FTSE Global Markets

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ROUNDTABLE: RISK AND RETURNS FROM FX TRADING ISSUE 34 • JUNE 2009

Hedge fund administration & independent pricing UK to lead European REITs revival?

Banking on Saudi real estate Vakifbank: the quiet contender comes of age

BERNIE DAN & MF GLOBAL’S FIGHTBACK THE INTRICACIES OF VALUING DISTRESSED ASSETS

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FTSE GLOBAL MARKETS • JUNE 2009

HIS EDITION IS about change. Inevitably, the continuing recession continues to shift the parameters against which investors, bankers and other market participants, measure risk, market infrastructure and returns. Asset classes that in bear markets were taken for granted, now have a much higher profile. Foreign exchange is one and is the heart of this edition’s roundtable talking shop. As Thanos Papasavvas, head of currency management at Investec Asset Management, notes,“Over the last few years the industry has had a low correlation to other asset classes, including last year when equities had something of a difficult time while currencies overall had positive return … We are seeing a continuing demand for currencies from the UK, Europe and, interestingly, from the States, which is coming round to favouring the asset class as a new way of adding returns.”

The asset management industry is another segment clearly undergoing substantial restructuring. Some market practitioners hold that market consolidation will produce stronger and fitter institutions better able to meet client needs. Others, however, feel beneficial owners could suffer as managers adjust to a new milieu. Lynn Strongin Dodds opens this edition with an overview of the key changes in the pension fund sector that will feed through to the asset management industry over the coming decade.

Not only the mainstream is under siege. The hedge fund industry is also facing “a major transformation in the coming years,” holds Jeff Wells, product manager for fund administration at Chicago-based Northern Trust.

David Simons looks at the substantive changes in play in the fund administration segment, with particular focus on the growing desire for independent and verifiable fund accounting. Extreme market events have combined to compel fund managers to modify their strategies, and concentrate on regulation and transparency. Inherent in that approach is a growing preference for independent administration.

Neil O’Hara, meanwhile, analyses the renewed investor focus on liquidity that may lead to structural changes in the way that some hedge fund strategies are packaged. Marty Kaplan, chief executive officer of Mesirow Advanced Strategies, points out, in Neil’s article, that for many credit event-driven and some activist equity strategies the underlying assets are relatively illiquid even in normal markets. “They are closer to private equity than to hedge funds,” he says, “We don’t think it’s appropriate to lump them together with liquid strategies like long short equity or global macro.”He expects the industry to move toward discrete pools that better match the liquidity of portfolio assets to the redemption terms offered to investors.

With so much in flux, it is difficult to pinpoint an exact route out of the financial mire. However, in working towards recovery, achieving marketwide consensus around the valuation of illiquid asset-backed securities is one important stepping stone. It is also a meaningful counterbalance, as uncertainty over valuations in this segment kicked off the financial storm in the first place. Up to now, efforts by US Treasury Secretary Geithner to encourage private funds to invest (in partnership with the government) to reduce banks’ exposure to structured finance securities have received ambiguous responses. Two questions continue to weigh on the market.

One, for how much will banks want to sell their structured finance portfolios? Two, what are these assets worth to an investor? Until the market privatises responses to these questions, rather than relying on a public sector infrastructure, no meaningful change or recovery is really possible. In securing our tomorrow, the market requires not only consensus, but also a willingness to participate actively in stirring what is still an illiquid credit pot.

Francesca Carnevale, Editorial Director May 2009

T

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Contents COVER STORY COVER STORY: BERNIE DAN LEADS MF GLOBAL’S FIGHTBACK..Page 75 MF Global continues to combat a series of glitches that have stumbled and sometimes humbled the New York based intermediary, since its listing on the NYSE Euronext in July 2007. Now armed with an immensely popular and populist chief executive in the form of Bernie Dan, ex-chief executive of the Chicago Board of Trade (CBOT) expectations of the firm are high once more. If anyone can turn around the fortunes of the seemingly starcrossed broker, Dan can, say market watchers. Francesca Carnevale reports

DEPARTMENTS MARKET LEADER

........................Page 6 Lynn Strongin Dodds surveys the changing asset management landscape in Europe

THE CONSEQUENCES OF FUND CONSOLIDATION

KEY ELEMENTS IN VALUING DISTRESSED DEBT ..............................Page 14

IN THE MARKETS

By Peter Jones & David Pagliaro from Standard & Poor’s FIRMS group

WHY LONDON WILL LEARN TO LOVE SUKUK ..................................Page 18

By Angela Savin, senior associate and Farmida B, partner at Norton Rose LLP

THE CONFIDENT BUILD OUT OF TURKEY’S BANKS ................Page 21 Turkey’s banks are well placed to leverage new opportunities?

VAKIFBANK COMES TO THE FORE ......................................................Page 26 The transformation of Vakifbank from public sector leviathan to febrile private sector bank

COUNTRY REPORT

SHIFTING SANDS IN SAUDI REAL ESTATE........................................Page 30 Mark Faithfull examines the outlook for the Saudi Arabia real estate investment market

THE SOFT RETURN OF MIDDLE EAST BANKS ..............................Page 34 Will Middle East banks lead the charge into a new era?

BRAZIL: LEADING TO TEMPTATION? ..................................................Page 42 John Rumsey asks if the world is ready for a revitalised Brazilian economy

REAL ESTATE INDEX REVIEW STOCK EXCHANGE REPORT COMMODITY REPORT

DATA PAGES

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........................Page 45 Mark Faithfull on the need for refinancing of many Asian real estate investment trusts

UK HOPES FOR A REVIVAL IN EUROPEAN REITS

......................Page 48 Simon Denham, managing director, Capital Spreads, takes the bearish long view

HANG ON TO YOUR HATS: INFLATION IS COMING

......................................................................................................Page 49 Richie Clark, partner at Fox Williams LLP, looks at the advantages of listing on AIM

ALL THAT GLISTERS

....................................................................................Page 51 Vanya Dragomanovich on the long term opportunity that is copper

COPPER HEADED FUTURE

Fidessa Fragmentation Index ....................................................................................PAGE 87 ETF Data, supplied by Barclays Global Investors ..................................................PAGE 89 Securities Lending Trends by Data Explorer ..........................................................PAGE 91 Market Reports by FTSE Research ............................................................................PAGE 92 Index Calendar ............................................................................................................PAGE 96 JUNE 2009 • FTSE GLOBAL MARKETS

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Contents FEATURES ASSET SERVICES & INVESTMENT STYLES

ALTERNATIVE FUND ADMINISTRATION ........................................Page 54

In the aftermath of the Madoff scandal, large institutional investors no longer appear willing to participate where an underlying portfolio of alternative assets is administered in-house. With these clients shaping the course of alternative investment psychology, self-administered fund managers will find it increasingly necessary to secure some degree of pricing independence—or possibly lose business if they do not. Dave Simons reports from Boston.

130/30: A DEAD DUCK OR WINGED RAVEN? ..........................Page 62

In last year’s downturn, not only did 130/30 portfolios fail to preserve capital—which should not have been a surprise—but in some instances they suffered bigger losses than both their benchmarks and long-only equivalents run by the same managers. The performance was hardly a ringing endorsement, but it is too soon to dismiss 130/30 as a bull market fad. Indeed, it may yet prove to be the new paradigm for core equity mandates its supporters claim. Neil A O’Hara looks at the outlook for investment style.

ASIAN SUB CUSTODY ....................................................................................Page 85 Before the recent financial turmoil, Asia scored high on the list of top ten emerging market destinations. Over the past few years, investors rushed in to capitalise on the booming growth stories but as with almost every investment strategy, enthusiasm has been tempered. This is likely to be a temporary phenomenon as the long-term drivers behind countries such as China and India have not disappeared. The difference today in custodial circles is that firms might not only think twice before setting up shop in a country but they are also likely to become more selective in their sub-custodial relationships. By Lynn Strongin Dodds.

ROUNDTABLE

FX: RISK MANAGER OR ALPHA GENERATOR?: ......................Page 65 The foreign exchange marketplace is in flux. The rules of the game are being re-written by the advent of new players and different ways of transacting FX thanks to new technology and the impact of the global financial meltdown. What are the trends in the FX marketplace and what opportunities and challenges do they present to the old and new market players?

TRADING

......................................................................Page 78 Cees Vermaas, executive director, sales and relationship management, European cash markets at NYSE Euronext says, “You need to create the possibility for electronic trading firms to arbitrage between platforms … With low fees we will add more flow from existing Euronext clients and then some firms come in using their smart order routers. And finally you reach the tipping point of 10% to 15% of market share. We cannot take too long to reach this tipping point with Arca.” Ruth Hughes Liley describes the possible futures of the new MTF on the block.

INNOVATORS IN TRADING

..................................................................Page 81 UBS has taken a significant battering of late, and many of its business departments have been decimated. Its equity trading operations remain a cornerstone of the UBS investment bank’s return to growth. Phil Allison’s particular story is that of a wise old head on still young shoulders. Is that enough to lead the investment bank back to halcyon days? Ruth Liley went to find out.

PROFILE: PHIL ALLISON/UBS

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JUNE 2009 • FTSE GLOBAL MARKETS

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BNP Paribas Securities Services THE CLOSER WE ARE, THE BETTER YOU PERFORM With our precise understanding of each market’s internal workings, you maximise your market and investment opportunities.

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BNP Paribas Securities Services is incorporated in France with Limited Liability and authorised by the French Regulators (CECEI and AMF). BNP Paribas Trust Corporation UK Limited and Investment Fund Services Limited are authorised and regulated by the Financial Services Authority. BNP Paribas Securities Services London Branch is authorised by the CECEI and supervised by the AMF and subject to limited regulation by the Financial Services Authority. Details on the extent of our regulation by the Financial Services Authority are available from us on request. BNP Paribas Securities Services is also a member of the London Stock Exchange.

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Market Leader ASSET MANAGEMENT: THE IMPACT OF CONSOLIDATION

IN THE

LION’S DEN

The asset management industry is undergoing substantial and far-reaching restructuring. Will pension funds and other beneficial owners benefit from the new reconfigurations emerging from this current spate of consolidation among asset management firms?

Some market practitioners hold that mergers will produce stronger and fitter institutions better able to meet their clients’ needs.

Others, however, feel beneficial owners could suffer as managers adjust to their new surroundings.

“Broadly speaking, consolidation is rarely good for pension funds,” holds Patrick McCoy, head of investment advisory at KPMG. Lynn Strongin Dodds looks for the middle ground.

ONSOLIDATION IS A recurring theme in the asset management world and right now the landscape is shifting again thanks to the financial crisis. A Darwinian outcome is likely for some firms while others are hiving off noncore businesses. Views are mixed on the effect this bout of restructuring will have on beneficial owners. However, many agree that fees are bound to fall and today’s crop of products will remain on offer. A more pressing question, perhaps, is the impact of change on performance. Mike O’Brien, head of institutional business EMEA at Barclays Global Investors, for instance, says: “Today, there is a battle for cost efficiency. The cost base and burden of regulation has increased at the same time as asset values and assets under management have fallen. Scaleability has become an issue and I think this will put pressure on mid-sized firms.

They will not only find it harder to retain talent but also to build the legal

C Photograph © Jumpingsack/Dreamstime.com, supplied May 2009.

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JUNE 2009 • FTSE GLOBAL MARKETS

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Market Leader ASSET MANAGEMENT: THE IMPACT OF CONSOLIDATION

and compliance services to meet existing and new legislation. I think we will see larger firms expanding their geographical footprint in a region across asset classes.”

Lennox Hartman, UK head of manager research at investment consultants Hewitt, adds:“The business models for some are not profitable or sustainable, but I do not see this as a wholesale move. We will not return to the days of eight to ten years ago when the pension fund industry was dominated by a handful of balanced fund managers.”

John Dickson, head of advice at Hymans Robertson’s investment practice, also thinks that “larger firms will become larger as they plug gaps in the asset classes they do not have. It will not, though, diminish the choice of investment styles or products to pension funds. We would need to see a great deal of consolidation before that happens. An example of what has typically occurred is that a growth style manager will buy a value manager and then offer both strategies to the client. We have seen similar models followed for the past ten years, without consolidating the underlying teams.”

In terms of merger activity, no one expects to see a frenzied rush towards acquisitions, for two reasons: the lack of financing available and an overall subdued mergers and acquisitions environment. Instead, a crop of fewer, yet larger headline-grabbing deals is emerging, such as the $362bn union of Crédit Agricole and Société Générale`s asset management units. The former owns a 70% chunk while the latter firm retains the rest.

The market is also likely to see specialist deals, such as the Credit Suisse and Aberdeen Asset Management transaction, which concluded last year. Credit Suisse sold off its traditional long-only fund

8

management business, encompassing some $74bn of funds under management, to the UK group for about £200m.

Figures recently released in a study by investment advisory firm Jefferies Putnam Lovell (JPL) neatly highlight both trends. According to JPL’s first quarter (Q1) 2009 tally, there were 37 global deals, down from 57 in the same period last year. Assets changing hands, however, spiked up to $522bn in Q1 this year from $362bn in Q1 2008, though the Crédit Agricole and Société Générale transaction accounted for 60% of the total. Other notable deals in the first three months of this year included Henderson Group’s £115m purchase of New Star Asset Management and Mitsui Life Insurance`s sale of its 25% stake in Sumitomo Mitsui Asset Management to three players: Sumitomo Mitsui Banking, which took a 10% stake; Mitsui Sumitomo Insurance Co, which took 10% and Sumitomo Life Insurance Co, with 5%.

The JPL study revealed that divestitures represented 51% of the deals announced in the first quarter of 2009, up from 28% in the same quarter in 2008, while the number of deals involving firms in the alternatives space dipped to 24% from 37% respectively.

Announced cross-border deals totalled 14%, compared with 32% in the first quarter of 2008. The main drivers were banks and insurance companies offloading profitable asset management businesses to unleash capital.

Since the end of March this year, CVC Capital Partners, the private equity group, agreed to buy Barclays iShares for $4.2bn, while BNP Paribas finally received the green light to buy 75% of Fortis in Belgium and Luxembourg, which gives the combined group assets under management of €660bn. In addition, Allianz Global Investors (AGI) bought

`

According to JPL’s first quarter (Q1) 2009 tally, there were 37 global deals, down from 57 in the same period last year.

Assets changing hands, however, spiked up to $522bn in Q1 this year from $362bn in Q1 2008, though the Crédit Agricole and Société Générale transaction accounted for 60% of the total.

Cominvest as part of a swap of its Dresdner Bank unit to Commerzbank.

Despite the muted activity expected this year, Roger Miners, head of business development & client service at RCM, the specialist global equity company within AGI, believes:“We are at the tip of the iceberg. The stronger asset management firms with robust ownership and commitment will emerge as the leaders. It will either happen by attrition (as assets naturally move to these firms), mergers and acquisitions, or by firms selling off their assets if they feel their asset management business model is no longer viable. Boutique firms, however, will survive as long as they have good risk management controls, transparency, and have managed their cost/income ratios carefully.”

Against this changing backdrop, market participants are divided as to whether pension funds will benefit from the new configurations. While some believe that mergers will produce stronger and fitter institutions better able to meet their clients’ needs, others feel pension funds could suffer as managers adjust to their new surroundings. “Broadly speaking, consolidation is rarely good for

JUNE 2009 • FTSE GLOBAL MARKETS

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Market Leader ASSET MANAGEMENT: THE IMPACT OF CONSOLIDATION

Bob McDowall, a research director working at financial technology consultancy TowerGroup, says: “Consolidation and shrinkage of the asset management industry poses potential threats to the pension fund industry.There is not enough attention in these mergers to strategic issues such as culture. I am not talking about the allocation of investments, which is highly individualistic, but the environment that they are working in. All fund management groups have slightly different styles and cultures and [an important point to determine is] whether the fund manager will continue to produce the same results in a different environment.”

Photograph kindly supplied by TowerGroup, May 2009.

pension funds,” says Patrick McCoy, head of investment advisory at KPMG. “The alignment of interest with clients tends to diminish and what tends to happen is that performance tails off.

They take their eye off the ball during the takeover and experience suggests that managers and assets move on.”

Bob McDowall, a research director working at financial technology consultancy TowerGroup, also believes “consolidation and shrinkage of the asset management industry poses potential threats to the pension fund industry. There is not enough attention in these mergers to strategic issues such as culture. I am not talking about the allocation of investments, which is highly individualistic, but the environment that they are working in.

All fund management groups have slightly different styles and cultures and [an important point to determine is] whether the fund manager will continue to produce the same results in a different environment.”

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Richard Phillipson, principal, investment practice at consultancy Investit, agrees, adding: “Pension funds not only have to ask whether fund managers that move over to [a merged] company will stay but also whether they will be successful. In other words, will they be properly incentivised and will the new environment be conducive to generating performance? If the answer is no, then it may prompt the pension fund trustees to move on and start again. It also depends on what else is on their agenda at the time.”

One key to success, of course, will be how well merging companies can blend their different styles so that they are complementary and not divisive, which is not always an easy feat. Take UK-based New Star and Henderson: New Star was seen as being more aggressive and entrepreneurial where leading managers were encouraged to flourish. By contrast, Henderson is widely regarded as a more staid and

cautious firm that emphasises teamwork rather than individual performance. Following on from the merger, Henderson has retained just under half of the 320 former New Star employees but only nine of its original team of 25 managers.

Those French deals will also face challenges. Société Générale’s roots hark back to the Paris of the 1860s, when the bank took the then unusual step of establishing a limited company. Crédit Agricole, on the other hand, can trace its history to the late 19th century and a statesponsored initiative which created regional banks to act as intermediaries between mutual cooperatives in rural France and the Minister of Agriculture. As a result, Crédit Agricole has developed more of a culture of consensus than its French rival.

While not able to address the specifics of the merger, Alain Pitous, head of equity, fixed income and balanced investments at Société Générale Asset Management (SGAM) in Paris, believes that consolidation among asset managers will only be viewed favourably by investors if managers can prove that it will reduce operational risks and offer better coverage of the investment universe, with more resources made available to clients. “This means increased transparency at all stages, based on simple and straightforward products, improved reporting, stable and comprehensive investment processes and strong risk control,”he says.

Moreover, he says:“Investors will be interested in products that will be able to provide good risk-adjusted returns.

Products will be adapted to client needs and the cycle should first favour fixed income credit strategies, followed by equity strategies. Hybrid products, such as convertibles, can also give value but whatever the asset class and investment style, liquidity

JUNE 2009 • FTSE GLOBAL MARKETS

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Market Leader ASSET MANAGEMENT: THE IMPACT OF CONSOLIDATION

and asset-liability management are going to remain key to the attractiveness of the products.”

According to Vincent Camerlynck, head of global business development at BNP Paribas Investment Partners (BNPP IP), (who also cannot discuss the details of the Fortis deal), there is no standard template and pension funds have to make their decisions on a caseby-case basis.“It is never easy to merge two companies and it will take time but one of the most important things is to communicate the process and timetable with people in the organisation as well as with pension fund clients. BNPP IP is a partnership driven model based on expertise, proximity to all our clients, a broad-based understanding of their specific issues, an entrepreneurial spirit, robust compliance processes and strong risk management tools.”

