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CHINESE MUTUALS STEP UP TO THE LINE ISSUE THREE • SEPTEMBER/OCTOBER 2004

Elliot Spitzer Saviour or Glorified Tax Collector?

AP3’s new moves FBR breaks out of the Beltway

ENHANCED INDEXATION LOOKS FOR DOUBLE DIGIT RETURNS

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Outlook EDITORIAL DIRECTOR:

Francesca Carnevale, Tel + 44 [0] 20 7074 0008, email: francesca@berlinguer.com CONTRIBUTORS:

Bill Stoneman, David Simons, Ian Williams, Neil O’Hara, Art Detman, David Burrows, Andrew Cavanagh, Angela May Ward, Karen Jones.

FTSE EDITORIAL BOARD:

Mark Makepeace [CEO], Peter de Graaf, Paul Hoff, Jerry Moskowitz, Paul McLean, Stuart Ives, Marianne Huve-Allard, Sandra Steel, Carl Beckley SALES DIRECTOR:

Paul Spendiff OVERSEAS REPRESENTATION:

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FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2004

s crude oil futures continue their upward march the financial markets around the world are experiencing a sharp intake of breath. Whichever American pundit said that US profits ignite the global economy didn’t get it quite right. These days it has to be qualified by the price of crude in the global markets. Following on from our coverage last issue on the impact of rising oil prices, in this issue we examine the underlying infrastructure which ensures that crude finally does reach the motorist on the streets.

Much of the feeling of wellbeing that has underpinned the vicarious financial markets over the last couple of years has been ever-reliable real estate. An upswell of real estate deals has been a feature of the US capital markets over the last year, in particular real estate investment trust [REIT] related deals. Still the entire preserve of the US – based on a particularly supportive local tax exemption regime – REITs are now being closely watched by market makers outside America hoping to emulate their success elsewhere. We take a hard look at Friedman, Billings, Ramsey, a rising star in the REITs market, that is hoping to repeat its US success in Europe. We also extend the real estate brief to focus on the efforts of US mortgage giant Freddie Mac to bring its financial reports up to date. The outlook for the corporation is fair – even in light of anticipated changes in the regulatory environment which governs Freddie Mac. As summer draws to a close, the global equity markets appear essentially unchanged. Stock prices remain trapped by an unhappy coincidence of heightened geopolitical risks and the prospects of interest rate rises in key markets. After a good first quarter, the upward momentum of the emerging markets has not been sustained.Yet, in spite of lingering market unease, fundamentals appear to remain strong across many areas. European growth prospects appear to be making marginal improvements – particularly important in the wake of accession. The pipeline for sovereign issues has been building nicely on the Continent and in separate articles we look at Turkey, which plans to raise almost $100bn this year alone to meet debt commitments and the sovereign issuance market in western Europe. Keeping the theme alive, according to a recent report in the UK, the European framework of the syndicated loan market is in flux. We examine the data behind a controversial thesis set out by Lloyds TSB, which anticipates a geographic shift in the market, away from London [traditionally supreme] towards Frankfurt.

Another highlight of this issue however is our feature on the crusading New York District Attorney, Elliot Spitzer, who has managed to polarise opinion over the efficacy of his reforms and efforts to clean up irregularities on Wall Street. Ian Williams reviews his track record and anticipates some of his future moves.

A

Francesca Carnevale, Editorial Director, June 2004

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Contents COVER STORY A MAN FOR ALL SEASONS

..................................................................Page 33 Elliot Spitzer, New York’s ebullient and crusading Attorney General polarises opinion.

Whether you admire his tenacity or suspect his motives, Spitzer is a powerful force.

He is also changing the landscape of New York’s financial community. Ian Williams assesses his achievements.

REGULARS IN THE MARKETS

Euroclear speeds up harmonisation ..............................................................................Page 6 The rise and rise of ETFs ....................................................................................................Page 6 DrKW banks on Russia ..................................................................................................Page 6 European private equity fights back ............................................................................Page 8 Collateral management hots up ..................................................................................Page 10

MARKET LEADER

............................................................................Page 12 Do they really matter and to whom?

REGIONAL REVIEW

US leveraged loans on the up and up ........................................................................Page 15 SEC wants comfort from independent chairs ............................................................Page 18 The rand continues its upward climb ........................................................................Page 21 Turkey’s $100bn borrowing requirement ..................................................................Page 24 ETFs celebrate one year in Taiwan ..............................................................................Page 27

EQUITY REPORT

........................Page 29 David Simons explains who’s who and tells us what they are up to.

DIVIDEND FORECASTS

CHINESE MUTUALS LINE UP FOR ACTION SOVEREIGN LENDING

DEBT REPORT

..............................................................................Page 70 Andrew Cavenagh examines the prospects for new issuers.

SYNDICATED LOANS

..................................................................................Page 74 Why Frankfurt is winning business from London.

SECTOR PROFILE

DOOR TO DOOR CRUDE

......................................................................Page 52 It doesn’t matter how much oil costs if you can’t get it to the motorist.

ENHANCED INDEXATION

......................................................................Page 81 Stuart Fieldhouse introduces the new players and trends.

INDEX REVIEW

UNCONSTRAINED BENCHMARKS ................................................Page 85 The quest for double digit returns.

Market Reports by FTSE Research ..............................................................................Page 88 Calendar ..........................................................................................................................Page 96

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SEPTEMBER/OCTOBER 2004 • FTSE GLOBAL MARKETS

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Contents FEATURES FRIEDMAN, BILLINGS, RAMSEY

....................................................Page 37 Just who or what is Friedman, Billings, Ramsey? Is it an upstart Washington investment bank, or an important and emerging force in US real estate financing?

Francesca Carnevale asks whether it will ever make the big time.

FREDDIE MAC, ARE YOU COMING BACK?

......................Page 43 After a bruising two years, the US mortgage giant is working hard to put its house in order. Most people seem to think it will all come good. But inside Freddie Mac some nervousness remains. And now, the US Senate is on its case.

AP3 SHARPENS ITS MOVES

................................................................Page 48 It is a time of renewal and change at Sweden’s leading state pension fund. Its rigorous, academic and questioning approach are refreshing. But is intellectual rigour and Nordic enthusiasm enough?

GREECE BANKS ON CONSUMER SPENDING

....................Page 57 Its boom time for Greece’s myriad banks. Even so, much needed changes beckon.

Realistically not all of Greece’s banks will be able to take advantage of the new market opportunities.

SECURITIES LENDING REPORT

............................................................Page 62 How do you balance demand and supply? Neil O’Hara tells you how.

What do you do with the EU and Basel too? Angela Ward explains. ..................Page 66

WHEN MAN MEETS TECHNOLOGY

............................................Page 77 The rarefied world of risk management analytics and software development is simply to rich and arcane for us lesser mortals. We give you an insight into an industry that invariably gets its product development right without recourse to focus groups.

4

SEPTEMBER/OCTOBER 2004 • FTSE GLOBAL MARKETS

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In the Markets Euroclear speeds up market harmonisation plans EUROCLEAR, PROVIDER OF domestic and cross border settlement services for bond, equity and fund transactions, will move to a cheaper, harmonised settlement platform for STP trades from Euronext’s single order book for local and overseas members by the end of 2006, providing clients with a single access point to settle trades on the Amsterdam, Paris and Brussels segments of the exchange.

A key factor underlying the development has been the Europe-wide harmonisation among the Euroclear group of important market rules and practices, including harmonised corporate

actions, central bank money settlement, and simplified account structures.

Clients will be able to settle transactions as easily as domestic trade and will be able to settle the cash component of their deals through any one of the three central banks within the Euronext zone.

Chief Executive Officer of Euroclear, Pierre Francotte, says it is an “important intermediate step towards the creation of a single transaction processing platform for the Euroclear group.”

The Belgian central securities depository, CIK, Euroclear France and Euroclear Nederland, will

use a common settlement and custody platform. The move is significant.

Euronext’s markets are set to become Europe’s first group of markets operating with a single set of procedures.

Market owned Euroclear comprises the Brussels based Euroclear Bank, Euroclear France and Eurclear Nederland as well as CRESTCo, the central securities depositories of France, the Netherlands, the UK and Ireland.

The total value of securities transactions settled by Euroclear is more than €250trn a year, while assets held for clients are valued at more than €12trn.

DrKW banks on new Russian business LED BY CARSTEN Stork, Head of Institutional Trading in Frankfurt, Dresdner Kleinwort Wasserstein [DrKW], the investment banking arm of Dresdner Bank, is launching its Russian and Eastern European equity trading business.

Following a feasibility study the bank noted several potential new revenue streams in Russia and Eastern Europe, where institutional interest is picking up. Stork has noted mounting demand from both US institutional investors and “more traditional European accounts, in particular from France, the United Kingdom and Germany.”

Cash and derivatives is one

6

key area in which the bank is building up “secondary trading, selling Russian products to existing institutional accounts and hedge funds that wanted access to this market,”explains Carsten Stork. The investment bank will be pushing Russian equities, ADRS, and derivatives business out from its now expanded trading teams in London and Frankfurt, where over the past month five new hires have been taken on. The bank is also “considering expanding its product sales to Russian and Eastern European banks and brokers.” The move also builds on the bank’s established franchise in

Russian and Eastern European fixed income and cash products.

Stork acknowledges that Russia is not entirely a safe bet but he points out that higher risk sometimes brings higher returns. However, “we think the volatility of recent months is a single and short lived event. Over the medium and long term my belief is that the situation will calm down and, over the medium to long term, Russia offers attractive prospects for investors.”

The expanded sales and trading teams will be working closely with the investment bank’s Moscow office, which has been established since 1993.

ETFs continue apace THE USE OF exchange traded funds [ETFs] by mutual funds in the US and Europe should increase in both numbers of users and amounts invested in ETFs over the next year, says a July report from Deborah Fuhr’s ETF strategy team at Morgan Stanley.

Byron Wien, US strategist at Morgan Stanley thinks that ETFs will be ubiquitous within the next five years. He has good reason. At the end of June some 304 ETFs, with combined assets of $246bn were being managed by 35 managers on some 28 exchanges, according to a recent release by Morgan Stanley. The US still dominates ETF issuance, with the largest number of products [134] and assets under management [$178bn]. Assets under management have increased by 16.2%, with Europe accounting for the biggest upsurge, with volume up 25.5% since January. ETF trading volumes are also up, by 7.6% based on the number of shares and also US dollar daily volumes.The report says that based on information from Carson Geo’s database, the number of institutional investors holding one or more US listed ETFs has grown by 6 % over the last 12 months.

SEPTEMBER/OCTOBER 2004 • FTSE GLOBAL MARKETS

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In the Markets European private equity on the offensive THE EUROPEAN PRIVATE equity industry faces a severe test as various European governments consider legal, tax and regulatory changes. The industry is fighting back however and in recent weeks has emerged victorious from at least one of the important battles it is facing, according to SJ Berwin, the specialist UK legal firm in London.

New risk weightings for the private equity industry proposed by European regulators charged with

formulating Basel II rules were deemed overly cautious. The regulators backed down after vociferous lobbying by both the European Private Equity and Venture Capital Association [EVCA]. The new risk weighting levels are no longer deemed damaging to the industry.

The industry is hoping now to repeat this success in the UK, where proposed changes to the UK pension’s regime could make some private equity deals uneconomic.

Wyn Derbyshire, partner at SJ Berwin in London

8

The British Venture Capital Association [BVCA] has asked the government to rethink its programme.

The Blair administration has parked the issue for the time being over the summer parliamentary recess, after which it will continue to be debated in the UK’s upper house, the Lords.

According to Wyn Derbyshire, partner at SJ Berwin in London, the Department of Work and Pensions [DWP] is going to consult with the industry during the summer recess.

“I don’t think you can automatically assume the government will make sweeping changes,”he says, a view contrary to general opinion that the government had backed down on some so-called ‘problem clauses’. Some of the issues worrying the private equity industry include the “retrospection” clause which would give powers to a regulator “to look at perceived evasion of debts both going forward and back to 2003”, explains Derbyshire. Other concerns include plans to give sweeping powers of the regulator to make bodies associated with defaulting employers liable for pensions debts. Further, he adds “the bill seems to have been rushed through

without proper and timely consultation with the industry and proper scrutiny in the Commons.

The British government introduced the problem clauses late in the day for proper discussion in the Commons, so now it is the House of Lords that has been analysing them.“ The industry has expressed widespread concern that the proposed changes are too broad in scope and “could have an adverse effect on private equity and mergers and acquisitions generally, discouraging potential foreign investment and hurting the British economy,” explains SJ Berwin’s Derbyshire.

One battle, it seems, may have been won, but the industry has yet to win the war. In the meantime, the EVCA is fighting moves to force funds to consolidate the accounts of all their portfolio companies under new GAAP international accounting standards.

National associations face various threats on the tax side and lobbying for coherent rules on European fund structures is urgent. A tough fight looms and questions still remain as to whether the UK government may be as flexible as the European regulators have been.

SEPTEMBER/OCTOBER 2004 • FTSE GLOBAL MARKETS

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In the Markets Hotter collateral management at JPMorgan Chase A NEW BATTLEGROUND for market share is collateral management. On the back of new trends driving collateral management and customer feedback, JP Morgan Chase has introduced an upgrade version of the collateral optimization product, called COMET 2.

Trends towards increased collateralisation, more backoffice efficiency, an increase in use of tri-party repo and an equally rapid rise in the number of broker/dealer collateral trading desks, have all contributed to the need for greater optimisation of collateral by broker/dealers and their clients.

The bank also expects that more types of deals involving collateral will utilise the services of tri-party agents, thereby continuing to expand tri-party beyond repos and securities lending, to include secured loan and derivative transactions. The market is becoming more competitive, with SunGard Trading and Risk Systems also announcing in early August a new version of its collateral management product, SunGard Collateral.

Both SunGard and JP Morgan Chase concur that efficient asset utilisation will be the key to the success of global collateral programmes.

10

COMET2 enables brokerdealers to allocate assets within their portfolios more efficiently to enhance the value from their collateral.

“Broker-dealers seek to maximise the use of less liquid assets to enhance returns, while also meeting lenders’ rules governing eligibility, asset concentration, volatility and quality of collateral.

COMET2 adds liquidity by satisfying both requirements,” says Rajen Shah, global head of collateral management at JPMorgan Chase. In addition, the increased flexibility of COMET2 allows JPMorgan Chase clients to actively manage their portfolios across multiple counterparts.

Additional features of COMET2 allow clients to work with ‘virtual collateral’, as the system allows the customer to work with a hypothetical set of assets to allow it to optimise its trading book, explains Shah.

“We have now been in the collateral management business for 12 years and pioneered the first tri-party deal that took place in Europe,” explains Shah, “About four years ago, we sensed a shift in the market, as it took a downturn and the healthy spreads earned by prime brokers were

Rajen Shah, global head of collateral management at JPMorgan Chase Inset: Murray Brown, global product manager for collateral management

squeezed. The cost of collateralizing deals became a much more significant element of the trade.”

Essentially the upgraded version of COMET allocates collateral according to the number of accounts linked to a broker, the quality and type of collateral required by its clients, and the terms of collateral usage defined within the collateral documentation.

“Equity finance desks can choose throughout the day the priority given to asset usage. In the morning, they may be long on US assets, but may need to use them later in the day. The system will book them as lower quality in the morning and replace them as high through the day. As their available asset pool changes – we can move the collateral for them,” explains Murray Brown, global product manager for collateral management.“Equally, a client with 20 or 30 counterparts will want to optimise the collateral committed to all those accounts. COMET2 allocates collateral in an optimal manner, so that all accounts are covered and does it in minutes throughout the day,” he explains.

“Each client can set its own priority listing. It gives a lot of control back,” explains Shah.

The take up of COMET2 will largely be in Europe and the US, although it can be used in other regions.

JPMorgan Chase’s efforts to dominate the market don’t just reside in London. Its US team is also pedalling hard to develop new products. In a separate development, JP Morgan Chase’s US collateral management operation recently partnered with the Chicago Mercantile Exchange [CME] to offer customers a flexible collateral management programme that allows its users to earn interest on 100% liquid cash accounts.

The programme, named IEF5 allows customers to satisfy their initial margin requirement using cash as collateral and earn hard dollar monthly returns. Cash designated by Futures Commissions Merchants for IEF5 is placed in accounts managed by the CME Clearing House and is administered by JP Morgan as the collateral agent.

SEPTEMBER/OCTOBER 2004 • FTSE GLOBAL MARKETS

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Market Leader FORECASTING

The importance of the dividend forecast John Price, founder and managing director of the Dividend and Derivatives Directory [DaDD], the specialist dividend forecasting service for equity derivative users and income managers bangs the drum for dividend forecasting. Accurate dividend forecasting is critical for anyone utilising derivatives and index products and invaluable for other market users, he argues.

N MARCH 2003, the FTSE 100 index looked so, so different. It had fallen from its high, back down to 3,300. The second Gulf War was about to start and the market was literally holding its breath.

Headlines in the financial press said that for the first time since the 1950s, the prospective yield on the index would surpass the yield on UK government bonds.

At the time we thought there were two components of the yield: the absolute amount of the dividend and the share price. It was unlikely that the market would stay at 3,300 for very long and that the increase in dividends would not match the acceleration in prices and thus the yield would fall back.

With the FTSE 100 index low at 4,400, the current year prospective dividend yield is back at 3.8% The market is up 33% from its low, and I expect that by the time the current financial year’s dividends are paid by

I

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the end of March next year the aggregate amount of dividends paid by companies in the FTSE 100 index will have increased by 13% over the past two years. [See table on page 14.]

With FTSE UK Large Caps seeming to have paused for breath, and with some divergence of views about where we go from here, can the forecast increase in dividend flows help in pointing to the future direction of markets?

One thing is clear. There’s much more interest in dividends, both by companies and by investors. As the use of indexation and equity derivatives continues to grow, the importance of having accurate dividend forecasts has also increased. That includes knowing both the amount and the timing of future dividends. For example, until they changed to quarterly dividend payments, HSBC paid out its final dividend in March. That dividend alone accounted for nine FTSE 100 index points and the possible ex-

“Dividend volatility has been a significant issue over the past few years and has caused substantial problems in the derivatives markets.”

dividend dates straddled the March index expiry.

The dividend yield is one of the key inputs into options models and, dependent upon the duration of the options or futures contract relative to the dividend season, the annualised yield on the FTSE 100 index can vary enormously. The annualised gross yield between now and the March 2005 expiry is 4.2% and between now and the December expiry is 3.6%.

The timing differences on the CAC 40 are even more marked, and yields can range between 0% and 2.6%.

The rapid growth in the use of exchange traded funds [ETFs] is

SEPTEMBER/OCTOBER 2004 • FTSE GLOBAL MARKETS

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Market Leader FORECASTING

another reason for focusing on dividends and their timing. We recently heard that the same ETF was trading cum the dividend on one exchange and ex-dividend on another. This was an arbitrageurs’ dream! There is clearly a need for greater transparency over the dividend payments on ETFs. Finally there is pressure on investors to increase total returns.

It’s particularly true in the United Kingdom, where fund managers are under pressure to make up the shortfall in the returns following the hijacking of tax credits by Gordon Brown, the chancellor of the exchequer.

Are companies pressured to pay bigger dividends?

Companies appear much more aware of the importance of dividend payments and see the need to increase the rewards to shareholders.

Cynics say it’s because they can no longer offer capital growth. But we are seeing companies world-wide reporting both substantial increases in earnings and a generous improvement in dividend policy. This is especially so in the case of the United States and in the Far East.

In the US the yield on the S&P 500 has increased substantially from 1% to 1.8% over the past year. This is partly in response to the US government’s enlightened policy of reducing dividend tax to encourage stock market investment, in stark contrast to our own government’s policy.

There are currently 53 stocks in the S&P 500 yielding over 3.5% with one as high as 7.5%. This is offset by 127 companies which are still not paying a dividend at all. This new diversity in approach increases the need for accurate forecasting.

There’s also pressure on companies to be competitive. We

14

often see a company within a sector improving its dividend policy, to be followed later by others in the sector bringing their policy up into line.

At the end of the day however it all comes back to the amount of cash which is available to pay dividends.

“The rapid growth in the use of exchange traded funds [ETFs] is another reason for focusing on dividends and their timing.”

If companies are paying out a greater percentage of their cash flow in dividends they are more likely to have to cut them if cash flow falls.

This will create more dividend volatility in the future. Dividend volatility has been a significant issue over the past few years and has caused substantial problems in the derivatives markets. As the markets collapsed during 2000 some traders increased yields in line with the falls, without taking account of falling underlying dividend payments. They learnt to their cost the need to forecast dividends on the underlying stocks as well as looking at the implied yields of the indices.

It is important that investors identify dividends which are at risk, in terms of both the amount and the timing. It seems, however, that dividends are still a low priority for many investment analysts and it still seems to take a long time for the latest news to be reflected in analyst forecasts.

For example, following the recent profits warning from Sainsbury, the UK retailer, and the near certainty of the dividend being cut, there are today still a substantial number of stale forecasts in the market. So instead of the consensus dividend forecast dropping immediately on the announcement of the news, it tapers down until all the forecasts have come into line.

So anyone depending upon the consensus dividend yield to price derivatives is likely to end up with the wrong option valuation. [This is a typical example of where we have to override the consensus.]

Returning to the earlier table on dividend growth, subject to the consensus cash flow projections proving accurate, the dividend growth should dictate a higher direction for the underlying markets.

At this stage we feel comfortable with dividend cover but will continue to monitor the situation.

Change/projected change in aggregate dividend payments Index 2003-4 [historic] 2004-5 [current] 2005-6 FTSE 100 Eurostoxx S&P 500 Hang Seng Nikkei 225

+4% -11% +11% +18% +20%

+9% +19% +10% +3% +10%

+11% +11% +5% +9% +7%

The table compares the total historic dividend flow for the major world markets for last year March 2003March 2004, and projects the change in dividend flows for the current year [March 2004-2005] and for 2005-2006. Dividend flow calculations are based on ex-dividend dates and not on a financial year basis, which has the effect of smoothing the percentage increase or decrease and thereby making it more accurate. DaDD uses I/B/E/S forecasts as a input source into its forecasting process.

Source: DaDD.

SEPTEMBER/OCTOBER 2004 • FTSE GLOBAL MARKETS

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Regional Review

EVERAGED LOANS NOW account for one third of the syndicated loan market, up from a quarter last year.

According to Allison Taylor, executive director of the Loan Market Trade Association, a nonprofit organisation for the corporate loan asset class: “Ten years ago 70% of all leveraged loans were purchased by banks. These days, 75% are purchased by institutional investors.” As loans are becoming more liquid, “the more investors want to come in. Demand is much greater than it used to be,”she adds.

Lucine Kirchhoff, managing director, loan syndication, Banc of America Securities LLC [BAS], a subsidiary of Bank of America Corporation, terms current investor interest in leveraged loans “insatiable.”Since most institutional investors are eyeing a rising interest rate environment, “the floating rate market becomes a more attractive investment market,” she adds. As a result, a lot of money has gone into prime rate funds and collateralized loan obligations [CLOs]. “There is a tremendous flow of funds into these institutional accounts, most of whom invest all or part of their money in the leveraged loan market,” she says.

Leveraged loans crank up the pace

USA

The US leveraged loan market is up a dizzying 95% in the first half of 2004 compared to 2003, according to the latest Bloomberg data, and shows no signs of slowing down. Often referred to as a “high risk, high yield” business, leveraged loans are made to noninvestment grade companies. Is it too much, too soon? And how long can the good times last? Karen Jones reports from New York.

L

Allison Taylor, executive director of the Loan Market Trade Association

Bloomberg recently reported Bank of America Corporation as the new market leader US leveraged loans.

But Kirchhoff argues: “we have been a longtime and consistent leader in the leveraged loan market. We do more deals than any firm. Our current forward calendar stands at

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2004

$34.8bn and 87 deals. That’s 125% more than the volume this time last year.” Some part of the reason for the uptick is Bank of America’s takeover of FleetBoston Financial Corporation. Kirchhoff says: “The Fleet acquisition has been very complementary to our leveraged

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loan business, particularly since they had a strong franchise in middle market and asset base lending, which dovetails nicely with the existing BAS franchise.”

Kirchhoff, however, also lists refinancing as a “tremendous component” of the growth in leveraged loans. “Many times we think that every loan that has been refinanced has already been done [sic]. But the market remains so strong there is always another round of refinancing, which brings prices down further.”

Cliff Abramsky, vice president and assistant portfolio manger at Hartford Investment Management and the Bank Loan Team, who helps manage $900m in loans, offers that companies are “taking advantage of the strong market conditions and obtaining lower spreads, so a company will refinance its whole bank deal with a new bank deal and count that in the volume number, just to take advantage of the lower spreads.”

He adds that as they almost always have collateral, it leads to higher recovery rates in case of default by investors.” Further, they are attractive to investors when rates may be on the rise because they have a lower volatility than high yield bonds and “don’t fall when the interest rates go up.”

Despite the huge spike in leveraged loans, underlining credit quality appears to be stable, explains Lucine Kirchhoff. “I still think it is very sound. In my opinion we are not doing crazy things as far as leverage levels. We continue to have a pretty sound credit hat on as an industry. It is a very issuer-friendly environment.” She adds that even though marquee issuers or repeat issuers with a proven track record are able to garner aggressive packages,“I don’t think we are being stupid.”

Cliff Abramsky feels that credit quality on a deal-to-deal basis is not necessarily declining and the industry is in “a very favourable part of the credit cycle right now, which should continue for the foreseeable future.”That said, he offers that this will eventually change “sometime down the road.”

“If you are lending to a highly leveraged company and even though you have done your homework, you can still get stuck,” warns Allison Taylor. If you are lending, for example, to a telecom company, those assets might be future customers. If the customers don’t materialize those assets might not be worth anything. “You’ve got to really study your company,”says Taylor.

Lucine Kirchhoff also offers a few cautionary notes: “In general, while our market is becoming more liquid, it is less so than other capital markets like the equity market.

Also, right now there is less supply of loans than demand, so it’s not big enough. There is less appreciation available to investors.”

As far as the US boom in leveraged loan affecting other markets, she says leveraged loans will affect the bond market because of their “brother/sister relationship” though she feels they are more driven by the bond market than vice versa.

As far as how leveraged loans affect international markets, there is “some bleeding over to the European market.” says Kirchhoff.

“As an example, financial sponsors who do very well in monetized positions in the US might want to deploy some of that money over to Europe. Financial sponsors are doing a lot more in a global perspective.” She adds that while the European leveraged loan market is not as evolved as the US,“they are increasingly taking cues from our

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2004

Cliff Abramsky, vice president and assistant portfolio manger at Hartford Investment Management

market, just coming along slower.”

Meanwhile, Cliff Abramsky thinks the strong demand here for leveraged loans helps foreign companies. “Many investors here including us need to buy dollar loans but it doesn’t have to be from USbased companies. There are examples of foreign companies [he cites the UK’s NTO cable] which may or may not have significant business in the United States issuing a piece of their loan in dollars to attract institutional investors.”

From whatever perspective you approach the leveraged loan market, business is clearly booming and likely to stay that way for some time, particularly if the economy continues to grow. “Part of it is investor confidence in the economy,” says Allison Taylor. “Last year we were still coming out of an economic downturn and investors were less interested in highly leveraged companies. Now, the economy is getting stronger and stronger and people are taking more risk.”

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Regional Review USA

SEC seeks a modern chair In an on-going effort to rehabilitate the troubled $7.5trn US mutual fund industry, the Securities and Exchange Commission [SEC] has mandated that 75% of each fund’s board of directors and all chairmen be independent by the end of 2005. Not a popular decision within the industry, there is a plethora of conflicting opinions as to its effectiveness. While many dismiss it as “window dressing” or pointing fingers, some analysts say it could be a positive step for shareholders. By Karen Jones.

ROPER GOVERNANCE OF mutual fund companies came to the forefront last year amid a scathing series of late trading and market timing scandals. This added to the already negative climate caused by major financial debacles of the past

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several years and ushered in the current SEC crackdown.“It boils down to a governance issue. Enron and WorldCom are hot on everybody’s lips at the moment,” says John Webster of Greenwich Associates, a consulting firm on the institutional providers of

financial services. “The interesting thing is whether inside chairman are better positioned to do the job or not.”

Many are quick to point out that firms with and without independent chairs were involved in the recent scandals and there is little evidence to suggest one performs better than another. Eric D. Roiter, senior vice president and general counsel of Fidelity Management & Research said in a report to Secretary Jonathan Katz of the SEC that a study commissioned by Fidelity found empirical evidence “strongly indicating neither superior investment performance nor lower expenses is advanced by having independent directors serve as fund board chairs. To the contrary, the evidence supports the conclusion funds with independent chairs have underperformed in a statistically significant way.”

Vincent Loporchio, a spokesperson for Fidelity adds “Independent trustees have always had the ability to choose an independent director. We feel it’s taking away their choice.”

Meanwhile, Jonathan Boersma of the Chartered Financial Analysis Institute (CFA) feels independent boards and chairs can only help shareholders.“The key is the board has a responsibility to represent the interests of the shareholders. When they are not independent, conflicts of interest exist. If you have somebody in the management of the company and serving on the fund board, whose interests are they going to look out for? I think the move to have a majority of independent directors is a welcome change. The abuses are a case in point. If these funds had a majority of directors, it would have been caught much earlier.”

SEC Commissioners Paul S. Atkins and Cynthia A. Glassman both voted against the ruling. Paul Atkins says in his report to SEC Chairman William Donaldson,“I am saddened to see that we have chosen to follow the path of

SEPTEMBER/OCTOBER 2004 • FTSE GLOBAL MARKETS

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Regional Review USA

The rise and fall of two corporations 1100 1000 900 800 700 600 500 400 300 200 100 0

Jun-93

Mar-94

Dec-94

Sep-95

Jun-96

Mar-97

WorldCom

Dec-97

Sep-98

Jun-99

Mar-00

Dec-00

Sep-01

Jun-02

Enron

Data as at 30 June 2004. Source: FTSE Group

Paul S. Atkins, SEC Commissioner

atmospherics and simplistic solution, rather than taking the harder course and deferring action until we can determine what is right.”He also states funds that betrayed investors have already been punished by the marketplace and why impose a “onesize-fits-all solution?”

Mr. Atkins also believes that all the focus on independent directors shifts the emphasis away from the fiduciary obligations of the fund advisor.“The fund board is there to police conflicts of interest, but the primary responsibility to see that investors’ interests are protected lies with the advisor as fiduciary.”

Jay Gould, counsel at White & Case LLP and former SEC Staff Attorney in the 1980s, has a completely different reaction to the ruling. He thinks that both the SEC and Congress, “totally missed the boat” and lost a prime opportunity to

20

completely restructure the fund industry.

He suggests boards (independent or otherwise) do not work as the guardians of shareholders’ interests because “they don’t have day to day knowledge of what goes on. They are far back from the process.

