FTSE Global Markets

BATTLING MARKET FRAGMENTATION: THE ASIAN ASSET SERVICING ROUNDTABLE ISSUE 32 • MARCH/APRIL 2009

How to conduct sovereign over-borrowing CVM sets the standard for Brazilian corporate governance Dutch pension funds lead on fiduciary management What now for offshore exchanges?

CLEARSTREAM: THE GLOBAL EQUATION THE IMPORTANCE OF COLLATERAL MANAGEMENT IN ASIAN SBL

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FTSE GLOBAL MARKETS • MARCH/APRIL 2009

F THERE IS a recurring topic in this edition, it is trust and fiduciary care. Paul Whitfield introduces the theme in the Market Leader, outlining a mounting trend in the Low Countries towards fiduciary management. The trend is expected to be replicated elsewhere in Europe.

Investment management firm BlackRock, for one, thinks the trend will be substantial. In December, it predicted that the value of assets run by fiduciary managers in the UK alone would rise from the current figure of about £2bn to over £300bn within the next few years.

Fiduciary management refers to the provision, by a single supplier, of a range of services that taken together remove the operational management of a pension fund from trustees, handing it to a third party manager. What it cannot do however is lift the fiduciary responsibility from the shoulders of the trustees, who are still ultimately responsible for the performance and lawful management of their fund.

The movements towards fiduciary care and transparency are global, rather than regional trends. Moreover, they encompass the spectrum of investment activity. Neil O’Hara picks up the theme in his article on the dynamics of the US asset servicing industry. While the global recession has dampened investor and banking sentiment and activity in the financial markets, asset service providers have directly benefited from the resulting downturn in two ways.

Following the rescue of Bear Stearns, the Lehman Brothers bankruptcy and Bernard Madoff's alleged Ponzi scheme, attention is now focused squarely on counterparty risk. Moreover, the safety of assets held in trust that are not exposed to the parent entity's credit risk has sent hedge funds and institutional investors scuttling to custodian banks. In addition, money managers who have seen their asset-based top line revenues slashed are now homing in on the bottom line. Asset service providers, who can take over middle and back office functions, turning them from fixed into variable costs, have benefited in consequence.

Emerging markets are jumping on a similar bandwagon. John Rumsey in São Paulo reports on moves by Brazil’s market regulator, the Comissão de Valores Mobiliários (CVM), to enforce procedures in cases concerning possible derivatives scandals (it is unable to name the companies). It looks to be a timely moment for the CVM to be designing new rules that will help further develop the corporate governance agenda in Brazil. The new focus is on achieving real gains through the fostering of greater transparency, which will increase the level of local disclosure requirements substantially.

In this and subsequent editions we will be looking at how regulators will help or hinder the rebuilding of the sometimes scorched remains of the financial markets. Our focus in this edition is on the UK’s Financial Services Authority (FSA). With its reputation dented in the wake of the financial crisis, the FSA finds itself under a spotlight, with market participants anxious to see how it intends to regulate going forward.

Some market watchers worry that the FSA will impose a US Sarbanes Oxley type regime, thereby eradicating the principles-based regulation that traditionally has been a cornerstone of the UK framework. Others believe that FSA will hold firm to its fundamental doctrines, albeit with a somewhat heavier hand under new chairman Lord Adair Turner. Lynn Strongin Dodds reviews the options.

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Francesca Carnevale, Editorial Director March 2009

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Contents COVER STORY COVER STORY: CLEARSTREAM: A GLOBAL VIEWPOINT ....................Page 65

Once upon a time pitted in a soulless debate on the efficacy of a horizontal versus a vertical clearing and settlement model in Europe, Clearstream broke out of its chains and into a new and seemingly limitless global future. Francesca Carnevale explains how Clearstream reinvented both itself and the opportunities provided by globalisation.

DEPARTMENTS MARKET LEADER

THE MOVE TOWARDS FIDUCIARY MANAGEMENT ......................Page 6 Why Dutch institutional investors are leading the way in Europe

STICKING TO PRINCIPLES? WHAT NOW FOR THE FSA?....................Page 12 Lynn Strongin Dodds assesses the options facing the UK’s financial regulator

IN THE MARKETS

CORPORATE GOVERNANCE, CVM STYLE ..........................................................Page 18 CVM’s efforts to introduce transparency into the Brazilian capital markets

..................................................Page 24 David Simons on the effects the easing of rules covering DR programmes

NEW RULES FOR DEPOSITARY RECEIPTS

FRANCE: CREDIT CRISIS SARKOZY STYLE........................................Page 28 The idiosyncrasies of Nicolas Sarkozy’s approach to the banking crisis

COUNTRY REPORT

..............................................Page 32 Liberalising the Saudi capital and investment markets is now a priority

SAUDI ARABIA: UNLOCKING POTENTIAL

SAUDI ARABIAN BANKS BUCK THE TREND ..............................Page 38 Why the country’s banks look to be relatively inured from the global credit crunch

INDEX REVIEW

..................................Page 42 Simon Denham, managing director, Capital Spreads on current index trends

ROCK, SCISSORS, PAPER, STOCK MARKETS

WILL THE PFANDBRIEF MARKET RECOVER BEFORE TIME? ..Page 43 The beginnings of a new issue pipeline in 2009

DEBT REPORT

......................................................................................................Page 46 Spanish covered bonds look ready for a recovery

CEDULAS RETUNED

..................................................................Page 48 Can the market cope with the explosion of sovereign issuance? Andrew Cavenagh reports.

A PILE UP OF SOVEREIGN BONDS

............................................................Page 81 Ruth Liley reports on the trading strategies employed in centres of non displayed liquidity

THE ATTRACTION OF DARK POOLS

TRADING REPORT

DATA PAGES

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................................................................................................Page 84

By Michael Krogmann, executive director, Cash Market Development, Deutsche Börse

THE NEED FOR SPEED

ETF Data, supplied by Barclays Global Investors ..................................................PAGE 86 Securities Lending Trends by Data Explorer ..........................................................PAGE 89 Fidessa Fragmentation Index ....................................................................................PAGE 90 Market Reports by FTSE Research ............................................................................PAGE 92 Index Calendar ............................................................................................................PAGE 96

MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

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Contents FEATURES EXCHANGE REPORT

THE OFFSHORE EXCHANGE DILEMMA ..........................................Page 50

Until recently, offshore exchanges have traded on their uniqueness. However, as the global financial markets undergo seismic shifts in the wake of the global liquidity crisis and falling exchange trading volume (albeit temporary). However, difficult questions are now surfacing. Will offshore exchanges ultimately be forced into mergers with onshore partners?

Or will they be able to develop other survival techniques? Lynn Strongin Dodds reports.

OTC STANDS ITS GROUND ........................................................................Page 54 Derivatives exchanges have had to watch from the wings in recent years while the OTC market ran away with the lion's share of new business. Protestations about counterparty risk inherent in bilateral contracts fell on deaf ears as investors chose to ignore the possibility that a major securities dealer could fail. The financial crisis—and the Lehman bankruptcy in particular—jolted market participants' faith. However, the derivatives exchanges have not yet been able to leverage that fact. Neil O’Hara explains why.

ECONOMIC REPORT

CALIFORNIA: ALL THAT GLISTERS ......................................................Page 57

Who dreams these days about living in California? As a standalone entity, the state remains one of the world’s top eight economies, yet it is beset with problems. It struggles with a dysfunctional legislature, and a $42bn budget deficit. California’s unemployment rate is third-highest in America, while its credit rating is the lowest among the 50 states. The state’s vast higher education system is outmoded and the crash in housing prices has wiped out $1trn in personal wealth. Meanwhile, California’s fabled venture capital (VC) industry—caught in the worldwide credit freeze—faces a “nuclear winter.” What next? By Art Detman

ASSET SERVICES

..................................................................Page 60 There’s more promise than SBL business in Asia outside of key markets (namely Japan, Australia, Hong Kong and Singapore). Even so, securities lending professionals remain upbeat about the medium and long term promise of the market. For now, collateral management is high on the agenda of market participants, which tend to be central banks, state pension funds and prime brokers. How soon before the promise breaks into a boom? Francesca Carnevale reports

ASIAN SECURITIES LENDING

..............................................Page 68 Bill Tyree, a partner and head of investor services and markets at Brown Brothers Harriman (BBH), says the benefits of independent custody often did not resonate with asset managers and hedge funds. They were too busy making money, and nothing had happened in the market to alert them to [any] danger—until last year's meltdown set off the alarm. Neil O’Hara reports on the business uptick in asset service provision in the United States.

US ASSET SERVICES ON THE UPTICK

ROUNDTABLE: ASIAN SECURITIES SERVICES ............................Page 71

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. This latest roundtable discussion highlights the challenges of building up asset services in the demanding and highly fragmented Asian landscape

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MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

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Market Leader EUROPEAN PENSIONS: THE APPEAL OF FIDUCIARY MANAGEMENT

While there is no hard-and-fast definition of fiduciary management, the term generally refers to the provision, by a single supplier, of a range of services that taken together remove the operational management of a pension fund from trustees, handing it to a third party manager. What it cannot do is lift the fiduciary responsibility from the shoulders of the trustees, who are still ultimately responsible for the performance and lawful management of their fund.

Photograph © Lajo_2/Dreamstime.com, supplied February 2009.

DUTCH TAKE A LEAD IN PENSION MANAGEMENT Pension managers in the Netherlands have taken a lead in adopting fiduciary management—handing operations to an outside supplier. The lure of maximising returns and managing risk may mean the UK is the next in line but there are issues to be resolved first. Paul Whitfield reports.

HEN IT COMES to pension management, where the Dutch lead others tend to follow. Pension funds in the Netherlands were among the first to embrace alternative asset classes, led the drive into private equity funds, championed absolute return funds, and have been at the forefront of the adoption of socially responsible investment criteria in their management processes.

Could fiduciary management be the next big thing to come from the low countries? That is the prediction of some experts who now constate that

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the boom in fiduciary management in the Netherlands will spread across Europe. The first stop in that expansion is expected to be the United Kingdom, according to BlackRock, a listed investment management firm. In December, BlackRock predicted that the value of assets run by fiduciary managers in the UK will rise from the current figure of about £2bn to £300bn within four years. “I am struck by the level of interest in fiduciary management,” says Andrew Dyson, managing director and head of BlackRock’s institutional business for the Europe, Middle East and Africa

(EMEA) region.“The financial crisis has created a tipping point. It brought home to many pension schemes how they don’t necessarily have the resources to maximise investment opportunities or manage risks.”

While there is no hard-and-fast definition of fiduciary management, the term generally refers to the provision, by a single supplier, of a range of services that taken together remove the operational management of a pension fund from trustees, handing it to a third party manager.

What it cannot do is lift the fiduciary responsibility from the shoulders of the trustees, who are still ultimately responsible for the performance and lawful management of their fund.

“Trustees can delegate authority but they cannot delegate responsibility,” says Clive Pugh, a partner at Burges Salmon and a former lawyer for Britain’s Pensions Regulator.“Fiduciary management seems to suggest that trustees are absolved of some of those duties, but that is not the case.”

A good, if still not perfect, comparison of the role of trustees and a fiduciary manager is that of a listed company in which a board, operating in a role similar to the trustees, oversees the functioning of a management team, operating in the fiduciary manager’s role.

The term fiduciary management was coined by investment bank Goldman Sachs & Co. It is also often referred to as implemented consulting. The father of fiduciary management is generally recognised to be the Dutch academic Dr Anton van Nunen, a director at Dutch pension consultants Van Nunen & Partners. Van Nunen has championed the idea for many years and published his thoughts and arguments in favour of a fiduciary management approach in the book Fiduciary Management: Blueprint for Pension Fund Excellence.

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A tipping point was reached in the investment manager services provider Van Nunen outlines a compelling case for fiduciary management in the Dutch market at the start of 2008 SEI. “It took hold in the Netherlands opening chapter of his book. “As the when for the first time the number of where you had a combination of some twenty-first century began to unfold, Dutch pension funds that had pretty powerful academic lobbyists that there was substantial discontent among outsourced management of their have a lot of influence in the pension plan sponsors and other institutions schemes to fiduciary services field and sophisticated pension funds regarding the prevailing investment outweighed those that retained confident enough to look at new ideas.” management structure. Too many control themselves. The 13th annual It has also enjoyed considerable people had a role while no one had review of the Dutch fund management support from Dutch industry groups. overall responsibility,” he wrote. “The industry, published in October by The Dutch Fund and Asset fund managers were not allowed to consultants Bureau Bosch, found that Management Association (DUFAS), share their expertise; their job was Dutch funds under fiduciary and the Dutch Association of simply to manage funds according to management had risen to €515bn, Company Pension Funds (OPF), in the style that had led to their selection accounting for about 72% of all November 2008 published a checklist of good practice for fiduciary … The consultants were paid a per diem pension fund assets. management. The document, and gave their advice which was supported by the accordingly … Meanwhile, industry, is intended to serve having outsourced much of “The reason there is a market for as a checklist for trustees as the work of running a fiduciary management is that defined pension plan, the plan they assess the benefits of sponsor was likely to be a fiduciary management and benefit pension funds are all dealing small organisation with to help them select the with increasingly complex issues and limited expertise. It was services they need. problems around the world, namely deeply dependent on both The dominance of fiduciary volatility of capital markets, changing its consultants and management in the Dutch regulations and accounting changes,” managers, just as it was market will be key to its dependent on its actuaries possible expansion into new says Patrick Disney, managing director and other experts for markets. It has proven to Institutional Business for the EMEA specialised counsel. providers, many of which are region of investment manager services Fiduciary Management international consultants and provider SEI. came into being in response banks with the resources to to these problems.” quickly replicate the model in new market, that fiduciary Fiduciary management The figure is slightly inflated by the management can provide a lucrative services typically include the provision of strategic asset allocation advice and inclusion of in-house fiduciary services new income stream.

The immediate problem for wouldthe development and maintenance of at some of the country’s biggest an investment policy; the screening pension funds, but the size and rapid be providers is that the number of and selection of external asset growth of fiduciary management in the markets in which fiduciary services can managers; the management of the Netherlands is still compelling and is be promoted is limited. The biggest underlying portfolio mix and risk demanding attention in other hindrance is that the provision of management, investment performance European markets.“The reason there is fiduciary services is limited to monitoring and reporting services. a market for fiduciary management is countries in which defined benefit For the time being the provision of such that defined benefit pension funds are schemes are the dominant model. The services remains nascent or non existent all dealing with increasingly complex other problem is a question of in most European markets.The exception issues and problems around the world, readiness. Pension funds need to have is the Netherlands where in the space of namely volatility of capital markets, embraced a level of complexity in about five years it has risen to become the changing regulations and accounting terms of their asset mix and be subject dominant pension management system changes,” says Patrick Disney, to sufficient reporting demands before director Institutional the simplification offered by fiduciary amongst the country’s defined benefit managing Business for the EMEA region of management becomes interesting. pension schemes.

FTSE GLOBAL MARKETS • MARCH/APRIL 2009

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Market Leader EUROPEAN PENSIONS: THE APPEAL OF FIDUCIARY MANAGEMENT

These are the main reasons that the UK, and to a lesser extent Germany, have emerged as the principal targets for expansion. It is also explains why there is little scope for fiduciary management services in other European pension markets. “Fiduciary management remains something that the Italian market is simply not prepared for,”says Giampaolo Serra, a senior consultant at Bologna, Italy based pension consultancy Prometeia.

For the short term, at least, the limited number of markets suited to fiduciary management services is not likely to be a problem. As BlackRock’s prediction makes clear, the UK market alone offers hundreds of billions of pounds of potential assets that could be added to fiduciary managers’books.

“In Europe, the UK and the Netherlands are going to be the key markets for years to come and they are the biggest defined benefit market,” says SEI’s Disney. “You will begin to see some interest in Germany, and possibly Switzerland, but it will take time for them to develop.”

The application of the FR17 accounting standards, which made funding of pensions more transparent and placed greater emphasis on scheme liability risk, and in the UK the findings of the Myners Report, which placed increased emphasis on the need to maximise and manage returns through asset allocation, has placed further stress on fund trustees. That has increased pressure on pension fund trustees, many of whom fulfil the role in a part time capacity.

The size of the mandates up for grabs in the UK was brought into focus last year when Watson Wyatt was appointed as a fiduciary manager for the £3.2bn Merchant Navy Officers Pension Fund. The appointment, made in September 2008, was the largest of its kind in the UK to date. Anecdotal evidence suggests that the majority of

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demand for fiduciary services in the UK is coming from larger pension funds.

“Our research suggests that it is the large schemes that are most open to the sort of services offered by fiduciary managers,” says Pugh of Burges Salmon. “Smaller schemes often lack the sophistication to be confident of effectively managing the relationship and are frankly under less pressure as the complexity of their funds are often less than those of larger funds.”

Larger funds also typically have more experience with the use of consultants and many, in both the UK and Germany, already use services known as implemented consulting or delegated consulting, which are reasonably close to the fiduciary services model of management. That tends to makes the transition to full fiduciary management less of a leap and thus more palatable.

Consultants tend to claim that the emergence of fiduciary management relationships is a result of the demand of clients who are eager to push dayto-day management responsibility back onto external experts.

There is of course a price to pay for these services and as with many manager-of-manager type services there is quite rightly some resistance to adding a new layer of fees to pension management. Fiduciary managers insist that their services add value and can improve the overall performance of a fund. “There are efficiencies to be targeted,” said Ruud Hendriks, Goldman Sachs Asset Management’s managing director EMEA, in a note on his group’s fiduciary offering. “An improved risk return profile…, time savings on the part of the pension fund since there is only one investment manager to communicate with and one consolidated set of reports… [and] flexibility to change the structure of the fund in step with changes to liabilities or market conditions.”

For all the potentially evident logic of such benefits there is however little hard data that proves that funds that adopt fiduciary management services do in fact outperform other pensions funds. That makes adopting the services something of a leap of faith and a potentially expensive one.

There are other potential barriers to the adoption of the fiduciary services across Europe. One of the biggest of those remains the legal questions raised by the outsourcing of almost all management decisions by trustees.

“The services that some fiduciary managers are offering in the Netherlands seem to go further than UK law allows,”says Pugh.“In the UK the trustee is the fiduciary and they certainly can not absolve themselves of that duty.”

Fiduciary services managers argue that there is no conflict with UK law as the trustees maintain their fiduciary responsibility in the management of the relationship with the fiduciary services supplier and through their right to change managers if they are not satisfied with the service.

Such a case is yet to be tested in court and not everyone is convinced that trustees will be fully protected.

“When something goes wrong there is bound to be an argument over the contractual terms and trustees may find they had no right to delegate the responsibilities that they thought they could,” says Pugh.

“Dutch law is different to the UK law and it may be that the reason that this [fiduciary management] turned up there first is that it better fits their legal framework.”

Given the challenges facing pension funds in the current investment environment such concerns are likely to take a back seat to the reassurance that fiduciary management provides trustees.That is good news for fiduciary managers’ expansion prospects.

MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

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In the Markets NEW LAMPS FOR OLD: REDEFINING MARKET REGULATION

Scarred by the financial crisis, the British government is encouraging a much tougher line on banking, trading and capital markets activity. The Financial Services Authority (FSA) is centre stage in the new financial order that will emerge post credit crunch in the United Kingdom. What is less certain is what kind of regulation will ensue in the coming months and years. Some analysts fear that a US Sarbanes Oxley type regime will be imposed, eradicating the principlesbased regulation that traditionally has been a cornerstone of the UK framework. Others believe that FSA will hold firm to its fundamental doctrines, albeit with a somewhat heavier hand under new chairman Lord Adair Turner. Lynn Strongin Dodds reviews the options.

There is no doubt firms will be required to strengthen their liquidity standards. Last December, the FSA published a consultation paper which aims to significantly improve firms’ ability to deal with liquidity risks and thereby increase the overall stability of the UK financial markets. The ideas also build upon current international work on liquidity such as Basel II. The consultation period ends March 2009 and the FSA hopes to introduce new rules by October. Photograph © Luca Oleastri/Dreamstime.com, supplied February 2008.

Will the FSA ditch its principles-based approach?

E NGLISH LIGHT OPERA composers Gilbert and Sullivan held that, “A policeman’s lot is not a happy one.” Pity then the FSA, now firmly centre stage, caught by populist desire to rein in and penalise the recent excesses of the financial

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markets and which, at the same time, must ensure that financial institutions are allowed sufficient laissez-faire to ensure that London maintains its financial markets pre eminence.

According to Mayiz Habbal, managing director of the Securities

and Investment Group at Celent, the Boston-based financial research and consulting company,“There could be a move towards rules-based regulation if there is a greater push towards nationalisation of the banks. This is because if the UK government is in control of these banks, they may create new rules and then the FSA would have to implement [them].”

John Tattersall, a partner in the financial services regulatory practice at PricewaterhouseCoopers, on the other hand does not think that will happen. “I think the FSA has learned the lessons from Northern Rock and there is no doubt that its touch will be tougher and management teams at banks will have to become more

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In the Markets NEW LAMPS FOR OLD: REDEFINING MARKET REGULATION

accountable. I hope we do not see regulation. The words 'intrusive It found that the FSA“failed in its duty as regulator” and did not allocate Sarbanes Oxley type of legislation supervision' will be the new mantra."

The debate about rules versus enough resources or time in dealing because it will stifle the banks. The benefit of principle-based regulation principle-based regulation is not with the troubled bank. A catalogue of is that you can adapt easily to novel. Over the years, there has been mistakes were made including high much discussion as to the merits of turnover of FSA staff directly changing circumstances.”

Alastair Graham, partner at law firm each. A rules approach is when supervising the bank, inadequate White & Case, agrees, adding, “When regulators try to prescribe in a numbers of staff, incomplete paperwork things go wrong, the knee jerk reaction detailed manner exactly what and only limited understanding in the is usually to call for tighter regulation. companies should and should not do supervisory team of the duties required.

However, experience has The FSA has fallen on its shown us that it does not sword, saying that it was work. The story we have guilty of supervising banks “on the cheap”. However, the been living for the past two regulator also stressed that it years is not new, it’s just that should not be made to the losses we are dealing shoulder the blame alone. with this time have more “The Financial Services Authority Market participants have noughts after them and the some sympathy with this size of the financial crisis is (FSA) was taken to task last year by the view, saying that the rules much larger. We may have a Treasury Select Committee's report into based approach favoured in case [such as] Bernie Madoff the Northern Rock debacle. It found today, but in the past there the United States was no that the FSA “failed in its duty as was Robert Maxwell, Barings better at anticipating or regulator” and did not allocate enough and Enron to deal with. The dealing with its domestic real issues are how can we banking collapse. resources or time in dealing with the change the mindset in David Rouch, a partner at troubled bank. A catalogue of mistakes financial services and law firm Freshfields, says, were made including high turnover of prevent the problems that "People are looking for FSA staff directly supervising the bank, we are reacting to.” someone to blame. The inadequate numbers of staff, Carlos Conceicao, politicians are not willing to incomplete paperwork and only limited partner at law firm Clifford accept responsibility. The FSA Chance and former head of has been self-critical and has team understanding in the supervisory accepted that there were the FSA's wholesale group of the duties required.” problems. However, the basic in enforcement, adds, framework of regulatory rules “There is no need of a is not broken." regulatory Big Bang to Selwyn Blair-Ford, senior change the world, but domain expert at risk and whilst I do not think we will regulatory see a Sarbanes Oxley consultancy response and the complete to meet their obligations. By contrast, FRSGlobal, notes, “There were some abandonment of principles-based under the principles method, warnings about the credit crunch but regulation, there will be much more regulators are less concerned about bankers, central banks, academics, prescription. 'Regulation by principle' the dotted Is and crossed Ts and finance ministers and regulators did not is not a catchy slogan at the moment. instead evaluate companies according foresee this financial crisis happening.

There will also be a change in the to broad doctrines.

This is why it is unreasonable to expect FSA's approach. Sensitive to Not surprisingly, the dialogue has that the FSA alone would have accusations that it has been a light- grown much louder over the past few predicted it although they have touch regulator, as the FSA has said months. The FSA was taken to task last admitted that they fell below standards. itself, it will be far more involved and year by the Treasury Select Committee's We expected them to have the aggressive in its day-to-day report into the Northern Rock debacle. infrastructure and expertise to deal with

14

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In the Markets NEW LAMPS FOR OLD: REDEFINING MARKET REGULATION

systemic risk. They did not and now they are having to play catch up.”

A new age is certainly dawning under Lord Turner, who took over the helm last September. Speaking at The Economist's recent inaugural City Lecture, he noted that the scale of proprietary trading over the past decade had created risks, while financial innovation had in many cases delivered minimal economic value and increased the dangers of financial instability. However, Lord Turner rebuffed calls to return to what he called “narrow banking” whereby institutions were restricted to either investment banking or commercial banking. He said the idea was a “nostalgic elegy for a past age of innocence and stability” where local bank managers and the“wide boys”of the City were far apart. The "originate and distribute" model of financing lending has a role to play in the future, but it needs to be reformed, with less complexity and opacity.

A blueprint for the FSA’s future is expected to be published in April. It will not only set out the changes the regulator has already made, but include proposals in principle which have been put forward and need consultation. It will also highlight areas where there is a need for global cooperation. High on the FSA’s agenda will be new approaches to capital adequacy, requiring more capital to be held by banks against risky trading strategies and countercyclical capital requirements to build up adequate buffers during good economic times, which can be drawn on during downturns.

Remuneration is also expected to be on the list. At the World Economic Forum at Davos, Lord Turner warned that banks’ remuneration committees would have "the FSA on their back" if they buckled under pressure and would be punished by having capital

16

Selwyn Blair-Ford, senior domain expert at risk and regulatory consultancy FRSGlobal, says, “There were some warnings about the credit crunch but bankers, central banks, academics, finance ministers and regulators did not foresee this financial crisis happening. This is why it is unreasonable to expect that the FSA alone would have predicted it although they have admitted that they fell below standards. We expected them to have the infrastructure and expertise to deal with systemic risk. They did not and now they are having to play catch up.”

requirements tightened. Many believe it was the prospect of eye-watering bonuses that partly led to the risktaking culture that toppled the industry.

The FSA, though, is not currently expected to impose tougher constraints, because banks’ capital is being eroded by the losses on bad loans.

There is no doubt, though, that firms will be required to strengthen their liquidity standards. Last December, the FSA published a consultation paper which aims to significantly improve firms’ ability to deal with liquidity risks and thereby increase the overall stability of the UK financial markets. The ideas also build upon current international work on liquidity such as Basel II. The consultation period ends in March 2009 and the FSA hopes to introduce new rules by October.

Under the proposals, firms will have to develop a new quantitative framework for liquidity risk management which places greater focus on assessing the risks and policies to tackle them. Firms will need to complete an individual liquidity adequacy form as well as conducting regular stress and scenario testing. This includes analysing the firm’s cash flows, liquidity positions, profitability and solvency from both a short and long-term perspective.

According to Blair-Ford, “These requirements will prompt a major change in the way firms manage their liquidity process. Not only will companies need to develop new metrics but their governance structures will also have to be tightened in order to meet these

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higher standards regarding liquidity than before.”

The FSA is also getting its own house in order. To address its failings in the Northern Rock collapse, the regulator set up a supervisory enhancement programme. The main planks comprise the creation of a core supervisory team to tend to the relationship with the core firm as well as more direct contact with senior managers within the supervisory team. Other key features include the expansion of the FSA’s specialist prudential risk department following the upgrade to divisional status, and bolstering resources in the relevant sector teams. In addition, current supervisory training and the competency framework for FSA staff will be updated.

The FSA is also taking a tougher stance on enforcement. In the past year, it has launched four criminal prosecutions in a renewed crackdown on insider dealing, a criminal offence

Page 17

that carries a maximum seven-year jail term. Last June, Margaret Cole, the FSA's head of enforcement, said, "One of our goals is to get the City to take this subject (market abuse) more seriously.

We feel that the threat of civil fines hasn’t worked as well as we would have liked. We’re convinced that the threat of a custodial sentence is a much more significant deterrent."

As one industry expert put it,“There is a lot of pressure on the regulator to come down hard on people who have misbehaved, and regulatory action has not delivered a sufficient deterrence."

In addition, the City watchdog is hoping to upgrade the calibre of its staff, which might not be that difficult in these credit crunch times when investment banks and other financial institutions are slashing their ranks.

Bob McGee, international economist at UK based economic consultancy Independent Strategy, says, “The FSA was a bit out of its depth in the current

financial crisis but one of the main criticisms over the years has been the quality of its staff. They have not been paid that well and as a result, it has been difficult to attract and retain good people.”

For example, four years ago, staff were provided with extra training on the back of surveys with industry executives who complained that some FSA frontline employees did not understand the businesses they regulated, were inconsistent decision makers and came across as adversarial. Rouch notes though, that "It is not always a case of hiring high quality people but getting the right people into the right job. There was an inadequate understanding of how macro factors would affect individual firms. When even management find that a challenge, regulators need people who can authoritatively question institutions about what they are doing."

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FTSE GLOBAL MARKETS • MARCH/APRIL 2009

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In the Markets BRAZIL: CORPORATE GOVERNANCE REFORMS

BRAZIL’S CVM UPS THE ANTE ON TRANSPARENCY Brazil is gearing up for a second wave of corporate governance reforms. These will focus on providing greater transparency for investors in areas such as shareholder conflicts of interest and clarity on remuneration as well as proposals to make voting at meetings easier. Some measures are being resisted by companies and the test of strength is just beginning, reports John Rumsey.

AST YEAR WAS not the best one for Brazilian corporate governance thanks to a scandal involving some of the country’s biggest exporters. Two companies reportedly lost hundreds

L

18

of millions of dollars each speculating in derivatives. At the same time, the loss of foreign investors has removed a key impetus for improving governance, even though Brazilian funds are

The CVM is working to foster greater transparency. The first big planned change is the release for public consultation of new rules on the information that companies need to provide to the market and this covers all companies listed as well as those that issue bonds, albeit with different levels of disclosure according to market segment. The proposed rules will increase the level of disclosure substantially, says Pinto.

Photograph provided by istockphoto.com, February 2009.

increasingly stepping into the breach. (Please refer to box: Brazilian funds promote tough governance agenda).

The derivatives scandals were whopping. Meat processor Sadia was forced to post a R545m write-down to cover the third quarter on bets against the dollar that soured as the real fell sharply against the greenback in the second half of last year. The company

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In the Markets BRAZIL: CORPORATE GOVERNANCE REFORMS

dismissed its chief financial officer and in February dismissed a further four directors, without indicating whether their sackings were related to the scandal. Meanwhile, paper and pulp company Aracruz recorded $2.13bn in losses stemming from similarly wrong bets. Sadia was trading at R4.80 on February 4th compared to a 52 week high of R12.49 reached in June last year, while Aracruz has fallen from a high of R17.5 in May 2008 to R12.6, its fall partly mitigated by a take-over bid from rival Votorantim.

These losses have encouraged typically passive institutional investors to become more involved in corporate governance. In a widelywatched action, Previ, the influential pension fund of the country’s largest bank, called for an extraordinary general meeting of Sadia, which was held in November. The pension fund wanted explanations of how the manager had allegedly flouted internal rules on hedging and called for greater transparency and control.

Some investors are now litigating to recoup some of the losses, notes Sandra Guerra, founder of Better Governance in São Paulo, which monitors and pushes for better standards. They may well have a case, she thinks. Company boards blamed the financial director of the company, but it would be surprising if the boards themselves did not know their level of exposure, she remarks.“This is part of a chief executive officer’s responsibility. You really cannot manage a company without knowing this,”Guerra says.

The market regulator, the Comissão de Valores Mobiliários (CVM), has enforcement procedures in two cases concerning derivatives (it is unable to name the two companies). “Brazilian law requires board and officers of companies to exercise utmost care. We will judge them by these standards,”

20

says Marcos Pinto at CVM. The good news is that the scandal has made investors much more aware of the importance of the nuts and bolts of reporting lines and authority, thinks Better Governance’s Guerra. Investors are asking who does what and who has authority to sign for what. They are seeking to identify who has overall responsibility, she says.

