there were 20,842 ETF trade on the ASX valued at A$1.2bn.

Meanwhile PowerShares has reportedly registered 31 new funds with the US Securities and Exchange Commission (SEC), including a long list of semi-active sector funds. Semiactive index investors will be able to

select among many industries for the first time. Some of the more intriguing new funds will include Buyback Achievers Portfolio, Autonomic Allocation Research Affiliates Portfolio, Cleantech Portfolio and India Tiger Portfolio. Buyback Achievers will target firms with consistent repurchase behaviour.

Firms with lots of cash on hand often buy back their own stock if management feels their stock is underpriced. Buybacks are untaxed and therefore more efficient than distributing cash through dividends, which are taxed at capital gains rates.

This is a first for ETFs. Lyxor Asset Management (Lyxor), Société Générale’s wholly-owned subsidiary has also announced the launch of four new emerging market ETFs: The Lyxor ETF Russia (based on the Down Jones Rusindex Titans 10 index, the first Russian ETF covering this market to be listed on the London Stock Exchange; the Lyxor ETF Brazil, the Lyxor ETF MSCI AC Asia Pacific ex-Japan, which is the first ETF covering all of Asia Pacific ex-Japan (including Australia and New Zealand) to be listed on the LSE and the Lyxor ETF China Enterprise. These ETFs are designed to provide investors with instant individual exposure to Brazilian, Russian, All Countries Asia Pacific (ex-Japan) and Chinese markets through one single share traded on the LSE, with Lyxor claiming that the ETFs have extremely competitive total expense ratios of 0.65%. The new ETFs follow Lyxor’s launch in November of the Lyxor ETF India and the Lyxor ETF South Africa, based on the FTSE JSE TOP 40. Lyxor already has a range of ETFs on the London Stock Exchange, including the Lyxor ETF FTSE All-Share, Lyxor ETF FTSE100 and Lyxor ETF FTSE250, which launched on the exchange back in May 2007.

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In the Markets TACKLING THE CREDIT MARKET LIQUIDITY DROUGHT

The Fed easing that wasn’t Photograph © Irockha; supplied by Dreamstime.com, November 2007.

It is likely that there will be no end to the term liquidity drought until market participants have a better grasp on the ultimate delinquency rate for sub prime mortgages originated in 2006 and the first half of 2007. Very little favourable data will be available much before the second quarter of 2008, think credit market watchers. At that point, bid-offer spreads will narrow and the market will begin to clear. Until then, potential buyers must assume the worst while sellers—such as special investment vehicles (SIVs) and conduits—equally cling to a more optimistic outcome. It is a standoff, writes Neil O’Hara, and while it lasts, banks will face a persistent liquidity threat.

HEN THE FEDERAL Reserve Board (Fed) cut its target overnight interest rate in September the equity markets soared.

It is the typical reaction to a rate cut.

Investors believe easier credit will stimulate the economy and propel corporate profits higher. Under normal circumstances, that is exactly what happens. However, back in September,

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the credit markets in the United States were anything but normal. After the credit crunch hit in early August, threemonth London Interbank Offer Rate (LIBOR) settled at a spread of at least 50 basis points (bps) over the Fed Funds rate, up from 10bps.

With so much credit priced off LIBOR—business loans, sub prime mortgages and interest rate swaps, for

example—the private sector interbank market effectively imposed the equivalent of a 40bps hike in Fed Funds. The Fed’s first 50bps cut did little more than offset that premium.

Why did the interbank lending market suddenly seize up? Investors and banks had known for months that US sub prime mortgages were in trouble, after all. HSBC reported in late 2006 that delinquencies on its sub prime mortgage book were coming in higher than expected. Sub prime mortgage originators started going belly-up left and right, including the biggest of all, New Century Financial.

However, the banks did not flinch at all, even with these signals writ large.

Moreover, they did not panic when losses in sub prime mortgage backed securities (MBS) caused UBS to pull the plug on in-house hedge fund manager Dillon Read Asset Management and two hedge funds run by Bear Stearns collapsed, either. Nor when several other hedge funds around the world imploded from bad bets in US MBS and collateralised debt obligations (CDOs): Caliber Investments in London, Bostonbased Sowood Capital and Basis Capital in Sydney, Australia, among them.

In fact, panic did not set in until distressed hedge funds and proprietary trading desks tried to offload their MBS and CDO portfolios. The proceeds from whatever they could sell came in far lower than the values at which the securities were carried on their books while the remainder attracted no bids at all. According to John Silvia, chief economist at Wachovia Corp. in Charlotte, North Carolina, BNP Paribas delivered the coup de grace on August 9th 2007 when the bank suspended redemptions on three funds that owned structured debt because it was “impossible to value certain assets fairly regardless of their quality or credit rating.”

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Banks reacted as if BNP Paribas had eaten forbidden fruit in the Garden of Eden. They saw a competitor was naked—and immediately realised everyone else was, too.“If BNP Paribas could not price certain assets it meant that other people could not mark to market,”says Silvia,“They did not have the liquidity they thought they had.”

For years, financial engineers explained to anyone who would listen that structured debt instruments turned the credit markets into a financial Eden. These alchemists took credit risk once concentrated at banks and dispersed it to whichever investors were most willing to accept it. The engineers neglected to check whether the investors were equipped to handle the risk, however. Worse still, nobody had the slightest idea what these exotic securities were worth. A typical $1.5bn residential MBS deal might have 40 different tranches, some of which were sold to just one or two investors. Market participants who needed to price instruments that never traded had to rely on computer models designed by the same engineers.

August revealed that this purported Eden was infested with serpents. The engineers had dispersed the risk but it did not go away—and nobody had a clue where it ended up. Banks began to wonder whether counterparties would be able to meet their obligations on time. Then a dirty little secret emerged: conduits and structured investment vehicles (SIVs) set up by the banks were big buyers of AAA- and AA-rated MBS, including those backed by sub prime mortgages.

Through sleight of hand permitted by porous accounting conventions, these entities existed off the banks’ balance sheets and outside regulators’ purview. In this financial limbo, SIVs funnelled profits to the banks from the oldest game in town: financing long term assets with short term debt.

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“We have seen this before in the savings and loan crisis,” says Scott Anderson, vice president and senior economist at Wells Fargo & Company in Los Angeles, California, “It is a mismatch between asset and liability maturities. This time it just seems less transparent because you do not know who is holding what.” He says many banks—especially those in Europe— that gobbled up sub prime MBS did not understand what they were buying, either.

To finance their operations, conduits and SIVs sold asset backed commercial paper (ABCP) supported by cash flow from their securities portfolios. Like corporations who sell commercial paper, SIVs and other ABCP issuers had backup lines of credit available in case investors refuse to buy new paper when the old matures. After fears about asset quality in SIVs surfaced in August, the ABCP market closed to new issuance and has since shrunk by more than $400bn.

Most of the questionable assets are still on the SIVs’ books, however.“The risk has crept back on to bank balance sheets through the back door,” says Anderson,“Banks are seeing a run on their credit lines, which is causing them to clamp down on lending.”

Claims on bank liquidity do not stop at ABCP issuers, either. The collateralised loan obligation (CLO) market shut down in July, leaving banks on the hook for about $300bn in private equity financing commitments.

Leveraged loans that banks intended to repackage and sell languished on their balance sheets until the CLO market reopened in September, but even then, banks had to dump loans at a discount as investors demanded more favourable terms. “The banks have had exceptional funding needs.

Worse still is their fear of unknown funding needs in the future,” says Tim Bond, managing director and head of

FTSE GLOBAL MARKETS • JANUARY/FEBRUARY 2008

According to John Silvia, chief economist at Wachovia Corp. in Charlotte, North Carolina, BNP Paribas delivered the coup de grace on August 9th 2007 when the bank suspended redemptions on three funds that owned structured debt because it was “impossible to value certain assets fairly regardless of their quality or credit rating.”

Banks reacted as if BNP Paribas had eaten forbidden fruit in the Garden of Eden. They saw a competitor was naked—and immediately realised everyone else was, too.

“If BNP Paribas could not price certain assets it meant that other people could not mark to market,” says Silvia,“They did not have the liquidity they thought they had.” Photograph kindly supplied by the Wachovia Corporation, November 2007.

global asset allocation strategy at Barclays Capital in London, “It completely froze up the money markets. They want to keep all the liquidity they have.”

Banks are in no mood to supply funds to the interbank market, although Bond says most banks are net borrowers from the money markets anyway. Central banks, corporate

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In the Markets TACKLING THE CREDIT MARKET LIQUIDITY DROUGHT

Scott Anderson, vice president and senior economist at Wells Fargo & Company in Los Angeles, California,“We have seen this before in the savings and loan crisis. It is a mismatch between asset and liability maturities. This time it just seems less transparent because you do not know who is holding what.” He says many banks— especially those in Europe—that gobbled up sub prime MBS did not understand what they were buying, either. Photograph kindly supplied by Wells Fargo & Company, November 2007.

treasurers and money market funds usually provide liquidity, but with so much uncertainty, nobody wants to take counterparty risk for as long as three months. Commercial paper issuers were able to shorten average maturities from 30 days or more to less than a week but borrowers shunned 3month LIBOR and forced the price up.

“It is not a shortage of liquidity per se,” says Bond,“It is a shortage of liquidity of the right maturity.”

Bond foresees no end to the term liquidity drought until market participants have a better grasp on the ultimate delinquency rate for sub prime mortgages originated in 2006 and the first half of 2007. He does not expect good data will be available before the second quarter of 2008. At that point, bid-offer spreads will

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narrow and the market will begin to clear, but meanwhile potential buyers assume the worst while sellers—SIVs and conduits—cling to a more optimistic outcome. “It is a standoff,” Bond says, “Until the fate of the SIVs and conduits is sorted out the banks will have a persistent liquidity threat.”

The workout will take some time. At the peak, UBS estimates that SIVs financed about $100bn through ABCP and another $300bn through medium term notes with an average maturity of 18 months. SIV assets have dropped to about $320bn, but the banks have little choice but to refinance the portfolios as the medium term notes fall due. The ABCP market will not be a viable option for most SIVs even if investors are willing to support the proposed MasterLiquidity Enhancement Conduit—and investors who will not lend to SIVs for 30 days certainly will not roll over 18month notes. William O’Donnell, rates strategist at UBS, points out that onemonth ABCP rates have been even stickier than LIBOR; they did not fall below July’s level until mid-October despite the Fed’s 50bps cut.

The LIBOR premium over Fed Funds might have stayed higher, too, had it not been for the Federal Home Loan Banks (FHLB). Unencumbered by portfolio caps imposed on Fannie Mae and Freddie Mac, UBS estimates that FHLB advances to member banks soared by up to $163bn during August and September.

Members pledged mortgage collateral to secure advances for various periods from short term all the way out to 10 years at rates generally cheaper than three-month LIBOR.“The lender of last resort proved to be not the Fed through the discount window but the FHLB,”O’Donnell says.

UBS expects tight conditions in the interbank market to persist into 2008.

Overnight index swap (OIS) rates indicate the spread between 3-month LIBOR and Fed Funds will narrow to

Tim Bond, managing director and head of global asset allocation strategy at Barclays Capital in London,“It completely froze up the money markets. They want to keep all the liquidity they have.” Banks are in no mood to supply funds to the interbank market; although Bond says most banks are net borrowers from the money markets anyway.

Central banks, corporate treasurers and money market funds usually provide liquidity, but with so much uncertainty, nobody wants to take counterparty risk for as long as three months. Commercial paper issuers were able to shorten average maturities from 30 days or more to less than a week but borrowers shunned 3-month LIBOR and forced the price up.“It is not a shortage of liquidity per se,” says Bond,“It is a shortage of liquidity of the right maturity.”

Photograph kindly supplied by Barclays Capital, November 2007.

15bps to 20bps by June but then stabilise. The market does not anticipate the risk premium on 3month LIBOR will return to 10bps for the near future. Banks have raised their lending standards too, so even though the Fed cut its target rate another 25bps on October 31 credit remains tight for many borrowers.

O’Donnell says the Fed has more to do just to get back to square one, let alone be a stimulant. It appears to be a rare case: a Fed easing that wasn’t.

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Index Review ECONOMIC WEAKENING ON THE CARDS

WHY EQUITIES MIGHT BUCK THE ECONOMIC TREND One can hardly claim that UK markets have been uninteresting over the last few months and since my last missive, volatility has been quite impressive while at the same time (ultimately) rather frightening. Indeed, it seems fear, rather than greed, is driving prices now. Investors remain on tenterhooks for the next piece of bad news that may send prices reeling once again. Sliding on the old ‘Tin Hat’ or hunkering down to await the end of the barrage has seldom seemed such a good piece of advice. The FTSE100 Index has seemed violent enough with trading ranges on a daily basis generally exceeding 100 points but the component parts have been even more extraordinary with banking, builders, retailers and builders suppliers all plumbing [sic] ever lower depths. At the same time mining, tobacco, and financial brokers have all fared rather well. So what’s to come? Simon Denham, managing director, of spread betting firm Capital Spreads argues that a weakening economy may not actually result in weaker equity prices in the UK through 2008.

UB-PRIME WORRIES aside, a key interest rate cuts and liquidity be a base line below which even reason for the weakness of the injections. Unfortunately, just as softer Chinese manufacturers could not go banking sector is that banks are interest rates would be helpful the old and regrettably, this level seems to exposed to ongoing fears of domestic worn spectre of inflation has made an have been reached. Moreover, the rising aspirations of the various Far economic woes and to falling revenues untimely reappearance.

For some years now, Asia’s Eastern domestic populations are now from sales of new financial engineering products. When you have been in the manufacturing powerhouses have kept compounding the issue. This double markets as long as I have, you will spot a lid on prices as they continually drive attack on production capacity and immediately available raw the never ending cycle that materials is causing a this encapsulates. Every six producer price index (PPI) or seven years a new For some years now, Asia’s squeeze. These factors (as ‘wonder drug’ is discovered manufacturing powerhouses have kept a well, obviously, as a host of which promises above others) are behind the LIBOR returns for ‘virtually lid on prices as they continually drive underlying swell of rising no risk’ and triple ‘A’ rated down production costs. The trend has price pressure. security. The problem is that forced marched the relocation of a huge In the UK market the normal 99% standard swathe of finished goods production watchers like to quibble deviation risk measures from the West to the East. over whether the Bank of always seem to miss out England is keeping something fundamental and inflation below 2% and the 1% failure probability consequently occurs rather more down production costs. The trend has whether the governor will have to forced marched the relocation of a write his fabled ‘letter to the frequently than forecast.

What you can be sure of, in this huge swathe of finished goods Chancellor’ about rising interest rates. game of musical chairs, is that when production from the West to the East. Although the UK has grown to the music finally stops Goldman In some markets, such as the UK, it has interest rates some 3% to 4% above Sachs will probably be the only ones also created a massive spending boom inflation, this is not the norm. Most finding a seat. In times past, this type as previously expensive consumer nations manage to get by with interest of financial crisis would warrant goods have come within the range of rates just one percent or so higher dramatic intervention in the guise of all. However, there was always going to than the CPI.

S

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In China meanwhile inflation is running at some 6.5%, growth at around 10% and interest rates in the region of the 4.5% to 5% level. They seem to be taking the not unreasonable view that you should be trying to put your money to work rather than beating the cost of living increase by simply leaving it sitting in your bank account and accruing the interest. The Bank of England has not managed, in 10 long years, to narrow the UK/Europe spread on borrowing rates one jot and the UK is now competing with countries such as Italy and Spain (historically suffering much higher borrowing rates) at a disadvantage. No wonder so much of the FTSE quoted stock revenue now comes from abroad.

Oddly enough, as the credit woes increase the flight to quality has driven

UK gilts and US Treasury bond prices to [seemingly] ridiculous levels with two year US yields now around 3% (current Fed Funds are at 4.5%). This would appear to indicate that the market expects rates around 3.25% this time next year falling to well below 3% in 2009. For many this seems rather an extreme view. Especially given the overall impression that the Fed is concerned about price pressure and not growth; and especially as the recent gross domestic product (GDP) numbers for the third quarter of 2007 were the best for some time (at almost 1% above initial Fed estimates). However, looking forward (rather than back) it is easy to see what is spooking the markets. Evidence over recent months is showing that cracks are beginning to open in the US and UK economies. Housing continues

to look weak, employment data would suggest a slackening in available jobs and retail sales are struggling to keep their head above water.

Fortunately, as a huge percentage of UK corporate earnings come from abroad so a slowdown in the domestic economy may not mean falling equity prices. In fact, it could easily be the trigger for a renewed rally. A slowing economy would mean lower interest rates and a potentially weaker currency both of which would enhance the attraction of stocks— especially those currently suffering under heavy debt levels and/or with high foreign earnings.

Which scenario will win out? The stagflation one or the lower interest rate/sterling one? As ever ladies and gentlemen place your bets.

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

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Real Estate EUROPEAN REITS: SPOTLIGHT ON PERFORMANCE

Joaquim Ribeiro, finance director of Sonae Sierra, the influential Portuguese-based shopping centre developer, and chairman of the EU REIT Coalition, insists: “Creating an EU REIT would turn [sic] the current fragmented EU market for property companies into the largest and likely most efficient property market in the world. Investors, small and large, private and institutional, would greatly benefit from that.” Photograph supplied by istockphotos.com, November 2007.

Will Europe’s REITs reach the heights in 2008?

At the start of 2007, there was a buzz of excitement around Europe. UK Real Estate Investment Trust (REIT) bosses, for one, were toasting the launch of their new funds. In Germany, real estate specialists were anxious to join the fray and several other European countries were preparing to ramp up their own REIT operations. Fast forward 12 months and the mood is less buoyant. The reasons are clear. Some REITs have enjoyed less than sparkling return and no wonder.

Significant shifts in asset class investment and the wideranging impact of the US sub-prime mortgage crisis have made it a tough year for the previously buoyant property sector. REITs have paid an inevitable price for market uncertainty. Even so, some analysts are saying hang tough, believing that 2008 might just be the year that Europe’s REITs take off. Mark Faithfull reports.

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HE TRUISMS THAT held fast at the start of 2007 have been given a thorough going over in the past 12 months. Back in January of 2007, European retail investments were being fought over by international funds and investors, private equity firms were trawling the continent in search of poorlyoperated property portfolios or speculative asset classes such as German multi-tenant residential properties and a lot of sensible money was pouring into a range of asset groups in the United States.

T

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Real Estate EUROPEAN REITS: SPOTLIGHT ON PERFORMANCE

The sub-prime crisis may have been markets. Throughout the 15 markets Europe is causing friction. In the most dramatic event to knock the analysed, average debt levels grew by November last year, the leaders of the ship off course but in truth, what it has about 6% to 40.29%, up from 34.24% European Landowners Organisation, highlighted is a significant shift in 12 months previously. “The US has the European Property Federation, the asset allocations across Europe. gone through an incredible run-up in RICS, The European Group of Valuers’ Nonetheless, despite the trials and REIT prices and in real estate values Associations and the Urban Land travails of 2007 (mainly in developed over the past several years,” says Institute Europe asked the European markets) the global REIT market Frankel. “At some point you figure Commission to create a European actually increased by 25%. Total investors might respond and say ‘this Union (EU) REIT to “overcome market capitalisation of publicly listed cannot go upward forever’ and trim obstacles to cross-border property REITs around the world grew to their exposure to US REITs in favour investment in the EU and enhance €515bn in the 12 months to June 30th. of foreign REITs, which have the market security and stability.”

Joaquim Ribeiro, finance director of In contrast, the US market lost almost potential for greater returns.”

Sierra, the influential Report author Ed Psaltis of Ernst & Sonae a quarter of its REITs through Po r t u g u e s e - b a s e d privatisation and mergers, shopping centre developer, according to a recent and chairman of the EU report by Ernst & Young.

REIT Coalition, insists: “Essentially, we have seen Ed Psaltis of Ernst & Young’s member “Creating an EU REIT a dramatic shift in REIT firm, Transaction Advisory Services would turn [sic] the current formation away from Group, points to the impact of recent or fragmented EU market for North America and toward pending REIT legislation in three major property companies into Asia and Europe in the last European real estate markets: the UK, the largest and likely most 12 months,” says Michael efficient property market Frankel, global director of Germany and Italy. “Moving into 2008, in the world. Investors, REIT Services for Ernst & we expect to see a much more stable small and large, private Young.“While a number of REIT market in the UK as more investors and institutional, would quite large North become educated about the sector, and greatly benefit from that.”

American REITs have been with Germany’s legislation now taking A Maastricht University taken private in the last study published in year, we have seen a effect and Italy coming on board in November 2007 outlines a tremendous outpouring of 2008, the potential exists for Euro-REITs preferred structure for an capital in Asia and Europe, to really take off,” says Psaltis.

EU REIT with no need for where REIT regimes in the tax harmonisation, as no UK and Turkey have approximation of tax rates helped the rest of the world surpass the US for the first time Young’s member firm, Transaction on shareholder dividends is required.

Advisory Services Group, points to the The study found that while 13 of the in total number of REITs.” According to the Ernst & Young, in impact of recent or pending REIT 27 EU member states have REITs, 2006 North America was home to 253 legislation in three major European whose regimes vary widely. Says Piet public REITs compared with 198 for real estate markets: the UK, Germany Eichholtz, professor of real estate the rest of the world. As of June 2007, and Italy. “Moving into 2008, we finance at Maastricht University and there were 253 global REITs, expect to see a much more stable REIT leader of the research team, adds:“The compared with 195 in North America. market in the UK as more investors very arbitrary nature of differences in However, the United States remains become educated about the sector, national REIT structures in Europe the largest single REIT market with and with Germany’s legislation now provide strong and fundamental 169 REITs. The total value of real taking effect and Italy coming on arguments for the creation of an EU estate owned by REITs globally now board in 2008, the potential exists for REIT. The EU REIT does not have to stands at €858bn, fuelled by rising Euro-REITs to really take off,” says be created from scratch. Both in the levels of debt among REITs globally, Psaltis. However, the variety of EU and outside of it, there is a lot of the result of low interest rates in many national REITs now available in experience with these regimes, and

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careful analysis of this experience provides direction towards an optimal pan-EU structure.”

Indeed, cross border purchasing now dominates the large funds and the tie up of France’s Unibail and the Dutch Rodamco property operations earlier in the year to create Europe’s largest REIT underlines the growing pan-European nature of development and investment, especially as the whole continent looks for more opportunities to its east.

“During the first half of the year, almost 70% of European shopping centre purchases were accounted for by cross-border investors,” adds Nick Axford, head of EMEA research & consulting at CBRE. “This demonstrates the ongoing desire by investors to build their European portfolios, preferably by diversifying their holdings across Europe.”

Yet despite the push for harmonisation, Europe’s largest REIT market, the UK, has had a particularly tough year. Shares in British Land have fallen by nearly half since it acquired REIT status in January, while

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Hammerson’s share price has also struggled.

Meanwhile, Land Securities, Britain’s largest property business, is preparing for a three-way split of its business. Analysts expect the move will trigger a wave of similar strategic reviews among conglomerate real estate groups.

Shares in Land Securities, which became a REIT in January 2007, have fallen by about a third over the last twelve months, leaving them at a discount of about 35% to adjusted net asset valuation. The rise in British interest rates over the past year, accompanied by instability in the credit markets, has not helped.

According to research firm IPD’s quarterly index, retail property delivered a negative return of 1.8% for the third quarter of 2007, a market sentiment British Land was on the wrong end of in October when it had to pull the sale of its shopping centre Meadowhall in Sheffield, which failed to bring in the anticipated €2 .4bn offer. Shopping centres and prime retail real estate has been on a bull run across Europe for the last

three years but, with yields compressing and consumer sentiment softening, many institutional investors have diverted funds to the prime office sector.

Even so, increasing discounts against net asset values within the biggest UK REIT portfolios have attracted interest from some of the Middle East’s globally active investors, notably Dubai-based Nakheel. It has announced its intention to buy a UK REIT and to start a REIT as it expands into property asset management.“UK REITs are trading at a 30% to 40% discount now and that is a huge opportunity,” says Kar Tung Quek, chief financial officer (CFO) of Nakheel. “There is no REIT market in Dubai yet, so we will be looking to build an international portfolio,” he adds.

Nakheel plans to start its first €470m REIT in the first or second quarter of 2008. The company will put homes from its Gardens and International City projects in Dubai into the trust, Quek motioned.

However, the trust will probably be placed in Dubai and Singapore.

Property investment returns across Europe in 2006 SECTOR

SHOPPING CENTRES

RETAIL1

OFFICE

INDUSTRIAL2

RESIDENTIAL2

COUNTRY

% return

% return

% return

% return

% return

Austria

12.2

8.4

5.2

not available

6.3

Belgium

16.4

16.4

6.5

10.6

not available 24.2

Denmark

15.1

15.4

16

not available

Finland

19.6

14.6

8.6

11.2

9.9

France

24.9

23.7

21.8

20.8

20.5

Germany

4.9

5.4

-0.9

not available

6.5

Ireland

20.5

26.8

27.6

25.4

not available not available

Italy

13

11.5

6.3

12

Netherlands

14.7

14.9

11.5

13

11.4

Norway

16.6

16.4

18.2

not available

not available

Portugal

16.6

15.9

5.7

7.7

not available

Spain

19.5

18.8

17.1

19.2

10.2

Sweden

18.1

18.5

15.4

25.4

16.9

Switzerland

7.8

7.7

5.6

not available

5.3

UK

15.6

15.2

23

17.7

not available

Source: CB Richard Ellis/IPD European Shopping Centre Digest ¹Retail including shopping centres ²IPD only publish figures for industrial and residential property in those countries where the sectors form a significant part of investment portfolios

FTSE GLOBAL MARKETS • JANUARY/FEBRUARY 2008

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In the Markets EUROPEAN REITS: SPOTLIGHT ON PERFORMANCE

COMPARATIVE TABLE OF EUROPEAN REITs REGIMES UNITED KINGDOM

Rules/COUNTRY

GERMANY

FRANCE

NETHERLANDS

LEGAL FORM

AG (stock corporation) with seat and management in Germany and obligatory listing within the EU/EEA

Any company with a share capital divided into shares.

Additional restrictions (not applying to SIIC sub of a SIIC). Listing in France and a minimum share capital of Euro15m

NV, BV (limited liability company) or FGR (mutual fund) or a comparable entity within the EU

Closed end company, listed on a “recognised” exchange.

Joint Stock Company, listed on Italian stock exchange. Company name must include Societa dl Investimento Immobiliare Quotata. MInimum share capital of Euro49m.

No investor must hold more than 10% of voting rights. At least 15% of shares must be held by investors who own less than 3% of voting rights.

No investor or affiliated group of investors may own more than 60%.

Upon election for SIIC regime 15% of the shares owned by investors with a maximum 2% interest.

Various shareholders’ restrictions apply for tax purposes. Simplified restrictions apply for listed FBI’s.

Must not be a “close” company

No investor must hold more than 51% of voting rights. At least 35% of shares must be held by investors owning not more than 1% of voting and dividend rights.

At least 75% of the assets must comprise real estate which meets the qualifying criteria and of at least 75% of gross income must come from letting such real estate assets.

Prohibition of real estate trading (=turnover of more than 50% of average real estate holdings within a 5 year period).

{French} real estate, non qualifying activities are allowed to a certain extent, however subject to standard CIT rate.

Only passive investments; project development for own portfolio within a taxable FBI subsidiary.

Must have at least 75% of its income and assets in qualifying profit rental business (PRB).

Development is permitted for investment purposes.

Owner occupied property does not county as PRB.

At least 80% of assets and income must comprise real estate.

55% of real estate value

No specific leverage restrictions, (however, regular thin capitalisation restrictions impact level of distribution obligations).

60% of fiscal book value properties; 20% for all other investments.

No restriction, but tax charge if finance cover is less than a ration of 1.25%

No specific restrictions yet (however, limitations may be introduced by regulatory provision.)

At least 90% of net annual income, 50% of capital gains included.

85%of the net rental income, 50% of capital gains and 100% of dividends from lower tier SIIC subsidiaries.

Applicable to full profit.

However, capital gains neutralised in tax free reserves.

90% of income profits of PRB (after deducting finance costs and capital allowances). No obligation to distribute capital gains.

At least 85% of income of real estate. Tax exemption for gain gain not (yet) implemented.

Full exemption from corporate income tax as well as local trade tax.

Exempt from CIT with respect to qualifying income; regular CIT treatment with respect to nonqualifying income.

Additional 20% levy on distributions to 10% or more exempt/low taxed shareholders.

Corporate income tax at a rate of 0%. Capital gains may be added to a tax free reinvestment reserve.

Qualifying income and gains of PRB (UK and indirectly held non-UK) are tax exempt. Charge on development if sold with a three year period. Residual business taxed in usual way. Tax charge in REIT if distribution made to corporate shareholder holding 10% or more.

Exempt from DIT with respect to income derived from rental or leasing activities. Regular CIT treatment with respect to capital gains.

As the G-REIT is subject to corporate income tax (although at a rate of 0%), in general, the G-REIT can make use of bilateral tax treaties.

In general, a SIIC can make use of bilateral tax treaties.

As the FBI is subject to corporate income tax (although at a rate of 0%) in general, the FBI can make use of bilateral tax treaties.

Treaties should apply in the usual way, as REIT is taxable.

Whether the treaty releive and the Parent Subsidiary Directive apply is not clear.

Dividend distributions are subject to 25% withholding tax (reduced to 15% or 20% under tax treaties.)

25% to non-resident shareholders and 0% to resident shareholders (see also extra levy above).

Dividend distributions are subject to 15% withholding tax.

Distributions from the reinvestment reserve can be made free from dividend withholding tax.

22% withholding, subject to treaty relief.

20% withholding tax on tax exempt income, can be reduced to 15% at dividends originating from residential building leases.

A credit for Corporate and business shareholders.

Until December 31st 2009, only 50% of capital gains which are realised through conversion into GREIT or a transfer of real estate to a G-REIT are taxable (exit tax privilege), subject to restrictions.

Latent capital gains are taxed at 16.5% upon election for the regime.

Same rate applies to capital gains on sales of properties by standard corporations to SIICs (holding period of 5 years). Reduced rate to sellers extended to Dec 2008.

No special favourable regime.

Charge of 2% on market value (to allow a step up in base).

Latent capital gains are taxed at a 20% rate upon election for the regime.

Same rate applies to capital gains realised by corporate shareholders contributing property to SIIQs (three years holding period).

INVESTORS’ REQUIREMENTS

ACTIVITY TEST

LEVERAGING LIMITS

DISTRIBUTION OBLIGATIONS

TAX TREATMENT FUND

TREATY APPLICATION

WITHHOLDING TAX TREATMENT

CONVERSION CHARGE REGIME

ITALY

Source: EPRA, November 2007.

22

JANUARY/FEBRUARY 2008 • FTSE GLOBAL MARKETS

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1st Annual RMA/SLD-SIFMA Conference on Latin American Securities Lending January 23-35, 2008 The Westin Colonnade Coral Gables, FL

We are excited to invite you to join us at the 1st RMA/Securities Lending Division of SIFMA Conference on Latin American Securities Lending. This collaborative effort between the two leading securities lending associations in the Americas provides a forum to promote and advance the industry in Latin America.

Topics will include a basic understanding of securities lending and global market updates. Updates on the specific markets of Mexico and Brazil will be represented.

Our panelists represent a wide range of experience and expertise in many area of the securities finance industry. x Lending in New Markets x A Beneficial Owners Perspective: Why Lend Securities x Securities Lending -Understanding the product, participants and its importance x The Evolution of Markets

Planning to Attend: For registration questions, call RMA, Kim berly Gordon (215) 446-4021 * E-Mail: kgordon@rm ahq.org or visit our W eb site at http://www.rmahq.org/RMA/SecuritiesLending

W. Tredick McIntire Conference Co-Chair President Boston Global Advisors

Conference Co-Chairs

Irving J. Klubeck Conference Co-Chair Managing Director Pershing LLC

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Real Estate US REITS: INVESTORS LOOK OVERSEAS FOR RETURNS

The lure of foreign REITs With domestic real estate funds reeling from the recent creditmarket debacle, many US investors are looking overseas, where improved regulatory conditions and the increased securitisation of real estate assets have created attractive opportunities. Dave Simons reports from Boston.

HE TIGHTENING OF the credit markets has been particularly rough on the once high-flying domestic real estate sector, which spent most of 2007 in negative territory. Despite some improvement during the third quarter, the United States’ REITs market entered the final three months down nearly 3.5%.