If the boards are ineffective, and this year has proven they have no real watchdog function, why not restructure?”

Instead of corporate governance, he advocates following certain European fund structures where the fund is the account of the investment advisor and has one all-in fee.“If the fees are set in advance and the funds remain subject to certain substantive provisions of the 1940 Act…there is no need for a Board to oversee shareholders interests because shareholders can walk away from the fund any day the stock market is open by exercising their right to redeem.”

Gould adds that the Investment Company Institute (ICI) the national association and lobby group for US investment company industry has already started an independent director’s council to “educate”potential new board members. “That is like

having the fox educate the hens so they taste better before they eat them. Its not just that independent directors are not going to make a difference, but the ICI has already co-opted the process.”

Meanwhile business continues and the mutual fund companies with it.“The bottom line is this is a regulated industry,” says Fidelity’s Loporchio.

“Mutual fund companies are accustomed to new rules from Congress and the SEC, so we will comply promptly and fully as we always do. It will not change the way Fidelity will run.

We will continue to do our job.”

Jay Gould, counsel at White & Case LLP and former SEC Staff Attorney

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The muscle-bound rand has created two distinct camps that, like fans of two soccer club archrivals, brook no sober notions. Barry Sergeant reports from Johannesburg.

HAT IS THE most useful way to measure the effect of more than eighteen months of a rand bull market? For some analysts, such an exercise should focus more on the dollar’s multi-year bear market, which triggered bull runs in most other currencies. The rand has appreciated from nearly R14 to the dollar late in 2001 to R5.88 late in July, a level not seen in five years.

Continuing dollar weakness has given resource-rich countries such as South Africa a positive boost. A weaker greenback inevitably translates into higher dollar commodity and metal prices. Since 1995, for example, gold has shown a 90% plus inverse correlation with the dollar. This has led to the informallydescribed “commodity currencies,” which include the rand, and dollars of Canada, Australia and New Zealand and possibly the Brazilian real.

All else being equal, higher commodity prices tend to improve the terms of trade in these countries, and can contribute to the elusive “virtuous circle.” Here, rising foreign exchange and related balances contribute to internal stability, which is characterised by robust economic growth, low inflation, and rising productivity.

While the good and bad of a strong [or weak] currency can be debated

W

endlessly, the simplest manifestation of the phenomenon for a resources rich country is that exporters suffer, and importers laugh all the way to the bank. Given the great openness of the South African economy, there is no end to speculation on the rand’s next potential move.

On the ground, exporters, led by a vocal mining sector, pay costs, many of which are administered, in rands.

Dollar proceeds, measured in rands, have eroded to the point where two in every five South African gold mines, owned by the country’s major producers, are operating at a loss at the current rand gold price. Almost another third are generating operating margins of less than 10%.

Previously dramatic expansion plans in the booming platinum sector have been trimmed back, and job losses mount across the general sector. However, resources stocks with transnational operations have prospered, relatively speaking. Among the gold stocks, AngloGold Ashanti has 25 operations in 11 countries, with production nearing 7m ounces a year.

Looking at dollar stock prices, AngloGold Ashanti has outperformed Durban Roodepoort Deep, a relatively high-cost South African focused producer, by a margin of about 50% over the past two years. Beyond single-commodity stocks, the two

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2004

SOUTH AFRICA

The rand in constant motion

large diversified resource entities, Anglo American and BHP Billiton, which hold multiple listings, have seen the benefits of higher dollar commodity prices outweight the negative effect of a weaker dollar. The prices of the two stocks on the London Stock Exchange are up by roughly a half since the rand hit its low point late in 2001.

Looking at the Johannesburg Stock Exchange [JSE] Securities Exchange, performance since the rand’s longerterm low in late 2001 has closely tracked other major markets, not least the leading indices on Wall Street and London. Most such markets touched medium-term highs in February and March this year. In dollar terms, the JSE is back at levels last seen in early 1998. The dollar index of the market almost doubled from mid-2002 to the highs seen earlier this year.

At current levels, the JSE’s overall price/earnings [P/E] ratio is around 13 times. It has re-rated from about nine times in late-April 2003, and remains above both the 20-year mean of 12.8 times, and above the very long-term [44-year] mean of 11.4 times. In recent years, sophisticated investors have become wont to strip out the dual listed stocks when assessing fair value on the JSE. Such stocks – mainly BHP Billiton, Anglo American, and SABMiller – tend to pick up higher ratings due to their primary inclusions in developed, rather than emerging, markets indices. Such stripping out inevitably shows that the “balance” of the JSE is cheaper than the overall average. The outlook, moreover, for corporate earnings is positive, and companies are generally lean on debt.

Recent results from dual listed landline monopoly Telkom [which owns 50% of mobile telephone entity Vodacom], and MTN, a Vodacom competitor, startled on the high side,

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Regional Review SOUTH AFRICA

along with figures from a host of companies across most sectors, such as retailer Edcon. But the miners with heavy reliance on domestic operations continue to hemorrhage.

One of the more eloquent voices among the export sector is that of Bobby Godsell, CEO of AngloGold Ashanti. In his view, South Africa is “dividing into a kind of strong rand, weak rand nation.”He draws a parallel

with the great two domestic football rivals, Kaizer Chiefs and Orlando Pirates, but says that even that analogy leaves lots open to debate. In a recent interview, Godsell said that he thought the critical question is –“as a nation, do we think we have the foreign and gold, note gold, exchange reserves that we want? Our foreign reserves are lower than those of Botswana. We are a much bigger economy, a very open economy, very open to global markets. I think we need to build our reserves.”

He continues: “The second question is – do we really want to run positive interest-rate differentials that take inflation in different countries of 4 to 5% above our competitors, both our trading partners but also our competitors, like Australia? I don’t think so.

“Third question is, do we really need the capital controls that are still being placed, particularly, on South Africa? One of the problems with the rand is that it’s a shallow, narrow market, and single transactions and

AngloGold Ashanti ISIN ZAE000043485 SEDOL 6565655 Exchange South Africa (Johannesburg) Country South Africa Economic Group Resources (00) Sector Mining (04) Sub Sector Gold Mining (043) Full Market Cap (ZAR millions) 53,728 The companies are constituents within the following FTSE headline indices: AngloGold Ashanti FTSE Global All Cap Index FTSE All-World Index FTSE Global Large Cap Index FTSE Advanced Emerging All-Cap Index FTSE All Emerging All-Cap Index FTSE Global Islamic Index FTSE/JSE Africa All Share Index FTSE/JSE Africa Top 40 Index

22

speculative trades deeply impact on the exchange rate. If we were to open up the exchange controls, I think you would have many more people standing in a line, both to buy dollars, but also to buy rands. And I think then the rand would find a much more natural level. So that’s the kind of debate, rather than thinking that it’s just strong or weak.”

Looking beyond the strong-weak rand debate, South Africa recently celebrated ten years of democracy. The financial markets cheered an overall cocktail of influences that can be described as anything but sour. The Reserve Bank governor, Tito Mboweni, reminded that the country has now experienced eighteen consecutive quarters of economic expansion, “this being the longest upward phase of the business cycle on record.”

The consumer price index [CPIX] is now at 1.2%, although the Reserve Bank prefers to use the CPIX measure.

This has declined from 11,3% in October and November 2002, and is now at 5%, and within the 3% to 6%

Durban Roodepoort Deep ZAE000015079 6267780 South Africa (Johannesburg) South Africa Resources (00) Mining (04) Gold Mining (043) 3,642

BHP Billiton GB0000566504 6016777 South Africa (Johannesburg) South Africa Resources (00) Mining (04) Other Mineral Extractors & Mines (048) 132,836

Durban Roodepoort Deep BHP Billiton FTSE Global All Cap Index FTSE/JSE Africa All Share Index FTSE All-World Index FTSE/JSE Africa Top 40 Index FTSE Global Mid Cap Index FTSE Advanced Emerging All-Cap Index FTSE All Emerging All-Cap Index FTSE Global Islamic Index FTSE/JSE Africa All Share Index

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Brothers, in giving South Africa the third-poorest score in its recent quarterly “Damocles” report, an analysis of 17 emerging markets. The Lehman Damocles Financial Crisis Index, a proprietary early warning system that helps identify the risk of a financial crisis in emerging economies, rated South Africa third to only Philippines and Hungary. High nominal – and real – domestic interest rates help to finance the currentaccount deficit, certainly in the short term. However, a longer-term way to address the challenge is yet to be articulated.

As a final word, it has not escaped attention that views on the rand differ at even the highest official levels.

South Africa Reserve Bank governor, Tito Mboweni, recently said that a strong rand was doing South Africa more good than harm by, for example, promoting increased productivity, especially in the export sector. Finance minister Trevor Manuel however, has expressed a sharply contrasting view, with express concerns over mounting

SOUTH AFRICA

target. CPIX is expected to climb in the months ahead, not least on high crude oil prices, and then decline from early in 2005. While the Reserve Bank has robustly denied any responsibility for the value of the rand, it appears to regard its role in managing the inflation rate as first on its list of priorities.

The anomaly here is that while South Africa’s rate of inflation is demonstrably low, and well below that say, in the US, its interest rates are substantially higher. The core FedFunds rate in the US is just 1.25%; the comparable rate in South Africa, the repo, is at 8%. The substantial difference between the two rates – as referred to by Godsell – is an undeniable attraction for neverending roaming global capital flows, also known as “hot money.”

There may be a simple reason for South Africa’s inexplicably-high interest rates. The country’s currentaccount deficit was identified as the country’s key financial concern by global investment bank, Lehman

job losses in the export sector.

Mboweni was reappointed governor of the South Africa Reserve Bank for a second period of five years at the end of July. The decision to renew his tenure came after talks between Mboweni, Trevor Manuel and board members at the central bank. The renewal of Mboweni’s tenure was not without debate – as recent press speculation had it that former deputy governor Gill Marcus was being considered as his replacement.

“While the good and bad of a strong [or weak] currency can be debated endlessly, the simplest manifestation of the phenomenon for a resources rich country is that exporters suffer, and importers laugh all the way to the bank.”

SAB Miller GB0004835483 6145240 South Africa (Johannesburg) South Africa Non-Cyclical Consumer Goods (40) Beverages (41) Beverages - Brewers (415) 79,798

Telkom ZAE000044897 6588577 South Africa (Johannesburg) South Africa Non-Cyclical Services (60) Telecommunications Services (67) Fixed-Line Telecommunication Services (673) 44,312

MTN ZAE000042164 6563206 South Africa (Johannesburg) South Africa Non-Cyclical Services (60) Telecommunications Services (67) Wireless Telecommunication Services (678) 47,205

SAB Miller FTSE/JSE Africa All Share Index FTSE/JSE Africa Top 40 Index

Telkom FTSE Global All Cap Index FTSE All-World Index FTSE Global Large Cap Index FTSE Advanced Emerging All-Cap Index FTSE All Emerging All-Cap Index FTSE/JSE Africa All Share Index FTSE/JSE Africa Top 40 Index

MTN FTSE Global All Cap Index FTSE All-World Index FTSE Global Large Cap Index FTSE Advanced Emerging Large Cap Index FTSE All Emerging All-Cap Index FTSE Global Islamic Index FTSE/JSE Africa All Share Index FTSE/JSE Africa Top 40 Index

Data as at 30 June 2004. Information regarding further indices of the companies e.g size, SRI, style and sector indices are available from www.ftse.com

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2004

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Regional Review TURKEY

Turkey steps up borrowing Debt levels once again top the agenda in Turkey. Despite the best efforts of the Erdogan government, the country is fighting a rearguard battle against rising debt levels.

OME SHORT TERM relief, very short term in fact, is in sight.

Against the backdrop of a debt service requirement of $9.8bn in August, the Treasury has announced intentions to raise $7bn from the markets. It’s a relative relief from an extensive debt raising programme, which is expected to top $100bn this year. With outstanding and fast rising domestic debts of some $115.5bn [up 15% on 2003], some 60% of the debt is to private sector banks and mainly short term [with maturities up to 360 days]. Its foreign debt levels are also a concern, topping $130bn, of which $60bn or so is direct government debt. Most of this debt is medium to long term.

According to Ozgur Unal, at Is Investment in Istanbul,“the significance of August’s borrowing programme is that the roll-over ratio target of 73% is significantly below the general roll-over target ratio of the Treasury, which is around 85%.”Turkey’s Treasury can claim a relatively strong hand at the moment, say analysts in Istanbul. Surprisingly, investors have also discounted new reports that the country’s worsening trade deficit has mounted to $16.44bn in the first half of this year – which will put increased pressure on the country’s current account.

With $4bn already in its coffers and a further $661m credit tranche due from the International Monetary Fund [IMF];

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Turkey’s stock in the international arena has improved. The market still awaits confirmation of a new IMF agreement for 2005 and the government will have submitted a three year programme by the end of this month. Its current three year standby accord, worth $20bn, actually ends in December this year. As well, the country’s reported growth figures in the first half of this year appear to be trending at higher than expected levels and recently released central bank figures confirm the economy grew at 5.9% in 2003. Analysts say that a deal that includes fresh lending from the IMF, rather than a monitoring agreement, will help provide the government with debt servicing relief over a period of heavy debt repayments.

The country’s benchmark Global-34 bond rose 0.50 points in early August, pulling the yield to 8.685%.

More importantly, however, is the consistency the Erdogan government has achieved in keeping inflation under control – this year it will be around 9%, down from 18.4% last year – a fair feat in a country where inflation commonly raged at levels between 50% and 120% during the 1990s.

Privatisation remains a sticking point.

No-one doubts the will of the government to push through with some high profile sales. However, growing internal political opposition and the lack

The Ataturk Mausoleum

of clarity of the legal position of some key planned privatisations could undermine the goodwill generated by the government elsewhere. Among the bigger state owned concerns up for sale are Bayindirbank; Pamukbank and Toprakbank; Turkish Airlines (THY); Turk Telekom; state paper and pulp company SEKA; fertilizer companies IGSAS and TÜGSAS; mining companies Eti Krom and Eti Gümüs, and steel manufacturer Erdemir. The planned merger between state-owned mobile phone network company Aycell with its private sector counterpart Aria [operated by a joint venture between Telecom Italia and Isbank] is currently in negotiations.

France’s Société Générale, Turkey’s Tekfen Holding [which already owns Tekfenbank], and a Libyan-Canadian consortium are reported to be bidding for Pamukbank. Doubts still remain, however, on the process by which both Halk Bank and Ziraat Bank – both are slated for privatisation – will be undertaken. The complex shareholding structure of Halk Bank and its legal status actually preclude a direct sell-off.

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Thereâ&#x20AC;&#x2122;s the old fashioned way...

...and then thereâ&#x20AC;&#x2122;s our way

FTSE Global Markets gives you immediate access to 20,000

issuers, fund managers, pension plan sponsors, investment bankers,

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TAIWAN

Anniversary for first Taiwan ETF Polaris International Securities Investment Trust [Polaris SITE], in cooperation with the US’s State Street Global Advisors [SSgA], launched the Polaris Taiwan Top 50 Tracker fund [TTT], along with the derivative Taiwan 50 Index Futures only a year ago. The fund has increased nearly nine-fold, from $123m on launch to $1.3bn today, attracting over 7,000 local and international investors. Holdings by foreign investors now account for almost 6% of TTT’s total assets under management.

HE ETF WAS Taiwan’s first and necessitated amendments to some 60 pieces of domestic legislation within a relatively short period of five months to facilitate the launch of the fund. Retail savings plans, warrants and life insurance policies linked to the ETF are now available.

Based on the Taiwan 50 Index of outstanding stocks, the underlying index was jointly compiled by the TSEC and FTSE Group. The index comprises 50 of Taiwan’s largest companies which together account for 68% of Taiwan’s weighted price index.

Nearly 50% of the constituents are high tech shares, such as TSMC and UMC. The index is reviewed quarterly and has a relatively high beta [1.08] and high volatility [30.77%] compared with those of the TAIEX and MSCI Taiwan Index. The correlations of returns among the three indices are also high.

TTT differs from other ETFs because of its trading mechanism.

Participating dealers [PDs] are market makers, creating an in-kind creation/redemption in the primary market, in which cash settlement is not involved. There are 25 PDs, of which 9 are foreign and 16 are domestic.

TTT is then bought and sold like any listed stocks on the secondary market and is settled in cash through an investors’ securities account.

Foreign participating dealers now include Citigroup, CSFB, Deutsche

T

Securities, Goldman Sachs, JP Morgan, Merrill Lynch, Morgan Stanley, SMBC-Cathay and UBS. On its first day of trading, TTT opened at $1.07 per share, with turnover of 9.9m shares. That level of trading has fallen off somewhat and today the average daily volume is around 6.7m shares [equal to some $9.36m in value terms]. At its highest point, back in April, daily trading of shares in the ETF hit an all time high of 31.2m shares.

Polaris SITE, the fund manager of the

TTT, is a member of the Polaris Financial Group and is 25% owned by Polaris Securities, which itself is listed on the Taiwan Stock Exchange. Polaris Securities chipped in some $21.3m into the fund, creating 20 million units – with a further $102.5 coming in from a team of sixteen local brokers, including KGI Securities and Yuanta Securities, and one foreign broker, Daiwa Securities SMBC Cathay, who also signed up as participating dealers. This raised just over $123m, equal to 116 million beneficiary units.

Chart 1: Taiwan 50 Index versus TAIEX versus MSCI Index Index* TAIEX Taiwan 50 Index No of Stocks* 645 50 Market Cap* $380 bn $260 bn Beta** 1.00 1.08 Volatility** 27.93% 30.77% Correlation** 100% 98.45%

MSCI Taiwan 100 $282 bn 1.06 30.34% 97.94%

Sources: *FTSE/TSEC Bloomberg/Polaris **Polaris/Bloomberg/MSCI 1/1/2001~6/30/2004

ISIN SEDOL Exchange Country Economic Group Sector Sub Sector Full Market Cap (ZAR millions) Polaris SITE is in the following key FTSE indices:

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2004

Polaris SITE TW0002854007 6697428 Taiwan (Taipei) Taiwan Financials (80) Speciality & Other Finance (87) Investment Banks (875) 21,685 FTSE Global All Cap Index FTSE All-World Index FTSE Asia Pacific Mid Cap Index Data as at 30 June 2004.

For a comprehensive list of the FTSE indicies that Polaris SITE appears in, please contact info@ftse.com

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SPONSORED STATEMENT

CSX

The Cayman Islands Stock Exchange (CSX) now enjoys status as a ‘recognised stock exchange’ under Section 841 of the Income and Corporation Taxes Act 1988. In today’s global marketplace, keeping pace with the latest innovation, regulation and trends is essential. Recognition by the UK Inland Revenue confirms the CSX as an exchange of comparable merit and capacity to those in a major economy or significant financial centre. It also confirms Cayman as a global player with the regulatory and legislative framework necessary for the conduct of international finance and securities transactions.

What does this recognition imply?

It is a significant advancement for the recognition and status of Cayman as a listing jurisdiction for funds and debt securities and opens new possibilities for funds that had previously sought listing on the Irish, London and Luxembourg exchanges.

• Companies listing the debt securities on the CSX can take advantage of the "quoted eurobond exemption". Interest on such securities is now paid without deduction of UK withholding tax. Already among leading jurisdictions for structured finance transactions, recognition of the Cayman Islands increases its attractiveness as an offshore financial centre for the issuance and listing of corporate debt and a variety of asset-backed and securitised interest-bearing notes.

• Securities of any company listed on the CSX may be regarded as "qualifying investments" for the purpose of investments in personal equity plans (PEPS) and individual savings accounts (ISAs).Therefore ISA and PEP managers can now invest in any debt securities, corporate bonds, notes, hedge and any other funds listed on the CSX. • Personal pension schemes can hold securities listed on the CSX. UK residents

can now invest their tax and retirement plans in CSX listed funds. Securities traded on a recognised stock exchange are a permitted investment for selfinvested personal pensions (SIPP) – including equities as well as equity warrants and convertible securities.

Hedge funds listed on the CSX also qualify as a permitted SIPP investment.

What other advantages does the CSX offer?

With 700 listings and a market capitalisation of over $50bn, the CSX has posted an annual growth rate of 45%. Much of its considerable growth can be attributed to the hedge funds that have listed on the Exchange since 2002 and the exchange is a market leader in this regards. The CSX combines several key elements attractive to capital market issuers around the world.

• Listing rules are ideal for institutional investors operating in sophisticated financial markets.

• The listing process is swift with an emphasis on the disclosure of all relevant information without imposing unnecessarily onerous conditions.

• The CSX is able to react quickly to changes in products and markets.

• No local listing agent is required for listing of specialist debt securities. Listing can be arranged by the issuer’s lead manager or Cayman legal counsel to the issuer, dealing directly with the CSX. • Unlike competitor exchanges in London, Ireland or Luxembourg, the CSX is not bound by the European Union Listing Directives and is therefore more flexible.

• The CSX staff is dedicated and professional, with vast experience in capital markets and regulation. They understand the complexities of specialist products.

• CSX’s competitiveness lies in adherence to an issuer’s timetable as well as offering low listing fees. Usually CSX staff guarantee a 2-5 day turnaround time for reviewing listing documents.

• Potential and current investors can get an added level of comfort that an issue is regulated and that an independent third party is monitoring compliance with the terms of operation stated in the offering memorandum.

• A CSX listing ensures a certain level of transparency and visibility, which is notably attractive to both future and current investors.

For further details please contact us by email csx@csx.com.ky or fax on (345) 945 6061 for the attention of the Chief Executive Officer.

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CHINESE MUTUALS

New funds step up for action The rapid growth of China’s mutual fund industry is reverberating at home and abroad. Many of China’s new stock of mutual funds are in fact joint ventures, between domestic and foreign institutions. Their explosion has coincided with a continued rise in the value of Chinese stocks and the liberalisation of the local insurance and pensions market.

So far the going has been good.

How long can the good times last? David Simons reports.

PARKED BY A succession of initiatives undertaken by the government, China’s economy has come alive, helped in part by the arrival of an estimated 700 foreign companies since the start of the year alone. The influx of capital has, in turn, energised the equities markets, centred in Shanghai and Shenzhen.

Emerging products such as the country’s first set of exchange traded funds [ETFs] are indicative of the country’s rapidly maturing financial markets. Additionally, China’s Banking Regulatory Commission is considering opening the market to foreign credit-card issuers; it has already approved increasing the range of coverage available to foreign insurers by year’s end.

Market sentiment is also strong that China’s comprehensive welfare system shows signs of crumbling,

S

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2004

creating a need to encourage more pension savings as its population ages. Hand in hand with the hastening growth of new mutual funds in China [often with the joint venture participation of a major foreign partner] increasingly well-known insurance names are coming to the fore.

Although worth only an estimated $20bn today, China’s mutual fund industry has much to look forward to.

According to end-of-year Central Bank statistics, there is at least $1trn in retail savings accounts round the country.

Interest is also kindled by the fact that the country’s stock market is expected to grow by at least 5% this year, in spite of some caution resulting from rumours that the country’s credit regime may tighten.

It also signals a general turnaround in China’s fund industry. China’s 102 funds are reported to have

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CHINESE MUTUALS Connie Bolland, regional economist for the Economist Corporate Network in Hong Kong

accumulated combined net earnings of RMB1bn [$112m] in 2003. At the end of July this year, the state media reported that already RMB85.3bn in funds were under management.

The rise of Chinese mutuals really began at the start of this year. The year kicked off with the first joint venture mutual fund deal, and a big one at that. Xiangcai Securities and ABN Amro Asset Management established the joint venture mutual fund ABN Amro XIANGCAI Fund Management Co. Ltd. Collaboration between Xiangcai Securities and ABN Amro is extensive, involving information exchange, equity investment, co-investment in fund, training and recruitment. ABN Amro Asset Management also committed itself to deploying specialist staff to investing, research, risk management, products and marketing to power ABN Amro XIANGCAI’s business growth. Previously Xiangcai Securities had operated the Xiangcai Hefeng Fund Management Co. Ltd, which had been formed in mid-2002 and is now folded into the joint venture. It also owns China-Euro Securities, China’s fourth-ranked securities firm.

ABN Amro XIANGCAI has RMB100m in registered capital, with 33% held by ABN Amro. The firm tapped investors throughout the first quarter of this year and by April had raised some $320m for an initial batch of mutual funds. ING Investment Management [INGIM], ABN Amro’s Dutch competitor has been hot on its heels. ING had set up a joint venture with Shenzhen-based China

30

Merchants Securities, in which it had taken a 30% stake. At the same time ABN Amro XIANGCAI was in the market looking for investor dollars, INGIM had also managed to raise over $300m. Analysts now expect the Chinese mutual fund market to rise rapidly in value, with some optimistic estimates having it that the sector could be worth $100bn by year end. That’s a big target, but for now, enthusiasm by foreign investment firms looking for entry into the country remains strong.

Most recently comes the news that the UK’s life insurer Prudential is seeking to establish an asset management business in China. Prudential already has a joint venture partner with the one time government development agency and now transnational conglomerate, the Citic Group, and extensive life insurance operations in Beijing, Guangzhou and Souzhou. Like other insurers, it is hoping to secure further city licenses. “Prudential is firmly committed to building its business in Asia for the long term,” said Jonathan Bloomer, group chief executive of the company. “China has one of the world’s most rapidly developing insurance markets, and it is a very high priority for us.”

Although opportunities abound, at present foreign insurance companies control less than 2% of the life insurance market in China, which is reckoned to be worth more than $1.3trn. In China’s major cities that figure rises to over 13%; no accident, given the restrictions of geographically limited operating licenses.

However, a proposed move by China’s Banking Regulatory Commission could change all that. Beginning in December, foreign insurers will be able to provide their services throughout the mainland and offer the same range of products as their domestic counterparts. The news touched off a flurry of activity among players such as Citigroup which, in June, became the latest in line to establish insurance operations. Since setting up shop in Beijing earlier this year, Prudential’s sales have risen over 50%, according to Bloomer.

The trend could have far-reaching impact according to a new report by Bank of China International (Boci) Research, which sees foreign insurers grabbing 25% of China’s life-insurance market share over the next five years, reaching a possible 50% by 2020.

“With China’s WTO membership, we see a strong commitment by the authorities to liberalise the regulations,” offers Werner Zedelius of the Allianz Group.

“China has come a long way, but we need to see further efforts in this direction.”

Fund Forays In March a new tone was set through Fortis Investments, Belgium’s ranking financial services group, which runs the Fortis Haitong Investment Management Co. Ltd, which launched a second mutual fund in China, raising RMB13.15bn [around $1.5bn]. The fund is now the single largest mutual fund in China and accounted for the largest mutual fund IPO in the country. The Fortis Haitong office is based in Shanghai.

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Since then, the market has dipped as concerns over based broking house. The joint venture, called AIGpotential overheating of the economy caused investors to Huatai Fund Management Company, with a registered take profits and adopt a cautious approach to Chinese risk. capital of Yuan100m [about $12.5m] with each partner They are not out of the woods. As investors start to holding a third of the stock. The fund will be based in discount some of the macro concerns, corporate earnings Shanghai.

“China’s fast economic growth and high savings rate, prospects in the second half of “2004 and next year look murky”, according to the Fund Manager’s report of the JF along with a lack of diversity and sophistication of investment options within China, presents good business Greater China Fund, released in July. opportunities to foreign That won’t stop market fund management firms liberalisation and it seeking to develop the won’t stop foreign firms “With China’s WTO membership, we see a Chinese market,” explains from taking advantage of Connie Bolland, regional the opportunities. Recent strong commitment by the authorities to economist for the Economist developments could cement liberalise the regulations,” offers Werner Corporate Network in Hong that view. The anticipated Zedelius of the Allianz Group.

Kong and a former vice launch of ETFs on the president for Lehman Shanghai Stock Exchange, Brothers in Tokyo. The influx which was announced in early July, will go far to help stabilise the market and of foreign companies has helped bring increased stability to encourage a longer term investment approach over the market, say observers, and has also contributed to the ongoing bull market in Chinese stocks. today’s short term trading bias.

China Asset Management [or Hua Xia] and Hua An Fund Management, as well as index-investment architect Control Issue Barclays Global Investors, are expected to become the first All foreign financial companies seeking to do business in batch of fund management companies to launch ETF China are required to enter into a joint partnership with products. Subject to terms to be announced by the a domestic entity by the Chinese Securities Regulatory Exchange, the cost of trading ETF units is expected to be Commission, which also limits foreign ownership to 33% about one-third to one-fifth of what investors will of the joint venture. Allianz Group teamed with Guotai otherwise pay in subscription and redemption of Junan Securities to form Guotai Junan Allianz Fund traditional mutual funds. That could cause some small Management. Its latest offering is the Desheng Small problems for mutual funds going forward, but for the time Cap Selective Fund, formed with strategic partner ICBC being their outlook remains positive.

Bank. AIG’s primary mainland partner is Huatai Assisting China AMC in the ETF deployment is Securities, which, combined with China's Souzhou New Boston-based State Street Corporation. Vincent Duhamel, District Hi-Tech Industrial Co. and Jiangsu Senior Principal and Chief Executive of State Street Communications Holding Co., controls two-thirds of the Global Advisors/Asia, underscores the benefits of the fund’s $12.1m holdings. collaborative venture. “We know the mechanics of the Though the 33% foreign-interest cap will improve to product very well, and China AMC is in a much 49% by year’s end, the unequal apportioning of assets has better position than we are to fine-tune and been somewhat of a deterrent, particularly where American customise the product to the local environment,” businesses are concerned. “This restriction presents said Duhamel. problems,”says Bolland,“Even 49% ownership won't help, In July, AIG Global Investment Corp. [AIGGIC], the because US firms want to have full control, i.e. 100% investment arm of the insurance conglomerate American ownership, of the firm for best fund performance, corporate International Group Inc. [AIG], the largest property governance and compliance control.” insurance company in the world and China’s leading Members of the European investment community, private-equity investor, announced a first foray into the however, appear to be more willing to accept the terms, Chinese mutual-fund business. AIG had been one the first preferring instead to focus on establishing initial firms to be granted new licenses to set up and operate fully relationships and securing a foothold in the burgeoning owned insurance operations in Beijing, Dongguan, market, according to Bolland. “Europeans seem to have a Souzhou and Jiangmen as part of a wider initiative to open better understanding and tolerance of the constraints of the up the Chinese insurance market to foreign insurance Chinese governments, especially those who have been companies back in the 1990s. operating in China for a long time,” says Bolland. “Also, AIGGIC, which has assets of more than $180bn [as of their quarterly fund performance or financial-reporting end December 2003] joins the growing list of China- standards may not be as stringent as their US counterparts.” based foreign financial companies into China. AIGGIC Given the current US stock-market uncertainty – and will establish a joint venture fund management company still licking their wounds from the recent mutual fund in Shanghai together with Huatai Securities, a Nanjing- scandals – investment groups may be loath to take the

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kind of risks required of a US-Sino financial pact. “That may well be the case,”says Bolland,“but most companies that have gone into China started researching the market well before that, bearing in mind that the hunting period can be as long as one or two years.” AIG, for instance, laid the groundwork for its insurance affiliation when outspoken chief executive officer Maurice Greenberg accompanied George Bush on the former President’s infamous 1992 Asian trade mission; the Allianz Group first arrived on the mainland a decade ago.

