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PUMPING UP THE VOLUME OF CARBON TRADING ISSUE 26 • JUNE 2008

Has tax nearly killed off UK REITs? Securities lending the Starble way EuroCCP to shake up clearing & settlement

TURKCELL:

WILL IT WIN THE BATTLE FOR EASTERN EUROPE?

TEMPERAMENTAL COPPER WIRES THE WORLD

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Outlook EDITORIAL DIRECTOR:

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FTSE GLOBAL MARKETS • JUNE 2008

S THE GLOBAL markets move beyond the echoes of sub-prime difficulties, the definition and appeal of emerging markets and commodities increasingly come to the fore. No apologies then that this edition has a strong focus on the new loci of liquidity: namely the Gulf Cooperation Council (GCC) countries; top flight emerging markets (Hungary and Turkey) as well as a fair smattering of commodities, with our review of the copper sector. It smacks fairly and squarely of the paradigm shifts that are rampant in the first half of this year; though signs increasingly tell of the beginnings of a resurgence in traditional markets by the third quarter. That however, is food for thought in the next edition.

It is a truism, but banking and capital markets activity remain the inevitable bellwethers of market change and rude financial health. In this edition we look intently at the key financial markets in the GCC countries, highlighting the complementary and competitive strengths of the Saudi banking sector; and the country’s efforts to deepen its capital markets. Moreover, we look at how Islamic finance is establishing a firmer footing in the wider Middle East, North Africa and Asian (MENASA) region; in some cases outstripping or supplanting traditional financing, as the cost of Islamic money nears market prices.

Turkey looms large: its banking sector refurbished and revitalised after a stinging start at the turn of the century. The banking crisis of 2001 took the wind out the sails of a sector that had taken at least one storm-battering in each of the closing decades of the last century. Although not everything in the banking sector is rosy. It is, after all, tied to some degree to the fortunes of Europe and the United States. Additionally, the government continues to reverberate to a series of internal crises and mismanagement of state-owned banks. However, the rigour required by successive years of IMF structural adjustment straightjackets and a willingness by the country’s private sector financial institutions to knuckle down and focus on traditional commercial and retail banking is beginning to pay dividends. Power balances within Turkey’s banking sector are shifting once more as Akbank, Garanti, and a resurgent Yapi Kredi under the stewardship of banking major Tayfun Bayazit continue to redefine the meaning of ‘value-added services’. We look at the new generation of visionary bankers in Turkey and in a related profile, Susan Sabanci Dinçer, Akbank’s chairwoman and managing director, outlines the sector’s challenges and Akbank’s particular responses.

Staying in Turkey, our cover slot this month focuses on Turkcell, Turkey’s lead telecommunication and technology operator. The firm is a touchstone of the challenges facing the sector. By fate, fortune or design, Turkcell is now a player in a complex (perhaps even Byzantine) tourney. The firm will emerge from the joust either as a lead regional telecommunications powerhouse; or as a cash-cow subsidiary of a more aggressive (and winning) operator. As the global telecommunications sector continues to smoulder through a succession of mergers and acquisitions, in the scrap for market share and augmented revenues,Turkcell must now formulate a winning game plan. Can it meet the competitive challenge?

Elsewhere, we look at carbon trading: a poster child of climate management. Three years out from Kyoto, carbon trading is flourishing; with an ever expanding array of products and services. The potential is great. The value of carbon trading in the US alone could reach $1trn by 2020—no wonder hedge funds have started to take note. The caveat? The US and China must become seriously involved in order for it to develop into a meaningful asset class.“The real challenges around the development of the carbon market are and always will be political,” notes Andreas Arvanitakis, a senior analyst at Carbon Point. “If international negotiations collapse at any point then the market cannot develop.”Who is helping it along? Find out on page 6.

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Francesca Carnevale, Editorial Director June 2008

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Contents COVER STORY COVER STORY: TURKCELL, THE BATTLE FOR MARKET SHARE ....Page 53 Turkey's lead Telecom operator Turkcell is now a player in a complex joust for market share in the Central Asian region. The firm will emerge from the joust either as a lead regional telecommunications powerhouse; or as a cash-cow subsidiary of a more aggressive (and winning) operator. As the global telecommunications sector continues to smoulder through a succession of mergers and acquisitions can Turkcell meet the competitive challenge?

DEPARTMENTS MARKET LEADER

MORE POLITICS PLEASE

..................................................................................................Page 6 Lynn Strongin Dodds reports on the rise of carbon trading

FX TRADING IN MULTI-MARKETS ......................................................Page 14 Managing risk & new product in a changing FX landscape

IN THE MARKETS

TOP-FLIGHT SERVICE ........................................................................................Page 18 Sungard’s Paul zur Nieden encourages the uptake of ASPs

HOW WELL DO YOU KNOW YOUR CUSTOMER?......................Page 22 Stephen Platt explains the pitfalls of US legislation on financial institutions

SHAKE, RATTLE & ROLL

INDEX REVIEW

................................................................................Page 24 Simon Denham, managing director, Capital Spreads, worries about the UK outlook

FACE TO FACE

Dave Simons in conversation with State Street’s Craig Starble

WHY THE SEC LENDING MARKET LOOKS QUITE BRIGHT ....Page 26 HUNGARY FEELS THE CRUNCH

............................................................Page 29 What is the effect of too many foreign banks? Julia Grindell reports

SAUDI BANKS ON INFRASTRUCTURE

..............................................Page 32 How local banks leverage the new infrastructure spending boom

THE BOOMING ISLAMIC ISSUANCE PIPELINE ..........................Page 38 How the credit crunch impacts on the GCC’s new issues

DOING IT THE SAMBA WAY ....................................................................Page 40

COUNTRY REPORTS

In conversion with CEO Eisa M Al-Eisa

WHEN EAST MEETS EAST

..........................................................................Page 42 The new geography of Islamic finance

THE RISE OF THE DME ..................................................................................Page 43 Why everyone wants a piece of the Dubai Mercantile Exchange

TURKEY’S BANKS TURN UP THE HEAT ..........................................Page 45 Why the financial market needs to decouple from the politics

AKBANK: THE QUIET PRETENDER ......................................................Page 50 Chairman Susan Sabanci Dinçer explains Akbank’s world view

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COMMODITIES REPORT

TEMPERAMENTAL COPPER WIRES THE WORLD ..................Page 57

REAL ESTATE

HAS TAX DAMPENED UK REITS? ............................................................Page 61

DATA PAGES

ETF data by Morgan Stanley ........................................................................................Page 84 Securities Lending Trends by Data Explorer ............................................................Page 87 Market Reports by FTSE Research ..............................................................................Page 88 Index Calendar ..............................................................................................................Page 96

Vanja Sliva makes sense of a cloudy future for copper, despite rising demand

Why UK REITs have been a damp squib

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With over 320 million barrels traded, 70 DME members, and having received FOW’s Exchange Newcomer of the Year 2008 award, this will be a first birthday celebration to remember. And we’re still growing. The introduction of two new financially settled futures contracts, the DME Brent Crude Oil Financial Contract and the DME Oman Crude Financial Contract, shows our determination to build on our success.

In the years to come, we will continue to take great strides and identify tomorrow’s trends. We mean business.

The DME is authorised and regulated by the Dubai Financial Services Authority (DFSA). All trades executed on the Exchange will be cleared through, and guaranteed by, NYMEX’s Clearinghouse which is licensed as a recognised body by DSFA.

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Contents FEATURES CROSS BORDER CLEARING & SETTLEMENT

EUROCCP: DOING THE CONTINENTAL ..........................................Page 65 While it is unlikely that development of a more complex trading environment will slow, the success of new multi-lateral trading facilities (MTFs) and inter-market competition could be tempered by the increase in operational complexity and costs associated with an unresolved cross-border clearing and settlement process. Does the DTCC’s EuroCCP hold the answer? Neil O’Hara reports.

LINK UP MARKETS............................................................................................Page 68 Seven central securities depositories (CSDs) signed an agreement in early April to establish Link Up Markets, a joint venture to improve efficiency and reduce costs of post-trade processing of cross-border securities transactions in Europe. Is it a first step towards the development of a truly pan European solution to more efficient and cost effective post trade processing of cross-border securities transactions? Or a marked counterpoint to EuroCCP?

CORPORATE PROFILE

STARBUCKS: COFFEE A GO GO ............................................................Page 69 Just two years ago Starbucks was opening coffee shops at a furious pace, sales were climbing steadily and its stock traded at record highs. Since then, the company suffered its first-ever decline in same store sales, a national consumer testing magazine judged brewed coffee from McDonald’s to be superior, and Starbucks’ shares are down nearly 60%. In January Howard Schultz returned as chief executive officer (CEO), warning investors not to expect a fast turnaround. Art Detman explains why they should believe him.

ALTERNATIVE FUND ADMINISTRATION

THE WATCHWORD IS CONVERGENCE

..........................................Page 73 The market for alternative fund administration services remains highly competitive, providing clients with a wide range of choices. While consolidation has greatly benefited those at the top of the spectrum, it has also created an opening eagerly exploited by boutique players, whose specialist approach continues enjoy surprising popularity. Dave Simons reports from Boston.

THE HEDGE FUND REPORT

DISCERNING PERFORMANCE & STRATEGY ................................Page 78 Hedge funds have always been the asset class that investors love to hate. The high fees, opaque strategies, not to mention the seemingly glamorous lifestyles of managers, have often raised hackles. Despite the negative publicity, though, they have been raking in the assets over the last few years. The credit crunch may have prompted a pause for reflection, but it is unlikely institutions will turn their back on hedge funds. Instead, they will be much more discerning in terms of strategy and performance.

ASIAN HEDGE FUNDS: BALANCING RISK & RETURN ........Page 81 In the greater Asia region investment flows into hedge funds continues apace. Assets under management (AUM) for a few funds in the space fell by over 70%, while falls of over 25% have been common. However, a few actually grew assets during the correction. Simon Coxeter, founder of AsiaSource Capital, assesses the short term outlook for the sector and outlines some of the more successful strategies.

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BANKING

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Market Leader CARBON TRADING: HOW TO LIFT TRADING VOLUMES

The problem today, is that China and India are on the road to becoming economic powerhouses with carbon emissions to match.

The latest forecasts from the International Energy Agency, show that China has already overtaken the US as the world’s biggest emitter in 2007, while India is slated to become the third biggest emitter by around 2015. These two countries bristle though at calls from the developed world to accept caps on future greenhouse gas emissions as part of a global deal to replace the Kyoto protocol. Photograph © Stephen Bourelle/Dreamstime.com, supplied May 2008.

MORE POLITICS PLEASE Three years after Kyoto Protocol came into force, carbon trading is flourishing. The market is flowing with an ever expanding array of products and services particularly from investment banks who never like to miss an opportunity. Europe is widely praised for leading the way, but progress will certainly be stalled unless the United States, India and China take a more proactive stance. In this market, financial clout is no match for political will. By Lynn Strongin Dodds CTUALLY, THE GROWTH of carbon trading over the last three years has been quite impressive. According to the 2008 Point Carbon Annual Report, the carbon market surged to €40bn last year, up a substantial 80% from 2006 volumes. This year could see a further jump to €63bn. The lion’s share is traded in Europe, which set up the European Union Emissions Trading Scheme (EU ETS) back in 2005; a “cap-and-trade” scheme to comply with greenhouse gas emission limits mandated by the 1997 Kyoto Protocol.

The two main products being traded are ‘allowances’, which are handed out to developed countries

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and effectively set a quota on their pollution, and project-based ‘certified emission reduction’ (CER) credits, which are verified by the UN and issued under The Clean Development Mechanism (CDM). This is an arrangement under Kyoto allowing industrialised countries committed to greenhouse gas reduction to invest in projects that reduce emissions in developing countries, as an alternative to what is generally considered more costly emission reductions in their own countries.

The potential is immense. Some analysts say that trading in the US alone could top the $1trn mark by 2020. That might explain why many

investment banks and hedge funds are showing more interest in the asset class. There is however, a caveat. The establishment of carbon trading as a sustainable and deep asset class is that the US as well as China must become seriously involved in supporting its expansion. In addition, a successor treaty to Kyoto, which expires in 2012, also needs to be hammered out. These are not easy tasks.“The real challenges around the development of the carbon market are and always will be political, “says Andreas Arvanitakis, senior analyst at Carbon Point. “If international negotiations collapse at any point then the market cannot develop. This is always an issue.”

Despite the wranglings on the international stage, all agree that the lack of engagement of the US lies at the heart of the matter. The country was heavily criticised for not signing up to the 1997 Kyoto Protocol, whose aim was to have developed nations reduce their carbon emissions an average of 5% below 1990 levels by

JUNE 2008 • FTSE GLOBAL MARKETS

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“A risk tamed is a reward captured.”

MICHAEL PLATT CEO and Founder, BlueCrest Capital Management Limited

For Michael Platt, nothing reduces the threat of risk like CME Group. As CEO and founder of London’s fast-growing BlueCrest Capital Management, Michael relies on the assurance — and innovation — of CME Group to protect and manage a $12 billion portfolio. With complete price transparency, liquidity and central counterparty clearing, CME Group guarantees the soundness of every trade. We’re committed to serving the needs of market users worldwide, allowing you to manage best what matters most.

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The Globe logo, CME®, Chicago Mercantile Exchange® and CME Group™ are trademarks of Chicago Mercantile Exchange Inc. CBOT® and Chicago Board of Trade® are trademarks of the Board of Trade of the City of Chicago. Copyright © 2008 CME Group. All rights reserved.

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Market Leader CARBON TRADING: HOW TO LIFT TRADING VOLUMES

of pushing through any 2012. Large developing legislation because of his nations like China, India track record on the issue. and Indonesia were excused McCain was not only one of from the treaty, since the few in the Republican limiting their emissions was Party but also one of the first seen as likely to limit their on Capitol Hill, to burgeoning economies. acknowledge the reality of The problem today is that global warming and the need China and India are on the to act quickly. Along with road to becoming economic Lieberman, he sponsored powerhouses with carbon cap-and-trade bills in 2003, emissions to match. The 2005 and early 2007, when latest forecasts to come from most senators on both sides the International Energy were not even thinking about Agency, show that China climate change. During the has already overtaken the primary, he has downplayed US as the world’s biggest that history, although many emitter in 2007, while India purport it was a necessary is slated to become the third strategy to secure the GOP biggest emitter by around [Grand Old Party] 2015. These two countries presidential nomination. bristle though at calls from There is a view that the developed world to McCain could use the accept caps on future Lieberman-Warner bill, greenhouse gas emissions which is set for a vote in as part of a global deal to Paul Ezekiel, head of global carbon trading at Credit Suisse, notes, June, as a way to woo replace the Kyoto protocol.

“As with any new market, we are seeing more participants and a independent voters and put Sara Stahl, who is the broadening of liquidity. It is still relatively early days and you distance between himself business development would expect to see fragmentation of that liquidity. However, and Bush. Despite the bill’s manager at European given that a large proportion of the market is over-the-counter popularity, its fate remains Climate Exchange (ECX), the (OTC), I am not sure that there will be enough liquidity to uncertain. Proponents are premier carbon exchange, support all the new exchanges that are expected to launch.” lobbying hard, highlighting notes,“It is difficult to expect Photograph kindly supplied by Credit Suisse, May 2008. that the costs of a cap and China and India to get involved when 85% of today’s carbon reductions in carbon emissions. This trade system will be more than offset dioxide emissions are caused by the is a first in a presidential campaign; by its benefits. This not only includes developed world. Their argument is although the issue has rarely been addressing the impact of climate why should we sign up to an accord raised in the three dozen change but also injecting money into when the US, one of the world’s largest presidential debates and the clean-tech industries and creating polluters, has not. They want the same candidates have not expounded on millions of so called new “green opportunities to develop their the finer points. What is known, collar”jobs.

There is strong opposition, though, economies as the developed world has. though, is that they all support the However, I think things could change bill introduced by Senators Joe from politicians who represent what is Lieberman and John Warner to left of the US’ coal fired industrial after the US elections.”

Stahl is not alone. There is a create a “cap and trade” programme heartland. About half of the country’s glimmer of hope because all three to cut greenhouse-gas emissions electricity and a third of its CO² pollution come from coal-fired power candidates [Democratic hopefuls 70% below 2005 levels by 2050.

Some industry participants believe plants, and most of these are clustered Senators Hillary Clinton and Barack Obama and Republican nominee that out of the three main contenders, in 25 states, each of which gets a John McCain] support mandatory McCain would have the best chance quarter or more of its electricity from

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Market Leader CARBON TRADING: HOW TO LIFT TRADING VOLUMES

coal. Although the bill gives the allowances. This is not the case with a plunge in the price of futures in the industry about $235bn for research primary CERs as they are more illiquid spring of 2006. This meant that and development, the concern is that and require structuring although this companies had a surplus and as a by creating a system in which electric may change as they become more result had no incentive to buy permits or cut emissions. This has been utilities pay for the right to pollute, established and mature.”

To date, the ECX has a firm lock on rectified as fewer permits have been electricity rates will increase in those states and this could prompt a shift to exchange traded products, accounting allocated in phase II (2008-2012).

Stahl comments, “The first three for 87%, up from 76% in 2006, natural gas.

Whatever the outcome, Simon according to figures from Point years were really about developing the market and getting people Shaw, chairman of EEA on board about this new Fund Management, which concept. Now carbon is manages UK equity becoming just like any portfolios and energy and other commodity markets environmental assets, says, with major investment “The Lieberman-Warner “The Lieberman-Warner bill is a sign banks launching indices. bill is a sign that the US is that the US is heading in the right Participants include 5,000 heading in the right direction. It may not get through but it companies representing direction. It may not get provides a cross party framework to 12,000 installations across through but it provides a work with. Another encouraging sign is the EU but we also have cross party framework to financial institutions such work with.

Another The Regional Greenhouse Gas Initiative, as investment banks, encouraging sign is The (RGGI, a cooperative effort by brokerages and hedge Regional Greenhouse Gas Northeastern and Mid-Atlantic states.” funds who provide the Initiative, (RGGI, a liquidity. Our newest cooperative effort by product is a futures and Northeastern and Midoptions contracts on Atlantic states to reduce carbon dioxide emissions), which has Carbon, the specialist consultancy and CERs, which we launched in March, news service. The other two main and later in the year, we plan to so far been adopted by 25 states.”

In the meantime, Europe will bourses are Oslo based power introduce a spread contract between continue to forge the main path, exchange Nordpool (6.3%) and the CER and the futures and options although it is facing increased France’s Powernext with 5.5%. contracts based on EU allowances competition as new exchanges enter Germany’s power exchange European (EUAs) to expand the existing range.”

Abyd Karmali, global head of the space, hoping to capture the Energy Exchange (EEX), is in fourth carbon emissions at Merrill Lynch, carbon wave. Roughly two-thirds of position, at 1.4%.

Launched in 2005, ECX is owned notes,“The market has done its job in the market in carbon trading is carried out over the counter via brokers, along with the Chicago Climate terms of creating a price for carbon. energy specialists as well as the large Exchange, by UK AIM-listed holding Emissions are being reduced and investment banks. Companies, can company Climate Exchange. The there is the additional multiplying also buy or sell directly from one difference between the two is the ECX effect of new technologies being another, or trade permits through operates an exchange focused on implemented. One of the problems in exchanges. Currently, there are 5,000 compliance certificates for the Phase I was that very few companies companies overseeing 12,000 energy mandatory EU ETS scheme while the had historical data on emissions and and industrial plans that are CCX remains voluntary, although as a result the regulatory authorities participating in EU ETS scheme. Geoff participants undertake legally binding did not set the targets tight enough. It Sinclair, head of emissions at commitments to reduce emissions. It was a design mechanism that has now Standard Bank, notes,“It is important has not been easy sailing for ECX. been fixed.”

Given the potential of carbon, it is for investors to understand that some There were teething problems during of the carbon market is conducive to phase I (2005-2007) of the EU ETS not surprising that other players want exchange trading such as the when an oversupply of permits led to to get in on the act. There are

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JUNE 2008 • FTSE GLOBAL MARKETS

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Market Leader CARBON TRADING: HOW TO LIFT TRADING VOLUMES

currently over 10 exchanges worldwide trading carbon emissions and several more are expected to introduce futures or spot contracts this year. The most recent entrant and the one many will be watching is the Green Exchange, launched earlier this year by The New York Mercantile Exchange (NYMEX), the world’s largest energy futures market.

NYMEX is offering contracts for trading carbon dioxide alongside crude oil, natural gas, gasoline, heating oil, electricity and other commodities. It is tipped to capture the bulk of US carbon trading volumes, which now resides with CCX. CCX has so far had its best year with 27.3m tons of carbon emission offsets being traded compared to 26.5m tons during all of 2007, and about 10m tons in 2006. However, NYMEX is expected to leverage its expertise and relationships in the energy arena to wrest control of a greater market share.

If the pace continues, a truly fragmented market could emerge although market participants are not convinced there will be enough of the cake to share. Paul Ezekiel, head of global carbon trading at Credit Suisse, notes, “As with any new market, we are seeing more participants and a broadening of liquidity. It is still relatively early days and you would expect to see fragmentation of that liquidity. However, given that a large proportion of the market is over-thecounter (OTC), I am not sure that there will be enough liquidity to support all the new exchanges that are expected to launch.”

Andy Strickland, associate director at ICAP Energy plc goes further.“At the moment carbon is headline news and everyone wants to be in the space. The ECX dominates and it has a robust platform. I am not sure that there is a need for more than one or two

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There is strong opposition to payments for the right to pollute though, from politicians who represent what is left of the US’ coal fired industrial heartland. About half of the country’s electricity and a third of its CO² pollution come from coal-fired power plants, and most of these are clustered in 25 states, each of which gets a quarter or more of its electricity from coal.

Although the bill gives the industry about $235bn for research and development, the concern is that by creating a system in which electric utilities pay for the right to pollute, electricity rates will increase in those states and this could prompt a shift to natural gas. Photograph © Pierdelune/Dreamstime.com, supplied May 2008.

exchanges. In the future, I expect to see the development of an options market with more sophisticated investors but that is still a long way off,”he says.

Oliver Maibum, managing director of EEX certainly has no plans for the EEX to give up its day job as a power exchange. “One of the biggest problems is that the fee for trading carbon is so minimal in comparison to the rest of the products that we trade $1 for every 1,000 tonnes that we trade. Although carbon has the potential to be a global market, I think liquidity will consolidate on the main markets such as ECX and the Green Exchange.”

The investment banks, however, are likely to continue revving their engines, especially as institutional investors are showing an interest.

Louis Redshaw, head of environmental markets at Barclays Capital, notes, “The carbon market is

for participants and those who trade associated products. Until recently, investors have gained exposure to carbon through a clean technology or dedicated carbon funds. However, they are now asking for more direct exposure as the market develops, for example through indices that track the price of carbon.”

Over the past six months, the market has seen the launch of Barclays’ Global Carbon Index, which tracks the performance of carbon credits in major emissions trading schemes, as well as UBS’ Greenhouse Index which combines carbon trading futures and weather linked future contracts for a more integrated approach. Merrill is the latest entry with its new global emissions benchmark, the MLCX Global CO² Emissions Index, which is based on contracts established under the EU ETS and Kyoto.

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In the Markets MANAGING FX RISK

As with equity and debt markets, foreign exchange rate volatility presents enormous opportunities but also enormous risks both for those trading for profit and those attempting to manage their clientâ&#x20AC;&#x2122;s currency exposure in multiple asset classes. In difficult times a comprehensive new business strategy for managing FX (providing timely and accurate execution) and risk management services may now require providers to extend the development of a variety of FX services across multiple markets at home and abroad.

Photograph Š John Bigl/Dreamstime.com, supplied May 2008.

EXTENDING THE FX FRANCHISE HESE ARE TESTING days for the global foreign exchange (FX) markets. The markets have been buffeted by a number of immediate factors: the knock on effect of the global credit crunch; rapid growth in trading in Asian markets (a trend that looks likely to continue over the short term); continued weakness in the US and sterling and a growing maturity in electronic FX (e-FX) trading platforms.

Most significantly perhaps, the fallout of the credit crunch continues to have an impact on the market, in terms of risk management and credit. Risk management issues are now high on the agenda as global banks struggle

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to control their overall exposure.

Moreover, FX market growth in Europe and the US has historically been driven by rising issuance and hedging of hedging of credit default obligations (CDO) and credit default swaps (CDS) and as these assets have diminished in the wake of the sub prime crisis, there has been an attendant knock on effect on volumes in the FX market. As credit levels have been reduced, highly leveraged institutions such as hedge funds have had less capital to trade with - depriving the market of some oxygen at home; and encouraging the development of new operations abroad.

In this environment of rapid

change, fundamental relationships between all participants in the market are being tested and transformed, with significant implications for market structure. In the immediate aftermath of the sub prime crisis and the continued growth of FX trading in key emerging markets, the ultimate direction of the market and the level of volatility that is likely during the rest of 2008 remain impossible to predict. One thing is constant: the need for banks to remain competitive.

Banks will remain under constant pressure to find ways of balancing the need to deal with expansion alongside their risk management and margin enhancement agendas.

A recent report cuts to the heart of the matter. The Global FX Market Study, commissioned by the Chicago Mercantile Exchange (CME) and undertaken by wholesale financial services consultancy ClientKnowledge and released in late March, shows that the $3.2bn global foreign exchange trading growth is driven by three trends: the rise of electronic trading and trading technology; cost control and risk concerns. In developed markets, FX has become a commoditised instrument and technology plays a great role in accelerating the growth of transaction volume by pushing forward an industrialised approach and by lowering transaction cost and risk.

Among the key findings in the study, is that while latency remains an important consideration, particularly with the electronic trading community, some 72% of participants in the research cited counterparty risk as their biggest concern, followed by settlement risk (64%). Specifically, settlement costs (including exchange fees) concerned 49% of active and 48% of less active traders, while in line with the relatively low number of algorithmic traders in the survey,

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In the Markets MANAGING FX RISK

reported fills relative to benchmark prices concerned 23% of active and 15% of real money traders. The findings point to the fact that increasing numbers of participants are looking for liquid venues with tight spreads and clearly defined settlement costs. CME took the results in entirety to mean that the exchange-style central clearing model, which it says lessens both these risks, has a distinct advantage in this regard. “The concerns about counterparty and settlement risk speak to the value that an exchange model brings to the FX market and the potential to play an even greater role in the market,” maintains Derek Shammann, managing director, CME Group FX Products. “The central counterparty model virtually eliminates both of these risks.”

In addition, the survey found that almost half of the transactions undertaken by respondents are initiated as hedging instruments, while quantitative trading models are used by proportionally fewer market participants, indicating that the majority of new entrants to the market are trading fundamentally.

Cross-product management of risk is key in this environment. The survey revealed that among the asset classes most likely to be additionally traded with FX, banks see money markets as most important (71%) while highly active traders looked to fixed income (53%), equities (41%), and interest rates (28%). According to the study, to fully exploit the FX relationship, providers need to have depth in other product classes. Finally, polled on their concerns regarding risks to the FX markets, not surprisingly the respondents cited liquidity crunch (40%), and macro-economic problems (31%).

In developing countries meanwhile, there is a current need for solutions

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that can increase the efficiency of FX markets. In an initiative that cuts to the rising tide of Asian business and the results of the CME sponsored survey Citi’s new domestic settlement service (DSS) for interbank foreign exchange trades, which was launched in early April, aims to help emerging economies lower settlement risk.

Developed for use by central banks in developing markets, the solution is designed to reduce settlement risk by simultaneously settling both sides of foreign exchange transactions. In Colombia, the Cámara de Compensación de Divisas, established in 2007 under the risk control initiative of Colombian’s central bank, Banco de la Republica, is now using Citi’s solution to provide a simultaneous settlement process for US dollar versus Colombian peso trades for same day settlement. Some 50 financial institutions are expected participate in Colombia’s simultaneous settlement process in the next few months, with the average daily trade volume in the market worth over $1bn.

With the rapid growth of high-value forex trades, addressing interbank settlement risk is more significant than ever. Forex trades inherently have high settlement risk due to the two-sided nature of the contract, where a timing lag in payments can occur between participants. In this scenario, one party can default before the funds are settled, leaving the other exposed to significant loss and it is this element that Citi’s initiative aims to tackle.

As traditional markets alter, traditional FX trading houses are looking at alternative business lines.

Barclays Capital is the latest house to want to break into the mass and private wealth management FX markets with the launch of a whitelabel margin FX trading service called

Barx White Label for Private Investors.

The service, which is already live with select clients of Barclays Stockbrokers in the UK, is underpinned by trading technology vendor Integral’s FX Power Trader system and BarCap liquidity and services. Barclays Capital now joins ABN Amro, Citi, Deutsche Bank, Goldman Sachs, Lehman Brothers and UBS in launching an initiative to take advantage of the lucrative business opportunity now presented by retail FX traders.

Estimates from ClientKnowledge puts the size of the market at almost $100bn a day, doubling in the past 12 to 18 months.

However, the UK bank targets this community in a different way from its wholesale peers. Goldman Sachs and Lehman entered the market by acquiring stakes in existing retail brokers, while ABN Amro, Citi, Deutsche Bank and UBS offer whitelabel platforms to clients directly.

Barclays differentiates itself by offering its white label partners with the ability to manage their own clients and work with the bank to help them build their business. The service extends an existing relationship between Barclays Capital and Integral, which together launched a wholesale white-label solution targeting regional banks two years ago. Integral came to BarCap with this latest technology a year ago, and a bespoke version for Barclays Stockbrokers was developed over the past seven months. The system offers precision pricing, advanced order types, charting, technical analysis tools, and an integrated and automatic risk management and system alerting capability. The trading platform also allows clients to access their trading account through desktop and browser-based software. White-label partners can enable clients to write algorithmic trading strategies such as stop orders if required.

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In the Markets APPLICATION SERVICE PROVIDERS (ASP) ON THE RISE

Photograph © Thea Walstra/Dreamstime.com, supplied May 2008.

TOP-FLIGHT SERVICE What’s the newest thing for asset managers? Application service providers (ASP’s) of course. Fast and low-cost implementation, coupled with improvements in secure technology, are encouraging the uptake of ASP. The arguments for adoption mirror those for outsourcing back and middle office operations: it is an increasingly compelling option for investment firms seeking to offload technology support functions in order to focus on their core competencies in an increasingly complex global investment market; although this time, technology remains in-house. Paul zur Nieden, vice president SunGard Asset Arena clarifies the trends.

GROWING NUMBER of asset management firms and thirdparty administrators are reaping the benefits of the secure and increasingly cost-effective solutions offered by leading application service providers (ASPs). An alternative to costlier installed platforms or complete business-process outsourcing (BPO), the ASP hosted model gives companies access to top-flight software applications that facilitate integral processes, including trading, portfolio management, compliance, performance measurement and attribution, investment accounting and transfer agency record-keeping, while also offering complete hardware maintenance, support and disaster recovery, all without compromising a company’s need for control. Fast, lowcost implementation, coupled with improvements in secure technology, make ASP a compelling option for large and small, traditional and alternative investment firms seeking to offload technology servicing functions in order to focus on their core competencies.

The expansion and increasing

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complexity of the global financial markets obliges institutional investors and asset managers to process a greater portion of their business around-the-clock and in different geographic locations. Coupled with increased demands for accounting transparency and the ever-changing regulatory landscape, the case for support systems that are as up-to-date as possible is invariably strengthened.

It also highlights a key benefit of the ASP model; applications are current, and therefore the need to create an internal project to upgrade is minimised. Application upgrades occur on a scheduled basis, and ASP users are the first to gain access to new features. Service providers who clearly demonstrate the cost-effectiveness and value-added capabilities of ASP, while offering a selection of customised investment-servicing platforms for an increasingly diverse market, are well poised to capitalise on these trends.

However, it is not a new proposition.

Early installments of ASP arrived on the marketplace many years ago. Despite a initial enthusiastic phase, concerns over

security issues, complex integration requirements and lack of customisation kept a number of financial-services firms from testing the waters and the rise of ASP in check. To win the trust of the investment community at large, ASP providers understood that minimising these issues was paramount. Accordingly, today’s leading players have the scale necessary to stay on top of cutting-edge solutions covering the entire breadth of IT functionality, from geographically distributed storage area networks, to virtualisation and advanced ondemand hardware, in addition to leveraging expanded communications bandwidth. Increasingly attractive is the “software as a service”approach (SaaS), a hybrid of the ASP model built around a software application deployment model that provides a broad list of applications available in a single environment under an on-request license model.

Asset management firms must continually improve their technology infrastructure in order to keep pace with a steady stream of regulatory demands and an increasingly diverse menu of investment products. However, the cost of building and maintaining IT systems internally, including software upgrades and accelerated disaster recovery programs, continues to rise, putting added pressure on margins and requiring a constant demand for highly skilled personnel. Preserving capital while concentrating on core business activities is a universal goal—and not surprisingly, companies of all shapes and sizes seeking an efficient thirdparty platform have benefited from ASP. For small and mid-tier buy-side firms without the means to support an internal application, ASP represents a golden opportunity to cover front, middle and back-office operations in a cost-effective and highly efficient package, giving investors the potential

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In the Markets APPLICATION SERVICE PROVIDERS (ASP) ON THE RISE

for higher returns and diminished risk through technologies that might otherwise be unattainable. Indeed, many mid-size firms are now benefiting from the same sophisticated functionality previously available only to large firms. Using ASP, these midsize firms have the flexibility to continue to expand their businesses, confident that their technology infrastructure can keep pace.

Moreover large firms that require coverage for a specific area, such as back office or investment accounting, without incurring the expense of a fulltime IT staff, are prime candidates for ASP. By addressing the problem of delivering large-scale, complex processing on a global basis, leading ASP providers have attracted multinational firms looking to establish multiple applications over numerous locations—thereby eliminating the need for an installed platform. Indeed, fast growing markets such as Asia represent a significant opportunity for ASP providers with a global reach.

Deploying new systems quickly and efficiently is vital, and rapid implementation is a key benefits of ASP. In many instances, clients can be up and running in a matter of weeks. Key to the process is immediate and seamless integration with existing trading, custody and reconciliation systems and processes, and vendors have factored in such requirements using messaging technology and open standards, thereby assuring successful ASP deployment.

While providers with a longstanding record of fast and cost-effective system delivery may have a leg up on the competition, initial speed to market is not the be all and end all. The best vendors also ensure that ongoing upgrades and software installations will be implemented with the same degree of efficiency, and in many instances can be loaded with few steps requiring little time and low risk. The importance of

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combining scale, breadth of functionality and customisation cannot be overestimated. Providers should be able to offer solutions that span the entire spectrum of workflows and operations, addressing the specific needs of the client through customized reporting capabilities, role-based workflows tailored to multiple users, connections to multiple market data sources, and more.