Analysts see the fallout from the slumping housing market continuing to affect commercial real estate for the immediate future. Meanwhile, the string of dismal reports from mortgage leaders such as government-sponsored Freddie Mac—whose third-quarter $2.03bn loss sent its stock price tumbling 30% in single day—paints a particularly bleak picture going forward.

Not surprisingly, US real estate investors have been taking their business elsewhere. Interest in overseas diversification in general has spilled over into the real estate sector, and with good reason. Funds with a wider exposure to foreign real estate assets have generally held their ground since the start of the credit debacle, and, more importantly, on a one-year basis foreign funds have gained 13.63%, compared to a loss of 2.04% for domestic funds year to date, powered by strong economic

T

24

growth and an increasingly favorable regulatory environment.

“Over the past 12 months, we have had negative returns on real estate for listed public equity in both the UK and the US,”explains Philip DeSantis, vice president and product manager of quantitative equities for Northern Trust Global Investments (NTGI). “By comparison, in countries [such as] Bulgaria, South Korea, Singapore, Malaysia, Australia and South Africa, property returns have ranged in [region of] 15% to 50%.”As investors look broader and deeper across benchmarks, regions and countries, it has been natural for them to consider global REIT opportunities, particularly as real estate evolves into its own separate asset class, says DeSantis.“If you are putting new money to work today, you would probably want an international tilt.”

The widespread securitisation of real estate assets in many foreign markets has increased accessibility, making it easier than ever to grab a piece of the global REIT action. According to Fidelity Investment’s Market Analysis, Research and Education group (MARE), demand among individual investors has prompted the passage of legislation throughout Europe and

Not surprisingly, US real estate investors have been taking their business elsewhere.

Interest in overseas diversification in general has spilled over into the real estate sector, and with good reason. Funds with a wider exposure to foreign real estate assets have generally held their ground since the start of the credit debacle, and, more importantly, on a one-year basis foreign funds have gained 13.63%, compared to a loss of 2.04% for domestic funds year to date, powered by strong economic growth and an increasingly favorable regulatory environment.

Photograph © Sean Gladwell, supplied by Dreamstime.com in November 2007.

Asia, allowing companies to convert their property interests into REITs. The subsequent expansion of the global REITs market has helped significantly boost liquidity levels. Equally, the expansion of REITs has also raised corporate-governance standards among foreign businesses— particularly in the buoyant regions of Brazil, Russia, India and China (BRIC), where real estate markets have matured at a rapid pace. Adding support to the trend is the steadily increasing number of multinational firms that have secured a presence in many of these locations.

“Both individual and institutional investors understand the benefits of diversifying across a number of regions,” says DeSantis. “With that, you now have the supply.”On a global

JANUARY/FEBRUARY 2008 • FTSE GLOBAL MARKETS

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THE FTSE I WANT TO INVEST IN SINGAPORE INDEX FTSE. It’s how the world says index.

FTSE Group, Singapore Exchange and Singapore Press Holdings have joined forces to bring you a revamped Straits Times Index (STI), part of the new family of 19 indices in the new FTSE ST Index Series which represents the Singapore market with a finer level of granularity. Because FTSE indices are independently verified by market practitioners, you can be sure they will always be in line with investors needs of investability, tradability and transparency. For more information please visit www.ftse.com/st

© 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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Real Estate US REITS: INVESTORS LOOK OVERSEAS FOR RETURNS

same experts think that the basis, REITs have grown at a next few quarters will offer a rapid pace, from less than 60 better indication as to the REITs a few decades ago to real direction of property well over 300 today, with valuations in general and the many forming within the last long-term health of the real five years alone. Today there estate market in particular. are 25 countries with REIT“There certainly could be type legislation currently on more downside as we wait the books, including Brazil, and see how far the sub China, Italy, Finland, India, prime mess spreads,” notes Phillipines, Spain and Christopher Reich, portfolio Sweden. “This will expand manager for the ING Global REITification even further, Real Estate Fund. and the listing market will In cities such as New York, continue to grow and grow,” London, Frankfurt and says DeSantis.

Tokyo, spreads on cap rates Investors looking to (the figure used to determine exploit foreign real estate values on income-producing opportunities have a number real estate, factoring in net of potential targets. The operating income and SPDR Dow Jones Wilshire property value), which once International Real Estate stood at 3% to 4% over 10ETF, launched by State Street Philip DeSantis, vice president and product manager of year Treasuries, have fallen Global Advisors late last quantitative equities for Northern Trust Global Investments dramatically during the past year, is the first-ever (NTGI).“Over the past 12 months, we have had negative returns three years, and now stand at exchange-traded fund to on real estate for listed public equity in both the UK and the or below one percent. “In cover the foreign real estate US,” he explains.“By comparison, in countries [such as] other words, cap rates are equity market. New to the Bulgaria, South Korea, Singapore, Malaysia, Australia and now in line with or less than block is a series of South Africa, property returns have ranged in the [region of] the cost of financing, which international REIT funds 15% to 50%.” As investors look broader and deeper across also underscores the impact launched by both Barclays benchmarks, regions and countries, it has been natural for them of sub prime on the broader Global Investors and to consider global REIT opportunities, particularly as real estate lending market,” says Chicago-based Northern evolves into its own separate asset class, says DeSantis.

DeSantis. In order for a Trust, all based on the FTSE Photograph kindly supplied by Northern Trust Global recovery to begin, net EPRA/NAREIT Global Real Investments, November 2007. operating income needs to Estate Index.

“Many US investors have trouble dividend yields, traditionally a major expand; valuations need to go lower— investing in the non-US real estate component of REIT returns, have or both. “By comparison, when you precipitously.

Though look at a lot of the international market due to high costs, lack of fallen liquidity and ways to access it,” notes valuations are generally more markets, you still have limited supply, Noel Archard, head of Barclay’s US attractive than their domestic and the underlying gross domestic long-term price product is very strong, particularly in iShares product development. “As counterparts, more REIT and REIT-like structures appreciation of overseas REITs is places [such as] Asia,”says DeSantis.

Ironically, while US real estate are created outside of the US, BGI certainly not a guarantee.

Obviously, all is not lost for the US investors have been pulling out of the expects more individual investors and financial advisors to consider real estate sector though domestic home market, the steadily weakening international real estate as an REIT valuations (while much dollar has prompted an influx of investment.” Not that it is a total improved) are still no bargain foreign funds to the US, as EU and cakewalk.

With demand for compared to other segments of the Asian investors scour the major international REITs on the rise, equities market, say experts. Those markets in search of property bargains.

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Debt Report

Christian Reusch, head of syndication at Hypovereinsbank (HVB) in Munich.

THE RESILIENCE OF COVERED BONDS C

OVERED BONDS—WHETHER backed by public-sector loans or mortgages—have historically ranked second only to prime sovereign issues in Europe as a safe and reliable haven for investors’ funds. While the global credit crisis shut down the markets for asset-backed securities and senior unsecured corporate debt in August, it was not until September that the contagion began to spread to covered bonds.

Spreads on covered bonds began to widen noticeably in September. Two of

THE SOLID PERFORMANCE OF COVERED BONDS

It may well turn out that the solid performance of covered bonds relative to other instruments through the credit crisis in the second half of 2007 proves a decisive factor in the take-up of the instruments outside Europe.

Several countries, including Canada, Japan and Turkey, are currently looking at legislation for covered-bonds. “This year has shown that covered bonds are the safest and most reliable source of funding mortgages for banks,” maintains Patrick Amat, chairman of the European Covered Bond Council (ECBC) and chief financial officer at French mortgage lender Credit Immobilier de France (CIF). “I think more and more states in the European Union – and beyond – are interested in this instrument.” Is that really true? Andrew Cavenagh goes in search of some answers.

the largest mortgage lenders in the United Kingdom—HBOS and Nationwide—had to price new issues they brought to market that month a good 10 basis points (bps) wider than they expected. Since then, secondary market spreads have been unusually volatile.“We saw a strong widening at the start of September, and then it calmed down again before widening out once more at the beginning of November,” observes Christian Reusch, head of syndication at Hypovereinsbank (HVB) in Munich.

FTSE GLOBAL MARKETS • JANUARY/FEBRUARY 2008

According to the indices published

by US investment bank Merrill Lynch, the spread premium over sovereign bonds (bunds) demanded by investors in German pfandbriefe—the largest and most stable category of European covered bond—rose from 23 bps to 38 bp over the six weeks leading up to November 20th 2007. This was the highest level that differential had reached for more than five years. This spread widening forced another big UK mortgage lender, Abbey National, to postpone a planned eurodenominated benchmark issue in mid-November and led the European Covered Bond Council to suspend market making in the instruments among its 8-to-8 committee of leading banks and issuers on November 21st.

The ECBC had started the 8-to-8

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Tim Skeet, head of bond origination at Merrill Lynch in London

Debt Report THE SOLID PERFORMANCE OF COVERED BONDS

committee of eight banks that arrange covered bond sales and eight representatives for issuers of the debt in September to set recommendations in deteriorating markets.

European banks agreed eagerly to suspend trading in the $2.8trn market to halt the slump that had appeared to close the region’s main source of financing for home lenders; though banks were still obliged to provide prices to investors. That perception was fueled by the suspension of some high profile deals. Abbey National, the UK lender owned by Banco Santander SA, for instance, was the third financial issuer to cancel a sale of covered bonds that week, as investors demanded that banks pay the highest interest premiums on covered bonds in five years.

The European Covered Bond Council (ECBC), a platform for covered bond market that represents almost 85% of all covered bond issuers in the EU stressed the suspension move was a short-term move. In fact, the suspension was

lifted on November 26th to restore stability.

The combination of widening spreads across the fixedincome markets as a whole and the unique market-making agreements that apply to the 8-to-8 group was having a“disproportionate impact”on the spreads of some covered bonds.

“When all the markets become illiquid, it becomes very difficult to maintain an inter-dealer market in one given product,” explains Patrick Amat, the ECBC chairman who is also chief financial officer at French mortgage lender Credit Immobilier de France (CIF).“That [the temporary suspension of inter-bank market making] was to avoid adding to the volatility in spreads.” Amat was keen to stress that the move had by no means closed down activity in the covered bond markets, as some had incorrectly assumed.

During the three trading days involved, there had continued to be a strong flow of trades between dealers and investors, and between dealers. It was only the obligation of the dealers

European covered bonds 2005-2008 Primary Market Activity

2005

2006

2007E

2008E

Spain

54.880

65.355

35.995

45.000

Germany

47.950

38.978

30.799

34.000

United Kingdom

9.000

20.500

17.250

25.000

France

7.850

19.200

36.075

35.000

Ireland

5.000

11.500

2.500

6.000

Sweden

0.000

5.250

6.000

11.000

United States

0.000

4.000

7.500

8.000

Italy

4.000

4.000

0.000

6.000

The Netherlands

2.000

3.500

5.500

8.000

Portugal

0.000

2.000

4.500

6.000

Austria

2.000

1.000

1.000

1.000

Finland

1.000

1.000

1.000

1.000

Norway

0.000

0.000

4.500

7.000

Luxembourg

0.000

0.000

0.250

1.000

Canada

0.000

0.000

2.000

6.000

Denmark

0.000

0.000

0.000

3.000

Greece

0.000

0.000

0.000

2.000

133.680

176.283

154.869

205.000

Source: ECBC, December 2007.

28

to quote specific sizes of deal (€15m) at specific spreads that had been suspended. “What I would like to underline is that it is not a crisis of the product itself, it is a crisis of bank liquidity that has an impact on dealers’ability to commit their balance sheet to inter-bank market making on any product,”he added.

It is also important to note that the widening of spreads on covered bonds has been marginal compared with the drop in value of other instruments, particularly senior unsecured corporate bonds and residential mortgage-backed securities (RMBS).

Tim Skeet, head of bond origination at Merrill Lynch in London, points out that while the covered bonds of UK issuers—which have probably suffered the worst reaction—may now be trading at 20bps over Libor, this compared with 50bps-60bps for tripleA RMBS. “Fundamentally there is still confidence in the product,” he maintained.“Compared to other asset classes, it has done incredibly well in the credit crisis,” agrees Julia Hoggett, head of capital markets at Depfa, the Dublin-based bank that issues covered bonds backed by public-sector loans.

Reusch at HVB says this relative resilience reflected the fundamental

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Debt Report THE SOLID PERFORMANCE OF COVERED BONDS

credit quality of the instruments – postpone the issue on November perceptible shift in the covered-bond which had not changed in contrast to 20th. In the same week, however, a market has been a marked investor that of some mortgage-backed German issuer managed to print a 5- preference for the instruments backed securities (which has less conservative year jumbo pfandbrief issue at 3bps by public-sector loans rather than criteria governing the collateral in over swaps.“The different parts of the mortgages. Spreads on the former their cover pools).“We have no issues market have responded in different have tightened appreciably over the in terms of credit, where the ways,”explains Skeet at Merrill Lynch. past three months.

Investors have also noticeably mortgage-backed underlying collateral or the “Anglo-Irish underlying institution is in trouble,”he products are trading unreasonably begun to favour bonds covered by legal frameworks (such as explains. Depfa’s Hoggett pfandbriefe and French meanwhile says there had obligations foncieres) nevertheless been some “One has to recognise that funding rather than the structured discernible shifts in sources other than covered bonds are instruments in which investor sentiment since either significantly more expensive or contractual commitments September; during which provide the security (as on time the covered-bond less accessible and reliable,” he says.

UK bonds right now). So market had seen the Amat at the ECBC says this was certainly what is the outlook for the launch €50bn of new evident in the way that several issuers sector over the next few issuance while activity in from various jurisdictions had decided to months? Will the recent the asset-backed and postpone issues during the recent spread trends continue and widen senior unsecured markets volatility rather than risk re-setting bond the spread differentials had virtually ground to a between the various types halt. The most obvious spreads at a higher level. “They have of bond still further and change has been proved that they are very responsible continue to inhibit issuance increasing spread covered-bond issuers,” he maintained. in some sectors of the discrimination between “Everybody needs this market, and market? Alternatively, will the different coverednobody is going to put it in danger.” such distinction erode once bond jurisdictions, after again when the wider such distinctions had financial markets recover narrowed to record levels wide, and the Spanish product is also their equilibrium? in the first half of the year.

It seems likely that the UK issuers This has hit issuers in countries suffering.”However, he says this is not where the fears about a collapse in the really surprising given that the big will find new issues a tough sell for a housing market are most pronounced investor base for covered bonds was in few more months at least. The recent —such as the US, the UK, Spain, and Germany, France and the Nordic trend for investors to prefer bonds Ireland. The most extreme example countries. It was quite natural for such with a legal rather than structured has seen spread differentials between investors to favour the domestic framework has obviously worked US covered bonds—which have not products that they understood best against them - although bankers often been helped by recent allegations of when the wider financial markets point out that the protection from bankruptcy under English commercial malpractice by one of Washington were so volatile.

He adds that (even before the credit law is every bit as strong as that of the Mutual’s outsourced mortgageappraisal firms—and German crisis hit) there have been issues legal frameworks for the instruments.

The covered-bond law that the pfandbriefe has widened to more than brewing in the background over the 40bps. The trend has obliged several past year or so that had exerted a British government is in the process of issuers to postpone deals. Allied Irish temporary influence on spread introducing to overcome such investor which will Bank’s mortgage subsidiary, for differentials, noticeably those on prejudice—and example, tried to place a 3-year euro Spanish covered bonds earlier in the “grandfather” all the existing benchmark bond in the second half of year. As concern about housing structured bonds in issue—will not November at 10bps over swaps but markets—and debt related to them— now come into force until March. In ultimately had to concede defeat and has grown since the summer, another the meantime, it is hard to see what

30

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will alleviate the sort of pricing pressure that obliged Abbey National to shelve planned benchmark issue in mid-November.

Reusch at HVB that while he had no fundamental credit concerns about the UK instruments, he believed it would take a considerable time for the spread gap that had arisen between them and pfandbriefe to narrow once again.“I think it will take at least 12 to 18 months for this to recover—but not to the point it [the differential between the two] was at prior to this market disruption.” However, while issuance of UK covered bonds will decline this year on 206 levels [see Table]; it is nevertheless forecast to pick up significantly in 2008. This is because several of the big mortgage lenders will need to find an alternative source of funding to securitisation, which has ceased to be a viable way of funding mortgages with RMBS tripleA spreads at their current levels.

As asset-backed bankers do not expect RMBS spreads to improve significantly for several months at least, it is logical that volume lenders will turn to covered bonds, to some extent at least, to make up the shortfall. Some of the big RMBS issuers (including Abbey National, HSBC, HBOS and Bradford & Bingley) already have covered-bond programmes in place, and others are setting them up. Barclays has set up a programme for next year, and Royal Bank of Scotland is thought likely to follow suit. The problem with the European RMBS market (in which UK issuers are the dominant force) has led to concern in some quarters that there will be a stampede of new issuance that will saturate the market and drive spreads out still wider.

Those at the coalface doubt, however, that this will happen. Reusch at HVB explained that while mortgage providers in the UK—and elsewhere—

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that did not have large deposit bases from which to draw funding would probably make more use of covered bonds and that the resulting increase in supply might put pricing pressure on some parts of the market, they would not want to jeopardise their one remaining source of low-cost funding.

Photo : © Pyramide du Louvre, architecte I.M.PEÏ / David Norton / Taxi/Getty Images - Concept Keima

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“One has to recognise that funding sources other than covered bonds are either significantly more expensive or less accessible and reliable,” he says.

Amat at the ECBC says this was certainly evident in the way that several issuers from various jurisdictions had decided to postpone issues during the

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Debt Report COVERED BONDS 32

UK

Portugal

Netherlands

Italy

Ireland

Germany

France

Spain

Outstanding RMBS and Jumbo covered bonds Holger Dohra, head of recent spread volatility business/relations rather than risk re-setting 400 €bn Residential mortgage-backed securities Covered Bonds management on the bond spreads at a higher 350 treasury side of DG level. “They have proved 300 Hypothekenbank, said that that they are very 250 in the more discriminating responsible covered-bond 200 environment that would issuers,” he maintained.

150 prevail next year, factors “Everybody needs this such as quality of market, and nobody is 100 individual asset pools and going to put it in danger.”

50 issuers’ track record would “I think the scare talk is 0 determine spread levels on overdone in terms of the a much less homogenous flood that might happen,” basis than in the past. agreed another banker.

Nevertheless, most market She pointed out that the Source: Merrill Lynch Secondary spreads of 5-yr RMBS and Jumbos participants seem big UK lenders—the ones convinced that the with the most immediate 110 bp European market for potential to switch large German Pfandbriefe 90 covered bonds will volumes of issuance from Spanish Cedulas continue to grow as a RMBS—will still subject to UK covered bonds 70 German RMBS high-grade asset class.

FSA restrictions on the Spanish RMBS Merrill Lynch expects new volume of covered bonds UK RMBS 50 issuance in 2008 to reach they can issue as a €2 05bn, with higher percentage of their total 30 volumes than this year assets. “The graduation from three of the four main towards covered bonds is 10 markets – Germany, Spain certainly a rational one, and the UK. but it is likely to be a -10 It may well turn out that controlled process,” she Jun Jul Aug Sep Oct Nov the solid performance of concluded.

Source: Merrill Lynch covered bonds relative to Another balancing factor Gross supply of RMBS and Jumbo covered bonds other instruments through on the supply-demand €bn 140 500% Residential mortgage-backed securities (RMBS) the credit crisis in the equation for covered bonds 450% Covered Bonds 120 second half of 2007 proves in 2008 will be a high RMBS 2007 vs. 2008 400% Covered bonds 2007 vs. 2008 a decisive factor in the number of redemptions 100 350% take-up of the over the course of the year.

300% 80 instruments outside HVB estimates that 250% 60 200% Europe. Several countries, redemptions of jumbo 150% 40 including Canada, Japan bonds (over €1bn in size) 100% and Turkey, are currently alone will total over €90bn 20 50% looking at legislation for against anticipated new 0 0% covered-bonds. “This year issuance of only €190bn to has shown that covered €200bn. German issuers Source: Merrill Lynch, *As at the end of September 2007 bonds are the safest and will lead the way, redeeming €6 5bn of pfandbriefe, while scrutiny of new issues in 2008 – which most reliable source of funding a further €15.1bn of obligation foncieres will oblige some to acquire become a lot mortgages for banks,” maintained will also reach maturity along with more familiar with transaction details.“A Amat at the ECBC.“I think more and €5.4bn of Spanish bonds. As inevitably lot of investors are going to have to do a more states in the European Union – occurs after a period of market lot more homework right now,” and beyond – are interested in this instrument.” dislocation, there will be greater investor observes Skeet at Merrill Lynch.

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Regional Review

It is a time of change and adjustment for Kuwait’s banking sector. While high oil prices continue to drive growth in the country, the political system is still wrangling over the scope and pace of market reforms. Kuwait’s overall economic story has tended to pale in comparison the other Gulf Cooperation Council (GCC) countries, even so Kuwaiti banks have been among the most innovative and expansion driven in the wider Middle East and North African (MENA) region. What now?

HE NUB IS this. In Kuwait, the banking sector dominates the financial landscape by a country mile.Yousef Al Jaseem, secretary general of the Union of Kuwaiti Bank. As is the case in the wider GCC region, he notes:“The conventional measures of financial deepening showed that the region has demonstrated a depth in its financial markets and the importance of long-term banking and a good degree of sophistication in these markets.”Kuwait’s banking industry in particular has made significant progress over recent years, posting strong performance. The Kuwaiti industry has “strengthened their financial position, upgraded their banking products and service, and improved their financial ratios in terms of liquidity and profitability,”notes Al Jaseem.“And we are aspiring towards making Kuwait a financial centre.”

With a population of 3.2m and gross domestic product (GDP) of some $104bn, Kuwait is the third largest economy in the GCC region, after

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Saudi Arabia and the United Arab Emirates (UAE). It has, however, the highest GDP per capita in the entire GCC zone (around $31,000 per head: about 60% above the GCC region), at level that is comparable with Singapore. The country’s economic performance is directly linked to oil prices; producing 2.5m barrels per day and at current output controls sufficient reserves to last well into the next century. Kuwait has recorded only one budget deficit in the last ten years and in 2006 enjoyed a budget surplus close to 35% of GDP and a current account surplus of 50% (the highest figure for any economy in the world).

The state itself is wealthy, owning an investment portfolio reckoned in excess of $600bn, though most of that money is invested overseas.

The only cloud on the country’s investment horizon is the growing disparity in approaches to development between the ruling government and the country’s elected National Assembly.

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KUWAIT

LOOKING OUT: LOOKING IN

The Assembly has fairly consistently opposed the government’s efforts to reform and restructure the economy; and has demonstrated a particular antipathy to foreign investment in the country’s oil sector and moves towards the privatisation of state owned assets.

While not a problem right now, it could hamper some of the country’s growth in future as its oil fields mature and foreign expertise in oil extraction from marginal fields becomes more important.

Additionally, government spending remains the main stimulus in the economy, a fact which leaves it vulnerable to local pressure groups. For instance in November, the chairman of the Kuwaiti Banks’ Union Abdulmajeed Al Shatti told reporters that local lenders have been in talks with the Central Bank of Kuwait regarding the issue of the government buying off consumer loans to help alleviate the debts of citizens. The matter was discussed earlier in the month at the National Assembly where protests were staged by crowds of Kuwaiti citizens demanding government assistance. The key issues are that income distribution is skewed with the differentials between rich and poor in Kuwait growing exponential. Added to that inflation in Kuwait is at an all time high of 6.2%.

What all this means for local banks, in a worse case scenario, is that Kuwait could lag the rest of the GCC in terms of the potential and business that Kuwaiti banks can capture as a result of continued high oil prices. In the near time, given that continued high oil prices will continue to be invested in infrastructure and development projects within Kuwait, in terms of the domestic market, the banks’ corporate books will invariably drive growth. Estimates vary, but most banking analysts have it that corporate lending with triple by 2012, spurred by infrastructure spending. On the other hand, retail lending growth is likely to decelerate (though still remain

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Regional Review KUWAIT

in double digits). These considerations Currently the bank is planning to from KD3.9bn in 2005 to KD4.6bn in now drive much of the strategy of the generate $1.5bn by selling shares to 2006. According to GulfMerger, car existing investors to help finance its financing has been a key contributor, country’s banks.

The market is served by seven acquisitions. The sale will close on accounting for KD340m in new loans in commercial banks, dominated by the December 26. The lender’s shareholders 2006, and an estimated KD390m in country’s big four: National Bank of gave the green light to a capital increase 2007. The research also reveals that the Kuwait (NBK―the largest bank in the in September to support the purchase of regional consumer finance market is country; Commercial Bank of Kuwait, Al Watany and the bank’s stake in relatively fragmented with a number of conventional and Islamic banks and Gulf Bank and Burgan Bank; though Istanbul’s Turkish Bank.

Although the big four have enjoyed a consumer finance companies. Among specialist financial institutions such as Kuwait Finance House, which is to relatively comfortable existence in the these players, there are several smaller date the country’s only Islamic bank local market, increased competition consumer finance companies that lack sufficient scale, brand are on the rise. The market awareness, access to low also has growing appeal cost funding sources and for foreign banks, with Although the big four have enjoyed a distribution arrangements, Doha Bank, Qatar’s relatively comfortable existence in the and that are therefore at a fourth-largest lender by local market, increased competition from particular disadvantage market value, reportedly specialist houses, such as Kuwait relative to their larger peers having applied for a license Finance House is being noted. The appears inevitable, both to operate in Kuwait. bank’s Bahrain office announced the with the GCC and Kuwait NBK is a microcosm of in particular.

The the challenges and launch of the first Islamic EMV compliant acquisition of smaller strategic drivers of the credit card with Visa. The Shari’aconsumer finance national banking sector. compliant card offers holders credit companies by national NBK appears to have facilities interest costs, instead just a banks. Such strategic moves reached critical mass in low transparent service charge. would help these banks certain sectors in the increase market share in domestic market and is one of the most profitable therefore shifting gears and is now looking for organic growth from specialist houses, such as Kuwait segments of the banking industry. through acquisitions in the wider Finance House is being noted. The Given their lower cost of funds, the Middle East region, encompassing bank’s Bahrain office announced the banks would also be well-positioned to Iraq (where it owns 75% of NBK Iraq), launch of the first Islamic EMV significantly enhance the profitability of 40% of Turkish Bank and 51% of Al compliant credit card with Visa. The newly acquired consumer finance Watany Bank in Egypt (though it has Shari’a-compliant card offers holders companies in a very short time by approval to increase its shareholding credit facilities interest costs, instead refinancing existing borrowings.

What looks likely in an increasingly to 100%). The bank has now made a just a low transparent service charge.

Aside from competitive pressures, tightening market is that Kuwait’s formal offer to buy out remaining minority shareholders in AlWatany at recent industry research from banks will follow NBK’s lead and EP77.01 ($13.95) a share. The offer GulfMerger, an independent financial diversify their holdings at home and applies to 3.96% of AlWatany shares, advisory firm, posits that GCC abroad to counter changing market Buoyed by growing which were trading mid December at consumer finance companies are conditions. poised to go through a wave of local corporate loans resulting from EP74.05 per share. growth, further NBK also has interests in Qatar, consolidation and regionalisation in the infrastructure owning 40% of International Bank of near term driven by industry players expansion in the private equity and Qatar, though this may rise to 60% in and private equity houses with clear structure finance sectors, and an increasingly deepening, though 2008 and Jordan, where NBK is strategic and financial imperatives. competitive retail GulfMerger cites the growth in increasingly planning to extend its branch network.

Additionally, is reportedly expanding in Kuwait’s consumer finance market, market, the future for Kuwait’s banks Dubai and possibly Saudi Arabia. with consumer loan portfolios growing remains bright.

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Stock Exchange Review BOVESPA AND BM&F PREPARE FOR COMPETITION

Investors dig deep to get a piece of Brazil’s exchanges

Photograph supplied by istockphoto.com, December 2007.

HARES IN BOVESPA HOLDING, which priced at R$23 apiece on October 26th this year blew through the original pricing range of R$15.5 to R18.5 and came at the very top of the revised pricing band of R$20 to R23.The offering raised a cool $3.7bn.

“Stock markets have an interesting model that is highly attractive to investors and can be summed up in two words, operational leverage. We are basically an entity with a fixed cost. The more business transacted over the exchange, the more profit we make,” says Gilberto Mifano, chief executive officer (CEO) of Bovespa. The proof of the pudding is seen in its $1bn cash hoard, which is “much more than we need,” he says, adding cash flow amply covers spending needs.

José Olympio, managing director and head of Brazilian investment banking at Credit Suisse in São Paulo, which led the Bovespa deal, says that during the initial book-building process, it became clear that there was little to no price sensitivity. That looks like an understatement. Shares went on to hit R$35 valuing the exchange at 50 times

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The initial public offering (IPO) of Bovespa Holding, the Brazilian stock exchange, was an explosion and the largest deal on that market to date. It pressed just about all the buttons for champagne all round. The price range was raised, the deal heavily oversubscribed and the shares shot up by over 50% on the first day of trading. Not surprisingly after its stratospheric launch, the Brazilian Mercantile & Futures Exchange (BM&F) IPO was a shoe-in. The deals cement the position of the two exchanges as the undisputed leaders in Latin America and the spicy pricing show the strengths of a near-monopoly industry in a growing economy and investors’ love affair with the exchange story. Can the rising spectre of enhanced competition in the long-term and weaker global markets now douse the feel-good factor? John Rumsey reports from São Paulo. forward earnings. Shares in the BM&F priced at TKTK, raising TKTK. Mifano is convinced that the consistent growth of the Brazilian market in the last years is sustainable and marks a secular change.“It is not a bubble. The market has changed profoundly. For the first time, companies are using the exchange to raise capital to invest to grow their business,”he says. The numbers speak for themselves. He points out that by number of IPOs, Brazil ranked as the third market in the world last year, trumped by just China and Hong Kong, a trend likely to continue as economic growth in emerging markets further outstrips developed countries.

For foreigners, who bought 78% of the shares of the Bovespa IPO, there are several reasons that help explain the strength of the IPO. Much of it is macro-related. “Brazil is one of the most dynamic regions in the world,” says an official from the NYSE, which bought a 1% stake in the Brazilian exchange. Neal Brady, head of business development, at CME Group, points out too that the country risk premium

for Brazilian debt has dramatically narrowed and the country is slated to achieve an investment grade rating.“It has become one of the hottest markets in the world”. CME Group is an entity that encompasses the Chicago Mercantile Exchange and the Chicago Board of Trade, which recently took a 10% stake in the BM&F. The Bovespa and BM&F deals are also riding the crest of a wave of consolidation as globalisation and electronic trading allow well-run exchanges to generate plenty of liquidity from foreign investors, feeding their trade-equals-profit business model.That consolidation trend means the $1bn in cash is a potentially useful war-chest.

Mifano says that the exchange is keeping an open mind on possible tieups and acquisitions. He admits that Bovespa Holding does not currently see interesting opportunities in the region, but ambitions are broader: “We could speak with much larger exchanges than us. We don’t have any barriers,”he says.

Any deal would need to meet the two key criteria that the deal makes sense for shareholders and the business model.

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Bovespa Peculiarities

and the continuing rapid establishment of Bovespa as the Bovespa There are some more individual premier exchange in the region, dampening effect of the Sarbanesreasons for Bovespa Holding IPO’s competition is locked out the Oxley Act (SOX) and its associated costs on foreign listings in the US mean success, notes Credit Suisse’s argument goes.

There is much in that view, but a many Brazilian companies are happy to Olympio. Broker fees paid to the exchange are passed on to investors. change in the competitive landscape stay at home. If SOX provisions were to That atomises the cost and as is the bear in the woods. Competitive be watered down, as the NYSE dearly investors are a diversified and loose threats could emerge from other wishes, or global liquidity trends turn group, there has been no outcry to physical exchanges, or electronics very averse, Brazilian companies might lower fees. Naturally, as brokers do ones. The New York Stock Exchange change their mind.

Mifano is sanguine about the threat not pay, they have little incentive to (NYSE) for instance, was for years the first choice for Brazilian companies from up north. He notes that since lobby the exchange to reduce it.

Then, there is the intriguing and still represents the biggest single 2004, only four companies carried out a dual listing in New York possibility that Bovespa and they had very specific will become a regional reasons for doing so; such as fund raising centre itself.