“Those with experience operating in China are better prepared to take on the challenges and secure deals with their Chinese partners,” adds Bolland. “Pricing, patience and persistence are critical to success in securing joint venture partners in negotiations.”

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Mutually Beneficial

FTSE/Xinhua China A 50 Index

FTSE/Xinhua China A 200 Index

FTSE/Xinhua China A All-Share Index

FTSE/Xinhua China A Mid Cap Index

Investment companies who are bullish on China say the terms of the joint venture offer substantial benefits for both sides. Unlike in the US where the percentage of cashsavings is among the lowest in recent history, a lack of investment alternatives in China has resulted in an estimated accumulated savings of nearly $1.3trn; even with only a half stake, foreign companies may nonetheless wind up with a substantial piece of the action in the long run. As Chinese citizens become increasingly acclimatised to the idea of equity investing, the prospect for the growth of pension equity funds seems particularly positive, given the current low returns on cash and the pressing needs of China’s elderly.

For China’s fund managers – many of whom have been weaned on the concept of trading, not holding, shares of stock – partnering with Western firms provides an opportunity to understand the basics of long-term capital appreciation. “It is also important for them to feel that the foreign firm is sincere, and treats them as equal partners,” says Bolland. “In the JV, foreign firms have to be patient because most of the decisions will need to be made jointly and by consensus.”

FTSE/Xinhua China A Small Cap Index

Lessons in Chinese Learning to adapt is the first order of business for any Western institution crossing into non-Western territory, says Teh-Hsiu Fu, manager of the newly formed AIGHuatai Fund Management venture. “Those who are not familiar with the Chinese market lack the proper understanding of its evolution, and therefore they occasionally find the market to be like an impossible maze,” notes Fu. “As many potential foreign partners eagerly try to enter the market, it remains quite important for these companies to demonstrate a valid business model that is capable of producing sensible revenue forecasts.”

“Foreign houses need to match their corporate strategies with their China strategies and know what sort of Chinese partners they need,” says Bolland. “After all, foreigners hope to tap into China’s vast domestic market

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Chinese historical large cap out performance – can the trend continue? FTSE/Xinhua China A Index Series

Jun-04

Data as at 30 June 2004. Source: FTSE Group

and huge savings. Chinese firms, however, seek to raise their competitiveness and market image by linking up with international firms with good brand names. They expect their foreign counterparts to transfer technology and management expertise to them. Over the longer term, they also hope that they can gain more investment options and product development techniques from their foreign partners.”

Looking Ahead Given the traditional volatility of the Asian markets in general – and the nature of China’s equities market in particular – foreign investors understand that the road ahead could be bumpy, to say the least. With inflation tripling year-to-year as a result of China’s surging economy, the potential for an increase in interest rates is substantial.“There are any number of risks, and the largest of them all is a tightening of monetary policy,”says Zheng Weigang, a senior analyst at Shanghai Securities.

Even if Beijing is successful in throttling down China’s current double-digit rate of growth, the investment outlook over the near-term is still robust.“I think that 7% to 8% growth per year for the next two years still looks possible,” says Bolland. “If China is to slow the economy, it’ll probably take another two to three years before the full impact is felt.”

Though the ongoing liberalisation of China’s financial system is encouraging, doubters may prefer to take a waitand-see approach until a substantive trend is established.

But for those willing to take the risk and roll with the changes, the payoff could be huge.

“It is still early,” says Bolland.“But for foreign firms who manage to cultivate happy working relationships in China, the key is to maintain a respect for their Chinese counterparts, and recognise that they, too, are looking for profitability and partnership.”

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seasons

COVER STORY

The man for all Elliot Spitzer, New York State’s energetic Attorney General, has reshaped his office into a hybrid of retributive ombudsman and tribune for the people. Running on a Democratic ticket does help, however, and when Spitzer runs, everyone agrees he runs hard, to the extent that his name was mentioned as an outside shot for Kerry’s Vice-Presidential candidate – but that’s another story. Ian Williams reports from New York.

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N HIS FIVE years in office as Attorney General for New people is what drives him. He has a winning smile. But he York State, Elliot Spitzer has attacked militant anti- can also cut the heart out of anyone who breaks the law. He’s abortionists and clinic-attackers, as well as populist a natural born prosecutor, very tough, very smart, and there issues such as polluting power plants, spammers, and the is no question that he has redefined this office.”

As one might expect, Bob Monks, corporate governance underpayment of employees. In one instance, however, he tackled an alleged case of overpaying an employee, in the activist and former head of Institutional Shareholder person of Richard Grasso, former chief executive officer Services, approves of Spitzer’s activities and explains the Attorney General’s success, “He has several natural [CEO] of the New York Stock Exchange [NYSE].

Perhaps Spitzer’s most sustained attack, however, has advantages, not least of which is that he is independently been on aspects of Wall Street that the Securities and wealthy, and that means that he has no need to pander to the Exchange Commission [SEC] had overlooked, insider rich and powerful. He can afford to be principled, idealistic, trading, tainted analysts, mutual fund fees and out of hours and aggressive. So he’s qualified by temperament, education, marketing for preferred clients and recently hedge funds. and wealth.”

He adds that Spitzer is also in the right location [New Depending on how you look at it, he is making the world safe for investors – or climbing to office over the ruins of York, the centre of America’s finance industry]. “It’s an unusual concatenation of events. Most public officials in the finance sector.

Although you sometimes get the impression that people the US are not so well endowed in any such sense, which is why for many years on Wall Street use Elliot corporate pressure has been Spitzer’s name to frighten to avoid Federal regulation their children into bed, it is “...He can afford to be principled, and to push for it to be left difficult to get them to idealistic, and aggressive. So he’s to other states. That, express their feelings on the unusually qualified by temperament, combined with the farrecord. No one wants to put reaching powers of the New their head above the parapet education, and wealth.”

York Attorney General, while the New York Attorney given to him under the General is on the prowl.

Martin Act, has provided Armed with the legislation he rediscovered and revived, the 1921 New York State Spitzer with an unparalleled opportunity – either to make Martin Act, Spitzer apparently has unbridled reach into the reforms or grandstand into higher office, depending on your point of view.” finance sector.

Alan Reynolds of the libertarian think tank the Cato For example, one would have thought that Grasso would be aching to unload his soul in a therapeutic way. But his Institute is one of the few public critics of Spitzer. He wryly office declined to comment on Spitzer, preferring to let his explains “I am independently wealthy as well, so perhaps recent Wall Street Journal op-ed speak for itself. In that, that’s why I can give Elliot Spitzer the finger”. He has no Grasso inveighed, “Mr. Spitzer’s decision to sue me and doubt whatsoever that grandstanding into public office is not Mr McCall, who signed the new contract three weeks the name of Spitzer’s game.

More indulgently, Reynolds muses, “If we were to take later, or the powerful CEOs who voted for my compensation year after year, makes clear that Mr. Spitzer the politics out of it, I would say that at heart he is a Naderite, [Ralph Nader is a regular third contender in US is running for governor, and running hard.”

Carl McCall is the [Democratic] New York State presidential elections and a prominent environmentalist comptroller-general, and Grasso’s allies point out that the campaigner], an old fashioned, ‘let-the-lawyers-runother CEOs whom Spitzer has similarly failed to sue all everything’ populist.

It is part of the old ‘corporations are not to be trusted and happen to be prominent Wall Street figures who are large we have to have big government agencies to regulate donors to political campaigns.

In fact, it is not at all clear that Spitzer is running for them,’ going back to Bryant and Roosevelt a century ago. governor. His political committee is “Spitzer 2006,” but the It’s probably deep in him, a matter of conviction. And a governorate is not the only office in contention in New York little bit of a matter of arrogance.”

Everyone agrees that Spitzer is ambitious and driven, that year. If Senator Charles Schumer, Hillary Clinton’s coSenator for New York State, fulfills the rumours and runs for and Reynolds acidly qualifies “self-interest has a way of governor then, by all accounts, Spitzer would try to join rationalising ideology. If you do something that makes you Hillary Clinton in the Senate. Indeed, he may end up rich and famous, and makes you feel good at the same competing with Clinton herself down the line. Political time, then of course you can afford to believe it.” Friends consultant Hank Sheinkopf, who worked on Spitzer’s media and foes alike agree that the Martin Act was Spitzer’s magic campaign in 1998, reports “Some people see him as the first wand. Indeed, some scholars suggest that it was because Jewish president of the United States. When you are as the Act was dormant for so long, that it was not lobbied young and as ambitious as he is, and as competitive, his life and legislated into attenuation the way more recent and is about not having bounds. Competition with other political visible regulatory legislation has been.

I

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For example, critic Reynolds considers “It all comes back to that Act. Some advisor told him ‘with that Act, you can do anything,’ and he said ‘Oh good! I will.’ It is just too darn loose, no rule of law, you can accuse almost anyone of anything. It’s too much power in one person’s hands and you know what they say about too much power. Like going after Grasso for earning too much money: that’s none of his business. Grasso has a contract.”

In fact, the NYSE is technically a New York State registered “not for profit” organisation [albeit an unlikely one] which gives the Attorney General oversight over it.

And it also gave Spitzer a golden opportunity to surf the

He has certainly changed the direction of lobbying in Washington. In the old days, corporate lobbyists tried to devolve legislation and regulation down to the state level, so they could cherry pick executive-friendly regimes in Delaware, for example to register their companies. Under assault from Spitzer, they now want Federal regulations that will pre-empt aggressive state attorneys like him and a few other colleagues.

Indeed, Spitzer has specifically admitted that he has been trying to spur on the SEC. He told a recent press conference, “If Washington were doing it, we wouldn't: we wouldn't need to. But if there is a void in the regulatory apparatus in

Perhaps Spitzer’s most sustained attack, however, has been on aspects of Wall Street... insider trading, tainted analysts, mutual fund fees and out of hours marketing for preferred clients and recently hedge funds

wave of public resentment over overpaid executives looting shareholders and employees alike. However even Sheinkopf agrees that,“Spitzer has tried to use the Martin Act to extend the boundaries of his office into outer space.

Because of that Act, there are no controls on him - and he’s relentless in everything.”

“When he was in the Manhattan District Attorney’s [DA’s] office, he went after the Gambini crime family in the garment district. He plays tennis relentlessly. He found a scandal in Wall Street, and he rode it like a bronco. His political enemies hope he will extend himself beyond safe boundaries. His friends assume he has no limits.” He concludes, pragmatically,“The truth is somewhere in between.”

So what has Spitzer actually achieved apart from a lot of bruised toes where he has trodden on them so forcefully?

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2004

Washington such that there are lapses or failures to address structural problems of this nature in Washington, then given the jurisdiction that my office has, we will use that jurisdiction to try to confront these problems.”

Ironically, while Spitzer himself condemned the Putnam settlement with the SEC as a sweetheart deal and thundered “My office, while committed to working with the Securities and Exchange Commission in our investigation of the mutual fund industry, will not be party to settlements that fail to protect the interests of investors and let the industry off with little more than a slap on the wrist”, critics from both left and right have accused Spitzer of going after financial settlements instead of sending wrongdoers to prison.

Reynolds argues that his first big case against Merrill Lynch “was really based on fraud, snippets attributed to

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COVER STORY Elliot Spitzer, Attorney General, New York

people who didn’t say them, taken out of context, and it was embarrassing because the press really ran with it.”He adds, “This is not the way to do things: he bypasses the courts and the legislature. If he took it to court he may lose.

He takes stuff to the New York Times and other papers and they print it saying ‘Oh, he’s such a saviour.’”

In fact, Reynolds charges “If it’s real fraud, he shouldn’t just be collecting money; he should be putting people in jail. Instead, he has been something of a tax collector.”

Indeed, one unforeseen and presumably unintended consequence of the settlements and fines from Spitzer’s active litigation, lauded by some of his supporters, has been to pump hundreds of millions of dollars into the New York State treasury during a period when the Republican Governor George Pataki needed it to avoid electorally unpopular cuts.

Many people welcomed his work on bias by sell-side analysts, and there is some quantitative evidence which indicates that the Spitzer crusade has had an effect.

Researchers StarMine showed that 14% of stocks rated by the 10 biggest Wall Street firms in Spitzer’s settlement now carry the lowest rating – compared with only 1% marked as sell in the decade until 2001. They even calculated the, benign, effect on portfolios of that change of advice, if followed.

Spitzer presents himself as the champion of the small “investors who did not know”, and assumed, for example that the tech stocks hyperbole had some substance. A lot of people lost money and they are the type of middle class investors who turn out to vote, so, politically the Attorney General clearly assumes that he is doing well by doing good. However, there is more to American industry than Wall Street. A former analyst himself, Garo Armen, CEO of

36

Antigenics, is an entrepreneur who took on the Street’s practices and won. He strongly approves of Spitzer,“What he has done is very important – the environment was definitely unacceptable.”

Piper Jaffray, the specialist investment bank, had covered Antigenics, rating it as a “Strong Buy” when it was lead underwriter for a secondary offering. When Antigenics took on UBS Warburg as lead, Piper dropped coverage.

Armen remembers that most people shrugged off such practices as part of the quaint customs of Wall Street – not least since it was dangerous to alienate the analysts and bankers. Armen, with a relentlessness similar to Spitzer’s own went after the bankers, until the NASD fined the company $250,000 and Scott Beardsley, its managing director, $50,000.

Armen says,“You can’t argue with his [Spitzer’s] overall direction, even if you disagree with the specifics.You could argue that he could go about it in a more balanced fashion, but then we all could! And there is no question that he has done a lot of good, reminding people in Wall St that they are accountable for their actions – after all, a lot of them had forgotten!”

Accountability is a double-edged sword however. As Spitzer raises his electoral profile higher, his actions will be weighed in the balance and found wanting whenever his opponents can tip the scales. So far Reynolds cannot substantiate his feeling that “it’s hard to believe that he has not damaged the regional economy some, I’d certainly be nervous about operating in New York with him around,”but he warns that while Spitzer may indeed have presidential ambitions, the Wall St people whose toes he has trodden on “will still have some money left and may harbor grudges.”

World-weary Sheinkopf discounts that view totally.

“Money is amoral. Money can live with anyone. It has no conscience. If his poll numbers are high enough: money will be there for him, governor, Senate, President, or even Mayor in 2009.”

However, even an avowed admirer like Sheinkopf can see some political risks in the strategy Spitzer has been following.“At some point, if the economy takes a dive, say in the insurance sector, where he is beginning to noodle around, and the finance sector, which is the controlling element of New York, the finger that he’s pointing could turn round to him”.

And young as Spitzer is, the pages of the political calendar are turning. Sheinkopf points out “He had to run for Attorney General not once but twice and won by the narrowest of margins. The problem is that in New York politics, more than two terms in the Attorney General’s office, and it’s difficult to get out.”

Monks, clearly an admirer, hopes that Spitzer will go for higher office, “He is someone who has actually done something, unlike most candidates nowadays. Do you think those other pansies would have had the guts to go after Grasso?” he asks. If enough voters share that admiration, we will see much more of Spitzer in 2006 and beyond.

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FBR

Founded in 1989, Washington Beltway-firm Friedman, Billings, Ramsey [FBR] has risen quickly through the ranks of discrete investment banks to become a market maker in sub prime assets and mortgage real estate investment trusts. It has topped aftermarket performance league tables for six consecutive years and last year came third in a league table of US IPO underwriters. It also claims to have the best return on shareholder equity of any major investment bank. Can FBR sustain its momentum and keep up with the big investment banks as confidence returns and IPOs get bigger?

HOW FAR FOR FBR? OU GET THE distinct impression that FBR leaves nothing to chance. Preparation is something that its’ staff takes seriously, paying attention to even small details. At a recent FBR investor forum in London, every member of the firm’s carefully coiffed team was exceptionally well-briefed on each guest, even down to their nicknames and special interests. During breaks, smiling FBR staffers [even the student interns] relentlessly worked the crowd asking individual, interested and pertinent questions.

It was all done with practised aplomb and knucklecrunching American handshakes – apt perhaps for a DCbased firm in a Presidential election year. “Focus and discipline” are the firm’s watchwords, admits FBR’s spokesman Lauren Burk.“We don’t miss much,”she says.

Y

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2004

It’s a successful formula. From seemingly out of nowhere FBR has bounded out from the traditional anonymity of Washington’s Beltway firms and shows all the signs of becoming a serious player.“Few people know what we do, although the bank has recently grown to be among the US’s top 10 underwriting firms,” says Dorian Prosdocimi, managing director, institutional sales, at FBR International Ltd. FBR Group Inc.’s business is built on investment banking and asset management services [it invests as a principal in mortgage-backed securities (MBS) and merchant banking investments]. In the last two years it has become one of America’s fastest growing investment banks, cannily placing itself in corporate America’s middle

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FBR

ground. It is territory that is only sparsely serviced by the US investment banking market which, over the years, has tended to polarise between Goldman Sachs-style bulge bracket operations and the infinitely smaller, specialist houses such as Park Avenue’s Blaylock & Partners, USBX in Santa Monica and Illinois’ Dresner Investment Services.

Position is everything, suggests Richard Erin Caddell, director and equity research analyst at Blaylock & Partners, one of only three houses to provide research on FBR – the other two being Flagstone Securities and Keefe, Bruyette & Woods. Citing recent data from Piper Jaffray, Caddell points out that 61% of US public companies have a market cap between $100m and $5bn and only 8% or so enjoy a

market cap of more than $5bn.“Simply, the majority of US companies are in FBR’s sweet spot,” says Caddell. “We’ve seen a big void in the middle market that a few years ago would have been filled by firms such as Robertson Stephens & Co. and Montgomery before they were acquired by larger houses.”

While FBR is ratcheting up to another level, notes Caddell, “it is also keeping an entrepreneurial and small firm approach. As a result, an FBR client gets much better access to the guys at the top. The fact is that if you are a mid-cap company Citigroup SSB will pay less attention to you than FBR will.”

To enable FBR to raise its game, the firm’s founding

ALL YOU NEED TO KNOW ABOUT REITS

R

EAL ESTATE INVESTMENT trusts [REITs] buy and manage a real estate portfolio where profits are passed on to investors without attracting corporation tax – provided certain conditions are met. Structured either as a corporation or business trust, a REIT must be managed by a board of directors and have at least 100 shareholders. No more than 50% of the shares can be held by five or fewer individuals during the last half of each taxable year and at least 75% of total investments must be in real estate. Or, the trust must derive 75% of its gross income from rent or mortgage interest. Either way, 90% of its taxable income must be paid out as dividends.

The trust can have no more than 20% of its assets in stocks in a taxable REIT subsidiary [TRS]. There are now some 300+ publicly traded REITs in the US with combined assets worth over $300bn.

REITs are liquid and tend to be stable, as the correlation of the value of a REIT to other financial assets is low.

They also share some performance characteristics with small-cap stocks and fixed income investments. On average though, “the dividend yield on REITs is six times that of an average mid-cap index dividend” says Dorian Prosdocimi, managing director of institutional sales, at Friedman, Billings, Ramsey International Ltd. REIT structures differ. Equity REITs predominate, accounting for over 90% of REITs in the US. They are responsible for the equity or value of their real estate assets and revenues come from property rents. Mortgage REITs make up 2% of the market. These particular trusts invest in and buy mortgages or mortgage-backed securities and revenues are generated by the interest Individual trusts distinguish themselves on mortgage loans.

Hybrid REITs combine the investment strategies of by specialisation. Some focus on equity REITs and mortgage REITs and invest in both location [region, state, or metropolitan properties and mortgages. Individual trusts distinguish area], or in property types, such as themselves by specialisation. Some focus on location retail, industrial, or healthcare facilities. [region, state, or metropolitan area], or in property types, such as retail, industrial, or healthcare facilities. Other REITs choose a broader focus, investing in a variety of property and mortgage assets across a spectrum of locations. About 33% of REITs invest only in industrial real estate and business offices; while 20% focus on retail properties and 21% prefer residential properties. Around 6% invest in leisure-related real estate.

REITs originated in the 1880s. Investors avoided double taxation as trusts were not taxed if their income was distributed to beneficiaries. In the 1930s passive investments began to be taxed at both corporate and individual income levels. In the 1950s demand for real estate funds ballooned and finally, in 1960, the real estate investment trust tax provision was signed. REITs re-qualified as pass through entities, eradicating double taxation.

The law has remained relatively intact with minor improvements. REIT investment grew in the 1980s as various real estate tax shelters were eliminated by successive US administrations. The US Tax Reform Act of 1986 authorised REITs to manage their properties directly, and in 1993 pension funds were allowed to invest in REITs. The US Work Incentives Improvement Act of 1999 contained the REIT Modernization Act, which came into force in 2001, allowing REITs to own a TRS. The Act also lowered the distribution requirement of REITs from 95% to 90%.

REITs became more flexible in terms of retaining capital and can now own up to 100% of the stock of a TRS that provides services to REIT tenants without disqualifying the rents that a trust receives from them. However, the size of a TRS is capped, to ensure that a trust remains focused on core real estate ownership.

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Enamuel Friedman co-chairman and chief executive officer at FBR

managers clicked to the fact that a makeover was due. In March last year, the holding company was merged with FBR Asset Investment Corporation, a real estate investment trust [REIT] externally managed by a FBR subsidiary and founded by Eric Billings, co-chairman and one of FBR’s two chief executive officers [CEOs]. “We advised shareholders that the combination of our operating businesses and a strong balance sheet would have a profoundly positive impact on our entire firm. FBR’s record results for the first quarter are evidence that our strategy and execution have been effective,”says Billings.

It’s an unusual structure, acknowledges Caddell.

However, it makes the firm tax efficient and “because it pays out earnings from its real estate and merchant

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2004

banking operations before tax, it has a high dividend yield, currently around 8%, which is nice recurring income and very favourable in comparison to bond yields. It’s also good for FBR employees who own a lot of the stock.”

The bank’s liquidity was also helped by a series of successful share issues. In October last year FBR announced the sale of 23m shares of its Class A [primary line] common stock in a public offering at $17.00 per share. FBR & Co. Inc., a broker-dealer subsidiary of FBR, was the sole book-runner, with JP Morgan Securities Inc. acting as co-lead manager. Some 3.4m additional shares of Class A common stock to cover overallotments were taken up by month’s end, earning the firm a further $58.6m. The merged entity gave FBR a growth vehicle, $400m-plus of our own capital, and recurring revenue through the mortgage REIT. The bank was also keen to diversify its product offering. In September 2003 both FBR and its wholly owned subsidiary FBR & Co, Inc. announced plans to enter the fixed income asset backed securities [ABS] business. A month earlier FBR had formed Georgetown Funding, a specialpurpose Delaware limited liability company [an SPV] which could issue extendable commercial paper notes in the asset-backed commercial paper market and enter into reverse repurchase agreements with FBR and its affiliates. The move marked a subtle shift in the bank’s portfolio. FBR now expects to provide full distribution capacity in the near future.

FBR’s mortgage-backed securities and merchant banking portfolios generated revenues of $102.4m during the first quarter [Q1] of 2004. Over $88m of these revenues are interest revenues generated from adjustable rate MBS guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae. The fair value of FBR's MBS portfolio totalled $10.9bn by Q1 end and the corresponding repurchase agreement and commercial paper liabilities [including those with the Georgetown SPV] were $9.8bn. Quarter-end leverage [debt to equity] was 9.5 and average leverage in the MBS portfolio for Q1 2004 was 9.3.

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FBR

same lines of business for which they have been responsible over the past several years. Eric Billings looks after FBR's capital markets businesses, including research, institutional brokerage and investment banking; the mutual fund organisation; and the firm's principal investments in its mortgage-backed securities and merchant banking portfolios. Emmanuel Friedman meantime looks over FBR's Alternative Investment business and its Private Client Group.

FBR has also remained committed to research and has now expanded the firm’s research team by 25% and expanded its remit to cover more than 470 companies.

According to Eric Billings, “FBR has increased the size, scope and capabilities of our offices in New York and San Francisco; hired new senior analysts to cover internet and Dorian Prosdocimi, interactive entertainment businesses, telecommunications managing director, services firms, communications equipment and storage institutional sales, at companies and semiconductor manufacturing firms; and FBR International Ltd added five new managing directors to our technology, media and telecommunications and healthcare FBR introduced a number of key management changes investment banking groups.” FBR is a contrarian firm, last year and brought in a host of experienced outsiders to explains Blaylock & Partners’Caddell,“and expanded when set off the firm’s structured finance operations. Hires everyone else cut back during the bear market.”

Restructured and diversified, the cash rich and tax included Michael Warden [previously managing director and head of mortgage finance at Wachovia Securities]. efficient firm was now ready to kick off a period of growing Warden took up the role of managing director, investment confidence and aggressive deal chasing. It’s a trend that has banking – Fixed Income ABS Group. He was accompanied accelerated in the opening months of this year. The firm’s 2003 performance showed

by Michael J. Ciuffo, who that it could compete for and joined as senior vice win far larger assignments president, in the bank’s fixed “FBR is a contrarian firm and expanded than before and FBR picked income and ABS Group. The when everyone else cut back during the up some $8.9bn worth of firm continues to take on bear market” deals. The build-up of a more staff and not just in pipeline of a further $5bn of structured finance, confirms deals in the first part of 2004 Prosdocimi.

FBR also laid out the groundwork for a new corporate is shown by significant up-ticks in the firm’s business culture. Two things stand out. One is the bank’s penchant development expenses of $16.5m in the first quarter [up to concentrate management decisions and actively devolve revenue generating responsibilities, starting right at the Friedman Billings Ramsey vs. a selection of FTSE US Sector top. FBR has two CEOs as well as two co-Presidents.“It’s a Indices very proactive and can-do culture,” says Prosdocimi. The second, according to Emmanuel Friedman,“is that we have the highest income per employee of any broker/dealer in the US”. It’s a very flat management structure, explains Blaylock & Partners’ Caddell. “They’ve made sure that dedicated management is thin on the ground and that virtually everyone in the firm is a revenue generator. It’s a smart approach.”

Topping the group’s holding are Emanuel Friedman, Eric Billings, and Richard J. Hendrix the firm’s Chief Investment Officer, who together with Rock Tonkel Jr. [Head of Investment Banking], is also co-President. It appears that there is more than enough authority to go around. “The Jun-02 Sep-02 Dec-02 Mar-03 Jun-03 Sep-03 Dec-03 Mar-04 Jun-04 CEO concept supports, strengthens and perpetuates the FTSE US – Banks Friedman Billings Ramsey (FBR) partnership culture upon which our company was built,” FTSE US – Investment Companies FTSE US – Real Estate explains Friedman.

FTSE US – Speciality & Other Finance Both Emmanuel Friedman and Eric Billings manage the Data as at 30 June 2004. Source: FTSE Group 250

200

150

100

50

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450% on 2003’s entire spend, in part due to sponsorship of a professional golf tournament], while professional services were up 251.7% as the firm paid out more in legal costs related to increased investment banking activity.

It was two seminal deals, however, that made FBR in 2003 and brought the firm to public attention. The first was a $1.3bn series of private placements for Consol Energy Inc. It encompassed a series of 11 private placements in the US and Europe involving some 69m shares as RWE Power AG of Essen in Germany divested its share position at a price of $17.50 per share. The deal was the largest private placement ever in the coal sector.

The second deal was completed in June. FBR priced a $699.4m IPO for Pennsylvania’s American Financial Realty Trust, a REIT that buys real estate assets primarily from

financial institutions. It was “one of the largest REIT IPOs in history," according to Emanuel Friedman. The 55.95m share offering consisted of 55.7m common shares, owned by the trust and priced at $12.50 per share, and 200,000 shares offered by a selling shareholder. It followed an initial and sole-managed private capital raising worth $400m, for the company back in September 2002. “We dominate the mortgage REIT underwriting market,”says Prosdocimi, “as we knew the market well, it was natural we were involved.”

The deal pushed FBR up the underwriting league tables. By the end of 2003, FBR had underwritten some $2.1bn worth of equity issuance, a close third to Goldman, Sachs & Co and Credit Suisse First Boston, who each underwrote $3.9bn worth of equity issuance.

If there is any concern about the rise and rise of FBR it

Friedman, Billings, Ramsey: Major Deals June 2003 to July 2004 [deals over $350m only] Date

Company

Amount

Type

BookRunners/Lead Managers

Comments

26-Jun

American Realty Trust

$699.4m

IPO

FBR

Real Estate Investment Trust [REIT]

17-Sep

Self-administered,

Banc of America Securities

Issued 55.95m shares@$12.50/share

self-managed REIT that

Deutsche Bank Securities

Shares trade on NYSE

buys corporate owned real

UBS Investment Bank

Follows a $400m private capital

estate from financial institutions

Wachovia Securities

raising in 2002

FBR

FBR was sole initial buyer & placement

Qanta Capital Holdings Ltd

$550m

Insurance and reinsurance

Private Offering

agent of the 144A/Regulation S offering

by FBR & Co and a private placement by Quanta. Quanta received $505m.

16-Dec

Fieldstone Investment Corp

$703m

Mortgage banking company

Private

FBR

Offering

Offer of 47.1m shares of common stock @ $15/share and included a 15% over

selling conforming and non-

allotment option. FBR was the sole initial

conforming family mortgages.

purchaser and exclusive placement agent,

It also manages a REIT.

which included 144A and Regulation S offerings. Fieldstone also arranged a private placement.

25-Feb

CONSOL Energy Inc

$1.3bn

The largest producer of bitumen

Private

FBR

Placement

A series of private placements – 11 in all – involving 69m shares creating an

coal in the US – with 19

aggregate value of $1.3bn. RWE Power AG

mining complexes in seven

of Essen, Germany, divested its entire 58m

states. It is also the US's largest

share position through the private

producer of coalbed methane.

placements. The remaining 11m were

The company has annual

shares issued by CONSOL. The deal is the

revenues of $2.2bn.

largest ever in the coal industry. 52.4m shares are registered under the 1933 US Securities Act, the rest are placed outside the US.

3-Mar

American Home Mortgate Inv. Co.

$359.3m

A mortgage REIT, through its taxable subsidiaries, it originates

Follow on

FBR

Offering

Lehman Bros

14.3m common shares were offered @ $25.00/share. Underwriters were given the option of a further 1.7m shares to

and services mortgage loans for

cover over allotments. Deal allowed the

institutional investors.

REIT to grow its portfolio. Mortgages are originated through a network of 272 loan productionoffices and through mortgage brokers.

