FTSE Global Markets

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BANCO ITAU & UNIBANCO: A MARRIAGE MADE IN HEAVEN? ISSUE 31 • JANUARY/FEBRUARY 2009

MTFs reap the uptick in European trading The problem with counterparty risk Why CACEIS stays on the up and up AIG: how much money to save a company?

THE GLOBAL LEADERS REPORT:

CAN NOMURA RETURN TO ITS GLORY DAYS?

MANPOWER INC: JOERRES TEMPERS THE EMPLOYMENT BELLWETHER

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Outlook EDITORIAL DIRECTOR:

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

Neil O’Hara, David Simons, Art Detman.

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Andrew Cavenagh, John Rumsey, Lynn Strongin Dodds, Ian Williams, Mark Faithfull, Vanja Dragomanovich, Paul Whitfield.

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

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FTSE GLOBAL MARKETS • JANUARY/FEBRUARY 2009

HIS EDITION IS all about managing change. Among the bright spots in the issue is a profile of US enabler, Manpower Inc, which appears to be able to buck today’s recessionary trends and build on employment opportunities around the world. Art Detman talks to its chief executive Jerome Joerres about the firm’s flexible growth strategy.

Additionally we are running the first in an occasional series called Global Leaders, where we highlight those institutions who may make a difference in difficult times and challenging markets. We look at some of the banking leaders in this edition; a theme we will revisit in subsequent issues, where we hope to cover other financial industry segments, such as asset management, private equity, and the capital markets.

Neil O’Hara opens the discussion about change in our Market Leader, focusing on new ways of handling counterparty risk in the aftermath of the collapse of Lehman Brothers. For hedge funds, short sellers and leveraged players, counterparty risk is a key consideration. These investors rely on prime brokers not only to settle trades but also to finance positions and facilitate stock borrowing. The additional functions introduce an ongoing bilateral credit relationship in which funds face severe disruption if the broker-dealer fails. The stakes ratchet up again when funds begin to trade over the counter derivatives in which both sides expect the other to stand behind obligations that often run for many years. Neil highlights ways in which investors have responded to new challenges, including looking at portfolio liquidity as a proxy to determine whether managers can move assets away from a troubled counterparty before it fails.

Managers are also reviewing the segregation of assets.

In the trading area, Ruth Liley looks at the impact of multi-lateral trading facilities (MTFs) on the European trading landscape one year on from the introduction of the Markets in Financial Instruments Directive (MiFID). Lynn Strongin Dodds takes the analysis one step further and looks at the way that MTFs have encouraged changes in the debate about the provision of settlement and clearing services on the continent. Once upon a time, debate hung around whether Europe’s settlement and clearing infrastructure required a vertical or horizontal solution.

Thankfully, the debate has moved clicks and parsecs away from that and is now firmly rounded upon issues of cost, efficiency and global rather than regional solutions.

On the sector side, we look at the fallout from the $150bn bailout of the American Insurance Group (AIG). Current government thinking seems to be that the combination of capital infusions to key institutions, plus the sequestration of toxic assets, will restore confidence in the credit-worthiness of those key institutions and the financial markets at large. Dave Simon’s questions whether AIG’s bailout burning tax payer money to no avail.

In Kurt Lewin’s much vaunted Theory of Change (published in 1995), he theorised a three stage model that basically requires established knowledge to be rejected and replaced if meaningful change is to take place. The first stage requires motivation to change; the second involves actual change and the third entails the adoption of new beliefs. If the turbulence that rocked the financial markets in 2008, which opened with sub prime woes and ended with the Madoff scandal, does not provide the impetus to take us all to that first stage, we do not know what will. How fast that change will take place; and how tightly the financial markets will adapt to new parameters is still in question; but change we all must. We will continue to cover those processes that will hurry or halt that change.

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Francesca Carnevale, Editorial Director January 2009

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Contents COVER STORY COVER STORY: GLOBAL BANKING LEADERS ................................................Page 45

With most of the G8 countries banks in disarray, we look at the successes of the banking industry through one of the most turbulent financial markets in living memory. Not all the news was bad and some banks managed to keep their head above the fray at key moments; while others took one knock after another. We highlight some of the success stories and single out the banks that might be better placed to leverage the upturn, if and when it comes

DEPARTMENTS MARKET LEADER

BACK TO THE FUTURE ..................................................................................................Page 6

Neil O’Hara explains why investors should take more notice of counterparty risk.

THE SEARCH FOR THE PERFECT DATA SET ..................................................Page 12 Colin Wheeler of HSBC Actuaries & Consultants, assesses the issues for DC pensions.

IN THE MARKETS

AIN’T LOVE JUST GRAND?..............................................................................................Page 15 John Rumsey reports on the marriage between Unibanco and Bank Itau.

....................................................Page 20 Peter Casey, director, policy and legal services, DFSA explains the issues.

THE REGULATION OF TAKAFUL FUNDS

FACE TO FACE COUNTRY REPORT INDEX REVIEW TRADING REPORT/MTFs SECTOR REPORT

KEEPING CACEIS ON AN UPWARD TRACK ....................................Page 24 Paul Whitfield talks to CACEIS chairman Francois Marion about the bank’s growth strategy.

..........................................Page 27 What now for Mexico? Will the current crisis highlight the country’s weaknesses?.

MEXICO: THE NEW GROWTH CHALLENGE

IS INDEX STABILITY HERE AT LAST? ................................................Page 30

Simon Denham, managing director, Capital Spreads on key index trends

TRADING PLACES ................................................................................................Page 32

Ruth Liley reports on the impact of MTFs on Europe’s new trading landscape.

CHANGING PLACES ............................................................................................Page 36

Lynn Strongin Dodds reviews Europe’s clearing and settlement infrastructure.

..................................................................Page 68 Ian Williams reports on the counter-cyclical trends running through the sector.

THE UPS AND DOWNS OF GOLD

..............................................................................................................Page 79 The latest in ETF and ETC trends.

THE ETF UPDATE

INVESTOR SERVICES

DATA PAGES

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THE INDEX BACKBONE OF ETFs ......................................................................Page 82

The role of index providers in ETF growth.

Fidessa Fragmentation Index ......................................................................................Page 86 ETF Data, supplied by Barclays Global Investors ....................................................Page 88 Securities Lending Trends by Data Explorer ............................................................Page 91 Market Reports by FTSE Research ..............................................................................Page 92 Index Calendar ..............................................................................................................Page 96

JANUARY/FEBRUARY 2009 • FTSE GLOBAL MARKETS

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Contents FEATURES AFTER THE FLOOD: INVESTOR SERVICES

THE NEW ARC OF TRANSITION MANAGEMENT ..................Page 41 There are substantive changes in asset allocation among key investment funds. Moreover, there has been something of a fallout in transition management over the last two years.

Together these trends have benefited those transition managers who have stayed the course. Which houses will continue to benefit going forward?

FUND ADMINISTRATION: BACK TO BASICS ..............................Page 52 While putting added pressure on fees, the recent market contraction has at the same time hastened the flight to quality. Well-established, highly diversified administrators who are capable of providing the full range of asset servicing needs, from performance calculation to trade processing and more, will likely weather the seismic shifts better than most. Dave Simons reports from Boston.

ASIAN CUSTODY: NEW ROADS TO FOLLOW ............................Page 56 The financial crisis has provided a challenging time for Asian asset service providers.

Institutional investors are more concerned now about counterparty risk and certain asset classes as well as the fund managers they are using. As a result, there has not been that much new business and providers are helping clients adjust to market conditions. Lynn Strongin Dodds reports.

PROFILE: MANPOWER INC

THE PROFESSIONAL EDGE ........................................................................Page 60

From its unlikely base in Milwaukee, Wisconsin, Manpower Inc. has become a worldwide powerhouse in employment services, with offices in 80 countries and territories and revenues approaching $22bn. After years of strong and profitable growth, the company is facing the most threatening economic environment in its history.

However, by controlling costs and focusing its resources on growth markets, Manpower expects to emerge from this recession stronger than ever. Art Detman explains why.…

AIG’S BLANK CHEQUE ..................................................................................Page 65 With its latest relief package - more flexible terms, more payoff time, and even more money - the government believes it has finally found the formula that will allow insurance giant American International Group the most realistic chance of recovering from its ruinous credit-related investment activities. Dave Simons reports.

COVERED BONDS

US COVERED BONDS: EMULATING EUROPE? ..........................Page 72

In the wake of the credit crisis, however, American regulators are pushing hard to develop a domestic market for an instrument that has long provided an inexpensive funding source for large banks in Europe. Neil O’Hara reports on the outlook for covered bonds in the New World.

ROUND ROBIN: SURVIVING THE CRISIS ........................................Page 74 Questions are still extant as to the true nature of covered bonds: either as a ratings or a credit product. Whatever the ultimate outcome of that debate, we asked some of the leading market makers in the covered bond market to give us their views on the sustainability and future of this deep and diversified market through 2009 and beyond.

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JANUARY/FEBRUARY 2009 • FTSE GLOBAL MARKETS

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Market Leader A RENEWED FOCUS ON COUNTERPARTY RISK

“There are no magic metrics to help you manage counterparty risk,”Jack MacDonald says,“It’s an intuitive process, but diversification is believed to provide some protection.”Photograph by istockphoto.com, supplied December 2008.

Back to the future What, me worry? To many asset managers, the demise of a major broker-dealer was never more than a theoretical possibility. The implosion of Bear Stearns should have been a wake-up call, but the firm’s shotgun marriage to JPMorgan Chase may have reinforced the belief that Wall Street’s titans were too big to fail. An age of innocence ended when Lehman Brothers went bankrupt and hedge funds that held assets at the firm discovered they could not get immediate access to their money. The lesson? Do not downplay counterparty risk, particularly if you are a hedge fund. Neil O’Hara reports.

UNDS THAT ALLOWED Lehman to rehypothecate their assets in a commingled pool had no priority claim when the bank went belly-up and had to wait in line alongside other unsecured creditors in a bankruptcy court proceeding.

Always a concern for the brokerdealer community, counterparty risk has now grabbed the attention of money managers as well.

In a bygone world, the buy side could afford to downplay counterparty risk. Even today, long-only managers who trade cash securities and do not use leverage have little reason to worry. For equities and other instruments that trade on an exchange or settle through a central clearing house the counterparty is backed by

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collateral from member firms and the risk is limited to three business days in most markets. In effect, these managers have a simple agency relationship with their broker-dealers.

For hedge funds, short sellers and leveraged players, it is another story.

These investors rely on prime brokers not only to settle trades but also to finance positions and facilitate stock borrowing. The additional functions introduce an ongoing bilateral credit relationship in which funds face severe disruption if the broker-dealer fails.“It is a big difference,” says Robert Sloan, managing partner of S3 Partners, a New York-based financing specialist and advisor to hedge funds, “People tend to underestimate the tail risk in their business.” The stakes ratchet up

again when funds begin to trade OTC derivatives in which both sides expect the other to stand behind obligations that often run for many years.

Sloan says his hedge fund clients are well aware of the mismatch in duration between their assets and liabilities but the speed with which funding can disappear came as a surprise to many. “It is a rented business model,”he says,“Redemption terms are quite short and a hedge fund’s hold on capital can be tenuous.”

Of course, it is rather hard to model counterparty risk. Unlike market risks in a trading portfolio, the outcome is binary: a counterparty is either good for the money or not. Sloan says people who chase hedge fund-like returns tend to ignore the implications of an incentive fee structure that encourages funds to close up shop when they start to lose money.The notion that the independent investment banks were hedge funds in drag may be uncomfortably close to the truth.“To get those returns, more often that not you bring into risk things that can’t be modeled but can put you out of business,” says Sloan, “The investment banks’ hold on capital was no greater than the other people trying to earn the same payoff.”

Jack MacDonald, president and chief executive officer of Conifer Securities, a hedge fund middle and back office service provider based in San Francisco, traces the heightened awareness of counterparty risk to the summer of 2007, when two hedge funds managed

by Bear Stearns hit the wall and most funds that relied on quantitative strategies took severe losses. Ever since then, more and more hedge funds have chosen to diversify their counterparty risk through multiple prime broker relationships—either at their own initiative or in response to pressure from investors.“Having more than one well-established well-capitalised counterparty has become the norm for

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EuroCCP A new era dawns for pan-European clearing and settlement

www.euroccp.co.uk

Europe’s securities markets are changing dramatically, and nowhere is that more obvious than in clearing and settlement.

For a trading firm, EuroCCP offers the lowest clearing fees for trades across European platforms. Your trades are netted down into a single position in each security, regardless of the platform they’re executed on – with savings you can pass on to your customers.

For an MTF or an exchange, EuroCCP gives a more competitive, all-in cost for trading, clearing and settlement.

EuroCCP is backed by DTCC’s three decades of experience in central counterparty risk management, an unparalleled track record in ensuring trades settle at the agreed price, even if a trading counterparty defaults.

With all this also comes world-class reliability, resiliency, capacity and an industry-governed, at-cost model that returns excess revenues to participants.

For more information, go to www.euroccp.co.uk

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Market Leader A RENEWED FOCUS ON COUNTERPARTY RISK

managers who are looking to grow their business,”MacDonald says.

The trend accelerated after Lehman failed. The asset threshold at which hedge funds add a second or third prime broker used to be between $400m and $500m.The decision was typically driven by a desire to improve access to securities lending portfolios, get better pricing through competitive bids, or expand into international markets where the existing prime broker had a limited presence. In the last couple of months, however, MacDonald has seen managers with as little as $50m to $100m under management looking for additional relationships. It is an expensive proposition.

A hedge fund that has only one prime broker can rely on a single set of reports for a complete picture of its positions and balance sheet. The moment it adds another counterparty, manager’s back office must not only reconcile each account but also consolidate reports, which may not be in the same format, to get a comprehensive view. Although some prime brokers offer shadow reporting for positions held elsewhere, the service is usually reserved for larger clients and does not include daily three-way reconciliation of trade and cash balances. In any case, most managers do not want a single prime broker to see what they have elsewhere. “It is a significant undertaking to support multiple relationships,” says MacDonald, whose firm has offered a multi-prime service for many years,“We are seeing a lot of demand. It is not something you can turn on overnight.”

Investors have begun to focus on portfolio liquidity as a proxy to determine whether managers can move assets away from a troubled counterparty before it fails.

MacDonald says asset allocators have begun to ask how quickly managers could go to cash if they had to. Some

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managers have embraced the concept in marketing documents that tout their ability to liquidate in a matter of days or raise enough cash to meet redemptions even in a distressed market.“There are no magic metrics to help you manage counterparty risk,” MacDonald says, “It is an intuitive process, but diversification is believed to provide some protection.”

Beyond diversification, MacDonald says managers are also reviewing the segregation of assets. Although broker-dealers have to keep customer assets separate and cannot lend out the securities in a cash account, the game changes when they extend credit to customers. Broker-dealers take a pledge over the securities in margin accounts, which act as collateral for the loan, and have the right to re-pledge those assets at will.

As hedge funds which had assets at Lehman discovered to their cost, rehypothecated securities were typically pooled with assets that belonged to other customers and the firm itself, which left individual funds with only an unsecured creditor’s claim against the bankruptcy estate.

Managers should have known about the risk, but economics may have played a part in their decision to ignore it. Broker-dealers charge more if they cannot commingle a customer’s assets in the securities lending pool, an insurance premium managers are more willing to pay now that counterparty failure has become an all-too-real possibility.

MacDonald says some hedge funds have taken segregation even further and moved surplus cash to custodian banks.

Other managers have entered into tripartite agreements for securities lending, which also puts assets in the hands of a custodian. These arrangements all cost money, of course, and MacDonald wonders whether hedge funds will reverse course when

Michael Conover, a partner in the financial risk management group at accounting firm KPMG, says that although money managers have ratcheted up their counterparty risk assessment they often gravitate toward firms they believe are too big to fail. Photograph kindly supplied by KPMG, December 2008.

the markets settle down. “Moves were done more as an emotional response than a real concern,” he says,“The fear and paranoia seems to have abated somewhat.”

In many cases, managers have been able to reduce counterparty risk simply by exercising rights they already had. It’s an open secret in the OTC derivatives market that buy side firms seldom called for collateral from dealers when they were entitled to it, and when they posted collateral to a dealer they did not call it back on a timely basis if prices moved in their favour. That all changed after the Bear Stearns hedge funds bit the dust.

Richard Metcalfe, head of policy at the International Swaps and Derivatives Association (ISDA) points out that fifteen years ago collateralisation was the exception rather than the rule but it had become common practice even before the Basel II regulatory framework, which gives capital relief for secured lending, came into force. ISDA has tried to promote collateral use through recommendations on technical matters like reset thresholds and minimum transfer amounts as well as what resources a collateral department needs to handle legal, risk management and operational concerns. ISDA has no enforcement power, so it has to rely on moral suasion. “It’s a ‘lead the horse to water’approach,”says Metcalfe.

Collateral has proved its worth in mitigating losses time and again, but it

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Market Leader A RENEWED FOCUS ON COUNTERPARTY RISK

only works if firms take possession of it. A promise to post collateral at some future date won’t do the trick, as the counterparties to credit default swaps sold by AIG discovered. They had no right to collateral until AIG’s debt rating soured, by which time the stricken firm couldn’t come up with enough cash to meet its obligations.

Metcalfe points out that market participants are all paid to make decisions about risk, which includes the credit risk they assume in trading with a particular counterparty. The presumption that AIG or Lehman would always be there was a risk decision, albeit one that most money managers were prepared to live with.

Metcalfe also acknowledges that counterparty risk is only one of many credit decisions firms have to make.

“It’s important that firms are on top of their counterparty risk,” he says, “But the bigger credit risk decisions are taken on other matters; for example, whether or not to invest in securities tied to sub prime mortgages.”

The credit crisis has galvanised efforts to create a central clearing house for over the counter (OTC) derivatives, which would eliminate counterparty risk almost entirely. The concept took root several years ago in the interbank market for interest rate swaps, where most transactions now settle through SwapClear. DTCC is already working on a clearing house for credit default swaps. ISDA’s Metcalfe notes that a central counterparty backed by capital commitments from its members creates an entity that is stronger than any of its individual participants. It also permits multilateral netting of transactions, which dramatically reduces required money flows and risk.

Despite these advantages, Metcalfe cautions that central clearing only makes sense for standardised products.

While many participants can meet their requirements within a standard

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framework, the big advantage of OTC derivatives lies in the ability to tailor contracts to handle specific risks.

“Central clearing exists as a possibility for some contracts within the OTC continuum as well as all those in the exchange listed environment,” says Metcalfe,“To move custom contracts to a centrally cleared environment is difficult if not impossible.”

Money managers value the ability to hedge specific risks through bespoke OTC derivatives contracts, however.

Counterparty risk will not go away, either in the OTC market or elsewhere in the financial system. The myth of sell side invulnerability dies hard, however. Michael Conover, a partner in the financial risk management group at accounting firm KPMG, says that although money managers have ratcheted up their counterparty risk assessment they often gravitate toward firms they believe are too big to fail.

KPMG is working with the Economist Intelligence Unit (EIU) on a global survey of senior risk officers about future risk management practices in the financial services industry. Conover says preliminary results indicate that respondents will pay more attention to risk culture and how they incorporate risk management into their business strategy. “It’s not about putting in a new system or creating a new report,” he says, “People are going to start at the top of the house for risk management and examine how to do it better on an enterprise-wide basis.”

It will require a significant change in attitude at many firms. A startling 76% of KPMG/EIU survey respondents still feel that risk is a support function.

Conover suggests that regulators may have to take the lead, perhaps by requiring a risk expert on the board of directors. “Why wouldn’t we want to have a risk specialist at the board of a risk taking organisation?” he asks.

Richard Metcalfe, head of policy at the International Swaps and Derivatives Association (ISDA) points out that fifteen years ago collateralisation was the exception rather than the rule but it had become common practice even before the Basel II regulatory framework, which gives capital relief for secured lending, came into force.

ISDA has tried to promote collateral use through recommendations on technical matters like reset thresholds and minimum transfer amounts as well as what resources a collateral department needs to handle legal, risk management and operational concerns.

ISDA has no enforcement power, so it has to rely on moral suasion.“It’s a ‘lead the horse to water’ approach,” says Metcalfe. Photograph kindly supplied by ISDA, December 2008.

Conover also expects chief risk officers to become peers with business unit heads, a recognition that risk management has not always had the right seat at the table at some firms.

A majority of survey respondents blamed compensation as the single biggest cause of the credit crisis.

Although Conover does not expect risk officers to set individual packages or compensation levels in the future, they may have a say in structuring compensation to reflect the risks in a particular line of business. “You have to change the risk culture, using the carrot and the stick,” he says, “That is why chief risk officers have to be more involved in the business strategy.”

No matter how best practices evolve in the risk management industry, It is a safe bet that hedge funds, asset managers, pension plans and other investors will not get lulled back into a false sense of security about counterparty risk any time soon. It is a new dawn, and not before time.

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In the Markets PENSIONS REGULATOR CONSULTS ON RECORD-KEEPING

The pensions industry has been subject to continual changes in legislation, affecting, for example, revaluation of deferred benefits, increases to pensions in payment and contracting out provisions.

Additionally, in recent years funding difficulties have led to many scheme sponsors changing benefits to make a scheme more affordable. Some schemes have ceased accrual and switched to some other basis for future benefits under the same trust. All of these changes impact on administration and make the task of maintaining good quality records challenging.

Photograph © Xyzproject/Dreamstime.com, supplied November 2008.

Perfect data flow: an unattainable goal?

Everyone recognises the benefits of working with good quality data. Administrators love to work with accurate and complete information, but are used to getting by with what is provided. The argument has always been that complete accuracy is essential only when benefits come to be paid, but with increased buy-out activity and closure of defined benefit (DB) schemes to future accrual, problems which were being stored up for a future date are actually coming to fruition now.

Colin Wheeler, national projects manager at HSBC Actuaries & Consultants, considers the UK Pensions Regulator’s latest consultation, which is aimed at those responsible for recordkeeping and those who administer schemes.

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HE LATEST INITIATIVE from the UK’s Pensions Regulator, the national regulator of work-based pension schemes, which stresses the importance of good record-keeping in the governance of pension schemes, is well-intended. To that extent, it is to be applauded. The question remains: how practical is it?

Many DB schemes have been going for decades in the United Kingdom.

Although of late, many have undergone substantial changes as a result of merger and acquisition activity, disposals, benefit changes and, of course, the multitude of legislative change that the pensions industry has faced. There are three key reasons why a typical DB scheme might have data of poor quality. The first and most obvious is legacy issues.

Most long-established schemes have changed administrator,

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possibly several times, and moved between different systems. These changes increase the possibility of data being lost or wrongly amended.

In some cases, data for members who left in the early days is still kept in paper format.

Two, legislative and scheme design changes have also played their role. The pensions industry has been subject to continual changes in legislation, affecting, for example, revaluation of deferred benefits, increases to pensions in payment and contracting out provisions. Additionally, in recent years funding difficulties have led to many scheme sponsors changing benefits to make a scheme more affordable. Some schemes have ceased accrual and switched to some other basis for future benefits under the same trust. All of these changes impact on administration and make the task of maintaining good quality records challenging.

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In the Markets PENSIONS REGULATOR CONSULTS ON RECORD-KEEPING

Three, there is the question of the trustees and employers is the even when all parties are working availability of data. Some employers are consultation document’s claim that together to clean the data, it may unable to trawl historic records to plug poor data can add as much as 5% to prove to be an incomplete exercise.

The consultation document details gaps, at least not without the cost of buyout. Furthermore, disproportionate effort, and therefore experience tells us that the day-to-day what it describes as“core data”; a list they can provide only incomplete data. running costs of a scheme can also be of all the bits of data that schemes Sometimes, employers find that reduced by improving the quality of should already have. The list is by no means extensive enough. This core required historical data no longer exists. the data.

The Regulator’s document data does not provide enough of the Increasingly, however, it is vital that those responsible for data provision addresses two principal groups: basic detail required for totally give full co-operation to scheme those responsible for record keeping accurate administration.

The administrators on such matters. (the trustees) and those to whom the operational validity (and even past Corporate transactions, actuarial valuation results) sometimes leading to of any scheme failing to possess at least the core frequent changes of the data would have to be called employers participating in into question. a scheme, can mean that it However, even the is increasingly difficult to existence of comprehensive ask the employer to The regulator’s consultation document core data does not respond to data queries acknowledges that “many trustees do necessarily equate to about particular members. not monitor administration performance possession of accurate data.

The recent regulator’s For example, do the salary consultation document effectively”. Better managed schemes histories held actually reflect acknowledges that “many will include a consideration of a the scheme’s definition of trustees do not monitor Stewardship Report or similar document ‘pensionable salary’? How administration performance in the governance section of their accurate are the spouses’ effectively”. Better managed trustee meetings. pension records for deferred schemes will include a members and pensioners? consideration of special Stewardship Report or Therefore, in addition to similar document in the plugging the missing gaps in governance section of their data, we must also consider trustee meetings. the validation of existing It is data. Therefore, while the important that whatever administration is document is to be welcomed, it seems document is used the information day-to-day conveyed is clear, complete, and delegated. This may ultimately be that the regulator may not have gone understood by the trustees. It can and extended to a third key party, the far enough, and underestimated the should create an opportunity for the employer, which is responsible for difficulties involved. Trustees should Historical ask more questions of scheme administrator to comment on the providing the data. overall data quality and point out other records are often incomplete and, in administrators about the quality of issues that the administrator wishes to some cases not accessible at all their data records and be prepared to because an employer no longer take action, such as a comprehensive raise with the trustees.

With quality of data now firmly on exists, though the scheme continues, data audit together with appropriate the regulator’s radar, trustees need to and verifying salary or contribution remedial action if the answers are not give greater consideration to the history may not be possible. acceptable. subject. This could entail less tolerance Confirming contracting-out records The Pensions Regulator’s consultation of poor quality or incomplete data and with National Insurance Services for they may have to work with the Pensions Industry (NISPI) is a document is available on employers to improve accuracy. What further area that has frustrated (www.thepensionsregulator.co.uk/ must be a sobering thought for many administrators for many years. So onlinePublications/index.aspx).

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BRAZIL: BANCO ITAU MERGES WITH UNIBANCO

Roberto Setúbal, left, Itaú bank president, and Pedro Moreira Salles, Unibanco bank president, attend a press conference in Sao Paulo, Monday, November 3rd, 2008. Brazilian banks Itaú and Unibanco announced they plan to merge and create South America’s largest private sector banking group.The new bank will be called Itau Unibanco Holdings SA and will have combined assets of R575.1bn (about $261bn). Photograph by Andre Penner, supplied by AP Photo/PA Photos, December 2008.

HAPPY DAYS OR FORCED BONHOMIE? The merger of the Brazilian giants, Banco Itaú and Unibanco, creates Brazil’s biggest bank and a leader in the Americas. The architects of the merger want to create a global leader and exploit a moment when Brazil’s global stature is growing and the banking industry at large is in disarray. At home, though, the news is a mixed blessing. As customers seek safety in the strongest institutions, the merger has prompted the government to push state banks to keep up, using new powers. Consumers will pay a premium for the safety of size. John Rumsey reports.

HE ANNOUNCEMENT OF the proposed merger of ItaúUnibanco in early November took the Brazilian markets completely by surprise. Its audacity—the bank will be the largest in the southern hemisphere and become one of the largest 20 banks in the world by market capitalisation— makes the secret negotiations all the more surprising.

T

The ability of the chief executive officer (CEO) of Itaú, Roberto Setúbal, and his opposite number at Unibanco, Pedro Moreira Salles, to negotiate the deal over a clutch of meetings in an apartment in a posh southern suburb of São Paulo and keep it a secret from the banking community underlines the importance of family ownership in

FTSE GLOBAL MARKETS • JANUARY/FEBRUARY 2009

the structure of the Brazilian banking system. Ultimate control of Itaú lies with the Egydio de Souza Aranha family while the Moreira Salles family controls Unibanco.

At a stroke, the estimated R26.5bn ($12.5bn) deal creates one of the biggest and most profitable banks of the Americas. Itaú-Unibanco will dispose of R575bn in assets, a network of 4,800 branches, and 19% of the local credit market. If the deal is approved, the new bank will become the largest in Brazil, leapfrogging current top dog in the private sector Bradesco and even the country’s largest bank, the publicly-owned Banco do Brasil.

Itaú-Unibanco does not just have clout through size but performance too. By third quarter results, the combined Itaú and Unibanco entity would rank as the second most profitable bank in the Americas and be placed top among Brazilian banks with $1.33bn in profits, according to the investment analysis firm

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In the Markets BRAZIL: BANCO ITAU MERGES WITH UNIBANCO

Economatica. Only Wells Fargo posted more profit at $1.637bn. Indeed, Economatica shows that of the 20 most profitable banks in the Americas, five are Brazilian. Stripping out the merger, Bradesco comes top among Brazilian banks with $977.9m in the third quarter, followed by Banco do Brasil with $975.3m, Itaú with $965.2m and next in line Unibanco, which revealed profits of $367.5m. The merger also opens up the gap between the Brazilian banks and the most important foreign competitor in the market, Santander which posted profits of $259.5m.

Pros and cons There are a number of obvious advantages to scale in an era when clients are desperate for the security of a bank that is seen as too large to fail.

A broader deposit base is also critical at a time of scarce credit. The merger will also allow for some cost cutting, although both banks have repeatedly stressed that there are no plans to lose staff except through natural wastage.

That said, the new entity may be able to squeeze out R3bn to R4bn in savings, including through tax and the ability to trim technology spend, according to Henrique Navarro,

analyst at Santander Investment Securities. The new entity will also benefit from Unibanco’s strengths in consumer credit while enjoying Itaú’s lower fund-raising costs, he points out. The bank sees itself becoming a Latin powerhouse, and indeed its own backyard is the first area for expansion.

Mexico is a priority, according to Moreira Salles, as is Chile. Itaú does not have a substantial presence there, making it high on the list of investment plans.“I always thought it strange that Brazil does not have a [banking] multinational, given its concentration of talent and developed

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rumours. “We heard financial system. Now stories about our this opportunity exists. derivatives losses that We want to build a were completely out of unique business in proportion.” In late which the country can October, he announced take great pride,” that bank clients would Moreira Salles adds. forfeit one billion reais The deal also opens to cancel leveraged up opportunities in positions and pointed secondary sectors, the out that most obvious being this insurance. Since the represented less than announcement of its 0.5% of total assets. The merger with Itaú, writing, however, was Unibanco has said already on the wall. that it is buying out a The question now is Behind the bombast, the reasons for the merger often look more prosaic. The 48% stake held by what the effect will be on purchase by Santander of ABN Amro’s Brazilian operations had raised the rescued US insurer the overall banking uncomfortable spectre of a foreign bank competing for the top spot among AIG in an insurance sector and its private banks, long held by the duopoly of Itaú and Bradesco. There was the joint venture between competitiveness. Brazil strong possibility that Santander and ABN Amro, with European roots, could the two. Unibanco has has a relatively leverage their experience of domestic mortgage markets to capture a big slice agreed to pay $820m concentrated banking of the next great opportunity in Brazilian banking, the flourishing of the in the deal, giving it sector with the five nascent mortgage market. Already, Santander had shaken up the Brazilian full control largest banks accounting over credit market, for example introducing fee-free credit cards, which were for 65% of the market.

Brazil’s fourth-largest quickly copied. Photograph © Alexandre Fagundes De Concentration has been insurer with total Fagundes/Dreamstime.com, supplied December 2008. increasing and as assets of R12bn. The Unibanco, long the third private recently as 1995, there were 240 banks sector has been booming on the back of areas including credit protection, bank, had a franchise which had lost in Brazil. That had fallen to 156 by June private health care and life insurance. space in some critical areas, such as 2008. Still, it is by no means the most Behind the bombast, the reasons for corporate banking. Its business was concentrated market in the region: the the merger often look more prosaic. seen as being the clincher for either top five banks in Peru enjoy 86% market The purchase by Santander of ABN Itaú or Bradesco to take the final step share, while the figure is 79% in Mexico Amro’s Brazilian operations had to becoming the dominant bank and and 75% in Chile. raised the uncomfortable spectre of a as such it had long been rumoured as The financial crisis means that foreign bank competing for the top a takeover target, although customers are already suffering with spot among private banks, long held management constantly repeated that higher fees. According to the Brazilian by the duopoly of Itaú and Bradesco. it was not up for grabs. The financial banking federation, Febraban, average There was the strong possibility that crisis, which emphasised the spreads in September consumer Santander and ABN Amro, with importance of strong ratings and deep lending were up by 3.6 percentage European roots, could leverage their pockets, was already challenging points year-over-year at a hefty 53.1% experience of domestic mortgage Unibanco. Then rumours started per annum. Even in the corporate markets to capture a big slice of the swirling that the bank had been sector, the average spread is up 2.1 next great opportunity in Brazilian deeply involved in selling US dollar percentage points in 12 months with banking, the flourishing of the forward contracts to clients, which an average charge of 28.3%. Further nascent mortgage market. Already, had gone sour as the real reversed its consolidation clearly does not bode Santander had shaken up the gains and slumped against the well for customers and probably Brazilian credit market, for example greenback. Moreira Salles was clearly reduces the likelihood that attempts introducing fee-free credit cards, aware of what was pressuring the will be made to win market share which were quickly copied. bank and looked to scotch those through competitive pricing.

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In the Markets BRAZIL: BANCO ITAU MERGES WITH UNIBANCO

Smaller banks With the merger, Unibanco has avoided the fate of many of its much smaller brethren, which have had to slam the brakes on all expansion plans. The elimination of smaller banks is also effectively exacerbating the concentration in the Brazilian banking industry. The last six months have been a gruelling time for smaller banks. Many had thrived in the previous three years by moving swiftly into new areas of the credit boom.

Starting in the payroll-deducted credit market, they had spread out into niches including lower income credit, auto and motorbike loans, including for second hand-purchases, as well as lending for small- and medium-sized enterprises. With ready capital through equity markets and securitisation, they had been witnessing lending growth of more than 30% per annum.

The scale of the turnaround can already be seen. São Paulo-based Daycoval saw net profits fall 18.4% in the third quarter to R47.1m and, more worrying still, a steep decline in deposits, which tumbled 10.8% between the second and third quarters to R2bn. The financial crisis has hit smaller banks hard for a number of reasons. The closing of equity and structured debt markets means that these banks no longer have access to new financing to grow and do not have sufficient balance sheet clout to sustain lending.

The inability to raise reasonably priced financing calls into question the very business model, according to Celina Vansetti-Hutchins, senior analyst at Moody’s in New York. At least until markets re-open, these banks will find themselves frozen out, adds Plinio Chapchap, professor of finance at Profins Business School and partner at Queluz Gestão de Ativos, a boutique asset manager and corporate

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advisor. He sees zero credit growth in Brazil next year. Chapchap also points out that one of the most dynamic credit segments, that of lending for car purchases, is likely to decline since manufacturers are already idling plants for weeks as demand outstrips supply. Extremely long tenors for loans enabling lower income borrowers access to consumer goods has all but disappeared, he notes.

The acquisition spree has not stopped there. Banco do Brasil has also been negotiating to buy Banco de Brasilia, has already agreed to buy the state bank Banco do Estado de Santa Catarina for R685m and more recently said it would pay R81.7m for the Banco do Estado do Piaui. It has also been widely rumoured that Banco do Brasil is negotiating to buy a stake in Banco Votorantim of some R7bn.

Chain reaction

Cinderellas

The predictable effect of the proposed Itaú-Unibanco merger has been to stimulate further moves towards consolidation in the belief that bigger is better. This comes at a time when the Brazilian government is desperate to ensure that the credit downturn does not exacerbate the economic slowdown already underway.