Vast improvements in secure ASP technology have reduced concerns over relinquishing data and compromising control. Encrypted communications circuits, intrusion detection systems, multi-layered firewalls, router-based access control and secure storage of authentication credentials—not to mention real-time replication and multiple sites for the safekeeping of logical data—are essential elements for providers seeking to host and manage the most mission-critical applications.

Additionally, vendors must be able to deliver platforms that sport fast, efficient and error-free virtual private networks (VPNs) or direct-line connectivity, have the ability to connect with multiple market data sources, and offer easy access to data in both shared and dedicated storage environments.

Demonstrating the value of risk management first-hand is essential to winning over even the most skeptical clients. Accordingly, vendors should be prepared to show how the software can specifically address a company’s problem areas, as well as how the provider’s support staff can effectively integrate with the client’s own personnel. A service agreement outlining key performance indicators, troubleshooting response times, possible workaround solutions, as well an itinerary of scheduled performancereview meetings provides the necessary details that give the client ultimate comfort in the vendor’s ability to deliver.

While the number of ASP providers

has grown significantly, service reliability over the long haul is of greatest importance. The tech implosion of the early part of the decade demonstrated all too well the vulnerability of start-up or undercapitalised third-party providers.

As such, ASP is beneficial only if an experienced, reliable vendor is selected.

Clients who perform due diligence on a prospective provider require a history of stability, ongoing investments in product development, and support staff with the expertise and knowledge to make the technology work to its fullest extent.

As recent research has shown, ASP models for investment accounting and portfolio management systems are already a proven entity, processing trillions in assets and gaining increased adoption with each passing year.

Looking ahead, increased complexity, competition and consolidation within the investment industry will likely continue and widen the trend toward outsourced solutions, as managers continue to divest themselves of noncore activities.The need for a consistent method of delivery across a single, efficient platform bodes well for firms seeking proven investment accounting and portfolio management ASP solutions. The availability of today’s comprehensive ASP offerings, which provide cost-effective IT functionality on an outsourced basis, makes for a very compelling argument going forward. At the same time, increased competition will compel technology providers to continually make ASP product innovation a top priority as they refine and develop their platforms as never before. As the markets become even more complex, demand for more sophisticated solutions and integrated global platforms will only increase. The more challenging it becomes to do business from an operational, compliance and reporting standpoint, the more these benefits will assert themselves.

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

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In the Markets THE EXPORT OF US COMPLIANCE OBLIGATIONS: KNOW YOUR CUSTOMER

Since 9/11, US authorities have deliberately expanded their reach, imposing so-called ‘know your customer’ obligations on non-US banks.

Each bank must provide assurances that its customers are not terrorists, drug traffickers, money launderers or anyone who is persona non grata in the international financial markets. For these banks, the price of noncompliance is high; being barred from doing business in US dollars. The risk is posed not only to banks but any financial institution, including investment businesses. By Stephen Platt, group managing partner of BakerPlatt.

O FURTHER ITS national security objectives, the United States has, for many years, systematically restricted transactions with various countries, through sanctions which are policed by the Office of Foreign Assets Control (OFAC). By and large, US financial institutions, aware of the draconian powers of OFAC and the Financial Crimes Enforcement Network (FinCEN), have toed the line. In a global economy in which the US dollar remains the currency of choice, the Bush administration has tired of its ‘enemies’ circumventing existing sanctions by transacting their US dollar business through non-US financial institutions. These financial institutions process such transactions through their own accounts at US banks [correspondent accounts] as the wrongdoer hides behind the good credit and unimpeachable reputation of a foreign bank.

The USA PATRIOT Act enacted in October 2001 imposed an obligation

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Photograph © Saniphoto/ Dreamstime.com, supplied May 2008.

on US banks operating correspondent accounts to force their foreign bank customers to comply with US regulations. In some instances, foreign banks have allegedly implemented ‘special procedures’ for certain fund transfers on behalf of Iranian customers, thus undermining the dual objectives of the PATRIOT Act and OFAC sanctions against Iran.

ABN AMRO suffered the ignominy of an investigation into similar alleged practices through its Dubai branch and was fined $80m as a result. In this instance, the US authorities were able to exercise jurisdiction by claiming

that the Dutch bank was a US person by virtue of its US branch. The fear in Washington is that the same stick cannot be wielded against foreign banks operating US correspondent accounts with no branch or subsidiary on American soil.

The response has been to apply direct pressure to foreign banks to force them to comply with US sanctions, at the risk of losing the privilege of doing business in dollars through the New York financial markets. This has resulted in a comprehensive export of US compliance obligations. The thinking

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goes that, if the US authorities have foreign banks by their correspondent accounts, their hearts and minds will follow. An international bank without a US correspondent account is effectively shut out of the global financial markets.

The US has loaded its enforcement arsenal with a number of effective weapons to force compliance with its sanctions and anti-money laundering programmes and has marshalled the US banks to act as its front line troops in the enforcement battle. If they are not assured of the foreign banks’ compliance with US regulatory standards, then they are obligated to close their vital correspondent accounts.

Further ammunition is provided under Section 319 of the PATRIOT Act, which permits US authorities to hold foreign banks responsible for the financial misdeeds of their customers and enables them to forfeit funds from a foreign bank’s US correspondent accounts for infractions of US law. This is an effective disincentive for two reasons: the action is brought against a bank’s property not against the bank itself, no wrongdoing needs be proven against the bank for the provision to bite; secondly, the civil and not the more onerous criminal standard of proof applies.

Of greater concern are the antiterrorism laws enacted in 1992 and 1996 which permit victims of terrorist attacks to bring civil actions against financial institutions that are alleged to have provided material support or resources, including financial services, to a foreign terrorist organisation in breach of the US Anti-Terrorism Act. The US civil plaintiff bar that waged the tobacco class litigation wars of the 1980s and 1990s now have foreign banks firmly in their sights on behalf of the victims of terrorist attacks.

Contingency fee arrangements in the

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US permit lawyers to recruit potential plaintiffs who pay no legal fees unless they win and bear no risk of costs if they lose. These lawyers are presumably well aware of the reputational cost to banks of defending claims brought by the victims of terrorism. NatWest is currently defending a series of claims

by US citizens and the heirs of foreign citizens injured or killed in ten terrorist attacks in Israel in 2002 and 2003. It is claimed that, by having maintained accounts and processed transfers in the UK for Interpal (a Palestinian charity registered with the UK Charities Commission), NatWest provided material support to terrorist organisations such as Hamas.

At the time the accounts were maintained by NatWest in the UK, Interpal was designated as a terrorist organisation only by the authorities in Israel. It was only later in 2003 that Interpal was sanctioned by OFAC. At all material times NatWest acted lawfully in the UK where the accounts were operated. Nevertheless, the bank now finds itself defending, at considerable expense, a claim that, whether it succeeds or not, will have done nothing to enhance its reputation. If the claims succeed, the US Anti-Terrorism Act’s ‘treble damages’ provisions are likely to guarantee that the sums in damages will be very substantial.

The position in which UK banks and companies have been placed has not gone unnoticed at parliamentary level. The House of Lords Economic Affairs Committee has expressed extreme concern at the US approach, noting that while it recognised the need to take vigorous action, it condemned the extra-territorial application of US sanctions as a violation of international law.

Domestic legislation exists, alongside EU Council Regulation

Stephen Platt, managing partner, BakerPlatt in Jersey. Photograph kindly supplied by BakerPlatt, May 2008.

2271/96 or the ‘Blocking Statute’, making it an offence to co-operate with US extra-territorial sanctions whether actively or through deliberate omission or through a subsidiary or intermediary. The Lords saw this as an effective and available response, if lacking in political will. Whilst the government have not yet sought to bring prosecutions in reliance on the legislation, UK banks may find themselves between a rock and a hard place. It is difficult to conceive of more powerful disincentives for non-US banks to act contrary to US foreign policy objectives wherever they conduct their business, whether they maintain a banking presence in the US or not. Consequently, it has become imperative that non-US banks understand the expanded reach of US law in designing their own compliance regimes. The costs of compliance to the non-US banking sector look set to continue to soar.

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Index Review BAD NEWS BEARS FOR UK ECONOMY

The UK senior indices, the FTSE 100 and FTSE 250, are increasingly polarised between genuinely UK based business (not good) and globally based equity (doing rather well). The obvious divergence is well known. Mining, which makes up an ever expanding weighting, is strengthening almost by the minute; retailing, industrials and banking struggle under the perception of an imminent collapse of the UK economy and fears over profit margins. Simon Denham, managing director, of spread betting firm Capital Spreads, outlines the bad and the worse news.

Simon Denham, managing director of spread betting firm, Capital Spreads, April 2008.

DIVERGING FORTUNES HE BANKING SECTOR is the bellwether of the UK’s now divergent and outrageous fortune.

Genuinely British focused units are plumbing ever lower depths. Bradford and Bingley is, at 145p, down 75% down from the highs of early 2006. Alliance and Leicester is off 65% from mid 2007; while semi-semi’s, such as RBS and Barclays, are off between 50% to 60%, though HSBC (with its more Eastern focus) is 5% up on the turn of the year and only 15% off their peak.

This somewhat dire UK centric stock performance is occurring as the economy is actually still growing and employment is rising. What, might we wonder, would happen is worst case fears had become fact. Right now, only banking and housing have hit the buffers as retailers (in the main) continue to show growth with Sainsbury sales up 8%, ASDA up 6%, Tesco up squillions, and even M&S managing to be positive. Industrials should be benefiting (albeit marginally) from the falling pound and any foreign earnings increased by their currency value. So where is the fire?

Well, it is truly hard to see how the current situation can be considered in a good light. Commodity inflation (which was not expected this time last year) is squeezing the bottom line of virtually every sector except, oddly enough, banking. It is also pinching the pockets

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of consumers, therefore even after the falls we have seen to date, expectations for returns over the next year look now to be somewhat optimistic.

Moreover, the constant picking of investors pockets for more cash via equity rights offers is now pushing the patience and resources of all the big players. Any future bull phase will have to pocket not only an inflated equity base but also the fact that there is a lot less money to slosh around. In the long run this might not be a bad thing. For many years the UK the Money Supply has been rising by more than 12%. That number must now go into reverse before any serious upturn can be contemplated, otherwise the effect will be inflation of gargantuan proportions. The 12% money increases had to go somewhere and for many years it went into bricks and mortar. With reasonably stable job security this was not a problem but for the first time we are seeing property weakness without any accompanying unemployment. Potential falls of 10% to 15% are popularly postulated in the housing market, but this now looks very optimistic, with possible catastrophic effects.

Additionally, a weak pound should mean good export growth but it is just not happening. Industrial production for March was actually down 0.5% and here we can see the dead hand of

the credit crunch finally coming through. Cash rich companies may be doing nicely, but the fact is that growth generally depends on borrowing to expand. With banks demanding huge margins over Libor from even good quality names, industry is struggling to be able to justify the expected returns from new business over the immediate costs of build. With the domestic market looking to contract the foreign opportunities need to be cast iron to justify the risk. With the recent CPI numbers showing that inflation is becoming more entrenched, rather than just one off shocks, the Bank of England is in a vice. Does it cut for growth or hike for inflation? Given that its remit is to tackle inflationary pressure, odds are that high rates are here for some time to come.

Into this grim mix we must add the effect of the failing attraction of the current administration. The fiscal position is now so strained that there is precious little room to manoeuvre for any stimulus package and Labour have tied themselves into so many knots recently over virtually every single proposal that inertia seems to be their only salvation. As with most of my messages since the middle of last year the prognosis looks grim. Sorry. As ever Ladies and Gentlemen, place your bets!

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Face to Face SECURITIES LENDING: THE NEAR TERM OUTLOOK

BIFOCAL MARKETS:

Why transparency and volatility count For beneficial holders furnishing assets to the securities-lending industry, the instability of the credit markets has, not surprisingly, led to a prolonged period of reassessment—but not retrenchment.

Though demand for information as it relates to specific portfolio detail has increased, alpha-seeking lending clients remain comfortable with current risk levels. With good reason. During the first quarter, State Street Corp’s securities finance revenue totaled $303m, up 209% from the year-ago period, a reflection of improved spreads and the Fed’s aggressive interest-rate intervention. At present State Street has some $650bn in assets on loan and roughly $3trn in total lendable assets. Moreover, the near-term prospects for the securities lending market look quite bright. David Simons talks to Craig Starble, senior managing director, global head of securities finance at State Street about his reasons for optimism over future securities lending flow.

SIMONS: In Europe we hear reports of clients becoming increasingly wary of the lending environment, particularly with regard to the nature of cash collateral reinvestment, in some instances severing securities lending relationships altogether.

What has been the situation in the United States, particularly as the crisis in liquidity continues to unfold? Have clients voiced concerns over issues related to the unwinding of the credit markets?

STARBLE: Clients are much more interested in transparency now. There certainly seems to be a greater focus on market volatility, net asset value (NAV) volatility, increased demand for information as it relates to specific portfolio detail, as well as our thoughts on the marketplace. In short, since the events of last August there has been more quality interaction with clients, discussions based on real-market activity. While we have seen some skittishness among

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lending parties particularly in Europe, from State Street’s standpoint clients are simply establishing more conservative guidelines within their reinvestment portfolio—as opposed to leaving lending programmes altogether—which is appropriate in this kind of environment. As investment managers, we have responded proactively by becoming more conservative ourselves, raising available liquidity in the co-mingled cash collateral pools or reinvesting in shorter-term assets. Not that this has hurt our programme; in fact, revenues during Q1 were up 209% year-overyear. It is obviously a very good indicator that this strategy has worked. Therefore, despite the perception of increased risk, clients are receiving returns that are far outstripping that risk, in my opinion.

SIMONS: Hedge funds have underpinned the surge in sec-lend activity in recent times; however many have retreated from the tremendously leveraged positions

Craig Starble, senior managing director, global head of securities finance at State Street.

Photograph kindly supplied by State Street Corp., May 2008.

that precipitated last summer’s turmoil. How, if at all, does a shift in hedge-fund investment strategy impact the market for securities lending going forward?

STARBLE: We have seen a lot of deleveraging take place, particularly among the quant strategists, which could lead one to believe demand for securities has diminished. Yet most of the demand has been picked up by other strategies—stock-picking, long only, long-short have all become significant players in this space.

Accordingly, our balances outstanding have been very consistent through this period of transition. Also, the fixed-income business has been monumental over the past six to eight months as a result of the huge flight to quality. Demand for treasuries has driven funding rates dramatically.

SIMONS: A number of pension programmes and endowments have made news recently as a result of losses from investments in failed

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hedge funds. Do you see these events negatively impacting the psychology of the lending constituency?

STARBLE: Among our top clients, there has not been a material change in the way we run their programmes or lend their securities. Which is not to say they are totally ambivalent about the lending process of late. However, they are still comfortable with that level of risk. The reality is when you lend securities, you receive collateral valued between 100% and 105% of the loan. Clients can choose to place their assets in an indemnified repo programme. Those who invest in comingled funds and bear the NAV volatility of that particular fund can take comfort in the knowledge that State Street’s securities lending portfolios do not have any impaired assets in them. We have a high creditquality standard, and have been able to prove to clients the merits of maintaining a buy-and-hold strategy within a high-quality portfolio.

SIMONS: Craig, how much of a factor is size when assessing one’s securities-finance programme?

STARBLE: We believe lending securities in a big programme has created a lot of value for the client.

Having the ability to continue to lend out additional balances during times of high volatility is a major part of a programme’s basic maintenance. We never want to be in the position of telling our cash-reinvestment managers, “Look, we need to raise cash, we cannot lend any more securities, therefore you are going to have to sell some securities.” Because no matter what kind of assets you have purchased over the last six months, you may be faced with price deterioration on any given day. A toprated lending agent has to maintain

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high levels of liquidity, keep a sufficient amount of cash in overnight repos, balanced with higher quality, longer-term assets—but always to the point where it can manage that liquidity on a dynamic basis, in order to protect the client from ever being forced to sell securities into the market. In short, we want to be able to tell our clients their investment activities won’t be hampered because their securities are on loan.

SIMONS: For example?

STARBLE: If a client suddenly wants to divest from an S&P 500 basket of stocks and their securities are on loan, we will get their shares for them; not from the broker-dealer per se, but by re-allocating across programmes to create the transition phase. This is important, because smaller programme do not have the capacity for this. They actually have to recall the securities and return the cash collateral to the broker-dealer, and that causes some dislocation in the marketplace. Big programmes can accommodate this type of large transaction to allow clients that kind of leverage. If you tell a client they can’t do a transition because they have something on loan, that creates an immediate problem. Which again points to the value for maintaining a transparent product.

SIMONS: In what other ways does scale enhance the lending process?

STARBLE: Over time I think we will see the scale of the large custody banks will make a very big difference in the risk-management aspect of lending. Having the personnel is important, as is maintaining the right kind of systems. When you look at strong revenue numbers, you also need to understand a significant

amount of expense and reinvestment is needed to continue this business.

Those resources help keep clients comfortable during periods of market volatility. I also believe there is going to be a huge move towards riskadjusted reporting, which the industry has not adopted yet, mainly because the volatility during the past couple of years has been so low. To that end, State Street is a strong advocate of allowing clients to obtain risk-adjusted returns published through any of the third-party aggregators currently on the market.

We believe it’s important for all the major players involved to subscribe to that practice.

SIMONS: Third-party players continue to gain ground, and State Street has made a concerted effort to meet the challenge of increased competition within that space. In terms of third-party capability, could you bring us up to date on any new developments?

STARBLE: Third party lending is an important product for us. We believe custody lending is more efficient and better for our clients overall, but there are certain lenders who may choose to custody their assets elsewhere. We have been an aggressive bidder for third-party assets, and for a number of reasons. One, it allows an agent lender to bid on the most attractive and valuable assets—clearly, lenders have greatly benefited by allowing those providers with the most competency within a given asset class to bid on those assets. As of last year, State Street had over $100bn in thirdparty assets on loan, or roughly onesixth of our business altogether.

Additionally, one of our larger thirdparty clients recently converted to a custody client. So directionally we think it is an interesting way to

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Face to Face SECURITIES LENDING: THE NEAR TERM OUTLOOK

cultivate business, since it can serve as a gateway into our custody program.

SIMONS: Do you believe the current growth trend for third party lending is sustainable?

STARBLE: Frankly, this market disruption has slowed the momentum of third-party lending. This is not altogether surprising, because while third-party lending can be an advantageous route-to-market, during times of volatility everyone realises custody lending is the way to go. There has been very little movement among beneficial owners to change either their current custodians or current lenders, just because the market is volatile and people are comfortable staying where they are. That said, I think third party lending will continue to expand, particularly as technology improves.

We remain an advocate of third party lending.

State Street has large operations and sales teams situated around the globe dedicated to securing more third-party business, as we tend to see more opportunities overseas than domestically. Clearly, it is the wave of the future.

SIMONS: Looking ahead, what sort of trends may have an impact on the way you maintain your business?

STARBLE: Approximately 85% of our business is cash collateral reinvestment. There has been a move on the part of the broker/dealers to raise non-cash levels, in part because they can control their balance sheets better, but also because obtaining cash has been expensive for them, therefore they would much rather exchange

securities instead. This is important, because lenders who can accommodate this kind of exchange will get a disproportionate amount of the business. In fact, from our current levels of 85/15 cash/noncash business, we could see incremental growth to the point of it becoming closer to 50/50. In other words, we believe our balances will continue to grow over time, but that growth will include a higher proportion of non-cash to cash collateral.

And we’re quite comfortable with that, because it still provides for some nice correlations to risk—so we have no problem providing equities and taking equities back in return. Also, where there’s now a much higher demand for pricing accuracy, because equities are all exchange-traded and you know the value every single day— that transparency is key.

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 fastdeveloping markets. For more information on how to order your individual copy of Emerging Markets Report please contact: Paul Spendiff Tel:44 [0] 20 7680 5153 Fax:44 [0] 20 7680 5155 Email:paul.spendiff@berlinguer.com

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Country Report HUNGARY FEELS THE EFFECTS OF THE CREDIT PINCH

FEELING THECRUSH The steady stream of privatisation in Hungary’s banking sector over the past 20 years has led to the inception of a foreign dominated market with 80% of registered capital coming from foreign direct investment (FDI). This has been a positive step in terms of credit expansion and the transfer of intellectual capital, laying the foundations for what has become a stable banking system progressing towards western European standards. However, the influx of foreign banks, in particular from Austria, has left Hungary somewhat over-banked. Moreover, as a relatively small market, awash with foreign multinational companies but few local corporates, competition to serve these domestic clients is huge. This dynamic has led to competitive lending spreads, which fosters a preference for debt and slows down growth in Hungary’s equity market. Julia Grindell reports from Budapest.

Photograph © Fat*fa*tin/Dreamstime.com, supplied May 2008.

segment, small and medium sized enterprises (SME) and micro companies offer the best potential, though the larger corporate market is proving more challenging.

Attractive returns and margins means that SME lending now accounts for around 50% of the banking sector’s total corporate loan portfolio. Peter Felcsuti, chief executive officer (CEO) of Raiffeisen Bank’s Hungarian subsidiary, says his bank has boosted lending within the SME segment in recent years and Raiffeisen’s corporate loan portfolio grew by 17% last year to reach HF1035bn ($6.5bn); cementing the bank as Hungary’s number two corporate lender. “Although growth within SME lending is strong, the concern has been in the large corporate sector,” admits Felcsuti. “There is a lot less growth potential in this segment because the market here is so small.”

Any number of factors contribute to the dynamic. Laszlo Urban, deputy CEO of the strategic and financial division of OTP Bank, says that one of the few trade-offs from privatisation is that it creates a corporate sector

dominated by international players that are reliant on their overseas parent rather than local banks for financing and strategy guidance.

“Because the corporate landscape is dominated by local subsidiaries of major international corporations the subsidiaries are not M&A targets and they are not making strategic decisions on their own,” he explains.

Laszlo Balassy, Citibank Zrt’s general manager of Citi markets and banking operations adds to the mix:“There are very few deals going on in the Hungarian market right now, there was the odd leveraged acquisition financing going on at the beginning of the year, but not a lot else.”

Given the current macroeconomic environment, domestic companies are finding it hard to grow beyond a certain threshold. The government’s efforts to reduce the fiscal deficit have not helped in this regard. The restructuring programme introduced last year included drastic revenueraising measures in the form of tax hikes. As a result,“it just does not pay for mid-size companies to grow their

FTER YEARS OF steady economic growth, a fiscal restructuring programme introduced by the Hungarian government in 2006 is beginning to take its toll on banking sector expansion, with corporate lending a prominent casualty. Moreover, as an emerging economy reliant on external market funding, Hungary is feeling the effects of the global credit pinch.

Even so, it is not all doom and gloom as retail and SME lending continues to offer strong growth potential.

Moreover, as market conditions and awareness improves, Hungarian banks are hoping the demand for more sophisticated financial services will grow apace.“The banking market is one of the most developed in the Central and Eastern European (CEE) region,” says Gabriel Kadasi, lead analyst for Hungarian and Slovak banks at Moody’s. “The market still offers good opportunities in both retail and corporate lending,” he says; with growth in the retail segment mainly driven by strong mortgage demand. In the corporate banking

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Country Report HUNGARY FEELS THE EFFECTS OF THE CREDIT PINCH

business in the country,” complains Urban. Large domestic companies are relatively few and far between; and with over 40 banks operating in the country, competition to serve this segment is stiff. Citibank Zrt’s Balassy, also points out that as Hungary is over-banked, lending spreads are lower than might be expected for a developing market. “Corporate lending spreads are very aggressive, particularly in the SME segment,” he states. “Debt is therefore readily available. What is also interesting is that equity is not a dominant source of capital at all but again, the incentives are just not there. There has never been much on the demand or supply side in pushing for listings on the stock exchange, therefore a lot of capital structures are based on debt and I see a tendency to very much stretch this debt capacity [sic].”

The government has also managed to dampen investment, in all sectors.

While it succeeded in reducing the fiscal deficit last year, its measures put a brake on economic growth which, in turn, led to a slowdown in banking sector expansion. “Lending to corporates has been more affected by the economic conditions than lending to retail clients,” admits Moody’s Kadasi.

Additionally, there has been some deterioration in asset quality. “Sectors such as construction, real estate and transport have been particularly high risk industries to lend to,” highlights Raffeisen’s Felcsuti and bankruptcies in these sectors have been on the increase. “[While] we have not had much direct exposure to the sub prime crisis, we have all heard of the butterfly effect,” says Felcsuti, who points out that it has had an impact on Hungary’s risk profile and thereby increased the cost of funding, while limiting access to new money. It is a bind, particularly as“domestic savings are not enough to fund Hungary’s credit expansion, it is a

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Laszlo Urban, deputy CEO of the strategic and financial division of OTP Bank, says that one of the few trade-offs from privatisation is that it creates a corporate sector dominated by international players that are reliant on their overseas parent rather than local banks for financing and strategy guidance.“Because the corporate landscape is dominated by local subsidiaries of major international corporations the subsidiaries are not M&A targets and they are not making strategic decisions on their own,” he explains. Photograph kindly supplied by OTP Bank, May 2008.

net importer of funds and risk premiums have gone up in line with this,” he explains. In accordance with the rising cost of bank funding lending spreads are going up. Balassy comments;“With the re-pricing of risk, spreads have expanded, though in the long term I expect aggressive [cuts to margins] to re-emerge because of the number of players in the market.”

In spite of the challenges arising from the overarching economy and the global credit squeeze, Hungarian banks will likely remain profitable. In fact, notes Kasadi, “banks in Hungary are relatively more profitable than their western counterparts when measured against risk weighted assets.” Lending growth, steady flows of interest income,

and improved operating efficiencies have all contributed to profits. Balassy cites the relative efficiency of Citi’s Hungary operations as a test case:“Our return on equity is particularly high at above 30%, and we employ far fewer people than elsewhere. So, if you look at that dynamic combined with our revenues, we are pretty well positioned to weather the storm.”However Balassy concedes that Citi might be a special case. It has a relatively small market share ( around 5%) in Hungary which limits market risks.

In contrast, OTP Bank is in another league. As a dominant force in Hungary’s banking sector, the bank is more exposed to the market’s problems. Invariably, growth in the bank’s corporate lending portfolio is hardest by the government’s fiscal restructuring programme.

As a consequence, OTP Bank’s Urban strikes a particular note. “We are planning to maintain our earnings from the corporate business by not expanding the corporate loan book in Hungary at all. In fact [we are thinking of] potentially shrinking this segment, so that we can release funds for higher yielding alternatives.” In this regard, OTP Bank in February sold its insurance arm Garancia to French insurer Groupama for HF164bn ($1.01bn), which it hopes to use to fuel expansions into markets offering higher growth potential.

“The financial sector growth outlook in countries such as Bulgaria, Ukraine and Russia is better than Hungary’s therefore we made the decision to boost our expansion abroad,” says Urban. OTP Bank purchased Bulgaria’s DSK Bank in 2003. “We have been most successful in Bulgaria,” says Urban. “It has become the crown jewel of our foreign expansion, where we have been the dominant retail player with a 25% market share.” More recently, OTP

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acquired Russia’s Donskoy Narodny Bank for $40.95m, marking its second Russian acquisition. It hopes that the move will accelerate its expansion in Russia following the purchase of Investsberbank in 2006. The bank aims to become one of the Russia’s top 10 retail lenders by 2010. OTP Group is also present in Slovakia, Romania, Croatia, Serbia, Montenegro and Ukraine. “Although our market shares in these countries are relatively small—with the exception of CKB in Montenegro, which is the market leader—their contribution to profitability is significant.” In 2007 investments outside of Hungary contributed 25 % of OTP’s group profits and it hopes that by 2010 this will exceed 50%.

Hungary’s third largest bank MKB, also began expanding into the CEE in 2006 through a number of small acquisitions in Romania and Bulgaria.

However, no further acquisitions were made in 2007. Urban says more foreign acquisitions are on the cards for OTP in the CEE and CIS regions but the current credit crisis is staying the bank’s expansion plans for now.

“We do not want to acquire a bank with huge funding needs at this time.

In Russia for example, there are some asset packages available such as mortgage portfolio packages, and we will probably make a move like that if there is an attractive price; or when the liquidity crisis improves,” he says.

Given the economic climate back at home and the growth potential in larger markets in the CEE region, one might ask why are so many foreign banks are sticking in Hungary?

Edit Papp, CEO of Erste Bank, Hungary’s second largest retail bank, explains the importance of Hungary in the bank’s regional strategy; “Alongside the Slovakian unit, Hungary is the most important subsidiary after our Czech and

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Romanian units.” Net profits from their Hungarian subsidiary reached €92.6m accounting for 10.6% of Erste’s profits earned in the entire CEE region. In other words in key sectors, Hungary remains a cash cow.

Raiffeisen’s Felcsuti also iterates its commitment to its operations in the country: “Our foreign expansion started here. As an Austrian bank, Hungary is naturally an important market for us so we are committed here.”Nevertheless, Felcsuti feels that for foreign competitors not in the vicinity, given Hungary’s outlook, could be tempted to pull out in the long term.“However, should branches be sold off by competitors they would still be good acquisition targets for those banks which are in for the longhaul,” says Felcsuti. Moody’s Kadasi believes that foreign banks are unlikely to leave the market in the short to medium term because of the relative ease with which they have generated profits in the country up to now. He also points out that most foreign players operating in the country through their subsidiaries, also have subsidiaries in other CEE countries so their presence in Hungary is part of their wider strategy in the region.

Nevertheless, “We see some consolidation in the market to be possible long term,”says Kadasi adding this will likely be driven mainly by deals between their parent banks.

There are signs this is already taking place with the recent merger of Hungary’s CIB Bank with Inter-Europa (a subsidiary of Italy’s Banca Intesa and Sanpaulo IMI) to form Hungary’s second largest bank by total assets.“On the other hand, there might also be some (albeit not many) new entrants, although they are likely to target niche market segments,”says Kadasi.

In terms of banking sector development and opportunities Balassy thinks Hungary still has some way to go

Edit Papp, CEO of Erste Bank, Hungary’s second largest retail bank, explains the importance of Hungary in the bank’s regional strategy; “Alongside the Slovakian unit, Hungary is the most important subsidiary after our Czech and Romanian units.” Net profits from their Hungarian subsidiary reached €92.6m accounting for 10.6% of Erste’s profits earned in the entire CEE region. In other words in key sectors, Hungary remains a cash cow. Photograph kindly supplied by Erste Bank, May 2008.

to reach maturity. “We would hope to see more sophisticated products, hedging programmes and more M&A and strategic thinking in the market in the future. There are still opportunities for us to work with clients to minimise cash flow volatility and I think we are well suited to capitalise on that,” says Balassy.“One would also hope that over time, there would be more access to capital markets and private equity; but I envisage that this will take a long time,” he says adding banking competition is still very stiff so debt will continue to be available. Erste Bank’s Papp agrees that the future of the Hungarian banking market lies in improving conditions for selling sophisticated financial services and believes this will come as awareness improves and the market develops.“EU subsidies will also have a positive impact on certain segments of the corporate market, and the market for SMEs is set for a period of financial growth,”she concludes.

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Country Report SAUDI ARABIA: FINANCING PETROCHEMICALS

SAUDI BANKS ON PROJECTS With a current account surplus of some $730bn Saudi Arabia is sitting pretty right now. So are Saudi banks. With a multi-billion infrastructure development programme in place, particularly in the downstream oil sector, the opportunity for Saudi banks to leverage their project financing expertise has never been so good. Julia Grindell and Francesca Carnevale provide a run down of the key petrochemical projects and the investment opportunities in the sector.

INANCIAL ADVISERS ON the world’s largest project financing deal, the Ras Tanura petrochemical complex in Saudi Arabia, are expected to be appointed shortly. Once selected, advisers will have to raise $10bn in financing, which will cost $25bn in total to develop.

BNP Paribas, Calyon, Citigroup, HSBC, Royal Bank of Scotland and Société Générale are in the bidding and a shortlist of local banks, with which the international firms will have to partner, has also been agreed. There are several groupings; HSBC will work with SABB, Calyon with Saudi Fransi, and Citigroup with Samba. Apicorp, Saudi Hollandi, Gulf International Bank and Riyad Bank, are short listed as potential local partners.

F

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Photograph © Faberfoto/Dreamstime.com, supplied May 2008.

Once appointed the banks will have over a year to finalise the project financing structure; which is said to include an initial public offering for up to 30% of the plant’s equity.

Meanwhile, agreement on the financing package supporting the on $5bn National Chevron Phillips petrochemicals scheme has been delayed until a rights issue by Saudi Industrial Investment Group, which holds about 30% of the equity in the project company goes through.

Maximising returns on its oil and natural gas reserves, Saudi Arabia is rapidly expanding its chemical production capacity. “With the bonus of relatively low domestic demand, the kingdom is intent on becoming a leading exporter in the sector, notes Robert Eid, managing director of Arab National Bank (ANB), which has a long history of involvement in the Kingdom’s petrochemical project financings, stretching back to the seminal 1997 YANPET project financing. Locally, Saudi Arabia is already a player, accounting for more than three quarters of the Gulf

Cooperation Council (GCC’s) countries’ production of petrochemicals and, in turn, already supplies 7% of global needs for basic, intermediary and final petrochemical products. The GCC countries themselves are considered a promising market for petrochemical products. In the next five years Saudi based manufacturers alone are predicted to double the current 1m tonnes-a-year of polymers they currently convert into items such as fibreglass products, pipes, storage products, insulation materials and home goods.

The petrochemical industry in Saudi Arabia concentrates on“the production of upstream chemical products such as ethylene,” notes Eid. Moreover, Saudi Arabia enjoys a cost advantage. The US natural gas reserves for petrochemical feedstock pre-2000 was relatively cheap—at around sub $2 per British Thermal Unit (btu). Since then natural gas prices have risen sharply and are now around $6/btu to $8/btu; high compared to the Saudi Arabian feedstock price of 75 cents/btu.“Some 70% of production costs are the costs

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Country Report SAUDI ARABIA: FINANCING PETROCHEMICALS

you pay for natural gas and crude oil.

Cheaper feedstock is a massive advantage,” says explains Hassan Ahmed, global head of chemicals research at HSBC. Low cost producers, such as Saudi Arabia, are ramping up capacity and will increasingly take market share. By the end of the decade Saudi Arabia could reach“ close to 10% of global ethylene capacity, up from today’s 7%,”says Ahmed.

Over $70bn worth of petrochemical projects are underway in the country with Saudi Basic Industries Corp.