He is sanguine about the impact on his clients. “I do not think clients will take rash action but conduct prudent analysis. One of the big questions they will ask is about the management capability in the underlying fund. The only key driver for us has and will always be the interest of all our clients, and in the end, I am convinced that pension funds will benefit from a stronger asset management company,” adds Camerlynck.

Phillipson comments: “I think what happens in most cases is that when there is a merger, pension fund trustees will feel it is their fiduciary duty to assess the situation. They will ask their consultant for advice and run through a checklist of questions about the investment process and staff turnover. One of the problems today, though, is that it is difficult to determine who to move over to as it is not clear which firm is doing better. It is also expensive to switch managers and asset allocation.”

Richard Warne, head of UK institutional business development

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Richard Phillipson, principal, investment practice at consultancy Investit, says: “Pension funds not only have to ask whether fund managers that move over to [a merged] company will stay but also whether they will be successful. In other words, will they be properly incentivised and will the new environment be conducive to generating performance? If the answer is no, then it may prompt the pension fund trustees to move on and start again. It also depends on what else is on their agenda at the time.” Photograph kindly supplied by Investit, May 2009.

at Aviva Investors, says:“I believe it is fair to say pension funds are being cautious about making changes because the cost of a transition during volatile markets can be as high as 600 basis points. As a result, they will take their time in making decisions but if they do move, the sustainability of the company will be an important factor. Counterparty risk has become much more significant after the collapse of Lehman.”

As for pension funds, it is unlikely they will follow in the footsteps of their asset managers, according to Andy Maguire, senior partner and managing director at Boston Consulting Group.“I do not see them consolidating because of the expense of merging separate pools of money and claims. Nor do I expect to see

legislation requiring companies to make mandatory payments into pension schemes. For now, with an economy already under pressure, companies would not want to take cash flow out of the organisation.”

James Hatchley, a managing director of Freeman & Co, a boutique mergers and acquisitions advisory and strategic management consulting firm for financial services, also does not foresee pension funds joining forces in the near future.“Pension funds are not corporate profit engines and they have set liabilities which are difficult to merge.

What we may see is pension funds with strong existing relationships combining their resources to invest in a particular asset class such as private equity. This would enable them perhaps to access a better manager and potentially negotiate better fees.”

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In the Markets ABS: VALUING DISTRESSED ASSETS

Reaching out for transparent value

Photograph © Dennis Thompson/ Dreamstime.com, supplied May 2009.

Achieving market-wide consensus around the valuation of illiquid asset-backed securities (ABS) is as critical to the debt markets’ recovery as it is to the wider economy. However, US Treasury Secretary Timothy Geithner’s plan for private funds to invest in partnership with the government to reduce banks’ exposure to structured finance securities has received a mixed reception from credit market commentators. Two questions have weighed on the market even before the highly detrimental collapse of Lehman Brothers last September. For how much are banks willing to sell their structured finance portfolios? Moreover, what are these assets actually worth to an investor? To try to tackle these questions, FTSE Global Markets spoke to Peter Jones and David Pagliaro from Standard & Poor’s Fixed Income and Risk Management Services (FIRMS) group—a service wholly independent from the S&P ratings business, set up to provide market intelligence and analytic insight for risk driven investment analysis.

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T THE END of the fourth quarter of 2008, market research analysts within S&P’s FIRMS group determined that in the US alone financial institutions were holding a total of $546bn worth of distressed, so-called FairValue Level 3, assets on their balance sheets. By measuring these Level 3 assets as a percentage of market capitalisation, S&P FIRMS analysts showed that Citigroup, Morgan Stanley, Goldman Sachs, and Merrill Lynch had all reported more than 100% of their market capitalisation in Level 3 assets at the beginning of the fourth quarter

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of 2008. The highest ratio belonged to Morgan Stanley, where, with a market capitalisation of only $15.6bn, its Level 3 assets constituted an incredible 548% of that figure. At the other extreme Wells Fargo reported only 20.7% of its market capitalisation in Level 3 assets.

As the market continues to slide, the ability of banks to have ratios that allow sufficient lending becomes increasingly crucial. A decline in investor confidence, despite the capital injection via the Washingtonsponsored Troubled Asset Relief Program (TARP), continues to leave banks struggling to survive. As Geithner is only too acutely aware, the global banking system’s collective leveraged exposure to these opaque, illiquid assets is one of the primary driving forces behind the sharp escalation in financial system credit risk aversion and the shrinking liquidity that has led the global

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economy into its current predicament.

The rise in unemployment and the decline in gross domestic product (GDP) do not lend themselves to banks opening up the vaults to consumers or businesses.

Assertions from the international accountancy boards of the need to apply fair value or mark-to-market valuation standards have not exactly been welcomed by holders of troubled structured bonds. As most banks have argued, attempting to meet these standards has made it even harder to resume lending.

Banks and institutional investors with exposure to the ABS markets would rather not write down billions of dollars on account of what they perceive to be artificial market values caused by forced asset selling and an illiquid secondary market for structured finance assets. The downward spiralling pricing environment, they would argue, does not reflect these

assets’ intrinsic value. The problems facing the market today are, first, how to work out intrinsic value and, second, how to agree on it.

Peter Jones, who heads the Valuation Scenario Services group within S&P’s FIRMS division, explains the root of the first problem: “With a significant decline in underlying asset prices widely predicted for an uncertain length of time, determining the intrinsic value of these assets has now become extremely difficult.”

Indeed, with market commentators agreeing that property prices are likely to continue to fall in the US and across Europe, and with many of the world’s major economies mired in recession, the continuing performance of underlying assets continues to remain uncertain. For this reason alone, the US government clearly has its work cut out encouraging private investors to re-enter the market in any significant numbers. However, to

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In the Markets ABS: VALUING DISTRESSED ASSETS

midtier RMBS on the balance some observers, the Public Private sheet at 80 cents on the dollar Investment Program (PPIP), and less than 10 cents on the announced by Geithner towards dollar can be as little as a 5% the end of March 2009, gives difference in assumptions over investors a fair combination of future default rates in the leverage and downside protection underlying collateral. “This is in order to partner with the where the Valuation Scenario government and buy up these Services (VSS) group is currently troubled assets from the banks. working very closely with a However, critics are saying number of banks, traditional Geithner has overestimated the investors and industry and quality of the deals that banks are regulatory bodies to help them holding. Not only does the enhance their valuation of these programme offer too little complex securities,” adds Jones. stimulus for investors to step in, Rarely before has the they say, but it also leaves US requirement for third party, taxpayers unfairly exposed to independent cash-flow valuation footing the bill should it not work. been so relevant.

The assumption underpinning Indeed, there are a number of the PPIP seems to be that the David Pagliaro, director, Standard & Poor’s Fixed Income underlying mortgage loans will and Risk Management Services (FIRMS). Photograph new players emerging into this mostly pay off, so that if the PPIP kindly supplied by Standard & Poor’s, May 2009. already populated marketplace, assisting credit-market clients with fund buys distressed assets and holds them at an above-present- convergence across asset classes:“There their internal assessment of their market price determined by the can be dramatic differences in the structured portfolios. However, the planned auction process, the simulated performance profiles of Valuation Scenario Services offering government's loan to investors to different structured finance asset from S&P is also intended to be a finance the purchase will not go bad. classes depending on how exactly the support for banks and institutional The key concern with the plan, underlying assets perform in stressed investors to meet today’s new regulatory therefore, is what happens if the conditions.” S&P’s structured finance accounting requirements, and to show underlying loans do not pay off. It platform gives subscribers access to the transparent operational and risk remains to be seen if the results of the loan-level data for hundreds of ABS management processes as delineated by individual bank stress tests recently deals and allows them to stress-test the financial reporting standard IFRS7, the undertaken will reveal the quality of deals under different assumed credit- Bank for International Settlements and assets in banks’portfolios.“The first step conditions. However, undertaking regulators such as the US Securities and for all participants in the credit market stress-testing exercises for each of the Exchange Commission (SEC) and the is to take the time to identify and underlying loans in a pool of ABS UK’s Financial Services Authority (FSA).

“Going forward, we will certainly understand the underlying assets that meets only half the challenge of see increasing demand for greater all these distressed assets’structures are determining the pool’s intrinsic value.

“The same structured finance transparency across all corners of the built upon. If you are able to study the underlying assets and assess how they securities can perform very differently structured finance market, in perform under different credit-stress when their underlying collateral is particular for loan level data and scenarios, it is entirely possible to value tested against even mildly different cash flows based on greater even the most illiquid and complex assumed credit conditions. Any underlying collateral analysis, exactly disparity in expectations for the the kind of data and functionality securities,”says Jones. can be sourced from Even so, David Pagliaro, EMEA performance of the underlying collateral that commercial director of S&P’s structured produces an environment of wildly ABSXchange,” adds Pagliaro. Market finance platform, ABSXchange, another differing asset valuations,”says Pagliaro. participants as diverse as Barclays According to S&P’s FIRMS research Capital European Securitisation member of S&P’s FIRMS division, stresses that simulations throw up little the difference between carrying a Research, M&G Investments, Crédit

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Foncier and the UK’s FSA have all recently signed up as users on S&P’s structured finance platform.

Jones adds:“It is clear we will see an ever increasing focus on the input assumptions going into valuations across all illiquid and complex structured finance asset classes. We believe that one of the major developments taking place today, and for the foreseeable future, will be the creation of a set of standards around valuation. The market needs to form a consensus around all the input assumptions, models and processes involved in a valuation.”

Trying to validate internal assumptions made for the valuation of structured finance assets is certainly one of the central challenges for global institutional investors today. While most structured finance market observers accept that secondary market pricing, where it exists, is not reflective of the current performance of the underlying pools of mortgage or loans standing behind many of the structured finance assets, achieving consensus on inputs into valuations is key to understanding what the assets’ intrinsic value actually is and what impairment investors should be applying.

As investors lose confidence, the secondary market reacts subjectively by assigning defensive (higher) discount margins and performance criteria, driving mark-to-market prices lower.

When estimating the net present value of modelled future cash flows for intrinsic valuation or impairment purposes, in order to achieve any semblance of pricing consensus in the market, participants on both the buy side and sell side must reach at least a broad agreement of the performance of the underlying loans themselves.This is not often reflected in secondary market sentiment, which can be volatile and based on a short time horizon.

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To address this issue, S&P’s VSS is conducting a number of “consensus surveys”. In the first of a series of surveys to be conducted, over 20 participants in the European structured finance market were invited by S&P’s VSS to quantify the four key assumptions they make when stress-testing the underlying loans and mortgages behind a structured finance transaction. The four valuation inputs are Constant Prepayment Rates (CPR), Constant Default Rates (CDR), Loss Severity (LS, the severity of any losses occurring on the collateral in default) and Recovery Lag (RL), in the case of this survey applied to a UK Prime RMBS transaction and a UK NonConforming Loan RMBS transaction.

“We asked respondents to quantify their assumptions under a base-case scenario in which current credit conditions remain prevalent and under what they deem to be a worstcase scenario,”explains Jones.

“The survey quantifies very clearly the disparities and inconsistency around valuation input assumptions made by the market today, and the market’s current high loss expectations for underlying mortgages,”Jones adds.

Respondents’aggregated expectations reveal default rate assumptions on UK Non-Conforming RMBS to be 4% under current conditions but as much as 21% under a worst case scenario. The aggregated expectation of Loss Severity on the collateral in default for UK NonConforming RMBS is 46% under current credit conditions and 66% under a worst case scenario. Meanwhile, the aggregated assumption for Loss Severity on the collateral in default in UK Prime RMBS is 25% under current conditions but more than doubles to 54% under a worst case scenario.

It seems market participants can agree on the poor performance of non-conforming loans but they do not

Peter Jones, director, Standard & Poor’s Fixed Income and Risk Management Services (FIRMS). Photograph kindly supplied by Standard & Poor’s, May 2009.

necessarily agree to what extent, and nor do they agree how the less risky Prime RMBS loans will perform. Until buyers and sellers alike can agree on the performance of the underlying loans backing these distressed assets held by banks in such vast quantities, the market will remain at an impasse.

“As we invite more market participants to provide us with their valuation input assumptions for other structured finance securities, we hope the increasing volume of data may display signs of convergence and that we can create a useful benchmark for the benefit of investors, those responsible for monitoring pools of ABS assets and other market participants,”Jones concludes.

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Regional Review SUKUK: UK EASES TAX TREATMENT

UK Eyes Sukuk Boost Photograph © Christos Giorgiou/Dreamstime.com, supplied May 2008.

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Three new proposed UK tax measures should enhance London’s position as a centre for Islamic finance and make it more likely the country’s first corporate or sovereign sukuk issue will appear in the near future, write Angela Savin, senior associate, and Farmida Bi, London banking partner at Norton Rose.

HE UK GOVERNMENT has taken fresh steps to promote the City of London as a centre for global Islamic finance and to level the playing field between conventional and Islamic products. Three measures easing the tax treatment of Islamic finance products were announced in the Budget statement in April and should become law later in the year.

The UK’s ambition to be the leading international centre for Islamic finance, supported by its strong legal and regulatory framework, will be strengthened by the proposals and there is therefore an increased likelihood of a UK corporate or government sukuk issue in the near future.

International Financial Services, London, which promotes the City, estimated that at the end of 2007 global Islamic assets had reached $729bn and, while Islamic financial markets have been significantly affected by the credit crunch, there remain significant funds available for investment in the right opportunity. The proposed legislation will make it easier for UK companies to access these funds. UK legislation does not prescribe who can issue sukuk in the UK, so it is open to UK companies to do so as well as those providing inward investment into the UK from the Gulf and other countries that require a Sharia-compliant structure.

Although the sukuk market has been severely affected by the downturn, with a reported 66% reduction in global

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issuance in 2008 compared with the boom sukuk market of 2007, there are signs the market may be stirring, albeit at a gentler pace than the heady days of 2007. The Indonesian Government’s $650m five-year sukuk issued in April 2009 is reported to have been seven times oversubscribed, suggesting that demand is returning for certain types of issuer. The Indonesian Government sukuk was able to attract improved pricing when compared to its $2bn conventional bond issued in February 2009, and was also able to attract a broad range of investors across the globe.

A number of other sovereign and quasi-sovereign issuers have announced their intention to issue sukuk including the government of Bahrain, the Islamic Development Bank and the Russian bank VTB. This is therefore the right time for the UK Government to ensure that UK companies are put in a position to access this improved liquidity by removing unnecessary tax and regulatory barriers to sukuk issuance.

The London Stock Exchange has listed 18 sukuk issues raising $10bn from overseas issuers, which is exceeded only by the NASDAQ Dubai exchange. There has not been a sukuk issuance from the UK and the much anticipated proposed government issue of Sharia-compliant Treasury bills was postponed in November 2008 because of concern that the government might not have been able to obtain value for money at that time. That concern may now be abating if market conditions continue to improve.

The 2009 Budget statement in April, which refers to Islamic finance as alternative financing instruments, included the following three measures: relief from stamp duty land tax (SDLT) on transactions undertaken as part of the issue of alternative finance property investment bonds; relief from tax on capital gains on transfers of land to and

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Regional Review SUKUK: UK EASES TAX TREATMENT

from sukuk issuance vehicles, and, the person obtaining the financing will continue to be entitled to claim capital allowances while the land is held by the sukuk issuance vehicle.

For some years, Her Majesty’s Revenue and Customs, the tax authority, has been working with advisers and industry members to ensure that the tax treatment of Islamic finance is no more onerous than conventional finance. The UK Government has, in Finance Acts since 2003, removed the tax barriers that made Islamic products less tax efficient than their conventional counterparts.

Finance bill The Finance Bill 2009 proposed in the Budget statement, when it is enacted in July 2009, will mean that from a tax perspective, everything is in place for a UK corporate to issue a sukuk based on an ijara (lease) of real estate assets. This is the most common sukuk structure and typically involves the entity which requires funding to sell or lease an asset such as a building or a piece of land to a sukuk issuance vehicle that funds its acquisition through the issue of sukuk.

The sukuk issuance vehicle then leases the property back to the transferor for the expected duration of the sukuk and the transferor undertakes to buy the property back at the maturity of the bond. The repurchase is at a pre-agreed price that is sufficient to allow the sukuk issuance vehicle to repay the principal of the sukuk, together with any accrued returns. This structure requires property to be transferred, which has a number of tax consequences which would make sukuk issuance extremely unattractive to a UK company without the changes proposed in the Finance Bill 2009.

SDLT could be due on the sale and re-transfer (the leaseback would be expected to be exempt under sale and leaseback relief). The Finance Act 2009

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will contain provisions to exempt both the initial transfer of land and the retransfer at the end of the sukuk term from SDLT. The certificates which are issued to sukuk holders give them an interest in the underlying assets of the sukuk issuance vehicle. The Finance Act 2008 included legislation which deemed sukuk certificate holders not to have an interest in the issuer’s assets for all tax purposes (and therefore, no SDLT should have arisen on issue or transfer of a sukuk certificate). The Finance Act 2009 will amend these rules to ensure that the issue and transfer of sukuk certificates will only be exempt from SDLT provided that an individual sukuk holder does not acquire control of the sukuk issuance vehicle’s assets by virtue of the holding of sukuk (although there will be a carve out from this restriction for underwriters, and the situation where the bondholder was unaware that he had control of the issuer’s assets). This is essentially an antiavoidance measure to prevent transfer of occupational and associated rights in the property to the sukuk holder without any incidence of SDLT; the relief should be available where the structure replicates a financing, and not where sukuk are used to effect an absolute transfer of the property to the sukuk holder.

The Finance Act 2009 will also contain two provisions which affect the tax treatment of the transferor of the land which is used to secure the sukuk issuance. The transfer of land to a sukuk issuance vehicle would constitute a disposal of that land by the transferor for the purposes of both corporation tax on chargeable gains and capital allowances. These rules will be amended so that: for corporation tax on chargeable gains, there will be no disposal of the land on transfer to the sukuk issuance vehicle, nor on the retransfer of the land at the end of the

sukuk term. No chargeable gain should therefore arise for the transferor on transfer of the land to the sukuk issuance vehicle. Similarly, for capital allowance purposes, the transfer of the land will not constitute a disposal event, and therefore the transferor will not be required to recognise disposal value and will, instead, continue to claim allowances in respect of any expenditure qualifying for capital allowance purposes. This change will also ensure that capital allowances which have already been claimed by the transferor are not“recaptured”when the land is transferred to the sukuk issuance vehicle. It is expected that this treatment will apply for both plant and machinery and industrial buildings allowances.

Regulatory review In addition to the tax changes, the UK Government has also reviewed the regulatory treatment of sukuk to address tax legislation anomalies. In response to market concerns, the UK financial regulator, the Financial Services Authority, and the Treasury issued a joint consultation last December on whether legislative amendments are needed to create a new instrument to explicitly exempt sukuk from the Collective Investment Scheme regulations. Any regulatory clarification which allows sukuk to be treated like conventional bonds rather than collective investment schemes will reduce the potential legal and compliance costs associated with sukuk issuances and is more likely to encourage UK companies to issue sukuk.