Initiatives at the CVM It looks to be a timely moment for the CVM to be designing new rules that will help further develop the corporate governance agenda in Brazil. The new focus is on achieving real gains, not superficial, perception-based initiatives, Guerra believes.

The CVM is working to foster greater transparency. The first big planned change is the release for public consultation of new rules on the information that companies need to provide to the market and this covers all companies listed as well as those that issue bonds, albeit with different levels of disclosure according to market segment. The proposed rules will increase the level of disclosure substantially, says Pinto.

These new rules will compel listed companies to give basic information regarding remuneration of managers, conflict of interest between controlling shareholders and more detailed general information on the business of the company, Pinto says. The section covering remuneration has been particularly controversial as it proposes revealing total packages paid to all executives rather than one universal number for the company’s directors, says Pinto.

The reaction has been mixed, Pinto confesses. Many investors say they want this information and see it as critical for judging management.

Companies are protesting that it is not necessary to provide such a

detailed breakdown and that releasing general information should be sufficient. The consultation period is slated to end in March 2009.

Measures to mitigate conflicts of interest focus on disclosure, in line with the CVM’s mandate. “We are being very strict about disclosure of information on related-party transactions,”says Pinto. The new law will require companies to disclose each related-party transaction (between managers and related companies) and provide comparison with market transactions. Brazilian corporate law states that companies have to be fair to all shareholders, Pinto notes. The Bovespa stock market has attracted many companies with controlling shareholders that have stakes in other companies and relationships between themselves. It’s very important for minority shareholders to know which transactions are happening so they can spot and avoid conflicts of interest, he says.

CVM’s reforms come at the same time as the Institute of Brazilian Corporate Governance (IBCG) is planning on making comprehensive changes to its code of governance, adds Guerra. The new code will be much more detailed in relation to risk and tighten control over the board’s responsibility in this area. This is likely to promote the role of audit committees and comes as many listed firms are trying to understand better and mitigate their exposure to risk as the economy deteriorates, says Guerra. The measures should dovetail with the CVM’s moves. The two organisations talk extensively and generally participate in each other’s public releases and consultations. The two operate in slightly different planes, with the CVM focusing on disclosure and the IBCG on best practice.

Another significant change is soon to

MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

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In the Markets BRAZIL: CORPORATE GOVERNANCE REFORMS

be released for consideration and affects the key area of attendance and voting at general meetings, long a contested area in Brazil thanks to restrictive requirements that shareholders appear in person at meetings. Given the size of Brazil and the number of foreign participants, that has effectively deterred participation and quora are often not met.

Last year, CVM decided that shareholders should be able to participate in annual general meetings (AGMs) via the internet, notes Pinto.

CVM is now floating an idea for a new rule that will oblige companies to provide for shareholders to vote by proxy. “Once we have given

shareholders more information on the companies they are willing to vote in, they will be more willing to participate in meetings and better able to monitor the activities of controlling shareholders,” reckons Pinto.

The moves will help stimulate investors to think more carefully about the role of corporate governance and promote more vigilant policies, thinks Guerra. In 2005-07, the years of sustained market rises, many investors’ interest in corporate governance was limited to asking if a company intended to list on the Novo Mercado, the segment with the most stringent listing rules, she points out. If the answer was yes, they thought they had completed

due diligence. They will now be looking to get under the surface, she believes.

Investors will also be more closely monitoring the decisions by individual board members and electing members with more knowledge of their background and voting patterns, she predicts. That could help promote more conversations between the board and investors. Moreover, she sees more tieups similar to that between UK pension fund Hermes and Brazilian fund Previ.

Previ has launched a guide for companies on how to conduct AGMs and a list of dos and don’ts. Hermes has supported the measure. “When you get big funds like this working together, it’s pretty powerful,” Guerra says.

BRAZILIAN FUNDS PROMOTE TOUGH GOVERNANCE AGENDA n January, a group of key Brazilian fund managers came together to force an extraordinary general meeting (EGM) on Telemig, a mobile phone company 100% owned by Spain’s Telefonica and Portugal Telecom, marking a milestone. They were calling publicly on the company to distribute some of its large cash pile and were finally defeated in their motion. The show of corporate governance muscle is very rare for Brazil, where the few actions have been mostly initiated by foreign investors.

Telemig’s EGM was watched closely both by other cash-rich Brazilian companies, trying to figure out what is prudent to keep on hand for a rockier year ahead, and Brazilian fund managers, who are starting to scrutinise practices of companies more closely to wring out more value at a time of poor market performance. Prior to the meeting, Telemig twice declined written requests to distribute some of its R714m in net cash, citing the current poor economic outlook and investment needs. The four Brazilian activists, Polo Capital, Claritas, GAP and Vinson, which own some 8% of Telemig, argued that it is precisely in testing times that companies needs to focus on efficiency and purging excesses and add that investments needs are small compared to earnings before interest, tax, depreciation and

I

22

amortisation (EBITDA.) Capital expenditure needs are some R200m against cash flow of R450m next year, according to their calculations.

The activists also point out that Telemig’s policies seem out of line with those pursued by parent companies Telefonica and Portugal Telecom, which both have net debt to EBITDA ratios of more than two times while Telemig’s net cash position gives it a negative ratio of 1.70. Telefonica’s own policies state the company should be “prioritising shareholders’ returns for the use of free cash flow”, they say.

Telemig is certainly not alone in Brazil in pursuing a share buyback programme, says Marcelo Mollica, senior analyst at GAP, who points out that from September to November, 14 Brazilian firms started buyback programmes against just four in the preceding eight months. “Companies are returning cash to investors where it’s not needed,” he says.

The move by the four managers is unusual for Brazil in its level of coordination. With many foreign investors having pulled out of the Brazilian stock markets over the last 12 months, it’s going to be more important than ever to get Brazilian shareholders involved in monitoring their own companies, says Mollica.

MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

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Doremu

In the Markets TAKING ADVANTAGE OF DEPOSITARY RECEIPT REVAMP

NEW RULES FOR DEPOSITARY RECEIPTS Edwin Reyes, managing director, Deutsche Bank Trust Company Americas. Like JPMorgan, Deutsche Bank also maintains strict guidelines for consulting issuers prior to the establishment a new programme. Says Reyes, “That way we are absolutely certain that there is no objection on the issuers’ part.”

Photograph kindly supplied by Deutsche Bank Trust Company Americas, February 2009.

OR THE BETTER part of a year, the depositary receipt industry has been a tale of two trends— liquidity, way up and new sponsored programmes, way down. An estimated $4.4trn in DRs was traded globally last year, up 34% from 2007. However, in 2008, there were just 20 new listings on European and Asian exchanges; only a dozen set up shop in the US. With world economies still drifting downward and new capital issuance in short supply, that situation is unlikely to change any time soon.

On the bright side, market volatility has done wonders for DR transactional revenue. Furthermore, efforts by the US Securities and Exchange Commission (SEC) aimed at making DRs more accessible and cost-effective, including guidance related to compliance and deregistration, are likely to help mollify long-frustrated foreign issuers in

F

24

A rule revision that took effect last October simplified the process for establishing unsponsored over-the-counter (OTC) programmes for non-registered United States companies, while making it easier for non-US companies to establish Level I programmes stateside. With many more shares now available to US investors in the form of depositary receipts (DR), banks are already gearing up to reap the benefits. From Boston, Dave Simons reports. particular. Meanwhile, a rule revision that took effect last October simplified the process for establishing unsponsored over-the-counter programmes for non-registered US companies, while making it easier for non-US companies to establish Level I programmes stateside. A recent report

by JPMorgan suggests a possible increase in US based merger-andacquisitions activity among foreign companies, which anticipate using American depositary receipts (ADRs) as their acquisition currency.

Unsponsored explosion In keeping with recent trends, ADRs have, in general, mirrored the reduced growth in volume of US domestic stocks. This, says Anthony Moro, vice president and head of ADR business development for the Bank of New York Mellon, indicates the secular changes affecting the global markets. “Despite the recent setbacks, the trend towards globalisation remains intact—the majority of the top oil, automobile and airline companies are all non-US. If you want to be involved in those

sectors, you need to go international.”

Last year’s SEC ruling opened the floodgates for Level 1 unsponsored ADRs, and in the few short months since the changes took effect business has been brisk, to say the least. Some 605 un-sponsored DR programmes were established in 2008, up 288 percent from 2007 (combined sponsored and un-sponsored programmes totalled 2,900 last year).

Says Moro, “It took 75 years for 2,000 programmes to come to the market, and in all likelihood the next 2,000 will be here by the end of next year.”

In reality, investors have had a similar tool at their disposal for years. So-called F-share securities—broker-created shares that resemble ADRs—have provided US dollar-denominated access to any foreign or private issuer, without notification. However, such securities are generally opaque and exceedingly volatile.

Through its latest effort, the SEC seeks to bring some of this cross-border activity out into the light. “It really isn’t a rule change per se and the SEC understands that,” says Moro. “The

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In the Markets TAKING ADVANTAGE OF DEPOSITARY RECEIPT REVAMP

demand has always been there, and the securities have been available as well— the only thing lacking was the transparency. This restores some sanity to that portion of the market.”

Still, some companies have raised concerns over the manner in which unsponsored DR programmes have been set up. According to Claudine Gallagher, global head of depositary receipts at JPMorgan, the unsponsored provision is advantageous so long as the issuing company is properly notified of the establishment of an un-sponsored programme. Unlike sponsored ADRs that benefit investor and issuer equally, investors stand to gain the most from an unsponsored programme. The equity from an unsponsored DR can be accessed simultaneously by a number of different depositary banks, which can lead to confusion even among investors, since banks may have different procedures and proprietary fee schedules.

“There is demand here in the US for securities to be held locally where no DR currently exists, and so the depositary bank will create an unsponsored programme to satisfy that need,” says Gallagher. “Which is great for the investor—however, the issuer still needs to be apprised of what is happening to their equity, which investors are holding it, as well as understand how the unsponsored programme functions and how it is performing over time.”

It is JPMorgan’s policy to launch all un-sponsored ADRs in conjunction with the issuing party. “We feel that it is very important that the issuer understands when a programme is going to be created and how it is going to operate before it gets established,” says Gallagher.

Like JPMorgan, Deutsche Bank also maintains strict guidelines for consulting issuers prior to the establishment a new programme, says Edwin Reyes, managing director,

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Deutsche Bank Trust Company Americas. “That way we are absolutely certain that there is no objection on the issuers’ part.”

Reyes is hopeful that the explosion of un-sponsored programmes will help buoy the market, particularly as any skittishness among affiliated companies begins to abate.

“Companies are beginning to see the benefits of these unsponsored ADR programmes,” he says. “Once the education process continues, at some point they may even consider converting to a sponsored programme.

That, in turn, becomes another avenue for the depositary banks to explore and naturally, as the markets begin to recover, we expect to see an overall improvement in DRs in general.”

There are already a number of positive signs. Compliance costs have come down, and most companies now seem to understand that it’s no longer impossible to get out of a listing if push comes to shove. This “means that companies may be more willing to register early on,” says Reyes, “rather than stay on the sidelines because they feared they wouldn’t be able to get out of the programme if it wasn’t working out for them.”

Liberalising the rules governing listing and de-registering provides much more incentive for would-be participants, agrees Gallagher. “Just two or three years ago, if an issuer had an ADR established it meant that the issuer was in it for good … Now if an issuer launches an ADR, luckily there is a way to exit. So this change has had a positive effect on the DR market.”

Additionally, the streamlining of certain reporting requirements is good news for prospective foreign private issuers, says Gallagher.

While capital raisings in general are expected to remain weak, there are a few potential bright spots. Smaller

Brazil, Russia, India, China (BRIC)based companies in cutting-edge sectors such as biotech and alternate energies have indicated a desire to get into the market during the latter part of the year. “ADRs have real appeal for those types of sectors, mainly because they believe that US tech analysts are better at valuing their businesses, which in turn will lead to better market valuations,” says Gallagher.

Despite the continued weakness, now is not the time to rethink one’s business model, says Gallagher.“The markets are going to eventually come back, and therefore you want to be in a position to respond very rapidly once the moment is at hand.” In the absence of new deals, Gallagher is confident that the returns on JPMorgan’s existing book of business will be more than sufficient.“ADRs tend to be a nice business model—when business is down, it’s because the markets are down, however under such circumstances, the increased volatility generally leads to higher-than-normal issuance and cancellation volume. This is not to say that we have no concerns whatsoever but there are certainly ways to get through difficult market conditions.”

As companies batten down the hatches, Bank of New York Mellon’s Moro sees a continuation of corporateactions work from existing clients, augmented by the occasional capital raising.“For now it’s all about staying in touch with our clients and helping them navigate around the rocky coast of this market,” says Moro. When the market does begin to recover, Moro believes that issuers will be at the front of the pack, led by equity offerings from the BRIC companies.“The debt markets will remain moderately closed, and, in turn, equity will become the new debt,” he says. In turn, says Moro, US listings will likely come back stronger than ever, as increased corporate governance entices buyers like never before.

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Country Report RESPONDING TO THE CREDIT CRISIS SARKOZY-STYLE

German Chancellor Angela Merkel, left, and French President Nicolas Sarkozy listen during a conference on security policy, (Sicherheitskonferenz) at the hotel Bayerischer Hof in Munich, southern Germany, on Saturday, February 7th 2009.

Photograph taken by Frank Augstein for Associated Press. Photograph supplied by PA Photos, February 2009.

LIBERTY, FRATERNITY & BANK BAILOUTS

It is not often that Nicolas Sarkozy chooses to shun the spotlight.

However, at the end of January the normally irrepressible French president was nowhere to be found. The reason for the low profile was not so difficult to track down as the president. On January 29th some 2m French workers marched in cities and towns across France to protest the government’s failure to adequately address their concerns arising from the financial crisis and France’s looming recession. Paul Whitfield reports from Paris on the impact of the Sarkozy government’s response to the global financial crisis.

ARKOZY IS NOT the first French politician to have been laid low by protests, a point he recognised himself when he resurfaced for a television interview on February 5th this year.

“Demonstrations are a constant for our country,” he said. “It is normal that the

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French people are upset.” However, even as Sarkozy swallowed his pride to empathise with his antagonists he could be forgiven for a metaphorical glance at his comparatively peaceful near neighbours in the United Kingdom and Germany and quietly pondering,“why me?”

The answer seems to have far more to do with the willingness of French voters to take to the streets than any particular failure on Sarkozy’s behalf.

Much like his peers, such as Germany’s chancellor Angela Merkel and the United Kingdom’s premier Gordon Brown, Sarkozy has unveiled a raft of measures designed initially to underpin the banking sector, and more latterly to invest in the economy at large and the labour market in particular. In December last year the government announced a €26bn (£22.7bn) stimulus including €10.5bn for loans to France’s biggest lenders that will be used to shore up capital reserves and should help them keep lending. A similar

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amount was made available to other French banks later in the month.

Moreover, at the same time, the state agreed to underwrite up to €110bn of new bank lending through 2009.

Sarkozy’s support for French banks differs from the UK bank bailouts in so much as they are meant to encourage lending by ostensibly healthy banks rather than saving failing banks. The French scheme has, however, tweaked the nose of the European Commission (EC), which initially considered the measures as unfair state aid. Sarkozy got his way, not least because other countries, including Merkel’s Germany, said they would follow the French path.

In consequence, the EC adopted new guidelines on state intervention in

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banks to allow Sarkozy’s model to play out. One key difference between Sarkozy’s package and those of Brown and Merkel is its size: it is far smaller than those of both its neighbours.

Sarkozy can thank good fortune rather than any particular skill for that difference. French banks have always been conservative lenders and through a mixture of good management and luck were less exposed to the fallout from the sub prime collapse in the United States than its counterparts in both the United Kingdom and Germany. Equally, the French government is in a stronger position to profit from its support than either of its neighbours—at least in the short term.

France’s €20bn of loans to its banks will

generate about €1.4bn of interest in 2009, which Sarkozy says he will use to fund “social schemes”. A further €3bn of state funds is being used to purchase equity in failed Franco-Belgian lender Dexia, though €2bn of that is being provided by France’s state-controlled investment fund CDC. These numbers pale against the £100bn that the UK Treasury said in January it expects to spend on measures aimed at unfreezing credit.

That sum comes on top of a £37bn bank bailout plan announced in October 2008 and a £20bn stimulus in November. The British government is also backing some £1trn of bank liabilities. Germany’s main retail lenders have also received significant

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Country Report RESPONDING TO THE CREDIT CRISIS SARKOZY-STYLE

support. Merkel’s government has extended €92bn in publicly funded debt guarantees and liquidity lines to prop up Munich-based property lender Hypo Real and is pondering its nationalisation.

In addition, the German state has spent €10bn buying Commerzbank equity and has earmarked €8.2bn more that will be made available in loans. A further €10bn has been made available to BayernLB. The total size of a German bailout package, hurried through the German parliament in five days, is estimated to be €480bn, of which €400bn is in a fund guaranteeing bank debt to jump-start lending and €80bn is earmarked for equity injections.

For all its relative modesty, the French bank bailout has attracted much ire from French unions and the general public, which claim the government has concentrated on propping up banks at the expense of supporting consumer spending and job creation.

Sarkozy is unrepentant about not doing more to support consumer spending. Speaking in his February television interview, he said that the US and British efforts to engineer a recovery by stimulating consumer spending had been a mistake that he would not repeat. “If the British do that [stimulate consumption] it is because they do not have any industry,” he said. “Gordon Brown can not do what I do…he cut VAT because he has little choice.”

It is not the first time that Sarkozy has sought to score points on the domestic front by criticising his foreign counterparts. In November last year he pointedly rebuked Angela Merkel at a joint press conference when he declared that “France is working on it [the crisis]; Germany is thinking about it.” In fact, Germany’s plan for dealing with the crisis sits somewhere between the French and the British plans, being a mixture of support for industrial

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investment and consumers. A package of measures agreed by Merkel’s coalition in mid-January included investment in public services, steps to lower health- insurance payments, cuts to the lowest income-tax rate and a family-targeted cash give away of €100 for each child.

Sarkozy, meanwhile, remains resolute in his belief that the best way to protect jobs is to stimulate business investment. In his February 5th interview he shunned calls for personal tax cuts or assistance and instead outlined plans to cut business tax by €8bn a year from 2010. He also reiterated plans to provide up to €6bn of aid to carmakers, noting that the industry accounted for about 10% of all French private sector employment.

Unemployment is fast emerging as Sarkozy’s Achilles heel. France is expected to enter its first recession in 16 years in 2009 and the jobless rate is rising at its fastest level in 10 years. The European Commission predicts the French economy will shrink 1.8% this year, its worst performance since World War II. Unemployment in France, which already stands at an uncomfortable 8%, is expected to reach 9.8% by the end of 2009 and top 10.6% by 2010, according to the Commission.

The rise in unemployment has brought with it specific political challenges for the French leader who must be acutely aware that the crisis, and rising unemployment, is playing into the hands of France’s rejuvenated radical left. Of particular concern to politicians of both the right and left central parties is the rise of Solidaire Unitaire Démocratique, a union with ties to far-left Trotskyist and other communist groups that has risen to become the second biggest union amongst France’s rail workers. There is no parallel to that in the political spectrum in either the UK or Germany.

Sarkozy’s personal approval rating

tumbled 6 percentage points following the strikes, to 41%, his lowest level since taking power last year, according to a Ifop/Paris Match poll published at the end of January.

Brown and Merkel also have their own problems. Brown has seen his popularity dip in recent months after it received an initial boost in the early days of the crisis. A recent poll, conducted by YouGov for Channel 4 News, found that just 36% of British voters thought Brown was the best leader to deal with the crisis, down from 41% in October.

Merkel, who faces elections in September, has also seen her party’s popularity slip, even as her personal ratings have held firm. Merkel’s coalition government, consisting of her own party the Christian Democratic Union, the Christian Social Union and Free Democratic Party, has fallen to just 50% in recent polls.

The pressures that the leaders are under coupled with their differing convictions on how to deal with the crisis makes the possibility of a coordinated response to the crisis from Europe’s biggest economies unlikely. In the early days of the crisis Sarkozy tried to harangue the European Union to come out with a unified response to the emerging crisis, though the best he could manage was to elicit a unified statement. He also notably attempted to push European governments into adopting his idea of launching sovereign wealth funds to invest in domestic business, only to be rebuffed by both Britain and Germany.

Sarkozy evidently remains an optimist. He wants European countries to adopt a common position on reforming the financial system and has said that he plans to lead talks on the matter. Sarkozy may have toned down his profile in France, European leaders clearly should not expect the same reticence.

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Country Report SAUDI ARABIA: CONTINUED MARKET LIBERALISATION

Among a raft of changes that are modernising and liberalising the Saudi trading market, perhaps the most significant of late is the introduction by the Capital Markets Authority (CMA) of a new law, last August, which allows non-resident foreign investors access to individually listed stocks for the first time. Until then foreign investors were restricted to investing in mutual funds.

Photograph © Krishnacreations/ Dreamstime.com, supplied February 2009.

UNLOCKING POTENTIAL The Saudi Arabian capital markets are complex beasts. Because retail, rather than institutional investors form the bulk of the activity on the Tadawul, the Saudi stock exchange, the market suffers from a higher volatility than would be expected of the largest exchange in the region. Moreover, the Saudi debt market remains flat, but with a massive internal infrastructure spending programme requiring significant investment inflows from both the public and private sector, could all that change in 2009?

T THE END of January 2009 the TASI, the main index of the Tadawul, the Saudi stock exchange, stood at 4,808, up 0.1% over December but 77% down on its all time high of 20,634 achieved almost three years ago on the 25th February 2006. At its peak the Tadawul was the tenth largest stock exchange in the world, based on the combined capitalisation of its listed stocks. While the Tadawul has often won plaudits for its trading and settlement set-up and competed in terms of market cap with the biggest exchanges in the world, in some ways the Saudi stock market is immature. Even as the

A

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market peaked in 2006 it had only 78 listed stocks, many with a limited free float. While institutional investors dominate most of the capital markets in Saudi Arabia, retail investors still account for 90% of trading volume on the Tadawul, with trading based as much on hearsay and market rumour as statistical research. Even so, the market is slowly evolving into a more broad-based investment market with a growing institutional investor base.

Among a raft of changes that are modernising and liberalising the Saudi trading market, perhaps the one most likely to have the biggest longterm impact is the introduction by the

Capital Markets Authority (CMA) of a new law, last August, which allows non-resident foreign investors access to individually listed stocks for the first time. Until then foreign investors were restricted to access only through mutual funds. Foreign asset managers are still not allowed to trade shares directly but must enter into an innovative swap arrangement in which their brokerage conducts the trade on their behalf and then retains the shares, passing on any profits or dividends until such a time as the broker is instructed to sell the shares and remit the proceeds.

“Overseas buying interest is a welcome introduction to the Saudi market,” says John Coverdale, managing director at SABB. “In normal market conditions, the nature of international investment flows means that when the market is undervalued money will come in and help underpin prices. Similarly when the market is too frothy or overvalued then overseas

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Country Report SAUDI ARABIA: CONTINUED MARKET LIBERALISATION

Adeeb Al-Sowailim, chief executive officer (CEO) at Falcom, one of the new breed of Saudi investment banks, thinks that the latest changes along with the introduction of new initiatives to boost disclosure, such as the publication of the identity of shareholders that hold at least a 5% stake in a company “ are welcome steps towards creating an environment that foreign investors feel comfortable with and that will eventually allow full foreign ownership of shares.” Photograph kindly supplied by Falcom, February 2009.

money tends to drain away so helping to reduce volatility.”

There are a number of drawbacks to this arrangement however. Most significantly perhaps is that as the shares themselves are not technically owned by the international investors, they are technically exposed to potentially a great degree of counterparty risk should their brokerage for any reason enter into administration. In the post-Lehman Brothers era then, there may be some reluctance by some international investors to rely on the CMA to protect their interests in the event of a default. The lack of direct ownership also prevents international investors who build significant stakes in companies from pushing for representation on the board or from voting in the event of a takeover.

Despite these limitations, Adeeb AlSowailim, chief executive officer (CEO) at Falcom, one of the new breed of Saudi investment banks, thinks that the changes introduced into the market along with the introduction of new initiatives to boost disclosure, such as the publication of the identity of shareholders that hold at least a 5% stake in a company, “are welcome steps towards creating an environment that foreign investors

34

feel comfortable with. Eventually the regime will allow full foreign ownership of shares.”

While foreign investors wait for an opportunity to tap the still resilient Saudi economy, the country is moving apace with modernisation of its capital markets. The opening up of the investment market for international investors has coincided with a significant increase in the amount of equity research available. Even though Saudi banks have long had in-house research teams they have traditionally focused on macro-level economic and sector reports rather than on individual stocks. A combination of competition from the newly licensed brokerage firms and a desire from the Saudi banks to improve their client offering has led to an explosion in both the quality, range and amount of research on offer. For the first time regular analysis of individual shares of major companies is now available, providing valuations based on internationally recognised models such as discounted equity cash flow, dividend discount and peer based valuations as well as buy, hold or sell recommendations. “The provision of this type of service is the first step if international investors are to commit significant funds into the Tadawul,” maintains Al-Sowailim. “The research

also provides a guide to the local retail investors as to likely long-term company valuations thereby lowering the influence of the rumour mill that can occasionally take hold of the market,” he adds.

For the brokerage firms, research is also seen as key differentiator in the highly competitive market and a strong show of commitment to their clients.

Many have invested heavily in expanding the depth of their research coverage, often focusing not just on companies in Saudi Arabia but across the six-member Gulf Cooperation Council (GCC). As research improves and Saudi firms become more comfortable with the levels of disclosure expected by international investors, the Saudi market should eventually attract significant investment flows, thinks Tim Gray, chief executive at HSBC Saudi Arabia which has now issued over $1bn of swaps on Saudi shares since the end of August 2008. “We already have excellent execution and clearing, settlement and custody capabilities so the introduction of better and more research completes the picture.” Although another key component, the ability to short and therefore hedge risk, remains off the agenda for the foreseeable future, in the view of most market participants the Tadawul is likely to become more

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Country Report SAUDI ARABIA: CONTINUED MARKET LIBERALISATION

firmly established on the radar of international investors.

Although the lucrative foreign investment market is the immediate focus of many brokerages, the longterm potential of the local retail market has not been forgotten and a slew of investment products are now being developed for both this and the institutional market.

The heavy fall of the TASI and the volatility sometimes exhibited by the Tadawul have opened the eyes of some of Saudi Arabia’s 15m retail investors, many of whom have been introduced to the stock exchange through their participation in the government’s initial public offering (IPO) programme, to the risks inherent in stock picking as an investment strategy. A number of the banks are investing heavily in their investment management arms and expanding the number of products available. One product, exchange traded funds (ETFs), is well suited to the day-trading environment of the Saudi retail market because they can be bought and sold like shares, have lower costs than mutual funds and give exposure to a wider constituent than individual shares. Falcom has already taken the first steps to launching an ETF with the creation of its Sharia Index which is licensed by the Tadawul. The index represents 112 companies, nearly 78% of the TASI index, that are approved by Sharia scholars.“The index is calculated in real-time, published in Saudi riyals and over time we expect it to be used as the basis of index-linked funds, ETFs and over-the-counter (OTC) products.

The Falcom Shariah index also has clear and transparent rules and governance procedures that ensure that it is investable and straightforward to track,” said Al-Sowailim.

With the TASI falling 52.5% in 2008 and remaining subdued in the opening weeks of 2009 investors are being

36

encouraged to look at Saudi Arabia’s nascent sukuk market. Saudi Hollandi Bank’s successful closing of a SR775m mudaraba sukuk, as part of a planned SR1.5bn Islamic note issuance programme, has given hope for a revival of the Saudi sukuk market which had been in the doldrums, along with sukuk issuance in other GCC countries and the global debt markets. Even so, issuance has been relatively constant albeit at a low level since SABIC’s ground-breaking SR3bn issuance in 2006. SABIC’s three issues still remain the de facto benchmarks for Saudi sukuk in the absence of government issued paper. This may change as companies previously reliant solely on bank funding or on shareholder capital seek alternative sources of funding as traditional sources continue to tighten during the course of 2009. Ultimately, the spur to further issuance may, ironically, be provided outside the country. The Malaysian sukuk market continues to be healthy, with a substantial issuance pipeline in the first half of 2009. Moreover, a fillip may also be provided by Turkey and South Korea, both of which are said to be planning substantial sovereign sukuk issues in the first quarter of this year. In their efforts to promote Riyadh as a centre for Islamic finance, the Saudi authorities are likely to be keen to promote wider use of sukuks by Saudi corporates.

The structure of the mudaraba sukuk is similar to that of a traditional securitisation in that a special purpose vehicle (SPV) is created and income relating to a specific project or income scheme is paid into this. The sukuk then represents ownership of units of equal value in the SPV equity and is registered in the names of holders and produces returns according to the percentage of ownership of share. This makes it an ideal structure for banks to raise capital to make loans as well as for companies involved in large

Tim Gray, chief executive at HSBC Saudi Arabia, which has structured a number of sukuks, thinks that the instruments will play a key role in the funding mix of projects alongside local and international bank funding, equity issuance, private equity and government pools. “The sheer scale of the projects planned in the Kingdom and the amount of funding required means that realistically every pool of liquidity will need to be tapped.” Photograph kindly supplied by HSBC, February 2009.

scale infrastructure projects which have clearly identifiable revenue streams. Gray at HSBC, which has structured a number of the sukuks issued to date, thinks that while the unique nature of each sukuk issued means it is difficult to boost issuance levels quickly they will undoubtedly play a key role in the funding mix of projects alongside local and international bank funding, equity issuance, private equity and government pools. “The sheer scale of the projects planned in the Kingdom and the amount of funding required means that realistically every pool of liquidity will need to be tapped.”

An increase in sukuk issuance will be welcomed by investors in what is still a “buy and hold” market with limited trading on the secondary market. An increase in issuance will eventually feed through though and should increase liquidity and tighten spreads. This will give confidence to international investors who have been largely untapped in what remains primarily a domestic market.

MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

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Country Report SAUDI ARABIA: FISCAL SURPLUS BUOYS BANKS

A stricter approach to credit risk is something that has been actively encouraged by the Saudi Arabian Monetary Agency (SAMA), the central bank. “There is considerable evidence from the international markets that many financial institutions fail because of high vulnerability to credit risk. Also, credit risk management in the banking industry is an area of primary concern and focus of SAMA’s off-site and on-site supervisory work and it continues to encourage banks towards more sophistication in this area,” explains Abdulrahman Al-Hamidy, deputy governor of SAMA. Photograph © Pavel Hamr/Dreamstime.com, supplied February 2009.

Saudi banks buck the trend The Saudi Arabian banking sector appears relatively immune to the vagaries of the global credit crisis. In part, this insulation is a result of the large fiscal packages announced by the Saudi government over the last 24 months, supporting a vast array of local infrastructure projects, either through direct investment or capital goods financing. While some of the infrastructure projects may be deferred, the majority of them look likely to go ahead, amounting to a stimulus worth a tad above $400bn into the Saudi economy over the next five years. Even if the oil price hovers at around $40 a barrel (and the Saudi government requires a price of around $50 to balance its budget) the large fiscal surpluses built up over the last few years more than cover any potential shortfall. Moreover, the banks appear to have solid support from the central bank, which has amply demonstrated its willingness to intervene to ease liquidity issues. How best can local banks leverage this project bonanza and central bank support? “

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E ARE IN a fortunate position in Saudi Arabia in that national spending plans and the strong fiscal position of the government means that while the Kingdom is not cocooned from the issues facing the global economy, it is probably cushioned, certainly at the moment, from the worst of its effects,” says John Coverdale, managing director (MD) at SABB. The positive banking results reported by Saudi banks for the

W

2008 financial year certainly support this view. While many banks reported some slowing in income growth and write downs in the fourth quarter of 2008, their aggregated performance and relatively upbeat projections for the 2009 financial year are in marked contrast to the dour predictions elsewhere in the region and further afield. Such is the divide in outlook that some of the Kingdom’s financial institutions appear to have

gone to some lengths to distance themselves from their former international partners.