(SABIC) and Aramco striving for the largest share of the pie. These include the Yanbu National Petrochemical Company (Yansab) in Yanbu Industrial City, and PetroRabigh on Saudi’s Red Sea coast. “With heavily discounted petrochemical feedstock costs and a growing chemical export market, Saudi’s downstream petrochemical industries are poised to reap huge profit margins as it opens up new export markets,”explains Eid. The $5bn Yansab project, (51% owned by SABIC and 35% in public ownership) will come on stream later this year, with an annual capacity of 4m-plus tons of chemical products.

PetroRabigh, meanwhile, a $9.9bn refining and petrochemical project (a 50:50 joint venture between Saudi Aramco and Japan’s Sumitomo Chemicals) will start commercial operations by year end. A related $8bn expansion of Saudi Arabia’s Red Sea refinery at Rabigh is now complete.

Integration between existing refinery ventures and add-on petrochemical developments are a typical feature of Saudi petrochemical sector development, allowing economies of scale in the use of feedstock and the sharing of utilities and infrastructure.

The strategy is to establish fully developed industrial centres, with the complexes acting as key distribution points. The supply of natural gas is vital

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Robert Eid, managing director of Arab National Bank (ANB). Photograph kindly supplied by ANB May 2008.

however. Aramco currently produces around 6bn cubic feet-a-day (cfd) rising to 7bn cfd next year. Ethane production is also increasing and is projected to reach 1.1bn cfd by 2010 years supported by supply from Aramco’s natural gas liquids development at Hawiyah and from fields in Eastern Province. There are also long-term supplies from massive gas programmes in the southern Rub al-Khali Empty Quarter.

The mighty Ras Tanura project involves a 1.2 m tons per year ethane/naphtha cracker, a 400,000 tons per year propylene, 400,000 tons per year benzene, 460,000 tons per year paraxylene and a polyolefin mix unit.

Aside from producing the commodity plastics, Ras Tanura will also produce ethoxylates, amino ethanols, amino methyls, dimethy formamide, choline chloride, phenol, cumene, and polycarbonate; the first time that specialist chemicals will be produced in

the Kingdom. It indicates a rapidly maturing petrochemical business, likely changes in buyer preferences and an inevitable downturn in prices for mainstream chemicals as supplies become more plentiful.

Ramzi Al Sewaidi, at Arab Banking Corporation’s (ABC’s) project finance unit in Bahrain says Saudi Arabia requires its plant to crack heavier liquid feedstock such as butane and ethane gas, so as to produce a wider product slate. “By cracking butane as well as ethane, you are able to produce a more diversified range of petrochemicals starting from ethylene and propylene, and all the way down to ethoxylates and polycarbonates,” he says. “These are all specialised products with a lot of added value, so the margins you can get on these products are a lot higher.”

“The economics of setting up these facilities are very attractive and banks are keen to finance these deals because of the huge cost advantage production plants have in the region,” notes Ahmed. The government is also an ardent backer, working through the Saudi Industrial Development Fund (SIDF) and the Public Investment Fund (PIF). PIF put up $1bn in capital to finance PetroRabigh’s project. However, “We now see more multi-tranche financing for large projects these days,” says Christophe Mariot of BNP Paribas.

“There is either a higher amount of equity at around 20% and even up as high as 40%, and some export credits such those from Japan’s JBIC, Italy’s SACE or the US’ new Eximbank tranche.Then, you often have an Islamic tranche which tends to put up in the region of $200m to $300m. Moreover, you have Saudi institutions such as PIF or SIDF which provide a cornerstone in closing projects by normally putting up amounts of about $1bn.”

Attractive profit margins in Saudi petrochemical projects is encouraging new entrants. The list includes Saudi

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Country Report SAUDI ARABIA: FINANCING PETROCHEMICALS

Kayan Petrochemical Company’s investments, worth $7bn, in new plant. In February this year, South Korea’s Samsung Engineering said it had secured a Won239.2bn ($253.5m) order from the firm to build a turnkey chemical factory in its complex. The project will be completed by the end of August 2009. Saudi Kayan had been on the boil for some time but only picked up momentum when SABIC acquired a 35% stake in the project.

Saudi Kayan also plans to have a 1.3m tons per year mixed feedstock cracker and a 1m tons per year of EO/EG unit within its overall project complex.

Meanwhile, Saudi European Petrochemical Company, a subsidiary of the SABIC has awarded Samsung Engineering Company of South Korea a contract for the construction of 500,000 tons per annum polypropylene plant. The plant at the Ibn Zahr complex in Al-Jubail, will be completed by third quarter 2008; the third polypropylene plant at Ibn Zahr.

Saudi Petrochemical Company (SADAF), meanwhile is already running the world’s single largest conventional production site at AlJubail, plans a third world-scale plant, boosting styrene production by over 60%, making it the world’s largest single-complex styrene producer by 2010. The Saudi Methanol company (Ar-Razi) is part-way through its fifth expansion project, Ar-Razi-5, due to go on stream this year offering an annual capacity of 1.7mtpa of methanol and the Al-Rajhi Group recently announced plans for a $4bn ethane cracker, as well as PP and EG units. The group is further planning a 55,000 tons per year benzene recovery unit from pygas. The INEOS/Delta Oil Company is pursuing a 1.2m tons per year ethane cracker and several downstream units including a PE plant costing $2bn. Commissioning has been set for 2009. Moreover, a

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group comprising Midroc, Sara Development Company and House of Invention (HOI) Company, is planning an olefins project in Jubail worth $2bn, including a 1.3m tons per year ethane/propane cracker among a series of specialist chemical plants.

Increased demand to develop profitable chemical plants is now beginning to present some challenges for financiers.“As projects grow in size and number your biggest challenge is now your contracting strategy,”says Al Sewaidi.“With the growing number of petrochemical plants being developed in the region on top of all the infrastructure and real estate projects, contractors are backlogged now and it’s very hard to find a contractor that is just sitting idle, which forces developers to draw on a number of contractors. Multiple contractors are harder and more expensive to coordinate and the more complex the contracting therefore, the more complex the financing. Contract risk is definitely there.”

“Lenders usually take the marketprice risk,”says Al Sewaidi.“The smaller producers benefit more if they take out an off-take agreement with a global player such as Basel or Vinmar. Because of the cost advantage in the region, even when the petrochemical cycle is down Saudi Arabian producers should be able to produce at a relatively lower delivered cash cost, so it’s more the higher cost companies in the other parts of the world that suffer first.”

PetroRabigh’s Japanese sponsor Sumitomo Chemicals will undoubtedly support the project through its international sales and marketing expertise as well as its ability to share complex chemical-production technology. In the same vein, SABIC strategically acquired US downstream petrochemical producer GE Plastics for $11.6bn last year. As Mariot says:“such acquisitions help Saudi companies

integrate with new markets as well as helping them better understand the downstream plastics industry.”

Overall, the global downturn will likely impact project finance in the region.“Project financing will be a little bit more challenging in terms of syndicated projects or underwriting, and the market will not be as aggressive as we have seen prior to now,” says Mariot.“We are seeing pricing go up by around 20 to 30 basis points (bps),” he adds.“The Federal Reserve has lowered rates, but the cost of borrowing for sponsors has not necessarily increased, so the banks will just need to be remunerated a little bit better to make sure that they close projects.”Moreover, traditional sources of financing are now incorporating new tranches, with Islamic structures very much in favour.

According to Samba managing director and chief executive officer Eisa Al-Eisa: “Islamic finance has been successfully integrated into power, petrochemical and industrial projects in addition to individual transportation asset financings (aircraft, ships), establishing a common framework for inter-creditor issues. Some projects are now being contemplated on the basis of a fully Shariah-compliant structure as opposed to merely a tranche in the financing.”

Even so, the economics of petrochemicals in Saudi, added to the wealth of the Gulf States, means that both are attractive investment and financing destinations. “The cost advantage of petrochemical production in Saudi Arabia is certainly sustainable for now given the competitively priced feedstock,”says HSBC’s Ahmed.

A new geo-strategic element is also creeping in. Saudi Arabia has recently invited Chinese entrepreneurs to invest in the country’s petrochemical sector. Local press reports indicate that investments ranging between $4bn and $10bn are under discussion.

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Country Report ISLAMIC ISSUANCE PIPELINE BUILDS IN GCC

AUDI BASIC INDUSTRIES CORPORATION (SABIC) indicates its $1.33bn Islamic bond will be priced at about mid-40 to 50 basis points (bps) above the threemonth Saudi Interbank Offered Rate.

The five-year bonds, which are expected to set a new benchmark in the Kingdom, are denominated in Riyals, according to lead manager and bookrunner HSBC. Ratings agency Standard and Poors has assigned the issue an A+ rating. SABIC is the worlds largest chemical company by market value.

John Coverdale, managing director of SABB notes that“The Islamic bond sale is the company’s third and will set a regional benchmark.”

“The dollar-denominated debt capital markets have not seen any sizeable offering taking place in the GCC post the global credit crisis in July 2007,” agrees Eisa M Al-Eisa, managing director and chief executive officer (CEO), Samba Financial Group, as margins of outstanding dollar-denominated bonds widened significantly due to the dollar liquidity crunch.

Equity-linked dollardenominated securities have been less affected by the credit crises as they target different investor base, who are less risk averse, and are willing to accept lower coupon rates due to the upside potential resulting from the conversion premium. On the other hand, local currency Sukuks have seen a significant demand from regional investors and financial institutions, awash with liquidity and looking for opportunities to invest their local currency funds,”he adds.

Bahrain-based Gulf International Bank (GIB) sole managed the sale of Dh600m ($163m) of Sukuk for Almana Group WLL, a Qatar-based trading, automotive and contracting company. Almana Group has a “BBB+” rating with a “Stable” outlook from Capital Intelligence (CI). The

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GCC ISLAMIC ISSUES REVITALISED The GCC countries’ debt markets are expected to deepen, with more corporate issuances from Saudi Arabia in particular, linked to the country’s massive infrastructure investment programme.

Increasingly Islamic tranches are featuring in local project financing structures. Moreover, commentators say that increasingly issuance is in local currency to issuers and investors who might want to steer clear of US dollar borrowing and assets. Here’s a ready reckoner of the key issues to look out for through the rest of 2008. proceeds of the Sukuk will go towards financing the Group’s expansion plans. The deal was the first for a Qatari company to raise a financing in dirhams. The Sukuk is set to mature in 2013 and pays a profit distribution of 2.5 percentage points over the threemonth United Arab Emirates interbank offer rate and will be listed on the Dubai International Financial Exchange (DIFX).

In Dubai meantime more than Dh10bn worth of Sukuks have been issued by the government, Nakheel and Emirates Bank so far this year.

More than Dh10bn Sukuks have been already issued by the Government of Dubai, Nakheel and Emirates Bank.

Taqa, Tamweel, the Ras Al-Khaima government, are among issuers yet to come to market. Ras Al-Khaimah plans to sell up to $2bn worth of Islamic bonds, with an average maturity of 5 years, this year to fund infrastructure projects. The first group of bonds will be at least of benchmark size, typically $500m, and Standard Chartered has been mandated as the sole lead-manager and book runner for the programme. Some of the bonds may end up as the first rated dirham sovereign Sukuk; while others will be priced in dollars. The Emirate

is rated A by both Fitch and Standard & Poor’s. “The outlook for domestic currency Sukuks is strong due to domestic liquidity and international investors remaining bullish on the region and banking on potential currency revaluation across the GCC,” says Samba’s Al-Eisa.

Petrodollar spending on infrastructure and diversification programmes is fuelling growth in non-oil sectors, notes SABB’s Coverdale. The dramatic decline in US interest rates and the continued repatriation of Gulf wealth, should boost asset prices, which is supportive of capital and real estate markets. By 2012, the Kingdom of Saudi Arabia plans to invest $70bn in its oil and gas infrastructure, $140bn in general infrastructure projects, $92bn into the petrochemicals and $88.9bn into power and water, “with Islamic tranches a feature,” adds Coverdale.

“To this should be added increased demand for housing finance, which is suited to Islamic financing structures, particularly with a new mortgage law pending this should provide interesting opportunities; replacing traditional lump sum financing for housing. Also Islamic leases are also on the rise.”

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Country Report SAMBA SETS A NEW PACE IN SAUDI BANKING

RAISING THE BAR Samba was founded in 1980 with the acquisition of Citibank's branches in Jeddah and Riyadh. Citigroup retained management rights and a 40% equity stake. In July 1999, Samba merged with United Saudi Bank (USB), creating the Samba Financial Group, now the second largest bank in Saudi Arabia. In September 2003, Citigroup handed over the bank's management to Samba and in May 2004, it sold out its remaining equity in the bank.

Samba is seen as an innovative player in Saudi Arabia. In 1997, it established Samba Fund Management, which introduced the first local equity fund open to overseas investors and is listed on the London Stock Exchange (LSE). Samba was also the first Saudi bank to establish an Internet-based banking platform (SambaAccess) in 2001. FTSE Global Markets talked to Eisa M AlEisa, managing director and chief executive officer (CEO), Samba Financial Group, about the bank’s latest initiatives.

What been the role of SAMBA in internationalising participation in Islamic financing structures? The Islamic banking market continues to grow rapidly and a distinct investor base has developed both in institutional and retail domains. Islamic financing represents the most inclusive means of tapping the Middle Eastern liquidity and international markets. Growth is fuelled by increased product innovation and client/sponsor’s need for investor diversification. Islamic structures are now standardised with costs and time to market comparable with conventional facilities. Sukuk is now being embraced by the global investment community and attracting the participation of corporate, government and financial issuers internationally as well as becoming a major asset class on its own. Moreover, the emergence of more innovative structures (convertibles and multicurrency issues) is a clear indication of increasing market depth and sophistication. With the globalisation of the Islamic investor base, there is also a clear shift in the market towards rated Sukuk offerings. Samba Capital has

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been involved in significant local and regional Sukuks and has a strong deal pipeline. Given its capacity for large scale transactions, Samba has played a key role in integrating various sources of financing through common terms agreement and ensuring that conventional project finance houses, including international banks in the region are at ease with Islamic structures. Islamic finance has been successfully integrated into power, petrochemical and industrial projects in addition to individual transportation asset financings (aircraft, ships), establishing a common framework for inter-creditor issues. Some projects in Saudi Arabia are being contemplated on the basis of a fully Shari’a-compliant structure (as opposed to merely a tranche in the financing). Additionally, international banks are willing to have their entire commitment allocated to an Islamic facility.

How has Samba encouraged the deepening of the Saudi asset management sector? Samba was the first bank in the Kingdom to launch a product catering to foreign investors

and giving them access to the Saudi equity market. The Saudi Arabian Investment Fund (SAIF) was launched in 1997 and is still the only Saudi equity fund listed on the LSE. Assets under management are now in excess of SR1bn. Additionally, late last year, the Capital Markets Authority (CMA) allowed foreign investors to invest in the Saudi equity market through mutual funds. We have been in discussion with a number of foreign investors and money managers interested in investing in the Saudi market through Samba Capital’s award winning Saudi and GCC funds.

Oil wealth is changing the spending patterns of governments, state-owned entities and private companies in the Gulf region. Saudi Arabia has undertaken several measures to improve its competitive edge following its entry into the World Trade Organisation (WTO) protocol and to open up its markets to international competition. According to a report of the United Nations Conference on Trade and Development (UNCTAD), Saudi Arabia was the largest recipient of foreign direct investment (FDI) in the Arab world in 2006, attracting $18bn, up 51% over 2005. As FDI becomes crucial, competition is increasing globally among developed and developing countries to attract foreign direct investment. This trend is evident in the vigorous efforts being taken towards changing national policies and laws related to foreign investment. In this context, the Kingdom seeks to sustain the current economic boom through a development strategy in which foreign investment plays a significant role.

A comprehensive work plan handling the challenges to the Kingdom’s performance in the international competitiveness indices is now underway. The plan aims to propel the Kingdom into the World’s top ten

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countries in terms of competitiveness and attractiveness of investments by the year 2010.

Moreover, the establishment of Samba’s branch in Dubai, our asset management department is looking to access international flows into the GCC. Can you please talk a little about the trading flow into Saudi Arabia from the GCC and other international markets? In line with local regulations Samba has been offering access to the local equity market to GCC and Foreign individuals through our pioneering electronic trading platforms and is in the process of setting up a number of relationships with GCC institutions for trading in the local market. With presences in Dubai and London, we plan to leverage our current operations to expand our services to both Individuals and Institutional customers and expand our global reach. Our brokerage division is in the process of setting up its international brokerage business in Dubai to provide Samba’s UAE client base with the opportunity to invest in global markets. In line with local regulations Samba has been offering access to the local equity market to GCC and foreign individuals through our pioneering electronic trading platforms and is in the process of setting up a number of relationships with GCC institutions for trading in the local market.

What is the outlook for the Saudi Arabian real estate sector? Can you tell us a little more about how the bank is managing the strategy of the funds? Real estate market in the Kingdom is in a growth phase; driven by strong fundamentals such as robust economic growth, consumer demand and demographics that are not set to change in the foreseeable future. In

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Eisa M. Al-Eisa, managing director and chief executive officer (CEO), Samba Financial Group, kindly supplied by Samba, May 2008.

value terms, the housing sector comprises 75% of all the real estate activity in the Kingdom. The country will need an investment of SR75bn a year to meet its housing demand through 2020; however, supply of affordable housing is a challenge in the short term. The market is also expected to become more structured and organised as large business houses in the Kingdom and leading developers from the GCC invest in the construction of large residential projects in the country. It is a market with tremendous potential.

Traditionally it has been a self funded market, with over 80% of residential units being self funded by owners; though increasingly banks and finance companies now offer Shariah compliant mortgage finance. Over time, our client base has increased in sophistication and after the severe 50+% downturn in the market in 2006, there is growing demand for diversified products and portfolio allocations. We launched the Samba Real Estate Fund in February 2007 to cater to our clients’ needs for an alternate asset class; and it provides

our clients with direct access to real estate projects in the Kingdom and hence allows them to participate in the rapid development taking place in that space. We will also launch some international products that provide relevant diversification across geographies and asset classes. There remains a great potential in the Saudi real estate market given the country’s economic growth and the attendant rise in household incomes, growing employment opportunities and the country’s demographic profile (over 70% of the population is 30 years and below, with 45% below the age of 15, for instance). There is also low housing finance penetration (about 2%), compared to 17% in Malaysia, 50% in the US and 72% in the UK. All major banks in the Kingdom offer Shariah compliant mortgage products.

The government has also been playing a pivotal role in making low cost finance available to low/middle income nationals. However, high penetration of consumer finance amongst the working population in the Kingdom will pose a challenge to making mortgage finance available. A new mortgage law is being finalised and this will boost the confidence of the market, especially the banks and the housing finance companies in the Kingdom.

What is the role or potential role of Samba in facilitating access to the GCC markets to foreign asset managers who want specific stocks or portfolio strategies implemented in the region? Samba Capital has eight equity funds, one fixed income and one money market fund sub-managed by international asset managers. We are also in the process of launching new international products for our clients.

These products will also be submanaged world class international asset managers.

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Country Report ISLAMIC FINANCE: GROWING GCC/ASIAN LINKS

When East is East, and East is Islamic The growth of the Islamic finance industry was largely spurred by a flood of petrodollars from the Middle East and capital repatriation from the West after 9/11. Now different paradigms have emerged: the rise of ever closer financial relationships between financial institutions in the Gulf states and Asia (particularly Southeast Asia) among them. Gulf financial institutions are increasingly looking at opportunities abroad to increase earnings and assets.

S THE COST of funding for Islamic securities nears market rates, the pick-up in issuance is rising apace. Harnessing growth in North Africa and the ASEAN countries (in Malaysia in particular) a new strain of banking and institutional relationships is emerging; encouraged by banks in the Gulf states that see close to saturation business at home and better opportunities abroad. The rationale is obvious; Islamic finance is a numbers game. Among varying growth estimates is that of Ernst & Young whose report claims Islamic assets are growing at more 20% plus a year, and will grow from $900bn in 2007 to as much as $2trn by 2010, thanks to high levels of surplus savings and reserves in the Gulf and Asia.

Building on that trend is an emergent relationship between Asian and Gulf financing institutions which was highlighted at the 5th Annual Summit of the Islamic Financial Services Board (ISFB) in Amman in mid-May. At the conference a number of initiatives were broadcast; among them Monetary Authority of Singapore’s (MAS’s) intent to facilitate Singapore dollar-denominated sovereign rated Sukuks. Moreover, MAS and the Central Bank of Bahrain (CBB) told attendees they will work together to develop their respective banking and financial sectors; with a particular focus on Islamic finance.

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The CBB has played a key role in innovating the development of Islamic financing across a spectrum of asset classes. Heng Swee Keat, managing director at MAS told the conference that its Sukuks will be priced against Singapore government securities; “providing a transparent price discovery mechanism for [the] instrument. As the (Singapore dollar) sukuk market grows and deepens in time, it can then develop its own pricing benchmarks.”

The new financial flows are also harbingers of future consolidation in the wider Asian Islamic finance industry. Dr Shamshad Akhtar, governor of the State Bank of Pakistan (SBP), noted at the conference that consolidation means providers of Islamic financial services will be able to offer scale and efficiency, which is vital if they are to compete effectively with the global players. Moreover, cross-fertilisation of ideas and cross border acquisitions will help standardise the governance, regulation, supervision and accounting practices applied to Islamic finance throughout the Middle East, North Africa and Asian (MENASA) regions. “Well developed and integrated Islamic money, capital, and foreign exchange markets will not only be beneficial for borrowers and institutional investors but can also further enhance the stability of Islamic financial institutions, providing them

with improved portfolio, liquidity and risk management tools,” she noted.

Moreover, the “Islamic financial industry would benefit by aligning and positioning itself in a way that it takes full advantage of financial globalisation.,”she said.

A point not lost on Abu Dhabi Commercial Bank (ADCB), which bought a 25% stake in RHB Capital, Malaysia’s fourth largest bank for $1.23bn (Dir4.51bn); at 2.2 times RHB’s book value and a 37% premium to the bank’s reported price. The deal is the largest investment to date by a Gulf investor in the Malaysian banking sector. While RHB Bank has four broad categories of business (insurance, commercial, Islamic and investment banking) its most immediate attraction is its Islamic banking operations where it offers a wide range of Islamic products, including business loans and investment banking services, as well as retail products such as home loans and car loans, that are in compliance with Islamic principles. In return, RHB hopes to exploit ADCB’s international Sukuk market, thereby enhancing its ability to syndicate Sukuk issuance.

ADCB’s deal could be the precursor to a round of purchases by Gulf banks in the MENASA region. RHB Capital itself has regularly been a target for buyers anxious to capitalise on Malaysia’s burgeoning Islamic finance market. RHB’s major shareholder (with 57%) is the Employees Provident Fund (EPF), the Malaysian state pension fund, which won a tough 2007 takeover battle for the bank, paying $3.6bn to fend off rival bids from Kuwait Finance House and Malaysian lender EON Capital. Other ASEAN banks look out.

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DUBAI MERCANTILE EXCHANGE: LEVERAGING CHANGE

The Dubai Mercantile Exchange (DME) reportedly plans to sell a stake of up to 20% in the bourse soon to help boost liquidity and attract more international players. The time is certainly ripe for the owners of the DME to cash in on the bourse’s success; particularly in a period when commodity trading is at an all time high. NYMEX chief executive officer, James Newsome told Dubai Eye radio in mid-May that the exchange has been approached by every major bank and energy company to buy an equity stake in the bourse. Why so popular?

THE GROWING APPEAL OF THE DME

Photograph © Maroš Markovič, Dreamstime.com, supplied May 2008.

T STAKE IS the creation of a benchmark sour crude futures contract. The DME launched trading back in June last year, with a sour Middle East crude futures contract, aiming to become the benchmark for pricing in the world’s top oil exporting region. The contract has survived longer than past attempts to launch sour crude futures, but has yet to establish itself as a benchmark for investment funds and for companies looking to hedge exposure to future energy price risk.

Part of the reason for that is the battle between The Intercontinental Exchange (ICE) and DME shareholder NYMEX, which each offer sour crude futures contracts.

The two US exchanges host the world’s leading oil futures contracts and continue to compete to establish a dominant contract linked to the Middle East

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sour crude market. ICE Futures, host of the European benchmark London Brent crude contract, began trading Dubai futures on 21st May, less than two weeks before the launch of a new Oman crude contract that its rival has been working on for years and the June launch of the DME itself. It has impacted on the Dubai exchange; an annoying development given that it is jointly owned by the joint venture between Tatweer, a member of Dubai Holding, the New York Mercantile Exchange Inc. (NYMEX), and the Oman Investment Fund (OIF). The DME is regulated by the Dubai Financial Services Authority (DFSA), and all trades executed on the exchange are cleared through, and guaranteed by, NYMEX’s AA+ rated clearinghouse.

ICE has been able to gain traction relative to the DME for a number of

reasons. It already had a wellestablished fully electronic exchange in London with a high volume of trade. Its members had easy access on the launch of the contact, as they were able to use the contract without registering on a new exchange, as they had to do in Dubai. Moreover, ICE had already launched a US crude contract to rival the NYMEX’s benchmark sweet crude West Texas Intermediate (WTI). With the addition of a sour contract also on the ICE exchange, users were able to hedge a wide range of oil risk using the same platform.

Although a late starter, the DME contract has recently come into its own. In February, the exchange announced a strong start to 2008 with the setting of a new monthly volume record and achieving the highest level of open interest in its benchmark Oman Crude Oil Futures Contract

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Country Report DUBAI MERCANTILE EXCHANGE: LEVERAGING CHANGE

since the launch of the exchange. The of prices for commodities ranging from investors overseas. If that was not DME has enjoyed the advantage of corn to crude oil worldwide are enough in early May, Democratic offering the first contract backed by a expected to be announced in early senators presented the proposed Middle East oil producer. On the June. The CFTC is widely expected to Consumer-First Energy Act of 2008, launch of the DME contract both outline measures to address the role which includes provisions similar to Dubai and Oman pledged to played by new financial investors in the House’s Renewable Energy and abandon their traditional pricing the futures markets; particularly Energy Conservation Tax Act of 2008, method and use the DME contract investors commodity index funds, which was passed 236-182 on Feb. 27. instead. Oman’s backing raised hopes which have grown in volume from If passed, the Senate bill will curb USbased oil traders from among oil traders that the routing transactions DME contract would be an through offshore markets alternative to a pricing to evade position limits. It system that some oil Although a late starter, the DME also means that traders say has outlived its contract has recently come into its own.

Commodities Futures usefulness. Ahmad Sharaf, In February, the exchange announced a Trading Commission will chairman of the Dubai be forced to raise margins Mercantile Exchange, strong start to 2008 with the setting of for oil trading. acknowledged the a new monthly volume record and Analysts say the “excellent start to 2008,” achieving the highest level of open probability is that the adding that: “The steady interest in its benchmark Oman Crude DME and the Dubai Gold growth in volume and Oil Futures Contract since the launch of & Commodities Exchange record open interest clearly will be winners if the US show that our Oman the exchange. restricts speculative Crude Oil Futures Contract activity. The Dubai Gold & has become the global Commodities Exchange benchmark for pricing the $13bn in 2003 to more than $250bn just launched cash-settled contracts region’s crude oil.”

Located within the Dubai this year, according to the New York on the world’s two crude oil International Financial Centre, the Times. On May 20th the Senator for benchmarks, West Texas Intermediate Joseph Lieberman (WTI) Light Sweet Crude (actually the DME is the first energy futures Connecticut exchange in the Gulf Cooperation chaired a Senate Homeland Security flagship contract of NYMEX) and Council (GCC). Its stated aim is to Committee hearing on the impact of Brent Crude Oil. NYMEX trades the provide price transparency and market speculation by institutional investors WTI for both physical delivery and liquidity for petroleum products in the and hedge funds on commodity financial settlement while its Brent region; addressing a local requirement prices. “My own conclusion is that contract is cash-settled. Moreover, the for price discovery of Middle East sour index speculators are responsible for a DME launched its own financiallycrude oil. It also offers the advantage of big part of the commodity price settled Brent contract in early June. In a convenience bridge between the increases,” Lieberman said at the an ironic move, it is exactly a mirror of time zone gap between Europe, Asia hearing. Among the legislative the product traded on over-themeasures envisioned by the counter and regulated markets owned and North America.

Now the DME may also benefit committee: barring institutional by ICE for either physical delivery or from efforts by the US commodity investors from investing in commodity financial settlement. The DME is also markets’ chief regulator to address markets via index funds and swaps. expected to launch a WTI contract public and political concerns that Index funds differ from traditional later this year. NYMEX’s stake in the market malfunctions may be commodity investors in that they do DME and the fact that it clears DME contributing to rising food and energy not sell commodity futures, but only contracts, means that if things do run prices. Impending measures from the buy them, which it is claimed has South in the US, it will be better Commodity Futures Trading helped drive up commodity prices placed than most US commodity Commission (CFTC), which oversees artificially. If as expected, it will rein in exchanges to weather any storms or exchanges central to the establishment activity in the US, it may push relocation of trading activity.

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TURKISH BANKING: COMBATING THE POLITICAL ELEMENT

The political hurdle Bolstered by the entry of a phalanx of foreign banks either as majority or strategic partners, and a rising tide of business, Turkey’s banks are weathering the less than temperate financial markets rather well. Moreover, the country’s demographics support continuing growth in the retail and real estate sectors. The only real clouds are a worsening of commodity prices and continuing political uncertainty, which could knock investor confidence. What now? Francesca Carnevale reports from Istanbul.

T’S GUNS AND ROSES for Turkish banking right now. While Turkish issuers have enjoyed lambent times of late, the latest crop of external fundraising has seen something of a change. Zorlu Enerji Elektrik Uretim’s $500m syndicated loan in late May, lead mandated to Standard Bank and HSBC, with local banks Is Bankasi, Garanti (Luxembourg branch), Denizbank, Vakifbank and Demir-Halk Bank (Netherlands) in arranging roles, came in at a margin of 2.9% (and will be repaid in seven semis commencing 24 months after drawdown). Garanti Bank too found that its latest $600m syndication on May 8th, secured from 31 international banks cost the Euro Interbank Offered Rate (Euribor) plus 675 basis points (bps); last year, it got the same deal at Euribor plus 475 bps.

On the equity side, the initial public offering (IPO) of shares in Turkey’s dominant fixed line operator, Turk Telekom, was priced at TL4.6 ($3.64) a share, near the top of its initial range, raising TL2.42bn from the sale of 15% of the company’s shares, giving the company a market value of $12.95bn.

Demand for shares among Turkish investors was 4.7 times higher than the amount on offer, and 4.3 times higher from international investors.

There is a fractal element in play in the domestic market.“We began to see

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some asset re-pricing both in consumer and corporate lending in the first quarter,” notes Hale Tunaboylu, head of investor relations atYapi Kredi.“Although the bank has a comfortable loan to deposit ratio, it is not true of all Turkish banks and we have noted that loan yields are on the rise. Domestically, we have noted an increase of 75 to 100 basis points for corporate loans and now its impact is being felt at home in slower demand.”

This mix of challenge and plenty is regular fodder for the country’s financial sector.

The reasons are many and varied.

An April Fortisbank reported that higher foreign exchange rates in March had pushed corporates’ outstanding debt up to $77.8bn, more than 10% of Turkish GDP; a trend beginning to weigh on investors. Even so, another $8.6bn has been raised in Q1 this year, with little sign of a let up in borrowing. Moreover, while the lira has been strong of late (appreciating by more than 30% again the US dollar), it recently tumbled from a high of TL1.16/$1 to TL1.26/$1 by mid May. Most analysts expect it to end the year around TL1.40/$1—a smooth depreciation which, say local bankers, will not be enough to put forexindebted corporates in difficulties.

Then again, the main Istanbul index dropped 24% this year to date,

Photograph © Triggerjoy/Dreamstime.com, supplied May 2008.

making investors a tad nervous.

Turkey invariably suffers from a perennial problem. Because of its political landscape Turkey, rightly or wrongly, suffers the jitteriness of international investors and market analysts more than many other leading emerging markets. A case in point? Well, Standard & Poor’s cut Turkey’s credit rating outlook on April 4th from stable to negative after the nation’s chief public prosecutor, Abdurrahman Kaya, demanded the closure of the country’s ruling Justice and Development Party (AKP). The AKP was/is pandering to the interests of Islamic fundamentalists, claims the prosecutor’s office thereby endangering Turkey’s secular status;

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Country Report TURKISH BANKING: COMBATING THE POLITICAL ELEMENT

banking system has grown by this latest accusation based a factor of four since the end on the lifting of a long of 2002, when total bank standing ban on women assets stood at $126.7bn. students wearing Growth has run parallel with contemporary Islamic an increasingly robust headscarves while attending economy, a stable lira and university. The constitutional record foreign investment into court is now considering the the banking system as the prosecutor’s indictment. The sector gradually reconstituted prosecutor also wants 71 itself after a devastating individuals, including prime banking and economic crisis minister Recep Tayyip in 2001. Turkish banks Erdogan and president reported record profits for last Abdullah Gül banned from year, as the economy sloshed political life for five years. The in an abundance of liquidity.

AKP meantime has Last year, Turkish banks had a suspended its plans to record total net income of prepare constitutional $12.73bn, up 61.3% on 2006, amendments that will prevent according to the BRSA. Over the Constitutional Court from the same period, the sector’s closing down the party. assets stood at $497.53bn, up Undoubtedly, the case will 43.4%.

Bank assets run and run and run; Tolga Egemen, executive vice president, Garanti Bank. represented 75.5% of Turkey’s providing fodder fuel to Photograph kindly provided by Garanti Bank, May 2008. gross domestic product (GDP) continuing tensions between of independent last year; compared with 65.7% in those who want to maintain a secular introduction state in Turkey and those who would institutions, the most important one 2006. The effects of the banking and Islamicise it. To date, the AKP has of which is the Central Bank of Turkey. economic crisis of 2001 still been moderate and has encouraged That is why the court case has not reverberate through the system the continuation of business, and has created a big mess, either. Besides, I however: some 50 banks now operate popular support; but when push would also argue that the banking in Turkey, down from 81 at the end of comes to shove, no one can predict sector in Turkey is now beginning to 1999. Turkey has 33 commercial banks, what the long term repercussions of show signs of decoupling from the of which three – TC Ziraat Bankasi, Halkbank and VakifBank – remain in either side claiming victory will be. political morass.”

Egemen points to three factors state hands; 11 are in the private While at times taking on the aspect of a local political spat, the cost to the which are strengthening Turkey’s sector (including Garanti, Akbank, country of the ‘wrong’ outcome could main banks. “One is improved Yapi Kredi), 18 are foreign banks and regulation and supervision from one is controlled by the Savings be immense.

As Tolga Egemen, executive vice Turkey’s Banking Regulatory and Deposits Insurance Fund (TMSF), a president at Garanti Bank, notes; “the Supervisory Agency (BRSA); two the state banking receivership fund.