In the current climate, when many UK companies are finding it difficult to access traditional sources of funding, some have been tempted to tap the Sharia-compliant funds that are based mainly in the six countries of the Gulf Cooperation Council (GCC) and in South East Asia. The British Government’s new proposals should start to change that.

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Country Report BUSINESS AS USUAL FOR TURKISH BANKS

Dual Tranche Funding Photograph kindly supplied by Dreamstime.com, May 2009.

That all-important tipping point in the history of the Turkish economy, and by extension the Turkish banking sector, that would propel the country out of its emerging market harness and, possibly, into the European Union, has never quite materialised. True, the country retains many infrastructural weaknesses that limit its appeal to its European neighbours. Even so, the Turkish banking sector is stronger than it ever has been in recent memory and among the most sophisticated in the world, at least at retail level. While recession continues to eat into the fortunes of the major players in Europe and the US, increasingly in Turkey it is business as usual, with a number of benchmark syndications coming to market in recent weeks. Francesca Carnevale reports.

URKEY’S BANKING SECTOR continues to outstrip expectations in spite of continuing disarray in government and its sometimes negative image in the European theatre.

That connotation is largely defined by the closely manacled relationship it appears to have with the International Monetary Fund (IMF), despite having achieved GDP growth rates in excess

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of 7% in recent years. Albeit, that this year, the country’s growth rate will likely be negative, according to Burak Tansan, executive vice president, Akbank. “The important thing is how quickly we get out of the crisis,” he adds.“It looks like we might start the turnaround in the third or fourth quarter of this year.”

Backed by a government anxious to establish its creditworthiness and

commitment to western free-market principles, the country’s banking sector has enjoyed a number of additional fillips of late. As Turkish Central Bank Vice Governor Mehmet Yörükoğlu recently stated, the Turkish banking system is in extremely good condition now, thanks largely to the “successful regulations adopted after the 2001 economic crisis”.

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Country Report BUSINESS AS USUAL FOR TURKISH BANKS

In mid-May, Turkish banks reported their first-quarter financials and most beat expectations. Profits at the top eight banks came in at TRY2bn (€940m) in the quarter, which was down only around 10% year-on-year.

Of particular note was that nonperforming loans (NPLs) accounted for between 3% to 5% of total bank lending (though this is expected to rise 6% by year end, according to a recent analysts report by Deutsche Bank) despite the downturn in the real economy, which is likely to see GDP contract between 5% and 6% in 2009. The banks have used their extra cash to invest in local treasury bonds (a long-standing strategy in the Turkish banking market), made more profitable by the central bank’s interest rate cuts. As a result, almost all Turkey’s banks put in strong bottom-line growth in the first quarter of this year compared with the same period a year earlier.

Turkey’s financial system has been able to steer clear of radical measures such as cash injections directly into financial institutions; largely because the capital adequacy ratios of most of the country’s banks, which appear to be a level that is double the international average. As the country’s central bank recently noted, the capital adequacy ratios of Turkish banks will not fall below the legally required level of 8% this year even in the event of a 15-point increase in overdue receivables. As of the end of February, the average capital adequacy ratio of Turkish commercial banks was around 18%.

“Moreover,” notes Tansu Yuksel, vice president, Vakifbank, “the provisioning level for nonperforming loans is somewhere between 80% and 85 %, for Vakifbank itself we are talking 92%, for some others 100%, so even in light of a crisis, we will come out

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standing up.” Nonetheless, the market has been impacted by contagion from the financial storms blowing outside the country.

This has encouraged the government to adopt a number of measures to try to protect the private corporate sector, through the reduction of interest rates and the provision of guarantees for the banking sector covering lending, particularly focused on private sector companies and then again on the small and medium- sized enterprise (SME) sector. The Credit Guarantee

`

Turkey’s financial system has been able to steer clear of radical measures such as cash injections directly into financial institutions; largely because the capital adequacy ratios of most of the country’s banks, which appear to be a level that is double the international average.

Fund (KFG) will act as a guarantor for 60% of the credit small and mediumsized firms obtain from banks, according to the arrangement. If any loans become overdue, lender banks can launch proceedings on the firm to collect the loan and apply to the KGF to request 60% of the outstanding amount. If monies are collected, the bank will repay the KGF. It is too soon to say whether the move will lift lending in the country, though some local bankers note: “It is a significant step in the right direction.”

Moreover, a no questions asked “wealth amnesty” programme was instigated in 2008, which encouraged nationals and expatriates to send money back to Turkey, without penalty. The move generated approximately TL13.5bn in bank deposits.

However, the banking sector remains impacted by corporate debt and the likelihood of it being rolled over in light of the very high current account deficit (CAD), negatively impacting interest rates and making borrowing more difficult. Loan defaults have been a real fear through 2009. According to Tansan: “Loan applications have picked up, there has been some real movement in the capital and equity markets and the overall mood in the financial markets is now much better. The positive results announced at the end of the first quarter of the year were a further positive sign, that things are returning to normal.”

The impact on the banking sector is that “long-term strategic plans are by necessity in this climate superceded by short-term adjustments,” highlights Tansan. Foreign fund levels is the principal indicator of the contagion in the financial markets spreading to Turkey. Syndicated loan rollovers through 2009 are scheduled to be over 50% of outstanding credits.

However, notes Yuksel:“Two elements have changed the nature of the game as regards the sector’s reliance on foreign funding. One is that reliance on wholesale funding is now only 13% of the sector’s liabilities and, in that respect, Turkey is clearly differentiating itself from the rest of the emerging markets. Second, despite the crisis, the banking sector remains very price conscious of its borrowing. In the past, Turkey’s banks were renowned for being stingy. That is now paying off in spades.”

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Country Report BUSINESS AS USUAL FOR TURKISH BANKS

Moreover, the exposure of the banking sector to foreign loans has also contracted: more a term trend, rather than an indication of the relative tightness in the syndication market for new capital raising. The amount that the sector has to repay over the coming year now in the Turkish banking sector’s total syndication repayment in the next 12 months is only $9.7bn, according to central bank figures.

Changes in the way that Turkey’s leading banks raise finance, though, have been underway for some time.

Nihan Turgay, senior vice president – head of financial institutions at Garanti, highlights: “The nature of syndication deals are changing back from club deals to general syndications. After the collapse of Lehman Brothers, the cost of borrowing in syndicated deals increased but stayed low compared to what was paid in other markets. The deepness of long lasting, transparent and trustworthy relationships led the Turkish Banks conclude their deals successfully.”

A further development, concedes Batuhan Tufan, vice president in structured finance - FI at Garanti, is that: “Recently, we have been selfcoordinating our deals so as to manage the process directly and focus on the relationship with our correspondents at the same time.”

In future the bank will be looking for alternative ways to raise capital,“tapping the capital markets by issuing new types of transactions and also diversifying our funding channels including institutions such as multilaterals, for instance,” explains Turgay. This is being driven by the search for available and reasonable sources of financing following the changing temperature in the capital markets.

April and May consolidated the reputation of Turkish banks to secure finance on relatively favourable

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terms. Late in the month Isbank secured a one-year $570m dualtranche term loan facility, funded in both euros and US dollars.

The transaction was a club deal, with 28 banks from 14 countries participating. The US dollar tranche, worth $255m, came in at LIBOR plus 2.5% (typical for the times and Turkish risk right now). The €225.25m tranche, meantime, has an extension option of a further one year and is priced at Euribor plus Burak Tansan, executive vice president, Akbank.“The 2.5%. Isbank is Turkey’s important thing is how quickly we get out of the crisis,” says largest private bank in Tansan.“It looks like we might start the turnaround in the terms of total assets third or fourth quarter of this year.” Photograph kindly (worth $64bn at the end supplied by Akbank, May 2009. of last year) and is rated ‘BB-’ by S&P’S and ‘B1’ by Moody’s. Agency Group (AFD). The loan has a Yapi ve Kredi Bankasi had entered maturity of 12 years and a prepayment the markets in April with a one-year option after seven years. Funds are benchmark dual tranche being used to finance clean energy facility (worth $136m and projects. A month later, the bank €210.5m respectively) at 2.5% raised €20m from the Development over LIBOR/EURIBOR. Bank of Turkey with a guarantee from Earlier in May Garanti signed a French Development Agency Group dual-tranche one year syndicated loan (AFD). The ten-year loan will be used split between two tranches, worth to finance SMEs with a turnover $110m and a €519m to replace a below €50m. €600m loan signed a year earlier, For the time being then, it is a where the sole purpose of the loan is gradual return to business as usual for to provide pre-export financing for Turkey’s banks, stresses Tansan.

Turkish companies. The deal, in which “Overall, loan penetration in Turkey, 31 banks from 15 different countries particularly at consumer level remains took place, carries an all-in pricing of low, compared to Europe,” he holds.

“We have a level somewhere in the 250bps over LIBOR/EURIBOR. The transaction builds on the bank’s region of 36%, compared to 157% in own efforts in raising long-term the European Union as a whole and financing through borrowings from even 70% in a country such as development banks. In February this Bulgaria. So, with that in mind, year Garanti secured a €50m expansion of the retail franchise still is subordinated loan from Proparco, a a cornerstone of the main banks in company of the French Development Turkey and in particular at Akbank.”

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Country Report PROFILE: VAKIFBANK: A NEW CONFIDENCE

High Tech Banking to the Fore Vakifbank is coming to the end of a five year mission to revitalise and prepare itself for the next decade, justifiably steadying itself for the inevitable upturn in business. The process has been long. Just after the turn of the century, the bank hired international consultant McKinsey & Company, setting aside some $160m to cover costs in redesigning and upgrading the bank over a five year period, beginning in 2004.

The transformation will eventually lead to full privatisation and an ambitious growth programme.

Can Vakifbank succeed?

Photograph © Norebbo/Dreamstime.com, supplied May 2009.

HE STATELY PROGRESS from public to private sector giant, is paying dividends for Vakifbank.

Latterly, the bank has steadily hired new staff and opened new branches, to help market its growing range of consumer led product and spent $25m in renovating its internal information technology system. The process has also included a raft of new product initiatives, including Vakif World and transportation card projects.“We have expanded our product line and gained

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market share in general purpose consumer, housing and total retail loans. In particular, Vakifbank has demonstrated a strong upward move in the last quarter of 2008, after launching our new credit card, Vakif World,” notes Tanju Yüksel, the bank’s assistant general manager and head of international banking.

In card related initiatives, Vakifbank has set a blistering pace in the country, at least in terms of innovative thinking. In November last year, in the

Mediterranean city of Antalya, VakıfBank announced that it had completed the infrastructure for a new system that combines banking, city transport and shopping in a single card. The card can be integrated into a watch, an compatible cell phone or a keychain and was rolled out initially for Antalya residents only.

VakıfBank’s partners in the project, AntKart—the company that provides Antalya’s public transportation card system used by nearly half a million of

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Country Report PROFILE: VAKIFBANK: A NEW CONFIDENCE

the city’s residents—and its technology partner Verisoft, completed the technological infrastructure for the new system.

The main driver behind the project was a change in corporate policy the bank adopted three years ago to concentrate on technology investments and a new human resources policy, explains Yüksel. NFC cell phones and watches with the integrated smart card have been made available for VakıfBank customers free of charge and similar projects relying on innovative technologies for consumers and commuters will be offered in other cities across Turkey in the near future.

The going has not been easy however. Undoubtedly there has been a contraction in the Turkish banking sector, particularly through 2008.

Despite the overarching market trend however, Vakifbank put in a strong performance. “Through 2008, we achieved 18% increase in net interest income. As we benefited from the fruits of restructuring, net fee and commissions income rose by 11% between the third and last quarter of 2008 and 29% year on year. Moreover, with 57 branch openings and 900 new employees, we managed to match expansion with increasing efficiency through a customer-focused business strategy. As a result, we have significantly improved our service quality in all areas,” adds Yuksel. “It was an important move, and timely, given that we are working in an aggressive growth market.”

The long term makeover is all directed at ensuring that Vakifbank becomes one of the top three banks in the country. It has been a long and steady journey for a bank, which for years was harnessed in an image of a staid, state controlled entity and the bank has worked hard to redefine itself as dynamic as any private sector financial institution.

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Photograph © Ira J Lyles/Dreamstime.com, supplied May 2009.

Briefly, VakifBank’s shareholding is largely controlled by over 40,000 charitable foundations managed by a special purpose institution within the office of the Turkish Prime Minister. The General Directorate of Foundations (GDF) was established in 1924 to administer and regulate existing and future Turkish charitable foundations as a governmental entity directly reporting to the Prime Minister’s office. GDF was subsequently given the authority to establish a bank subject for the purpose of managing the foundations’ revenues and expenses and remains to this day as a separate legal entity with its own budget.

In November 2005, VakifBank and VakifBank’s Pension Fund sold, respectively, 27,900,000,000 and 4,300,000,000 Class D common shares of VakifBank in an initial public offering, representing 21.8% and 3.37%, respectively, of VakifBank’s total shares. Following the IPO, GDF’s equity interest in VakifBank shrank from 74.75% to 58.45% of the bank’s shares. Meanwhile the VakifBank Pension Fund has retained a 16.10% interest in the bank’s share capital, as a Class C shareholder. VakifBank’s employees contribute to VakifBank Pension Fund as opposed to the mandatory social security coverage provided by the state Social Security

Institution and membership of the fund is mandatory for bank employees.

The third quarter of 2008 was a period in“which we speeded up our investments to establish tomorrow’s VakifBank,”notes Yüksel. “We renewed our corporate identity and completed restructuring in credit cards. Furthermore, we launched pay-pass card projects starting with the AntKart scheme in Antalya. Adding 80 new branches in one year, we have now reached to 521 branches. We will continue to open new practical branches focusing on retail banking services. While growth in our balance sheet is dominated by loan book expansion, we maintain our asset quality.”

With an expected loan book growth rate of 15% in 2009, Vakifbank will continue funding the “real sector aimed at boosting the contribution to the national economy,”he adds. The bank is actively seeking to establish market dominance in mortgage and consumer lendingVakifbank’s net profits for the first quarter of this year reached TRY294.2m, while its asset size rose 8% year to date to TRY56.2bn, achieving at 20% return on equity, according toYüksel.

Cash loans increased to TRY31.1bn and total deposits rose to TRY39.5bn up by 6.5% year to date, a growth rate outperforming the sector average; supporting “a deposit heavy funding structure,”notes Yüksel.“We increased

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total of cash and non-cash loans to almost TRY40bn. Growth in total loans continued in 1Q 2009 even though the pace eased compared to last year. Lending will pick up in the second half of the year.”

While growth in balance sheet was dominated by loan book expansion, the bank says it has experience no deterioration in asset quality. The bank’s non performing loan ratio was down from 4.64% to 4.57% over the year and an above 92% loan to deposits ratio is proof of the bank’s strong balance sheet, compared with an average 82% to 85% for the sector as a whole. High liquidity, sound balance sheet structure and deposit based funding strengthened the position of Vakifbank in the current crisis environment,”continues Yüksel.

The bank has been actively seeking to establish a dominant share in the Turkish mortgage and consumer

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lending segments. To this end, Vakifbank has also refocused some of it business lines. In November last year the bank’s board decide to divest a 31% Vakif Venture Capital Investment. “t was also decided that the company will continue its operations as a venture capital investment but an application will be made to the Capital Markets Board for an additional period of one year in order to form venture capital portfolio.

The bank’s funding rounds were completed by the end of last year, when in December the bank signed a $335m syndicated loan coordinated by West LB AG, and raised by a consortium of 12 banks consisting of US dollar and euro tranches. The loan has an all in cost of LIBOR +2,00% and EURIBOR +2,00% for the dollar and euro tranches respectively. Yüksel explains it was “a good deal at the time, well priced and was a 90% roll-

over of a $375m syndicated loan in 2007.

It underscored market confidence in the bank.”

However, how pricing for Turkish risk had changed was clearly exemplified by a loan agreed early in 2008, having borrowed $750m via one year dual tranche syndicated loan, to support the bank’s SME lending and pre-export financing facilities, with an all in cost of LIBOR+%0.77 and EURIBOR+%0.77 for the dollar and euro tranches respectively.

This year, expects Yüksel, he expects loan rollovers to be between 50% and 60% of last year’s borrowings. In part, this reduction is related to the fact that the Turkish banking sector as a whole is reducing its reliance on overseas funding for its activities. “Funding is only 13% of the banking sectors liabilities. It is a significant turnaround and one that differentiates the country from other emerging markets,”he adds.

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Country Report SAUDI ARABIA: BOLD PLANS FOR THE FUTURE

Saudis Feel the Sand Shifting

OT ONLY HAS Saudi Arabia managed its national finances prudently but its real estate market is supported by a genuine need for more buildings at almost every level. Unlike most of the Gulf countries, Saudi Arabia’s population is dominated by its indigenous people rather than expatriates and with large family sizes the country’s existing infrastructure is struggling to cope so it has embarked on major plans to build more affordable housing, schools, medical facilities, offices and shopping centres. In part it has done this through expanding its existing cities, but new city projects are also leading the push to expand. With latent demand at breaking point, rumours also abound that Saudi Arabia will lift its restrictions on foreign ownership and that overseas property companies may finally be allowed to join the party.

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Massive potential

Photograph © Dawn Hudson/ Dreamstime.com, supplied May 2009.

Saudi Arabia’s economic progress has looked tame ever since new kid on the block Dubai exploded on the scene with its promise of Westernfriendly finance and a liberal approach to expatriates living and working in the emirate. Gulf neighbours Abu Dhabi, Bahrain, Qatar and Oman have followed with strategies for growth while pedestrian—and ultra-conservative—Saudi Arabia has remained the region’s sleeping giant. While the sovereign wealth funds of other Gulf states invested in hedge funds and private equity and took stakes in western banks, the more cautious Saudis largely parked their investments in US and European government bonds. It was the sort of steady-as-she-goes strategy which once was scorned but makes the kingdom look prescient and the potential opening of foreign ownership makes it a highly attractive investment, reports Mark Faithfull.

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“It is a very different market in that 80% of the population are from the country. So the global situation has not been as difficult because there is real and continuing need because of the demographics—the average household produces five children and so the country has a young and growing demographic,” adds Fadi Moussalli, Dubai-based regional director of property agent Jones Lang LaSalle. “That means massive potential for affordable housing, healthcare, education and retail.”

While the plunge in oil prices has hurt, the Saudis have more than $500bn in foreign assets—enough to pay for five years of imports—and an additional $226bn in deposits in the domestic banking system. Riyadh plans to draw on these funds to increase infrastructure, education, and healthcare spending by an estimated 10% this year to about $150bn.

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That said, the sudden collapse in the barrel price of oil will not leave the country untouched should the softening prove to be prolonged. “To balance the state budget the Kingdom of Saudi Arabia (KSA) has to pump oil at $30 per barrel and we are not that far above that at the moment,”reflects Moussalli. “So it is possible the balance could fall below income and Saudi is now more interested in foreign money—a dose of oxygen into the market.”