Samba MD and chief executive officer (CEO) Eisa al-Eisa, for example, when announcing net income for the bank of SR4.5bn in 2008, was keen to disassociate the bank from its previous partner Citigroup, explaining that Samba had separated from Citigroup back in 2003. Although Samba’s overall net income was down 7.7% year-on-year

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after a challenging fourth quarter, the bank says its outlook remains positive.

Samba’s total assets last year rose by 16% to SR179bn, compared to SR154bn in 2007. Over the same period investments rose to SR54bn, a modest 1% increase, while total loans and advances stood at SR98bn, up 22% versus the previous year. Total deposits were up 16% versus 2007 at SR134bn and Samba’s loan-todeposit ratio was 73%, well below the regulatory requirement of 85%.

Commenting on a balance sheet with total equity standing at SR20.2bn supporting total assets of SR 179bn, al-Eisa believes that, “Samba’s performance was achieved despite the financial and economic crises gripping the world’s economies. Our financial position is based on a sound footing, with adequate capitalisation and healthy regulatory ratios.”

Another Saudi bank that appears to buck the global trend is Arab National Bank (ANB), which posted net profits in 2008 of $663m. The key to the bank’s success “against the backdrop of a challenging global environment” believes MD and CEO Dr. Robert Eid, “is a high level of diversification in terms of income and the robust nature of our asset mix.” This allowed assets to reach $32bn in 2008 against $25bn, an increase of 28%. Investments reached $7.5bn compared to $5.6bn for the same period last year representing an increase of 34%, while the loans portfolio rose by 22% to $19.9bn and customers’ deposits increased by 26% to $24.7bn Even so, brokerage and listings advisory business was one area where virtually all of the Saudi banks’ income declined. Saudi banks account for over 90% of the trading activity on the Tadawul, the Saudi stock exchange, which recorded a 27% fall in the volume of transactions (from 65.67m trades in 2007 to 52.14m last year).

Page 39

Samba, for instance, saw income from brokerage reduce by SR304m.

The turmoil on the Tadawul, where the TASI, the main index, dropped by a massive 52.5% last year, limited the number of initial public offerings (IPOs) to just 13 in 2008 compared to 26 in 2007. Saudi Arabia’s stock exchange has always been vulnerable to massive swings as it remains essentially a retail market, with institutional funds accounting for less than 3% of the total.

Saudi banks face significant and growing competition in the retail segment from both the rise of local brokerages, such as Falcom and international companies such as EFG-Hermes which have recently established operations in the country, mostly working out of Riyadh. The government is encouraging competition. The Capital Markets Authority (CMA) as of the end of January 2009 had issued 110 licences to institutions wishing to set up operations in the Kingdom. While many of these are relatively small, with little or no business, others have set up much larger operations. The consequence of this influx is that the already tight margins on brokerage operations in the country are now under renewed pressure as the new entrants look to gain market share.

Changing conditions in the local market have encouraged many Saudi banks to actively diversify their business streams. SABB’s Coverdale, for instance, attributes much of the bank’s stable performance through 2008 (a more than satisfactory 12% uptick in net profits to $779m) to the growth in non-funds income. A substantive upturn in revenue was recorded largely across the board in SABB’s card, account relationship management and trade-related businesses.

“This sustained performance has been achieved by

FTSE GLOBAL MARKETS • MARCH/APRIL 2009

Samba managing director and chief executive officer (CEO) Eisa al-Eisa announced net income for the bank of SR4.5bn in 2008 and was keen to disassociate the bank from its previous partner Citigroup. (Samba separated from Citigroup in 2003). Although Samba’s overall net income was down 7.7% year-on-year after a challenging fourth quarter, the bank says its outlook remains positive. Photograph kindly supplied by Samba, February 2009

SABB’s continued focus on core banking activities, supported by the underlying fundamental strength of the Saudi economy. The quality of our asset book remains strong, with loan growth being fully funded by increased customer deposits. Surplus deposits raised have been invested in accordance with our conservative investment policy,”explains Coverdale.

According to Coverdale, SABB uses sophisticated modelling, credit scoring and risk analysis in its various businesses lines and also sets the bar high in terms of loan qualification.

Saudi banks are also supported by local loan repayment practices. When loans or mortgage products are sold in Saudi Arabia to individuals, for instance, repayments are normally deducted at source from their salary

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Country Report SAUDI ARABIA: FISCAL SURPLUS BUOYS BANKS

via the employer in much the same way that income tax is deducted elsewhere in the world. This process significantly reduces the levels of nonperforming loans in the Kingdom. AlEisa says that Samba’s “nonperforming loans (NPLs)-to-loan ratio now stands at 1.8%, compared to 2.3% back in 2007. We continue to set aside much higher provisions than the regulatory requirement, thereby improving our loan leverage ratio (LLR) coverage to 167% compared to 160% in 2007.”

Another bank taking a conservative approach is Riyad Bank. At the end of 2008 its loan book rose stood at SR96.4bn, up 43% on the year and 7% on the quarter. Much of this growth has been in loans to small and medium sized enterprises (SMEs), a sector the bank has been heavily targeting. More importantly Riyad Bank has met with significant success in attracting new deposits, which surged 20% in the fourth quarter in a highly competitive market. This helped drive down the loans-todeposit ratio to 92% (from 103% in September) and leaves the bank well positioned going into 2009.

This stricter approach to credit risk has been actively encouraged by the Saudi Arabian Monetary Agency (SAMA), the central bank. “There is considerable evidence from the international markets that many financial institutions fail because of high vulnerability to credit risk. Also, credit risk management in the banking industry is an area of primary concern and focus of SAMA’s off-site and onsite supervisory work and it continues to encourage banks towards more sophistication in this area,” explains Abdulrahman Al-Hamidy, deputy governor of SAMA. The implementation of Basel II at the beginning of 2008 has given further impetus to management of all risk in

40

the banks, he adds. “The credit risk management systems in banks are going through a thorough review and enhancement as most banks are working on the implementation of their internal credit risk rating systems,” notes Al-Hamidy. “These systems are expected to collect qualitative and quantitative financial data on their customers and also data on their facilities, collaterals, and other related information. Furthermore, these systems will help collecting data on customer default history and credit losses. The objective of these systems is to provide information on the probability of default and loss given default.”This process should be further aided by the creation of a national data pool for corporate customers which is currently being developed.

SAMA is also active elsewhere.

Although the lack of liquidity in the banking system and wider economy is less of an issue in Saudi Arabia than elsewhere, some of the banks are exposed to overseas borrowing.

However, this accounts for only a small proportion of their funding.

Nonetheless, there is undoubtedly competition between institutions for deposits and this trend is only expected to intensify as more foreign banks enter the country. In the meantime, in their search for liquidity, local banks have been helped by SAMA’s intervention in the markets. At the end of November, the central bank lowered the repurchase (repo) rate from 4% to 3% and the cash reserve requirement on demand deposits from 10% to 7%.

Since then SAMA has made two further cuts to the repo rate. The latest intervention came on 19th January this year when the central bank took the repo rate down to 2% and the reverse repo rate to 0.75% in order to “ensure that credit is available for genuine corporate demand at lower rates,” according to an official statement.

John Coverdale, managing director (MD) at SABB. According to Coverdale, SABB uses sophisticated modelling, credit scoring and risk analysis in its various business lines and also sets the bar high in terms of loan qualification.

Moreover, Saudi banks are also supported by local loan repayment practices. Photograph kindly supplied by SABB, February 2008.

Repo and reverse repo transactions are the primary tools that SAMA has used to offset temporary swings in bank reserves, as well as to boost liquidity. A repo temporarily adds reserve balances to the banking system while reverse repos have the opposite effect. In repos, SAMA makes overnight loans to banks in collateral of the government securities portfolio held by banks with a maximum of 75% of this portfolio at the announced repo rate. In reverse repo, SAMA borrows from banks at the reverse repo rate. The latest action

by SAMA of reducing repo and reverse repo rates adds more stability to the inter-banking market, boosts liquidity and makes more reserves available for banks, at a lower cost, if the need emerges. In October SAMA announced that to date no bank had used this facility but as conditions worsened for the banks in the fourth quarter there was no indication whether this was still the case.

MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

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Spotlight on Colombia: A Q&A Session with Global X Funds founder and CEO Bruno del Ama Why did you choose the FTSE Colombia 20 Index as the basis for Global X’s newest Exchange Traded Fund?

It is difficult and expensive to access the Colombian market and this is the first Colombian ETF globally. FTSE developed a custom made index for the Colombian market that balances the liquidity needs of an ETF with the diversification requirements from U.S. regulators. The index represents the performance of the top 20 stocks, ranked by liquidity, then size, in one of the world’s fastest growing emerging markets.

What is the performance story?

Amidst global market turmoil over the course of the trailing year, ending 30 January 2009, Colombia was one of the top performing emerging markets. The FTSE Colombia 20 Index was down only 5.38% in USD total return terms over that period, as compared with the FTSE Emerging All Cap Index, which fell by 50.92%.

FTSE Colombia 20 1-Year Performance Index Rebased (31 Jan 2008 =100)

140 120 100 80 60 40

-2

00

9

8

Ja n

No

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20

00

08

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20

20

08

08

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20 nJu

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FTSE Latin Americas All Cap Index

08

8 00

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FTSE Colombia 20 Index

00

8 00 ar -2

-2 Fe b

Ja n

-2

00

00

8

8

20

FTSE Emerging All Cap Index

What kinds of companies are found in the Colombia 20 Index?

The constituents of the Colombia 20 index span multiple industries, although there is some concentration in Oil & Gas, Banks, and Financial Services as classified by ICB supersector. The top two companies in the index are Ecopetrol SA, the largest Latin America IPO in 2007, and Bancolombia SA, the largest commercial bank in the country.

FTSE Colombia 20 Top 5 Constituents Rank Constituent Name

ICB Supersector

Index Market Cap (USDm)

Index Weight (%)

1,012

19.87

1

Empresa Colombiana de Petroleos

Oil & Gas

2

Bancolombia

Banks

423

8.30

2

Bancolombia PN

Banks

570

11.19

3

Colombiana de Inversiones

Financial Services

258

5.07

4

Banco De Bogota

Banks

253

4.98

5

Inversiones Argos

Construction & Materials

250

4.92

2,766

54.32

Totals

Source: FTSE Group, as at 30 January 2009. FTSE does not accept any liability for any errors or omissions in the FTSE indices or underlying data. No further distribution of FTSE Data is permitted without FTSE's express written consent

For further information about GlobalX Funds, please contact Bruno del Ama at bdelama@globalxfunds.com or visit www.globalxfunds.com

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. Wherever you invest, FTSE gives you the clearest view of how you are doing. www.ftse.com/invest_world © FTSE International Limited (‘FTSE’) 2009. All rights reserved. FTSE ® is a trade mark owned by the London Stock Exchange Plc and The Financial Times Limited and are used by FTSE under licence.

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Index Review INDEX REVIEW: THE DARKEST HOUR BEFORE THE DAWN?

ROCK, PAPER, SCISSORS, STERLING At times like this, where the dark before the dawn seems ever deeper, it is quite simple to advise investors to keep their hands in their pockets rather than risk a punt or two on a reversal of fortune. Even so, traders should always be aware that bear markets do end at some point and the resulting bounce can be dramatic. Simon Denham, managing director of spread betting firm Capital Spreads, looks for hope amid the wreckage.

Y LAST MISSIVE concerned the need for that iconic moment when a major name disappears and defines the moment when we can say “that was the bottom”. Might it be near? Both RBS and Lloyds/HBOS look suspiciously terminal; indeed, at 11p per share the entire share capital of RBS is now valued at little more than a three month call option.

In the Scandinavian banking crisis of the 1990s equity holders were wiped out and many banks merged or sold off to create Nordea Group. The potential for huge job losses if the UK takes this same route will cause alarm in the Exchequer as tax revenues and spending are already under pressure.

Truth is, capital economies rely on strong banks for growth. A major handicap for both the communist and the Islamic economic models over the last century has been their lack of ability to borrow to expand. Everything had to be centrally planned/funded or paid for cash down. The upshot is much slower growth and the depressing fact that the poor generally remain poor and the wealthy reap all the rewards. If too many banks go to the wall and/or their appetite for lending is seriously curtailed it will have a serious affect on growth potential for many years to come.

M

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The UK’s public fiscal position is precarious as ever more funds have been committed to social wellbeing programmes with little consideration given to the long term costs of such projects. Over the last three months untold billions have been added to this total in the form of props to the financial services sector. The result, predictably, is an economy resembling one of those test crash dummies driving into a brick wall. Business surveys are reporting unheard of weakness in confidence, order books and rate of decline.

It is tempting to say that equity markets and investors tend to look past current problems and focus on future opportunity.

However, companies which have not reported losses for decades are now swimming in red ink and the situation for weaker businesses remains grim and is likely worsen. The destruction of capital has been monumental and there will be a massive issuance of Gilts, Bunds, Treasuries etc over the next three to six years. This glut of state debt is likely to soak up a big chunk of available investment funds and may create a heavy squeeze on investment elsewhere. From where are the excess funds, needed to drive a serious bull market, going to come?

While equity market returns look

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

tempting the same can be said for corporate bonds. Much of the five to eight year UK corporate debt is giving yields in the low teens when the equivalent equity return is generally at 4% to 6%. This yield gap is giving company treasurers little scope to issue debt to finance growth (with no real appetite for equity issuance either).

Markets are current oscillating around the same general area day after day, with the FTSE struggling to break away from the 4000 to 4450 range. It had broken above and below these levels several times since October but only for a few days until the pressure to return becomes too great. This weakness might be considered surprising as the index is comprised of so many foreign and international firms (given the thrashing being given to sterling). It is said over 70% of the turnover of FTSE 100 stocks is made abroad. If this is indeed the case, the attraction for UK stocks in their sterling depreciated state must be compelling. The problem is that any foreign portfolio manager looking at UK equities investments is looking at serious value destruction over and above the mere weakness of the actual stock. Sterling has more than halved versus the yen since the summer of 2007 and has given up 35% against the dollar and euro. It is a brave fund manager who is willing to buck a trend like that.

As ever Ladies and Gentlemen, Place your bets.

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Activity in the pfandbrief market since October 2008 has dropped to less than half its previous level. Government guarantees to save the banking system from collapse have seemed to rule out any further public issues of German covered bonds in the near term. However, the successful launch of two €1bn jumbo pfandbrief issues at the beginning of February this year— albeit at considerably wider spreads than the last issues of 2008—has raised hopes that the market will recover sooner than most thought likely a few weeks ago. Andrew Cavenagh reports.

S IN OTHER European countries, the overhang of government-guaranteed bank bonds will clearly continue to inhibit issuance of all other types of capital market debt in Germany. This looks likely to remain the case, at least through the first half of 2009. The Federal government has committed €480bn to support the country’s financial institutions—most of it in the form of debt guarantees—and the availability of such a huge volume of high-yielding, sovereign-backed instruments in a still nervous market will inevitably stifle demand for alternative fixed-income investments.

A

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HOPES FOR EARLY RECOVERY IN PFANDBRIEF ISSUANCE

Although the VDP’s weekly polls have suggested that issuance levels are starting to pick up, the organisation was not expecting jumbo issuance to resume quite so soon. However, Landesbank Baden-Württemberg (LBBW) surprised the market with a €1bn benchmark issue of an öffentliche (public sector) pfandbrief on February 4th. The following day Deutsche Postbank launched a hypotheken (mortgage-backed) deal of the same size. Photograph supplied by Istockphoto.com, February 2009.

??

While the risk on the guaranteed German bank debt is probably not exactly the same as that on bunds—one would need to see the covenants concerned to determine the precise difference—it is clearly close enough to make such paper a compelling investment in the current climate.

German guaranteed bonds currently offer a yield pick-up of around 60-70 basis points (bps) over bunds, although they are a relatively short-term investment with a maximum tenor of three years and an origination deadline of December 2009.

The current spreads in the public pfandbrief market are significantly wider than this. According to the most recent figures from theVerband deutscher Pfandbriefbanken (VDP, the Association of German Pfandbrief Banks), the spread on 10-year jumbo issues had widened to 80bps to 90bps over bunds by the end of the first week of January, while those on five-year jumbo issues had gone out to 110bps-120bps.

The comparable spreads over swaps were 30bps-35bps and 45bps-50bps respectively. “As across most bond markets, the spread landscape in pfandbrief has changed considerably compared to where we were a year ago,” acknowledges Dr Louis Hagen, executive director of VDP. He admits that the large volumes of governmentguaranteed debt pose “a great challenge” to the pfandbrief market in the near term, but he maintains that appetite for

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the covered bonds will return as investors regain the confidence to look beyond short-term horizons.“Given the maximum maturity of three years and therefore a best-by date of December 2012 for German government guaranteed bank bonds, we expect pfandbrief issuance to gain more momentum as investors look for longer-dated maturities to match their long-dated liabilities,”he says.

For the time being, however, German institutions eligible for the guarantees—while the government has not identified a formal list, it includes all the country’s mortgage banks and state landesbanks—which need to raise several billion euros of liquidity have little incentive to look anywhere else. Right now, “for the large liquidity chunks that you need that’s probably the only place that you are going to be able to get it,” said Marcel Kullmann, head of covered-bond funding at leading pfandbrief issuer Eurohypo and its parent Commerzbank. Eurohypo and others have nevertheless continued to place smaller transactions of bearer and registered pfandbriefe in the private market. These more individually tailored instruments continue to offer domestic insurance companies, and to a lesser extent pension funds, important benefits, even in the current climate.

The advantages include accounting treatment (registered pfandbriefe do not require mark-to-market valuations), the ability to match long-dated assets and liabilities more closely (with available maturities of between three and ten years), and the negotiation of pricing on a one-off bilateral basis. As a result, issuers can secure pricing levels well inside the secondary market spreads that are now on offer in the jumbo market.“We have seen a shift in our activities, and I think that would also be true of the other pfandbrief issuing banks,” says Kullmann. Such private placements have historically accounted for 30%-40% of Eurohypo’s coveredbond issuance, he adds.

The volume of private business, however, has also predictably dropped off since September. The VDP figures indicate that from mid-October to the third week in January the total weekly issuance of pfandbriefe averaged little over €1.5bn, compared with a monthly total of €14bn in September.

While spreads may be inside those in the jumbo market, they are still well above historical norms. Hagen confirms that issuers were obliged to write “more generous” coupons than previously to sell deals in the private market. “Today, levels north of plus-60bps for a mortgage pfandbrief are frequently observed.”

Although the VDP’s weekly polls have suggested that issuance levels are starting to pick up, the organisation was not expecting jumbo issuance to resume quite so soon.

However, Landesbank Baden-Württemberg (LBBW) surprised the market with a €1bn benchmark issue of an öffentliche (public sector) pfandbrief on February 4th. The following day Deutsche Postbank launched a hypotheken (mortgage-backed) deal of the same size. Both deals offered investors generous spreads—the five-year LBBW bond priced at 75bps over mid-swaps, while the Postbank issue came in at 85bps over the benchmark. These levels compare

Dr Louis Hagen, executive director of VDP. Photograph kindly supplied by VDP, February 2009.

with a spread of 110bps over mid-swaps at which BNP Paribas priced a €1.5bn, five-year structured covered bond on January 8th and bankers in the market believe issuers will need to continue offering such pricing for the forseeable future.“That is the new world—you’re in direct competition and you have to pay for it,”holds Menko Jaekel, the co-head responsible for pfandbrief origination in the debt capital markets financial institutions group at the French bank.

“Every investor has lots of opportunities out there in the government-guaranteed sector. The likelihood of a widening of new issue spreads is higher compared to a tightening (due to the impressive amount of supply)”.

At such spread levels, the pfandbrief deals sold well. The lead managers on the LBBW issue were able to close the book after just one hour as it was oversubscribed by a factor of three. “The very well diversified order book contains some 120 national and international investors,” adds Jörg Huber, head of debt capital funding at the landesbank.

Foreign buyers accounted for 30% of the issue.

Hagen at the VDP says pricing in the pfandbrief market should be viewed in the context of the spread widening that had taken place on sovereign agency and other publicsector issuance such as the 37bps margin over the relevant bund that state-owned development bank Kreditanstalt für Wiederaufbau (KfW) had been obliged to pay on the €3bn issue it launched in January.

How quickly other jumbo issuers follow the lead of LBBW and Postbank remains to be seen, but the resumption of the market was widely hailed as an encouraging sign. While pfandbriefe will clearly cost their issuing banks more than guaranteed debt (although the allin difference is less than first appears once the fees attaching to the latter are included), the longer maturities that covered bonds offer will enable banks to limit what could otherwise become a potentially huge refinancing risk in 2012, when all the guaranteed paper matures.

Pfandbrief bonds also match the requirements of German mortgage lending well, and the more limited market of the past four months has reinforced a trend that had become evident through the earlier part of 2008—a sharp increase in issuance of mortgage-backed deals as the number backed by public-sector loans continued to decline. The VDP’s figures from October to the end of the third week in January

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New issuance vol. /month (bn €)

show that hypotheken PFANDBRIEF ISSUANCE 2007-TO OCTOBER 2008 pfandbrief accounted for the dominant share of the market Start of Credit Crises 25,0 over the period. This followed a 20,0 dramatic increase in the first 10 15,0 months of 2008, when issuance 10,0 of hypotheken and ship pfandbriefe (of which the vast 5,0 majority were the former) 0,0 soared over the same period of 2007 by 174% to €49.6bn.

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Meanwhile, issuance of 07 07 07 07 07 07 07 07 07 07 07 07 08 08 08 08 08 08 08 08 08 08 Jumbo (Bearer) Pfandbriefe öffentliche bonds fell by 12% to Bearer Pfandbriefe €83.3bn on the year before.

Registered Pfandbriefe This shift in the market was inevitable as the removal of Source: VDP, Deutsche Bundesbank, HVB/UniCredit. Data supplied February 2009 sovereign guarantees for the senior unsecured debt of the landesbanks back in 2005 market to the same extent as they had done in the past. filtered through into the system (as the huge volumes of preOn the mortgage side, by contrast, Hagen says VDP funding they put in place before the expiry of the guarantees expects issuance to continue growing, particularly given the matured) and the pricing of public-sector debt has tightened. strong performance record of the bonds. No hypotheken Hagen said the“razor-thin margins”now offered on public- bond has ever defaulted, and the German government sector debt would lead to further consolidation of the stressed at the time it announced the support package for öffentliche bond market, as they would discourage issuers the banks in October that one of the purposes of the massive from funding this type of lending through the pfandbrief state intervention was to ensure that this remains the case. ar

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Nevertheless, there is broad confidence that a public market for cédulas will come back ahead of other asset classes.“I think that covered bonds will find their place again rather easier than others,” concludes the head of capital markets funding at another leading Spanish bank.“Although with the market focusing on the government-guaranteed debt for the time being, it’s very hard for me to make a crystal-ball assessment and say when.”

Photograph © Enrula/Dreamstime.com, supplied February 2009.

It would be a brave man who bet on public issuance of Spanish covered bonds— cédulas— resuming in the first half of this year, but despite record secondary-market spreads and dire forecasts for the national economy the outlook is brighter than it was in October. Andrew Cavenagh reports.

PANISH BANKS WILL continue to place their mortgage portfolios into cédulas structures to access funding from the Financial Assets Acquisition Fund, which the government set up in October last year to provide liquidity to a banking market paralysed by the credit crunch. The fund, which has an initial size of €30bn but could be expanded to €50bn, will only accept assets that are rated triple-A. It acquired €7bn of such collateral at its last auction in December 2008 and will remain the only significant buyer of cédulas in the near term. Jose de Leon, senior credit officer at Moody’s in Madrid, says the fund should ensure that a similar or higher volume of cédulas issuance is forthcoming this year compared with 2008. “Furthermore, multi-cédulas issuances, where

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Spanish entities pool their issuance of cédulas together, are accepted as eligible collateral for Eurosystem operations. This will encourage the use of cédulas in 2009 as well,”he added.

In the meantime, as in Germany, a market for smaller privately placed issues tailored to the requirements of individual investors has emerged since the seizure of all bond markets that the collapse of Lehman Brothers precipitated in September. “We are still doing private placements—this year we have done two private placements and one registered covered bond,” says Carlos Stilianopoulos, head of capital markets at Caja Madrid, Spain’s second largest savings bank and historically its fourth-ranked cédulas issuer. “I am more optimistic than I

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was four or five months ago. I think the market is slowly and well capitalised,”explains Tim Skeet, managing director picking up.” and head of covered bonds origination at Bank of America With quoted secondary-market spreads for cédulas out Merrill Lynch in London.“They’re probably better prepared between 90 basis points (bps) and 130bps over Euribor to absorb losses than other people.” (most maintain actual trading is too thin for this to be a While they are bound to sustain losses on propertyreliable pricing guide), there is clearly little incentive at related loans, concerns that a nose-dive in the Spanish present for any originating bank to attempt sell a jumbo property market will seriously erode the collateral backing issue in the public market, particularly as the government is cédulas hipotecarias may also have been overdone. One providing up to €100bn of guarantees for senior bank debt great strength of these covered bonds is that banks’ entire issued up to the end of 2009, with maximum maturities of portfolios of eligible mortgage loans—those with a loan-tovalue (LTV) ratio of 80% or less—support the issues five years.

As in all the leading European countries, the overhang of (although all assets serve as security in the event of an issuer this guaranteed debt will continue to curb activity in other default), which provides investors with massive overbond markets through 2009. “What we need is for all this collateralisation. However, a drastic decline in property government-guaranteed paper to come to the market and prices that led to a widespread increase in LTVs over the hopefully it will open up other types of issuance as well,” 80% eligibility criterion could clearly weaken this position. commented Stilianopoulos.

This does not appear to be As the surprise launch of happening, despite the two jumbo pfandbrief bonds prophecies of doom over in Germany in the first week Spain’s property market. of February showed, The latest government Carlos Stilianopoulos, head of however, this will not figures for the end of 2008 show that while activity in necessarily inhibit other capital markets at Caja Madrid, the the market (in terms of forms of issuance altogether. country’s second largest savings bank sales) had certainly Following Standard & Poor’s and historically its fourth-ranked plummeted by 30%-40%, decision in January to cut cédulas issuer, said, “I’m more the average house-price Spain’s sovereign rating to optimistic than I was four or five decline over the year was double-A plus, cédulas now months ago. I think the market is just 2% (although offer a marginally stronger considerably higher in the credit than sovereign debt slowly picking up.” coastal regions). (and by association the guaranteed paper).“It makes The seasoning of Spanish cédulas slightly more mortgages is an advantage attractive,” confirms here—about 80% are at Stilianopoulos.“Right now it’s the only triple-A paper you least five to six years old and this means that house prices can get out of Spain.” would need to drop by around 40% to seriously jeopardise Another encouraging development—no doubt driven by the volume of eligible cédulas collateral.“The levels of overthe widening of spreads on all Spanish capital market debt— collateralisation are still very high—approximately 180% as has been a significant increase in the take-up by domestic of September 2008 as an average—if we measure the total investors of the bank issues that have come to the market this cover pool,” confirms De Leon at Moody’s. “However, this year. The lack of a home investor base has always been seen does not mean that in all circumstances a full recovery for as a weakness of the cédulas market, as historically it has all issuers can be assumed, given the high credit and accounted for only around 10% of jumbo issues. refinancing risk.”

La Caixa placed 52% of the €1.5bn, three-year Moody’s highlighted refinancing risk as the main guaranteed bond it placed at the end of January with challenge for the Spanish and other European covered Spanish buyers at a spread of 80bps over mid-swaps. By bond markets in an analysis it published in January, and de contrast, 90% of the un-guaranteed €1bn five-year bond Leon said the agency was applying“very high discounts”to that BBVA closed in the first half of the month (at a spread the Spanish mortgage portfolios on account of the long of 180bps over mid-swaps) went to international investors. average lives of loans in the cover pools (over 10-12 years in “Domestic investors are the big buyers now for most of the most cases). Nevertheless, there is broad confidence that a debt,”says Stilianopoulos. public market for cédulas will come back ahead of other Despite the grim outlook for the Spanish economy in the asset classes.“I think that covered bonds will find their place near term and the inevitable impending deterioration in the again rather easier than others,” concludes the head of government finances, the country’s banks are also not as capital markets funding at another leading Spanish bank. imperilled as some of their European counterparts, with a “Although with the market focusing on the governmentrelatively high base of individual savings. “It is quite clear guaranteed debt for the time being, it’s very hard for me to that the Spanish banking system overall is perfectly secure make a crystal-ball assessment and say when.”

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SOVEREIGN BONDS: ISSUANCE VOLUMES RISE

“Investors are spoilt for choice,” says Tim Skeet, managing director and head of covered bonds origination at Bank of America Merrill Lynch in London.“They can certainly get low risk at a much more decent return than they did in the past, and there’s still an enormous amount of liquidity out there at a price.” Photograph © Stasys Eidiejus/Dreamstime.com, supplied February 2009.

Sovereign bonds face their most turbulent year for decades as the trillions of dollars, euros and pounds that the US and European governments have pumped into the global banking system cause unprecedented upheaval in the historically most stable of fixed-income markets. Andrew Cavenagh reports.

Sovereign Guarantees Offer Returns Amid the Turmoil T HE GUARANTEES THAT governments are providing for enormous volumes of commercial bank debt (over £500bn in the case of the UK alone) have had the most immediate impact on sovereign issuance. The emergence of this new and vast class of bonds that offer significantly higher yields than traditional government debt but carry substantially the same risk has inevitably dislocated the market for all fixed-income securities. The guaranteed paper offers a compelling combination of security and returns for investors who remain nervous after the events of the past four months. Some of the guaranteed debt was trading at as much as 70 basis points (bps) to 80 bps over comparable sovereigns in the second half of January. “Investors are spoilt for choice,” says Tim Skeet, managing director and head of covered bonds origination at Bank of America Merrill Lynch in London.

“They can certainly get low risk at a much more decent

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return than they did in the past, and there’s still an enormous amount of liquidity out there at a price.”

“What we are witnessing,” Skeet adds, “is a significant crowding out in the markets as investors gravitate towards low risks and high spreads, or even un-guaranteed bank paper with marginally higher risk but even higher spreads.”

(An uncovered Commerzbank issue in January offered a margin of 210bps over mid-swaps.) One predictable consequence of the deluge of guaranteed bank debt has been some loss of appetite for new sovereign issuance—at least at recent historical prices—as evidenced by the failure of the year’s first auction of German bunds on January 7th, when the German government was obliged to retain 32% of the €6bn issue.

The yield on the 10-year bond, offering a coupon of 3.75%, rose immediately by 34bps and took secondary market spreads on other bunds and European sovereigns with it. The message was clear: sovereign issues are now in a more competitive environment and will need to offer investors better returns over the next 12 to 18 months.

Although analysts point out that the failure of the auction reflected the difficulty of managing such processes in volatile markets and the current inability of many large banks to take significant positions as they continue to bolster their own balance sheets, they believe there is a real risk of more under-sold auctions this year. Marc Ostwald, strategist on the institutional bond desk at Monument Securities, says that in 20 years of covering bund auctions he cannot remember the Bundesbank being left with a third of the bonds before, and it was a poor omen.“We are going to have more auctions that are quasi failures.”

This has the potential to embarrass several European governments, given their need to increase levels of sovereign issuance considerably this year—partly to finance the direct support they are providing through equity

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injections to several leading commercial banks on top of the much more widespread debt guarantees. At the end of January, Fitch Ratings estimated that the 16 European governments with high-grade sovereign ratings would need to raise a further €270bn in 2009 for this purpose alone. The agency calculated that this additional requirement would increase their total borrowing needs for the year to just under €2,000bn, a 45% increase on 2008 and equivalent to 17% of their collective gross domestic product (GDP).