Turkey also has 13 development and input of foreign country has shown itself resilient to substantial internal political turmoil during the shareholding into the sector as a investment banks, of which three are unexpected events of presidential whole; and finally, liquid local deposit state owned, six are privately owned elections and the early parliamentary markets, which is strengthening the and four are foreign owned. There are elections over the past year. This is banking sector as a whole. Total also four small Islamic-style banks. thanks to having executed important international funding, for example, as Yet, even with this plethora of structural reforms during the post- a ratio of total liabilities is down to institutions Turkey remains underbanked and total assets held in the crisis period of 2001 which aimed at 13%,”he says.

Official figures show banking is sector at the end of 2007 were isolating politics from the financial markets and economy by the heading Egemen’s way. Turkey’s equivalent to less than one-third of

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those of Bank of America.“For the first time in 20007, the profitability of the banking sector was solid and near to where it should be,” notes Mehmet Erten, chief executive officer of Eurobank Tekfen.“The average return on equity was higher than on risk free investments; this was not the case for many years and marks a turnaround.

To a degree the influx of foreign banking interests has helped the revival; but there has been substantial momentum from local banks as well.”

Greek bank EFG Eurobank Ergasias holds a 70% share in Eurobank Tekfen (for which it paid $182m), whose customer base is a mix of small and medium sized enterprises (SMEs) and high net worth clients.

The total assets of foreign banks in the system increased to about 40% at the end of 2007, from just 5% in 2000, as more institutions rushed to snap up shares in Turkish bank assets after the country’s EU membership talks began in October 2005. The expansion of foreign bank interests in Turkey began in earnest through 2006/2007, with National Bank of Greece buying a 46% stake in Finansbank from Fiba Holding for $2.8bn; Belgium’s Dexia Group’s buying a 96.6% stake in Denizbank from Zorlu Holding and other shareholders for $3.16bn; while Citibank acquired a 20% stake in Akbank from Sabanci Holding for $3.1bn. Kazakhstan’s Turan Alem Bank bought 34% of Sekerbank for $260m; Lebanese Bank Med and the Jordanian Arab Bank bought 91% of MNG Bank, changing its name to Turklandbank and ING Bank bought Oyakbank for $2.67bn.

Foreign investment in the Turkey’s banking sector is a no-brainer: the country is replete with opportunity.

While corporate finance continues to be the major area of lending for most commercial banks, many banks have been shifting to consumer finance,

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private banking, lending to SMEs, and financing agricultural companies and farmers in expansion moves.

Consumer banking in particular has become a major area of focus in recent years and, with all the larger banks jumping into the market. As a result competition is stiff. In 2007, consumer loans stood at about $61bn; 25% of total loans. Nearly half of all consumer loans in 2007 were housing/mortgage loans. In 2005, consumer loans stood at only $16.5bn, accounting for only 16% of all bank loans. Bankers predict that consumer loans will eventually increase to 50% of all bank loans in the next five to 10 years. In addition, credit and debit card use is on the rise.

Turkey is now the third biggest credit card market in Europe, after Germany and England, ranks it 10th in the world, according to the Interbank Card Center (BKM). Nonetheless, the country still remains under-banked and while bank lending is on the rise, mortgage penetration is only at 4%, offering substantial growth potential.

In spite of short term political problems, which hamper the image of the country, the banking sector is pressing ahead with its branch expansion plans. Yapi Kredi, explains Tunaboylu, is undergoing an ambitious branch opening plan.

“Despite the changes in the global market and the political challenges at home, we are committed to our accelerated growth plan. We think it is a good opportunity to get ahead.”

In 2007, the bank “regained a lot of commercial focus, transitioned to a new platform and began extending out from its 638 branches in July 2007 to a planned 1000 branches by the end of 2009,” she adds. “As also confirmed by our 1Q 2008 results which are very positive, we are already gaining traction from the 110 branches opened since the launch of accelerated growth plan in July last

year. Only six are below their revenue targets; the rest have or are ahead of plan. As of April 2008, Yapi Kredi has already moved up a rank to become the third largest bank in terms of number of branches in the banking sector” Egemen boasts similar optimism. “We had an extraordinary year in 2007, with 26% return on equity and growth across all business lines. While we expect corporate lending to slow this year, we are still seeing upside on housing and car loans and as such are building both branches and electronic banking services: very much a clicks and bricks strategy.”

Both Egemen and Erten agree that while the retail sector is a solid rock upon which investment in the Turkish banking sector will be built, a key task ahead is for the banks to encourage the deepening of the Turkish lira fixed income capital market over the medium to long term. “The relatively high level of indebtedness of the Turkish treasury and continuing high T-bill rates, does put a dampener on domestic private sector intentions to issue Turkish lira bonds,” notes Erten.

Moreover, Garanti, which has lead arranged most of the country’s leading bond issues has noted a mid-term fall off in volumes. “We are leading only four or five right now. We have some way to go to be on the same level as say Brazil,”notes Egemen.

Right now, the focus is on steering the country through the next IMF agreement; “at the end of the day, when politicians have not the right kind of discipline, then the IMF is good to have as a third party regulator,” notes Erten. It is a view in sympathy with that of Egemen.

“Proper regulation is crucial for sustainable growth. We need to make our systems fully compatible with the European Union and we are still part way there. There is still much to do.”

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Bank Profile AKBANK: BANKING ON NEW OPPORTUNITIES

Celebrating 60 years in business in January this year, Akbank has always been Turkey’s banking bellwether. Founded in Adana back in 1948 to provide financing for local cotton producers, the bank has steadily risen to become Turkey’s largest bank by market capitalisation and one of the largest banks in loans and assets. Working via a 727 strong branch network the bank now offers a wide range of retail, commercial, corporate, private banking and international trade finance services. While regarded as one of the most assertive business accumulators in Turkey, the bank has always retained the air of a sedate, high end investment bank. At the end of March, Akbank’s board voted in a new chair, replacing Erol Sabanci, who had served in that capacity since 1998. Francesca Carnevale went to Istanbul to talk to Suzan Sabanci Dinçer on the incoming chairwoman’s vision for Akbank’s future.

HE ACCESSION OF Suzan Sabanci Dinçer from managing director to chairwoman marks the end of one era and the start of another at Akbank. Her predecessor Erol Sabanci, who was first acclaimed director of the bank way back in 1963, is largely credited as being the brains and visionary behind the sustained success and growth of Turkey’s largest private bank. No question, Erol Sabanci is a hard act to follow; a fact that might have discouraged a less confidant successor. Suzan Sabanci Dinçer is however made of sterner stuff. “Remember I have served at this bank for many years. I have been in training for this job from the start and over the years have enjoyed the advice

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Susan Sabanci Dinçer, chairman, Akbank. Photograph kindly supplied by Akbank, May 2008.

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and support of in particular Mr Sabanci; Mr Karahan, the board member in charge of credit risk and Andrew Buxton, ex chairman of Barclays, previously advisor to the board of Akbank. These days, I really appreciate the quality of my mentors.

Learning in this business is a continuum and I think it is vital to remain open minded—but it is equally important that you have good quality friends and advisors.”

Nonetheless, Sabanci Dinçer will likely be an arbiter of change; albeit merged with the pragmatic requirements of the Turkish banking theatre. She explains that in her debut year, the bank’s focus is firmly on the domestic market: “for two important reasons: one, the growth potential of the Turkish banking market is enormous and two, we are fairly and squarely driven by the level of competition. Many foreign institutions are focusing on the opportunities here and while that is happening we do not want to diversify away from our main objective, which is to be first (or at least second) in every business segment in the country.”

Moreover, in a pivotal development, Sabanci Dinçer argues that Akbank has always been ready to embrace change and as a result has transmuted from a product led institution to a customer oriented bank.“I am confident that over the long term we can achieve much, much more and will be admired as a bank with a remit in the wider economic region. But for the immediate future, our focus is domestic. Here we see opportunity in leveraging efficiencies in the bank, leveraging customer loyalty and goodwill and benchmarking the institution against the best banks working in the European Union.”

Sabanci Dinçer thinks that in order to achieve these goals she has to instill a collegiate and clear customer focused approach among the bank’s staff;“from the top down. I am a team player and I

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firmly believe that in today’s market effective teamwork is a deciding element in successful businesses: everyone working with clearly defined goals in mind. In addition, you have to be able to react quickly and effectively, be able to take effective and rapid decisions in response to market events and that is where the application of teamwork is vital: being able to take everyone with you in that vision and commitment.”

Unswerving focus then is a touchstone of Akbank’s success.“It has resulted in good returns for the bank and that focus and growth has left us better armed to handle the vagaries of the international market,” claims Sabanci Dinçer.“Our capital adequacy ratio (17%) is high and we boast high liquidity in foreign exchange and Turkish lira. We have a strong deposit base. That means we remain in a good position to review internally, where we offer value and scale and focus on our client’s business strategies, looking at the countries in which they do business and helping them accordingly.”

Sabanci Dinçer claims there are four key elements creating a “powerful infrastructure” upon which the bank’s business growth strategy rests.“A strong capital base is a must, then quality of assets, prudent risk management and a strong commitment to transparency and good corporate governance,” she stresses. “We simply do not believe in growth without a strong balance sheet.”

That will be particularly important in a year in which Akbank’s stated aim is to secure a 25% share of Turkey’s corporate banking market. Turkey’s corporate banking sector is expected to be worth $30bn in 2008. Last year the bank’s corporate and project finance lending totalled TL12.1bn, (around $10.4bn), up 35% on the previous year. In the first quarter this year, the bank claimed corporate lending had topped TL15.6bn, well on its planned trajectory.

“Growth in corporate loans was

particularly strong, up 29% as a result of investment and acquisition financing, despite an otherwise testing market on the corporate financing side. The fact that we can outstrip other corporate lenders in this regard gives us added confidence that we can achieve our goals,”says Sabanci Dinçer It all adds up to a benchmark year, acknowledges Sabanci Dinçer. In a year in which both corporate and retail lending are poised for sustained growth over the medium term (political considerations notwithstanding in the country). It is a seminal year in that the bank introduced a number of innovations through 2006 and 2007 which were intended to come to fruition through 2008/2009. Certainly from its first quarter figures, released recently, the bank appears on track, with net profit for first three months of 2008 of TL 720m, up 61% on the same quarter year on year.

Cannily, the bank approached the market for two major loans last year, rather than this year, thereby avoiding the rising margins on lending to Turkish financial institutions. The bank secured a loan from European Investment Bank in December last year, worth €150m, notable for its 12 years maturity of which 2 years is grace.The funds will be used to support its SME financing operations.

Earlier in the summer, at the height of the credit crisis, the bank managed to secure a €1bn syndicated loan, the largest ever in Turkish banking history at a rate of Libor plus 0.475%, with proceeds being used pre-finance exports; a popular source of corporate financing in the country. Moody’s had assigned a bank financial strength rating (BFSR) of C- to the bank prior to the loan, which translates into a Baseline Credit Assessment (BCA) of Baa1.

Akbank’s BCA is the highest assigned in Turkey, which says Moody’s reflects the bank’s “strong franchise in the local market, as well as its excellent financial

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Bank Profile AKBANK: BANKING ON NEW OPPORTUNITIES

metrics. At the same time, the BFSR is negatively affected by the Turkish operating environment, high levels of exposure to theTurkish government, and a relatively untested credit environment, particularly on the retail side”.

On the retail product development side, Akbank has striven hard to provide a range of innovative retail and consumer focused services, both through its traditional delivery channels, which include Credit Express consumer loan-only branches and Big Red House mortgage loan only branches, and through a series of specialised retail and corporate Internet branches. These include smsCredit, enabling customers to apply for consumer loans solely with their citizenship number via an SMS message;, and a new credit card called Wings, which the bank claims is the first of its kind in the sector “with the most advantageous mileage programme”. It also provides a localised Telephone Banking Centre, and new high-tech channels such as cell phones and webbased platforms. Additionally, free banking areas have been set up inside branches in which customers have access to both Internet and telephone banking services.“Innovation for us is a climate, or culture,” notes Sabanci Dinçer.“At every stage we ask ourselves: how can we reach clients in a more innovative way that reduces costs and introduces efficiencies and best helps the customer. We are always ready for feedback from the customer as to whether our plans add value to their relationship with us.”

Leaving nothing to chance, Sabanci Dinçer introduced a special task force into the bank entirely focused on customer care. “It analyses customer feedback and channels the comments and ideas into new business lines. It has had an empowering effect on both the bank and its clients.” As an example, Sabanci Dinçer outlines the development of the Credit Machine

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which gives a client the opportunity to secure a loan without having to visit the bank in person. “We found that some customers were reluctant to come into the bank to ask for money. So we established a new route, whereby they can apply for a loan over the phone (mobile or landline) and if the loan is approved, they can come in and sign the paperwork at leisure.” Similarly she points to Credit Express, where clients apply for loans via their credit card.“They provide the relevant information, receive rapid response and the value of the credit is automatically credited to their cards. The client then simply goes to a bank to cash in the loan.” The innovations have taken root, according to the bank’s latest quarterly report, growth in deposits rose 14% for the first three months of 2008 against sector growth of 8% year to date; while growth in net commission income reached 9% year on year, driven by credit card and asset management commissions.

Moreover, the bank reported growth across the range of its operations during the quarter under review. Consumer loan balances were TL9,254m, with demand particularly high for general purpose loans and mortgage loans.

Credit card balances were TL3,897m; and SME loans totalled TL14,434m. For the time being, Sabanci Dinçer sees the real estate segment as an important new business centre.“We will be introducing a raft of new products and services, to take account on the growth of real estate development in the country.”

To strengthen its underlying structure, in January last year, the bank inked a strategic partnership agreement with Citigroup, which acquired a 20% equity stake in the bank for some $3.1bn (around TL0.095 per share). The agreement established the terms of collaboration between the two banks to pursue new commercial activities, referral arrangements and joint ventures and

to share certain expertise and technology. The terms granted Citigroup the right to appoint one non-executive director to Akbank’s nine-person Board, and the Sabanci Group, the majority shareholder in Akbank, the right to appoint one nonexecutive director to the Board of Citigroup’s Turkey subsidiary. “The partnership with Citigroup has contributed positively to the development of new commercial banking activities, to the improvement of available products and to the development of new products,” notes Sabanci Dinçer, who points to the bank’s 2007 year end results as proof positive of the benefits of Citigroup’s involvement with the bank:“Net profit reached TL2bn ($1,76bn) and assets amounted to TL72.1bn (about $62.2bn)”, she notes. Meticulous in quoting figures, Sabanci Dinçer notes that last year consumer loans grew by 43%, “increasing to TL8.8bn, reaching a market share of 13.2%. Meanwhile, general purpose loans were up 83%, valued at TL3.4bn resulting in an increase in market share from 10.4% to 11.6% over the previous year. In 2007, deposits grew by 21.3% reaching TL43.6bn coupled with an increase in market share from 11% to 11.6%”.

In part, the future growth of Akbank will assume the same characteristics as it has done over the last 60 years: organic growth, with a conservative risk profile and stringent application of risk management through the bank.“As a 20 year employee of the bank, uppermost in my mind, even my blood, is prudent management. I have been instilled with the understanding that sustained growth is not achieved too quickly.”

What that means over the medium to long term is that future growth for Akbank will continue organically rather than accretively. “However,” notes Sabanci Dincer, “if we see the right opportunity we will also buy.”

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Surreya Ciliv, Turkcell’s chief executive officer.Photograph kindly supplied by Turkcell, May 2008.

By fate, fortune or design Turkcell, Turkey’s telecommunication and technology company is now a player in a complex (perhaps even Byzantine) tourney. The firm will emerge from the joust either as a lead regional telecommunications powerhouse; or as a cash-cow subsidiary of a more aggressive (and winning) operator. As the global telecommunications sector continues to smoulder through a succession of mergers and acquisitions, in the scrap for market share and augmented revenues, Turkcell must now formulate a winning game plan. Can it meet the competitive challenge? Francesca Carnevale reports from Istanbul.

S APRIL CLOSED Turkey’s mobile operator Turkcell moved to buy an 80% stake in Byelorussia’s third largest mobile operator, Belarus Telecommunications Network (BeST). The $500m transaction was approved at the highest level, say Belarus press reports, which also hinted at a geo-strategic decision to plump for Turkcell over Russian competitor Vimpelcom. On the surface the deal is relatively straightforward; Turkcell will pay for the transaction in three tranches, the last tranche maturity date coinciding with the first profit received by BeST. Underneath however, runs a labyrinthine sub-current of moves and countermoves—all for control of the west and eastern European mobile phone market. BeST is the third largest Belarus cellular operator, with 180,000 subscribers, accounting a mere 2.5% of the republic total subscriber base. Turkcell’s acquisition comprises shares from state enterprises: the Automation Research Institute (75%) and Beltelecom (25%).Vimpelcom was expected to run away with the acquisition of BeST; but failed to establish a

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direct foothold in the Belarus market, for the third time on the trot. The acquisition signifies a pivotal turn of events in Turkcell’s favour to establish a dominant position in neighbouring countries. Lucky then, that this falls entirely in its medium term international strategy; and of expanding at home and abroad, first horizontally and then vertically.

Not that Turkcell has much to complain of at home: Turkey is one of Europe’s largest and fastest growing mobile phone markets with a GSM subscriber base of 62m; up substantially from 16.1m subscribers in 2001. Moreover, mobile phone use in Turkey continues to escalate; a trend influenced by the fact that Turkey has the youngest population in western Europe [with a median age of only 27.1 years in 2006]. It is a mobile operator’s ideal demographic [Turkey has more than 11m subscribers under the age of 25]; with a burgeoning under-25 age segment that increasingly spends its money on new generation mobile telephony and the Internet. Furthermore, at current

COVER STORY: TURKCELL FIGHTS ON TWO FRONTS

TURKCELL & THE BATTLE PLAN FOR EASTERN EUROPE

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birthrates, Turkey will boast western Europe’s largest population; overtaking Germany when it is expected to increase to 86.2m by 2015. However, the future is not always bright and one significant limitation on the growth of Turkey’s mobile phone market is that 44% of the cost of a phone is tax; the highest percentage of 101 countries examined by the GSMA, the global trade association for mobile operators. Up to now, however, that has not dented Turkcell’s ambitions and, according to its management, it will not be turned from its growth trajectory.

You can tell a lot about the company on arrival at Turkcell Plaza HQ. For one, it leaves little to chance [you are phoned three times in the hour before your arrival to check on your progress]. Two, the firm is firmly focused on delivery.

Turkcell’s receptionist greets you by name as you approach the desk, informs you that the PR executive will be down in three minutes (he is), and that you will see chief executive officer (CEO) Surreya Ciliv five minutes later (you do).Three, it is quickly apparent that tight planning and unswerving focus are Turkcell’s cardinal skills; pointedly useful as the company travels a highly profitable yet distinctly rocky road.

It is a telling tactic in the involuted cross-trends of the global telecommunications market; and the chilly crosswinds that the firm navigates in terms of both its expansion plans and handling the fallout of scraps between its shareholders.

It’s useful then that it’s CEO is a considered and wily operator: with an eye for the main chance and a reliance on product innovation. Ciliv acknowledges that his approach to business was forged during his ten year tenure at Microsoft, which has encouraged the application of five sets of cultural “or behavioural values,” he says. These include; “customer intimacy, agility, being open and self critical, making a difference and being passionate about technology and having a passion for the people who work in the Turkcell ecosystem,”explains Ciliv. His world view;“to win we must offer innovation and operational excellence,” and his strategy are clearly stated.“We are dedicated to winning against all opposition, driving customer satisfaction and loyalty and growing the business as a result.”

All these elements converge into a seemingly straightforward tactical approach.“We focus in all our markets, but in Turkey in particular, on increasing our subscriber base in the first instance and then by increasing the average revenue per user. In harnessing that stickiness (through quality of service and innovation) we then look at leveraging the relationship through pricing, by minute or by unit,” explains Ciliv. It appears to be a winning approach. In a three player market, Turkcell is now the lead GSM operator in Turkey with 35.4m post-paid and prepaid customers by the end of 2007 and a market share of some 57% (in terms of subscriber numbers it is also the second largest GSM operator in Europe as of 2007 year end). Telsim-Vodafone, its nearest rival, has a 26% market share, while third-runner Avea (the mobile operation of land operator Turk Telekom) has 17%.

Turkcell’s world is particularly knockabout right now, even with BeST in the bag; with issues to beard at home and abroad.

While the firm reports a 78.9% rise in Q1 2008 first-quarter net

profits to $486.8m, Ciliv acknowledges a continuing softening in the domestic market.Turkcell’s top line revenues rose 21.6% to $1.57bn, due to growing usage and a rise in post-paid subscribers and corporate business. However, consolidated revenues were down 12.9% compared to the last quarter of 2007; the impact, he says, of the introduction of increased usage incentives in late February and incentivised tariff options in Q4 2007 because of competitive pressures. The short term domestic market prognosis is also testing.

“Turkey’s mobile phone market will slow in 2008 after a slower first quarter, notes Ciliv.“The global macro economic environment combined with economic and political developments in Turkey have affected consumer confidence.

In light of current trends, market growth this year will be at a slower pace than previously anticipated, and mobile line penetration should reach about 95% by the end of 2008.”

Moreover,“The pace of growth of our subscriber base may be at a slower rate compared to that of the market in 2008.”

While Turkcell is Turkey’s leading GSM operator, it also has to bend to the will of a regulator, which reportedly remains in thrall to state-owned domestic rival TurkTelekom, whose partial privatisation and stock market debut took place in mid-May. The pressure has been relentless. Through 2007 the firm noticed a step up of both regulatory force, which impacted to a degree on its competitiveness. Turkey’s Telecommunications Authority (TA) stymied Turkcell’s expansion plans in October last year, forcing the company to reduce retail tariffs. Naturally, “we have been impacted by these regulatory developments and since then have made certain adjustments in our pricing structure. We believe we are now in line with the TA’s recent decisions. Since the end of February [however] we believe we have regained our flexibility to an extent to introduce new campaigns and offers to be able to sustain our competitiveness going forward,”admits Ciliv.

Competition and straightening circumstances at home is encouraging Turkcell’s expansion abroad.“The firm’s growth strategy is a mix of organic and accretion through acquisition. We have a strong cash position and are happy to acquire the right assets,” notes Ciliv. “Our approach to acquisition is value focused, we do not spend unnecessarily on high priced assets.” Turkcell already has interests in mobile phone operations in Ukraine, Kazakhstan, Azerbaijan, Moldova and Georgia. Now that Turkcell is in the process of acquiring and assimilating BeST, it is looking to consolidate its growing hold on the east European market through its road-tested growth strategy (first horizontal, then vertical). In Belarus’s case, Turkcell, will be taking on MDC, the country’s second largest mobile phone operator (operating under the Velcom brand, which was sold to Telekom Austria for $1bn last October) and market leader MTS Belarus, which is co-owned by Russia’s number one cell phone operator, Mobile TeleSystems. Ciliv remains optimistic about Turkcell’s ability to win market share.

For one, expansion in the eastern European zone is “logical,” argues Ciliv.“as there is a combination of growth potential and the opportunity to achieve high levels of

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market penetration. Culturally, we know how to work in these countries and our natural evolution is developing from a leader in the Turkish market to being a leader in the broader region.” Additionally, Turkcell’s vision is grandiose.

The definition of‘regional’by Turkcell is, for instance, much broader than most: “we can see ourselves expanding the definition to include, Egypt, Syria, Iraq and even Iran.”

Nonetheless, vision is tempered by pragmatism. As Ciliv concedes, Iran is a particularly tough nut to crack. He has good reason to believe so. In mid-January this year Turkcell filed an arbitration lawsuit against the government of Iran for allegedly blocking its acquisition of a stake in Iranian mobile operator Irancell. A consortium led by Turkcell had been approved as the winning bidder in a tender to take a 51% stake in the newly-created national mobile licensee Irancell back in February 2004, in a deal that was reportedly worth $2.25bn. Just before completion however, the deal ran into difficulty. Turkcell had expected to secure a majority stake in Irancell under the bidding terms, but the government unexpectedly pushed through legislation in April 2005 to limit its stake to 49%. Then, in another turnaround conservative Iranian politicians reportedly suspended the contract altogether. Turkcell acknowledges that it then faced a series of blocking tactics against its efforts to resurrect the deal and was finally left with little choice but to walk away from the transaction altogether. MTN of South Africa took its place in the consortium in October 2005 and Irancell has gone on to take second place in the country’s mobile market, with 3.72m subscribers at the end of September 2007.

Although the company has not enjoyed the most smooth growth trajectory, it remains on a substantial upward growth trend. No surprise then that it remains a battleground for shareholders wanting control of a company that seemingly managers to overcome insurmountable obstacles. Turkcell’s major shareholders are Nordic telecommunications company TeliaSonera AB, the Russian private equity firm Altimo and unlisted Turkish conglomerate Çukurova. In a complex shareholding superstructure, some 51% of Turkcell’s share capital is held by Turkcell Holding, 4.22% by Çukurova Group, 13.07% by Sonera Holding, 2.32% by M.V. Holding and 0.01% by others while the remaining 29.38% is free float.

Through the division of shares in Turkcell Holding however, it’s two most significant founding shareholders, Sonera Holding BV and the Çukurova Group own approximately 37.1% and 17.9%, respectively, of the company’s share capital. Çukurova is perhaps the most interesting of Turkcell’s owners and has seemingly held on tenaciously to its holdings in the firm in trying circumstances. The collapse of one of its two banks five years ago should have ended Çukurova’s control of the firm, but it hung on despite heavy pressure for it to sell. It’s tenacity is understandable. Over the last five years Turkcell has grown into one of the most valuable assets in its portfolio. However, Çukurova still stands in the shadow of two legal initiatives aimed at unwinding its stake in the mobile operator. In the first, Sonera Holding, the parent of TeliaSonera, went to international arbitration seeking to force Çukurova to honour the agreement it made two years ago to

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Ciliv acknowledges that his approach to business was forged during his ten year tenure at Microsoft, which has encouraged the application of five sets of cultural “or behavioural values,” he says. Photograph kindly supplied by Turkcell, May 2008.

sell it the bulk of its stake in Turkcell. Meanwhile, Russia’s Altimo, which loaned Çukurova money to help it keep its stake in the telecom provider also went to court, claiming a stake in Turkcell in lieu of late repayment of its loan. Despite this double pincer movement, few analysts are betting against Çukurova ever losing control of the mobile operator.

The reason is Çukurova’s web-like stakeholding in the firm.

Added to that is the power the Çukurova Group is able to exert in the Turkish market through its extensive media interests and political relationships. The firm is reportedly a master of Turkey’s perennially intricate corporate/political power plays, which has allowed the group to remain afloat, in spite of occasional cash flow problems. In consequence, Çukurova remains a dominant player in Turkcell, even with a seeming minority holding. The extent of its political clout was clearly shown back in 2003 when the Turkish banking regulator, backed by the newly elected government of the Justice and Development Party (AKP) loaned Çukurova $264m to help it buy back shares in Turkcell from its former banks, on the understanding that future earnings from Turkcell coupled with the still solvent Yapi Kredi bank, would be sufficient for Çukurova to cover the debts of Pamukbank (which had effectively collapsed) and its outstanding loans to debtors.

In intervening years, the group has also benefited from the fact that under the leadership of Tayfun Bayazit, a highly experienced banker, the fortunes of Yapi Kredi have gone from strength to strength. Moreover, as foreign banks have increasingly acquired interests in Turkey’s still promising banking sector, the value of Çukurova’s stake in

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Yapi Kredi has been pushed way beyond previous estimates to somewhere in the region of $1bn-plus.

Irrespective of those positive developments Çukurova from time to time still faced problems meeting its debt obligations and in 2005 it had reached an agreement to sell control of Turkcell to Sonera for $3.1bn. This involved Çukurova selling its share of Turkcell Holding AS, an SPV which holds 51% of shares in Turkcell proper and in which Çukurova holds 52.92%, and Sonera 47.08%. With its existing 13.07% stake this would have resulted in Sonera owning 64.07% of Turkcell, leaving Çukurova with just the 13.22% it held outright.

Before the transfer occurred, Çukurova backed out, citing a better offer from Altimo, whose parent company, the Alfa Group then lent $1.7bn to Çukurova to help cover its outstandings to the government and other creditors, in return for a minority share of 49% in Telecom Holding. The shareholding structure subsequently gave Alfa a 13.22% stake in Turkcell proper, but crucially left control of the company with Çukurova despite its only holding a stake of 26.9% (compared with 37.07% for Sonera). Sonera then launched its legal action at the international court of arbitration in Vienna. To complicate matters further, the Alfa Group then fell out with Çukurova and launched its own legal action demanding Çukurova’s share in Çukurova Telecom Holding. Most recently, in April this year telecoms firm TeliaSonera said it had offered to buy some of the Turkcell shares put up for sale by Çukurova, but had not been allocated any. Speaking after the company’s first-quarter results, TeleSonera chief executive Lars Nyberg clarified the statement, saying he had wanted to buy some of the 4.1% stake sold by Çukurova but had not been successful.

The arbitration tribunal of the International Chamber of Commerce in Vienna has reportedly found Çukurova violated certain share transfer restrictions in the shareholders’ agreement between Çukurova and TeliaSonera. The tribunal ordered Çukurova Holding to take all measures available to it, including good faith negotiations with the Alfa Group, to repurchase the transferred shares.

The arbitration tribunal has also reserved its rights to decide about other claims brought by TeliaSonera, including damages. Çukurova argued that the merger between Telia and Sonera in 2002 violated the share transfer restrictions in the shareholders’ agreement, but Çukurova’s counterclaim was dismissed by the arbitration tribunal.

The picture is further complicated by Turkish stock exchange rules under which Alfa and Çukurova should have launched a share call two years ago when the SPV, Çukurova Telecom Holding was set up with its indirect holding of 26.98% of Turkcell. The legal challenges are labyrinthine, and too complex to go into in detail, however legal challenges alone, particularly those going to arbitration outside of Turkey, are not likely to loosen the Çukurova group’s hold on Turkey’s biggest mobile operator. Not when there are so many rich pickings to be had. Turkcell’s Ciliv remains sanguine about the furore circling around the company. As Ciliv notes:“all have had one thing in mind: that Turkcell has a bright future. Turkcell’s success represents their success in

Turkey; their investments have borne fruit. Çukurova have been really good to us and we value their shareholder status.

We go back a long way with TelioSonera and they also provide a lot of value add. The Russians, who also own Vimpelcom, are masters of value creation.”

In spite of the turmoil around it, Turkcell’s CEO says he is not deflected from his purpose and explains that his company is a juggernaut, refusing to rest on its laurels, Turkcell continues to expand the range of its international roaming services and broaden its GPRS coverage through the GPRS roaming agreements (it currently has international roaming agreements with 568 operators in 197 countries). Moreover, Turkcell’s EDGE technology in Turkey allows its customers to enjoy 2G data transfer inside the country and can use the services of roaming partners employing 3G standard while abroad. Turkcell has managed to retain a 60% market share, while at the same time charging a bit more per subscriber than its closest competitors.The company receives an average of $14.10 per customer per month, versus Vodafone’s $11.70 and the smaller Avea which receives $9.80. Analysts point to pricing power as the strength behind Turkcell’s strong margins and expect the company to be able to keep margins high throughout the next few reporting periods.

Nonetheless, some domestic challenges remain; market saturation is one. Ciliv acknowledges that Turkey has 87% SIM card penetration. Another is number portability.

Turkish Telecommunications Board [TTB] is expected to mandate the ability to move phone numbers between carriers in November 2008. This would make it much easier for clients to switch carriers without the hassle of receiving a new number. Portability would create a much more price sensitive environment, which could have a negative effect on margins. However, the company can also differentiate itself based on service provided and the quality of its network, according to Ciliv.

Most recently the firm launched its mobile signature service, in which it maintains it enjoys first mover advantage in its markets and which will tip the firm into a broader range of services. User uptake has been strong based on the number of different service providers supporting mobile signatures and the different applications available. Turkcell launched the service with five banks committed to using mobile signatures for their online banking security. By the end of 2007, 12 banks use mobile signatures: Akbank, Bank Asya, Denizbank, Garanti, HSBC, Kuveyt Turk, TEB, Turkiye Finans, Turkiye Is Bankasi, Finansbank, Sekerbank and Yapi Kredi. Consumers use mobile signatures for digitally signing loan applications, online bank authentication, transaction confirmation, mBanking and cardless ATM usage and Ciliv thinks that this is a growing area for the firm.“You can also open your front door now with your mobile signature,” he adds. “the next generation of services will involve mobile advertising and healthcare and the convergence of Internet and content with mobile services.”

Ciliv is confident about the future.“How do we make the user experience very simple? Add to that, if people see value in the service we offer, they will come to us.”

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COMMODITY PROFILE: COPPER

TEMPERAMENTAL COPPER WIRES THE WORLD

Of all the metals traded on various global futures exchanges the short term outlook for copper is probably the least clear. Prices are currently at their highest levels ever. In mid-April copper futures traded at around $8,800 a metric tonne on the London Metal Exchange (LME) This is seven years into a rally that started in late 2001 with prices around $1340, a rally which is probably about to run out of steam. Most analysts say that the market is close to being in balance but short term supply problems still have the potential to push prices temporarily higher.

Vanja Sliva reports.

Copper, or the red metal as the industry calls it, has proved quite the temperamental redhead recently; volatile and difficult to predict. A soft and malleable metal, copper is used in pipes and roofing, but its most important feature is that it is an excellent conductor of electricity making it crucial for the electric industry. Photograph Š Alice Herden/Dreamstime.com, supplied May 2008.

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OPPER, OR THE red metal as the industry calls it, total world copper. The strike situation which, at the time of has proved quite the temperamental redhead writing, had lasted for a week, but was likely to be resolved recently; volatile and difficult to predict. A soft and fairly quickly, is the smaller of Chile’s problems. The bigger malleable metal, copper is used in pipes and roofing, but its and the more longer-term one, that of unreliable power most important feature is that it is an excellent conductor supply, remains unresolved. There are several world-class of electricity making it crucial for the electric industry. copper mines spread around Chile, including Escondida, Copper prices are currently at their highest recorded level, owned 57.7% by Anglo-Australian mining behemoth BHP but on a five to ten year horizon, prices are far more likely Billiton and 30% by Rio Tinto.

Mining requires the intensive use of electricity and to be lower than today—although not as low as in 2001.