Currently foreign investors are unable to invest directly in property but they can buy shares in Saudi firms through swap arrangements with local brokers under significant rule changes put in place in August. Moussalli believes that the kingdom will look at relaxing rules for foreign ownership from other Gulf Cooperation Council (GCC) countries first: “Foreign ownership will come but it will be GCC countries first, then international. One step at a time,”he says.

Current approach Benoit Bellerose, chief financial officer of Saudi Arabian developer Dar Al Arkan, is keen for that foreign investment to be encouraged and believes that although the current approach has prevented a boom and bust cycle in the country, foreign money is required to help relieve the supply shortage.

“It is a long-term process. Going to the swap mechanism is a good start,” he says.“They want to monitor it and make sure it is working well before it becomes a free market. There is no doubt that in the long run, that is where they want to be.”

Saudi Arabia has gone about setting itself on a sustainable footing and generating new real estate with equal doses of both pragmatism and wild ambition. To train its workforce and encourage domestic employment it

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introduced a ‘Saudiisation’ programme several years ago—a controversial system whereby employers have been leaned on to ensure a high quota of Saudi workers in the workforce rather than filling all their posts with expatriates. While most businesses have publicly backed the plan, behind closed doors employers admit that it has caused a massive staffing headache as expatriate workers tend to be more highly skilled, cheaper and harder

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Continuing urbanisation will be a major driver of real estate growth. As well as the rapid expansion of its existing cities, notably Riyadh and Jeddah, six Special Economic Cities (SECs) are being developed, which by 2020 are expected to account for up to 30% of the Saudi economy and house 4m to 5m people.

working.“Unlike other GCC countries the population and the workforce is dominated by the indigenous population. However, the distribution of wealth is not as even as other parts of the region,” adds Nick Maclean, head of property firm CB Richard Ellis’s Middle East office.“But the skills-set is improving and workforce mobility is better than a year ago.”

Continuing urbanisation will be a major driver of real estate growth. As well as the rapid expansion of its existing cities, notably Riyadh and Jeddah, six Special Economic Cities (SECs) are being developed, which by

2020 are expected to account for up to 30% of the Saudi economy and house 4m to 5m people.

The Saudi Arabian General Investment Authority, the government agency responsible for development strategy, is initially focusing on four integrated SECs: King Abdullah Economic City (KAEC) in Rabigh, north of Jeddah; Knowledge Economic City (KEC) in Madinah; Prince AbdulAziz bin Mousaed Economic City (PABMEC) in Ha’il and Jizan Economic City (JEC) on the Red Sea Coast. A further two economic cities are being planned, one each in Tabuk and the Eastern Province. The new cities will combine the status of free trade zones with state-of-the-art infrastructure and integrated new urban development.

The KAEC is located mid-way between Mecca and Madinah and the commercial hub of Jeddah. It encompasses 168 sq km (about the size of Liechtenstein) and is being developed by Dubai-based giant Emaar, while the KEC, situated in Madinah, is being designed to develop the kingdom’s technology base, creating 20,000 jobs.

PABMEC is in Ha’il, 720km north of Riyadh, and is slightly smaller than KAEC, covering an area of 156 sq km.

The city will be developed by the private sector, headed by Rakisa Holding Company.

Heavy industry JEC is intended to become another all-inclusive city similar to KAEC and 725 km south of Jeddah; it will have its own desalination plant and a power plant. Heavy industry will be a key sector for investment, with plans in hand for a privately owned oil refinery, a steel factory, a copper smelter and an aluminium complex.

Bahrain-based International Investment Bank has confirmed that it

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Country Report SAUDI ARABIA: BOLD PLANS FOR THE FUTURE

is looking to invest in the Saudi real estate market this year as a partner in a $500m project. Chief executive Aabed Al Zeera says that it will be partnering with real estate companies in Saudi Arabia because of rising demand for housing. Similarly, Dubai sovereign wealth vehicle Limitless is planning a $12bn community called Al Wasl, to the north of Riyadh.

However, Saudi Arabia is looking more attractive to business. The country is by far the biggest market in the region. King Abdullah has introduced changes in the government, getting rid of some conservatives and in February appointing a woman as deputy minister of education, the highest ranked position for a woman in the history of the kingdom.

Massive redevelopment Despite the influx of investment, not everything is rosy in Saudi Arabia.

“There has been massive redevelopment of Jeddah to compete with Riyadh but projects like the KAEC are indicative of the KSA’s reliance on outside companies to provide construction and development and the credit crunch may well impact those companies’ abilities to do that,” warns Maclean.“There is no doubt that there is demand for facilities but whether that demand is sufficient for a project like KAEC is another question. The market has appeal for the oil and gas sector and defence contractors but not currently for other sectors, it lacks diversity so there are a limited number of potential entrants, but that could change.

“The government is looking at manufacturing, at bringing in global corporations and at tourism. It is a changing environment and one that will be very different 20 years from now.”

In addition analysts forecast 2% real gross domestic product growth this year, down from 4% in 2008 and banks have tightened lending, so the Saudis will have to pull back on some of the big projects. A $20bn Saudi Aramco petrochemical plant with Dow Chemical at Ras Tanura has been delayed and will not start until 2014 and Riyadh will almost certainly need to give more financial support to projects, even though they were supposed to be largely financed by the private sector.

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Maclean believes that a GCC-wide strategy could be the way forward: “The GCC markets are also starting to compete for health tourism, aiming to attract surgeons and to provide an alternative to Geneva and London. Saudi, Qatar and the UAE are all aiming to provide family-friendly hospitals – the next step is to attract top surgeons on flying visits”.

modern needs. There is also a lack of housing for expats on compounds, with a 10-year waiting list.”

However, he also warns that the pace of change will add its own pressures.“Saudi is not an easy market in which to work and change will trigger social pressure,” he says. “For politicians they have the problems of the bombs of 2003/04 and hardline attacks, though not frequent, tend to come in waves. Modernisation will create tension.”

Part of that modernisation is in improving legislative strictures. In March the country decided to ban the sale of off-plan properties as a step towards setting up stringent regulations for the kingdom’s real estate sector. The move banned the promotion and sale of real estate on the basis of development plans without the consent of a committee comprising representatives from the Saudi Ministries of Commerce and Industry, Municipal and Rural Affairs, the Saudi Arabian Monetary Agency and the kingdom’s General Commission for Housing. It covers the sale of residential, commercial, office, service and industrial units.

The way forward Investors are anticipating that at least some mega-projects will continue. A $10bn refinery venture with France’s Total looks solid and major initiatives such as KAEC are unlikely to be shelved. “Once we get to the other side of the valley of the global recession,” says Brad Bourland, chief economist of Riyadh-based Jadwa Investment, “Saudi Arabia will emerge as an extremely attractive place to invest.”

Moussalli adds, “There is a great need for infrastructure improvements.

Most of the office buildings available are obsolete. They are not adapted for

Maclean believes that a GCC-wide strategy could be the way forward.“The GCC markets are also starting to compete for health tourism, aiming to attract surgeons and to provide an alternative to Geneva and London.

Saudi, Qatar and the UAE are all aiming to provide family-friendly hospitals – the next step is to attract top surgeons on flying visits,” he says. “To me there is an opportunity for the GCC countries to work together.

There are only six of them so unlike the European Union it is easier to make decisions and there is an opportunity for them all to define their own roles clearly within a larger regional plan.”

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Country Report MIDDLE EAST BANKS REBUILD MARKET SHARE

The Middle East’s banking sector appears to be biding time until the global markets turn upwards. Will the bank’s be encouraged to move before time? Certainly, while investor sentiment appears to be rising throughout the region, reflected in an uptick in most of the region’s stock exchanges, internal demand for credit remains stubbornly low. However, local banks appear to be surviving the crisis, with across the board reporting of modest but definite upticks in profits: although most banks concede that corporate lending and traditional banking business is at a lower level and that the make-up of banking revenues continues to change.

HERE IS A growing urgency across the Middle East to revive a quiet capital market. Certainly, in the Gulf, analysts point to indications that general business sentiment is reviving. SHUAA Capital, for instance, issued its second monthly GCC Investor Sentiment Report in late May, which draws together the submissions from international and regional institutional investors and attempts to formulate a GCC Investor Confidence Index. Looking at the region as a whole the report notes that whole investors felt that economic conditions were more likely to improve over the next six months across GCC markets (60.6%) and global emerging markets (59.2%) than BRIC nations (50.7%).

Oliver Schutzmann, chief communications officer at the firm and author of the Investor Sentiment Report says: “The United Arab Emirates saw a modest increase in

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Photograph © Dawn Hudson/Dreamstime.com, supplied May 2009.

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Country Report MIDDLE EAST BANKS REBUILD MARKET SHARE

Hisham Ezz Al-Arab, CIB’s chairman and managing director . Photograph kindly supplied by CIB, May 2009.

investor confidence in May with the SHUAA UAE Investor Confidence Index seeing an improvement of 4.4 points, moving to 107 points from 102.6 points in April.

This performance is slightly behind the GCC Investor Confidence Index itself which increased by 2.7 points to 112 points in May from 109.3 points in April. “Whilst the current investor sentiment is weak for the UAE with just 11.3% of investors reporting positively about the overall economy, the outlook is very different. Some 43.7% of investors expect the UAE economy to improve over the next six months, with just 16.9% anticipating a decline in the overall economic condition,”notes Schutzmann.

Investors rank the Abu Dhabi Securities Exchange as the most undervalued market in the region (43.7%), according to the report, although slightly down on being ahead of the Saudi Stock Exchange (38.0%) and the Dubai Financial Market (31.0%). “Looking ahead six

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months, 59.2% of investors, a significant rise on last month, felt that ADX stock prices would rise ahead of the Doha Stock Market (49.32%) but behind the Saudi market (63.4%),” notes Schutzmann.

“An overwhelming 60.6% of investors are calling a bottom for the Saudi Stock Exchange (Tadawul), while 21.1% are undecided and 12.7% remain bearish. For the Doha Stock Exchange 40.8% see the bottom, while 28.2% remain undecided and 21.1% have a negative view on the stock market.

Positive signs are also evident for the Abu Dhabi Stock Exchange with 35.2% of investors calling a bottom.

Although 43.7% are not calling a bottom for the Dubai Financial Market, the majority of investors are either undecided or positive.”

The region’s banks have been consistently reporting an uptick in profits, albeit with significant changes in the make up of business. A trend that might have long term implications for fund raising in the region. However, a dampened capital markets has impacted on banking business, certainly in the corporate sector; both on the level of profit growth and in the make up of revenue.

In part, this is due to the obvious fact that the region’s capital markets remain in the doldrums. Initial public offerings (IPOs) in the Middle East raised Dh306.8m ($83.6 m) in the first quarter (Q1) of this year, only 2.1% of the amount over the same quarter last year. First quarter issuance figures across the Middle East, recently released by accounting major Ernst & Young shows that the global financial crisis has had a deep impact on the regional IPO market. Even with a relatively rich and liquid marketplace, it appears that the timeframe for recovery will be much longer than anticipated. There are, however, many

quality companies from both developed and emerging markets, which have delayed or deferred their public listings. These companies continue to ready themselves to go public while waiting for market conditions to stabilize.’

According to the Ernst & Young report, which covers the Gulf States in detail, there was a significant drop in capital raised, as only two IPOs were launched. Saudi Arabia’s Etihad Atheeb Telecommunications Company, which raised $80m and listed on the Riyadh Stock Exchange, was the largest IPO in the Middle East during this period. It was ranked third in terms of capital raised amongst a total of 50 IPOs worldwide, all of which raised just $1.4bn.

A Syrian company, Al Adham Foreign Exchange Company, was the only other regional IPO in Q1 2009. It raised $3.62m and listed on the Damascus Stock Exchange.

According to Azhar Zafar, head of mergers and acquisitions, Ernst & Young Middle East, ‘The deal threshold required to make the top 20 global IPO list has fallen significantly over the past year: $6.84m in Q1 2009 compared with $126.9m in Q1 2008.

The difference between the threshold values for the top ten is even more marked, falling from $416.5m in Q1 2008 to $10.11m in Q1 2009.’’

Phil Gandier, head of transaction advisory services at the firm notes that, “Of the 136 regional companies that have announced IPO plans, we do not expect more than a handful to list during the next quarter. The regional IPO juggernaut of 2007 and 2008 has come to an abrupt halt over the last two quarters. A turnaround in its numbers will be based on signs of global economic recovery. Firms are assessing investor appetites and market sentiments before committing to any plans. The long term outlook

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can potentially make up for slack in the short to medium term periods.”

Data from Dealogic shows that globally, 37 IPOs have been postponed or withdrawn in Q1 2009, which follows from 85 in the previous quarter. The decline may be due to lower levels of filings in recent months. However, the 2009 IPO pipeline remains robust.

While, the dearth of capital markets activity have been amply reflected in the make up of banking revenue through the region, it has not stopped the region’s banks continuing to register growth. According to official figures by the Saudi Arabian Monetary Agency (Sama), for example, Saudi banks have made approximately SR11.3bn in net profits in the first four months of this year. At an average monthly of about SR2.83bn, the profits are higher than the average monthly earnings of SR2.49bn recorded in 2008. Saudi bankers have said the healthy profits were achieved due to a sharp decline in provisions for impaired assets and higher net interest income because of the widening rate margin.

Eisa Al-Eisa, Samba MD and CEO, Samba Financial Group, whose net profits increased by 54% over the last quarter of 2008 to SR1.3bn, up 6% on a year on year quarterly basis, acknowledges that the markets have been challenging for the global industry as a whole. Nonetheless, “Deposits grew by 4% to SR 124 billion over the same period last year. Annualized return on assets rose to 2.9% versus 2.7% in the 4th quarter last year, while return on equity rose 26% over the 4th quarter last year,”portending the ability of the banking group to leverage opportunity when it arises.

It is a view reflected by Richard Groves, managing director of SABB, said: “The first quarter 2009 performance reported by the bank is

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encouraging and demonstrates our continuing commitment to delivering sustainable results from our core banking businesses. The quality of our balance sheet remains strong based on long-term relationship lending, with surplus deposits invested predominantly in Saudi government instruments or with the Saudi central bank. The SAR12.7bn ($3.3bn) or 19.1% increase in loans and advances compared to 31 March 2008 has been more than covered by the $4.9bn in customer deposits, a 23.2% increase.

This has allowed SABB to maintain a strong liquidity position.”

The term reliance on local government instruments as a revenue generator complements the fact that corporate financing volumes are down across the board.

Moreover, opportunities for fee income are also curtailed in the current climate.

Mergers and acquisitions throughout the Middle East and North African region, for instance, have fallen by a massive 66%, according to an end of May report by Ernst and Young. Only 47 mergers and acquisitions transactions were announced in the opening quarter of this year, around a third of the 140 deals announced in Q1 2008. Within these, outbound deals fell from 48 deals in Q1 2008 to 11 deals in Q1 of 2009, a drop of 77%, and the number of inbound deals also fell from 20 in Q1 of last year to 5 in Q1 2009, reflecting a drop of 75%. Domestic (MENA) deals fell 57%, from 72 to 31 in Q1 2008 and Q1 2009 respectively.

Azhar Zafar, head of mergers and acquisitions at the first notes, “The drop in the number and value of deals in the Middle East is reflective of the global economic recession and follows the trend in world-wide M&A activity.

Deals within the MENA region have fallen by 57%. However, it is worth noting that inbound and outbound deals into and from MENA have fallen

in excess of 70%, showing that investors are looking inwards and are more cautious when it comes to crossborders deals. The Q1 statistics for 2009 also confirm our experience of the market place. Investors took more time or did not make decisions as they were unsure of how much bad news was yet to come. However, astute investors continued to acquire companies with good business models and sound cash flows at reduced valuations.”

Deal sizes have also been impacted, with the average transaction falling by almost half to $116m this year from $215m last year. Moreover, the value of disclosed deals over the quarter fell by a whopping 73% (from $42.2bn last year to $11.5bn this year). Domestic deals saw a fall of 79% in terms of value (from $8.8bn to $1.9 bn this year.

Energy, oil and gas was the top sector for regional mergers and acquisitions in the first quarter of this year, with six deals while Financial Services and Banking had five deals and Telecom had four. Going forward, Azhar thinks that M&A activity in the next several quarters will be dependent on the availability of liquidity in the marketplace and the willingness of sellers to accept realistic valuations.

“However if liquidity continues to remain tight, we could expect to see mergers especially as declining revenues and margins would force competitors to consolidate in order to reduce costs and continue operating profitably,”he concludes.

The challenging environment is encouraging the region’s banks to best leverage existing client relationships and cross-selling wherever feasible. It is a strategy, clearly extant at Egypt’s CIB. The delivered net profit after tax of EGP1.615m for the last quarter of 2008, its last reporting period, up 31.01% compared with the last quarter of 2007, however the management

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acknowledges that the make up of revenue is altering, and that trend has been underway for some time. As a consequence CIB management believes that the key success factor in any growth ambitions is building “adequate capacities to ensure the sustainability of our business,” says chief executive Hisham Ezz Al-Arab, CIB’s chairman and managing director . “Accordingly, during the last 2 years the bank has been actively implementing an extremely ambitious organic growth plan.”CIB intends to capitalise will capitalise on the strength of its corporate banking franchise through developing a proactive approach in the key relationships. “This entails, support clients with tailored financial and innovative business solutions. In addition, “cross-selling between both corporate banking group and the SME segment” is expected to help expand market share. Furthermore, the bank will leverage on its international relationships and correspondent network to boost fee based income. It appears to be working, as the bank beat forecasts by posting a 1.4 pct rise in first quarter net profit to $83.9m for the first quarter.

While undergoing a testing period, the region’s banks appear to be committed to expanding their reach across the zone. Arab Bank in Jordan, for one, is approaching the future proactively. “we still have been expanding into new business; for example, we launched Islamic Finance windows in Qatar and the UAE and are about to begin the operations of our newly established, fully owned Islamic subsidiary, Arab Sudanese Bank,” notes Abdul Hamid Shoman, Arab Bank’s chairman and chief executive.

Banks in the Middle East might be revising and redrawing their business growth plans for some time to come.

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A STEADY FLOW O With a US crude oil price now well above the key $50/pb support level again, and every indication that OPEC will steer it higher still, there is a wave of fresh money looking for a home in Islamic investment.

Photograph © Youdesign/ Dreamstime.com, supplied May 2009.

There is much cause for optimism for new Islamic offers, writes Simon Watkins. April saw Abu Dhabi raise $3bn in its first sale of bonds in two years, priced to yield 340 basis points (bps) over US Treasuries (+USTs), and $1bn of 10-year bonds priced to yield 380bps over USTs. Given that these were the first such issues at all since September last year, they were of particular import. “They mark a very important first step in the right direction of establishing the needed yield curve to give some sort of benchmark indicating where to price regional fixed income debt,” says Mary Daunter, director of Insinger de Beaufort, in London. What next?