To maintain credit growth, the government has pushed through measures including a lowering of what have been very high reserve requirements. More controversially, it has pushed a measure (MP433) through Congress to allow public sector banks to take over other financial institutions. In the case of Caixa Econômica Federal, the giant mortgage bank, the government went a step further and allowed the bank to buy stakes in real estate companies.

Banco do Brasil has been on something of a rampage. On November 21st, the bank announced that it had bought a 71.2% stake in Banco Nossa Caixa, a state bank owned by the government of São Paulo, for R5.39bn, representing a premium of 38% over the previous trading day’s closing price. The subsequent reaction of the share price suggested that investors believed Banco do Brasil overpaid, with its shares tumbling 14% for a decline of over 60% year-to-date while Nossa Caixa shares ended up.

The big question now is how the mighty Bradesco and Spain’s Santander keep up in this more competitive environment in which Banco do Brasil seems willing to spend significant premiums to buy up banks.

Marcio Cypriano, president of Bradesco, has been at pains to stress that the bank is not going to be bounced into making a precipitate acquisition to keep up.“What interests us is efficiency (and) returns for our shareholders,”he said. The bank is not imminently going to look for expansion overseas to keep up with Itaú-Unibanco either, he adds.

Bradesco is pessimistic about Brazil’s expansion next year, predicting anaemic growth of 2.5%.

Meanwhile, Spanish banking giant Banco Santander’s plans to become the most profitable bank in Brazil seem to have retreated further from reality. Santander Chairman Emilio Botín recently said his bank would invest R2.6bn over two years to expand its business by 15% with 400 branch openings. Customers of Brazil’s banks may be thankful for the moment that the money is in safe hands, though down the line they may rue the day that the banking sector consolidated still further. As for Itaú-Unibanco, it is likely to find that the lower fees charged in Latin America make these markets less appetising than staying at home.

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THE FTSE HOW DO I GET INTO REAL ESTATE INDEX FTSE. It’s how the world says index.

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© FTSE International Limited (‘FTSE’) 2008. All rights reserved. FTSE ® is a trade mark jointly owned by the London Stock Exchange Plc and The Financial Times Limited and are used by FTSE under licence.

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In the Markets REGULATORY ISSUES FOR ISLAMIC FUNDS

Photograph supplied by istockphoto.com, December 2008.

SHARIA F COMPLIANT INVESTING The Islamic funds industry is growing rapidly, as investment managers seek to tap into the high levels of liquidity which still exist in the Gulf countries, and as Muslim investors recognise that there are viable alternatives to conventional funds. At the same time, as Islamic finance grows, there is an increased focus on its regulation. There are, in fact, relatively few regulatory issues specific to Islamic funds but, outside the very important one of Sharia governance, the similarities to conventional funds are much more important than the differences. Indeed, the relatively conservative models forced on Islamic funds by Sharia limitations will tend to limit the regulatory difficulties that may arise. Peter Casey, director of policy in the Dubai Financial Services Authorityâ&#x20AC;&#x2122;s policy and legal services division, outlines the issues.

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ORTUNATELY FOR THE funds industry, regulatory issues for Islamic funds are in many ways simpler than for other areas of Islamic finance. This is because the operation of Islamic funds can generally replicate structures and processes which are familiar from conventional finance.

Whereas other Islamic finance structures, such as profitsharing investment accounts, or takaful, sit rather uneasily within conventional regimes, and significant modifications are necessary, with funds the situation is much simpler.

An Islamic fund must operate within Sharia principles. The prohibition in Islam against riba will prevent a fund lending or borrowing at interest, or investing in interest-bearing securities.

Moreover, the fund may not invest in unclean or unethical activities such as those involving pork, alcohol, pornography or prostitution. It may also not invest in conventional financial institutions, or enterprises which receive or pay substantial amounts in interest.

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

Because investors always want superior returns, FTSE has developed a range of investment strategy indices that are designed to offer an enhanced risk / return profile. Alongside traditional indices, we offer indices that use alternative weighting criteria, which include sales, cash flow, book value and dividends, instead of market capitalisation. www.ftse.com/invest_intelligent

© FTSE International Limited (‘FTSE’) 2008. All rights reserved. FTSE ® is a trade mark jointly owned by the London Stock Exchange Plc and The Financial Times Limited and are used by FTSE under licence.

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In the Markets REGULATORY ISSUES FOR ISLAMIC FUNDS

There are standard“Sharia screens”, some operated by third parties, for determining whether investments are acceptable. Where an investment produces a small proportion of its return from unacceptable sources — for example a trading company which also arranges interest-bearing loans for its customers — that investment may be regarded as acceptable if it is “purified” by giving the unacceptable proportion of the return to charity. A fund may not sell goods or instruments which it does not (or will not certainly) own. This limits the ability to sell short or to enter into some types of futures contract.

The prohibition against gharar (risk) will also limit some types of contract, including for example contracts for differences. Debt obligations are generally not considered to be tradable. (The situation is, however, complicated and baskets which contain a proportion of debt obligations may be accepted as tradable.) The main contractual arrangements, especially those with investors, will be conducted under one of the contractual forms known from the early Islamic period.

In the conventional funds area, international standard for evaluating a regulatory regime is the International Organisation of Securities Commissions (IOSCO) Objectives and Principles of Securities Regulation, especially Principles 17 to 20, and the supporting evaluation methodology. These principles are naturally focused on funds of securities, and would need some adaptation to deal with, for example, commodity or real estate funds. One manifestation of the increased interest in the regulation of Islamic finance was the setting up by IOSCO of a Working Group to consider the application of the IOSCO Principles to Islamic finance. The report of this

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group, on which the Dubai Financial Services Authority (DFSA) was represented, was published in September 2008, and this particular article draws heavily on its analysis.

The key issue for Islamic funds is, of course, Sharia governance. By holding itself out as Islamic, any fund makes at least an implied claim that its activities, and specifically its investments, conform to Sharia principles. What is the role of the regulator in relation to this claim?

Some regulators would take the view that they should not be involved in any way with this claim, seeing anything with a religious overtone as being outside their remit - though some might modify this by relying on general disclosure obligations to achieve disclosure of Sharia compliance, as something relevant to an investor’s decision. Other regulators see it as their duty to oversee Sharia compliance directly, and to impose consistent interpretations in their jurisdictions.

They generally do this by creating a single Sharia Board of their own, though there may be further boards at firm or fund level. The third approach, which the DFSA has followed, is to focus the role of the regulator on Sharia systems: that is, to ensure that a firm, or a fund, has the systems in place to ensure Sharia compliance, but without dictating interpretations centrally.

Such an approach would typically require a fund, or its operator, to establish a Sharia board of competent scholars, to have mechanisms for ensuring that its rulings are implemented, and to conduct periodic Sharia audits. Of course much of this approach would also be present in those jurisdictions where Sharia is more directly regulated.

Associated with any active approach to Sharia governance, there are likely to be disclosure requirements, in line with the IOSCO view that “full disclosure of information material to

investors’ decisions is the most important means of ensuring investor protection.” These disclosures would typically include the names of the relevant Sharia advisors, and their roles and responsibilities. They might also include the basis on which the fund is deemed to be compliant, and strategies to address the possibility of non-compliance, for example when an investment ceases to pass the Sharia screens. Where this involves giving part of the fund’s income to charity, this would certainly need to be disclosed as a material departure from normal fund principles.

The requirement for Sharia compliance, and for disclosures, also has effects on the competences that a regulator would expect to see in the fund operator. It will clearly need to have the ability to deal with Sharia issues and, at point of sale, to make the necessary disclosures. It may well be possible to acquire some of the necessary competencies through outsourcing. There is a growing industry base of consultancies offering various Sharia advice and compliance services. However, as with other outsourcing, regulators will hold the operator ultimately responsible, so that it will need at very least to have the competence to manage its service provider.

As regards issues such as accounting and valuation, an Islamic fund may be more likely than a conventional longonly fund to invest in securities which are not traded in deep, liquid and transparent markets. However, the problems are conceptually no different from those faced by many conventional funds. The fund will also need to use appropriate accounting standards.

There is, of course, increasing convergence worldwide on International Financial Reporting Standards (IFRS), but to date the International Accounting Standards

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Board (IASB) has given little attention yet by all the Islamic schools of resort is normally to borrow against to the specificities of Islamic finance thought, and this would inevitably the assets. Although this should in and instruments. This led to the diminish the marketability of a fund principle be possible, it is not clear creation of the Accounting and based on it. Islamic commodity funds that it will be as simple to arrange in Auditing Organisation for Islamic exist, and in general pose few an Islamic fund as a conventional one, Financial Institutions (AAOIFI), whose problems from a regulatory point of especially since regulators normally standards have been adopted for view. The inhibition on short selling, prefer funds to retain good title to Islamic finance in some jurisdictions. It and the fact that a seller must have their assets, while Islamic mortgage is essential that Islamic accounting constructive possession of any structures often involve the lender standards remain consistent with IFRS, commodity he sells, combine to make assuming full or partial ownership.

In brief, therefore, there are a few and there is currently debate about how these rather conservative in character. this should be achieved. Fortunately, Real estate funds, however, are regulatory issues specific to Islamic however, the issues are less significant another matter. Real estate is in funds but, outside the very important for most Islamic funds than in some principle an attractive investment in one of Sharia governance, the similarities to conventional other areas, such as Islamic funds are much more banking. important than the As far as funds of differences.

Indeed, the securities are concerned, relatively conservative models Islamic funds have tended Although there have been attempts to forced on Islamic funds by to be relatively structure Islamic hedge funds, none of Sharia limitations will tend to straightforward, because the techniques employed has yet limit the regulatory difficulties the Sharia compliance achieved general recognition as being that may arise. requirements set out at the acceptable to Sharia.

All this, however, is subject beginning of this article are to one very important caveat: substantial impediments to it assumes the existence of a either leverage or short general fund regime selling. Although there have been attempts to structure Islamic finance, because it clearly conforming to IOSCO Principles.

Islamic hedge funds, none of the involves tangible assets. However, There are many jurisdictions which do techniques employed has yet there is much less consensus than in not have such a regime, including achieved general recognition as being equity funds about how far non- some in which Islamic finance is In addition, modern acceptable to Sharia. Some existing Sharia compliant income may be significant. funds claim to be hedge funds, but it tolerated, and how it should be Islamic finance was originally driven by is difficult to see where the element of treated. The Sharia screens familiar in the banking sector, and often regulated hedging enters, or that they have equity investment do not exist in the by banking rather than securities (or much in common with the strategies same way for real estate. So there is integrated) regulators. It therefore has of conventional hedge funds (except no consensus, for example, on a legacy of fund or fund-like structures possibly in the remuneration whether a fund can invest in a established within banks, but without strategies of their managers). Should building 90% of whose rental comes the governance structures (trustees, further“Islamic hedge funds”emerge, from residential tenants, but which oversight committees, independent those regulators who take an interest has a conventional bank on the custodians, etc) that are normal for in Sharia will need to scrutinise their ground floor. collective investment schemes. For In addition, real estate is a funds established in this way — and claims carefully.

There are, however, some ways to notoriously illiquid investment, and independently of their Islamic obtain leverage. There are borrowing regulators adopt various devices to character — there are frequently acute structures, often based on the ensure, so far as possible, that funds issues of conflict of interest which need murabaha contract, and the arboun can meet redemptions without being to be managed. As the Islamic finance contract has been used effectively to forced into a fire sale of assets. This industry matures, these funds need to replicate a call option over shares. This can of course be achieved by retaining be brought within the established latter use is, however, not accepted as part of the fund in cash, but the next parameters of governance.

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Face to Face CACEIS: THE HIDDEN MOTOR OF THE FINANCIAL MARKETS

OUT OF THE SHADOWS Asset servicing does not tend to grab headlines. When all goes well, firms operate happily in the shadows of their higher profile bank, broker and investment fund clients. Of course not all is well of late, and in mid-November CACEIS, the investor services business jointly owned by France’s largest retail bank Crédit Agricole and France’s number three investment bank Natixis, found itself at the top of the French business pages. A story, which first appeared in French daily La Tribune, claims Natixis, which has been buffeted by sub prime-related losses, had hired Rothschild to find a buyer for its stake in CACEIS. Natixis declined to comment, though a spokesman noted the bank was conducting a strategic review of all of its operations. In the meantime, Paul Whitfield talked to CACEIS chairman François Marion about the changing markets and their impact on his asset servicing business.

URRENT SPECULATION AS to the fate of CACEIS is not a slur on its business. Instead it is testament to the rapid rise and success of the Paris-based asset servicing firm, that was established in September 2005 when Crédit Agricole and Groupe Caisse d’Epargne combined their custody, asset administration and asset services operations.

In the subsequent three years Credit Agricole-Caisse d’Epargne Investor Services (CACEIS) has cemented a prominent position in fund administration in both France and Europe, and a third place ranking in the key Luxembourg fund market. It also ranks number one in France in depositary/trustee custody, and number four in Europe. A rapid expansion of operations, coupled with steady returns and resilience in the face of the wider stock market and economic downturn, have made CACEIS one of Natixis’s most saleable assets. The investment bank’s 50%

C

CACEIS chairman François Marion.

Photograph kindly supplied by CACEIS, December 2008.

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stake in CACEIS could be worth about €1bn, according to speculation in the French press.

The man who has overseen and can rightly take much of the credit for CACEIS’s success is its chairman François Marion. He joined the business in June 2004 as managing director of Crédit Agricole Investor Services (CA-IS), then became chief executive of CA-IS Bank and chairman of CA-IS Bank Luxembourg.

“My first task was to find a way to grow the business,” he says. “So we negotiated the partnership with Caisse d’Epargne.”

Assets under custody at CACEIS topped €2.2trn at the end of the third quarter of 2008, ranking it number ten in the world by that measure. Assets under administration came in marginally above €1trn, while net income from CACEIS operations was €366m for the first three quarters of the year, according to Crédit Agricole’s most recent quarterly report.

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If Marion is concerned by the rumours of an impending sale by Natixis, and the corresponding arrival of a new shareholder, or shareholders, he shows little sign of it. He claims he is not aware of Natixis’s intentions and when pressed says that he has not even spoken to the investment bank about its plans for CACEIS. It is perhaps telling, though, that when asked if Credit Agricole might also consider selling up he has no hesitation in ruling out the possibility. “The commitment from Crédit Agricole is total,” he says.

Separately, press reports have suggested that Crédit Agricole could seek to raise its 50% stake by 1%, to gain outright control of CACEIS, if Natixis pushes ahead with a sale.

However, neither Natixis nor CACEIS would comment on this presumption.

A sale of the stake makes sense for Natixis. The investment bank needs cash to offset losses of about €500m resulting from trading operations, sub prime exposure and its exposure to the bankruptcy of Lehman Brothers.

In September it sold €3.7bn of new shares to shore up its depleted capital base but only after offering the stock at a huge discount to its then trading value. Further falls in its share price mean going back to the market is out of the question for Natixis, leaving it with little option but to sell assets.

The bank had put its insurance business in the window but pulled the sale after bids came in about a third lower than its asking price of €1.6bn.

CACEIS, which escaped the banking collapse relatively unscathed, could prove a more attractive target, though the offer of only a 50% stake, and possibly less if Crédit Agricole chooses to boost its position, may limit interest from both trade and financial buyers. For CACEIS, which still harbours acquisitive intentions of its own, a new owner, without the financial woes of Natixis, could provide the financial muscle to

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expand at a time when the cost of making acquisitions has fallen. Marion is clear that CACEIS is in the market for new investor services operations— when the opportunity presents itself.

Acquisition, he insists, is the only way to expand his operation beyond its existing borders.“If you are already in a market, and established, you can win clients and grow in that way but if you want to move into a new market you can not simply set up an operation and hope to develop a business. It is impossible,” says Marion.“You have to go there and buy assets,”he notes.

CACEIS has no option but to undertake that kind of acquisition thinks Marion. He divides the investment services world into three parts. The top table consists of those US firms large enough that there is no imperative for them to expand. They include Bank of New York Mellon, the world’s biggest custodian business, and its three smaller compatriots JPMorgan Chase & Co, State Street Corp and Citigroup Inc, all of which benefit from their presence in their home US market, which accounts for about 60% of the global asset servicing market. At the other end of the spectrum, Marion claims the smaller firms have already missed the opportunity to be anything other than fodder for the larger firms’ expansion plans.“They have to sell,”says Marion. That leaves the middle tier of operators, including CACEIS and its European peers, such as French banks BNP Paribas and Société Générale, Britain’s HSBC and UBS of Switzerland.

Marion suggests that these investment services operations will never rise to compete on size with the US giants, principally because they do not have the exposure to the US market. They do still have room to grow in alternative asset markets and in some of the more peripheral European markets. “Italy and Spain are interesting, because we do not

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have a presence there,” he says.“They are also attractive because [profit] margins are higher than in other European markets mainly because the competition is not as intense.”

Marion has no shortage of experience in making acquisitions.

CACEIS has made four major acquisitions and sold off a subsidiary.

In July this year, CACEIS took control of a €200bn custody and €100bn fund administration business from Natixis.

The most significant of those deals, however, came in July 2007 with the purchase of the custody interests of Germany’s HypoVereinsbank (HVB) for €461m. That purchase added €400bn of assets to CACEIS’s assets under custody and gave the French group about a 15% share of the German custody market and a footprint in one of Europe’s biggest asset services markets. The transfer of HVB’s business, now called CACEIS Bank Deutschland, onto the CACEIS platform has not been a simple operation.“We have had to disentangle the HVB business from its parent,”says Marion. “It has not been a simple integration, but it is proceeding well.”

CACEIS also landed a second, important, albeit smaller, deal just days after the HVB acquisition when it paid €243m for Olympia Capital International, an independent investor services operation with $70bn of funds domiciled in Bermuda, the Cayman Islands, British Virgin Islands, Ireland, Canada and the US.The deal marked its first foray into the North American market, albeit in the niche alternative funds sector. Marion dismisses any suggestion that Olympia might be used as a stepping stone into the mainland US market as fanciful. “We are in the offshore market and that is very different to the mainland market,”he says.“There is no way we can compete in the domestic US market. No European firm can enter that market in my opinion.”

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Face to Face CACEIS: THE HIDDEN MOTOR OF THE FINANCIAL MARKETS

The barriers to entry do not just of funds in their care. Yet as Marion ratio of about 70%, the same as Mellon operate in one direction, however. US points out the decline has not been all and State Street,” says Marion. That firms have paid a hefty price for their bad for his group’s revenues.“We have a ratio is better to most of his European efforts to expand into the European balanced business model that includes a peers, he says. It is all the more market and have struggled to build on lot of cash products and the crisis has impressive given that CACEIS’s home the assets that they have acquired. “US meant that the spreads on those market of France, in which it has an firms have found it much more difficult operations have moved in our favour.” about 40% share of the investor than expected to integrate and turn a The financial crisis has also helped many services business, is one of the most profit in businesses they acquired in customers to realise the value of a good competitive and thus lowest margin Europe,” says Marion. Part of the asset servicing and custodian partner. markets in Europe. problem has been the US companies’ Nowhere has that been more true than Marion’s professional experience reluctance to put senior people on the in the alternative funds market, a sector would seem to make him the ideal ground in the markets in which their that includes hedge funds, where huge candidate for watching the pennies in European operations operate, according redemptions have forced many funds to a business that is at once a sprawling to Marion. “They have to understand liquidate assets quickly, leading the technology network, and yet also local regulations and practice and if they funds, in many cases, to suspend highly labour intensive — CACEIS are trying to do that from Boston or New withdrawals temporarily to give them employs 3,500 staff. In the years immediately prior to taking York, I am not sure that it is the reins at CACEIS, Marion easy for them.” was in charge of budget For the time being at least By most measures CACEIS has not the merger and acquisition planning for Crédit Agricole that have characterised the Indosuez and of had a bad financial crisis. The company battle for market share in the information technology for responded early to signs of trouble in asset services industry has the entire Crédit Agricole the credit markets by implementing stalled in the face of the Indosuez group. what Marion describes as "crisis global financial crisis.

While other asset service measures" in the summer of 2007.

Marion says he has no businesses have tried to immediate plans to expand impose their operational processes on new markets, CACEIS’s operations.“ By most measures CACEIS has not more time to liquidate assets and raise Marion says CACEIS is not governed had a bad financial crisis. The cash. “We are speaking with our by any specific operational doctrine. company responded early to signs of alternative asset managers every day at “We do what is necessary to comply trouble in the credit markets by the moment,” says Marion.“There have with local regulation and to best implementing what Marion describes been a lot of redemptions and we clearly service the needs of clients. You can’t as “crisis measures” in the summer of have an important role to play in apply a single model across different 2007. It notably decided to round off facilitating that process. That has not countries,” he insists. “The French its exposure to failed US investment changed our commitment to the sector model won’t fit into Italy and the US bank Lehman Brothers before it filed though. It is not going to disappear and model won’t fit into France. The for bankruptcy on September 15. “We we are in it for the long run.”

CACEIS model is to be pragmatic, to cut all exposure to their [Lehman’s] Given the pressure on the asset keep common elements where we can prime broker service before the service operations from increased and to adapt where we have to.” collapse and did not lose a penny as a client demands and the decline in fees With the expectation of a long-term result,”says Marion.“Not many of our as a result of the declining value of downturn in the financial markets competitors can say the same.” assets, the importance of keeping a lid putting pressure on fees, record No asset servicing operation or on costs has become paramount. volatility buffeting client funds, and custodian has been able to completely CACEIS has proven particularly sharp the prospect of an imminent change its ownership structure, escape the fallout from the recent market at keeping its cost base down, a focus in collapse, not least because, like many of that has allowed it to operate at a cost pragmatism and a willingness to the asset managers they serve, fees are to income ratio on a par with its larger adapt is something that CACEIS may charged as a percentage of the total value US rivals.“We operate at a cost income need in spades in the coming months.

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Country Report MEXICO BRAVES STORMY WEATHER FROM THE NORTH

Smiles in the eye of the storm Mexico’s President Felipe Calderon, left, waves as Brazil’s President Luiz Inacio Lula da Silva looks on during the summit of Latin American and Caribbean for Integration and Development, CALC, in Costa do Sauipe, Brazil, Tuesday, December 16th 2008. The two-day summit covered the strengthening of political and economic ties in the Latin American sub-continent. Photograph taken by Lucio Tavora, for Associated Press. Supplied

by PA Photos, December 2008.

With more than 80% of its exports going north and workers’ remittances crucial to its balance of payments, Mexico is especially vulnerable to shrinking American consumption. With US investors repatriating funds as the credit crunch bites, the country faces a tough time. There is, however, still investment interest despite security fears, Ian Williams reports.

HE FACTORS THAT have helped Mexico thrive since the beginning of the century, above all its proximity to the United States, are now showing their downside. Having hitched a lift on the rising prospects of its neighbour and North American Free Trade Agreement (NAFTA) partner, Mexico is now being dragged down by the recession and economic turmoil north of the border.The peso, which had been rising against the dollar, has begun to fall, and over 7% inflation is envisaged for the year 2008.

Over 80% of Mexican exports go north, and the emigrant workers’ remittances are the second biggest earner after oil. Together they make Mexico uniquely vulnerable to

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shrinking American consumption, whether from a potential slowdown of the flow of remittances from emigrant workers, or slackened demand from consumers for the goods made in the maquiladoras, the bonded factories producing goods for export.

Similarly, American institutions facing cash calls as the credit crunch bit had been repatriating their overseas investments, above all in the emerging markets such as Mexico, leading to a rapid exit of capital, which, thanks to NAFTA, flows out as easily as it recently flowed in. In October, even well established and globally operating Mexican companies including CEMEX were having difficulty rolling over credits as

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liquidity froze both south and north of the border. Adding to liquidity difficulties, worried by the rising peso several companies had heavily hedged based on a falling dollar, and the greenback’s somewhat anomalous rise during the crisis drained their cash reserves.

Illustrating the effect, the market cap of The Mexico Fund, a New York Stock Exchange (NYSE) listed fund investing in companies south of the border, dropped its market capitalisation from $975m the year before to $351m by the end of October, and no less than $190m of that evaporated in that last month. Several scheduled Mexican initial public offerings (IPOs) have followed the current global habit of procrastination and have been rescheduled for an indeterminate date in 2009, while the government has been sitting on several planned infrastructure projects.

Soaring oil prices through much of 2008 should have helped both the Mexican economy and PEMEX, the state controlled oil monopoly.

However, constrained by political and constitutional barriers to foreign investment, not to mention a policy of subsidised fuel supplies to domestic

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Country Report MEXICO BRAVES STORMY WEATHER FROM THE NORTH

consumers, the gains were relatively limited. One unexpected side-effect of temporarily soaring oil prices that did benefit Mexico was the surge in shipping costs of goods from Asia.

Suddenly, maquiladora production became more competitive than Chinese manufactures.

PEMEX is, paradoxically perhaps, almost too successful. It accounts for 35% of federal revenue, and sends over 80% of its revenues to the government. That government, is in turn addicted to PEMEX’s funds.

Moreover, it cannot safely forgo those revenues to allow the company to reinvest in new refining capacity and exploiting deep offshore reserves.

Mexico imports about 40% of the gasoline it uses, according to the International Energy Agency (IEA).

PEMEX meantime estimates that imports of oil could actually grow to 50% of total domestic consumption in 2009. Industry experts also predict that from being currently the third biggest oil supplier to US, it may become a net importer in the near future.

At the end of October 2008, President Felipe Calderón finally managed to get his Energy Reform law passed, which will allow some very limited private and foreign investment in the oil industry, whose domestic control is enshrined in the constitution.

“The reform guarantees that only Mexicans will own our oil,”he declared patriotically, adding for the benefit of the business pragmatists:“The stimulus the reform gives our oil industry will allow us to reactivate our economy.”

Texan offshore rig specialists are already looking forward to the contracts to drill offshore, but others are less sanguine about the immediate economic effects of the reform.

Eurasia Group’s Enrique Bravo comments:“In reality the reform leaves very little opening for private investment. Private companies will

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only be able to continue providing services to PEMEX and will not be able to participate in profit or production sharing contracts. The government backed off from a far-reaching transformation of the energy sector in Mexico because it knew it did not have the necessary political backing for it. It would have entailed a constitutional reform and the Calderón administration did not have the votes.”

Albeit limited, the reforms should make PEMEX more efficient, and give it greater operational autonomy, flexibility in its budgetary allocation and the ability to establish service contracts, with some additional incentives based upon contract performance. But Bravo cautions: “Given the conditions of the industry and potentially lower oil prices, all this will not really help the company ramp up its exploration and future production. Even so, it’s possible that in a few years, once it becomes clear it will not solve the problems of the company, the political elite in Mexico will have no choice but to open up its oil sector. At that point it will have to do so without much room to control the process, especially if production falls to a degree that the public finances take a serious toll.” That is precisely what most analysts foresee.

There is a golden mean between selling out to foreigners and stagnating independently, as some mining companies have demonstrated.

Nonetheless analysts consider Calderón’s ability to get anything at all in the way of reforms, no matter how attenuated, to be a significant political victory. After all, the opposition, some of whom still refuse to recognise his election, had physically blockaded Mexico’s Congress earlier in the year in an innovative pre-emptive filibuster to avert any such legislation.

Overall, however, despite his highly qualified success over Energy, Bravo

comments, “Calderón has managed to advance his reform agenda much more successfully than his predecessor, even though his tenure began under a much more conflictive political environment after a much contested presidential election. His approach has been to try to move things forward, even if this has been with very gradual, incremental changes. No reform so far has satisfied anyone, but given the current distribution of power in Mexico, his reforms are no minor achievements.

Much work remains ahead, and there is, of course, the perception that Mexico has no time to waste, which creates some frustration for the people who know that the Mexican economy could be growing more and that it could be way more competitive than it is today.”

The relative political stability implied by the reform process is countered by what Bravo calls “a very complicated public safety situation”.

During a downturn, such factors become more important than before and Ulysses de la Torre, director of Research at Distributed Capital Group, explains from his personal experience: “One of the biggest constraints foreigners find themselves accounting for much more than they planned is actually personal security—assaults, kidnapping threats and the like.”

To illustrate the point, two hand grenades were thrown into the crowds celebrating Mexican independence day in September, which was linked to competition between drug cartels. The government itself reported a rise in commercial kidnappings for ransom.

Despite such tangible evidence, De la Torre points out, “Mexicans really don’t like it when anyone refers to Mexico as ‘becoming the new Colombia.’ How much of an issue this becomes probably depends on where in the corporate hierarchy the foreigner in question sits and what sort of ‘investing’ one is getting

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involved in, whether it is the physical/hard asset sort involving infrastructure, buying a factory, etc or the financial sort involving buying Mexican stocks, bonds, etc.”

De la Torre points out that there are ripple effects. “From an investing standpoint, this may manifest for the hard asset investor in the precautions he or she will have to take when visiting the site of whatever asset is being invested in. For the financial investor, this may manifest in a price

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differential or risk premium on any instrument whose underlying exposure more directly faces the areas where personal safety is an issue.”

Despite the temporary uncertainty unleashed by the credit crisis in the US, whose effects are scarcely unique to Mexico, Bravo and others report a continuing level of interest in investment in the country, between oil, relative political stability, and above all location. He comments: “Corruption has been a problem in Mexico for

many years, and while it is a serious problem, it has not prevented investors from coming into the country. I think this will not change anytime soon, neither to reduce corruption, nor to impede greater inflows of foreign investment.”

If one assumes that the US will recover, then Mexico’s proximity, relative fiscal sobriety, low costs and free trade policies will keep foreign investment coming despite the constraints of vested interests in oil and telecoms.

THERE’S GOLD IN THEM THAR’ HILLS – if miners mind their manners! hile the nationalists parade about Mexican oil, they have, perhaps fortunately, overlooked the treasures of the Sierra Madre. Mexico is one of the world’s major gold producers and many foreign companies are operating there.

Colin Sutherland, chief executive officer (CEO) of Toronto-listed Nayarit Gold, lists Mexico’s comparative advantages as he extols the business climate in the country as “friendly to mining companies like us when we do development and exploration work on properties. Mexico, at federal and state level, recognises that mining is very expensive, it takes a lot of time and funding to develop your deposits and as you go along here you will be spending a lot of money in your local area, before producing an ounce of gold.”

However, it takes investment in the community as well. “From a community, environmental, political and social standpoint we are very active. The companies that do not do a good job on those four issues get into trouble. We recognise that it can be very invasive coming in, drilling, so we agree on infrastructure projects for local towns, sewage system, enhancing a bridge, schools, churches and so on to give them improved quality of life. Any problems are likely to be related to a lack of communications with the local community and government, or your hiring practices,” says Sutherland.

He had had experience in Mexico before so he knew. “The companies that do not do a good job on those issues are those that get into trouble. If you are lax in those areas it will create problems and so

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if you have experts helping you then it becomes easier.” Ethical corporate practice is critical, he suggests. “We are transparent, a publicly traded company. We report our revenues, 95% of our money is invested in Mexico and more is on the way as we expand.”

Sutherland explains that NAFTA makes US and Canadian investment in Mexico a special case.

“Unlike some other Latin American countries that have created significant challenges for Canadian and US companies to develop minerals, in Mexico there’s no left-wing move to create challenges and road blocks to mining. The rules are fair, they’ve promoted the mining community for some years, and they’re very progressive on their tax rates as well.”

Most of the capital for his operation was raised through Toronto’s TSX Venture Exchange—$10m last summer—since Canadian investors are mining-savvy.

“We have had some financing inside Mexico from some fairly wealthy individuals taking part, but we never approached the investment banks up till now, since there has been no need since the flow of capital into the mining sector has been very good since the bull run started in 2001, and it was just as easy going to Toronto or New York to raise money as Mexico City. In this environment, as we move to the next stage of development, we may need to look at other sources of financing. If there is an appetite in Latin America then we may go there.” In Mexico though, he will continue to dig for treasure, employing as many Mexicans as possible.

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Index Review INDEX REVIEW: WHEN WILL THE STALEMATE BREAK?

Indices seem to have reached a point of stability (albeit with heavy swings in either direction) as the FTSE 100 oscillates violently around the 4,200 level. Every time it looks set to slide, western central banks announce yet another stimulus package so up we go. Then, as we all put on our buying boots some dire piece of economic or corporate news slams us back down in to the mud. The resulting gyrations are beginning to hamper trading volume as it becomes ever more difficult to measure one day’s activity from the last. Simon Denham, managing director of spread betting firm Capital Spreads, gives us his personal view.

The turning point?

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HE CITY APPEARS to have reached a kind of stalemate with many units looking to cut costs but senior management anxious not to leave themselves short-handed if an upturn should materialise. There is a perception that redundancies are being delayed until February/March next year, firstly to avoid a period of bad PR close to Christmas and secondly to cling on a bit longer just in case. This could be a long and dismal winter across the London trading floors with slow dribbles of job losses rather than the headline-grabbing swathes of the last three months.

With huge government issuance likely to dominate the markets over the next few years there may be precious little spare liquidity for big deals and in any case the appetite from the banks to lend will be muted compared to their desire to get rid of the various state stakes built up in their businesses. These factors may conspire to make the outlook for M&A particularly grim and this will affect many areas of City deal making.

Many satellite industries have grown fat on the continued churn, from legal to accounting, and while there will be money to be made from the recession (administration and restructuring etc) this is much tougher and less rewarding than arranging deals

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between units in good health.

Most recessions require the failure of some iconic brand as a turning point for financial historians to identify as the spot where the economy began to turn and with GM and Chrysler struggling for survival it is tempting to speculate that the demise of one or both will be just such a moment. Unfortunately for the capitalists amongst us this is neither a new nor a likely scenario. There has been a huge surplus in auto supply for many years but (as with state airlines) no political appetite for any country to shut excess production. Too much national pride and status involved!

Better to continue with quasi state support in the hope that someone else will blink first.

To bite this particular bullet would be a major step even for a country which almost worships capitalism.

Funds which would be better spent on saving the walking wounded or on major infrastructure projects will almost certainly be diverted in a vain attempt to save a few hundred thousand jobs for another few years.

The expense will probably cost twice that number in failed companies with better prospects but a smaller voice and fewer political friends and in the cancellation of sorely required major projects.

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

So we will probably have to wait a little longer for that iconic failure (unless Lehman was just such a moment).

My last message on the equity markets, written at the end of October, indicated that after almost a year of pessimism I was willing to be tentatively optimistic, as the prospect of a year end bull rally seemed good. With the indices holding their own since the middle of that month a nice little bear trap would be just the thing to really get traders excited over the next quarter.

The markets like to say that they predict the turning point of the economy around a year prior to the actual event.

Many respected commentators are doing just that. I salute their bravery but I fear that the time is not here yet. Hope over the new president-elect will probably push a concerted move higher in the markets but printing money to solve a problem caused by too much of it in the first place does not seem to me to be a suitable or sensible solution.

With companies big and small just about clinging on, the expected increase in unemployment across the OECD nations will be viewed with dread.“If we are only just surviving now what will it be like in another 12 months after the impact on consumer consumption of mass redundancies?” is probably the mantra on many a board member’s lips.

Over-leveraged companies are still clinging on. There will be some major casualties yet. As ever, place your bets Ladies and Gentlemen!

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EXCHANGES ADAPT TO A MIFID WORLD

Photograph © Michael Currie/Dreamstime.com, supplied December 2008.

JOSTLING FOR MARKET SHARE In November 2007, the European Union shook up securities trading with the Markets in Financial Instruments Directive (MiFID). Newcomers have taken market share from the established exchanges, which have smartened up their act.