That is because global demand has moved on. Some of the shocks to power supply can also severely disrupt largest copper discoveries have already been made, with no production. Chile has an energy grid divided into two huge new projects coming on line, and the mining industry major zones; both of which are facing problems but from has been cutting costs over the last decade, storing all sorts different issues. The smaller of the two supplies the of production problems which are already starting to northern region and relies on gas from Argentina, which is manifest. This includes a lack of investment in mines, and being cut during periods when Argentina requires more gas. The central and shortage of skilled and southern region, where experienced staff. half of the electricity is Copper futures are generated from hydro traded 24-hours a day on sources, is currently the three main exchanges suffering a drought. in London, New York and The world’s largest mine, Chile’s Because power is so Shanghai. Over 90% of the state-owned Corporation National del important to production, futures are traded on the Cobre (Codelco) is currently being some of the mines have LME, which, with 130 severely impeded by striking contract back-up generators while years of trading under its others are either in the belt is the oldest of the workers who are demanding the same process of installing them three, the biggest wage as union-backed permanent or switching from gas to exchange dedicated to staff. Codelco produces 11% of total diesel or other fuel. metals, and the only one world copper. The strike situation Going forward, having a still trading open outcry in which, at the time of writing, had good source of electricity London. NYMEX in New will remain a problem for York recently became part lasted for a week, but was likely to be other mining areas too, of the Chicago Mercantile resolved fairly quickly, is the smaller like the African copper Exchange (CME), the of Chile’s problems. belt, where it is already biggest commodities affecting Zambia, another exchange in the world. The significant producer, and Shanghai Futures the Republic of Congo. On Exchange (SHFE) caters to the demand side, like in so the biggest consuming region in the world and prices there tend to be an excellent many other commodities at present, China dominates the indicator of local Chinese demand. Occasionally prices on equation. To put China’s role into perspective, global use of the three exchanges diverge slightly, as is the case now copper excluding China fell slightly last year by 1.4%. With between the LME and SHFE, but arbitrage tends to even China in the picture, global demand increased by 6.5% in this out fairly quickly. Apart from the exchanges 2007, according to the International Copper Study Group.

China’s domestic expansion, including the building of themselves, copper is also traded over-the-counter and between physical merchants. Despite the fact that cities, the fast growth of various industries, and a move by investment funds, or even more so hedge funds, are some of its rural population into towns, is having a massive accused of distorting prices and creating volatility in the effect on all industrial metals. Last year Chinese copper market, medium term prices are usually a fairly good demand rose at a pace of 18%, according to Gayle Berry, analyst at Barclays Capital, and this year, although demand reflection of the global supply and demand balance.

On the supply side, Chile, one of the main global will slow down, it is still projected to rise at a pace of 11.5% producers, has been facing serious problems with labour a year. Berry says this translates into a 535,000 rise in disputes and power shortages. The world’s largest mine, consumption, on top of an already high base demand.

Chile’s state-owned Corporation National del Cobre Short term, however, Chinese buyers are holding back and (Codelco) is currently being severely impeded by striking working off their current stockpiles. This is clearly reflected contract workers who are demanding the same wage as in SHFE copper prices, which currently trade at a discount union-backed permanent staff. Codelco produces 11% of to the LME.

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Zambian president Levy Patrick Mwanawasa. Going forward, having a good source of electricity will remain a problem for other mining areas too, like the African copper belt, where it is already affecting Zambia, another significant producer, and the Republic of Congo. Photograph supplied by PA Photos, May 2008.

The current lack of Chinese buying comes in reaction to its aggressive buying of LME copper at the end of 2007.

Domestic prices also rose sharply as China imposed restrictions on imported metal. At the time local copper prices rallied much faster than LME prices, creating a massive arbitrage opportunity. Given that the LME has warehouses in Singapore and South Korea, even with the additional cost of having to ship that metal into China, it became much cheaper to buy LME copper than to buy in Shanghai. The upshot is that users like semi-fabricators stocked up on the metal.“It will take three to six months for the surplus to get absorbed,”says John Kemp, economist at Sempra Metals Trading, an LME market maker, adding that lower SHFE prices will act as a drag on LME prices in the next three to six months.

As it is possible to trade LME copper for three, six, nine, 12 or even 27 months in advance, the LME forward price curve is a good indicator of what the market thinks prices will do in the future. Currently, the LME’s 27-month forward price is $7,800, or a full $1,000 below the current price. This may change closer to the time however if supply shortages persist and Chinese demand continues to be strong. Analysts’ forecast back up the view of lower prices going forward, with average price forecasts for this year ranging between $7,500 and $7,900 a tonne, while five years ahead they fall to between $4,400 and $5,000 a tonne.

James Reade, head of metals strategy at UBS says that the copper price is“pretty full, based on what the Chinese are telling us from arbitrage.” He is neutral on copper and says that he expects the average price this year to be

FTSE GLOBAL MARKETS • JUNE 2008

$7,700/ton. Meantime, a report by Macquarie Bank Commodities Research says that in coming months China should be seen as strong support factor—a market that will buy on price dips—rather than as something that is going to push the price to new highs.

There has been a lot of talk recently about investment players making futures prices more volatile. Certainly, short-term speculators, such as hedge funds, are becoming more active and their presence is occasionally forceful enough to move prices several hundred dollars in either direction but overall the level of “this type of activity is relatively small and certainly not of sufficient magnitude to be a driver of long-term price trends or push prices out of line with fundamentals for more than a few weeks,” says Kevin Norrish, analyst at Barclays Capital.

The LME publishes open interest data, showing how many open positions there are in the market but does not specify if they are on the long or short side. Open interest surged at the beginning of 2008 in all metals, most of all in copper, as investors poured money into the metal. Analysts say that this was mainly because commodity funds were readjusting their allocations in the metals to stay in line with commodity indices which they trade.

Since the beginning of April however there has been a sharp drop in open interest, which was accompanied with rising prices, indicating covering of short positions.

Macquarie Bank says that what is most likely happening at present is physical buyers (either producers or consumers) are buying, but speculative players are selling. Barclay’s Norrish adds that there are new sources of buying such as

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both capital intensive projects which take years to come on line, by which time the price picture might have changed completely. Their fixed costs are fairly high and even at times of low prices they will tend to operate at full capacity for as long as possible, only closing down some of their operations when they can no longer cover their costs. This, in turn, will start a whole new cycle.

From an investment point of view, futures remain the most risky type of investing in commodities because of high leverage, which can exacerbate both gains and losses. One lot of copper, or the minimum amount that can be traded on the LME, is 25 tonnes, which, taking a current price of $8,000 a tonne, would cost $200,000, yet the margin, or the minimum amount required to get involved in the contract is $15,000. This means that if the price goes up 10% to $8,800 the value of one warrant would rise to $220,000 making the profit $20,000. If it falls 10%, the investor would lose $20,000 or more than the initial margin. This of course multiplies with the amount of money invested.

A less risky investment play is exchange traded commodities (ETCs) which trade just like shares. They give investors exposure to commodities via ordinary brokerage accounts without trading futures or taking physical delivery. Fees are typically around 0.5% Gayle Berry, analyst at Barclays Capital. Berry says that last year Chinese copper demand of the investment value, which compares rose at a pace of 18% and this year, although demand will slow down, it is still projected to with 2% for mutual funds and hedge rise at a pace of 11.5% a year. This translates into a 535,000 rise in consumption, on top of funds. There is currently a whole wealth an already high base demand, she adds. Short term, however, Chinese buyers are holding of ETCs out there, from straight-forward back and working off their current stockpiles. This is clearly reflected in SHFE copper prices, ETCs invested in grains, gold or any other which currently trade at a discount to the LME. commodity, to leveraged and short ETCs. exchange traded commodities and structured products but “The advantage of ETCs is that you can quickly get access in comparison to traditional buyers who are typically either to commodities. You don’t need to be a specialist in big mines hedging production, fabricators of copper platinum or hogs, you don’t even have to decide on which products or merchants, the fast moving speculative part of commodity you want to invest in, you can, for instance go for an ETC in agriculture to get exposure to that particular the market is just a fraction of the whole futures trade.

The reason why the copper industry, or any other metals market,” says Nick Burns, head of research and strategy at industry for that matter, is an intensive user of futures, is ETF Securities, one of the largest providers of ETCs. ETF because it is easier to protect yourself from price swings by Securities has three copper instruments—ETFs Copper, hedging production—fixing prices several months or even ETFs Short Copper and ETFs Leveraged Copper.

ETCs have proven so popular that the inflow into ETF years ahead—than it is to adjust production. All raw materials industries regularly go through boom and bust Securities’ instruments has risen from $200m 15 months cycles. Neither supply nor demand is responsive to small ago to $5bn in the first quarter of this year. Be it copper price changes because they operate on large economies of futures or ETCs, the metal remains one to watch. While scale and will change production levels only when there is current levels may not be sustained throughout the year, no other choice. For instance, when prices are high, with Chinese demand likely to remain strong in the near producers will either plan a new mine or a new smelter, term, any price dips may prove a good buying opportunity.

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A lot has happened since a large chunk of the UK property industry converted to real estate investment trusts (REITs) at the start of 2007 and not much of it has been good. The credit crunch has hit the UK hard and at the depths of last year the net asset values (NAVs) of some of the biggest REITs plunged by as much as 60%.

Coupled with that, while the UK largest property portfolios opted to take the tax advantages on offer by converting to REIT status, there has been no sign of the raft of specialist funds that were supposed to proliferate, says Mark Faithfull.

T NEW YEAR 2007 it was all supposed to be so different. UK REITs were launched to great fanfare, with German REITs (G-REITs) to follow shortly after; bringing Europe’s two biggest property markets into the global REIT family. But politically-motivated compromises and caution in the German market, where open and closed end funds dominate, has left the country’s property sector largely unmoved. As for the UK, the major property investment and development companies all dutifully changed to REIT structures, then watched as their valuations tumbled. In the meantime the slew of specialist REITs expected to be drawn into the market singularly failed to materialise.

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Photograph supplied by Dreamstime.com, May 2008.

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REAL ESTATE REPORT: WHATEVER HAPPENED TO UK REITS?

Are UK REITs boxed-in by tax?

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REAL ESTATE REPORT: WHATEVER HAPPENED TO UK REITS?

“What you have to ask is “The UK is unique in ‘what did that add to the that it is the only country The other disappointment is the lack market’,” says Knowles. which introduced REITs at of specialist funds. In the US, REIT “No-one from outside the the height of the cycle,” legislation has encouraged a host of sector has launched a REIT. reflects John Knowles, The idea of specialisations managing director of specialist property portfolios to wrap just has not developed.” corporate finance at global themselves up in REIT structures, However, Patrick real estate adviser DTZ.“In representing asset types from prisons Sumner, chairman of other markets the prime to residential homes to hotels. In the industry organisation Reita motivation for enabling UK pub groups, healthcare specialists and head of properties at REITs has been to bring in Henderson Global additional liquidity and to and several other peripheral real Investors, believes that the stimulate the market. In estate asset groups have nibbled at worst may be over. “The the UK the market was the edges of converting to REIT Investment Property flying and had already status, but ultimately failed to bite.

Databank (IPD) monthly sucked in enormous index [a noted property amounts of both trends measures] is likely to commercial and retail investment. Consequently, with the credit crunch we have show capital values falling for another few months, but at a seen net asset values (NAVs) plunge as much as 60%, slowing rate. The full year results announcements from although the typical REIT is now trading at more like 30% British Land and Land Securities in May will show further value write-downs, but this is already ‘in the price’ and the off its NAV.” The other disappointment is the lack of specialist funds. pattern of income and dividend growth could well be In the US, REIT legislation has encouraged a host of encouraging,” Knowles says. “There is evidence that specialist property portfolios to wrap themselves up in sentiment is improving, with flows to property equities funds REIT structures, representing asset types from prisons to turning positive for the first time in nearly a year,”he adds.

Moreover, Sumner thinks that those results announcements residential homes to hotels. In the UK pub groups, healthcare specialists and several other peripheral real may well accord with a wider upturn.“It is perhaps axiomatic estate asset groups have nibbled at the edges of converting that property share prices are a good predictor, six months in advance, of underlying property trends. If that is true, then the to REIT status, but ultimately failed to bite.

LEADING UK REITs Company Big Yellow British Land Brixton Derwent London Great Portland Estates Hammerson Land Securities Liberty International Local Shopping REIT McKay Securities Mucklow (A&J) Group Primary Health Properties Rugby Estates Investment Trust Slough Estates Group (SEGRO) Shaftesbury Town Centre Securities Warner Estate Holdings Workspace Group Total

Sector focus

Market cap (£m)

Gross dividend yield (%)

Self storage Diversified Industrial Offices Offices Diversified Diversified Retail Retail Offices Industrial offices Health care Diversified asset managers Industrial Retail Retail Retail Offices industrial

473.9 4,695.7 841.3 1,470.3 889.7 3,197.7 7,029.1 3,489.9 96.7 174.0 200.8 94.0 37.3 2,138.8 760.5 305.4 417.3 469.1 26,781.5

2.30 3.76 4.34 1.54 2.30 2.48 3.51 3.54 3.29 2.68 4.80 5.11 0.00 4.66 1.36 1.31 2.50 1.58 Source: REITA, supplied May, 2008

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bottom of the share market was in November and the IPD capital value index will stop falling in May,” he says.

Additionally, some of the REITs themselves are beginning to eye opportunistic buys.

Industrial REIT Slough Industrial Estates (SEGRO), a net seller of UK property for the past three years, says it has £1.1bn of firepower to take advantage of falling asset and company values. Although chief executive Ian Coull warns: “Looking forward, we expect the continuing weakness in the credit and real estate investment markets to maintain downward pressure on UK commercial property values during the first half of the year,” of SEGRO’s plans he also counters with: “We are quite excited about the prospect of being able to come back more aggressively into the UK market than we have been for the past few years.”

Meanwhile property unit trusts are mulling the logistics and costs of switching to an open ended investment company (OEIC) structure following the most recent UK Budget which levelled out the tax treatment of REITs and direct property funds. Under the existing regime, direct property funds pay tax on rental income before distributing income.

Patrick Sumner, chairman of industry organisation Reita and head of properties at Henderson Through the new rules, which became Global Investors, believes that the worst may be over.“The Investment Property Databank effective on the 6th April this year, (IPD) monthly index [a noted property trends measures] is likely to show capital values dividends are paid to investors before falling for another few months, but at a slowing rate. The full year results announcements tax. That means REITs (which do not pay from British Land and Land Securities in May will show further value write-downs, but this tax on income before distribution) lose is already ‘in the price’ and the pattern of income and dividend growth could well be their tax advantage over direct property encouraging,” Knowles says.“There is evidence that sentiment is improving, with flows to funds. However, property funds, which property equities funds turning positive for the first time in nearly a year,” he adds. are structured as unit trusts, will be Photograph kindly supplied by Reita, May 2008. required to transfer to OEIC status if “It’s early days for some of the new sovereign wealth they want to exploit these rules.

Moreover, market uncertainty has also brought another funds, like those of China and Russia,”says Keith Steventon, potential investor to the fore—sovereign wealth funds. Until head of research at property consultancy Atisreal.“Currently last year, few sovereign wealth funds had made headlines. we are not detecting any major interest in real estate and my Run by the governments of some of the world’s richest feeling is that when they do they will buy in expertise. That exporting nations, they are largely based on the huge trade may mean, like Kuwait, setting up a dedicated real estate excesses amassed as the prices of oil, gas and natural company or buying a business but rather than a REIT I resources have skyrocketed. With the sub prime crisis making would anticipate it being a nice private company.”

Steventon also believes that the first moves are unlikely to cash king, they have found their moment.

There have been some big investments in the banking represent substantial capital investments but will more likely world but these funds have yet to make a serious impact on focus on trophy assets. Knowles concurs: “There are some the property world; however, analysts believe they will and positive signs; we are seeing a trend in divesting out of soon. With estimated assets of some $2.5trn, sovereign wealth dollar-denominated funds and an increased liking of real funds are aggressively seeking investments that will yield estate as an asset class, for instance. However, our sense is above-average returns as they seek to diversify their huge that the new sovereign wealth funds will be searching for portfolios out of such traditional holdings as US Treasuries. As prestige developments, they are still drawn to trophy assets.”

There are signs, in fact, that a fledgling movement toward REIT valuations fall and capital becomes more constrained, retail real estate is already under way. In December The sovereign wealth funds may well see a chance to profit.

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Rebased(100=30 Apr. 2003)

owner of shopping centres in the US and Australia’s largest shopping mall owner, has plunged into a financial spiral since posting a record half-year loss of $1bn in December and writing down nearly the same again on US investments. Amid a lot of bad news, the worst was to come; admission that it had $3.7bn in short-term debt and few options on how to refinance its capital obligations. Centro’s Australian creditors have agreed to extend the repayment term to April 30th and another debt of $1.3bn, associated with affiliate Centro Retail Trust’s US joint venture, has been extended until September 30th, but what remains of the business is reckoned by local commentators to lack general appeal.

Ironically, Centro’s reckless foray into the US comes at a time when Australia’s own economy is thriving on the back of a natural and mineral resources boom and its REIT industry is one of the most established and professional in the global market. That position could be under threat before long by neighbouring Japan, where the government will allow Japanese REITs to invest overseas later this spring. J-REITs, of which there are now about 40, have amassed sizable portfolios, capitalised to the tune of over $56bn, since their creation in 2000, but have been restricted to domestic activity. Now the thinking is that they will be more competitive if they are able to participate in the growing transnational real estate investment market.

There is also increasing speculation that Canadian pension funds will begin to flex their muscles outside the Americas. Buoyed by the government’s compulsory pensions saving legislation and by an oil and natural resources boom which has turned locations like Calgary into latter day oil rush towns, the funds are weighted down with capital and are likely to become a key capital exporter.“Europe is an obvious target and the UK, because of its cultural and language similarities, is an obvious first stop,”says Steventon.

So for now, national funds—be they sovereign or pension funds—are becoming increasingly important investment sources at a time when leveraged-deals have dwindled in both volume and transaction size. Whichever investment course the funds choose, it is clear that they are not going away. In an analysis released last year, Morgan Stanley predicted that sovereign wealth funds could total $12trn by 2015.

5-Year Total Return “The property industry has a tendency to think of itself as a small club of property companies and investors,” says Knowles. “But the reality is that there are more international investors looking to have real estate represent 10% to 20% of their asset allocations. What we’re seeing is those potential investors getting bigger FTSE EPRA/NAREIT Global Index and bigger.”

Ap r-0 Ju 3 l-0 Oc 3 t-0 Ja 3 n0 Ap 4 r-0 Ju 4 l-0 Oc 4 t-0 Ja 4 n0 Ap 5 r-0 Ju 5 l-0 Oc 5 t-0 Ja 5 n0 Ap 6 r-0 Ju 6 l-0 Oc 6 t-0 Ja 6 n0 Ap 7 r-0 Ju 7 l-0 Oc 7 t-0 Ja 7 n0 Ap 8 r-0 8

REAL ESTATE REPORT: WHATEVER HAPPENED TO UK REITS?

Related Companies, developer of New York City’s Time Warner Center, received $1bn in debt financing from three Middle Eastern investors: an affiliate of the Abu Dhabi Mubadala Development Co investment agency, Saudi Arabia’s family-owned Olayan Group and an unidentified sovereign wealth fund. Early this year, Singapore’s Government Investment Corporation (GIC) announced that it had built up a stake of just over 3% in UK REIT British Land. GIC was already an active investor in office REITs around the world. Similarly, Qatar completed the acquisition of Chelsea Barracks in London through CPC at the end of January for £959m.

Indeed, in the current market, UK REITs make an obvious acquisition target. They are all run by professional property teams with long and largely successful track records in domestic and international development, making them ideal partners in joint ventures. There is also the possibility of a distress sale, should any of the REITs have liquidity problems in the current market, although their capital structures make this scenario unlikely. More probable is that persistently low net asset values (NAVs) will make one of the REITs look highly attractive as a good value purchase.

Such a move was unlikely before the latest UK Budget because of punitive tax legislation on the buyer but the UK government has confirmed that any purchaser of a UK REIT would not face capital gains tax liabilities that were payable when a property company converted to a REIT should they take the vehicle private. In the past few months the lack of clarity on this point has acted as a major barrier to merger and acquisition activity, with the general assumption that the tax advantages of REIT status would evaporate. But this clarification means that buyers would get the assets at current value, which means they could be sold without tax.

However, a bigger hurdle to any purchase is the actual price a REIT could be picked up for. Depressed NAVs may make the apparent prices enticing but most analysts believe it is unlikely that there are bargains to be had should a serious bid be mooted.“The headline prices look very attractive but nobody really believes that a REIT could be bought at such a big discount off NAV,”says Knowles.“A bidding war would almost certainly ensue and we’d see the actual offer price driven up again. To my mind there are other concerns, for example FTSE EPRA NAREIT UK Index how much has been done Performance (GBP) on cost control at the REITs? 450 The idea is that by 400 distributing profits they 350 produce very clean income 300 but are UK REITs really lean 250 and light machines?”

200 A look to the other side of 150 the world demonstrates, 100 however, that a more 50 dramatic play-out cannot be completely discounted.

Australia’s Centro Properties EPRA/NAREIT UK Index Group, the fifth-largest

Source: FTSE Group, data as at 30 April 2008

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The introduction of the European Union's Markets in Financial Instruments Directive (MiFID) and the creation of a pan-European securities market in 2007 resulted in a paradigm shift in Europe's equities markets. But while MiFID will ultimately impel development of a pan-European market at the trading level, the clearing and settlement superstructure remains organised largely on national lines with deep-seated regulatory, legal, fiscal and market-practice barriers, keeping cross-border clearing and settlement costs in Europe relatively high. While it is unlikely that development of a more complex trading environment will slow, the success of new multi-lateral trading facilities (MTFs) and intermarket competition could be tempered by the increase in operational complexity and costs associated with an unresolved cross-border clearing and settlement process. Does the DTCC’s EuroCCP hold the answer? Neil O’Hara reports.

INVESTORS HAVE WAITED so long for pan-European trading to become more than a pipe dream it is hard to believe it may be about to happen at last. A combination of regulatory changes and advances in technology have opened the door to multilateral trading facilities (MTFs) such as Instinet’s Chi-X and Turquoise, a new platform backed by nine major securities dealers that is expected to go live in August 2008. In an effort to avoid the ignominious failure of earlier multilateral trading venues such as NASDAQ Europe and Jiway, the latest MTFs have designed settlement procedures that allow investors to keep their securities at whatever central securities depository (CSD) they already use. It is a revolutionary concept that could shake up the entire market for clearing and settlement services across Europe.

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FTSE GLOBAL MARKETS • JUNE 2008

The clearing agent that will perform this magic for Turquoise is EuroCCP, a newly-minted subsidiary of Depository Trust and Clearing Corporation (DTCC), the industry-owned utility that has handled securities settlement in the United States for more than 30 years.

Right from its inception, Turquoise recognised the key to success lay in making the use of its platform as seamless as possible to investors.“It was absolutely essential that if an investor traded a German share on Turquoise that that [sic] share would be fungible with German shares traded on Deutsche Börse,”says Adrian Farnham, the London-based chief operating officer of Turquoise, “We were looking for pan-European clearing with domestic settlement.”

It proved to be a tall order. When Turquoise put out a request for proposals in 2006, Farnham says the major incumbent clearing firms, which comprised LCH Clearnet, Eurex Clearing, Cassa di Compensazione e Garanzia SpA and SIS x-clear, could offer only partial solutions. EuroCCP did promise the most complete coverage on the clearing side, but it was a partnership with Citi Global Transaction Services (GTS) to handle settlement all across Europe that tipped the balance in its favour. It had a compelling cost advantage, too. For Turquoise, a new player itself, picking an upstart was a risk, albeit a calculated one. At the time, EuroCCP had not received regulatory approval from the United Kingdom’s Financial Services Authority (FSA) as a Recognised Clearing House; a hurdle it did not overcome until March 2008. The gamble did not worry Farnham, who says, “If DTCC cannot do clearing and Citi, one of the biggest transaction businesses in the world, cannot do settlement, we will all be in trouble.”

Turquoise plans to start full-scale testing with EuroCCP and Citi GTS in May, three months ahead of its scheduled live launch. At the outset it will offer trading and settlement in seven currencies. These include the euro, sterling, US dollar, Swiss franc, Danish krone, Swedish krona and

CLEARING & SETTLEMENT: EUROCCP MAKES ITS MARK

In an effort to avoid the ignominious failure of earlier multilateral trading venues such as NASDAQ Europe and Jiway, the latest MTFs have designed settlement procedures that allow investors to keep their securities at whatever central securities depository (CSD) they already use. It is a revolutionary concept that could shake up the entire market for clearing and settlement services across Europe. Photograph supplied by istockphoto.com, May 2008.

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In order to compete with traditional exchanges, Norwegian krone. It will also offer the services in 14 countries, comprising Austria, Belgium, France, Ireland, Turquoise will insulate market participants from Italy, Finland, Netherlands, Norway, Portugal, the United counterparty risk. It achieves this through a settlement Kingdom, Switzerland and Sweden, thereby covering 1,500 guarantee that shifts the risk to EuroCCP as soon as trades of the most actively traded European equities. Future are validated; a split second after the point of trade. Legally, expansion plans will add more countries—Spain and the shift constitutes a novation in which EuroCCP steps in Greece are top priorities (although legal technicalities have to replace the original party to the trade. That nuance has to be surmounted) followed by Eastern Europe—and so far kept Turquoise and EuroCCP from entering Spain eventually other asset classes. Farnham also expects more and Greece, where procedures for registering trades banks will sign up to Turquoise, which will extend effectively prevent novation.

EuroCCP will underwrite the guarantee through riskparticipation beyond the initial nine sponsors: Credit Suisse, Deutsche Bank, Goldman Sachs, Morgan Stanley, based margin assessed against members derived from Merrill Lynch, Citi, UBS, BNP Paribas and Société Générale. algorithms developed by the National Securities Clearing The European Union’s Markets in Financial Instruments Corporation (NSCC) in the US, which has never had to Directive (MiFID), which took effect in November last year, assess members for a loss in more than 30 years of existence. obliges brokers to deliver best execution to their customers, The collateral movements will be handled by Citi GTS, but they may take into account speed and cost as well as which will also settle securities movements daily between Clearing Participants price.

Turquoise and EuroCCP in the members will not be local CSD for each able to direct order flow market on a to the platform, but they delivery/receipt versus have committed to link Turquoise members will not be able to payment basis. their various trading direct order flow to the platform, but they Alan Cameron, head systems to Turquoise have committed to link their various trading of product management and implement smart systems to Turquoise and implement smart for direct clearing and order routing custody in Europe, the algorithms that monitor order routing algorithms that monitor Middle East and Africa at multiple trading venues multiple trading venues and direct orders to Citi GTS, says it is a and direct orders to get get the optimum outcome for customers. natural role for the firm, the optimum outcome which offers direct for customers. The custodian services in 52 Turquoise platform will countries around the be cheaper and faster than trading on the traditional exchanges, claims Turquoise, world—far more than its nearest competitor. Citi GTS already so Farnham expects little difficulty in attracting order flow provides general clearing member services for existing central counterparty clearing houses (CCPs) in Europe and based on its own vaunted merits.

He has good reason to be optimistic. Chi-X, which elsewhere and will offer the same service to institutions that celebrated its first anniversary of live trading in April, has want to use EuroCCP. It has a scalable technology already snagged more than 10% of the volume in stocks infrastructure, standardised systems and as far as possible that make up the FTSE 100 Index; 6% for the CAC 40 and uniform operating procedures in each market. “The whole the DAX 30; and 8% of the AEX 25. In doing so, Chi-X has idea is that back office flows should not have to change to not taken significant volume away from the established cope with Turquoise and EuroCCP,” says Cameron, “It is as stock exchanges, either; for example, the London Stock close to business as usual as we can get it.”

Cameron emphasises that while MiFID was designed to Exchange (LSE) continues to report big volume gains year over year (85% by number, 45% by value in January; 33% by bring competition and lower costs to the securities markets in Europe regulation alone was not enough. Earlier number, 1% by value in March despite the market sell off).

Fast, inexpensive execution has attracted incremental attempts to create multi-market trading platforms never liquidity to Chi-X from investors pursuing trading took off because brokers did not have smart order routing strategies such as rapid-fire statistical arbitrage that were and participants could not leave their securities in the local perhaps not as economic in the stock exchange CSDs. “It is the technology combined with the regulatory environment. Although similar in concept, Turquoise goes changes that have allowed pan-European trading and one better; it will offer broader geographical coverage, settlement to happen,”Cameron says.

The established markets will not stand aside while more securities and access to dark pools of liquidity, which are not available on Chi-X. Farnham believes dark pools Turquoise and other MTFs siphon away their livelihoods, of will play a particularly important role in trading the mid- course. Both local exchanges and other established trading capitalisation stocks that make up the smaller end of the venues are scrambling to develop pan-European platforms, including NASDAQ OMX’s proposed Pan European Turquoise universe.

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European penetration has Market, NYSE Euronext’s lagged the US Chan says SmartPool, Berliner that in 2007 the value of Boerse’s Equiduct Trading shares traded in the US was and NYFIX’s Euro1.5 times the amount Millennium, which went traded on the European live in March. Clearing exchanges, but the number houses with local business of US transactions was 5.6 such as LCH in the United times higher. Algorithms Kingdom and Eurex in typically generate a large Germany now need to number of small trades, so offer settlement in other she expects the new MTFs markets so Cameron will foster rapid growth in anticipates growing European transaction demand for Citi GTS’s volume as well as an services in Europe above increase in value. and beyond what It is all grist to the mill EuroCCP will generate. for EuroCCP, whose “The market revenue depends on ticket infrastructures—a client volume rather than value. base as we would regard Charges will start at €0.06 it—suddenly has to have Diana Chan, chief executive officer of EuroCCP, says every MTF is a per side but EuroCCP will cross border capabilities,” potential client for her "hourglass" business model in which EuroCCP offer volume discounts he says, “The service we will be the conduit in the middle that provides clearing services to based on the number of already provide for other multiple trading platforms at the top and settlement capabilities in all transactions cleared similar clients has become the national CSDs on the bottom. "I want to be the CCP of choice, first through it across all trading very relevant in this new for the MTFs and then for other venues as well," she says. Photograph platforms. Chan says the European world.” kindly supplied by the DTCC, May 2008. lowest fee will be €0.025, Although Turquoise is EuroCCP’s first client it will not be the only one. MiFiD was and although that is still nearly six times the $0.006 cost designed to bring competition and lower costs to the DTCC users pay in the US it is a fraction of the current securities markets in Europe, so the “voluntary” Code of ticket cost at incumbent clearing houses in Europe.

Conduct for clearing and settlement requires that trading EuroCCP’s charges will drop after it has recovered its startplatforms, CCPs and CSDs adopt an open architecture that up costs because, like its parent DTCC, it will be an fosters access and interoperability. Diana Chan, chief industry utility operated at cost.

The ability to draw on DTCC’s decades of experience executive officer of EuroCCP, says every MTF is a potential client for her “hourglass” business model in which gives EuroCCP an edge no other start-up can match. It has EuroCCP will be the conduit in the middle that provides access to robust risk management algorithms that have clearing services to multiple trading platforms at the top already survived market stresses and clearing member and settlement capabilities in all the national CSDs on the bankruptcies—although they had to be tweaked for the bottom.“I want to be the CCP of choice, first for the MTFs European context and to handle multiple currencies. It will draw on DTCC’s technology infrastructure, too; the data and then for other venues as well,”she says.

While clearing members can hedge their bets by backing centres are all located in the US, including exceptionally multiple MTFs—for example, eight of the nine charter strong backup business continuity arrangements. “After members of Turquoise bought into Chi-X in December— 9/11, you can imagine the high standard of resiliency DTCC they have a strong incentive to consolidate transactions at a has to achieve as the clearing and settlement infrastructure single clearing house whenever they can. A member who for the U.S. equity markets,”Chan says.

Trade processing costs have long been notoriously high in buys 100 shares of Vodaphone on one platform and sells them on another that uses a different CCP has to put up Europe, the result of fragmented trading venues that follow margin in two places even though it has no underlying different market practices and multiple infrastructures for economic exposure, while trades on any platform that clears clearing and settlement. It is an information technology through a single CCP can be netted for both margin business with high fixed costs, so a Balkanised infrastructure calculations and settlement in each CSD.“From the clearing disperses the volume and raises the unit cost. Pan-European member’s point of view having multiple platforms all trading and clearing will transform the economics overnight. connect into EuroCCP saves a lot of margin,”Chan explains. “EuroCCP’s most powerful value proposition is that we The proliferation of MTFs combined with smart order deliver the scale economies of the US to Europe,”says Chan. routing and settlement is likely to propel pan-European It’s been a long time coming, but European capital markets growth in algorithmic trading, a technology in which are about to become much more competitive against the US.

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EUROPEAN TRADE PROCESSING: THE NEXT STEP

Photograph © Andrei Teodorescu/Dreamstime.com, supplied May 2008.

Seven central securities depositories (CSDs) signed an agreement in early April to establish Link Up Markets, a joint venture to improve efficiency and reduce costs of post-trade processing of cross-border securities transactions in Europe. Is it a first step towards the development of a truly pan European solution to more efficient and cost effective post trade processing of cross-border securities transactions?

UROPEAN CSDs CLEARSTREAM Banking (Germany), Hellenic Exchanges (Greece), IBERCLEAR (Spain), Oesterreichische Kontrollbank AG (Austria), SIS SegaInterSettle AG (Switzerland), VP Securities Services (Denmark) and VPS (Norway) have joined together to provide a single access point to provide simplified cross border book entry of securities and clearing and settlement. Link Up Markets is a Madrid based company and will be run by Tomas Kindler, who was appointed managing director in mid-May. Kindler joins Link Up Markets from Clearstream, the settlement and custody division of the Deutsche Börse Group and will work to launch the initiative in the first half of 2009.The joint venture will establish a common infrastructure allowing for easy implementation of links between CSD markets and introducing efficient cross-border processing capabilities.

CSDs are suppliers of domestic post-trading services.

Their core tasks include the settlement of securities transactions and the safekeeping and administration of securities held on behalf of their customers. Between them, the members of the new venture represent almost 50% of market share in European securities and boast €12trn in assets under custody. It will, say participants, contribute to a more efficient European securities market by providing seamless and cost-efficient services. It is also a likely harbinger of more cross-border initiatives in a post-MiFID world where trading venues are multiplying, while the pressure to unify clearing and settlement processes in the European theatre intensifies. The creation of the company is subject to approval by competent competition authorities in Europe. Each participating CSD will take an equity stake in the company, whose role will be to develop, maintain and operate the business and work together to further leverage the joint service portfolio. “In 2009, Link Up Markets will deliver its first results. In doing so, it will pave the way towards realising a single European Capital Market for securities,” says Kindler.“We welcome all other CSDs who

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share our ambitions to improve and harmonise post-trade securities processing to join our solution.”