In the case of the UK, the increase in gilt issuance will be far more dramatic. The British government will attempt to treble the amount it raises from the capital markets in 2009 over the previous year to £146.4bn or 10% of GDP. Many believe it will have some difficulty in doing so, as it is obliged to run large budget deficits over the next two years.

The International Monetary Fund (IMF) warned at the end of January that the UK would be the hardest hit of all the developed countries in the recession, with GDP expected to shrink by 2.8% in 2009.

The UK Treasury’s Debt Management Office concedes that it may face constraints on raising the money required from the capital markets. Although it successfully auctioned off around £13bn of gilts in January, its chief executive Robert Stheeman acknowledges that future auctions in 2009 may not attract full orders.“In theory it could happen … if we were to have a series of uncovered auctions, that’s not something we would welcome at all,”he says.

Brian Coulton, head of sovereign ratings at Fitch in London, agrees that this could be a“serious concern”, given that the UK along with most other high-grade sovereigns did not typically hold large fiscal reserves, but he maintained that such fears were probably exaggerated. He stresses that recent auction failures were down to pricing issues, and he sees “no reason to doubt that pricing adjustments would ultimately do their job of equating supply and demand”.

Another problem likely to confront sovereign issuers over the next two years, as their levels of debt issuance soar and their public finances deteriorate both in terms of overall debt to GDP ratios and current account deficits, is downgrades to their ratings. Such action will obviously make life more difficult for governments looking to tap the capital markets, as it will increase the cost of the borrowing and reduce their potential pool of investors. Sovereign buyers tend to be ratings restricted, several limited to triple-A investments.

The threat is already a reality for some. Standard & Poor’s cut Spain’s triple-A sovereign rating by a notch on January 19th, in a move the agency says reflects the outlook for the country’s public finances in a shrinking economy and concerns that “the policy response may be insufficient to effectively counter the related economic and fiscal challenges”. While the downgrade did not have a noticeable impact on the relative spreads on Spanish sovereign bonds—those on the country’s 10-year benchmark instruments remained around 115bps over comparable bunds—the market had probably already factored in the downgrade when S&P warned six days earlier that it was

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considering the move. However, the cost became apparent when the Spanish government placed a €7bn, 10-year bond in the first week of February paying a coupon of 4.6% and with an issue price at 90bps over mid-swaps. It nevertheless proved the point that there is plenty of liquidity in the market at the right price.

Six days before its announcement on Spain, S&P had also downgraded the sovereign rating of Greece a notch to single-A minus, just days after the Greek government issued a further €2.5bn of short-term debt—some with a tenor of just three months—because it feared that it would not be able to find investors for bonds with longer maturities. The downgrade drove spreads on Greek 10-year sovereign debt out to more than 230bps over bunds of comparable maturities.

The agency has also placed the triple-A rating of the Republic of Ireland and Portugal on negative watch, and there were even suggestions that the UK’s triple-A was under threat after the government enlarged its package of support for the country’s banks to £850bn in January. While S&P was quick to dismiss the suggestion, some analysts do not consider the prospect to be that far fetched, given the imminent rise in UK sovereign debt (it will hit 70% of GDP by 2010), the outlook for government revenues, and the country’s heavy reliance on foreign capital as opposed to domestic savings.“To my mind, the UK should be much more vulnerable than people are thinking,”says Ostwald at Monument.

The UK does still have the traditional options of devaluing the currency and cutting interest rates to rebalance its national finances, which Spain and Ireland as members of the euro do not. They can only raise taxes and/or cut public expenditure, both of which have the potential to create serious political and social unrest—the sort of doomsday scenario that sceptics of the single currency prophesied at its launch in 1999. “Now we are actually facing a potential fall-out, as noted by the rating agencies,”observes Skeet at Bank of America Merrill Lynch.

Ostwald thinks that in the current environment any more sovereign downgrades would also have a big ripple effect.

“All the government-guaranteed paper is also at risk, and you are certainly talking about what would have been a stone in the water becoming a boulder.”Although issuance of guaranteed bank debt is expected to drop off sharply this year, a huge volume of such paper is likely to remain outstanding for at least the next three years. While logic dictates that such bonds should always price off the sovereign instruments of the country concerned, it was notable that in mid-January the credit default swaps on some of the guaranteed UK bank bonds were tighter than those on 30-year gilts.

All of this suggests that spread differentials on sovereign bonds will be more volatile in 2009 than at any time for the past 30 years. This will clearly create spectacular opportunities for judicious investors, but with commensurate risks for those who read the market wrong.

“It’s certainly going to be a trader’s market, but you’re going to have to be very disciplined,”concludes Ostwald.

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Offshore exchanges flaunt benefits

Stock exchanges in offshore tax havens are resisting pressure to consolidate despite the current gloom. They are also holding out against those who want a regulatory clampdown. In the meantime, could there be more deals like one between Luxembourg Stock Exchange and NYSE Euronext? Lynn Strongin Dodds reports.

VER THE PAST few years, offshore exchanges have been trying to differentiate themselves with a host of specialist offerings. Today, the mantra is simplicity with every player trying to steer its way through the financial morass. Some have fared better than others although there is no doubt that the future will be challenging. It is too early to predict who will weather the crisis or be subsumed into a larger organisation. For now, though, the dust is far from settled and it will take an equally long time for coffers to be replenished before any bourse can make a move.

As Hubert Grignon Dumoulin, vice president securities and issuers at the Luxembourg Stock Exchange, puts it,“In

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Market participants also expect that there will be more partnerships between larger and smaller players such as the deal struck in 2007 between the Luxembourg Stock Exchange and NYSE Euronext whereby securities listed on Luxembourg were made available on the NSC, the pan-European trading platform used by all Euronext cash markets. Last year, the two joined forces to create the European Economic Interest Grouping (EEIG) under their Luxnext brand to develop a common standard for the listing and trading of corporate bonds.

Luxnext offers a single access point to information on all 31,000 NYSE Euronext and Luxembourg Stock Exchange corporate bonds. Photograph © Kentoh/Dreamstime.com, supplied February 2009.

this current market environment, consolidation would be difficult. The players might not have enough cash resources nor can they easily raise the money to make an offer. There will be an evolution of the marketplace but at the moment it is difficult to predict what it will be.”

To some, it will be a matter of the survival of the fittest.

Herbie Skeete, managing director of Mondo Visione, believes, “Some of the stock exchanges will disappear and there will be a move towards the gold standard players who have the best quality products, services and platforms. The ones that succeed will also have to have diversified business models and not stick to trading a single asset class such as hedge funds. If they do, they will face an uncertain future.”

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Laurent Collet, head of the Luxembourg capital market group of PricewaterhouseCoopers Luxembourg, notes, “Obviously the financial crisis is having a clear impact. All exchanges are suffering from less trading volumes and initial public offering activity. The smaller ones will not disappear though, as we need niche players and not every company wants to be listed on one of the larger exchanges.

While they all have different areas of expertise, they will have to continue to be innovative and develop products in order to survive.”

Market participants also expect that there will be more partnerships between larger and smaller players such as the deal struck in 2007 between the Luxembourg Stock Exchange and NYSE Euronext whereby securities listed on Luxembourg were made available on the NSC, the pan-European trading platform used by all Euronext cash markets. Last year, the two joined forces to create the European Economic Interest Grouping (EEIG) under their Luxnext brand to develop a common standard for the listing and trading of corporate bonds. Luxnext offers a single access point to information on all 31,000 NYSE Euronext and Luxembourg Stock Exchange corporate bonds.

The Luxembourg Stock Exchange, whose LuxX index plunged by almost 60% last year, also recently signed a memorandum with the Tokyo Stock Exchange to explore opportunities for exchanging information and working on the development and the listing of financial products. Collet also predicts that there could be tie-ups between the smaller players and the new alternative trading platforms born out of the Markets in Financial Instruments Directive (MiFID) to offer complementary service and products.

Moreover, new opportunities will emerge from the current gloom. Although no one is willing to pinpoint what exactly they might be, new services and products targeted at over the counter products as well as exchange traded funds could be two potential growth areas.

Greg Wojciechowski, president and chief executive officer at Bermuda Stock Exchange (BSE), echoes the sentiments of many of his counterparts when he says, “Numerous challenges are facing all global capital market operators on a scale not seen in most of our professional lifetimes. These challenges are creating an unprecedented level of stress on the global capital markets and are challenging those that provide infrastructure to ensure and maintain integrity and stability throughout the system.

“The challenges will be faced and during the process, those with solid, well run operations will prevail and those that do not will experience attrition. Those that have been deliberate in their approach and have strong foundations will be in a strong position to seize new opportunities when this cycle begins to turn. We believe we will be able to take advantage of our geographical position of being nestled in the middle of the world’s major capital markets.”

BSE, which is one of the world’s largest offshore exchanges, saw its RG/BSX index slide around 30% last year which was at the smaller end of the 30% to 50% drop

Tamara Menteshvili, chief executive officer (CEO) of the Channel Islands Stock Exchange (CISX) says,“We do not see ourselves as an offshore exchange but an international stock exchange that offers a full range of services. We are in a strategic time zone but are out of the European Union region which means we can be more flexible and innovative. However, we follow the same internationally accepted standards and regulations as the larger exchanges, and have received wide internationally recognition.” Photograph kindly supplied by the Channel Islands Stock Exchange, February 2009.

experienced by stock exchanges overall. Listings rose to 599 as of 31 December 2008 compared to 543 in 2007. This year, the BSX is tending to its housekeeping, enhancing its existing range of offerings and technology, while keeping a vigilant eye on future trends.

The Channel Islands are also optimistic for the future.

“Jersey, for example, has so far been quite insulated from the financial crisis although we are not naive to think that we will totally escape,”says Robert Kirkby, technical director at Jersey Finance.“One of the reasons for this has been that we are a single economic jurisdiction and do not have sectors such as manufacturing and cars which have been badly affected. Our business is finance and it is run on a pretty lean basis. We tightened up the operational model and made it much more efficient after the dot com crash.”

Tamara Menteshvili, chief executive of the Channel Island Stock Exchange (CISX), adds, “We have not been as dramatically affected by the crisis as other international finance centres. We service the specialist debt securities, which are still active as well as a broad range of investment funds. The CISX achieved its 3,000 listings in 2008 which can only be described as a difficult market environment. The key to our success is our ability to be innovative, to listen to our members and issuers and to find gaps in the market.”

Menteshvili points out that the CISX was the first stock exchange to introduce limited-partnership interests and trading on partly-owned shares. More recently, it listed nine new funds—traditional and Sharia compliant vehicles—by Arab Bank, which owns the largest branch network in the Middle East. The CISX also plans to launch a central shares system for its open ended investment companies, which Menteshvili hopes “will revolutionise the way open ended funds are treated.”In addition, the exchange is targeting the

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more esoteric end of the alternative spectrum including assets such as wine, plus it is building upon its expertise in listing property funds where it is seeing renewed demand.

All exchanges are also ensuring that their technological offering remains cutting edge. CISX recently enhanced its news service to allow clients to conduct advanced searches for market data including corporate actions, closing prices, net asset values and other information on listed companies.

Meanwhile, the Luxembourg Stock Exchange is bolstering its efforts in data distribution and dissemination, publication and reporting systems, news services and post trade operations. Last year, it introduced a central counterparty (CCP) service, along with LCH.Clearnet to allow participants to use both international central securities depositories to settle trades—Clearstream Banking Luxembourg and Euroclear Bank.

As for the bread and butter listing activities, difficult market conditions will persist in 2009. Grignon Dumoulin says,“There is no doubt that the listing market is difficult.

We had 10% less activity in 2008 than in 2007 which was not too bad relatively speaking. This is due to the diversification of the financial instruments we list. Listing will also be affected this year but we are also developing other activities that are linked to financial services.”

Other offshore exchanges, especially those with a strong focus on hedge funds or heavy exposure to the banking sector, have had a trickier time. For example, the mass redemptions and contraction in the hedge fund industry have impacted the Cayman Islands while the Irish Stock Exchange (ISE) has also been hard hit by the banking turmoil. Currently trading at around 75% below its peak at the end of 2006, the market capitalisation of the ISE plummeted to about €32.4bn at the end of 2008 from €93.5bn in 2007. While it is hard to predict how this year will unfold, there is no doubt over the short to medium term that neither Allied Irish Banks, Bank of Ireland nor Irish Life and Permanent will regain their former positions.

Despite the volatile conditions, the ISE did proceed with several new initiatives. These included a transparency service for its listed asset backed securities plus a regime for a new category of fund—the super sophisticated investor fund (SSF)—which contained minimal listing conditions but higher standards applied to the investor. For 2009, the priority list includes investing in strategic infrastructure and the establishment of a new supervisory entity which will provide clarity between the ISE’s supervisory role and the broader promotion and management of the exchange to help restore confidence in the Irish market.

Although the financial crisis will prove to be the major challenge this year, one of the other issues facing these exchanges is the continuing probes into offshore centres.

Last December, the UK government instigated a review of offshore financial centres, while the French and German governments have urged the nations in the Organisation for Economic Cooperation and Development (OECD) to become tougher with offshore tax havens.

In the meantime, one of President Barack Obama’s

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Greg Wojciechowski, president and chief executive officer at Bermuda Stock Exchange (BSE), echoes the sentiments of many of his counterparts when he says,“Numerous challenges are facing all global capital market operators on a scale not seen in most of our professional lifetimes. These challenges are creating an unprecedented level of stress on the global capital markets and are challenging those that provide infrastructure to ensure and maintain integrity and stability throughput the system. Photograph kindly supplied by the Bermuda Stock Exchange, February 2009.

campaign pledges was to clampdown on offshore tax centres, which have been estimated to cost the US government at least $50bn a year in lost revenue. In 2007, the then Senator Obama launched the Stop Tax Haven Abuse Act, followed by the Incorporation and Transparency and Law Enforcement Assistance Act, which aims to make corporate ownership structures more transparent and to stop the flow of offshore funds to the US from hedge funds and private equity that are of “unknown” origin and have not passed money laundering checks.

For their part, the stock exchanges defend their business model and jurisdictions, and bristle at being called offshore.

Instead, they see themselves as small global exchanges which follow the same rules and regulations as their larger brethren. This is especially true of Ireland and Luxembourg, according to Collet.“The concept of offshore, particularly in terms of the European Union, is obsolete. Exchanges such as Ireland and Luxembourg are operating on the same level playing field as France and the UK. Overall, in the broader capital markets landscape, there has also been more integration in terms of infrastructure and regulation, particularly in the post trading space.”

Menteshvili of the Channel Islands Stock Exchange adds, “We do not see ourselves as an offshore exchange but an international stock exchange that offers a full range of services. We are in a strategic time zone but are out of the European Union region which means we can be more flexible and innovative. However, we follow the same internationally accepted standards and regulations as the larger exchanges, and have received wide internationally recognition.”

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DERIVATIVES EXCHANGES: BACK TO THE FUTURE

Rick Redding, managing director, Products & Services, at the CME Group, which operates the Chicago Mercantile Exchange (CME), and recently absorbed the Chicago Board of Trade and NYMEX, says that although trading in fixed income products has slowed—third quarter (Q3) 2008 average daily volume for Treasury futures on the CME was 2.478m contracts, 18% below the previous year— extraordinary volatility fuelled record trading in other products. Photograph kindly supplied by Chicago Mercantile Exchange, February 2009.

STAND IT’S GROUND Now that counterparty risk has taken centre stage, derivatives exchanges have bold plans to recapture business siphoned away by their upstart over-the-counter (OTC) rivals. It is an uphill battle, however, as many players prefer the flexibility and anonymity of OTC, reports Neil O’Hara.

ERIVATIVES EXCHANGES HAD to watch from the wings in recent years while the OTC market ran away with the lion’s share of new business.

Protestations about counterparty risk inherent in bilateral contracts fell on deaf ears as investors chose to ignore the possibility that a major securities dealer could fail. The financial crisis—and the Lehman bankruptcy in particular—jolted market participants’ misplaced faith.

While everyone (investors, dealers and regulators) supports moves toward centralised clearing of OTC derivatives to eliminate counterparty risk, market participants have less to gain if execution shifts to an exchange and the major dealers in particular would lose their treasured anonymity.

The market turmoil has so far been a mixed bag for the

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derivatives exchanges. Rick Redding, managing director, Products & Services, at the CME Group, which operates the Chicago Mercantile Exchange, and recently absorbed the Chicago Board of Trade and NYMEX, says that although trading in fixed income products has slowed—third quarter (Q3) 2008 average daily volume for Treasury futures on the CME was 2.478m contracts, 18% below the previous year— extraordinary volatility fuelled record trading in other products. Equity index futures volume rose; the Standard & Poor’s 500 E-mini future averaged 2.705m contracts per day in Q3 2008, up 27%. Energy and metals were also well ahead of the comparable 2007 period.

The fixed income side could have been worse, though.

Redding says market participants have lost their appetite for the highly structured customised OTC transactions that became so popular in recent years.“Clients are now looking for more standardised products where there is better liquidity,”he says.“They want to be able to get in and out easily.”

CME Group clients are also showing greater interest in clearing services for OTC derivatives. Redding says volumes soared in products handled by its ClearPort platform for OTC energy derivatives—up from 351,000 in Q3 2007 to

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492,000 in Q3 2008, a 40% increase. CME picked up ClearPort when it bought NYMEX last year, and the merger is already paying off: of the 141 products listed on ClearPort in 2008, 97 were added after the NYMEX merger.“We hear loud and clear that clients want more solutions like ClearPort,” says Redding. “They would like to get more products into a clearing house.”

Many derivatives exchanges run their own clearing houses, of course, and several are scrambling to expand their services into OTC derivatives. Bclear, a division of NYSE Euronext, the Chicago Board Options Exchange (CBOE) through a joint venture with hedge fund Citadel Investment Group, the Intercontinental Exchange (ICE) and Eurex (part of the Deutsche Börse Group) have either already launched clearing services for credit default swaps or announced plans to do so.

ICE launched its new European clearing house in November and plans to roll out more than 50 cleared OTC derivatives during 2009, including contracts for power, natural gas, oil and coal. The exchange added OTC swaps for sugar, coffee and cocoa at its US clearing house in January, too. ICE is awaiting regulatory approval for ICE Trust, its credit default swaps clearing facility, which will not require trading on an exchange but will still provide the benefits of straight through processing, transparency and a guarantee fund to eliminate counterparty credit risk.

Brendan Bradley, global head of product strategy at Eurex, says his firm expects to roll out its credit default swaps clearing service by the end of the first quarter. Eurex will clear only index contracts at first, but plans to add single names later. The infrastructure required to process these complex products will be robust but flexible, a platform designed to enable Eurex to handle other OTC asset classes in due course.“Eurex is very strong on the equity and equity index derivatives side,” Bradley says. “We are looking to expand into areas like variance swaps and total return swaps.”

While Eurex is keen to capitalise on the switch to central clearing, Bradley is less enthusiastic about exchange trading.

Before the credit crisis, he points out that the dealers had an economic incentive to prefer OTC trading and resist central clearing. Banks with the highest credit ratings leveraged their superior standing to extract a premium spread in bilateral derivatives transactions; a central counterparty would level the playing field and cut off that extra return. In a world where most banks have lost their top-notch ratings, the competitive advantage has largely evaporated. Add an aversion to counterparty risk and the ability to reduce capital employed through multilateral netting and it’s no wonder that dealers have now embraced central clearing.

Execution is a separate function that does not have to go hand in hand with clearing, however. Trades including OTC derivatives can be cleared without shifting the venue to an exchange. Two years ago, Eurex listed several products designed to mimic major credit default swaps indices, but they languished when the major dealers ignored them.

Bradley says the OTC market for credit default swaps grew so fast that dealers built their own infrastructure and were

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Ed Tilly, vice chairman of CBOE, says the exchange has petitioned the SEC to change the pre-hedge rules to permit firms that commit capital to trades of 500 or more contracts to hedge their position before they expose the transaction to the exchange’s trading crowd. Dealers could then bring a tied order to the floor as a volatility trade, which attracts a wider audience than an unhedged trade encumbered with delta risk.

Photograph kindly supplied by the CBOE, February 2009.

reluctant to see it supplanted. They didn’t see any advantage in standardised products or a central order book, either.“We are not going to hit our head against a brick wall,” says Bradley.“The dealers see value added in central clearing but not in an exchange trading platform.”

If a dealer puts a big block of options up on an exchange, the market knows at once who did the trade and what hedge that dealer is likely to need. Aggressive traders try to front run the hedge and market makers pull back leaving the dealer exposed. But dealers don’t have to disclose OTC trades, which allows them to hedge their exposure before the market knows a big trade has gone through. In an attempt to accommodate dealers’ concerns, Bradley says Eurex now permits them not to disclose trades above a certain size in some of the derivatives products it lists.

In the United States, Securities and Exchange Commission (SEC) rules prohibit dealers who commit capital to an options trade on an exchange from “anticipatory hedging,” which means the derivatives trade has to print before dealers are able to hedge the position in the cash market. To a dealer who is facilitating a large customer trade, having to open the kimono is a huge disadvantage.“In the OTC market you can do a trade in the dark, put on a big options contract and initiate a hedge for hundreds of thousands of shares without disclosing any information to the market,” says Boris Ilyevsky, managing director of options business at the International Securities Exchange (ISE).“Due to the different rules that apply when transacting on an exchange, this anonymity is not possible.”

The difference makes a mockery of fair competition, but the laugh is at the expense of the derivatives exchanges—and CBOE, for one, is not amused. In fact, Ed Tilly, vice chairman of CBOE, says the exchange has petitioned the SEC to change the pre-hedge rules to permit firms that commit

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capital to trades of 500 or more contracts to hedge their significant portion of their business OTC,” he says.“In the position before they expose the transaction to the exchange’s current market environment, however, heightened concern trading crowd. Dealers could then bring a tied order to the about counterparty risk has trumped a lot of those reasons.”

As the leading venue for individual stock options, ISE floor as a volatility trade, which attracts a wider audience than an unhedged trade encumbered with delta risk. endured an inevitable dip in volume. Some reports say more CBOE has also asked the SEC to relax settlement date than arch-rival CBOE, which retains the exclusive right to restrictions on its Flex Option product, which allows traders trade the most popular cash index options. Actively traded to customise the terms. Tilly explains that when the SEC first names such as Bear Stearns, Lehman Brothers, Merrill Lynch approved CBOE’s Flex Options it decreed that they could and Washington Mutual have vanished altogether, while not expire on expiration Friday or the two business days crippling losses put some hedge funds out of business and before and after. CBOE has led an effort over the past year to left the survivors nursing a much reduced capital base. eliminate the blackout dates in an attempt to bring OTC Ilyevsky sees a silver lining in the credit crisis fallout, options back to the exchanges. Tilly says many OTC options however.“Equity options have been extremely attractive as a are“exchange look-alikes”anyway, contracts that differ only risk management tool,”he says.“As an industry, we are still in a non-standard strike price or settlement structure (i.e. gaining new customers among market participants who European vs. American exercise), for example. have realised that options offer hedging possibilities that Although SEC rulemaking could have offset some of the is still in progress for both losses they experienced in the market decline.” requests, Tilly is optimistic The tussle between about the outcome. “The CME Group clients are also exchanges and proponents of SEC understands the showing greater interest in clearing OTC trading is likely to importance of pushing services for OTC derivatives. Redding continue, however. CME ended products back to exchanges” says volumes soared in products up with egg on its face when says Tilly. “They have been very eager to work with us.”

FXMarketspace, its muchhandled by its ClearPort platform for Exchanges can tweak the ballyhooed platform for trading OTC energy derivatives—up from rules to make themselves spot foreign exchange, failed to 351,000 in Q3 2007 to 492,000 in more attractive but they can’t catch on. The CME pulled the Q3 2008, a 40% increase. CME force market participants to plug just 18 months after picked up ClearPort when it bought abandon the OTC market. launching the “world’s first Tilly admits that even if the centrally-cleared, global foreign NYMEX last year, and the merger is SEC approves the proposed exchange platform for the OTC already paying off. rules some firms will still market.” EBS Spot, the leading prefer the anonymity OTC foreign exchange trading trading affords.

When platform owned by ICAP, a dealers trade less liquid names, a large option block often prominent interdealer broker, already allowed participants to skews the volatility curve around the contract expiration control counterparty risk by adjusting bilateral lines of credit date for an extended period. “Options classes with higher at any time. In addition, trades in the major currencies are volume and open interest—whether listed or flex option settled through CLS Bank, the industry utility, in close to real contracts—are impacted less by large orders,”Tilly says.“In time.“When Lehman collapsed, all their trades on EBS went the top 100 equity names we can take down serious size through,”says Steven Toland, head of foreign exchange sales and it doesn’t become a huge issue. The further down you for Europe, the Middle East and Africa at ICAP. “The go in average daily volume, the greater the impact.” performance of OTC platforms like EBS, and their respective Other market participants may prefer the additional post trade service providers, showed these platforms work transparency of trading on an exchange, but as the principal well.” The market’s verdict? FXMarketspace was trying to suppliers of liquidity the dealers have a disproportionate solve a problem that didn’t exist. influence on where trading takes place. Nevertheless, they OTC trading will continue to play an important role in the cannot ignore customer preferences entirely. ISE’s Ilyevsky derivatives markets because the standardised size, notes that although hard data isn’t available for the OTC expiration date and other terms required for exchange market anecdotal evidence suggests that volumes have traded contracts do not always meet investors’ tumbled even more for OTC options than for listed requirements. The exchanges have a golden opportunity to products. Average daily options volume on the ISE plunged build a business in clearing OTC derivatives transactions, from a record 4.8m contracts in September to 2.6m in but they face an uphill battle to become the venue of choice December, although it rebounded to 3.7m in January. for execution. However hard they try to link central clearing Ilyevsky says the decline would have been worse if investors and exchange trading in the minds of regulators and the had not switched some business to the exchanges. “The general public, they can’t fool market participants, who larger desks always had good reasons for transacting a know they are distinct.

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ALL THAT GLISTERS

ALIFORNIA IS A basket case.” This is California Political Week’s 26 year-veteran political commentator Dick Rosengarten’s acrid assessment as it became clear that California’s state budgets for both fiscal 2009 and 2010, ending on June 30th were unbalanced. Officials estimate state spending plans for the 18 months through financial year 2010 exceed income by $41.8bn, a great deal of money even for a state with nearly 37m people, a gross domestic product of $1.8trn, and annual budgets north of $140bn. In Sacramento, the state’s capital, the legislature’s Democrats are mostly liberal and favour tax increases and moderate spending cuts to solve the problem. Republican legislators, entirely conservative, oppose any tax increases and look for deep budget cuts.

Governor Arnold Schwarzenegger favours tax increases smaller than the Democrats propose, spending cuts smaller than his Republican colleagues want, and other measures, such as shrinking the school year by five days and reducing the pay of more than 200,000 state workers to the federal minimum of $6.55 per hour. That idea is still being fought over, but a Superior Court judge approved the governor’s plan to force most employees to take off the first and third Fridays of each month (equivalent to a 9% wage cut and saving $1.3bn through June of next year).

How did California—with a vibrant economy larger than those of Brazil, Russia or India—get into such a bind?

Rosengarten traces the state’s fiscal problems back to the

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California, the world’s eighth-largest economy, is beset with problems. It never fully recovered from the dot.com bust and Enron energy scam. Today it struggles with a dysfunctional legislature and a $42bn budget deficit. California’s unemployment rate is third-highest in America, while its credit rating is the lowest among the 50 states. The state’s vast higher education system is outmoded and the crash in housing prices has wiped out $1trn in personal wealth. Meanwhile, California’s fabled venture capital (VC) industry— caught in the worldwide credit freeze— faces a “nuclear winter.” Art Detman reports from Los Angeles.

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CALIFORNIA: COPING WITH THE DOWNTURN

California’s housing market, which became the state’s economic engine after the dot.coms collapsed, continues to implode. Nearly a quarter million homes in the state were lost to foreclosure last year, the most of any state. Indeed, more than one in five of all foreclosures nationwide were in California, and in Stockton—a city of nearly a half million in the state’s lush Central Valley—almost one in 10 homes received a foreclosure notice last year, the highest rate in the country. The median price of a house in California dropped from a peak of $505,000 in 2007 to $278,000 in December 2008. All told, more than $1trn in the value of houses in the state vanished. Photograph of state governor Arnold Schwarzenegger, soon after his inauguration back in 2003.

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electrical energy crisis of 2000-2001, when Enron Corporation began playing the state’s deregulated market for electricity. Rates shot up, rolling blackouts hit much of the state, and Pacific Gas & Electric was forced into bankruptcy. When it was all over Houston-based Enron was gone and its chief executive was in prison, but Texans had mugged California to the tune of billions of dollars.

Moreover, when the dot-com boom turned to a bust, the frenzy of Silicon Valley start ups and initial public offerings died. As state income tax revenues from capital gains dwindled, an increase in the auto registration fee automatically kicked in. Even though the increase was intended to offset an $11bn budget deficit, car-crazed Californians were angry. In the political equivalent of road rage, they voted out Democratic Governor Gray Davis in 2003 and voted in Schwarzenegger, who rolled back the fee hike on his first day in office. The rollback cost the state $5bn in tax revenues in 2003, rising steadily to $6.5bn in 2009.

development. Proposition 13 was backed by owners of commercial properties. However, since commercial properties change hands far less often than single-family houses, over time a greater portion of property taxes has shifted to homeowners. It was an entirely foreseeable consequence, but back in 1978 hard-pressed homeowners wanted immediate relief. Today, the idea of exempting commercial properties from Proposition 13 is vigorously opposed by the business community.

Unions, too, have successfully backed voter initiatives.

Proposition 98, for example, mandates that 40% of all general tax revenues go to K-12 (primary and secondary) education and was supported by the powerful California Teachers Association.“So if you raise the income tax to take care of the $42bn deficit, 40% of that increase has to go to education,” explains Tim Hodgson, director of the Center for California Studies at Sacramento State University. “In addition, each year’s funding for education becomes the floor to calculate funding for the next year.”

Coming to terms with legislators His supporters hoped Schwarzenegger would emulate great past California legislators such as Earl Warren, Goodwin Knight and Pat Brown. Schwarzenegger, however, appeared to have had a different role model in mind. Instead of taking his proposals to the legislature, he took them to the voters. For a while it appeared that he might be able to govern solely by getting initiatives passed, but when a clutch of his proposals came onto the ballot in 2006, every one was defeated. The voters had put Arnold in his place, and now he had to work with the legislature but it would be a difficult relationship. The Democrats were looking ahead to 2010, when Schwarzenegger’s second and (by law) last term ends. As for Republicans, they had written him off as a Rino: Republican in name only.

Although fiscally conservative—eager to lay off state workers and cut benefits to the poor— Schwarzenegger is too liberal on abortion and gay rights for their liking.

Complicating California’s political picture is the requirement that both the budget and any tax increase be passed by a two-thirds majority in both the Senate and Assembly. Although Democrats have a 25 to 15 advantage in the Senate, it is two votes shy of a super-majority. Their 51 to 29 advantage in the Assembly meanwhile is three votes short. The Republicans’ opposition to higher taxes is almost cast in concrete: 43 of the 44 Republican legislators have signed a“no new taxes”pledge.

While California is the most expensive state legislature in the US, it also is probably the most active in legislating by ballot measure. Proposition 13, passed by voters in 1978, put a cap on property taxes but it also mandated the twothirds requirement for tax increases. A result was that an untold number of homeowners did not lose their properties to taxes that rose along with soaring market values. Another was that cities and counties began to favour retail development over industrial expansion because stores generate sales taxes. Today, California has far too much retail space and too little industrial

The impact on education As for higher education, California has a system of universities and community colleges that is the biggest in America. The University of California (UC) has 10 research universities while the California State University (CSU) system has 23 four-year campuses, and the community college system comprises 110 schools and 2.6m students.