Even so, the main boards are not quaking in their boots. Why? Well the size of the overall cake has gotten much bigger. Additionally, they are comforted by the experience of the North American market, which exploded with new electronic communication networks (ECNs) venues as this century opened, but have now been left with only three principal contenders and those are now owned by exchanges. Might that same outcome be true in Europe over the longer term? Ruth Liley reviews the multilateral trading facilities (MTF) scene a year after the introduction of MiFID.

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HERE IS A new battleground in Europe. The arrival of pan-European exchanges called multilateral trading facilities (MTFs) on the trading landscape during 2008 is redrawing the trading map of Europe. BATS Trading launched the MTF BATS Europe on October 31st 2008, almost exactly one year on from the Markets in Financial Instruments Directive (MiFID), which came into force on November 1st 2007. The directive blew open the door to competition among exchange venues in Europe by dispensing with the concentration rule that trades should be conducted on a local exchange. Trading venues had to register with their local regulatory body either as a regulated market or as a multilateral trading facility (MTF) or in the case of internal crossing networks as a“systematic internaliser”. No fewer than 120 entities have applied for approval and are listed on the MTF database of the Committee of European Securities Regulators. They range from small dark pools with market share of less than 1%,

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to MTFs such as Chi-X which is regularly seeing market share of more than 10%.

A natural consequence, the first to feel the competition from MTFs were the incumbent exchanges. Shares in some stock exchanges lost 4% of their value on the day that Turquoise was first announced as a concept in November 2006. Moreover, incumbent exchanges at first glance have much to ponder. Financial markets research firm TABB Group estimates that the plethora of MTFs will win 21% market share over the next three years. Even so, senior consultant Miranda Mizen of TABB Group, co-author of a report on liquidity, trust and competition in the European equity market structure, thinks we should not underestimate them: “These exchanges also have the top 600 stocks in Europe and it is hard to take what belongs to someone else. They have revamped their pricing models and some have launched dark pools. They have a rich history of continuum and constant mutation.”

In response to the MTFs, the primary exchanges have widened their offering. The London Stock Exchange (LSE) has announced much faster turnaround of trades and now offers trade clearing services and Börse Berlin has almost completely rebranded. With the acquisition of Equiduct Systems, the 323-year-old German exchange describes itself as a “start-up” with its Equiduct Trading platform due to launch early in 2009. Equiduct Trading is not registered as an MTF but rather as a regulated market and joint Chief Executive Artur Fischer says that Börse Berlin, which is still a separate entity, has taken a brave step to set up the Equiduct model to address a public need: “We can see that the traditional model will not last in the medium to long term, so we wanted to prepare ourselves to exist for 323 years more.”

Equiduct’s offering includes a real-time consolidated tape, processing 140m quotes a day from seven exchanges: LSE, Xetra, Euronext, Chi-X, Turquoise, BATS Europe and Nasdaq OMX. Deutsche Börse is also used to competing for order flow; the federal system of government in Germany has led over the centuries to seven exchanges in the country.“We have always had to adapt,” says Michael Krogmann, head of section cash market development at Deutsche Börse. The exchange has been monitoring market share volumes for several years and to compete with MTFs’ lightning speed technology, will roll out an even faster version of its low latency technology in June 2009.

Krogmann stresses: “It is like comparing apples and oranges. The service we provide can’t compare to that of the MTFs. We offer the full range of services through to post trade services and even IPOs. Many MTFs outsource all their extras.” He believes that Deutsche Börse will keep market share.“Nobody knows what volumes are traded so we don’t know whether it is new volumes which are passing to the new MTFs or whether they are stealing share from the existing exchanges. We are analysing order flow and can’t see any negative impact and in fact we could even see an increase in trade as the buyside posts bids and offers on MTFs but have to hatch their plans on the regulated markets.”

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Richard Hills, head of electronic services of Société Générale, says: "The MTFs are selling themselves on the basis of lower cost and low latency technology, but in the end the main differentiating factor will be liquidity. Based on our experience of the 60 or so venues in the US, you can’t realistically be in all of them simultaneously. Photograph kindly supplied by Société Générale, December 2008.

Since launching in March 2007, well before MiFID, Chi-X Europe has steadily built substantial market share. “When we launched Chi-X was up to ten times faster and ten times cheaper than the closest incumbent exchange,” says Peter Randall, chief executive of Chi-X Europe. “We had an 17month first mover advantage and everyone else has had to define their offer in relation to us. But we are not complacent. We know that we have still got some way to go in terms of market share.”

In 2008, Chi-X doubled its turnover from quarter to quarter, going from €74bn in the first quarter to €132bn in the second and €246bn in the third. Meanwhile, Turquoise had launched with the support of nine major investment banks and within two weeks had 1,500 stocks available, actively trading 270 each day. By the end of its first month of trading, it had a turnover of €1.5bn, topping €2bn one day in October.

The second half of 2008 saw a ramping up of MTF launches, many based on the US model of ECNs but all seeking to differentiate themselves from each other as they jostle for market share. BATS Europe, based on its US platform counterpart, launched in October with ten UK FTSE 100 securities but quickly grew to include stock from all the top European indices. MTFs scheduled for launch in 2009 include Pipeline, based on its US model, which will trade blocks without fragmenting the order and Burgundy, which will specialise in Nordic equities and is backed by 11 Swedish financial institutions and a Danish firm. Turquoise meanwhile is differentiated through its visible order book

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Many are asking whether or not market share is so which interacts with dark orders to complete the trade. Not to be outdone, Chi-X has launched Sponsored Access, important when the cake seems to have grown. When Chiwhich allows the buyside to trade directly with them while X launched it took share from the LSE, but many believed still maintaining their normal brokerage channels, saving extra liquidity had been created. Roland Bellegarde, head of precious time.

European cash equity markets at NYSE Euronext, for one Exchanges themselves are launching their own MTFs, notes:“The bulk, but not all, of what MTFs are trading now among them NYSE Euronext which is creating Arca Europe, is new volumes. Since the pricing has become more again based on the US model to focus on high speed high competitive, they have attracted intra-day customers who frequency trading and SmartPool, a dark pool for large block do not usually trade on exchanges. There are more orders and which is a joint venture with JPMorgan, HSBC customers and more own-account handlers because the and BNP Paribas. The London Stock Exchange (LSE) will pricing system is low enough to make it worthwhile.”

Moreover, Randall admits that Chi-X Europe has drawn launch its own dark pool MTF, technically a dark pool aggregator, called Baikal, named after Lake Baikal (the out new liquidity: “A lot of incumbent exchanges were deepest lake in the world) in the second quarter of 2009. It sluggish in terms of innovation and pricing and technology. will have up to three technology partners replacing the Our participants have conducted research showing that by original Lehman Brothers participation. offering new competition it has attracted new liquidity to As the number of trading venues has increased, liquidity Europe, which we believe can only be good for the buy side has fragmented, bringing benefits to the statistical arbitrage and fund performance.” It is hard to assess volumes, as Duncan Higgins, client players through tighter relationship manager with spreads and to the brokers Turquoise, explains: “There who can afford to invest in are three concepts. You better technology. The have a new source of Fidessa Fragmentation The London Stock Exchange (LSE) will liquidity either through Index gives a daily analysis launch its own dark pool MTF, lower pricing or of how many venues an technically a dark pool aggregator, committed market making order must visit to be called Baikal in the second quarter of executed. So on one day in from shareholders; you see 2009. It will have up to three November, it showed more arbitrage share of trades in FTSE 100 opportunities because of technology partners replacing the stocks were split with the existence of multiple original Lehman Brothers participation.

London at 80%, Chi-X platforms; or there is client with 14%, Turquoise with order flow being sent 5%, BATS with 1% and straight to the MTFs that Nasdaq OMX with 0.05%. would otherwise have This fragmentation of liquidity has led to fragmentation gone to the exchanges. But how do you measure it? It is very of post-trade reporting, throwing up transparency as an difficult to separate these and analyse which works best.”

All the players in the new trading environment have issue for the buyside, an unintended consequence of MiFID, which put responsibility for best execution with the broker upped their technology game and incumbent exchanges and the buyside rather than the trading platform.“MiFID is have invested an estimated €229m to compete with the a child of the regulators, so they will have to make sure it is MTFs in developing faster technology to cope with larger managed properly,” says Peter Randall.“Having started the volumes and the demand for speed and increased data flow. best execution hare running, they need to keep it running The LSE is anticipating a huge rise in volumes in spite of the and make sure that people are using decent policies to fall-off at the end of 2008 and has invested in high speed ensure best execution. The buyside might not be getting data delivery mechanisms as well as responding to strong best prices, but without regulatory incentive to move, they demand for hosting firms’black boxes from within the LSE’s data centre to try to eliminate network latency from their might not change to another provider to get them.”

George Andreadis, head of Advanced Execution Services trades. From day one, NASDAQ OMX Europe was also (AES) Liquidity Strategy in Europe at Credit Suisse, says offering space to clients to“co-locate”their trading engines competition is good for the market:“It is good because it has physically next to NASDAQ’s servers to shave milliseconds created new liquidity as well as introducing new off trading time and BATS Trading claims a best speed of functionality to the exchange landscape. Ultimately the 200 microseconds or two milliseconds and trades 80% of all winners will be the platforms that have the best prices and orders at under 400 microseconds.

Andreadis thinks speed is vital:“If you are in a boxing ring volumes for the stocks they support. BATS as an ECN came to the party late in the States, but quickly swept up 10% of and you are five times slower at pulling a punch than your market share. So just because you aren’t first to the party opponent you are five times more likely to be hit before you doesn’t mean you are not going to be successful as a new have even pulled the first punch. If you are providing trading platform.” liquidity to the market it is very important in a fragmented

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market to be able to get in and out of positions very quickly. Likewise if you are smart order routing to a trading venue that you know is 10 times faster than another you will preference the faster venue when both show the same price point and volume.”

Brokers have also been investing heavily: an estimated €714m on market data and trading infrastructure during 2008 and this is expected to rise in the next two years as brokers maintain and update their software and hardware systems, particularly in smart order routers to seek out liquidity across all venues and to be able to capture the best price in a millisecond.

“Smart order routers are at the heart of differentiation,” says Richard Balarkas, CEO of Instinet, an execution-only house.“You can’t eyeball 25,000 prices a second and stand wondering about which MTF to connect to. You need connectivity to all the exchanges but you also need dynamic queue management to help you know how to split your orders and you need to chase invisible prices based on probability that the liquidity is there.

“Budgets were cut in 2008 and it will be difficult to invest in 2009 so we’ll see a different pecking order beginning to develop,” adds Balarkas. However, Richard Hills, head of electronic services of Société Générale, says:“The MTFs are selling themselves on the basis of lower cost and low latency technology, but in the end the main differentiating factor will be liquidity. Based on our experience of the 60 or so venues in the US, you can’t realistically be in all of them simultaneously. The brokers will create preferences in their smart routers to the venue where you are most likely to execute and this will drive out the winners and losers. The question is, will we follow the US model, or will we jump straight to the end game with a handful of successful MTFs creating competition without unreasonable fragmentation.”

Certainly the costs of trading have fallen sharply as MTFs compete. NASDAQ OMX gives a 25 basis points (bps) rebate for posting or making liquidity and charges 25 bps for taking liquidity, meaning trading will be free for some.

Additionally, they cut their prices for onward routing orders to the LSE, so that it became cheaper to trade on the LSE via NASDAQ OMX than directly. BATS and Turquoise also employ the maker-taker model, and prices are coming down as competition bites. Data is being offered free by the top four and other special pricing models have emerged.

Although TABB Group does not expect to see significant consolidation for three years, there are signs that collaboration at least has started to occur. BATS, NASDAQ OMX and others have set up forum to discuss efficiencies, including the adoption of common stock symbols, to enable smart order routers to read orders more easily. In the area of price formation, some MTFs are collaborating to produce a consolidated tape to encourage price formation on MTFs as well as primary exchanges, where most prices are currently formed.

In an increasingly global market, US platforms are being used to launch their European version MTFs. Bellegarde

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Duncan Higgins, client relationship manager with Turquoise, explains: “There are three concepts.You have a new source of liquidity either through lower pricing or committed market making from shareholders; you see more arbitrage opportunities because of the existence of multiple platforms; or there is client order flow being sent straight to the MTFs that would otherwise have gone to the exchanges. But how do you measure it? It is very difficult to separate each effect.” Photograph kindly supplied by Turquoise, December 2008.

points out: “From next year NYSE Euronext clients will be able to trade European and US shares with a single connection, whether through our regulated markets or Arca Europe. MiFID says anyone can create an MTF, so there is a real opening for globalisation of the market.”

So what of 2009? Many expect a tough year with business levels low, with the trend continuing through most of 2010 and possibly beyond. Higgins believes that just having a great product will guarantee success:“Our members want a sustainable business model and the four things that will determine who wins among the MTFs are pricing, technology, having a different model and liquidity.” Others may not be as lucky. As the magazine went to press, rumours are running through the market that an existing MTF is already up for sale. Even while more entrepreneurs will chance their arm on a continuing uptick of liquidity across the continent over the medium to long term: not all MTFs will survive. The experience of the US market must give some houses pause for thought.

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A driving force behind the changing clearing landscape has been the financial crisis and the aftermath of the collapse of Lehman Brothers. Counterparty risk suddenly became a hot topic as the spotlight fell on how the clearers were going to handle exposures. Wayne Eagle, director of equities for LCH.Clearnet, says: “The development of the clearing industry has been born out of incumbents slow to react in terms of the new MTFs. However, the seismic shift in the markets in September and October and the continuing turmoil has focused investors’ attention on safety and security. I think looking ahead we will see a flight to quality.” Photograph © Vladimirdreams/Dreamstime.com, supplied December 2008.

New Engines of Change New trading regulations in Europe have led to a plethora of choice in clearing and execution but consolidation is already under way and some say only the strong will survive, Lynn Strongin Dodds reports.

HROUGH 2008 THE focus in the clearing and settlement arena was on three areas: the European Commission’s Code of Conduct; interoperability and the European Central Bank’s Target 2 Securities (T2S) initiative. While these considerations have motored through changes in the European clearing and settlement infrastructure, it has been the launch of multilateral trading facilities (MTFs) launched under the EU’s Markets in Financial Instruments Directive (MiFID) that has ignited a fire under the clearing community. MTFs have not only fragmented liquidity across Europe’s trading venues, but also they have resulted in more choice for traders and investors in clearing and settlement.

The fledgling execution venues have sought a nontraditional and broader response to the clearing and settlement equation. Instead of turning to tried and tested providers, MTFs have made their own arrangements. As Philippe Robeyns, head of clearing services at Société Générale Securities Services (SGSS), notes:“The main difference [is that]

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new platforms such as Turquoise and Chi-X are pan-European and [are] looking for clearing facilities that could offer this type of service for blue chips stocks across 14 European markets.

They did not want to use purely local players.”

Right now, Europe’s clearing landscape is dominated by six players: Deutsche Börse’s Eurex Clearing, London Stock Exchange’s Italian clearer CC&G, SWX Group’s SIS x-clear and EMCF, owned by Fortis, the Belgo-French bank which is now majority owned by the Dutch government, together with NASDAQ OMX (which has a 22% stake).

EMCF in turn has a 5% stake in NASDAQ Clearing Corporation (NCC), a clearing and settlement system for US cash equities that the exchange plans to launch in 2009.

The remaining providers are the US Depository Trust & Clearing Corporation’s (DTCC’s) European arm, EuroCCP and LCH.Clearnet, which are about to merge.

Up to now, the main beneficiaries of the new business emanating from the MTFs have been EuroCCP and EMCF. There were concerns, through the autumn of 2008 that the financial problems wreaking havoc at Fortis would affect confidence in EMCF. Those concerns, however, have been allayed by a €16.8bn government bailout. As one market participant says: “There were many hearts in mouths over Fortis. MTFs were worried about what would happen to their business if EMCF collapsed.”

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ahead we will see a flight to quality.”

Hugh Cumberland, strategic business development manager at BT Global Services, says: “There has been a great deal of discussion on the interoperability piece but I have always had my doubts.

The collapse of Lehman proves that. LCH.Clearnet dealt more than competently with the open trades and the position fallout caused by the demise of Lehman. I am not convinced multiple systems would have fared as well. As for the MTFs, the explosion of new trading platforms has definitely encouraged home grown responses but I am not sure this is a long term solution from a risk mitigation and cost reduction perspective.”

Alan Cameron, head of clearing, settlement and custody client solutions at BNP Paribas, adds: “We have certainly seen the knock-on effect that the fragmentation of liquidity has had in the clearing space. In the short term, there will be a plethora of solutions but in the long term, there will be a Darwinian selection of the fittest. This will lead to consolidation among trading venues as well as clearers and we are already seeing evidence of that with the merger between LCH.Clearnet and EuroCCP.” Some market participants believe that it will be the creation of this behemoth transatlantic clearing house and not interoperability that will be the ultimate driver behind reducing clearing costs. The objective is to create a userowned, user-governed model, with LCH.Clearnet moving to an at-cost based structure comparable to DTCC’s within three years. The terms involve DTCC, the largest US clearer, acquiring all of the shares in LCH.Clearnet, Europe’s largest independent clearing house. In turn, LCH.Clearnet shareholders would receive up to €10 a share, which gives the European group an equity value of €739m. Euroclear, currently the largest shareholder in LCH.Clearnet with a 15.8% holding, intends to support the transaction in principle and remain a shareholder of LCH.Clearnet HoldCo. It is anticipated that the proposed merger will yield significant cost savings deriving from technology synergies, enhanced economies of scale, integrated and efficient collateral management and other operational efficiencies.

Initial estimates undertaken by both clearing houses reveal that the merger should generate synergies worth between 7% and 8% of the combined group’s operating costs.

Negotiations are still under way and detailed terms are

Frank Reiss, director and head of equity product at Euroclear, says: “We have definitely seen an increase in transaction flows due to the introduction of MTFs. The strategy we are pursuing is to have an open architecture model in order to serve clients that chose to trade via an MTF. We are not sure who the winners will be among the MTFs or CCPs, but there definitely will be further consolidation. As for settlement, there are different solutions but it is equally difficult to predict if there will be an ultimate solution.” Photograph kindly supplied by Euroclear, December 2008.

EMCF currently clears for Chi-X Europe, NASDAQ OMX Europe and BATS Trading Europe while EuroCCP has Turquoise under its remit as well as NYSE Euronext’s European trading offering; which is set to make its debut in early 2009.

The MTFs are also forcing the hand of interoperability under the Code of Conduct, which requires that market infrastructures offer reciprocal open access. Progress has been slow because of national regulatory barriers and a fear among some exchange-owned clearers that they could lose clearing revenue. More than 80 requests for “interoperability” are outstanding between various clearers and exchanges with their own clearing operations, but few have moved to final agreement and implementation.

Chi-X recently announced its plan to extend its clearing operations beyond EMCF while NYSE Euronext also intends to allow EuroCCP’s rivals to join the party in 2009.

In addition, the LSE agreed to let SIS x-clear to create a link with its long-time central counterparty (CCP), LCH.Clearnet, allowing customers to clear trades through either. LSE will use X-TRM, the post-trade router of Italian securities depository Monte Titoli, (a subsidiary of Borsa Italiana, which LSE acquired last year) to manage the trade flows between the clearers.

The other driving force behind the changing clearing landscape has been the financial crisis and the aftermath of the collapse of Lehman Brothers. Counterparty risk suddenly became a hot topic as the spotlight fell on how the clearers were going to handle exposures. Wayne Eagle, director of equities for LCH.Clearnet, says: “The development of the clearing industry has been born out of incumbents slow to react in terms of the new MTFs. However, the seismic shift in the markets in September and October and the continuing turmoil has focused investors’ attention on safety and security. I think looking

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expected to be announced by March 15th 2009. Diana Chan, chief executive officer of EuroCCP, also notes that the two together would offer market participants a more cost effective and independent option.“If you look at the way the market has developed, with the introduction of MTFs, we are back in some cases to the vertical model that trading firms wanted to get away from in the first place. For example, one MTF has openly invested in the CCP it has chosen, and there may well be other CCPs which are offering trading venues economic benefits in an attempt to get them to use their services,” she says. “In the EuroCCP model, which is usergoverned and at-cost, 100% of the economic benefits are passed to the users. There is no misalignment of interest. The merger will further reduce the costs. In the vertical, partvertical or hidden-vertical structures, the business model is one in which the trading venues Philippe Robeyns, head of clearing services at Société Générale Securities Services (SGSS). The fledgling use clearing as an additional execution venues have sought a non-traditional and broader response to the clearing and settlement source of profits,”she adds. equation. Instead of turning to tried and tested providers, MTFs have made their own arrangements. As EuroCCP entered the market Robeyns notes: “The main difference [is that] new platforms such as Turquoise and Chi-X are panwith the intention of being the European and [are] looking for clearing facilities that could offer this type of service for blue chips stocks lowest cost provider to both across 14 European markets. They did not want to use purely local players.” Photograph kindly supplied exchanges and MTFs, and

by Société Générale Securities Services, December 2008. according to a study it conducted in July 2008 it has achieved that goal. It charges combined platform will be able to leverage off the economies an average of just 2.9 euro cents per transaction, with a of scale from the US market infrastructure. In general, maximum charge of 6 euro cents compared to its though, I do not believe that there will only be one platform competitors’ average charge of 26 euro cents. Based on in Europe. I envision two dominant players—the combined EuroCCP’s calculations, CCG had the second-lowest price entity and Eurex, and possibly a few smaller players but it tag (9 eurocents a side) while Eurex Clearing’s was the depends on how they can compete with the lower pricing.” highest, ranging from 32 eurocents in Ireland to 55 As for settlement, market participants are waiting to see eurocents in Germany. LCH.Clearnet charged an average how the different initiatives, namely T2S, Euroclear’s single 19 euro cents for LSE trades and 23 euro cents for the platform and Deutsche Börse’s Clearstream’s Link-Up NYSE Euronext markets. The report estimated that SIS x- projects, pan out. T2S aims to set up a single settlement clear charges an average 20 eurocents, while EMCF, which engine that would become the platform to which the euro zone’s 17 central securities depositories (CSD) would also touts its cost-effectiveness, was at 14 eurocents.

By contrast, in the US, where, all securities clearing is outsource settlement of securities trades. The European handled by DTCC, the cost is just about 0.33 eurocents per Central Bank has said that T2S, which could create a single transaction. Paul Bodart, executive vice president at BNY euro zone settlement hub beginning in 2013, could save Mellon Asset Servicing, says “We think the merger between banks as much as €207m a year in back-office costs. It DTCC and LCH.Clearnet is a positive step in the right hopes to have all EU countries signed up by the first direction although it should have happened six years ago. I quarter of next year but there are doubts in the marketplace think it will reduce the cost of clearing even further as the as to whether this will happen.

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Euroclear’s project hopes to create a unified securities processing system and depository across its five markets (the UK, Ireland, France, the Netherlands and Belgium) as well as the Finnish Suomen Arvopaperikeskus Oy (APK) and Swedish VPC central securities depositaries.

Clearstream’s Link-Up, on the other hand, is a joint venture between seven CSDs (including Greece’s Hellenic Exchanges, Spain’s Iberclear, Austria’s Österreichische Kontrollbank, Switzerland’s SIS SegaInterSettle, Denmark’s VP Securities Services and Norway’s VPS).

Right now, the market plays to incumbents; for many reasons. One is the complexity of trading behaviour.

Different CCPs may have different buy in rules, for instance, which could have an impact on the ways that clearing member firms manage the settlement of trades. Equally, because trades executed on a regulated exchange and trades executed in the same securities on an MTF will result in two separate settlement instructions (one for each CCP), initially there does not seem much scope for settlement cost savings from the use of new CCPs. Moreover, as MTFs typically settle on an over the counter (OTC) platform, a settlement instruction originating from an MTF might even be disadvantaged as some CSDs have different platforms for the settlement of on-exchange and OTC trades.

Other issues are infrastructure based. Incumbent CCPs,

such as LCH Clearnet, for example, have settlement arrangements already in place for trades in currencies that are not normally eligible for settlement in the local CSD. Settlement of these trades are invariably done in an international CSD (such as Euroclear Bank); but these are arrangements that are not yet fully in place across all MTFs or their new CCPs. All this may change however as Euroclear and others work on developing generic, nettingmodel and neutral interfaces for multiple CCPs to CSD and international CSD data flows.

Robeyns of SGSS points out however that any progress will be gradual. “There will be consolidation but it will be slower because settlement is a more difficult area to deal with. Even with Target 2 you are dealing with different tax systems, regulations and cultures. It tends to be stickier and more complex to harmonise.” Frank Reiss, director and head of equity product at Euroclear, says: “We have definitely seen an increase in transaction flows due to the introduction of MTFs. The strategy we are pursuing is to have an open architecture model in order to serve clients that chose to trade via an MTF. We are not sure who the winners will be among the MTFs or CCPs, but there definitely will be further consolidation. As for settlement, there are different solutions but it is equally difficult to predict if there will be an ultimate solution.“

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THE NEW ARC OF BUSINESS

TRANSITION MANAGEMENT: THE NEXT PHASE

After the seismic shifts in the global markets through 2007 and 2008, who should have been surprised by the equally powerful changes running through transition management? Back in heady days of 2005/2006, transition managers sat prettily on a rising volume of business and a blossoming profile in the asset management industry. There was much to look forward to: a substantive movement away from direct benefit (DB) towards direct contribution (DC) pension schemes; the onset of a muscular and seemingly farreaching trend away from passive towards active and high growth asset investment styles; the explosion of funds of funds and the materialisation of a raft of alternative investments in mainstream asset management. Photograph supplied by istockphoto.com, December 2008.

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Transition management has been buffeted by fair winds and foul through the last two years. Not all transition management houses have stayed the course; but those that are still in the business have benefited from rising volumes and report a positive outlook for 2009. Historically, transition management was used almost exclusively for the movement of equity portfolios, but nowadays the complexity of asset movements vary widely and include fixed income and more occasionally foreign exchange, derivatives and private equity. The complexion of the business changed substantially through 2008 and will continue to evolve over the coming year as transition managers increasingly focus on mitigating opportunity cost, market impact and other trading and investment risks. What now in 2009? Francesca Carnevale reports.

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HE NEWS THAT Citi shut its transition management (TM) businesses in Europe and the US came in a 2008 year-end shocker for both asset managers and rival transition management teams. The industry was rocked in the immediate pre-Christmas run up by the announcement, as Citi was among the longest serving investment banking providers of transition management services and its TM team consistently ranked in the top five transition client surveys. The bank’s Asia-Pacific transition management operations, run under Michael JackettSimpson will however remain open for business.

The closure of Citi’s US and European TM operations ended extensive discussions (carried on through late November and December) over proposals to restructure the business model. Various options were reportedly considered, including relocating the teams into the bank’s Global Transaction Services (GTS) operations (essentially custody) or move it directly into the bank’s trading floor (which, as every follower of modern day post-T Charter transition management knows is something of a no-go).

Some of the nine jobs at risk over the announcement however might be saved by this latter proposal.

Citi’s decision comes after the bank announced substantive cuts in overall headcount within its global capital markets business, where employee numbers are reckoned to be reducing by up to 20% across the board.

Even so, the decision was something of a surprise as Citi’s transition management business was understood to be profitable as a business unit, with a high revenues to cost ratio throughout 2008. No one in Citi’s TM team have been available for comment.

Citi’s loss could be another financial institution’s gain if the team is swept up en masse, with a bulky client portfolio in their pocket. Equally possible is that the team will be cherry picked for their particular expertise by any one of the extant TM businesses that are now enjoying the fruits of a highly concentrated market. However, transition managers say privately that they expect market consolidation to continue through 2009 and that the number of transition managers who actively pursue transition mandates will continue to drop over the next two years, especially among investment bank providers.“Given the current cost-cutting environment, along with the transition business’s relatively slim margins,”says one transition manager,“I expect one or two houses to make either a soft exit from the business, or be swallowed up in a larger bank merger.”

Citi’s move is interesting nonetheless and perhaps indicative of the sometimes ambivalent relationship between equity trading and transition management in investment banking operations. The often arcane nature of the portfolio transition process, which is highly methodical, thoughtful and project based, often escapes the day to day concerns of trading operations. Moreover, while responsible for a sizeable chunk of trading flow through trading desks, transition management teams operate at a substantial distance from cash equities and portfolio trading. Although most of the time the relationship

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John Minderides, global head of transition management, JPMorgan.

Minderides is adamant however that the expertise of transition managers is not in alpha generation,“but in minimising the risks and cost of the transition and in finding necessary liquidity”. While implementation shortfall remains the most cited headline risk and the main measure of the success of transitions, some of the greatest risks in a portfolio transition continue to be “market impact and opportunity cost,” he says. Even so, Minderides concedes that transition managers have evolved into trusted advisers for pension funds as market circumstances have changed. Photograph kindly supplied by JPMorgan, December 2008.

between in-house TM teams and the trading desks is optimal; at crunch times when headcount against revenue and trading flow is calculated, the benefits of sometimes fee-based business over flow-based (commission) revenue can be overlooked. It is particularly pertinent at a time when the relationship between transition management and portfolio trading has rarely been closer.

Nomura, for instance, was quick to pick up on the possibilities offered by a shrinking TM provider landscape when it bought the European trading operations of Lehman Brothers in the autumn of last year. The transition management team at Nomura is already understood to have a number of transitions under its belt in its new guise and will officially open for business in the early months of 2009. Other houses, such as JPMorgan’s TM business, have been leveraging the body count elsewhere. JPMorgan now counts Jody Windmiller (ex UBS and Bear Stearns) among its 26 strong global transition team and is continuing to expand headcount as more business gravitates towards key houses.“We took advantage of the Bear Stearns acquisition to restructure our team,” notes John Minderides, global head of transition management at JPMorgan.“We have had a net/net increase of five people, slightly against the trend, and we have brought Mike Gardner to London from the US to add strength in Europe.”he adds.

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After the seismic shifts in the global markets through 2007 and 2008, who should have been surprised by the equally powerful changes running through transition management? Back in heady days of 2005/2006, transition managers sat prettily on a rising volume of business and a blossoming profile in the asset management industry.

There was much to look forward to: a substantive movement away from direct benefit (DB) towards direct contribution (DC) pension schemes; the onset of a muscular and seemingly far-reaching trend away from passive towards active and high growth asset investment styles; the explosion of funds of funds and the materialisation of a raft of alternative investments in mainstream asset management.

Transition management looked set for a golden era. So much so, that it felt able to pull itself up by its bootstraps and connect in an extensive debate on the merits of the business practices of a by then overly bulky transition management service sector. The resulting T-Charter set a benchmark from which both asset owners and transition managers could engage in meaningful and measurable debate and from which emerged a set of governing principles that are now undergoing further revision and upgrading. In its current iteration, the T-Charter is chaired

by Inalytics chief executive, Rick Di Mascio, who is leading a specialist working group (comprising transition managers and consultants as well as representation from the National Association of Pension Funds [NAPF]) which is honing the charter into a substantive mechanism for pension funds to help them identify key issues when transitioning assets, including actuarial evaluation assessments; asset and liabilities study evaluation and the hiring and firing of managers.

Now though, and rather like its charter, transition management itself is changing. There are fewer TM providers for one thing. At its peak four years ago beneficial owners had to choose from more than 29 headline providers of the service. Today some 17 transition management operations are listed on the Inalytics site (though as mentioned earlier, the European and US operations of Citi are now closed). Credit Suisse, another mainstay of transition management, restructured its operations, losing a few members of its London-based team headed by Graham Dixon, and restructuring all operations on global lines through its New York-based US team, guided by Hari Achuthan and Lance Vegna.

Second, there is a something of a fault line developing between the US and Europe in the scope, if not the practice of transition management. The US walks to the tune of a different beat where there is a different relationship between transition managers, which are regarded as fiduciaries, and trustees. Moreover, in the US, the evolution of trading and risk management technology has shifted the primary focus of transition management from operations to risk management, with the preservation of the value of a client’s assets the most important aspect of the transition.

In last year’s report by the Boston based TABB Group on

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Mark Dwyer, vice president UK sales, Mellon Transition Management, transitions involving non-governmental bonds sometimes forced transition managers to hold assets longer than usual. As Dwyer notes,“you can spend a long time looking for a competitive price for a particular bond,” however, he adds, a lot of the issue is “price discovery. Photograph kindly supplied by Mellon Transition Management, December 2008.

The Optimal Transition: Mitigating Risk and Minimising Market Impact the introduction of new trading technologies, such as dark pools and crossing systems, were held to have helped minimise the execution risks associated with information leakage and opportunity cost.

In addition, the report cited the agency-only brokerage model as being“on the cutting edge of trading technology,” because of the need to be efficient at finding liquidity.

In the event, this was fine as far as it went with equity transitions and the US marketplace. In Europe, the heart of the matter lay elsewhere as fewer transitions were equity only. Over the last two years fixed income has become an escalating feature in portfolio transitions in Europe.“Fixed Income has accounted for around 50% of transition business in 2008,” notes Lachlan French, head of TM at Barclays Global Investors (BGI). Moreover, alternative assets, such as hedge fund strategies and occasionally private equity have also featured with multiple asset class transitions increasingly the norm,“with some of the larger transitions involving multi-managers. We’ve restructured a broad range of strategies including active to passive equity and bonds, corporate bonds, two way flow in index linked bonds, government bonds, sovereign wealth funds and emerging market debt,”explains French.

This growing level of complexity is set against particular market challenges, of which“Liquidity is the key challenge in this environment,” notes Hari Achuthan, global head of transition management at Credit Suisse. In fixed income, for example, credit spreads have been healthy and

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increased significantly compared with 2007, he notes with demand continuing high in 2008.

The market in asset backed and mortgage papers in particular stagnated, turning them into virtually untradeable assets. That means says Mark Dwyer, vice president UK sales, Mellon Transition Management, transitions involving non-governmental bonds sometimes forced transition managers to hold assets longer than usual. As Dwyer notes,“you can spend a long time looking for a competitive price for a particular bond,” however, he adds, a lot of the issue is “price discovery. The recorded value you have for an asset is not necessarily the same as a price traded in the market; while this may be an opportunity for a buyer, it might also be a problem for the seller. Our job is to secure maximum value.”

The rise of fixed income transitions does have an impact on who can deliver the best TM process and that means: “those houses with a strong fixed income capability who are also a strong counterparty,” says Achuthan. The ability to tap into fixed income trading expertise or fixed income asset management expertise is key. Moreover, the growing complexity of some of the larger transition mandates sometimes require transition managers, “to integrate their approach with asset management skills,” adds Mellon’s Dwyer. That plays to the strength of houses such as BGI, BlackRock (for Merrill Lynch) or Standish (in the case of Mellon). Key to success in any transition, especially complex transitions, Achuthan adds is “the specialist expertise and experience he can provide in physicals and derivatives, dedicated resources and true multi-asset class capability”.

JPMorgan’s Minderides is adamant however that the expertise of transition managers is not in alpha generation, “but in minimising the risks and cost of the transition and in finding necessary liquidity”. While minimising “market impact and opportunity cost” (implementation shortfall) remains the main measure of the success of transitions, some of the greatest risks in a portfolio transition continue to be market and exposure risks, the tracking errors between legacy and target portfolios and the corresponding delays in implementation, he says. Even so, Minderides concedes that transition managers have evolved into trusted advisers for pension funds as market circumstances have changed.

Going forward, the picture is not yet clear, though Credit Suisse’s Achuthan thinks there will be something of a rebound in equities by the end of the first quarter this year, “or at least the beginning of the second quarter, though everyone is waiting for the markets to stabilise,” he concedes. JPMorgan’s Minderides believes that “when volatility reduces, then funds will likely need to buy equities to rebalance to their benchmarks,”though he notes that the workings of benchmarks may need to be revisited after the current crisis is over. “Either there may be a demand for new indices or for the methodology of some existing indices to be revisited: current approaches to rebalancing exposures and weightings in markets that have

Lachlan French, head of TM at Barclays Global Investors (BGI).