Sources: Friedman, Billings, Ramsey website July 2004/ Dealogic/Blaylock & Partners, New York, July 2004

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FBR

centres on the fact that the firm’s MBS earnings outstrip capital markets revenue. “But what we see with even the larger investment banks is that they are all taking on more proprietary risk. At least with FBR you get a lot of disclosure,”says Blaylock & Partners, Caddell. Disclosure is also the key to FBR’s consistent performance as leading Dealogic’s aftermarket performance tables for six consecutive years. “FBR has always been forced to have wide distribution for its deals because they were not well known, and thus were never in a position to get large orders from the major buy-side firms that are the traditional focus for bulge-bracket underwriters,” explains Caddell. “Fragmented distribution helps aftermarket performance.”

FBR’s 2004 first quarter [Q1] results showed record quarterly earnings of $253.4m with net income of $89.6m [up from $49.5m and $5.7m respectively on the same quarter last year]. The serious up-tick in revenues comes on the back of a 528% gain in investment banking income, improved underwriting revenues of $91.1m and the raising of over $4.5bn for issuers in the quarter, of which $1.7bn was corporate debt. In comparison, in Q1 2003, the firm managed three public offerings, raising only a modest $626.2m. “We’re pleased with the results of the first quarter,”says Friedman.

Eric Billings, co-chairman and chief executive officer at FBR

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ISIN SEDOL Country Exchange Economic Group Sector Sub Sector Full Market Cap (USD millions) FBR is in the following key FTSE indices:

FBR US3584341081 2516817 USA NYSE Financials (80) Real Estate (86) Real Estate Holding & Development (862) 2,293

FTSE Global All Cap Index FTSE All-World Index FTSE Developed Index FTSE US Small Cap Index Data as at 30 June 2004.

Source: FTSE Group

Institutional brokerage income rose 211% to $35m and FBR is currently working on more than 60 investment banking assignments, adds Prosdocimi. The company also managed three ABS deals in Q1 totalling $2.1bn, down somewhat on the bank’s expectations on the issuance side. However,“the first quarter was one of FBR’s best in terms of raising new assets from private and institutional clients. Our private investment partnerships continue to provide exceptional returns to investors,” says Emanuel Friedman. “This performance has been a catalyst for growth in assets under management.” Inflows for Q1 2004 into funds managed by FBR exceeded the inflows for the entire year of 2003, he adds.

Asset management revenues in the quarter were $14.6m, including $5.5m in net investment income while inflows into FBR’s six equity mutual funds were just under $150m.

The non-prime mortgage market continues to grow at 25%, says Friedman, “There is a powerful trend also underlying mortgage REITs. I predict that over the next 12 to 18 months, more and more mortgage originators will turn into REITs.” Prosdocimi’s focus is now building FBR’s mandate overseas. The bank began operations in Europe only six years ago. FBR’s European banking team is small and concentrated in London and Vienna, but is expected to burgeon.“As in the US, the bias is towards real estate and financial services. We think there is a lot we can do in the US, France and Germany,”says Prosdocimi.

Immediate concerns for the bank remain the US Federal Reserves attitude to raising interest rates further and the outcome of the Presidential elections. With some number of equity deals in the pipeline, volume looks relatively solid, though advisory revenue from M&A will likely push up income figures over the coming months. FBR is advisor on the $417m sale of Group 1 Software to Pitney Bowes.

Nevertheless, continued difficulties in the US capital markets in Q3 could begin to put some pressure on the bank’s upward trajectory.

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FREDDIE MAC

THE RECONSTRUCTION OF FREDDIE MAC At the end of June, a full year after an accounting crisis, mortgage giant Freddie Mac reported a 52% drop in earnings for 2003 amid volatile interest rates and losses as it hedged against risk. Freddie Mac had delayed its 2003 report as it implemented new accounting methods. The corporation is pedalling fast to rectify its reporting infrastructure and appears to be emerging from the dark. Ostensibly, the situation appears to have calmed, but the corporation could face continued and extreme scrutiny for some time to come.

T HAS BEEN two years of lows and lows for US mortgage giant, the Federal Home Loan Mortgage Corporation [FHLMC or, colloquially, Freddie Mac]. Consequently, when Wall Street analysts predicted that Freddie Mac which is based in McLean,Virginia, would announce a year on year halving of its income, the corporation did not disappoint.

Analysts were expecting a 2003 profit of $5.90 per share, with estimates ranging from $5.70 to $6.56 per share. At the end of June, Freddie Mac reported its 2003 income had fallen from $10.1bn [$14.18 a share] in 2002 to $4.9bn [$6.79 a share] last year, a drop of 52% – largely the result of the drop in value of derivatives it uses to hedge against interest rate swings. And, it’s not over.

The corporation has warned of similar swings in the future. Freddie Mac’s mortgage portfolio, a key driver of earnings, grew by 7% to $1.4trn in the year.The company says that during the first part of 2004, its retained portfolio purchases were low due to tight mortgage-to-debt optionadjusted spreads. Together with high liquidations, this has caused a decrease in its retained portfolio; consequently it forecasts that its 2004 retained portfolio growth would be in the low single digits.

Ironically, the move marked a new milestone in the corporation’s efforts to rebuild its reporting credibility and its accounting and reporting procedures. Both were battered in the wake of a restatement of its 2000-2002 earnings last year. A report commissioned by its

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board found management had not kept to accounting intended to reduce its implied support of the GSEs. Fitch rules to hide earnings and volatility and the accounts were Ratings’Marc Yaklofsky thinks differently.“The GSE status is an extension of the role the government has played in all restated by $5bn.

Freddie Mac, together with the Government National areas of social interest, a role that Fitch believes will not Mortgage Association [GNMA or Ginnie Mae] and be changed by the legislative and regulatory proposals Fannie Mae, form a triumvirate of giant domestic home- under consideration.”

In the end, a compromise was agreed which would mortgage institutions in the US. Freddie Mac was allow Congress to review technically chartered by any recommendation to put Congress as a private a GSE into receivership. company serving a public Freddie Mac and Fannie Mae have The capital requirement service in 1970. While it is a reprieve; as the congressional debate for the corporations also sometimes referred to as a has subsided and did not make it outside came under review. “The government sponsored the committee. capital requirement for both enterprise [GSE] or a Fannie Mae and Freddie Mac “corporate instrumentality is part of statute. Any change of the United States,” Freddie Mac is not an agency of the government nor does in the requirements would require Congressional action,” explains Lesia Bates Moss, senior vice president, real estate it receive federal funds.

Freddie Mac together with the Federal National finance at Moody’s Investor Services. An important Mortgage Association [FNMA or, Fannie Mae], have been provision in the proposed legislation included giving the under investigation by regulators since reporting problems regulator the authority to set minimum and risk-based came to light at Freddie Mac last June. Despite superficial capital levels. The committee decided however that the appearances to the contrary, the crisis at Freddie Mac was regulator can set capital levels over and beyond what is profound. It forced out two chief executives and other top now required by law. The bigger issue of debate, however, officials and resulted in investigations by the Justice was the receivership provision. The compromise was that Department and the Securities and Exchange Commission the Receiver would have to submit its recommendation to [SEC]. The company paid a record $125m in civil fines in Congress for review and final approval.

Freddie Mac and Fannie Mae have a reprieve, as the December last year in a settlement with federal regulators, who allegedly blamed management misconduct for the congressional debate has subsided and did not make it outside the committee. But it could bound right back. faulty accounting.

Possibly as a consequence, in March a US congressional Lesia Bates Moss thinks that: “there is a good possibility committee debated a partisan bill, introduced by the that it will be raised in Congress once the presidential Republican Senator for Alabama, Richard Shelby, which elections are over.”

Two factors weigh in the balance. The first, according to attempted to redefine the regulatory framework governing both Fannie Mae and Freddie Mac, and [potentially] Federal Moody’s Bates Moss is that the bill was partisan and for it Housing Loan Banks [FHLBs]. Shelby wanted a completely to have a chance of coming into US law, it would require new regulatory authority overseen by the Federal Housing firm bi-partisan support. The second is the fact that these Enterprise Board. It was an operational framework rather institutions remain in a precarious position. “These different than that operating today, where Freddie Mac is institutions were created by Congress to provide liquidity regulated by the US Department of Housing and Urban to the US mortgage finance markets, yet they have substantial, complex risk Development [HUD]. The exposures, which have to be bill was, in fact, passed but managed,” she explains. didn’t receive bi-partisan The company paid a record $125m in Moody’s believes that the support. That means it can’t civil fines in December last year in a enhanced supervision and pass into legislation. Most settlement with federal regulators, even tighter capital rules likely it will be revisited soon would likely be a credit plus after the presidential for these GSEs. In addition, elections due in November and will see some modifications to attract support from the proposed advisory board for the new regulator would likely make the ties between the US government and the both sides of the political divide.

Debate centred on giving the GSE regulator the same GSEs even closer. The bill would establish a new, kind of regulatory control given to bank regulators to independent regulator with expanded oversight, protect US depositors. Controversially, the debate also programme approval and powers of corrective action. The covered granting the regulator extended receivership rights. upshot is clear. Freddie Mac and Fannie Mae will come It could, it was suggested, be granted authority to liquidate under scrutiny for some time to come.

As if that isn’t enough, in early May HUD published for a GSE in distress. Some commentators smelled blood and suggested that such a move implied that the government public notice and comment a proposed rule that would

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establish higher affordable housing mortgage purchase goals for Freddie Mac and Fannie Mae in 2005 through to 2008.

HUD proposed new goals for purchase-money mortgages. It will be some time before HUD announces its ruling, as the end of the comment period has been deferred. Freddie Mac has warned however that the rule could have a material adverse impact on future performance as a result of “increased credit losses on purchases of goal-qualifying mortgages or reduced purchases of non-goal-qualifying mortgages. If a final rule were to be adopted substantially as proposed, Freddie Mac would take measures to reduce or eliminate material adverse business impacts; however, there could be no assurance that any such measures would be fully successful,”it stated in an official release.

The corporation has also had to endure continued market volatility. In late June it announced that the size of its investment, or retained portfolio, grew at an annualised 4.6% in May after a 7.8% decline in April. It was a small, but welcome relief. Freddie Mac had posted the first increase of its retained portfolio after six straight months of decline, according to its monthly business summary, which also said that its duration gap, a measure of exposure to interest rate risk, averaged zero months in May, unchanged from April. What this means is that that Freddie Mac's mortgage assets are closely matched with the debt it issues to buy those assets.

Until recently, it had been expensive for Freddie Mac and Fannie Mae to buy mortgages assets in the secondary market. Hedge funds, commercial banks and FHLBs had been heavy buyers of mortgage assets, driving up prices.

Unusually, none of the leading credit ratings

Name

SEDOL

Country

Exchange

Freddie Mac

2334150

USA

NYSE

Fannie Mae

2333889

USA

NYSE

agencies took action either in the lead up to, or in the wake of, the results. At the end of June Moody's Investors Service affirmed its Aaa senior debt, Aa2 subordinated debt, Aa3 preferred stock, Prime-1 short-term and A-financial strength ratings and added that its ratings continue to have a stable outlook. The 2003 results were: “consistent with Moody’s expectation of greater volatility in the firm's GAAP earnings due in large measure to the accounting effects of FAS133,”said the rating agency.

“We take comfort in the fact that its core business performance is still solid. They’re fundamentally sound,” says Marc Yaklofsky, director in financial institutions at Fitch Ratings in New York. He adds that the company’s capital reserves continue to exceed regulators’ guidelines and “its risk profile remains stable.”

Freddie Mac’s chief financial officer, Martin Baumann, said in the release that the company is "making substantial progress overhauling [its] financial reporting and accounting systems, but this process is a challenging one and more hard work is in front of us." With confidence obviously knocked, Frank E. Nothaft, Freddie Mac’s chief economist, over in London for an investor conference, declined to speak to us on the day the results were announced.

Like Fannie Mae and Ginnie Mae, Freddie Mac is a secondary market lender. Like the others, it is also a financial giant.

The combined assets of Fannie Mae and Freddie Mac alone [estimated at more than $2trn] would more than outstrip the annual GDP of most G7 countries. Of the three only Ginnie Mae is actually a government agency, and operates under the aegis of the Federal Housing and

Economic Group

Sector Group

Sub Sector

Full Market Cap (USD m)

Financials (80) Financials (80)

Speciality & Other Finance (87) Speciality & Other Finance (87)

Mortgage Finance (877) Mortgage Finance (877)

43,511 69,155

Source: FTSE Group, as at 30th June 2004 Freddie Mac and Fannie Mae are in the following key FTSE indices: FTSE Global All Cap Index, FTSE US Large Cap Index, FTSE All-World Index, FTSE4Good Global 100 Index. For further details regarding FTSE indices please visit www.ftse.com

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Urban Development Department. Ginnie Mae performs a Turbulent times – Freddie Mac and Fannie Mae vs. FTSE US similar role to Freddie Mac, but only for loans insured by the Federal Housing Administration and Veterans Affairs.

Freddie Mac is regulated however. The Federal Housing Enterprises Financial Safety and Soundness Act of 1992 created a regulatory oversight structure to address Freddie Mac’s mission and soundness. HUD has oversight responsibilities for the housing mission of Freddie Mac. In 1996, HUD set affordable housing goals for Freddie Mac based on income and population diversity. The goals require, for example, that a certain percentage of the mortgages it buys support low cost housing. Under its charter, Freddie Mac is exempt from registration filing requirements with the SEC. However, the corporation makes available analogous disclosures. They will voluntarily file once their financial statements become Data as at 30 June 2004. Source: FTSE Group current and Fannie Mae already does file voluntarily.

The publicly-traded, independent companies that are now deposit insurance premiums because everyone assumes Freddie Mac and Fannie Mae have been proud of regularly their debt is insured by the US Treasury – even though outperforming, on an earnings per share [EPS] basis, the federal law specifically states it is not the case. They are also average S&P500 company. Although these days they are tax exempt entities at both a national and local level.

If the corporation was rocked by its 2003 results, its private sector organisations, in some respects, Freddie Mac and Fannie Mae still act and are regarded as federal agencies. morale began to bounce back quickly. At the end of July, While it is only implicit, crucially for both institutions, they Freddie Mac announced that it had priced some $2bn of new three-year callable are widely seen as being fully notes, which marked a backed by the US Treasury.“In historic milestone for the the event of a crisis, we corporation. “Gross issuance believe government support Both companies are paid fees to will invariably be guarantee home loans that they don't buy, now exceeds $50bn,” said Louise Herrle, vice forthcoming. There are three, but which meet their strict risk criteria. president, treasurer and strategic reasons why this is And they have other money-making home- head of global debt funding the case,” explains Fitch mortgage businesses as well. in an official release.

Ratings’ Marc Yaklofsky. First, Callable debt is one of the “there’s the profound impact three pillars of Freddie Mac’s of housing on the US funding programme. economy; second, successive It might not have been enough for investors, as stock governments have been committed to the importance of expanding home ownership in the US, and finally, because of prices for Freddie Mac [and Fannie Mae] have taken a dip. the size and stature of both Freddie Mac and Fannie Mae in It could be because of reduced confidence in the the global capital markets, we believe the government would corporations while they are under the spotlight. But, say have to act.” However, Yaklofsky believes that implicit analysts, both will benefit as higher interest rates improve government support would not extend to the subordinated the spread between mortgage rates and their cost of borrowing. That has been widening. Fitch Ratings’ Marc debt and preferred stock levels.

Fannie Mae and Freddie Mac make money on the spread Yaklofsky remains sanguine: “Regulators are still reviewing between the cost of buying loans and the cheap federal Fannie Mae’s accounting procedures, but we are not seeing money they can borrow because of their special charters. the same kind of issues coming out of Fannie Mae. It has They also profit from issuing mortgage-backed securities been somewhat reassuring thus far. The regulator that represent pools of home mortgages. Another business disagreed with how they valued certain securities and is insurance. Both companies are paid fees to guarantee asked for a more conservative approach.”

Equally, there have been rumblings that Freddie Mac home loans that they don’t buy, but which meet their strict risk criteria. And they have other money-making home- was beginning to lose some potency. Says Fitch Ratings’ Marc Yaklofsky: “Freddie Mac did lose a bit of market share mortgage businesses as well.

They also enjoy a number of important benefits. Because to Fannie Mae and FHLBs are more visible these days, of their charter and status as a GSE, they have a lower but in late 2003 and early 2004 Freddie Mac has taken capital requirement than banks [about half], giving both steps to regain market share, which has been fairly corporations a much higher rate of return on equity – of successful as market share statistics have returned to more between 20% and 25%. They also don’t have to pay heavy normal levels.”

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The corporation is also bending over backwards to securities offerings by both Freddie Mac and Fannie Mae implement a cohesive reporting structure. Most of Freddie are looking increasingly attractive as a substitute.

Undoubtedly the events of the last two years have jabbed Mac’s new reporting systems are still in development.

Consequently it is first producing preliminary financial market confidence, affirms Moody’s Lesia Bates Moss. figures with its existing systems and then reconfiguring the While the criticisms surrounding the fact that it is not a figures using interim processes,“with several dependencies current reporting entity are valid,“it will catch up in 2005,” on manual off-line processes,” to adjust to GAAP she states. “Investors have legitimate concerns about the standards. “The continued existence of material unknown: particularly over the way that Freddie Mac manages risk.” It’s an issue weaknesses in our controls Moody’s will be addressing surrounding financial in a specific risk reporting and the need for Fannie Mae and Freddie Mac make management report on both back-end analytical review money on the spread between the cost Fannie Mae and Freddie procedures are highlighted of buying loans and the cheap federal Mac. Nonetheless, she says, by the fact that, in the course money they can borrow because of while Moody’s and others of the 2003 close process, we have been aggressive in their identified a number of their special charters. scrutiny of the organisation, immaterial errors in our Freddie Mac has been previously published results, which have been recorded as corrections in the first quarter “proactive and thoughtful in their responses.” It should of 2003,” said the corporation in the June release, count for something.

Marc Yaklofsky has the final word. “While Freddie Mac continuing: “For the remainder of 2004 and into 2005, we will continue to re-engineer and build systems to eliminate has made significant progress towards building a more effective accounting and financial report framework, the our two-step closing process.”

Longer term, trends are also moving Freddie Mac’s way. fact that it won’t be current on its financial reporting until Hedge funds and other private investors are reportedly well into 2005 and that several adjustments had to be made growing shy of the secondary home mortgage market's to 2002 results, prove that there is a lot of work to do still. risks. Some may even begin to leave the field. As well, with Despite this, we are encouraged that Freddie Mac fewer US Treasuries being issued, fixed-income investors continues to build capital that should help mitigate are looking for more high-grade investments. The potential operational issues.”

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AP3 FUND PROFILE

AP3 MOVES FOR ADVANTAGE Tredje AP-fonden [AP3], one of Sweden’s largest pension funds, faced many challenges throughout 2003. It has been especially hard for a pension fund that has a robustly open, theoretical and rational approach to business. In 2003, the fund saw its capital value increase from SKr120bn to SKr142bn last year and reported a healthy 16.3% return on assets. But that was nowhere near good enough for a fund with AP3’s high standards.

Then 2004 hit and AP3 has had to endure some swingeing changes it did not necessarily want. Even so, many at AP3 remain buoyant. An incoming CEO promises a fresh approach – what will it all mean for the fund’s asset managers? Francesca Carnevale reports.

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HERE ARE THOSE who would say that to lose two during 2003 has indicated that the selection and diversification chief executives in quick succession is unfortunate. To of managers within the mandate could be improved”. Capital lose three, is rather careless. Actually AP3 is neither. International held on to its mandate to manage 50% of the The fund is an exacting and generally careful organisation equity portfolio, while Schroders was replaced with JP Morgan but, during the last year and half, it admits to having been Chase and Nomura Asset Management, who each took 25%. sorely tested.“It’s not as bad as it looks,”maintains the lively The previous year AP3 had introduced some changes to its Pernilla Klein, board member and communications director reference portfolio and this had included a 2.5% increase in the for the fund.“But it’s fair to say we’ve been in a transitional weighting of Asian equities.

The move was part of the emergence of an evolving phase over the last few months. We’ve taken the approach strategy to diversify the portfolio. “In 2001 and 2002 the that it is business as usual.”

AP3 recently lost its chairman, who was removed from absolute return of the fund was poor due to the downturn his office by the government following allegations of in the stock market,”says Klein.“The evolving strategy had insider trading irregularities. The chairman continues to much more to do with new investment rules which allowed us to diversify from domestic protest his innocence, but to global and to move from the government has clearly bonds to equity,”she adds. In preferred him to conduct his Kerstin Hessius is proactive and general, AP3 has a long term defence outside of the fund dynamic and is well suited to AP3 horizon: “typically 30 years – and not while he is leading it. culture. She’s very strong on corporate so two years out of that is to Meanwhile, AP3’s Chief be put in context.”

Executive Officer [CEO] governance," says Klein.

That resulted in a Tomas Nicolin, resigned in major portfolio transition the early summer to head up Alecta, Sweden’s largest mutual fund company; while it’s management project as it moved from a predominantly Deputy CEO also resigned to join Carnegie Asset Swedish portfolio to a global one. While it hired Management. “Both the CEO and Deputy CEO went to specialist managers, it also undertook some of the work itself – a sign of growing confidence at the fund – better jobs,”says Klein.

The good news is that Nicolin will be replaced by, Kerstin through its in-house trading operations. In the fixed Hessius, who is currently president of Stockholmsborsen, income area, Deutsche Bank, JPMorgan Chase, SEB and the Swedish stock exchange, and a member of the UBS are AP3’s main brokers; while Citigroup, Enskilda, Commission on Business Confidence, and who joins on Goldman Sachs, Neonet and UBS broke the fund’s equity September 1.“It’s a very positive move; Kerstin Hessius is transactions. “Occasionally we will also award them proactive and dynamic and is well suited to AP3 culture. transition management projects,” says Klein. Further changes are afoot.

She’s very strong on corporate governance,”says Klein.

Corporate governance is a “focus area” for the fund, she explains.“Our previous CEO had a very high profile in this regard. For example, we got involved with the Scandia case at an early stage.”The Swedish financial services group initiated an internal review of remuneration last year, under pressure from investors, led by AP3. Klein says:“We won a lot of credit for what he did.There are quite a few people here involved in corporate governance. Kerstin has a lot of knowledge about these issues and is known as a very active and outspoken person. We will carry on with this at a high level.”

Hessius’ background also includes a tour of duty as deputy governor of the Riksbank, the Swedish central bank and two years as chief executive of Ostgota Enskilda Asset Management. Prior to that she headed up fixed income sales and trading at Alfred Berg. Strategically, this appointment is important.” It’s not the only one. The fund has also appointed Lars Orest, former head of FX reserve management at Riksbank, as head of its fixed income and foreign exchange operations after Lennart Nordkvist, announced his departure to Morgan Stanley in June.

As well as losing Nicolin, AP3 dropped Schroder Investment Management from a €200m share of its Japanese equity portfolio. An official release by AP3 at the time stated:“A weak Pernilla Klein, board member and relative performance of the overall Japanese equity portfolio communications director for the fund

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Throughout its short history AP3 had tended towards a maximum 5% of its assets may be invested in unlisted passive investment style. Over the last 12 months that securities; and at least 10% of the fund’s assets are to be approach too has changed, explains Klein. “Now we are managed by external asset managers. The funds must also more active and have adopted a ‘manager of managers’ take environmental and ethical considerations into account approach. We are trying to get the right mix – harnessing without relinquishing the overall goal of a high return on different investment styles; so I guess overall we are capital. It’s a requirement close to Pernilla Klein’s heart, as neutral.”Nonetheless, she maintains that diversification is she has special responsibility in the area of socially a major driver. AP3’s overall asset mix is 37% fixed income responsible investing [SRI].

AP3 works with UK agency CoreRatings, an expert firm investments, 54% equities of which one third are in Swedish equities. Real estate investments account for that evaluates and assesses social and environmental risks. approximately 8.5%, while index linked bonds remain at AP3 takes a proactive stance, explains Klein. “If we own 9.5%. Interestingly, the fund does not invest in the more than 1% of a company’s shares, they are most likely to hear from us, if we are emerging markets – the concerned about any most exotic geographic risk deficiencies.”

AP3 does not on the fund’s books is AP3’s strategy is to generate active employ a negative screening “developed Asia Pacific return based on the unique ability of or share blacklisting policy: markets,” says Klein. The the asset managers, rather than any “we think we have a greater fund may change its mind conviction about future market trends. impact on the engagement however and is now track,” she says. How do undertaking an internal companies react? “It varies,” risk/return analysis to help it determine whether it should assume more exotic risks into laughs Klein. Much of the time, she says, if AP3 is on a campaigning visit, it will take a member of CoreRatings its rather conservative portfolio.

It goes to the heart of the contradictions within AP3 along. “It allows us to bring independent expertise and which, in fact, regards itself in Klein’s words as a “very knowledge to bear, sometimes to explain how competitors internationally oriented best practice pension fund.” In deal with managing social and environmental risks.”

AP3’s impact in this regard is measurable. Swedish part, she acknowledges the academic tendencies within the fund and its predisposition to hire executives with senior Match is an example.“It had no code of conduct on child management backgrounds has provided it with some labour,” explains Klein. “We raised the issue at their GM unique characteristics. As a consequence of the relative and soon afterwards they issued a code of conduct. Most of seniority of much of its highly experienced staff and their the time we don’t crusade in public – but we continually international credentials,“the fund barely has a hierarchy,” work with companies to encourage better practices.”

Approximately a quarter of AP3’s assets are managed by says Klein. “Our management structure is quite flat and responsibility is decentralised. So whether someone is in external asset managers and selecting which fund our back office or performance management sections, they managers to entrust with its money is a high priority for the carry a lot of decision-making responsibility.” She is also fund, explains Klein. The fund uses a four step process in quick to point out; “that we have a really good time choosing managers. Briefly the process involves together. It’s a highly intellectual environment. It’s difficult advertising; a qualitative evaluation based on the fund not to be challenged and inspired – almost on a daily basis. managers’ responses to questions in the fund’s Request for Proposal document; selection of a list of qualified portfolio You simply learn so much here.”

AP3 is one of four independent buffer funds in the managers which represent a range of asset management Swedish pay-as-you-go public pension system. Its’ current styles [the list usually contains three to eight names]; and activities were defined at the beginning of 2001, when new finally portfolio construction and contract. The overall aim legislation came into effect that radically changed the explains Klein is “that the portfolio as a whole should organisation and mandate of the AP funds. New flexible represent a neutral stance with respect to market trends investment rules were introduced allowing funds to and investment style.” It’s a demanding approach in fact. increase exposure to foreign assets as well as equity assets. AP3’s strategy is to generate active return based on the Investments could now be made in all instruments unique ability of the asset managers, rather than any occurring in the capital market that are quoted and conviction about future market trends. Outperformers are marketable; although 30% of fund assets were to be rewarded however. Klein explains that “we work with invested in interest-bearing securities with low risk. A performance-related fees linked to superior returns above maximum of 40% of assets may be exposed to currency set benchmarks. It’s a complex system – but the gist is that risk. During 2004 the ceiling has been dropped to 30% of they get paid more if they provide us with active returns.”

AP3’s procurement procedure is governed by the Swedish the market value of the fund’s asset. The ceiling will be raised each year by 5 percentage points per year until 2006. Public Procurement Act. “It’s a more time-consuming Each fund was to be allowed to own a maximum of 10% of process than we had first imagined,” says Cecilia Sven, the voting power in a single listed company, and a portfolio manager, in a recent AP3 paper, “and it can

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take up to a year between advertising a mandate and signing FTSE Sweden All Cap Index vs. FTSE Developed All Cap Index the contract.”

The number of asset management firms with which we sign contracts exceeds the number that actually receive mandates. This means AP3’s fund manager pool increases with every round of tenders. Currently, the fund has contracts with over 35 asset management firms for six mandates in various regional markets. However, only 13 of these are currently funded. The challenge is to get the right mix of managers, that complement the fund’s internal operations, asserts Klein. It’s an issue which will feature largely for the fund in future months. “We have put and will put a lot of effort into internal modelling.”

AP3 doesn’t leave much to chance in this regard – it can’t as a major pillar of Sweden’s model pension fund market.

“We continually work with data related to growth and Data as at 30 June 2004. Source: FTSE Group demographics, as well as financial markets information.

We don’t believe in there being only one way to look at from 2001 to 2003 it beat the -2.5% benchmark by 0.7 percentage points.” the world.”

It was a very different approach than that of Lars Alternative assets have been a particular choice, with Private Equity Funds popular. AP3 now invests in over 12 Idermark, who is chief executive of the second Swedish such funds worldwide. Within its existing portfolio further national pension fund, Andra AP-fonden [or AP2]. The diversification has occurred. It has expanded its remit in fund reported a yield on assets of 17.7% in 2003 but also failed to beat its benchmark. Idermark was delighted with real estate, for example, to include forest land.

More significantly perhaps, the risk exposure to foreign his fund’s performance. “The good result is primarily currency assets rose from 10.8% to 19.3%. It was a bold attributable to retention of a high ratio of equities in the move in some ways, as historically, the fund had relative portfolio throughout 2003, at a time when the world’s little exposure to foreign currency. However, its current leading stock markets were posting sharp increases in holdings remain well below the maximum level of 30% market rates,”he told the same newspapers.

In May, the performance of the entire Swedish pension that the law allows. The scheme’s shift into the Japanese markets follows a three-year push away from its domestic fund system came under its regular annual review. The Swedish market. At the beginning of 2001 the fund held evaluation looked at risk diversification between the funds just SKr1.7bn of its then SKr134bn fund in global equities and their mutual independence. A government paper but by the mid point of last year this had grown to presented by Gunnar Lund, Minister for International SKr28.5bn. At the same time its holdings in European Economic Affairs and Financial Markets to the Swedish stocks grew from SKr1.7bn to SKr23.3bn, while its parliament showed that while [overall] Sweden’s AP pension funds achieved good results, management costs for exposure to domestic equities dropped by a third.

Talking to Klein you get the strong impression of an the funds as a whole appeared high relative to “the degree working environment that is rarely satisfied with its of management activity.”

Lund expressed himself satisfied with the AP Funds’ performance. A point made pertinent by the outgoing CEO’s comments once the 2003 results had been “increased activity concerning holdings, which can be expected to have a positive announced. Although AP3 effect on the long-term yield was able to post returns of of the funds.” However: “A 16.2% after expenses in AP3 does not employ a negative comparison of the yields 2003, it had not managed to screening or share blacklisting policy from the First-Fourth AP beat its benchmark over the Funds since mid-2001 year. The result was just indicates a lesser degree of below the average return achieved by all seven of Sweden’s main pension funds [an risk diversification than could have been expected as a average return of 16.4%]. Ex-CEO Tomas Nicolin told the result of dividing the buffer capital of the pension system Swedish press: “Despite recouping the losses we incurred into four separate funds,” said Lund in his report. “With during the stock market crash and posting good absolute regard to the management of the First-Fourth AP Funds, returns, we are not happy with our return in relation to our the government notes that the returns so far have shown benchmark. For the market-listed part of the portfolio, little deviation from the comparative index, which indicates which excludes real estate and private equity, AP3 returned a low level of risk-taking,”he added. Lund’s paper stressed 17.2% last year. The result was slightly less than the fund’s the importance of good results being produced by all the reference index of 17.3% but over the three-year period country’s seven major pension funds.