Competitive threats could emerge wanting to give investors This year, the exchange from other physical exchanges, or direct peer comparisons. He has accounted for some electronics ones. The New York Stock admits that SOX has helped 80% of listings in Latin Exchange (NYSE) for instance, was for Bovespa build up its America and that liquidity business, but argues that it is starting to interest nonyears the first choice for Brazilian is a prop that is no longer Brazilian companies. companies and still represents the needed. Bovespa is now Argentina’s Banco biggest single potential rival, according firmly established and that Patagonia listed a to Olympio. Larger companies of the ilk even if SOX is diluted, the concurrent Argentine, of Petrobras, CVRD and Gerdau have NYSE will be hard-pressed Brazilian and international American Depository Receipts (ADRs) to win back business, he offering of shares: reasons. “[Some] 70% to Brazilian Depositary trading in New York on the NYSE. US 80% of our IPOs are bought Receipts (BDRs) and investors are still the single biggest by foreigners. They are American Depositary buyers of Brazilian stocks and the US comfortable investing Share (ADSs) in July. The exchange clearly has a service level, directly in Brazil,” he says. bank sold 200m shares cachet and aura that Bovespa up to One investor however, who through JPMorgan. declined to be named, The Bovespa Holding now has not always matched. believes that the emergence deal has had a halo effect of electronic trading too, reckons Olympio.

For many overseas investors, it was potential rival, according to Olympio. platforms could chip away at their first foray into Brazil. They are Larger companies of the ilk of Bovespa’s business. Mifano says that now coming back for more:“Bovespa’s Petrobras, CVRD and Gerdau have while that is not impossible over the IPO helped Bovespa’s business,” he American Depository Receipts (ADRs) longer term, Brazilian legislation has says. The listing will continue to trading in New York on the NYSE. US erected some tricky hurdles for that deepen the market both in its own investors are still the single biggest business model. They include right and through this attraction of buyers of Brazilian stocks and the US identification of the final beneficiary new investors. So far, so good. exchange clearly has a service level, of a trade and the imperative that However, it is less clear that other cachet and aura that Bovespa up to transactions involving either an institutional investor or financial trends are favourable to the exchange. now has not always matched.

For now at least, direct competition intermediary use a regulated market One of the key selling points for Bovespa Holding has been the lack of from the NYSE looks unlikely, Olympio for transactions. That means a new competition from other exchanges. believes. The combination of a better- competitor would need to create an With high barriers to entry, and the run, more liquid home market in organised market.

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Regional Review BOVESPA AND BM&F PREPARE FOR COMPETITION

macroeconomic trend is Other bankers see Other bankers see rivalry from the positive and the exchange rivalry from the newlyprofitable, it’s also partly demutualised and cash newly-demutualised and cash rich BM&F investors buying into a fad. rich BM&F turning its turning its attention to the cash market.

“There is a sort of mania attention to the cash In the short- to medium-term that makes surrounding stock market. In the short- to no sense, reasons Mifano. “We both exchange IPOs,” he medium-term that makes have to do lots in each of our respective believes.

Furthermore, no sense, reasons Mifano. markets. It’s not reasonable that they while Bovespa may well “We both have to do lots in emerge as a regional hub each of our respective would de-focus on their market.” Indeed, he pours cold water on its markets.

It’s not the tables might be turned according to significance, noting the reasonable that they would one banker who suggested that the more paucity of listings from de-focus on their market.” likely scenario is for Bovespa to move other markets. Argentina, Indeed, the tables might be onto the BM&F’s turf. Unlike Bovespa, the largest other market, is turned according to one in a “populist trap”‘ and banker who suggested that the BM&F does not have its own unlikely to offer rich the more likely scenario is depository, for example, he pointed out. pickings for now. There are for Bovespa to move onto some red flags in the wider the BM&F’s turf. Unlike Bovespa, the BM&F does not have its shares have also proved volatile IPO market in Brazil too. Recently, a own depository, for example, he trading by more than 7% in one day. number of IPOs have traded down in pointed out.

They are trading at the very high end the immediate aftermarket. Moreover, of international exchanges, between while corporate governance standards Shanghai and Hong Kong exchanges, are good, some companies respect the Irrational exuberance?

At one stage, Bovespa Holding’s share the top two thanks to exposure to an letter rather than the spirit of the law. price valued the exchange at about half economy with much brighter Giant ethanol producer Cosan, once a the value of the NYSE, even though economic prospects than that of Brazil. darling of the exchange, moved its For respected economist Luiz Carlos listing to Bermuda to enable the owner the combined value of companies trading on the NYSE was $16trn in Mendonça de Barros, who is a founder to keep control of the company with a September, compared with just $1.2trn and partner of Quest Investments in 10% stake. That contributed to a on the Bovespa. Bovespa Holding São Paulo, while the long-term collapse in the share price.

CME’s STRATEGIC INVESTMENT IN BM&F n taking a 10% stake in the Brazilian Mercantile & Futures Exchange (BM&F), CME Group is cementing a long relationship, says Neal Brady, head of business development at the CME Group. The cross-share swap also gives BM&F a 2% stake in the CME, he notes. CME took its stake in BMF alongside General Atlantic, which also took 10% and has a seat on the board. Brady believes that they bring complementary strengths with CME providing technical know-how and General Atlantic strategic input.

The BM&F, which is the fourth largest such market in the world, has been a: “Shining success story in a market that has been very volatile. It has earned a great reputation,” he says. Investors can see exactly what has happened to electronic privatized exchanges in the US and Europe and map that to a growth story and the asset base to run calculations. The CME/BM&F deal also exploits new global trends. Clients increasingly wanted to trade in Brazilian assets and set up hedging strategies, which regulation makes relatively easy. Equally, there is demand from Brazil to trade offshore and get exposure to CME products. “This has come together in the last few years and particularly months [with the merger of CME and CBOT],” opening a far broader suite of products, says Brady. Other factors include the move from floor to screen-based trading allowing more complex execution arrangements—and some cross-over in the products offered on the Brazilian and overseas exchanges, including the overnight interest rate, FX and agricultural contracts. Management of both institutions is world class, Brady believes. Indeed one of the main attractions of the BM&F was the strength of its management. That means that there will not be need for any major change of course.

I

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Stock Exchange Review BERMUDA

BSX receives UK designation The Bermuda Stock Exchange (BSX) has been designated as a recognised stock exchange for tax purposes by the board of the United Kingdom’s HM Revenue and Customs (HMRC). The designation extends to the entire exchange and as such, securities listed will meet the HMRC interpretation of 'listed' as set out in the 2007 Income Act and as amended by the UK’s Finance Act. Designation by the UK’s Revenue and Customs is a significant development for the BSX that expands the services provided by an offshore stock exchange to unprecedented levels.

So what’s in store now for issuers and investors?

HE BERMUDA STOCK Exchange now joins a long list of recognised exchanges worldwide, including those registered with the Securities and Exchange Commission (SEC) of the US as a designated offshore securities market as well as an approved stock exchange as set out by the Australian tax authorities. It is also currently the only offshore stock exchange which is a full member of the World Federation of Exchanges.

Greg Wojciechowski, BSX’s president and chief executive officer notes,“The BSX began work to create a fully operational, modern stock exchange platform in the offshore region which is well regulated and globally recognised as far back as the early 1990s. Full recognition has been some time in coming and the decision by HMRC is evidence of the BSX’s commitment to meet and exceed international operational and regulatory standards.”

The definition of a recognised stock exchange is given in the Income Tax Act 2007. It includes the London Stock

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Exchange, plus listed market and any such stock exchange outside the UK as is “designated in an Order of the Board” of HMRC according to a BSX release. Wojciechowski explains that designation was not an automatic process, but “required due diligence and detailed analysis of the BSX by HMRC during the application process. BSX clients have asked for the exchange to seek this designation as they have indicated an interest in having their investment universe of “qualifying investments” expanded or in other instances to have an alternative to the current listing venues for the listing of their Eurobond or debt products. We have been able to deliver on both counts and look forward to further growing the international business of the exchange in this regard.”

BSX was established in 1971, primarily as a domestic equities market. However as the Island's international financial sector grew so too did the exchange and in 1992 the company was restructured into a

demutalised, for-profit entity. BSX now claims to be the leading electronic offshore securities market, with a current market capitalisation (excluding mutual funds) in excess of $350bn. Approximately 500 securities are listed on the BSX, of which more than 350 are offshore funds and alternative investment structures. The exchange specialises in listing and trading of capital market instruments such as stocks, bonds, mutual fund (including hedge fund structures) and derivative warrant programmes. The Bermuda Stock Exchange's significant growth over the last several years is due in large part to the company's innovative and flexible approach. Says Wojciechowski, “The exchange has sought to create unique products and services for its niche offshore market.”

A case in point is the BSX's Mezzanine Market , pre-IPO market listing for start-up, high growth potential companies. Unlike AIM in the UK, the BSX Mezzanine Market offers development stage companies the opportunity to list on a recognised international stock exchange without having to commit to a full IPO. This is due in large part to the fact that the BSX restricts access to the Mezzanine Market to either institutional or sophisticated investors, which are designated as 'Qualified Investors'. In this way, the BSX relies on transparency and full risk disclosure in the issuers listing documentation.

Another contributing factor to the exchange's growth is the BSX's “commercially sensible'” regulatory environment which makes it conducive to new and innovative product listings, especially 'institutional only' securities, says Wojciechowski.

It is vital that BSX continue to show momentum following this latest designation, acknowledges Wojciechowski, who says that the designation broadens the investment

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BERLINGUER CONFERENCES

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Stock Exchange Review BERMUDA

opportunity for UK structures such as sign up for a secondary listing on the because it can take as little as a month PEPs and ISAs for retirement plans BSX in a bid to improve its visibility in to establish an insurance company in and in practical terms “broadens the the Island's business community and the jurisdiction. By comparison, it can investment potential for UK to provide support to the local take up to nine months to get an investment structures,” he adds. economy where it is headquartered, insurance company up and running in Additionally, Wojciechowski, is now according to chairman Martin Thomas. the United Kingdom. The Bermuda working with his team on expanding Lancashire Holdings was incorporated insurance industry is subject to the range of products offered on the in October 2005 in the wake of comprehensive, but not overly exchange, “which we can migrate hurricanes Katrina, Rita & Wilma and burdensome, regulations aimed at offshore to trade here. These raised $1bn via an initial public offering supporting Bermuda's credibility as an structures will be able to benefit from and went public on the London Stock international financial centre, notes Wojciechowski.

"The Bermuda supporting infrastructure, such as our Exchange’s AIM board two years ago.

“We have developed a set of Insurance industry has the intellectual electronic settlement system, that we regulations that are specific to capacity and regulatory environment to have in place.” allow them to quickly Wojciechowski is provide insurance capacity particularly proud of BSX’s and products when and ability to attract insurance where needed. They were and reinsurance companies The BSX firmly believes that the therefore able to work that are domiciled and wonders creating new risk doing business in combination of a modern internationally models in the aftermath of Bermuda.

"From the recognised stock exchange and a the hurricane and beginning when we resuccessful global insurance industry earthquake episodes,” launched the exchange makes Bermuda uniquely positioned to he notes.

ACE and XL were the first support, develop and drive forward the Bermuda is also a to list and we have had convergence of the insurance and leading centre for mutual representatives from each and hedge Funds (known of the new classes of capital markets. as Collective Investment insurance company Schemes). The island subsequently list,” explains provides a sophisticated Wojciechowski. “It is a infrastructure for fund product area where we see huge potential and will work closely insurance related securities and will management that is administered by with Bermuda’s insurance industry to seek to encourage further listings not the Bermuda Monetary Authority create, list and trade new and exciting just from Bermuda based companies (BMA), explains Wojciechowski.

Bermuda is an ideal jurisdiction for insurance related products. The BSX but also those from overseas.“ adds listings of specialised fund products firmly believes that the combination of Wojciechowski Incorporations in Bermuda have and securitised transactions, stresses a modern internationally recognised stock exchange and a successful global been holding steady at near-record Wojciechowski. “With its location an insurance industry makes Bermuda levels, but in the insurance sector, even easy commute from the United States uniquely positioned to support, before 9/11, there were many notable and Europe; its political and economic develop and drive forward the Class 4 incorporations (companies stability; effective judicial system; convergence of the insurance and with capital and surplus in excess of favourable tax regime; the absence of $100m). After 9/11, Bermuda attracted exchange control and currency capital markets.”

Two of the most recent companies to a flood of new capital and several new restrictions; the presence of light but regulation; and the list on BSX were Flagstone Reholding re-insurers were formed. Bermuda was effective and Lancashire Holdings, which both already established as a recognised availability of professional advisors listed in the fourth quarter. Lancashire insurance market (arguably now the and service providers, makes it a very proposition going holdings, which has a market second largest in the world), but after favourable capitalisation of $1.38bn decided to 9/11 it came into its own. In part, that is forward,”he says.

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2008 THOUGHT LEADERSHIP ROUNDTABLE SERIES

PRIVATE EQUITY IN EMERGING MARKETS NEW RISK/RETURN PARADIGMS

The PANEL:

Sponsored by:

CANER ONER, Chief Financial Officer, OYAK Group TOM SIKORSKI, Chief Executive, First Reserve ANDRES RUBIO, Head of Morgan Stanley Private Investment SEV VETTIVETPILLAI, Chief Executive, Aureos Capital JONATHAN BLAKE, Senior Partner, SJ Berwin

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TOP LINE TRENDS: AN OVERVIEW TOM SIKORSKI, CHIEF EXECUTIVE, FIRST RESERVE:

I work in the energy sector where supply chain issues predominate; although we work in both the supply and demand sides around the world. The growth of offshore development is an example of a significant supply trend and is an area that we focus on. On the demand side, emergent growth in places such as China and India requires significant infrastructure investment and this is another set of issues in terms of delivering value to the infrastructure side in emerging markets.

ANDRES RUBIO, EUROPEAN HEAD OF MORGAN STANLEY PRINCIPAL INVESTMENTS: We now look more and more at

the emerging markets rather than the developed markets of Western Europe; that is, Eastern Europe, the Middle East and Africa, where we have found more reliable and more attractive secular trends (economic and industrial) that allow us to make attractive investments. The challenge in all of the emerging markets to different degrees is valuation.We tap into companies that have experienced sometimes extremely high growth over the last few years.Valuation is an important consideration: how much growth, for example, are you willing to pay for at today’s prices? Another important consideration is transparency and corporate governance associated with any individual company we would be investing in. If you have a medium to long term point of view, and you can withstand certain levels of volatility relative to more developed markets, these are in our opinion some of the most attractive risk/reward ratios you can obtain globally. The other challenge is to understand how we can capitalise on an environment where there is a tremendous amount of strategic attention: because when you have a financial entity making an investment and you have strategics coming into the same market, be it consumer goods or banking say, it is very difficult to compete in terms of investments.Where we have the greatest level of success however, in trying to get deals completed and achieve good investments, is in playing the flexible partner role. Therefore, we typically look at existing ownership groups who do not want to sell control necessarily, but want to obtain a capital infusion and receive an endorsement of their progression to date and an endorsement of their future prospects.

SEV VETTIVETPILLAI, CHIEF EXECUTIVE AUREOS CAPITAL: There is a significant supply of capital on the move

to emerging markets, fuelled by lack of growth and opportunities in the more developed markets including high valuation as well as real growth opportunities in the emerging markets.Valuations are being driven up significantly. Has the businesses within them grown to the extent that they can command that kind of valuation? No. It is driven by supply of capital. I would also like to put on the table that there are different segments of the market: you have the small to mid cap; then the mid to large (or mid cap) and then the large.The large cap is the $50m-plus transaction per ticket; the mid to large is anywhere between $25m to $50m and then you have the $15m to $25m where you have the pure mid-cap and then everything below— small to mid cap—and then below that

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there is a plethora of $2m deals, which is really venture funding. In Latin America, Africa and in Asia, we see that distinction becoming increasingly clear.

JONATHAN BLAKE, SENIOR PARTNER, SJ BERWIN:

Private equity has become more mature, and a huge amount of financing is now coming into private equity, partly because that is the stage of the cycle, but also because it has become a proven asset class. The UK is a reasonably well trodden market and offers perhaps less opportunity and more people are looking toward Europe. Then they are looking on from Europe towards the emerging markets.

There is also a credit crunch and even if it is relatively shortlived, I do not believe that anybody is expecting things to go back to what they were before: where you could get debt without any covenants on it at all. As that becomes more sensible, and we see fewer deals in the very largest segment, the same amount of money still needs to be invested so people will be looking for opportunities in other areas.

There is also more diversity in funds formation. Hedge funds are moving into illiquid investments as well as liquid investments. Moreover, there has been a huge surge in infrastructure investing in the last year or two.

CANER ONER, CHIEF INVESTMENT OFFICER, OYAK: We have so far invested mainly in Turkey. Our main areas of investment are in the automotive sector, cement, energy production, iron and steel, financial services and logistics.

Recently, there have been many new private equity entrants into the country; many foreign private equity investors have come in and a number of local private equity investor companies have started to emerge. Foreign investment inflows have focused in particular on the country’s privatisation projects, where banking, real estate, logistics have been prominent. Nowadays energy is more significant: both in production and distribution.

MARKET VOLATILITY & ITS IMPACT ON PRIVATE EQUITY ANDRES: The credit crunch does nothing but highlight the attractiveness of the emerging and high growth markets.

Classic LBO firms, which typically do very large deals in developed markets, with significant leverage have had to change the way that they look at the world, because of the quantum of money they have and the relative lack of, or lower level of leverage that exists today. Hedge funds are moving more and more into minority or private stakes, where they will use some leverage, but it is not primarily the leverage that drives the outsized return. We are also seeing are large LBO firms investing with no/limited leverage in the current environment. For instance, in Eastern Europe, we have seen a large blue chip global LBO firm attempting to purchase half of a company with no leverage. That tells you they are reacting to the market, they are moving to where there is growth and higher returns; and that if they want or need leverage that they can obtain it later, when the market reopens, to enhance what is already an attractive return due to the underlying fundamental prospects of the business.

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TOM: We have always tried to look for local partners or

investors who have capability or clout or contacts to act as a hedge against some of the incumbent risks in any local market against any lack of knowledge on our part, of either management teams or the dynamics in markets. We have also been more willing to take a minority stake in a local market where we might not have done a deal historically. As an example, we are a reference shareholder in China Coal, which was a pre IPO stake that we took last December, as the lead non-Chinese investor and is it an investment that has worked out very well. We are now doing something similar in the Czech Republic. We pursue these types of investments because we are a sector fund and can bring some specific leverage to bear in the energy markets. We also act as a strategic investor for local financial investors who are seeking to leverage their stake with more focused partners.

SEV: The larger the size of the transactions the more important leverage becomes in the equation. At the larger end of the market, there have been very few leveraged buyouts and more expansion capital. As you come down the scale, leverage is not a major issue. In the mid-market, at market caps of $15m to $30m, leverage is something you can get pretty quick and in some cases banks compete for it, and get good terms. However, as you go up the scale, to say leverage of $500m, many emerging markets do not have capacity and you have to bring in external leverage.That is where the credit crunch becomes an issue. However, if you pick the wrong company, none of this matters. Moreover, if you are paying too much for a company, the headroom you have is very limited and in emerging markets (where volatility is high); the deal becomes much more risky. Hence, the valuation premium is the biggest problem in these markets. Additionally, if you take a snapshot of the quoted exchanges of these markets, the top 30% of these companies’ market capitalisation would be in excess of $100m. In other words, 70% or more firms listed on the exchanges have market caps of below $100m. So when you look at the pool of capital that comes into these markets, what is focusing on the 30% and what is focusing on the 70%? There is a disparity. We do see deals in India being done at EBITDA multiples of between 15 and 20. They are doing it because they are confident that the market will keep going up.

CANER: While Sev was talking, I was trying to compare the things he mentioned with our experiences and make some generalisations. However, looking back to each of the investments we have made, I realised that each was a case on its own and evinced its own characteristics. According to statistics, Turkey is expecting about $25bn in foreign direct investment in 2007. Some companies inside the country are not in need of cash, there is a lot of liquidity, so owners in these companies looking to sell their shares will be looking for more strategic type of partners, not financial investors. Like Sev said if the amount is small then they sometimes are looking for investors only. Therefore, it varies from company to company and each deal has its own characteristics. When we invest, we usually try to acquire a majority share. We do not normally go for minority stakes; we either buy the whole of a company or as a minimum 51%, because we want to control the company.

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JONATHAN BLAKE, SENIOR PARTNER, SJ BERWIN SJ Berwin LLP is a pan-European law firm with offices in Berlin, Brussels, Frankfurt, London, Madrid, Milan, Munich, Paris and Turin.

The firm advises on a comprehensive range of legal services including corporate finance, commercial, real estate, finance, reconstruction & insolvency, and financial services. Acting for management teams and small independent fund managers, as well as some of the largest institutional investors, the range and depth of our experience is unique, handling both private equity funding, as well as LBO, merger and acquisition transactions. The firm also handles private equity in emerging and well as developed markets, with special expertise in Eastern Europe.

That is our strategy and it won’t change. But we recently we have noted private equity companies coming into Turkey just for investment purposes, companies such as KKR, Texas Pacific Group and strategic partner companies such as Mittal.

Therefore, we see both types of investor companies trying to get a foothold and somehow become a partner with a company.

FRANCESCA: As deals diffuse from developed to high growth markets are you noting changes in deal structures?

JONATHAN: I guess it is in fact‘back to basics’. In the period up to the beginning of the credit crunch, there was huge competition for deals in Western Europe, in the UK and in the United States. As I said earlier, we have seen private equity deals being done almost without documentation at all because people have been so sure that the deal is right and that they wanted to do it. One of the ways of beating other people to the deal has been to do it without documentation, or with very scant documentation. None of that really applies to the emerging markets. There people have really gone back to first principles. We have seen a much greater proportion of the investment being development capital, which has rather disappeared from the UK. Quite a large a large proportion of what goes into emerging markets is

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downstream delivery of each commodity and so when we segregate each country, we evaluate whether it is a supply centre or a demand centre. They are all demand centres, but in particular, a place such as Turkey would be more a demand centre with the growth that it has and with its central location and the knock on Central Europe growth, there are some NEW SOURCES OF interesting trends. In each CAPITAL market, we try to deliver what we call sub-vertical bits of SEV: American investors appear expertise. In Turkey, it might be more prone to investing in Latin demand for oil and gas products America and Asia while (like a Tupras), so that we might European investors are more have knowledge and expertise focused on Africa. In Asia, there in refining or market industry are three countries that everyone SEV VETTIVETPILLAI, CHIEF EXECUTIVE, AUREOS know-how. Given the massive wants to get involved in: India, Aureos Capital Limited (Aureos) was established in July 2001 liquidity globally and the large China and Russia.

North as a joint venture between CDC Group plc, a UK amounts of capital coming from Americans appear to invest government-owned fund of funds, and Norfund, the (in particular) the energy supply much more in China than in Norwegian investment fund for Developing Countries, and centres —frankly Russia and the India. Europeans are more Aureos took on 139 portfolio companies with a book value of Middle East—we need to be interested in India than China. $72m. As at the end of April 2007 Aureos had effected 116 cognisant of those trends and What is more interesting about exits. The remaining 23 portfolio companies are valued at try and deliver people, capital, emerging markets is the rapid around $26.3m. The expected realised and unrealised cash know how and experience in change it is going through and multiple will be around 1.7 times book value. Aureos has also the global footprint for each of the opportunities it is generating sponsored and raised 10 new regional SME funds for the those sub-verticals. for investments. Seven to ten emerging markets with total capital commitments of $468m. years ago, there was no real local FRANCESCA: In Russia, there institutional capital investing in any private equity or any sort have been problems over the last few years with foreign of equity transactions in these markets. Today, the number of investors going in and then suddenly finding the local pension funds that are looking to invest in the alternative investment agreements have been nullified, either by local asset class in the wake of the reforms that are taking place oblast or the central government. When you are within the pension industry is releasing large sums of capital marshalling investments around the globe Tom, how into the local markets such as Peru, Colombia, etc. Pension mindful are you of local regulations and the protection that funds under management is increasing at a faster rate than local regulation gives you as an investor? they can sensibly invest it, fuelled by the high growth in their TOM: Very mindful. Our business model, which was developed own markets.Traditionally they have been allowed to invest in largely in the US market, is predicated on being a pick and their local stock markets and have done so, but now feel the shovel provider. Therefore, for us, 65% of our investment is in need to diversify their holdings and are investing in other enabling equipment or services. What you find in a place where markets in and around their region. It is not just in Asia. there is a strong national element to the ownership of Pension funds in Nigeria, for example, are being opened up; as commodity is that the technology of the service provider is the case in Kenya. There is so much money around that is becomes quite critical. It is much harder to disaggregate the not necessarily sourced in the developed markets that is service provider from an ownership perspective because they looking for a home, and what they are really looking for is good allow a national government, or a proprietary group to extract a quality managers to deploy this capital in emerging markets. commodity better. Therefore, if we are a technology leader in TOM: For us, it means more competition. Therefore, what we pipes, pumps or service or engineering, it is very hard to continually try to do is develop a more in-depth business displace that. In addition, there are a number of global model. We have found that our business model is reasonably companies that have business models that employ local scalable geographically. If you think about a grid, with energy workforces. Particularly in the energy sector, there is a global as a commodity on the vertical axis, with gas, coal, nuclear, shortage in engineering right now. In any of these places, such electricity, maybe renewables and carbon credits and then all as India, China, Russia, there are outstanding local engineers of the supply chain for each commodity on each horizontal that you can hire relatively inexpensively. Therefore, not only axis. That would encompass the upstream extraction and the can you be an enabler, but you can also be a local employer and development capital where the investment house doesn’t take a majority, but a minority stake of 20%, 30% or 40% alongside the owner and or other investors. Things are also much more carefully documented, debt being less prevalent than we have seen before, so a much more careful approach.

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relationships, it is easier to turn that allows you to gain a local it around. Our goal is to achieve footprint. In Russia, it is hard for the highest return from the them to displace Schlumberger investments we make and so for example – terrific company, our market focus up to now has global company, lots of local been domestic. In future, of employees and footprint, lots of course, that is likely to change. good technology. It is easier for them perhaps to alter ownership for an oil merger even if they CORPORATE have fantastic capability, GOVERNANCE although that is more related to the reserve and not necessarily FRANCESCA: What catalytic the enablement of the extraction role does an investor play of their minerals.Therefore in the Andres in bringing good oil sector we want to be more business practices into these focused on those services and high growth markets? equipment businesses, as it is less ANDRES: Corporate threatening and we pursue the governance and transparency same strategy in coal, in nuclear are not at the levels in emerging and in power in all those places. markets that you would expect TOM SIKORSKI, CHIEF EXECUTIVE, FIRST RESERVE A tradition LBO oil investor, in some more developed First Reserve is a private equity firm specialising in the energy either in developed or emerging markets. Transparency is a key industry with over $12.5bn under management and has markets likes a scalable, issue—both at the shareholder developed a franchise of investing exclusively in the energy leverageable, free cash flow and senior management level. industry. Since raising its initial pure buyout fund in 1992 business. What you find in the Essentially, you have to be First Reserve has completed over 60 principal transactions, energy sector is that the asset side comfortable with your partner. investing over $3.5bn in equity, with an aggregate total value tends to be at the commodity You can do the legal work, and of over $10bn. In addition, First Reserve portfolio companies level, whereas in the services or in some markets, for example in have completed another $5bn of acquisitions through more equipment sector, you get that Russia, it is more challenging than 225 add-on transactions.“First Reserve generally targets very scalable business. Therefore, because of the nature of the investments of $100m to $1bn in global energy companies with if we stick with the picks and legal system: but you have to enterprise values of $300m to $4bn,” says Sikorski. shovels, we get very scalable, know your partner no matter leverageable, recurring revenue, traditional LBO type assets. how legally protected you may be and no matter how high the SEV: No matter how good the investment is, if you have to expected return. Then, you embed in your valuation a risk pick it up you are in trouble. Therefore, the quality of the premium. We talk about risk/reward. We look at things on a relationship with local partners and entrepreneurs is key to risk adjusted basis. You can have an emerging market getting a good exit out of even a half performing investment. company with three or four times the growth of a comparable CANER: As a pension fund and with a mission to provide a company in the developed markets, but you have a risk high return for our members, that mission underlies all the premium that means you perhaps should invest at a lower investments we make. We have to know the company we multiple because you have a greater level of risk and therefore invest in well and have a good idea of the potential dividend require a larger margin of safety. Economically, this margin of stream we might expect to receive. Therefore, we have tended safety must cover all risks, political as well as economic. One to stay in our own country, as we know the market very well. of the ways we evaluate these risks is taking advantage of our As an example, two years ago we acquired the only flat steel global footprint. Russia is an example; we are one of the producer in Turkey. We paid $3bn for 52% of Erdemir. At that leading IPO underwriters in the market. We have been there time the market cap was a little bit more than $3bn (market for nearly 15 years and we have an established position in the cap to mean the total value of the company based on the share country, so it is easier for us to understand who we should be price the day we bought) which is not really the market value investing with and with whom we shouldn’t. However, we of that company—and we had to take that distinction into find that for our investments in emerging markets, such as account. Today it is $8bn. At the time we acquired the Russia and the Middle East, after we invest and we are on the company, there was some commotion that we had perhaps board, the board meetings run differently. There is much more paid too much for it. However, other major players had also an institutional feel as compared to the period prior to the been bidding for the company and we won it. If you know the investment. Once we are associated with the company, the company and what you can do with it, in a short time it can corporate governance practices improve and strategic players become a good investment. Last year we managed to give to who know we have invested in the company contact us our members, a 26% return (with inflation between 9% and because they want to talk to that company. Therefore, we are 10%). When you know a company and its people and business facilitating the integration of that company into a wider

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community within its industry and a wider community within its potential capital providers on a global basis. All that said, you need to be active. Even in a minority position, you need to be on the committees of the board and you need to know the management team and talk to them regularly. It is not a passive role, otherwise there is much more limited strategic and governance benefit.

FRANCESCA: Sev, Aureos is closely associated with the CDC Group, whose stated mission is to be a catalyst for growth of a domestic market. Is this really a bi-product of private equity in emerging market? Can you give any examples of this economic cascade and the knock on benefits of private equity investing?

SEV: We look to provide either growth capital: either acquisition financing to implement a“buy & build”strategy or management buy-outs or buy-ins. There isn’t sufficient depth in many emerging markets to scale up quickly. Therefore, with each investment you need to consider multiple markets within a region, in order to scale up your transactions. Moreover, you need to manage risks. There are several risks inherent in investing in emerging markets: currency risk, political risk, management risks for instance. It is imperative to understand before embarking on a transaction what those risks are as some of those risks will affect the company throughout the holding period.The approach we apply is that we have a pot of money and this money is going to be invested in 12 or 15 companies and each company is different and each company has its own risk return profile. On a portfolio basis therefore the risk is mitigated. Our investors are looking for a return at the fund level and not just individual portfolio company level.

However, there also intangible risks to consider. For example, we invested in the largest indigenous pharmaceutical company in one country in Africa. As we got into the transaction, there were real business principle issues, which had to be addressed up front and to be fair it was a disclosed up front.This is typical of family owned businesses in emerging markets. Managing that transition involved taking specialist advice, legal and accounting and from London and try to mitigate that risk.

Would we have paid a premium to listed entities or other comparables for that company? Not a chance. In fact, it is hardly ever do we pay a price that is less than 50% discount to listed comparables at entry.Today it is under consideration as a trade sale by a much bigger buyer from South Africa, who is only willing to buy that because over the last three or more years we have not only grown the company by a factor of three and put in place all the books, systems and board meeting minutes, etc in place. A clear value creation.

CANER: We have had similar experiences. First there are many companies in Turkey owned either by a family group or a person and most of them are not public. Transparency is sometimes an issue. For our group, we try to adhere to corporate governance principles as much as possible and don’t see it as an issue. Although we are not a public entity, we insist on all these measures because we believe in transparency and because of that, besides our financial strength, our ratings are high. We were the only group rated by both Moody’s and S&P. Our foreign currency ceiling is

higher than the sovereign ceiling. However, not all companies are doing the same thing. One development that will bring transparency and corporate governance to the fore is Basel II compliance. Once banks have to comply with Basel II they will force companies to have audits and ratings and the whole corporate scene will ultimately change. Companies looking for an investor or a strategic partner know that they have to change their way of doing things and operations and so, increasingly, companies are approaching auditors and announcing publicly their corporate governance guidelines.

JONATHAN: This was also the case with the early days of the venture capital and private equity market in Europe. The introduction of an external investor particularly an international investor introduces disciplines into a company that are similar, perhaps along a continuum, to an IPO. The company has to begin to professionalise and do things in the proper way. In an IPO you have to go further, but at least here it is on a flexible discussion basis, but it does begin to introduce that sort of discipline. In the early days of panEuropean investment, the problem was that German, French and UK accounting standards were completely different.