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OF ISLAMIC ISSUANCE ith a US crude oil price now well above the key $50/pb support level again, and every indication that OPEC will steer it higher still, there is a wave of fresh money looking for a home in Islamic investment. This money is coming both from the Middle East, and from burned West-averse investors. In consequence, thinks Jarmo Kotilaine, chief economist at NCB Capital, in Jeddah, 2009 could mark the alltime record year for sales of new sukuk securities, led by issuers from the Persian Gulf, with an estimated $39.3bn of new issues very definitely in the pipeline. In this respect, he says, quite aside from the stillperceived lower risk profile of such investments by Western investors, further attention has focussed upon them as, against a backdrop of plummeting Western interest rates, sukuk yields have become much more

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According to local banking sources, sales are already planned for Emaar Properties ($2bn sukuk), Doha Bank ($1bn sukuk), Islamic Development Bank ($1bn sukuk), and First Gulf Bank ($2.5bn sukuk), to name but a few notables. attractive. In fact, although down from a record high of 14.9% on February 11, the average yield on corporate and government sukuks now stands at just under 12%, according to the HSBC-Nasdaq Dubai indices, a spread above Libor of just under 10%. “Despite the fact that we saw a drop in new bond issues in the Middle East of around 80% during 2008, sukuk actually maintained their market share, and we have seen governments make sure that markets are available for new issues from important companies to a particular country, so we see major opportunities in sukuks ahead this year,” underlines Mohieddine Kronfal, managing director of Algebra Capital, in Dubai.

In this vein, April alone seems to have marked something of a tipping-point for new Islamic financial offerings. On the corporate side, for example, the Dubai Electricity & Water Authority, albeit a state-owned utility,

FTSE GLOBAL MARKETS • JUNE 2009

received a $2.2bn syndicated loan 18 international and local banks to refinance maturing debt, whilst the Dubai Civil Aviation Authority raised $635m in an ijaara loan (a contract in which a bank buys and then leases back an item to a customer for a specified rental price over a specific period, both agreed in advance).

This type of deal thinks Abdul Khadir Hussan, chief executive officer of Mashreq Capital DIFC, in Dubai, will be typical of the types of offers from the corporate sector that we will see in the near future: “For the next couple of quarters, the market will focus on just the high quality names –strong companies, that may include banks, but not yet at this time a sovereign issue from Dubai.”

There is certainly much scope for strong corporate issues on their own, just in this one state, as Dubai government-backed companies alone need to repay $10bn of bonds and syndicated loans by the remainder of this year, $7bn next year, and $25bn in 2011, according to figures from S&P, in New York, and the numbers do not include money owed by banks. According to local banking sources, sales are already planned for Emaar Properties ($2bn sukuk), Doha Bank ($1bn sukuk), Islamic Development Bank ($1bn sukuk), and First Gulf Bank ($2.5bn sukuk), to name but a few notables.

Given the dearth of global credit available, it is hardly surprising, then, to hear of similar Islamic bond offering plans from Indonesia ($650m, five year, in August, to be led by HSBC, Standard Chartered, and Barclays), Bahrain ($500m, five-year, in May), and Pakistan ($500m, in the next 12 months). Hot on the heels of this resurgent interest in Islamic products (Moody’s estimates that the Islamic banking industry will grow by as much as 15% this year, after expanding at an average of 25% a year in 2006 and 2007), came the announcement that the end of March that Qatar Islamic Bank, the Gulf’s biggest lender complying with Shariah banking rules, is intending to raise at least $200m for a Europe-based fund that will solely invest in sukuks. And another first came with the statement in mid-April that an as-yet undisclosed French financial institution is to issue an $1bn sukuk as early as June, marking the inaugural offering of Islamic corporate debt to be listed on Euronext (France is also to licence its first Islamic bank by the end of June as well).

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Country Report BRAZIL: ECONOMIC THAW?

Will Brazil Lead the Way to Recovery?

Henrique de Campos Meirelles, Governor of the Central Bank of Brazil, spoke with businessmen at a seminar at Sao Paulo’s industrial association, FIESP, about the impact of the financial crisis in the industry on April 13th 2009. Photograph by Adam Berry for Bloomberg News /Landov News, supplied by PA Photos, May 2009.

HE BACKGROUND TO market improvements stems from better economic data and Brazil’s scope for monetary policy easing. The central bank cut interest rates by another 100 basis points (bps) on April 29th bringing the benchmark Selic rate down to 10.25%. Many economists expect the rate to be cut to 9% or slightly more.

President Luiz Inácio Lula da Silva has been helping out struggling industries too. He has slashed taxes on cars, construction materials and home appliances, injected about $90bn in currency and money markets and has reiterated his commitment to

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Emerging markets analysts have consistently maintained that the emerging markets would walk out of the economic mire much earlier than developed markets. That did not look to be the case in the first quarter of this year, but as the second quarter matures, welcome signs of an upturn are beginning to emerge. Certainly, much warmer economic winds are being felt across Latin America and ambitious and cash-strapped companies are eyeing the region’s capital markets. Brazil, though, continues to be a bellwether with the high-yield market already re-opening, a significant rally in equity markets underway and some private equity deals getting done in the background. John Rumsey reports from São Paulo. carry out public works through the government’s so-called Growth Acceleration Programme.

Meantime, the BM&F Bovespa has been recuperating some of its lost

ground and appeal to foreign investors. The key index, Ibovespa, had sunk as low as 29,435 on the 27th October of last year, having comfortably surpassed 70,000 five

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months earlier. Since that low, the market has jumped back up to over 50,000, closing at 50,670 on May 5th.

New records are being set as the market revives. The session on May 4th saw a record number of transactions and a jump of 6.59% in the Ibovespa. That trading record was a mirror image of the previous one, set on 27th October, when the market was speeding on its way down. With April representing the highest volume in the last six months, the São Paulo stock market gained 23% in dollar terms, notes Edmar Bacha, senior economic adviser at Banco Itaú.

Encouragingly, a large part of the renewed trading volume has been stimulated by the return of foreign investors. In March, foreign capital flows other than foreign direct investment (FDI) turned positive for the first time since September and Brazilian firms were able to tap the Eurobond market, a source of funding that had been shut to them since the bankruptcy of Lehman Brothers, Bacha notes.

Even though there are signs of life in secondary markets, primary equity issuance has been moribund in Brazil for over a year, as it has in the rest of the world. Bankers are now watching and waiting for the long expected deal by credit card processor, VisaNet, which is rumoured to be preparing to revive its stalled plans for a public offering. There are suggestions that the company could raise as much as $4.5bn on its debut, when it finally comes to market.

The VisaNet initial public offering (IPO) is being talked up as a potentially attractive deal partly because competitor Redecard’s shares jumped 27% on its first day of trading back in July 2007. However, that debut was in very different market circumstances.

The buzz around bringing the VisaNet deal to market any time soon suggests

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It is proving exceptionally difficult to finalise some private equity deals because many company owners have not yet faced up to the lower valuations available in today’s financial markets.“We are seeing trouble concluding investments as it takes time for owners of private companies to adjust to the new market reality,” confirms Luiz Eugenio Figueiredo, president of Abvcap, the Brazilian private equity and venture capital association in São Paulo and a manager of private equity company Rio Bravo. Photograph of Avenida Paulista, São Paulo. Photograph © Alexandre Fagundes de Fagundes/Dreamstime.com, supplied May 2009.

that any reopening of the equity markets will initially be confined to well-established names with solid track records. Secondary market issues will also prove easier to launch, say bankers.

Private equity gains ground The space left by the moribund public equity markets has to some extent been filled by private equity deals, although even here the news is mixed.

Until the stock market started heading down, private equity firms were increasingly locked out of dealmaking thanks to generous valuations from public equity and debt capital markets, abundant credit from banks and even hedge funds that started taking pre-IPO stakes in companies in the knowledge that the shares would jump on going public. With these former competitors of private equity licking their wounds, there is a new sense of opportunity among funds.

However, two significant drawbacks remain. It is proving exceptionally difficult to finalise deals because many

company owners have not yet faced up to the lower valuations available in today’s financial markets. “We are seeing trouble concluding investments as it takes time for owners of private companies to adjust to the new market reality,” confirms Luiz Eugenio Figueiredo, president of Abvcap, the Brazilian private equity and venture capital association in São Paulo and a manager of private equity company Rio Bravo.

The other issue is fund raising.

Facing an uncertain outlook for future fund raising, private equity firms are hoarding resources and seeking out only the very best opportunities. There are bright spots. Asset-rich funds, which are able to sell assets to raise money for new investments, are at an advantage. São Paulo-based manager Tarpon’s pipeline for new deals has increased two or threefold, says partner Eduardo Mufarej. “Now we may face tough decisions such as whether to sell an investment cheap to buy something even cheaper,”he adds.

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The enormous difficulty in fairly pricing equity, both public and private, and the divergences between seller and buyer in such an unstable economic environment is unlikely to be resolved soon. That has many bankers looking at debt markets for rays of hope. Indeed, debt markets are showing more signs of life than their equity equivalents. They may be acting as the canary in the mine, a useful indicator of future activity.

A select group of companies has already tapped the debt markets. The problem is that investors are still seeking eye-watering prices even for the most blue chip of names. Recently, investors seem to be less risk-averse and rates have started to drop. The meatpacking firm JBS Friboi, which went on a worldwide acquisition spree in the fat times and is relatively leveraged, successfully placed a bond deal in April. The company was originally set to issue a $400m issue of 2014 for its US business with an indicated yield of 13%. It was able to up the size of the deal to $700m thanks to strong demand from highyield investors. Moreover, it placed amid growing problems for Brazil’s agricultural producers with companies such as Independencia and Arantes Alimentos seeking judicial protection from creditors. The Friboi deal was led

by Bank of America and JPMorgan.

Investment banking shake-out Even companies without a connection to developed markets are finding it possible to prise markets open.Telemar, the acquirer of Brasil Telecom, issued $750m in ten-year bonds, through Citigroup, Banco do Brasil, Bradesco, Itaú and Santander in April. Earlier in the year, giant construction firm Odebrecht placed $200m of five-year bonds and Petrobras was able to come to market with $1.5bn of ten-year bonds back in February.

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With the thin pickings available in markets, it is not surprising that the Brazilian investment banking industry has also been undergoing a shakeout. The staff moves are more than the usual musical chairs and brand new firms are challenging what was until recently a very cosy market. The dismemberment of Lehman Brothers after its collapse on the 15th September last year proved a seminal moment. It has helped to jump start two entrants in Brazil.

The purchase of Lehman’s Brazilian business by start-up BTG helped to get the firm of seasoned investment banker André Esteves off the ground.

Esteves then turned round and sold parts of the Lehman business to Standard Chartered Bank, which in turn gained assets totalling $4.3m and a global markets team.

Standard’s drive to expand in the country is part of a wider Latin America strategy. The bank has been picking off professionals from well-established shops as well. It hired AirtonVillafranca from Banco Santander, where he was previously international director, and earlier brought on board Eduardo Centola, former co-head of Brazilian investment banking at Goldman Sachs, to lead up its operation.

For BTG, more buying activity was in store.

The unexpected announcement by UBS that it was selling its Brazilian business, UBS Pactual, for $2.48bn was huge as UBS Pactual had built one of the country’s most successful franchises. The history of Esteves and UBS has been deeply intertwined. The Swiss bank bought Pactual operations in 2006 from Esteves and appointed the Brazilian as head of global fixed-income sales and trading. Esteves left to set up BTG last year. The UBS acquisition repositions BTG at the vanguard of an anticipated global phenomenon: a boutique investment bank.

Moreover, BTG has more than just local ambitions, asserts Esteves.

Headquartered in São Paulo, the firm also has offices in Rio de Janeiro, New York, London and Hong Kong, he notes. Esteves’ vision is to create a mid-sized, global investment house and merchant bank with advisory business. Even before the takeover of the UBS Pactual franchise in Brazil, Esteves had re-assembled a rock solid team and many of the Pactual team were to be found there, including the heads of fixed-income, currency and equities.

He emphasises the enlistment of strategic thinkers, such as Pérsio Arida, the former central bank governor and ex-head of development bank BNDES, as a key plank in his business model.

League table turmoil There is probably more change to come. The capricious mood of capital markets has thrown the league tables into turmoil. The once seemingly unbreakable Swiss duopoly of UBS Pactual and Credit Suisse, was increasingly attacked by Itaú BBA and faced inroads from the likes of Merrill Lynch, Citi in M&A and Morgan Stanley and JPMorgan in the boom. This year, on very thin new issue volumes, the capital markets leaders are all new names, according to Dealogic. In the debt markets, HSBC is followed by JPMorgan, while M&A league tables are led by Morgan Stanley and JPMorgan. Equity markets, with just one deal, are unrepresentative.

Given the combustible mix of significant shifts in team members and the fortunes of banks as well as sudden changes in the ability of Brazilian companies to tap different markets, there are going to be many more upsets in the Brazilian investment banking industry this year.

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Country Report REITS: UK TO LEAD BOUNCEBACK IN EUROPE?

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

SHOWING THE WAY Battered and bruised by the severity of the continent’s real estate crisis, Europe’s real estate investment trusts (REITs) continue to divide opinion sharply on their short-term prospects. These taxefficient investment vehicles have come to symbolise property’s bullish high. Now, after the shock of the collapse of net asset values (NAVs) in these property portfolios, a more forensic examination of their performance has begun. The result is that London—the epicentre of Europe’s real estate collapse—is emerging as an unlikely saviour for the REITs industry. Mark Faithfull reports.

OREIGN INVESTORS HAVE the opportunity for a bounce as the global economic data (while still awful) is not actually getting worse and even the transient (but still very real) fears of swine flu have been forgotten as investors quietly return to the fray. The huge sums being spent by various nations on propping up the financial sector and generating some seed corn for economic growth should, one would hope, have some effect. The very pressing worry is that most of the money will be wasted propping up major industrial units which should in normal times be allowed to fail.

It would seem the combination of Britain’s property capital value decline and the fall in sterling have made

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prime real estate in London affordable. After a period of historically low transaction volumes, deals are actually being done, allowing some of the country’s biggest REITs to work their cash flow.

That is far from being the only good news for UK REITs. Investors have been getting much more forensic in their examination of exactly “how it got this bad”and some confidence has returned to the sector, which has punched above its weight in attracting fresh funds.

Although UK REITs comprise only 2% of the equity market, it has raised 12% of the rights issue monies as real estate businesses seek to balance their capital value requirements. With REIT shares on deep 25% discounts with 6% dividend yields, there have been five

rights issues by REITs in 2009. The first was a small issue by Workspace; then, in quick succession, came Hammerson, British Land, Land Securities and Segro.

These raised over £2.65bn, considerably more than the market expected.

Patrick Sumner, chair of industry body REITA, adds:“These issues were fully underwritten, and the response from general investors was broadly positive. The discount offered provided an interesting entry point, with a juicy yield and a reasonable cushion against further value erosion.

But there remains a question mark over those companies that have yet to raise new money. The rights issue opportunity has probably passed, and the only route is now asset sales, but at what price?” We may find the

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answer to that question sooner rather than later. In late April, shopping centre REIT Liberty International affirmed plans to place new shares to reduce its burgeoning debt. Liberty intends to place between £470m and £570m of new ordinary shares with institutions and needs to raise at least £350m to pay down debt. However, Liberty’s issue is not underwritten, like the transactions by the UK’s other REITs, and some analysts believe it may simply have delayed too long and that whatever amount it manages to raise may not be enough.

The company has estimated that £500m equity will cover a potential 30% decline in values but Collins Stewart analyst Aaron Guy, who estimates a 25% fall in values for the company, counters it will“leave little headroom by the end of the year, assuming the above estimates of decline actually occur.”

Investment Property Databank estimates that peak-to-trough commercial property had fallen 41.4% by the end of the first quarter. While property values are forecast to plunge another quarter in 2009, the prediction for 2010 has eased to a fall of less than 3% and analysts such as Nomura issued NAV upgrades in April, arguing that the UK Government’s quantitative easing could not only stop the property decline but re-price prime buildings where credit quality is strong and the lease length is long.

Nomura Real Estate has upgraded its target prices for UK REITs by 9% on average, Driven by increased NAV forecasts for 2010, the first upgrade by the property analyst team for 30 months. In a sector note, the broker said its upgrades indicate positive real estate returns in 2010, with REITs shares leading the recovery by six to 12 months.

Analyst Mike Prew explains: “We believe that the arbitrage between public and private real estate is shifting

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back in favour of REITs. It appears that real estate’s devaluation is moderating and investment turnover is picking up.

We believe buyers are focusing on prime buildings with leases long enough to see through the rental recession.

“The Bank of England printing money through quantitative easing will, we think, set a floor under the corporate bond market and underpin real estate prices.”

The market is now looking for a symbolic “green shoot” and that may come from British Land. It had to give away a four-year, rent-free period to pre-let 38% of Ropemaker Place in the City of London, but it has sold 2-3 Triton Square, on Regent’s Place in London, for £115m at an initial yield of 7.2% against a valuation of 6.7% in December. It has also disposed of half of its stake in shopping centre Meadowhall in Sheffield and may be about to dilute its interest in London’s Broadgate Estate after it entered talks to sell half of its £2.5bn holding to private equity investors.

Partial sale The company is in negotiations with the Macquarie-backed Australian fund manager MGPA about a partial sale of the office campus, a legacy asset from its deal-making during the last recession.

Hammerson and Land Securities are also close to securing the sale of two properties in the City of London for a total of more than £560m. The State of Oman is in exclusive talks with Hammerson to buy its Bishops Square development in Spitalfields for more than £460m and Land Securities is close to selling its One Wood Street property for £100m to fund manager Aerium, at a yield of 6.8%.

The deals add to the growing sentiment that transaction volumes in central London will pick up during the remainder of the year, as international

investors in particular begin to realise that prime real estate is now cheap.

“The assumptions on which the rights issues were based were that the companies should protect themselves against a peak-to-trough fall in property values of 60%,”says Sumner.

“The IPD index has fallen 40% so far and is expected to fall further. REIT managers can do little to influence market pricing, but they can work closely with tenants to maintain or limit falls in rental income.” In fact, there is increasing speculation that the REITs are mulling bond buybacks, following the example set by banks.

Flush with cash from their rights issues, the REITs are setting aside funds to buy heavily discounted bonds or commercial mortgagebacked securities (CMBS). Demand for CMBS has collapsed ever since the crisis hit the market for such complicated credit vehicles early in 2007, leaving trading in secondary markets at a standstill.

In April, Canary Wharf Group, the operator of London’s second biggest financial district, bought back notes with a total face value close to £120m for £35.5m, with discounts ranging between 50% and 80%. The success of the deal, which slashed £84m off the group’s long-term debts, has ramped up the probability of big bond buybacks in the sector. Land Securities has fuelled speculation that it will take this route after banking the fresh capital from its rights issue rather than paying down borrowings.

There is also growing institutional investor interest in residential property as an asset class, with residential property values continuing to fall and rental yields improving. However, Peter Cosmetatos, operating director of REITA, says: “Residential property investment has generally tended to offer a modest income yield, with total returns brought up to attractive levels

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by capital appreciation. Falling capital values improve the income yield, but investors should probably be thinking of capital appreciation as a bonus and not as an essential component of the return from residential property.”