By connecting to the common infrastructure, each participating CSD has access to the services of the other participating CSD markets across all asset classes (except derivatives). Link Up Markets will absorb any differences in communication standards across the markets, while leveraging the existing infrastructures and processes of CSDs. As a result, the solution can be provided quickly and with minimal adaptations for the participating markets.The initiative is a result of the changing market environment and aims to promote simplified cross-border business as requested by the Lisbon Agenda (an action and development plan for the European Union agreed in Lisbon in 2000, around which current unified market initiatives, such as MiFID, have coalesced).

Customers will benefit from a single access to almost 50% of the European securities market. At the same time, they will benefit from consistent CSD settlement and custody services throughout the group countries and reduced cross-border transaction costs and savings from a harmonised set of processes. A centralised Securities Database, Corporate Action & Event Storage Engine as well as a ProxyVoting Portal covering the involved markets, are among the services which will be available from its launch next year. Clients will be able to access a comprehensive set of core settlement and custody services for all asset classes eligible in the seven participating markets. Services include corporate actions services, tax services, shareholders services, cash and securities forecasts, securities administration as well as diverse reporting possibilities.“For many years, customers have been requesting a solution for easy access to other markets. The CSDs participating in the initiative have developed a unique solution geared at reducing the complexity and the costs of cross-border transactions. We establish an environment that creates the potential to reduce current cross-border settlement costs by up to 80%”, says Jeffrey Tessler, chairman of Clearstream Banking AG, speaking for the joint venture.

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EXPRESSO

A GO GO

T IS AS if the gods of commerce, after smiling on Starbucks Corporation (SBUX) for a quarter century,are now angry at the company and the man who built it into one of the great success stories of retailing. Granted; neither plagues nor locusts have appeared (yet), but just about everything else that could go wrong has. In the space of 18 months, Starbucks has run into problems on nearly every front, ranging from its standard coffee (Consumer Reports said McDonald’s was better) to its costs for coffee beans and milk (both rising fast) to the US consumer (who is in recession) and company profits (off sharply).

These and other problems led Starbucks’board of directors on January 7th this year to suddenly name Howard Schultz as CEO, a post he held from 1985 to 2000. He has been chairman since 1985, a job he retains. Jim Donald, CEO since 2005, was out, although it appears his main misdeed was doing pretty much what Schultz and the board wanted.

Indeed, Schultz has been quick to take full responsibility for the company’s current predicament. Even though 54-yearold Schultz did not found Starbucks, the company is totally his creation and it is clear he wants to restore its former glory.

Investors cheered the news, driving up the stock 8% in a day.

Despite the abundance of problems, SBUX remains an extremely successful retailer. From a mom-and-pop retailer of premium coffee beans in Seattle, where its headquarters and heart remain, Starbucks has grown into the world’s largest roaster and purveyor of specialty coffees. It has more than 16,000 coffee houses in 44 countries.Virtually single-handedly Starbucks has created demand in America and elsewhere for premium coffee and fancy coffee-based beverages like espressos, lattes and cappuccinos. Its stores (many comfortably furnished with overstuffed chairs and end tables) have become a“third place,”along with work and home, for people to meet, or just relax in solitude with a Starbucks beverage.

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Starbucks Corporation chairman and chief executive Howard Schultz drinks a cup of coffee in this March 19, 2008 file photo at Starbucks’ annual shareholders meeting in Seattle. Starbucks will start serving up a new “everyday” coffee on Tuesday, April 8, 2008, hoping the signature blend will help revive slumping sales in its crucial U.S. market. The new coffee is called “Pike Place Roast,” and is named after the first Starbucks store in Seattle’s famed public market. Photograph taken by Ted S Warren and supplied by Associated Press/PA Photos in May 2008.

FTSE GLOBAL MARKETS • JUNE 2008

PROFILE: THE REMAKING OF STARBUCKS

Just two years ago Starbucks was opening coffee shops at a furious pace, sales were climbing steadily, and its stock traded at record highs. Since then, the company suffered its first-ever decline in same store sales, a national consumer testing magazine judged brewed coffee from McDonald’s to be superior, and Starbucks’ shares are down nearly 60%. In January Howard Schultz returned as chief executive officer (CEO), warning investors not to expect a fast turnaround. Art Detman explains why they should believe him.

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Revenues in fiscal 2007, ended September 30th, were $9.4bn, up 21% from the prior year and an astonishing 48% from fiscal 2005. Indeed, as recently as 2000 sales were less than $2.2bn. Fiscal 2007 earnings were $673m, up nearly 16% from fiscal 2006. Per-share earnings were 87 cents, up 16%. However, despite 2007’s record sales and earnings, the company has been showing signs of distress. For example, in July 2006 same-store sales—sales at stores open 13 months or longer—rose only 4%, well below the typical 8% to 10% gain. Company executives seemed baffled by the decline and attributed it to a heat wave over much of the United States, which caused demand to shift to cold, sweet drinks that take longer to make, resulting in longer lines that discouraged customers.

Other restaurant chains have said they are being hurt by high fuel prices and declining average household income in the US. Before he left, CEO Donald dismissed any connection between the slowdown at Starbucks and the slowdown in the economy: “We have always said that Starbucks is an affordable luxury.” This pronouncement was corporate scripture and historically well-founded.

However, as Donald and Schultz found to their dismay, it suddenly no longer applied to Starbucks. However, the thoughts of Schultz were not made available to FTSE Global Markets because the company declined to arrange an interview with him, or with any other corporate officer.

During 2006 and 2007, Starbucks continued to grow in the US and abroad. Schultz, a true believer, maintained that Starbucks was underestimating worldwide demand for not only its coffees and other beverages but for its compact discs, books, coffee mugs, and other merchandise that was filling up shelf space at its stores.“This is still the opening act,”he said confidently. To prevent the defection of hungry customers to fast-food restaurants, Starbucks added breakfast sandwiches that were heated to order and, for the lunch crowd, cold salads and sandwiches. Both the sandwiches and salads were prepared offsite (Starbucks shops don’t have kitchens), which meant that Starbucks was serving fresh coffee but not fresh food.

Meanwhile, the company experimented with a number of brand extensions. It decided to sell books but just one title at a time. The first was For One More Day, a novel by Mitch Albom, whose Tuesdays with Morrie had been a bestseller. The next was a much darker volume, A Long Way Gone: Memoirs of a Boy Soldier by Ishmael Beah. Both books were big sellers at Starbucks. Starbucks CDs, too, have proved successful. Some, such as Simon & Garfunkel: Live 1969, can be found only at Starbucks. Last year the company’s recording label, Hear Music, signed Paul McCartney to an exclusive contract. Moreover, Espresso machines—precision devices that force very hot water at high pressure through finely ground coffee—are sold at many stores. Some models are priced at $399, others range up to $1,199.

Some brand extensions flopped. Starbucks briefly became, with major studios, a co-producer of motion pictures; but neither Akeelah and the Bee nor Arctic Tale

made money, and it appears that the company has lost its taste for Hollywood. Other failed efforts included a sitdown restaurant (Café Starbucks), a tavern, and even a literary magazine.

In retrospect, it’s easy to see why the books and CDs were successful and the other endeavors were not. By focusing on a single title, Starbucks does what TV talk show star Oprah Winfrey did so well: give a book a seal of approval from an well-respected source. As for CDs, with the demise of many record chains, there’s room for niche marketers of CDs, especially exclusive recordings. In contrast, all of Starbucks failures were in areas where there is no shortage of product, such as movies, sit-down restaurants, taverns and magazines.

During 2006 Starbucks’stock traded in the high 30s, with an intraday high of 40.01. By early 2007 it was still valued at 35 times earnings. Many security analysts said its current price (then in the low 30s) was cheap by historical standards. Chances are Schultz thought so, too. Even so, he had another concern, and on Valentine’s Day 2007 he put his thoughts into an 800-word memo, titled “The Commoditisation of the Starbucks Experience.” The memo was leaked and touched off a debate involving not only analysts and investors but employees and customers. In essence, Schultz said that Starbucks had lost its way and was in danger of losing its soul.“We have had to make a series of decisions that, in retrospect, had led to the watering down of the Starbucks experience and what some might call the commoditization of our brand.” By adding hot food and drive-through windows, Starbucks was becoming more like a fast-food chain.“We desperately need to look into the mirror and realise it’s time to get back to the core and make the changes necessary to evoke the heritage, the tradition, and the passion that we all have for the true Starbucks experience.”

Schultz is often described as messianic, even fanatical, when it comes to promoting and defending the Starbucks concept. After all, he invented it. In 1981 Schultz was selling Swedish-made plastic housewares in his hometown of New York City. A small Seattle company that sold only whole-bean coffee was an exceptionally good customer for plastic coffee filters. Intrigued, Schultz visited the company, which had been founded in 1971 at Seattle’s Pike Place Market. He was instantly taken by the experience of smelling and drinking freshly ground premium coffee. In 1982 he joined Starbucks as its retail director. After a trip to Italy, where he discovered caffé e latte (espresso with milk) he lobbied Starbucks’ three owners to set up espresso bars in their stores. They refused, so Schultz left and formed his own coffee house chain, Il Giornale, in 1985. By 1987 he had raised $3.8m and bought Starbucks, merging it into his own company but keeping the Starbucks name.

Then, as now, Schultz was a visionary who thought big.

He opened stores in Chicago and Vancouver, and by 1991 was in Los Angeles. San Diego, San Francisco and Denver followed the next year, and in 1993 the first Starbucks was opened inside a Barnes & Noble bookstore. An $80.5m

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convertible debenture offering was floated in 1993, followed by an initial public offering of common stock in 1994. By the end of that year there were 425 Starbucks stores across the US and Canada.

Although most Starbucks stores are company owned and operated, Schultz did grant licenses to financially strong partners who opened their own Starbucks stores.

Moreover, he entered into joint ventures with several companies, such as Pepsico, Kraft, Hershey and Dreyers to manufacture and distribute Starbucks-branded products in supermarkets and similar outlets.

In a world of McDonald’s, Denny’s and Dunkin’Donuts, the Starbucks stores were exotic and exciting. Sales clerks—er, baristas (Italian for bartenders)—ground coffee to order and pulled levers on Italian-made La Marzocco espresso machines. Soon the stores fell victims to their own success. Customers were waiting five minutes or more in lines that sometimes literally went out the door.

The company responded in two ways. First, it replaced the manual espresso machines with automated Verismo Model 801s; baristas simply pushed a button and the machine did all the work. Second, Starbucks embarked on a saturation strategy that in some locations meant three stores on four corners. Yes, each store suffered from cannibalisation, but altogether the net result was increased sales. It was as if Schultz did not want to lose the sale of even one cup of coffee. According to Pete Bocian, Starbucks executive vice president and chief financial officer, at the company’s end of April Q2 earnings call:“we expect consolidated revenue growth of 13% to 14% for the year, with year-to-date revenue growth at 15%.” Bocian outlined the key thought processes behind the company’s targets.“First we had a strong focus on controllables: cost and expenses, stories, and overall capital expenditures.

Second we made a commitment on International [sic] to deliver the growth and margin potential of the heavily licensed model; third, we needed to stabilise the US business, to grow earnings with a more conservative assumption around same store sales growth and, lastly, we made sure we had significant investment in the customer experience to drive traffic.”

It was an important statement. Since the beginning of the year Wall Street had its doubts; for good reasons. While the Dow Jones 30 rose in early 2007, SBUX fell. The cost of milk—the second most important commodity for Starbucks—was rising fast, and the company could not hedge against rising milk prices the way it could hedge against rising coffee bean prices. Consumer spending was flat, but here the common wisdom favoured Starbucks. In past recessions, consumers boycotted major purchases but increased spending on “affordable luxuries” like movie tickets and lipsticks. Surely that would be true of lattes and cappuccinos.

Meanwhile, McDonald’s had unveiled plans for coffee bars in many of its restaurants and a wide menu of specialty coffee-based products. Dunkin’ Donuts and 7Eleven both had introduced premium coffees. When

FTSE GLOBAL MARKETS • JUNE 2008

Then, as now, Schultz was a visionary who thought big. He opened stores in Chicago and Vancouver, and by 1991 was in Los Angeles.

San Diego, San Francisco and Denver followed the next year, and in 1993 the first Starbucks was opened inside a Barnes & Noble bookstore. An $80.5m convertible debenture offering was floated in 1993, followed by an initial public offering of common stock in 1994.

By the end of that year there were 425 Starbucks stores across the US and Canada. Although most Starbucks stores are company owned and operated, Schultz did grant licenses to financially strong partners who opened their own Starbucks stores. Photograph © Natalya Gudyma/Dreamstime.com, supplied May 2008.

Consumer Reports conducted a taste test, it judged McDonald’s coffee the best of the bunch: “decent and moderately strong. . . . it had no flaws.”Starbucks everyday brew, in contrast,“was strong, but burnt and bitter enough to make your eyes water instead of open.” The report, just a half page in the March 2007 issue, was widely publicised and probably hastened the introduction of a new everyday brew at Starbucks, Pike Place Roast, which was rolled out in March. Without mentioning the Consumer Reports findings, the company hailed the new coffee as“a smoother roast with cocoa and nut flavours.”

Yes, the Pike Place Roast was better than the old coffee, critics agreed. However, in the words of China Millman of the Pittsburgh Post-Gazette,“it is still a one-note, fairly harsh cup of coffee.” Besides, Starbucks still insisted on serving it at 200 degrees—instead of the 185 degrees that most coffee afficionados believe is the best temperature.

At the Q2 earnings call Bocian announced that over the 2009 to 2011 period,“we plan to reduce the number of net new store openings in the US” to “less than 400 stores per year, with approximately 250 company-operated stores opening in each period”. Over the three year period, he said, Starbucks will open 1200 stores, “with the goal to make these our ‘best of the best’ opportunities.” Moreover,

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on the international front: “We plan to continue accelerating the unite growth in our international business with net new story opening targets of 1,050 in 2009, 1,150 in 2010 and 1,300 in 2011,”with some 65% licensed over the three years. “Factoring in the lower 2008 store target for the US, total store count at the end of 2011 will be about 21,500 stores,” he adds, pointing out that the share of international stores in the portfolio will rise from 30% to 40% over the period.

In stores, the much unloved breakfast sandwiches would be phased out by year’s end. Hungry customers would have to make do with “healthy options” and high quality baked goods. A new espresso machine, the Mastrena, has been ordered from Thermoplan, a Swiss manufacturer. Supposedly more precise than the existing model (also made by Thermoplan), the new machine is seven inches shorter and will allow baristas to maintain eye contact with customers as they draw their espressos.

Starbucks also acquired Coffee Equipment Company, a small Seattle manufacturer of coffee brewing machines, including the Clover, which combines French press and vacuum brewing technologies to brew single-cup batches of coffee, such as high-end brews from the highlands of Ethiopia and Guatemala. Starbucks says the Clover is the most advanced coffee machine in the world. Schultz also announced that most stores will resume the grinding of coffee for home use. As a time-saving expediency, Starbucks has been packing coffee in“flavour-locked”bags and shipping them to stores. The reversion will again mean a rich coffee aroma at most Starbucks stores.

Schultz also announced plans to introduce three new drinks this year; an energy drink (which contains B vitamins, ginseng and guarana, but no additional caffeine, notes a Starbucks spokesperson), an icy Italian coffeebased drink, and a “healthful” fruit-based smoothie. By March he also had up and running the Internet equivalent of a customer suggestion box. MyStarbucksIdea.com is described as a social networking site that allows customers to propose ideas and comment on the ideas of others (a staff of 48 specially trained hosts moderate the interaction).

It is not a new idea—Michael Dell at Dell Computer launched a similar site a year ago. Evidently, it has caught on. In its first month of operation, the site processed more than 200,000 votes for various proposals.

For all that, the short-term outlook is cloudy. In April Schultz projected single-digit percentage declines in samestore sales for the year, due partly to the elimination of breakfast sandwiches, and earnings per share that would fall short of fiscal 2007’s 87 cents. He also said he was suspending reporting of same-store sales for an undisclosed period of time. Starbucks shares dropped below 16 for four days running; since then they have recovered a bit to the mid 16s.

In turning around Starbucks, Schultz is swimming upstream during a 100-year flood. The American restaurant industry is badly overbuilt: the number of locations increased by 45% from 1990 to 2006 while the country’s

Meanwhile, McDonald’s had unveiled plans for coffee bars in many of its restaurants and a wide menu of specialty coffee-based products.

Dunkin’ Donuts and 7-Eleven both had introduced premium coffees.

When Consumer Reports conducted a taste test, it judged McDonald’s coffee the best of the bunch: “decent and moderately strong. . . . it had no flaws.” Starbucks everyday brew, in contrast,“was strong, but burnt and bitter enough to make your eyes water instead of open.”

Photograph © Svetlin Russev/Dreamstime.com, supplied May 2008.

population grew only 20%. Same-store sales of all US restaurants fell in March by 0.8%, the first such decline in five years. Even high-end steak houses have posted lower same-store sales, as have mid-priced casual-dining chains.

Only the low-priced fast-food chains such as McDonald’s are experiencing growth, and that growth is anaemic.

Home prices are falling at an accelerating rate. The Case-Shiller index of house prices in 20 major metro markets in America plunged 14.8% from July 2007 to March 2008, and some economists predict an additional 10% decline. Housing woes are especially bad in California and Florida, which together account for nearly a third of Starbucks revenues. In the first quarter of the year, home foreclosure notices in California rose 143% compared with 2007’s first quarter.

Meanwhile, an uninvited“activist investor,”Nelson Peltz, has acquired nearly 900,000 shares of SBUX but has not announced why. These shares amount to less that 1% of the total outstanding, far less than the 5% that Schultz himself owns. Still, it must be unsettling to any CEO to have a shareholder who in the past pressed for changes at companies such as Wendy’s, Kraft and Heinz.

For all that, Schultz has several positive factors working for him: weak competition from other coffee house chains (Minneapolis-based Caribou Coffee, for example, has only 475 stores), a strong balance sheet, strong cash flow, and— perhaps most important—a strong brand name. True, he will never recreate the exciting early days of Starbucks (although it is not clear he understands this). The company is now a corporate giant, and has to be managed like one.

However, after a very rough patch Schultz can look forward to better days; days when once again he can proudly announce same-store sales results.

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THE WATCHWORD IS

CONVERGENCE The market for alternative fund administration services remains highly competitive, providing clients with a wide range of choices. While consolidation has greatly benefited those at the top of the spectrum, it has also created an opening eagerly exploited by boutique players, whose specialist approach continues enjoy surprising popularity. Dave Simons reports from Boston.

HE SCRAMBLE FOR liquidity has been keenly felt within the hedge-fund sector, leading to a marked reversal in investment psychology as evidenced by the surge in long-only, 130/30 and other divergent strategies. Not that any of this has necessarily been bad for the business of alternative fund administration. Despite the growing list of notable implosions within the hedge-fund world of late, fund flows from large pension plans, endowments and high net-worth individuals have shown extraordinary resilience, and the long-term trends point to continued growth. Hedge funds need to put that money to work; and at the same time require an outside source capable of handling the entire realm of administration duties, particularly as fund flows increase and products become even more sophisticated. As a reflection of that, alternative assets under administration have been growing at least as rapidly today as they were before the crisis began. “We are seeing a convergence between alternative and traditional mangers,” says Paul Schaeffer, managing director of strategy & innovation for SEI’s Investment Manager Services Unit.“About three years ago, the industry was still organised into silos of mutual funds, hedge funds

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and separate accounts but all that has been washed away by what we are now calling convergence.”

While the largest fund administrators continue to draw in business by way of selective accretion, the continued buoyancy has also created whole new channels of opportunity for a growing list of upstart providers. In a recent report about trends within the alternative administration space, Boston-based research and advisory firm Aite Group suggested that so-called boutique service providers, many of them domiciled in offshore locales such as Bermuda and the Caymans, wield considerable power due to rapidly growing client interest and, given their determination to succeed, may have the wherewithal to do some acquiring themselves. “Administrators may well consolidate further in the next few years,” says Denise Valentine, senior analyst at Aite Group,“but the acquiring firm could easily be one of the independent or spin-off administrators.”

From the perspective of Jack Klinck, executive vicepresident, offshore and alternative management, State Street, alternative fund flows remain strong, and evidenced by the vigorous expansion of the company’s administration revenues. “Our assets are growing as rapidly now as they were a year ago,”affirms Klinck.“In short, despite what has happened, people are still keeping their long-term strategies in place.” Current demand for alternative administration services is such that both stalwarts and upstarts can happily co-exist, notes Klinck. “In the short run, you have a market that is growing at up to 20 percent annually, the margins are good and the barrier to entry is relatively low. As such, it is a good climate for entrepreneurial newcomers to come into the space.”

ALTERNATIVE FUND ADMINISTRATION

While the largest fund administrators continue to draw in business by way of selective accretion, the continued buoyancy has also created whole new channels of opportunity for a growing list of upstart providers. In a recent report about trends within the alternative administration space, Boston-based research and advisory firm Aite Group suggested that so-called boutique service providers, many of them domiciled in offshore locales such as Bermuda and the Caymans, wield considerable power due to rapidly growing client interest and, given their determination to succeed, may have the wherewithal to do some acquiring themselves. Photograph © Bejhan Jusufi / Dreamstime.com, supplied May 2008.

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Marina Lewin, managing director and head of relationship management and business development, alternative investment services unit, Bank of New York Mellon, believes that growth trends for alternative administration can easily support the expanding field of competitors, at least for the time being. “Which is a great thing,” says Lewin. “However, from our perspective, having the backing of a large financial institution that can custody long assets, take in cash, provide valuation under duress, and has been instrumental in injecting liquidity into the market is a real plus, particular for those who are looking for real diversity of product base.” Photograph kindly supplied by Bank of New York Mellon, May 2008.

Jack Klinck, executive vice-president, offshore and alternative management, State Street, says that alternative fund flows remain strong, evidenced by the vigorous expansion of the company’s administration revenues.“Our assets are growing as rapidly now as they were a year ago,” affirms Klinck.“In short, despite what has happened, people are still keeping their long-term strategies in place.”

Current demand for alternative administration services is such that both stalwarts and upstarts can happily co-exist, notes Klinck.“In the short run, you have a market that is growing at up to 20 percent annually, the margins are good and the barrier to entry is relatively low. As such, it is a good climate for entrepreneurial newcomers to come into the space.” Photograph kindly supplied by State Street, May 2008.

Should large institutional investors such as pension plans and endowments continue to drive asset flows, however, it may be more difficult for smaller players to stay in step, he adds.

Moreover, he explains that when it comes to the quality of back-office administration services provided, these types of investors are much more demanding.“For instance, we have had hedge fund clients come to us with their knuckles sort of dragging on the ground, saying,‘We have just won this great piece of business from this pension plan, but in order to make it happen they insist on outsourcing our operations to you.’”

Additionally, many of these institutional clients already have pre-existing custodial relationships with State Street, and view working with State Street as, “A sort of a good housekeeping seal of approval,” says Klinck. “When they choose us over a boutique, they get things such as size, scale, a balance sheet, disaster recovery plans, all within a highly regulated environment. For many investors, that’s absolutely critical. In short, there is a feeling of safety and security when you are working with a big, global, highly regulated, deeppocketed, rich balance sheet type of organisation.”

Like Klinck, Marina Lewin, managing director and head of relationship management and business development, alternative investment services unit, Bank of NewYork Mellon, believes that growth trends for alternative administration can

easily support the expanding field of competitors, at least for the time being.“Which is a great thing,”says Lewin.“However, from our perspective, having the backing of a large financial institution that can custody long assets, take in cash, provide valuation under duress, and has been instrumental in injecting liquidity into the market is a real plus, particular for those who are looking for real diversity of product base.”

While a standalone administrator offering a niche service may have its merits, in times of crisis, those with long positions looking for a safe haven often find solace in the massive infrastructure and breadth of choice offered by a commercial bank.“A hedge fund may be diversifying into a hybrid private-equity structure, or perhaps moving into long assets as a reaction to the shake-up in liquidity,”says Lewin.

“In these situations, the ability to offer a multitude of products is a natural advantage.”Product alternatives ranging from long only and 130/30 to more sophisticated solutions will propel the alternative administration sector over the near term, and providers must be able to accommodate all the different strategies in order to fully capitalise on that growth, explains Lewin. “Strategies go in cycles, and the beauty of hedge funds is that they can be flexible enough to move in and out of the various strategies as they see fit, knowing that a strategy that may be out of favor at the present time may come back full force a few years from now,”she adds.

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For their part, niche administrators have been circling the wagons in hopes that their specialist approach will continue to reap benefits in an increasingly homogenised world. One of the newest members is Bermuda-based ISIS Fund Services, an offshore hedge-fund administration group formed last fall by a breakaway team of ex-Citigroup alternative-fund specialists led by chief executive officer Ede Conyers, the former head of Citi Bermuda’s Alternative Investments group. In a business where scale is increasingly regarded as the key driver of growth, ISIS, which currently boasts $2.5bn in assets under administration, sees steady demand for the kind of customised solutions that smaller niche players can readily provide.“Larger administrators and investment banks that participate in the hedge fund administration space are focused on two primary criteria—profitability and assets under administration,”offers ISIS managing director Jason Bibb. To keep up with the demands of technology and other internal resources, the world’s leading administrators have in some instances raised their minimum market threshold per client to as high as $500m. However, as Bibb points out, nearly two-thirds of the market is comprised of hedge funds with under $100m in assets; fertile ground for niche firms like ISIS. “This is creating opportunities for smaller boutique administrators to enter the market, and as they get bigger, these small firms grow in tandem,” says Bibb.

Additionally, large administrators regularly divest themselves of smaller, less profitable clients, providing fresh prospects for mid-size and smaller providers, he says.

Offshore jurisdictions such as the Cayman Islands, Bermuda, the British Virgin Islands (BVI) and the Channel Islands of Jersey and Guernsey as well as Ireland continue to figure prominently in the growth of the worldwide alternative administration space. At present, total alternative assets in offshore funds are estimated at approximately $2trn, compared to some $655bn for onshore funds. Bibb suggests there are a number of factors at work besides traditional tax considerations. “For one thing, there is a concentration of expertise [in these regions] in fund structuring, hedge-fund administration and third-party provision servicing,” he notes, “and that plays a huge role in perpetuating the success of the offshore world.”

Flexibility often makes boutiques better equipped to deal with the complexities and exceptions inherent in smaller, more complicated funds that are frequently cast off by larger administrators, offers Tim Clipstone, partner, Investment Funds and Regulatory with BVI law firm Harneys Westwood & Riegels, an advisor to offshore fund managers and administrators. “Arguably, boutique administrators could be the best choice for all but the largest funds with unusual strategies. Also, due to their lower overheads, the boutique administrators are able to undertake the work profitably for lower fees.”

Furthermore, adds Clipstone, offshore jurisdictions are likely to become increasingly important as managers and

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Tim Clipstone, partner, Investment Funds and Regulatory with BVI law firm Harneys Westwood & Riegels, an advisor to offshore fund managers and administrators. “Arguably, boutique administrators could be the best choice for all but the largest funds with unusual strategies. Also, due to their lower overheads, the boutique administrators are able to undertake the work profitably for lower fees.” Photograph kindly supplied by Harneys Westwood & Riegels, May 2008.

Peter O’Connell, managing director of BVI-based Conifer Fund Services Ltd.“Much of the administration that takes place offshore is not legally required to take place offshore, however the funds have selected offshore based service providers anyway,” says O’Connell.

“That decision reflects the fact that the offshore providers can compete and win business against an onshore provider in terms of quality of service and value for money.” Photograph kindly supplied by Conifer Fund Services Ltd, May 2008.

their onshore advisors absorb the impact of the Chapter 15 ruling in the Bear Sterns liquidations. “The old ‘10 commandments’are likely to be dusted off as US lawyers in particular look to ensure that their US-managed offshore funds have their centres of main interests (COMI) outside the US and, if a conservative approach is taken, to help establish that‘mind and management’were being exercised in the jurisdiction of establishment of the fund.” Since many of these “10 commandments” are functions that can be carried out by administrators, Clipstone sees a potential for the resurgence in popularity of US-managed funds residing outside of the US. Because such services contribute greatly to the local economies, offshore jurisdictions are eager to encourage the provision of administration services, notes Peter O’Connell, managing director of BVI-based Conifer Fund Services Ltd.“Much of the administration that takes place offshore is not legally required to take place offshore, however the funds have selected offshore based service providers anyway,” says O’Connell. “That decision reflects the fact that the offshore providers can compete and win business against an onshore provider in terms of quality of

service and value for money.”Indeed, other jurisdictions are revisiting established regulations in an effort to replicate the flexibility and freedom granted to hedge funds in the mainstream jurisdictions, says Bibb. These include Mauritius and its favorable double-taxation treaties established with India and China, as well as the jurisdictions of Singapore, Dubai and Malta.

Yet another advantage for small-scale players is the ability to offer proprietary technology platforms, says Ron Suber, president of Chicago-based Spectrum Global Fund Administration. “Providing seamless customer relationship management (CRM) via the web, along with a single integrated platform that can handle trade capture, transaction processing, financial reporting, reconciliation and investor communications, enables a company like Spectrum to differentiate itself.” O’Connell agrees that flexibility is a key differentiating factor in terms of technology deployment.“It is far easier for a smaller organisation to change parts of its technology platform that the bigger players…where a client demands a particular technology solution, the boutique provider is able to respond to that need, without being hindered by the bureaucracy of the larger players.”

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Squeezed in the Middle

having a wide choice of providers,”says Conifer’s O’Connell.

With growth mainly confined to the opposing ends of the “However, as several of the recent consolidations were administration spectrum, State Street’s Klinck sees trouble amongst the larger organisations, perhaps the market has ahead for mid-sized players. “They are the ones who are become slightly more polarised between the boutiques and struggling, which is a classic kind of phenomenon.” Adds the larger administrators. Boutique providers continue to Harneys’Clipstone,“In my view, there will always be a place offer a high quality of service and continue to win and retain for the niche players, since the super-sized companies are clients. The larger administrators are of course also growing; unlikely to be sufficiently flexible and have sufficiently low however, their growth has not prevented, nor will ever overheads to satisfy many start-up and boutique fund prevent, the success of the boutique firms.” managers. The mid-sized are, however, likely to be squeezed and forced to consolidate.”

Niche players themselves may find the going more difficult, particularly as clients grow more sophisticated and as issues like safety, security and liquidity become even more important.“At this point, I don’t think there are any serious competitors who don’t have scale,” suggests T Andrew Smith, managing director and head of North America securities and fund services at Citigroup. “Which is not to say that they can’t carve out a niche for themselves and have plenty of satisfied clients—because it’s not always about the numbers, it’s about the people. But it’s not getting any easier to make that happen.”

While it remains to be seen whether flexibility is enough to keep specialist administrators from becoming completely marginalised if the trend towards big consolidations ject management continues, for now Bibb is confident l p ro l u f that staying small is the right call. r service offering? er s off of ou “Boutique administrators cannot t t r a a h p who’s the o er t ds as benefit significantly from economies nly provid uess n u G f of scale,”says Bibb.“Instead we focus ce servi s for the launch of new on our abilities to innovate and deliver a value-added product and service. It could be argued that boutique administrators can react to challenges and opportunities in the marketplace a lot quicker than our large competitors, and this allows us to thrive. By the very nature of being a ‘boutique’ administrator, we are :RUG·V *HWWLQJ $URXQG« providing hedge fund managers with a different type of product offering, delivered in a different manner and adding value in a For more information on our services please contact: Fearghal Woods (Dublin) at +353 1 670 0300 or visit www.boiss.ie different way.”

“The market for alternative fund Bank of Ireland Securities Services Limited is authorised by the Financial Regulator under the Investment Intermediaries Act 1995 administration services remains highly competitive, with clients

FTSE GLOBAL MARKETS • JUNE 2008

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HEDGE FUND REVIEW

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Hedge funds have always been the asset class that investors love to hate. High fees, opaque strategies—not to mention the seemingly glamorous lifestyles of managers—have often raised hackles. Even so, negative publicity aside, hedge funds have been raking in assets over the last few years. The credit crunch may have prompted a pause for reflection, but it is unlikely institutional investors will turn their back on hedge funds. Instead, they will be much more discerning in terms of the strategies and performance of the hedge funds they invest in.

Equally, the credit crunch is encouraging hedge funds to review providers of prime broking services. Lynn Strongin Dodds reports

LEARNING TO LOVE HEDGE FUNDS —AGAIN EDGE FUNDS CAME under concerted fire in the immediate aftermath of last summer’s sub prime crisis: with many an institutional investor wondering what exactly had been the role of hedge funds in helping fuel the continuing drama. Even now, the industry has taken sustained fire for its alleged role in the implosion of Bear Stearns, the dramatic collapse of Halifax Bank of Scotland’s (HBOS’s) share price; as well as the weaknesses of the entire Icelandic economy. Such was the level of criticism that it actually prompted a raft of investigations by financial regulators in the UK, US, Iceland and Australia to see whether some hedge funds had in fact spread false rumours to push down the prices of securities they had sold short.

Short-selling, occurs when an investor sells shares that he does not own in the hope that the price of those shares will drop, and he will profit by buying them back at a lower price. Although the tactic is a legitimate trading practice, when used illegally—the so called“trash and cash”trade— the results can have dire implications. As one industry participant notes,“There have been claims that hedge fund traders have been manipulating individual stocks but in

H

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times of acute financial stress, it is not unusual to see investors drive markets in a certain direction. However, hedge funds on the whole have a good track record of fair dealing and it is unfair to blame them all.”

With cool rationality, Andrew Gibson, head of client management of fund of hedge fund group International Asset Management, highlights the fact that,“Hedge funds will not survive if they solely adopt a shorting strategy which is designed to create rumour mongering and profiting. It is a dangerous investment approach and they will eventually be found out by the regulators.”

While few feel sorry for hedge funds, many believe they are an easy target, particularly due to the extravagant lifestyle of some hedge fund managers. Stuart McLaren, a director at Deloitte, who works in the hedge fund practice, notes,“I think in the hedge fund world, there is an element of the tall poppy syndrome; meaning that if anyone sticks their head above the podium they will immediately get it cut down. Also, people do not want to read about successful hedge funds who have generated strong performance. They are much more interested in the ones that fail and go out of business.”

Frederic Ponzo, managing director of consultancy NET2S, agrees, adding, “Hedge funds are getting stick for the sub prime crisis and I think this is unfair. The finger should be pointed at the investment banks and rating agencies who did not properly do their job. Those investors that have lost money in hedge funds that were exposed to these toxic loans should have known that a higher return comes with higher risk.”