All operate under a Master Plan developed in 1960 which stipulates that the UC system would have the capacity to accept the top eighth of all state high school graduates, and the CSU system would be able to accommodate the top third of graduates. As for the community colleges, it was envisaged that they would provide a low-cost two-year college education to any Californian with a high school diploma. “The Master Plan was very progressive for its time,” says Hans Johnson, associate director of research at the Public Policy Institute of California. “When it was developed, only a little over 10% of all adults in California had a college degree. Today, we still have the same onethird goal in our master plan, but now about one-third of adult Californians have a college degree.”

Even so, now the Institute warns that California may face a shortage of college-educated workers over the next 20 years. It will soon release a report calling for changes in the Master Plan. The UC and CSU systems could be expanded to accommodate the top 40% of high school graduates, perhaps more. Higher education funding, which once accounted for 17% of the state’s general fund, would be increased sharply from its current 10% level.“Yes, we have this fabulous college system,” says Johnson.“But given the size of our population, it’s not that impressive. California’s college-going rate, that is, the rate at which high school graduates directly enrol in college the following year, is actually below average among the 50 states. And if you look at the college-going rate to four-year universities, we’re in the bottom 10. So in some ways California is resting on its laurels.”

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California’s physical infrastructure likewise needs of politics is the absolute big story. Politics, as Aristotle rebuilding. Highway capacity has lagged far behind traffic defined it, is the art of the possible. It is now impossible to growth. Average speeds on many freeways during peak govern California.” hours are now below 20 miles per hour. The condition of So far, the Sturm und Drang of California politics and roads and highways is often ranked last among the 50 budget gridlock have not affected the state’s venture capital states. Similar problems plague the state’s water and waste (VC) industry but the dot-com bust and ensuing decline in water system, its airports and mass transit authorities, and initial public offerings have sorely tested it. Last year there its deep water ports and electrical power grid. The Silicon were only six initial public offerings (IPOs) of high-tech Valley Manufacturing Group warned that the area’s high- companies in the state, the fewest since the 1970s, and only tech companies could lose as much as $1m a minute during 325 sell-outs, the least since 2003. At Sequoia Capital, one of the giant VC firms on Sand Hill Road in Menlo Park, rolling blackouts.

Meanwhile, California’s housing market continues to there was talk of a “nuclear winter” in coming years. implode. Nearly a 250,000 homes were lost to foreclosure Institutional investors have been reneging on their last year, the most of any state. Indeed, more than one in commitments to VC funds, which in turn threatens the five of all foreclosures nationwide were in California, and in viability of companies just a few years old and still Stockton—a city of nearly a 500,000 in Central Valley— dependent on start up cash. Michael Moritz, a Sequoia almost one in 10 homes received a foreclosure notice last partner, expects there will soon be far fewer VC firms in California.

Dixon year, the highest rate in the Doll, founder of Doll Capital country. The median price Management and current of a house in California chairman of the National dropped from a peak of Venture Capital Association, $505,000 in 2007 to blames massive over funding $278,000 in December of start ups for damaging the 2008. All told, more than Do not for a moment think VC market in California. $1trn in the value of houses California’s venture capital industry Do not for a moment think in the state vanished. is on the ropes. Peter Cohan, a California’s venture capital industry is on the ropes. Peter VC industry resilient Massachusetts-based consultant, Cohan, a MassachusettsThe turmoil in housing believes it would require five or even based consultant, believes it reflects the state’s high 10 years of low activity in the IPO would require five or even 10 unemployment rate. At market to bring down California’s years of low activity in the 9.3% in December, it was vaunted VC infrastructure.

IPO market to bring down behind that of only California’s vaunted VC Michigan and Rhode infrastructure. “That’s the Island, and was California’s worst case scenario,” he says. highest in 15 years. The unemployment rate also is What about challenges from due to the exodus of India, Texas, Florida, Indiana companies from California. and Massachusetts? “I can’t Some, like Countrywide Financial, were acquired by other think of any other place in the world that is better companies. Others, like Computer Sciences and Hilton positioned to do venture capital.”

Mumbai-born Sanjay Subhedar, a founder of Storm Hotel moved to the east coast or, in the case of Nissan Ventures, is another believer in California’s VC industry.

North America, to the Midwest.

The budget crisis, the housing collapse, and the “We have here in Silicon Valley a unique ecosystem. We unemployment rate have combined to trash the state’s have built a culture that rewards innovation. It is an credit rating, once among the highest in the nation. In ecosystem that people elsewhere don’t understand. They’ve February Standard & Poor’s reduced it a notch to single-A, tried it in Shanghai, Bangalore, Bombay, Florida and below that of even Katrina-ravaged Louisiana. So, what’s Indiana. To some extent, they have it in Boston. But they all wrong? Kevin Starr, state librarian emeritus and professor pale in comparison to Silicon Valley.” For now, VC industry of history at the University of Southern California, says the is waiting and praying for a resurrection of the IPO market. problem is the triumph of partisan politics over the Even if that happens, venture capital in California can’t California dream. On one side are Democrats who are escape the fact that it is in California. A page one editorial totally committed to the retention of New Deal by the Los Angeles Daily News summed up the gridlock in programmes, and are beholden to unions. On the other Sacramento very well: “This inaction is so serious that it side are Republicans, who 76 years after FDR’s threatens the economic stability of every resident and inauguration remain vehemently anti-New Deal. “I’m a business of this state.” That includes those on Sand Hill social and cultural historian, and so to me the breakdown Road in Silicon Valley.

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ASIAN SECURITIES LENDING HOLDS FIRM

The focus on ease of service is a key element in the skittish Asian landscape, which has taken to SBL unevenly. According to the 2008 Pan Asian Securities Lending Association (PASLA) newsletter, last year marked something of a watershed for securities lending with a heightened focus on cash collateral reinvestment, counterparty credit and enforced restrictions on short selling as a result of the global fallout of the sub prime and banking liquidity crises. Photograph © Paul Moore/Dreamstime.com, supplied February 2009.

While securities lending practitioners working in Asia accept that the volume of business is not of the order of late 2007 and early 2008, they remain upbeat about the medium to long term prospects for the market. Although the credit crisis has caused something of a contraction in the multi-trillion dollar securities lending business, volumes have begun to pick up in Asia in the opening months of this year. Moreover, the drive towards market liberalisation in key markets, such as Malaysia, India and China, is encouraging securities lending agents to think about positioning themselves to leverage the inevitable uptick in business throughout the region over the medium to long term.

Francesca Carnevale reports.

FLOATING SLOWLY UPWARDS

RIAN LAMB, CHIEF executive officer (CEO) at EquiLend’s New York headquarters, is upbeat.

“EquiLend’s newest trading service suite Trade2O looks to be a very good fit for the Asian market, either for single trades, list of equity trades or baskets of equities.”Lamb says that Trade2O has gained significant traction and its screen based trading user interface“is especially well suited to the Japanese securities borrowing and lending (SBL) market.”

Trade2O allows traders to negotiate and agree trade terms for both equities and fixed income securities and process them straight through to a proprietary system.

“From what I know of securities finance, a lot is still done by phone, Bloomberg and Excel spreadsheets. Our service is a good combination of these methods and is easy for

people to use,” explains Lamb. “Clients can get it up and running in a day.”

The focus on ease of service is a key element in the skittish Asian landscape, which has taken to SBL unevenly.

According to the 2008 Pan Asian Securities Lending Association (PASLA) newsletter, last year marked something of a watershed for securities lending with a heightened focus on cash collateral reinvestment, counterparty credit and enforced restrictions on short selling as a result of the global fallout of the sub prime and banking liquidity crises. By the end of 2007, says PASLA, the securities lending market had grown by a massive 825% from the start of 2004, with a market value estimated at $910bn. It has been fuelled by market liberalisation, an explosion of hedge funds anxious to

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leverage fast growing and still volatile Asian stock markets, and the provision of a raft of securities by beneficial owners looking at long term returns.

However, the Asian securities lending market remains concentrated. Japan, Australia and Hong Kong still dominate the Asian market by a long mile, explains Lamb, “The rest have seasonal characteristics.” In part this is because a significant element of demand for Asian stocks is actually sourced out of the UK, Europe and the United States. Outside of Japan and Australasia the local supply of securities and demand for stocks is generally limited to government pension funds, central banks and sovereign wealth funds. “Central banks sit on huge amounts of assets,” notes Philippe Metoudi, member of the executive board and head of client relations Asia-Pacific, Middle East and Africa at Clearstream, which claims to work closely with some 21 central banks in the Asia-Pacific region in this regard. When the central bank of Mongolia, for instance, needed an agent last year, it approached Clearstream to take over responsibility for its portfolio of assets and hand it over to professional distributors in the industry.

Another source of securities is beneficial owners in the developed markets or large asset aggregators. George Trapp, regional manager for securities lending at Northern Trust, which has been lending securities since 1981, explains that while the provision of securities on loan is predominantly sourced through the global asset management firms, “our asset base in the Asian region has grown substantially as Northern Trust has won custody and securities lending throughout the entire region.”

This patchwork creates, in turn, two clear streams of demand for Asian securities, notes Trapp. In the larger developed markets of Hong Kong, Japan and Australia, “similar to the demand profile in the United States and Europe, we see a distinction between large cap (general collateral) stock and small cap (hot) stock. Currently we are seeing many large cap names trading hot in the current environment. That is very different to the situation six months ago and is providing incremental returns to clients,” he says.

In the smaller SBL Asian markets on the other hand, “there is often a premium paid for any stock, particularly those in Taiwan and South Korea,” he adds. While fixed income remains a substantial element in securities lending in Europe and the United States, in Asia it is a marginal activity and largely confined to Japan and Australia.

However, there may be opportunities for growth in the fixed income markets in the future as those markets develop further in Asia.

In spite of the short term selling restrictions which recently impacted securities lending in selected Asian markets in the last quarter of 2008, over the medium to long term market, professionals say the region is replete with opportunity. “PASLA recently hosted a roundtable on Malaysian SBL,” reports Trapp, a member of the PASLA executive committee, who says that the industry association encourages collaboration between market regulators,

Brian Lamb, chief executive officer of EquiLend, says,“From what I know of securities finance, a lot is still done by phone, Bloomberg and Excel spreadsheets. Our service is a good combination of these methods and is easy for people to use,” explains Lamb.“Clients can get it up and running in a day.”

exchanges, and other SBL market participants. PASLA is currently focused on assisting in key regional markets, namely India, China and Malaysia. “It is an exciting development,”says Trapp. He is encouraged by the response to the Malaysian round table but sees these SBL markets as work in progress.

With so much in flux in the regional and global markets, it is no wonder then that questions about the cost of securities finance, flexible collateral and collateral management have come to the fore in recent months.“Triparty repo has not yet picked up in Asia,”concedes Stephan Lepp, member of the executive board of Clearstream Banking in Frankfurt and head of the firm’s Global Securities Financing (GSF) business, who explains that uncollateralised money market trading is dominant.

However, “collateral management is just beginning to pick up,”he says. Before the global liquidity crisis really took hold Lepp’s GSF had achieved monthly average outstandings (on a global basis) of a record €415bn in May (up 27% on the same month in 2007). Since then, volumes have continued to grow, reaching €428bn on average for the fourth quarter of 2008, an almost 20% increase over the same period in 2007 (which touched €349bn). Lepp underscores the growing importance of secured financing and the continued flight of collateral towards central liquidity pools going forward.“Through to the end of 2007, many people did uncollateralised trading; only after

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AT STATE STREET, WE INSIST ON DOING THINGS IN A VERY SPECIFIC WAY. YOURS.

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Lehman’s collapse did collateral really return,” notes Lepp.

“Our job is to train the market in terms of what happens in Europe but we are not in Asia as school teachers.You simply cannot force repo on the pan Asian marketplace,”he adds.

Collateral is a topic that has been in focus for over two years. eSecLending, a third party securities lending agent that utilises a competitive blind auction to determine the optimal route to market for their clients’ assets, recently established a presence in the Asia Pacific region, building upon their relationships in the region. Giselle Awad, senior vice president of eSecLending Asia-Pacific explains.“Market turmoil has raised awareness amongst industry participants and in particular the cash collateral reinvestment portion of a lending program has become more of a focal point. The focus on counterparty risk management has also increased.

All of this has caused beneficial owners to place an increased emphasis on risk management across both the lending and cash collateral reinvestment portions of their programs.”

On the demand side, volatility in the cost of financing means,“borrowers reward lenders that take a broader array of collateral,” notes Trapp. From the point of view of a lending agent such as Northern Trust, Trapp clearly understands the need for quality collateral that can be valued on a mark to market basis on a daily roster since this is what his clients demand.

Clearstream, like other firms, is looking over current market volume to a future of powerful consolation as major emerging markets, such as China, promise to come on stream. “Right now, Clearstream is the only centralised securities depository (CSD) with a link to the People’s Republic,”says Lepp.“Up to now this has only encompassed B shares, and which is only a small part of the total.

However, when the Chinese start, they will start fast and everything will happen at once.”

The biggest challenge for securities lending in Asia going forward, thinks Equilend’s Lamb, is a “protracted continuation in the economic slowdown, which might impact on trading strategies.”He points to the pull back by hedge funds in particular, a fact underscored by Northern Trust’s Trapp, who has noted a decrease in demand from the borrowers in addition to the lower asset values. However, Trapp believes that over time,“money will flow back to the SBL market as demand increases for the trade strategies that require necessary liquidity that is provided by SBL.” Awad agrees,“While current lending volumes across the market are lower than in years past, we do expect an increase in activity as we head into the 2009 dividend season. Our experience so far this year confirms that borrowers are still bidding aggressively for attractive supply,”she says.“We conducted several auctions in January 2009 totalling over $50bn in global equities and fixed income securities with over 15 global banks and broker dealers placing bids. We were encouraged by both the levels of the exclusive bids received and by the breadth of participation across borrowers.”

However, Awad notes that,“Demand has shifted in some areas where one market may have historically commanded

George Trapp, regional manager for securities lending at Northern Trust, says while the provision of securities on loan is predominantly sourced through the global asset management firms “our asset base in the Asian region has grown substantially as Northern Trust has won custody and securities lending throughout the entire region.”

higher bids in years past while others are seeing much stronger bids in 2009.” In addition, eSecLending predicts that as more beneficial owners in Asia recognise securities lending as an investment management and trading discipline that the global trend in recent years toward unbundling the lending decision from custody and the use of multi-manager programmes and specialists will only accelerate in Asia in 2009 and beyond.

From the agent lender standpoint Trapp believes beneficial owners will continue to be more involved in their lending programmes as a result of the recent market volatility. “We are having more dialogue with our clients, who are showing more interest in the daily reporting we provide around the risks and returns of their securities lending programme,” says Trapp. It is a view endorsed by Clearstream’s Lepp, who says,“We are being asked a lot of detailed questions, particularly about the use of collateral.”

Returns on lent assets remain a salient consideration.

“Obviously clients understand that it is still important to generate incremental revenues, and they remain in general positive.” Even so, Lamb thinks that market efficiencies are key in this interim period. Lamb firmly believes that EquiLend’s “trade and post trade solutions, when used as designed, is the most cost effective solution I have seen in the market. In fact if all pieces of the offering are used as designed we are dirt cheap, though more than one element in the service has to be used to gain this level of efficiency.

Using just one element, will not achieve that end, frankly.”

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CHANGING THE RULES

HE IMAGE OF Clearstream, the custody and post trading services arm of the Deutsche Börse Group, has laboured under a basic misconception, thinks Jeffrey Tessler, its urbane and up front chief executive.

Explaining the inexorable constancy of Clearstream’s business volume in the white heat of a global financial meltdown, Tessler explains that“we enjoy a low risk profile.

We never had the big broker dealers as our clients, which meant that we did not suffer on anywhere near the scale endured elsewhere. Our key clients include central banks, commercial banks and wealth managers, which meant that in the midst of this crisis, Clearstream became a valuable liquidity hub.”

The growing perception that Clearstream was a safe haven, low risk environment, says Tessler, meant there was, “an explosion in our cash balance, which rose 300%” through 2008”. However, he concedes that the firm is not entirely immune from the crisis. By December last year, the value of assets under custody held on behalf during the year of

T

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Jeffrey Tessler, chief executive officer, Clearstream.

Photograph kindly supplied by Clearstream, February 2009.

customers registered an almost 6% decrease to €10.2trn, primarily due to lower equity market valuations. Moreover, while securities held under custody in Clearstream’s international business rose by a touch under 7% to €5.2trn through last year, domestic German securities held under custody were down by almost 16% to €5.0trn over the same period. The yearly average of the value of assets under custody held on behalf of customers were up marginally (by 1%) to €10.6trn over the same twelve months.

Clearstream focuses on four clear delivery lines. In addition to its securities settlement business, it offers management, safekeeping and administration of the securities on deposit through its custody operations. Moreover, it provides securities lending and borrowing (SBL), collateral management and tri-party repo via its Global Securities Financing (GSF) operation, and finally, solutions for the fund industry, which includes its Vestima+ and CFF offering.

Clearstream’s key business is in post trade transactions and in this the upswing was marked. In December 2008,

COVER STORY: CLEARSTREAM’S GLOBAL AMBITION

Since Jeffrey Tessler took over the reins at Clearstream, it has redefined the reach of post-trade securities services. Once the bystander in a long running, and ultimately fruitless debate, about the optimum structure of clearing and settlement in Europe (would a horizontal or vertical model prevail?) as soon as Tessler came on board, he successfully re-wrote the game play. Now Clearstream has its sights set firmly on global, rather than regional objectives. How far can it go?

Francesca Carnevale reports.

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some 2.67m international transactions were processed, up Tessler took his turn at the helm of Clearstream that the almost 18% on the previous year; while over the counter breaking of traditional paradigms would be the order of (OTC) bond transactions grew by a sprightly 41% to 1.31m. the day. After all, this was a man who was a 25 year Of all the international transactions processed, 71% were veteran of The Bank of New York, which through the late OTC, and the balance stock exchange transactions. Even 1980s and the 1990s completely reinvented itself from a here though, Clearstream clocked a 12% decrease in the state focused commercial banking franchise to a global volume of international transactions processed over the year, securities services specialist. in spite of a 28% uptick in OTC bond transactions handled Greater impetus to Clearstream’s focus on interoperability by the firm; a measure of the growing iciness in the global was provided by the European central bank, which says Tessler, encouraged the process. “It allowed us to feel capital markets.

In its German domestic market, Clearstream settled some comfortable in a T2S world. From this Link Up Markets, our 7.08m transactions last year, up by just under 17%, of which initiative which allows central securities depositaries the bulk were stock exchange trades, and the remainder anywhere in the world to lock into our platform, providing a OTC; though it registered a 5% decrease in domestic single pipe linking custody, and settlement to T2S, became settlement transactions. Its combined GSF services enjoyed the route of choice.” an uptick of more than 24% over the year, with average For many years it had been thought that the consolidation monthly outstandings of €398.8bn in 2008 and a peak of of clearing and settlement in Europe was an impossible dynamic. Ironically perhaps it €434.1bn in December and was the introduction of the January.

Stefan Lepp, Markets in Financial member of the executive Instruments Directive (MiFID) board of Clearstream and Clearstream’s Link Up markets and the opening up of the head of its GSF business initiative cut the Gordian knot that had market to increased diversity acknowledges that while, tied the debate over single engine in the choice of clearing and “2008 was extremely clearing and settlement to an entirely settlement venues, that has challenging. Nonetheless, it was a record in terms of new supported Clearstream’s European context. It was a fact not lost business.”Meanwhile its moves to facilitate linkage on the US’s Depositary Trust and investment funds services between the continent’s Clearing Corporation (DTCC) which has operations noted a 20% Central Securities similar global ambitions, but has so far decrease over 2007 as a result Depositories (CSDs) and concentrated its international spread of reduced European International Central investment funds Securities Depositories through organic growth and acquisition. transactions.

(ICSDs) and create an While Tessler remains environment where cross pleased with the firm’s border interoperability overall performance, given the global context, he is not overly became possible. From then on it became a matter of where confident about the prospects for the immediate term.“There one wanted it to stop. From Clearstream’s clear vantage is too much that is unknown. The banking crisis of 2008 has point it became described by global rather than regional turned into a fully fledged financial crisis. Ultimately we are a ambitions.You can see, talking to Tessler where the essential banker’s bank and that in itself makes the future unknown. divergence took place, and how he took his company down Until now we have benefitted in the crisis as most of our a route unconfined by the European paradigm. “What T2S clients are guaranteed by the state. However, the move does is create a neutral provider of core settlement services towards zero interest rates,” he concedes, “could have an and it essentially prescribes cross border asset servicing impact on us, though frankly that will not be long-lived.” capability. We spent our money on interoperability, Even so, he points to a number of offsetting factors that unconfined by a single all encompassing solution (which we provide powerful consolation to Clearstream’s management: think is too costly). It is easier, cheaper, faster to work on “We have become a giant machine that is financially sound, linking up with other CSDs. In addition to the cost and have zero balance sheet pollution, are AA rated and we are efficiency advantages, we believe it creates an even playing bolstered by 2500 clients in over 110 markets.” That last field, a more competitive and innovative environment.” statistic cuts to the heart of Clearstream’s globalised, rather The Link Up initiative kicked off in April last year, when than regional world view and upsets the apple cart of the Clearstream Banking launched the idea, together with the traditional debate in Europe about the future structure of CSDs of Austria, Denmark, Greece, Norway, Spain and clearing and settlement.“Five years ago, everyone thought we Switzerland in an effort to improve efficiency and reduce the would build a single engine system for settlement in Europe. costs of post-trade processing of cross-border securities We decided instead to focus on interoperability, and that has transactions in Europe. Cyprus joined later in the year. Each CSD will have direct access to the services of the other CSDs application around the world,”notes Tessler.

One should not have been surprised perhaps that once by connecting to the infrastructure of Link Up Markets,

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which now provides direct access to almost 50% of the European securities market. “They will receive consistent best-in-class CSD settlement and custody services which translate into reduced cross-border transaction costs and savings from a harmonised set of processes,”says Tessler.

Clearstream’s Link Up markets initiative cut the Gordian knot that had tied the debate over single engine clearing and settlement to an entirely European context. It was a fact not lost on the US’s Depositary Trust and Clearing Corporation (DTCC) which has similar global ambitions, but has so far concentrated its international spread through organic growth and acquisition.”Europe has elected to go for a competitive clearing and settlement model,” wrote Larry Tabb, founder and CEO at TABB Group, in a recent report on European Clearing and Settlement: Breaking Barriers—Building Alliances in contrast to the centralised clearing and settlement model supporting equity trading in the US. “Interoperability is critical to this approach, allowing competing organisations to interact in a consistent market framework,” he added. Tessler thinks it is more straightforward even than that. “The benefit of the model resides in the very simplicity of the model,”he avers.

“Why has Clearstream evolved differently?” asks Tessler rhetorically. “I think it is fair to say that we have suffered somewhat from messages given by the competition that liquidity is with them. That may have been clear years ago, it is quite different now. Liquidity means cash today and in this market cash is king.”Tessler thinks that in the short term the creation of liquidity centres is critical in the crisis stricken markets and one of the drivers of future initiatives in the Clearstream product spectrum. In this regard, therefore Clearstream offers an extreme advantage. “I think we (Clearstream and Deutsche Börse Group) have understood the importance of becoming a liquidity hub and a reliable source of collateral. It is now all about trust in the market; quality collateral and being prepared for bad weather. We supply on all three counts,”notes Tessler.

Clearstream’s renewed emphasis on the GC Pooling product is typical of this new found strength and confidence and reflects the synergies within the Group. Eurex, the derivatives arm of Deutsche Börse Group, launched Euro GC Pooling in March 2005 as a solution for the Euro Repo market, allowing banks to manage their liquidity and securities holdings and offers participants the ability to access an electronic trading system including a central counterparty, a collateral management service and the automated exchange of securities and money.

In the summer of 2008, the governing council of the European central bank approved the use of a direct link from Clearstream Luxembourg and Clearstream Banking Frankfurt to assist in the collateralisation of the Eurosystem’s credit operations, allowing counterparties to include assets from Clearstream’s collateral management services in their collateral pool. The service was extended to the French bond market in October, thereby adding to the range of securities available to Clearstream’s clients to pledge as collateral.

Explained Marcel Naas, managing director of Eurex Repo

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GmbH, at the time,“The GC Pooling market has proven to be a reliable liquidity pool, even in difficult market circumstances. [The addition of] French bonds as eligible collateral increases the efficiency and cash funding potential for our participants.”

Lepp puts it in context.“In times of uncertainty, we offer them the possibility to actively and closely manage their cash liquidity as well as to optimise the use of their collateral through Clearstream’s wide range of Collateral Management Services.” How useful the service is, was clearly illustrated by the take up through the liquidity squeeze through last year. By September, the average outstanding volume in Euro GC Pooling peaked at €47bn compared to €15bn a year earlier. The fact that Euro GC Pooling has seen a new peak of €67bn in February this year indicates that this strong trend remains intact.

With 20% of Clearstream’s business coming from outside Europe, it hints of a future defined well outside the geographic barriers of the European sub-continent. “After Germany, France and Italy, China is now our fourth largest market,” notes Tessler. “We look at it this way, across our product range we do not have users we have clients, wherever they may be.”

Armed with offices in Dubai, Hong Kong, Singapore and Tokyo and an operating ethos that focuses on local management and local decision making,“we are building the Clearstream franchise,” explains Tessler. “Given our natural strength and experience in servicing central banks, this global outlook makes sense. We utilise this constituency as a gateway to other banks in countries around the world.”

Even so, Tessler concedes that if the European landscape was and is testing, the extreme fragmentation of the Asian financial marketplace does present unique challenges.

“Certainly there is no cross border settlement solution in sign. But what is important is to have the tools that will allow interoperability when it is viable.”

With a global future of powerful consolation ahead of it, for now Clearstream is focused on the growing diversity in its existing markets. This includes initiatives in the Islamic finance area, which is, thinks Tessler, a natural extension of its fixed income franchise. “We have a substantial sukuk business already and we were the first ICSD to accept the first internationally listed sukuk in dirhams (the currency of the Gulf Emirates states) in 2006 and in Bahraini dinars in 2007 for clearing in our platform. Throughout the years, we have enhanced our understanding and compliance of Sharia rules, being privileged to share our expertise with 20-plus Islamic banks in the region,”adds Tessler.

While the EU and the rising number of clearing and settlement venues in the European arena continue to battle with the pros and cons of a single settlement engine and a centralised clearing depositary, Clearstream has achieved its aim of defining its business strategy on a much broader canvas. Through its tight focus on market entry via central banks, and with access now to 110 markets, its global reach appears unassailable and appears well set to take advantage of the global upturn, when inevitably it comes.

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Increased focus on the safety of assets held in trust has sent hedge funds and institutional investors beating a path to the doors of a few big asset servicing firms who can handle middle and back office processing and have the clout to run robust IT systems. Neil O’Hara reports on a bright future for these firms.

THE TRUST FACTOR

OOM AND GLOOM pervade the financial markets, but you wouldn’t know it in the prosaic world of asset servicing. After the rescue of Bear Stearns, the Lehman Brothers bankruptcy and Bernard Madoff’s alleged Ponzi scheme focused attention on counterparty risk, the safety of assets held in trust that are not exposed to the parent entity’s credit risk has sent hedge funds and institutional investors scurrying to custodian banks.

In addition, money managers have seen their asset-based top line revenues slashed as securities prices have tumbled— and their bottom lines may sink into the red if they do not cut costs. Enter the asset servicers, who can take over middle and back office functions and turn them from fixed into variable costs. Managers shed the capital spending on IT infrastructure as well, which is absorbed by firms that have the scale and resources needed to stay ahead in a neverending technology arms race. The major asset servicers are sowing the seeds for a new day in the sun as a result.

At its simplest level, asset servicers hold investors’ assets in safekeeping, process and reconcile trades, ensure that dividends and interest payments come in on time, and handle stock splits, takeovers and other corporate actions. Beyond basic custody, asset servicers also offer fund accounting and administration, performance and risk analytics, client and regulatory reporting, securities lending, cash management and collateral management—all the way through to fullblown outsourcing of the middle and back office.

Risk management has long been part of the asset servicer’s sales pitch, but Bill Tyree, a partner and head of investor services and markets at Brown Brothers Harriman

D

(BBH), says the benefits of independent custody often didn’t resonate with asset managers. They were too busy making money, and nothing had happened in the market to alert them to the danger—until last year’s meltdown set off the alarm.“We have been pitching a consistent story all along,”Tyree says,“All of a sudden it’s getting a tremendous amount of attention from clients.”

In an indication of how nervous investors have become, asset servicers were themselves tainted by rumours of financial distress early in 2009. In mid-January, State Street’s share price dropped by more than half after the firm disclosed a 70% slide in net income for the fourth quarter of 2008 and warned of escalating losses in off-balance sheet asset backed commercial paper conduits the bank administers. The announcement spooked clients across the whole industry at a time when they were already hypersensitive to counterparty risk.“Boards summoned their custodians to give financial reviews, asking why they should keep their assets there,”says Tyree,“The asset servicer should be the fund’s absolute safe haven. The industry is going to have to work hard to restore confidence.”

Prior to that hiccup, concerns about credit risk played right into the hands of the asset servicers. Historically, custody banks handled traditional unleveraged long only investors like mutual funds, pension funds and insurance companies, while prime brokers provided similar services to hedge funds, 130/30 funds and other investors who used leverage or sold short. The credit crisis changed all that.

“With the Lehman problems, people recognised they really didn’t know where their assets were,” says Joseph

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Antonellis, vice chairman of State Street,“We have seen a flood of requests to become the custodian for either hedge funds or 130/30 funds.” With more than $12trn in assets under custody State Street is the world’s largest custodian and handles an estimated 15% of all investible assets.

In the revamped hedge fund model, managers hold their long positions and surplus cash at a custodian bank, which insulates those assets from any prime broker credit risk, and hire an independent fund administrator to protect against fraud. While third party administration has long been common practice in Europe, most US hedge funds used to handle it inhouse. Now, however, Antonellis says institutional investors are pushing even the largest hedge funds to accept the checks and balances a third party provides. The pressure is so compelling that State Street’s hedge fund custody revenue grew during the fourth quarter of 2008 notwithstanding a precipitous drop in hedge fund industry assets.

Hedge funds began moving toward the new model after Bear Stearns’ brush with death, but the Lehman Brothers bankruptcy triggered a stampede. Managers recognised that self-administration was a deterrent to new investors and a pretext for existing investors to pull their money out.

It wasn’t a core competency, either.“Anybody who is doing anything self-administered can’t get it out of their house fast enough,” says Robert Wallace, managing director of fund services at Citi’s Global Transaction Services, “With asset levels and revenues coming down, it really makes the decision to move it outside a non-decision.”

Concerns about counterparty risk have also lowered the threshold at which hedge funds turn to multiple prime brokers. In the past, managers stuck to a single prime broker until they had perhaps $400m-$500m under management, but prudence and investor pressure now oblige managers with $100m or less to diversify their funding base. It creates an accounting headache, however, because managers can no longer rely on a single source for a consolidated view of their positions. It’s a natural fit for asset servicers, who are already well equipped to handle the chore. “It’s the hedge fund equivalent of the master custodian concept,”says James Palermo, co-chief executive officer of asset servicing at The Bank of New York Mellon (BNY Mellon), “The global custodian role took shape because institutions had multiple managers and wanted an independent third party to provide the administration.”

Among mainstream institutional investors, State Street’s Antonellis has seen increased demand for sophisticated risk and performance analytics from pension plan sponsors seeking greater transparency into managers’ portfolios as they assess how to rebalance existing assets and deploy new cash. Traditional asset managers, whose asset-based fee income is likely to plummet 30% or more in 2009 unless the markets bounce back, have stepped up outsourcing in a desperate effort to cut costs. Clients are beating down the doors for help with derivatives, too.“We have seen a boom in collateral management,”says Antonellis.“Back offices are getting swamped. It’s a relatively new product for us but we have had triple digit growth.”