So is the worst really over? The UK is generally agreed to be ahead of other developed European markets in value adjustments—an industry euphemism for the fact that the bottom fell out of the UK real estate market first—although certain markets, such as Spain, Ireland and central and eastern Europe are in worse shape. Investment values in the other REIT markets, France, Germany and Italy, are falling, but from less dizzy heights and with less inherent leverage.

Any positive news from the UK would inevitably have a feelgood impact on other western European REIT markets, although eastern Europe’s problems are too entrenched to feel much benefit.

“There are some signs of confidence in the general world economy,” says Colin Dyer, CEO of Jones Lang LaSalle. “Worldwide, REITs are up from their lowest by up to 50% and are beginning to attract equity and debt capital again, with $6bn being raised in the US alone, but, to date, we have seen little positive impact on commercial real estate markets, which have continued to trade poorly.”

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To track global developments, FTSE Group launched its new FTSE EPRA/NAREIT Global Indices in March. Following the December 2008 expansion of the FTSE EPRA/NAREIT Global Real Estate Index Series to include emerging markets, the new global indices now represent a composite of both developed and emerging sub-sets.

“Globalisation of REITs and public real estate will continue to grow, driven by the fact that investors worldwide are seeking diversification, but diversification can only be achieved when coverage includes both geographic and property type exposure,” says FTSE’s head of alternatives Ronnee Ades.

“The focus in 2008 switched away from capital raising as fund managers and investors sought to resolve issues in existing investments,” says Georg Allendorf, managing director of RREEF Spezial Invest and vicechairman of non-listed property organisation INREV. For 2009, the downward trend is expected to continue, with fund managers planning to raise €6.1bn, a further decrease of 41%. The ratio of capital called in to capital raised could reach 80% compared with a four-year average of about 50%.

Not everyone shares in the optimism for REITs, however. JPMorgan has downgraded its forecasts and in a recent note declared:“We estimate that still 44% of European property stocks face issues regarding upcoming refinancing and potential covenant breaches. We still believe more companies need to take action; for example by issuing equity or buying back debt at discounted prices.”

The UK REIT sector was generally disappointed with Chancellor Alistair Darling’s Budget, which failed to make the called-for changes to REIT rules, although Darling did introduce technical changes to REIT legislation to make it “clearer and more consistent”.

Most importantly, REITS will be able to raise funds by issuing convertible preference shares. There will also be an amendment to the“balance of business asset”test, which requires 75% of REIT assets to be income-producing.

Despite the perceived lack of action by the UK Government, for British REITs the opening months of 2009 may finally be a light at the end of the tunnel. If the UK’s biggest property players can weather the storms of 2009 then Britain’s recession-ravaged REIT sector might just come to be the unlikeliest of white knights for Europe’s REIT and listed property funds markets.

FTSE EPRA/NAREIT GLOBAL INDICES: Data as at: 21/05/2009 Index Code

Index Name

Number of constituents

Euro Index

Euro TRI

Mcap (EUR)

Dividend Yield

ENHG RNGH ENHE RNHE ENHA RNHA ENHP RNHP ENHN RNHN ENHU RNHU ENHM RNHM

FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE FTSE

326 326 228 228 131 131 101 101 94 94 83 83 11 11

839.33 839.33 949.09 949.09 707.77 707.77 992.13 992.13 852.73 852.73 827.46 827.46 1146.75 1146.75

869.46 864.14 979.88 977.17 737.4 728.63 1019.38 1018.91 888.95 883.14 861.48 855.67 1205.92 1200.99

323951.9898 323951.9898 215827.698 215827.698 125149.6528 125149.6528 140687.945 140687.945 58114.39205 58114.39205 52898.49597 52898.49597 5215.896077 5215.896077

5.80% 4.90% 5.63% 5.20% 6.09% 4.31% 5.06% 4.97% 6.96% 5.96% 6.78% 5.77% 8.77% 7.89%

EPRA /NAREIT Global Index EPRA /NAREIT Global Index Net TRI EPRA /NAREIT Global Index ex US index EPRA/ NAREIT Global Index ex US Net TRI EPRA/NAREIT Americas Index EPRA/NAREIT Americas Index Net TRI EPRA/NAREIT Asia Pacific Index EPRA/NAREIT Asia Pacific Index Net TRI EPRA/NAREIT EMEA Index EPRA/NAREIT EMEA Index Net TRI EPRA/NAREIT Europe Index EPRA/NAREIT Europe Index Net TRI EPRA/NAREIT Middle East & Africa Index EPRA/NAREIT MIddle East & Africa Index Net TRI

Source: FTSE Group, May 2009

FTSE GLOBAL MARKETS • JUNE 2009

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Index Review INDEX REVIEW: ON A KNIFE-EDGE

Hold onto Your Hat There may be signs of an upturn, but fiscal stimuli and bailouts amount to a huge fiscal black hole so we all face huge tax hikes before long. That is going to push any real growth way out into the distance. Simon Denham, managing director of Capital Spreads, reads the runes.

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

but, in reality, there is precious little to back up a serious long-term bull run.

Not only this but, for those of you with longer memories, the current woes pale into insignificance against the real levels of pain experienced in the early 1980s and 1990s at the back end of those downturns. We are continually told that this is the worst economic situation for 50 years and yet, to be honest, there appears to be little evidence on the ground to that effect.

As the tax burden increases and more people join the ranks of the unemployed there is an increasing fear of serious breakdowns in public order, not just in the UK. Multiply this effect across the globe and you end up with an enormous number of angry young men with nothing to do and no money with which to do it. Let us also remember we are still on the way down economically.

In the UK, the Chancellor has produced, probably, the most ridiculous budget in living memory, relying on a series of events that is akin to the Red Queen believing as many as six impossible things before breakfast. While it is tempting to have a sense of sympathy with poor old Alistair Darling over the poisoned portfolio he inherited from his boss, his response in penalising one sector of society (the very wealthy) in a blatant attempt at electioneering is pathetic. Rather than addressing the real problems in our economy he has revealed the total paucity of either intellectual

capacity or any courage whatsoever at the heart of this administration.

Unfortunately, the past 12 years of economic mismanagement has built a structural burden on the economy in the guise of a massively bloated public sector sucking on an increasingly weakened private arena. Even if we take out the £50bn (one-off) contribution to the banking sector, we will still be left with a shortfall of £125bn this year and an even greater one in the next. This represents a near 10% of gross domestic product black hole. Initially the slack will be taken up with gilt issuance but if the economy does not grow reasonably quickly after 2009/10 then appetite for UK debt will ease off significantly except at ruinous interest levels. At some point everyone (not just the wealthy minority) will have to pay considerably more tax every year for a very long time indeed.

It is this future burden that is preoccupying investors at the moment.

UK hopes of a pickup towards the end of 2009 are balancing on a knife edge but my real fear is that no matter what happens, any small signs of growth are going to run full tilt into massive tax hikes initially, in 2010, for the very wealthy but then, in a series of ever increasing pain levels, for everyone else. In the face of this problem, real growth (i.e. non-public sector) is likely to remain a long, long, way in the distance.

As ever ladies and gentlemen, place your bets.

ARKETS HAVE TAKEN the opportunity for a bounce as the global economic data (while still awful) is not actually getting worse and even the transient (but still very real) fears of swine flu have been forgotten as investors quietly return to the fray. The huge sums being spent by various nations on propping up the financial sector and generating some seed corn for economic growth should, one would hope, have some effect. The very pressing worry is that most of the money will be wasted propping up major industrial units which should in normal times be allowed to fail.

As in classic economic case studies this will probably mean that well-run units, which will receive no state aid, will falter and be dragged down by subsidised competition from the mortally wounded. The overall impact on the sectors involved will be lower funding for reinvestment, marketing and ultimately curtailed growth. In normal times state fiscal stimuli are generally triggered only after the worst has already happened and any new money can be used to aid the survivors. In today’s swirl of political desperation one is left with the unavoidable conclusion that major economic decisions are being made merely on the grounds of avoiding immediate bad news rather than on their individual long-term merits.

The recent market rally is all very nice and most players have made a tidy little bundle on the bounce back

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Stock Exchange Report LONDON’S AIM: SOME CANADIANS THINK AGAIN

Photograph © Mxk/Dreamstime.com, supplied May 2009.

ALL THAT GLISTERS AIM, the junior UK stock market, has been a major and particular draw for Canadian companies looking for liquidity and an understanding of their business that they could not find elsewhere. However, the junior board appears to have lost some of its lustre in the global economic downturn. Consolidation and the cost of compliance are among the reasons cited for some recent delistings. Richie Clark, of law firm Fox Williams, looks at the wider trends impacting on junior boards.

INCE ITS INCEPTION in 1995, London’s AIM has been the most successful growth market in the world, enabling companies from around the globe to raise vast sums of capital to further their businesses.

AIM’s rise was not lost on Canadian companies, which have forged a significant presence on the London Stock Exchange’s junior market, attracted by the deep pools of capital traditionally available in London, the willingness of its institutional investors to back businesses located in all corners of the globe, and the market’s flexible and principles-based approach to regulation. A key difference between

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AIM and other markets is that AIM companies are supervised by a nominated adviser (usually referred to as a “nomad”) rather than by a securities regulator. Nomads are typically Financial Services Authority-regulated financial advisers who act as quality controllers for the market, lending their reputation to the companies for which they act.

More than 30 Canadian companies are currently listed on AIM, though at least double that number have listed and tapped the UK capital markets over the years, which represents over 10% of all overseas companies on the market.

These figures do not capture a number of Canadian businesses which have

moved their domicile or put an offshore holding company structure in place, largely for tax reasons.

Apart from the obvious benefits of being a source of capital, AIM also offered a number of strategic advantages for those Canadian companies that conduct business in a sector that is more highly valued in Europe than in Canada; have assets or operations in foreign jurisdictions that may be undervalued in Canada; anticipate making acquisitions, since having a European listing may make their stock more desirable to a wider range of European and international targets. Moreover, AIM offers foreign companies a higher UK or European profile due to their operations or customers in the region. Alternatively the size of listed companies is such that they cannot absorb the regulatory compliance costs associated with certain jurisdictions, such as the SarbanesOxley regime in the United States.

Indeed, this last point has made AIM a compelling alternative to NASDAQ. AIM has provided opportunities to a number of Canadian companies which were not available in their home market.

A prime example is First Calgary Petroleum, whose extensive Algerian asset base was simply not appreciated by the Canadian investment community in the same way it was in London. First Calgary used AIM as a platform to grow,

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Stock Exchange Report LONDON’S AIM: SOME CANADIANS THINK AGAIN

before ultimately being taken over last year, realising considerable value for its shareholders.

First Quantum Minerals is another Canadian success story, growing into one of the biggest companies on AIM its takeover of another AIM-listed Canadian company, Adastra Minerals, before graduating to the London Stock Exchange’s main market. DHX Media, a television and feature film production company that not only produces Canada’s longest running comedy series but creates and licenses children’s programming in the UK and around the world, was attracted to AIM in large part due to the UK’s thriving media industry and correspondingly greater coverage of the sector. With fewer comparables in Canada, coming to AIM helped DHX obtain a better valuation of its shares than was likely had it sought to float only in Canada.

IPOs in flux A consequence of the downturn is that new capital raising for initial public offerings (IPOs) has dried up, new entrants to market are few and far between and the justification for remaining on AIM for those Canadian companies that joined in the boom times is under constant review. AIM has been shrinking, with just under 1,500 companies on the market at the end of March, down from the peak of almost 1,700 at the end of 2007. This is the result of a combination of a significant decrease in new listings— there were only 115 new admissions in 2008, down from 284 in 2007 and a record 462 in 2006—and a increase in delistings. Close to 300 companies left the market in the past year, including Canadian companies DragonWave, JumpTV, Medoro Resources and RedKnee Solutions.

There are a number of reasons for the delisting wave, but for Canadian companies three factors come into

50

play. One, in light of difficult trading conditions and the decrease in available capital, many firms are deciding that the perceived benefits of AIM no longer justify the costs of maintaining the listing. These are conservatively estimated to be upwards of £100,000 annually, when fees of the nominated adviser, broker, auditors, solicitors, PR and others are taken into account. Two, the majority of AIM companies trade higher volumes on Toronto’s TSX, where most Canadian companies also have a listing; a fact which, in turn, has led to questions about the levels of liquidity for some of those stocks listed on AIM. While liquidity can be aided by companies regularly interacting with the UK investment community to generate interest, for some their size and lack of a permanent UK strategy make it hard to get on the radar screen.

Three dual-listed Canadian companies have cited the sometimes frustrating experience of complying with a second layer of regulation, be it “light touch” or not. While on the whole compliance is generally similar, there are small differences between the regulatory regimes, such as the obligation to announce trading by directors and insiders without delay on AIM rather than the longer period provided under Canadian securities rules.

While there is some merit in these reasons, the reality across all junior markets worldwide is that those firms with a market capitalisation of less than £10m are, with very few exceptions, not going to be overly liquid and costs and the burden of regulatory compliance will necessarily creep into greater focus.

The sharp decline in share prices over the past year has brought many more companies, Canadian and nonCanadian, below this threshold.

Notwithstanding the current downsizing of AIM, and departure of a number of Canadian companies, there

are still a number of positives to take away from the state of the AIM market.

During the boom times of recent years, for instance, a large number of companies (including some Canadian firms, it has to be said) were brought to the market and which in hindsight should not have been. As a result, the recent departure of so many small cap companies can be seen as enhancing the quality of the AIM market as a whole, and reinforce the need for nomads to be more selective as to which companies they bring to market in future. For Canadian companies, this will require the evidence of compelling strategic considerations rather than a bare need for new capital.

£3bn raised While there has been far less appetite for bringing new ventures to market as IPOs, secondary fundraisings for proven companies are still happening.

Over £3bn has been raised in the past year, for instance, for Canadian companies including Bankers Petroleum, Caza Oil & Gas and Quest Capital. Additionally, opportunities are rising for Canadian companies and investors to snap up companies and assets on the AIM market which are currently substantially undervalued.

Moreover, industry consolidation has also been a positive reason for the contraction of the market, with Grove Energy, Fun Technologies among the raft of Canadian businesses being acquired. Consolidation is expected to remain a significant trend over the next year, enabling companies to gain sufficient size and asset spread to enhance their ability to obtain much needed capital. Capital markets are cyclical and AIM is no different. While conditions will remain challenging in the short term, AIM will be anything but dull in the coming months and Canadian companies will be expected to continue to play a vibrant part.

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Commodities COPPER: TAKING THE LONG VIEW

Short Term Pain, Long Term Gain?

With metal prices sky high, Californian police last year reported an increase in the number of cases of people stealing fire hydrants, particularly the brass bolts on the hydrants, which they would sell for scrap. Photograph © Sanman/ Dreamstime.com, supplied May 2009.

Copper makes a good investment case in the long term but could drop in the short term. Irrespective of the fundamentals, volatility is here to stay for copper and across commodities exacerbated by the speculative presence of large investment banks, which increasingly trade not only on behalf of their clients but also for their own accounts. Damien Honey, a partner in the commodities group at law firm Holman Fenwick Willan, says: “Banks’ proprietary desks have been getting bigger and bigger over the last five years and although the credit crunch has slowed down some of the trading, it is expected to pick up later this year and next year.” By Vanya Dragomanovich.

AST YEAR, AS metal prices soared, California police reported an increase in cases of people stealing fire hydrants, particularly the brass bolts on the hydrants, which they would sell for scrap. In one tragic case firefighters responding to a fire found five useless hydrants because all the bolts had been removed.

One bitter American blogger commented that by the time the Californian firefighters arrived those

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FTSE GLOBAL MARKETS • JUNE 2009

brass bolts, and copper wire which was also being frequently stolen, were half-way to some copper smelter in China. Although brass can be recycled, it cannot really be used in copper smelters but the blogger was right in that China remains the single biggest driver of the copper market.

Since the start of this year copper prices have risen 50%, more than any other commodity, but those brass hydrant bolts will probably be safe a

little while longer because prices are more likely to come down in the short term before embarking on a long-term rally. Yet again, China played a crucial role. The rise was not caused by broadbased buying but because China’s State Reserve Bureau was stocking up at very low prices. Investors and speculators jumped onto the coat tails of this buying spree, desperate for a good investment story after months of bad news from the commodities markets.

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Commodities COPPER: TAKING THE LONG VIEW

Like other metals, in the last six months of 2008 copper gave up a great deal of value as prices dropped from a peak of almost $9,000 a tonne (t) to just under $3,000. At those low prices, China, which has been burnt in the past when it had to pay high prices for raw materials, started buying and stockpiling the metal.

On top of that, a lot of Chinese smelters are built to operate at least partly on scrap metal, normally retrieved from old fridges and washing machines shipped from the United States and Europe. With the credit crunch, however, fewer machines are thrown away in the West resulting in a shortage of scrap travelling to China.

The country is already short of the metal and it only produces one fifth of its annual requirement so smelters had to either buy copper concentrate to make up for the lack of scrap or reduce production. Chinese wire and cable producers that also normally use scrap had to buy copper cathode—pure copper bars that are sold on exchanges.

Copper futures prices on the Shanghai Futures Exchange shot up and at the beginning of May traded at $5,500/t compared with London Metal Exchange prices of $4,600/t, prompting a flood of arbitrage buying.

Shanghai prices frequently trade at a premium to the LME to allow for transport costs which are typically a few percent of the total cost per tonne, but at a difference of $900 the arbitrage window is wide open, and LME prices have no reason to decline even though the fundamental picture does not merit copper’s stellar rise.

Copper is used perhaps more widely than any other metal in products from power cables, pipes, fridge and car parts to telephone lines, and is a good indicator of what is happening in the construction, manufacturing and car industries.

Because it is so closely linked to

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`

One of the world’s largest producers, BHP Billiton’s Escondida mine in Chile, the promised land of copper, has recently said that it found that the grade of copper in the deeper levels of the mine much lower than expected and that it produced 30% less than it had planned.

manufacturing it is relatively easy to estimate levels of future demand for the metal: it moves in close correlation with global gross domestic product (GDP) growth.

There are, however, a number of mixed signals this time around to be considered in assessing the outlook for the sector, despite the fact that Federal Reserve chairman Ben Bernanke recently said the US recession appears to be losing steam and that growth will likely resume later this year. Of the top copper consuming countries in the world, China and India are the only ones expected to show growth in GDP this year. The remaining eight, including the US and the largest eurozone economies, constituting around 70% of copper demand, are all expected to show negative GDP in 2009.

According to the International Copper Study Group, there will be an extra 345,000 tonnes of copper without a buyer this year, and this will rise to 400,000 tonnes next year. That does not compare too badly with the total of 17.23m tonnes of copper expected to be used this year, but it is a surplus nevertheless. Deutsche Bank is even more bearish and argues that the market surplus will be more in the region of 480,000 tonnes through calendar 2009.