There was a famous case: I think it was of Daimler. Under German accounting standards they were making a huge profit and under UK and US accounting standards they were making something of a loss. So to all intents and purposes part of this debate must focus on whether there are proper international benchmarks for this kind of transparency.

FRANCESCA: Tom, because you are in such a high profile strategic sector, do you have a much easier time of it as Sev and Andres?

TOM: Not really. In a country that has nationally owned assets, transparency is always challenging, because disclosure is not as prescribed or required. In addition, even with the advent of IFRS accounting standards, reconciling accounting performance to cash on cash return is always a challenge. What we want to focus on is in some sense an arbitrage because there are historic depreciation or non-cash items that are embedded in accounting that do not always accurately reflect cash on cash return issues.

We are very process driven in our approach to this analysis. I appreciate the comments that Sev was making and for me, it was interesting listening to other investors in other markets. We try and copy others’ pattern recognition, because there is an algorithm, in every market, in sector processes and analytics that people bring. A lot of those are general and quite disciplined, but there are also some that are quite market specific and there are nuances that we are always focused on and in the energy sector it is no different.

ALL AISLES LEAD TO AN EXIT FRANCESCA: Is there a commonality in your business growth strategy that leads you to you exit strategy? For example, will the fact that you view a stock market listing as your exist strategy determine the kind of turnaround you might implement?

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in the banking business, but we There was some would not have made that level discussion earlier about relative of return for our members, and valuation in emerging markets so it made sense to exit. and it is the same in western Moreover, we can use that markets in our sector. If things money elsewhere to make are expensive, it may be cheaper better profits, therefore from to build than buy. Therefore, the our point of view this is a good initial ante of buying a company time to sell. In general, we have might have such a high valuation no special attachment to any of that if you just buy and hold you the companies in which we won’t make your returns. We do invest. These are objective have one eye on the exit, but the investment tools for us. In fact, key is the value creation strategy we tend to avoid establishing and perhaps that is embedded in an overly close relationship a control oriented philosophy. In with the companies that we a way we are always cognisant of invest in. Although we do have external forces, but if we do our some companies in which we job right we are creating value have been invested for a very somewhat independent of what long time. For example, we markets are. Particularly in the ANDRES RUBIO, EUROPEAN HEAD OF MORGAN have a joint venture with current environment we are STANLEY PRIVATE INVESTMENT. Renault – which is the best more focused on the‘build’side. I Morgan Stanley Principal Investments ("MSPI") invests selling car in Turkey and so, for say that in quotes because we do Morgan Stanley's capital in attractive return investments that the foreseeable future, no not want to take naked greenleverage Morgan Stanley's proprietary relationship network. matter what, we will stay with field risk, but we like having Recent MSPI investments include Moelnlycke Care Group AB, that shareholding structure. It things that need capital, that Grifols S. and US Oncology. Andres Rubio runs Morgan is a good partnership. need project work, that need add Stanley principal investments, which is a $3bn global on Sometimes it is very profitable, on capital, because the second balance sheet pool of capital, that is neither sector nor though profitability has varied, investment is usually a higher geographically focused.“By definition we look across geographies depending on the economic rate of return. On the exit side in and across sectors and we are generalists. In addition, I have a situation of the country. particular, our market has been particular interest in the European region,” says Rubio. busy and we have done eight JONATHAN: Perhaps a bigger IPOs in the last 18 months, all but one in western markets. We issue than whether you are grooming a company for a have one in emerging markets coming. It’s fun to have a broad trade sale or an IPO is a question of what the basic strategy access to the markets of the world through these kind of exits of the investor is in the first place. Of those firms around and it is why the large emerging company needs access to this table, three are investing their own money and Aureos someone like us, or someone who is broader and more is investing other people’s money that in itself doesn’t financial because they see it as a competitive tool to tap into really matter. But the traditional private equity model is global capital raising; because it is so much more liquid and that you are investing for capital gain, rather than for more powerful and you can expand that much more rapidly. income. That exit is critical. Some people criticise it for CANER: If I look back to the companies we have divested or being short term. In fact it is not short term, it is medium sold, we sold for two reasons. One, it was not profitable term, but there is a discipline there of going into a anymore, or there was saturation in the sector and the company, of grooming it to a particular stage and having company was no longer creating the dividends we were that stage happen and then moving on to something else, looking for. Moreover, we wanted to use that money rather than a long 20 or 30 year investment, where you are elsewhere for a better return. Second, the underlying waiting for annual income. That particular approach is a conditions in that market became too complicated, not very good thing. However, the horizon issue is a much comfortable any more. New entrants, either local or foreign, more critical issue and whether you are looking at carried came in making the company’s natural market much more interest for yourself and whether you are getting money competitive and complex. Invariably it means we would have back to investors and capital gain, rather than income. had to inject more money in a company than what we could FRANCESCA: Andres, are investment horizons in have gotten out of it. So it made sense to exit. Now, of course, emerging markets longer or shorter? a third reason is emerging: namely trade sales where it is more ANDRES: One needs to have the flexibility to be a longer term profitable to sell than to keep the investment. For example, we investor because you do go through a greater level of volatility. acquired a bank six years ago, for about $36,000 and we Historically, though to a lesser degree in the current crisis, signed a sales agreement with ING group, we are selling the when there are global capital squeezes, liquidity has dried out same bank for $2.7bn. It is good profit. We could have stayed in these markets more so than in developed markets. You have TOM:

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to be able to weather those storms and have the ability to extend the investment horizon if you need to. Ultimately if you have a medium to long term view of these markets, they are reasonably resilient. In the most recent credit squeeze these emerging markets appear to have decoupled partially from the rest of the world with strategic and financial activity remaining high. Their secular forces are that strong this time around as compared to past times of crisis. Even if there are extensions to your investment horizon due to any disruptions, these markets have proven to come back eventually to the point where you will be able to exit. Because we all have assumptions when we go into an investment to get our required return, we have to assume some level of theoretical timeframe as well as what will be the exit and what will be the value upon exit. For us, it depends, but we generally only like to rely on something that we can control. The public markets, for example, are observable, although you may have to wait awhile if there is some kind of disruption. Assuming acceptable markets, going public is within the Company’s control. A trade sale is something that we do not necessarily rely upon. They are generally done at a higher level than a public market, so if that materialises that is upside for all investors.

MANAGING INVESTOR EXPECTATIONS FRANCESCA: What kind of returns should limited partners or interested parties expect from investing in private equity, in comparison to investing either directly in the stock market or in sovereign or other types of debt?

TOM: I am still trying to calculate the return on Caner’s bank realisation! The energy wave has provided pretty good success for us and I appreciate the point on cycles in emerging markets. We also used to be in a cyclical business. It is not right at the moment, but it will be again, so from an investment horizon standpoint, we always invest with two cycles in mind, in case we screw up on the first one, and always with an eye to building value. On a base case western market return, we look at both IRR and multiple of invested capital because frankly our investors look at that and that is what we are paid upon.

So I would say, to use an average number in the western markets, it would be 25% IRRs and two and a half times your money in a kind of base case. In emerging markets, one would want to reflect a premium for that dependent upon the relative risk-adjusted returns on that basis.

ANDRES: We don’t have limited partners, it is the firm’s capital, but in western markets, it is generally the levels that Tom outlined and I do think that when we look at investing in emerging markets and when we look at investing in higher growth markets and higher growth situations there is definitely a required premium.

SEV: I have just spent half the week in the United States, talking to US investors about their expectations of investing in emerging market. Funnily enough, they are predicting that the returns from private equity investments in developed markets are on their way down to approximately 15% net return in average, whether this is true or not I have no idea but clearly there is a perception in the market place. This is the first time I

have heard that number, in the past I have heard people talking about 30% IRR and saying that it was impossible to get 30% in the emerging markets. The dynamics have changed in the developed markets vis-à-vis emerging markets regarding returns. Certainly in the small to mid cap area we take typically significant minority position in our investments, we are a generalist, not a specialist in any one sector, although we have certain sectors that we really do want to do, such as a financial services, construction and engineering, logistics, etc for instance. Our expectations in terms of net returns to the fund is in the high teens to low 20s. What are driving those returns?

Buying in at very good valuations, typically at three or four times max EBITDA multiples, and then add value by applying buy and build strategies and get uplift on the multiple as well as the earnings growth. We do listings as one of the primary exit routes, but we also get involved in trade sales. Because we are dealing with the small to mid cap and it is too risky to assume all your investments will achieve exit through IPOs and trade sale, we tend to structure our transactions such a way that during the holding period we get a strong yield and some capital back as a preferential and contractual cash flows. This essentially allows us to get our total, if not bulk of our, cost of our investment back through the internally generated cash, whilst mitigating our liquidity and currency risk.

CANER: We did not just buy the bank and six years later we sold it for some huge amount. Of course, during those six years there was a lot of effort put into changing the bank and the bank has changed a lot! It was a small bank with 11 branches.

Now it has 350 branches and it is the seventh largest private bank in Turkey. It has a good loan book and that is why the valuation was so high. The amount of capital injected into that bank to keep it running was quite substantial. To get to the answer about managing investor expectations: our investors, which are members of the armed forces inTurkey, have actually very high expectations. For the last seven years, the benchmark they have given us, was 20% percentage points higher than the rate of inflation and we have managed to achieve that. In a country where inflation rates are coming down and down every year, which means interest rates are coming down year on year, therefore the amount you invest and the amount you receive is coming down. It is not so easy to make that rate of return, so therefore you rely more on private equity where we hope that we can get a better return in terms of dividends.

FRANCESCA: Jonathan, on the capital formation side, are you seeing any changes in Europe in terms of the expectations that investors have of private equity.

JONATHAN: Yes and no. I guess what we are seeing are different formats: the traditional private equity format, the hedge fund format, and then either a new thing or a very old thing, which is sometimes called a permanent capital vehicle.

These apply to external fund raising, so there is also the question of when you have got something like your internal fund, whether that conforms to an internal discipline of trying to emulate a position if it were an external fund, you know, that is, what its time horizon is and what it is trying to achieve and how the incentive to the managers operate, the carried interest. What we do most of the time is set up private equity

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pots. Latin America, where some of the market policies have never been this good.

Domestic market demand is driving a lot of this growth and Mexico is a good example. The middle class population has grown by around 20m people in the last five years, the purchasing power of that domestic market is unbelievable: hence the huge potential. Moreover, Mexico’s growing second tier companies now look southwards for new NEW OPPORTUNITY business, in places such as Peru, Colombia and Central America.

ANDRES: The BRIC In Africa, Nigeria is very phenomenon is the one most interesting. South African talked about: but some very CANER ONER, CHIEF FINANCIAL OFFICER, OYAK GROUP companies that see saturation in interesting opportunities lie in OYAK is the largest second-tier, non-state pension fund and third their domestic market are now areas of EMEA, my primary area largest conglomerate in asset size, in Turkey. It is a pension fund looking north; to capture of focus. Western Europe still that invests and manages its assets as a private equity fund, yet market share and North African has, for a developed market, a operates as an industrial holdings company with strict companies are looking south significant amount of transparency and corporate governance standards.“We have especially the francophone consolidation, family 230,000 plus members from the armed forces. Everybody who countries in West Africa. They shareholder ownership issues carries a rank, either on the shoulder or on the arm is also have affiliations to the and emerging industries. automatically a member of OYAK. We control about 60 Middle East, as opposed to Eastern Europe and those companies and are among the largest groups in Turkey—certainly moving further south into the markets that lie on the edge of the most profitable group—and over the years with the rest of Africa. In Asia, India and the EU also provide interesting investments made in companies we have became a private equity China remain the driving opportunities. In these countries investor. Our assets at the end of last year were $4.7bn; we are factors, but are not the only one. you effectively have EU risk but looking at a balance sheet of $8bn in assets at the end of 2007, Vietnam is perhaps overblown at higher than EU average “says Oner. and there is potential for growth, creating an interesting arbitrage. In the case of Turkey, for example, there is the correction, but still it has 80m people, which is huge pent up medium/long term possibility of entering the EU. Turkey has demand. In central Asia, Kazakhstan is a story that has been done a fantastic job of stabilising the economy and kept quiet for too long. Growing at double digits for the last implementing structural reforms and has one of the youngest several years, it was the first country to pay off its entire IMF and most productive populations. The Middle East, with debt earlier. The Middle East is now becoming a centre for significant income generation resulting from the oil boom and cross border transactions and trade: Asia versus Africa and an unprecedented level of domestic investment, is in my some of the companies we deal with in Africa are setting up opinion underappreciated as an investment destination and offices in the Middle East in the hope of leveraging this trend. still, as widely reported, an important source of capital for It is the obvious place to be now. Dubai is fast becoming an investments globally. I view Africa as three distinct international financial centre. We see it as a conduit and geographies: North Africa, which essentially an extension of catalyst to add value to our portfolio companies in Africa and the Middle East, with Egypt and Libya most interesting and Asia in addition to raise significant capital for our funds.

Libya recently returning to the international community.Then CANER: In the past, privatisation projects offered opportunity. there is sub-Saharan Africa, which is very much a developing Now it is all about energy production and distribution. Real market: Nigeria of course being a very large economy that sits estate is another sector. Many companies are selling assets in in that geography that has tremendous economic potential logistics and tourism. In terms of markets, we were domestically (due to natural resource richness) and challenges (due to lack focused. We know the market and it is easier for us to operate. of transparency). Third, there is South Africa, which is a Now we believe it is time to look beyond the boundaries of developed market within a developing region. Each of these Turkey and if we do, we will rather look westward rather than geographies offer unique opportunities but the most attractive towards the east. We feel more comfortable working with opportunities are, in my opinion, most definitely in the higher western companies because of transparency issues, legal growth and emerging markets. infrastructure and corporate governance. Therefore, that is the SEV: I would split the emerging markets globally into three direction that we will move in. funds which would be transparent pools of money, usually with multi investors, sometimes with a single investor, existing to make a single stream of investments unleveraged at the fund level and drawn down as needed to make those investments.Then, as each investment is realised, the money is returned rather than being reinvested, so that the fund is self liquidating.

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AON: RESTRUCTURING FOR GROWTH

GETTING THE BEST OUT

OF CHANGE & CATASTROPHE Greg Case, president and CEO, Aon Corporation. Photograph kindly supplied

by Aon Corporation, December 2007.

The global insurance industry faces something of a market paradox. A period of relative respite in catastrophe losses through 2007, and stronger than expected property and casualty insurance sales, are factors expected to boost the insurance sector outlook in 2008 and 2009. Moreover, the crossover between insurance and the global capital markets will become even stronger through the coming twelve months. Even so, insurance mavens appear to expect flat—even negative—premium growth for the year. How timely then that in 2005 global insurance major Aon Corporation embarked upon a comprehensive three year makeover programme to help prepare the firm to best leverage impending changes in the global financial markets. The corporation’s third quarter 2007 results show a revenue uptick of 92% year on year.

Clever planning? Prescience, or sheer good luck?

Francesca Carnevale went to Chicago to find out.

S BENJAMIN DISRAELI repeatedly noted: “change is inevitable.”The Chicago headquartered Aon Corporation took Disraeli’s favourite chestnut to heart in late 2005, embarking on a three year restructuring programme involving the rationalisation of its 43,000 strong workforce, the sale of no longer core assets and a refocusing of its business sales and development model. It appears to be working. After a lacklustre 2006, Aon’s 2007 performance improved in proverbial leaps and bounds, culminating in a third-quarter 2007 profit increase of 92%. The

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uptick in Aon’s revenue is due to not only cost cutting, but also organic growth, with the company reporting an improvement of margins across the board, helped by growth in brokerage and insurance underwriting premiums and higher consulting fees.

According to the corporation’s third quarter 2007 financials, net income rose to $204m (or 64 cents per share), from $106m, (32 cents a share) on the same quarter in 2006. Profit from continuing operations more than doubled to $188m. Greg Case, Aon Corp’s president and chief executive officer explains the context.“The need to restructure was no one’s fault, rather it was a product of how Aon had been constructed over the years. You cannot always build and integrate at the same time. We understood clearly therefore that we had to reduce frictional costs. It was hard, yes, but we had a single focus, around which colleagues could begin to serve clients more effectively. That focus has allowed us to unleash the commercial energy in the firm.”

The corporation’s restructuring was propelled by three considerations: a belief that the firm’s risk management expertise would finally come into its own; an understanding that premium income would come under pressure for the near future; and a deliberate and strong focus on customer benefit. Over the last three years, Aon’s restructuring programme has involved the consolidation of functions such as personnel, finance and its worldwide information technology systems, as well as the streamlining of its real estate structure. The programme itself— though a constant process—has been carried out in two bulk rounds. The first began in November 2005, and involved the cutting of 3,600 jobs, incurring a $365m restructuring charge and resulting in

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$280m in annual savings as of the end of 2007. The second round was announced in the fall of last year, when Aon announced plans to cut 2,700 jobs (about 6.3% of its work force) in predominantly non-client facing roles, including the outsourcing of more than 1000 jobs. Aon expects savings of between $50m and $70m are achievable in 2008, rising to $175m to $200m next year and then $240m by 2010; though it will incur associated costs of $360m pre tax.

Some industry mavens posited that this latest round of restructuring was inevitable, as the company was not growing business fast enough to achieve significant margin expansion and Aon had to take aggressive action in the last quarter of 2007 to protect income over the medium term.

That may well have been the case. Even so, the corporation appears to be moving in the right direction. Aon’s stated aim has been to seek brokerage margins of at least 20% and while the July through September is a seasonally weak quarter, on an adjusted basis the corporation posted margins of 17.5%.

It is understandable that market watchers would take the latest round of restructuring to signal that Aon needed to continue to seek efficiencies to keep margins aloft. Through 2006 and 2007, the reasons for increased efficiency continued to be writ large.

Through 2006 and 2007, the insurance market itself appeared unremittingly softer than expected. Like New York-based Marsh & McLennan Co. Inc, its main insurance brokerage rival, Aon has been trying to sustain commissions as property and casualty insurance rates have fallen during the last two years. There were other problems as well to face.

Although the corporation’s first quarter 2007 results showed an 8% uptick in its Brokerage Americas unit on the same period a year before, first quarter 2006 had included a special charge of $6m related contingent commissions, which Aon’s brokers had received from insurers for steering business to them—in 2005, Aon had agreed to stop accepting contingent commissions as part of a regulatory settlement with the then New York Attorney General Eliot Spitzer.

In May 2007, Case told journalists that he expected insurance rates for products his brokers handle to decline between 10% and 20% through the year. As the largest insurance broker in the world, Aon helps companies find property and casualty insurance, reinsurance and legal liability coverage. Its business is dependent, in part, on commissions from these sales. The lower the rates, the smaller the commissions. Case noted that rates initially declined in casualty insurance, which covers companies against lawsuits, but were also down in property and catastrophe coverage.

Moreover, he noted that directors and officers insurance, which protects top company officials against shareholder suits for errors of judgment and wrongful acts, was becoming increasing competitive, with rates dropping by 20%.

Rates were also down for Aon Re, which helps property insurers get back up coverage in case of natural catastrophes, by as much as 20%, particularly for home coverage.

Aon made up the loss of commission revenue by retaining more of its clients and performing additional work for them, explains Case (Aon consults, for instance, for many of its

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Steve McGill, CEO of Aon Risk Services Americas and CEO of Aon Global. “Over the last decade, clients have demonstrated greater interest in our actuarial and risk modelling capabilities, which are valuable in helping those clients balance risk transfer with risk retention. Over the next 10 years, new risks will emerge, particularly in areas like reputational risk and in risks tied to outsourcing and/or investments again in emerging markets,” says McGill. Photograph kindly supplied by Aon Corporation, December 2007.

clients). Additionally, Aon began focusing on its financial risk management expertise. The rationale was obvious.“The top 20% of our client base are typically multinational, with a broad range of businesses and exposures and with captive insurance operations. These global clients are financially sophisticated and rely on Aon to design risk management programmes that utilise their capital efficiently,”notes Steve McGill, CEO of Aon Risk Services Americas and CEO of Aon Global. “Over the last decade, clients have demonstrated greater interest in our actuarial and risk modelling capabilities, which are valuable in helping those clients balance risk transfer with risk retention. Over the next 10 years, new risks will emerge, particularly in areas like reputational risk and in risks tied to outsourcing and/or investments again in emerging markets,”he adds.

Case acknowledges the drivers. For one, he says, “the insurance world is incredibly competitive and the client has substantial choice in its approach to insurance.” Moreover, Aon’s clients are increasingly focused on risk management as the global markets become more complex.“Look who is in our space,”notes Case,“private equity, the world’s biggest banks and financial institutions. We touch at least one third of what you see: one third of the global economy and so that market impact means something. We don’t change it, but we are in the business of helping our clients perform better.” The beauty is in the simplicity and cost effectiveness of building market share in the sector.“There are no barriers

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to entry,” notes Case.“What is important is understanding what our clients require and being really useful to them.

That means putting teams of people at the disposal of key clients, or individuals within a firm if necessary. You can then imagine how the business evolves.”

In the case of Aon, this also means offering human capital consulting to organizations around the world. Aon Consulting Worldwide develops retirement, health care, talent management programs and the like that are aligned with an organization’s business goals and drive toward productivity.

Andrew Appel joined Aon Consulting Worldwide as CEO in July 2005, and is leading the charge to deliver truly distinctive client value. “We are embedding value and innovation in every service we provide, which we believe gives us a significant advantage over our competition,” said Appel.

“Additionally, we’re developing a culture where this type of value-based thinking is prevalent as we serve and grow our existing client base and work to secure new business.”

In growing its overall market share, Case acknowledges that current market volatility plays into the corporation’s long term business aspirations. Managing risk will be a key note through this year and next,“The way we bring capability to our clients is evolving, though delivering value is at the core of every one of our activities,”stresses Case.“The overarching strategy is to build globally and then deliver locally.”

The application of that strategy is exemplified by its UK business, where Aon is relying on organic growth after two less than shining years. Aon's UK unit was hit hard by the contingent commissions agreement with Spitzer; performance of its local unit—the group's third largest regional business –suffered a downdraft. The unit has been brought back on track by slashing costs, including cutting hundreds of jobs and targeting new areas of business, such as high net-worth individuals, and which is among the corporation’s fastest-growing businesses. Intermediary services and risk management advice to UK-based global corporates, a market in which it has a 20%-plus market share is also on the rise. Small and medium-sized construction, media and technology firms“are key areas of growth”, while insurance services to affinity groups, such as unions, employer groups and hobby associations are also on the rise.“Our plan focuses on our competitive positioning; our growth levers; organisational effectiveness; performance management; and, leadership and behaviours,”notes Peter Harmer, CEO of Aon’s UK operations.“Our growth strategy has been very simple: we are very focused on ensuring we understand our clients’ riskbased needs in the context of their overall business objectives,” adds Harmer.

Roelof Hendricks, Aon’s CEO for Europe, Middle East and Africa is clear on what will create more value for its clients, commenting, “Our new business approach comprises three elements: winning new clients, crossselling services to existing clients and innovating new products and services for the market.”

Perhaps the strongest single reminder of Aon’s new focus came in mid-December 2007, when the corporation announced that it had signed definite agreements on the sale

of Combined Insurance Company of America (CICA) to ACE Limited for $2.4bn and Sterling Life Insurance Company (Sterling) to the Munich Re Group for $352m. [Additionally, Aon will enjoy a one-time cash dividend of $325m from CICA prior to the close of the transaction. Aon Capital Markets, Credit Suisse Securities (USA) LLC and Merrill Lynch & Co. acted as advisors on the separate transactions.]

The sale of Glenview, Illinois-based CICA is the largest of a US life insurer since Aviva Plc bought AmerUs Group Co. for $2.9bn in 2006. CICA has 4m policyholders and almost 7,000 sales agents and the deal will probably close by the end of the second quarter. ``We had tremendous interest across the board,”notes Case.

In effecting the sale, Aon is giving up the last vestige of its origins, which trace to W Clement Stone, a door-to-door insurance salesman who founded Combined Registry Co. in Chicago in 1922 with $100 in cash. Patrick Ryan, who succeeded Stone as chief executive officer in 1982 and now is Aon’s executive chairman, built the company into one of the world's largest insurance brokerages through a rapid and comprehensive succession of acquisitions. When Case left McKinsey & Co to take over from Ryan in 2005, he rapidly sold or closed some of Aon's insurer units, including ones that sold auto warranties and liability protection for construction projects in an effort to simplify the corporation’s global structure and exit the lowermargin and more capital-intensive insurance underwriting business. The current sell offs continue in that same strategic vein. As Case explains it,“Our core assets will now be more strategically aligned as we expand our capabilities to better serve our risk brokerage and consulting clients.”

Total after-tax cash proceeds and dividends are expected to be some $2.6bn, subject to final transaction costs. The funds are to be used, depending on “prevailing market conditions” to bolster an authorised share repurchase programme, worth $2.78bn. Aon had already repurchased 48.1m shares through 2006 and 2007, worth $1.82bn under a $2bn share repurchasing programme that had been authorised in November 2005 and increased a year later.

The Sterling transaction is expected to be completed by the end of March, while CICA’s sale should complete by June.

“At the same time, the increased share repurchase programme reflects our ongoing belief in the underlying positive momentum of the business,”adds Case.

The move is also in line with wider market trends, where the vast majority of the industry's profits in 2007 look to be reinvested back into the business. There is excess capital in the insurance industry today—estimated by some analysts to be as much as $100bn that is driving down returns on equity. Aon, like its insurance counterparts, in an effort to manage this impact is returning capital to shareholders in the form of increased dividend and share repurchases. In the wider context, analysts note that share repurchase activity in 2007 will shatter all previous records and could constitute a return of 4.5% to 5% of the industry’s capital to owners. [In fact, through the third quarter of 2007, $17.4bn in share repurchases had been transacted, a figure that is

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already 133% above the previous record of $7.1bn for all of 2006 and it is likely total share repurchases will have exceeded $20bn by the end of 2007.]

Profits continue to bolster the industry's policyholder surplus —a measure of claims paying capacity, or capital— providing an additional buffer against any natural catastrophes that may lie ahead. An improved capital position also helps insurers meet the higher capital requirements imposed on them by ratings agencies in the wake of Hurricane Katrina— requirements that oblige insurers to demonstrate an ability to pay claims arising from more than one major catastrophe per year in order to maintain and improve financial strength ratings. Actually, 2006 was a hurricane-free year, and there is now, reportedly an abundance of capital in the insurance industry. Catastrophe bonds and“sidecars,”which insurers use to get additional capacity, has added $8bn of liquidity to the market. Moreover, Florida's Hurricane Catastrophe Fund, a state-backed fund that increases property insurers' access to reinsurance coverage at below-market rates, freed up $14bn worth of reinsurance.“We have seen a block of new capital come into the reinsurance market and in such a climate as it, insurers will generally find sufficient capacity at the right terms,”says Ted Devine, chief executive of Aon Re. “This is a cyclical market and will always have cyclical characteristics. But I think the nature of the cycles have changed and will change going forward,” notes Case. The future looks much brighter from where Case sits in Chicago, casually mulling over industry trends. Further consolidation in the reinsurance industry is a given, he thinks, though is quiet in terms of how that may play out.

Aon currently is a rising star among the four major players in the reinsurance broking industry, namely Aon Corp, Marsh, Willis Group Holdings and Benfield; though only Benfield has been recently mooted as a possible acquisition target by either another reinsurer or a private equity player.

Analysts meantime expect the wider insurance industry's profitability to continue in 2008, albeit with an underwriting performance that will generate a moderately smaller underwriting profit, according to the results of the Insurance Information Institute's Earlybird Forecast 2008. Each year the survey reviews the prospects for the industry. This latest report moots that the continuing respite in catastrophe losses in 2007 combined with strong performances in virtually all major lines of property and casualty (P/C) insurance will propel the industry to another best performing year. The survey also shows that analysts uniformly expect premium growth in 2007 to come in below expectations while the outlook for 2008 remains completely flat to slightly negative.

This apparent paradox of strong profits but stagnant premium growth is a reminder of the highly cyclical nature of the property/casualty business and the fact that the industry's financial fortunes are determined by a myriad of factors.

Aon has been setting a pace for restructuring and a more rigorous market approach. Market players attribute this new discipline not only to the quality of leadership in the firm, but also to a number of external factors, including savvier investors, better technology and data to understand

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Ted Devine, chief executive of Aon Re.“We have seen a block of new capital come into the reinsurance market and in such a climate as it, insurers will generally find sufficient capacity at the right terms,” says Devine. Photograph kindly supplied by Aon Corporation, December 2007.

Peter Harmer, CEO of Aon’s UK operations.“Our growth strategy has been very simple: we are very focused on ensuring we understand our clients’ risk-based needs in the context of their overall business objectives,”says Harmer. Photograph kindly supplied by Aon Corporation, December 2007.

exposures as well as greater scrutiny from investors, analysts and regulators. Credit rating agencies, for instance, which play a crucial role in the insurance and reinsurance businesses, are also seen as having taken a far more active role in monitoring company behaviour, industry players say.

The industry is also facing some regulatory risks. In the US, for instance, some states continue to attack the right of insurers to use certain well-established underwriting criteria.

That said, insurers such as Aon will need to come to carefully manage a variety of challenges unrelated to catastrophe losses, including increasing price pressure, slow growth and the legal, legislative and regulatory environments, all of which could erode underwriting performance and profitability in the year ahead. For the time being Case is sanguine.“Much of what we have invested in over the last three years is value accretion.That’s because our business ultimately rests on the value of our team and what they can bring in terms of real benefit to our client. I am not talking about the Chicago team, but our global team. The great thing about Aon is the tremendous opportunity that it is providing to our clients and shareholders, particularly with a market that is now playing to our strengths.”

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US FUND ADMINISTRATION

UND ADMINISTRATION IN the United States is in its cups, with high-end providers fueled for further expansion as client investment strategies become increasingly complex and international. They are also sitting pretty as merger activity among the industry’s toptier players continued to shape the asset-servicing business during 2007 and set the pace of new service provision, harnessing business flow into the hands of fewer players.

The year that began with the Bank of New York’s acquisition of Mellon Financial Corp was quickly followed

by State Street Corp’s purchase of Boston-based Investors Financial Services Corp (the holding company for Investors Bank & Trust), a leading hedge-fund administrator. Not to be outdone, in May Citi joined the fray by acquiring the Investment Services Division of Bisys Group for $1.45bn, giving Citi itself a major leg-up in the hedge fund and private-equity field.

An increasingly complex investment climate, coupled with demands for greater transparency, has only strengthened the case for outsourcing among investment managers, which in turn continues to boost the fortunes of the industry’s leading administrators. However, realism must and will always collide with optimism. As the sub prime debt crisis continues to erode stock prices and dampen investor sentiment in the United States, all major fund administrators agree that the current level of revenue streams is something that cannot be taken for granted. In that light, further market consolidation is inevitable.

The strategy of purchasing boutique or “bolt-on” fundservicing businesses distinguishes JPMorgan from its peers while enabling the company to build out its core product suite, says Mark Kelley, senior vice president and head of JPMorgan Worldwide Securities Services’ fund services business in the US. JPMorgan’s acquisition of Integrated Investment Services (IIS), the Cincinnati-based fund accounting, administration and transfer-agency business, is the most recent example of such a“capability-based”pick-up.

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Alan Greene, executive vice president and head of State Street’s US mutual fund servicing business, something that cannot be underestimated in today’s market. “A lot of the growth opportunities for management companies in particular are outside the US, especially in areas [such as] Europe and Asia,” offers Greene.

Photograph kindly supplied by State Street, December 2007.

A BETTER CASE FOR FUND ADMINISTRATORS In spite of recent market turbulence, demand for administration services, from US mutual funds to private equity and hedge funds, remains unusually buoyant, as investment managers continue to see the benefits of outsourcing a host of operations in order to meet their objectives. For the industry’s leading fund administrators, that is a very bullish sign. Dave Simons reports from Boston.

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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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Penelope Biggs, executive vice-president and head of worldwide business development for asset servicing at Northern Trust.“Because we have not had the result of multiple mergers, integrations and acquisitions, we tend to have a more holistic approach to the holding and processing of assets,” says Biggs. Photograph kindly provided by Northern Trust, December 2007.