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TANKER/REFINERY CAPACITY

DOOR TO DOOR CRUDE Economic recovery in the US and economic boom in China are propelling global demand for oil. With prices higher than they have been for some years, it is prime time for suppliers and shippers. Even so, some uncomfortable questions arise. Can Nirvana last? Can oil transportation and downstream facilities handle the higher volume required? The tanker market is already tight, reports Neil O’Hara in New York, and it could get tighter. So where do we go from here?

HEN THE ORGANISATION of Petroleum Exporting Countries [OPEC] adopted higher old quotas, cynics sneered that it made no difference to supplies. OPEC members were already pumping that much oil, they said. Laurence Eagles, senior analyst, Price and Downstream, at the International Energy Agency, disagrees. He has no doubt that Saudi Arabia has increased output. Lifting oil is one thing. But crude stored in the Persian Gulf doesn’t fill gas tanks in the US. Tankers have to load up at Ras Tanura on the Red Sea and haul crude to the US Gulf Coast, where refineries must process it.

Economic recovery in the United States and surging growth in China are propelling demand for oil, but a leading shipbroker doesn’t see any tanker capacity restraints.“The increase in quotas is only formalising what they are already doing,”says Cliff Tyler, director at Clarkson Research Studies [CRS], which is part of Clarksons, the

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shipping services provider.“They are producing more than the revised quota.”

Even so, the tanker market is tight. Although rates have fallen from seasonal peaks in winter, ship owners are enjoying unaccustomed prosperity. In June, very large crude carriers [VLCCs] were costing “$70,000-$80,000 a day,”according to Robert Cowen, senior vice president and chief operating officer [COO] of Overseas Shipholding Group, a tanker owner. “That’s extremely high for June.

Tanker utilisation is in the mid-90s”he adds.

“The market is finely balanced,” admits William Box managing editor at the International Association of Independent Tanker Owners [INTERTANKO] “Rates are more volatile any time utilisation is over 90%,” he adds.

Until 1990 peaks in demand developed over several months and coincided with geopolitical disturbances [the Korean War, the closing of the Suez Canal and the invasion

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of Kuwait, for example]. “The market has much shorter, sharper peaks than it used to,”notes Box. CRS’s Tyler acknowledges that spare capacity is scarce.

“All the tankers that want to work are working, whether single or double-hulled,”he says.“There is almost no lay up at all.” Driven by environmental regulations, the tanker fleet is switching from older single-hulled vessels to double-hulls, which are less likely to spill oil. [Please refer to Chart: INTERTANKO: Tanker Fleet by Hull.]

The tanker fleet is now about 60% double-hulls, so it is becoming harder for first class charterers to justify using single hulls,” says Robert Cowen. European Union [EU] authorities accelerated the transition to double-hull tankers in EU waters after the Erika wreck fouled beaches along the Bay of Biscay in 1999 and the Prestige sank off Galicia in 2002. “Ships on order represent 26.4% of the fleet in tonnage equivalent, more than 80m dead weight tons [dwt], evenly spread over 2004-2006,” says William Box. That will more than replace all single-hull vessels due for retirement by 2005 under international regulations. Newer single-hulls can continue in service until 2010 – and possibly on to 2015 on some routes – if port and flag states permit.

“Theoretically, the phase-out should be smooth. It is the

Fleet by hull percentage 100 26 80

49

17

Single Hull share (%) Double Hull share (%)

40

78

60

94

40

74 49

20

83

60

22 6

0

1991

1997

End 02 End 03 End 05 End 10

Source: INTERTANKO 2004

first time that the shipping industry has had a chance to place for replacing tonnage,” says Captain Saurabh Nakra, senior consultant at Drewry Shipping Consultants in Delhi, India. He sees no problem until 2010 – when a large number of ships built before 1988 must retire.

According to INTERTANKO’s 2003 Annual Review and Report, “less than 45% of VLCC replacement needs up to 2010-2015 has been ordered already.” Shipyards deliver

The US International Petroleum Supply and Demand: Base Case [Million Barrels per Day] [Energy Information Administration (EIA)/Short-Term Energy Outlook – June 2004]

2003

Year 2004

2005

Demanda OECD U.S. [50 States] U.S. Territories Canada Europe Japan Other OECD Total OECD Non-OECD Former Soviet Union Europe China Other Asia Other Non-OECD Total Non-OECD Total World Demand

2003

Year 2004

2005

8.8 3.1 3.8 6 1.6 23.4

8.7 3.2 3.8 5.9 1.6 23.2

8.8 3.3 4 5.9 1.6 23.6

30.5 27.1 10.3 3.5 11.8 56.2 79.5

32 28.2 11.1 3.5 12.3 59 82.2

32.2 28.4 12 3.4 12.7 60.3 83.8

Supplyb 20.1 0.4 2.2 15.2 5.4 5.3 48.5

20.4 0.4 2.2 15.4 5.4 5.4 49.2

20.8 0.4 2.3 15.6 5.5 5.5 50

4.2 0.8 5.5 7.9 12.6 31 79.5

4.1 0.8 6.2 8.2 13 32.3 81.6

4.3 0.8 6.9 8.5 13.3 33.8 83.8

OECD U.S. [50 States] Canada Mexico North Seac Other OECD Total OECD Non-OECD OPEC Crude Oil Portion Former Soviet Union China Other Non-OECD Total Non-OECD Total World Supply

a Demand for petroleum by the OECD countries is synonymous with “petroleum product supplied”, which is defined in the glossary of the EIA Petroleum Supply Monthly, DOE/EIA-0109. Demand for petroleum by the non-OECD countries is “apparent consumption”, which includes internal consumption, refinery fuel and loss, and bunkering. b Includes production of crude oil [including lease condensates], natural gas plant liquids, other hydrogen and hydrocarbons for refinery feedstocks, refinery gains, alcohol, and liquids produced from coal and other sources.

Notes: Minor discrepancies with other published EIA historical data are due to rounding. Historical data are printed in bold; estimates and forecasts are in italics.

The forecasts were generated by simulation of the Short-Term Integrated Forecasting System.

Sources: EIA: latest data available from EIA databases supporting the following reports: International Petroleum Monthly, DOE/EIA-0520; Organization for Economic Cooperation and Development, Annual and Monthly Oil Statistics Database.

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tankers two to three years after receiving orders, so that thirds of the forecast growth in non-OPEC supplies from they can build additional tonnage in time to avert any 2003 to 2005. Caspian Sea oil ships from Novorossiysk, a shortage – provided yard space is available. Tankers do not Russian Black Sea port, through Turkey’s Bosporus to markets have a lock on the order book. Robert Cowen believes in the Mediterranean and Western Europe. Bad weather and shipyards may hold back slots to meet growing demand for short daylight hours caused severe delays last winter.“Ships container ships and liquefied natural gas carriers.“They are over a certain size can only move through the Bosporus in daylight.The tightness peaked more profitable than plain around the shortest day,” old tankers,”he says. explains Laurence Eagles, As new ships enter service, “The fragmented gasoline market also senior analyst, Price and CRS’s Tyler sees a potential strains storage capacity because refiners Downstream, at the surplus. “There may be a must drain tanks completely before filling International Energy Agency window of over-capacity in them with a different product.”

[IEA] – which was established the next year or two because in 1974 – after the eponymous new ones may be added oil crisis – as an autonomous faster than the old ones are retired if the rates are good,”he says. Any excess won’t last entity within the Organisation for Economic Co-operation long because rates will fall until scrapping accelerates, an and Development [OECD].

Congestion eased as winter turned to spring. “The adjustment that today’s high steel prices will hasten.

Shifting trade patterns have pushed tanker demand up bottleneck in the Bosporus has largely disappeared,”says faster than incremental oil production implies.“The market is CRS’s Tyler.“Delays are down from three or four days to being driven by increased demand from China and the US. one day, which frees up a lot of tonnage.” Now rates in These are long haul routes that require more ton-miles of the Mediterranean have dropped much more than for tanker capacity, says Saurabh Nakra. Geopolitical influences other routes.

It is not just the Bosporus, notes INTERTANKO’s William have had the same effect.“The problems in Venezuela mean that shorter-haul supplies that could have reached the US are Box. “If wind speed or wave height gets too much you cannot load at Novorossiysk. And if you are loading, you being replaced by longer hauls,”explains Richard Cowen.

The location of new crude sources has extended route have to stop.” A pipeline under construction from the length as well. “More oil comes from West Africa and the Caspian oil fields to Ceyhan on Turkey’s Mediterranean Black Sea,”says Cliff Tyler.“There are longer hauls, like West coast – that is due for completion by year end – will carry Africa to the Far East, which puts pressure on tonnage.” one million barrels per day [b/d] at full capacity. It will eliminate congestion and weather delays but not the [Please refer to Chart: BP: Major Oil Trade Movements.]

Energy Information Administration [EIA - the statistical need for tankers. “The distance from the Black Sea or agency of the US Department of Energy] estimates show that Ceyhan to end markets is about the same, but the oil from the former Soviet Union countries represents two pipeline will remove the bottleneck in the Bosporus,” says Saurabh Nakra.

Black Sea crude has increased Oil refinery utilisation demand for Suezmax [an Percentage arbitrary designation denoting 100 the largest size of vessel that can sail through the Suez canal fully loaded], which typically range 90 between 120,000 and 150,000 dwt [the quantity of cargo tankers can carry fully loaded]; 80 and Aframax [which is a smaller designation] ranging from typically 80,000 to 120,000 dwt 70 relative to VLCCs that carry in excess of 200,000 dwt. “VLCCs have always depended on supplies from the Middle East, 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 but now more than ever,” says North America S. & Cent. America Europe Middle East Africa Asia Pacific Drewry Shipping Consultants’ Nakra. “Gulf production has Refinery capacity utilization increased in the key consuming regions of North America, Europe and Asia Pacific in 2003, as oil demand growth picked up. While Asia Pacific utilization reached a new peak, North America and Europe faded, which has caused the remained below the highs of the late 1990s. softness we have seen in VLCC rates in the past two years.”VLCC Source: BP Statistical Review of World Energy 2004

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© BP

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Baltic Tanker Indices 350

300

250

200

150

100

50

23

/0

4

4 5/

4

23 /0 4/

4

23 /0 3/

4

23 /0 2/

23 /0

03

W. Africa/U.S. Gulf

1/

03

/2 3/ 12

03

/2 3/ 11

3

/2 3/ 10

23 /0

3

M.E. Gulf/Singapore

9/

3

23 /0 8/

3

23 /0 7/

3

23 /0 6/

23 /0

3

M.E. Gulf/U.S. Gulf

5/

3

23 /0 4/

3

23 /0 3/

3

23 /0 2/

23 /0 1/

12

/2 3/

02

0

Black Sea/Mediterranean

Source: The Baltic Exchange, July 2004

Edward Porter, Research Manager at the American rates may firm as Saudi Arabia ramps up production and Petroleum Institute [API], notes that the last new refinery Iraqi exports recover.

Russia ships Siberian oil from the Baltic Sea, another built in the US came on stream in 1976. The number of US seasonal trouble spot. “The Russian terminal at Primorsk refineries has dropped from 325 to 149 since 1981. on the Gulf of Finland is kept open by ice-breakers in Expansion at the remaining plants has not prevented total winter. The rates for ice-strengthened tankers went sky capacity shrinking from 18.6m b/d to 16.8m b/d.“In the US we have a combination of high,” says INTERTANKO’s refining capacity restraints,” Box. Political wrangling has says Porter. “We have not delayed a proposed pipeline “Industry experts believe growth in been able to build a new one from Siberia to the ice-free global oil demand will drive the market for a quarter of a century. We port at Murmansk. The in the long term.” produce 20 different types of private Russian oil gasoline for different areas at companies behind the different times of the year. project face opposition from Transneft, the state pipeline monopoly that operates The refining capacity we do have is not used as efficiently as it should be.” The fragmented gasoline market also Primorsk.

Hauling oil to the consuming countries is only half the strains storage capacity because refiners must drain tanks battle. When it arrives, refiners must process crude into the completely before filling them with a different product. gasoline, middle distillates and heating oil that consumers And nobody wants tanks or a refinery in their back yard.

Simple crude distillation doesn’t deliver what the market need. How tight is downstream capacity? The IEA’s Eagles believes that last winter’s spikes in product prices needs in the right quantities, so refiners must upgrade the overstated the constraints.“There was a lot of maintenance heavy fractions. US refiners have invested in cokers, catalytic and upgrading in Europe and the Middle East and some in crackers and hydroskimmers to satisfy demand for gasoline. the US,” he says. “There was a disjoint between “In the US half the refinery output is gasoline, then distillates maintenance schedules and demand. As soon as those and fuel oil,” explains Laurence Eagles. “Europe has more balanced demand for diesel and fuel oil. Government refineries came back on stream, prices backed off.”

Although West Coast refining margins briefly hit $20 per initiatives switched demand towards diesel cars.

Crude oil varies in consistency and sulphur content barrel [10 times the long term average], Laurence Eagles believes the industry is in no hurry to expand capacity.“If depending on its origin, so refineries cannot switch you look at the past 10 years, or the past 30 years, refining supplies at will. Light, sweet [low sulphur] crude oils has not been that profitable,”he says. Operators like to run command a premium price over heavy, sour grades. refineries flat out to maximise the return on an enormous Refiners also blend different crude grades to optimise their output and operating costs.“The perception is that OPEC’s capital investment.

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Major oil trade movements

Refineries in Latin America, the Caribbean, Europe and Trade flows worldwide (million tonnes) occasionally the Middle East 244.2 supply 10% of US refined 126.1 product needs today. It is a figure 25.1 50.1 likely to grow.

208.4 Available foreign refining capacity does not help unless it 102.0 36.4 70.8 51.8 154.3 can supply products that meet 19.7 90.6 US environmental standards.

81.5 333.7 34.0 28.8 “Refiners in other places will not 120.9 invest in the technology on the 35.3 off-chance it might be needed for 21.4 a couple of months a year,” says Bob Slaughter, who worries that USA the US might become a niche Canada Mexico market – rather like California.

S. & Cent. America 36.0 Europe & Eurasia “The market is supplied by Middle East Africa California refineries who have Asia Pacific made the investment to meet the strictest air quality standards in the country,”he says.“There is no Source: BP Statistical Review of World Energy 2004 © BP excess capacity. If there are problems, you cannot easily find increased production is at the heavy, sour end. Heavy Saudi substitutes.”Tight EPA rules may replicate the problem on a crude though is not that heavy. It is like the Urals, not Latin national scale.

Industry experts believe growth in global oil demand will America or Libya,” says Eagles. Some crude oils are so viscous they will not flow through pipelines unless heated. drive the market in the long term. “The IEA and the Heavy crude produces more fuel oil, which the US Department of Energy are talking about 120m b/d by 2025,” doesn’t need because many electricity generators have says API’s Edward Porter.“That’s 40m more. It is like adding switched to natural gas. Eagles believes the market is more five or six Saudi Arabias over the next 20 years.”He debunks flexible than people realise. “Hydroskimming capacity the idea that the world is running out of oil, but says crude produces more fuel oil and distillates than gasoline,” he will come from less developed countries.“Thirty years ago adds. “If there is too much fuel oil, the hydroskimmers the new supplies were in OECD countries, Alaska and the refine sweet light crude and the catalytic crackers go to North Sea. Now it is Russia and West Africa where there’s sour crudes. You can get more gasoline from sweet crudes not a well-developed business environment.”Oil produced far from consuming countries will require more tankers to in a cracker, but it is more expensive.”

Although US refineries can handle a wider range of haul it as well as new refining capacity. crudes than foreign plants, tighter environmental health standards demand more downstream processing. “In the A bubble on the horizon, or just plain sailing?

1990s, the industry spent $20bn, mostly on environmental FTSE Shipping & Ports Index vs. FTSE All-World Index regulations,”says Bob Slaughter, president of the National Petrochemical & Refiners Association. “It will spend another $20bn this decade through 2010.” By January 2006, Environmental Protection Agency rules cut the permitted sulphur content in gasoline from 340 parts per million [ppm] to 30ppm and in diesel from 500ppm to 15ppm. “You lose material when you process more, there is less output per barrel,” explains Slaughter. “In effect, it reduces refining capacity.” It also raises US demand for crude.

With US refineries running at 96% of capacity, can imports meet incremental demand for refined products?

“Globally, you do not see the same utilisation rates we have in the US. Europe is a bit lower while South America and Africa have 75% utilisation,” says API’s Edward Porter.

200

175

150

125

100

75

50

Jun-01

Sep-01

Dec-01

Mar-02

Jun-02

Sep-02

FTSE Shipping & Ports

Dec-02

Mar-03

Jun-03

Sep-03

Dec-03

Mar-04

Jun-04

FTSE All-World Index

Data as at 30 June 2004. Source: FTSE Group

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Greece’s banks have had it all to play for in the last eighteen months. Accelerated consumer spending, a continuing run of positive economic growth and expansion opportunities in the neighbouring states of southeast Europe have combined to promise much for the banks. But not all of them have enjoyed the good times in equal measure and change is in the air.

Francesca Carnevale reports from Athens.

ESTRUCTURING HANGS HEAVILY in the air of Greece’s principal banks – not least in the state sector. “We’re definitely in line for significant changes,”predicts Ioannis Papadakis, senior management advisor and division manager at Emporiki Bank in Athens.“The major drive is how to reform the operations and asset distribution of the publicly-owned banks and how to reconcile them with new accounting standards.”

The move is widely welcomed.“It’s long overdue, not just in Greece, but all over Europe,” says Nicholas Nanopoulos, chief executive officer [CEO] at EFG Eurobank Ergasias [EFG Eurobank].

With a population of only 10.2m, it can be said that the country suffers a surfeit of banks. The sector comprises

R

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banks on improved consumer sentiment some 22 commercial banks and a further 19 cooperative banks and specialised credit institutions. Business has coalesced in the top five domestic banks and they now control almost 80% of the market. While there are also twenty or so foreign banks in Greece, they have tended to have a hard time of it in the country, and over the years have managed to wrest control of only 8% or so of the market. This has left the myriad other domestic financial institutions controlling very little indeed. It’s a condition that looks ripe for change.

Size is also a problem. Only 13 banks in Greece have assets in excess of $10bn. The National Bank of Greece [NBG] dominates, with total assets nearly twice those of its nearest competitors Alpha Bank and EFG Eurobank. After the ‘big three’ come Emporiki Bank and Piraeus Bank.

Thoughts of consolidation, therefore, rise inexorably.

Although the government officially encourages consolidation – it does so with significant caveats.

Certainly, as part of its wider economic policy, the New Democracy government has stated it “wants to roll back state control over the business sector as a whole,” says Plutarchos Sakellaris, chairman of the council of economic advisers at the Ministry of Economy in Athens.

According to Platon Monokroussos, head of research at

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GREEK BANKING Nicholas Nanopoulos, chief executive officer [CEO] at EFG Eurobank Ergasias [EFG Eurobank]

EFG Eurobank, however, two schools of thought have emerged on the future of the industry: “One argues that state-controlled banks should become the vehicle for the intensification of competition in the sector. The other is that there are too many banks in Greece and that consolidation is required.” Monokroussos points out that there appear to be other strategies applied to the National

58

Bank of Greece [NBG] and Emporiki Bank – both of which, he says, are being encouraged to cultivate relationships with foreign partners. “A different recipe again seems to apply, for example, to the Postal Savings Bank and the Agricultural Bank of Greece and both could remain entirely under state control,” he points out.

The ambiguity is made clear by Sakellaris,“Obviously we are very concerned about competition,” he says,“but we are not in favour of a rush towards consolidation.

Without opposing it, we are keen to ensure competitive conditions are maintained.” Sakellaris underscores an additional requirement: “Adaptation to the Eurozone will inevitably push further change.”

State ownership in itself is not a concern, says Paul Mylonas, director of research, chief economist of the group, and head of investor relations at NBG, as the government has had a hands off attitude with regard to the bank’s operations for years. Even so, it is well known that Economy Minister, Giorgios Alogoskoufis, is keen to reduce public ownership of the country’s banks. The government owns shares through the state pension funds which have significant holdings in the banking sector.

After a sale of 11% of NBG to investors, which generated close to €489m, the Greek state now holds only a direct 17.1% stake in NBG and a further 3.9% indirect stake through other statecontrolled institutions, equalling 21% in total.

The conservative government says it will give priority to selling strategic stakes in two statecontrolled commercial banks – National Bank of Greece and Emporiki Bank, the former Commercial Bank of Greece, which was re-named last year. As the country’s biggest bank with a sizeable presence in the Balkans, National could be an attractive investment prospect.

France’s Crédit Agricole already holds a 10.5% stake in Emporiki and could increase its stake to 33% if the issue of

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unfunded pension liabilities can be resolved, say Greek Historical underperformance – FTSE Greece Banks Index vs. press reports. Ionnis Papadakis would not be drawn FTSE Europe Banks Index however. “Pension liabilities are a problem across the banking system,”he acknowledges.

For the time being then consolidation is sidelined: “The banking system is quite bureaucratic and local labour laws remain restrictive. It’s not an environment that encourages consolidation. Answers will have to be found elsewhere,” confirms EFG Eurobank’s Nanopoulos.

It’s not yet a necessity, he thinks, as most banks in the country are expanding their businesses. Domestically, growth is based on a booming credit and mortgage market.

Internationally, growth is predicated on regional expansion in the neighbouring states of Southern Europe. However, as new business opportunities have opened up, it is clear that not all of Greece’s banks have enjoyed the party to the Data as at 30 June 2004. Source: FTSE Group same degree. The country’s private banks such as EFG Eurobank Ergasias [Eurobank] and Alpha Bank have taken on the bank’s restructuring. “It’s obvious that NBG and a disproportionate share of consumer credit business over ourselves have lost some market share to Alpha and the last two years and look to repeat the experience in both Eurobank. So we are rethinking the whole story. The new the corporate finance and asset management areas. management at NBG and our bank is of the same mindset.

“Eurobank had already moved heavily into retail by the We have everything to gain from a new approach.” Loan time of the market upturn,”explains a banker in Athens.“It quality is also something of an issue – but not an imperative. “Using even the was consequently well usual indices,” expands placed to take advantage of Papadakis, “we are not the retail boom.” The bank’s Internationally, growth is predicated on looking at a situation where share of the household regional expansion in the neighbouring loan quality has deteriorated. lending market rose by 60bp states of Southern Europe.

But we do need to clean up to 16.4% in 2003, according the asset/liability accounts – to figures released by the before we can talk about bank in February this year.

“Eurobank now represents formidable competition for profitability. We do it to keep in line with the new reporting both NBG and Alpha, achieving 37% growth in pre-tax requirements of the Athens Stock Exchange [ASE], the profits of €373m in 2003,” says CEO Nanopoulos. “The Central Bank supervisory board and international bank has rolled out a series of initiatives in recent years, accounting standards.”

Emporiki [formerly Commercial Bank of Greece] then is including several acquisitions, of those the InterTrust acquisition is the most recent, though it is not yet finalised. a microcosm of the changes required. Underpinning All have contributed to improved efficiency and led to an change has been the appointment of new senior personnel increase in the bank’s market share. Now if we do buy at the state banks. Takis Arapoglou, formerly a senior something, it will be strategic, and selective, rather than adviser in global corporate and investment banking at buying market share.”

Nonetheless, he adds, the nature of business has also A new beginning? FTSE Greece Banks Index vs. FTSE undergone something of a change. First, says Nanopoulos: Europe Banks Index “Nine months ago, capital markets business was booming.

Now we are more concerned with household lending.”

Second, there’s systemic change ahead.“There’s no doubt that the state banks will achieve more efficiency. The challenge for us will be to stay ahead of them,” says Nanopoulos. “We are a product-led bank trying to transform itself into a customer-led bank. Our ability to achieve this will be tested. It’s not an exact science and it will depend on a combination of initiatives.”

Even so, EFG Eurobank’s success to date has not gone unnoticed. Emporiki’s Papadakis is blunt about the need of the state banks to fight back. Previously at General Bank [which has been recently bought up by France’s Société Générale], Papadakis is a key adviser to the Emporiki board Data as at 30 June 2004. Source: FTSE Group 150

125

100

75

50

25

0

Jun-99

Dec-99

Jun-00

Dec-00

Jun-01

Dec-01

FTSE Greece Banks

Jun-02

Dec-02

Jun-03

Dec-03

Jun-04

FTSE Europe – Banks

170

160

150

140

130

120

110

100

90

Jun-03

Aug-03

Oct-03

FTSE Greece Banks

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Feb-04

Apr-04

Jun-04

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closer to rates elsewhere in south east Europe,”he adds.

New Democracy pledged during the election campaign to deliver growth rates of around 5% yearly that would reduce the unemployment rate from around 8.8% to 6% and bring real convergence with Greece’s EU partners. Greece can also count on continued high flows of EU structural aid until 2007 – equivalent to more than 3% yearly of GDP, says EFG Eurobank’s Monokroussos. Invariably though, this aid cannot be counted on indefinitely. In 2004, the accession of 10 new member-states, [every one in more dire need than Greece for structural assistance], will inevitably reduce Greece’s portion in the next structural package.

That consideration aside, Greece’s banks are enjoying an eighteen month run of good results. According to the Bank of Greece [the central bank], average profits of the major Plutarchos Sakellaris, chairman of the banks were up 40% year on year in council of economic advisers at the Ministry 2003 as consumer credit rose 27%, of Economy in Athens while costs were down by over 5%.

Last year, each of the country’s three largest banks [NBG, Alpha Bank and Citibank took up the reins as chairman and governor of EFG Eurobank] reported returns in excess of 15%. Business NBG in March, following the death of Theodorus Karatzas, grew speedily as the outgoing PASOK government who had died earlier in the month, just prior to elections belatedly liberalised Greece’s consumer credit regime and which had brought in the Karamanlis New Democracy encouraged the establishment of the Credit Bureau of government. Karatzas had been chairman for over eight Teiresias, Greece’s first domestic credit rating company for years and despite many improvements he made, the bank consumer and mortgage loans. There’s also more to come. still has significant shortcomings, especially those relating According to a 2003 research paper issued by Alpha Bank, mortgage lending as a percentage of GDP is only around to human resources management.

Arapoglou, on the other hand, marks a line of more 17% in Greece in 2003 compared with 32% in the Eurozone, while consumer ‘entrepreneurial’ managers loans run at only 8% of GDP brought in by New in Greece, a level that is only Democracy to head up Plutarchos Sakellaris says the government half the Eurozone average, strategically important state will streamline the administrations and suggests Ioannis Papadakis at owned entities.

Emporiki Bank.

Restructuring of the banks codify legislation to promote investment, Opportunities also abound is, however, a priority and it both domestic and foreign. [albeit in the longer term] in is probably a good time to do the wider Southern European it, say market watchers. Any region. However, it is unlikely change will take place against a backdrop of complementary developments, such as that the state banks will hold on to all their current new corporate tax laws and developments in the mutual Southern European holdings. Investment by Greek banks fund sector, which are expected to be announced in October. in the Balkan states has been impressive and totals around Plutarchos Sakellaris says the government will €700m, according to recent central bank estimates.

The rush by the country’s banks to develop sites and streamline the administrations and codify legislation to promote investment, both domestic and foreign. “The lending in the Balkans followed the successful expansion of Minister has also pledged to overhaul the tax system and Greek companies, such as telecoms provider OTE. But reduce corporate tax rates from 35% to 25%, bringing them while Greek companies are still an important part of the

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banks’ regional business, domestic loans form the growth effectively a convergence play. But the situation also end of the market; and it is here that difficult questions are refocuses the role of Greece. Until recently, Greece was a virtual island, cut off from the rest of the EU by land. That’s being faced. Should the banks stay or quit?

The state banks were among the first to expand overseas – changed and will change even more with expanded often propelled by national rather than commercial strategy. membership of the EU. It gives us a head start to develop our expertise in the wider It was an exercise that Southern European region.” sometimes exerted strains on EFG talks from experience. performance or at least “The fact is that expansion for some It is the only bank to have expectations of performance.

Greek banks was the result of the acquired a Serbian bank, NBG provides a template, government’s efforts to gain prestige EFG Eurobank Beograd – although a distinction should only to see the country’s be made between NBG’s in neighbouring countries...” economic performance dip. historical acquisitions and its “It happens, but we see the current strategy in Southeast Europe. For historical reasons, related to the Greek diaspora, region moving ahead.You cannot expect to adopt a foreign NBG has acquired an extensive overseas network [relative to strategy without taking some risks.” NBG meanwhile, the size of the bank] encompassing branches in South Africa, succeeded in turning around the profits of Macedonia’s a 23-branch Atlantic Bank of New York operation, which also Stopanska Banka, which had been burdened with a high acquired in turn, the Allied Irish Bank branch in New York. percentage of unrecognised bad loans.

With its population of just over 10m and a combined More recently, it has expanded in Southeast Europe, initially following its clients. Specifically, it bought an 80% stake population in south and eastern Europe at least five times Banca Romaneasca in Romania and controls United that number, the broader region will be seen as a panacea Bulgarian Bank, the leader in retail lending in Bulgaria; for Greek financing institutions seeking greater market Stopanska Banka, the biggest bank in Macedonia, as well as share. Whether all will be able to share in that bonanza is branch networks in Albania and Serbia. Now NBG’s assets in still to be determined. the Balkans are estimated to be worth some €2.5bn. NBG’s Paul Mylonas now raises the interesting teaser that the bank’s overseas assets are under review. Although he will not be drawn on specific assets, he acknowledges that the bank is reviewing its overseas operations and that non-profitable assets will likely be disposed of.“It may be that we retrench from markets that are less strategically important to us.Those would comprise banks that are geographically more distant,” he states.

Emporiki may take things a step further.“The fact is that expansion for some Greek banks was the result of the government’s efforts to gain prestige in neighbouring countries. It’s nice to do as a government. It’s not necessarily nice to have to do it as a bank,” says Ioannis Papadakis, senior management advisor and division manager at Emporiki Bank in Athens. “We are reconsidering the whole Balkans policy, looking at the market’s potential returns. If we determine it’s too little, anything can happen.”

Papadakis admits that the previously unthinkable is now possible. “There can only be more competition – the opportunities are obvious, but we are not the only ones who think so,” he states. While the French are concentrating on developing their hold on the Mediterranean market; the Germans, Italians and Austrians are seeking strong footholds in Southern Europe.

Austria’s Raiffeisen Zentralbank Öesterreich [RZB]; France’s Société Générale and Italy’s Unicredito are all present in the region.