“We’ve restructured a broad range of strategies including active to passive equity and bonds, corporate bonds, two way flow in index linked bonds, government bonds, sovereign wealth funds and emerging market debt,” explains French. Photograph kindly supplied by Barclays Global Investors, December 2008.

moved dramatically can result in large increases in exposures to particular issues, which may not be desired from a specific risk perspective.”

According to BGI’s French, “The value of fixed income has increased as a percentage of the average fund. In general, I think we find people are moving back to basics and moving away from the more complex and opaque investment structures. We are also seeing funds taking advantage of investment anomalies as they occur, for example we have recently seen buyers of index linked gilts which are currently yielding more than index linked inflation swaps despite the superior credit risk. Will this increased weighting towards fixed income change? Will deficit schemes go into equities or bonds? These are the long term questions that need answers; but few are forthcoming. We will have to let the dust settle before the way forward in terms of asset allocation becomes clear.”

In terms of transition management itself, some things will remain constant for the foreseeable future. Outside of Australia and New Zealand, which remain competitive markets, Asia remains a new frontier; though with fewer houses providing transitions, Europe, the US and the Middle East remain fertile grounds. “RFPs remain important,” says Mellon’s Dwyer, though as Dwyer and BGI’s French note, some clients are by-passing the RFP altogether as repeat business and relationships come to the fore. As Dwyer observes:“there is the beginning of a flight to quality in transition management, and well-established houses with multi-asset capability will be the ones to benefit from this trend.”

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AFTER THE FLOOD: THE BANKING CHALLENGE Some banks take the world by storm. Others fail and yet others take a slow, steady and sometimes circuitous route to greatness. This section features a cross section of the bold and the cautious; innovators and those institutions which have honed traditional skills to a new level. It is not meant to be comprehensive. It is written more in a spirit of hope; to highlight in these gloomy days that an end to the current financial crisis will come; the global financial markets will rebuild and here are at least some institutions that could reap the whirlwind when it arrives, even if todayâ&#x20AC;&#x2122;s challenges seem insurmountable.

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HILE QUESTIONS STILL circle over the efficacy of government and central bank policy measures to combat global recession and re-boot the capital markets, the global banking sector remains firmly in defensive mode. Even so, while fears of deflation become more real by the day and G8 currencies look increasingly over-valued, the role of banks in returning the world to some kind of normalcy is increasingly important.

The story of the financial meltdown is well documented and will not be revisited at length here. Exacerbated by a seemingly endless process of asset price deflation and deleveraging in the financial system, the financial crisis has now evolved way beyond the housing market. Large loan write-offs are the order of the day shrinking bank capital, the lifeblood of lending, along the way. Banks have been selling

W

GLOBAL BANKING LEADERS: MEETING THE CRISIS HEAD ON

Jiang Jianqing, chairman of the Industrial and Commercial Bank of China (ICBC), participates on a panel on financial reform at the 2008 Boao Forum for Asia in Boao, Hainan Province, China in an archive photo taken on April 12th 2008. The Boao Forum is a non-government, nonprofit international organization modeled after Davos. Photograph by Nelson Ching for Bloomberg News /Landov, supplied by PA Photos, December 2008.

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assets and cutting back on lending to help heal damaged balance sheets. How much damage that process in turn that has inflicted on the productive global economy will become increasingly apparent through the first half of 2009.

To date, total banking sector write offs among G7 banks are reckoned to be north of $600bn, though new capital injections are thought to be much lower than that (at around $450bn). As the recession deepens bank loan losses must invariably rise (taking us all into perhaps unthinkable territory). The IMF reckons that eventual loan losses in the global banking system will top $1.4trn; and an important question to address is whether the banking sector as a whole and G7 governments can absorb write offs of this magnitude and whether more banks will disappear (even perhaps one or two mentioned here).

The same late October 2008 IMF World Economic Outlook posits that a gradual recovery is likely in late 2009 based on the stabilisation of commodity prices, the assumption that the US housing market will hit rock bottom during the year thereby ending its intense drag on US growth and, “notwithstanding cooling of their momentum emerging economies are still expected to provide a source of resilience, benefiting from strong productivity growth and improved policy frameworks.”However, it acknowledges that the longer the financial crisis lasts, the more likely it is that emerging markets will be affected. Certainly, in the United Kingdom, the likelihood is that the crisis will stretch on for a protracted period, as already there are rumours that the £36bn already injected into the system through 2008 will not be sufficient. UK banking analysts expect local banks to continue rationing capital and liquidity until the recession troughs or until the Brown government intervenes either to guarantee borrowers or by providing cheap bank funding against new loans (as has been suggested by the Crosby report). Multiply those same dynamics over the G8, G15 or even G18 countries and you have some measure of the barriers that financial institutions (lenders or investors) face over the coming year in returning to health and positive bottom lines.

Against this background the reality is that some banks will be more resilient than others to the emerging new world order in the financial markets. The banks highlighted in this particular segment have not been immune to the vagaries of the market. In fact, all of them have been through the mill in more ways than one. The selection rests on a number of factors: in the case of Nomura and JPMorgan, it is that ability to shake a fist at fate and roll the dice with brio. In the case of BNP Paribas, and Banco Santander, it is the ability to roll with the punches and still come out smelling of roses: backed by a steady and considered accretion strategy that evolves their global footprint. In the case of HSBC and The Bank of NewYork Mellon, it is a recognition of their glowing expertise in their selected fields, while in the case of ICBC it is squarely about the opportunities it (and others like it) will be able to leverage in the new world order of the second decade of this century.

Some commentators have posited that the global

Nomura Holdings President & CEO Kenichi Watanabe photographed during a press conference in Tokyo, Japan, in late November 2008. The head of Nomura Holdings Inc., Japan's biggest brokerage, told journalists that while the immediate liquidity crisis may be receding, global leaders must now find ways to bolster their faltering economies. Watanabe praised financial authorities from major countries who met in Washington earlier in the month for cooperating amid the turmoil and helping restore liquidity flows. Photograph by Shizuo Kambayashi for Associated Press. Supplied by PA Photos, December 2008.

banking system is in the last throes of vomiting up toxic risk exposure and that 2009 should witness a gradual settling down; others point to growing concerns about the ability of banks in the G8 countries to retain their market positions.

Whatever the ultimate outcome of the current crisis at least bank on the fact that things will never quite be the same. If that sentiment causes doubt: remember Lehman Brothers. Remember too, the immediate repercussions of the decision by Deutsche Bank, Europe’s biggest investment bank by revenue, to pass over an opportunity to redeem €1bn (about $1.4bn) of subordinated bonds, saying it would be more expensive to refinance the debt. The bank had the option to buy back the 3.875% notes on January 16 or pay a so-called step-up coupon of 88 basis points more than Euribor, Frankfurt-based Deutsche Bank said in a statement. The cost of protecting the bank’s debt from default jumped and its shares dropped more than 7% on the day of the announcement.

The decision shook note holders as issuers are expected to repay callable notes at the first opportunity and notes are valued on that basis. As well, where Deutsche Bank has led, others might follow (thereby redrawing the configurations of the interbank lending market). A psychological barrier has been breached for sure, with possible downside effects on prices, particularly if the exercise is repeated. However, let’s not overstate the case. On sustained consideration move is eminently sensible. The bank was battered by losses of €1.26bn from trades made for its own account in the third quarter of 2008, and continues to face soaring borrowing costs; in part because of its results, in part because investors continue to appear to shun all but the safest government debt. By accepting the step-up and not calling the bonds it will pay annual interest of some 4% compared with as much as 7% if it tried to raise new debt (thereby the right move in anyone’s book).

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Nomura’s gamble Fortune favours the brave, goes the old chestnut and few have been braver this year than Nomura Holdings. What do you do if your business is losing money and your home market is shrinking fast? If you are Nomura’s president and chief executive officer (CEO) Kenichi Watanabe you put the remaining pot behind an acquisition, refocus your firm on an overseas strategy and redraw your client profile in the process.

The past year has been something of a curate’s egg for Nomura; in other words, generally awful but actually good in parts. With Watanabe in place since only April last year, the markets wondered whether 2008 was the year that Nomura retook its crown among the pantheon of global brokerages.

After all, the Nomura Holdings had been the brains and the finance behind new and successful multi-lateral trading venue Chi-X and broker dealer Instinet and claimed some historical branding rights (extending as far back as pre-Big Bang days in the 1980s. Even so, despite the innovation and the bravura that Nomura has exhibited of late, it has also endured a year of high highs and painful lows.

On the surface Nomura appeared to be on the upswing for most of last year. When Lehman Brothers Holdings Inc. collapsed, the bank pounced, snapping up Lehman’s operations in Asia, Europe and the Middle East for a measly $2bn in what Watanabe described at the time as a“once-ina-generation”opportunity. It later added three of Lehman’s subsidiaries in India. Having snaffled up Lehman’s much vaunted trading operations, will the acquisition really herald a new dawn for the Japanese bank?

The market is divided; in part, because Nomura remains a hostage to fortune. Much of its success depends largely on factors outside the company’s control, at least in the short term. Moreover, Nomura’s financial acumen has been hammered in three consecutive quarters through 2008 due to deteriorating market conditions, trading losses and real estate write-downs, thereby putting the company’s overseas acquisitions strategy under sharp scrutiny. Most recently, the firm reported a net loss of Yen72.9bn ($754.5m) for the July-September 2008 period, which undershot the consensus analysts forecast by a country mile. Ratings agency Standard & Poor’s (S&P) was quick off the block, highlighting the level of residual doubt over the efficacy of the bank’s overall strategy, downgrading its credit rating outlook on Nomura Holdings and unit Nomura Securities Co. to its lowest“negative”level.

Even so, it has to be acknowledged that Watanabe and his management team took a bold but necessary step in moving its focus outside of its home market. Japan has been a quasi-comatose market for decades and shows few signs of bursting through the current market storm. Watanabe also needed a substantive response to Mitsubishi UFJ Financial Group’s investment in Morgan Stanley (for which it paid $9bn for a 21% stake) and which also recently finalised the purchase of UnionBanCal Corporation.

The group has much to play for. In December 2008 Nomura Holdings announced its new management structure

Alfredo Saenz, chief executive officer of Banco Santander Central Hispano SA, gestures during a press conference in Madrid, Spain in an archive photo, dated April 2008. Banco Santander SA is Spain's biggest bank, Photograph by Santi Burgos for Bloomberg News /Landov, supplied by PA Photos in December 2008.

for its global wholesale business in preparation for the opportunities and challenges ahead. It is a move that also effectively brings to an end the transition process following its acquisition of parts of Lehman Brothers, Watanabe, says the new management structure is “aimed at further driving the build up of our international franchise. We have now completed the transition process and are moving into the integration phase. We are bringing together the best aspects of both firms to create a new business model focused on our clients.” While Nomura’s main equities clients are pension and mutual funds, he noted, Lehman’s customers were mainly hedge funds. The Lehman takeover also diversified the Japanese company’s overseas fixed income business and added considerable weight to its European mergers and acquisitions operations. If Watanabe’s calculations are spot on, then Nomura will emerge from 2009 with much to celebrate and an extended client franchise, which will rebrand it as a serious global player once more.

Notwithstanding these elements, the integration and retention of 8,000 ex-Lehman workers poses a rather big test of Watanabe’s mantra of change. Rivals including JPMorgan, Credit Suisse, Barclays Capital and UBS have landed some high-profile Lehman departures, raising questions about Nomura’s ability to keep top talent. The company is quick to point out that more than 95% of exLehman employees have accepted employment with Nomura, and Watanabe downplayed suggestions of any friction.“It’s not about trying to keep the old Nomura or the Lehman culture,”he said.“We want to transform ourselves to become the new Nomura.”Watch this space.

ICBC: the emerging powerhouse Winner of The Banker’s“Bank of theYear in Asia”for the first time, the Industrial and Commercial Bank of China Limited (ICBC) has enjoyed a banner year. A popular contender among banking analysts as a bank that is clearly lifting itself out from a domestic to a clearly international player, the ICBC cemented its growing popularity by announcing steady growth and profits for more than six consecutive quarters, no mean feat in these times of mean liquidity and pressure on profits. The bank came into its own in 2006, when it comfortably raised $21.9bn on its October debut on the Hong Kong Stock Exchange. It was a significant turnaround from its days in the late 1990s when

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it was refinanced by the Chinese central bank and cleansed, together with China’s other top three lenders of more than $27bn of non performing loans (G8 banks take note). To its credit, once cleansed and revitalised, it then went on to swoop on new fee income and regularly managed to raise quarterly revenues by a regular 35% by between 2000 and 2006; helped also by widening interest rate margins on its own lending. With its shares rising in value by more than 60% in the year following its market debut, ICBC overtook Citibank as the world’s largest bank by market capitalisation; a crown it is unlikely now to relinquish any time soon. Its shareholders have agreed to substantive investments in the bank’s infrastructure and the upgrading of its banking network at home and abroad, as well as new investment in staff training and customer satisfaction surveys. ICBC is the nation’s largest lender in terms of assets and branch network, but complaints over weak customer service has made it a target of increasing public criticism in its home market: to which it has attended of late with alacrity; refocusing customer facing staff and reducing waiting times.

Like those much vaunted sovereign funds which carry substantive political clout, ICBC, rather like Citigroup before it, carries substantial political capital in its wake.

Until now, the global banking market has not been impacted too greatly by the growing power of ICBC; and the current crisis may temper its reach for some months to come. However, the once mighty power of Citigroup helped define the globalisation of investment and commercial banking expertise and in recent years, set down an important marker in the provision of asset services. Whether ICBC yet understands what its future role will be, is not yet fathomable, but its eventual impact is unavoidable.

JPMorgan: good luck or fine judgement?

In spite of continuing write-downs JPMorgan made substantive gains through 2008, positioning itself well to ride the rough winds of the coming years. While the overall profit outlook for the bank remains soft (analysts at Citigroup and Fox-Pitt Kelton noted at year end that their fourth-quarter estimates have been cut to reflect the recent company outlook of higher-than-expected loan loss reserve additions, likely write downs as well as private equity losses), the bank made impressive gains across its corporate finance, investment banking and asset servicing businesses. The bank, however (which bought Seattlebased thrift Washington Mutual’s banking units in September) is still highly exposed to consumer credit, a fact which analysts continue to highlight vociferously as they downcast its short term equity price outlook. Even so, those same analysts concede that the bank will continue to outperform for those investors wanting exposure in financials. The reasons are obvious: the upside from the ultra-cheap purchases of Bear Stearns and Washington Mutual and the bank’s ability to leverage its global franchise across a raft of capital markets, investment

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Stephen Green, chairman of HSBC, speaks at a CBI conference in central London, on November 24th 2008. Photograph by Chris Ratcliffe for Bloomberg News /Landov, supplied by PA Photos, December 2008.

banking and asset servicing products.

JPMorgan clearly showed in 2008 that outside of a massive uptick in consumer risk exposure, it also had other fish to fry. In terms of mergers and acquisitions, JPMorgan did the unthinkable, and together with UBS, toppled Goldman Sachs and Morgan Stanley from their historic perches at the top of the global mergers and acquisitions league tables. While Goldman Sachs managed to retain its lead in the US by volume of deals, JPMorgan topped it in terms of deal values. Moreover, Goldman Sachs was roundly replaced by JPMorgan at the top of the global value tables (sourced by UK based specialist research firm Mergermarket), while UBS proved to be the most active firm. Even so, JPMorgan managed a more than respectable third placing in the global deal ranking, with 260 deals completed last year. No surprise then that the bank secured more top ratings than any other administrator, according to the Global Custodian 2008 Private Equity Fund Administration Survey. The firm was rated “excellent” and “top notch” for the second year in a row by private equity fund managers. “JPMorgan has somehow managed to improve on the already astonishingly high scores of a year ago. In every service area, the averages are either excellent or as close as makes no difference,”the magazine said.

Aside from its corporate banking services and asset service provision, the bank recently unveiled a global investment plan (worth $1bn) to strengthen its cash management and treasury liquidity capabilities, as well as investing further in technology and expansion of its global footprint in this regard. Like BNP Paribas (below) JPMorgan has made significant contributions in commercial banking through up to and through 2008; strengths upon which both banks will build new business as the markets go full circle and return to traditional trade financing, pure project financing and ECA-backed credits.

Additionally, both will be bolstered by recent investments in supply chain, logistical advisory services provision and risk mitigation solutions. More than many other banks, JPMorgan’s rigorous internal processes will help bring credit and risk management back into full focus over the coming years.

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BNP Paribas: market focus France’s banking powerhouse BNP Paribas has never been afraid of reinvention and 2008 caps another year of change, customer focus and accretion. Baudouin Prot, BNP Paribas’ chief executive officer noted in December last year that:‘“BNP Paribas’robust business model has a track record of delivering strong and diversified earning streams from all its business lines. This is thanks to its excellent client franchises and the quality of its teams. While obviously not immune to the financial crisis, BNP Paribas’ stringent risk policy culture and good cost control during these difficult times have positioned it well to continue growing organically over the cycle.”

With the recent acquisition of Fortis, BNP Paribas is the number one bank in Europe by deposits and significantly strengthens its capital position. The last few years have seen the bank expand its footprint globally and across retail, investment banking and asset servicing, the bank looks likely to continue this expansion relatively unhindered over the coming decade. One of the few banks to utilise the French State’s scheme on entrepreneurial, rather than distressed terms, BNP Paribas intends to utilise a recent $2.55bn debt issue (entirely bought by SPPE, a company created by the French State for this purpose) to fund its organic growth strategy.

Like JPMorgan (above), BNP Paribas has strength in depth; an element that will increasingly come into play as the global wholesale and commercial banking approaches go ‘back to basics’. It has spent the last eighteen months undergoing a major overhaul of its major business line; revamping its wealth management brand and service offering, and expanded its asset servicing and post trade service offering to take account of substantive changes in the European trading and settlement landscape post the introduction of the Markets in Financial Instruments Directive (MiFID). The bank has also refocused its global footprint in the retail space (of its 6,000 branches globally, more than 4,000 are outside France), overhauling the management team and rolling out new client service initiatives in this segment.

The acquisition of Fortis in 2008 cemented the bank’s position in its natural European hinterland, while at the same time, the bank has carefully prepared its emergence as a truly global player. In spite of the difficulties of last year, BNP Paribas’ innnovation in key service areas (and in asset servicing in particular) has prepared it well to weather further changes and an eventual uptick in the global financial markets.

HSBC: intellectual capital While HSBC continues to go from strength to strength across the spectrum of banking services, we have decided to highlight the bank’s quiet contribution to intellectual capital and market change. While the markets have been in convulsion over the provision of financing to high credit risk sectors, HSBC got on with the establishment of a new $5bn global working capital fund for small and mediumsized businesses (SMEs) to ensure that they continue to

have access to appropriate credit through the current financial and economic crisis.

The fund represents new money, over and above what HSBC would normally expect to lend in the current business environment, and will be funded from HSBC’s own resources. That can-do approach, and the capital strength with which to provide it has been the mainstay of the bank’s local and global success.

Continuing in the intellectual theme, the bank is one of only five institutions to sign a new code, titled The Climate Principles, which is the first comprehensive industry framework for the sector’s response to climate change.

Other early adopters include Crédit Agricole, Munich Re, Standard Chartered, and Swiss Re. The principles guide operational greenhouse gas (GHG) emission reduction commitments, but also provide strategic direction across the full range of financial products and services including research, asset management, retail banking, corporate banking, insurance and re-insurance, investment banking and project finance. It is intended to align with, and build on, existing initiatives to ensure a consistent and effective approach to addressing climate change. The bank is following this up with key initiatives in carbon trading, new carbon indices as well as developing a range of environmentally aware investment initiatives.

The bank continues to set the pace in emerging market financing and development, adding to its already impressive array of global banking operations, having opened new offices in Central Asia, Algeria, Vietnam and a host of other frontier markets. It continues to be well positioned in key emerging markets, increasing its share in Korea Exchange Bank and opened a range of sophisticated banking services in Poland through 2008. The bank’s Daily Quant report, remains the most comprehensive indicator of global trading activity in emerging markets.

Bank of New York Mellon: asset service kings With a specialist focus on asset service provision, The Bank of New York Mellon has extended its service range, in the post merger period. From initiatives in the provision of specialist fund administration services to Islamic funds, through enhancements to its over-the-counter (OTC) derivatives services which enable the bank to deliver daily, automated OTC position reconciliation and market value reconciliation with counterparties, to the closure of the process of absorbing the remaining elements JPMorgan’s trust business in 2008, the bank has continued to extend its product range on a steady basis.

The bank’s natural strength in custody and specialist fund administration was highlighted by the fact that it has been able to grow alternative assets under administration by more than 77% over the past three years and a half years, as well as the global expansion of its fund administration team in Europe, Asia and the Americas. In addition to hedge fund administration the company offers a wide range of accounting, cash management, collateral management, custody, corporate

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trust, asset management and wealth management services to the hedge fund industry.

The bank’s strength in the depositary receipt area has come under pressure of late, due to market conditions and growing competition from Deutsche Bank, JPMorgan and Citi; however the bank has shown flexibility and resilience and exhibited its ability to respond to opportunities thrown up by the current market crisis, including its participation in the FDIC’s Temporary Liquidity Guarantee Program, which provides 100% insurance coverage for domestic non-interest-bearing transaction accounts. The FDIC first announced the expanded deposit insurance program in mid-October, and eligible institutions were automatically enrolled during an introductory period through early December. The company also is participating in another provision of the program that provides for the guarantee of newly issued senior unsecured debt of eligible financial institutions. Funded through insurance premiums on newly issued debt.

In similar vein, the bank has always had an ability to spot an upcoming trend at fifty paces and its investment in Eagle Investment Systems, now looks prescient as demand for data management solutions, and issuer and risk exposure reporting is skyrocketing, as recent market volatility that has left many institutional investors scrambling to quantify their true exposure to distressed investments.

The bank’s ability to innovate has never been in doubt, the question is whether it can keep pace with the staggering changes ahead in asset servicing over the coming decade and growing competition from Asian houses anxious to establish their own global footprint.

Banco Santander: the retail king It has been a period of sustained accretive growth for Spanish banking giant Banco Santander. While its main stomping ground continued to be continental Europe, where its main commercial units include the Santander and Banesto networks in Spain, Santander Totta in Portugal and Santander Consumer Finance, and Abbey in the United Kingdom; the group’s key expertise has also been in the now fashionable markets of Latin America. Here Santander is the biggest financial franchise in the subcontinent and holds a substantial market share in the key economies of Brazil, Mexico and Chile. Most recently it has expanded its international footprint through the acquisition Banco Real in Brazil, of the retail specialists Alliance and Leicester and more latterly Bradford and Bingley in the UK through Abbey and then in October 2008 it secured Sovereign Bancorp in the United States; giving it a triple crown in terms of market share in retail and the commercial sectors and all at knockdown prices. Juan Inciarte, executive board member of Banco Santander, noted last October that the acquisition “represents an excellent opportunity ... We know Sovereign very well. It is a strong commercial banking franchise in one of the most prosperous and productive regions of the United States, with high growth potential, which will further diversify

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The Bank of New York president, Gerald L. Hassellin, left, and chairman, Robert P. Kelly, speak at a news conference in Pittsburgh, Pennsylvania in an archive photo dated November 2006. Photograph by Andrew Rush for Associated Press, supplied by PA Photos, December 2008.

Banco Santander’s geographical reach.” It was a bold move for a European bank; as its peers have tended to find the United States something of a commercial graveyard, requiring long term investment, patience and a willingness to adapt to the country’s particular ways.

Santander is notable for doing what it does best (retail and commercial banking) well. Billionaire Emilio Botín has now fulfilled his lifelong ambition: to transform a small regional bank once run by his grandfather into an international player.

Already the largest bank in Latin America by assets, the bank came to prominence after its $15bn purchase of Britain’s Abbey National in 2004, bring the bank into the world’s top ten banking institutions by market capitalisation. Most recently the bank is noted for maintaining capital integrity.

Following its November 2008 €2.7bn rights issue, Botín noted, “Banco Santander has always had a very clear approach to capital strength. That is why, although we are starting from a very strong position – our core capital ratio at September 30th was 6.31% - the Group has raised its goal to 7%, in response to our higher expectations in the current economic environment.” Banco Santander had a series of asset sales underway which would have served to raise its capital, but in view of market conditions decided to postpone those divestments until prices have recovered to acceptable levels. The likelihood is however, that Santander’s inexorable expansion will continue for some time, as it establishes itself as a benchmark in the retail financing sector.

What next is a key question for this bank. Like all the one’s highlighted, the coming decade will throw up increased competition from a new set of players which may redraw business lines. Certainly the new batch of newcomers have capital strength with which to play in a straightened field. Interesting times ahead for all then.

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While the savaging of the major market indices has kept many players frozen in their tracks, Kathleen Cuocolo, managing director of US fund and ETF services for The Bank of New York Mellon, nevertheless sees a return to the kind of dynamics that have been driving the market all along. That is, investment managers assessing which responsibilities they need to keep in house, and which can be outsourced.“I think that will continue—with the issue for all administrators going forward being the level of assets on which fees are paid, governing all types of services,” says Cuocolo. Photograph © Sebastian Kaulitski/Dreamstime.com, supplied December 2008.

THE HEART OF THE MATTER

While putting added pressure on fees, the recent market contraction has at the same time hastened the flight to quality. Well-established, highly diversified administrators who are capable of providing the full range of asset servicing needs, from performance calculation to trade processing and more, will likely weather the seismic shifts better than most. Dave Simons reports from Boston.

HE UNPREDICTABLE AND erratic investment climate—which in turn has increased demands for transparency and the need for accounting and reporting independence—continues to work to the advantage of the industry’s leading fund administrators. Though licking their wounds from a brutal fall while adjusting to life without big leveraging, hedge funds remain the heart and soul of the administration business. With budgets being trimmed and competition on the rise, alternatives will continue to offload non-core activities in order to make room for the business of generating alpha, depositing even more business at the door of well-placed service providers “We anticipate that, in an analogy to the hedge fund industry, the administration space will experience further ‘barbelling,’[sic]” says Isabel Schauerte, analyst with Bostonbased research group Celent and coauthor of the recent report Trends in Hedge Fund Administration 2008. “The ongoing institutionalisation of hedge funds will ultimately lead to a

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two-tiered market, with large multi-service administrators on the one hand and niche players left to service startups and independent boutiques on the other,”she notes.

While the savaging of the major market indices has kept many players frozen in their tracks, Kathleen Cuocolo, managing director of US fund and ETF services for The Bank of New York Mellon, nevertheless sees a return to the kind of dynamics that have been driving the market all along. That is, investment managers assessing which responsibilities they need to keep in house, and which can be outsourced. “I think that will continue—with the issue for all administrators going forward being the level of assets on which fees are paid, governing all types of services,”says Cuocolo.

Despite the ongoing spate of redemptions, hedge funds continue to build out their infrastructure with an eye toward the future, says Marina Lewin, managing director, alternative investment services for Bank of New York

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Marina Lewin, managing director, alternative investment services for The Bank of New York Mellon.“It is true that there has been real retrenchment within the fund business, and yet from our point of view, the industry will still move forward, particularly as toxic debt is absorbed,” she says. Lewin sees hedge funds continuing to operate with a lean infrastructure, affording considerable back- and middle-office outsourcing opportunities for administrators.“More and more, these funds are asking their service providers to get involved in performance calculation, trade processing and trade flow, liquidity and so forth.

That’s where we’ve seen the greatest emphasis,” she adds. Photograph kindly supplied by The Bank of New York Mellon, December 2008.

Mellon. “It is true that there has been real retrenchment within the fund business, and yet from our point of view, the industry will still move forward, particularly as toxic debt is absorbed.” Lewin sees hedge funds continuing to operate with a lean infrastructure, affording considerable back- and middle-office outsourcing opportunities for administrators. “More and more, these funds are asking their service providers to get involved in performance calculation, trade processing and trade flow, liquidity and so forth. That’s where we’ve seen the greatest emphasis.”

While putting added pressure on fees, the market contraction has at the same time hastened the flight to quality, says Lewin. Diversified administrators who can also provide custodial support are much better suited to weathering seismic shifts within the market.“Many of our current customers have legitimate concerns about counterparty risk, and are looking for a safe haven. As a financial institution that can offer custodial, short-term money management as well as corporate-trust services, in addition to administration services, we feel we are in a very good position, particularly as the industry finishes its retrenchment and begins to gradually recover.”

Peter Cherecwich, head of global product and strategy for Northern Trust’s asset servicing business, agrees that

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administrators with custodial ties have a competitive advantage in this type of environment.“Custodians have the flexibility to shift clients in and out of strategies with much greater ease, he says, adding:“If your entire infrastructure is only geared towards alternative classes, you may not be able to adapt as quickly.”

Though the momentum has slowed for the time being, Cherecwich believes that alternative classes will not be down for long. “We’ve seen anywhere from 30% to 50% growth in the derivatives market over the past few years, and that has obviously flattened out. In the meantime, there has been this great push towards risk management and, along with that, better administrative tools to help measure that risk. Which, in turn, compels us to go to provide our clients with the kind of tools and information that can help them better understand what they’re getting into.”

The overriding factor, says Lewin, is the constant need for reporting independence, and those who haven’t yet outsourced will likely get on board over the near term.“In order to keep their institutional investors satisfied, managers are looking to go to the highest-quality type of financial institution for their administrative needs— whether it is an accounting division looking for independent price verification, or providing institutional investors the security of knowing that their portfolio is being carefully monitored. All of these things will work as a benefit to the stronger administrators.”

Tech Still Tops A report issued by Celent calls for a decrease in technology spending among investment managers throughout 2009.

As a result, managers will likely continue to outsource IT in an effort to keep pace while lowering costs, says Alan Greene, executive vice president and head of US Investment Servicing for State Street Corporation. “The weakening economy will lead managers to trim this portion of their budgets at a time when implementing new functions could be more necessary than ever. This highlights the benefit in shifting the expense obligation and responsibility for technological enhancements to a third-party provider.”

It is difficult to envisage any administrator maintaining a competitive offering in the fund services industry without investing in the kind of software that can meet the increased demand for transparency, argues Richard Harland, business development manager for Mourant International Finance Administration. “Mourant continues to invest in market leading software solutions across our global office network and our systems enable bespoke solutions to client needs and serve as powerful reporting tools,”he says.

Servicing alternative fund structures, the impetus behind last year’s acquisition of Bisys, remains a core competency for Citi, says Andrew Smith, head of the bank’s North America funds and securities services.

Robust investments in technology that allow alternative managers to access data in real-time and meet clients’ need for transparency and performance evaluation

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Richard Harland, business development manager for Mourant International Finance Administration.“Mourant continues to invest in market leading software solutions across our global office network and our systems enable bespoke solutions to client needs and serve as powerful reporting tools,” he says. Photograph kindly supplied by Mourant International Finance, December 2008.

Andrew Smith, head of North America funds and securities services.

Robust investments in technology that allow alternative managers to access data in real-time and meet clients’ need for transparency and performance evaluation reporting is key to this effort.“To the extent that the systems, products and processes can be leveraged across all of our business lines, we certainly welcome these synergies where they make sense,” he says. Photograph kindly supplied by Citi, December 2008.

reporting is key to this effort. “To the extent that the systems, products and processes can be leveraged across all of our business lines, we certainly welcome these synergies where they make sense,”he adds.

Nor does Smith rule out the opportunity to make strategic acquisitions where applicable. “The ability to innovate and stay ahead of the next wave of alternative investment managers drives the desire to acquire another service provider. If you have time and money to reinvest in these businesses you will win your fair share of mandates.

If you lack technology or expertise and you want to be a leading servicer of alternative funds, it becomes a necessity to buy functionality and technology.”

A hallmark of any bona fide administrator is the ability to adapt to radically changing market conditions, and having the proper tools on board makes the job that much easier, thinks Lewin.“Our approach has been to build out native technology systems that can allow us to work through the many kinds of investment structures, from fund-of-funds to private equity to hedge funds, with all the various hybrids in between,”she says. Commitments to technology are more vital now than ever before, concurs Seán Páircéir, managing director, Brown Brothers Harriman (BBH), in Dublin. “BBH will continue to invest to support the sophisticated business needs of our clients as part of our core strategy. We are committed to enhancing our competencies with innovative technology solutions like virtual pooling which meet and anticipate our clients’ development,”says Páircéir.

Rather than actively seeking bolt-on providers, however, BBH, in keeping with its established business model, prefers a more organic approach technological growth.“We can tailor our ability to service sophisticated asset managers by bringing ever more specialised pricing

capabilities from the market,”says Páircéir,“participating in automation initiatives in the OTC marketplace, and attracting product expertise in specialist areas like real estate fund servicing.”

Pension pinching Poor returns and bad press have put a dent in the once impenetrable veneer of the hedge-fund industry since the crisis began. While some continue to forecast tough times for alternative strategies as mainstream investors rush to the sidelines, observers like Lewin remain optimistic. “We firmly believe that absolute and alternative strategies will continue to be an integral part of the investment portfolio in the long run.”

One group that is likely to stay put are large public pension funds, which have come to depend on the extra octane provided by alternative classes in order to help cover potential liability gaps.“Pension plans [such as] MassPRIM or CalPERS are looking at liabilities that run 40 years out in actuaries, if not longer,”says Smith.“Clearly, finding alpha is their main objective.” Which in turn points to more asset classes, more complexity, and more customised reporting.

“While the traditional asset manager might be focused on a ‘back-to-basics’strategy, the alternative manager, by nature, is driven to find value even in the worst of markets.”

Accordingly, Smith says that Citi has not made any changes to its core strategy based on current market conditions.“We continue to reinvest in these businesses and develop new products and services, and we are working with a wide variety of independent pricing sources to help with security valuations, particularly as hedge funds seek returns from esoteric asset classes and securities.”

Despite the current and seemingly perpetual havoc on Wall Street, Richard Harland, business development manager for Mourant International Finance Administration, says that

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individual investors have not been completely deterred. On the contrary, many may well be considering a shift in their own investment allocation into alternatives. “Equities are phenomenally volatile and a large number of investors are seeking a longer term yield, including the kind of returns which are offered through alternative investments such as a closed-ended structure, as well as investments in private equity or real estate,” says Harland. “We are seeing a great deal of activity and there is a feeling that investing in the current climate could prove the next few years to be vintage.”

Turning up the heat In the United States, a new administration and a more powerful Democratic congressional majority point to an even greater emphasis on transparency and regulatory oversight. Meanwhile, the universal crackdown on short selling is evidence that governments everywhere are just as willing to tighten the screws. “In September alone there were at least 15 regulatory changes dictated from the Securities and Exchange Commission (SEC), the Federal Reserve Board (FRB), the Commodity Futures Trading Commission (CFTC) and from the Financial Accounting Standards Board (FASB),”notes State Street’s Greene. Many of these changes require adaptation and implementation within weeks of their announcement, he adds. “Changes in regulation will drive up the cost of compliance, requiring continued investment in order to keep pace.” This once again points to the value of outsourcing in order to achieve the goal of lowering costs while implementing new standards, says Greene.

Mourant’s Harland agrees that the recent economic turbulence has led to increased pressure for the regulation of certain financial markets. “A key requirement of the administrator is to maintain granular data of the fund or funds which it administers, which is managed by informed client-relationship teams with a broad knowledge of financial reporting standards as well as regulatory and investor requirements. We believe this enables us to respond to the changing reporting requirements of investors, clients and regulators.”

For instance, in the United Kingdom the guidelines for transparency outlined in last year’s Walker Report serve as an example of how the reporting environment is changing.