“As our customers’ needs continue to evolve, we need to make sure that we are able to properly service them,” says Kelley. “So when we see the industry moving in a certain direction—say, towards derivatives and hedge-fund servicing, as it did beginning a few years ago—we assess own infrastructure and decide whether we have all the tools necessary to handle that business, or whether there’s an acquisition solution that can address those needs in a costefficient manner. Our book of business is already robust— don’t look to do deals purely to achieve scale. Our goal is to continue to build a set of capabilities that we can package with our existing products, and in turn create solutions for customers that are multi-faceted and can handle not only the services and needs of their current book of business, but in turn where they want to go with it over the near-term.”

The evolution of fund administration has been marked by a pronounced shift towards highly complex information systems, the likes of which include JPMorgan’s ACCESS web-based Treasury & Securities Services management system, which offers self-service access to a wide range of trust, custody, trade and cash-management information.“The old style of providing data to customers just won’t cut it anymore,”says Kelley.“A system such as ours provides a view of the total portfolio ranging from fund performance to compliance and regulatory requirements, allowing the customer to more accurately measure the portfolio on a broader spectrum. Being part of JPMorgan’s global franchise gives us the resources to invest heavily in technology.”

State Street’s purchase of IBT in February 2007 gave the company top ranking in the hedge-fund administration business, a position it has since bolstered with the acquisition of Palmeri Fund Administrators (PFA), a New Jersey-based provider of fund administration services to the private equity industry. Partnering with State Street gives customers of the acquired firm a global reach, says Alan Greene, executive vice

Mark Kelley, senior vice president and head of JPMorgan Worldwide Securities Services’ fund services business in the US. JPMorgan’s acquisition of Integrated Investment Services (IIS), the Cincinnatibased fund accounting, administration and transfer-agency business, is the most recent example of such a “capability-based” pick-up.“As our customers’ needs continue to evolve, we need to make sure that we are able to properly service them,” says Kelley.

president and head of State Street’s US mutual fund servicing business, something that cannot be underestimated in today’s market. “A lot of the growth opportunities for management companies in particular are outside the US, especially in areas [such as] Europe and Asia,”offers Greene.

With consolidation continuing to whittle away at margins and creating intense competitive pressure, staying focused on the core asset-servicing business is key to survival, says Greene. “As our business has grown more capital intensive and complex, it becomes much more challenging to be all things to everybody. It forces us to really focus on our strategic advantages as a global service provider.”

Merge—or move over Greene agrees that the level of complexity driving today’s market—from the hedge-like strategies of 130/30 funds to the derivative instruments of 40 ACT funds—requires copious amounts of technology-based capital, putting the pressure on the field of leading providers to join forces or lose business. “It costs a fair amount to get these developments built, and if you have a large asset base, you have some pretty important unit-cost advantages.” By comparison, those without proper scale may find it necessary to cut corners, defer them, or ultimately look for a partner, says Greene.

Rumours of potential suitors notwithstanding, Chicagobased Northern Trust has to date maintained its independence, and, according to Penelope Biggs, Northern Trust’s executive vice-president and head of worldwide business development for asset servicing, is better off for it.

“Because we have not had the result of multiple mergers, integrations and acquisitions, we tend to have a more holistic approach to the holding and processing of assets,”says Biggs.

“Scale, or ability to compete, does not necessarily relate to

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Marina Lewin, managing director and head of relationship management and business development in the alternative investment services unit of The Bank of New York Mellon. “Everything that has happened over the last six months has put a focus on how the industry is operating, particularly with regard to performance risk.

Increased reporting requirements, as well as the need for independence, has clearly been accelerating as a result of the recent hiccups in the market,” notes Lewin. Photograph kindly supplied by The Bank of New York Mellon, December 2007.

how big you are—it is how effectively you use your resources.

What we have seen, particularly when people are looking for a service such as administration, is that they do not just want a process. They want something value-added around the service. In addition, as long as we maintain that single, global operating model, we can derive an economy of scale even while delivering custom solutions. Which is quite a different perspective compared to some of the other providers.”

The need for transparency that has been amplified as a result of the credit-market crisis underscores the importance of maintaining an independent administrative body, says Marina Lewin, managing director and head of relationship management and business development in the alternative investment services unit of Bank of New York Mellon. “Everything that has happened over the last six months has put a focus on how the industry is operating, particularly with regard to performance risk.

Increased reporting requirements, as well as the need for independence, has clearly been accelerating as a result of the recent hiccups in the market.”Yet even with the recent turbulence, Lewin still sees extraordinary levels of investor activity within the hedge-fund sector.“I think this is all very healthy, and in the end it will have a positive impact on the administration space and the industry will continue to evolve and mature.”

Northern Trust’s Biggs agrees that the market for administration services, from US registered funds to hedge

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T Andrew Smith, managing director and head of North America securities and fund services at Citigroup, considers the tremendous flow of pension fund and endowment allocations into the alternative space a particularly bullish sign. “There are so many hedge-fund strategies to choose from, from equity and debt, to currency, markets, segments of business—it is almost unlimited where you can go,” says Smith. Photograph kindly supplied by Citigroup, December 2007.

funds and private equity funds, remains unusually buoyant in spite of the sub prime tremors. Biggs attributes this to a range of factors including new funds being launched, reviews due to growth and changes in strategy, as well as the overwhelming trend towards consolidation of administration providers. “As a result, it is a very exciting time, particularly in the US and European markets,”she says.

While prime brokerages have attracted their share of hedge fund outsourcing business, Biggs detects that, in times of discomfort, managers often gravitate towards more traditional entities for safekeeping and administration of their assets.“Prime brokers have a huge strength in so many areas, no doubt, but safekeeping may not always be closest to their hearts. It is times like these when the track-record of a proven conservative asset servicing entity becomes that much more attractive.”

T Andrew Smith, managing director and head of North America securities and fund services at Citigroup, considers the tremendous flow of pension fund and endowment allocations into the alternative space a particularly bullish sign. “There are so many hedge-fund strategies to choose from, from equity and debt, to currency, markets, segments of business—it is almost unlimited where you can go,”says Smith. At the same time downside risk has increased dramatically, as was revealed last summer when Bostonbased hedge fund Sowood Capital collapsed overnight, taking with it billions in endowment capital. “Obviously there is a constant need to control such risk,”says Smith. If anything, he says, such events, though unfortunate,

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SECURITIES SERVICES

increase the need for diversification and transparency.“As a result, the markets are much better equipped to withstand these isolated fund implosions.”

How much is too much?

Though State Street has a history of making good on its major investments, the company’s offer of just over $65 a share for IBT was a bit too rich for some analysts, who have questioned the cost-effectiveness of such major acquisitions. Jay Hooley, vice chairman and head of global

THE RISE OF THE PURE PLAY ADMINISTRATOR You simply cannot escape Newton’s third law of physics and every action has an equal and opposite reaction even in the arcane world of fund administration and accounting. As merger activity consolidates mass business in the hands of global players providing scale and multiple service platforms, a raft of high specialised (or pure play) fund administration providers are also making their mark. Not all are discrete scale operations; others are backed by large banks.

The alternative space is clearly a continued area of growth, and the recent merger activity in the assetservicing arena speaks volumes for the lengths that administrators are willing to go to in order to boost their standing in the hedge-fund world. The purchase of Investors Bank & Trust (IBT) by State Street helped narrow the field of pure-play hedge-fund administrators, and helped raise the profile of companies such as Spectrum Global Fund Administration, a provider of middle and back office outsourcing and administration solutions to hedge funds and fund of funds. Spectrum currently maintains a client roster of 110 funds with $33bn under administration.

Last fall Spectrum, which has locations around the globe, made news when it decided to move its Bangalore, India workforce stateside to its offices in Chicago and Columbus, Ohio. According to Spectrum president Ron Suber, the move was prompted in part by communications and accuracy issues. “It is clearly a trend,” says Suber. “We were fortunate to find a team of people who had the right experience and expertise, which allowed us to move the production functions of the financial reporting and reconciliation back to the US.” Domestic firms with offshore operations have been feeling the impact on revenues from the continued decline in US currency, and Spectrum was no different; in the last five years alone, the dollar has tumbled 20% against the Indian rupee. “And because our expenses were in rupee, there was a severe currency mismatch, and our margins were declining,” notes Suber. “Since we have been back, we have been contacted by other administrators who are experiencing the same problem, asking how they too

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investment servicing and investment research and trading at State Street, defended the deal, saying,“The business is extremely competitive right now, and therefore we needed to take a very aggressive approach. However, we are highly confident in our ability to transition the customer relationships and get the cost synergies to our target level.

As such, I feel very comfortable with the price that we paid for IBT and that it will return a smart dividend to customers, shareholders and employees.”

Maintaining a competitive edge using top-tier technology

can move their business back to the US.” Suber does not believe we have seen the last of the big mergers involving top-shelf administrators. “I think there is another wave of consolidations coming—the smaller firms do not have the technology to compete, and the bigger funds at the smaller firms are leaving, all of which makes it very difficult to be an administrator with under $10bn these days. The major investors are really allocating towards the top 200 funds, and as a result, the opportunity for smaller funds to grow using institutional money has dramatically declined.”

Of course, not everyone enjoys being shuttled from one merged company to the next and may decide to move on. Such defections represent ripe opportunities for the likes of Spectrum, post-consolidation. “Some funds do not necessarily like the idea of being with a large institution, and since they have to change anyway, they would rather make the change of their choice,” says Suber. Spectrum has recently begun giving select clients direct access to its proprietary technology, the Virtual Back Office (VBO), which facilitates all financial-reporting, general-ledger, portfolio-accounting, reconciliation, over the counter (OTC) processing, pricing and investor-servicing functions. “This new offering, coupled with the fact that we have capacity at a time when there’s not a lot in the industry, puts us in a very good position.”

Chicago’s LaSalle Global Fund Services, is another pure play fund administration business which, buoyed by growing demand in a specialised space, established a European foothold by setting up an alternative fund administration business in Dublin in March 2007. Although La Salle Fund Services itself is a full service provider with custody, banking and

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systems while expanding one’s global reach may require a constant need for scale, says Citi’s Smith. Still, at the end of the day, it all comes down to the process—and, most importantly, the people. “The Bisys play wasn’t completely about technology—it brought us some scale and size, yes, but most importantly it brought us some really good, smart people, who grew up in this industry and who came aboard with the right DNA, if you will. It was a great acquisition for us, and it has been a very smooth integration.”

What is next for those who are trying to make a go of it selling

the likes of transfer agency, fund accounting and fund administration without such supplemental services as custody and settlement?“There are those who probably won’t be longterm survivors unless they do some soul-searching and ask themselves,‘Is this really the place we want to be?’”says Smith.

“At this point, I don’t think there are any serious competitors who don’t have scale.Which is not to say that they cannot carve out a niche for themselves and have plenty of satisfied clients; because it is not always about the numbers, it is about the people. But it’s not getting any easier to make that happen.”

treasury services as well as administration. By September, it had extended its presence in Europe by securing an operating licence for its Jersey operation to service locally domiciled hedge funds and other alternative investment vehicles. “We have an experienced team backed by LaSalle Bank, which is recognised globally for its position in providing trustee services for commercial mortgage-backed securities and collateralised debt obligations (CDOs) explains Dublin-based Morgan Downey, managing director of LaSalle Global Fund Services in Europe: “Now the first half dozen clients are on board. The demand is certainly out there and by opening our offices in Dublin and Jersey, we are meeting the expectations of the alternative investment industry here.”

The firm’s team in Jersey is headed by managing director Michael Rothwell, who previously was in charge of Invesco International’s operation on the island, a role in which he developed an operational platform with fund administration, private client, transfer agency and client servicing capabilities.

Rothwell was also responsible for Invesco’s Luxembourg management company. Downey’s fund administration expertise was honed at Fortis.

Downey is fully focused on the opportunities for business growth in both Dublin and Jersey, which he notes are popular locations for investment managers using CDOs and asset-backed securities; particularly in the wake of the sub prime crisis. Equally, Downey notes continued opportunity for specialist fund administration services for these instruments from existing clients, along with the continued appeal of both jurisdictions for alternative investment funds of funds and property funds. “Simply we can handle smaller specialist funds more efficiently and because of the bank’s particular expertise in the CDO market, we can handle complex credit funds.” In 2008, the company also plans to launch operations in Guernsey and in Asia, “probably later in the year,” says Downey.

The Channel Islands have enjoyed an impressive run of success in recent years, promoting themselves heavily as domiciles of choice for the still booming alternative funds market. The introduction of the Expert Fund Guide in Jersey—quickly emulated by

Qualifying Investor Funds (QIF) in Guernsey are initiatives which opened the door to a raft of new business from private equity, property and hedge fund and alternative asset promoters and fund administration specialists such as LaSalle.

According to Downey, however, the benefits of working with the firm are not simply locally based: “we have the backing of LaSalle’s extensive CDO and asset backed administration businesses in Chicago, London and Mexico. Dublin is now the European hub of this new wave of business growth.”

Chicago-based LaSalle Bank, which until recently was owned by ABN Amro was a key subject of a legal tussle between Bank of America and the consortium headed by Royal Bank of Scotland that successful bid to acquire the Dutch-based banking group.

LaSalle Bank’s Global Securities and Trust Services has served as trustee, custodian or agent on more than $1.5trn in assets, offering the global capital markets securitisation trustee and agency services, corporate trust, institutional custody and escrow services. Parent company LaSalle Bank meantime, has some $73bn in assets and $44bn in deposits and LaSalle Bank Corporation, also headquartered in Chicago, has more than $118.3bn in assets. As we all now know, Bank of America won the fight for LaSalle, though right now in the initial days of the acquisition, Downey says it is too early to see how the bank’s new owner will ultimately influence either LaSalle’s Global Fund Services business in general and the offshore fund administration business in Dublin and Jersey in particular but that “hopefully there will be synergies we can leverage. It will give us the backing of a global player, while still providing the high touch of a smaller outfit,” Downey explains.

Even the current credit crisis cannot dampen Downey’s optimism. “Truthfully, up to now we have not been affected by it. In part, that is because of the demand out there. New funds are springing up all the time, some of which will take advantage of the marking down of prices of assets in existing funds. And while there is certainly a lot of marking down, the underlying problem is not as bad as the market is pricing it.”

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OUTSOURCING: A WIDER CHOICE

The outsourcing of back and middle office services has suddenly become much, much more complex.

Component outsourcing has moved up a level and in doing so has taken on a completely new meaning as asset allocation strategies become more sophisticated and increasingly absorb a wider array of “alternative” investments. As service providers offer an ever more generous menu of services, the choice on offer for clients has never been so good. How do clients now choose between service providers and how do service providers ensure that they capture the most profitable business lines? Lynn Strongin Dodds highlights the new relationship patterns emerging between client and securities service providers.

Tony Solway, head of BNP Paribas Securities Services, explains that, “In today’s world, I think it is highly unusual for a major asset manager to have all its arrangements with one provider.

The fund manager is likely to use two to three different securities service providers because there is recognition that no one firm can offer all services across every geographical location.”The stakes for providers have been raised over the past two years due to regulatory and accounting changes that have sharpened the pension fund industry’s focus on better matching liabilities and asset.

Photograph kindly supplied by BNP Paribas, December 2007.

THE I APPEAL OF HIGHER MARGIN MENUS

T WAS NOT too long ago that the end-to-end lift out model of outsourcing was all the rage in asset management circles. Today, thanks to an increasingly complex investment landscape, fund managers are opting for a more component based approach. The challenge for securities service providers—especially the top brass—is to capture as much of the higher margin business as possible.

Daron Pearce, head of relationship management, Europe, Middle East and Africa within BNY Mellon Asset Servicing, notes: “Asset managers are still going to their main securities service providers, but we are definitely seeing a shift away from the one stop shop strategy. Overall, they are looking for a more a modular based architecture versus the full soup to nuts proposition.”

Tony Solway, head of BNP Paribas Securities Services, adds, “In today’s world, I think it is highly unusual for a major asset manager to have all its arrangements with one provider. The fund manager is likely to use two to three different securities service providers because there is recognition that no one firm can offer all services across

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every geographical location.”The stakes for providers have been raised over the past two years due to regulatory and accounting changes, which have sharpened the pension fund industry’s focus on better matching liabilities and asset. In addition, the introduction of the Undertakings for the Collective Investment of Transferable Securities (UCITS) III has opened the door to the use of derivatives.

As a result, asset management groups have increasingly added over the counter (OTC) derivatives to their portfolio mix as well as alternative asset classes, such as private equity, hedge funds, property, currencies and commodities. In addition, some are taking tentative steps towards liability driven investment strategies and increasing their intake of structured products such as long/short funds, capital protected, equity linked notes and total return swaps.

The product currently causing the most stir is the 130/30 fund which typically involves putting 100% into an index and selling short 30% in stocks expected to under perform the market. The proceeds from the short sales are then used to go long on stocks likely to beat the index. Grappling with the back and middle office burdens of these newer instruments is no easy task. Many traditional managers, particularly those entering the OTC derivatives fray or the alternative world for the first time, do not have the have the appropriate systems and processes to handle these investment strategies. Not surprisingly, asset managers across the spectrum are taking stock of both their operational needs as well as their providers.“In this brave new world, there is a clear challenge—making everything work together seamlessly for the client,” says John Lockbaum, head, North America Service Delivery for RBC Dexia Investor Services. “Clients and their administrators need to work in partnership to build solutions that are flexible enough to handle the growing number of asset classes and instrument types, especially those involved OTC transactions or structured products.”

As James Hockley, a principal in the operations practice at Investit, a UK-based investment consultancy, notes,“There has been a huge blurring between the traditional and alternative asset management products which has resulted in securities service firms having to service a much broader asset class range. What we are now seeing is fund managers reassessing the future state of their operating model to decide which functions are part of their value proposition and which ones they can (and should) outsource.”

Historically, asset managers have handed over their back office activities, such as custody and fund accounting, while keeping middle office capabilities in house. However, most of the previous deals focused on cash products and did not take into account the shift into more illiquid or complex instruments, many of which require specialist capabilities. This is especially true of OTC derivatives, which can prove to be the most challenging because they are not easy to process or value.

For example, unlike the traditional exchange traded or listed products, these instruments are negotiated trader to trader and their valuations are derived from sophisticated pricing models.

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Jez Bezant, head of business management, at Morley Fund Management, explains,“When the outsourcing deal was first struck OTC derivatives were not an issue, but volumes have been creeping up.

The problem is that they can be manually intensive and we realised that our existing systems, built for exchange traded contracts, were not going to cope with the increase in OTC contracts. We decided to work with JPMorgan to develop a process and now they do everything including collateral and independent valuations.” Photograph kindly supplied by Morley Fund Management, December 2007.

Naturally, fund managers turned to their administrators for help, although reportedly many were disappointed by the level and quality of service across the different geographical locations. There was a general criticism that asset securities service firms had not kept pace with technological developments. They did not seem to possess the scaleable prowess for derivatives, for instance, that they offered for their three main instruments—cash, equities and fixed income.

According to Jim Connor, partner and investment management and systems specialist at UK based consultancy Morse,“In some cases, the fund management group found that the relationship with its custodian did not fulfil all of its needs, particularly in the area of derivatives processing. This does not mean, however, that they are now throwing out their provider, but instead turning to more to specialist firms for certain middle office functions such as derivatives pricing, collateral management, hedge fund administration, and in some cases client reporting or specialist performance/risk measurement.”

For example, in the derivatives space, players such as Statpro, Proforma and SS&C Technologies have carved out a name in performance measurement while Fundworks

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James Hockley, a principal in the operations practice at Investit, a UK based investment consultancy, notes,“There has been a huge blurring between the traditional and alternative asset management products which has resulted in securities service firms having to service a much broader asset class range. What we are now seeing is fund managers reassessing the future state of their operating model to decide which functions are part of their value proposition and which ones they can (and should) outsource.” Photograph kindly supplied by Investit, December 2007.

and Kurtosys are known for client reporting. As for independent pricing, Markit and Superderivatives are industry leaders while Swapswire and DTCC DerivServ are noted for trade confirmations. Many specialists have also capitalised on the derivatives boom by strengthening their product reach. Recently, GlobeOp Financial Services launched its GoOTC service as a standalone outsourced package for OTC derivatives trade processing. It was previously only available as part of GlobeOp’s integrated middle and back-office service, but now the package is available to all firms trading in OTC derivatives.

It was only a matter of time, though, before the major securities service contenders raised their game, developing new tools and procedures to take account of new operational and risk management challenges presented by more complex investment strategies. Products are the mainstays, but suddenly solutions became the buzzword with the larger providers hoping to cater to most of their client’s demands.

Some firms such as BNY and Mellon have joined forces to become a global powerhouse while others have acquired niche firms to plug the gaps. They all offer lift out services as well as component outsourcing but the name of the game is to ensure that the more profitable, higher margin components are neatly packaged with the commoditised custody and fund accounting products. As Toby Glaysher,

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head of Northern Trust’s Global Fund Services (GFS) group for the UK, notes,“It is not as profitable to offer standalone services by themselves. It makes more sense to bundle services that fit together.”Lockbaum adds,“Style convergence is an ongoing challenge to the market. Managers no longer fit into neat little boxes—retail, wholesale, traditional, alternative, etc. Administrators have to construct a service model that cuts across every investment style and product for any market, because that is what global investors expect.”

The technology, of course, is crucial but relationships are key. Pearce of BNY Mellon observes,“One of the challenges for securities service firms is to have as broad a set of products as possible and to generate enough revenue so as to continue to develop these capabilities. The important thing is to keep up to date with the needs of our clients and to be able to offer solutions for every part of the trade lifecycle this allows our clients to pick and choose the product set which best fits their needs.” Hockley concurs, adding, “The key objective for the larger players is to capture as much of the value chain as possible. If they have a good relationship with a client then they will be able to sell more services. This is why we have seen the big boys buying specialists to bolt onto their platforms.”

Most recently, Citi purchased Bisys for its hedge fund and private equity offering, while State Street purchased Investors Financial Services to sharpen its hedge fund acumen. Other firms have made their own internal adjustments to bolster their capabilities. Take JPMorgan.

The US bank decided to merge the operations units of its investment bank and its worldwide securities services business together under a shared management team. The rationale is that it would offer customers the benefits of scale, greater capacity for growth and the ability to leverage its model to provide a better service.

In the meantime, other custodians have not gone down the niche acquisition trail but are using specialist capabilities to enhance their overall package, according to David Marlborough, director of business consultancy at BCS Group, a UK based financial services firm. “Many of the traditional custodians made the strategic decision not to do their own valuations because they do not have the technology or sufficient skills set to do the work. In addition, some were concerned how it would affect the independence of their fund accounting services. As a result, they are using firms such as Standard and Poor’s or Markit because that is where expertise lies.”

Northern Trust and State Street chose Markit Group as their preferred provider of valuations for OTC derivative valuations and other complex instruments. Markit’s tailored service provides independent post-trade calculation of the gross asset value of a portfolio of OTC derivatives trades. Valuations are provided for both vanilla and exotic instruments, and the service is adjusted to Markit’s proprietary data, which is gleaned from over 75 leading market makers.

Simon Pilkington, of State Street Investor Services, says,“In the financial service industry, there are always larger players

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prime broker and we work with and boutique firms that offer our custodian in order to get the more bespoke services. I do not best service and execution. Our see a firm [such as] Markit as a business is fund management competitor but more as a and if it isn’t part of our core complement to our existing business then we will outsource services. We see ourselves as a the function. This is our global service provider with a philosophy not only for wide product range but we are derivatives but across the asset not a one-stop shop. The type of class spectrum.” outsourcing depends on the In the meantime, Fortis client and the type of relationship Investments decided to expand that we have with them.”Morley its derivatives reach but it did Fund Management, for example, not possess the administrative turned to JPMorgan Securities infrastructure to handle all the Services about 18 months ago to requirements. Keith Rake, the handle its burgeoning use of firm’s chief operating officer, derivatives. The fund manager notes, “In line with the had already contracted out its tremendous growth in our back office functions to the US derivatives business, we have firm four years ago and decided it made a significant investment did not want to make the in our OTC processing and substantial investment needed to technology infrastructure over upgrade both their systems and the last year. However, when we people. Jez Bezant, head of Daron Pearce, head of relationship management, Europe, needed to launch the 130/30 business management, at Morley Middle East and Africa within BNY Mellon Asset product early in the year, this Fund Management, explains, Servicing, notes: “Asset managers are still going to their was still a work in progress and “When the outsourcing deal was main securities service providers, but we are definitely so we decided to use a prime first struck OTC derivatives were seeing a shift away from the one stop shop strategy. Overall, broker - Merrill Lynch. One of not an issue, but volumes have they are looking for a more a modular based architecture the problems with this kind of been creeping up. The problem is versus the full soup to nuts proposition.” Photograph kindly component outsourcing is that that they can be manually supplied by The Bank of New York Mellon, December 2007. you need to be able to integrate intensive and we realised that our existing systems, built for exchange traded contracts, were not one or more providers seamlessly into your front to back going to cope with the increase in OTC contracts. We decided workflow. We were able to do this and the resultant rapid to work with JPMorgan to develop a process and now they do time to market made it worthwhile,”Rake says.

However, not all institutions are endowed with these everything including collateral and independent valuations.”

BlackRock, on the other hand, has decided to choose resources, which perhaps explain why the smaller to medium sized firms another route and it tend to use one or two employs at least three to custodians for all their four asset securities Most recently, Citi purchased Bisys for its needs while the larger providers for different hedge fund and private equity offering, while fund manager who aspects of its business, State Street purchased Investors Financial have the internal according to Tony resources, might use to Stenning, managing Services to sharpen its hedge fund acumen. three to four providers. director of BlackRock’s Other firms have made their own internal The typically operate on unit trust business for adjustments to bolster their capabilities. Take a hub and spoke model UK retail. For example, JPMorgan.

The US bank decided to merge the with the custodians on the over the counter operations units of its investment bank and its providing the core back derivates front, the fund office functions with manager uses Lehman worldwide securities services business niche players offering as its prime broker and together under a shared management team. the specialist services.

BNY Mellon, as its The rationale is that it would offer customers Going forward this is custodian while the benefits of scale, greater capacity for likely to change as the conducting valuations growth and the ability to leverage its model to top contenders either itself. “The prices are provide a better service. buys or build those based on the information value add products. we receive from the

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DISTRIBUTION SUPPORT OUTSOURCING

THE EMERGING ASIAN MODEL OF FUND DISTRIBUTION The largely European drive towards higher levels of automation of funds processing has never travelled to the Far East. Faxes, paper instructions still dominate in the market as the standard method of communication. Simon Shapland, of RBC Dexia Investor Services explains why global asset managers need to take a fresh approach to fund sales if they want to win in Asia.

He posits a global operating model, which begins with the critical transfer agency function, which he notes is vital if managers want to distribute funds effectively through the region.

OTHING HURTS FUND managers more than having to return money to potential investors.

Turning away clients is not only bad for business; it also goes against all the instincts of the professional asset gatherer.Yet, the management team at the China Southern Fund Management Company could probably afford to be philosophical when they recently had to return more than $2.5bn to unsuccessful applicants for its first qualified domestic institutional investor (QDII) fund, which enables Chinese domestic investors to gain access to overseas stock markets.

The massive reimbursement exercise recently undertaken

by China Southern Fund Management Company goes some way to illustrate the potential offered by China and other markets in greater Asia. Attracted by the region’s fertile and indeed febrile markets, it is no wonder leading asset managers are lining up to capture their own share of the expanding wallets of Asia’s investing classes.

Acting as sub-advisers to fund such as China’s QDIIs is one way of getting a foothold in the region. Another strategy is to structure offshore UCITs III funds, domiciled in Luxembourg or Dublin that will appeal to Asian investors. In some markets that approach has already been successful. According to research by the Association of the Luxembourg Fund Industry (ALFI), more than two-thirds of all fund authorised by the Securities and Futures Commission in Hong Kong are UCITs III funds, with the vast majority based in Luxembourg or Dublin.

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The growth challenge However, the rush to capitalise on the enormous potential within Asia has come at a price. As a highly fragmented region in which each market has its own regulatory environment, tax regime, reporting requirements, trading conventions, customs and practices, there are no economies of scale and few opportunities to replicate operating models

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across multiple jurisdictions. Every time a manager enters a new market, it is with a clean sheet of paper.

Add to this the fact that the largely European drive towards higher levels of automation of funds processing has never travelled further east, with faxes and paper instructions still predominant as the preferred (or at least available) method of communication. With that observation in mind, it is not hard to see why the opportunities to prosper in the region can be severely dented by the costs and risks of manual processing.

As trade volumes from Asia have exploded (Taiwan, for example, has recorded year on year increases in offshore investment outflows of 150%) the processing and operational challenges are mounting in tandem. A model that can handle 50 trades per day is unlikely to be able to handle a tenfold increase in volumes unless it is scalable, robust and linked electronically to all parties in the trade processing chain. As managers see their volume rising in Asia, they all face the same challenge, which leads them to ask: why are we in the processing business, when the core competency of an investment fund is asset management?

The question has been asked before, in different circumstances, most obviously when asset managers began to outsource their back and middle offices to specialist service providers. However, the challenges presented in Asia are different. What managers operating in the region require is support with implementation of their distribution strategies. They want and need to roll out new products in diverse markets as quickly and as painlessly as possible, gaining critical competitive advantage in doing so.

Historically, the structure of Asian distribution models has been fragmented and inefficient. This is in good part because global money managers have not had the expertise to deal with the broad range of working conditions in the region, including: • A manual processing environment

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The era of distribution support • Different cultural approaches to has arrived think a growing asset management number of asset servicing • Language barriers providers. In turn, asset managers • Varying time-zones want to understand how they can • Variations in local service quality be helped in their efforts to break • Different regulatory requirements into new markets. Asset • Cost of establishing discrete managers now expect as a matter operating models of course to outsource all the • Sub-optimal trade and cash underlying administrative work flow channels to third parties that can deliver • Multiple operating platforms the expertise, systems, scale and • Fragmented data provision local presence to streamline their Asia is therefore a test-bed for resource commitments. what is being described as a Essentially, the outsourcing of second wave of outsourcing. distribution support should allow Global asset managers realise the manager to set a high level that, with rising volumes and Simon Shapland, head of sales and relationship outline of the objectives and increasing market liberalisation, management, UK & Middle East, RBC Dexia requirements of the fund and they must deploy an operating Investor Services. Photograph kindly supplied by deploy local or regional sales model that maximises their sales RBC Dexia Investor Services, December 2007. resources. They can then delegate opportunities while minimising their exposure to operational risk and process failure. They many of the other tasks to their distribution support provider. need to allocate their resources as effectively as possible by The provider’s responsibilities can go much further than the implementing distribution strategies that deliver broad transfer agency role; incorporating functions such as fee jurisdictional and product coverage without the cost and negotiations with local promoters, tax management, order processing and confirmation, corporate actions and management burden of a heavy infrastructure.

To do this they will have a sales and client management administration, through to the drafting of investment team on the ground and, wherever possible, will outsource management agreements and prospectuses. The service most of the local administrative and operational functions range can also include liaising with regulators and, ultimately, to a third party. Using a local partner with specific market project management of the launch of new products. knowledge and contacts not only saves money, it also improves time-to-market for new product launches as A work in progress legal and regulatory issues are addressed more rapidly, Changing the status quo is never simple or easy. What leveraging the partner’s extensive local expertise. cannot be ignored is the significant gap between what managers can achieve by themselves and what they can achieve with the support of service providers that can Building a global model For this type of arrangement to be fully effective, the genuinely deliver a global solution. The global/local model distribution support model needs to be global in scope. It must has to be the most effective means of closing that gap and offer the benefits of scale and standardisation as well as having tacking the Asian opportunity head on. The potential for the facility to focus on the intricacies and wrinkles of each local growth in the region can only be realised if the underlying market. Deploying single country distribution support foundations for asset management are sufficiently robust. solutions will negate their value, as managers will still be left In that situation, asset managers can begin to enjoy the real with the significant challenge of aggregating disparate sources benefits of a global architecture, including: of data that may each require a high degree of manipulation • Reduced cost from harmonised operational processes before they can be usefully viewed by management, • Increased efficiency throughout the trade life cycle compliance, operational and client service teams.

• Reduced risk through automation and standardisation The global operating model, which begins with the • Upgraded service quality resulting from consolidated critical function of transfer agency, is vital for those data management managers that want to distribute funds across Asia. Not • Heightened awareness of cultural nuances and local only does the global model provide the benefits of a single, practices consolidated data feed, but also it enables managers to Are we there yet? It is fair to say that construction of the interact with a wide variety of distribution channels. As optimal model is still a work in progress. Asset managers and Asian investors begin to fully exercise their knowledge and their service providers are still feeling their way as they become buying power, they will use a number of different media for more comfortable with distribution support outsourcing. Even access to funds, with open architecture and the rise of fund so, Asia provides the opportunity for both sides to work platforms leading to a more complex trade order routing together on an exciting new development. For those teams and processing chain. that get it right, substantial rewards are in near reach.