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Mark Kelley, asset gatherers segment executive at JPMorgan Worldwide Securities Services. Even though custodians always segregate clients’ assets, investors feel more comfortable in the current environment if the parent entity has a strong balance sheet.

Sophisticated investors also prefer firms with a global footprint and a common technology platform that can produce reports in the same format no matter where they choose to invest, says Kelley. Photograph kindly supplied by JPMorgan, February 2009.

Bill Tyree, a partner and head of investor services and markets at Brown Brothers Harriman (BBH), says the benefits of independent custody often didn’t resonate with asset managers. They were too busy making money, and nothing had happened in the market to alert them to the danger— until last year’s meltdown set off the alarm.“We have been pitching a consistent story all along,”Tyree says. Photograph kindly supplied by BBH, February 2009.

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A flight to quality has driven more business toward the biggest asset servicers, according to Mark Kelley, asset gatherers segment executive at JPMorgan Worldwide Securities Services. Even though custodians always segregate clients’ assets, investors feel more comfortable in the current environment if the parent entity has a strong balance sheet. Sophisticated investors also prefer firms with a global footprint and a common technology platform that can produce reports in the same format no matter where they choose to invest. It all plays to the strengths of big players like JPMorgan, whose acquisition of Bear Stearns last March transformed it into the only bank that offers both equity prime brokerage and traditional asset servicing.“We have a vast breadth of clients: hedge funds, private equity funds, mutual funds, pension funds, endowments and foundations,”says Kelley,“We are a onestop shop on a global basis.”

In another indication of how much size matters in asset servicing today, Daniel Wywoda, head of global product development at BNY Mellon says the bank used its own balance sheet to accommodate clients during the run on money market funds after the Reserve Primary Fund broke the buck in September. Everybody wanted to switch from funds that invested in corporate credit to US Treasury funds, but the transitions didn’t always go smoothly.

Lehman Brothers had just failed, so hedge funds were pulling money away from their prime brokers, too.“A client would call at the end of the business day and say,‘We have $10bn. Can you take it?’,” says Wywoda,“At one point we elevated our balance sheet by about $100bn over its normal level.” Only the largest institutions have the capital to handle such a dramatic influx.

JPMorgan’s Kelley anticipates the regulatory response to the financial crisis will hit full stride in 2009 and believes the leading asset servicers will be best placed to meet any incremental demands for information. Asset managers will have to figure out how to collect the relevant information, which takes time and money they can ill afford in 2009— yet another reason for them to outsource the work to asset servicers, who benefit from economies of scale. Regulators charged with preserving the safety and soundness of the financial system do not write rules for the convenience of computer geeks, either.“The industry has to find the right place to capture the data and get it to the responsible entity,”says Kelley,“We have to build it in. We need to meet the regulatory requirements without slowing down the transactional processing.”

The capital expenditure needed to keep the IT infrastructure up to date is not a one-off expense, either.

Somebody somewhere is always tinkering with the regulations, and even if they were not, clients are always asking for improvements in reports, risk management and performance attribution tools. Tim Theriault, president of corporate and institutional services at Northern Trust, says his firm will spend $1bn on technology over the next three years to keep Northern at the forefront of what has become almost an arms race among the major asset servicers.“We

Robert Wallace, managing director of fund services at Citi’s Global Transaction Services.“Anybody who is doing anything selfadministered can’t get it out of their house fast enough … With asset levels and revenues coming down, it really makes the decision to move it outside a non-decision,” says Wallace. Photograph kindly supplied

by Citi, February 2009.

use the same technology platform globally for all our clients,” Theriault says, “That gives us the best scale and allows us to offer effective pricing to our clients and provide high levels of service.”

Clients today expect access to critical information in real time, of course, but Northern’s platform goes beyond a passive look at the portfolio. For example, if news affects a particular stock the system flags other companies in that sector or geographic area, helping clients stay one step ahead.“Boards will ask what is our exposure and what does it mean to us,”Theriault says,“Clients appreciate a holistic view of the various dimensions they may consider in their analysis.” Northern has also invested in technology and analytics to price illiquid assets, a skill Theriault says played a critical role in snagging a large mandate late last year.

Brown Brothers Harriman’s’Tyree says his firm spends“in the high teens” as a percentage of revenue on technology just to keep pace. He sees strong client interest in technology that will improve the efficiency of electronic messaging all the way through to the end investor. For example, a pension plan may insist its managers hold assets at a local bank that uses antiquated software and proprietary formats for messages.“We can take trade messages from clients’systems and convert them into formats local banks can accept and process. Then we convert and deliver the replies,”says Tyree, “Clients have devoured that service.”

Citi’s Global Transaction Services, which includes cash management, trade finance, fund administration and issuer services like depositary receipts as well as asset servicing, spends $1bn a year on technology, but Wallace is convinced it pays off. “When we ask why people choose us, many times it is our technology platform, the flexibility in it today and its ability to grow with the firm,” he says. He expects the industry to evolve towards a barbell structure; the big players will get bigger at the expense of the middle tier, while smaller players will thrive in specialised niches.

For the handful of firms at the top of the heap, it’s a bright new dawn for asset servicing.

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2009 THOUGHT LEADERSHIP ROUNDTABLE SERIES

ASIAN ASSET SERVICING ON THE CUSP OF RISING VOLUMES

Participants:

Supported by:

From left to right Scott McLaren – managing director, RBC Dexia Investor Services, Hong Kong Lennie Lim - managing director, Legg Mason Francis Teo - head of operations, UOB Asset Management Paul Hoff – managing director, FTSE Group, Asia-Pacific Dr. Tan Chong Koay - CEO, Pheim Asset Management Marcel Weicker, co-managing director, BNP Paribas Securities Services, Singapore Francesca Carnevale - editor, FTSE Global Markets Lee Soon Kian - principal investing consultant, Mercers

FTSE GLOBAL MARKETS • MARCH/APRIL 2009

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THOUGHT LEADERSHIP ROUNDTABLE

THE ASIAN LANDSCAPE/OVERVIEW SCOTT MCLAREN, MANAGING DIRECTOR, RBC DEXIA INVESTOR SERVICES, HONG KONG

What are the key trends? You can see right now that there is a large component of UCITs funds that need to be taken into consideration, in particular with reference to the Hong Kong, Singapore and Taiwan markets.

Moreover, there is that play between domestic and offshore funds where, in some markets, you cannot import offshore funds, yet you have a strong domestic market. So from the clients perspective we are seeing this drive towards single solutions, regional and even global solutions. Clients are also looking for best leverage into the market, and that’s why we all have some work to do because no single solution will speak to every fund manager’s strategy or geography (albeit globally).

Moreover, we are entering a phase in Asia where we will see more consolidation. Some asset managers will become bigger and will have a larger geographical footprint. Asset services will need to follow the clients to an extent, to be able to put products and services in new jurisdictions across the region where a physical presence is required.

LEE SOON KIAN, PRINCIPAL INVESTMENT CONSULTANT, MERCER:

Obviously the financial crisis has heightened institutional investors awareness of risks. As a result, we received a number of requests from clients asking us to review their risk management policies and systems. The first layer of risk management structure is very much tied to the strategic asset allocation of their investment programme. As part of our service, we always advise our clients to review this important decision once every three years or earlier if there is a material change in our client return requirement and risk tolerance, and/or liquidity needs. In addition, material changes in the market environment are catalysts for clients to review their prior strategic asset allocation decisions to ensure that their investment programme remains relevant to their objectives. We have also received a number of requests to look at the middle and back office operations of their counterparties. More specifically, with the Lehman Brothers collapse, the difficulties experienced in the money markets have resulted in some problems with securities lending and collateralisation. Clients are now waking up to the inherent risks in these transactions, which were previously being ignored. In a way, this financial storm has brought these risks to the fore. We think that the focus on operational risk will be around for a while.

LENNIE LIM, MANAGING DIRECTOR, LEGG MASON

One of the key drivers in Asia is the need for individuals to undertake active financial planning and this requirement is driven partially by demographics.

Compared to some European countries, we are a young population in Asia and several countries in the region

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Dr Tan Chong Koay, chief executive officer, Pheim Asset Management

with a more developed regulatory framework have shown great foresight in terms of developing pension schemes, policies and safeguards to allow for future financial planning and wealth creation to take place. We see Asia as a big opportunity in terms of growing our business and tapping into this developing trend. As Lee mentioned, another trend that will emerge more clearly will be the need for greater investor education and protection.

PAUL HOFF, FTSE GROUP

As an index provider obviously we supply data to a number of investment banks, asset management companies, and other users who are looking to take advantage of the shift to more passive management and low cost management. We are therefore in discussions with a lot of people about bringing out more funds and identifying specific asset clusters where people will be comfortable with that kind of approach. We also have people coming to us asking for new ideas. They need new themes for creation of mutual funds, so we are working with people to create custom indices, but again relying on the transparency and the simplicity that you can get by having an index and making the index available to people. We think there is significant potential for a lot of these custom indices this year.

MARCEL WEICKER, CO-MANAGING DIRECTOR, BNP PARIBAS SECURITIES SERVICES, SINGAPORE

BNP Paribas Securities Services is the largest global custodian in Europe and as such is an alternative to the large US global custodians in this part of the world. The AA rating

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of BNP Paribas helps in that regard in the current environment and provides an additional security to potential outsourcers. Clients become more and more global, so from that standpoint we also need to become globally modelled to be in a position to service our clients worldwide.

ARE PAN ASIAN SOLUTIONS POSSIBLE? FRANCESCA: How do you provide Pan-Asian solutions in a marketplace, which is highly fragmented and has quite different market conditions?

MARCEL: It is fair to say that finding a global solution to a fragmented market is not the easiest of things to do.

You pretty much need to have a physical presence in most of the markets in order to really be in a position to provide services that clients expect.You could try to serve only those global clients who distribute their European products on a regional basis out of one location, but even that is not the easiest thing to do because rules and regulations, tax, clients, investor information regulatory reporting really varies from one country to another. So from a systems standpoint you need to be in the position to be geared up to provide services in various jurisdictions in line with the respective countries’ laws and regulations.

SCOTT: From an assets servicing perspective, at RBC Dexia we break the world up into two strategies: offshore and onshore. Certainly from the onshore perspective you need to have presence and capabilities in the local market. In terms of this strategy, whether you use a single IT platform strategy or a multiple strategy really depends on the business model in play. However, it is fair to say that you need to adapt local systems to global tax regulations, and local languages. We have just applied this approach for a client working in Thailand for example, which was a project not on our own radar, but was client driven. Additionally, you also have to have to provide flexibility around reporting and time limits. Now, certainly, servicing in the local time zone is important.

Therefore, if you hub out of one country for the region as a whole, as long as it’s on the Asian time zone, it is still a pretty acceptable operating model. However, from a user’s perspective with UCITs in mind, the combination of Europe and Asia is very important, because of the vast assets that are gathered in the Asian region right now and the European domicile component FRANCESCA: Is there consistency from the assets service providers in terms of what they can offer you and your firm? Can you see that the development of a potential international passport in terms of your asset management and distribution capabilities through these global houses that are present and working in the region?

FRANCIS TEO, HEAD OF OPERATIONS, UOB ASSET MANAGEMENT

Let me frame my reply in context. We are looking to expand in Singapore and the rest of Asia. Our speciality

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Lennie Lim, managing director, Legg Mason

is small and mid-cap and Islamic funds. Our expansion has been quite rapid from $98m under management in 1997 to over $1bn today. To support our business strategy we actually have outsourced some of our operations to our service providers in order to help us become more efficient and focus on our growth strategy. We work with a current service provider in our four key markets because we do not have good service capability within our own organisation. We see a lot of issues as we expand in the region because we have presence in Thailand and we have presence in Malaysia and distribution is a challenge for us. The current phase in the UOB business plan is to ensure that our current service provider has the regional capability to support our business growth.

DR. TAN CHONG MANAGEMENT

KOAY,

CEO,

PHEIM

ASSET

I can only say very specifically that we do try to use a custodian that has regional strength. However, there might be a revision of this policy going forward, particularly if and when we move out of the ASEAN region. We can see the trend is for the greater geographical coverage. So we are definitely interested in providing regional customer services.

LENNIE: This is an interesting question. A robust panAsian solution requires scale. In the current Asian

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landscape there is an imbalance between scalability and local adaptation. The asset management business is about building scale and if you have a global or regional platform that of course makes a lot of sense. Thereafter you need to address Asia’s diversity—as already mentioned, fragmentation of markets within Asia, local adaptation to languages, legislative regimes, different reporting requirements, and varying investor expectations are just some of the characteristics that hinder a pan-Asian solution from taking off the ground in the near future. A coordinated effort amongst key regulatory bodies would be another key driver in order for Asia to have a similar regional platform as we see working under UCITS. FRANCESCA: How as a consultant, are you bridging the requirements of the buy side with the product suites offered by the sell side in Asia?

LEE: Actually, Mercer is not only well placed to reconcile the demand for investment products and the supply of these by fund management companies, but to also ensure that good quality investment products are being bought by investors. We devote huge resources to evaluate investment products available in the market place. To date, we have more than 60 full time manager researcher, whose job is to evaluate these products. The end result of their work is to provide a Mercer ratings on each of these products. These research are are being stored in Mercer Global Investment Management Database (GIMB). The database contains not only our research notes and ratings, it also contains the fund manager’s investment philosophy and process as well as up to date developments within their businesses. More importantly, we have been tracking the performance of our ratings versus the ability of these managers to add value versus their benchmarks. Since inception to date, our managers have added more than 1% for their clients.

THE FOCUS ON LOCAL REQUIREMENTS FRANCESCA: It is only in selected markets where the full

spectrum of that asset servicing range can be really exploited. Can we explore the implications please?

PAUL: As Scott highlighted we are client driven, when the client needs something; when they can come to the point of understanding what they are really asking us for, then we can apply our broad database and help them out with some solutions. There are a lot of issues and variations in the ability of investors to access some of the Asian markets. Therefore in providing products to investors it is necessary to do the analysis in order to provide a data product that people can use effectively. We work with a lot of partnerships—that is probably different than many people around this table who work in much more competitive environment. Even so, FTSE partners with the exchanges and the investment officers in financial institutions which help us define what is investable and

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make it easier for the fund managers to provide a product in that area. The other step that we are taking is to diversify our business. Therefore, as everyone says, you just have to have a presence in each of the areas. We have now reshaped our research department with local teams based in London, Hong Kong and the United States. We are doing the same with our index maintenance groups, with operational hubs being set up in NewYork and Hong Kong also. We recognise that servicing the client has to be done on a much more local basis.

FRANCESCA: How do the dynamics between local needs and international cross border expertise and the establishment of product on both an onshore/offshore basis apply on a day-to-day basis?

SCOTT: We are looking now at a much more global servicing model, and it is fundamentally driven by two things. One is cross border distribution and the other is fund managers expanding their operations to capture more assets in more markets, particularly in Asia. If you look at the history of the funds industry in this part of the world it is actually not that old. We have witnessed fund managers moving into the new markets and potentially capturing them early on. That has driven asset servicing into new regions, but from a day-to-day perspective it can boil down to just the client content of client services.

The culture of investing in Asia is very different from Europe and the United States. The United States is a largely automated model, and it is a single currency environment for a single country, in a domestic market that is the largest in the world. In Europe there is much more fragmentation, but thanks to the euro, it makes it largely a single currency market and less complex than it was. That being said, you have still got this language issue and a different servicing culture. What that means is that asset service providers might have to produce reporting, in six, seven or eight different languages across Europe. English has been sufficient for some of the markets in Asia, such as Singapore and Hong Kong.

Outside of these markets, such as China, Taiwan and Korea you definitely have to adopt local customs and language in providing a platform to support distribution.

MARCEL: The most important thing is to listen to the needs of your clients and adapt your services accordingly; though it is easier said than done. Again, it is a question of market fragmentation, market specifics, language, client reporting, regulatory reporting; the tax component in some markets such as Australia, for instance, is a challenge—to be in the position to provide that kind of service out of one jurisdiction and with one systems platform. It simply may not be possible. From that point of view then it is a question of evaluating whether you have a global platform for all markets, or you have regional platforms, or you have local platforms in order to service specific markets which have specific requirements.

FRANCESCA: Has anything concrete emerged that might lead to a UCITS’ style solution within Asia?

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PAUL: ASEAN exchanges came to FTSE because they

wanted to have an ASEAN 100 index, so we did some work with them and eventually we brought out a 40 stock index, which represents the five markets that are investable. They continue to want to have the ASEAN markets viewed as a common market. However the difference in their individual currencies, the differences in their settlements, the difference in their trading culture are still completely diverse. They are now talking about sorting out common ground but this presents challenges. There is still a lot of work to be done and a common market seems far away.

DR TAN: The ASEAN countries have discussed many times ways in which they can cooperate. However each has their own agenda; Malaysia for instance with its Islamic finance ambitions and each of the countries are strong in their own right. Any cooperation is concentrated in the large cap area where all of the key international interest is going to be. However, coupled with the trading difficulties across the markets I just can not see the small cap area, for instance, getting a common platform.

LENNIE: Achieving concrete developments in this area is a very slow and cumbersome process, but once achieved it will have huge benefits. To string in an earlier question about local versus cross border application in Asia – ultimately it’s about being client focused. What does the end investor need? Investors in Asia are focused on three main deliverables; best of breed managers that deliver performance results, the lowest cost service provider and increasingly an organization to partner with that has a solid reputation that they can trust. Legg Mason’s model of housing over ten independent investment affiliates with unique investment styles, philosophies, strategies and geographic locations allows us to work well with our distribution partners in meeting their client’s needs across different markets. The fact that we largely operate on a regional and global fund distribution platform also means that our investors can benefit from economies of scale as the various fund related costs are spread across a larger AUM and number investors. Having on-theground servicing teams in key countries is also critical because we can work hand-in-hand with our partners on product positioning, education and to build trust over the long haul.

MARCEL: I believe it’s not only a question of fragmentation, but also a question of competition between the various countries. Singapore and Hong Kong are vying to be Asia’s premier financial hub, so is Korea and more recently Malaysia. Even looking at Europe today, the European Union, is it really a union?

The answer is possibly no, because in case of crisis each country looks after its own interest first and foremost.

Luxembourg is criticised over its private banking secrecy rules and regulations. Lately France was hitting on Luxembourg because of the Madoff scandal and so on. In Europe the discussions about Union began in the 1950s

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Francis Teo, head of operations, UOB Asset Management

with a plan extending out to 2001. Based on that timeline, talks going on in Asia today would materialise in an Asian Union to come into existence in 2050, may be in 2030, most probably not in the next five to ten years.

Too much competition, too much self-interest, too much protectionism exists between the various countries, in my opinion, for anything of that nature to happen soon.

LENNIE: I agree with you that competing priorities make it difficult for the various local governments and regulators to coordinate their efforts and it’s unlikely that we will see the same achievements as Europe in the short term. European governments, however, have been successful and ASEAN countries are a quick study and will adopt similar best practices in time. The current market turmoil may also act as a catalyst for ASEAN regulators to band together and implement a set of common guidelines relating to sales processes, investor education and protection that will help to speed up the development of a local UCITs platform.

LEE: When you look at the entire Asian landscape, each capital market is at a different stage and pace of development. Achieving uniformity requires time and technology. Time is needed for these markets to mature and grow in sophistication. With time, these markets will become more similar in terms of product offerings and investors’ needs. This makes it easier to achieve a more

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unified approach. Additionally, Asian markets lack a central governing body to push for a unified approach, as is the case in Europe. In ASEAN, unless there is a strong political will to establish such a body to promote uniformity in approach and regulation of financial products in the region, progress will be slow. We believe that every financial players around this table is interested to see this happening because the benefit is obvious to all of us. This begs the question of how and what would cause the various ASEAN government to act on this. The key is education, that is education of governments around the region on the attractiveness of a unified investment vehicle or structure along the line of UCITs in Europe and thereby reinforcing the outcome of unified approach as a “win-win” solution for all. Unless these governments are able to understand and appreciate the potential benefit to their countries, beyond what they can immediately see, there will not be any particular political will to push for it.

SCOTT: Actually, UCITs have now been around for 20 years, and are an extremely complex engine and model to get up and running and maintain. In that regard, there is a barrier to entry for another jurisdiction or region to come up with something similar that has such cross border appeal. I hesitate to introduce the concept of transparency because there are still quite a lot of things that need to be ironed out. Although Asia as a region is big, each individual market is small. Three markets in this region have embraced UCITs. The most advanced of these is Hong Kong where about 97% or 98% of the funds are either Luxembourg or Irish domiciled UCITs funds which have been sold into the market. Singapore is also an adopter, and 60% to 70% of the funds are UCITs funds now as well. That’s a fairly recent phenomenon, but we do see this desire to import product. Taiwan’s another market that has moved in that direction.

However, there is an inability for any Asian country to export its product to other regional jurisdictions.

Australia has ambitions, like every other country in Asia, to be a hub for Asia Pacific and it is actually the biggest market in the region, with a A$1trn or so in assets under management. However, local legislation just doesn’t allow Australians to sell their funds into a different jurisdiction. Scale is also important. Luxembourg for instance, with €2trn of assets under management can provide enormous scale to fund managers into the industry, and offer that product across the globe. I like to compare it to free trade agreements, basically some markets are open to importing UCITs funds, some are halfway to accepting but still maintaining local ‘production’ and others are closed to offshore funds and maintain their own local industry.

THE IMPORTANCE OF SCALE FRANCESCA: Can we build on this point please?

SCOTT: We can tackle that question from a number of

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Paul Hoff – managing director, FTSE Group, Asia-Pacific

different angles and, the first one is that Asia already is providing scale to another jurisdiction, because around 50% of the assets in UCITs funds are gathered outside of Europe. South America and Asia are the big contributors to UCITs, Asia probably more so than South America. The second way of tackling it, is that in Asia we still have a lower cost profile than some of the European markets, or the US markets, as of today. There is therefore opportunity definitely for fund managers, asset services, research companies, to locate some of their activities in the Asia region and gather some cost streamlining from that. Then companies like ourselves operate out of Asia to support some of our global functions, and our recent office opening in Malaysia is part of that strategy. An important element is scale, but another is being lean, and being lean may mean moving more functions out to Asia to achieve a more global and cost efficient operating model.

LENNIE: Scalability is quite crucial in this industry. In some ways, the authorities spend too much time looking at symptoms, rather than finding the right antidote to the problem. However, I’m glad that they’re starting to look at expense ratios in greater detail and focusing on ensuring that the products being brought into their countries have the right scale and mass to benefit end investors. Recently, authorities looking after the MPF in Hong Kong and CPF in Singapore have been placing greater scrutiny on TERs which will ultimately be in the best interest of end investors. Scalability or critical mass really means that government are willing to accept cross border funds into their pocket. Whether its UCITs three,

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four or five, it doesn’t matter really - it’s a matter of having that critical mass of funds to manage and pulling together investors globally into one pot. For me this is the most cost efficient way of bringing a product into the various markets.

PAUL: There still is a reliance on the international providers for ETFs that are going to give the broadest exposure to asset classes. There are a few champions in each of the local markets who are doing the national ETF, but when you look at what’s truly available, it tends to be the cross listings coming in from Europe, where the real professional funds are being provided. So we are looking at the development of many of these local markets, and they’re building up the ability to handle a global portfolios. However, it is very tough, very tough.

DR TAN: Even if you have the liquidities over there or if you want to use it, in Asia, you can’t do it—there is no liquidity. Singapore is not a sufficiently large provider of liquidity. Hong Kong is slightly better but not enough.

However, for a big global fund manager I am quite sure they are cracking the whip every day to find things.

FRANCESCA: What’s stopping you going to Europe to raise money?

MARCEL: Rules and regulations. For Singapore or Hong Kong funds to be authorised by the European Union to be distributed European wide is, for the time being at least, impossible. You can register a Singapore Unit Trust, for instance, in Europe, in one specific jurisdiction going through the three months, six months, or even 12 months approval process, but a Singapore Unit Trust or Hong Kong Mutual Fund or Unit Trust to be accepted in Europe for public distribution, at this stage, certainly is not possible. Whether that is something which is feasible in the future, potentially yes; though I do not believe that aside from the UCITs structure, you would have another structure that would be globally acceptable.

PAUL: I have not really seen any discussion at all of these ASEAN Finance Minister’s meetings about any kind of funds measures. They are focussing on their stock markets; they are focussing on trading in stocks, cross markets, and they’re not even looking at the funds area in any serious way that I’ve noticed. Has anybody seen that happening?

LENNIE: Another way to look at this question is to recognise the fact that there is a huge amount of wealth in Asia. Increasingly many fund management companies are looking to the international space, especially Asia for their future growth. The current issues that we are facing with cross border funds being broadly accepted and what’s being done on the funds side will slowly turn the tide. Pension funds will also drive the way forward – pension funds in the various Asian countries are getting bigger and more global in their search for offshore investments. In China, QFII was designed towards foreign investments flowing into the country, whereas QDII is really an instance about companies like Legg Mason bringing cross border expertise and funds to retail investors. If you were to take this as an example, again

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Marcel Weicker, co-managing director, BNP Paribas Securities Services, Singapore

it’s a case where governments are looking to encourage wealth creation within the country. Not dissimilar to my earlier discussion on what investors are seeking, governments first of all are looking for services and products that are of benefit to the end investors. Again, it’s about fund management firms being able to offer best of the breed investment capabilities, low cost investment structures and trust. If we deliver these benefits, then we will see more jurisdictions opening up.

FRANCESCA: But does that mean then that over the long term asset flows move into only very select markets?

LENNIE: Assets will always move to where there are investment opportunities. This is basically a wealth creation business. We are in the business, as I like to tell my clients, to make our clients rich or richer.

DR TAN: With one exception that when the market is just too high, people should watch out, because economy and the market are too different things, if you look at December 2007 the market was record high in most places, with the exception of Japan. Japan is the one market that in December 2007 the market was not really anywhere. You look at Iceland, you look at China, India,

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they were all at a very high level and when they are at that high level investors should be very, very careful, because any economy and/or market at the tail end of a boom is very dangerous.

FRANCESCA: What do you think were the lesson learned from the Asian currency crisis?

DR TAN: One very clear cut lesson. Do not overreach yourself. Many companies now have very low gearing in this part of the world; but even that won’t save you if your share price becomes too high. However, this time it’s a very different dynamic, this time it’s global.

FRANCESCA: One of the casualties of this current financial crisis has been China, in terms of the drag on the wider region. Do you think that the next year, you will see, as a custodian, lower volumes of assets held in custody because of that?

MARCEL: We are looking at the US, we are looking at Europe, we are looking at Asia altogether including China and India, so from that point of view, everything needs to come together in order for the current economic environment to dramatically improve. Assets obviously suffer in terms of valuation, I believe, all markets have come down by what, 30% or 40%, so assets under custody, obviously to a certain extent decrease as well.

You can gather new assets, but that is, to a certain extent, limited too. Therefore, it is a relatively difficult market environment for the time being, for service providers as well as asset managers. The best we can do is hope that the current crisis passes very fast. Dr Tan when is that going to be?

DR TAN: Pass!

LEE: If you look at the current crisis from a fund management companies’perspective, we do know that a lot of active managers are having a very tough time. In fact, most active managers, including well rated ones, are underperforming their benchmarks. Despite this, we remain confident that good active fund managers, over time, will still deliver good value add to their clients.

However, what we have experienced over the last 12 months are experiences that cannot be extrapolated, because it is an unusual time of extreme market conditions.

In such a market, fundamentals do not matter, liquidity does. Liquid stocks are sold to raise much needed cash by individuals as well as fund managers facing heavy redemptions. These often are stocks with good fundamentals held by the same fund managers who are selling them. Such indiscriminate selling has resulted in these fund managers underperforming their benchmarks.

In essence, these managers have not become bad overnight, but they are feeling the neat nonetheless. Also, people now may be looking more closely at Beta plays now given that these Beta has been beaten down to attractive level. The search for Alpha is not so compelling given current market valuations. When the market is near full valuation or over valued, Alpha play makes a lot of sense. The reverse is now true. Beta has become cheap. In addition, investors in Alpha plays have also become a little disillusioned with the higher

than expected correlation of an Alpha strategy to the underlying asset classes. Mercer has been advising our clients to refrain from adding investments or initiating investments into hedge fund strategies for the time being.

On the other hand, we have identified a number of Beta plays for investors looking for opportunities.

FRANCESCA: Paul, does this resonate with you?

PAUL: The move to passive management to capture Beta and to do that at a very low cost is key here., People are wanting to see that now applied to a variety of asset classes, so we’re dealing with client’s request for custom indices where they want something quite simple. An example is in investment banking. A client might want to be able to put together some notes based on a futures index; a total return futures index, whether it be just the return of the investments of the futures contract with the overnight interest rate. It is simple, but an innovative product that will attract attention and have a high level of transparency.

RISK MANAGEMENT CONSIDERATIONS SCOTT: I recently met a regional head of an asset manager who said that he’s done four business plans in the past three or four months and he’s thrown them all in the rubbish bin. He wasn’t going to write another one until things stabilised, so when you look at our clients’ plans, that would definitely describe the current market.

However, in every situation, product providers sit down, think about what’s happening and then retool in a different way, We will definitely see different products coming out to suit the market. Singapore used to have a history of capital protected funds and we may well be going back to that model. Most likely funds will become less complex, a move that will be welcomed perhaps, because there is a distinct lack of education among some of the investor base across the region. I have spent a lot of time in the MPFA in Hong Kong and investor education is always on their agenda, particularly when you look at some of the recent scandals that have hit the press. Asia is probably one of the most, opportunistic markets right now, and we are talking about a lot of fund managers who have asset valuations that are drastically down 40% or more. What we have not mentioned is that there are still some fund managers that have outperformed the market and shown positive returns.

On the asset servicing side, the current situation creates opportunity in terms of dialogue and discussion with clients, particularly if you’ve got head count freezes or layoffs. Nowadays the dialogue involves people, perhaps long term partnership, or the mutual benefit of outsourcing rather than only core product outsourcing.

Although we look at middle office, performance, attribution, risk reporting, as well as more outsourcing of core administration, these days a true partnership with strategic clients, needs to be much broader.

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FRANCESCA: Marcel, in terms of the service provision

Scott McLaren, managing director, RBC Dexia Investor Services, Hong Kong and Lee Soon Kian, principal investing consultant, Mercers.

LENNIE: I will say for sure that Asia will outperform the

rest of the world in terms of recovery. The last Asian crisis has made the region a lot more resilient and we have some of the fastest growing economies on the planet. In the new environment there is going to be increased due diligence undertaken. On that basis our approach is to firstly focus on investor education. While we do not sell directly to end clients, we work very closely with our distribution partners in terms of educating their sales force and clients on investments. Secondly, it’s about helping our partners effectively adopt any new sales processes and guidelines that may be set by regulators to promote greater transparency and product understanding. Building strong, trusting and long-term partnerships with distributors will be a priority for asset managers in what is likely to be a different operating environment going forward.

FRANCIS: From the asset management side, we are looking increasingly at counterparty risk and who our counterparty is in a transaction, and that it does not compromise disclosure requirements. In the general market, we expect more hands on regulation. Because of the current situation in India, we expect there will be definitely more and more regulatory requirements on investors, especially alternative investors.

FTSE GLOBAL MARKETS • MARCH/APRIL 2009

side, how can you help the process from distribution through to risk measurement at the investment level?

MARCEL: In the context of the question, whether the problems emanated in Asia or somewhere else, first of all, they are global companies that have the same risk controls in place in the various jurisdictions. Being a French company, from that standpoint, the same risk controls are in place in Paris like they would be in the UK and like they would be implemented in Singapore as well. BNP Paribas Securities Services, or BNP Paribas globally, has passed through this crisis pretty well, and the risk controls are very well in place. However, I guess I’ve seen in the latest developments around the current crisis, that there are always ways and means around improvements. In that sense, I believe you pretty much have to look at what has been going wrong, and what has been going right over the last 12 to 18 months and improve on that, wherever you can.