“We have seen a number of clients, from start-ups to blue chip firms, acknowledging and taking steps towards adopting the Walker guidelines,” says Harland.“Our teams are well placed to provide clients with guidance on how to implement the various aspects of the report.”

Given the current regulatory environment, BBH’s Páircéir is hopeful that forthcoming policy procedures are moderate and can be easily leveraged. “Daily NAV production and underlying delivery of portfolio information to investors, transparency of information to stakeholders in investment vehicles, and directors’ oversight and responsibility all lead to an already significant volume of reporting. We support the current level of necessary oversight measures, but see no real need for an increase in this burden.”

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Peter Cherecwich, head of global product and strategy for Northern Trust’s asset servicing business, thinks that administrators with custodial ties have a competitive advantage in this type of environment.

“Custodians have the flexibility to shift clients in and out of strategies with much greater ease, he says, adding: “If your entire infrastructure is only geared towards alternative classes, you may not be able to adapt as quickly.” Photograph kindly supplied by Northern Trust, December 2008.

Seán Páircéir, managing director, Brown Brothers Harriman (BBH), in Dublin.“BBH will continue to invest to support the sophisticated business needs of our clients as part of our core strategy. We are committed to enhancing our competencies with innovative technology solutions like virtual pooling which meet and anticipate our clients’ development.” Photograph kindly supplied by Brown Brothers Harriman, December 2008.

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ASIAN CUSTODY: U HELPING CLIENTS ADJUST

The financial crisis has provided a challenging time for Asian asset service providers. Institutional investors are more concerned now about counterparty risk and certain asset classes as well as the fund managers they are using. As a result, there has not been that much new business and providers are helping clients adjust to market conditions. Lynn Strongin Dodds reports.

NTIL RECENTLY, THERE was a view that Asia would remain on the periphery of the financial crisis rocking Western economies. As time went on, those expectations proved unfounded. Global custodians, though, have not lost heart and are prepared to wait it out based on the region’s long-term growth prospects. The larger, better capitalised firms are also hoping to be the beneficiaries of a flight to quality to providers who have strong balance sheets and high investment grade ratings.

For now, all the major global custodians such as HSBC, Standard Chartered, BNY Mellon, BNP Paribas, Société Générale Securities Services and Northern Trust, are staying the course. The short-term forecasts may be gloomy but they are all banking on the bigger picture which places the Asia Pacific region as one of the longterm drivers of worldwide growth. One reason is that economists expect that emerging markets in the Asian region will be more resilient than their Western counterparts and will recover much faster. This is because the de-leveraging purge will not be as great in general in emerging markets. Photograph © Dawn Hudson/Dreamstime.com, supplied December 2008.

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Over the past couple of years, global custodians have business, adds: “While proving resilient at first, the trends either bolstered their existing operations or forged a new now seen within the Asia funds management industry path in the Asia Pacific region in order to capitalise on the mirror those that have been apparent in the US and Europe. business opportunities. Growth has been fuelled by the Investors have substantially reduced their appetite for creation of new sovereign wealth funds, a burgeoning local leveraged and complex investment products.”

Chong Jin Leow, head of Asia, BNY Mellon Asset investment community as well as the outsourcing of global equity and fixed income mandates to foreign asset Servicing, also points out: “There has definitely been a managers by large public pension schemes in countries slowdown in fund launches. The larger organisations such as Taiwan and Korea. whether it be sovereign wealth funds, pension funds or In addition, asset securities service firms intend to cater to insurance companies are also increasing their focus on the growing Asian cross-border fund market taking shape performance and risk reporting as well as investment under the Undertakings for Collective Investment in guidelines reporting. In the past, fund managers would Transferable Securities (UCITS) banner. Different have provided such services but now they are asking regulations and tax structures, not to mention the absence independent providers to do it.”

Institutional investors are also seeking refuge in plain of a regional body such as the European Union, had made it difficult to create a common framework for funds across vanilla, risk adverse assets. Pow notes:“Fund managers will the multiple Asian take a hard look at their jurisdictions. However, business models in light of fund centres in Dublin and these market events and Luxembourg have been will start assessing what Alastair Pow, Singapore based global sort of product mix to focus busy developing UCITS head of fund services for Standard on in the future. We have products for both Chartered’s securities services business, seen a flight to low fee fund European as well as Asian classes such as cash or investors. adds: “While proving resilient at first, the ETFs (exchange traded When the sub prime trends now seen within the Asia funds funds) and an outflow of crisis began in the summer management industry mirror those that what are regarded to be 2007, many market have been apparent in the US and riskier, higher fee fund participants predicted that Europe. Investors have substantially classes such as hedge the region would be funds. This does not mean somewhat insulated due reduced their appetite for leveraged and an end to alternative to its strong liquidity complex investment products.” strategies. Far from it. For position, its relatively example, I think old-school well protected banking private equity funds industry and distance from the US epicentre. However, the bankruptcy of Lehman managing distressed assets will do well in this type of followed by the near death experiences of some of the environment.” world’s most venerable institutions—the most recent being Fund management groups are also looking at safe havens the $300bn US government bailout of Citigroup—shook all in terms of where to outsource their custody, fund accounting and back office functions. Marcel Weicker, head global investors to the core.

Lawrence Au, Hong Kong based senior vice president of location, Singapore for BNP Paribas Securities, says: and the North Asia business executive and head of asset “There is no doubt that everything seems to be on standby servicing for Northern Trust, says: “Obviously everything and new business had dried up. Investors are staying away changed since September after Lehman went into from anything with the slightest hint of risk. They are also bankruptcy. Prior to then, the Asia Pacific region was not looking to do business with highly rated companies. Our that much impacted and custodians and fund double A rating is a major asset and goes a long way in administrators were adding new resources and people. retaining and attracting business.”

However, when the problems began, there was a realisation Tony Lewis, head of global custody for HSBC Securities that markets were a lot more intertwined and had not Services in Hong Kong, adds: “We are seeing a move to decoupled as people had thought. Since then, it has been a providers who can demonstrate strong risk management challenging time for asset service providers. Institutional and control environments as well as strong balance sheets. investors are more concerned now about counterparty risk, Clients want to ensure that the providers they are doing certain asset classes as well as the fund managers they are business with will continue to deliver and invest in these using. As a result, there has not been that much new products and services. They are also looking for a one-stopbusiness although we are still busy helping clients adjust to shop where clients can get access to a range of securities current market conditions.” and capital markets products from a single provider. We Alastair Pow, Singapore based global head of fund have this advantage as clients are able to leverage our services for Standard Chartered’s securities services universal banking capabilities.”

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Lawrence Au, Hong Kong based senior vice president and the North Asia business executive and head of asset servicing for Northern Trust, says: “Obviously everything changed since September after Lehman went into bankruptcy. Prior to then, the Asia Pacific region was not that much impacted and custodians and fund administrators were adding new resources and people. However, when the problems began, there was a realisation that markets were a lot more intertwined and had not decoupled as people had thought.” Photograph kindly supplied

by Northern Trust, December 2008.

Chong Jin Leow, head of Asia, BNY Mellon Asset Servicing, also points out: “There has definitely been a slowdown in fund launches.

The larger organisations whether it be sovereign wealth funds, pension funds or insurance companies are also increasing their focus on performance and risk reporting as well as investment guidelines reporting. In the past, fund managers would have provided such services but now they are asking independent providers to do it.”

Photograph kindly supplied by BNY Mellon Asset Servicing, December 2008.

For now, all the major global custodians such as HSBC, Standard Chartered, BNY Mellon, BNP Paribas, Société Générale Securities Services and Northern Trust, are staying the course. The short-term forecasts may be gloomy but they are all banking on the bigger picture which places the Asia Pacific region as one of the long-term drivers of worldwide growth. One reason is that economists expect that emerging markets in the Asian region will be more resilient than their Western counterparts and will recover much faster. This is because the de-leveraging purge will not be as great in general in emerging markets.

This is particularly true in Asia, which had experienced its own banking crisis in 1998. They had learnt the lessons of the past and had adopted much more conservative and rigorous policies towards lending. As a result, with the exception of South Korea, eastern Asia’s central banks have substantial foreign currency reserves, limited leverage and low indebtedness.

The Asia Pacific region is also expected to register economic growth. Gross domestic product growth will be

slower but still relatively robust compared to the recessionary figures being churned out by the US, UK and Europe. For example, according to the latest crop of regional figures from the International Monetary Fund (IMF), China’s growth will slip to 9.7% for 2008 and 8.5% in 2009 from 11.9% in 2007 while India will churn out 7.8% and 6.3% respectively, down from 9.3%. Overall, the IMF forecasts 8.3% and 7.1% respective growth rates for developing Asia as a whole.

As for the funds industry, assets under management (AUM) will slip in 2008, but then should resume their upward curve. Data from financial research firm Cerulli reveals that mutual fund AUM in Asia excluding Japan could drop by nearly a fifth this year, but reach 2007’s record levels of $1.13trn by 2010 and $1.583trn by 2012. As for institutional funds, industry reports that Asian sovereign wealth funds manage around $1trn, or 29% of the assets held by global funds.

Chong Jin Leow of BNY Mellon says: “We are hopeful that things will start to pick up next year. I think we will see the insurance sector continue to develop, pension funds in

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general looking to invest overseas, and more interest in offshore funds in the Caymans, Dublin and Luxembourg.

We have strengthened our infrastructure in custody and put more people on the ground in Taipei, Shanghai and Seoul.

We will also be looking at putting more staff in Beijing once we get our branch licence. While products and services are important, relationships are key in Asia. Clients want people who speak their local language and are available to deal with their day to day issues.”

Weicker of BNP Paribas Securities agrees, adding: “It is crucial to establish a presence in Asia and develop personal relationships. It is not sufficient to meet someone once or twice but you need to spend time building trust. It is more about taking a medium to long term approach in order to win a client.”The French based bank is on course to roll out its global custody and clearing offering in the first quarter of 2009, targeting Singapore, Hong Kong, Taiwan and Japan.

“It is a question of following the sun in terms of providing our global clients including sovereign wealth funds, large corporations and financial institutions such as insurance companies with global custody and local clearing,”Weicker adds.

Its French rival Société Générale Securities Services is also hoping to extend its footprint through its recently approved joint venture with Mumbai-based State Bank of India (SBI). SBI will have a 65% stake in the company while SGSS will have 35%. The new custodial group, which is expected to be up and running by the first quarter of 2009, intends to offer a range of services, including safe-keeping and settlement, reporting, corporate actions, dividends collection and distribution, proxy voting, tax reclaim services, fund administration and securities lending.

Ramy Bourgi, head of emerging markets development for SGSS, notes, “The service will be geared towards institutions who want to invest in India as well as local institutions who are looking to invest locally and overseas.

The advantages of the joint venture are that it combines SBI’s domestic expertise with our global capabilities which together will enable us to provide a world class service.”

Northern Trust is also moving forward with its plans to roll out its global fund service platform across the region in 2009, according to Au.“In the past 18 months we have been actively building infrastructure and adding legal, audit, compliance, risk management and client facing resources across the Asia Pacific. Despite market conditions, we are continuing with plans to build our back office processing centre in Bangalore. This will help strengthen our global business continuity capabilities and it allows us to offer our clients in the Asia Pacific time zone a more timely service.”

In the meantime, Standard Chartered, which is one of the region’s three dominant providers of sub-custody and clearing, made a foray into the securities services arena about three years ago. The bank recently broadened its fund services coverage to 10 full-service centre locations throughout the region including Hong Kong, Singapore, Thailand, Indonesia, China, Philippines, India, Taiwan, Malaysia and Korea and has now also introduced an

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Tony Lewis, head of global custody for HSBC Securities Services in Hong Kong: “We have been through an intense period where, for example, trading volumes have increased or decreased dramatically on a daily basis. This has reinforced the need to have real time, accurate information and a scalable platform. It is also of huge importance both for our business, and for our clients, to have information at our fingertips to enable fast and appropriate decision making and management of operational and credit risks, for instance.” Photograph kindly supplied by HSBC Securities Services, December 2008.

enhanced alternative fund administration service.

Pow says:“Despite the market downturn and decline in asset values, the long-term prognosis for the fund management industry is good. At Standard Chartered, we are expanding our fund administration services to meet this expectation. Our focus continues to be to support and service fund flows for asset managers, insurance companies, sovereign wealth funds and pension funds operating in our key markets, principally Asia.” Looking ahead, not surprisingly, the biggest challenges are tied to the unpredictability of the financial markets. Lewis of HSBC, says: “We have been through an intense period where, for example, trading volumes have increased or decreased dramatically on a daily basis. This has reinforced the need to have real time, accurate information and a scalable platform. It is also of huge importance both for our business, and for our clients, to have information at our fingertips to enable fast and appropriate decision making and management of operational and credit risks, for instance.”

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Photograph © Alexei Kashin/Dreamstime.com, supplied December 2008.

Solving Tomorrow’s Problems Today From its unlikely base in Milwaukee, Wisconsin, Manpower Inc has become a worldwide powerhouse in employment services, with offices in 80 countries and territories and revenues approaching $22bn. After years of strong and profitable growth, the company is facing the most threatening economic environment in its history. However, by controlling costs and focusing its resources on growth markets, Manpower expects to emerge from this recession stronger than ever. Art Detman, himself a Milwaukee native, explains why.

LOSING BELL CEREMONIES at the New York Stock Exchange (NYSE) are often fraught with symbolism, none more so than on 14th November, when the 60th anniversary of the founding of Manpower was celebrated. Participating in the bell-ringing were not only Jeffrey A Joerres, the company’s current chief executive officer (CEO), but also his only two predecessors: 96-yearold Elmer Winter, who co-founded the company and served as CEO from 1948 to 1976, and Mitchell Fromstein, CEO from 1976 until 1999, when Joerres took over. During the trio’s tenure, Manpower grew into one of America’s

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most respected companies, a truly global enterprise that derives 90% of its revenues from outside the United States, operates 4,500 offices, and employs 33,000 people.

Although its core business remains providing clerical and light industrial workers on a temporary basis, the company is steadily diversifying into more profitable services.

For 2007, as the last economic up-cycle crested, Manpower reported record sales and earnings. Revenues grew to $20.5bn, an increase of 9% in constant currency (an oftenheard term in a company with operations in more than 65 countries plus entities such as Hong Kong, Taiwan and the Virgin Islands). Net earnings from continuing operations surged 59% to $485m, and diluted earnings per share from continuing operations jumped 65% to $5.73 ($4.68 before a windfall caused by a retroactive change in French payroll tax rules). In addition, three key metrics continued to improve.

The operating profit margin grew by 30 basis points to 3.3%; Manpower’s return on invested capital was 14.9%, up for at least the fourth year running; and free cash flow improved to $341m, a 22% gain. The 3.3% and 14/9% are excluding the windfall caused by a retroactive change in the French payroll tax (however, the $341m excludes this impact).

Alas, when results for 2008 are tabulated the figures will not look nearly as good, and it is almost certain that they will

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worsen still further in 2009 as America’s recession, triggered by the meltdown in sub prime mortgages, deepens and spreads worldwide. “We are a cyclical company,” Joerres readily admits. “We understand that. During any economic downturn, we will see our revenues decrease.” Although revenues for 2008 are expected to rise by 6.3% to $21.8bn, earnings will be down sharply. For example, analyst Andrew Steinerman of JPMorgan, who had once expected 2008 earnings per share (EPS) of $5.10, cut his estimate to $4.88, down 14.8% from 2007’s results.

Even more pain will come in 2009. “We are seeing a global weakening,”acknowledges analyst Kevin McVeigh of Credit Suisse.“This has impacted our estimates, which we have cut dramatically in both earnings and revenues for 2009 on a magnitude that is even greater than what we saw in the last economic cycle.” McVeigh looks for 2009 revenues of $18.7bn, down 14%, and EPS of just $2.50, down 48% from 2008’s results and down 56% from 2007’s record.

This grim outlook comes as no surprise to Joerres and his management team. Since 1962 the company has conducted quarterly surveys among large companies regarding hiring plans for the following three months. The survey for the quarter ended 31st December found that the net employment outlook (the difference between those companies that expect to increase hiring and those that expect to lay off employees) had fallen to just nine percentage points, down sharply from the 20-point spread during most of the 2004 to 2006 period. Similar downturns were found in key foreign economies, including those of the United Kingdom, Japan, Singapore, Hong Kong, Australia, New Zealand, Ireland, Norway, Spain and Mexico. For all that, many analysts who follow Manpower believe that the company will emerge from the current recession in a stronger relative position due to its geographical diversification, range of services, solid balance sheet, and (perhaps most important) strong management team. JPMorgan’s Steinerman sums it up this way: “Manpower’s discipline now will provide for a more profitable recovery later.”

Weathering recessions Manpower has weathered ten recessions since its founding in 1948 by Winter and Aaron Scheinfeld. The two attorneys were facing a tight deadline to complete a legal brief and discovered there were no companies that furnished temporary clerical help. After they met their deadline, they founded Manpower and promptly ran into America’s first postwar recession, which lasted nearly a year. Their business survived and soon had branch offices throughout the Northeast. After successfully establishing offices in Montreal and Toronto, Manpower moved overseas to open offices in the UK and France. Today, the company’s foreign operations are conducted through more than 330 subsidiaries, such as Intellectual Capital of Australia, Right Grow Talent Services of India, Elderly House of Israel, JobSearchpower of Japan, Girlpower of the UK, and Manpower Business Services France. Virtually all foreign offices are managed and staffed by locals.

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The 1957 move into France has been especially rewarding. In a country where preserving jobs is more important than creating them, employers began to rely on temporary staffing to fill positions at the margin.

Manpower’s French unit now serves not only France but Guadeloupe, Luxembourg, Martinique, Monaco, Morocco, New Caledonia, Reunion and Tunisia. Today it is Manpower’s single largest national market, accounting for a third of company revenues. The French connection also illustrates Manpower’s willingness to take reasonable risks for the sake of long-term growth. Fifty years ago few companies of Manpower’s size were willing to go overseas.

However, Manpower’s progressive thinking built it into the world’s third-largest temp firm, behind Swiss-based Adecco and Randstad Holding, a Dutch company that leapfrogged past Manpower when it acquired Vedior last year.

“Manpower from its earliest days was fairly agnostic in regards to where it would invest in terms of new offices,”says analyst Mark Marcon of Robert W Baird & Co.“The French were one of the earlier adopters of temporary staffing, and Manpower was early to the party and established a good position there.”Marcon (who works from Baird’s Milwaukee office, not far from Manpower’s headquarters) ticks off other examples of the company’s well-timed moves. It opened permanent placement offices in Italy years before temporary staffing was made legal there, and when it was - in 1998 Manpower had a head start. Today, Italy accounts for 7% of Manpower’s revenues but 13% of its operating earnings.

Marcon believes this will grow steadily as temps become more accepted by Italian business.

Similarly, Manpower was among the first temp firms in India and China, has just received a business licence to operate in Vietnam, and expects to open offices in Egypt soon. Recession or not, the company intends to continue expanding abroad. “We work really hard,” says Joerres, “at balancing between good expense management and investing in the future so we can accelerate on the other side of any downturn. When we see a sharp downturn, we do all the things that you would expect a company to do, but we will not starve high-growth markets.” Indeed, despite the accelerating downturn in late 2008, Manpower’s headcount remained virtually unchanged from a year earlier.“They have been extremely progressive and flexible,” Marcon says. “Manpower’s management team is almost universally highly admired. They are extremely hardworking and diligent and have been very progressive in terms of making investments in growth markets.” As a result, notes Marcon, Manpower has become a worldwide company with the ability to shift its assets across the globe much more easily than the vast majority of companies.

McVeigh of Credit Suisse is among those who agree:“We hold CEO Jeff Joerres and CFO Mike Van Handel in very high regard for their business acumen, integrity and transparency. Under the leadership of Joerres, Manpower has increased its margins, returns and growth rate by pushing more aggressively into non-US markets, having more price discipline, and adding more specialised staffing.”

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though Manpower management The company regularly shows knew that it was not the optimal up on “best of” lists. In 2008, time to acquire a counter-cyclical Barbara Beck — president of business, their hand was forced,” Manpower’s unit responsible for he says.“If they did not act then, much of Europe and all of the they would have never gotten a Middle East and Africa — was big platform in this business. named in Pink Magazine’s list of Manpower also had an HR the Top 15 Women in Business. consulting practice and so it was Other awards have included from Institutional Investor (Most able to merge the two to create Shareholder-Friendly Company an even bigger practice that in the Capital Goods Industry) would have a greater impact on and Fortune (Most Admired their clients.” Although Joerres Company in the staffing believes that other prospective industry). Clearly, Steinerman, takeover targets (companies that Jeffrey A Joerres, Manpower Inc’s chief executive officer operate at the high end of the Marcon and McVeigh are not the (CEO). We work really hard,” says Joerres,“at balancing business and generate gross only admirers of Manpower. between good expense management and investing in the profit margins of 40% or so Even so, not everything has future so we can accelerate on the other side of any instead of the 18% that worked to plan. For example, downturn. When we see a sharp downturn, we do all the companies like Manpower and Jefferson Wells was launched in things that you would expect a company to do, but we will Kelly Services earn) are 2001 but has yet to make a profit. not starve high-growth markets,” says Joerres. Photograph undervalued right now, he The concept seemed inspired: kindly supplied by Manpower Inc, December 2008. doesn’t seem eager to pursue Jefferson Wells is staffed by a any. “It would have to be very small cadre of full-time compelling and extremely professional accountants and Many analysts who follow consultants who are augmented accretive to earnings for us to do Manpower believe that the as needed by similarly qualified it,”he says.“Otherwise, we prefer company will emerge from the temps from Manpower to wait and see what is Professional. The resulting task happening in the economy.” current recession in a stronger forces help client companies with Then, too, it is not likely that relative position due to its a range of complex issues, such as Joerres or Van Handel would geographical diversification, want to soon use stock again to taxes and finance, at less cost than range of services, solid balance buy another company. From a comparable services from the Big sheet, and (perhaps most high above $97 in 2007, Four accounting firms. Manpower important) strong management Manpower plunged to below Professional is another laggard. $28 in late 2008. Andrew Fones, Although profitable, it still team. JPMorgan’s Steinerman a UBS analyst, believes that if accounts for perhaps no more sums it up this way: the economic downturn than 10% of Manpower’s entire “Manpower’s discipline now will becomes severe, the stock could permanent and temporary provide for a more profitable go to $15. This is hardly a placement business (light recovery later.” cheerful prospect for industrial is around 50% and shareholders, but it would be clerical around 40%). But Joerres is optimistic and continues to good for the company’s invest in the business.“There are long-term growth trends in ambitious share buyback programme. Long term, higher level skills, such as engineering and finance, that are Manpower’s fans are almost certainly right. Even with most of its business still at the low-margin end of the spectrum, working to our advantage.”

Joerres’s desire to lessen Manpower’s dependence on the Manpower has grown and prospered. Its reputation is low-margin business of placing light industrial and clerical sterling, it is expanding in value-added services, and the temps led the company to acquire Right Management, whose secular trends are favourable.“The goal of companies is to outplacement services are counter cyclical to the staffing get away from fixed costs, toward more flexible business. The acquisition — a share deal valued at $630.6m employment, which suits the temp industry,”says Professor — was made in early 2004, when Right’s stock was riding Peter Cappelli, director of the Center for Human Resources high. Other suitors also wanted the company, but Manpower at the University of Pennsylvania’s Wharton School. won the ensuing bidding war. Since then, the company’s That is the future. In the here and now however, the market value has declined and last year Manpower took a markets are unforgiving and without sentiment. On the day that Jeff Joerres and his predecessors rang the Big non-cash charge of $163m, a 26% haircut on its investment.

Baird’s Marcon is undisturbed at the write-off. “Even Board’s closing bell, Manpower was down 5%.

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MANPOWER: A WORLD OF SERVICES From a company offering just one service (office temps) and operating in just two cities (Milwaukee and Chicago), Manpower has evolved into a global leader in employment services, including: • Permanent, temporary and contract employment, which accounts for perhaps 95% of revenues. The overwhelming majority of these placements — nearly 5m a year — are light industrial and clerical workers, who are placed through the Manpower brand. A growing number are professionals such as engineers, accountants and sales executives, who are placed through Manpower Professional. Manpower does almost no placement of part-time workers, and long ago stopped placing day labourers.

• Employee training, including Manpower’s online Global Learning Center, which offers 3,600 courses in several languages. At any time, about 200,000 trainees are participating.

• Outsourcing of the recruiting function. Through its Manpower Business Solutions operation, Manpower acts as an organisation’s recruiting office, responsible for candidate sourcing, screening, hiring and orientation. Among its clients

are Visteon, a US tier-one auto parts company, and the Australian Defence Force.

• Human resource consulting, which is conducted largely through Right Management, a 2004 acquisition. In essence, Right — as this operation is known within Manpower — trains HR executives to perform their jobs more effectively.

• Outplacement services for laid off employees. Right is the world’s largest provider of these services, and recently restructured its offerings and placed them under the new Right Choice brand (a name that, to those using its services, might seem bittersweet).

• Professional services in areas such as internal controls, tax planning, technology risk management, finance and accounting. These are offered through Jefferson Wells, which has a core group of full-time professionals who are augmented on a project basis by temps from Manpower Professional. In Europe, Manpower’s Elan operation provides informational technology professionals.

Right Management and Jefferson Wells are operated on a global basis. In contrast, permanent and

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temporary placement is managed on a geographic basis.

Operationally, the entire company is divided into seven operating units: France is by far Manpower’s biggest national market, generating $7bn in revenues (34% of the total for 2007) and $390m in operating earnings. Revenues are likely to be boosted in the next year or two now that the French government is allowed to use temporary workers. Gaining on France is Other Europe, Middle East and Africa (Other-EMEA). As CEO Joerres notes, this is a descriptive but inelegant name for an operating unit, especially one that is growing smartly. Revenues were $6.75bn and operating earnings were $257m. Other Operations is a catchall category for countries not under any other umbrella, mainly those in Latin America (notably Mexico and Argentina) and Asia (including Japan, Singapore, India and China).

Revenues amounted to $2.6bn but operating earnings were only $73.5m, reflecting the relative newness of many of these markets.

The US, Manpower’s original market, now generates less than 10% of corporate revenues and operating earnings, just under $2bn and $80m respectively. In the meantime, Italy’s 2007 revenues were $1.4bn, 7% of the total, but operating earnings were $104m, a princely 13% of the total and greater than US earnings. Manpower’s Right Management subsidiary is a human resources consulting firm that also is a leader in outplacement counselling. Revenues were $410m (2%) and operating earnings were $34.6m (4%) in 2007, reflecting the higher valueadded nature of the business.

Jefferson Wells is Manpower’s consulting arm, formed in 2001 and as yet unprofitable. On revenues of $332m, Jefferson Wells incurred a loss of $5m in 2007.

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What price saving a company from collapse? Like other insurers, insurance giant American International Group (AIG) has been thumped by the severe downturn in the credit markets as fears that the gamut of complex, structured investments it insures will default. A 24 month $85bn line of credit proved insufficient, an additional $40bn did not help much, either.

However, with its latest relief package—more flexible terms, more payoff time, and, yes, even more money—the government believes it has finally found the formula that will allow AIG the most realistic chance of recovering from its ruinous credit-related investment activities. Third time lucky? David Simons reports from Boston.

By the end of November the company finally issued some good news: some $53.5bn in mortgage debt obligations would be cleared from AIG’s books, part of an agreement with the federal government to purchase upwards $70bn worth of toxic credit-based assets. AIG would continue to be liable for assets not yet obtained, however.

The government contends that its course of action has more to do with preventing the carnage from spreading throughout the entire global financial community, rather than sparing AIG itself. Even so, it is a tremendous gamble, one with potentially enormous consequences. Should AIG recover and its stock price rally, the government would turn

CORPORATE PROFILE: AIG

AIG’S BLANK CHEQUE

HEY KNEW THE risks, watched as losses piled up, but told auditors almost nothing. In an era of increasingly tough oversight standards, they routinely avoided regulatory independence and put the kibosh on finger-pointing insiders. When the house of cards finally fell last September, AIG—at one time the single largest insurance entity in the world with facilities in more than 130 countries—found itself at the doorstep of the federal government, hat in hand. The powers that be sized up the situation, pronounced AIG “too big to fail,” and proffered a generous credit line of $85bn, but it was not enough.

By November 2008 the largest bailout of a non-banking firm in the history of the United States had swelled to over $150bn, and included more favourable terms than the initial package offered.

Not even that chunk of change could guarantee a surefire recovery as long as the company continued to go into the hole in order to cover its toxic portfolio of complex credit investments. These included the super-senior tranches of collateralised debt obligations (CDOs) accumulated by AIG’s Financial Products Corp subsidiary.

Photograph © Robert Mizerek/Dreamstime.com, supplied December 2008.

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a handsome profit from its now 80% equity stake in the company. If the insurer collapses, however, taxpayers would be left holding the bag, and, even worse, the systemic aftershocks affecting innumerable companies with business links to AIG would be dire, to say the least.

Funding or floundering Until recently, government efforts to address the haemorrhaging at financially beleaguered firms such as AIG have proven largely ineffective; at least measured by the recent numbers posted by AIG, Fannie Mae and Freddie Mac and, most recently, banking giant Citigroup. In November, Fannie Mae reported a third quarter 2008 net loss of $29bn, two months after the Federal Housing Finance Agency (FHFA) placed Fannie and Freddie under its control. In a thinly veiled critique of the Federal Reserve’s intervention tactics, Fannie noted that efforts to help stabilise the ailing mortgage market were being hindered by its“limited ability to issue debt securities with maturities greater than one year”and has requested that its original agreement with the Federal government be revised to include more favourable terms. Under the current arrangement, the agency said it might not be able to “continue to fulfill our mission of providing liquidity to the mortgage market at appropriate levels.”

Speaking on behalf of AIG, current chief executive officer (CEO) Edward Liddy offered a similar assessment.“It was obvious to me from the start that the terms of that arrangement were really quite punitive in terms of the interest rate and the commitment fee and the shortness of it,’’ said Liddy, the former head of Allstate Corp. who succeeded outgoing AIG CEO Robert Willumstad last September.

The government’s realisation that its initial action had had little impact on AIG’s financial standing became obvious during the third quarter, when AIG lost $9.24bn, or $3.42 per share, more than four times the consensus estimate loss of 80 cents (US insurers as a whole posted a total of $100bn in write downs and losses through the period). The damage was due in large part to a pre-tax charge of more than $7bn for a net unrealised market valuation loss related to the super senior CDS portfolio held by AIG’s Financial Products Corporation. Earlier hopes that AIG could raise enough cash to begin to sustain itself through the sale of once valuable subsidiaries were dashed once the markets began to tumble (by late October shares of AIG had fallen from a post-bailout high of $5 to an all-time low of $1.35). As the credit markets continued to deteriorate, AIG found itself struggling to maintain payments on its structured-credit obligations, tightening the noose even further.“Confidence in the sector has come under considerable pressure,’’ affirmed Nigel Dally, a Morgan Stanley analyst.

In reality, the government lacked the weaponry needed to properly contain the damage prior to the passage of Congress’ bailout package in early October. However, the enactment of more sweeping measures such as the Troubled Asset Relief Program (TARP) has allowed

regulators to approach the problems at AIG and elsewhere with greater clarity. The latest version of the AIG bailout offers the NewYork-based insurer the most realistic chance of wriggling out of the hole it dug for itself as a result of its credit-related investment activities, say observers.

Key to the new deal is a lower lending rate as well as three additional years for AIG to pay off its debts, with the goal of buying the company enough time to unload its marketable assets to willing buyers. For AIG’s CDO holders—which include global banks like Merrill Lynch, Goldman Sachs and Deutsche Bank—the arrangement provides for a generous settlement at or near par, notes Thomas Walsh, a Barclays Capital Research analyst, who called the deal“a significant positive for CDO holders that were previously facing an impaired counterparty.”

Bankruptcy instead of bailout?

Reports of lavish junkets and posh severance packages have done little to further AIG’s cause in the months since the handouts began, nor have comments made by company executives openly critical of government policy.

Though he apparently ignored the warnings of an internal auditor who had questioned the accuracy of the company’s credit default swap (CDS) valuation, deposed CEO Martin Sullivan, who resigned last June, nevertheless assumed a defensive posture during a recent Congressional hearing.

“When the credit markets seized up, like many other financial institutions, we were forced to mark our swap positions at fire-sale prices as if we owned the underlying bonds, even though we believed that our swap positions had value if held to maturity,”said Sullivan.

At the same time, Maurice Greenberg, former company chairman and CEO and a major AIG shareholder, complained in a Wall Street Journal opinion piece that high interest payments to the government could force the company “into effective liquidation” which, in turn, would ultimately “wipe out the savings of retirees and millions of other ordinary Americans.” However, Felix Salmon, commentator for the Market Movers blog, bristled at the suggestion that AIG’s federal benefactors were not doing enough. Greenberg was instrumental in setting up the renegade AIG Financial Products division, said Salmon, therefore, “he, as much as anybody, is to blame for AIG’s enormous losses. And he certainly does not deserve a personal bailout, which seems to be what he is asking for here.”

For that matter, many believe the financial world probably would not have crumbled had the insurer been left for dead. “‘Remember Lehman’ now seems to be the rallying cry to justify any and all financial bailouts,” says Peter Schiff, president & chief global strategist for Darien, Conn.-based Euro Pacific Capital.“But Lehman’s demise is in no way responsible for our current problems, and the decision to let them fail is the only bright spot in otherwise consistent record of policy mistakes. We bailed out Bear Stearns and AIG, and what did that get us?”

However, Robert Bruner, dean of the Darden Graduate School of Business Administration at the University of

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Edward Liddy, chairman and chief executive officer of American International Group Inc., (AIG), speaks after a luncheon speech in Hong Kong Thursday, December 11th 2008. AIG noted a day earlier that it is working on resolving nearly $10bn in soured investments, without asking taxpayers for more money. Photograph by Kin Cheung, supplied by AP Photo/PA Photos, supplied December 2008.

Virginia and author of The Panic of 1907: Lessons Learned from the Market’s Perfect Storm, suggests that the chaos erupting from an AIG failure would have been inestimable, therefore making government intervention mandatory.

“There is no doubt that AIG met the ‘too big to fail’ criteria, being the dominant counter-party in the credit default swap market,” says Bruner. The step-wise progression has the appearance of an ad-hoc treatment of the crisis, and yet it is in no small part a reflection of the steady revelation of the deepening exposure of the financial system to the destructive quality of the sub-prime loans. I doubt that it would have been possible for the government to have jumped in with a massive, one-shot, solves-everything type of solution last September, at the time of the initial action.

That said, this intervention on behalf of one company, both in size and intrusiveness, is unprecedented; but then again, so is the grave exposure of the financial system to the potential failure of this one firm.”

While the bailout of a non-banking entity may be precedent setting—one that has certainly helped frame the debate over the current auto-industry rescue proposal—as Bruner notes, the financial markets are largely agnostic about the classification of the institution. “Whether it’s a bank or non-bank, in the illuminated part of the financial system or operating in the shadows, counter-parties recognise that all money is green, and that what truly matters is the credit-worthiness of the counterparty, its transparency and the capital standing behind the trades.”

CDOs have got to go At a recent presentation to the New York Chapter of the Risk Management Association, Chris Whalen, senior vice president and managing director of Torrance, Californiabased Institutional Risk Analytics, a provider of risk

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management solutions, stated that the only clear way around the AIG problem(and others like it) is to cleanse the system of all CDS products once and for all. Referring to AIG’s “CDS sinkhole,”Whalen argued that even the most concentrated efforts to boost liquidity have been marginalised by the $50trn in outstanding CDS contracts.

“The threat from CDS is not from a default-type event as many fear…but rather in the normal operation of this market”as with AIG, says Whalen.