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COLLATERAL MANAGEMENT

Photograph supplied by istockphoto.com, December 2007.

SPOTLIGHT IN THE

The recent upheaval in financial markets has dragged collateral management out of the closet on to centre stage. As the credit markets have unravelled, the purported benefit of structured debt instruments—the dispersion of risk to those most willing to accept it—became a fatal weakness. Particularly when participants realised they had no idea who had what exposure to potential losses from sub prime mortgages and leveraged loans. In a knee-jerk reaction, money market lenders shortened duration and everyone took a long hard look at whether they held adequate collateral to mitigate counterparty credit risk. Neil O’Hara highlights the role of collateral in keeping the credit and derivatives markets sane.

OLLATERAL MANAGEMENT HAD already migrated from an arcane back office function to the middle office as the volume of collateralised agreements ballooned. The International Swaps and Derivatives Association (ISDA) 2007 Margin Survey reported $1.33trn of collateral in use at year end 2006, a third more than the $1trn in place three years earlier. The number of collateralised agreements rose two and a half times, from 54,000 to 133,000, over the same period.

Despite the growing use of collateral, ISDA found only 59% of respondents’derivative transactions are covered by collateral agreements and 59% of mark to market credit exposures are secured. Robert Pickel, chief executive officer of ISDA, says that collateral usage and awareness are on the rise. He notes that some market participants collateralise fully while others are willing to trade with creditworthy entities on a fully or partially unsecured basis, including sovereign borrowers; government sponsored entities such as Fannie Mae and Freddie Mac; and

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supra-national entities such as the World Bank.

The numbers understate unsecured credit risk because collateral does not afford protection unless the counterparty takes possession of it. Helen Bramley, product director of risk solutions at Lombard Risk, a London-based provider of collateral management and trading software, points out that although ISDA’s standard credit support annex provides for daily margin calls counterparties often don’t bother to exercise that right.

Or didn’t, until the credit crunch hit. But when they tried to enforce collateral provisions to the letter, some Lombard clients encountered resistance.“The pricing of collateral has always been an issue,” Bramley says,“Some counterparties abuse the difference in valuations as an excuse to stall.”The collateral value is not in doubt. Some 75% to 80% is cash and the rest is mostly G7 government bonds—but if the secured assets include illiquid securities there is room for disagreement, legitimate or otherwise. Players who duck margin calls soon get a bad reputation, so the market tends to police itself against miscreants. In fast markets, though, the potential for genuine disputes escalates because no two firms use exactly the same pricing model for every product.

Bramley says ISDA is working to develop standards but the industry has wrestled with the problem for years.

Lombard’s COLLINE® Collateral Management product automates the work flow associated with collateral agreements. Clients enter the economic terms of every trade, the software calculates margin calls based on pricing feeds for each asset class, notifies the counterparties and then books the tickets. It’s a huge boon for active players, who no longer spend all day just calculating where they are by hand. Not surprisingly, Lombard has seen renewed interest in its product in recent months, including some prospects that had previously opted to stick with their existing manual processes.

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Dealers are also under pressure to automate collateral management from hedge fund clients and others who are pressing for cross-product margin capability to optimise their use of capital. Bramley points out that collateral management evolved as a back office chore at independent trading desks handling repos, OTC derivatives and stock lending, each of which built systems to meet their own requirements without regard to others’needs. Incompatible legacy software has bedevilled industry efforts to satisfy buy-side demands for integrated margin calculations as a result. ISDA’s Pickel says the big dealers are now moving to centralise collateral management across the whole firm, integrating management of collateral used for bilateral swaps, collateralised debt obligations and securities lending. The new structure not only improves capital allocation at the dealers but also facilitates their crossproduct margin capabilities.

Dealers have to address legal obstacles to centralised collateral management, though. For historical and regulatory reasons, the major securities houses have used separate legal entities as counterparties for different trades; for example, a subsidiary in the United States may book domestic trades while foreign subsidiaries handle clients in Europe and Asia. Different entities may handle different products, too.

Susan Hinko, managing director for industry relations at London-based TriOptima, says that although firms can offer cross-product margin if the same legal entity acts as counterparty they typically can not do it across multiple entities. TriOptima supplies post-trade processing solutions tailored to the financial services industry, including triResolve, a portfolio reconciliation tool designed for collateral management. The service tackles a major source of valuation disputes: counterparties who calculate margin calls based on different trade populations.

Hinko says market participants often wait until they have a dispute before they try to find the discrepancies, and the party that owes money has little incentive to rush. In a fast market, the party that made the original call might find the shoe is on the other foot before the reconciliation is completed, too. “There are shifting incentives in a reactive situation,” Hinko says,“A lot of times dealers will just split the difference.” triResolve takes a proactive approach. The parties reconcile their positions once a week so they only have to look at incremental trades to identify any differences in population. The web-based system also flags inconsistencies in trade terms and valuations so that counterparties can focus on problem trades rather than having to review the entire population from scratch. Hinko says triResolve’s management reports proved a big help to clients during the credit crisis, too. “Credit departments and senior management could see what the positions and exposures were,”she says,“It gave them a lot of comfort.”

Efforts to automate trade processing have reduced trade population disputes as well, according to ISDA’s Pickel. For example, the Depository Trust and Clearing Corporation’s

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James Malgieri, managing director, global product manager for global collateral management at The Bank of New York Mellon. Lenders still willing to take private label ABS with a big haircut are looking for high yields, too, which is why ABS collateral hasn’t altogether disappeared. “The lender is going to get compensated for that risk by the borrower,” Malgieri says. Photograph kindly supplied by The Bank of New York Mellon, December 2007.

(DTCC’s) matching service for credit default swaps and SwapsWire’s affirmation service for interest rate swaps have eliminated most of the paperwork backlog that threatened to swamp dealers in 2005.

Pickel says market practices have become more rigorous since the Long Term Capital Management (LTCM) debacle in 1998 so that parties mark to market every day even if they do not always call for collateral.“Firms monitor how the positions fluctuate over time and therefore when a counterparty calls for collateral it is not a surprise,”Pickel says.

Michael Bryant, managing director of London-based risk management consultants InteDelta, notes that trade population discrepancies are easier to resolve than pricing disputes. It is a question of fact whether a trade took place between two counterparties, after all; and although Bryant says agreements are sometimes ambiguous as to which types of transactions are covered the parties almost always arrive at an outcome satisfactory to both.

Mark to market disputes are another matter, of course.

The final decision rests with whichever party is designated the calculation agent under a collateral agreement.“A lot of these assets are very difficult to value,” Bryant says, “It is handy to be calculation agent in times like this.” The uncertainty over pricing that leads to disputes has plagued

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banks’ and analysts’ efforts to put hard numbers on potential credit losses in the current crisis, too. As securities linked to sub prime mortgages plunged to levels never contemplated by stress testing models, lenders hiked both margin requirements and haircuts for illiquid instruments, particularly for hedge fund clients. The enforced deleveraging pushed a few funds over the edge but Bryant says most funds that shut down did so in orderly liquidations that left collateral creditors whole.

There were exceptions, of course. Two hedge funds run by Bear Stearns that imploded lost their entire equity value, which left unsecured creditors in the lurch and probably hurt some secured lenders too, because hedge fund financing is almost all collateralised. Although lenders have tightened credit standards, the exponential growth in collateral agreements is likely to continue.

Collateral proved its value again this year, as it did in 1998 when LTCM failed. Any losses secured lenders do incur will be far lower than they would have been without collateral support. The pending Basel II regulatory capital framework gives banks a strong incentive to favour secured lending, too.

Bryant points out that once banks establish a robust collateral management infrastructure the marginal cost of adding new agreements is negligible.“The motivation is to put more and more transactions under ISDA credit support annexes,”he says.

Times of crisis tend to bring more business to triparty collateral managers as well. In the first half of 2007 the cash repo market was so inundated with money that spreads shrank to unprecedented levels and participants lowered their standards for acceptable collateral. That all changed in August, when spreads blew out and term repo—seven days to one month—disappeared as the market refused to accept longer maturities. Although counterparty risk was a concern, James Malgieri, managing director, global product manager for global collateral management at The Bank of New York Mellon, says it wasn’t the main event.

“If they do that trade for a week or a month they can’t change the collateral eligibility requirements during the life of that trade,” he says,“That’s why the market moved to overnight.”

Some cash lenders no longer accept private label asset backed securities (ABS) as collateral and those that do have increased the haircuts on ABS to boost their protection against loss in the event of default. As a result, triparty collateral managers are seeing more requests from borrowers to put up equities as collateral. Lenders still willing to take private label ABS with a big haircut are looking for high yields, too, which is why ABS collateral hasn’t altogether disappeared.“The lender is going to get compensated for that risk by the borrower,” Malgieri says. Triparty collateral managers see the shortened maturity, higher haircuts and tighter collateral requirements as a natural response to the credit crunch and a return to a more rational market.

Participants may be nervous but they haven’t panicked, either. It’s a market in which good relationships between dealers and cash lenders pay off. Aggressive players who

Robert Pickel, chief executive officer of ISDA, says that collateral usage and awareness are on the rise. He notes that some market participants collateralise fully while others are willing to trade with creditworthy entities on a fully or partially unsecured basis, including sovereign borrowers; government sponsored entities like Fannie Mae and Freddie Mac; and supra-national entities such as the World Bank. Photograph kindly supplied by ISDA, December 2007.

chisel for every last basis point are more likely to find counterparties reluctant to trade with them.

The Bank of New York Mellon has a small but growing presence in collateral management for OTC derivatives, too. Malgieri says business has ticked up as firms that in the past have not taken collateral against derivatives rethink their policy. In some cases, the credit crunch accelerated plans already on the drawing board. Clients and prospects who needed to look at collateral management anyway for Basel II are stepping up to the plate today. In triparty repo programmes, collateral providers pay a fee based on assets in the program but cash lenders get a free ride. The market evolved that way 25 years ago because the borrowers—mostly the big securities dealers—needed an incentive to wean cash lenders away from bilateral delivery repo. The model has not changed, although fees have dropped as volumes have grown and the business became commoditised. New asset classes command a premium price, at least in the early years. For example, triparty asset managers charge higher fees for an equity repo book than for fixed income to cover the software development costs and data feeds that are more expensive for equities than treasuries. Equity repo looks set for rapid growth as dealers unable to raise cash against private label ABS—or unwilling to pay the price—look for other ways to liquefy their balance sheets. As the old proverb has it: it is an ill wind that blows no good. The “some good” is that the carnage from the credit crisis has left collateral managers poised for future growth.

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2008 THOUGHT LEADERSHIP ROUNDTABLE SERIES

SHAPING THE FUTURE OF US TRANSITION MANAGEMENT

The PANEL:

Sponsored by

CAROL A McFATE, chief investment officer, Xerox JAMES G CASHMAN, director, Mellon Transition Management Services WILLIAM D STUSH, director, Transition Management, Merrill Lynch Global Markets & Investment Banking KAL BASSILY, CFA, managing director and global head of BNY Global Transition Management.

PAUL G SACHS, Mercer Investment Consulting MATTHEW E STROUD, practice leader, greater New York, Watson Wyatt Investment Consulting

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MARKET OVERVIEW KAL BASSILY: One of the characteristics of the US market is a very high level of understanding on the part of asset owners of the transition process; what goes into effecting a transition; what goes into measuring the overall transition cost on a pretrade and a post trade basis. We did not see this three or four years ago. Asset owners know exactly what they expect and we no longer hear the question:“What does opportunity cost mean?”You might get the question: “How do you measure it?” However, there is consensus among most providers on the measurement of the different components of transition costs. Consultants in particular have done a very good job with asset owners, explaining the processes involved in a transition. Additionally, we have also noted the trend to constitute transition management panels; a trend that we think will accelerate on the public funds side of the business MATTHEW STROUD: We also note improving literacy. It is vital, as transitions are becoming more complex, driven in part by regulatory changes in the US that are having an impact on a number of qualified plans. Fixed income transitions are also more prevalent, though they present unique difficulties that perhaps many sponsors may not have seen much of the in past. Therefore, improving literacy is all to the good. We have not seen quite as much of the panel activity, as Kal has done, largely because one-to-one relationships are more typical in the corporate fund sector, than the public fund arena.

JAMIE CASHMAN: There is also heightened competition—especially at the higher end of the market.

As well as putting together transition management panels, these multi-billion dollar funds also look to bid out their transitions, for one-off situations. At the smaller end of the market— in terms of asset size—there has been a wider adoption of transition management among foundations and endowments, corporates, and smaller public and county plans, which several years ago might not have even considered transition management.

FRANCESCA: Carol you did a mega-transition some time back.

How difficult was it to choose the right transition manager?

CAROL McFATE: We transitioned $3.6bn out of a $5bn defined contribution/401(k) plan. Any plan sponsor will always say that their situation is unique. However, ours was especially unique! XEROX decided to outsource its plan investment management five/six years ago and our manager of managers decided to discontinue its fund offerings to the defined contribution marketplace, creating an urgent need to in-source the investment management of those assets. We did not have much legacy in-house experience with transitions and we had to come up to speed extraordinarily quickly as we had only seven months or so to complete the transition. We had a very short period to determine how we were going to take this suite of investment alternatives (which was a little dated) and update it to provide a good, complete and prudent selection for plan participants. Moreover, we only had a threeday window (black-out period) in which to accomplish the transition of all of these funds. As a result, we hired an investment consultancy and worked with their internal

JAMES G CASHMAN, director, Mellon Transition Management Services Photograph supplied by Berlinguer Ltd, December 2007.

person— who works exclusively on transitions— to help us navigate this complex process. We needed their expert guidance because it was something that had not been done by the company for a long time and the company’s investment committee was naturally nervous, given the size of the transition and the short period of time in which we needed to execute. We received excellent advice and in the end, it was a good experience. It required a tremendous amount of coordination—I wouldn’t want to call it micro-management— but there was a need to focus on many minute details. At the end of the day, it all worked probably about as well as it could have, but it was a breathtaking process.

PAUL SACHS: Collectively, the industry and its customers have a much better comprehension of the transition business now, which is reflected in improved transparency and vocabulary that is more standard. What helped that along is common agreement on using implementation shortfall as the evaluation framework. Moreover, if I look at the distribution of bids we would receive in a‘cost and risk discovery’three years ago, low-to-high might have been a range of 20 basis points (bps), which is huge. Today, we frequently see low-to-high in a range of 6bps. This clearly indicates that providers and their processes have become more competitive. On the client side, not only have they moved beyond looking solely at explicit costs such as commission, today the general recognition is that opportunity cost (market risk) is the single biggest factor that can make or break a transition. Controlling risk during a transition is now the number one priority, on the provider side and the client side.

CAROL: This was a world with which I had no familiarity until I moved into this job. You had to look at the issues in terms of people, their experience, and your confidence that

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they could execute well on your behalf. There was a legacy investment bank attached to the transition manager selected. We had to look for areas of potential conflict and examine their experience. We also recognised that no one had done a defined contribution transition recently, let alone a transaction worth $3.6bn. It was a fairly Herculean task.

Frankly, I did not realise how monumental an undertaking it would be when I joined the company. It was a tremendous amount to accomplish in a very short period of time.

FRANCESCA: Does any of what Carol says resonate with you?

BILL STUSH: It all resonates. What I am impressed by on the sponsor side is what Carol described in terms of the decision making process. Clients are looking deeper than just explicit costs when evaluating proposals—which is something we probably all appreciate. However, choosing the right transition manager is a challenge for them, because of the legacy relationships they might have, relationships they might be beginning, custodial considerations, and issues such as pricing models to consider. There are many factors involved in making that choice. Clients are fully aware of these issues and are cognisant of the factors are that important to them. They are making their evaluations based on all these factors and not just looking at commission, or impact or spread, or record keeping. They are looking at the bigger picture. It’s an advantage and it is incumbent on to all of us to be able to demonstrate what we can bring to the table to help them.

CAROL McFATE, chief financial officer, Xerox Corporation Photograph supplied by Berlinguer Ltd, December 2007.

FOR LOVE, MONEY & SERVICES? KAL: As asset owners better understand the nature of costs

and how to measure cost, it is forcing providers to be very competitive. However, there are certain things where it does not apply. You cannot be competitive on, say, the fee that you charge. However when you talk about implicit cost, market impact, or opportunity cost, you find it in a very tight range but I wouldn’t say it is competitiveness that is driving that: rather, it is the level of comprehension out there.

JAMIE: I would certainly imagine that, in a transition like the one Paul was contemplating, if you have a range of costs that are separated by 6bps, then the decision is not solely being made on whomever is the lowest cost provider. When there is some level of cost parity amongst the different providers then there is the question of what else can they provide, such as project management or operational support, for example. Part of that is being driven by the growing level of knowledge amongst stakeholders: whether it is consulting firms or the asset owners. There is also a greater acceptance that transition management is often times a prudent instrument to help plans to make the shift from A to B. Today, the business is often about the services that providers offer, rather than the relative merits of using a transition manager in the first place.

FRANCESCA: Carol. For you was it a case of ‘deliver me this new structure of fund relationships?’or was it more than that?

CAROL: It was much more than that. Given that we were working with defined contribution money, which is

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participant money, the fiduciary standard to which you hold yourself, is rather high. You want to have your provider be cost competitive. You want transparency. You want an understanding of what is happening at every step of the process and concur with the way the transition is being managed. In our case, recognising that we had a bit of learning to do in terms of this particular topic, the advice that we got from our investment consultant was particularly valuable. What they did for us was take a similar portfolio to the one we owned, and effectively bid it out blind, so nobody knew that it was us, to get a sense of the what the cost dynamics would be. However, there were other soft factors around that. You want somebody who is going to be there shoulder to shoulder with you as a fiduciary, effectively to feel like they are in your shoes. You need to know they are going to be as careful as you would be with those funds, making sure that you have market exposure during the transition, and effectively you are doing the best possible job to try to makes sure that the participants’ money is well managed and fully invested during the period.

FRANCESCA: Bill, how does what Carol says apply to you in practice?

BILL: Clients see the benefit of somebody standing shoulder to shoulder with them, rather than treating the process as a transaction, or as an adversary. That is why we use the term partner or collaborator and why we focus on achieving our client’s goals. Whether you are looking at fiduciary issues, pre-trade costs or some of the operational needs such as

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valuation and blackouts for 401(k)-plans, it is vital that there is an evolution of metrics.You can talk to Paul about the way they look at their business.You can talk to Carol and talk to her consultant about what they were looking at. I am sure it’s no different with other firms. We benchmark transactions we do for our own clients, for our own trading, for transitions and we are using tools that are now available to everybody – and which are not unique to transition management. There are so many ways you can gather information now.

However, what clients see, and Kal and Jamie will back me up on this, transitions are now about partnership—one that we hope is long lasting and might lead to other opportunities through the development of a discussion.

PAUL: One of Bill’s points concerns the dramatic evolution of trading. We did a round of due diligence visits earlier this month just because trading technology has changed so much. Technological innovation needs to be taken into account. Looking at the big picture, for the average transition, explicit costs are something like 25% of total cost, and the remaining 75% are implicit costs, which are affected by trading technology. Unsurprisingly, we see about 75% of evaluation decisions come down to factors that do not involve explicit cost. The decision points may be implicit costs, they may have to do with the risk exposure, or they may have to do with some of the soft functions that Carol was talking about that could be essential to a client’s transition.

MARKET TURBULENCE & TRANSITIONS FRANCESCA: How have the last turbulent few months

impacted on your business?

JAMIE: We have been blessed to live in interesting times. It

has really made our jobs—having to solve all sorts of challenging investment problems—really invigorating. On the quantitative side, the recent environment has presented some issues. Like many of the people around this table, we use multi-factor models for estimating transition costs. In virtually all of these models, volatility is a key input into determining what the expected transition cost is going to be. In markets that are jumping around like this, you need to have sensitivity as to how that input is being incorporated into the rest of the model; and whether a model that is using historical volatility that has gone back 60 days or so, is appropriate in this kind of environment.

Likewise, it has forced us all to re-examine the models that we are using, not only on the pre-trade side but also in real-time as each transition is unfolding. On the qualitative side, it has presented another challenge in that this business to a certain degree has always been about communication. There are lots of moving parts and lots of stakeholders (custodians, investment managers asset owners, and consultants) involved. Within an environment like this, communication a few times a day may not be sufficient. You may have to be talking to the investment managers much more frequently as circumstances dictate.

We had a recent situation where a stock on a target manager’s buy list opened down 20%. Naturally, you have

WILLIAM D STUSH, director, transition management, Merrill Lynch.

Photograph supplied by Berlinguer Ltd, December 2007.

to ask: “Do you still want to own this stock?” rather than blindly follow a mechanical trading programme.

MATTHEW: Broadly speaking, what we see is an increasing robustness in the fiduciary oversight process. Market volatility during 2001 and 2002 and then in the more recent past, as well as the legal and regulatory environment, has had an effect. We live in a world now where we are being asked questions in terms of manager selection. Clients want to understand who is a better fit with their needs and objectives more than they ever did before: rather than just deferring completely with a recommendation.They really want to understand how you get from A to Z. From a process point of view, while clients now understand the process they also want to articulate to their board what they did, why they did it and how it went.

MEASURING THE IMPACT OF MARKET COMPLEXITY FRANCESCA: Kal, do you think that as markets become

more complex, only those players that can provide an extensive range of services will ultimately dominate or control the transition management?

KAL: Players that will add value going forward are those that understand that the number one job of a transition manager is risk management. The market volatility of the last few months has taught us all that risk management is key. That is not to say that project management is not important, it is; communication is very important, but we have to take those as given and what we really want to focus on as providers is to manage the risk during the implementation period. Jamie talked earlier about stocks opening down or up 20% and how

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you should react to that. A transition is not a discrete event in the life of a pension fund, it is one point on that investment process continuum and whatever happens, while you are carrying out the transition it does impact on the investment performance of the whole fund. So you have to pay attention to risk, you have to measure it right and you have to manage it right, introducing hedge tools, be that futures or index option, or how fast you can access liquidity and what kind of algorithms you use to implement your transition.

JAMIE: The one thing that I would say to that Kal is that there is a slight danger in characterising risk management solely as quantitative in nature; i.e. only managing the risk of the tracking error in portfolios. There is also management of operational risk, especially in defined contribution transitions, that has got to be integrated in the whole process. I could not agree with you more that this business is fundamentally about risk management, however, it is a comprehensive risk management. In certain transitions, the high risk of that transition is because of the high tracking error between portfolio strategies or illiquid securities that present a quantitative problem. However, in certain other transitions— such as a multi-billion dollar defined contribution transition with a three day blackout— that is operational risk that no multi-factor model is going to be able to help you solve!

However, it is no less important to the success of the transition.

We have had clients that have come to us and told us that it doesn’t matter what the implementation shortfall might be, if the transition screws up their accounting, it was not successful.

We need to take a more holistic view of what risk management is and be able to deliver solutions that address all sides of this.

PAUL: For a sponsor such as Carol, both investment risk and operational risk translate into reputational risk, which is a huge exposure for many investors. You do need to take a broad view of transition managers, even into such things as the organisational stability of the parent organisation. There are nine major categories that we are looking at when we look at transitions, and only one of them is execution.

BILL: People are asking those nine questions and more.

Now clients spend as much time on evaluating the service as they do everything else. We have not done anything new.

Yes, we have new algorithms and new techniques, but it is the evaluation process, it is what Matthew and Paul bring to it. Everyone is now collaborating to get all the right information out in the open.

MATTHEW: It is not just consultants. There is a general improvement throughout the industry. A lot of clients are saying, “Look I have a separate account component to the transition. Talk to me as much about your project management skills, with respect to that as well as giving me the 20 pages on your trading expertise and algorithms.”

Therefore, if you blow the operational aspect, you now have a problem and it is focusing attention on where it should be.

Consultants are part of it, clients are part of it, transition managers are part of it and increasingly the environment we are in is a part of it, not just the volatility in the marketplace, but also the legal and regulatory environment with respect to the US and the changing regulations around the world.

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MATTHEW E STROUD, practice leader, Greater New York, Watson Wyatt. Photograph supplied by Berlinguer Ltd, December 2007.

IN THE UNLIKELY EVENT THAT SOMETHING MIGHT GO WRONG …

KAL: The best way to avoid those ugly situations is to have

an open dialogue with the asset owner up front. Again, we take a page from the asset management book, where you take objections and constraints and you try to optimise a solution for them for whatever the situation is. You do the same for a transition. If the client says his priority is to get this transition done in a week or for you not to mess up his accounting, we take that as gospel. Of course, market conditions can change mid way through a transition. You can start a transition and then the liquidity goes away.

Things happen.Years ago, we all saw some providers come in with proposals that looked attractive: that the transition was going to be easy; that it would be done in three days and the overall transition cost was going to be real low. I personally no longer see these kinds of proposals from any serious provider. However, when market conditions change and you find yourself stuck, you talk to the client and the investment manager. Does the target manager want cash instead and they can build the tail end of the portfolio in their own good time?

MATTHEW: The understanding of how objectives get rank ordered by client preferences is key. Exigencies often resident with a transition often force people to rank order competing objectives. Is speed key? Or is cost management

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mission critical? Yes or no? Do I want to pull out of this right now? Can I live with it for a few more days? That is when you really learn to define what your preferences are in the face of competing investment objectives.

BILL: A famous consultant used to say many years ago that difficult times were as important as good times as they gave you a chance to reach out to your customers. They teach you that you cannot look away from tough times, you have to face them down. So if you adopt that approach and pick up the phone, personalise it, draw people’s attention to it, you will go a long way. It is easy to get information out.

JAMIE: This speaks to the role of the fiduciary in the whole process. People often think that being a fiduciary simply means that a transition manager is not going to front run your trades. Beyond that, it means, among other things, that I am not going to be anything less than transparent in the way I handle your trades. However, there is more to it. A fiduciary is someone who tells the client when they, as a transition manager, cannot do something. Let’s say we have a portfolio with two Lithuanian stocks, and we have never traded in Lithuanian stocks before: we have to tell the client that and say, “Look I am not in a position to unwind this Lithuanian stock portfolio as we have no expertise there.You don’t want us, you want somebody else, a Lithuanian transition manager perhaps.”That mindset is critical to this whole discussion process about the role of a fiduciary.

PAUL: What struck me when you talked about this is the thought of somebody discovering three or four weeks into a transition that liquidity is a problem. It re-emphases the point that the most important part of the transition is the strategic planning, weeks in advance of the actual event. If you are surprised by an illiquid tail, I would say, if I were in that position, “Shame on me.” The whole point of the planning process is to consider contingencies and to have a strategy in place. If you have a substantial small cap portfolio and you are in a defined contribution environment, your transition manager should already have an idea about possible strategies for dealing with it. Where a transition manager can truly add value for a client is for the transition manager to come up and say, “We anticipate a problem. We have three possible strategies to address it.” and then they go into the dialogue that Bill talked about. That is essential.

FRANCESCA: Let’s turn it on its head. What happens if a target manager gives you an optimum portfolio, an ideal portfolio of stocks that are hard to source.

PAUL: What you describe almost never happens in equities, but it happens more frequently in fixed income.

Upon occasion, a fixed income manager may say, “I want some of these seven and five-eighths of 2019”, knowing they trade very infrequently. He would love to have the transition manager buy them because he can’t buy them!

BILL: It kind of marries what Kal and Paul talked about.

There is a comfort level dealing with a fiduciary. The ability to transact in futures, in principal trades, and other derivative type contracts that maybe would not have happened, if they had not had vetted the process of what they were doing and hired an advisor. However, I don’t

PAUL G SACHS, Mercer Investment Consulting Photograph supplied by Berlinguer Ltd, December 2007.

think you are finding counterparties that are trying to put you in a difficult spot. I like to think we are working on even ground. If we are not, the whole pre-trading process should vet that and give us the chance to say,“Hey, here is what I have uncovered through my analysis and what I am looking at, and this is the challenge if we walk down this road, so we will adjust here and adjust there.”

JAMIE: Whereas a fundamental investment manager three or four years ago might not have really focused on what the cost really was because they are picking the right stocks, they are sensitive to it now. That ties into working with managers in transitions. They recognise the value and role that the transition manager can provide, and they like the idea of inheriting a portfolio of stocks and not having to incur all those transaction costs, so it is much more of a collaborative relationship than something that is combative.

BILL: They are sensitive not only to building that portfolio, but also to the fact that at some point they might want to unwind their positions. They are sensitive to re-evaluate their portfolio and not just look at these core statistics, but at the cost of transacting in and out. It is a round trip.

Therefore, if I am a micro cap manager and I am going to be the largest holder of a particular stock and I will have to hold it forever, I might not buy it. I may be able to replace it with something else. I might be able to source the exposure via derivatives, I might hold some cash for a period of time, accumulate a smaller position, whatever alternative that might minimize my transaction costs yet deliver alpha.

MATTHEW: In terms of the formal inclusion of T-cost analysis in standard buyside portfolios, we have definitely seen more of that. What is driving that? Part is the increasing performance sensitivity in light of modest expected forward returns for equities. Added to that is the recognition that Tcost is something that has to be carefully managed.

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THE ONE ABOUT THE T-CHARTER FRANCESCA: I know you have all signed up to the voluntary code that is the T-Charter. I wanted to garner your views on what you think its impact will be?

MATTHEW: Like any marketplace, you have an expectation that is dynamic. A lot of the major players anticipated this, once it became clear that it had some traction behind it. So disclosure had been improving, the client confidentiality clearly is being taken very, very seriously, and you can actually argue that it always has been. All the things called for in the T-Charter, have been recognised and provided for by all the major players in advance of the formal recognition. So, like any robust marketplace, where there is a very active competitive element, the anticipation of its has served its purpose in advance of its formal adoption.

KAL: If you look at a list of the participants many of them have been conducting their business in exactly the way that the T-Charter prescribes. What the T-Charter will do is make it easier on the asset owners to hire a transition manager. When they shop around, for lack of a better term, for a transition manager, they know that group of participants operate under a certain code and that I assume will give a certain level of comfort to asset owners knowing that everyone is playing on a level field.

PAUL: Various people have asked me what will be the impact of the T-Charter in the United States. A few have suggested to me that maybe we need something like that in North America and Asia. How many global standards do you need?

This is it. Investors in the United States ought to become familiar with the T-Charter, because it is going to have a big impact on the transition business here over the next 18 to 24 months. I don’t think it is a fanfare situation, or that we will see the impact over a few weeks. Matt’s point is that providers have already begun to raise their level of conduct in anticipation of it and if a global organisation signs a document in London, it reflects and represents what they are doing in Sydney, Singapore, Chicago and Dubai.The announcement of the T-Charter is a great event because it really does lift not only conduct, but also it makes it more measurable.

BILL: Competition in general drives all of us continually to improve our overall offering and the benefits we provide to clients: whether that is in the principles of the T-Charter or outside them.The adoption of theT-Charter will of course give comfort to the participants that are using the service that there is collaboration; that providers are working together to try to define standards. However, it is not limited to the T-Charter prescriptions. Transition managers continually improve their product to distinguish themselves; to offer a better service and to help their clients by providing solutions. It is a combination of factors: transition managers moved to accommodating the T-Charter and putting a code of practice around the principles and having an awareness of it, even before it was signed. After all, the more education that is out there the better.

FRANCESCA: What happens to institutions that don’t sign up?

JAMIE: To Paul’s point. Obviously it has been a UK initiative, but has global implications. There was an element of peer pressure

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KAL BASSILY, CFA, managing director and global head of BNY Global Transition Management. Photograph supplied by Berlinguer Ltd, December 2007.

at play. No one wanted to be off the list for fear of it becoming an ‘us versus them’ issue. Transition managers that hesitated endorsing the T-Charter may have envisioned having to defend the untenable position of having client say to you:“what don’t you like about transparency and serving the best interests of the clients?” It is a good first step in terms of a common agreement.

It is an extension of one of our earlier themes about the evolution of the industry. Despite heightened competition, I do not feel that there is any rancour in the transition management community, the T-Charter is a good example of our ability to come together for what is in the best interests of the client.

NEW FACES, NEW MARKETS, NEW PROBLEMS FRANCESCA: Can we talk a little of new markets please?

There are new pots of money that are approaching transition management market to help them implement changes in investment strategies, such as central banks. How are these new markets changing transition management?