SCOTT: As you quite rightly say, Francesca, that’s going to require a lot more compliance and risk people, so if you’re looking for your next career and you have experience in risk and compliance, then you’ve got a guaranteed job in the industry.

PAUL: Fund managers, as a sort of overlay to this whole discussion, have different needs. At different ends of the spectrum you can have some that are not present in this market, some that just have a sales presence in this market, or some that have a full blown operational capability. To a larger or a less great extent, they may outsource all, they may outsource some, they may in source all, so it is really a dialogue with the clients as to how we can absorb some of the greater requirements for this enhanced controls and reporting in line with the regulations.

FRANCESCA: What concrete role can consultants play and how effective can they be in helping clients define an effective risk management policy?

LEE: The first building block of a risk management policy begins with strategic asset allocation (SAA). This is then followed by the careful selection of fund providers in terms of Alpha generation capabilities and ensuring that investment mandate/guidelines do not deviate too far from the benchmark used in SAA. This is followed by close manager monitoring. Notice that we prefer to look at monitoring investment programmes from the angle of manager monitoring rather than performance monitoring.

We believe that a consultant role must be void of potential conflict of interests. As such, our business model has been one whereby we do not receive compensation from fund management companies for our evaluation of their strategies. Our compensation comes solely from our clients. In transition management, we do not act as the transition manager, but rather as an advisor to the process doing the necessary due diligence as well as undertaking the study of how successful the process has been executed by the appointed transition manager. We prefer a close and complete relationship that covers all aspects of our clients’ investment programmes. This gives us a better overview of

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their needs and enables us to deliver customised solutions that best serves their needs. In the post crisis environment, we expect investors to focus more on risks, wherever these exist. Good risks, ie risks that pay in terms of return, will be managed within the tolerance of investors. On the other hand, investors are keen to minimise if not eliminate bad risks, ie risks that do not pay in terms of returns.

PAUL: One of the key phrases that we use in virtually everything is investability, and the committees that work with us studying the rules for our benchmarks, and the quality of markets criteria that we use for evaluating the markets. The people who have to passively track our indices want to be able to replicate them and if we’re not creating benchmarks that can be replicated. It’s going to increase the risk of them being able to meet the mandates that they’ve got. We do a lot in that area with analysis and free flows and liquidity screenings to make sure that the underlying constituents are valid. Really, we’re just setting the baseline for the fund managers, these are either in terms of a benchmark or in terms of something that they’re going to be passively tracking. Some like to say, the only free lunch you have is the diversification and the one thing that FTSE can do or any index provider with a global product is to allow the opportunity sets to be broken up into the different asset classes: the large caps, the small cap, the developing, the emerging, the frontier markets, and having those quite distinct areas where when the asset allocation process is being done and the risk is being budgeted out.

MARCEL: You really have to distinguish between the small boutique houses as well as the large asset management houses. Large asset managers today look at the possibilities of outsourcing middle office, back office functions in order to outsource, to a certain extent at least the risk component as well as the fixed cost component to a specialised company. We are specialised in middle office and back office functions, so from a risk controlling environment, all systems are geared up to provide these benefits.

CONCLUDING REMARKS LENNIE: I’d like to reiterate the fact that you really need to be client focused, a low cost producer and a best of the breed manager. Outsourcing is also a key component for any asset management firm regardless of its size in order to gain efficiencies. This is where I have regular discussions with people such as Marcel on what else Legg Mason can do to ensure that we have the right technology in terms of support and the right core product offering to meet our client’s needs across the various markets. At the end of the day, asset servicing is not a commodity, it involves specialised skills, especially on the active asset management side, and that’s where we want to bring our strong investment management capabilities to the end investor. Legg Mason is rather unique in the

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sense that we are a collection of managers, so we operate under different brands and offer a broad range of investment styles and talent to our partners. We are also a truly global firm and enjoy a strong reputation as a pure play asset manager. My last point is that I am very glad to be in Asia because this is where the opportunities for the fund management industry lie.

PAUL: I guess I would just go back to the one ideal that I mentioned earlier, that I haven’t really seen, let’s say, at the Asian level, the interest in having a US style or approach in the region. There is a lot of education that needs to take place in each of the markets. There certainly is a need for some kind of move for standardisation or opening up the borders to allow more than just share trading, and really start to get some real trans-Asian activities going. In the meantime, like everyone else, we go into each market, and try and work with the key players, to make sure that they know what’s available to them in terms of the kinds of services that we have to provide and just hope that things will continue to move in a positive direction.

MARCEL: We are living in exceptional times, which obviously offer opportunities, specifically to companies like ourselves that have passed through the crisis pretty well, so from that standpoint, I believe there is business out there. It actually focuses asset managers on their real skills and the need to do things in house, or the potential, the possibilities in outsourcing certain activities to outside specialists. As Lennie says, Asia is the place to be and from our own viewpoint, we are in the right space at the right time.

FRANCIS: In the mutual fund world, we have work groups that look at office processes in investment groups in Hong Kong and there’s another work group in Taiwan, and there’s one in Australia also. Unfortunately nobody strings this together.

SCOTT: There is a lot of opportunity, that will probably come out over the next six to 12 months. We like to think that there is a large element of thought leadership that we can bring to our clients to enable them to achieve their goals and help them deliver on their strategy. These are going to be by and large more customised solutions, particularly around outsourcing functions that maybe have not been outsourced before. One of the overarching dynamics of the industry is greater consolidation and we’ve seen one fairly large one recently in this region. We also look to encourage an open dialogue between fund managers across the industry and already we have participated in some of working groups on automation, which is an important consideration in both the reduction of costs and risk. We also look to encourage best practice, and work across the various stakeholders, not only in the region but also globally. In conclusion, as we survey the year ahead, there’s going to be a large element of going ‘back to basics’ and encouraging ‘out of the box’ thinking. We need to look for opportunities to provide win wins across the industry for our investors, our client’s clients and for fund management at large.

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Tim Wildenberg, UBS’s head of direct execution, Europe.

“Non-displayed liquidity has always been there and a good old fashioned dealer could find it and work it but you have to know where to look for it and it is dependent on the skill of the buyside dealer. These days it also depends on high level technology for that invisible liquidity to be accessible.”

Photograph by Mark Mather, from Berlinguer photo archives, retrieved February 2009.

DARK POOLS: HEADACHE

DARK POOL TRADING STRATEGIES

Dark pools, or “non-displayed liquidity” as some traders prefer to call them, are taking their place in the echelons of global share trading, particularly where participants seek anonymity. As dark pools come into their own, each centre of non-displayed liquidity is developing its own peculiarities, as competition between pools intensifies. Ruth Hughes Liley surveys the chequerboard.

OR PANACEA? AS PANDORA’S BOX opened in 2008?

Certainly, the global trading market has witnessed more than its own fair share of challenges and change of late. Traders have faced extreme volatility (at up to three times its normal level); the explosion of trading volumes and subsequent icy contraction of the same; the launch of multilateral trading facilities (MTFs) in Europe and the rise of trading on alternative venues; particularly dark pools. In practice dark pools are not a recent phenomenon. Buyers and sellers have always been able to trade large orders anonymously without moving the market because price and quantity are

W

FTSE GLOBAL MARKETS • MARCH/APRIL 2009

not quoted publicly pre-trade and therefore the practice has existed since floor traders first received orders probing their stock. Later, post Big Bang, this took on an electronic character in 1987, when POSIT became the first electronic crossing system.

“People have started to talk about non-displayed liquidity, rather than dark pools, which have had a bad press,” says Tim Wildenberg, UBS’s head of direct execution, Europe. “Non-displayed liquidity has always been there and a good old fashioned dealer could find it and work it but you have to know where to look for it and it is dependent on the skill of the buyside dealer. These

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days it also depends on high level technology for that invisible liquidity to be accessible.”

There are a number of ways to trade non-displayed liquidity. It can be executed via a traditional iceberg order on a quoted exchange; if the trade is large enough (Large in Scale waiver); if the dark pool takes its reference prices from a quoted venue; or, if the price is negotiated as an over-the-counter (OTC) deal.

TABB Group estimates OTC orders make up a quarter of all European trading orders and will grow 10% by 2010.

Kevin McPartland, author of the study Liquidity, MiFID and the Brokerage Relationship, says: “Although these orders must ultimately be reported, price discovery is hampered, as these primarily block-sized orders are negotiated privately, providing no access for outsiders to the liquidity.”

John Barker, head of Liquidnet Europe, sees differences between the United States, where dark pools first emerged, and Europe: “In the US there are 40 or 50 venues and the moment you get that many, you get different models of operation. I think there is a greyness about the dark pools which exist today. A true dark pool has no price formation, but matches on the quantity of shares traded. In Europe, we are expanding into a similar position, but we have fewer pools and are still only a third the size of the US market.”

Since the European Union’s Markets in Financial Instruments Directive (MiFID) and the development of multilateral trading facilities, traders are using nondisplayed liquidity more frequently and different models have emerged. Some are broker-dealer owned and are a bank’s internal crossing engine and registered as systematic internalisers. Some are independent dark pools in their own right, such as NYFIX Euro Millennium or Turquoise and registered as MTFs. Some always set the share price at the mid taking their reference price from the quoted markets, while others, Liquidnet included, have a “negotiated”model where there is no compulsion to trade unless the price is right. Many now have dark liquidity interacting with lit liquidity. Some are specific to one country such as Instinet KoreaCross. Some offer scheduled crosses (Goldman Sachs Sigma X has introduced one at 10.30 am EST) while others offer continuous crossing.

Some are owned totally by a consortium (for example, BIDS Trading) while some have been set up directly by exchanges themselves. Of those set up by exchanges in a bid to fight back against the competition posed by MTFs, one of the latest is the New York Block Exchange set up jointly in January 2009 by NYSE Euronext and BIDS Holdings. It will allow non-displayed liquidity to access both displayed and reserve liquidity of the NYSE order book anonymously.

In Europe, NYSE Euronext has teamed up with BNP Paribas, HSBC and JPMorgan to launch SmartPool, a new MTF trading platform for large block orders in European listed stocks. It is currently in its soft launch phase.“Given the speed and complexity of today’s dynamic market place, there is a need to resolve the problems inherent in executing block trades in an increasingly fragmented

trading environment,” says Larry Leibowitz, group executive vice-president and head of US execution and global technology at NYSE Euronext. Claiming NYBX is the first platform to unite dark and light liquidity, he says it will reduce market fragmentation for larger orders, electronically replicating traditional block trading and representing a“major advancement”in block trading.

The London Stock Exchange’s much anticipated dark pool, Baikal, will similarly allow searching in the dark and if no match is found it will interact with other lit venues, its own SETS included. Baikal will draw on liquidity from at least 14 markets and over 20 trading venues, aggregating the liquidity. January saw the first meeting of its buyside advisory group where fund managers and hedge fund representatives discussed how Baikal could best serve them.

CESR and the post MiFID landscape Given how fast dark pools have flooded on to the market in Europe, it is not surprising that the Committee of European Securities Regulators (CESR) is looking at the post-MiFID landscape, in particular by comparing pretrade and post-trade reporting.

CESR called for submissions in November 2008 and by the end of January had received 34 responses from across the financial services industry including exchanges and brokers. The UK’s Financial Services Authority (FSA) is due to report its own broad findings by the end of February.

The London Stock Exchange (LSE), in its CESR response, said, “Liquidity captured by dark pools is diverted away from optimal matching of supply and demand that pre-trade transparency is designed to recreate. This should not be a problem if liquidity within each pool is sufficiently deep, or if smart order routing is effective in its ability to retrieve and benchmark the best price from a range of different venues.” MiFID may have started a trend away from “clear, fair, transparent” markets, says the LSE, “encouraging trading on to OTC platforms where there is no pre-trade transparency (and indeed dark pools run by exchanges and MTFs).” It also fears that market surveillance, which traditionally has been provided by the exchanges, will be reduced as dark pools are classified as either systematic internalisers, OTC venues or MTFs. Bloomberg, in its response, believes dark pools have increased in popularity during the credit crisis partly because hedge funds and institutional clients view them as an opportunity to shield trading strategies. However, it fears that dark pools, to the extent they represent a significant portion of the trading activity in a given security, also raise questions about the reliability of public pricing mechanisms: “Our greatest concern remains with the transparency of dark pool trades and the ability to consolidate these trades with other post-trade information. If dark pools are reported instantaneously and it is clear which venue they have been traded on, that would significantly resolve concerns about their possible

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adverse impact on the reliability of the public markets as a pricing mechanism.”

Reporting challenge Accurate reporting is a problem: nobody knows exactly how much trade is being done in total as there are no reliable figures for how much liquidity is resting in dark pools at any one time. In addition, different pools use different counting methods; some count both sides of the trade, while others just one. In such an environment, there is a fear of an order being “gamed”, where traders take a calculated guess at the amount of hidden volume of a stock in a dark pool and gamble on pushing up the price on a public venue to enable them to take a profit.

“It is important to know there is anti-gaming technology in the dark pool you are trading in,” says Scott Cowling, head of equity trading at Barclays Global Investors.“But in truth sometimes people have more scepticism than is warranted. There are concerns about prop trading, for example, which is sometimes perceived as a secretive world that investment banks control. Buyside traders have to complete orders before they lose their value but with minimal market impact so we have to route to many venues, rerouting where successful. With significant volume of orders we are reliant on algorithms and on brokers to give us the facts.

“The growth in dark algorithms offered by the sellside has improved crossing opportunities,” says Cowling.

“Scheduled crossing involves many different participants with different agendas; you can be ships in the night but in a continuously crossing pool, there should be a fair price and people can come and go at their leisure with better chance of execution. The increase in electronic trading has meant that this process is much more efficient.”

With so many dark pools offering a price set midway between best offer and best bid, some are questioning whether dark pools pose a hindrance to the ability of institutional investors to comply with MiFID’s regulatory requirement for best execution, while others see it as helping price improvement in volatile times, as wider spreads move the mid-point and give better saving.

Wildenberg at UBS notes: “More often than not clients ask us to manage the search of non-displayed liquidity and to find it for them. Direct Market Access in its purest form with a connection from the client to a single market is almost irrelevant now and we are seeing clients migrate to smart order routers, which can approach all venues intelligently.”

However, smart order routers by their nature sweep dark pools to find liquidity, all the more important in a volatile market. “You haven’t got the luxury of time in a volatile market. If you hold off executing an order your performance will be impacted,”says Duncan Higgins, client relationship manager at Turquoise.“With dark execution, if nobody waits, nobody trades. You have to have people resting in a dark pool and the more flow resting, the more liquid the dark pool.”

FTSE GLOBAL MARKETS • MARCH/APRIL 2009

Turquoise has announced it is to launch a dark liquidity aggregator in the first quarter of 2009, drawing liquidity from the larger bank-operated internal dark pools. The service will route and distribute orders to connected brokers to access liquidity and maximise cross rates. “The more fragmented the liquidity, the harder it is to find a match, so bringing pools together with the aggregator will improve matching rates,” says Higgins. “We’ll send orders to banks operating dark pools. We’ll make instant judgments about how and where to trade ensuring clients’ anonymity throughout the execution process.”

In another bid to consolidate fragmented liquidity, Liquidnet will launch its H2O version in Europe later this year, allowing retail-size flow to match against existing wholesale liquidity on the Liquidnet platform. It has so far signed up 25“streaming liquidity partners”to its US version.

John Barker of Liquidnet is expecting to see the size of its average block trade rise as it draws more institutional flow and can match larger sizes.“I’m expecting our match rate to reach 20% as we get more institutional and external order flow. But we are never going to match 100% of everything.

There is always going to be a need for both services.”

Hidden orders Traders are voting with their feet between hidden orders on exchanges and dark venues. Rosenblatt, in its monthly liquidity tracker for October, noticed a possible inverse correlation between the two: “It suggests that perhaps traders responded to rising volatility by seeking a balance between reduced information leakage on one hand and immediacy and greater certainty of execution on the other.”

Hidden orders on exchanges and electronic crossing networks (ECNs) in the US fell back in November, when volatility remained high (62.6 on VIX, the Chicago Board Options Exchange volatility index) and volumes contracted. Traders are finding comfort in dark pools as a place where they increasingly place smaller orders to find liquidity and Rosenblatt estimates that in November more use was made of “algorithm-friendly, small-ticket-size venues than of block-focused crossing networks that tend to suffer most in volatile environments.”

Chris Marsh, head of AES trading and product development, says: “Fragmentation has made the landscape slightly more complicated because you have to spend a lot of energy connecting to different types of pools but from this comes more competition, new ways to trade and new participants bringing more liquidity than would otherwise be there. So there are net positives that come from a crowded marketplace, something that is very important in the current environment.”

However, Kevin Bourne, head of e-equities, HSBC, urges caution in the new world order: “No-one is compelled to link to other people’s systems. They are all in competition with one another and doing one another’s jobs.

Theoretically, a stock exchange could admit to trading every security in Europe, so you could see 40 exchanges with 9,000 securities in each. That’s a headache.”

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THE NEED FOR LOW LATENCY

In a global environment only those exchange trading venues will survive that are offering a wide range of liquid securities, best prices and uncompromised transparency. For their long-term success they need to provide cutting-edge technology and to continuously invest in infrastructure. Their innovative strength in all facets of the exchange business will be key, as well as their intimate understanding of the fast evolving requirements of traders and investors worldwide.

Photograph © Sailorman/Dreamstime.com, supplied February 2009.

THE NEED FOR SPEED A clear understanding of the business strategy of market leading institutions is key in volatile and/or markets in recession. In the first of an occasional series, we have asked leading institutions to outline their business strategy in a particular segment or product suite. Low latency remains a significant consideration in equity trading, particularly where the proliferation of algorithmic trading requires firms to react to market events faster than the competition to increase profitability of trades and capture optimum price. Some market commentators have suggested that every millisecond lost can result in $100m in lost opportunity on an annualised basis. In this inaugural article, Michael Krogmann, executive director, Cash Market Development at Deutsche Börse explains the exchange’s build strategy in ensuring lightning fast latency for its clients.

TOCK EXCHANGES HAVE come a long way—from marketplaces where sellers and buyers met in person to engage in trade, to electronic platforms, where participants can trade thousands of securities in only a few milliseconds. Today, market participants, especially statistical arbitrage traders, ask for highest liquidity, lowest round trip times and lowest possible costs.

The urge for ever lower round trip times emerged with automated trading more than a decade ago. Back then, a handful of market participants started to run statistical arbitrage trading models which were purely electronically driven and interacted with the manual order flow on an exchange. The speed and availability of the trading system consequently became a key success factor in securities trading.

Deutsche Börse embraced this trend by continuously updating its system and network as well as by introducing a pricing scheme that allows rebates on trading and

S

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clearing fees for automated order flow. As a result, today’s automated trading accounts for 55% of orders and 40% of executed trades on Xetra®, thus making it the leading panEuropean algorithmic cash trading platform. The Ithanium CPU-powered trading system allows average round trip times of 7 milliseconds (ms), while market participants profit from optional bandwidths of up to 1Gbit/s.

Furthermore, Deutsche Börse’s proximity services, a colocation solution for Xetra members and their clients eliminate the main cause for latency – the physical distance between market participant and trading venue – bringing the fastest orders to round trip times of 2ms.

The readiness and reliability of a trading system is just as important as its speed – although this factor is often underestimated in the ongoing latency debate. Even in 2008, with its most testing and volatile market conditions, Xetra has delivered an average system availability of 99.99%.

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Liquidity and transaction costs While it is relatively simple to measure the speed and availability of a trading venue, it is considerably harder to identify the overall transaction costs of a trade. Market participants are well aware that trading costs are an important performance parameter. However, simply adding up explicit transaction costs – the fees for trading, clearing and settlement – doesn’t give the full picture. Implicit costs, which result from the depth of an order book, indicate the liquidity of a trading venue and account for up to 80 percent of overall transaction costs. Liquidity is crucial: more buy and sell orders will lower the implicit transaction costs.

Over the past five years, Deutsche Börse has reduced these implicit costs by two thirds. As a leading liquidity pool for many European benchmark equities and ETFs, Xetra offers the lowest overall transaction costs for trading these types of securities. With its integrated clearing facility provided by Eurex Clearing, it is also one of the most advanced trading platforms in terms of counterparty risk management. In addition, Xetra’s order flow is boosted by the great diversity of market participants: around 5,000 registered traders from over 250 institutions have access to the central limit order book. Their different expectations and trading motivations provide a highly efficient price formation. Moreover, Xetra’s high levels of liquidity increase the probability of immediate order execution which is so crucial to effective trading.

Continuous technology upgrades To ensure that customer demands will be met in the future,

Deutsche Börse is continuously enhancing the functions of the trading system. Most recently, Xetra MidPoint was introduced, enabling Xetra members to trade around 1,500 equities and exchange traded funds (ETFs) at the midpoint of the current bid/ask spread of the open Xetra order book.

Xetra MidPoint enables market participants to execute larger orders on market-neutral terms and to lower their trading costs.

In June 2009, Deutsche Börse will introduce two new low latency socket-based optional interfaces on Xetra, which will primarily cater to the needs of automated trading, further increasing efficiency and speed. Market participants will be able to use separate connections for receiving un-netted market data in full order book depth via the first interface, while enjoying high speed access to the Xetra trading system via the second. This new Xetra network connection will provide significantly faster trading and data reception, compared to the usual VALUES/MISS connections. The two new interfaces allow Xetra members to design their infrastructure according to their specific needs.

In a global environment only those exchange trading venues will survive that are offering a wide range of liquid securities, best prices and uncompromised transparency.

For their long-term success they need to provide cuttingedge technology and to continuously invest in infrastructure. Their innovative strength in all facets of the exchange business will be key, as well as their intimate understanding of the fast evolving requirements of traders and investors worldwide.

DRAWN A BLANK? If you need reprints for your marketing needs Simply call or email Contact: Paul Spendiff Tel: 44 [0] 20 7680 5153 Email: paul.spendiff@berlinguer.com

We will be pleased to tailor our reprints to your specific requirements.

FTSE GLOBAL MARKETS • MARCH/APRIL 2009

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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

1 1 1 US$0.03 Bn

230 375 8 US$53.04 Bn

9 24 2 US$1.96 Bn

118 260 6 US$22.51 Bn

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

Belgium P Listings: T Listings: Managers: AUM:

1 1 1 US$0.04 Bn

15 255 5 US$0.92 Bn

1 1 1 US$0.00 Bn

14 70 3 US$0.23 Bn

Netherlands P Listings: T Listings: Managers: AUM:

Portugal P Listings: T Listings: Managers: AUM:

South Africa

21 145 5 US$9.56 Bn

159 296 7 US$34.68 Bn

77 77 3 US$12.97 Bn

5 120 2 US$4.16 Bn

P Listings: T Listings: Managers: AUM:

17 17 5 US$1.14 Bn

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

Finland P Listings: T Listings: Managers: AUM:

2 2 2 US$0.10 Bn

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

6 6 2 US$0.26 Bn

Hungary

P Listings: T Listings: Managers: AUM:

Austria

P Listings: T Listings: Managers: AUM:

Japan

P Listings: T Listings: Managers: AUM:

1 1 1 US$0.01 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:

Malaysia

P Listings: T Listings: Managers: AUM:

11 11 2 US$1.29 Bn

5 22 5 US$0.81 Bn

Singapore

P Listings: T Listings: Managers: AUM:

Taiwan

P Listings: T Listings: Managers: AUM:

2 2 2 US$0.06 Bn

11 23 5 US$12.66 Bn

Hong Kong

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:

4 20 2 US$0.99 Bn

P Listings: T Listings: Managers: AUM:

1 1 1 US$0.04 Bn

Italy P Listings: T Listings: Managers: AUM:

P Listings: T Listings: Managers: AUM:

1 1 1 US$0.01 Bn

China

Slovenia P Listings: T Listings: Managers: AUM:

Switzerland P Listings: T Listings: Managers: AUM:

France P Listings: T Listings: Managers: AUM:

Canada P Listings: T Listings: Managers: AUM:

Mexico P Listings: T Listings: Managers: AUM:

1 1 1 US$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:

EXCHANGE TRADED FUNDS: LISTING & DISTRIBUTION

MARCH/APRIL 2009 â&#x20AC;˘ FTSE GLOBAL MARKETS

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Worldwide ETF and ETP Growth

Assets US$ Bn

ETF Assets $2,200 Total

# ETFs 1,800

$2,000

1,600

$1,800

1,400

Assets USD Billions

$1,600 1,200

$1,400 $1,200

1,000

$1,000

800

$800

600

$600 400

$400

200

$200 $0 ETF Assets Total

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Sep-08

Dec-08 2009-F

2011-F

$0.8

$1.1

$2.3

$5.3

$8.2

$17.6

$39.6

$74.3

$104.8

$141.6

$212.0

$309.8

$412.1

$565.6

$796.7

$764.1

$711.0

$2,000

$0.1

$0.1

$4.0

$5.8

$23.1

$21.3

$35.8

$59.9

$90.8

$104.0

$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

$596.4

$1.98

$5.02

$3.80

$4.00

$6.06

$8.86

$15.6

$28.1

$45.9

$58.3

$53.2

ETF Commodity Assets

$0.0

ETF Fixed Income Assets ETF Equity Assets ETP Assets Total # ETPs # ETFs

3

3

4

21

21

31

$0.1

$0.3

$0.5

$1.2

$3.4

$6.3

$9.2

$1,000

0

$9.9

2

14

17

17

17

18

23

70

134

268

271

33

92

202

280

282

336

461

714

1171

1499

1590

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

ETF LISTINGS BY EXCHANGE (as of end December 2008) Region Listed

# Primary ETF

# Total ETF

($bn)

AUM

20 Day ADV

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 21 36 11 2

53.07 1.04 0.99 1.26 13.43 0.40 0.87 0.00 9.54 17.89 0.30 0.27 0.91 2.73 1.35 0.07

849.81 11.29 160.03 23.93 204.78 0.00 2.42 0.00 98.55 70.71 0.03 0.11 3.95 99.55 20.92 0.82

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 4 77 6 5 46 647 -

888 4 77 121 5 46 647 -

564.31 1.02 13.26 4.48 100.61 16.24 380.27 -

124,009.46 1.04 502.69 127.81 0.00 12,284.02 0.00 568.44 802.20 312.29 396.91 14,775.56 27,417.68 0.00 20,471.48 0.00

585 1 1 2 174 252 1 1 1 1 15 14 6 1 1 17 9 7 21 6 118 1,590

1,412 21 1 2 316 404 1 1 1 1 255 72 6 1 1 17 25 7 126 20 6 272 2,658

146.69 0.03 0.05 0.11 38.77 63.17 0.08 0.01 0.00 0.03 0.95 0.26 0.14 0.00 0.01 1.25 2.15 1.47 10.60 0.00 0.11 24.87 711.00

2,404.20 0.67 0.33 3.98 340.70 824.94 0.11 0.11 0.00 0.21 310.62 24.25 47.57 0.00 0.00 4.89 17.04 114.05 111.93 8.14 18.39 202.03 14.04 198.66 80,599.9

Country

Exchange

Australia China

Asia Pacific

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

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 Chi-X (not an official exchange) European Reported OTC

Grand Total

($m)

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

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EXCHANGE TRADED FUNDS: LISTING & DISTRIBUTION

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

Number of ETFs

Total Listings

AUM ($bn)

% Total

North America - Equity 471 Fixed Income - All (ex-Cash) 149 Europe - Equity 350 Emerging Markets - Equity 227 Asia Pacific - Equity 135 Global (ex-US) - Equity 60 Fixed Income - Cash (Money Market) 13 Global - Equity 98 Commodities 49 Currency 13 Mixed (Equity & Fixed Income) 25 Total 1,590

625 269 693 442 211 63 25 214 78 13 25 2,658

$342.51 $91.68 $75.59 $70.84 $52.10 $44.48 $12.35 $10.91 $9.90 $0.39 $0.27 $711.00

48.2% 12.9% 10.6% 10.0% 7.3% 6.3% 1.7% 1.5% 1.4% 0.1% 0.0% 100.0%

Region of exposure

1.4%

1.7%

Mixed (Equity & Fixed Income)

Global (ex-US) Equity

0.1% Currency

6.3%

0%

Asia Pacific Equity

7.3%

Emerging Markets - Equity

10.0%

Europe - Equity

10.6%

North Americas Equity

48.2%

Fixed Income - All (ex-Cash)

12.9%

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

TOP 25 ETF PROVIDERS AROUND THE WORLD: ranked by assets under management (AUM)(as of December 2008) November 2008 PROVIDER

iShares State Street Global Advisors Vanguard Lyxor Asset Management db x-trackers PowerShares ProShares 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 Commerzbank ETFlab Investment BBVA Asset Management Credit Agricole Structured AM Rydex Claymore Securities XACT Fonder

Year to Date Change

# ETFs

AUM ($bn)

% Total

# Planned

# ETFs

% ETFs

AUM ($bn)

361 98 38 113 99 142 64 29 1 8 23 8 54 16 1 4 50 3 50 10 8 24 31 54 11

$324.84 $146.00 $45.15 $33.23 $24.06 $22.28 $20.32 $14.94 $6.69 $6.19 $6.05 $5.94 $4.47 $4.45 $3.64 $3.30 $3.23 $2.82 $2.59 $2.52 $2.09 $1.86 $1.82 $1.62 $1.52

45.7% 20.5% 6.4% 4.7% 3.4% 3.1% 2.9% 2.1% 0.9% 0.9% 0.9% 0.8% 0.6% 0.6% 0.5% 0.5% 0.5% 0.4% 0.4% 0.4% 0.3% 0.3% 0.3% 0.2% 0.2%

13 33 1 2 0 41 90 0 0 0 1 0 8 14 0 0 68 0 0 0 0 0 82 11 0

40 15 1 26 48 28 6 22 0 6 18 0 24 8 0 0 11 0 50 10 1 21 8 4 2

12.5% 18.1% 2.7% 29.9% 94.1% 24.6% 10.3% 314.3% 0.0% 300.0% 360.0% 0.0% 80.0% 100.0% 0.0% 0.0% 28.2% 0.0% 100.0% 100.0% 14.3% 700.0% 34.8% 8.0% 22.2%

-$77.77 -$6.40 $3.18 $1.17 $13.24 -$15.74 $10.62 -$2.51 -$3.46 -$2.88 -$1.58 $0.97 -$2.22 $0.96 -$0.10 $2.26 -$1.30 -$1.89 $2.59 $2.52 $0.90 -$1.16 -$0.83 -$0.84 -$0.99

% % Market AUM Share

-19.3% -4.2% 7.6% 3.6% 122.4% -41.4% 109.6% -14.4% -34.1% -31.8% -20.7% 19.6% -33.2% 27.4% -2.7% 216.0% -28.7% -40.1% 100.0% 100.0% 76.3% -38.5% -31.4% -34.3% -39.4%

-4.8% 1.4% 1.1% 0.6% 2.0% -1.6% 1.6% -0.1% -0.3% -0.3% -0.1% 0.2% -0.2% 0.2% 0.0% 0.3% -0.1% -0.2% 0.4% 0.4% 0.1% -0.1% -0.1% -0.1% -0.1%

Source: ETF Research & Implementation Strategy, Barclays Global Investors, Bloomberg. All data supplied February 2008.

NOTES At the end of December 2008 the ETF industry had 1,590 ETFs with 2,658 listings, assets of $711.0 billion, from 85 providers on 42 exchanges around the world. Assets fell by 10.8%, which is less than the 42.08% fall in the MSCI World index in USD terms. The number of ETFs has increased 36% YTD. The average daily trading volume in US dollar has increased by 33% to US$80.6 billion YTD. European ETF AUM has increased by 11.2% while the MSCI Europe Index is down 47.87% YTD. In Europe net sales of mutual funds (excluding ETFs) were minus $493.2 million while net sales of ETFs domiciled in Europe were positive $67.05 million during the first 11 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. © 2009 Barclays Global Investors. All rights reserved.