From this point everything depends on estimates of how quickly global economy will recover. Deutsche Bank forecasts global GDP to contract by 1.9% this year but it expects that the global economy will start to grow next year and expand by 2.2%. In individual countries, the trend is much more difficult to call. For the time being, for instance, numbers emanating from the US still indicate that while the downturn in consumer spending has slowed, it has not started moving upwards. The US economy shrank at a 6.1% annual pace in the first quarter, and consumer spending, which makes up 70% of the economy, fell by more than expected in March.

Then again, once the US does start to recover it will be from a much lower base than it was at only two years ago.

The equally heralded and derided domestic stimulus package will have an effect on metals but possibly less than initially expected. Estimates suggest that the US stimulus could translate into an increase in demand for steel and copper of around 10% of domestic demand.

At this stage, there is no shortage of supply either. Unlike other metals, such as aluminium, the general decline in metals prices has not really hurt copper producers because the cost of production remains, in aggregate, well below current prices.

Deutsche Bank analyst Joel Crane estimates that the marginal cost of production—the cost at which the most expensive producers make copper—$2,700/t. Most producers, however, can turn out the metal at comfortably well below that price or a good $2,000/t cheaper than where the metal is trading on global exchanges.

Compare this with aluminium, which at the current $1,450/t is making a loss for over one third of all producers. In theory this should mean no shortages of copper going forward but analysts

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forecast that in a few years’ time the market will become extremely tight, thereby pushing up prices and profits for those same producers.

Deutsche Bank’s Crane says that copper has one of the best investment cases of all metals. Chinese demand is expected to pick up again out of pure manufacturing demand, not stockpiling. To put the figures into perspective, in March alone China imported 300,000 tonnes of copper, the equivalent of the forecast surplus this year.“Over the next 10 years China will need monstrous amounts of the metal to develop at the rate it wants to develop,”says Francisco Blanch, Merrill Lynch’s commodity strategist. He also says that the Chinese Government has gone further than the West in injecting money to help the economy and that results will start showing in increased industrial production sooner than in the more developed markets.

Moreover, once the US and Europe pull out of recession, collective demand will be such that even with new projects coming on line it will be difficult to cover the requirements for the metal.

One of the world’s largest producers, BHP Billiton’s Escondida mine in Chile, the promised land of copper, has recently said it found that the grade of copper in the deeper levels of the mine are much lower than expected and that it produced 30% less than it had planned. Some market watchers dismissed the news as spin on the part of the company in order to stop prices from continuing to fall but the fact remains that Chile is by far the world’s largest producer of copper and that if Escondida’s output continues at a lower rate it will have significant implications on the market.

Apart from Escondida’s problems there are signs that other big projects due to come on line in the next five years will be delayed. Another BHP project, expansion of its massive open

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Photograph © Emilia Stasiak/ Dreamstime.com, supplied May 2009.

pit mine Olympic Dam in Australia, which is also the world’s biggest uranium deposit, has been plagued with technical problems. More recently BHP has been grappling with financing and had to cut hundreds of jobs and slow down work on the mine.

The mine is expected to yield 750,000 tonnes of copper per year in 2014.

There are other factors that will work in favour of not only copper but commodities across the board. After what happened in the markets over the last few years, large long-term investors such as pension funds are increasingly allocating a portion of their investment into commodities as a counterbalance to the usual investment in equities and bonds. Even a relatively conservative investor such as the UK’s Royal County of Berkshire Pension Fund recently reduced its equity allocation in favour of putting assets into infrastructure, alternative investments and (9.2% of it) into commodities.

On a smaller scale, investors continue to flock into exchange traded commodities (ETC). London ETC provider ETF Securities said flows into long metals ETCs continue unabated with most of the freshly invested money going into a broad industrial metals ETC and copper and nickel ETCs. Irrespective of the fundamentals, volatility is here to stay for copper and

across commodities, exacerbated by the speculative presence of large investment banks, which increasingly trade not only on behalf of their clients but also for their own accounts.

Damien Honey, a partner in the commodities group at Holman Fenwick Willan, says: “Banks’ proprietary desks have been getting bigger and bigger over the last five years and although the credit crunch has slowed down some of the trading, it is expected to pick up later this year and next year.”

So what to do with those brass bolts and copper wire? In the short term the price is more likely to move down than up. Leon Westgate, analyst at Standard Bank, says we are moving into a seasonally weak period for demand, the time of year when factories typically close down for a period of time over summer to do maintenance work. Deutsche Bank goes even further and recommends selling three-month futures and buying futures 27 months ahead, arguing that equity markets have moved too far too fast to reflect a real recovery in the economy. The bank forecast a correction in the market and a recovery much later in the year.

However, if the banks’ long-term forecasts are correct any dips will be a good entry point for investment.

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CHERRY PICKING TALENT In the aftermath of the Madoff scandal, large institutional investors no longer appear willing to participate where an underlying portfolio of alternative assets is administered in-house. With these clients shaping the course of alternative investment psychology, self-administered fund managers will find it increasingly necessary to secure some degree of pricing independence— or possibly lose business if they do not.

Dave Simons reports from Boston.

Photograph © Dreamstime.com, supplied May 2009.

N CONTRAST TO their continental Europe and Asiabased counterparts, a large portion of US alternative fund programmes have, until recently, remained selfadministered, or use “NAV lite” administrative services (whereby a third party gathers and compiles data supplied by the fund manager, rather than seeking valuations independently). Then the collapse of Lehman Brothers, the Madoff scandal, and other key turning points came into play, which is expected to encourage regulatory lords to move quickly in an effort to right the transparency ship once and for all. This has particular urgency, following well publicised moves by such powerful hedge fund investor banks as UBP and Banque Edmund de Rothschild, that they will not invest in self-administered funds.

There remain a number of self-administered hold outs, such as Renaissance and other well-capitalised firms, but many others now believe the time is ripe to re-examine the workflow process, and have begun scouting the administration market in an effort to gain some degree of pricing independence. Citadel meanwhile has set up its own administrator, Citadel Solutions, which, says one market watcher, “could present other due diligence problems to investors on the‘too close for comfort’syndrome [sic]”.

There is little you can do to stop a really dedicated crook, thinks Butler, just keep upping the game and doing regular due diligence certainly, “however, administrators need to

I

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become au fait with immutable ways of verifying transactions and that inevitably means that administrator costs will go up”. Butler explains that three-way reconciliations will have to become the norm, in this regard. “You can approach brokers and counterparties which provide an electronic download of yesterday’s trades, for instance and through a three-way reconciliation, if it all comes to zero, you have an accurate indication of an investor’s position,” he notes. However, he points out that “with active futures funds, it is almost inevitable that two or three times a week there will be a break, with one party entering long as short say, or wrongly input numbers.

Usually it is immaterial, or even if there is a difference of a few basis points you can resolve it the next day.

However if, as with Madoff, copies of purported transaction confirms sent out by Madoff’s brokerage arm were not executed at all, how would you know? It would not be difficult for a determined crook, for example, to get hold of all the prices for the shares of an actively traded company for March 2008, for instance. He could put together a fake trading book, by designing a series of transactions, in hindsight, at the end of the month, pretending he had bought shares on day one, sold options on day two, to generate premium income, and then closed out the positions later in the month at prices which netted a non-existent 1% profit. I am not saying Madoff did this,

but I guess he did something very similar. He could sell that as real and get people to give him more money.”

With these issues in mind, “The hedge fund industry is facing a major transformation in the coming years,” holds Jeff Wells, product manager for fund administration at Chicago-based Northern Trust.“In addition to the various hedge-fund related scandals, a series of extreme events— the credit crunch, historic market volatility and the collapse of some very established financial organisations—has pushed fund managers to change their strategies, put a greater focus on regulation and transparency and turn toward independent administration.”

Not that this is necessarily an idea they would have come up with on their own. Large institutional clients continue to shape the course of alternative investment psychology, and as performance flattens or goes negative, from a compliance and corporate-governance standpoint there is a heightened awareness around the infrastructure in support of the investment management. “Many investors are simply no longer willing to participate where the underlying portfolio is administered in-house,” explains Iain Stokes, head of private equity funds, Europe, at Mourant International Finance Administration. “In the private-equity space, limited partners are seeking increased investor reporting which may be best provided by an independent administrator.”

Custom House’s Dublin office, which is authorised by the Irish Financial Regulator under

Section

Intermediaries

10 Act

of

the

Investment

1995, achieved

an

exception-free SAS70 Type II and was the first hedge fund administrator to be awarded a Moody’s Management Quality Rating.

For more information on Custom House, please review our website: www.customhousegroup.com or contact Dermot Butler (dermot.butler@customhousegroup.com)

Custom House Offers 24/5 Service Custom House Global Fund Services Limited now offers its clients a full “round the world” and “round the clock” hedge fund administration service through its network of offices which, following the merger with Equity Trust’s fund services business, includes Amsterdam, Chicago, Dublin, Guernsey, Luxembourg, Malta, and Singapore.

FTSE GLOBAL MARKETS • JUNE 2009

a member of the

Group of Companies

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Marina Lewin, managing director, alternative investment services for Bank of New York Mellon, sees a much greater reliance on external administrators in future. Furthermore, the role of administrators is becoming more operationally focused, says Lewin. While cost will continue to be a leading factor, Lewin agrees that investors will ultimately dictate the move toward outsourcing administrative functions.“They will increasingly demand that there be some form of third party that will handle certain aspects of the back office,”says Lewin.

“This can be a full outsourcing arrangement, or a more limited form of outsourcing that perhaps starts with independent price verification, asset validation or transfer agency type of work. Many of the larger companies have made considerable investments in their infrastructure and believe they are in the best position to handle the work. At the same time, they recognise that they need the assistance of an external party to provide investors with the knowledge that there is still someone independently involved.”

Trends that had already been in place prior to the upheaval of last year have been “violently accelerated,” according to Ron Tannenbaum, co-founder of GlobeOp Financial Services, a provider of business-process outsourcing, financial technology services and analytics to the buyside. Like others of its ilk, GlobeOp stands to greatly benefit as the trend towards independence continues. Last December, Millennium Management, a global multi-strategy investment management firm with over $11bn in assets under management, selected GlobeOp to handle administrative duties for its Millennium USA, Millennium International, and Millennium Global Estate series of funds.

“In order for our industry to maintain credibility with investors, there needs to be a true separation of duties among all parties involved—which means a fully independent administrator, custodian and broker-dealer,” underscores Tannenbaum.

Bob Wallace, global head of fund services at Citi, agrees that the fallout from Madoff has had a pronounced impact in the US, where self-administration has been more prevalent. “While third-party servicing has been a part of the European landscape for some time now, in North America both institutional and retail investors are now demanding an independent presence for the purpose of calculating net asset values (NAVs) and in the way certain portfolio activities are handled. Also, since these investors control the money—and distribution has always been key regardless of the product—we are now seeing many selfadministered funds beginning to have a dialogue with administrators to see how they can outsource some of their activities in order to satisfy investor demand.”

As the hedge fund industry becomes ever more institutionalised, funds will increasingly have to answer to trustees for the performance and operation of their investments, adds Chris Adams, head of product for alternative funds, BNP Paribas Securities Services. “In this environment, it is very difficult to explain to a trustee why an independent administrator who can offer a

Iain Stokes, head of private equity funds, Europe, at Mourant International Finance Administration.“In the private-equity space, limited partners are seeking increased investor reporting which may be best provided by an independent administrator.” Photograph kindly supplied by Mourant International Finance Administration, May 2009.

Ron Tannenbaum, co-founder of GlobeOp Financial Services, a provider of business-process outsourcing, financial technology services and analytics to the buyside. Like others of its ilk, GlobeOp stands to greatly benefit as the trend towards independence continues.

Photograph kindly supplied by GlobeOp Financial Services, May 2009.

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sophisticated asset valuation and accounting service has not been appointed.”

Should new subscriptions continue to lag, it will become increasingly difficult for remaining self-administered hedge fund managers to buck the trend towards valuation independence. “Investors are basically voting with their feet,” says Wallace. “It may not happen immediately, of course. However, if they do not see a tangible response to requests for third-party services, when investors do return to the market they may simply decide to look elsewhere.”

At the same time, institutional clients also want to ensure that due diligence is performed on the underlying administrator before they agree to maintain a relationship with the fund manager. “In other words, just saying that you’re SAS 70 compliant is not sufficient anymore,”remarks Jose Santamaria, director, business development for alternative investments at RBC Dexia.

Products such as over-the-counter (OTC) derivatives and illiquid instruments not only demand technological wherewithal but must equally be complemented with quantitative proficient staffing, says Santamaria.

Furthermore, those seeking administration services have become increasingly sophisticated and demand real value at competitive prices. As such, providers must be properly equipped and have the ability to handle both middle- and back-office processing functions—all at a price that is agreeable to cost-conscious managers reeling from loss of revenue.

Mourant’s Stokes says that the administration industry must change from being a “reactive back-office partner of variable quality” to a proactive middle-office partner responsible for the tracking and reporting of transactions at a cost-effective price.“As the alternative asset space is likely to become increasingly regulated and good corporate governance a priority, administrators are well placed to provide good quality support in these areas.”

The rush to retain third-party services Stateside puts added pressure on so-called NAV-lite administrators, who receive the bulk of their information directly from the managers. “They are going to have a lot more difficulty because they may not have the in-house expertise to quickly move from simply being a receiver of pricing to an actual gatherer of pricing,”notes Wallace.“This means that the larger administrators are probably better positioned to take on these new services and also have the wherewithal and the resources to make investments where they are needed most.”

Given the level of regulatory change, market turbulence and the corresponding product innovation in need of support, Adams believes that it is key that administrators be sufficiently capitalised and committed to the industry over the long haul. “There will always be a place for administrators who are able to offer a service based on niche requirements. However, the ability to offer highquality service covering a broad range of asset classes and domiciles over the long term requires significant capital investments, and the likelihood is that only the largest

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Marina Lewin, managing director, alternative investment services for The Bank of New York Mellon. Lewin sees a much greater reliance on external administrators in future. Photograph kindly supplied by The Bank of New York Mellon, May 2009.

administrators will be able to sustain this. In short, small is not necessarily beautiful.”

The ongoing turbulence has also highlighted a need for improved monitoring of counter-party risk. Accordingly, hedge funds will require that third-party administrators offer risk management services in addition to independent valuation and pricing. “Another point of diversification for funds will be the continued movement away from the prime broker as fund administrator,”says Wells of Northern Trust.

“This benefits funds by separating key providers and also opens up other value-added benefits, such as independent pricing and valuation. These market trends will create unique opportunities for administrators that can integrate traditional middle-office services with fund administration services such as accounting and back-office reporting.”

Butler at Custom House thinks that the sector will have to go one step further than that.“As a matter of policy, we will not run risk models in-house. We use a third party, as the risk is too high on all sides.”Custom House takes it to the limit in this regard, still refusing to provide middleand/or back-office administration for the manager as

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Butler believes that introduces a potential conflict—although he is open to persuasion on this subject. “Most Chinese walls are made of Gruyere cheese,”he wrily notes.

Hedge fund redemptions appear to have levelled off for the time being, an indication that some stability has begun to return to the marketplace, says Gary Enos, executive vice-president and head of relationship management and client strategy for State Street’s Alternative Investment Solutions (AIS) group.

Still, the regulatory outlook has given some top managers the opportunity to consider whether or not they really want to continue in a self-administrative role, says Enos.“That is what has been happening of late—we are getting calls from prospects who previously had not been interested in retaining a third-party provider, and who now see us as a flight to safety, given our standing in the administration business.”

State Street’s 2002 purchase of hedgeJose Santamaria, director, business development for alternative investments at RBC fund administrator International Fund Services, as well as its subsequent Dexia. Photograph kindly supplied by RBC Dexia, May 2009. acquisition of Palmeri Fund Administrators (PFA), a New Jersey-based provider of fund administration will not turn back to hedge funds as an investment strategy services to the private equity industry, continues to work to in future. However, Custom House’s Butler is more the company’s advantage.“The idea of holding long assets sanguine. “Most administrators have suffered from the with a qualified custodian is also viewed as a positive,”says redemptions in the hedge fund industry and some from Enos. “It has created a dialogue within a segment of the even traditional funds trading badly. Hedge funds used to hedge fund market that didn’t exist even a year ago.” promise alpha and to preserve capital.

That has not happened, however your average longIn the aftermath of Madoff, investors have increasingly taken a pro-active approach to securing information, even going so only fund last year declined between 30% and 50%. far as sending due-diligence inquiries directly to the Hedge funds by and large lost between 15% and 20%, administrator. “That was a first for us,” says Enos. “It really which represents a mean 22.5% alpha, which by any points to the level of interest that now exists among standard is exceptional. To be a good hedge fund you shareholders over matters of independence and transparency.” need good analysis and more importantly good leverage.

Once the banks took credit away from the hedge funds it was akin to pulling away a tablecloth and taking the No guarantees While the appointment of an independent administrator may crockery with it. I think pension funds realise this and be an important part of an overall governance programme, as will come back.”

While the jury is still out with regard to the exact nature Madoff revealed, by no means does it guarantee the detection or prevention of fraud. Despite the likelihood of increased of future regulation, one can safely assume that there will regulatory oversight in the hedge-fund space, at present be much greater demand for reporting and transparency of there is nothing preventing self-administration other than data on an operational level, says Lewin of BNY Mellon. investor demand, says Ian Headon, product manager for “Therefore, our role as a service provider will be to fund administration at Northern Trust.“However, as a large maintain that kind of data in support of our clients so they asset-servicing house, we strongly believe in independent can quickly respond to the regulatory body.” administration. As recent market events have shown, If an impartial third party is key to restoring transparency investors are seeking a more robust governance and to the marketplace, that is a partnership that should be oversight infrastructure and many are demanding welcomed by all, says Stokes. “As Simon Walker, chief independent administration as part of that. Clearly, investors executive of the BritishVenture Capital Association, told the audience at a recent Mourant breakfast seminar, ‘There is are the key factor in this consideration.”

According to a recent survey by specialist research firm nothing to fear from greater transparency’… indeed, the Casey, Quirk and Acito, sponsored by The Bank of New more we tell our story, the more our role will be understood York Mellon, 50% of beneficial owners surveyed say they and appreciated.”

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Can Hedge Funds Really Make a Comeback?

Photograph © Rolffimages/Dreamstime.com, supplied May 2009.

F HEDGE FUNDS are to adapt to the new realities in the wake of the credit crisis it will require gutwrenching changes in an industry whose economic clout has already shrunk by more than 50%. Aggregate hedge-fund exposures (capital plus borrowings) tumbled from a peak estimated at $5.5trn in early 2007 to about $2.5trn two years later, according to Mustafa Jama, chief investment officer and head of the fund of funds team at Morgan Stanley Alternative Investment Partners, a fund of funds manager based in West Conshohocken,

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Pennsylvania. The firm has $9.2bn invested in hedge funds.“It is a huge reduction,”he says.“It is attributable in roughly equal proportions to performance, redemptions and deleveraging.”

Although individual investors have pulled the most money out, institutions have not been immune. Everyone needs to rebalance their portfolios after the market collapse left institutional investors with underweight equities and facing capital calls from private equity, to which many were already overcommitted. Jama says some endowments cut their hedge fund allocations to fund capital calls, while a worsening mismatch between the duration of assets and liabilities forced pension plans to redeem assets, too.