MATTHEW: It is a very interesting area. We are seeing large, professionally managed asset pools outside of the United States transitioning not so much from very exotic strategy to another, but from large domestic market-oriented strategies, say as in the case of South Korea, having principally South Korean equity exposure, towards broader market exposures.

This is not confined to any one segment of institutional investors. We’ve seen this across large insurance companies as

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well as sovereign funds and now looking overseas from their home markets. We are seeing a broadening then of investment agendas basically, both by asset class exposure within equities and then extending to alternative and advanced strategies.

Large sovereign funds for sure are behind a lot of this and growing rapidly, in Asia and Australia and it is not just sovereign funds, but also insurance companies as well.

KAL: We see a broadening of the user base of transition management. Traditionally, central banks managed debt but now they also manage reserves. Most of them are in fixed income investments right now, but as Matthew said, many of them are experimenting with equity investment and crossborder investment. They are leaving South Africa, South Korea, and Malaysia and investing overseas and in equities. The other trend we are seeing in terms of the user base of transition management is financial institutions, such as multi-managers, mutual fund complexes or any situation where money is subadvised, such as life-cycle funds, professional investors, because they go through exactly the same exercise that a pension fund would go through when they reallocate money from one manager to another and increasingly they use transition managers. Over the last 18 to 24 months this trend is definitely on the rise. How it has changed the way that we do business?

You have to remember that those are institutions that have centralised dealing desks; they are very well schooled in trading and dealing with them has its own set of requirements and challenges and because many of them do daily accounting; they have to strike NAV on a daily basis, nobody stops trading the portfolio while you are effecting the reallocation. Again, it is not the same as a pension fund saying“Here are the assets, I will segregate them in a transition account and no one will touch them until you build a new portfolio.” It has been a challenge, but most of us have adapted to that challenge.

JAMIE: The numerous fund of fund products that are out there are often a perfect fit for the use of a transition manager. A few years ago, there were very few of them that actually realised that. The other element of your question was how transition management has evolved to cope with the rise of new markets and alternative products. In other words, to the extent that clients are moving away from say large cap US equity and not replacing it with another large cap US equity manager, but putting on a sort of a Liability Driven Investment (LDI) strategy, or earmarking the money for a hedge fund of funds, or a 130/30 or something like that. No one of the transition managers around the table is purchasing timber! It might yet happen, but we are certainly thinking of different ways that we can hedge an exposure for a client. Assets may be earmarked for an alternative asset allocation or for a fixed income portfolio where it does not make sense for us to purchase the portfolio because of the level of substitution that Paul cited. In those cases, we have to think of different ways in which we can hedge this exposure for the client. What instruments are out there that serve as a good proxy for what they want to accomplish?

BILL: There is broad acceptance, understanding if you will, of the transition manager as more of a generalist. Seeing what we do, we don’t just see large cap active portfolios moving into an S&P index. We see fixed income, we see that

sponsors are moving into alternative assets and we have to figure out a way to overlay cash into some product while they do that. We have broad knowledge and we bring in specific expertise depending on what we are doing and tools to help people out and create solutions: whether it be central banks or fund of funds. Transition management has escaped from simply buying and selling equity or selling and buying fixed income. We are seeing global bids that go from equity to fixed income, and when they go into alternatives, we have to consider, for instance, what to do with the cash?

PAUL: One of the biggest areas of new opportunity for general investors is still in the area of fixed income and multi-asset class transitions. Equity-to-equity is something that, I would say, the industry has addressed effectively. They do that extremely well; but asset class shifts and the exposures that are involved, the customisation that is necessary in formulating that new target portfolio in fixed income can be quite challenging. A portion of Jamie’s point was that investment managers are much more willing to work with transition managers today. That does not mean that every strategy is done better by a transition manager than by a target fixed income manager. If you look at some of these strategies, some of the hybrids and swaps that are in a fixed income portfolio today, it really does need to be done by the target manager. In that situation, the transition manager may be serving the client’s interests best by giving a laddered portfolio of treasuries or gilts to maintain duration, because something like 83% of the risk in the average fixed income transition is durational.

IT’S A COMPETITIVE WORLD OUT THERE FRANCESCA: Increasingly some beneficial owners have brought trading capability in house. Is that a trend here and how are you countering that? I am happy to go on the record here and say that I find that particular trend something of a worry.

CAROL: I find it almost incomprehensible that somebody would not employ a transition manager for a transition of any size or complexity. There is simply too much at risk not to hire a professional to assist in this critical piece of the process.

BILL: They may not be taking on every aspect of transition management, irrespective of what they might be claiming.

There is probably some partnership, or vendor relationship somewhere that they are accessing to do parts of it: maybe they are outsourcing the administration, or the performance measurement or their broker networks to trade and the algorithms their broker provides on their desks. When we hear that somebody is doing transition management themselves, we always have to drill down and ask;“What is it that they are actually doing as part of that?” They might actually be using transition management in a way that we might not recognise, in that we might offer entire traffic control and fiduciary and they might simply be using a fiduciary to trade or to manage money temporarily in an overlay strategy. You really have to drill down before you

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get too afraid of what they might be employing that helps them get to where they might want to go.

PAUL: I know of at least one large corporate in-house investment management firm, with tens of billions of assets, contemplating a transition, but electing not to do it in-house. Is it that they lack trading capability? Absolutely not. They have great trading expertise. The question is“Do they have the project management skills and the right procedural controls around the process?” That is not something that you want to invent on an ad-hoc basis.

Unless you do transitions on a day-to-day basis and are committed to eliminating the sixth decimal of risk, you probably don’t want to go up that learning curve.

BALANCING RISK AND CREATIVITY JAMIE: Two things. There has been a greater acceptance on the part of the end user and the consultant to look at transitions as a risk management exercise and not simply a cost minimisation exercise. Rather, cost minimisation is derived from risk management. Nonetheless, there is still some room for us to be able to advance that idea and for people to think about transition costs in risk adjusted terms.

In comparing cost proposals, how much risk must the client assume to achieve that cost outcome? Maybe there is a way that I can lower explicit trading costs (by trading over a longer horizon or crossing more), but the only way that I can do that is for the client to bear more risk. There is also room for transition managers to better articulate this concept to the end user. Second, Bill touched on this earlier, is that the client will increasingly look at transition management in the same way they approach their distressed debt manager; or their custodian, or whomever.You won’t hire a transition manager because they are the last person to come through your door and they are a name you remember, or that they happen to be a custodian or because they happen to be your index manager.

There is a level of due diligence that needs to be completed and we are seeing a greater recognition of that by the client.

MATTHEW: I agree wholeheartedly, as far as an improved understanding and perhaps an awareness of absolutely taking on one objective very well at the expense of other things that you may want in a transition. Then clearly formalising the selection process along the lines of how you select an investment manager. At Watson Wyatt we encourage a strong focus on business people and process, and we apply the same rigour and reference points and formalise the process and have it be comparable with any other selection process.

BILL: You don’t buy Jamie’s, Kal’s or my transition model, put it on your desk and press a button. People don’t buy that anymore. We are getting greater opportunity to discuss what it is that we do, and on the other side of the table, asset owners are driving and understanding the discussion, the framework and the metrics and all of us getting a much greater understanding of what it is that our clients are trying to achieve. Once we fully understand that we can enhance our service to help them get where they really want to go. It is collaboration, discussing what is available; discussing fixed

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income; discussing defined contribution plans; cash that is going into alternatives. We are all continually advancing the process and so it is no longer“Fire me your bid and I will take a look.”We are all getting opportunities, fair opportunities to present fully what we do and explain what it is we can provide, and not what our model is and that theme will continue. I don’t know if you can call it a future trend, I am not so bold.

CAROL: In terms of future expectations, it is almost sounding as if it is a commoditisation of the business model. That may be an extreme view, but things are becoming more the same. You have the T-Charter that will drive it in towards greater standardisation and you have competition that will drive it further in that direction, etc.

While I recognise that each firm has its own unique capabilities to bring to table, it will probably, from a plan sponsor’s point of view, bring about a more transparent and hopefully more cost efficient process, with even better risk controls. But in terms of any future transitions, I would suspect that we would do nothing different than we did in the process that we concluded at the end of June.

KAL: The cry is now: “Give me a solution,” or preferably, “Give me a set of solutions for the problem I have.” Now those solutions are comprehensive as we noted earlier and so it becomes how you manage market risk, operational risk and how you are going to handle the trades.That particular aspect will continue to allow us to differentiate ourselves from one another. It will be about creativity: who can put three or four solutions to a particular transition on the table. If I have five trading strategies, each one will come with a certain combination of market impact and opportunity cost and depending on how much risk you are prepared to bear, you tell me what you want me to do.That will be the way forward.

CAROL: I said that more to be provocative than anything else.

However, it could go that way. If transition managers are pitching directly to me—and I made the mistake early on in having one transition manager do that—it is very difficult for plan sponsors, unless you have done a lot of transitions, to ascertain what they are really good at and how they distinguish themselves from other transition managers. Are they good project managers? You cannot know that, without direct experience. Therefore, it is useful to hire a consultant to help you as they can give you more intelligence on those soft factors and more clearly distinguish how particular firms stack up.

PAUL: Looking at transition managers does require focus and specialised expertise to be able to do it well. When I heard Kal talking about the trends he sees, I expect that there will be (hopefully) a more universal adoption of best practice. Improved governance is where there is an opportunity for investors. The US is regulated by policy, as opposed to regulation. Last February the President’s working group suggested that we don’t need to regulate hedge funds: that was the headline everyone saw.

However, buried in the announcement was the advice that institutional investors do need to scrutinise and monitor all service providers. The due diligence and governance that is now taking place around transition management is a great thing for investors.

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Photograph © Rolf Images; supplied by Dreamstime.com, November 2007.

Metal Commodities:

Blast-off or Meltdown?

While even the most bullish of metal mavens would not be surprised to see more turbulence ahead, even sceptics agree that the economies of Asia—the lifeblood of the commodities sector—are much too powerful to ignore. What lays in store for the metal sector in 2008? Dave Simons reports.

HE SEE SAWING price action of the metals markets during 2007 should have been enough to chase away even the most hardened investor. Not it seems commodities proponents, who instead choose to focus on the seemingly endless growth within countries such as India and China as proof that fundamentals are still strong.

Those same optimists consider any price drops in base and precious metals as solid buying opportunities. “Insatiable demand” and “insufficient supply” continue to be mantras for major bulls like Jim Rogers, creator of the Rogers International Commodities Index (RICI).“If you can speak Chinese and you know about commodities,” says Rogers, “you are going to be one of the most successful people in the world in the next 20 to 30 years.”

Rogers, who co-founded the Quantum Fund with George Soros (and whose own daughter is fluent in both Mandarin and English), has even put his New York townhouse up for sale with plans to permanently relocate to China in order to get closer to the action. A quick look at the charts, however, may give one cause to doubt Rogers’

T

wisdom. Though still at historically lofty levels, prices on most base metals have fallen precipitously over the past 12 months, an indicator of underlying global economic concerns, say some observers. Meanwhile gold has jumped $200 since the start of the year—too far too fast, say the bears, who forecast gloom and doom anytime soon.

While the most bullish of metal mavens would not be surprised to see more turbulence, even skeptics agree that the economies of Asia (today’s muscular drivers of the global commodities sector) are much too powerful to ignore. During the third quarter of 2007, China’s economy grew 11.5% after registering a near-record 11.9% growth during the previous three-month period. China’s rapid development has sparked an unprecedented construction boom, and the copper wiring used in new homes in China has helped contribute to the rise in the price of the metal. In 2007, China’s copper usage increased by 20% over the previous year, and the country’s demand is unlikely to abate over the near term, say analysts, particularly as urban populations continue to grow.

While zinc usage in North America has slowed, steady demand by China may help prevent further price erosion.

China, the world’s leading producer of steel, is forecast to add 3.8m tonnes of zinc-galvanized steel capacity in 2008, supported by demand for galvanized steel products for the construction and audio industries. In fact, commodity bulls believe that the unprecedented cycle of undersupply and over-demand—a “supercycle” as some have called it— coupled with a rolling global economy particularly in emerging nations, make this advance far different from any we have seen in the past.

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Cashing in on China’s quest for metals may be a bit tougher going forward, however, following the Chinese government’s move to increase restrictions on foreign investment in certain non-recyclable metals including tin, uranium and tungsten, as well as energy-consuming or highly polluting projects. At present, 16 of the 20 most polluted cities in the world are located in China, the result of under-regulated industrial activity and automobile emissions levels that lag global standards. With the 2008 Summer Olympics in Beijing just around the corner, China has pledged to clean up its act in hopes of containing the country’s growing environmental problems. “Facing an overly large trade surplus and rapid growth in foreign exchange reserves, we will no longer employ a policy that gives blanket encouragement to exports,” said China’s National Development and Reform Commission in a recent statement.

Copper Off Elsewhere, economic tailwinds have conspired to create volality. Take copper, for instance. The late November announcement by US Treasury secretary Henry Paulson that the rate of home defaults was “significantly bigger” than originally thought helped send prices on copper plunging 11%. Copper historically serves as a bellwether for economic activity, and the sell-off suggests that investors are concerned that the US debt crisis, coupled with a slowdown in Europe, could conceivably threaten China’s expansion plans and result in weakened demand, says Eric Wittenauer, energy and industrial-metals futures analyst at A.G. Edwards & Sons Inc. in St. Louis. “Global central banks have recently moved to tighten monetary policy in an effort to control growth and inflation rates, and this may limit intermediate-term demand as global growth diminishes,” says Wittenauer.“Copper usage may suffer as a result.”

Additionally, energy costs could negatively affect copper mining output, says Wittenauer, who points to the correlation between rising crude oil prices and the pullback in copper. “Again, this seems indicative of economic concern, and rising red metal stockpiles may portend increasingly soft demand,” he notes. Even so, any deacceleration in the West is unlikely to negatively affect Asia’s economies over the long term. “If investors prove correct in holding to the widespread belief that vigorous growth in numerous developing countries such as China and India will persist for the foreseeable future,” says Wittenauer, “then long-term demand for copper could expand just as rapidly.”

According to Huw McKay, senior international economist at Australia’s Westpac, the economies that are best prepared to absorb a US slowdown are those with ex ante current account surpluses, relatively closed financial systems and some existing momentum in domestic demand. The sound performance of the commodity markets, on balance, indicates that global demand for basic materials has yet to slow, notes McKay. “Activity is being

FTSE GLOBAL MARKETS • JANUARY/FEBRUARY 2008

Stuart Burns, managing director at Chicago-based Aptium Global, a middle-market focused direct materials advisory firm, says that the influence of the US on global commodities has been greatly diminished in recent years. Where all other economies once looked to the US for direction, “that situation is changing,” says Burns, “as the growth of Asia in general and the BRIC countries in particular has created a second source of growth and massive demand that will continue to power the world economy.” Photograph kindly supplied by Aptium Global, November 2007.

supported by accelerating net exports, buoyant consumption, the on-going investment boom and ample internal liquidity. While this absolute level of growth depends upon a continual expansion in China’s share of global exports, from the capacity side double digit expansion is not stressing resources unduly.” India also continues to post tremendous growth numbers, and, despite a current account deficit, “the overall balance of payments picture is significantly healthier now than at any time in recent decades,”says McKay.

Golden Glow Gold, the dollar’s traditional hedge, has advanced some 40% since the start of 2007, and with the dollar maintaining its downward trajectory; analysts see prices continuing to climb at least for the short term. An RBC Capital Markets report entitled Gold—Returning to a Monetary Standard forecast a possible price target of $900 an ounce during the first quarter of 2008. RBC’s Russell Jones put it in historical terms: “The late 1960s saw first France and then Germany and Britain all start to swap their dollar reserves for gold as they questioned why they should continue to accumulate assets at depressed yields in a currency that was only going to go one way – down. [We]

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several years, suggests may well be witnessing Burns. Zinc, which a similar situation recently traded at today, as spare capacity $1.05/pound, is roughly is increasingly half of its value from a exhausted and price year ago. Nickel is off in the pressures 50% since last spring, emerging world build. and both aluminum and And the greater the copper ended the year instability in prices, the roughly where they greater the likelihood of A menagerie of metals. Photograph © Frederic Fahraeus, supplied by started. Only lead has currency realignments.”

Dreamstime.com, December 2007. reached new highs in Nevertheless, Patrick Fearon, senior economist at AG Edwards and Sons in St. recent months, the result of consistent worldwide demand.

In fact, bulls believe that oversupply is the only viable Louis, sees choppy waters ahead for gold investors, particularly as the dollar stabilises. Because such threat to the long-term stability of the metals market. developments would be bearish for gold, traders Because China and India continue to change the supply attempting to take advantage of price pullbacks “will have and demand balance for commodities, many analysts to be very nimble and should be prepared to exit any long continue to forecast a secular bull market in commodities positions early,” warns Fearon. However, like most base until supply begins to address changes in demographics metals, the rapid economic growth of the larger developing and global growth, offers Lee Kranefuss, chief executive of countries in general and China and India in particular will Barclays Global Investors’ (BGI’s) iShares. BGI’s own menu most likely translate into significantly higher values for of exchange-traded funds include the metals-based iShares precious metals, says Fearon, with increased inflation Comex Gold Trust and iShares Silver Trust. Business has acting as a potential source of indirect strength. Though been particularly brisk in precious metals ETFs throughout silver may be more vulnerable to a global slowdown due to 2007 due to their low expense ratios and minimal exposure its industrial uses, long-term Asian demand will ultimately to capital gains. “Because of the cyclical nature of commodities, we think a properly arranged commodities carry the day, he adds.

Stuart Burns, managing director at Chicago-based portfolio is a sound idea for investors who want a decent Aptium Global, a middle-market focused direct materials return while minimising risk,” says Kranefuss. Other ETFs on the market include advisory firm, says that the PowerShares DB the influence of the US Precious Metals, Base on global commodities In fact, commodity bulls believe that the Metals, Silver and Gold has been greatly unprecedented cycle of undersupply and funds, which debuted on diminished in recent the Amex last May, and years. Where all other over-demand—a “supercycle” as some are designed to track the economies once have called it—coupled with a rolling global Deutsche Bank Liquid looked to the US for economy particularly in emerging nations, Commodity Index. direction, “that make this advance far different from any Even with the situation is changing,” we’ve seen in the past. tremendous price says Burns, “as the movements of the past growth of Asia in few years factored in, general and the BRIC countries in particular has created a second source of commodities mavens such as Rogers believes there is still a growth and massive demand that will continue to power long way to go. Rogers—who criticised the Fed for helping the world economy.” Asia has taken over from the US as to devalue the dollar even further with its September rate the largest consumer of most base metals; at present, cut—says near-term economic activity will only support almost half of the world’s copper supply is consumed by higher prices. While the possibility exists for institutions to Asia, notes Burns, compared to just 22% in Europe and unwind positions in order to raise cash as the liquidity only 14% in the US. China is also the largest consumer of crunch worsens or consumption is affected by a lack of aluminium, lead, nickel, zinc and tin. “A significant investment and consumer demand, the bottom line, says proportion of China’s growth is now fueled by internal Aptium’s Burns, is that the market for metals is more than consumption,” says Burns, “particularly base metals for likely to be supported by the continued strong growth from construction and industrial development, and will continue the East. “New production capacity takes a long time to come on stream,”says Burns,“and so we can expect to see regardless of a reduction in US demand.”

Furthermore, the severe price drops in base metals the current supply-demand balance continue for the during the latter part of 2007 has helped deflate the foreseeable future, largely regardless of the fallout from the speculative bubble that had been building over the past current credit crisis in the West.”

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Reaching for the stars

by plumbing the depths Normally, minerals tend to be recovered by surface mining on shallow continental shelves or near shore coasts. However, metaliferous oxides (such as manganese nodules) and metaliferous sulfides do occur in the deep ocean. Metaliferous oxides were collected by the ship HMS Challenger as far back as 1872, yet deep ocean mining of mineral ores still appears to be in its infancy. In part, this is due to costs associated with deep sea mining (DSM).

At depths between 4,000m and 6,000m, the mining and processing technologies needed to recover minerals from nodules (such as nickel, copper, cobalt, and manganese) require large investments. However, soaring demand for minerals means that ultimately we will become more dependent on the oceans as a mineral resource reservoir in the future.

Simon Watkins reports on a future trend.

EEP SEA MINING (DSM) may well be the shape of things to come in an attempt to satiate the world’s growing appetite for mineral resources. With mineral ore resources becoming increasingly difficult to extract economically on land, some analysts now believe that DSM may offer a viable way forward—particularly when it comes to extracting rich ore deposits of seafloor massive sulphides (SMS), including gold, silver, copper and zinc, in a cost-efficient way. Deep sea mining for mineral resources is an industry in relative infancy. Nonetheless, it is developing at a stunning rate, and demanding attention.

At the end of June, Vancouver-based Nautilus Minerals Inc. announced the discovery of high-grade deposits of gold, copper and zinc mineralisation on the ocean bottom near its Solwara 5, 6 & 7 sites in the relatively shallow waters of the Bismarck Sea, off Papua New Guinea (NPG); a part of the seabed territory licensed to the company for exploration and where it had been exploring since 2006.

Analysis of the samples taken showed an average grade of 17.5 grams per tonne (g/t) gold, 8.94% copper, 16.84% zinc and 298 g/t silver—altogether much richer than deposits found on land. While finding rich mineral deposits in PNG is nothing new, the Nautilus discovery and its proposal to begin mining within the next two years is ground-breaking: particularly as the deposits are valuable and hard to ignore.

David Hayden, chief executive officer (CEO) of Nautilus, thinks that mining the sea bottom is as revolutionary as the development of off-shore oil rigs was in the 1950s and will be needed to meet growing global demand for minerals.

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FTSE GLOBAL MARKETS • JANUARY/FEBRUARY 2008

Nautilus says it can extract minerals from the ocean floor through the use of a new, undersea mining technology. The company has contracted with an American shipbuilder for a $120m custom-made vessel to serve as the floating command centre for submerged remote-controlled mining machines that will begin operations in 2009. Indeed, says Haydon, deposits located at Conical Seamount in Papua New Guinea (PNG), show ores containing up to 26% zinc, 15% copper, 15g of gold, and 200g of silver, all without having to drill through a kilometre or so of rock, as might occur on the land surface.

The find is also significant in that right now, deep sea mining specialist firms are rare. Cape Town based engineering company, Marine and Mineral Projects, installed and launched an advanced remote crawler technology on the first deep sea mining vessel, The Peace in Africa, to operate off the South Africa coast in May 2007. The Peace in Africa is a De Beers Consolidated Mines owned ship converted into a floating diamond mine over a two year period. Marine and Mineral Projects were contracted to fit the ship with deep sea mining crawler technology, which included the remotely controlled crawler, launch and recovery system and vessel mooring system. Moreover, only two AIM-listed firms offer exposure to the opportunity presented by DSM: namely Nautilus Minerals Inc., and Neptune Minerals. However, these diverse operations will likely have more competition as (in economic terms); arguments for the development of DSM become more compelling. As Heydon explains, the capital costs of mining

SECTOR REPORT: DEEP SEA MINING

Photograph © Annsunnyday; supplied by Dreamstime.com, November 2007.

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underwater can actually be lower than mining on land: “Land-based areas have been explored to death [sic]. The same high grades of materials that the good old timers took out 100 years ago on land and filled their wheelbarrows up with are just sitting around on the seafloor.”

“In fact,” says Heydon, “it is obviously cheaper to put a pipe through a couple of thousand metres of water than to sink a shaft through a similar depth of rock on the surface and develop a working mine.”This said, of course, although DSM technology may not need to be as large in scale to operate at a profit as terrestrial mining, which has been forced to develop large extraction equipment to counter falling ore grades, and use economies of scale. However, DSM does need to be able to operate in an extreme environment, Heydon stresses. Temperatures at hydrothermal vents (in which SMS occurs) can reach as high as 400 degrees centigrade but may drop to as low as two degrees just a short distance away. Additionally, the acidity around such vents may have a range of PH3 to PH5, and the topography around them may also be extremely rugged.

Nonetheless, of course, the demand for such materials means that the surmounting of any such problems well worth the undertaking, thinks Dr Simon McDonald, CEO of Neptune Minerals, in Sydney: “Current resources of land-based materials are being depleted and mining companies need new sources to meet production demands from developing countries, particularly China and India.”In this regard, he adds, the marine technology required to exploit SMS deposits commercially is rapidly being developed through existing technological advances in the offshore oil and gas, marine diamond mining, trenching, and cable laying sectors.

Certainly, from the perspective of China, there seems no sign of demand for such materials doing anything other than continuing to rise. In this regard, both Goldman Sachs JB Were and Deutsche Bank, to name but two, recently raised their estimates for the benchmark base metals price—that of copper—on the basis that demand from China (the world’s largest user of the metal) continues to exceed expectations.

Goldman Sachs thereby has revised its year-end forecast to $3.14 per pound, up from $3.09 per pound, while Deutsche Bank has raised its estimate 6% to $2.86 per pound.

As it stands, China’s copper imports more than doubled in February this year over the same month last year, principally on rising demand from its power and construction companies, and Goldman expects the copper market to be in deficit to the tune of 202,000 tonnes this year—more than double the 57,000 tonne deficit a year ago.This comes on the back of an estimated 12% increase in China’s copper usage this year, compared to the previous forecast of 8%.

Both Nautilus and Neptune are significantly upping the ante in meeting this demand, sooner rather than later. At the end of March, for example, Nautilus announced the commencement of its 2007 exploration and development programme with the mobilisation onsite at its Papua New Guinea field of the 141 metre vessel ‘Wave Mercury’. “This marks the start of the world’s largest-ever exploration and development program for

Deep sea mining specialist firms are rare. Cape Town based engineering company, Marine and Mineral Projects, installed and launched a advanced remote crawler technology on the first deep sea mining vessel, The Peace in Africa, to operate off the South Africa coast in May 2007. The Peace in Africa is a De Beers Consolidated Mines owned ship converted into a floating diamond mine over a two year period.

Marine and Mineral Projects were contracted to fit the ship with deep sea mining crawler technology, which included the remotely controlled crawler, launch and recovery system and vessel mooring system.

Photograph kindly supplied by Nautilus Minerals Inc, November 2007.

high grade SMS systems,”says Heydon.“This programme will see environmental, mining and metallurgical studies completed on our 100%-owned Solwara 1 project, where surface sampling in 2006 returned average grades of 15.5g/t gold, 9.6% copper, 138g/t silver, and 5.1% zinc.”

An associated Aquila programme, meanwhile, will involve approximately 60 days of geophysical target generation over a number of structural zones. In the meantime, Neptune approved expenditure of about $5m in the first half of this year on exploration for SMS deposits on its Kermadec project which is the most advanced of its three granted licences which cover about 63,000km² and extends some 900km north-north east from the North Island of New Zealand, taking in prospective seabed features along the parallel Kermadec and Colville Ridges and the intervening Havre Trough. Certainly the omens seems propitious, if the past is anything to go by as, within six weeks of October 2005’s AIM-listing, the firm had mobilised a vessel, coring system and sub-sea remotely operated vehicle to start exploring waters off New Zealand in what was the world’s first commercial coring of SMS deposits.

The recovery of cores, surface SMS samples and highdefinition seafloor survey data was successfully completed on time and below budget and the results did not disappoint. Assayed samples of SMS material collected during the program contained average 11.2g/t gold, 122g/t silver, 8.1% copper, and 5% zinc, and preliminary test work showed that the material could be successfully treated using existing metallurgical processes. Such activity, underlines Heydon, has prompted the International Seabed Agency, in a paper prepared for it by the Frieburg University of Mining and Technology, and the Geological Survey of Canada, to state recently that: “Considering all critical factors, mining of seafloor polymetallic massive sulphide deposits is likely to take place in the current decade.” Given this, underlines Sam Barden, chief executive officer of SBI Fund Management, in Moscow: “It should be remembered that only around 30 years ago, the oil industry went offshore, which no one can doubt was an extremely successful move, and so with the mining industry now doing the same.”

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A BRIEF HISTORY OF DSM The world’s first attempt at undersea mining began in the late 1950s when American Sam Collins established Tidal Diamonds to mine at sea off the Skeleton Coast of Namibia, where diamonds were more abundant on the seabed than on land. He mined the ocean floor for nine years and extracted 1.5m carats of diamond. The finds were not enough to fund expansion and in the 1960s, the company was bought out by the De Beers group.

In the late 1970s, scientists discovered mineralrich manganese nodules on the sea bottom of the Atlantic, near submerged volcanic domes and chimney-like vents called ‘black smokers’ because of the plume of black, mineral-rich water spewing like smoke from the chimneys. The chimneys sit on fractures in the Earth’s crust that release streams of super-heated sea water that is rich in dissolved metals. When these hot fluids hit the cold sea water, metals precipitate out of the solution and drop down to the ocean floor, forming mounds and chimneys of sulfides rich in copper and gold. However, these metals are usually found at depths or more than 5000 metres, and until recently were out of the reach of mining technology.

High projected costs and the regulatory restrictions on deep sea mining in international waters through the United Nations Convention on the Law of the Sea (UNCLOS) held back development of deep sea mining. In a 1994 treaty, the International Seabed Authority (ISA) took responsibility for ensuring the benefits of mining in international waters beyond the continental shelf are equitably shared, with emphasis on ensuring developing countries get a fair payment and the protection of the environment from harmful effects.

However, the ISA’s authority is limited and does not extend to national territorial waters, where local governments have the final say.

Deep sea mining is less invasive than land based mining and produces far less waste material, which all has less of an impact on the environment, claim deep sea mining companies. In contrast, they maintain, land based mining operations often disturb large areas to get to the minerals, whereas, in the ocean the deposits are literally sitting on the seafloor and in the mining process there is less of an impact and quicker rehabilitation takes place.

However, in a May 2007 article in Science, world famous marine geologist Jochen Halfar of the University of Stuttgart noted that the environmental

FTSE GLOBAL MARKETS • JANUARY/FEBRUARY 2008

At the end of June, Vancouver-based Nautilus Minerals Inc. announced the discovery of high-grade deposits of gold, copper and zinc mineralisation on the ocean bottom near its Solwara 5, 6 & 7 sites in the relatively shallow waters of the Bismarck Sea, off Papua New Guinea (NPG); a part of the seabed territory licensed to the company for exploration and where it had been exploring since 2006. Analysis of the samples taken showed an average grade of 17.5 grams per tonne (g/t) gold, 8.94% copper, 16.84% zinc and 298 g/t silver—altogether much richer than deposits found on land. Photograph kindly supplied by Nautilus Minerals Inc, November 2007.

consequences of seabed mining are generally unknown and theorises they could even be severe.

Mining of massive sulphide deposits near “black smokers” could, say scientists, smother sensitive chemosynthetic life forms (in other words sulphurloving bacteria and worm and clam species) that contaminate these communities, which some biologists argue may represent the origins of life on earth. Halfar goes further, worrying that nutrient-rich, warm water from near the vents could cause ecological changes in sea life when it is pumped to the surface, warming the much cooler upper levels and causing algal blooms and threatening commercial fishing Deep sea mining operations essentially use a strip mining approach to remove deposits within the top 20 metres of the sea floor, using remotely operated underwater mine cutters and hydraulic pumps to haul ore up to the surface. Recent studies of undersea manganese mining in the equatorial region of the Pacific have found that the environmental risks outweigh the benefits of exploration and the long term environmental impact of deep sea mining has yet to be quantified. However, as deep sea, mining becomes more widespread and hand in hand with wider issues such as climate change, refocusing attention on environmental risks, it is likely that debates around the efficacy of deep sea mining will continue for some time.