Sweetmeats aside, the industry is not blameless. After years of heralding their attributes of being non-correlated with equities, they were caught in the sub prime maelstrom which brought down every asset class. Explains Jim Connor, a partner at consultancy Morse, “One of the main problems is that hedge funds set themselves apart from other assets classes. Many sold themselves as absolute return funds and not as index huggers, and gave the impression that they would still perform if the markets went south or sideways. This is not what happened but that does not mean investors should shy away from hedge funds or throw away their investment strategies . Instead, there needs to be more communication and education about their limitations.”

Truth be told, a green-eyed monster also made an appearance. The lavish pay packets in the industry have invariably rankled and the latest crop, reported by Institutional Investor’s Alpha magazine, were seen as too sumptuous even by Wall Street standards, where money is often a measure of success. William Gross, the chief investment officer of the bond fund PIMCO, summed it up for many, when he was quoted as saying,‘’There is nothing wrong with it. It is not illegal, but it is ugly.”

According to Alpha’s annual survey, the average compensation for the top 25 fund managers last year was an eye watering $892m, up 68% from 2006. The minimum compensation included in the ranking was $210m, which is

FTSE GLOBAL MARKETS • JUNE 2008

more than triple the $67.9m awarded Lloyd Blankfein, chief executive officer of Goldman Sachs. The combined take in 2007 of the top 50 hedge fund managers totalled $29bn, which is about the same as the annual gross domestic product of Kenya, a country of 32.5m people, and a billion dollars less than the GDP of Sri Lanka, the home of 20m people. The headline earner was John Paulson, founder of Paulson & Co, who made $3.7bn from betting against certain mortgages and complex financial products that held them. Next on the list were James Simons, a mathematician and former US Defence Department codebreaker and George Soros, one of the world’s most successful speculators and richest men. Each took home almost $3bn due to the stellar performances of their respective flagship funds.

Since 1913, the US has witnessed only one other year of such unequal wealth distribution—1928—the year before the stock market crashed. While 2008 is unlikely to be a repeat of 1929, this year will be much tougher for the hedge fund managers. March was the worst month, since the collapse of Long Term Capital Management (LTCM) in 1998, according to Chicago-based Hedge Fund Research. It showed that, the average fund tracked by its HFRX index was down 2.4% for the month.

On average, hedge funds world-wide across all investment styles posted losses of 2.8%. They were caught when the widespread bet on commodity prices going up and the financial sector suffering turned against them. The worst affected were the relative-value managers and those specialising in fixed-income trading strategies, which were down 2.6% to 6%, on average, depending on their focus.

Reportedly, the biggest losers included UK-based $3bn (£1.51bn) Endeavour Capital, which plummeted 34% in March and the London Diversified Fund Management’s flagship fund, which dropped about 10% in the first quarter.

The flagship bond fund of John Meriwether, the former LTCM co-founder, also dropped about 28% in March.

This year has also seen high profile closures; most notably the UK-based $2bn Peloton Asset Back Security Fund which missed margin calls after betting that the price of mortgage securities would recover. Private equity giant Carlyle Group also made the headlines when it was forced to pull the plug on its £11bn Guernsey-based hedge fund after banks, including Merrill Lynch, refused to support a refinancing package. In addition, Sailfish Multi-strategy fixed income fund closed its doors after large redemptions on the back of plummeting values.

Looking ahead, there are likely to be other collapses this year as prime brokers tighten the credit strings and investors decide to ask for their money back. Robert Howie, senior investment consultant and head of European hedge fund research at Mercer says, “I suspect that we will see other closures due to the current circumstances. This is particularly true with the harder to trade securities. If a prime broker cuts the lines of credit, then it is difficult to get liquidity and a hedge fund may be forced into an unwind situation.”

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While prime brokers have become more selective as to generate returns. However, they account for a small whom they do business with, hedge funds have also percentage of the total number of hedge funds in the become choosier—a trend that started long before the market. This highlights how important it is for investors to credit crunch. Today, they are not only expanding the have a diversified portfolio of high quality hedge funds and number of relationships but turning to their tried and so avoid too much concentration of risk.”

Stephen Oxley, managing director of Pacific Alternative trusted custodians for security. As Connor of Morse observes, “The Bear Stearns collapse was a wake-up call Asset Management Company (PAAMCO) “Investors need for many hedge funds and underscored the need to have to be defensive and conservative but when markets go into more than one prime broker. Managers realise the spasm, there are always opportunities for canny hedge importance of not putting all their eggs into one basket. I fund managers. Also, it is important for managers to be think going forward we will see hedge funds using highly active and nimble to take advantage of these different prime brokers for financing and custodians to opportunities. As for investors, some have to stop an obsession with weekly and monthly numbers, and focus safeguard their cash.”

By contrast, Ponzo believes there will be a split in the way more on long term returns.”

The most popular strategies so far this year include the industry operates. “The hedge funds that are strong, consistent performers may focus on one or two prime global macro, which makes bets on macroeconomic trends, as well as commodity brokers in order to trader advisers negotiate better fees. strategies (CTA) which The less creditworthy look to take advantage players, however, are of the rising prices of likely to shop around Ponzo believes there will be a split in the world commodities. for four or five prime Distressed, of course, is brokers to service their way the industry operates. “The hedge funds also another possibility needs in order to ensure that are strong, consistent performers may but many agree it is too that their requirements focus on one or two prime brokers in order early to pounce. are being met.” to negotiate better fees. The less According to Martin Despite the current creditworthy players, however, are likely to Harrison, client director turmoil, the general of Dublin-based GAM, consensus is that hedge shop around for four or five prime brokers to the firm’s multifunds will continue to service their needs in order to ensure that manager approach has feature in an their requirements are being met.” used the recent equity institution’s portfolio, market rally to reduce although inflows are further its equity down this year. Hedge exposure, while Fund Report says that increasing its “long overall net inflows were a mere $16bn in the first three months of the year, a volatility” allocations and also to those strategies that will staggering 75% drop than the same period last year. Not continue to benefit from the violent market dislocations we surprisingly, hedge fund managers will have to have seen in the past six months.“It is generally regarded demonstrate their acumen and track record in order to as too early to try to buy“distressed”assets, as they are not retain as well as attract new clients. After all, making yet pricing in an appropriate level of risk reduction in money from the market swings is a different skill set than global investor demand. We are, and will remain, vigilant of exploiting leverage, which today is a rare commodity. As opportunities in this space. However, the amount of money Daniel Sheard, chief investment officer of Augustus Asset waiting to buy such assets is almost guaranteed to ensure Managers, a London-based specialist fixed-income and that prices do not fall to attractive levels,”says Harrison.

Aside from carefully watching the markets, managers are currency asset management firm, says, “Hedge fund managers will have to justify their fee structure. It is easy to also keeping busy lobbying to stem the threat of tighter make money in good times but now it is down to their regulation. The general consensus is that draconian genuine investment skill. I think there will be a greater measures will be avoided but there will be a need for divide between the funds with the right systems, processes stricter self-regulation. The most likely outcome is the and approach in this current environment, and these adoption of best practice guidelines from groups such as the US President’s Working Group for Financial Markets in winners will take a bigger share of the market.”

Tim Gascoigne, global head of portfolio management at the US and the UK Hedge Fund Working Group. Both HSBC Alternative Investments, also believes that the emphasise improved disclosure and risk management. current environment needs to be into perspective. “The Investors are not necessarily looking for a completely funds that struggled, and suffered drawdowns, in some transparent view of strategies and positions but they want cases closing tended to rely on significant leverage to enough information to make informed decisions.

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BALANCING RISK AND RETURN THE GREATER CHINA hedge fund industry grew rapidly in 2006 and 2007. AsiaSource Capital’s internal database of Greater China focused hedge funds, estimates assets under management (AUM) at the peak of last year reached over $18bn; still small both in the global context and in relation to the underlying capital markets, but a sizeable jump from the circa $5bn under management towards the end of 2006.

This compares to the entire Asian hedge fund industry which managed $111bn in assets by the end of 2007,according to Hedge Fund Research.Weak performance and redemptions over the last six months have taken a bite from assets, although some funds have suffered noticeably larger drops than others. Perhaps unsurprisingly, the correlation between large redemptions and weak performance has been quite high. AUM for a few funds in the space fell by over 70%; and falls of over 25% have been common. Nonetheless, a few actually grew assets during the correction.

Net redemptions in the Greater China hedge fund space contrasted with the net inflows of $1bn for the broader Asian hedge fund universe during the first quarter of 2008.

Fund closures have already started, although causality was perhaps not completely attributable to the market downturn (manager’s personal reasons, etc). Without dwelling on grim predictions, for some funds launched last year, wrong-footed by the whipsaw price action and now

T

shouldering inception-to-date losses, survival is uncertain and retaining key personnel will be a challenge.

It is worth examining one of the most common ‘pushbacks’ for the Greater China, and indeed Asian hedge fund space – that it offers little more than beta exposure with negligible contribution to portfolio diversification.

Thinking here is coloured by the widely-held perception that Greater China markets remain under-developed and that shorting tools are illiquid and small in number. This perception had grounds a few years ago, but is probably a little harsh now. Hong Kong’s market—the most developed of the Greater China markets—had an average daily trading value of $11.2bn in 2007 (cf. London Stock Exchange 2007 average of $20.6bn), up from $1.9bn in 2004; single-day trading value reached a record high of $26.9bn on October 30th; 84 new companies were listed in 2007; $75.6bn of equity funds were raised during the year; the value of short selling transactions, involving over 400 listed securities, reached $166bn; trading value of derivative and equity warrants was $602.4bn.

In addition, 133 callable bull/bear contracts are now listed on the main board, and the listed stock option contract market, though still small, grew significantly over the last year, with contract value of $13.6bn in 2007, up 500% from 2006. General trading costs in Hong Kong are

GREATER CHINA HEDGE FUND RETURNS

Weak performance and redemptions over the last six months have taken a bite from assets employed in the Greater China region, although some funds have suffered noticeably larger drops than others. In the greater Asia region, meanwhile, investment flows into hedge funds continues apace. Perhaps unsurprisingly, the correlation between large redemptions and weak performance has been quite high. Assets under management (AUM) for a few funds in the space fell by over 70%, while falls of over 25% have been common. However, a few actually grew assets during the correction Simon Coxeter, founder of AsiaSource Capital, assesses the short term outlook for the sector in the region and outlines some of the more successful strategies.

Photograph supplied by istockphotos.com, May 2008.

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Simon Coxeter, founder AsiaSource Capital, explains that this year is shaping up to be a challenging one for managers in the region, but it may also present an opportunity for some to differentiate and demonstrate genuine alpha. It was quite difficult to lose money in 2006 and 2007, but many funds are down significantly so far this year, with approximately a third down more than 20% for the first quarter. Photograph kindly supplied by AsiaSource Capital, May 2008.

competitive with those in developed European markets, but the cost of shorting in particular remains higher for all but the more liquid securities. Put simply, the playing field for Greater China hedge funds does not preclude the successful execution of value-adding strategies.

Although there are funds in the universe which deserve this ‘pushback’, it is a simplistic generalisation, and appropriate due diligence in the fund selection process would at least partially sift out such funds. It might be that foreign perception of funds in the region is subject to, for want of a better phrase, colonial prejudice. In other words, judging a hedge fund in the region against the template of a US-based hedge fund may lead to sub-optimal allocation decisions, if only because strategies, and indeed managers, that work well in the US market do not always transplant well into these markets. We have certainly come across managers with strong backgrounds and track-records with US or European hedge funds who have failed to extract a good risk-adjusted or absolute return in this region.

In an academic study commissioned by Fullerton Fund Management Company last year, Professor Melvyn Teo of the Singapore Management University evaluated the performance of a universe of Greater China equity long/short funds between 2000 and 2006 relative to an assetbased factor model, finding that betas and correlations were similar to the historical market betas for hedge funds investing in the United States. Professor Teo also found that alpha-generation for top Greater China hedge funds could not be explained by luck or sample variation alone.

However, looking specifically at the implementation of short strategies, some managers have perhaps strayed too far from their core competence in long-only stock selection over the last couple of years. It has not been easy to make shorting a successful part of any portfolio over the last year, with frequent whipsaw price movements and concentrated index benchmarks catching many managers on the wrong

side of the exposure scales, or just hedged poorly against a non-index long-book. Equally, escalating implied volatilities made many hedging tools expensive, and difficult to palate for those with a positive medium-term view on market direction.

Anecdotally, one manager commented that after considerable pressure from marketers to justify hedge fund fees, he was running a consistently high hedge in 2006 and 2007 in spite of being bullish on the market. Indeed, as funds focusing on the region multiplied, there has been increasing pressure to ‘differentiate’ from the majority of long-bias long/short funds, which in some cases markedly compromised the expression of investment view within a portfolio to serve marketing aims. However, the shorting element of a strategy is not the only justification for higher fees, and for strategies with limited total capacity and high risk-adjusted returns hedge fund style fees may be necessary to provide economic motivation to those who are capable of implementing those strategies.

Selecting the avenues through which risk management was achieved in a portfolio of funds has been important in defining both absolute returns and volatility. Of course, in addition to finding managers best qualified to run a shortbook, funds with inherently lower equity market exposure in strategies like distressed debt and hybrid credit, which were not available a few years ago, now provide useful tools to an investor looking for a broader-based, less volatile exposure to asset-pricing inefficiencies within the region. Although it is expected that the long/short strategy will dominate for some time to come, a number of fund launches in other strategies over the last 18 months helped to diversify the opportunity-set. This positive trend is likely to continue, particularly after the effect of a severe multimonth correction on long/short funds in the space was experienced first-hand by investors.

Performance of Greater China focused hedge funds, which now number over 100, has in part reflected the dispersion in returns across the regional market. According to AsiaSource Capital’s database, an equal investment in the five worst performing funds in 2007 would have lost over 2%, whereas an investment in the five top performing funds would have gained over 133%.

In 2007, funds braving the liquidity-driven rally on the mainland and in Hong Kong-listed China stocks were generally the best performers. Funds with relatively concentrated portfolios of Hong Kong-listed value names, or a distinct skew towards Taiwan, tended to perform poorly. A number of managers torpedoed healthy longbook returns through the somewhat undisciplined execution of the short-book.

Perhaps most noteworthy, a good number of managers achieved absolute returns well in excess of relevant equity benchmarks with much lower levels of leverage than characteristic of the US hedge fund industry. Indeed, many of those same managers, although negatively impacted by the correction, minimized at least some of the loss relative to index benchmarks. Although statistical measurements

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must be treated with caution given the length of trackrecords and the rapid evolution of the market environment, it is worth noting that half of the fund universe had annualised Sortino and Sharpe ratios above 4.8 and 1.7 respectively at the end of October last year; but after the correction to the end of March, comparable ratios fell to 1.7 and 1.1 respectively.

This year is shaping up to be a challenging one for managers in the region, but it may also present an opportunity for some to differentiate and demonstrate genuine alpha. It was quite difficult to lose money in 2006 and 2007, but many funds are down significantly so far this year, with approximately a third down more than 20% for the first quarter. Some managers now ‘shy’ from increasing exposures, driven more by an instinct towards business preservation (i.e.‘we cannot afford to be down another 10% from here’) than an instinct to buy cheap assets and sell expensive ones. But it isn’t all gloom. A handful of funds in the equity space managed to achieve positive returns both in the five month period from the end of October and in the particularly difficult month of January. The few genuine Greater China market-neutral funds managed to navigate the downswing well, providing them with the first opportunity to differentiate positively in a couple of years.

With growing breadth and depth to the region’s capital

markets, more sophisticated players are entering the fray, and the number of US and European hedge funds establishing offices in Singapore and Hong Kong bears testament to the expanding market opportunity.

In broader terms, allocations to Asia from US and European investors remain small. Interacting with investors, we are often struck by the disconnect between the uncontroversial confidence in Asia’s economic and market growth prospects over the coming decade, and the decision to cap portfolio allocation to the region at a few hundred basis points. The disconnect is occasionally more acute when an investor is either neutral or despondent on the topic of developed world equity markets but has a 30% or 40% portfolio allocation to them. Although this disconnect can partly be explained by factors like liquidity and risk preference for some allocators, other probable drivers include a fear of the unknown. Fear of the unknown, or just local bias, certainly contributed to the meagre international exposure for institutional investors two decades ago, and drawing upon such historical shifts in the allocation of developed market capital there is but one direction for the allocation trend to the Asia-Pacific region.

Greater China, its economic centrifuge, will be a significant beneficiary, and with it those alternative strategies bringing diversification to equity market returns.

THE SHARPE & SORTINO RATIOS: The Sharpe Ratio is a risk-adjusted measure of performance, which is often used to evaluate the performance of a portfolio and its manager. Simply put, the ratio measures the return generated by the portfolio in comparison to the amount of risk taken.

The more risk taken, the higher the return should be to compensate for the risk. The ratio is calculated by taking the return of the portfolio and subtracting the risk-free rate of return. The result is then divided by the standard deviation of the portfolio. The higher the Sharpe ratio, the better the performance of the portfolio is considered to be.

The Sharpe ratio was derived in 1966 by Economic Science Nobel Prize winner William Sharpe and has been one of the most referenced risk/return measures used in finance ever since. Its popularity is attributed to its simplicity, and much of this popularity can be attributed to its simplicity. The formula is stated as: S(X) = (rх-Rғ)/StdDev (X)

The Sortino Ratio is similar to the Sharpe Ratio, in that it is risk adjusted, except that instead of using standard deviation as the denominator, it uses downside deviation (or semi-variance). Frank Sortino, now a director of pension research institute in San Francisco, developed the Sortino ratio. Like the Sharpe Ratio, it is straightforward The Sortino Ratio classifies risk in terms of upside and downside risk. It arrives at a minimum acceptable return (MAR) for an investor by asking the investor to set a return that he/she would be comfortable with. Any return below this is deemed to be downside deviation and is included for the purpose of calculating the Ratio. Whenever the fund return is less than the MAR, it adds the underperformance, but does not add out-performance. This, say some analysts is a better measure of risk than volatility, used by Sharpe ratio. The Sortino (S) Ratio is calculated as follows: S = (R - MAR) / DD

Where:

Where:

X is the investment rх is the average rate of return of x Rғ is the best available rate of return of a risk free securities (i.e. T-Bills)

R = service’s return, MAR = minimum acceptable return DD = downside deviation

FTSE GLOBAL MARKETS • JUNE 2008

Source: Various websites, May, 2008

83

ETF Listings as of End Q1 2008

Ireland P Listings: T Listings: Managers: AUM:

Germany P Listings: T Listings: Managers: AUM:

Spain P Listings: T Listings: Managers: AUM:

Iceland

1 1 1 US$0.07 Bn

186 323 8 US$58.71 Bn

12 27 3 US$3.06 Bn

103 217 4 US$23.65 Bn

United Kingdom P Listings: T Listings: Managers: AUM:

Belgium P Listings: T Listings: Managers: AUM:

1 1 1 US$0.08 Bn

7 221 3 US$1.08 Bn

2 58 2 US$0.41 Bn

Netherlands P Listings: T Listings: Managers: AUM:

South Africa

21 139 4 US$9.32 Bn

122 190 6 US$45.37Bn

61 61 3 US$16.54 Bn

5 111 2 US$4.58 Bn

P Listings: T Listings: Managers: AUM:

11 11 4 US$1.88 Bn

Norway P Listings: T Listings: Managers: AUM:

Turkey P Listings: T Listings: Managers: AUM:

4 4 2 US$0.30 Bn

6 6 2 US$0.18 Bn

Sweden P Listings: T Listings: Managers: AUM:

India P Listings: T Listings: Managers: AUM:

Australia P Listings: T Listings: Managers: AUM:

7 7 1 US$2.32 Bn

8 8 3 US$1.31 Bn

Finland P Listings: T Listings: Managers: AUM:

2 2 2 US$0.22 Bn

New Zealand P Listings: T Listings: Managers: AUM:

6 6 2 US$0.43 Bn

Hungary

P Listings: T Listings: Managers: AUM:

Austria

P Listings: T Listings: Managers: AUM:

Japan

P Listings: T Listings: Managers: AUM:

1 1 1 US$0.02 Bn

1 21 1 US$0.05 Bn

36 37 4 US$33.15 Bn

3 3 2 US$0.39 Bn

5 5 4 US$3.37 Bn

23 23 4 US$1.76 Bn

South Korea

P Listings: T Listings: Managers: AUM:

Malaysia

P Listings: T Listings: Managers: AUM:

4 17 4 US$1.63 Bn

Singapore

P Listings: T Listings: Managers: AUM:

1 1 1 US$0.10 Bn

10 10 2 US$1.77 Bn

10 19 5 US$10.86 Bn

Hong Kong

P Listings: T Listings: Managers: AUM:

Taiwan

P Listings: T Listings: Managers: AUM:

Thailand

P Listings: T Listings: Managers: AUM:

P Listings = # Primary Listings, T Listings = # Total Listings. Source: Morgan Stanley Investment Strategies, Bloomberg

1 1 1 US$0.01 Bn

Indonesia P Listings: T Listings: Managers: AUM:

4 18 2 US$1.44 Bn

P Listings: T Listings: Managers: AUM:

1 1 1 US$0.10 Bn

Italy P Listings: T Listings: Managers: AUM:

P Listings: T Listings: Managers: AUM:

1 1 1 US$0.01 Bn

China

Slovenia P Listings: T Listings: Managers: AUM:

Switzerland P Listings: T Listings: Managers: AUM:

France P Listings: T Listings: Managers: AUM:

Canada P Listings: T Listings: Managers: AUM:

Mexico P Listings: T Listings: Managers: AUM:

1 1 1 US$2.08 Bn

612 612 19 US$534.4 Bn

United States P Listings: T Listings: Managers: AUM:

Brazil P Listings: T Listings: Managers: AUM:

EXCHANGE TRADED FUNDS: LISTING & DISTRIBUTION AS OF END Q1 2008

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Worldwide ETF and ETP Growth

800

1400

700

1200

Assets USD Billions

600

1000

500 800 400 600

# ETFs

ETF Data 26.qxd:.

300 400

200

200

100

0

1993

1994

1995

1996

1997

1998

1999

2000

2001

$0.81

$1.12

$2.30

$5.26

$8.23

$17.60

$39.61

$74.34

$104.80

$0.12

$0.10

$0.81

$1.12

$2.30

$5.26

$8.23

$17.60

$39.61

$74.34

$104.66

$0.04

ETF Assets USD Billions ETF Commodity Assets USD Billions ETF Fixed Income Assets USD Billions

2002

2003

$141.62 $212.02 $0.11

$0.32

$3.97

$5.83

$137.54 $205.87

2004

2005

2006

2007

Q1 08

$309.80

$412.09

$412.09

$796.60

$760.80

$1.20

$0.46

3

3

4

21

21

31

33

92

202

280

282

$6.32

$8.66

$23.05

$21.32

$21.32

$59.93

$75.39

$286.28

$389.57

$389.57

$730.28

$676.76

$15.58

$15.58

$45.87

$56.40

461

714

1171

1,280

23

70

134

211

ETF Equity Assets USD Billions # ETFs

$1.20

336

# ETPs

0

Source: Morgan Stanley Investment Strategies, Bloomberg

ETF Listings by Exchange as of End Q1 2008 – Asia Pacific Region

# Primary ETF Listings

# Total (USDBn)

AUM (USDMM)

20 Day ADV

Australian Securities Exchange Shanghai Stock Exchange Shenzhen Stock Exchange Hong Kong Stock Exchange Bombay Stock Exchange National Stock Exchange Indonesia Stock Exchange Osaka Securities Exchange Tokyo Stock Exchange Bursa Malaysia Securities Berhad New Zealand Stock Exchange Singapore Stock Exchange Korea Stock Exchange Taiwan Stock Exchange Stock Exchange of Thailand

111 4 3 2 10 1 7 1 4 32 3 6 4 23 10 1

148 18 3 2 19 1 7 1 4 33 3 6 17 23 10 1

$56.22 $1.44 $1.23 $2.15 $10.86 $0.00 $1.31 $0.01 $11.57 $21.58 $0.39 $0.43 $1.63 $1.76 $1.77 $0.10

$540.85 $0.02 $107.88 $26.82 $100.49 $0.00 $2.10 $0.01 $92.86 $97.70 $0.14 $0.14 $8.91 $56.89 $45.60 $1.30

Sao Paulo Toronto Stock Exchange Mexican Stock Exchange AMEX Boston CBOE Chicago Cincinnati ISE FINRA ADF NASDAQ NYSE NYSE Arca Philadelphia

679 1 61 5 345 0 1 0 0 0 0 30 0 236 0

785 1 61 111 345 0 1 0 0 0 0 30 0 236 0

$557.55 $2.08 $16.54 $4.58 $217.93 $0.00 $4.07 $0.00 $0.00 $0.00 $0.00 $18.22 $0.00 $294.13 $0.00

$89,096.26 $3.56 $612.00 $177.36 $1,578.77 $0.00 $297.94 $452.47 $1,525.06 $102.72 $21,586.64 $34,998.15 $0.00 $27,725.30 $36.30

1,280

2,165

$760,80

$91,563.70

Exchange

ETF Listings

Australia China

Asia Pacific

Hong Kong India Indonesia Japan Malaysia New Zealand Singapore South Korea Taiwan Thailand Americas Brazil Canada Mexico US

Grand Total

Source: Morgan Stanley Investment Strategies, Bloomberg

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Global ETF Assets by Type of Exposure as of the end of Q1 2008 Region of Exposure

Total Listings

# ETFS

AUM (US$bn)

Commodities Global

% TOTAL

Global (ex-US)

1.4%

1%

Currency

0%

7.4%

North America Europe Emerging Markets Fixed Income Asia Pacific Global (ex-US) Global Commodities Currency Total

456 271 170 137 91 46 66 39 4 1,280

599 545 355 246 154 48 150 64 4 2,165

$355.36 $96.02 $93.79 $75.32 $64.46 $56.04 $10.58 $9.17 $0.06 $760.80

46.7% 12.6% 12.3% 9.9% 8.5% 7.4% 1.4% 1.2% 0.0% 100.0%

Asia Pacific

8.5%

North Americas

Fixed Income

46.7%

9.9%

Emerging Markets

12.3%

Europe

12.6%

ETF Managers Around the World ranked by AUM, as of End Q1 2008 Year End 2007 Manager

AUM # ETFs (USD Bn)

Barclays Global Investors State Street Global Advisors Vanguard Lyxor Asset Management PowerShares DB X-Trackers ProFunds Nomura Asset Management Nikko Asset Management Daiwa Asset Management Bank of New York AXA IM / BNP AM Credit Suisse Asset Management Van Eck Associates Corp WisdomTree Investments Nacional Financiera Hang Seng Investment Management Ltd BBVA Asset Management Credit Agricole Structured Asset Management XACT Fonder

321 83 37 87 114 51 58 7 2 5 1 30 8 8 39 1 3 7 3 9

$402.61 $152.39 $41.97 $31.50 $38.02 $10.82 $9.70 $17.44 $9.08 $7.63 $10.15 $6.69 $4.97 $3.49 $4.52 $3.74 $4.71 $1.18 $3.02 $2.51

% Total

50.6% 19.1% 5.3% 4.0% 4.8% 1.4% 1.2% 2.2% 1.1% 1.0% 1.3% 0.8% 0.6% 0.4% 0.6% 0.5% 0.6% 0.1% 0.4% 0.3%

YTD 2008

YTD Change

AUM # # ETFs (USD Bn) % Total Planned

328 $369.98 85 $135.89 37 $44.16 105 $37.96 117 $30.43 77 $18.23 58 $16.19 24 $15.91 6 $8.69 5 $8.50 1 $8.33 32 $6.93 8 $5.73 12 $5.09 40 $4.32 1 $4.21 3 $3.84 7 $2.84 3 $2.58 11 $2.45

48.6% 17.9% 5.8% 5.0% 4.0% 2.4% 2.1% 2.1% 1.1% 1.1% 1.1% 0.9% 0.8% 0.7% 0.6% 0.6% 0.5% 0.4% 0.3% 0.3%

14 20 4 3 52 17 87 0 1 1 0 8 0 14 29 0 0 0 0 0

AUM # ETFs % ETFs (USD Bn)

7 2.2% 2 2.4% 0 0.0% 18 20.7% 3 2.6% 26 51.0% 0 0.0% 17 242.9% 4 200.0% 0 0.0% 0 0.0% 2 6.7% 0 0.0% 4 50.0% 1 2.6% 0 0.0% 0 0.0% 0 0.0% 0 0.0% 2 22.2%

-$32.63 -$16.50 $2.19 $6.45 -$7.59 $7.41 $6.50 -$1.53 -$0.39 $0.87 -$1.82 $0.24 $0.76 $1.60 -$0.20 $0.47 -$0.86 $1.65 -$0.44 -$0.06

AUM % Market % Share

-8.1% -10.8% 5.2% 20.5% -20.0% 68.4% 67.0% -8.8% -4.3% 11.4% -17.9% 3.5% 15.3% 45.8% -4.4% 12.6% -18.3% 139.8% -14.7% -2.6%

-1.9% -1.3% 0.5% 1.0% -0.8% 1.0% 0.9% -0.1% 0.0% 0.2% -0.2% 0.1% 0.1% 0.2% 0.0% 0.1% -0.1% 0.2% 0.0% 0.0%

Source: Morgan Stanley Investment Strategies, Bloomberg

NOTES At the end of Q1 2008 there were 1,280 ETFS with 2,165 listings with assets of $760.8bn, managed by 79 managers on 42 exchanges around the world. During the quarter 121 ETFs were launched and there are plans to launch a further 550 ETFs, 58 in Europe, 423 in the US and 69 in the rest of the world. Over 2,200 institutional investors reported using one or more ETFs listed on exchanges through 2006 and over the last nine years, the number of users has increased by 1,242%.

Four new ETF managers entered the market in the quarter. ETFLab is the largest new ETF manager in terms of assets with $0.93bn under management in five new ETFs, following by i-VCAP Management with $0.23bn under management in one new ETF. Worldwide, ETF assets under management declined by 4.4% in the quarter, while other exchange traded products assets under management increased by 23.0%, driven in large part by US listed exchange traded commodities (ETCs) assets, which grew by $7bn, following by European ETC assets, which grew by $2.3bn and US listed exchange traded currency products, which grew by $1bn.

There are now 300 options and 13 futures on ETFs listed on exchanges in the US. Europe and Canada.

Disclaimer: This material is not a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. This material was not prepared by the Morgan Stanley Research Department, and you should not regard it as a research report. Morgan Stanley may deal as principal in or own or act as market maker for securities/instruments mentioned or may advise the issuers.

We do not represent this is accurate or complete and we may not update this. Š 2008 Morgan Stanley Contact info: Comments/suggestions are always appreciated and Morgan Stanley can provide customized modeling analysis or implementation strategies where appropriate. Please contact Deborah Fuhr on +44 20 7425 5598 or email Deborah.Fuhr@morganstanley.com.

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The market reported 2,538,986 transactions in the month, with 207,063 securities available for lending, worth $14,286bn; while 39,246 securities were out on loan, worth $3,747bn.

Group Results (USD): The following table details the aggregated group results for all Performance Explorer participants and provides a high level summary of the activity in particular assets. This table represents a summary of the 309 separate asset classes in the data set.