“It is becoming a two-tier market,” explains EFG Eurobank’s Nanopoulos.“Bulgaria and Romania are set for Paul Mylonas, director of research, chief economist of the group, and membership of the European Union and this makes them head of investor relations at NBG

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HOW DO YOU BALANCE DEMAND AND SUPPLY? The deal calendar is picking up.

“The question is whether lenders will be able to meet demand from deals now that there is more hedge fund demand as well,” says Edward O’Brien, executive vice president and head of State Street’s Securities Finance division. As hedge fund assets under management soar towards $1trn, demand for borrowed securities rises because most strategies depend on both short and long positions. How has hedge funds’ growing appetite affected securities lending? Neil O’Hara reports from New York.

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HORT SELLERS DO not own what they sell.

Nonetheless, buyers expect delivery on settlement date. Sellers borrow deliverable securities from their prime broker, which many lend from their own ‘box’ – that is, securities held in customers’ margin accounts. Or, they borrow from pension plans, insurance companies and other institutional investors either directly or through custodian banks. When the trade settles, the lender retains the sale proceeds plus a small margin as collateral for the loan.

Although the cash belongs to the seller, the lender and prime broker each take a share of the interest earned as a fee. How much depends on market conditions, including whether the security is hard to borrow, or special.

Securities lenders flourished during the bull market, when frenzied merger and capital markets activity boosted demand from arbitrageurs and underwriters hedging their exposure. That evaporated as equities collapsed.“We saw big drops in activity in 2001, so even though hedge funds were growing it didn’t affect spreads because the market was driven by other fundamentals,” says Christopher Stavrakos, senior vice president, chief investment officer and director of liability management at Mellon Global Securities Lending.

Hedge funds shifted their focus to fixed income during the bear market. “Equity hedge funds went into distressed Kathy Rulong, senior vice president and executive director at Mellon securities,” says Jeffrey Benner, head of securities lending trading, North America, at Northern Trust. He has seen explains the RMA’s Adamczyk. “Stock lenders will say, I’ll steady growth in demand for corporate bonds and believes lend you $X of hard names at the prevailing market level if funds will stay in the distressed arena when mergers pick up. you take $5X of easy borrows as well.” A lender typically “The players have found there is money to be made,”he says. has a few securities in hot demand, a larger number Government and mortgage-backed securities attracted partially lent and many more that are never out and never hedge funds as well. “Fixed income arbitrage is growing likely to be.“The risk reward in securities lending is skewed exponentially,” says Peter Adamczyk, chairman of the Risk in favour of the lender,” says Adamczyk. “It really is a Management Association’s [RMAs] securities lending question of whether I make a little money or a lot.”

Some lenders auction their portfolios to prime brokers in committee. Expectations of rising interest rates fuelled recent loan demand for treasuries as macro funds reversed exchange for guaranteed minimum income and a share of carry trades and hedged mortgage-backed portfolios, any additional earnings. The $166bn California Public Employees’ Pension System [CalPERS] has attracted such according to Stavrakos.

Last year’s strong market inflated lenders’ equity aggressive bids that Adamczyk wonders whether the balances. Volume is recovering too. “This is our third winners make any money. “People have climbed out on a ledge,” he says. The consecutive year of profit and successful broker has balance increases on our “A lender typically has a few securities bragging rights to a huge equity book,” says Kathy portfolio, but needs high Rulong, senior vice president in hot demand, a larger number partially utilisation to cover the and executive director at lent and many more that are never out guarantee. Other clients may Mellon. Hedge funds using and never likely to be” receive no more than long-short equity strategies minimum commitments continue to grow, and others turned to convertible arbitrage when merger activity because the broker needs to work CalPERS’ book so hard.

“You have to look at the opportunity cost. If you put out a plummeted. “You can have convertible bond trades out there for three to four years at a clip,” says O’Brien. “Our portfolio and merger activity heats up, you cannot business is up substantially in pairs trading too. There has participate,” says Patrick Dunne, manager of securities been an increase in trades that stay out for a long time with lending for the US and Canada at Barclays Global Investors [BGI]. Dunne reckons he makes better returns for clients by stable balances.”

Margins in securities lending depend on cash lending individual securities. Mellon takes a similar view.“We management skills and milking specials for all they are do money fill, general collateral, but we retain the right to call worth. “If the borrower will give me a big cash balance, I back issues and substitute others,”says Rulong. If one of the can manage it more aggressively and make more money,” large capitalisation stocks that make up general collateral gets

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tight, Mellon trades it as a special.“Money fill is the highest actions and deals in the past few months, mitigated by volume and has been the majority of earnings from time to deals that have less premium. People are not overpaying. time, like when virtually all merger and acquisition activity There’s less room for lending premiums.”

Securities lenders prefer size to a big spread. “If some dried up in 2001 and 2002,” says Christopher Stavrakos at small hedge funds offers me 10 times the spread I could get Mellon Global Securities Lending.

If thin margins on big cash balances are bread and butter from another prime broker, I make more money on the revenue to securities lenders, specials are the jam. “Fixed hard-to-borrow - say $10,000 instead of $1,000,” says the RMA’s Adamczyk. “But he income specials are on-thewon’t borrow the other $100m run treasuries. If brokers are “Some lenders auction their portfolios to of securities on which I can underwriting a deal they prime brokers in exchange for guaranteed make $100,000.” That assures hedge their exposure, or it minimum income and a share of any big funds better access to may be tied to mortgagespecials and finer spreads. backed,” says BGI’s Dunne. additional earnings.”

S3 Asset Management’s When interest rates rise, Sloan thinks the growing clout consumers stop refinancing so the duration of mortgage pools increases. Shorting of hedge funds has put pressure on pricing.“If you are a $5bn treasuries offsets the negative convexity. “Traders go to the fund, the question is how much I will make per annum, not biggest, most liquid issues, or they use futures. That puts what is the fee,” he says. “At some point it is not a cost of doing business.” pressure on benchmark issues,”says Stavrakos.

Large funds play multiple prime brokers off against each Lenders keep a close watch on the market to extract maximum value from specials.“My team is constantly trying other to reduce costs. Explains Adamczyk: “They will come to figure out why hedge funds are doing the trades,”Benner to you and say: ‘I have X position at several brokers.You can says.“It is easy in risk arbitrage, but there is less disclosure have it all, if you quote me a good rate.’I go running around looking for all the stock I can find but, meanwhile, the in bonds. It is not as obvious what the funds are doing.”

The real money is in equities says Robert Sloan, founder hedge fund tells all their other lenders the same thing.” and managing partner of S3 Asset Management and When the bidding stops, the losers return the stock to former head of prime brokerage at Credit Suisse First lenders – who often put it back out through the winning Boston [CSFB]. “The most you can make on specials in broker at a less profitable rate.

Prime brokers are reluctant to talk about securities fixed income is the difference between Fed [sic] funds and zero,”he says.“That is not true for equities. The spread can lending. Perhaps it is because it has no public profile.“The go negative.” Share exchange merger transactions and consumer is a hedge fund, who is convinced prime convertible arbitrage generate the most profitable brokerage is a commoditised business,”says Robert Sloan. opportunities. “In equities, deals dictate spreads and “There is an iceberg effect. They only see what is above the demand,” says Stavrakos. “We have seen more corporate waterline. But when they put their assets on a brokerdealer platform, the broker-dealer gets to use the assets.”

Hypothecation agreements allow the broker to lend or pledge the assets. The broker meanwhile controls the reinvestment of cash collateral.“The hedge fund thinks its cost is 200 basis points, when it is really 350,”adds Sloan.

“Prime brokers do a great job for the market,”says RMA’s Peter Adamczyk. “They do credit intermediation. They charge a lot of money, but they are worth it.” Securities lenders view unregulated hedge funds as unacceptable counterparties, so they pay prime brokers to take on that risk.“I’m comfortable lending billions to the big securities houses,” he adds, “though I would not touch some hedge funds with a ten foot pole.”

New supply has helped prevent higher lending spreads.

“The RMA went out to participants in mid-2003 and asked where lenders got their equity securities from. Some 45% of the lendable pool was from mutual funds. That was less than ten per cent five years ago,” says Adamczyk, who thinks that the market has already tapped the best US Patrick Dunne, manager of sources. Jeffrey Benner, head of securities lending trading, securities lending for the US North America, at Northern Trust agrees. However, he says and Canada at Barclays that contributions to pension plans are increasing his book.

Global Investors [BGI] Last year’s tax changes caused a hiccup in mutual fund

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lending. An investor who buys stock from a short seller Yet Mellon Global Securities Lending has profited from receives dividends [now taxed at 15%], but the lender a lender client base that is skewed toward tax-exempt receives payments in lieu from the short seller [taxed at pension funds and endowments unaffected by the new higher ordinary income rates]. Many mutual funds have law. “We have seen increased demand from prime broker both individuals and tax-deferred 401(k) plans as clients. More securities go special over record dates,” says shareholders [The 401(k) plan is a type of defined Kathy Rulong, senior vice president and executive director. contribution pension plan available in the US. Named after Pressure from the US Securities and Exchange a section of the 1978 Internal Commission on institutional Revenue Code, it is a device investors to require a “Securities lenders view unregulated to provide tax advantages on shareholder meeting could hedge funds as unacceptable money set aside for force lenders to recall stock retirement.] “Now the agent too. It is a talking point. counterparties, so they pay prime has a problem,” says “Corporate responsibility – brokers to take on that risk.”

Adamczyk. “If he goes on how much do they have to lending, he’s disadvantaging vote? Will voting 10% of [sic] taxable shareholders, but if he stops the 401(k), people their position do?” asks Rulong. That may suffice for a won’t benefit from the increased yield.” straightforward vote to elect directors and appoint Some lenders see no lasting effect.“It is only an issue if the auditors, but what about controversial shareholder securities lending income exceeds the management fee,”says proposals, mergers or contested elections? “Except in a BGI’s Patrick Dunne. State Street’s Edward O’Brien points out very small percentage of votes, institutions have a higher that the 15% rate does not apply to all dividends.“A particular duty to generate income and competitive returns from fund may only get a two to three per cent advantage, which lending,” says Edward O’Brien. But if that percentage they have to weigh against the lending income. There was includes most corporate actions, record dates could squeeze hedge funds hard. some initial concern, but it’s really a non-event,”he adds.

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Paul Wilson, head of securities lending, JP Morgan Investor Services

What to do

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There are wide ranging changes in prospect for Europe over the whole financial services sector.

Today there are more than 20 directives either already in course or in prospect, as a result of the Financial Services Action Plan. In addition, the introduction of Basel II will also bring changes for the securities lending market.

Angela Ward reports on the impact of expected changes infrastructure of Europe’s securities lending market.

ASEL II WILL have a profound impact on the securities lending business. It will complicate the infrastructure required and drive more elaborate processes, says Fred Francis, vice president, securities finance and global products, RBC Global Services. “These changes will lead to the demise of those lending who don’t have the economies of scale and/or vision to invest in these new changes,” he says.

Mark Hutchings, chairman of the UK-based International Securities Lending Association [ISLA], has a broader view. He is markedly upbeat as he looks forward to a unified financial market in Europe as the cross-border barriers are broken down. “I can see huge opportunities for increased activity in securities trading which will, in turn, provide our members with further opportunities to lend, safely and cheaply, throughout the ever expanding European marketplace,” he muses. As with any financial transaction, he points out, people often point out that it has potential risks – but professionals in the securities lending market argue that they are minimal.

“The key is to understand the risk and ensure that each lender only takes on a level of risk with which they are comfortable and which is justified by the likely return,” Paul Wilson, who heads up the securities lending business for JP Morgan Investor Services, explains. “At JP Morgan we work with each of our lenders and offer them the ability to customise the lending parameters in our programme according to their needs.”

Andy Clayton, head of international securities lending, Northern Trust Global Investments adds: “As with all investment activities, there are risks. However, in the securities lending world these are low. Knowing your counterpart well and having a good working relationship with them is imperative. A rigorous internal borrower approval process, supported by senior credit and business analysts ensures we only lend to highlyrated entities.”

Fred Francis says that far from being risky, securities lending has a risk mitigation effect.“While there have been some well publicised losses incurred over the last 20 years; in 90% of cases, the problem has arisen from the cash reinvestment component that follows from, but is not part of, the securities lending process itself,”he says.“If there is risk in securities lending, it is not credit or market risk, but rather operational risk. At RBC, we have made major

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Tim Smollen, the global co-head of agency securities lending at Dresdner Kleinwort Wasserstein

investment in operational infrastructure and robust technology and, as a result, operational risk is significantly minimised or mitigated.”

Until recently there was very little competition in the securities lending marketplace. Now, however, competition has increased and there is an array of alternative service providers to choose from including third party providers.

“While the concept of third party lending has been around and accepted for many years in the US, it is now getting a lot of attention and focus in other parts of the world, as investors un-bundle the services they use from their custodians,” says Tim Smollen, the global co-head of agency securities lending at Dresdner Kleinwort Wasserstein. “In the past the custodian did it all, but sophisticated investors are now going out to find the best providers for each of these services.”

With an increase in alternative routes to market, lenders now have greater choice about how they want to manage their lending programmes and some are bringing alternative lending managers onboard. eSecLending, for example, is a global securities lending manager utilising a proprietary auction process to generate premium returns for its clients. “Rather than

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EXPLAINING SECURITIES LENDING

“Principal borrowers of securities have tended to be proprietary dealers, market makers and prime brokers.”

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ECURITIES LENDING IS driven by demand from large banks and brokers/dealers, fuelled by different trading and arbitrage activities “plus the underlying requirement to borrow securities to alleviate fails and shortages in the market,” explains Susan C. Peters, chief executive officer, eSecLending – the global securities lending manager that is part of financial services group Old Mutual plc.

Kathy Nelson, strategic planning coordinator, inventory management, AXA Investment Managers, a dedicated multi-specialist asset manager, backed by the AXA Group adds, “Principal borrowers of securities have tended to be proprietary dealers, market makers and prime brokers. In recent years, there has been an increasing demand from structured product divisions of investment managers.” Equally, in the last decade the market has become segmented, specialist regional players emerged and outsourcing has become more popular.

Securities lending began informally, between brokers who, from time to time, had insufficient share certificates, either because clients had mislaid their certificates, or the brokers had not received them by the settlement date of the transaction. The International Securities Lending Association [ISLA] describes securities lending as the temporary transfer of a security by its owner to another investor or financial intermediary. Once the securities have settled, the title and voting rights are transferred to the borrower, who can sell or re-lend the borrowed securities during the life of the loan. In return, the borrower agrees to return the loaned securities, secure the loan with collateral of equal or greater value than the loaned securities, and pay any user fees, and remit to the lender any dividends, coupon interest or other distributions that occur during the time the securities are on loan. It also ensures an orderly and efficient marketplace.

“The ability to lend and borrow securities has advantages to support trading strategies of dealers, hedge funds and other asset managers, while for securities lenders it provides revenue to institutional investors, custodian banks and prime brokers,” adds Andy Clayton, head of international securities lending, Northern Trust Global Investments.

Securities lending has advantages for all parties, says Fred Francis, vice president, securities finance and global products, RBC Global Services: “From a broad capital markets’ perspective, lending is a liquidity provider and a stabiliser for stock markets. Recent studies show that it helps to reduce volatility. It enables

lenders to generate additional return at a time when asset performance is suffering and every penny counts. Finally, it allows borrowers to execute complex investment strategies that would otherwise not be open to them.”

“Investors participate in securities lending to hopefully earn a few extra basis points on the portfolio,” adds Tim Smollen, global co-head agency securities lending, Dresdner Kleinwort Wasserstein.

“If you are running a mutual fund, a couple of extra basis points can sometimes mean the difference between third and tenth in performance tables.”

“Changes to regulations, tax laws and improvements in settlement systems, have seen the industry develop considerably enabling trading houses to pursue different trading strategies, safe in the knowledge that they will be able to deliver the stock if required,” concludes Mark Hutchings, chairman of the ISLA. “The last 15 years or so have also witnessed a huge increase in the value of securities lent. Whilst the price paid for borrowed securities has tumbled, there are now many more lenders active in the market, not only earning more from their portfolios, but also contributing to overall depth and liquidity of the markets in which they are investing.”

FTSE Hedge trading strategies that involve shorting securities vs. FTSE All-World Index 200

175

150

125

100

75

50

Dec-97

Jun-98

Dec-98

Jun-99

Dec-99

Jun-00

Dec-00

Jun-01

Dec-01

Jun-02

Dec-02

Jun-03

Dec-03

FTSE All-World Index

FTSE Hedge – Equity Arbitrage

FTSE Hedge – Convertible Arbitrage

FTSE Hedge – Merger Arbitrage

FTSE Hedge – Fixed Income Arbitrage

FTSE Hedge – Distressed & Opportunities

Six FTSE indices that involve shorting securities

Data as at 30 June 2004. Source: FTSE Group

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Fred Francis, Vice President, Securities Finance and Global Products, RBC Global Services

pooling all client assets together and lending them on a ‘best efforts’ basis as demand arises, we arrange exclusive principal relationships between our clients and borrowers via a competitive, blind auction process,” explains Susan C. Peters, chief executive officer, eSecLending. “This process has proven to generate significantly higher returns for our clients than their previous custodial programme structures.”

Adds Fred Francis: “An auction is about matching a special buyer with a portfolio on offer that meets their needs. The real value is in having the talent and skills to expand the broadcast of your portfolio to attract special buyers and discover/identify new special buyers.

Auctions offer certainty. If you are a hedge fund that has a special strategy that demands very specific stocks or markets, you want to lock up that supply. Locking it up means having first right of refusal and the ability to access that supply at will.”

After many failed attempts over the years, electronic access platforms seem finally to have made a breakthrough in the securities lending market.“I think that it is inevitable that they will play an ever increasing role in supplying the day to day basic needs of the market – and this is what has happened in most other markets, for example market making and foreign exchange,” says the ISLA’s Mark Hutchings.

Adds eSecLending’s Susan C. Peters: “Operational trade flow and system enhancements have improved volume processing and decreased the level of exception processing

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which is very important to the integrity of the loan transaction. Electronic trade negotiation has also helped to improve the market by more efficiently matching supply and demand.”

The ISLA is looking ahead to a European market that will offer even more opportunities for securities lending.

“Eventually, I would expect full harmonisation of the trading and settlement systems, together with legal, regulatory and taxation regimes coming together,” says chairman Mark Hutchings. “With this, I would expect much securities lending to be automatically executed by the settlement systems themselves. I also expect the wider, integrated European market to be much more active. Historically, the automation of trading and settlement, not only bringing greater safety but also reductions in unit costs, has led to greater securities lending activity, and I see no reason for this to change.”

The ISLA works very closely with regulators to promote securities lending. In the UK, for instance, it has representation on the Securities Lending and Repo Committee, a group of market practitioners chaired by the Bank of England. It also points to the Stock Borrowing and Lending Code of Guidance as a key document.

“All prospective lenders should thoroughly familiarise themselves with this and ensure that they follow all the advice,” says Mark Hutchings. “This Code is regularly updated and ISLA is currently working with the Bank of England on a revised version, which we expect to be published at the end of this year.”

Susan C. Peters, chief executive officer, eSecLending

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Bond investors can expect a further stream of sovereign offerings throughout the remainder of this year and 2005, as the prospect of rising global interest rates encourages governments in both the leading industrial economies and the emerging markets to lock their long-term debt into prevailing rates. Andrew Cavenagh reports.

Sovereign issues resurge HE G7 COUNTRIES will lead the way. Economic growth is forecast to remain strong in the US, Japan and UK, and there are finally signs of a sustainable pick-up in the leading countries of the Eurozone – Germany, France and Italy – giving governments the confidence to increase borrowing now on the strength of the projected growth in their future revenues. “I think you’ll see a lot more issuance now

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from governments in the major economies,” says Carl Beckley, director of research and development at FTSE Group.“They all now are net borrowers.”

Analysts at a number of the leading banks, including Merrill Lynch and Barclays Capital, believe the US Treasury may sell more than $800bn of notes by the year end to finance a record budget deficit, which some expect to exceed $500bn by the end of the fiscal year on September 30.

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Merrill Lynch also forecasts that Germany, France and Italy will need to raise over €450bn of long-term borrowing in 2004. The second week of July alone saw the governments of these countries and three others – the Netherlands, Spain and Greece – issue almost €20bn of sovereign debt.

The UK will also be a heavy borrower, as its Budget deficit continues to grow in the run-up to the next general election – in stark contrast to the Budget surpluses [and lack of issuance] that characterised the early years of Tony Blair’s Labour Government. The Debt Management Office at the UK Treasury has said it will issue £48bn of gilts in the 2004/2005 fiscal year. “The rate of issuance for the developed sovereigns will go on at much the same rate for the rest of the year – maybe a little bit less,” says Lionel Price, chief economist at Fitch Ratings.

Others expect the rate of new issuance to slow down between now to the end of the year, however, as governments have weighted their 2004 programmes in expectation of a series of US-led rate hikes in the second half.

“They have been quite aggressive in front-loading issuance,”explains John Lee, international rate strategist at Barclays Capital in London. “I think we’ve probably seen most of the increases now and that – by and large – the volume of issues will start to decline from here on in.”

counsel in London for the Bond Market Association, which represents the firms and banks that underwrite, distribute and trade in fixed-income securities.

Sgouridas adds that one clear indication of the maturing market for emerging country debt is the increasing use of the bonds by banks in repo and securities lending operations.“They’re being included in those activities more than they were two or three years ago.

Another sign has been the tightening of spreads on emerging market sovereign issues. Brazil was able to issue $1.5bn of 30-year bonds in February at just 376bp over the comparable US Treasuries, and investor willingness to take on greater risk to enhance yields has seen demand outstrip supply spectacularly in some cases.

Spreads Despite the volume of issuance from both the industrial and emerging markets, the spreads on sovereign bonds have remained tight as investors appear to have become less and less discriminatory about the issuer. In mid-July, for example, the 10-year bonds of Greece and Italy were trading at 18 and 19 basis points [bp] respectively over the equivalent German bunds, while those of Ireland were coming in at 9bp under the German benchmark.

“Bond spreads have just got very narrow,” says Lionel Price, the chief economist at Fitch Ratings.“They seem to

Emerging markets The same is true of the emerging markets, which are expected to issue between $45bn and $50bn of sovereign debt as improving credit ratings make the global bond markets more accessible to most of these countries.

At the beginning of July, for instance, Fitch Ratings raised the sovereign ratings on four of the countries that acceded to the European Union at the beginning of May – Estonia, Latvia, Lithuania and Slovenia – by one notch [to grades ranging from A-minus to double-A minus] on the strength on the “increasing certainty” that they would all adopt the euro by 2007/2008. The following week, the agency put the BBB-rating of Croatia – a member of the second group of countries applying to join the EU - on “positive”outlook.

The Latin American countries – with the obvious exception of the defaulted Argentina – have also seen their outlook improve over the past year. Brazil and Uruguay achieved upgrades, to B-plus and B respectively, while Chile, Panama and Peru are all on “positive”outlook.

The much smaller amounts that emerging countries require – Fitch estimates they need to raise $40bn in 2004 to cover interest and redemption payments on outstanding bonds – has enabled them to front-end load a much higher proportion of their requirements.

Collectively they raised more than $19bn from the capital markets in the first quarter of 2004, and the Bank of England’s latest Financial Stability Review reported that they had met two-thirds of their needs by the end of May. The figures for Mexico and Brazil were 83% and 75% respectively [see table].“I think these countries are really in an upswing now,” says Markus Sgouridas, European legal

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John Lee, international rate strategist at Barclays Capital in London

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By way of explanation, Price at Fitch notes: “It is half a century since an industrial country defaulted”. This record clearly makes such sovereign bonds – downgrade nonwithstanding – a relatively secure investment compared with high-yield and corporate alternatives, and Beckley at FTSE Group believes the interest-rate considerations are fuelling a flight to quality.“I just get the feeling people are getting a little more risk-averse.”However Price adds, that the returns will be commensurate in a rising interest situation. “You are not going to make a huge amount of money out of bonds.”

Inflation-linked bonds

Lionel Price, chief economist at Fitch Ratings.

have got over-compressed.” [Please refer to graph] This largely reflects the migration by institutional investors into fixed-income products as the equity markets have fallen away over the past 18 months. “On the investor side, money is moving into bonds from equities,” says Beckley at FTSE Group. Regulatory action has accelerated the trend in the some cases, as in the UK where the Financial Service Authority has obliged life insurers to reduce the percentage of higher-risk investments in their portfolios.

Price at Fitch cautions that when sovereign spreads compress to the point where Slovenian bonds trade at 20bp over Germany’s, the pricing is no longer reflects the risk and could be vulnerable to sudden volatility. “If someone gets suspicious, the yields could rise quite quickly.”

There was limited impact in the market, however, when Standard & Poor’s downgraded Italy’s sovereign rating from double-A to double-A minus on July 7 – the first such rating agency action since the introduction of the Euro in 1999.

Despite S&P’s observation that Italy’s budget deficit was likely to widen further in 2005 if €12bn of planned tax cuts went ahead, the 19bp yield gap between the 10-year bonds and their bund equivalents remained unchanged, leading Lee at Barclays Capital to comment.“The downgrade hasn’t done much to anything.”

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This perhaps explains the growing interest in – and market for - sovereign bonds that are linked to official inflation indices, also know as total return bonds. While the UK has been issuing index-linked bonds since the then Chancellor Nigel Lawson broke the taboo surrounding the instruments – that they recognise [and perpetuate] inflation – during the Thatcher years, more countries are now developing the market.

The US TIPS [Treasury Inflation Protected Securities] programme, which has been running for seven years, launched its first 20-year bond in July after a BMA survey of its members at the end of last year concluded that this maturity would attract the most investor interest. “It’s certainly a very fashionable market,” says the BMA’s Sgouridas.“The sovereign investor community is very keen on those bonds - at every conference I attend the message from investors is for governments to issue more.”

France, Italy, Greece and Sweden have all joined the club, and even Germany – with its historical dread of inflation – is expected to issue a first inflation-proof bond in the near future. “What’s really surprised me in the last few months is Germany talking about issuing index-linked debt,”observes Price. Inflation linked bonds are particularly appealing to investors with similarly linked liabilities, such as pension funds, and the tax revenues that pay the interest are also in effect index-linked - as a rule they will rise year on year. “In a way, it’s a natural hedge for governments,” said Price at Fitch.

Most of the demand for the £2.2bn long-dated 2038 gilt that the UK Treasury auctioned on July 22 – with an indexlinked coupon of 4.75% – came from pension funds and insurance companies.“They’re obviously great news if you’re looking to protect asset values – like pension funds,”explains Beckley at FTSE Group.“The interest is also being sparked by views that inflation may be rearing its head again.”The BMA believes there could soon be a significant global market for long-dated, index-linked sovereigns, and the most recent euro-denominated French issue – the 15 year €4bn OAT€i bond launched in January 2004 – certainly confirmed the significant cross-border interest in the securities. Two-thirds of the issue was sold to investors in the Eurozone [of which two thirds were in France] and 40% outside the Eurozone – in particular, the UK, the US and Asia. In a recent presentation, Sylvain De Forges, chief executive of Agence

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France Trésor, stressed the benefits of such bonds for both issuers and investors.The inflation-indexed OATs, first issued in 1998 by the French Treasury are bonds with a fixed realrate coupon. The principal of these bonds is guaranteed at par, and is usually protected against inflation by indexation to a daily reference calculated on the basis of the Eurozone consumer price index [HICP] excluding tobacco. The bonds pay an annual coupon [in the instance of the bond issued in January, it was 2.25%] calculated as a fixed percentage of the inflation-adjusted principal.

As well as asset-liability matching, De Forges pointed out that the inflation-linked instruments also offer investors valuable portfolio diversification - as a safe haven in uncertain times, they can increase a portfolio's potential for riskier holdings.

From the issuer’s perspective, De Forges says indexlinked bonds help to smooth budgets – by providing a negative correlation between budgets and fiscal deficits – and should also save the taxpayers money. "If the market is efficient, inflation is fairly priced into expectations and the nominal and real bonds are equivalent and the inflationrisk premium is saved," he said. De Forges believes the market for inflation linked-bonds has “vast potential”, as they currently account for only a small fraction of the total sovereign issuance in the leading industrial countries.

The BMA is equally bullish on their prospects. Sgouridas says while each state needs to evaluate the impact of indexlinked issues on its internal financing system, the signs so far were highly encouraging.“It may be at some point those bonds will dominate sovereign issuance.”

High oil prices One wider economic consideration that is a potential threat to economic growth in both industrialised and emerging countries – and by implication the standing of their sovereign debt – is the future direction of world oil prices.

For the industrial countries, the issue is no longer a huge threat despite a Fitch report at the end of May concluding

Are emerging market bonds on the road to recovery?

FTSE Eurozone Government Bonds Index vs. FTSE Euro g g y Emerging Bonds Index 140

130

120

110

100

90 Jun-99

Dec-99

Jun-00

Dec-00

Jun-01

Dec-01

FTSE Eurozone Government Bonds

Jun-02

Dec-02

Jun-03

Dec-03

Jun-04

FTSE Euro Emerging Bonds

Data as at 30 June 2004. Source: FTSE Group

that an average price for North Sea Brent of $36 a barrel over the year would raise the import bill of the G7 net importers [France, Germany, Italy, Japan and the US] by $60bn to $300bn. While these figures are large, oil import costs in the G7 countries now represent a small fraction of GDP – only about 1.3%.

“In the major industrial countries, oil isn’t as important to the current account deficit as it used to be,”comments Price.

The situation is more potentially serious in some of the emerging market countries, with the import bills in Thailand, the Philippines, Chile and Turkey forecast to be between 3% and 5% of GDP. The emerging countries of Europe – Slovakia, the Czech Republic, Poland and Hungary – spend nearer 2% on oil imports but also import a lot of gas. The flip side of the coin, of course, is the exporting countries, where the high prices are supporting comparable levels of sovereign issuance. “Bonds, such as those issued by Russia and Kazakhstan’s at the moment are sitting pretty,”observes Price.

Debt Issuance in Selected Emerging Markets [$bn] 2003 Actual Brazil Hungary Mexico Poland Turkey Asia Emerging Europe Latin America Middle East And Africa Region totals

Forecast Annual Requirement

2004 Actual [end May]

% of forecast

4.5 2.2 7.4 4.3 5.3

4.0 3.7 3.5 6.2 6.0

3.0 2.2 2.9 3.1 2.8

75 58 83 50 46

6.1 15.6 20.9 3.7 46.3

5.1 21.3 14.4 4.1 44.9

4.3 11.7 11.5 3.0 30.5

85 55 80 74 68

Source: Bank of England Financial Stability Review

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SYNDICATED LOANS

FINAL Destination Europe's syndicated loan market is in flux. Although the banking market is highly liquid, business confidence is still lacking. Important shifts are now evident, which could affect London's dominance of Europe's loan market, says new research from Lloyds TSB Corporate. Director and head of loan syndication, Ian Fitzgerald, explains.