Whalen goes so far as to propose putting AIG into bankruptcy while requiring CDS holders “to accept a negotiated ‘tear up’ of extant contracts under authority of the bankruptcy court,” as opposed to “muddling along” buying back CDOs using borrowed taxpayer money which, he argues, would lead to“a death by a thousand cuts.”The situation is so dire, says Whalen, that Congress should be called upon to enact legislation that makes mandatory by exchange the removal of all outstanding CDS and other complex products from the entire global marketplace. “So serious and enduring are the negative effects of OTC financial instruments such as CDS, CDOs and other complex structured assets, that the only way to save the patient and restore function to global economy and financial system is mandatory surgery: cut the cancer out.”

Though the government appears to have finally found its theme—corralling those toxic credit instruments that are sucking the life out of companies like AIG—the ongoing crisis has taught us that we still don’t know the full extent of the exposure, or, ultimately, the silver-bullet remedy. Says Bruner hopefully,“It does seem likely that the combination of capital infusions to relevant institutions, plus the sequestration of toxic assets, will restore confidence in the credit-worthiness of those key institutions.” Only time will tell if that assessment is correct.

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GOLD: SET FOR A REBOUND?

GOLD GETS ANOTHER CHANCE Some analysts were surprised that the gold price failed to benefit at the height of the credit crisis.

That may have been because gold holders short of other ways of raising cash quickly sold out.

Now the industry is pinning its hopes for a rebound on supply constraints and a flow of money looking for a home.

Vanya Dragomanovich reports.

T DOES NOT compute. The price of gold fell in the autumn even while the US federal government had the printing presses churning out greenbacks and the country’s financial system teetered on the brink. Moreover, counter-intuitively, the dollar rose. The world is already thoroughly hung-over from a strongly held economic theology, so any calls for a return to the gold standard are unlikely to be well received. However, most observers expected the precious metal to have more allure as the safe haven of first resort, as indeed it did when Bear Sterns failed and it shot up to $1,032 an ounce.

I

Gold’s very success as a store of value may be responsible for its blip. Elaine Ellingham, until recently mining principal for the Toronto Stock Exchange, admits that the “gold community”was equally puzzled at first, until they realised.

“People always say gold is something you buy for a rainy day; and this it, the rainy day,” she said. Many funds had ‘investment gold’ in their fund portfolios, and faced with redemptions and margin calls they have been selling off their gold holdings, in part because it was a chunk of their portfolios that had kept more of its value than bonds and stocks and in part because it was liquid. Indeed, as auction rate securities and other previously liquid assets froze, some gold holders had no option but to cash out.

Ellingham notes however that, “People who have held gold through [this period] have certainly done a lot better than people who bought indices. It has proven to be a better store of value than the equity markets in general.” Even allowing for the recent fall off in price, the value of gold has risen over 200% since 2001. Now senior vice president for Iamgold Corporation, a major producer, Ellingham says right now gold is“the logical place for people to go.”

While people anxiously wonder when peak oil will arrive, peak gold arrived long ago, back in 2001 to be exact, and production has flattened out since then even as gold prices continued to rise, making new mines increasingly viable. However, gold in all its forms is an unusual commodity. The World Gold Council estimates that 158,000 tonnes of it have been refined since records began. Of this amount, 65% has been mined since 1950, and all but 10,000 tonnes has been mined since the California gold rush of 1848. Unlike oil though, no one burns gold.

It sits in gold ingots, or is stored as jewellery and coins, and whenever possible, it is recycled.

Photograph © Dmitry Sunagatov/Dreamstime.com, supplied December 2008.

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The financial climate has led to credit constraints for the junior companies that have traditionally undertaken prospecting and resource identification. Colin Sutherland notes: “In the last few years the number of one million ounce deposits that has been found has declined considerably. If you cannot raise money then you cannot advance your project. The supply side is going to be impaired if the credit markets do not open up enough. The result is a supply constraint [and] increasing difficulty in finding major deposits. If the money does not start flowing for new projects senior producers are going to be out there with no pipeline of projects and with reserves starting to drop.” Photograph © Mirek Hejnicki/Dreamstime.com, supplied December 2008.

Colin Sutherland, a self-confessed “gold bug” and chief executive officer (CEO) of Nayarit Gold, a Canadian junior gold miner with a prospective mine in the Sierra Madre in Mexico, notes that while investment gold has dropped as funds take their profits, physical gold is at a premium. “Demand for physical gold is still high. If you were to try to buy a gold coin you would have to pay a higher price, since on the physical side of things, a lot of the mints just do not have the supply,” he says. Many small investors buy gold coins such as the South African Rand, the American Eagle or the Canadian Maple Leaf as the equivalent of managed fund gold holdings, and jitters about the dollar and indeed the whole financial system, have whetted their appetite, hence the shortage.

Moreover, gold for jewellery is overwhelmingly sold to the Middle East and South Asia. “The Indian buying season, for example, starts in October ready for the wedding season, and the word is that fearful about where the commodity price is going, they have been a little reluctant to engage in buying [sic]. If there is a weakness in the price I expect them to come in buying aggressively.”

If you think these issues are tangential, consider that in South Asia male chauvinism traditionally has a lock on land inheritance, therefore gold jewellery is regarded as a form of advance alimony and a widow’s pension for Indian brides. These days, of course, its socio-economic rationale is also subsumed in ostentatious consumption fuelled by rising living standards. So while the central banks around the world sit on 30,000 tonnes of gold, wedding buying and Diwali in India, the Lunar New Year in China and similar festivities are enough to cause an annual surge in price each winter and to consume up to 60% of the new gold that is mined and refined each year.

While people anxiously wonder when peak oil will

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arrive, peak gold arrived long ago, back in 2001 to be exact, and production has flattened out since then even as gold prices continued to rise, making new mines increasingly viable. However, gold in all its forms is an unusual commodity. The World Gold Council estimates that 158,000 tonnes of it have been refined since records began. Of this amount, 65% has been mined since 1950, and all but 10,000 tonnes has been mined since the California gold rush of 1848. Unlike oil though, no one burns gold. It sits in gold ingots, or is stored as jewellery and coins, and whenever possible, it is recycled. The World Gold Council estimates that 95% of all gold ever mined is still in use in one form or another. However, with an expanding world population and economy, and the esoteric demands on it as a store of value, its future value seems assured by a growing shortage.

In addition, the financial climate has led to credit constraints for the junior companies that have traditionally undertaken prospecting and resource identification. As Sutherland notes: “In the last few years the number of one million ounce deposits that has been found has declined considerably. If you cannot raise money then you cannot advance your project.The supply side is going to be impaired if the credit markets do not open up enough. The result is a supply constraint [and] increasing difficulty in finding major deposits. If the money does not start flowing for new projects, senior producers are going to be out there with no pipeline of projects and with reserves starting to drop.”With his own project’s funding secured, he sees opportunity in others’ distress.“I’m a true fundamentalist. If you have gold increasing on the demand side and the supply side going down, it will play to our advantage,” says Sutherland, estimating the bottleneck to begin showing possibly in as little as two years.

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One possible brake on such optimism is that the world’s finance and the listing of gold mining companies is central banks could dump their reserves on the markets. Toronto. Canada itself is a major gold producer, but Toronto However, any concerted action in this direction would is the home of major international gold miners such as actually start to devalue central bank reserves. Currently Goldcorp, Barrick, Newmont and Iamgold. The Toronto central banks sell less than 400 tonnes a year, although their Stock Exchange (TSX) claims 57% of the world’s mining five-year agreement allows them to sell up to 500 tonnes. listings, involving 1,200 companies, spread between the Indeed, if ever the Asian central banks decided to put even main board and its new venture arm, the TSXV. Junior just one or two per cent of the reserves they currently hold miners are the explorers and developers, and if they hit a in rapidly inflating dollars, and turn those into gold, Natalie motherlode, they grow up to be seniors and graduate from Dempster of the World Gold Council points out“it would the TSXV to TSX. “In Canada there is a commodity driven community in have a huge impact”. China for example, with its huge currency reserves, has only 600 tonnes of gold in its the local banks that knows what you are talking about, and on the exchanges, the vaults, compared with the regulators understand the over 8,000 tonnes the US industry,”says Sutherland. keeps. China has hinted at The country also has a diversifying away from its high proportion of active US dollar reserves, “Globally, any project that has costs individual investors who leading to great in excess of $500 to $600 an ounce is are attuned to gold and expectations from the mining, while its world’s gold community. likely to have some challenges over the proximity to the US also Dempster says gold is a short term. Worldwide, the average means that it attracts significant export for many production cost is somewhere between many investors from the emerging countries with $420 and $450 per ounce. With gold US. Surprisingly though, important revenues for approaching $800 there is still some there are few investors South Africa, China, Russia, margin but fluctuations, with a $50/60 from the Middle East and Peru, Mexico and others.

Asia where most of the However, their physical swing in any given week, pose an miners’ product is reserves are already being additional challenge for expenditure consumed. One would mined, and newer reserves planning,” notes Sutherland. “If it were have thought that both tend to be smaller, more to swing back to $600/$650 you would institutions and sovereign expensive to work and thus see a massive correction with gold wealth funds would be more vulnerable to price interested in investing volatility. They are also in producers trying to reduce costs and back up the value chain, remote areas where miners move out some of the inflation in the but Ellingham has seen have to build infrastructure system,” he adds. no sign of it so far. to get the ore out, and Gold has often been spend on infrastructure to lumped in with other buy acceptance from local, mineral commodities for often poor, communities.

Nayarit Gold’s experience in Mexico is typical. The company investment purposes, but the rueful expressions of those who invests not only in physical infrastructure but also in social went long on iron, oil and the like show that it is a separate infrastructure, schools, churches and other facilities as a cost case. Overall, the yellow metal becomes brighter when the of doing business. Such cost margins make new mining economic skies are dark, and they have rarely been as dark as investment heavily reactive to the vagaries of the market now. Like many other prospectors, Sutherland is betting his price.“Globally, any project that has costs in excess of $500 future Mexican mine on anticipated demand by China’s to $600 an ounce is likely to have some challenges over the central bank and a slew of Indian weddings. He also looks to short term. Worldwide, the average production cost is the US government as a driver for pushing up gold prices.“In somewhere between $420 and $450 per ounce. With gold this environment, the strengthening of the dollar is approaching $800 there is still some margin but fluctuations, temporary, and as the Federal Reserve continues to finance with a $50/60 swing in any given week, pose an additional bailouts, the excess of dollars will lead to inflation, which is a challenge for expenditure planning,”notes Sutherland.“If it prime indicator for gold to take off. In addition, there is a lot were to swing back to $600/$650 you would see a massive of money being redeemed and there are people sitting on correction with gold producers trying to reduce costs and cash which they want to keep safe. With that economic environment, I’ve not heard anyone in the industry say that move out some of the inflation in the system,”he adds.

While gold bullion reserves are concentrated in the gold isn’t going back up to $1,000.” industrialised world, and many of the physical reserves are Of course they would say that, but the flood of dollars in the developing world, the lodestone for gold mining from the Fed is indeed highly convincing.

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In the United States, covered bonds were a long time coming. The crème de la crème of private sector bank credit in Old Europe since the days of Frederick the Great did not reach the New World until September 2006, when Washington Mutual (WaMu) launched the first covered bond programme for a US issuer. In the wake of the credit crisis, however, American regulators are pushing hard to develop a domestic market for an instrument that has long provided an inexpensive funding source for large banks in Europe. Neil O’Hara reports on the outlook for an old asset class in the New World.

NVESTORS ACCEPT A yield lower than for conventional unsecured bonds because covered bonds represent both a senior obligation of a major financial institution and a priority claim against a segregated pool of high quality assets if the issuer fails. Nevertheless, issuers and underwriters face a challenge in educating US investors who, although familiar with traditional bonds and securitised debt, have no experience of a hybrid that combines features of both.

I

Although US regulators began to press for a local market in covered bonds only after the credit crisis took hold, they have made rapid progress, according to Florian Hillenbrand, a vice president and senior analyst at Unicredito in Munich.

“The first time I heard US guys speak about covered bonds as something that might be of interest for domestic banks was in January,”he says,“Six months later they were saying on balance sheet funding is good for asset quality and you had co-ordinated statements from supervisory bodies. That is impressive.” In July, the Federal Deposit Insurance Corporation (FDIC) put out a Final Covered Bond Policy Statement and two weeks later the Treasury followed up with its Best Practices for Residential Covered Bonds.

Even so, it will take more than regulatory support to develop a covered bond market in the US. Although Bank of America, Citi, JPMorgan Chase and Wells Fargo have all expressed interest in issuing covered bonds, investors are unlikely to want to jump on the bandwagon until they see good two-way flow. Dan Markaity, head of global public credit at Merrill Lynch in New York outlines some of the requirements. He thinks that covered bond issues need to be large—preferably $2bn or more, so that dealers will not be afraid to sell them short; a prerequisite for liquid secondary markets. Moreover, Markaity believes covered bonds should be available to small

COVERED BONDS: THE US OUTLOOK

OLD WINE IN NEW WORLD GLASSES

Photograph © Lazarx/Dreamstime.com, supplied November 2008.

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Ben Colice, head of covered bond origination in the Americas asset securitisation group at Barclays Capital in New York. Photograph kindly supplied by Barclays Capital, December 2008

Heiko Langer, senior covered bond analyst at BNP Paribas in London.

Photograph kindly supplied by BNP Paribas, December 2008

investors as well as institutions, given a 20% risk weighting for regulatory capital purposes and accepted at the Federal Reserve discount window.

The goal is to have investors treat covered bonds pari passu in credit quality and liquidity with US government agency bonds. An orderly market will require cooperation among issuers to regulate supply, too.“If five issuers each float $2bn bonds in a single week, secondary market prices will tank and buyers will go on strike,” Markaity says, “We need a traffic cop.”Merrill Lynch has urged the Treasury to set up a covered bond council in the US made up of issuers, investors and dealers to fulfill that role and resolve competing interests that might otherwise undermine the fledgling market.

At first blush, covered bonds backed by residential mortgage loans—the most common form of collateral—look a bit like mortgage backed securities (MBS). However, the resemblance is superficial. Covered bond investors rely primarily on the issuer’s cash flow for interest and principal payments and only turn to the collateral pool in the event of issuer default.The pool is over-collateralised and dynamic, too. Issuers have to ensure pool assets meet rigorous credit quality standards. Any loans that fall below the threshold must be replaced with others that do qualify. This mechanism, policed by an independent cover pool monitor, ensures that the assets upon which investors depend for future payments if the issuer goes bust will be top quality performing loans right up to the date of failure.

“Covered bonds have nothing in common with a pool of static assets that have been hived off and from whose cash flows investors are expected to live or die,” explains Timothy Skeet, head of covered bonds at Merrill Lunch in London,“They have prime underlying assets and are issued by prime financial institutions that have regulatory and government support.”

From the issuer’s perspective, MBS represent the outright sale of assets for cash. Securitisation facilitates the“originate and distribute”model that allows banks to make or buy more loans without tying up regulatory capital. The bank has only a short term funding requirement, too; mortgage loans pile up on the balance sheet only until they can be repackaged

into MBS and sold. In a covered bond program, however, the mortgages stay on the bank’s books, as does the debt; it is a long term funding tool rather than a way to shed assets.

US covered bonds endured a baptism of fire when Washington Mutual hit the skids last summer. Spreads over benchmark 6-month Euribor interest rates blew out to more than 600 basis points (bps) as the rating agencies issued a series of downgrades. However, both ratings and spreads snapped back after JPMorgan Chase agreed to assume the liability—and the cover pool assets—in its FDIC orchestrated acquisition of WaMu.“The senior unsecured debt was left out in the cold,”says Skeet,“That is a key signal that the FDIC and Treasury want to ensure that covered bonds are treated differently and seen as robust credits.”

In contrast, MBS investors receive interest and principal payments from a static pool of mortgages sold to a special purpose vehicle (SPV) that has no recourse to cash flow from either the loan originator or the entity that sponsored the SPV. The structure may incorporate over-collateralisation, but once any credit support is exhausted, investors have no further protection against deteriorating credit quality, delinquency or default. Investors assume prepayment risk, too; if a borrower chooses to repay a mortgage early (either through refinancing, sale of the house or otherwise) investors receive their share of the principal at that time and must reinvest at whatever interest rates then prevail.

“A mortgage backed securities investor is looking to the performance of specific assets for cash flows and therefore has to worry about duration uncertainty,”notes Ben Colice, who heads covered bond origination in the Americas asset securitisation group at Barclays Capital in NewYork,“That is not the case for covered bonds.” Covered bondholders do not receive accelerated repayment if the issuer defaults; in most jurisdictions, the covered pool monitor uses cash flow from the dedicated assets to make interest and principal payments as they fall due.

In a twist that distinguishes the two US covered bond programs launched so far—for WaMu and Bank of America—the cover pool monitor does not retain the pool

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assets upon default. Instead, it sells the assets and reinvests sheets, the existing highly liquid agency MBS market will the cash proceeds in guaranteed income contracts to fund compete for available collateral. Issuers could still use future interest payments and the repayment of principal. To covered bonds to refinance jumbo loans and other high Heiko Langer, senior covered bond analyst at BNP Paribas quality non-conforming mortgages, of course, but the in London, the liquidation procedure poses an additional larger opportunity will arise if Congress curbs the GSEs’ risk for U.S. covered bondholders. “It is always easier to future growth. Says Barclays Capital’s Colice, “If the liquidate part of the portfolio whenever a payment becomes agencies go away or their role is less significant in due,” he says, “It is more difficult to find a buyer for the mortgage finance, the US Treasury is likely to promote the whole portfolio and will probably result in lower prices.” covered bond market to provide banks a viable way to In practice, the risk is low, however. Regulators in finance mortgages.” An innovation from Europe may Europe who want to preserve the brand image of finally take root in the New World—almost two hundred covered bonds prefer to arrange rescue bids for failed and forty years after covered bonds were first issued. banks rather than risk higher funding costs for healthy institutions that might result if the bonds went into default.

US regulators demonstrated the same concern when WaMu failed. JPMorgan’s assumption of the covered bond liability underscored the superior credit quality of covered bonds over senior unsecured debt. The precedent should encourage US investors to bestow upon covered bonds the same pristine reputation they have long enjoyed in Europe. Although issuing banks have failed in Europe from time to time—including German banks, whose Pfandbriefe, the local version of covered bonds, are considered the gold standard—Merrill Lynch’s Skeet says nobody has ever lost money on covered Gu bonds through default. ess wh Most European countries have enacted o’s 3rd covered bond laws that prescribe th par el t ya ar minimum credit quality standards and dm i nis gest establish government-approved trat of Ex chan or oversight to ensure that issuers adhere to ge Tr a d e d local requirements, which differ from one Funds in Europe? jurisdiction to the next. While countries in which common law prevails (such as the United Kingdom and US) can achieve the same result by contract, many investors value the additional reassurance a statutory regime provides.

The UK, another recent convert to the merits of covered bonds, passed a law in 2008 to fall in line with European practice, but in the US neither federal nor :RUG·V *HWWLQJ $URXQG« state governments have yet followed suit.

The government sponsored housing finance entities (GSEs) will play a For more information on our services please critical role in how the US covered bond contact: Fearghal Woods (Dublin) at market develops. The Treasury +353 1 670 0300 or visit www.boiss.ie guidelines for covered bond collateral overlap in many respects with what Bank of Ireland Securities Services Limited is authorised by the Financial Regulator under Fannie Mae and Freddie Mac require for the Investment Intermediaries Act 1995 conforming mortgages. As long as the GSEs are free to expand their balance

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Talking Point

THE OUTLOOK FOR EUROPEAN COVERED BONDS:

MARKET COMMENTATORS: Dr. Louis Hagen, executive director, Association of German Pfandbrief Banks Nicholas Lindstrom, financial institutions group, Moody’s Investor Services Ted Lord, managing director and head of covered bonds, Barclays Capital Carlos Stilianopoulos, executive managing director and head of capital markets, Caja Madrid Tim Skeet, managing director, head of covered bonds, Merrill Lynch

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Covered bonds have underlined their importance and stabilising role in mortgage financing in Europe to such an extent that the authorities in the United States are seeking to introduce a set of guidelines designed to replicate the high quality of this quintessentially European instrument. In part because of the safe-haven reputation of covered bonds it appeared for most of 2007 and early 2008 to have successfully withstood the credit crisis. However, partly because the availability of executable prices for bonds on screens highlighted their vulnerability, and partly because the fixed bid/ask spreads in covered bonds started to become far smaller than the bid/ask spreads in any comparable markets (most significantly perhaps in the swaps and agency markets) the contagion that affected other credit markets began to impinge on Europe’s covered bonds. Questions are still extant as to the true nature of covered bonds: either as a ratings or a credit product. Whatever the ultimate outcome of that debate, we asked some of the leading market makers in the covered bond market to give us their views on the sustainability and future of this deep and diversified market through 2009 and beyond.

After what looked to be a protracted period of stability, the European covered bond market hit a high wall in the late summer/early autumn, as it began to feel the impact of the contagion that has created extreme volatility in the global capital markets. What do you think were the main reasons for the relative lateness of this dip and the intensity of the dip when it did arrive?

DR. LOUIS HAGEN, ASSOCIATION OF GERMAN PFANDBRIEF BANKS: Until mid-September at least the

Pfandbrief market proved exceptionally resilient to dislocations in the capital markets in general and their impact on the covered bond market in particular. This is due to the solid legal foundations provided by the Pfandbrief Act and the flawless track record of the Pfandbrief market and its committed domestic investor base. The different formats of Pfandbrief, i.e. bearer instruments in traditional or Jumbo size and registered Pfandbrief offer a wide spectrum to investors. Especially tailor made issues and private placements were sought for and the German investor community proved to be solid as a rock. The suddenness of the disruption in demand clearly had some irrational motives when Pfandbrief was taken hostage by negative headlines that originated in the US and in Ireland. Pfandbrief markets were shocked by two events. First the Lehman insolvency and subsequently the Hypo Real Estate rescue action. The bail-out of HypoRealEstate closed the market where you may have expected it to underpin the commitment of the entire German financial community to protect the Pfandbrief from harm. In the aftermath of the European rescue packages and the creation of a new asset class – state guaranteed senior unsecured bank bonds – the market now is going through a period of re-pricing in order to find levels commensurate with the new credit environment and new competitors. But I would like to make clear that Pfandbrief issuance is still working. Issuance levels, however, have halved during the last two months.

TED LORD, BARCLAYS CAPITAL: Throughout the credit

crisis and liquidity problems facing many sectors of the

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capital markets, investors have maintained their faith in the covered bond asset class. Investors still purchase covered bonds in private placement format and in the secondary market. Due to the liquidity problems in the secondary market, however, some investors are seeing covered bonds more as a credit product and not as much as a rates/government bond surrogate product.”

CARLOS STILIANOPOULOS, CAJA MADRID: Since the beginning of the crisis back in August 2007 investors´ appetite has been draining away gradually from the different products in accordance with their risk perception on the products. This is probably why investors have been buying Covered Bonds all the way up to summer 2008, whilst at the same time they had stopped buying other products which they considered riskier, starting on securitized transactions, tier II and tier I deals, and finally senior unsecured. However, further turmoil in the markets during the months of September and October has even affected safer products such as Covered Bonds.

Do you think there were infrastructural weaknesses or vulnerabilities in the make up of the trading market, which were exacerbated by the global crisis, such as: the availability of continuous executable prices on bond screens?/ or the extreme narrowing of bid/ask covered bond spreads?

TIM SKEET, MERRILL LYNCH: The recent re-pricing of the SSA curve, though itself not helpful in the overall picture of the capital markets evolution has at least served to bring a measure of consistency to the performance of all the asset classes. Covered bonds have suffered but without exception so has every part of the market

Despite the current turmoil, there is a belief that the European covered bond model is far superior to that in the United States. Is this wishful thinking, or is there real substance behind the claim.

Moreover, if it is true, in a post crisis market is it feasible for Europeans to export their expertise to the US and Asia?

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DR. LOUIS HAGEN: The covered bond model in general certainly misses the shortcomings of securitization especially the consequences of the off-balance sheet concept that was at the root of irresponsible lending.

However, the European Covered Bond market is a very diverse animal. Though we have seen some convergence with a view to establishment of dedicated legal frameworks for covered bond programmes in Europe, the specifications and standards still do vary substantially. Covered bonds are essentially a European affair even though we have seen a couple of structured issues in the US. Recent remarks made by officials from US Treasury or the Fed are evidence that there is an increased awareness of the covered bond concept’s appeal. I do believe that covered bonds still have to come a long way down to Main Street, though.

European expertise is provided, e.g. expert opinions from investment banks and rating agencies. However, I suggest the US administration ask issuers and investors, too, what a US covered bond should look like given that rating agencies and investment banks played a prominent role in the advent of the current crisis.

TIM SKEET: The US covered bond initiative has been pushed back in time. The flurry of excitement last July was welcome, but that moment has passed and other matters preoccupy the government. Moreover, we will have to wait for the new administration to form before we are able to get a clearer view of the degree of future governmental enthusiasm for the asset class. Nevertheless, the covered bond offers exciting opportunities to finance prime mortgage portfolios. The asset class offers private sector money, new investors and longer maturities, and in addition encourages banks to retain mortgage risk thereby tightening underwriting criteria. The question still remains as to what structures will be adopted. Certainly they will have evolved from the early Washington Mutual and Bank of America offerings. Watch this space.

TED LORD: The European covered bond model has been

copied in North America and is in the process of being applied in the Asia Pacific region. Investors seek greater transparency from the banks in general and favor covered bonds with their cover pool disclosure and the fact that they remain on the balance sheet of the lender.

All things being equal, do you think that the current crisis has highlighted the obvious strengths of the covered bond market: namely, the underlying protection against risk which is built into the product; clear asset eligibility criteria?

TIM SKEET: One of the features of the market is the village

nature of its market. It has its own press, personalities and products. It attracts a lot more comment than other asset classes that cannot be so readily identified and pigeonholed. Now the village people have woken up with an unexpected hangover after years of easy partying.Given

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Tim Skeet, managing director, head of covered bonds, Merrill Lynch.

According to Skeet, the recent re-pricing of the SSA curve, though itself not helpful in the overall picture of the capital markets evolution, has at least served to bring a measure of consistency to the performance of all the asset classes. Covered bonds have suffered but without exception so has every part of the market.

Photograph kindly supplied by Merrill Lynch, December 2008.

the dynamics of the market and how it might evolve in future, the village people nature of the sector will fundamentally endure, although questions will be asked as to which syndicate teams and trading groups will handle covered bonds in future. Those questions can only be answered once markets reopen and a clearer view is formed of how investors will re-calibrate their

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thoughts and expectations of relative value. Expect a debate in due course.

year tenor, although very gradually given the increased competition from agencies and guaranteed bank bonds.

DR. LOUIS HAGEN: The current crisis has clearly

TED LORD: Many covered bond issuers are looking for the opportunity to come to the market should conditions improve. The stronger names with solid business models should lead the way in the tough markets for 2009.

Investors want to purchase names that can keep doing a profitable business in the current climate and those firms that are not too highly leveraged.

demonstrated that covered bonds have been able to withstand the earth quake when other funding markets especially structured products had already been destroyed.

Within the covered bond family again we saw a substantial spread differentiation with some products showing more resilience than others. Since September we are in a situation in which it seems that almost only government products or government guaranteed products are able to attract a wider audience. But even within the government sector there is a wide range of differentiation.

CARLOS STILIANOPOULOS: The strengths of the

Covered Bond product has been highlighted by current market conditions. Even though spreads have widened substantially, demand has remained relatively strong during this period. There have been many private placements done in the Covered Bond market lately, and this shows there is still investor appetite for the product which cannot be said for other asset classes. The reason for this? Probably because of the strength of the product in itself.

Given the depth of the current crisis, how might it impact on the covered bond market in the immediate term?

TIM SKEET: The once homogeneous asset class has definitively splintered by geography, structure and issuer into a hitherto unanticipated pattern. Each jurisdiction makes claims about the robust nature of its domestic bonds, although investors do not always appear to be swayed by the arguments. Divergent nominal trading levels in the secondary markets illustrate this. Gone probably forever is the notion that this is a unified asset class. This realisation represents furthermore a challenge which will require more work on the part of investors. Let us hope that the market, with its cadre of analysts supported in future by credit and macroeconomic specialists, will rise to this. Better communication, greater transparency and attention to the mechanics of transactions will be required.

The way that this will impact spreads and where the asset class trades relative to senior unsecured or agency debt is not clear. Nevertheless, the degree of government support, specific laws in many cases, and security on the back of prime bank credits should combine to preserve the premium quality status of most of the asset class. Market practitioners can still dream on.

What does the issuance calendar look like for the rest of this year and for the first half of 2009?

DR. LOUIS HAGEN: We do expect issuance to gain

momentum in 2009 especially in maturities beyond the 3-

FTSE GLOBAL MARKETS â&#x20AC;˘ JANUARY/FEBRUARY 2009

Why did registered covered bonds become more popular over the summer of 2008? Was it to avoid any mark to market adjustments? Or is that too simplistic and where other issues in play?

DR. LOUIS HAGEN: Registered bonds are an important

pillar of the Pfandbrief market. About one third of 840 billion Euro Pfandbrief outstanding comes in registered format. Registered Pfandbrief offer more flexibility to many institutional investors like insurance companies and other banks given they do not have to mark them to market. In times of severe dislocations like today institutional investors resort to registered bonds given the lack of any indication of fair values. In addition most registered Pfandbrief are tailor made at the request of the investor.

Was the jumbo covered bond market more or less impacted by the crisis than other covered bonds?

TIM SKEET: Trading had been one of the marketâ&#x20AC;&#x2122;s key attractions. Jumbos offered a real sense of liquidity relative to other asset classes. The jumbo market-making conventions in force proved excellent for fair weather trading, but exacerbated the spiral when the winds turned.

Now the market is wrecked, how best should the traders set about moving forward? Optimists point to the fact that members of the trading community are taking the initiative and moving towards more open and modern trading standards that suit variable market conditions better. It is likely that although Jumbo trading and that sector of the market will revive in due course, more flexible issue sizes may emerge into the mainstream, offering issuers greater control over maturities, and investors more choice on spread and other parameters. Rating agencies may encourage this in order to alleviate refinancing risks. It is therefore possible that issues of say â&#x201A;Ź500m will be more frequently seen in future and more flexible taps (as seen recently in the Pfandbrief sector).

DR. LOUIS HAGEN: One cannot compare the Jumbo

market with the traditional market. The Jumbo model aims at providing liquidity to the investor whereas traditional Pfandbrief does not. The liquidity of the Jumbo Pfandbrief was impacted first having proven its resilience quite a long time after the crisis loomed in summer 2007 when spreads had remained almost unaffected as had volumes.

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We see continued investor demand for UK and Dutch covered bonds, but for mainly the stronger names.

How much was the European covered bond market impacted by the mark to market write-downs that impaired other structured products? How much was the mark down of asset backed securities elsewhere affecting new issue premiums and/or trigger price adjustments of new covered bonds?

TED LORD: The mark-to-market principle has had an effect on the covered bond market - especially those covered bond markets where the spread widening has been the most significant. Firstly, the general spread widening has led to performance problems against certain indexes resulting in investor redemptions at the major fund managers. Since many of the securitised markets shut, the investors needed to sell what they could and sold the covered bonds.

Typically, covered bonds have enjoyed the highest ratings. In the aftermath of this current credit crisis, what challenges will ratings agencies face in providing ratings for new covered bond issues? Are ratings consistent, for example, across different agencies in the covered bond segment? Should they be?

Ted Lord, managing director and head of covered bonds, Barclays Capital. According to Lord, throughout the credit crisis and liquidity problems facing many sectors of the capital markets, investors have maintained their faith in the covered bond asset class. Investors still purchase covered bonds in private placement format and in the secondary market. Du to the liquidity problems in the secondary market however, some investors are seeing covered bonds more as a credit product and not as much as a rates/government bond surrogate product. Photograph kindly supplied by Barclays Capital, December 2008.

In 2008 we saw legislation passed which created legal frameworks for the issuance of covered bonds in the United Kingdom and the Netherlands. Current market conditions aside, what is the view of the possibilities offered by these markets?

TED LORD: There is trend among many covered bond issuers to prefer those covered bonds covered by a legal versus solely on a contractual relationship. In this respect, the moves to have a legal framework for covered bonds in the United Kingdom and the Netherlands is a positive step.

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TIM SKEET: We should not underestimate the impact of evolving rating agency attitudes. With stress in the cover pools, stress at the level of the parent banks and significant stress in refinancing capacity and liquidity, the AAA status of some parts of the market can no longer be taken for granted. This is something that will need to be addressed by the industry and investor expectations will need to be managed accordingly.Governments have consistently supported and sponsored the product, not just in Germany but elsewhere. Investors should take note.

Nevertheless, with the ratings pressure and investor jitters, governments need to remain vigilant that the product will continue to benefit from their support. There are good political reasons for this in view of the role this product plays in housing finance in Europe.

NICHOLAS LINDSTROM, MOODY’S INVESTOR SERVICES: The key challenge in the current market is in

the approach to rating risks. Where ratings between the rating agencies differ, typically Moody’s has the lower covered bond ratings. We believe the primary reason for this may be that we are more focussed on refinancing risk than the other agencies. As already seen during the credit crunch, refinancing risk can be a very volatile risk, and this risk is arguably one of the cornerstones of the credit crunch. The vast majority of covered bonds are “bullet bonds” (i.e. exposed to refinancing risk). Refinancing risk arises following the default of the bank supporting a covered bond. When this happens, the covered bond must be repaid from the assets backing the covered bond. For

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“bullet bonds”, the natural amortisation of the assets cannot be relied on to repay the bonds. This means that funds need to be raised against the assets backing the covered bond – possibly through the firesale of the assets.

The discount on the price achieved to complete such a firesale of the assets, in the potentially stressed environment following the default of the bank that originated these assets, is referred to as refinancing risk.

Because of the uncertainty surrounding this “refinancing risk”, Moody’s does not believe that there is a very high certainty that a“bullet”covered bond would receive full and timely payment following the default of the bank supporting the covered bond. This is the primary reason that if the supporting bank falls below a certain rating level, then a Moody’s covered bonds rating will usually start migrating.

Moody’s has published the rating levels of the supporting banks which are expected to constrain the rating level of the covered bonds.

Some markets do not suffer such material refinancing risks. For example, in Denmark, the majority of covered bonds are pass-through bonds, which means that following the default of a bank supporting a covered bond, the covered bonds should be able to rely on the natural amortisation of the assets to pay them back – i.e. the requirement for a firesale of assets into an illiquid market is much more remote.

Will these challenges be the same across all types of covered bonds? Or are Jumbo bonds, or bonds with cross-border pooled assets, for example, different?

NICHOLAS LINDSTROM: Refinancing risks vary deal by

deal and jurisdiction by jurisdiction. The extent to which refinancing risk is dealt with tends to be different under different covered bond laws. Further, refinancing risk varies deal to deal, for example based on the average life of the assets, and the type and quality of assets included in a cover pool. Some markets do not suffer such material refinancing risks. For example, in Denmark, the majority of covered bonds are pass-through bonds, which means that following the default of a bank supporting a covered bond, the covered bonds should be able to rely on the natural amortisation of the assets to pay them back

If you enjoyed this article, or any other in this edition of FTSE Global Markets and would like reprints, please contact Paul Spendiff, Director, Berlinguer Ltd Telephone: 00 44 207 680 5153 Email: paul.spendiff@berlinguer.com Fax: 00 44 207 680 5155 We will be pleased to help you.