Security Type

All Securities

Lendable Assets (M)

Balance vs Cash (M)

Balance vs Non Cash (M)

Total Balance (M)

Utilisation (%)

SL Fee (Bp)

Revenue SL Return to Share f rom Lendable SL (%) Assets (Bp)

Total Return Lendable Assets (Bp)

SL Tenure (days) 116

14,282,237

2,153,856

1,593,001

3,746,857

20.73

61.35

74.34

8.98

14.53

All Bonds

6,086,539

1,170,748

769,361

1,940,109

29.37

6.59

19.55

1.98

10.62

130

Corporate Bonds

3,318,380

239,598

139,803

379,401

10.03

-10.33

-54.12

-1.19

2.18

147

Government Bonds

2,656,604

922,082

625,832

1,547,914

54.32

10.73

28.78

6.00

21.47

125

All Equities

8,191,919

983,082

823,628

1,806,711

14.33

120.16

89.04

14.18

17.44

102

Americas Equities

4,581,188

568,070

128,308

696,378

11.93

59.61

70.02

5.51

9.39

126

Asian Equities European Equities

830,050

60,017

98,087

158,103

13.94

65.94

85.12

7.50

9.70

114

2,377,397

265,223

576,277

841,500

19.29

187.00

96.78

34.34

36.54

85

239,897

49,268

6,539

55,807

13.11

93.90

84.08

7.51

11.64

61

72,153

37,245

8,518

45,762

22.84

45.08

72.64

13.94

24.71

43

Depository Receipts Exchange Traded Funds

The following tables show the largest utilisations with the largest balance against securities held by Performance Explorer Lenders:

Equities:

Corporate Bonds:

Top 10 By Utilisation and Lenders Balance

Top 10 by Utilisation and Lenders Balance

Rank

Stock description

Rank

Stock description

1

Handelsbanken XACT OBX

1

Landesbank Baden-Wurttemberg (2.629% 10-Dec-2015)

2

Idera Pharmaceuticals Inc

2

FN 0715A GM

3

iPath ETN MSCI India A

3

Bayerische Landesbank (Lon) (4.785% 23-Jun-2009)

4

Thomson Reuters Corp

4

Pfandbriefbank schw eiz Hypo (2.03% 01-Mar-2012)

5

Bh Macro Ltd

5

Enel Spa (5.04% 18-Sep-2009)

6

Gtx Inc

6

Pfandbriefzentrale Schw eizKantonal (2.75% 20-Jun-2014)

7

Air Berlin Plc

7

Royal Bank Of Canada Europe Ltd (2.18% 01-Jul-2008)

8

Crow n Media Holdings Inc

8

Pfandbriefbank schw eiz Hypo (2.87% 20-Jan-2014)

9

Icahn Enterprises Unt

9

CWHL 0346 4A1 Sr Vari

10

Emcore Corp

10

Programa Independiente Hipotecarias (5.125% 20-Jul-2022)

The Total Income generated by lending a security can be split in two; the amount generated from the fee charged, and the amount generated by reinvesting any cash which is received back as collateral. The following tables detail the securities generating the largest income through a combination of these two components:

Equities:

Corporate Bonds:

Top 10 Securities by Total Return

Top 10 Securities by Total Return

Rank

Stock description

Rank

Stock description

1

InterOil Corp

1

Sally Holdings Llc (10.5% 15-Nov-2016)

2

Thornburg Mortgage Inc

2

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

3

Conn'S Inc

3

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

4

Groupe Eurotunnel Sa

4

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

5

Imergent Inc

5

Michaels Stores Inc (11.375% 01-Nov-2016)

6

Wci Communities Inc

6

Freeport-Mcmoran Copper & Gold Inc (5.5% Undated)

7

Osiris Therapeutics Inc

7

St Jude Medical Inc (1.22% 15-Dec-2008)

8

Nutrisystem Inc

8

RAIT Financial Trust (6.875% 15-Apr-2027)

9

Medis Technologies Ltd

9

Rambus Inc (0% 01-Feb-2010)

10

Corus Bankshares Inc

10

Chesapeake Energy Corp (2.5% 15-May-2037)

SECURITIES LENDING DATA by DATA EXPLORERS

KEY PERFORMANCE EXPLORER STATISTICS as of 7th May 2008

Disclaimer and copyright notice The above data is provided by Data Explorers Limited and is underpinned by source data provided by Performance Explorer participants and also market data. However, because of the possibility of human or mechanical errors, neither Data Explorers Limited nor the providers of the source or market data can guarantee the accuracy, adequacy, or completeness of the information. This summary contains information that is confidential, and is the property of Data Explorers Limited. It may not be copied, published or used, in whole or in part, for any purpose other than expressly authorised by the owners. info@performanceexplorer.com www.performanceexplorer.com

FTSE GLOBAL MARKETS â&#x20AC;˘ JUNE 2008

Š Copyright Data Explorers Limited May 2008

87

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

Ap r-0 8

Oc t-0 7

Ap r-0 7

15:40

Oc t-0 7

Index Level Rebased (31 Apr 03=100)

26/5/08

Ap r-0 6

Oc t-0 5

Ap r-0 5

Oc t-0 4

Ap r-0 4

Oc t-0 3

Ap r-0 3

MARKET DATA BY FTSE RESEARCH

FT SE

MARKET REPORTS 26.qxd:MARKET REPORTS 26.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

-10

FTSE RAFI Emerging Index

2-Month Performance

10

8

6

4

Capital return

2

Total return

0

-2

1-Year Performance

40

30

20

10

0

Capital return

Total return

-20

-30

JUNE 2008 â&#x20AC;˘ FTSE GLOBAL MARKETS

MARKET REPORTS 26.qxd:MARKET REPORTS 26.qxd

26/5/08

15:40

Page 89

Table of Capital Returns Index Name 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

Currency

Constituents

Value

2M (%)

6M (%)

12M (%)

YTD (%)

Actual Div Yld (%)

USD USD USD USD USD USD

2,910 2,448 2,008 902 440 462

250.66 438.33 235.53 588.12 539.29 704.08

3.5 3.7 3.7 2.1 4.0 -0.6

-10.2 -10.0 -10.2 -9.9 -6.7 -14.1

-1.4 -2.4 -3.9 22.4 21.9 23.2

-4.9 -4.6 -5.1 -3.9 1.5 -10.8

2.52 2.56 2.57 2.16 2.39 1.83

USD USD USD USD USD

7,984 6,167 1,817 936 881

419.44 396.94 828.00 770.86 957.23

3.3 3.5 1.4 3.8 -1.8

-10.6 -10.6 -10.8 -7.8 -14.6

-2.2 -4.5 21.8 21.4 22.2

-5.0 -5.1 -4.9 1.2 -12.3

2.45 2.49 2.13 2.37 1.80

USD

719

123.15

-0.5

8.1

13.2

5.9

3.33

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

USD USD USD USD USD

291 189 226 235 56

2330.09 1037.66 2144.50 1154.25 1441.36

5.8 6.6 5.6 5.0 7.4

-14.0 -12.3 -12.6 -12.4 -17.7

-16.0 -17.5 -12.8 -19.6 -5.6

-1.1 1.7 -0.9 1.5 -6.6

4.00 4.98 4.77 4.80 2.11

USD USD

241 100

10426.75 10269.73

2.3 2.7

-5.5 -4.8

2.9 2.7

-5.8 -5.4

3.10 3.12

SRI FTSE4Good Global Index FTSE4Good Global 100 Index

USD USD

706 105

6486.05 5541.52

4.5 5.4

-11.7 -11.9

-6.6 -6.9

-5.7 -6.5

3.09 3.31

Investment Strategy FTSE GWA Developed Index FTSE RAFI Developed ex US 1000 Index FTSE RAFI Emerging Index

USD USD USD

2,008 1,015 361

3957.28 6844.24 7001.04

3.6 2.8 2.1

-11.2 -10.7 -11.0

-6.3 -2.9 28.9

-5.2 -5.3 -3.4

3.03 3.65 2.71

Currency

Constituents

Value

2M (%)

6M (%)

12M (%)

YTD (%)

Actual Div Yld (%)

USD USD USD USD USD USD

2,910 2,448 2,008 902 440 462

294.71 691.65 276.51 716.45 662.50 847.40

4.2 4.4 4.4 2.5 4.5 -0.1

-9.1 -8.9 -9.1 -9.1 -5.6 -13.6

0.9 0.0 -1.5 25.1 24.9 25.5

-4.1 -3.7 -4.2 -3.2 2.4 -10.3

2.52 2.56 2.57 2.16 2.39 1.83

USD USD USD USD USD

7,984 6,167 1,817 936 881

470.61 444.84 949.97 892.87 1081.39

3.9 4.2 1.8 4.2 -1.3

-9.6 -9.5 -10.0 -6.8 -14.1

0.1 -2.3 24.4 24.4 24.4

-4.2 -4.2 -4.2 2.1 -11.9

2.45 2.49 2.13 2.37 1.80

USD

719

169.64

0.1

9.8

17.6

7.1

3.33

Table of Total Returns Index Name 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

USD USD USD USD USD

291 189 226 235 56

3348.08 1141.18 2306.32 1268.30 1505.98

6.7 7.6 6.6 6.1 7.9

-12.3 -10.1 -10.4 -10.3 -16.8

-12.8 -13.5 -8.8 -15.9 -3.8

0.3 3.4 0.6 3.2 -6.1

4.00 4.98 4.77 4.80 2.11

USD USD

241 100

12024.99 11872.41

2.8 3.2

-4.3 -3.6

6.0 5.9

-5.0 -4.6

3.10 3.12

SRI FTSE4Good Global Index FTSE4Good Global 100 Index

USD USD

706 105

7559.71 6501.35

5.3 6.2

-10.4 -10.6

-3.9 -4.0

-4.6 -5.5

3.09 3.31

Investment Strategy FTSE GWA Developed Index FTSE RAFI Developed ex US 1000 Index FTSE RAFI Emerging Index

USD USD USD

2,008 1,015 361

4236.43 7341.91 7206.08

4.4 3.9 2.5

-9.9 -9.2 -10.0

-3.7 0.2 32.1

-4.1 -4.0 -2.6

3.03 3.65 2.71

FTSE GLOBAL MARKETS â&#x20AC;˘ JUNE 2008

89

% Change

F FT TS SE E A m N FT ort eric h a Am s I F T SE La n FT S SE E A tin eric dex a m A N FT ort eri me Ind ca r ex SE h s ica A La Am I tin eri ll C nde ap ca FT x SE Am A In LA eric ll Ca de x TI a p A B I FT FT EX ll C nde SE ap S A x In Am F E LA ll-S er TSE TI har dex B e ic In FT FTS as LAT EX Go IB TO de SE E x EP US ver EX P I F FT RA A G nm Br nd FT TS a e S / o s x SE E E E E NA ve ent il PR RE rn B In EP P R IT me ond dex RA A/N A/ n N N /N AR A I t AR E RE orth Bo nde n I x EI I T No T U Am d In T er No rt S d rth h A Div ica ex In A m ide M FT me eric nd dex ac + SE ric a qu I R a ar FT NA No en nde S ie t No E N REI n-R al I x rth AR T C en nd ta ex o A EI M ac me T E mp l In os qu q d r ar ica uity ite ex ie I I US nfra REI nde T s x A In tru s In fra ctu d e FT stru re I x FT SE ctu nde SE 4G re x 4G oo In oo d U de x d S FT U F In SE FT TS S d RA SE E G 100 ex FI RA W In US FI A U de x S U M id S 1 Ind Sm 00 ex 0 al l 1 Ind 50 ex 0 In de x

90 % Change

Ap r-0 8

Oc t-0 7

15:40

Ap r-0 7

Index Level Rebased (31 Apr 03=100)

26/5/08

Oc t-0 7

Ap r-0 6

Oc t-0 5

Ap r-0 5

Oc t-0 4

Ap r-0 4

Oc t-0 3

Ap r-0 3

MARKET DATA BY FTSE RESEARCH

F FT TS SE E A m N FT ort eric h a Am s I F T SE La n FT S SE E A tin eric dex m Am a I No e n FT ric e r de SE t h as ric x A aI La Am tin eri ll C nde a c FT x a p SE Am Al In LA eric l Ca de x TI a A pI B FT FT EX ll C nde SE SE Al ap x l In Am F LA -S er TSE TI har dex BE e i c L In A X FT FTS as Go TIB TO de SE E x EP US ver EX P I FT A B FT nm RA ra nde G FT S S x SE E E E E /NA ove ent sil EP PR PR RE rnm Bo Ind IT RA A/N A/ en nd ex N /N AR NA I t AR E RE orth Bo nde n IT x EI IT No U Am d In T er No rt S d rth h A Div ica ex A m ide In M FT me eric nd dex ac + SE ric a qu ar FT NA a N Ren Ind S ie e o t No E N REI n-R al I x rth AR T C en nd e E ta o x I A M ac me T E mp l In os qu q d r ar ica uity ite ex ie I I US nfra REI nde T s x A In tru s In fra ctu d ex r s e t FT ru I FT SE ctu nde SE 4G re x 4G oo In oo d U de x d FT U S In F SE FT TS S d RA SE E G 100 ex W FI R In US AFI A U de x US S M In id 1 Sm 00 dex 0 al l 1 Ind 50 ex 0 In de x

MARKET REPORTS 26.qxd:MARKET REPORTS 26.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

14

12

10

8

6

4

Capital return

2

0

Total return

-2

-4

1-Year Performance

50

40

30

20

10

Capital return

0

Total return

-10

-20

JUNE 2008 • FTSE GLOBAL MARKETS

MARKET REPORTS 26.qxd:MARKET REPORTS 26.qxd

26/5/08

15:40

Page 91

Table of Capital Returns Index Name

Currency

Constituents

Value

2M (%)

6M (%)

12M (%)

YTD (%)

Actual Div Yld (%)

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

USD USD USD

862 726 136

569.84 586.37 1007.49

3.9 3.8 4.7

-9.6 -10.3 2.7

-2.8 -4.7 41.2

-4.6 -5.2 7.2

2.01 2.00 2.17

USD USD USD

2,793 2,594 199

361.82 346.63 1505.33

3.7 3.7 4.5

-9.9 -10.5 2.0

-3.2 -4.9 39.6

-4.6 -5.2 6.8

1.93 1.91 2.15

Region Specific FTSE LATIBEX All-Share Index FTSE LATIBEX TOP Index FTSE LATIBEX Brasil Index

USD USD USD

36 15 13

3545.70 5212.00 14316.00

-2.0 3.0 1.1

-3.9 -3.7 -3.6

36.5 23.1 48.4

-3.0 3.2 1.4

na na na

Fixed Income FTSE Americas Government Bond Index FTSE USA Government Bond Index

USD USD

155 135

114.88 112.28

-1.9 -1.8

2.8 3.1

5.4 4.8

0.9 1.1

3.76 3.75

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 FTSE NAREIT Composite Index FTSE NAREIT Equity REITs Index

USD USD USD USD USD USD

119 95 114 5 135 109

2422.55 1936.06 1113.65 1194.82 161.71 513.38

10.5 12.0 10.2 13.0 9.2 11.5

-10.6 -9.5 -10.1 -15.0 -10.3 -9.5

-17.1 -17.0 -17.5 -12.6 -19.2 -16.3

4.8 6.6 5.1 1.7 3.9 5.8

4.69 4.76 4.78 3.88 5.3 4.7

Infrastructure Macquarie North America Infrastructure Index Macquarie USA Infrastructure Index

USD USD

97 90

8712.02 8641.03

5.4 6.3

-6.0 -5.6

-1.6 -2.6

-5.2 -5.2

2.91 2.87

SRI FTSE4Good US Index FTSE4Good US 100 Index

USD USD

147 101

4927.77 4733.05

4.3 4.4

-14.9 -14.9

-10.9 -10.4

-8.7 -8.8

2.33 2.35

Investment Strategy FTSE GWA US Index FTSE RAFI US 1000 Index FTSE RAFI US Mid Small 1500 Index

USD USD USD

670 1,009 1,491

3432.96 5604.98 4921.47

3.3 2.6 3.0

-11.5 -11.8 -13.0

-9.1 -9.8 -11.9

-5.9 -6.0 -5.7

2.32 2.53 1.88

Currency

Constituents

Value

2M (%)

6M (%)

12M (%)

YTD (%)

Actual Div Yld (%)

FTSE All-World Indices FTSE Americas Index FTSE North America Index FTSE Latin America Index

USD USD USD

862 726 136

871.49 950.30 1270.81

4.2 4.1 5.4

-8.7 -9.4 4.1

-0.9 -2.8 44.6

-4.0 -4.7 8.3

2.01 2.00 2.17

FTSE Global Equity Indices FTSE Americas All Cap Index FTSE North America All Cap Index FTSE Latin America All Cap Index

USD USD USD

2,793 2,594 199

397.12 379.81 1775.23

4.0 4.0 5.2

-9.0 -9.7 3.4

-1.4 -3.1 42.9

-4.0 -4.7 7.9

1.93 1.91 2.15

Region Specific FTSE LATIBEX All-Share Index FTSE LATIBEX TOP Index FTSE LATIBEX Brasil Index

EUR EUR EUR

36 15 13

na na na

na na na

na na na

na na na

na na na

na na na

Fixed Income FTSE Americas Government Bond Index FTSE USA Government Bond Index

USD USD

155 135

173.88 169.26

-1.1 -1.0

4.9 5.3

10.2 9.6

2.4 2.5

3.76 3.75

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 FTSE NAREIT Composite Index FTSE NAREIT Equity REITs Index

USD USD USD USD USD USD

119 95 114 5 135 109

3752.26 2082.77 1226.73 1291.55 3574.89 8786.74

11.4 13.0 11.3 13.1 10.3 12.5

-8.4 -7.3 -7.8 -13.8 -7.9 -7.3

-13.3 -13.2 -13.7 -9.9 -15.2 -12.5

6.3 8.2 6.7 2.8 5.6 7.3

4.69 4.76 4.78 3.88 5.26 4.72

Infrastructure Macquarie North America Infrastructure Index Macquarie USA Infrastructure Index

USD USD

97 90

10013.31 9922.60

5.7 6.6

-4.7 -4.3

1.2 0.1

-4.4 -4.4

2.91 2.87

SRI FTSE4Good US Index FTSE4Good US 100 Index

USD USD

147 101

5538.07 5338.35

4.6 4.7

-13.9 -13.9

-9.0 -8.4

-8.1 -8.1

2.33 2.35

Investment Strategy FTSE GWA US Index FTSE RAFI US 1000 Index FTSE RAFI US Mid Small 1500 Index

USD USD USD

670 1,009 1,491

3636.04 5923.81 5063.49

3.6 3.0 3.3

-10.5 -10.8 -12.3

-7.2 -7.9 -10.7

-5.2 -5.3 -5.3

2.32 2.53 1.88

Table of Total Returns Index Name

FTSE GLOBAL MARKETS • JUNE 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

Ap r-0 8

Oc t-0 7

Ap r-0 7

15:40

Oc t-0 7

Index Level Rebased (31 Apr 03=100)

26/5/08

Ap r-0 6

Oc t-0 5

Ap r-0 5

Oc t-0 4

Ap r-0 4

Oc t-0 3

Ap r-0 3

MARKET DATA BY FTSE RESEARCH

FT SE

MARKET REPORTS 26.qxd:MARKET REPORTS 26.qxd Page 92

Europe, Middle East & Africa Indices

5-Year Total Return Performance Graph 500

FTSE Europe Index

400

FTSE All-Share Index

300

FTSEurofirst 80 Index

FTSE/JSE Top 40 Index

200

FTSE Gilts Fixed All-Stocks Index

100

FTSE EPRA/NAREIT Europe Index

0

FTSE4Good Europe Index

FTSE GWA Developed Europe Index

-10

-20

FTSE RAFI Europe Index

2-Month Performance

10

8

6

4

2

0

Capital return

-2

Total return

-4

-6

1-Year Performance

30

20

10

0

Capital return

-30

Total return

-40

-50

JUNE 2008 â&#x20AC;˘ FTSE GLOBAL MARKETS

MARKET REPORTS 26.qxd:MARKET REPORTS 26.qxd

26/5/08

15:40

Page 93

Table of Capital Returns Index Name

Currency

Constituents

Value

2M (%)

6M (%)

12M (%)

YTD (%)

Actual Div Yld (%)

FTSE All-World Indices FTSE Europe Index FTSE Eurobloc Index FTSE Developed Europe ex UK Index FTSE Developed Europe Index

EUR EUR EUR EUR

579 2,048 383 513

219.96 122.04 225.12 215.04

1.4 2.7 1.9 1.5

-16.4 -15.1 -15.0 -16.5

-15.2 -13.4 -14.5 -15.7

-11.4 -11.7 -11.0 -11.2

3.46 2.99 3.45 3.55

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

EUR EUR EUR EUR

1,709 834 1,143 1,591

364.87 396.11 396.91 359.39

1.1 2.5 1.8 1.2

-17.0 -15.6 -15.4 -17.0

-16.2 -14.5 -15.4 -16.7

-11.3 -11.5 -10.8 -11.1

3.37 3.45 3.36 3.45

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

GBP GBP EUR EUR EUR ZAR ZAR USD

664 102 78 98 313 41 166 15

3099.94 6087.30 4917.78 4280.83 1337.68 28675.37 30743.49 1401.07

2.9 3.5 2.3 2.2 1.7 1.2 0.2 8.3

-10.3 -9.4 -14.7 -16.0 -16.2 0.7 -1.9 -0.8

-7.6 -5.6 -12.2 -13.3 -14.8 13.6 9.1 21.0

-5.7 -5.7 -12.5 -11.9 -11.2 9.2 6.2 -2.4

3.60 3.71 3.74 3.81 3.57 2.33 2.53 1.37

EUR EUR GBP

239 417 28

97.81 104.98 147.76

-1.9 -2.0 -0.9

-0.1 -0.6 0.8

-0.8 -1.6 1.0

0.3 -0.1 -1.3

4.45 4.83 4.81

EUR EUR EUR EUR EUR

95 38 47 81 14

1903.85 815.65 2350.97 918.47 913.17

-5.2 -3.7 -2.5 -5.2 -3.8

-17.2 -13.9 -9.7 -16.3 -29.9

-34.9 -30.7 -24.4 -34.4 -41.9

-4.1 -1.8 1.6 -3.3 -16.2

3.95 4.04 4.71 4.09 1.63

USD

55

13845.99

1.4

-4.9

9.8

-6.5

3.24

EUR EUR

294 55

4328.98 3763.66

1.8 2.8

-17.2 -16.7

-17.7 -16.9

-11.5 -11.5

3.88 4.09

EUR EUR

513 521

3469.75 5356.29

1.9 1.0

-18.1 -17.6

-18.0 -16.1

-11.5 -12.0

4.10 4.19

Currency

Constituents

Value

2M (%)

6M (%)

12M (%)

YTD (%)

Actual Div Yld (%)

EUR EUR EUR EUR

579 2,048 383 513

274.29 156.84 276.22 268.73

2.5 3.6 3.1 2.7

-15.1 -14.0 -13.7 -15.1

-12.4 -10.5 -11.9 -12.9

-10.2 -10.7 -9.8 -9.9

3.46 2.99 3.45 3.55

EUR EUR EUR EUR

1,709 834 1,143 1,591

427.78 462.70 460.79 422.05

2.2 3.4 2.9 2.4

-15.7 -14.5 -14.2 -15.7

-13.6 -11.8 -12.9 -14.0

-10.1 -10.5 -9.6 -9.9

3.37 3.45 3.36 3.45

GBP GBP EUR EUR EUR SAR SAR USD

664 102 78 98 313 41 166 15

3772.33 3593.84 5816.17 5123.69 1769.30 3094.29 3288.71 1426.80

4.1 4.7 3.2 3.3 2.9 1.9 1.0 8.3

-8.5 -7.6 -13.6 -14.6 -14.7 1.8 -0.7 -0.2

-4.3 -2.1 -9.1 -10.0 -11.9 16.4 11.9 23.0

-4.2 -4.2 -11.6 -10.7 -9.9 10.3 7.2 -1.9

3.60 3.71 3.74 3.81 3.57 2.33 2.53 1.37

EUR EUR GBP

239 417 28

160.22 182.53 2049.20

-1.2 -1.2 -0.8

2.1 1.4 3.3

3.6 2.5 6.2

1.7 1.3 -0.1

4.45 4.83 4.81

EUR EUR EUR EUR EUR

95 38 47 81 14

2558.66 890.92 2606.70 988.55 938.12

-3.9 -2.5 -0.7 -3.9 -3.5

-15.6 -12.2 -7.5 -14.6 -29.5

-32.5 -27.9 -21.2 -31.9 -41.3

-2.5 -0.2 3.8 -1.6 -15.9

3.95 4.04 4.71 4.09 1.63

USD

55

16171.17

1.8

-3.9

13.3

-5.9

3.24

EUR EUR

294 55

5310.51 4657.39

3.0 3.9

-15.7 -15.3

-14.8 -13.7

-10.2 -10.3

3.88 4.09

EUR EUR

513 521

3785.62 5786.81

3.4 2.3

-16.5 -16.2

-15.0 -13.1

-10.1 -10.7

4.10 4.19

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

Table of Total Returns Index Name 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

FTSE GLOBAL MARKETS â&#x20AC;˘ JUNE 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

Ap r-0 8

Oc t-0 7

Ap r-0 7

15:40

Oc t-0 7

Index Level Rebased (31 Apr 03=100)

26/5/08

Ap r-0 6

Oc t-0 5

Ap r-0 5

Oc t-0 4

Ap r-0 4

Oc t-0 3

Ap r-0 3

MARKET DATA BY FTSE RESEARCH

FT SE

MARKET REPORTS 26.qxd:MARKET REPORTS 26.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

10

5

0

-5

Capital return

-10

Total return

-15

-20

1-Year Performance

50

40

30

20

10

0

Capital return

-10

Total return

-20

-30

JUNE 2008 â&#x20AC;˘ FTSE GLOBAL MARKETS

MARKET REPORTS 26.qxd:MARKET REPORTS 26.qxd

26/5/08

15:40

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

2M (%)

6M (%)

12M (%)

YTD (%)

Actual Div Yld (%)

USD USD USD

1,328 859 469

283.75 494.90 93.65

2.0 1.5 2.8

-11.9 -15.3 -15.7

4.8 16.6 -19.3

-4.8 -7.2 -7.7

2.21 2.66 1.58

USD USD USD

3,288 1,985 1,303

497.93 659.68 329.62

1.5 0.9 2.6

-12.5 -15.8 -16.1

4.3 16.0 -20.0

-5.4 -8.0 -8.0

2.22 2.66 1.59

USD USD MYR TWD CNY HKD

157 40 100 50 1,032 25

466.33 9381.95 8373.60 6356.89 8995.43 23235.64

-2.6 -1.6 -6.9 5.1 -17.6 3.7

-7.4 -5.4 -8.9 -9.1 -27.0 -24.3

12.7 11.9 -3.1 11.9 5.9 44.4

-5.4 -3.9 -11.9 3.1 -24.6 -8.9

3.11 3.14 2.89 3.51 0.60 1.60

USD

253

100.05

-0.8

13.5

19.9

9.4

1.60

USD USD USD USD USD

77 38 51 40 37

2125.38 1628.00 2565.26 1201.26 1496.76

5.6 7.4 2.0 3.5 7.0

-18.5 -15.5 -18.5 -19.7 -17.8

-8.7 -8.4 -2.5 -17.1 -2.2

-7.6 -4.5 -11.8 -7.5 -7.6

3.33 6.1 4.75 5.65 1.84

IRP IRP

85 30

1338.66 1425.88

-4.1 -5.5

-21.1 -21.4

38.9 46.9

-26.1 -27.6

0.48 0.53

JPY

195

5171.67

4.4

-13.4

-17.3

-6.4

1.55

USD MYR JPY

100 30 100

6062.28 10361.35 1404.71

2.5 -8.3 0.2

-8.3 -2.3 -17.8

4.6 14.3 -20.8

-2.6 -11.1 -11.0

1.97 2.24 1.67

JPY AUD AUD SGD JPY JPY HKD

469 112 57 16 298 1,026 50

3655.29 3908.38 5875.27 7429.20 5110.99 5229.91 7508.50

3.0 1.2 -0.4 5.1 2.1 3.1 2.7

-14.6 -18.5 -16.8 -12.5 -14.4 -20.2 -22.7

-18.9 -10.8 -10.9 -1.9 -18.4 -17.5 41.6

-7.0 -12.3 -11.9 -5.0 -7.4 -12.4 -8.3

1.62 5.46 5.30 3.75 1.67 3.36 2.28

Currency

Constituents

Value

2M (%)

6M (%)

12M (%)

YTD (%)

Actual Div Yld (%)

USD USD USD

1,328 859 469

327.69 620.92 112.90

2.5 1.9 3.7

-11.0 -14.4 -14.9

7.0 19.7 -18.0

-4.0 -6.5 -7.0

1.86 2.45 1.17

USD USD USD

3,288 1,985 1,303

554.27 773.83 351.64

2.0 1.3 3.4

-11.6 -14.9 -15.3

6.6 19.1 -18.7

-4.6 -7.2 -7.2

1.84 2.37 1.17

USD USD MYR TWD CNY CNY

157 40 100 50 1,032 25

577.20 10392.08 8905.35 7587.62 9719.99 28379.26

-1.9 -0.8 -6.5 5.1 -17.5 3.9

-6.2 -4.2 -7.8 -9.1 -26.9 -24.2

16.3 15.6 -0.1 15.7 6.6 46.8

-4.5 -3.1 -11.1 3.1 -24.6 -8.7

2.71 2.81 2.50 3.38 0.55 1.49

USD

253

117.72

-0.6

14.4

22.5

10.0

1.60

USD USD USD USD USD

77 38 51 40 37

2828.89 1807.97 2764.24 1346.88 1554.20

6.3 8.1 2.8 4.4 7.6

-17.1 -13.9 -16.5 -17.5 -16.9

-5.8 -5.2 1.8 -12.7 -0.6

-6.6 -3.4 -10.6 -5.8 -7.1

2.85 5.0 3.86 4.66 1.53

IRP IRP

85 30

1344.71 1433.63

-4.1 -5.5

-20.9 -21.2

39.6 47.7

-26.0 -27.5

0.51 0.66

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

FTSE GLOBAL MARKETS • JUNE 2008

JPY

195

5570.12

5.3

-12.6

-16.0

-5.6

1.24

USD MYR JPY

100 30 100

6329.50 11098.22 1486.64

3.0 -7.8 1.0

-7.4 -1.4 -17.0

6.6 17.7 -19.5

-1.8 -10.5 -10.3

1.73 2.59 1.24

JPY AUD AUD SGD JPY JPY HKD

469 112 57 16 298 1,026 50

3797.06 4397.47 6590.03 8028.19 5294.84 5548.55 7727.16

3.9 2.0 0.4 6.0 2.9 3.9 3.2

-13.7 -16.6 -14.8 -11.2 -13.6 -19.0 -22.3

-17.5 -6.9 -6.8 1.7 -17.1 -15.1 44.8

-6.2 -10.9 -10.5 -4.2 -6.6 -11.5 -7.8

1.23 3.77 4.14 2.96 1.26 2.65 2.05

95

GM EDITORIAL 26.qxd:Issue 26

26/5/08

14:51

Page 96

CALENDAR

Index Reviews June – September 2008 Date

Index Series

Review Frequency/Type

Effective Data Cut-off (Close of business)

Early Jun Early Jun Early Jun Early Jun Early Jun Early Jun 1-Jun 2-Jun 5-Jun 10-Jun 10-Jun 11-Jun 11-Jun

ATX KOSPI 200 IBEX 35 CAC 40 OBX S&P / TSX S&P / ASX Indices DJ Global Titans 50 DAX NZSX 50 OMX I15 FTSE UK Index Series FTSE Global Equity Index Series (incl. FTSE All-World) FTSE techMARK 100 FTSEurofirst 300 FTSE eTX FTSE/JSE Africa Index Series FTSE EPRA/NAREIT Global Real Estate Index Series S&P MIB NASDAQ 100 S&P BRIC 40 S&P US Indices S&P Europe 350 / S&P Euro S&P Topix 150 S&P Asia 50 S&P Global 1200 S&P Global 100 S&P Latin 40 VINX 30 OMX S30 Baltic 10 OMX C20 OMX N40 FTSE Bursa Malaysia Index Series DJ STOXX Russell US Indices TOPIX FTSE Xinhua Index Series TSEC Taiwan 50 PSI 20 OMX H25

Quarterly review Annual review Semi-annual review Quarterly review Semi-annual review Quarterly review Quarterly Review Annual review of index composition Quarterly review Quarterly review Semi-annual review Quarterly review Annual review - Emgng Eur, ME, Africa, Latin America Quarterly review Quarterly review Quarterly review Quarterly review

30-Jun 9-Jun 1-Jul 20-Jun 20-Jun 20-Jun 20-Jun 20-Jun 20-Jun 30-Jun 30-Jun 20-Jun

31-May 31-May 31-May 31-May 31-May 30-May 30-May 30-Apr 31-May 31-May 31-May 10-Jun

20-Jun 20-Jun 20-Jun 20-Jun 20-Jun

31-Mar 30-May 30-May 30-May 6-Jun

Quarterly review Quarterly review - IWF Quarterly review/ shares adjustment Semi-annual review - constituents Quarterly review - shares Quarterly review - shares Quarterly review - shares Quarterly review - shares Quarterly review - shares Quarterly review - shares Quarterly review - shares Semi-annual review Semi-annual review Semi-annual review Semi-annual review Semi-annual review Semi-annual review Quarterly review Annual / Quarterly review Free float weight periodic review Annual Review Quarterly & annual review Semi-annual review Semi-annual review - consituents, Quarterly review - shares in issue Annual review Quarterly review Quarterly review

20-Jun 15-Jun 20-Jun 20-Jun 20-Jun 20-Jun 20-Jun 20-Jun 20-Jun 20-Jun 20-Jun 30-Jun 30-Jun 30-Jun 20-Jun 20-Jun 20-Jun 20-Jun 27-Jun 30-Jul 18-Jul 18-Jul 31-Jul

6-Jun 8-Jun 31-May 16-May 6-Jun 6-Jun 6-Jun 6-Jun 6-Jun 6-Jun 6-Jun 31-May 30-May 31-May 30-May 31-May 30-May 20-May 31-May

31-Jul 19-Sep 5-Sep 29-Aug

30-Jun 30-Jun 30-Jun 31-Jul

Annual Review / Japan 19-Sep Semi-annual review / number of shares 30-Sep Annual review of free float & Quarterly Review 19-Sep Quarterly review - constiuents, shares & IWF 19-Sep Quarterly review/ Ordinary adjustment 19-Sep Quarterly review - shares, S&P / ASX 300 consituents 19-Sep

30-Jun 31-Aug

11-Jun 11-Jun 11-Jun 11-Jun 11-Jun 12-Jun 13-Jun 13-Jun 13-Jun 13-Jun 13-Jun 13-Jun 13-Jun 13-Jun 13-Jun Mid Jun Mid Jun Mid Jun Mid Jun Mid Jun 17-Jun 18-Jun 20-Jun 1-Jul 8-Jul 10-Jul Mid Jul Mid Jul Mid Jul 8-Aug 15-Aug 2-Sep Early Sep Early Sep

SMI Family Index Hang Seng MSCI Standard Index Series FTSE Global Equity Index Series (incl. FTSE All-World) ATX CAC 40

Early Sep 3-Sep 5-Sep

S&P / TSX DAX S&P / ASX Indices

23-Jun 30-Jun 30-May

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

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

96

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GM EDITORIAL 26.qxd:Issue 26

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Page IBC1

THE FTSE I WANT THE WORLD INDEX FTSE. It’s how the world says index.

Global markets grow more complex and interconnected every day. To stay abreast, you need a comprehensive index that can slice and dice markets the way you do. The FTSE Global Equity Index Series was the first benchmark to cover the world seamlessly with a single consistent and transparent methodology. Because FTSE indices are independently verified by a panel of market practitioners, you can be sure that they will always be in line with investors’ needs.

Wherever you invest, FTSE gives you the clearest view of how you are doing. www.ftse.com/invest_world

© FTSE International Limited (‘FTSE’) 2007. All rights reserved. FTSE ® is a trade mark jointly owned by the London Stock Exchange Plc and The Financial Times Limited and are used by FTSE under licence.

GM EDITORIAL 26.qxd:Issue 26

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March 2008

December 2007

Qatar Petroleum

Borse Dubai Limited

QAR1.8 billion

USD5.8 billion

November 2007

Dubai Financial LLC

USD1.1 billion

Initial Public Offering

Syndicated Loan Facility

Acquisition of a 15% stake in Bank Muscat through a capital increase

Adviser and Lead Manager

Bookrunner, Facility Agent and Mandated Lead Arranger

Sole Financial Adviser

August 2007

July 2007

July 2007

Sabic Innovative Plastics

Abu Dhabi Ports Company

Gulf Finance House

USD8.165 billion

USD10 billion

USD200 million

Debt facilities backing the acquisition of GE Plastics by SABIC

Khalifa Port and Industrial zone project

July 2012

Bookrunner and Lead Arranger

Ongoing Financial Adviser

Bookrunner and Joint Lead Manager

July 2007

July 2007

July 2007

Qatari Diar

Qatari Real Estate Investment Company

Saudi Electricity Company

GBP767 million

USD300 million

USD1.3 billion

January 2011

Sukuk August 2012

July 2027

Sole Issuer and Joint Lead Arranger

Sole Lead Arranger, Bookrunner, Ratings Adviser and Trustee

Lead Manager and Sole Bookrunner

May 2007

April 2007

USD1.2 billion Acquisition of Lyondellâ&#x20AC;&#x2122;s Millennium Inorganic Chemicals business by Cristal Global

Sharjah Investment Center

USD880 million

AED480 million

Acquisition Facilities

Lead Arranger and Sole Bookrunner

Joint Lead Manager and Joint Bookrunner

Middle East M&A Adviser of the Year

Let HSBCâ&#x20AC;&#x2122;s global network open up a world of opportunity for your business.

For more information, contact: Global Banking: 971 4 509 3300 Global Markets: 971 4 507 7296

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