HE EUROPEAN LOAN market has been affected by declining prices [please refer to Figure 1]. The graph shows that German benchmark pricing for BBB/A type corporations peaked in late 1999 at around 55 basis points [bps], with French and UK prices coming to a peak in mid 2001 at around 62bps and 55 bps respectively.

All three markets currently average below 40 bps.

As prices have declined, the pricing curves have also started to converge. In some senses, this is the natural byproduct of increased openness and competition between European banks. The effect seems to be that syndicated lenders in Europe are now taking a more continent-wide view on pricing. Indeed, country specific pricing may have been consigned to history.

Even so, increased competition and the resulting price convergence are taking place against a very different background in the UK market to the markets of France or Germany. Figure 2 illustrates this well. The diagram charts loan market volumes and the number of transactions in Europe for 1999-2004. The results clearly indicate a five-year

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high in transaction volume being reached in the first half of 2004. Interestingly, most of this increase can be explained by a substantial rise in activity in the French and German loan markets, which were up 64% [to $84bn] and 73% [to $59bn] respectively compared with the same period in 2003. By comparison, first half volumes in the UK show an 8% volume reduction against the same period last year – confirming a three-year decline [please refer to Figure 3]. Transaction numbers have been especially hit, reaching an eight-year low.

Thee low volumes in the UK reflect a decline in large acquisition facilities – the asset class that has historically provided the largest volumes for the UK market. Indeed, memories of the high point provided by Vodafone’s takeover of Mannesmann in 2000 – and the €30bn package that financed it – are fading fast. And with them fades some of the UK’s dominance of the European syndicated loans market.

This dominance has been hard to sustain in an environment where low prices and limited business investment have seen refinancings replace ‘new’ loans as

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the main constituent of the UK market. Although 70% of total volumes in the UK are now accounted for by such refinancings, only on the continent can refinancings really yield ‘jumbo’ facilities to sustain the market – this year including France Telecom [€10bn], Volkswagen [€11bn], Daimler Chrysler [€6bn] and Suez Group [€4.5bn].

This list of borrowers reveals a key structural difference between the French or German economies from that of the UK. France and Germany retain a far higher number of industrial manufacturing and centralised utility entities than the UK and these are typically the companies that continue to drive loan market growth. The French and German automotive industries, for instance, have an inherent, ongoing demand for large working capital facilities – a demand far from evident in the service-based UK economy.

And while demand for such facilities also relies on business confidence, it is nonetheless constant when compared with the more cyclical demand for facilities to support UK merger and acquisition [M&A] transactions.

What our research confirms, therefore, is that an important gravitational shift in the European syndicated loan market has taken place. The French and German loan markets now have a more sustained demand for syndicated loans than the UK market. Continental banks are reinforcing this trend by converting large bilateral facilities into syndicated loans – maximising balance sheet efficiency by spreading low-priced credit risks to create a widened loan portfolio.

The UK loan market’s proportionally greater reliance on M&A activity appears, therefore, to have rendered it more sensitive to downturns in overall business confidence. This is partly demonstrated by the reaction of UK banks to low prices, which has been very different to that of their continental counterparts. As the continental markets tend towards increased syndications – both for new deals and the refinancing of past bilateral facilities – the top UK wholesale banks are making larger commitments to individual borrowers in order to defend their market share and customer relationships. Indeed, in the UK there appears to be a renewed emphasis on relationship banking. It has contributed to lower bank fees, which are being eroded as banks turn instead to relationshipbuilding in the hope of these relationships yielding more profitable facilities when the market picks up.

Ian Fitzgerald, director and head of loan syndication, Lloyds TSB Corporate

So the question taxing syndicated lenders [and not just in the UK] is: where are the high-profile M&As that could inspire the market to greater confidence?

An early surge in Q1 2004 failed to translate into the sustained increase in transactions that many had hoped for. This was true, even in the face of a reported rise in the equity value of European deals in the first half to $278bn – slightly up from $268bn last year. Although the US market has experienced a strong resurgence, cautious European companies have so far been less willing than their US counterparts to spend cash surpluses on acquisitions. The UK market, in particular, has only seen one of Europe’s top ten announced event-driven M&A deals of 2004 – in Philip Green’s attempt to acquire Marks & Spencer Group plc. Even so, announced UK M&A first-half deal value did increase to $68bn, up from $58bn in 2003. But given that such activity has not yet had an impact on the volume of syndicated loan issuance, the upturn appears to be caused by activity in the mid-market.

From being the most competitive and well-banked of the European markets, therefore, the UK market volumes are down compared to its neighbours. And although the City has been speculating over an increase in corporate activity Figure 2: European loan market volumes and number of transactions, 1999–2004

Figure 1: UK, France, & Germany, 5-year benchmark pricing for BBB/A type corporates

400 500 350 300

UK

70

Volume ($bn)

France Germany

60

300 200 150

200

100

40

100 50

30

0 1H04

2H03

1H03

2H02

1H02

2H01

1H01

2H00

1H00

0 2H99

20

1H99

Basis points

50

400

250

Number of transactions

80

10

Source: Dealogic

* Estimated

Volume $bn

No. of transactions

Jan 04

Jan 03

Jan 02

Jan 01

Jan 00

Jan 99

Jan 98

Jan 97

Jan 96

Jan 95

0

Source: Dealogic, Lloyds TSB Corporate

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income from other products. This means that focused banks will choose their relationships carefully: focusing on 180 140 niche areas and sector specialisations; as well as 160 120 140 concentrating on the customer relationships that yield 100 120 100 profits across the board. But, by the same token, those 80 80 60 relationships that become uneconomic may find cheap 60 40 40 money increasingly hard to come by.

20 20 Although there is no doubt that the balance of power is 0 0 currently with the borrowers, we must also be aware that other factors will occur which might change the situation.

Volume $bn No. of transactions Source: Dealogic * Estimated These include changes in the geo-politics and economic conditions, [including such as concerns as stability in the in the wake of Philip Green’s recent campaign, the only Middle East, terrorism, interest rates and election really encouraging transactions so far this year have come outcomes]. In addition other factors should also be from continental Europe – including the €16bn facility considered, namely the introduction of new International recently provided to Sanofi-Synthélabo, and the €1.65bn Financial Reporting Standards [IFRS], particularly International Accounting Standard [IAS 39] and the loan to Carlsberg.

Although such high-profile acquisitions have not implications of Basel II. The Basel II Accord, due to be implemented in 2007, is graced the UK market this year, the resultant price decline should itself provide some incentive to encouraging banks to take a long, hard look at the returns generated by balance sheet companies to use the lending to some corporate syndicated loan market in customers. The accord support of potential M&A “This means that focused banks will contains capital adequacy activity. These borrowers choose their relationships carefully – adjustments based on the know that, in whatever focusing on niche areas and sector credit rating of the borrower, shape or form, a specialisations, as well as concentrating which will affect banks turnaround in the market is willingness to lend to these largely inevitable. on the customer relationships that yield Yet the influence of the profits across the board. But, by the same borrowers at low prices. But banks that are compliant UK market’s internal token, those relationships that become with the new accord at the dynamics – as opposed to uneconomic may find cheap money ‘advanced’ internal ratingsEurope-wide trends – on a increasingly hard to come by.” based level will have greater future turnaround remains freedom to determine their unclear. In the past, the UK capital-adequacy provisions market has followed a nine-year pricing cycle – as evidenced by our 20-year according to the individual credit quality of the borrower.

Now is the time, it seems, for borrowers to establish – or analysis of five-year benchmark pricing for BBB/A-type corporations [please refer to Figure 4]. The graph highlights consolidate – the relationships that will best serve them in price compression and a density of transactions at the the future. With the right positioning borrowers should be bottom of the pricing curve [see, in particular, 1988 and able to take advantage of prices for at least another year.

1997], with the red price boundary illustrating a compression of spreads at times of high liquidity.

Figure 4: UK 5-year benchmark pricing for BBB/A type corporates Conversely, the graph also points to an increasing price 100 Transaction differentiation in credit spreads at times of market stress 90 Moving average when bank liquidity is low [see 1993 and 2003].

Indicative pricing curve 80 Pricing differentiation The graph contains a potentially ominous message for 70 lenders in the UK market. Notwithstanding pressure from 60 Europe, the UK’s internal dynamic is likely to see low prices 50 for at least another year. Combined with the renewed 40 willingness of UK banks to retain a larger portion of new 30 loans on their own balance sheets, this can only mean one thing – a review of certain customer relationships.

20 As such, a renewed focus on relationship banking is the 10 most viable response of a banking market squeezed by 0 pricing pressure and high liquidity. Banks are likely to remain willing to lend for the sake of relationships – but Source: Dealogic, Lloyds TSB Corporate relationship managers will be expected to balance this with 220

160

200

Number of transactions

180

76

Jan 04

Jan 03

Jan 02

Jan 01

Jan 00

Jan 99

Jan 98

Jan 97

Jan 96

Jan 95

Jan 94

Jan 93

Jan 92

Jan 91

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Jan 88

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Jan 86

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Jan 84

Basis points

1H04

2H03

1H03

2H02

1H02

2H01

1H01

2H00

1H00

2H99

1H99

Volume ($bn)

SYNDICATED LOANS

Figure 3: UK loan market volumes and number of transactions, 1999–2004

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The arcane world of risk management analytics and software development marches to the beat of a different drum. In a market dominated by only two companies, Barra and Northfield Information Services [NIS], contemporary rules of product development and product offerings just don’t seem to apply. Why is that? Francesca Carnevale talks to NIS to find out what makes it tick.

HERE’S AN OLD, hoary joke in the analytics software community. Two statisticians go deer hunting. They spot a deer and the first statistician fires at it. He misses – by a good five feet to the front. The second statistician now fires. He misses too – by a good five feet to the rear. The deer scampers away unharmed. But the two statisticians are happy and jubilantly congratulate each other, for hitting the deer “on average”. The joke was recently regurgitated in the most recent NIS newsletter, the Northfield News. It provides an important pointer to the fact that in a fluid and indeterminate world, the establishment of some defined measurements of risk

T

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2004

PROFILE: NORTHFIELD

WHEN MAN MEETS TECHNOLOGY provides investors [and fund trustees] with a disproportionate amount of comfort. “It’s not about a number, or a magnitude of risk, but of how successful a portfolio can be and how the component parts of a portfolio interrelate and work” says Dan diBartolomeo, founder and president of NIS. In the esoteric hothouse that is the risk management software and modeling market, providers such as NIS have leveraged five ideas very successfully. First, is the notion that sufficient variables exist in the investment in and trading of securities for asset managers to rely on formal risk and cost modeling to help manage their portfolios more effectively. However, NIS is quick not to take the entire credit for this: “While we had the first commercially available system for dealing with optimising taxable portfolios, the real breakthrough in the way we think about the problem came in a 1996 paper by a team from JP Morgan,” says diBartolomeo. Second, as scrutiny of the activities of asset managers heightens in the wake of a series of corporate reporting and mutual fund scandals, computer-based modeling and portfolio management systems are deemed to provide accurate, reliable and transparent reporting systems.

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PROFILE: NORTHFIELD

Third, as costs come under pressure, the need for feely lingo of customer-focus is king, accepted wisdom in optimising models that help reduce trading costs and the analytics software world has it that providers have a minimise the impact of large trades on share prices is more perfect understanding of the requirements of growing rapidly. Fourth any risk management information portfolio risk management than their clients. It’s an entirely academic approach and one has to be translated into a which has resulted in an form that allows portfolio managers to act on it – “Finally, and this was an important kicker iterative approach to product development.“The process is not merely be aware of in the mid-1990s: "there was a real it. NIS systems allow change in thinking about how you managed defining models, not talking to people and deciding the computation of a investments for private clients which what’s interesting,” explains theoretically ‘optimal attracted tax, as opposed to pension diBartolomeo, “Statistical portfolio’ which takes into schemes, which were tax-exempt” theories define the number account an asset manager’s of variables needed and we view of market condition also study finance theory and and individual securities.

Optimising technology is not to be regarded as supplanting financial literature to isolate the most relevant variables. human judgment – instead it can go a long way to ensuring Eventually we focus on a number of issues which are that asset managers can act efficiently, with the full array of sufficient in their completeness to have statistical properties in their results. It’s definitely not a heuristic facts before them.

Finally, and this was an important kicker in the mid- process,”he adds.

Like academics in ivory towers, the providers also keep 1990s: “there was a real change in thinking about how you managed investments for private clients which attracted themselves to themselves. NIS is typical. It doesn’t much tax, as opposed to pension schemes, which were tax- like publicity, or marketing for that matter. Not that the exempt,” asserts Dan diBartolomeo. Tackling this thorny company doesn’t understand it – or its value. It’s simply: problem changed entire investment approaches, he “not what we do,”explains diBartolomeo. It’s a-typical in a explains. To minimise tax liability, active investors avoided world dominated by publicity and customer-led business trading activity on taxable accounts. In the mid-1990s NIS strategies. NIS is quick to say, however, that it does not analytics showed that that was a bad approach and ignore its clients’ requirements. “We listen to clients very determined that more trades not fewer trades improved the intently, but our work is governed by theoretical principals overall tax position and returns, he states. It provided an that we cannot compromise, because the result would be important fillip for the firm and had a significant impact on unsound,” says Russ Hovanec, NIS’s senior vice president the way private clients began to invest in individual of business development.“Imagine what any sane architect securities rather than relying on anonymous investment would do if approached by a client to create a building in the shape of a pyramid, but with the pointed end at the pools which were not necessarily tax efficient.

NIS was actually established however for very different bottom rather than at the top.”

NIS has also relied on word of mouth promotion to grow reasons. “In the mid-1980s analytics software providers, such as Barra, announced that they didn’t think that its business to a level where only two software providers personal computers would be powerful enough to run their dominate the global market: Barra, which is now part of software,” says diBartolomeo. “I disagreed and we worked MSCI, and NIS. Russ Hovanec explains: “We sell our to develop software that was usable on the small and not very powerful personal computers of the day.” It was a A measurer of risk – Barra vs. FTSE US compelling initiative in a market that “paid $30,000 per annum for the software and another $30,000 per annum time share rent on the large mainframe computers needed to run the software,” he adds. The rest, as they say, is proverbial history. NIS offers three software independent platform-based programmes, and some seven contemporary modeling templates which can variously be applied to equity, fixed income, real estate and other portfolio assets, either singly or in combination.

Risk management analytics software providers live in a complex, and rather academic, world – one that is predicated on objective mathematical models, often based on complex theories and equations derived from the disciplines of physics, engineering and statistical analysis.

It’s a far cry from a ‘gut feel’for a good stock buy. Unusually, however, in today’s corporate world, where the touchyData as at 30 June 2004. Source: FTSE Group 400

350

300

250

200

150

100

50

Jul-99

Jan-00

Jul-00

Jan-01

Jul-01

Barra Inc.

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Jan-03

Jul-03

Jan-04

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portfolio analytic tools directly and indirectly through our business partners, such as FactSet, Instinet and Rimes Technologies – among others – primarily to asset management firms.”NIS now has some 240 clients in over 20 countries.

Actually, in reality, NIS does as much marketing as any other firm – it just does it differently. NIS relies instead on issuing academic papers outlining the latest portfolio management theory; a specialist newsletter to keep its clients abreast of new products, and its staff attend and present at industry and investor seminars. The firm has also been canny in setting up strategic alliances, which have helped the company build up market share through direct and indirect sales agreements. Alpha Neural Networks, a Hong Kong based boutique financial consulting firm, supports NIS’s sales and implementation in the Asia Pacific, for example. Factset Research Systems and Rimes Technologies, data integrators and research service providers to investment managers, have meanwhile integrated NIS portfolio construction and management tools within their respective offerings. Similar relationships have been established with CheckFree Investment Services [a provider of portfolio accounting solutions in the separately managed accounts space], Haugen Custom Financial Systems [a provider of custom alpha models] and R-Squared, a provider of customer risk models.

Strategic alliances are de rigueur this year for providers.

The Berkeley, California-based Barra Inc., the dominant force in the analytics software market, has gone one step further. In June this year it sold out to Morgan Stanley, on behalf of its subsidiary Morgan Stanley Capital International Inc. [MSCI] the equity, fixed income and hedge fund indices provider. The two operations will be combined to form MSCI Barra. Barra has now de-listed from the Nasdaq National Market.

It’s a development that is unlikely to change NIS’s own growth plans in the short term. “We’ve no debt, no corporate parent, we’re not listed, and we are beholden to no-one, so we can do what we like” says diBartolomeo.

“We’ve always treated clients as partners in the business,” asserts Russ Hovanec, “It’s given us an edge. Because we are small, we have direct relationships with our clients.”

There’s also little immediate competitive threat from newcomers. Barriers to entry to the world of Barra and NIS can be excessive, as the intellectual and dollar investment costs are unseasonably high. You also, it seems, need an absurd amount of patience. NIS’s growth trajectory tells it as it is. Founded in 1985, with offices in both Boston and London, it was not until 1987 that NIS had a deliverable, platform independent, product explains diBartolomeo and by 1989, the firm had only a handful of clients. In part the pace of growth was determined by NIS itself.“We’ve always been reluctant to expand rapidly. But also, it takes time for the investment community to trust you,”he confirms.

Nonetheless, new opportunities beckon and diBartolomeo is anxious to develop product which addresses the entirety of a firm’s investment portfolio.

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2004

Dan diBartolomeo, founder and president of NIS

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PROFILE: NORTHFIELD

“In case of real estate, on the other hand it’s a different “Specifically, we need to ensure that the brand is maintained and enhanced,” says diBartolomeo. “We also approach,” explains diBartolomeo. “It’s not easy for many funds to fully understand the risks and management of have to continue our expansion into Europe and Asia.”

NIS’s forward business strategy is predicated on four their diverse assets, including office property and other real pillars; improving its core offering for institutional asset estate, within a consistent framework.” Traditionally, commercial real estate has managers and developing its been managed as a separate business in the areas of private banking, portfolio “We’ve no debt, no corporate parent, we’re portfolio by asset managers and kept apart from other transition and commercial not listed, and we are beholden to no-one, pension assets. NIS is now real estate. These are the key so we can do what we like.” working to express the areas in which the company financial characteristics of a is either improving an real estate portfolio in terms existing offering [private banking] or applying its intellectual capital to a new that equity or fixed income managers are familiar with, so that they can “get a better aggregate view of portfolio risk,” product [portfolio transition, for example].

NIS’s private banking initiative will build on the explains Hovanec. “As a result, real estate will soon be developments begun in the late 1990s, and further included within our cross asset class model.”

Together with Instinet, NIS is also now looking to offer leverage the “tremendous increase in the number of individuals with considerable financial assets resulting trade prioritisation and trade scheduling tools to help buy from the robust US economy of the late. 1990s,” states side traders to manage real time buy and sell orders that Russ Hovanec. NIS has been a leader in tax are linked to a portfolio rebalancing exercise.

The long term outlook, while comforting for NIS, also optimisation, and has established a partnership with Softpak Financial to offer a portfolio manufacturing brings its own challenges. “Barra will remain strong,” says platform that can readily handle thousands of accounts. diBartolomeo.“But I think the world needs more than one “We’re selling intensively to private banks and asset significant provider. We seem to be having some success – but we will have to wait to see how the market will unfold.” managers,” adds diBartolomeo.

Russ Hovanec, NIS’s senior vice president of business development.

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INDEX REVIEW

can enhanced indexation deliver double digit returns?

FTSE GLOBAL MARKETS â&#x20AC;˘ SEPTEMBER/OCTOBER 2004

Index-tracking strategies are enjoying a new lease of life. Many asset managers have woken up to the fact that simply tracking a major index will allow an investment to outperform many actively managed strategies and can frequently prove more cost-effective. This view is reinforced by the fact that, during the bear market, asset managers with core equity mandates did not perform to their benchmarks. It created no small degree of disenchantment in the institutional investment community.

Stuart Fieldhouse reports.

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INDEX REVIEW

T IS POSSIBLE for the disciple of index-investing to FTSE Customised Asia Pacific ex Japan High Yield Index travel one step further on its journey towards predictable, low-risk passive investment, by using an enhanced index strategy. Several major names in the banking and asset management industry are now offering clients strategies that are designed to provide marginal outperformance of major indices, while replicating their risk characteristics. Enhanced index-tracking strategies have, in fact, been around in one form or another since the mid-1980s. In the last couple of years however they have experienced massive interest from the institutional investment community.

State Street is one of the prime movers in the marketing of enhanced indexation as an investment strategy. The Boston bank can point to a growing list enhanced indexing equity mandates on the part of State Street Global Advisors Data as at 30 June 2004. Source: FTSE Group [SSgA], its asset management division.

“Enhanced indexation has become a very popular “The reality is that enhanced managers have been very investment strategy in recent years,” says Kanesh consistent and have outperformed in many different Lakhani, head of European marketing and consultant market environments,” says Simon Roe, a portfolio relations at SSgA in London. “The prospect of adding manager with SSgA in the UK.“One of the key reasons for modest amounts of value under differing market this consistency of enhanced managers is risk control. conditions is finding favour with long-term investors. The ...The ability to avoid the no-shorting constraint is key to delivery of higher information ratios by enhanced their success compared to active managers.” managers is highly valued as more attention is paid to the Many enhanced managers try to avoid being caught out efficient use of risk budgets.” by the market by avoiding market-timing bets. They The enhanced index approach to investment has reaped neutralise style, size, beta, and even country risk by taking dividends for the bank, and positions that match the proved popular with the UK index entirely. They can also “The prospect of adding modest amounts take numerous small stock institutional investment community. At the end of of value under differing market conditions and industry positions which June State Street reported an have the benefit of keeping is finding favour with long-term investors” increase in assets under exposure to any one stock management of more than down to a minimum. Any 50%, with its enhanced investment strategy playing a big extreme movement in a particular share will thus be role in winning new funds. unlikely to derail performance, allowing the enhanced Global chief investment officer Alan Brown says the manager to avoid most of the disasters that can ruin the bank’s enhanced strategies have attracted much more performance figures of an actively-managed fund. attention over the last three years. A number of major Methods of achieving index outperformance will vary from investors have moved into enhanced indexation strategies manager to manager.There is no generally accepted approach following the collapse of the last bull market. Interest has to enhanced indexation as an investment style, although been surprisingly global in its origins, and certainly not many pursue a variant of the approach described above. Some restricted to the more ‘savvy’ institutional investors in strategies fit into this quantitative mould, with risk levels of Europe and North America.

2% or even higher [more accurately termed active quant by In terms of performance, according to publicly-available some commentators], while others are scaled-down versions data in the US [e.g. the PSN and Mobius performance of traditional, fundamental active management strategies. databases], enhanced managers have outstripped their There are even derivative-based synthetic strategies benchmarks on a three and five year timeframe, regardless employing index futures combined with aggressive cash of the style of market [bull, bear, large cap, small cap, value, management. Merrill Lynch Investment Managers and so on].

[LMIM], for example, builds enhanced index portfolios Risk is another major selling point for enhanced which seek to closely track benchmark indices, while indexation strategies. They would be nowhere near as applying quantitative stock selection and stock substitution attractive to institutions if they mirrored active strategies to procure their extra performance.

“We’re willing to look at any benchmark, as we are strategies in their risk characteristics. Higher risk levels would place them firmly outside the ‘risk budgets’ of the generally applying the same set of strategies,” says Rick many institutional investors who make use of index- Vella, head of business development for enhanced index products at MLIM. tracking strategies.

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Whereas enhanced indexation strategies offer a good alternative to traditional passive index management, they also suffer from increased volatility of returns when compared against strictly passive strategies. Volatility is rarely high, and is usually regarded as the price to be paid for enhanced performance.

Vella feels investors should focus on the relative risk engendered by individual enhanced strategies: “Our goal in the UK is to beat the FTSE benchmark by 75 basis points,” he says. “Some of our competitors are trying to add a lot more.”

Exactly which index to use can also be an important decision for an institutional investor, and for the fund manager tailoring strategies for big clients. Fund managers need not use publicly available indices against which to base an enhanced strategy.

For example, high yield or low yield benchmarks can be tailor-made, based on an existing index like the FTSE 350, or the FTSE Asia Pacific ex-Japan for example. In the illustrated example, the index provider created a high yield index as a benchmark for the fund manager to base his strategy against.

“We effectively create a universe from which the manager picks their stocks,” says Graham Colbourne, director at FTSE Group.“I think it’s important to have a lot of measuring sticks out there.”

An active quant strategy, for example, could vary between 200 and 250 basis points – on either side of the index.

There is not enough space here to describe the many other approaches to achieving an enhanced index strategy, but one of the more interesting approaches comes from INTECH, a subsidiary of fund manager Janus Capital Group, and a specialist in achieving excess returns using a sophisticated mathematical strategy [stochastic calculus].

Based on a paper authored by a Princeton professor in the early 1980s, the INTECH approach is nonquantitative. Rather than trying to predict which stocks in an index will do better than others, it tries to rebalance the index more efficiently – the INTECH theory argues that an index based on the capitalisation of the individual component companies is not the most efficient means to utilising those components. INTECH monitors the volatility of the component stocks, and their correlation to each other, and tries to formulate more effective weightings of index shares. This strategy has the added advantage of a very low tracking error, and no additional risk.

At the moment the strategy tracks the S&P500 and the Russell100, as well as offering growth and value sub-sets of these portfolios. INTECH is also in the process of developing an MSCI World product. INTECH already has $17bn under management, and a projected capacity of $50bn in its US large cap strategies, so there are no liquidity concerns here.

“We’re not doing big trades in and out, we are simply rebalancing to optimal weight on a weekly basis,”explains David Schofield, European director of institutional sales at

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2004

Graham Colbourne, director, FTSE Group.

Goldman Sachs recently published a study on enhanced indexation, analysing its capability to add alpha1, and under which market circumstances this was achieved.

Janus Capital.“Capacity is considerable, and we can accept large volumes of assets.”

Goldman Sachs recently published a study on enhanced indexation, analysing its capability to add alpha1, and under which market circumstances this was achieved. It found that, on average, enhanced indexation managers were more successful in momentum-driven and small-cap tilted markets, although the momentum bias applied more to the later part of the study’s timeframe [after 1996]. The bank based its research on a basket of funds following an enhanced indexation strategy over the period 1990-2004, but excluded managers that used predominantly nonequity instruments or derivatives to add alpha: “We found

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INDEX REVIEW

that the alpha of those funds was not influenced by any of outperformance target means the risk of the strategy is low. “To keep the risk low, you have to take small bets,” the factors we examined”.

The research was restricted to retail mutual funds due to says SSgA’s Roe.“And, by making small bets, you help to the difficulty of obtaining daily or weekly data from minimise trading costs by keeping market impact costs institutional managers. The report reveals that the average to a minimum.

Although many major investors have been drawn to enhanced index fund was found to perform in line with the enhanced indexation because of their dissatisfaction with S&P500 index on a gross-of-fees basis. active managers, others have “The common intuition been attracted to it because that active managers tend to Tierens reckons the vast majority of they want to see better perform better in down enhanced indexation managers are using numbers from a ‘core’ markets does not hold up for that has enhanced indexation bottom-up stock selection-driven strategies. position traditionally been invested in managers,” says Ingrid a conventional indexTierens, the author of the Goldman Sachs study. “While we found a significantly tracking strategy.“Many realise it is very difficult to beat the negative link between manager alpha and market returns market long-term,”says MLIM’s Vella.“To achieve 75 basis for active institutional equity managers, the alpha points over the market in the long run is good going. Many generated by enhanced indexation managers does not bear people have been disappointed with their active managers over the long term.” a significant connection with market direction.”

Enhanced index products can be found charging on a The bank also discovered that even though the overall market environment has some impact on the ability of performance-fee basis, charging higher fees only when enhanced index managers to beat the S&P500, outperformance of the index has been achieved. This idiosyncratic rather than market-wide factors appear to be allows them to compete more effectively against passive the main drivers. While the alpha of institutional active index strategies on pricing. Net of fees, they are still much equity core and value managers, as well as long/short and cheaper than active strategies.

Looking forwards, enhanced strategies are likely to market neutral hedge fund managers seems to improve when dispersion across stocks is high, the alpha of become even more popular. While the 1990s delivered enhanced indexation funds appears to be driven mainly by market returns of an average of 17-18% per year [well in excess of required actuarial returns for pension fund momentum in the market.

“These alpha drivers could potentially indicate biases managers], institutional investors will now have to seek embedded in the investment processes of the ‘typical’ above-market risk returns in order to meet their targets.

They are facing huge challenges to meet their liabilities enhanced indexation manager,”the report states.

Tierens reckons the vast majority of enhanced indexation going forwards in an environment where indices like the managers are using bottom-up stock selection-driven S&P500 are providing single digit nominal returns. strategies. “A growing number of managers are using Enhanced strategies look set to be one of the few low-risk means of attaining this. fundamental quant-driven strategies,”she comments.

Enhanced managers are also better able to exploit 1 The abnormal rate of return on a security in excess of what would be predicted by alpha because returns are not diluted by transaction an equilibrium model such as the capital asset pricing model [CAPM]. costs. As a result, enhanced funds have been able to sustain their performance levels, despite the large quantity of assets that have been flowing into them. FTSE 350 Higher Yield vs. FTSE 350 Index From an investor’s perspective, the benefits are large. An enhanced manager controlling 40% of the assets in a portfolio and adding one per cent per annum, will deliver the same amount of excess return as an active manager with 10% of the assets who delivers four per cent performance. A low added-value on a large amount of assets can add real value to a fund.

For institutional investors, the main reasons to consider such an enhanced index strategy are as an alternative to pure index management, or to improve the overall efficiency of a manager structure. Promoters of enhanced strategies argue that the use of enhanced indexing may actually help reduce risk, especially when the minor increase in risk is compared against overall portfolio risk.

Another big selling point is the ability to absorb large amounts of assets, primarily because the low 130

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Jun-02

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FTSE 350 Index

Source: FTSE Group. Data at 30th June 2004.

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JULY 2003 SURVEY by Hewitt Bacon & Woodrow found that 70% of fund managers would like the freedom to buy only the stocks they find attractive.

They felt restricted in their stock selection by the index imposed on them by their clients as a benchmark for investment performance. However, it is fair to expect investors and asset owners to want some sort of measurement of the performance of their investments. This is what benchmark indices provide. So while standard index offerings may not be ideal for less constrained mandates, they will still be used to measure the performance of the resulting funds.

There are two issues to consider: the first is the expectations of investors; the second is the requirements of fund managers. Investors have become increasingly sophisticated. They are looking for fund managers that offer specialised funds often not appropriately measured by

A

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UNCONSTRAINED BENCHMARKS

new possibilities Fund managers’ demands for greater freedom in their investment choices have fuelled FTSE’s innovation. As the complexity and range of investments continue to grow and change, fund managers are calling for greater use of unconstrained benchmarks, says Gareth Parker, head of index design, FTSE Group.

existing indices. Usually it’s because investors look for funds based on their own investment criteria, which include factors such as their attitude to risk, and whether they are looking for capital growth or income. Sometimes, investors’personal beliefs on issues such as corporate social responsibility or Islamic principles also need to be taken into account.