FTSE GLOBAL MARKETS • JANUARY/FEBRUARY 2009

Are there instances of covered bond ratings delinking from the issuer and other categories of its debt exposure? Is this feasible going forward?

NICHOLAS LINDSTROM: Currently Moody’s does not rate any covered bond as delinked. However, if a covered bond structure was sufficiently sound, a delinked rating could be assigned. It is easier to envisage a structure without refinancing risk achieving a“delinked”rating than a structure that suffers from“refinancing risk”.

How might approaches to ratings change going forward?

NICHOLAS LINDSTROM: The current extreme climate has

also highlighted the volatility associated with “refinancing risk”, a risk that the vast majority of covered bonds are exposed to. In response to this risk Moody’s has updated some of the refinancing stresses it applies to covered bond programmes.

Looking forward, given the nature of the product, do we anticipate an early revival?

TIM SKEET: The key question remains as to when the covered bond market will revive. A general expectation is that it will be amongst the first of the asset classes to revive, although precise timing will depend heavily on the passage of the government guaranteed bonds and success of the financial bail outs. The second quarter of 2009 appears to be the current hope. Investors will also be seeking assurances on the supply situation as the risk of substantial supply in to a shrinking investor base was at least one factor that penalised some parts of the sector previously. Supply will need to be carefully handled, and market participants will have to be attentive to the conflicts of interest that will arise between competing issuers. Contracting bank balance sheets, de-leveraging and economic slowdown present macro-economic constraints on supply, but investors will need to understand how these influences translate into numbers. Still, regulatory pressure on banks to raise and maintain liquidity and push out maturities, combined favourable treatment of the covered bond as an asset for those additional liquidity reserves, bringing more of this group of product buyers back to the game, should provide a solid basis for the return of the asset class.

CARLOS STILIANOPOULOS: We have to go a step at a time. Currently the appetite is for Government Guaranteed Bonds, and I am afraid this will last for at least the first six months of 2009. Probably the next asset class to come back to the market, in a substantial enough size, will be the Covered Bond market. However, the question is in what form will it come back? Will it be mainly in jumbo deals or small targetted placements? What will hapen with the market making commitments? There will be too many questions and it is still too soon to know the answers.

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THE EXPANDING WORLD OF ETFS 80

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The world of exchange traded funds (ETFs) is still an open book. As investment trends diversify and change in the post credit crunch world, the increasing focus on transparency, cost efficiency and risk mitigation has created ideal conditions for a resurgence in index based investible products, not least ETFs which are flexible enough to accommodate varied asset classes.

Imogen Dillon Hatcher, managing director, Europe, FTSE Group, outlines the key trends.

Investors looking to diversify their portfolios should be aware, as competition among providers ripens, that the number of ETFs based on indices in innovative areas such as emerging markets, real estate and investment strategies is growing considerably. With such a variety of product on offer, choosing the right product can be confusing. Photograph © Thea Walstra/Dreamstime.com, supplied December 2008.

INDICES: THE ETF DRIVER VER THE LAST few years exchange traded funds (ETFs) have evolved to become an institutional investment tool of choice across the globe.

Nowadays they are regarded as a straightforward, low cost and flexible way to access the potential rewards of the market. When looking at transparency in particular, which is becoming key in the current market, it is believed ETFs are a preferred choice over many other financial products according to Deborah Fuhr’s ETF and ETP Industry Highlights Q3 2008 (produced by Barclays Global Investors) and ETF assets under management (AUM) is expected to exceed $1trn in 2009, rising to $2trn by 2012.

With such a rapid pace of growth and a magnitude of funding, ETFs are now available for almost every niche and market, allowing investors to explore new and inventive areas of investment. Index providers are also a vital part of the ETF story, and many index providers including FTSE Group have had great success in the creation of indices to support these products. As ETFs are designed to sit on or track an underlying index, in order for their performance to mirror a broader stock universe, they are often based on an accepted benchmark, with the index contributing to the market acceptance and understanding of the investment opportunity. FTSE Group believes that an independent rules-based index design provides the market with the highest level of transparency and confidence needed, while index liquidity rules ensure a more than acceptable level of ETF liquidity.

Investors looking to diversify their portfolios should be aware, as competition among providers ripens, the number of ETFs based on indices in innovative areas such as emerging markets, real estate and investment strategies is growing considerably. With such a variety of product on offer, choosing the right product can be confusing. Even so,

O

the due diligence or work involved in making the right choice for a particular portfolio should not outweigh the benefits that can be derived from innovation that is based upon a recognised index. In addition, with increasing competition among ETF providers, investors must ensure they remain informed about the technical workings of ETFs. This is becoming ever more important in a time when volatility is high and where there is a noticeable movement away from active to passive asset management (particularly as factors such as rising fees and transparency become additional considerations). In the current dynamic climate ETFs are not only seen as attractive but also as a vital component of an effective risk managed strategy.

ETF providers have committed generous marketing budgets on promoting their ETFs, with names such as BGI iShares, Lyxor and DB x-trackers dominating the market.

However, while having confidence in the ETF provider is critical for investors, the choice of the underlying benchmark is also important. Investors need to pay increasing attention to the accuracy and methodology of those indices which are used as the basis for ETFs. In times of market uncertainty, in particular, those ETFs tracking effective benchmarks from reputable index providers will continue to offer investors a low cost and transparent way to gain exposure to different markets.

Innovation: A new game plan The current environment creates a real opportunity for ETFs growth and at FTSE Group there is a strong feeling of resurgence for index tracked investments from asset owners.

This, teamed together with a rise in innovation in order to best deal with current market trends has created a marked interest in the concept of wrapping investment strategies within indices. One such approach is the use of shorting

JANUARY/FEBRUARY 2009 • FTSE GLOBAL MARKETS

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strategies and FTSE Group has expanded its range of short and leveraged indices; FTSE’s 100 Short Index serves as the basis for DB x-trackers FTSE 100 Short ETF, as part of its short ETFs range. The new indices allow money managers to exploit volatility in the UK market by allowing investors to go short the market or gear up. The indices will serve as the basis for ETFs, benchmarks and other index-linked financial products and are an extension of FTSE Group’s range of investment strategy indices that are designed to provide asset managers with strategic investment tools.

Another area where indices are making headway is in the emerging and frontier markets such as Africa and the Middle East. Emerging and frontier markets are areas in which many index providers have a growing presence. This divergence from the developed world towards the new geographies reflects the eagerness of investors to ensure they can achieve a well diversified portfolio while, at the same time, having the confidence of being able to rely on a transparent methodology they can track. ETF providers are no strangers to this fact. As a result, there has been an explosion of country based ETFs from the BRIC countries down to the Sub Saharan region of Africa and across the Middle East, such as the Lyxor ETF based on the FTSE Coast Kuwait 40 Index.

This move also ties in well with the increase in the number of stock exchanges around the world that are bidding to create new regional and partner indices in order to gain market exposure to an international investment community and which provide the underlying infrastructure for such ETFs. As a global index provider, FTSE Group works with over 18 stock exchanges across the world to provide indices created to enhance growing economies, such as that achieved with the JSE (South Africa) and ATHEX (Greece). Such partnerships are a perfect example of the potential successes from combining domestic know-how with international distribution to bring innovative product to market.

Simultaneously amid the tumultuous conditions the industry is faced with, index providers are now more than ever a much needed auxiliary to banks’ in-house quant teams who choose not to solely manage and calculate proprietary indices. Increased collaboration between these two parties can prove mutually beneficial, with banks profiting from credible products based on objective third party run indices and the index provider gaining new business opportunities. These trends have largely been driven by the growing requirement among investment firms for transparency, risk management and cost efficiency.

Moreover, it is also increasingly important these days within the industry to harness real and focused expertise.

Equally, the world of indexing has moved on considerably and over the past few years at FTSE Group, there has been a wave of index innovation from the introduction of the much lauded Sharia compliant indices and infrastructure indices to the creation of indices that cover issues such as responsible investment. Most recently there has been significant development undertaken on environmental technology indices. In combination, all of

FTSE GLOBAL MARKETS • JANUARY/FEBRUARY 2009

Imogen Dillon Hatcher, executive director, FTSE Group. Photograph kindly supplied by FTSE Group, December 2008.

these are ripe for and have formed the basis of structured products such as ETFs. The creation of new ways to benchmark has not stopped at existing asset classes either. Alternative asset classes such as real estate investment trusts (REITs) and hedge fund of funds (HFoF) have also taken off and these have gone some way to provide investors with greater choice over and above the traditional equity class.

Indices, ETFs and the future With transparency being the buzzword of the moment, it is clear that both index and ETF providers must work together to ensure investors are not only served but also kept informed and educated. The use of open and transparent rules driven methodology in addition to independent index committees (made up of market practitioners) is vital for a healthy and most importantly tradable index, a philosophy which FTSE Group applies across its 120,000 indices. With a migration towards passive management and a resurgence of portfolio rebalancing, it is evident that indexing is a first choice for investors looking for that long term investment in a transparent, risk managed and cost effective way.

The ETF market, in common with all areas of the financial arena, becomes ever more competitive and in our view is nowhere near saturation. ETF players are ensuring healthy competition through increasing innovation, creating original products driven by investor demand.

They will continue to add credibility to this investment segment and emphasise the benefits of a ready-made diversification of index tracking with the ease and flexibility of trading shares.

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ETCs gain as commodities remain popular In an inaugural regular commentary on the rise of the exchange traded fund (ETF) industry, we look at the key trends in exchange traded commodities (ETCs) as well as ETFs through the recent holiday period. Not surprisingly, given the continued volatility in global equities in recent months, investors continued to build positions in ETCs, particularly in gold and oil. While traditional equity based ETFs have been relatively quiet, and equity based ETFs have been impacted by some of the outflows suffered by equity based mutual funds and hedge funds, some market watchers think that by and large, equity ETFs have maintained inflows, though overall assets held in ETFs have fallen. What are likely to be the key trends in the first half of 2009?

XCHANGE TRADED COMMODITIES (ETCs) have reportedly begun the New Year on a upbeat note as investor sentiment continued to favour commodities, cash and foreign exchange over traditional equities as 2008 drew to a close. Specialist ETC and ETF provider ETF Securities, says it has seen continued strong inflows into ETCs since early November last year. By mid December the firm reported that $323m had flowed into a range of ETCs including precious metals, energy and industrial metals, comprising inflows of $403m into long ETCs including Classic, Forward and Leveraged ETCs and outflows of $80m from Short ETCs. Oil inflows continue to be strong and continued to dominate the ETC sector. Inflows into long oil ETCs rose by $218m in late October and early November last year reversing the strong outflows during August and September. Over the period, energy ETCs saw some $225m of inflows, compared with the outflow of some $30m from short energy ETCs, say ETF Securities analysts, with energy ETCs contributed 53% to the total net long position added to ETCs. Physical metals, such as gold and platinum recorded similar tends, while industrial metal ETCs also saw some smaller scale inflow activity. In total, $13m of long industrial metal ETCs were added. However the largest trades were seen in outflows of short industrial metal ETCs. Short industrial metal ETCs experienced outflows of $25m. This equates to a net long position of $38m being added to industrial metals, says the firm.

The driving factors behind commodity prices in 2008 included increasing demand, particularly from China and other emerging nations, numerous supply related issues, and the global financial crisis which caused a sell off in

E

virtually every asset class. Over the past 12 months, gold appears to have been the standout performer with a return of approximately 2% in US Dollars, 37% in sterling (though that percentage will have risen as the British currency continues to dive) and 18% in Euros. Over the longer term, commodities have outperformed almost every other asset class, with energy and precious metals some of the top performers over the last five and ten years. Grains and precious metals were also featured among the top performers over the past three years.

According to Nik Bienkowski, chief operating officer (COO), at ETF Securities: "Inflows into ETCs over the past five weeks shows that many investors are still interested in a wide range of commodities despite the recent pull back as a result of the weakening economy. $323m of inflows into ETCs over five weeks is a good achievement in any market. … With oil having fallen from $147 per barrel to around $45 per barrel, many investors now see this as a long term buying opportunity. While demand for oil has fallen, longer term supply issues still exist such as falling production, falling reserves and a shortage of skilled workers. Regardless of an investor's view, ETF Securities offers both long and short ETCs which enable investors to profit in a rising or falling market.”

Barclays Global Investors (BGI), citing data verified up to the end of November 2008 noted a largely positive 11 month period, and posited an improved outlook for ETFs through 2009. In the current market turmoil investors are becoming even more concerned about counterparty risk, transparency, liquidity and the use of derivatives and structured products, notes Deborah Fuhr in a recent release. At the end of November 2008 the ETFs industry had 1,539 ETFs with 2,580 listings, assets of $633.83bn, managed by 86 managers on 42 exchanges around the world, with ETFs increasing overall by 31% with over 414 new launches through 2008. However, Fuhr notes that assets fell by 20.4%, though she says it is less than the 43.80% fall in the MSCI World index in US dollar terms.

Moreover, the use of ETFs to implement exposure to cash, fixed income, commodities and equity indices is becoming more popular, she notes. Fuhr also points out that the use of ETFs is likely to increase significantly by independent financial advisers (IFAs) in the UK based on the regulatory proposals outlined in late November last year in the Retail Distribution Review (RDR) feedback statement by the UK’s Financial Services Authority (FSA), the official regulator.

Fuhr adds that there are plans extant to launch some 570 new ETFs in train, of which the bulk are in the United States (469) and the rest in Europe.

JANUARY/FEBRUARY 2009 • FTSE GLOBAL MARKETS

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REAL ESTATE REPORT: THE IMPACT ON LONDON

Photograph © Jon Le-bon/Dreamstime.com, supplied December 2008.

Arabian Knights to the rescue?

The City of London’s real estate market has been hit hard twice. Along with the rest of the UK real estate market it has suffered from the fundamental triggers of this recession: the imbalances that have built up during the past decade, the hyper-inflated values of housing and commercial property and the overavailability of credit. It is starting to look eerily similar to the market depression of the early 1990s. The difference this time round is that the City is wooing money from all around the world and one of its biggest investment targets is the cash-rich Middle East. Mark Faithfull reports.

HE CITY OF London and its neighbouring areas were always at risk from a sharp real estate downturn. The type of building required by occupiers is typically on such a scale that to acquire a site, secure planning, demolish existing buildings and then construct is by its nature a drawn-out process. Consequently, the decision to develop is often taken in a very different market from the one in which the project is delivered.

T 84

Although the development pipeline is not as super-heated as it was in the last recession, the figures do not make for comfortable reading. Agent Jones Lang LaSalle (JLL) warns that 3.7m ft² of speculative office space is due for delivery in the next 18 months. Some 5.7m ft² of office space is already sitting empty, up 12% in the third quarter of 2008. This puts the vacancy rate in the City at 5.5% and JLL predicts this will more than double by 2010, with rents falling from a peak of more than £65 a ft² last year to about £47.50. CB Richard Ellis (CBRE) has an even gloomier prognosis, predicting a total of 6.5m ft² of new development, which will send the availability rate rise to 13% in the City. It forecasts prime office rents will decline for the next two years, falling by 22% to the end of 2010 and then recovering to regain their end-2007 level by 2013, although it warns there are“substantial downside risks to this scenario”.

Cushman & Wakefield reports that a total of 16 deals were completed totalling around £550m during the third quarter of 2008 in the City, down 50% from the second quarter and just 10% of 2007’s third quarter turnover.

Moreover, the City of London could lose 62,000 jobs by the end of 2009, wiping out all the growth of the last 10 years, the Centre for Economics and Business Research warns.

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Employment in London's financial district will have fallen by 28,000 in 2008, with a further 34,000 to go in 2009 as a result of the credit crunch. The slump could take the City back to levels last seen in 1998.

That is the bad news and there is plenty of it. However, over-development is nowhere near as excessive as in the 1990s and lest we forget, last time round Canary Wharf and London Docklands were coming on line, offering huge amounts of space to rival the City’s dominance. So in 2008 take-up, while clearly down, is still expected to reach 4m ft², compared with a five-year average of 5m ft² to 6m ft².

What the City needs is alternative financing and in an age where it has traded on globalisation, appropriately enough it has turned to the cash-rich emerging nations, with the Middle East a particular target. Can and will the Gulf respond positively? “To date, the City market has performed differently to the West End market, in the style of Middle Eastern money that it has attracted,” says Andrew Hawkins, a director in JLL’s City investment team.

“The West End market has been characterised by more active private wealth management or royal family money, but has largely been focused on wealth preservation in the super-prime markets of Mayfair and St James. Examples include the Saudi Arabian royal family (Lancer Trust) buying 50 Stratton Street for £130m on a 5% yield.

Similarly, a private Middle Eastern investor acquired 63 St James’s Street, for £31.12m, again reflecting a yield of 5.00%,”says Hawkins.

This, he says, contrasts with the City, where Middle Eastern investors have been seeking to move further up the risk curve. In particular, Hawkins cites an appetite from ‘petro-dollar’ investors for development opportunities.

Amid the turmoil the City has scored extraordinary successes for landmark developments, with a strong Gulf connection. For example, the State General Reserve Fund of Oman is one of three investors behind Heron’s development at Heron Tower on Bishopsgate. Likewise, a syndicate of Middle Eastern private family houses and institutional investors is backing Arab Investments' proposed development at The Pinnacle, also on Bishopsgate. Finally, the Qatari royal family is the dominant partner behind Irvine Sellar’s development of the Shard, on the Southbank.

Peter Damesick, head of UK research, CBRE says that “Within Europe, the UK, and London in particular, maintained its absolute attractiveness to Middle Eastern money in the first half of 2008 compared to 2007. At the same time Middle Eastern investors have increased in importance within the property investment market which is showing substantially lower volumes,” says Peter Damesick, head of UK research, CBRE. CBRE Research shows that in the first half of 2008 Middle Eastern investors spent £1.3bn acquiring UK real estate, which represented 73% of all Middle Eastern investment in Europe, with London alone accounting for 60%.The UK and London’s shares of Middle Eastern investment in Europe in H1 2008 were double those in 2007. In the City office

FTSE GLOBAL MARKETS • JANUARY/FEBRUARY 2009

market, Middle Eastern investors spent £530m in 2008 to the end of the third quarter, compared to £524m in the whole of 2007. The Middle Eastern share of total investment in the City office market by the end of November 2008 was 22%, compared to 7% through the whole of 2007.

Headline projects Headline projects have provided another fillip. HSH Nordbank extended a loan used to purchase the Pinnacle tower site in the City for another year, as developer Arab Investments pushes ahead with its speculative development plans. The German bank funded the £200m purchase of the site in May last year, from German fund manager Union Real Estate, for a consortium fronted by Arab Investments. Arab Investments plans to develop the Kohn Pedersen Fox-designed scheme in Bishopsgate area and the 945 ft Pinnacle will be one of London’s tallest towers. It will have 63 floors and around 1m ft² of office space. At the start of 2008 privately-owned Sellar Property Group defied the critics and the credit crunch to secure funding for their enormous London Bridge Shard concept.

It is a project with which they have become synonymous and began with the fractious partnership with former development partners Simon Halabi and CLS Holdings, which became immersed in lawsuits and an expensive and long-drawn-out public planning inquiry.

The entire 2m ft² scheme was almost derailed when Sellar attempted to secure funding just at the moment the world’s credit markets plunged into crisis. But in January Sellar clinched backing from a consortium of four Qatari banks (Qatar National Bank, Q-Invest, Barwa International and the Qatar Islamic Bank) to bankroll the ambitious Renzo Piano-designed scheme.Four Qatari banks snapped up 80% of the Shard's development rights at a very competitive price of less than £100m. However, to secure the deal Sellar had to reduce its holding of development rights from one third to 20%. Government-owned Transport for London is the key tenant in a 200,000 ft² office pre-let on an initial £38/ft², rising to £42/ft² on completion. It accounts for about a third of the initial office provision. However, Sellar was unable to retain accountant PricewaterhouseCoopers, the original tenant at Southwark Towers, which will make way for the Shard, and had to pay £70m to buy in the long lease.

With huge schemes still getting the green light the City’s demise it not yet set in stone. Despite conjecture about whether the current crisis will weaken the City, London sits in the most opportunistic time zone to serve both the Asia Pacific and North American markets. Moreover, London is one of the few global cities whose population is forecast to continue to grow and has an infrastructure which is thousands of years old,” stresses JLL’s Hawkins. “Cities are about people and talent. While talent can be attracted by financial rewards, there will always be a significant element of the employment market that is driven by a wider more nebulous concept, namely quality of life for family, schools and culture, all of which London has in spades.

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EUROPEAN TRADING STATISTICS

THE FIDESSA FRAGMENTATION INDEX (FFI) The Fidessa Fragmentation Index (FFI) was designed to provide the trading community with an accurate, unbiased measurement of the state of liquidity fragmentation across the order driven markets in Europe. Liquidity is fragmenting rapidly as new MTFs have unveiled a range of low cost alternative trading platforms. It is essential for both the buy and the sell side to understand how different stocks are fragmenting across the new venues. To make it easy to measure and compare fragmentation across Europe, the Fragmentation Index provides a single number to show how a stock or index is fragmenting. It is calculated using proven mathematical principles and shows the average number of venues that should be visited to achieve best execution when completing an order. An FFI value of 1 therefore means that the stock is still traded at a primary exchange. An FFI value of 2 or more shows that the stock has been fragmented significantly and can no longer be regarded as having a primary exchange. The FFI is calculated daily across all the constituents of the major European indices; which illustrates how many stocks are fragmenting and the rate at which they are doing so.

Electronic order book trades in major stocks: April through November 2008 (Europe only) Apr

May

Jun

Jul

Aug

Sep

BTE/BATS CIX/Chi-X

37,304,564,510

37,670,297,814

CPH/Copenhagen

4,706,051,470

ENA/Amsterdam

54,969,452,411

ENB/Brussels

Oct

Nov

12,912,601

1,692,679,055

50,543,504,106

69,784,319,667

65,485,105,599

100,401,073,369

106,153,062,152

55,474,806,309

5,630,036,158

5,036,109,648

6,845,034,577

6,715,541,919

9,088,419,945

9,799,125,787

5,627,172,892

44,058,608,934

53,130,208,269

58,889,709,527

40,078,363,113

62,969,948,029

58,477,575,182

29,515,979,897

10,873,940,327

10,035,942,732

11,266,781,699

11,264,584,729

7,769,551,527

12,362,582,317

10,689,261,202

5,618,466,860

ENL/Lisbon

4,835,970,481

4,053,264,202

4,289,780,382

5,217,860,359

3,265,459,550

4,358,621,402

4,105,636,725

2,613,601,564

ENX/Paris

113,356,288,859

98,370,505,430

118,794,877,669

130,727,562,834

89,561,950,040

143,845,030,869

158,687,540,849

83,259,044,929

GER/Xetra

119,047,141,851

100,116,783,024

117,572,355,884

138,538,693,267

96,074,671,382

171,318,595,178

206,777,148,040

86,619,580,417

HEL/Helsinki

21,258,871,334

14,474,306,434

15,704,074,093

16,983,014,044

11,476,253,210

18,654,125,589

19,248,238,567

10,391,280,842

LSE/London

188,767,416,200

171,362,331,104

198,850,156,278

228,447,427,572

154,886,443,195

240,104,147,083

218,235,697,409

128,535,134,938

MAD/Madrid

72,167,290,723

59,767,720,389

73,739,528,010

76,936,873,296

44,029,717,439

79,041,830,393

86,557,745,208

47,772,645,094

MIL/Milan

88,069,977,469

115,732,058,029

76,999,997,645

68,998,216,420

47,007,014,009

103,999,753,619

69,520,744,329

40,577,825,970

17,962

45,339,983

138,799,631

NEU/Nasdaq-OMX STO/Stockholm

41,237,977,314

31,944,689,500

28,218,322,073

28,711,580,518

TRQ/Turquoise

22,502,159,413

35,401,145,511

34,318,445,867

20,077,565,709

311,082,282

17,716,364,835

27,088,688,572

19,577,155,245

VTX/SWX

70,145,373,130

55,750,343,806

67,560,353,571

72,309,962,390

48,685,822,760

79,997,213,817

86,469,471,856

45,647,116,803

Grand Total

826,740,386,972

749,478,220,996

822,387,304,850

914,539,760,442

638,420,599,362

1,080,717,983,703

1,099,954,393,992

584,468,357,214

% Market share in electronic order book trades in major stocks: April through November 2008 (Europe only)

86

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

BTE/BATS

0.00%

0.00%

0.00%

0.00%

0.00%

0.00%

0.00%

0.29%

CIX/Chi-X

4.51%

5.03%

6.15%

7.63%

10.26%

9.29%

9.65%

9.49%

CPH/Copenhagen

0.57%

0.75%

0.61%

0.75%

1.05%

0.84%

0.89%

0.96%

ENA/Amsterdam

6.65%

5.88%

6.46%

6.44%

6.28%

5.83%

5.32%

5.05%

ENB/Brussels

1.32%

1.34%

1.37%

1.23%

1.22%

1.14%

0.97%

0.96%

ENL/Lisbon

0.58%

0.54%

0.52%

0.57%

0.51%

0.40%

0.37%

0.45%

ENX/Paris

13.71%

13.13%

14.45%

14.29%

14.03%

13.31%

14.43%

14.25%

GER/Xetra

14.40%

13.36%

14.30%

15.15%

15.05%

15.85%

18.80%

14.82%

HEL/Helsinki

2.57%

1.93%

1.91%

1.86%

1.80%

1.73%

1.75%

1.78%

LSE/London

22.83%

22.86%

24.18%

24.98%

24.26%

22.22%

19.84%

21.99%

MAD/Madrid

8.73%

7.97%

8.97%

8.41%

6.90%

7.31%

7.87%

8.17%

MIL/Milan

10.65%

15.44%

9.36%

7.54%

7.36%

9.62%

6.32%

6.94%

NEU/Nasdaq-OMX

0.00%

0.00%

0.00%

0.00%

0.00%

0.00%

0.00%

0.02%

STO/Stockholm

4.99%

4.26%

3.43%

3.14%

3.52%

3.28%

3.12%

3.44%

TRQ/Turquoise

0.00%

0.00%

0.00%

0.00%

0.05%

1.64%

2.46%

3.35%

VTX/SWX

8.48%

7.44%

8.22%

7.91%

7.63%

7.40%

7.86%

7.81%

Grand Total

100.00%

100.00%

100.00%

100.00%

100.00%

100.00%

100.00%

100.00%

JANUARY/FEBRUARY 2009 â&#x20AC;˘ FTSE GLOBAL MARKETS

GM EDITORIAL 31.qxd:Issue 31

6/1/09

16:19

Page 87

TRADING DATA FOR MID DECEMBER 2008 (EUROPE ONLY) Venue turnover on the 16th December 2008

Index market share by venue as of 16th December 2008

Venue

Trades

Turnover € 000's

Share

London

568,413

4,251,708

20.11%

Xetra

163,028

3,273,703

15.49%

Paris

284,185

3,026,720

14.32%

Chi-X

330,286

1,929,602

9.13%

Madrid

89,375

1,798,618

8.51%

SWX

92,050

1,754,416

8.30%

Milan

117,759

1,234,710

5.84%

Turquoise

148,958

1,046,458

4.95%

Amsterdam

102,796

1,018,204

4.82%

Stockholm

56,901

742,664

3.51%

Helsinki

35,489

368,062

1.74%

Brussels

40,710

272,433

1.29%

Copenhagen

14,224

164,686

0.78%

BATS

37,436

164,267

0.78%

Lisbon

14,957

78,734

0.37%

Nasdaq OMX

2,706

12,893

0.06%

%

I I I I I I I I I

BATS Chi-X Copenhagen Amsterdam

1,692,679,055 55,474,806,309 5,627,172,892 29,515,979,897

Brussels Lisbon Paris Frankfurt Xetra

5,618,466,860 2,613,601,564 83,259,044,929 N/A 86,619,580,417

I I I I I I I I

Helsinki London Madrid Milan Nasdaq-OMX Stockholm Turquoise SWX

10,391,280,842 128,535,134,938 47,772,645,094 40,577,825,970 138,799,631 20,077,565,709 19,577,155,245 45,647,116,803

Index Market Share by Venue as of 16th December 2008 Primary

Alternative Venues

Index

Venue

Share

AEX

Amsterdam

78.56%

BEL 20

Brussels

CAC 40

Paris

Chi-X

Turquoise

Nasdaq OMX

BATS

Copen.

Amst.

Paris

Xetra

13.67%

6.35%

0.03%

0.74%

94.46%

3.99%

1.44%

0.02%

0.06%

81.24%

11.76%

5.54%

0.05%

0.84%

1 1

0.03%

1

1

DAX

Xetra

83.35%

9.71%

4.87%

0.04%

0.64%

FTSE 100

London

75.42%

14.66%

7.96%

0.14%

1.81%

FTSE 250

London

89.03%

9.89%

0.05%

0.14%

0.89%

IBEX 35

Madrid

99.84%

MIB 30

Milan

94.25%

2.37%

2.90%

0.02%

0.19%

NORDIC 40

Stockholm

54.55%

3.06%

2.44%

0.06%

0.01%

PSI 20

Lisbon

99.23%

SMI

SWX

91.33%

0.02%

0.01%

1

Helsinki

0.28% 1 0.35%

0.04%

12.10%

1

0.12% 0.68%

27.03%

0.77% 3.57%

5.06%

COMMENTARY Turquoise achieved over 10% market share in four FTSE 100 stocks by early December (Wolsey, Tesco, Drax and Kingfisher).

Interestingly, Chi-X had a good sliceof these stocks too and so it looks like the first hard evidence is emerging that some FTSE 100 stocks will fragment substantially over multiple MTFs. Most significant was that nearly 40% of Kingfisher (FFI 2.17) was traded away from the primary exchange on alternative MTFs. This is good news for new venues like BATS and Nasdaq OMX as it seems to indicate that there is no defined limit yet as to how far a stock will fragment away from its primary market. Some observers thought that the new MTFs would be crabbling over the same amount of “alternative” liquidity. In fact, it seems that the opposite is the case and that, as more alternative venues launch, then more and more liquidity will divert to the new venues. The bigger question, though, concerns viability. Just because an alternative venue can attract market share in some stocks there’s no guarantee that it can actually make money. Nasdaq is extending its net zero pricing model in “its determination to attract liquidity”. While this is to be applauded, new venues need to understand why some stocks fragment more than others and focus on these. History shows that there are no winners in wars of attrition. In Fidessa's view it is far better to find a niche and expand than it is to attack on all fronts.

All data © Fidessa Group plc.

All opinions and data here are entirely the responsibility of Fidessa Group plc. If you require more information on the data provided here or about FFI, please contact: fragmentation@fidessa.com.

FTSE GLOBAL MARKETS • JANUARY/FEBRUARY 2009

87

ETF Listings as of End November 2008

Ireland P Listings: T Listings: Managers: AUM:

Germany P Listings: T Listings: Managers: AUM:

Spain P Listings: T Listings: Managers: AUM:

Iceland P Listings: T Listings: Managers: AUM:

1 1 1 US$0.03 Bn

230 375 8 US$53.04 Bn

9 24 2 US$1.96 Bn

1 1 1 US$0.04 Bn

5 120 2 US$4.16 Bn

77 77 3 US$12.97 Bn

159 296 7 US$34.68 Bn

21 145 5 US$9.56 Bn

Switzerland P Listings: T Listings: Managers: AUM:

France P Listings: T Listings: Managers: AUM:

Canada P Listings: T Listings: Managers: AUM:

Mexico P Listings: T Listings: Managers: AUM:

1 1 1 US$0.71 Bn

688 688 19 US$443.83 Bn

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

Brazil P Listings: T Listings: Managers: AUM:

1 1 1 US$0.01 Bn

118 260 6 US$22.51 Bn

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

Slovenia P Listings: T Listings: Managers: AUM:

Belgium P Listings: T Listings: Managers: AUM:

Portugal P Listings: T Listings: Managers: AUM:

Italy P Listings: T Listings: Managers: AUM:

1 1 1 US$0.04 Bn

1 1 1 US$0.00 Bn

15 255 5 US$0.92 Bn

14 70 3 US$0.23 Bn

Netherlands P Listings: T Listings: Managers: AUM:

17 17 5 US$1.14 Bn

South Africa P Listings: T Listings: Managers: AUM:

Norway P Listings: T Listings: Managers: AUM:

Greece P Listings: T Listings: Managers: AUM:

Turkey P Listings: T Listings: Managers: AUM:

6 6 2 US$0.25 Bn

1 1 1 US$0.07Bn

6 6 2 US$0.12 Bn

1 1 1 US$0.00 Bn

Indonesia P Listings: T Listings: Managers: AUM:

Sweden P Listings: T Listings: Managers: AUM:

India P Listings: T Listings: Managers: AUM:

Australia

7 7 1 US$1.28 Bn

11 11 6 US$1.12 Bn

4 20 2 US$0.99 Bn

Finland P Listings: T Listings: Managers: AUM:

2 2 2 US$0.10 Bn

6 6 2 US$0.26 Bn

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

Hungary

P Listings: T Listings: Managers: AUM:

Austria

P Listings: T Listings: Managers: AUM:

Japan

P Listings: T Listings: Managers: AUM:

1 1 1 US$0.01 Bn

1 21 1 US$0.04 Bn

61 63 5 US$24.66 Bn

3 3 2 US$0.28 Bn

5 5 4 US$2.22 Bn

36 36 6 US$1.81 Bn

South Korea

P Listings: T Listings: Managers: AUM:

China

P Listings: T Listings: Managers: AUM:

Malaysia

P Listings: T Listings: Managers: AUM:

5 22 5 US$0.81 Bn

Singapore

P Listings: T Listings: Managers: AUM:

2 2 2 US$0.06 Bn

11 11 2 US$1.29 Bn

11 23 5 US$12.66 Bn

Hong Kong

P Listings: T Listings: Managers: AUM:

Taiwan

P Listings: T Listings: Managers: AUM:

Thailand

P Listings: T Listings: Managers: AUM:

Source: ETF Research & Implementation Strategy Team, Barclays Global Investors, Bloomberg.

P Listings: T Listings: Managers: AUM:

EXCHANGE TRADED FUNDS: LISTING & DISTRIBUTION AS OF END Q3 2008

JANUARY/FEBRUARY 2009 â&#x20AC;˘ FTSE GLOBAL MARKETS

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Page 88 16:34 6/1/09 ETF Data 31.qxd:.

ETF Data 31.qxd:.