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SECURITIES LENDING DATA

A SNAPSHOT VIEW OF THE SECURITIES LENDING MARKET AS OF DECEMBER 2007 Top 10 Equities By Daily Total Return

Top 10 Corp Bonds By Daily Total Return

Rank Stock description

Rank Stock description

1

Camaieu Sa

1

Fremont General Corp (7.875% 17-Mar-2009)

2

Groupe Eurotunnel Sa

2

Rotech Healthcare Inc (9.5% 01-Apr-2012)

3

Imergent Inc

3

Tekni-Plex Inc (12.75% 15-Jun-2010)

4

Wci Communities Inc

4

Magnachip Semiconductor Finance Co (8% 15-Dec-2014)

5

Syntax-Brillian Corp

5

K Hovnanian Enterprises Inc (8.875% 01-Apr-2012)

6

Alitalia - Linee Aeree Italiane Spa

6

Burlington Coat Factory Warehouse Corp (11.125% 15-04-14)

7

Medis Technologies Ltd

7

Dollar General Corp (10.625% 15-Jul-2015)

8

InterOil Corp

8

Beazer Homes Corp (8.125% 15-Jun-2016)

9

Sulphco Inc

9

K Hovnanian Enterprises Inc (8.625% 15-Jan-2017)

10

Osiris Therapeutics Inc

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

Camaieu Sa

2

Imergent Inc

2

Nutrisystem Inc

3

Wci Communities Inc

3

Cree Inc

4

Syntax-Brillian Corp

4

Corus Bankshares Inc

5

Alitalia - Linee Aeree Italiane Spa

5

USANA Health Sciences Inc

6

Medis Technologies Ltd

6

Indymac Bancorp Inc

7

InterOil Corp

7

Beazer Homes Usa Inc

8

Sulphco Inc

8

Lululemon Athletica Inc

9

Osiris Therapeutics Inc

9

Meritage Homes Corp

10

Dendreon Corp

10

Force Protection Inc

Corp by Fee > 10 < 100 Mln

Corp by Fee > 100 Mln

Rank Stock description

Rank Stock description

1

Fremont General Corp (7.875% 17-Mar-2009)

1

Dollar General Corp (10.625% 15-Jul-2015)

2

Rotech Healthcare Inc (9.5% 01-Apr-2012)

2

Freescale Semiconductor Inc (10.125% 15-Dec-2016)

3

Tekni-Plex Inc (12.75% 15-Jun-2010)

3

Bon Ton Stores Inc (10.25% 15-Mar-2014)

4

K Hovnanian Enterprises Inc (8.875% 01-Apr-2012)

4

Realogy Corp (12.375% 15-Apr-2015)

5

Magnachip Semiconductor Finance Co (8% 15-Dec-2014)

5

Archer-Daniels-Midland Co (0.875% 15-Feb-2014)

6

Burlington Coat Factory Warehouse Corp (11.125% 15-Apr-2014)

6

Calpine Corp (8.5% 15-Feb-2011)

7

Beazer Homes Corp (8.125% 15-Jun-2016)

7

Ford Motor Co (4.25% 15-Dec-2036)

8

K Hovnanian Enterprises Inc (8.625% 15-Jan-2017)

8

Cch I Holdings Llc (13.5% 15-Jan-2014)

9

Yankee Acquisition Corp/MA (9.75% 15-Feb-2017)

9

Gie Suez Alliance (5.125% 24-Jun-2015)

10

James River Coal Co (9.375% 01-Jun-2012)

10

Pilgrims Pride Corp (8.375% 01-May-2017)

Govt by Fee > 10 < 100 Mln

Govt by Fee > 100 Mln

Rank Stock description

Rank Stock description

1

Resolution Funding Corp (0% 15-Jul-2019)

1

Federal Home Loan Mortgage Corp (5.125% 15-Jul-2012)

2

United States Treasury (0% 15-Aug-2021)

2

United States Treasury (3.875% 31-Oct-2012)

3

United States Treasury (0% 15-Aug-2013)

3

United States Treasury (0% 28-Feb-2008)

4

United States Treasury (0% 15-Nov-2027)

4

United States Treasury (0% 27-Dec-2007)

5

United States Treasury (0% 15-Feb-2011)

5

United States Treasury (4.5% 15-May-2010)

6

United States Treasury (0% 15-Nov-2013)

6

United States Treasury (0% 06-Mar-2008)

7

United States Treasury (0% 15-Nov-2024)

7

Argentina, Republic Of (Government) (8.28% 31-Dec-2033)

8

United States Treasury (0% 15-May-2015)

8

United States Treasury (0% 15-Nov-2011)

9

United States Treasury (0% 15-May-2030)

9

United States Treasury (0% 03-Apr-2008)

10

United States Treasury (0% 15-Aug-2026)

10

United States Treasury (4.25% 15-Nov-2017)

Source: Data Explorers, 2007. All figures kindly compiled by Data Explorers, December 2007.

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

Al lF Wo FT TSE rld SE W Ind FT or D ex SE FT eve ld FT Ad SE lop Ind SE va Em e d e x In e Se nce co d E rgin de x nd g m FT ary erg Ind F T SE Em ing ex SE G In e FT De lob rgin de al SE x F g v In Ad TSE elo All de C va E pe x nc me d A ap In ed rg ll F Ca de FT TSE Em ing x p Al SE er In S Gl eco gin l Ca de x ob nd g Al p In a a F T l G ry l F d ov Em Cap ex FT TSE SE EP e r n e r SE In E EP PRA RA me gin dex RA /N /N nt g I AR nd A / B F FT TSE NAR REI EIT ond ex SE In E P EI T T G Gl d o EP lo R RA A/N Glo ba bal ex In /N A ba l R AR RE l D EIT de M x M acq EIT IT G ivid s I ac lo en nde G qu uar ba d+ x ar ie lob lR In a G ie Gl lob l No ent de x a ob al n In -R l In al In fra ent de x fra st al ru I s FT tru ctu nde c r x S FT tu e In SE E4G re FT SE FT 4G oo 100 dex RA SE ood d G In FI GW G lob de x De A lob al In ve De al d 1 lo v pe elo 00 ex FT d In p de SE ex me RA US nt I x FI 10 nd Em 00 ex I er gi nde ng x In de x

FT SE

88 % Change

No v07

Ap r-0 7

10:00

No v07

Index Level Rebased (29 Nov 02=100)

13/12/07

Ap r-0 6

No v05

Ap r-0 5

No v04

Ap r-0 4

No v03

Ap r-0 3

No v02

MARKET DATA BY FTSE RESEARCH

FT SE

MARKET REPORTS 23.qxd:MARKET REPORTS 23.qxd Page 88

Global Market Indices

5-Year Total Return Performance Graph 800

700

FTSE All-World Index

600

FTSE Emerging Index

500

FTSE Global Government Bond Index

400

300

FTSE EPRA/NAREIT Global Index

200

FTSE4Good Global Index

100

Macquarie Global Infrastructure Index

0

FTSE GWA Developed Index

20

10

FTSE RAFI Emerging Index

2-Month Performance

8

6

4

2

-2 0

Capital return

-6 -4

Total return

-10 -8

1-Year Performance

60

50

40

30

Capital return

0

Total return

-10

-20

JANUARY/FEBRUARY 2008 â&#x20AC;˘ FTSE GLOBAL MARKETS

MARKET REPORTS 23.qxd:MARKET REPORTS 23.qxd

13/12/07

10:00

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

2860 2442 2000 860 442 418

266.99 466.14 251.82 609.01 534.18 774.37

-0.6 -0.9 -1.0 3.2 0.8 6.5

2.2 1.0 0.3 20.4 13.5 30.9

14.2 12.7 11.4 42.3 35.2 52.7

11.7 10.4 9.2 36.0 30.3 43.9

2.23 2.27 2.25 2.05 2.44 1.54

USD USD USD USD USD

7811 6078 1733 921 812

447.27 424.39 865.27 768.25 1065.35

-0.8 -1.3 3.0 0.1 7.1

1.4 -0.5 20.4 13.2 30.9

13.8 11.0 43.6 35.7 55.1

11.4 8.8 37.4 30.8 46.5

2.15 2.18 1.98 2.37 1.48

USD

717

112.02

3.7

3.5

4.4

3.7

3.30

USD USD USD USD USD

295 188 228 239 56

2494.64 1076.18 2265.60 1202.75 1642.17

-5.8 -8.1 -5.5 -8.0 -0.5

-10.6 -14.7 -8.3 -16.2 5.2

-2.5 -11.0 -2.1 -10.8 23.9

-4.6 -11.3 -3.7 -12.7 20.7

3.55 4.59 4.35 4.42 1.64

USD USD

222 11095.80 100 10905.76

6.7 7.2

7.2 6.9

22.9 22.6

19.7 19.2

2.77 2.80

USD USD

695 105

7004.50 6034.62

-1.6 -1.2

-1.0 -0.3

9.0 7.0

6.5 5.1

2.66 2.95

USD USD USD

2000 994 351

4250.60 7352.27 7271.29

-2.1 0.4 4.4

-1.9 2.7 25.2

9.5 17.0 51.3

7.0 13.4 42.1

2.57 2.77 2.39

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

2860 2442 2000 860 442 418

310.71 727.85 292.54 735.63 649.21 926.79

-0.3 -0.6 -0.7 3.4 1.0 6.6

3.1 2.0 1.2 21.8 14.9 32.0

16.7 15.3 13.9 45.5 38.6 55.5

14.0 12.8 11.6 38.9 33.4 46.4

2.23 2.27 2.25 2.05 2.44 1.54

USD USD USD USD USD

7811 6078 1733 921 812

496.85 470.76 984.72 880.72 1197.06

-0.5 -1.0 3.2 0.2 7.2

2.3 0.4 21.7 14.6 31.9

16.2 13.3 46.8 39.0 57.9

13.6 11.1 40.2 33.9 49.1

2.15 2.18 1.98 2.37 1.48

USD

717

151.40

4.3

5.5

8.3

6.6

3.30

USD USD USD USD USD

295 188 228 239 56

3521.79 1157.49 2385.90 1293.18 1702.10

-5.3 -7.7 -5.0 -7.6 -0.1

-9.0 -12.9 -6.4 -14.5 6.2

0.8 -7.2 1.9 -7.3 26.1

-1.9 -8.1 -0.3 -9.8 22.6

3.55 4.59 4.35 4.42 1.64

USD USD

222 12669.02 100 12486.40

7.1 7.6

8.7 8.4

26.6 26.2

23.1 22.6

2.77 2.80

USD USD

695 105

8065.46 6995.81

-1.2 -0.7

0.1 0.9

11.7 10.0

9.1 8.0

2.66 2.95

USD USD USD

2000 994 351

4495.32 7777.33 7411.10

-1.8 0.7 4.6

-1.0 3.8 26.7

12.1 20.2 55.4

9.4 16.4 45.3

2.57 2.77 2.39

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;˘ JANUARY/FEBRUARY 2008

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 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 All 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 d ha AT Am FT ex re IB e r SE In ica LA EX F TI TO dex s FT TS G B E P SE US ove EX In E Br rn de A a m FT PRA x FT G en si l SE /N ov F T SE In t e A de EP SE EP RE rnm Bo x EP RA RA I en nd /N T N RA /N t B Ind or /N AR AR ex on t E h E d IT M ARE IT A ac US me Ind N qu IT No orth Di rica ex ar vi rt ie A I No h A me den nde d+ x rth me ric a r A ica Re Ind M ac me e n N x ta ri qu o ar ca I n-R l In ie nf de en US ra x st tal A In ruc Ind tu ex fra re s F T t ru In FT SE ctu dex re SE 4G In 4G oo oo d U dex d S In FT FT US FT SE 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

90 % Change

No v07

Ap r-0 7

10:00

No v07

Index Level Rebased (29 Nov 02=100)

13/12/07

Ap r-0 6

No v05

Ap r-0 5

No v04

Ap r-0 4

No v03

Ap r-0 3

No v02

MARKET DATA BY FTSE RESEARCH

F FT TSE SE Am N e FT orth rica SE Am s I FT L 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 All Ca dex ric tin p a FT Am I A nd SE ll e LA rica Cap ex TI I Al B l C nde F T EX x FT Al ap SE SE In l-S ha de Am FT LAT 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 e n si l SE /N ov F T SE I t Bo nde EP AR ern SE EP x EP RA RA EIT men nd /N RA /N t B Ind No /N AR AR e o r t x nd EI h M ARE EIT A T ac US me Ind N qu IT No orth Di rica ex ar vi rt ie A I No h A me den nde d+ x rth me ric a ric A Re Ind M a ac me e n No x ta ri qu ar ca I n-R l In ie n de en US fra x t al st A In ruc Ind tu ex fra re s F T t ru In FT SE ctu dex 4 SE Go re I 4G n o oo d U dex d S In FT FT US FT SE SE 10 dex 0 RA SE G RA WA Ind FI US FI US ex U M id S 1 Ind ex Sm 00 0 al l 1 Ind ex 50 0 In de x

MARKET REPORTS 23.qxd:MARKET REPORTS 23.qxd Page 90

Americas Market Indices

5-Year Total Return Performance Graph 350

FTSE Americas Index

300

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

8

6

4

2

-2 0

-4

Capital return

-6

Total return

-10 -8

-12

1-Year Performance

80

60

40

20

Capital return

0

Total return

-20

JANUARY/FEBRUARY 2008 • FTSE GLOBAL MARKETS

MARKET REPORTS 23.qxd:MARKET REPORTS 23.qxd

13/12/07

10:00

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

860 724 136

600.63 622.72 929.59

-2.3 -2.7 5.4

-1.4 -2.3 18.2

9.0 7.3 56.1

7.6 6.2 45.7

1.88 1.86 2.24

USD USD USD

2717 2515 155

381.08 367.69 1396.38

-2.5 -2.8 5.2

-2.0 -2.8 17.6

8.8 7.1 55.9

7.6 6.2 45.3

1.80 1.78 2.19

38 3492.70 15 5034.90 13 13963.20

4.6 1.6 6.2

20.0 6.7 28.3

61.9 43.5 76.2

50.7 33.3 62.3

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

4.01 4.04

USD USD USD USD

119 95 115 4

2449.11 1929.49 1125.73 1209.39

-8.7 -9.0 -8.5 -9.9

-16.1 -16.9 -16.4 -12.7

-15.2 -17.2 -15.3 -14.8

-13.4 -15.3 -13.7 -10.3

4.51 4.62 4.63 3.46

USD USD

97 90

9142.37 9092.53

5.3 5.4

1.6 1.2

14.3 14.0

13.7 13.6

2.68 2.64

USD USD

145 101

5474.49 5260.31

-3.4 -3.1

-4.2 -3.6

3.4 3.7

1.8 2.0

2.14 2.16

USD USD USD

667 970 1315

3689.99 6050.63 5248.99

-4.3 -3.6 -4.9

-5.7 -5.8 -9.8

3.6 4.1 -0.8

2.0 2.4 -1.3

2.08 2.16 1.36

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

860 724 136

911.21 1001.36 1158.60

-2.0 -2.4 5.8

-0.5 -1.4 19.3

11.0 9.2 59.7

9.5 7.9 48.7

1.88 1.86 2.24

USD USD USD

2717 2515 155

415.03 399.87 1627.29

-2.2 -2.5 5.5

-1.1 -2.0 18.6

10.7 9.0 59.4

9.3 7.8 48.3

1.80 1.78 2.19

EUR EUR EUR

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

4.01 4.04

USD USD USD USD

119 95 115 4

3715.64 2032.02 1213.38 1292.52

-8.1 -8.5 -8.0 -9.2

-14.3 -15.1 -14.7 -11.3

-11.9 -13.9 -11.9 -12.1

-10.4 -12.3 -10.7 -7.5

4.51 4.62 4.63 3.46

97 10399.01 90 10334.74

5.8 5.9

3.1 2.6

17.5 17.2

16.7 16.5

2.68 2.64

USD USD USD USD

145 101

6098.50 5880.28

-3.0 -2.7

-3.3 -2.6

5.4 5.8

3.8 3.9

2.14 2.16

USD USD USD

667 970 1315

3874.03 6336.77 5366.47

-3.9 -3.2 -4.7

-4.7 -4.8 -9.2

5.6 6.3 0.4

3.9 4.3 -0.3

2.08 2.16 1.36

FTSE GLOBAL MARKETS • JANUARY/FEBRUARY 2008

91

FT ve S l F E FT ope TS Eu SE d E E rop FT E De ur 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 x E r SE d E op ur In De Eur uro e A ope de x ve op blo ll I 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 FT pe U nde SE All S I x 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 Go E R ll-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 /N EP E s 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 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 i ar E v T d ie Eu uro ide s I ex r n n Eu op pe d d + e ro e pe No Ren In x n- ta de I F n FT F TS fr Re l 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 e x ro Ind pe e In x de x

De

% Change

De

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 n p FT e U d SE All S I ex 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 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 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 x ie u ro de I 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 ex r l e FT op op I SE ed e 5 nd RA Eu 0 I ex FI rop nd Eu e e x ro Ind pe e In x de x

FT SE

92 % Change

No v07

Ap r-0 7

10:00

No v07

Index Level Rebased (29 Nov 02=100)

13/12/07

Ap r-0 6

No v05

Ap r-0 5

No v04

Ap r-0 4

No v03

Ap r-0 3

No v02

MARKET DATA BY FTSE RESEARCH

FT SE

MARKET REPORTS 23.qxd:MARKET REPORTS 23.qxd Page 92

European Market Indices

5-Year Total Return Performance Graph 400

350

FTSE Europe Index

300

FTSE All-Share Index

250

FTSEurofirst 80 Index

200

FTSE/JSE Top 40 Index

150

FTSE Gilts Fixed All-Stocks Index

100

FTSE EPRA/NAREIT Europe Index

50

0

FTSE4Good Europe Index

FTSE GWA Developed Europe Index

0

-5

-10

FTSE RAFI Europe Index

2-Month Performance

15

10

5

Capital return

Total return

-10

-15

1-Year Performance

40

30

20

10

0

Capital return

Total return

-20

-30

JANUARY/FEBRUARY 2008 â&#x20AC;˘ FTSE GLOBAL MARKETS

MARKET REPORTS 23.qxd:MARKET REPORTS 23.qxd

13/12/07

10:00

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

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

EUR EUR EUR EUR

589 2000 385 522

251.39 138.88 255.39 245.74

-1.6 -0.4 -1.3 -1.8

-5.4 -4.3 -5.4 -6.1

6.2 10.3 8.5 5.8

2.4 6.1 4.3 2.0

2.90 2.54 2.88 2.97

EUR EUR EUR EUR

1761 852 1171 1640

417.30 450.71 449.94 410.89

-2.1 -1.0 -1.9 -2.3

-6.5 -5.5 -6.4 -7.2

5.5 9.6 7.9 5.1

1.6 5.2 3.5 1.2

2.82 2.89 2.80 2.88

GBP GBP EUR EUR EUR ZAR ZAR USD

685 3280.87 102 6432.45 79 5624.57 99 4895.88 313 1526.59 41 27629.35 236 30307.80 417 1378.78

-1.1 -0.5 0.3 -0.8 -1.6 1.3 1.2 7.1

-4.6 -2.9 -2.4 -3.6 -5.3 7.5 5.9 28.2

5.2 6.3 11.8 7.1 6.6 27.0 26.5 16.1

1.8 3.4 8.0 4.1 2.9 22.2 21.6 12.6

3.02 3.17 3.19 3.24 3.00 2.23 4.32 4.66

EUR EUR GBP

236 417 30

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

4.37 4.66 4.60

EUR EUR EUR EUR EUR

97 37 47 83 14

2077.07 862.29 2412.42 992.74 1154.15

-11.7 -11.2 -8.0 -11.7 -12.5

-28.8 -27.0 -22.8 -29.1 -25.0

-24.8 -24.4 -11.6 -25.1 -20.3

-30.8 -30.2 -19.2 -31.2 -23.2

3.48 3.54 4.42 3.63 1.31

USD

50 14879.86

9.4

14.0

34.6

29.5

2.87

EUR EUR

292 55

4959.64 4324.35

-2.9 -2.3

-7.4 -5.8

2.3 0.7

-1.1 -1.5

3.26 3.53

EUR EUR

522 462

3986.23 6163.66

-3.5 -2.1

-1.6 -6.1

10.8 7.0

6.5 3.0

3.35 3.16

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

589 2000 385 522

309.12 176.51 309.15 302.63

-1.3 -0.1 -1.1 -1.5

-4.4 -3.5 -4.7 -5.2

9.3 13.6 11.6 9.0

5.4 9.3 7.2 5.1

2.90 2.54 2.88 2.97

EUR EUR EUR EUR

1761 852 1171 1640

482.58 520.70 515.43 475.65

-1.8 -0.7 -1.7 -2.0

-5.6 -4.7 -5.8 -6.3

8.5 12.7 10.9 8.2

4.4 8.2 6.3 4.0

2.82 2.89 2.80 2.88

GBP GBP EUR EUR EUR SAR SAR USD

685 102 79 99 313 41 236 417

3928.05 3733.64 6581.45 5781.39 1989.81 2951.14 3206.56 1396.37

-0.6 0.0 0.7 -0.4 -1.3 1.6 1.5 7.2

-3.1 -1.2 -1.5 -2.4 -4.3 8.8 7.2 29.6

8.5 10.0 15.4 10.8 9.8 30.2 29.8 17.4

5.0 6.9 11.5 7.7 6.0 25.1 24.6 13.8

3.02 3.17 3.19 3.24 3.00 2.23 4.32 4.66

EUR EUR GBP

236 417 30

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

4.37 4.66 4.60

EUR EUR EUR EUR EUR

97 37 47 83 14

2742.65 925.00 2616.38 1048.98 1180.43

-11.3 -10.8 -7.5 -11.2 -12.5

-27.9 -25.8 -21.8 -28.0 -24.7

-22.6 -21.9 -8.2 -22.8 -19.5

-28.9 -28.1 -16.2 -29.2 -22.6

3.48 3.54 4.42 3.63 1.31

USD

50 17255.82

9.8

15.6

38.9

33.5

2.87

EUR EUR

292 55

5993.32 5275.70

-2.5 -1.8

-6.3 -4.5

5.6 4.4

2.1 2.1

3.26 3.53

EUR EUR

522 462

4276.62 6556.34

-3.2 -1.7

-7.3 -5.1

6.5 10.3

2.4 6.2

3.35 3.16

FTSE GLOBAL MARKETS • JANUARY/FEBRUARY 2008

93

F As TS ia E Pa As cif ia F As TS ic Pa E ia e c A Pa s F x J ific i cif a TS ap In P ic a E an de ex cif Ja I x FT Ja ic A pan nde SE pa ll I x Ja n A Cap nde pa ll In x C n FT a d 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 F ic 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 o EP EP EI AR EI n nde R RA T E T d x FT A/N /N As IT A As Ind FT SE AR AR ia s 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 rs FTS TS tru uct l In x u E a M E S 4G ctu re dex al G o re In FT ays X S od 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 RA I A stra In x d FT FT FI iust lia I ex SE SE Sin ra nd lia e g R R a x FT AFI AF por Ind SE K I J e e x 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

% Change

F As TS ia E Pa As cif ia F 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 r s E/ A S E 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 0 cif /X ua a n In x i F ic G nh All 5 de FT SE FT TSE ov ua -Sh 0 In x C e EP SE EP rn hi 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 Asi ia ex SE I E EI Div a 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 Sha 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 ral nd RA R ga ia I ex FT FI AF por nd SE K I J e e x 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

No v07

Ap r-0 7

10:00

No v07

Index Level Rebased (29 Nov 02=100)

13/12/07

Ap r-0 6

No v05

Ap r-0 5

No v04

Ap r-0 4

No v03

Ap r-0 3

No v02

MARKET DATA BY FTSE RESEARCH

FT SE

MARKET REPORTS 23.qxd:MARKET REPORTS 23.qxd Page 94

Asia Pacific Market Indices

5-Year Total Return Performance Graph 2400

2100

FTSE Asia Pacific Index

1800

FTSE/ASEAN 40 Index

1500

1200

FTSE/Xinhua China 25 Index

900

FTSE Asia Pacific Government Bond Inde

600

FTSE IDFC India Infrastructure Index

300

0

2-Month Performance

30

20

10

0

Capital return

Total return

-10

-20

1-Year Performance

180

160

140

120

100

80

60

Capital return

40

20

Total return

-20

0

JANUARY/FEBRUARY 2008 â&#x20AC;˘ FTSE GLOBAL MARKETS

MARKET REPORTS 23.qxd:MARKET REPORTS 23.qxd

13/12/07

10:00

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

1271 798 473

304.93 538.05 105.23

0.0 1.1 -5.1

9.1 21.2 -12.6

20.9 42.4 -3.9

17.4 37.0 -8.6

1.91 2.36 1.30

USD USD USD

3139 1813 1326

538.08 721.71 371.79

-0.1 1.0 -5.2

9.2 20.9 -12.7

21.5 43.4 -4.2

18.1 38.0 -8.8

1.90 2.31 1.32

USD USD MYR TWD CNY HKD

150 480.93 40 9468.25 100 9109.50 50 6219.08 1007 10447.36 25 26949.78

3.0 3.0 4.7 -6.4 -16.4 3.2

11.0 7.5 2.8 6.0 11.9 59.9

38.5 30.8 30.1 10.7 164.5 92.8

34.3 26.7 27.9 8.8 128.4 62.3

2.90 3.06 2.86 3.61 0.51 1.28

USD

255

86.63

4.5

2.6

2.7

3.4

1.50

USD USD USD USD USD

79 39 52 41 38

2446.07 1825.13 2998.43 1370.52 1732.30

-1.7 -1.9 0.2 -6.4 1.5

2.4 0.3 10.7 -7.7 10.1

24.6 20.8 31.7 10.4 35.9

18.8 15.0 24.4 4.7 30.1

2.73 5.1 3.94 4.83 1.39

IRP IRP

63 30

1658.45 1811.35

24.1 29.3

58.8 70.8

101.6 116.4

98.5 113.3

0.40 0.47

JPY

192

5699.31

-4.0

-12.5

-3.9

-9.1

1.28

USD MYR JPY

100 6387.47 30 10974.37 100 1612.23

-2.4 12.2 -8.0

7.8 16.6 -10.4

15.3 56.6 -1.3

10.5 52.6 -8.2

1.77 2.39 1.35

JPY AUD AUD SGD JPY JPY HKD

473 110 54 19 344 997 50

-4.6 -1.7 0.0 -7.2 -5.1 -4.5 5.9

-12.8 2.7 1.4 -3.2 -11.9 -9.1 52.3

-3.5 18.0 17.7 23.2 -2.3 8.2 na

-8.3 14.2 12.8 15.5 -7.3 2.3 na

1.35 3.91 4.09 3.39 1.41 2.71 1.74

4066.63 4634.30 6837.26 7805.43 5658.62 6018.11 8570.53

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 USD USD USD

1271 798 473

Value 2 M (%) 6 M (%) 12 M (%) YTD (%) Actual Div Yld (%) 348.97 0.1 10.3 23.3 19.6 1.86 668.88 1.3 23.0 46.3 40.6 2.45 125.74 -5.0 -12.0 -2.7 -7.5 1.17

USD USD USD

3139 1813 1326

593.56 839.00 393.06

0.1 1.3 -5.1

10.3 22.6 -12.1

23.9 47.2 -3.0

20.3 41.5 -7.7

1.84 2.37 1.17

USD USD MYR TWD CNY CNY

150 588.53 40 10368.28 100 9576.45 50 7423.13 1007 11276.83 25 32843.74

3.3 3.3 5.1 -6.4 -16.4 3.2

12.8 9.3 4.3 9.6 12.4 61.2

42.9 34.9 34.1 14.4 166.2 96.4

38.3 30.4 31.4 12.5 129.9 65.3

2.71 2.81 2.50 3.38 0.55 1.49

USD

255

101.02

4.8

4.0

4.9

5.2

1.50

USD USD USD USD USD

79 39 52 41 38

3207.76 1994.28 3165.06 1497.94 1784.84

-1.4 -1.6 0.7 -6.1 1.9

3.9 2.1 13.0 -5.5 11.0

28.3 24.5 37.2 15.7 38.1

21.6 17.9 28.4 8.7 31.8

2.85 5.0 3.86 4.66 1.53

IRP IRP

63 30

1662.87 1816.82

24.1 29.3

59.2 71.3

102.9 118.0

99.6 114.8

0.51 0.66

JPY

192

6083.23

-4.0

-11.9

-2.7

-8.0

1.24

USD MYR JPY

100 6615.65 30 11648.43 100 1692.07

-2.2 12.2 -7.9

8.9 18.1 -9.8

17.3 61.1 0.0

12.4 56.6 -7.0

1.73 2.59 1.24

JPY AUD AUD SGD JPY JPY HKD

473 110 54 19 344 997 50

-4.5 -1.2 0.6 -7.0 -5.1 -4.2 5.9

-12.3 5.0 4.0 -1.4 -11.4 -8.1 53.8

-2.2 22.7 23.0 27.4 -1.1 11.0 na

-7.2 18.4 17.5 19.0 -6.1 4.9 na

1.23 3.77 4.14 2.96 1.26 2.65 2.05

FTSE GLOBAL MARKETS • JANUARY/FEBRUARY 2008

4186.13 5119.16 7534.57 8324.24 5808.67 6307.18 8774.29

95

GM EDITORIAL 23.qxd:Issue 23

22/12/07

11:16

Page 96

CALENDAR

Index Reviews January – April 2008 Date

Index Series

Review Type

Effective Data Cut-off (Close of business)

9-Jan

FTSE/Xinhua Index Series

Quarterly review

18-Jan

10-Jan

TSEC Taiwan 50

Quarterly review

18-Jan

31-Dec

Mid Jan

PSI 20

Semi-annual review

31-Jan

31-Dec

Mid Jan

OMX H25

Semi-annual review consitutents, Quarterly review of number of shares

31-Jan

31-Dec

Late Jan/Early Feb

BEL 20

Annual review

3-Mar31-Dec

Late Jan/Early Feb

AEX

Annual review

3-Mar31-Dec

8-Feb

Hang Seng

Quarterly review

3-Mar

31-Dec

15-Feb

MSCI Standard Index Series

Quarterly review

29-Feb

31-Jan

26-Feb

FTSE All-World

Annual review Asia Pacific ex Japan

21-Mar

31-Dec

Early Mar

ATX

Semi-annual review / number of shares

31-Mar

29-Feb

Early Mar

CAC 40

Quarterly review

21-Mar

29-Feb

Early Mar

S&P / TSX

Quarterly review

21-Mar

29-Feb

3-Mar

S&P / MIB

Semi-annual review

19 Mar

10 Mar

3-Mar

S&P / ASX Indices

Annual / Quarterly review

21-Mar

29-Feb

3-Mar

DAX

Quarterly review

21-Mar

29-Feb

11-Mar

NZSX 50

Quarterly review

31-Mar

29-Feb

11-Mar

S&P MIB

Quarterly review - shares & IWF

15-Mar

10-Mar

12-Mar

FTSE Asiatop / Asian Sectors

Semi-annual review

21-Mar

29-Feb

12-Mar

FTSE/ASEAN 40 Index

Annual review

21-Mar

29-Feb

12-Mar

FTSE UK

Quarterly review

21-Mar

11-Mar

12-Mar

FTSE All-World

Annual review Asia Pacific ex Japan

21-Mar

31-Dec

12-Mar

FTSEurofirst 300

Quarterly review

21-Mar

29-Feb

12-Mar

FTSE techMARK 100

Quarterly review

21-Mar

29-Feb

12-Mar

FTSE eTX

Quarterly review

21-Mar

29-Feb

12-Mar

FTSE/JSE Africa Index Series

Quarterly review

21-Mar

7-Mar

12-Mar

FTSE EPRA/NAREIT Global Real

24-Dec

Estate Index Series

Quarterly review

21-Mar

7-Mar

14-Mar

NASDAQ 100

Quarterly review / Shares adjustment

21-Mar

29-Feb

14-Mar

S&P US Indices

Quarterly review

21-Mar

7-Mar

14-Mar

S&P Europe 350 / S&P Euro

Quarterly review

21-Mar

7-Mar

14-Mar

S&P Topix 150

Quarterly review

21-Mar

7-Mar

14-Mar

S&P Asia 50

Quarterly review

21-Mar

7-Mar

14-Mar

S&P Global 1200

Quarterly review

21-Mar

7-Mar

14-Mar

S&P Global 100

Quarterly review

21-Mar

7-Mar

14-Mar

S&P Latin 40

Quarterly review

21-Mar

7-Mar

19-Mar

DJ STOXX

Quarterly review (components)

21-Mar

20-Feb

19-Mar

DJ STOXX

Quarterly review (style)

21-Mar

1-Mar

19-Mar

Russell US Indices

Quarterly review - IPO additions only

31-Mar

29-Feb

9-Apr

FTSE/Xinhua Index Series

Quarterly review

18-Apr

24-Mar

9-Apr

FTSE Nordic 30

Semi-annual review

18-Apr

31-Mar

10-Apr

TSEC Taiwan 50

Quarterly review

18-Apr

31-Mar

Mid April

OMX H25

Quarterly review - shares in issue

30-Apr

31-Mar

Late April

FTSE / ATHEX

Semi-annual review

30-May

30-Mar

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

96

JANUARY/FEBRUARY 2008 • FTSE GLOBAL MARKETS

GM EDITORIAL 23.qxd:Issue 23

22/12/07

11:16

Page IBC1

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.

GGM EDITORIAL 23.qxd:Issue 23

22/12/07

11:16

Page OBC1

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