However, before investing - and for as long as they retain the investment – most investors will evaluate the performance of their choice of fund managers against their peer group and against the most suitable benchmark index available to them. For the investor then, while unconstrained mandates provide more flexibility in choosing investments, they still will want to measure the performance of their investments against a benchmark of some sort, even if it is only cash. More often though, it will be equity-based.

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In the past, for example, those wanting to invest in UK Most fund mandates are specified, together with a benchmark by which the performance of the manager stocks had only the FTSE All-Share Index and its industry will be measured. Fund managers are, of course, acutely sectors to use as benchmarks. Demand for an index aware of the risk of investing in stocks not included in representing a smaller and more liquid basket of the largest the benchmark by which they will be measured. companies resulted in the development of the FTSE 100 Although there may not be a specific requirement to Index.This allowed investors to measure the performance of these large companies invest only within the independently to those of the stocks included in that There can often be notable differences market as a whole, and in index, the fund manager may feel obliged to comply. between a fund manager’s preferred way of turn spawned a whole series Even if the stocks in managing the mandate they are given, and of size-based indices such as the FTSE 250, FTSE SmallCap question fall outside the the benchmark specified. and FTSE Fledgling indices. particular investment In September 2003, FTSE expertise or style of the manager, the investment will be made in order to Group launched the FTSE Global Equity Index Series decrease the risk of outperforming or underperforming [GEIS], an enhanced FTSE All-World Index Series with the addition of its new FTSE Global Small Cap Indices. The the benchmark.

Despite this, fund managers are constantly looking for new FTSE Global Equity Index Series contains more than ways to increase the return on the investments that they 7,000 companies from 48 countries across the globe, with manage. It may be the case that their specific area of no double counting and no stocks that are not investable expertise allows them to be able to see opportunities and represents a global set. With its many sub-indices, outside the component stocks of their benchmark index. FTSE GEIS pushes the number of indices FTSE calculates For example, they may be managing a Mid Cap Far Eastern to around 60,000. As these developments show, index Fund benchmarked against a standard index comprising providers must be flexible to remain competitive and be companies from all sectors with a market capitalisation of able to change their products and services in order to between US$500m and US$3bn. The fund manager in continue to meet the needs of their clients and investors.

What is particularly relevant to any discussion of question’s expertise might, though, be in companies with a market capitalisation of between US$1bn and US$5bn. In unconstrained mandates, however, is that once such a addition to this, trustees often put restrictions on what can comprehensive set of indices as the FTSE UK or FTSE GEIS be included in their portfolio. They may, for ethical or other indices is created, and a supporting database exists, more reasons, require that the fund manager avoids investing in specific needs can be met. The design of these indices companies from certain industries like tobacco, steel or specifically allows index users to custom create benchmark indices, with complete flexibility to overlay any investment sportswear, for example.

Thus there can often be notable differences between a mandate as to region, size, style, multinational/local, SRI, or fund manager’s preferred way of managing the mandate any other index customisation.

As the resulting indices are still calculated within the same they are given, and the benchmark specified. It does not mean that a manager will necessarily under-perform the calculation and management environment as the “core” index. They may very well outperform it. A primary concern FTSE indices, FTSE Group has become the first global index – that the mandate’s specified benchmark index is affecting provider able to meet a fund manager or investor’s particular decisions that the manager would prefer to make without requirements by creating customised, yet still entirely keeping the risk profile relative to the index acceptable – independent, indices to meet each particular mandate and also each trustee or investor’s requirements. Although these nonetheless remains.

Fund managers have felt restricted by standard are not a perfect solution to the unconstrained benchmark benchmarks; and it may not only be the fund manager who issue, these products can provide a much more appropriate benchmark for the fund feels this way. As a result of manager that still meets the the demand for specialist Fund managers have felt restricted by needs of the investor, fund funds by investors, and the call from fund managers to standard benchmarks; and it may not only manager or trustee.

FTSE believes that the use have investment mandates be the fund manager who feels this way. of benchmark indices will that will give them more increase rather than diminish scope to buy stocks they find attractive, some argue that the use of indices will diminish. in the future and that it will be accompanied by an equal or In fact, FTSE Group has found the opposite to be the case. possibly faster growth in the use of unconstrained Instead of reducing index use, such concerns have driven benchmarks or customised indices. As fund managers start the index providers to offer more robust all-inclusive offering more niche type products such as general ethical indices that are a more accurate representation of the funds, funds following specific industries, or funds investing in specific geographical areas, indices will be global investment opportunity set.

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developed to fill the gaps in the existing index provision.

They may even create a gap where fund managers hope to attract investors by providing funds based upon indices that match their specific requirements.

Customised indices are not a new phenomenon. Indeed, increased demand for this type of index by both investment fund managers and pension fund managers resulted in the development of the FTSE Global Equity Index Series, enabling faster and more accurate responses to requests for indices.

The structuring of FTSE indices has recently been the subject of some industry comment. Some fund managers may not think that they are truly representative of the market as they see it. One recent suggestion was that the indices’ sector or country weights should be calculated by determining their contribution to GDP. As has always been the case, if we receive enough support from the investment community, we consider very carefully changing the structure of the indices. Indeed, we have done this fairly recently, with the introduction of free-float weightings.

FTSE Group’s ability to customise existing indices means that even without broad investor support, any client could approach us and request an index that is calculated on this basis and we would build one for them. The scope for this sort of customisation is almost infinite.

In future index providers will be judged not on their standard benchmark indices but on the range and flexibility their indices offer in terms of customised mandates. The ability to create individual indices to match the fund

When saying you “invest in the US” does not necessarily give you the full picture 135

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Mar-03

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FTSE US Large Cap

FTSE US Info Tech All Cap

FTSE US Value

FTSE US Small Cap

FTSE US Multinationals

FTSE4Good US

Jun-04

Jul-04

Data as at 30 June 2004. Source: FTSE Group

manager’s or investor’s needs, will be key to success. Another important factor that will contribute to the continued success of an index provider will be the quality of the data. Does the index offer full global investability? Does it accurately capture everything? Is it seamless and exclusive?

FTSE Group continues to develop and deliver benchmark and customised indices to a range of clients and believes that the market for both will continue to grow.

Rather than a decline, we see increasingly sophisticated investor requirements being met by increasingly sophisticated investment tools that even better represent the fund manager’s strategy and investment mandate.

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To discuss advertising insertions, tip-ons, supplements, sponsored sections, bookmarks or your own special requirements Contact: Paul Spendiff Tel: 44 [0] 20 7074 0021 Fax: 44 [0] 20 7074 0022 Email: paul.spendiff@berlinguer.com

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2004

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MARKET REPORTS BY FTSE RESEARCH

FTSE Global Equity Index Series – Global YTD 2004 31st December 2003 - 30th June 2004 FTSE Regional Indices Performance 130 125 120 115 110 105 100 95 90 85

Dec03

Jan04

Feb04

FTSE Global AC (US$) FTSE Developed Europe AC (US$)

Mar04

FTSE Japan AC (US$) FTSE Asia Pacific AC ex Japan (US$)

Apr FTSE Middle East & Africa AC (US$) FTSE Emerging Europe AC (US$)

May04

Jun04

FTSE Latin America AC (US$) FTSE North America AC (US$)

FTSE Regional Indices Capital Returns [USD] 15

10

5 % 0

-5

-10

FTSE Global AC

FTSE All-World (LC/MC)

FTSE Global LC

FTSE FTSE Global MC Global SC

FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE Developed Adv Emerging All-Emerging Latin Middle East North Asia Pacific Japan AC AC Emerging AC AC AC America AC & Africa AC America AC ex Japan AC

FTSE FTSE Dev Emerging Europe AC Europe AC

FTSE Developed Country Indices Capital Returns [USD] 30 25 20 15 %

10 5 0 -5 -10 FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE Australia Austria Belgium/ Canada Denmark Finland France Germany Greece Hong Ireland AC AC Lux AC AC AC AC AC AC AC Kong AC China AC

Dollar value

FTSE Italy AC

FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE Japan Nether- New Norway PortugalSingapore Spain Sweden Switz- United USA AC lands AC Zealand AC AC AC AC AC erland Kingdom AC AC AC AC

Local Currency value

Key: AC = All Cap, LC = Large Cap, MC = Mid Cap, SC = Small Cap, LC/MC = Large and Mid Cap

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FTSE All-Emerging Country Indices Capital Returns [USD] 30 20 10 %

0 -10 -20 -30 FTSE FTSE Argentina Brazil AC AC

FTSE Chile AC

FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE China Columbia Czech Egypt Hungary India Indonesia Israel AC AC Republic AC AC AC AC AC AC

Dollar value

FTSE FTSE FTSE FTSE FTSE FTSE Korea Malaysia Mexico Morocco Pakistan Peru AC AC AC AC AC AC

FTSE FTSE FTSE FTSE FTSE FTSE FTSE Philip- Poland Russia South Taiwan Thailand Turkey pines AC AC Africa AC AC AC AC AC

Local Currency value

FTSE Global All Cap Sector Indices Capital Returns [USD] 15 10 5 %

0 -5

Real Estate

Speciality & Other Finance

Investment Companies

Life Assurance

Banks

Insurance

Electricity

Utilities – other

Telecommunication Services

Transport

Food & Drug Retailers

Media & Entertainment

Support Services

Leisure & Hotels

Tobacco

General Retailers

Total Return

Information Technology Hardware Software & Computer Services

Capital

Pharmaceuticals & Biotechnology

Health

Personal Care & Household Products

Beverages

Food Products & Processors

Household Goods & Textiles

Electronic & Electrical Equipment Engineering & Machinery Automobiles & Parts

Aerospace & Defence Diversified Industrials

Steel & Other Metals

Forestry & Paper

Chemicals

Construction & Building Materials

Mining

-15

Oil & Gas

-10

Stock Performance Best Performing FTSE All-World Index Stocks [US$] Aristocrat Leisure 160.2% Nishi-Nippon Bank 159.5% Hylsamex 142.9% Hynix Semiconductor 132.9% LG Corp 111.5%

Worst Performing FTSE All-World Index Stocks [US$] LG Card -92.8% Natural Park Co -72.4% Interchina Co Holdings -67.8% DBS Thai Danu Bank -63.3% Quanta Storage -56.8%

Overall Index Return FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE

No. of Consts 7,165 1,013 1,796 4,356 2,809 1,625 180 84 1,430 175 2,444 1,227

Global AC Global LC Global MC Global SC All-World Asia Pacific AC ex Japan Latin America AC All Emerging Europe AC Developed Europe AC Middle East & Africa AC North Americas AC Japan AC

Value

1M

3M

YTD

274.73 273.89 346.66 316.05 164.96 281.34 332.35 336.59 278.21 312.06 266.76 306.02

1.9% 1.5% 2.8% 3.6% 1.7% -1.3% 3.4% 1.2% 1.2% 2.9% 2.0% 5.7%

-0.4% -0.3% 0.1% -0.4% -0.4% -9.2% -8.3% -14.8% 0.8% -1.0% 0.9% -3.2%

3.0% 1.6% 6.5% 7.5% 2.5% -2.5% -0.9% 5.3% 1.7% 6.1% 3.0% 12.0%

Actual Div Yld 1.96% 2.10% 1.69% 1.56% 2.01% 2.80% 3.21% 2.82% 2.73% 3.10% 1.62% 0.91%

Key: AC = All Cap, LC = Large Cap, MC = Mid Cap, SC = Small Cap, LC/MC = Large and Mid Cap

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FTSE Global Equity Index Series – Developed ex US YTD 2004 31st December 2003 - 30th June 2004 FTSE Developed Regional Indices Performance [USD] 115

110

105

100

95

90 Dec03 Jan04 FTSE Developed (LC/MC) FTSE Developed Europe (LC/MC)

Feb04 FTSE Developed Asia Pacific (LC/MC) FTSE All-Emerging (LC/MC)

Mar04 Apr04 FTSE Developed ex US (LC/MC) FTSE US (LC/MC)

May04

Jun04

FTSE Developed Asia Pacific ex Japan (LC/MC)

FTSE Developed Regional Indices Capital Returns [USD] 15

10 %

5

0

-5

FTSE Developed

FTSE All-Emerging

FTSE Developed ex US

FTSE Developed Europe

FTSE Developed Asia Pacific

FTSE Developed Asia Pacific ex Japan

FTSE Eurobloc

FTSE US

FTSE Developed AC ex US

FTSE Developed LC ex US

FTSE Developed MC ex US

FTSE Developed SC ex US

FTSE Developed ex-US Indices Sector Capital Returns [USD] 25 20 15

%

10 5 0 -5

Information Technology Hardware Software & Computer Services

Real Estate

Speciality & Other Finance

Investment Companies

Insurance

Life Assurance

Banks

Electricity

Utilities – other

Telecommunication Services

Transport

Food & Drug Retailers

Support Services

Media & Entertainment

Leisure & Hotels

Tobacco

General Retailers

Pharmaceuticals & Biotechnology

Health

Capital

Personal Care & Household Products

Beverages

Food Products & Processors

Household Goods & Textiles

Electronic & Electrical Equipment Engineering & Machinery Automobiles & Parts

Aerospace & Defence Diversified Industrials

Steel & Other Metals

Forestry & Paper

Chemicals

Construction & Building Materials

Mining

Oil & Gas

-10

Total Return

Key: AC = All Cap, LC = Large Cap, MC = Mid Cap, SC = Small Cap, LC/MC = Large and Mid Cap

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Stock Performance Best Performing FTSE Developed ex US Index Stocks [US$] Aristocrat Leisure 160.2% Nishi-Nippon Bank 159.5% Sammy 93.5% Hokugin Financial 89.7% Caltex Australia 84.7%

Worst Performing FTSE Developed ex US Index Stocks [US$] Interchina Holdings -67.8% Seat-Pagine Gialle -55.9% Asia Aluminum Holdings -50.9% Brilliance China Automative Holdings -46.4% China Everbright [Red Chip] -42.9%

Overall Index Return FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE

No. of Consts 1,282 638 1,920 889 477 734 299 3,386 487 1,796 4,356

Developed ex US [LC/MC] USA [LC/MC] Developed [LC/MC] All-Emerging [LC/MC] Developed Europe [LC/MC] Developed Asia Pacific [LC/MC] Developed Asia Pacific ex Japan [LC/MC] Developed AC ex US [LC/MC] Developed LC ex US Developed MC ex US Developed SC ex US

Value

1M

3M

YTD

171.12 465.77 163.54 209.32 169.05 167.11 232.54 285.90 272.19 318.27 339.72

2.0% 1.7% 1.8% -0.3% 1.1% 3.8% 0.0% 2.2% 1.6% 3.6% 4.1%

-1.0% 1.2% 0.2% -10.2% 0.8% -4.3% -5.8% -0.8% -1.2% -0.1% 0.4%

2.7% 2.7% 2.7% -0.9% 1.0% 7.1% -0.8% 3.5% 1.6% 6.9% 11.2%

Actual Div Yld 2.36% 1.67% 1.98% 2.60% 2.77% 1.56% 3.32% 2.31% 2.43% 1.69% 1.56%

FTSE Global Equity Index Series – Asia Pacific YTD 2004 31st December 2003 - 30th June 2004 FTSE Asia Pacific Regional Indices Performance 120 115 110 105 100 95 90 85 Dec03

Jan04 FTSE Global AC FTSE Developed Asia Pacific (LC/MC)

Feb04 Mar04 FTSE Developed Asia Pacific ex Japan (LC/MC) FTSE Asia Pacific AC

Apr04

May04 Jun04 FTSE All-Emerging Asia Pacific AC FTSE Japan (LC/MC)

FTSE Asia Pacific Regional Indices Capital Returns [USD] 15

10

%

5

0

-5

FTSE Asia Pacific AC

FTSE Global AC

FTSE Developed Asia Pacific (LC/MC)

FTSE Developed Asia Pacific ex Japan (LC/MC)

FTSE All-Emerging Asia Pacific AC

FTSE Developed Asia Pacific AC

FTSE Japan Index (LC/MC)

FTSE Asia Pacific (LC/MC)

FTSE Asia Pacific MC

FTSE Asia Pacific SC

FTSE Asia Pacific LC

Key: AC = All Cap, LC = Large Cap, MC = Mid Cap, SC = Small Cap, LC/MC = Large and Mid Cap

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2004

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25

20

15

10 % 5

0

-5

Real Estate

Information Technology Hardware Software & Computer Services

Total Return

Speciality & Other Finance

Investment Companies

Insurance

Life Assurance

Banks

Electricity

Utilities – other

Telecommunication Services

Transport

Food & Drug Retailers

Support Services

Media & Entertainment

Leisure & Hotels

Tobacco

General Retailers

Pharmaceuticals & Biotechnology

Health

Capital

Personal Care & Household Products

Beverages

Food Products & Processors

Household Goods & Textiles

Electronic & Electrical Equipment Engineering & Machinery Automobiles & Parts

Aerospace & Defence Diversified Industrials

Steel & Other Metals

Forestry & Paper

Chemicals

Construction & Building Materials

Mining

-10 Oil & Gas

MARKET REPORTS BY FTSE RESEARCH

FTSE Asia Pacific All Cap Sector Indices Capital Returns [USD]

Stock Performance Best Performing FTSE Asia Pacific Index [LC/MC] Stocks [US$] Worst Performing FTSE Asia Pacific Index [LC/MC] Stocks [US$] Aristocrat Leisure 160.2% LG Card -92.8% Nishi-Nippon Bank 159.5% Natural Park Ltd -72.4% Hynix Semiconductor 132.9% Interchina Holdings -67.8% LG Corp 111.5% DBS Thai Danu Bank -63.3% Sammy 93.5% Quanta Storage -56.8%

Overall Index Return

FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE

Global AC Asia Pacific AC Asia Pacific [LC/MC] Asia Pacific LC Asia Pacific MC Asia Pacific SC Developed Asia Pacific ex Japan [LC/MC] Developed Asia Pacific [LC/MC] All-Emerging Asia-Pacific [LC/MC] Japan Index [LC/MC]

No. of Consts 7165 2852 1308 464 844 1544 299 734 574 435

Value

1M

3M

YTD

274.73 295.14 167.30 283.30 324.45 338.36 232.54 167.11 169.13 114.10

1.94% 2.80% 2.56% 2.13% 4.26% 5.01% -0.03% 3.78% -2.38% 5.29%

-0.38% -5.73% -5.92% -6.15% -4.99% -4.00% -5.76% -4.32% -12.22% -3.77%

3.04% 5.72% 4.96% 4.33% 7.48% 13.23% -0.83% 7.12% -3.39% 10.44%

Actual Div Yld 1.96% 1.67% 1.69% 1.73% 1.51% 1.54% 3.32% 1.56% 2.23% 0.89%

Key: AC = All Cap, LC = Large Cap, MC = Mid Cap, SC = Small Cap, LC/MC = Large and Mid Cap

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FTSE Global Equity Index Series – Europe YTD 2004 31st December 2003 - 30th June 2004 FTSE European Regional Indices Performance [EUR] 115

110

105

100

95 Dec03

Jan04 FTSE Global AC (EUR) FTSE Developed Europe ex UK LC/MC (EUR)

Feb04 Mar04 FTSE Eurotop 300 (EUR) FTSE Developed Europe AC (EUR)

Apr FTSE Eurofirst 100 (EUR) FTSE Eurobloc LC/MC (EUR)

May04 FTSE Eurofirst 80 (EUR)

Jun04

FTSE European Regional Indices Capital Return [EUR] 10

5 %

0

-5

FTSE Global AC

FTSE Europe AC

FTSE Europe LC

FTSE Europe MC

FTSE Europe SC

FTSE Developed Europe AC

FTSE All-Emerging Europe AC

FTSE FTSE FTSE Eurobloc Developed Eurotop 300 LC/MC Europe ex UK LC/MC

FTSE Eurofirst 80

FTSE Eurofirst 100

FTSE Developed Europe Sector Indices Capital Returns [EUR] 30 25 20

%

15 10 5 0

Real Estate

Speciality & Other Finance

Investment Companies

Life Assurance

Banks

Insurance

Electricity

Utilities – other

Telecommunication Services

Transport

Food & Drug Retailers

Media & Entertainment

Information Technology Hardware Software & Computer Services

Total Return

Support Services

Leisure & Hotels

Tobacco

General Retailers

Pharmaceuticals & Biotechnology

Health

Capital

Personal Care & Household Products

Beverages

Food Products & Processors

Household Goods & Textiles

Electronic & Electrical Equipment Engineering & Machinery Automobiles & Parts

Aerospace & Defence Diversified Industrials

Steel & Other Metals

Forestry & Paper

Chemicals

Construction & Building Materials

Mining

Oil & Gas

-5

Key: AC = All Cap, LC = Large Cap, MC = Mid Cap, SC = Small Cap, LC/MC = Large and Mid Cap

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MARKET REPORTS BY FTSE RESEARCH

Stock Performance Best Performing FTSE Europe Index Stocks [€] Ericsson B 70.4% Reuters Group 65.6% EMI Group 61.3% Nobel Biocare Holding 60.2% Verbund Oesterreich Elektrizitats 56.1%

Worst Performing FTSE Europe Index Stocks [€] Seat-Pagine Gialle Ryanair Holdings LogicaCMG MLP Ord Volkswagen

-54.3% -30.5% -25.0% -21.7% -21.4%

Overall Index Return No. of Consts 7165 1514 200 333 981 1430 84 682 942 300 80 100

FTSE Global AC FTSE Europe AC FTSE Europe LC FTSE Europe MC FTSE Europe SC FTSE Developed Europe AC FTSE All-Emerging Europe AC FTSE Eurobloc AC FTSE Developed Europe ex UK AC FTSE Eurotop 300 FTSEurofirst 80 FTSEurofirst 100

Value

1M

3M

YTD

274.73 263.93 300.11 309.24 312.01 263.31 318.56 270.02 271.54 998.28 3513.19 3354

1.94% 1.60% 1.23% 2.29% 3.10% 1.60% 1.62% 2.46% 2.27% 1.20% 2.27% 0.83%

-0.38% 1.53% 1.75% 2.14% 1.43% 1.79% -13.99% 1.81% 2.16% 1.71% 1.47% 1.31%

3.04% 5.47% 3.57% 9.64% 12.40% 5.42% 9.11% 4.13% 5.11% 4.21% 2.12% 2.07%

Actual Div Yld 1.96% 2.73% 2.81% 2.58% 2.36% 2.73% 2.82% 2.63% 2.47% 2.78% 2.71% 2.97%

FTSE UK Index Series – YTD 2004 31st December 2003 - 30th June 2004 FTSE UK Index Series Performance [GBP] 125

120

115

110

105

100

95 Dec03

Jan04 FTSE 100 FTSE All-Share

Feb04 FTSE 250 FTSE Fledgling

Mar04 FTSE 350 FTSE AIM

Apr04

May04 FTSE SmallCap FTSE techMARK 100

Jun04

Key: AC = All Cap, LC = Large Cap, MC = Mid Cap, SC = Small Cap, LC/MC = Large and Mid Cap

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FTSE All-Share Sector Indices Capital Returns [GBP] 35

30

25

20

% 15 10

5

0

-5

Software & Computer Services

Real Estate

Speciality & Other Finance

Investment Companies

Life Assurance

Banks

Insurance

Electricity

Utilities – other

Telecommunication Services

Transport

Food & Drug Retailers

Support Services

Media & Entertainment

Leisure & Hotels

General Retailers

Tobacco

Total Return

Information Technology Hardware

Capital

Pharmaceuticals & Biotechnology

Health

Personal Care & Household Products

Beverages

Food Products & Processors

Automobiles & Parts

Household Goods & Textiles

Engineering & Machinery

Electronic & Electrical Equipment

Aerospace & Defence

Steel & Other Metals

Forestry & Paper

Chemicals

Construction & Building Materials

Mining

Oil & Gas

-10

Stock Performance Best Performing FTSE All-Share Index Stocks [GBP] Cairn Energy 251.6% Charter 105.5% Alvis 84.7% Pendragon 84.1% Ashtead Group 77.4%

Worst Performing FTSE All-Share Index Stocks [GBP] Jarvis -62.4% Antisoma -56.4% Bookham Technology -56.1% Molins -51.0% Courts -50.9%

Overall Index Return

FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE

100 250 350 SC All-Share Fledgling AIM techMARK 100

No. of Consts 100 250 350 342 692 424 748 100

Value

1M

3M

YTD

4464.07 6277.95 2267.58 2582.79 2228.67 2815.91 888.25 1170.34

0.8% 3.7% 1.2% 3.0% 1.2% 3.0% 3.2% 2.3%

1.8% 0.3% 1.6% -1.9% 1.4% -0.4% -2.0% -0.5%

-0.3% 8.2% 0.8% 4.4% 1.0% 7.3% 6.3% 15.3%

Actual Div Yld 3.26% 2.71% 3.19% 2.30% 3.16% 2.59% 0.61% 1.31%

Net Cover 1.86 1.96 1.87 1.24 1.86 -3.07 -1.68 -

P/E Ratio 16.48 18.82 16.77 35.2 17.08 -12.6 -97.56 -

FTSE Market Reports are researched and produced on a monthly basis by FTSE Research. For more information about market analysis based on FTSE indices, please contact Gareth Parker, Head of Global Research, FTSE Group at gareth.parker@ftse.com

Key: AC = All Cap, LC = Large Cap, MC = Mid Cap, SC = Small Cap, LC/MC = Large and Mid Cap

FTSE GLOBAL MARKETS • SEPTEMBER/OCTOBER 2004

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CALENDAR

Index Reviews September-November 2004 Date

Index Series

Review Type

Effective [Close of business]

Data Cut-off

Early Sep

MIB 30

Semi-annual review

20-Sep

31-Aug

Early Sep

ATX

Semi-annual review / number of shares

30-Sep

31-Aug

1-Sep

STOXX BLUE CHIPS

Annual review

17-Sep

31-Aug

1-Sep

SMI

Annual review/Semi annual rebalance

30-Sep

30-Jul

7-Sep

FTSE Goldmines Index Series

Quarterly review

17-Sep

24-Aug

8-Sep

FTSE/JSE Africa Index Series

Quarterly review

17-Sep

3-Sep

8-Sep

FTSE UK Index Series

Quarterly review

17-Sep

7-Sep

8-Sep

FTSE All Share

Quarterly review

17-Sep

7-Sep

9-Sep

FTSE Eurotop 300

Quarterly review

17-Sep

3-Sep

9-Sep

FTSE Euromid

Quarterly review

17-Sep

3-Sep

9-Sep

FTSE Global Equity Index Series Annual review Developed Europe & Japan

17-Sep

30-Jun

9-Sep

FTSE/Hang Seng Asian Sectors Semi-annual review

17-Sep

31-Aug

9-Sep

FTSEurofirst 80 & 100

Annual review

17-Sep

31-Aug

10-Sep

FTSE/Hang Seng Asiatop

Semi-annual review

17-Sep

31-Aug

10-Sep

NZSX

Quarterly review

30-Sep

10-Sep

FTSE Multinational

Annual review

17-Sep

30-Jun

10-Sep

FTSE4Good Index Series

Semi annual review

17-Sep

31-Aug

10-Sep

FTSE Global Islamic

Semi annual review

17-Sep

1-Sep

13-Sep

FTSE European Sectors

Semi annual review

17-Sep

31-Aug

13-Sep

FTSE Global Style Index Series

Semi annual review

17-Dec

30-Nov

13-Sep

FTSE exUK 100

Quarterly review

17-Sep

3-Sep

13-Sep

FTSE Global Sectors

Semi annual review

17-Sep

31-Aug

13-Sep

FTSE Global 100

Quarterly review

17-Sep

31-Aug

13-Sep

S&P/ASX 200

Quarterly review

17-Sep

13-Sep

NASDAQ 100

Quarterly share adjustment

17-Sep

13-Sep

FTSE techMark 100

Quarterly review

17-Sep

31-Aug

13-Sep

FTSE eTX

Quarterly review

17-Sep

3-Sep

13-Sep

FTSE TMT

Annual review

17-Sep

7-Sep

15-Sep

STOXX

Quarterly share adjustment

17-Sep

15-Sep

S&P 500

Quarterly share adjustment

17-Sep

15-Sep

S&P / TSX 60

Quarterly share adjustment

17-Sep 30-Sep

15-Sep

Mid Sep

Nikkei 225

Annual review

15-Sep

S&P MidCap 400

Quarterly share adjustment

17-Sep

Early Oct

S&P / TSX Composite

Quarterly review

15-Oct

6-Oct

FTSE/Xinhua Index Series

Quarterly review

22-Oct

24-Sep

6-Oct

FTSE NOREX

Semi annual review

15-Oct

30-Sep 30-Sep

7-Oct

Taiwan 50

Quarterly review

15-Oct

17-Oct

AEX

Quarterly review stock classification

1-Nov

25-Oct

Hex 25

Quarterly review of number of shares

29-Oct

End Oct

FTSE/ASE 20 Index

Semi-annual review

30-Nov

Oct/Nov

Hang Seng

Semi annual review

30-Nov

15-Sep

30-Sep

Oct/Nov

CAC 40

Quarterly review

Nov/Dec

Early Nov

DAX 30

Quarterly share / FF Adjustment

17-Dec

29-Oct

10-Nov

FTSE Med100

Semi annual review

19-Nov

29-Oct

17-Nov

MSCI

Quarterly review

30-Nov

16-Nov

STOXX

Quarterly review (components)

17-Dec

29-Oct

30-Nov

FTSE Goldmines Index Series

Quarterly review

17-Dec

26-Nov

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

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To find out more about how you and your company can help UNICEF when an emergency occurs, please go to: www.unicef.org.uk/emergencyrelief if you are in the UK or www.supportunicef.org if you´re outside of the UK. Thank you for your support

AP/Wide World Photos

The earthquake that hit Iran in December 2003 left more than 40,000 dead and injured tens of thousands more.

Images like the one you see right are now unfortunately a regular feature not only in Iran but in many countries affected each year by humanitarian disaster.

With a presence in over 190 countries, UNICEF (The United Nations Childrens Fund) is uniquely positioned to react quickly to these emergency situations by providing clean water and sanitation, healthcare, nutritional and emergency education supplies. As we receive no funding from the UN, we desperately need the help of individuals and companies to support this work.

FTSE already support UNICEF (nearly ÂŁ1,000,000 donated through FTSE4Good so far) and in doing so help us to alleviate the distress and hardship caused to children who find themselves suffering in the aftermath of emergencies such as the recent earthquake in Iran.

5/8/04

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Authorised by Commission Bancaire in France and by the Financial Services Authority; regulated by the Financial Services Authority for the conduct of UK business.

FCB

MARKET REPORTS.QXD

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