6/1/09

Assets USD Billions

ETF Assets $2,200 Total $2,000 1993 $0.8 1994 $1.1 $1,800 1995 $2.3 1996 $5.3 $1,600 1997 $8.2 $1,400 1998 $17.6 1999 $39.6 $1,200 2000 $74.3 2001 $104.8 $1,000 2002 $141.6 2003 $212.0 $800 2004 $309.8 $600 2005 $412.1 2006 $565.6 $400 2007 $796.7 Sep-08 $764.1 $200 Oct-08 $643.0 Nov-08 $633.8$0 2009-F $1,000 ETF Assets Total 2011-F $2,000

Equity Assets $0.8 $1.1 $2.3 $5.3 $8.2 $17.6 $39.6 $74.3 $104.7 $137.5 $205.9 $286.3 $389.6 $526.5 $729.9 $664.1 $548.6 $534.9

16:34

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Commodity Assets Worldwide ETF and# ETPs ETP Growth Assets Total # ETFs

Income Assets

$0.1 $0.1 $4.0 $5.8 $23.1 $21.3 $35.8 $59.9 $90.8 $87.0 $90.0

$0.0 $0.1 $0.3 $0.5 $1.2 $3.4 $6.3 $9.2 $7.2 $8.5

1993

1994

1995

1996

1997

1998

$0.8

$1.1

$2.3

$5.3

$8.2

$17.6

$1.98 $5.02 $3.80 $4.00 $6.06 $8.86 $15.6 $28.1 $45.9 $58.3 $46.2 $48.2

3 3 4 21 21 31 33 92 202 280 282 336 461 714 1171 1499 1502 1,539

$0.8

$1.1

$2.3

$5.3

$8.2

$17.6

# ETPs # ETFs

3

3

4

21

21

31

1,400 1,200

2 14 17 17 17 18 23 70 134 268 269 274

1,000 800 600 400 200

1999

2000

2001

2002

2003

2004

2005

2006

2007

Sep-08

Oct-08

Nov-08

2009-F

2011-F

$74.3

$104.8

$141.6

$212.0

$309.8

$412.1

$565.6

$796.7

$764.1

$643.0

$633.8

$1,000

$2,000

$0.0

$0.1

$0.3

$0.5

$1.2

$3.4

$6.3

$9.2

$7.2

$8.5

$0.1

$0.1

$4.0

$5.8

$23.1

$21.3

$35.8

$59.9

$90.8

$87.0

$90.0

$39.6

$74.3

$104.7

$137.5

$205.9

$286.3

$389.6

$526.5

$729.9

$664.1

$548.6

$534.9

$1.98

$5.02

$3.80

$4.00

$6.06

$8.86

$15.6

$28.1

$45.9

$58.3

$46.2

$48.2

ETF Fixed Income Assets ETF Equity Assets

1,600

$39.6

ETF Commodity Assets

ETP Assets Total

1,800

2

14

17

17

17

18

23

70

134

268

269

274

33

92

202

280

282

336

461

714

1171

1499

1502

1,539

0

Source: ETF Research & Implementation Strategy Team, Barclays Global Investors, Bloomberg.

ETF Listings by Exchange as of End November 2008 Region

Country

# Primary ETF Listings

# Total ETF Listings

AUM (US$Bn)

20 Day ADV (US$Mn)

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

154 4 3 2 11 2 9 1 6 55 3 6 5 36 11 2

194 20 3 2 23 2 9 1 6 57 3 6 22 36 11 2

53.07 0.99 1.02 1.19 12.66 0.38 0.74 0.00 8.53 16.13 0.28 0.26 0.81 1.81 1.29 0.06

849.81 12.72 183.98 22.78 275.42 0.00 2.47 0.00 122.11 94.41 0.01 0.13 8.09 61.71 20.77 0.70

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

760 1 77 5 5 0 0 0 0 0 0 0 46 0 637 0

888 1 77 120 5 0 0 0 0 0 0 0 46 0 637 0

564.31 0.71 12.97 4.16 82.33 0.00 0.00 0.00 0.00 0.00 0.00 0.00 15.20 0.00 346.30 0.00

124,009.46 1.91 683.01 163.57 450.59 14,882.18 0.00 956.48 2,866.31 638.21 486.07 19,183.41 45,199.90 0.00 29,368.02 0.00

Wiener Borse Euronext Brussels Helsinki Stock Exchange Euronext Paris Deutsche Boerse Athens Exchange Budapest Stock Exchange Iceland Stock Exchange Irish Stock Exchange Borsa Italiana Euronext Amsterdam Oslo Stock Exchange Euronext Lisbon Ljubljana Stock Exchange Johannesburg Stock Exchange Bolsa de Madrid Stockholm Stock Exchange SIX Swiss Exchange SWX Europe Istanbul Stock Exchange London Stock Exchange

585 1 1 2 159 230 1 1 1 1 15 14 6 1 1 17 9 7 21 0 6 118

1,412 21 1 2 296 375 1 1 1 1 255 70 6 1 1 17 24 7 126 19 6 260

146.69 0.03 0.04 0.10 34.68 53.04 0.07 0.01 0.00 0.03 0.92 0.23 0.25 0.00 0.01 1.14 1.96 1.28 9.56 0.00 0.12 22.51

2,404.20 0.76 0.45 2.95 349.24 666.48 0.18 0.20 0.00 0.25 216.16 28.81 63.34 0.00 0.00 7.08 13.54 106.40 114.19 6.86 20.84 175.94

1,539

2,580

633.79

117,458.62

Exchange

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

EMEA (Europe, Middle East and Africa) Austria Belgium Finland France Germany Greece Hungary Iceland Ireland Italy Netherlands Norway Portugal Slovenia South Africa Spain Sweden Switzerland Turkey United Kingdom Grand Total

Source: ETF Research & Implementation Strategy Team, Barclays Global Investors, Bloomberg.

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Global ETF Assets by Type of Exposure, as at end November 2008 Global - Equity Fixed Income Commodities Cash (Money Market) 1.5%

# ETFS

Total Listings

AUM (US$bn)

% TOTAL

North America - Equity 467 Fixed Income - All (ex-Cash) 149 Europe - Equity 328 Emerging Markets - Equity 220 Asia Pacific - Equity 128 Global (ex-US) - Equity 58 Fixed Income - Cash (Money Market) 14 Global - Equity 96 Commodities 48 Mixed (Equity & Fixed Income) 25 Currency 6 Total 1,539

615 266 669 436 204 61 24 197 77 25 6 2,580

$311.58 $79.35 $67.23 $61.83 $47.58 $37.01 $10.66 $9.71 $8.47 $0.23 $0.17 $633.83

49.2% 12.5% 10.6% 9.8% 7.5% 5.8% 1.7% 1.5% 1.3% 0.0% 0.0% 100.0%

Region of Exposure

1.3%

1.7%

Mixed (Equity & Fixed Income)

Global (ex-US) Equity

0%

Currency

5.8%

0%

Asia Pacific Equity

7.5%

Emerging Markets - Equity

9.8%

Europe - Equity

10.6%

North Americas Equity

49.2%

Fixed Income - All (ex-Cash)

12.5%

Source: ETF Research & Implementation Strategy, Barclays Global Investors, Bloomberg

Top 25 ETF providers around the world ranked by AUM, as of end November 2008 Nov–08 Manager

iShares State Street Global Advisors Vanguard Lyxor Asset Management PowerShares ProShares db x-trackers Nomura Asset Management Bank of New York Nikko Asset Management Daiwa Asset Management Credit Suisse Asset Management AXA IM/BNP AM Van Eck Associates Corp Nacional Financiera Zurich Cantonal Bank WisdomTree Investments Hang Seng Investment Management ETFlab Investment BBVA Asset Management Commerzbank Rydex XACT Fonder Claymore Securities UBS Global Asset Management

Year to Date Change

# ETFs

AUM (USD Bn)

% Total

# Planned

# ETFs

AUM % Change ETFs (USD Bn)

356 98 38 113 142 64 99 29 1 8 23 8 53 16 1 4 42 3 10 8 28 31 11 54 8

$288.44 $129.18 $40.23 $29.97 $21.42 $20.89 $20.04 $13.40 $5.90 $5.55 $5.45 $5.31 $4.06 $3.76 $3.38 $2.97 $2.79 $2.69 $2.23 $1.90 $1.85 $1.71 $1.44 $1.53 $1.27

45.5% 20.4% 6.3% 4.7% 3.4% 3.3% 3.2% 2.1% 0.9% 0.9% 0.9% 0.8% 0.6% 0.6% 0.5% 0.5% 0.4% 0.4% 0.4% 0.3% 0.3% 0.3% 0.2% 0.2% 0.2%

13 33 0 2 41 90 0 0 0 0 1 0 8 13 0 0 37 0 0 0 0 82 0 10 0

35 15 1 26 28 6 48 22 0 6 18 0 23 8 0 0 3 0 10 1 28 8 2 4 -1

10.9% -$114.17 18.1% -$23.21 2.7% -$1.74 29.9% -$2.10 24.6% -$16.60 10.3% $11.19 94.1% $9.22 314.3% -$4.04 0.0% -$4.25 300.0% -$3.53 360.0% -$2.18 0.0% $0.34 76.7% -$2.63 100.0% $0.27 0.0% -$0.36 0.0% $1.93 7.7% -$1.73 0.0% -$2.02 100.0% $2.23 14.3% $0.72 100.0% $1.85 34.8% -$0.94 22.2% -$1.07 8.0% -$0.93 -11.1% -$0.88

% AUM Market % Share

-28.4% -15.2% -4.1% -6.5% -43.7% 115.4% 85.2% -23.2% -41.8% -38.9% -28.6% 6.8% -39.3% 7.7% -9.7% 184.5% -38.2% -42.9% 100.0% 60.6% 100.0% -35.6% -42.7% -37.9% -40.9%

-5.0% 1.3% 1.1% 0.7% -1.4% 2.1% 1.8% -0.1% -0.3% -0.3% -0.1% 0.2% -0.2% 0.2% 0.1% 0.3% -0.1% -0.2% 0.4% 0.2% 0.3% -0.1% -0.1% -0.1% -0.1%

Source: ETF Research & Implementation Strategy, Barclays Global Investors, Bloomberg

NOTES At the end of November 2008 the ETFs industry had 1,539 ETFs with 2,580 listings, assets of $633.83 billion, managed by 86 managers on 42 exchanges around the world. Assets fell by 20.4%, which is less than the 43.80% fall in the MSCI World index in USD terms. The number of ETFs has increased 31% YTD. The average daily trading volume in US dollar has increased by 94% to US$117.5 billion YTD. In the first ten months of 2008 we have seen investors move assets into ETFs providing exposure to fixed income and commodity indices while the assets in ETFs tracking equity indices, especially global (ex US) and emerging market indices, have declined.

European ETF AUM has decreased by 2.8% while the MSCI Europe Index is down 50.56% YTD. In Europe net sales of mutual funds (excluding ETFs) were minus $505.7 million while net sales of ETFs domiciled in Europe were positive $61.6 million during the first 10 months of 2008 according to Lipper Feri.

Important Information Source: ETF Research & Implementation Strategy Team, Barclays Global Investors, Various ETF Managers, Bloomberg. Please contact Deborah Fuhr on +44 20 7668 4276 or email Deborah.Fuhr@barclaysglobal.com if you have any questions or comments.

This communication is being made available to persons who are investment professionals as that term is defined in Article 19 of the Financial Services and Markets Act 2000 (Financial Promotion Order) 2005 or its equivalent under any other applicable law or regulation in the relevant jurisdiction. It is directed at persons who have professional experience in matters relating to investments. These materials are not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use is contrary to local law or regulation.

Although Barclays Global Investors Limited (“BGIL”) endeavours to update and ensure the accuracy of the content of this document, BGIL does not warrant or guarantee its accuracy or correctness. Despite the exercise of all due care, some information in this document may have changed since publication. Investors should obtain and read the ETF prospectuses from ETF managers and confirm any relevant information with ETF managers before investing. Neither BGIL, nor any affiliate, nor any of their respective officers, directors, partners, or employees accepts any liability whatsoever for any direct or consequential loss arising from any use of this publication or its contents. © 2008 Barclays Global Investors. All rights reserved.

JANUARY/FEBRUARY 2009 • FTSE GLOBAL MARKETS

GM EDITORIAL 31.qxd:Issue 31

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16:19

Page 91

The market reported 1,948,937securities transactions, with 188,268 securities available for lending worth €6,928bn through November. Some 33,801 securities were out on loan worth €1,451bn.

The following tables show the scale of activity in the market:

Equities

Corporate Bonds

Top 10 by Total Balance

Top 10 by Total Balance

Rank

Stock description

Rank

Stock description

1

Total SA

1

Goldfish Master Issuer BV (4.721% 28 Nov 2099)

2

GDF Suez SA

2

Canada Housing Trust No 1 (4.55 % 15 Dec 2012)

3

Volkswagen AG

3

European Investment Bank (6% 07 Dec 2028)

4

Bayer AG

4

Canada Housing Trust No 1 (3.6 % 15 Jun 2013)

5

Exxon Mobil Corp

5

Canada Housing Trust No 1 (3.95 % 15 Dec 2011)

6

Siemens AG

6

European Investment Bank (5.625% 07 Jun 2032)

7

HSBC Holdings Plc

7

Canada Housing Trust No 1 (4.6% 15 Sep 2011)

8

Telefonica SA

8

Cassa Depositi e Prestiti Spa (3.75% 31 Jan 2012)

9

Eon AG

9

KfW International Finance Inc (6% 07 Dec 2028)

10

Carrefour SA

10

Cassa Depositi e Prestiti Spa (3% 31 Jan 2013)

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

Equities

Corporate Bonds

Top 10 Securities by Total Return

Top 10 Securities by Total Return

Rank

Stock description

Rank

Stock description

1

Sears Holdings Corp

1

Barclays Bank Plc (5.926% undated)

2

Osiris Therapeutics Inc

2

Morgan Stanley (3.875% 15 Jan 2009)

3

Life Partners Holdings Corp

3

Freescale Semiconductor Inc (10.125% 15 Dec 2016)

4

Usana Health Sciences Inc

4

ING Groep NV (8% undated)

5

Greenhill & Co Inc

5

Parex banka AS (5.625% 05 May 2011)

6

Cal-Maine Foods Inc

6

MGM Mirage (13% 15 Nov 2013)

7

Mediobanca - Banca di Credito Finanziario Spa

7

Goldman Sachs Group Inc (3.875% 15 Jan 2009)

8

McClatchy Co

8

Torchmark Corp (6.375% 15 Jun 2016)

9

Under Armour Inc

9

Voto-Votorantim Overseas Trading Ops (7.75% 24 Jun 2020)

10

Nutrisystem Inc

10

Colonial Pipeline Co 7.63% 15 Apr 2032)

The following tables detail the top securities by fee within two bands of total balance out on loan:

Equities by Fee

Corporate Bonds by Fee

Top 10 by Balance >$10m <$100m

Top 10 by Balance >$10m <$100m

Rank

Stock description

Rank

Stock description

1

Osiris Therapeutics Inc

1

Freescale Semiconductor Inc (10.125% 15 Dec 2016)

2

Life Partners Holdings Corp

2

ING Groep NV (8% undated)

3

Usana Health Sciences Inc

3

Parex banka AS (5.625% 05 May 2011)

4

Cal-Maine Foods Inc

4

Goldman Sachs Group Inc (3.875% 15 Jan 2009)

5

McClatchy Co

5

Smurfit Kappa Funding Plc (7.75% 01 Apr 2015)

6

Nutrisystem Inc

6

Americredit Corp (8.5% 01 Jul 2015)

7

Lululemon Athletica Inc (B23FN39)

7

Neiman Marcus Group Inc (10.375% 15 Oct 2015)

8

Redwood Trust Inc

8

Wharf Finance (BVI) Ltd (6.125% 06 Nov 2017)

9

Lululemon Athletica Inc (B23N515)

9

Compagnie de Financement Foncier (6.125% 23 Feb 2015)

10

Arthrocare Corp

10

MGM Mirage (8.375% 01 Feb 2011)

SECURITIES LENDING DATA by DATA EXPLORERS

KEY PERFORMANCE EXPLORER STATISTICS as of 26th November 2008

Disclaimer and copyright notice The above data is provided by Data Explorers Limited and is underpinned by source data provided by Performance Explorer participants and also market data.

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

FTSE GLOBAL MARKETS • JANUARY/FEBRUARY 2009

© Copyright Data Explorers Limited September 2008

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Index Level Rebased (28 November 2003=100)

5-Year Total Return Performance Graph 600

FTSE All-World Index

500

FTSE Emerging Index

400

FTSE Global Government Bond Index

300

FTSE EPRA/NAREIT Global Index

200

FTSE4Good Global Index

100

FTSE GWA Developed Index FTSE RAFI Emerging Index 08

8 M

ay

No v-

-0

07 No v-

7 M

ay

-0

06 No v-

6 M

ay

-0

05 No v-

5 M

ay

-0

04 No v-

M

ay

-0

03

4

0

No v-

MARKET DATA BY FTSE RESEARCH

Global Market Indices

Table of Total Returns Index Name

Currency

Constituents

Value

3 M (%)

6 M (%)

12 M (%)

YTD (%)

Actual Div Yld (%)

FTSE All-World Index

USD

2,869

172.36

-34.3

-42.5

-44.5

-43.9

3.98

FTSE World Index

USD

2,420

409.20

-33.8

-41.8

-43.8

-43.0

3.99

FTSE Developed Index

USD

1,997

166.69

-33.0

-40.6

-43.0

-42.2

3.94

FTSE All-World Indices

FTSE Emerging Index

USD

872

323.94

-44.8

-55.8

-56.0

-56.2

4.38

FTSE Advanced Emerging Index

USD

423

299.21

-45.0

-56.2

-53.9

-53.7

4.83

FTSE Secondary Emerging Index

USD

449

384.26

-44.4

-55.1

-58.5

-59.3

3.72

3.91

FTSE Global Equity Indices FTSE Global All Cap Index

USD

7,768

272.63

-35.1

-43.1

-45.1

-44.5

FTSE Developed All Cap Index

USD

6,005

265.59

-33.9

-41.4

-43.6

-42.8

3.86

FTSE Emerging All Cap Index

USD

1,763

422.69

-45.3

-56.3

-57.1

-57.4

4.42

FTSE Advanced Emerging All Cap Index

USD

919

397.30

-45.5

-56.7

-54.9

-54.5

4.86

FTSE Secondary Emerging Index

USD

844

481.76

-44.9

-55.6

-59.8

-60.7

3.78

USD

713

167.78

1.8

0.4

5.4

6.0

2.75

Fixed Income FTSE Global Government Bond Index Real Estate FTSE EPRA/NAREIT Global Index

USD

282

1591.79

-44.0

-51.3

-54.8

-52.3

7.70

FTSE EPRA/NAREIT Global REITs Index

USD

185

555.00

-45.2

-50.5

-52.1

-49.7

9.32

FTSE EPRA/NAREIT Global Dividend+ Index

USD

249

1107.40

-45.2

-51.0

-53.6

-51.7

8.87

FTSE EPRA/NAREIT Global Rental Index

USD

230

624.42

-44.8

-50.0

-51.7

-49.2

8.79

FTSE EPRA/NAREIT Global Non-Rental Index

USD

52

653.44

-41.7

-54.5

-61.6

-59.2

4.51

FTSE4Good Global Index

USD

684

4488.90

-33.4

-41.1

-44.3

-43.4

4.57

FTSE4Good Global 100 Index

USD

102

3970.79

-31.9

-39.1

-43.2

-42.3

4.67

FTSE GWA Developed Index

USD

1,997

2418.89

-35.2

-43.2

-46.2

-45.3

4.86

FTSE RAFI Developed ex US 1000 Index

USD

1,002

4076.99

-35.4

-44.8

-47.6

-46.7

5.44

FTSE RAFI Emerging Index

USD

358

3516.68

-41.5

-52.4

-52.5

-52.5

5.07

SRI

Investment Strategy

92

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Americas Market Indices Index Level Rebased (28 November 2003=100)

5-Year Total Return Performance Graph 300

FTSE Americas Index

250

FTSE Americas Government Bond Index FTSE EPRA/NAREIT North America Index

200

FTSE EPRA/NAREIT US Dividend+ Index 150

FTSE4Good USIndex 100

FTSE GWA US Index FTSE RAFI US 1000 Index 08

8 M

ay

No v-

-0

07 No v-

7 M

ay

-0

06 No v-

6 M

ay

-0

05 No v-

5 M

ay

-0

04 No v-

-0 ay M

No v-

03

4

50

Table of Total Returns Index Name

Currency

Constituents

Value

3 M (%)

6 M (%)

12 M (%)

YTD (%)

Actual Div Yld (%)

FTSE Americas Index

USD

846

555.35

-31.7

-37.8

-39.1

-38.8

3.11

FTSE North America Index

USD

708

617.74

-30.7

-36.3

-38.3

-38.0

3.06

FTSE Latin America Index

USD

138

559.44

-48.4

-59.7

-51.7

-52.3

4.09

FTSE Americas All Cap Index

USD

2,651

250.08

-32.8

-38.8

-39.7

-39.6

3.01

FTSE North America All Cap Index

USD

2,448

243.69

-31.9

-37.4

-39.1

-38.8

2.97

FTSE Latin America All Cap Index

USD

203

777.88

-48.7

-59.9

-52.2

-52.7

4.09

FTSE Americas Government Bond Index

USD

151

183.01

4.0

6.2

8.1

7.7

2.98

FTSE USA Government Bond Index

USD

134

180.29

4.9

7.6

9.4

9.2

2.94

FTSE EPRA/NAREIT North America Index

USD

116

1814.64

-48.7

-51.9

-51.2

-48.6

9.45

FTSE EPRA/NAREIT US Dividend+ Index

USD

93

1002.83

-48.7

-51.9

-50.6

-47.9

9.74

FTSE All-World Indices

FTSE Global Equity Indices

Fixed Income

Real Estate

FTSE EPRA/NAREIT North America Rental Index

USD

113

619.77

-47.0

-49.7

-48.9

-46.1

9.13

FTSE EPRA/NAREIT North America Non-Rental Index

USD

3

123.29

-87.2

-90.7

-90.5

-90.2

40.42

FTSE NAREIT Composite Index

USD

129

1814.81

-45.8

-49.7

-48.8

-46.4

10.42

FTSE NAREIT Equity REITs Index

USD

107

4379.55

-47.5

-50.5

-49.2

-46.5

9.39

FTSE4Good US Index

USD

149

3669.69

-30.2

-34.4

-39.8

-39.1

3.40

FTSE4Good US 100 Index

USD

101

3543.85

-29.9

-34.2

-39.7

-39.0

3.42

FTSE GWA US Index

USD

652

2260.26

-32.1

-38.0

-41.7

-41.1

3.89

FTSE RAFI US 1000 Index

USD

978

3699.30

-31.5

-37.6

-41.6

-40.9

3.84

FTSE RAFI US Mid Small 1500 Index

USD

1,403

3129.12

-37.8

-40.7

-41.7

-41.5

2.65

SRI

Investment Strategy

FTSE GLOBAL MARKETS • JANUARY/FEBRUARY 2009

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5-Year Total Return Performance Graph Index Level Rebased (28 November 2003=100)

500

FTSE Europe Index FTSE All-Share Index

400

FTSEurofirst 80 Index 300

FTSE/JSE Top 40 Index FTSE Gilts Fixed All-Stocks Index

200

FTSE EPRA/NAREIT Europe Index 100

FTSE4Good Europe Index 0

08

8 M

ay

No v-

-0

07 No v-

7 M

ay

-0

06 No v-

6 M

ay

-0

05 No v-

5 -0 ay M

No v-

-0 ay M

04

4

FTSE GWA Developed Europe Index

03 No w-

MARKET DATA BY FTSE RESEARCH

Europe, Middle East & Africa Indices

FTSE RAFI Europe Index

Table of Total Returns Index Name

Currency

Constituents

Value

3 M (%)

6 M (%)

12 M (%)

YTD (%)

Actual Div Yld (%)

5.51

FTSE All-World Indices FTSE Europe Index

EUR

559

177.59

-28.5

-36.2

-42.5

-41.9

FTSE Eurobloc Index

EUR

2,023

98.05

-29.9

-38.3

-44.5

-44.2

4.89

FTSE Developed Europe ex UK Index

EUR

382

177.64

-28.8

-36.6

-42.5

-42.0

5.93

FTSE Developed Europe Index

EUR

496

176.20

-27.7

-35.0

-41.8

-41.0

5.54

FTSE Global Equity Indices FTSE Europe All Cap Index

EUR

1,682

273.46

-29.5

-37.0

-43.3

-42.6

5.48

FTSE Eurobloc All Cap Index

EUR

832

286.86

-30.6

-38.8

-44.9

-44.5

6.28

FTSE Developed Europe All Cap ex UK Index

EUR

1,135

292.43

-29.8

-37.5

-43.3

-42.6

5.90

FTSE Developed Europe All Cap Index

EUR

1,562

272.96

-28.7

-36.0

-42.6

-41.7

5.51

Region Specific FTSE All-Share Index

GBP

662

2661.82

-24.8

-29.3

-32.2

-32.4

4.67

FTSE 100 Index

GBP

102

2596.43

-23.1

-27.6

-30.5

-30.8

4.60

FTSEurofirst 80 Index

EUR

81

3766.95

-28.1

-36.0

-42.8

-42.8

6.53

FTSEurofirst 100 Index

EUR

101

3445.88

-25.9

-33.1

-40.4

-39.9

5.75

FTSEurofirst 300 Index

EUR

312

1168.87

-27.3

-34.5

-41.3

-40.5

5.58

FTSE/JSE Top 40 Index

SAR

41

2131.86

-23.3

-34.1

-27.8

-24.0

4.30

FTSE/JSE All-Share Index

SAR

164

2319.07

-22.4

-32.0

-27.7

-24.4

4.46

FTSE Russia IOB Index

USD

15

473.14

-57.9

-71.8

-66.1

-67.5

4.26

FTSE Eurozone Government Bond Index

EUR

233

170.23

5.6

7.6

7.6

8.1

3.84

FTSE Pfandbrief Index

EUR

409

189.74

3.7

5.0

5.0

5.3

4.57

FTSE Gilts Fixed All-Stocks Index

GBP

32

2200.19

4.9

8.9

9.1

7.2

4.09

FTSE EPRA/NAREIT Europe Index

EUR

92

1373.32

-37.6

-44.0

-49.9

-47.7

7.37

FTSE EPRA/NAREIT Europe REITs Index

EUR

39

518.21

-33.6

-38.9

-44.0

-42.0

7.32

FTSE EPRA/NAREIT Europe ex UK Dividend+ Index

EUR

48

1508.45

-33.9

-41.0

-42.3

-39.9

8.12

FTSE EPRA/NAREIT Europe Rental Index

EUR

79

538.70

-37.1

-43.2

-48.6

-46.4

7.57

FTSE EPRA/NAREIT Europe Non-Rental Index

EUR

13

373.28

-47.3

-58.3

-68.4

-66.5

2.73

FTSE4Good Europe Index

EUR

273

3548.37

-26.6

-33.4

-40.8

-40.0

5.84

FTSE4Good Europe 50 Index

EUR

52

3233.94

-24.6

-30.4

-38.7

-37.7

5.78

FTSE GWA Developed Europe Index

EUR

496

2350.64

-30.4

-37.7

-45.0

-44.2

6.49

FTSE RAFI Europe Index

EUR

512

3704.55

-28.3

-35.8

-43.5

-42.8

6.33

Fixed Income

Real Estate

SRI

Investment Strategy

94

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Asia Pacific Market Indices 1200

FTSE Asia Pacific Index

1000

FTSE/ASEAN 40 Index FTSE/Xinhua China 25 Index

800

FTSE Asia Pacific Government Bond Index

600

FTSE EPRA/NAREIT Asia Index 400

FTSE IDFC India Infrastructure Index 200

FTSE4Good Japan Index

0

M

ay

No v-

08

8 -0

07 No v-

7 M

ay

-0

06 No v-

6 M

ay

-0

05 No v-

5 -0 ay M

No v-

-0 ay M

No v-

04

4

FTSE GWA Japan Index

03

Index Level Rebased (28 November 2003=100)

5-Year Total Return Performance Graph

FTSE RAFI Kaigai 1000 Index

Table of Total Returns Index Name

Currency

Constituents

Value

3 M (%)

6 M (%)

12 M (%)

YTD (%)

Actual Div Yld (%)

FTSE Asia Pacific Index

USD

1,313

181.35

-34.1

-44.8

-48.0

-46.9

3.98

FTSE Asia Pacific ex Japan Index

USD

854

293.68

-41.4

-52.0

-56.1

-55.8

5.17

FTSE Japan Index

USD

459

68.42

-34.1

-41.4

-45.6

-43.6

2.80

FTSE Asia Pacific All Cap Index

USD

3,228

304.24

-34.4

-45.2

-48.7

-47.6

4.03

FTSE Asia Pacific All Cap ex Japan Index

USD

1,953

356.45

-42.4

-53.2

-57.5

-57.3

5.30

FTSE Japan All Cap Index

USD

1,275

216.57

-33.3

-40.6

-44.9

-42.8

2.78

FTSE/ASEAN Index

USD

156

289.74

-40.1

-50.0

-50.8

-52.1

5.95

FTSE Bursa Malaysia 100 Index

MYR

100

6034.65

-21.5

-31.6

-37.0

-39.8

5.10

TSEC Taiwan 50 Index

TWD

50

4071.08

-36.4

-44.8

-45.2

-44.7

8.60

FTSE Xinhua All-Share Index

CNY

958

4566.11

-22.1

-48.9

-59.5

-64.6

1.80

FTSE/Xinhua China 25 Index

CNY

25

14497.17

-37.3

-47.1

-55.9

-53.4

3.73

USD

255

130.93

14.1

13.3

21.7

22.3

1.41

FTSE EPRA/NAREIT Asia Index

USD

74

1372.95

-37.3

-49.1

-57.2

-54.7

6.13

FTSE EPRA/NAREIT Asia 33 Index

USD

36

932.10

-35.2

-46.0

-53.3

-50.2

9.97

FTSE EPRA/NAREIT Asia Dividend+ Index

USD

63

1320.48

-40.0

-49.8

-58.3

-57.3

8.32

FTSE EPRA/NAREIT Asia Rental Index

USD

38

697.13

-37.5

-46.8

-53.5

-51.2

9.17

FTSE EPRA/NAREIT Asia Non-Rental Index

USD

36

721.27

-37.3

-50.7

-59.6

-56.9

3.95

FTSE All-World Indices

FTSE Global Equity Indices

Region Specific

Fixed Income FTSE Asia Pacific Government Bond Index Real Estate

Infrastructure FTSE IDFC India Infrastructure Index

IRP

96

529.89

-46.8

-56.4

-68.1

-70.9

1.17

FTSE IDFC India Infrastructure 30 Index

IRP

30

572.48

-46.3

-55.6

-68.5

-71.0

1.21

JPY

190

3280.71

-35.8

-43.1

-46.1

-44.4

3.01

FTSE SGX Shariah 100 Index

USD

100

3715.16

-31.3

-42.2

-43.8

-42.4

3.79

FTSE Bursa Malaysia Hijrah Shariah Index

MYR

30

7245.85

-19.9

-34.6

-37.8

-41.6

4.67

JPY

100

887.26

-36.3

-43.3

-47.6

-46.5

3.09

SRI FTSE4Good Japan Index Shariah

FTSE Shariah Japan 100 Index Investment Strategy FTSE GWA Japan Index

JPY

459

2267.31

-35.4

-42.4

-45.8

-44.0

2.97

FTSE GWA Australia Index

AUD

108

3027.47

-24.6

-30.7

-40.9

-38.7

7.78

FTSE RAFI Australia Index

AUD

55

4853.66

-20.4

-26.6

-35.6

-34.1

7.69

FTSE RAFI Singapore Index

SGD

16

4783.35

-36.0

-41.3

-42.5

-42.9

6.54

FTSE RAFI Japan Index

JPY

297

3294.52

-33.7

-40.2

-43.3

-41.9

2.87

FTSE RAFI Kaigai 1000 Index

JPY

1,001

2921.38

-42.2

-47.7

-53.7

-53.4

4.97

HKD

49

4277.73

-34.4

-58.6

-51.2

-49.0

4.52

FTSE RAFI China 50 Index

FTSE GLOBAL MARKETS • JANUARY/FEBRUARY 2009

95

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CALENDAR

Index Reviews Jan – April 2009 Date

Index Series

Review Frequency/Type

Effective Data Cut-off (Close of business)

06-Jan 08-Jan 08-Jan

FTSE/Xinhua Index Series TSEC Taiwan 50 TOPIX

16-Jan 16-Jan

22-Dec 31-Dec

29-Jan

31-Dec

Mid Jan

OMX H25

Quarterly review Quarterly review Monthly review - additions & free float adjustment Semi-annual review consitutents, Quarterly review of number of shares

31-Jan

31-Dec

PSI 20

Annual review

02-Mar

31-Dec

BEL 20

Annual review

02-Mar

31-Dec

AEX TOPIX

Annual review Monthly review - additions & free float adjustment Quarterly review Quarterly review Annual review Asia Pacific ex Japan Semi-annual review / number of shares Quarterly review Quarterly review Quarterly review Semi-annual review Annual / Quarterly review Monthly review - additions & free float adjustment Annual review Asia Pacific ex Japan Semi-annual review Annual review Quarterly review Quarterly review Quarterly review Quarterly review Quarterly review

02-Mar

31-Dec

26-Feb 02-Mar 27-Feb 20-Mar 31-Mar 20-Mar 20-Mar 20-Mar 20-Mar 20-Mar

30-Jan 31-Dec 31-Jan 31-Dec 28-Feb 28-Feb 27-Feb 28-Feb 28-Feb 27-Feb

30-Mar 20-Mar 20-Mar 20-Mar 20-Mar 20-Mar 20-Mar 20-Mar 20-Mar

27-Feb 11-Feb 28-Feb 28-Feb 11-Mar 28-Feb 28-Feb 28-Feb 07-Mar

20-Mar 20-Mar 20-Mar 20-Mar 20-Mar 20-Mar 31-Mar 20-Mar 20-Mar 20-Mar 20-Mar 20-Mar 20-Mar 20-Mar 31-Mar 17-Apr 17-Apr 17-Apr

07-Mar 28-Feb 28-Feb 06-Mar 24-Feb 06-Mar 28-Feb 06-Mar 06-Mar 06-Mar 06-Mar 06-Mar 06-Mar 16-Mar 28-Feb 23-Mar 31-Mar 31-Mar

29-Apr 30-Apr 29-May

30-Apr 31-Mar 31-Mar

Late Jan/ Early Feb Late Jan/ Early Feb Late Jan/ Early Feb 05-Feb 10-Feb 13-Feb 24-Feb Early Mar Early Mar Early Mar 04-Mar 06-Mar 06-Mar 06-Mar

Hang Seng MSCI Standard Index Series FTSE All-World ATX CAC 40 S&P / TSX DAX S&P / MIB S&P / ASX Indices TOPIX

07-Mar 11-Mar 11-Mar 11-Mar 11-Mar 11-Mar 11-Mar 11-Mar 11-Mar 12-Mar 13-Mar 13-Mar 13-Mar 13-Mar 13-Mar 14-Mar 14-Mar 14-Mar 14-Mar 14-Mar 14-Mar 17-Mar 24-Mar 07-Apr 09-Apr 09-Apr 07-Apr

FTSE All-World FTSE Asiatop / Asian Sectors FTSE/ASEAN 40 Index FTSE UK FTSEurofirst 300 FTSE techMARK 100 FTSE eTX FTSE/JSE Africa Index Series FTSE EPRA/NAREIT Global Real Estate Index Series FTSE4Good Index Series NASDAQ 100 S&P Asia 50 DJ STOXX DJ STOXX Russell US/Global Indices S&P US Indices S&P Europe 350 / S&P Euro S&P Topix 150 S&P Global 1200 S&P Global 100 S&P Latin 40 S&P MIB NZX 50 FTSE/Xinhua Index Series FTSE Nordic 30 TSEC Taiwan 50 TOPIX

Mid April Late April

OMX H25 FTSE / ATHEX

Quarterly review Semi-annual review Quarterly review / Shares adjustment Quarterly review Quarterly review (components) Quarterly review (style) Quarterly review - IPO additions only Quarterly review Quarterly review Quarterly review Quarterly review Quarterly review Quarterly review Quarterly review - shares & IWF Quarterly review Quarterly review Semi-annual review Quarterly review Monthly review - additions & free float adjustment Quarterly review - shares in issue Semi-annual review

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

96

JANUARY/FEBRUARY 2009 • FTSE GLOBAL MARKETS

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Page IBC1

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

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

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

© FTSE International Limited (‘FTSE’) 2008. All rights reserved. FTSE ® is a trade mark jointly owned by the London Stock Exchange Plc and The Financial Times Limited and are used by FTSE under licence.

GM EDITORIAL 31.qxd:Issue 31

6/1/09

16:19

Page OBC1

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