88

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Number of Securities

Value of Securities (US$ Bln)

179,220

8,830

32,530

1,743

Securities Available for Lending Securities On Loan Securities Transactions

1,819,018

Group Results (USD): The following table details the aggregated group results for all Performance Explorer participants and provides a high level summary of the activity in particular assets. This table represents a summary of the 304 separate asset classes in the data set.

Security Type

Lendable Assets (M)

Balance vs Cash (M)

Balance vs Non Cash (M)

Total Balance (M)

Utilisation (%)

SL Fee (Bp)

All Securities

8,829,688

1,032,058

711,017

1,743,075

16.64

24.92

42.25

All Bonds

4,691,178

611,783

465,494

1,077,277

21.37

3.40

8.12

Corporate Bonds

2,366,484

85,156

63,839

148,995

5.72

5.74

Government Bonds

2,194,786

521,958

400,308

922,265

39.27

All Equities

4,130,157

420,275

245,148

665,423

Americas Equities

2,491,299

267,776

44,271

312,047

Asian Equities

469,321

32,666

32,086

European Equities

972,766

81,471

163,965

Depository Receipts

103,901

17,659

2,158

66,427

18,723

1,207

Exchange Traded Funds

Revenue SL Return to Share from Lendable SL (%) Assets (Bp)

Total Return Lendable Assets (Bp)

SL Tenure (days)

3.00

9.73

106

0.68

9.51

115

12.71

0.39

2.87

142

2.95

7.16

0.99

17.09

110

11.29

59.78

68.93

5.65

9.99

93

10.19

36.40

48.42

3.63

8.49

92

64,752

9.58

80.54

77.06

6.47

9.78

95

245,436

14.92

90.22

88.00

10.86

13.96

99

19,817

12.58

69.78

67.45

4.09

10.51

49

19,930

11.34

-31.88

531.38

0.05

7.82

60

Size isn’t everything, but the scale of activity in a security can be interesting, particularly if you hold that security.

Equities

Corporate Bonds

Top 10 by Total Balance

Top 10 by Total Balance

Rank

Stock description

Rank

Stock description

1

Siemens Ag

1

Goldfish Master Issuer Bv (4.721% 28-Nov-2099)

2

Total Sa

2

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

3

Volkswagen Ag

3

European Investment Bank (6% 07-Dec-2028)

4

Banco Santander Sa

4

Canada Housing Trust No 1 (2.7% 15-Dec-2015)

5

Gdf Suez Sa

5

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

6

Bayer Ag

6

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

7

Mizuho Financial Group Inc

7

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

8

Royal Dutch Shell Plc

8

European Investment Bank (5.625% 07-Jun-2032)

9

Eni Spa

9

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

10

Sanof i-Aventis Sa

10

KfW International Finance Inc (6% 07-Dec-2028)

Collateral management This is central to the securities lending industry. The following chart detail the cash/non-cash split from a borrower’s perspective.

100%

SECURITIES LENDING DATA by DATA EXPLORERS

KEY PERFORMANCE EXPLORER STATISTICS as of 28th January 2009

90% 80% Cash

70%

Non-Cash

60% 50% 40% 30% 20% 10% 0% Corporate Bonds Emerging Market Bonds

Government Bonds

Americas Equities

Asian Equities

European Equities

Other Equities

Depository Receipts

Exchange Traded Funds

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 • MARCH/APRIL 2009

© Copyright Data Explorers Limited January 2009

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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.

Venue turnover in major stocks: April 2008 through January 2009 (Europe only). (â&#x201A;Ź 000s) Jun

Jul

Aug

Sep

BTE/BATs CIX/Chi-X

50,543,504,106

69,784,319,667

CPH/Copenhagen

5,036,109,648

ENA/Amsterdam

53,130,208,269

ENB/Brussels

Oct

Nov

Dec

12,912,601

1,692,679,055

3,117,405,897

Jan

4,790,110,404

65,485,105,599

100,401,073,369

106,153,062,152

55,474,806,309

37,565,687,908

46,712,279,892

6,845,034,577

6,715,541,919

9,088,419,945

9,799,125,787

5,627,172,892

3,169,443,325

4,658,766,694

58,889,709,527

40,078,363,113

62,969,948,029

58,477,575,182

29,515,979,897

23,377,293,076

28,998,109,764

11,266,781,699

11,264,584,729

7,769,551,527

12,362,582,317

10,689,261,202

5,618,466,860

5,525,054,653

6,557,604,579

ENL/Lisbon

4,289,780,382

5,217,860,359

3,265,459,550

4,358,621,402

4,105,636,725

2,613,601,564

1,781,804,343

1,942,925,835

ENX/Paris

118,794,877,669

130,727,562,834

89,561,950,040

143,845,030,869

158,687,540,849

83,259,044,929

65,223,182,965

68,569,494,159

GER/Xetra

117,572,355,884

138,538,693,267

96,074,671,382

171,318,595,178

206,777,148,040

86,619,580,417

67,500,746,934

65,531,679,523

HEL/Helsinki

15,704,074,093

16,983,014,044

11,476,253,210

18,654,125,589

19,248,238,567

10,391,280,842

6,544,928,692

8,018,556,502

LSE/London

198,850,156,278

228,447,427,572

154,886,443,195

240,104,147,083

218,235,697,409

128,535,134,938

88,925,334,643

98,676,987,434

MAD/Madrid

73,739,528,010

76,936,873,296

44,029,717,439

79,041,830,393

86,557,745,208

47,772,645,094

38,385,030,437

43,520,648,521

MIL/Milan

76,999,997,645

68,998,216,420

47,007,014,009

103,999,753,619

69,520,744,329

40,577,825,970

27,355,375,071

33,878,620,775

17,962

45,339,983

138,799,631

290,807,724

603,441,883

NEU/Nasdaq-OMX STO/Stockholm

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

15,283,216,874

18,432,301,605

311,082,282

17,716,364,835

27,088,688,572

19,577,155,245

15,473,634,349

26,311,426,009

VTX/SWX

67,560,353,571

72,309,962,390

48,685,822,760

79,997,213,817

86,469,471,856

45,647,116,803

35,217,759,178

39,198,800,982

Monthly Total

821,706,049,326

913,654,839,199

637,849,135,438

1,079,258,869,918

1,096,186,634,329

583,138,856,156

434,736,706,069

496,401,754,564

Market share by venue in electronic order book trades in major stocks: April 2008 through January 2009 (as a percentage)

90

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Jan

BTE/BATs

0.00%

0.00%

0.00%

0.00%

0.00%

0.29%

0.72%

0.96%

CIX/Chi-X

6.15%

7.64%

10.27%

9.30%

9.68%

9.51%

8.64%

9.41%

CPH/Copenhagen

0.61%

0.75%

1.05%

0.84%

0.89%

0.96%

0.73%

0.94%

ENA/Amsterdam

6.47%

6.45%

6.28%

5.83%

5.33%

5.06%

5.38%

5.84%

ENB/Brussels

1.37%

1.23%

1.22%

1.15%

0.98%

0.96%

1.27%

1.32%

ENL/Lisbon

0.52%

0.57%

0.51%

0.40%

0.37%

0.45%

0.41%

0.39%

ENX/Paris

14.46%

14.31%

14.04%

13.33%

14.48%

14.28%

15.00%

13.81%

GER/Xetra

14.31%

15.16%

15.06%

15.87%

18.86%

14.85%

15.53%

13.20%

HEL/Helsinki

1.91%

1.86%

1.80%

1.73%

1.76%

1.78%

1.51%

1.62%

LSE/London

24.20%

25.00%

24.28%

22.25%

19.91%

22.04%

20.45%

19.88%

MAD/Madrid

8.97%

8.42%

6.90%

7.32%

7.90%

8.19%

8.83%

8.77%

MIL/Milan

9.37%

7.55%

7.37%

9.64%

6.34%

6.96%

6.29%

6.82%

NEU/Nasdaq-OMX

0.00%

0.00%

0.00%

0.00%

0.00%

0.02%

0.07%

0.12%

STO/Stockholm

3.43%

3.14%

3.53%

3.28%

3.13%

3.44%

3.52%

3.71%

TRQ/Turquoise

0.00%

0.00%

0.05%

1.64%

2.47%

3.36%

3.56%

5.30%

VTX/SWX

8.22%

7.91%

7.63%

7.41%

7.89%

7.83%

8.10%

7.90%

Montly Total

100.00%

100.00%

100.00%

100.00%

100.00%

100.00%

100.00%

100.00%

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TRADING DATA FOR EARLY FEBRUARY 2009 (EUROPE ONLY) Venue turnover for the week ending 6th Feb Turnover € 000’s

Share %

London

3,068,690

24,716,022

20.41%

Xetra

782,608

14,639,760

12.09%

Paris

1,340,359

14,498,171

11.97%

SWX

608,213

11,465,812

9.47%

Chi-X

1,934,576

11,427,018

9.43%

Madrid

482,529

9,175,221

7.58%

Milan

782,987

8,511,213

7.03%

Turquoise

986,150

7,390,400

6.10%

Amsterdam

618,454

6,627,863

5.47%

Stockholm

381,959

5,612,284

4.63%

Helsinki

169,815

2,189,993

1.81%

Brussels

238,440

1,522,064

1.26%

BATS

274,610

1,440,392

1.19%

Copenhagen

87,685

1,335,680

1.10%

Lisbon

79,503

418,778

0.35%

Nasdaq OMX

28,270

151,410

0.13%

1.8 1.6 1.4 1.2 1 04 04 /20 /0 08 5/ 04 200 /0 8 6/ 2 04 0 /0 08 7/ 04 200 /0 8 8/ 04 200 /0 8 9/ 2 04 0 /1 08 0/ 04 200 /1 8 1/ 04 200 /1 8 2/ 04 200 /0 8 1/ 2 04 0 /0 09 2/ 20 09

Trades

04 /

Venue

Figure 1: The inexorable rise in fragmentation across the main European indices

AEX

DAX

CAC40

UKX

Index market share by venue for the week ending 6th February Primary

Alternative Venues

Index

Venue

Share

AEX

Amsterdam

69.88%

Chi-X

Turquoise

Nasdaq OMX

BATS

13.59%

9.12%

0.09%

1.28%

Copen.

Amst.

Paris

BEL 20

Brussels

60.71%

5.79%

3.12%

0.16%

0.58%

CAC 40

Paris

71.16%

12.52%

7.90%

0.10%

1.74%

5.95%

DAX

Xetra

79.15%

11.03%

7.60%

0.10%

1.35%

†

FTSE 100

London

74.82%

15.01%

7.75%

0.25%

2.16%

FTSE 250

London

90.15%

8.24%

0.14%

0.23%

1.23%

IBEX 35

Madrid

99.96%

†

MIB 30

Milan

93.61%

2.91%

2.95%

0.06%

0.41%

NORDIC 40

Stockholm

57.40%

3.45%

2.55%

0.11%

0.06%

PSI 20

Lisbon

99.80%

SMI

SWX

89.75%

0.08%

29.06%

0.03% 0.12%

0.02%

†

6.19%

Helsinki

0.02%

† 13.66%

†

0.18% 3.90%

Xetra

2.11%

0.01% †

0.03% 0.37%

22.40%

0.02% 0.05%

0.11%

COMMENTARY

† market share < 0.01%

Is fragmentation here to stay? The figures seem to show an emphatic yes – although the final form is far from decided. At the end of January, all of the Fidessa Top 20 of fragmented stocks had a fragmentation index figure (FFI) of more than 1.8, and the top five were above 2. Figure 1 above illustrates the inexorable rise in fragmentation across all the major indices.

Since the turbulent events in the last two months of 2008, the pace of fragmentation seems to be accelerating, especially in mainland Europe. The picture for smaller cap stocks is less clear, however. The FFI of the FTSE 250 reached a peak of 1.35 in November but shows a 12-month average of less than 1.2. This may be because trading in small caps is less liquid and so proportionally more volume is traded off exchange away from the lit venues.

Nevertheless there are still more MTFs set to launch which will test the market’s appetite for yet more alternative venues. In the current economic climate it would seem likely that we may experience a degree of MTF fatigue amongst participants and the predicted lower overall trading volumes will only up the competitive ante among those MTFs that are already live.

The most interesting development is going to be the fight back from the traditional exchanges as both the LSE and NYSE Euronext will be launching their own hybrid dark/lit MTFs later this year.

In fact, the interaction between lit and dark liquidity is going to be where the battle will be fought. The winners will be those venues that can create the most effective liquidity aggregation service as this is what the market needs.

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.

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5-Year Total Return Performance Graph 500

FTSE All-World Index

400

FTSE Emerging Index

300

FTSE Global Government Bond Index

200

FTSE EPRA/NAREIT Global Index

100

FTSE4Good Global Index

Index Level Rebased (30 January 2004=100) Ja n04

FTSE GWA Developed Index 9

8

Ja n0

Ju l-0

8 Ja n0

7 Ju l-0

7 Ja n0

6 Ju l-0

6 Ja n0

5 Ju l-0

5 Ja n0

04

0

Ju ly-

MARKET DATA BY FTSE RESEARCH

Global Market Indices

FTSE RAFI Emerging Index

Table of Total Returns Index Name

Currency

Constituents

Value

3 M (%)

6 M (%)

12 M (%)

YTD (%)

Actual Div Yld (%pa)

FTSE All-World Index

USD

2,826

163.36

-11.3

-39.0

-42.1

-8.7

4.15

FTSE World Index

USD

2,380

387.28

-11.5

-38.5

-41.5

-8.8

4.17

FTSE Developed Index

USD

1,958

156.99

-11.8

-37.8

-41.1

-8.9

4.14

FTSE All-World Indices

FTSE Emerging Index

USD

868

326.40

-6.9

-48.7

-50.0

-6.4

4.29

FTSE Advanced Emerging Index

USD

422

306.30

-7.5

-47.9

-47.5

-6.3

4.75

FTSE Secondary Emerging Index

USD

446

378.21

-5.9

-49.7

-53.3

-6.5

3.60

4.07

FTSE Global Equity Indices FTSE Global All Cap Index

USD

7,733

259.44

-11.2

-39.5

-42.5

-8.5

FTSE Developed All Cap Index

USD

5,991

251.23

-11.7

-38.3

-41.4

-8.8

4.04

FTSE Emerging All Cap Index

USD

1,742

427.02

-6.6

-49.0

-50.9

-6.4

4.33

FTSE Advanced Emerging All Cap Index

USD

907

407.67

-7.2

-48.4

-47.9

-6.3

4.77

FTSE Secondary Emerging Index

USD

835

475.49

-5.7

-50.0

-54.7

-6.4

3.67

USD

715

173.18

6.9

3.0

5.2

-3.8

2.62

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

USD

263

1521.10

-18.3

-47.6

-52.4

-12.9

7.67

FTSE EPRA/NAREIT Global REITs Index

USD

179

525.76

-21.8

-47.9

-51.0

-14.1

9.38

FTSE EPRA/NAREIT Global Dividend+ Index

USD

233

1069.93

-18.4

-47.3

-51.3

-12.6

8.71

FTSE EPRA/NAREIT Global Rental Index

USD

218

586.66

-21.8

-48.0

-51.0

-13.9

8.92

FTSE EPRA/NAREIT Global Non-Rental Index

USD

45

655.24

-6.7

-46.5

-55.7

-9.9

4.21

FTSE4Good Global Index

USD

671

4160.95

-14.5

-39.3

-42.9

-10.7

4.81

FTSE4Good Global 100 Index

USD

102

3622.47

-16.7

-39.0

-42.4

-11.0

4.98

FTSE GWA Developed Index

USD

1,958

2247.62

-13.3

-40.7

-45.2

-10.3

5.99

FTSE RAFI Developed ex US 1000 Index

USD

995

3842.19

-10.8

-41.1

-44.6

-10.4

5.80

FTSE RAFI Emerging Index

USD

357

3454.25

-7.5

-46.9

-46.5

-8.0

5.06

SRI

Investment Strategy

SOURCE: FTSE Group and Thomson Datastream, data as at 30 January 2009

92

MARCH/APRIL 2009 â&#x20AC;˘ FTSE GLOBAL MARKETS

DATA PAGES 32.qxd:.

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Page 93

Americas Market Indices 5-Year Total Return Performance Graph FTSE Americas Index

Index Level Rebased (28 January 2004=100) Ja n04

250

FTSE Americas Government Bond Index

200

FTSE EPRA/NAREIT North America Index

150

FTSE EPRA/NAREIT US Dividend+ Index

100

FTSE4Good USIndex FTSE GWA US Index 9 Ja n0

8 Ju l-0

8 Ja n0

7 Ju l-0

7 Ja n0

6 Ju l-0

6 Ja n0

5 Ju l-0

5 Ja n0

Ju l-0

4

50

FTSE RAFI US 1000 Index

Table of Total Returns Index Name

Currency

Constituents

Value

3 M (%)

6 M (%)

12 M (%)

YTD (%)

Actual Div Yld (%pa)

FTSE Americas Index

USD

809

518.08

-13.5

-35.8

-39.3

-7.7

3.21

FTSE North America Index

USD

673

574.06

-13.8

-34.8

-38.7

-8.0

3.17

FTSE Latin America Index

USD

136

576.59

-3.8

-51.0

-47.9

0.0

4.06

FTSE Americas All Cap Index

USD

2,660

234.65

-13.4

-36.5

-39.6

-7.7

3.10

FTSE North America All Cap Index

USD

2,459

227.70

-13.8

-35.6

-39.2

-8.0

3.06

FTSE Latin America All Cap Index

USD

201

802.29

-3.7

-51.3

-48.2

-0.1

4.05

FTSE Americas Government Bond Index

USD

153

186.05

5.9

7.0

6.9

-2.1

2.77

FTSE USA Government Bond Index

USD

136

183.17

6.0

8.2

7.9

-2.0

2.73

FTSE EPRA/NAREIT North America Index

USD

115

1743.83

-26.1

-49.5

-49.9

-16.8

9.22

FTSE EPRA/NAREIT US Dividend+ Index

USD

92

969.59

-26.7

-49.3

-49.3

-17.9

9.46

FTSE All-World Indices

FTSE Global Equity Indices

Fixed Income

Real Estate

FTSE EPRA/NAREIT North America Rental Index

USD

112

588.63

-26.1

-48.2

-48.1

-16.5

8.99

FTSE EPRA/NAREIT North America Non-Rental Index

USD

3

252.50

-25.3

-76.2

-79.6

-27.7

19.34

FTSE NAREIT Composite Index

USD

113

1759.48

-24.0

-46.5

-47.8

-16.4

9.88

FTSE NAREIT Equity REITs Index

USD

98

4215.20

-25.9

-48.4

-48.0

-17.3

9.05

FTSE4Good US Index

USD

140

3312.50

-18.3

-35.4

-41.0

-10.8

3.40

FTSE4Good US 100 Index

USD

101

3191.05

-18.5

-35.3

-41.0

-10.8

3.41

FTSE GWA US Index

USD

619

2051.32

-16.7

-37.4

-44.0

-10.1

4.24

FTSE RAFI US 1000 Index

USD

969

3356.90

-16.8

-36.6

-43.6

-10.6

3.95

FTSE RAFI US Mid Small 1500 Index

USD

1,390

2913.66

-18.9

-39.9

-41.9

-11.7

2.75

SRI

Investment Strategy

SOURCE: FTSE Group and Thomson Datastream, data as at 30 January 2009

FTSE GLOBAL MARKETS • MARCH/APRIL 2009

93

DATA PAGES 32.qxd:.

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Page 94

5-Year Total Return Performance Graph

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

9 Ja n0

8 Ju l-0

8 Ja n0

7 Ju l-0

7 Ja n0

6 Ju l-0

6 Ja n0

5 Ju l-0

5 Ja n0

4 Ju l-0

4

FTSE GWA Developed Europe Index

Ja n0

Index Level Rebased (30 January 2004=100)

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 (%pa)

5.90

FTSE All-World Indices FTSE Europe Index

EUR

553

163.64

-14.2

-33.3

-39.2

-3.9

FTSE Eurobloc Index

EUR

2,017

91.47

-12.4

-33.8

-40.2

-7.1

5.10

FTSE Developed Europe ex UK Index

EUR

380

166.51

-12.6

-32.3

-38.0

-6.1

6.43

FTSE Developed Europe Index

EUR

492

163.29

-13.5

-31.8

-38.1

-3.8

5.95

FTSE Global Equity Indices FTSE Europe All Cap Index

EUR

1,666

253.02

-13.9

-33.8

-39.7

-3.5

5.85

FTSE Eurobloc All Cap Index

EUR

826

268.71

-12.1

-34.0

-40.4

-6.7

6.82

FTSE Developed Europe All Cap ex UK Index

EUR

1,126

275.21

-12.3

-32.8

-38.5

-5.7

6.37

FTSE Developed Europe All Cap Index

EUR

1,548

253.96

-13.3

-32.4

-38.7

-3.3

5.89

Region Specific FTSE All-Share Index

GBP

616

2598.72

-4.0

-23.0

-27.8

-5.8

4.80

FTSE 100 Index

GBP

102

2517.18

-4.4

-21.9

-26.3

-6.4

4.75

FTSEurofirst 80 Index

EUR

80

3470.03

-13.2

-33.4

-39.3

-8.7

7.24

FTSEurofirst 100 Index

EUR

99

3148.34

-14.0

-31.5

-37.5

-4.8

6.25

FTSEurofirst 300 Index

EUR

311

1082.81

-13.6

-31.6

-37.6

-4.1

5.84

FTSE/JSE Top 40 Index

SAR

41

2044.07

-2.6

-26.8

-23.9

-4.7

4.50

FTSE/JSE All-Share Index

SAR

166

2254.24

-1.6

-24.3

-22.1

-4.2

4.60

FTSE Russia IOB Index

USD

15

396.40

-31.1

-70.3

-66.7

-7.7

4.81

FTSE Eurozone Government Bond Index

EUR

235

169.98

3.6

6.9

5.5

-1.2

3.95

FTSE Pfandbrief Index

EUR

403

191.63

3.1

5.7

4.2

0.2

4.50

FTSE Gilts Fixed All-Stocks Index

GBP

32

2209.57

4.9

7.6

7.3

-4.5

4.12

FTSE EPRA/NAREIT Europe Index

EUR

84

1279.68

-20.5

-40.9

-51.4

-5.2

7.93

FTSE EPRA/NAREIT Europe REITs Index

EUR

39

472.30

-22.5

-38.5

-48.5

-5.3

8.05

FTSE EPRA/NAREIT Europe ex UK Dividend+ Index

EUR

47

1599.82

-5.4

-29.0

-36.1

-0.1

7.90

FTSE EPRA/NAREIT Europe Rental Index

EUR

74

501.07

-20.8

-40.4

-50.7

-5.7

8.08

FTSE EPRA/NAREIT Europe Non-Rental Index

EUR

10

376.69

-10.7

-47.9

-62.4

12.8

3.67

FTSE4Good Europe Index

EUR

270

3266.07

-14.6

-31.0

-37.6

-3.8

6.29

FTSE4Good Europe 50 Index

EUR

52

2940.57

-16.4

-30.3

-35.7

-4.2

6.31

FTSE GWA Developed Europe Index

EUR

492

2143.24

-14.9

-35.0

-42.3

-5.3

8.79

FTSE RAFI Europe Index

EUR

508

3374.74

-15.1

-32.9

-40.9

-4.8

6.87

Fixed Income

Real Estate

SRI

Investment Strategy

SOURCE: FTSE Group and Thomson Datastream, data as at 30 January 2009

94

MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

DATA PAGES 32.qxd:.

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Page 95

Asia Pacific Market Indices FTSE Asia Pacific Index 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

9 Ja n0

8 Ju l-0

8 Ja n0

7 Ju l-0

7 Ja n0

6 Ju l-0

6 Ja n0

5 Ju l-0

5 Ja n0

4 Ju l-0

4

FTSE GWA Japan Index

Ja n0

Index Level Rebased (30 January 2004=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 (%pa)

FTSE Asia Pacific Index

USD

1,313

182.84

-3.2

-37.0

-41.2

-7.2

4.03

FTSE Asia Pacific ex Japan Index

USD

854

297.23

-5.4

-44.4

-49.0

-7.4

5.10

FTSE Japan Index

USD

459

64.81

-9.5

-39.8

-41.4

-7.8

2.96

FTSE Asia Pacific All Cap Index

USD

3,201

307.64

-2.8

-37.2

-41.5

-7.1

4.06

FTSE Asia Pacific All Cap ex Japan Index

USD

1,926

361.96

-5.3

-45.3

-50.2

-7.4

5.21

FTSE Japan All Cap Index

USD

1,275

205.65

-8.8

-38.9

-40.4

-7.7

2.93

FTSE All-World Indices

FTSE Global Equity Indices

Region Specific FTSE/ASEAN Index

USD

156

303.72

1.2

-41.7

-46.1

-4.4

5.68

FTSE Bursa Malaysia 100 Index

MYR

100

6199.87

3.1

-23.2

-36.2

1.3

4.71

TSEC Taiwan 50 Index

TWD

50

3867.72

-14.7

-38.2

-41.2

-7.9

9.06

FTSE Xinhua All-Share Index

CNY

970

5202.69

28.0

-26.4

-54.5

12.6

1.57

FTSE/Xinhua China 25 Index

CNY

25

14137.69

3.7

-43.3

-43.2

-9.6

3.91

USD

254

140.72

11.8

22.4

24.3

0.3

1.26

FTSE EPRA/NAREIT Asia Index

USD

64

1312.86

-7.9

-43.7

-52.2

-8.8

6.04

FTSE EPRA/NAREIT Asia 33 Index

USD

31

881.20

-9.0

-41.4

-49.1

-8.0

10.34

Fixed Income FTSE Asia Pacific Government Bond Index Real Estate

FTSE EPRA/NAREIT Asia Dividend+ Index

USD

53

1299.25

-3.8

-43.0

-52.8

-5.8

7.91

FTSE EPRA/NAREIT Asia Rental Index

USD

32

638.31

-11.3

-44.2

-50.0

-7.9

9.56

FTSE EPRA/NAREIT Asia Non-Rental Index

USD

32

710.76

-5.6

-43.4

-53.6

-9.4

3.68

Infrastructure FTSE IDFC India Infrastructure Index

IRP

96

552.90

-0.6

-47.1

-62.7

-9.0

1.18

FTSE IDFC India Infrastructure 30 Index

IRP

30

611.50

2.4

-44.8

-61.9

-7.3

1.21

JPY

190

3125.31

-11.9

-41.3

-42.0

-7.7

3.15

FTSE SGX Shariah 100 Index

USD

100

3762.03

-6.3

-33.8

-36.9

-6.3

3.84

FTSE Bursa Malaysia Hijrah Shariah Index

MYR

30

7506.14

4.9

-22.6

-37.8

2.6

4.38

JPY

100

839.46

-11.0

-41.0

-43.5

-7.6

3.27

SRI FTSE4Good Japan Index Shariah

FTSE Shariah Japan 100 Index Investment Strategy FTSE GWA Japan Index

JPY

459

2173.76

-8.8

-40.2

-41.5

-6.6

3.32

FTSE GWA Australia Index

AUD

108

2835.62

-12.9

-26.2

-35.9

-5.1

10.08

FTSE RAFI Australia Index

AUD

55

4454.41

-14.3

-23.6

-33.0

-6.4

8.38

FTSE RAFI Singapore Index

SGD

16

4815.62

-0.5

-37.9

-34.1

-1.1

6.44

FTSE RAFI Japan Index

JPY

297

3126.29

-9.0

-39.1

-39.6

-7.9

3.02

FTSE RAFI Kaigai 1000 Index

JPY

985

2505.39

-23.2

-50.6

-54.4

-12.1

5.29

HKD

49

4054.28

-0.6

-41.7

-41.4

-8.8

4.76

FTSE RAFI China 50 Index

SOURCE: FTSE Group and Thomson Datastream, data as at 30 January 2009

FTSE GLOBAL MARKETS • MARCH/APRIL 2009

95

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Page 96

CALENDAR

Index Reviews March - May 2009 Date

Index Series

Review Frequency/Type

Effective Data Cut-off (Close of business)

Early Mar

ATX

Semi-annual review / number of shares

31-Mar

28-Feb

Early Mar

CAC 40

Quarterly review

20-Mar

28-Feb

Early Mar

S&P / TSX

Quarterly review

20-Mar

27-Feb

04-Mar

DAX

Quarterly review

20-Mar

28-Feb

06-Mar

S&P / MIB

Semi-annual review

20-Mar

28-Feb

06-Mar

S&P / ASX Indices

Annual / Quarterly review

20-Mar

27-Feb

06-Mar

TOPIX

Monthly review – additions & free float adjustment

30-Mar

27-Feb

07-Mar

FTSE All-World

Annual review Asia Pacific ex Japan

20-Mar

11-Feb

11-Mar

FTSE Asiatop / Asian Sectors

Semi-annual review

20-Mar

28-Feb

11-Mar

FTSE/ASEAN 40 Index

Annual review

20-Mar

28-Feb

11-Mar

FTSE UK

Quarterly review

20-Mar

11-Mar

11-Mar

FTSEurofirst 300

Quarterly review

20-Mar

28-Feb

11-Mar

FTSE techMARK 100

Quarterly review

20-Mar

28-Feb

11-Mar

FTSE eTX

Quarterly review

20-Mar

28-Feb

Quarterly review

20-Mar

07-Mar

11-Mar

FTSE/JSE Africa Index Series

11-Mar

FTSE EPRA/NAREIT Global Real Estate Index Series

Quarterly review

20-Mar

07-Mar

12-Mar

FTSE4Good Index Series

Semi-annual review

20-Mar

28-Feb

13-Mar

NASDAQ 100

Quarterly review / Shares adjustment

20-Mar

28-Feb

13-Mar

S&P Asia 50

Quarterly review

20-Mar

06-Mar

13-Mar

DJ STOXX

Quarterly review (components)

20-Mar

24-Feb

13-Mar

DJ STOXX

Quarterly review (style)

20-Mar

06-Mar

13-Mar

Russell US/Global Indices

Quarterly review - IPO additions only

31-Mar

28-Feb

14-Mar

S&P US Indices

Quarterly review

20-Mar

06-Mar

14-Mar

S&P Europe 350 / S&P Euro

Quarterly review

20-Mar

06-Mar

14-Mar

S&P Topix 150

Quarterly review

20-Mar

06-Mar

14-Mar

S&P Global 1200

Quarterly review

20-Mar

06-Mar

14-Mar

S&P Global 100

Quarterly review

20-Mar

06-Mar

14-Mar

S&P Latin 40

Quarterly review

20-Mar

06-Mar

17-Mar

S&P MIB

Quarterly review - shares & IWF

20-Mar

16-Mar

24-Mar

NZX 50

Quarterly review

31-Mar

28-Feb

07-Apr

FTSE/Xinhua Index Series

Quarterly review

17-Apr

23-Mar

07-Apr

TOPIX

Monthly review - additions & free float adjustment

29-Apr

30-Apr

09-Apr

FTSE Nordic 30

Semi-annual review

17-Apr

31-Mar

09-Apr

TSEC Taiwan 50

Quarterly review

17-Apr

31-Mar

Mid April

OMX H25

Quarterly review - shares in issue

30-Apr

31-Mar

29-May

31-Mar

Late April

FTSE / ATHEX

Semi-annual review

07-May

TOPIX

Monthly review - additions & free float adjustment

28-May

30-Apr

08-May

Hang Seng

Quarterly review

01-Jun

31-Mar

Mid-May

FTSE Med 100 Index

Semi-annual review

15-May

30-Apr

15-May

MSCI Standard Index Series

Annual review

29-May

30-Apr

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

96

MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

GM EDITORIAL 32.qxd:.

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Page IBC1

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

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

© FTSE International Limited (‘FTSE’) 2009. 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 32.qxd:.

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10:29

Page OBC1

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FTSE d 02122009 F i dd 1

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