When they could, that is. Hedge fund managers caused uproar when they put up gates and refused to honour redemption requests. No matter that the documents spelled out the managers’right to do so in plain English, nor that the intent was to protect investors who wanted to stay in the fund from the adverse effects of large simultaneous redemptions. Tom Brown, European head of investment management in the London office of accountants KPMG, says private clients were particularly upset, while institutions tended to accept that it could be in everyone’s best interest to avoid a fire sale of distressed assets.“If investors understand the benefit of putting up the gate it should not be a problem,” says Brown, “but it will be very difficult for them to trust managers who put up gates in their own interest rather than investors’.” Managers who abused the gates may well discover they have signed their own death warrants.

HEDGE FUNDS: ATTRACTIVE ONCE MORE?

Hedge funds did not cause the financial crisis, but you would not know it from the vitriol they attract from politicians. European governments, led by France’s Nicholas Sarkozy and Germany’s Angela Merkel, are eager to clamp down on these icons of Anglo-Saxon free market capitalism; even the British and Americans are demanding more disclosure. Meanwhile, Uncle Sam is after managers’ wallets with proposals to tax money received from carried interests—which include performance fees—as ordinary income even if the underlying transactions would otherwise qualify for capital gains tax treatment. Moreover, alleged frauds such as that involving Bernard Madoff have scared away individual investors. Institutions meanwhile are demanding greater transparency from an industry that, from the outset, has cultivated a secretive mystique. How will hedge funds adapt to a shifting investor base and heightened scrutiny from all sides?

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Institutional investors have not lost faith in the hedge fund concept, however. Steve Vogt, chief investment officer of Mesirow Advanced Strategies, a $10bn Chicago-based fund of hedge funds, says clients who used hedge funds to replace part of their long equity allocation were quite pleased with performance that, though negative, spared them an additional 20 to 30 percentage point loss relative to traditional equity strategies in 2008. Clients who treated hedge funds as a bond substitute were not so happy; the Barclays Capital Aggregate Bond Index, which is dominated

by US Treasuries, had a positive return last year while the HFRI Fund Weighted Composite Index fell 18.4%. One big disappointment was among investors using hedge funds in portable alpha strategies, who suffered big losses on their equity portfolios while in most cases the hedge funds that were supposed to deliver alpha did not come close to covering the cost of the associated swaps.

The carnage among hedge funds has raised questions about the future of some strategies, particularly those that rely on high leverage and illiquid assets. While global macro, managed futures and statistical arbitrage have prospered in the last 18 months and should continue to do well, tight credit has undermined the economics of fixed income arbitrage. Convertible arbitrage, long considered a consistent low volatility money maker, had a dreadful year in 2008, which highlighted the risk of crowded trades in a market dominated by a single class of investors. Hedge funds own about 80% of all convertible bonds outstanding, so when margin calls came in and every hedge fund had to sell, nobody was there to take the other side of the trade.

Prices plummeted in a self-reinforcing spiral that left the HFRI Convertible Arbitrage Index down 34.67% last year.

“Investors could buy a convertible bond that has optionality in it rather than a plain vanilla bond and get the same yield,” says Morgan Stanley’s Jama. “Finally, real money guys stepped in to buy them.” The market has bounced back in 2009, but the experience has left Jama wary of convertible arbitrage as a standalone strategy.

A renewed investor focus on liquidity may lead to structural changes in how some hedge fund strategies are packaged. Marty Kaplan, chief executive of Mesirow Advanced Strategies, points out that for many credit eventdriven and some activist equity strategies the underlying assets are relatively illiquid even in normal markets.“They are closer to private equity than to hedge funds,” he says.

“We do not think it is appropriate to lump them together with liquid strategies like long short equity or global macro.” He expects the industry to move toward discrete pools that better match the liquidity of portfolio assets to the redemption terms offered to investors.

That might resolve an anomaly in the current market.

Kaplan observes that some firms already offer distressed and credit strategies in a private equity format, while other managers invest in identical assets through hedge fund structures. “There is no logical reason why that should occur,” he says. “If you are truly matching liquidity the vehicles should be one and the same.”

Mustafa Jama, chief investment officer and head of the fund of funds team at Morgan Stanley Alternative Investment Partners, a fund of funds manager based in West Conshohocken, Pennsylvania. The firm has $9.2bn invested in hedge funds.“It is a huge reduction,” he says.

“It is attributable in roughly equal proportions to performance, redemptions and deleveraging.” Photograph kindly supplied by Morgan Stanley Alternative Investment Partners, May 2009.

Hedge fund managers are likely to face pressure from investors in other areas, too. In the aftermath of the Madoff scandal, institutional investors have pushed US hedge funds that handle administration in-house to adopt what has long been standard practice in Europe and hire third parties to perform valuations and provide independent verification that fund assets exist. Even the largest funds are not exempt; DE Shaw, the $30bn New York-based multistrategy firm, announced in March that it planned to appoint an independent administrator.

“Hedge funds are coming around to the view that in order to maintain trust with their investors they need to be a little more flexible,” says Jeffrey Gabrione, head of investment manager research for the Americas at Chicagobased Mercer Investment Consulting.

Investors are pressing for more generous economic terms as well. For example, if a fund locks up capital for two years, investors are demanding that performance fees should be subject to a clawback until the end of the lockup period. The conventional annual vesting leaves investors without recourse if a manager takes a fee after one good year and then loses money in year two, even though they never had a chance to get out.

Matt Steffora, a senior investment analyst at Ennis Knupp + Associates, a consulting firm based in Chicago, says investors are pushing for lower fees, too. Although the headline management and performance fee numbers have not come down much yet, he says some managers have allowed investors to switch into distressed opportunity funds and keep their old high water mark. The manager still has to make up prior losses before it earns a performance fee on money contributed to the new fund.

Others have agreed to add a hurdle rate the fund must earn before the performance fee kicks in.

CalPERS, the $175bn pension plan for California government employees, served notice in March that it

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would seek these and other concessions from the 26 hedge funds and nine funds of hedge funds in which it has $5.9bn invested. In addition, CalPERS will ask managers to set up separate accounts for its direct hedge fund investments to eliminate the risks inherent in pooled vehicles, including gates, suspension of redemptions and “side-pockets”, the vehicles hedge fund managers often use to warehouse illiquid assets until they can be sold. Only the largest investors will be able to follow the CalPERS lead, which is not without its own risks: Bernard Madoff’s fraud would not have gone undetected for so long if the money had been in a pooled vehicle subject to an annual audit.

Nevertheless, if managers accede to its requests, CalPERS will have complete control over its hedge fund investments, full transparency and lower fees.

Fund administrators, who already stand to gain from the push for independent valuations and reconciliation, will pick up even more business if big institutional investors switch to separately managed accounts. Hans Hufschmid, the London-based chief executive of GlobeOp, a middleand back-office service provider, says that in the past hedge funds tended to avoid managed accounts which introduce additional complexity at both the fund manager and investor level. “Investors retain ownership and control of the assets,” he says. “As the legal counterparty, they are responsible for establishing the legal and administration infrastructure—such as prime brokers, the International Swaps and Derivatives Association (ISDA), and counterparty agreements. They have to monitor the account to ensure payments are made and reconciliations with counterparties are performed.” Most institutions are ill-equipped to handle these operational chores and will outsource the work to third parties like GlobeOp. CalPERS may not get everything it asks for, however.

Bryan Decker, managing director of Norwalk, Connecticutbased investment consultants Evaluation Associates, says managers are more willing to acquiesce on transparency than agree to lower fees. Second-tier managers with lower asset bases may need to give investors a break, but he expects the largest players to stand firm, at least on fees.

“The top tier will not ever have to compete on a fee basis,” Decker says.“But everyone understands that transparency needs to improve, and they are moving in that direction.”

Others are not so sure managers will be able to hold the line, particularly on management fees. “Investors do not mind paying for performance, but they do not want to pay a rich management fee,” says KPMG’s Brown. As hedge funds grow ever larger, the 2% management fee becomes a profit centre in its own right, an incentive to gather assets rather than deliver strong performance. Investors are trying to revive the original hedge fund model in which management fees cover only fixed costs and managers have to eat what they kill.

Transparency comes at a cost, of course, which will increase the minimum economic asset base for a hedge fund and raise the barriers to entry. That is before the regulators and legislators have their say, too. A bill working

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Hans Hufschmid, the London-based chief executive of GlobeOp, a middle-and back-office service provider, says that in the past hedge funds tended to avoid managed accounts which introduce additional complexity at both the fund manager and investor level. Photograph kindly supplied by GlobeOp, May 2009.

its way through Congress would give the Securities and Exchange Commission explicit authority to regulate hedge fund managers that have $50m or more under management and require them to register with the agency.

In a report released in March, the International Organization of Securities Commissions (IOSCO) called for registration of hedge fund managers so that regulators could better protect investors and gather information about potential systemic risks and counterparty exposures to prime brokers. The European Commission, the G20, the Financial Stability Forum, the President’s Working Group in conjunction with the Alternative Investment Management Association and the Managed Funds Association, and the Hedge Fund Standards Board are all eager to influence future regulations and best practices.

It is too soon to tell what the final rules will require, but it may take some time to resolve a fundamental conflict between authorities in the UK and US, who favour registration and increased disclosure, and European governments, who are keen to restrict what hedge funds can do. The threat of future regulation is already affecting behaviour, though.“I am not going to hold my breath that something will get done this year,” says Mercer’s Gabrione.“An element of self-regulation has already taken place. The industry realises it needs to regain some of the trust it lost last year.”

Hedge funds may be bloodied and bruised, but many strategies delivered strong performance in the first quarter of 2009. The panic redemptions that began last autumn have tailed off and asset flows have started to turn around.

For investors who stay the course, Morgan Stanley’s Jama expects a leaner, meaner hedge fund industry is poised for strong returns and a return to asset growth.“Hedge funds have de-levered plus the investment banks’ proprietary trading desks are not in the game,” he says.“It should be an attractive investing environment for hedge funds.”

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130/30: NINE-DAY WONDER OR NEW DAWN?

KEEPING FAITH WITH STRATEGY In last year’s downturn, not only did 130/30 portfolios fail to preserve capital—which should not have been a surprise—but in some instances they suffered bigger losses than both their benchmarks and long-only equivalents run by the same managers. The performance was hardly a ringing endorsement, but it is too soon to dismiss 130/30 as a bull market fad. Indeed, it may yet prove to be the new paradigm for core equity mandates its supporters claim. Neil A O’Hara looks at the outlook for investment style.

N THE DYING days of the late bull market, investor interest in 130/30 “short extension” strategies surged. A host of new products flooded the market in late 2007 and early 2008, but the great bear mauled 130/30 managers last autumn along with everyone else. They still have plenty of advocates but misperceptions about 130/30 strategies abound, especially among investors who treat them as “hedge fund light.” While 130/30 managers do use techniques (leverage and shorting) commonly employed by hedge funds—and some hedge fund managers have launched 130/30 funds—the resemblance ends there.“It’s a benchmark-driven relative strategy,” says Steve Landau, managing director for product development at New York

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Life Investments (NYLI).“It is not absolute return oriented or a cheap way to access hedge funds. If that is what investors expect, they are in for a big disappointment.”

NYLI currently manages $473m in three large cap equity 130/30 funds and the MainStay 130/30 HighYield Fund, the first and only 130/30 mutual fund focused on high yield corporate bonds.

Landau sees 130/30 as a more efficient way to manage benchmarked portfolios than a simple long-only mandate.

A look at how 130/30 funds work supports his view. The idea is to leverage managers’ research by relaxing the longonly constraint. If a stock has a 25 basis points (bps) weighting in a benchmark and the mandate authorises up to 100 bps variance, long-only managers can underweight by only 25 bps before they eliminate the position. In contrast, 130/30 managers can sell short to express as much

Photograph © Rolffimages/Dreamstime.com, supplied May 2009.

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of the permitted variance as they wish—a maximum of short 75 bps in this example. To maintain full market exposure (beta equal to one), 130/30 managers then use their existing positions as collateral to finance enough additional purchases of their favourite stocks (either names already in the portfolio or new ones) to offset the shorts.

Short market value is capped at 30% of portfolio capital, so a fully-invested manager has 130% of capital in long positions and 30% in shorts—hence the name.

To William Morgan, director of global long short equity products at UBS, 130/30 represents a portfolio construction technique rather than a distinct source of excess return or alpha. At year end 2008, UBS had $678m under management in five 130/30 products, covering the US, Europe, Asia and the UK. In every case, the product relies on management teams which have delivered alpha for years from equivalent long-only portfolios. “The existing strategy is an alpha source,” says Morgan. “Loosening the long-only constraint just allows us to transfer more of the insight into active positions in the funds.”

In effect, 130/30 magnifies the returns from stock selection, the active element in active management. If managers pick well, 130/30 portfolios deliver enhanced returns for the same level of risk as long-only—but if their choices don’t beat the benchmark, the 130/30 portfolios will underperform by a wider margin than their long-only equivalents. “Sometimes people get so focused on the mechanics of what 130/30 is, they forget they are magnifying the manager’s skill. That goes both ways,”says Jeb Doggett, a partner of Darien, Connecticut-based Casey Quirk & Associates, a management consulting firm that focuses on investment managers.

Although the track record of most 130/30 funds is relatively short, the performance to date confirms that the construct delivers added value only if the manager has skill. NYLI’s Landau says that US large capitalisation managers (the biggest 130/30 category with the longest track records) who beat their benchmark in 2008 in longonly portfolios did even better in their 130/30 vehicles, while managers who fell short in long-only underperformed by a wider margin in 130/30.

Last year was a difficult time for active managers across the board, of course. In extreme market conditions where technical pressures—margin calls, redemptions and deleveraging—dominate, selling becomes indiscriminate.

Stock pickers depend on a relationship between intrinsic values (as defined by their models) and market prices, which breaks down when investors have to sell no matter what.

Against that background, Landau says 130/30 programmes delivered just what investors should expect from a short extension strategy.

Quantitative managers account for more than 90% of 130/30 funds, in part because their investment process automatically generates a complete ranking of their universe, unlike most fundamental managers who focus their research on stocks they favour and spend little time on those they don’t like. Casey Quirk’s Doggett notes that

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quantitative models—whether for long-only or 130/30 programmes—try to project future trends from backwardlooking regressions, a technique that works well enough in normal market conditions but tends to trip up at turning points like 2008.

In the early stages, Doggett says most of the money in 130/30 programmes came from product sponsors selling to existing long-only clients rather than traditional open manager searches. He expects investor interest to pick up steam again when more managers have established threeyear track records.

Not everyone agrees, however. Amid a rush to stake a claim in the 130/30 market, Nadia Papagiannis, hedge fund analyst at Chicago-based fund tracker Morningstar, says some managers who had no prior experience in short selling jumped in and discovered it was not as simple as they anticipated. Short positions require operational skills in handling collateral and prime broker relationships as well as risk management disciplines that long-only managers often lack. For example, if a long-only manager picks a loser, it represents a smaller proportion of the `

“Sometimes people get so focused on the mechanics of what 130/30 is, they forget they are magnifying the manager’s skill. That goes both ways,” says Jeb Doggett, a partner of Darien, Connecticutbased Casey Quirk & Associates, a management consulting firm that focuses on investment managers. portfolio as the price drops so that further declines have a diminishing effect on the net asset value (NAV). In contrast, a losing short position grows larger and has an even greater impact on NAV if the price continues to rise.

So 130/30 managers have to beat a negative carry, too.

Prime brokers hold the cash proceeds of short sales as collateral and retain a portion of the interest earned as a fee for arranging the stock loan. Managers must borrow to finance the incremental 30% long positions, which means they have to earn the spread between what they pay for loans and what they receive on the collateral just to break even.

Papagiannis says the average US 130/30 equity mutual fund NAV fell 39.1% in 2008 compared to a 37% drop in the Standard & Poor’s 500 over the same period. The CRM 130/30 Value Fund delivered the best performance—down 33.9%—while RiverSource 120/20 Contrarian Equity Fund delivered the worst performance: down 44%.

While the better 130/30 programmes permit managers to vary the short-extension percentage beyond 100% based on the opportunities they perceive, Papagiannis says others—typically created by aggressive marketing departments—stick to a strict, inflexible discipline. “A fixed mandate is a bad idea to begin with,” she says.

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“Those 130/30 funds were created to ride the wave of interest in alternative investments.” She notes that although 130/30 portfolios should always have 100% market exposure, managers who can alter their extension percentage over time have a better shot at delivering alpha.

From a marketing perspective, full market exposure is critical, however. Ric Thomas, head of alternative investments at State Street Global Advisors (SSgA), says institutions put 130/30 vehicles in their equity allocation precisely because beta is equal to one, even though they contain a 30% market neutral component. A pure market neutral strategy, for which beta is zero, would have to compete for space in the far smaller allocation to alternative investments.“Therefore 130/30 looks a lot like a market neutral strategy that is equitised,” says Thomas.

“It’s a substitute for an active long-only manager for somebody who wants an equity allocation. Market neutral is an alternative investment.”

At year end 2008, SSgA had $2.2bn under management in 130/30 products, which have delivered mixed performance so far. Its US Active Core Hedge strategy beat the Standard & Poor’s 500 by an impressive 8.91% in 2008, while the less aggressive US Index Plus Edge portfolio lagged the index by 2.21%. Market conditions that favoured momentum over value tipped the balance toward the more actively-traded funds in the US and elsewhere, according to Thomas.“Momentum models did very well in the last couple of years, whereas valuation models, which have low turnover, tended to perform poorly,” he says.

“Ironically, the more aggressive the strategy was, the better we performed.” He expects the US Index Plus Edge programme, which is down 0.78% since inception three years ago, will move into the black relative to the benchmark when markets calm down.

The market collapse has triggered modest outflows from SSgA’s 130/30 programmes but no major haemorrhage. The firm has seen significant inflows into passive strategies, an industry-wide reaction to the lacklustre recent performance of active managers in general, not just in 130/30 programmes. Thomas expects the trend to taper off as people recognise that market risk is the problem, not the solution. “Beta was the big risk, not just alpha,” he says. “I don’t think a lot of people expected the market to do what it did last year. The alpha wasn’t the surprise, it was the beta.”

Thomas and others say that costs have ticked up a bit because more stocks have become hard to borrow and the premium charged for borrowing those stocks has increased. Concerns about counterparty risk prompted the withdrawal of several big players from the stock lending market late last year. Managers of 130/30 also had to cope when regulators imposed restrictions on short sales at the height of the market panic last year. Focused on financial stocks and of limited duration in most cases, the restrictions caused managers few problems because existing positions were grandfathered.

For UBS, which focuses on the largest, most liquid equities, the direct cost of shorting has not increased.

Jeb Doggett, a partner of Darien, Connecticut-based Casey Quirk & Associates, a management consulting firm that focuses on investment managers. Photograph kindly supplied by Casey Quirk & Associates, May 2009.

Morgan says deleveraging and redemptions at hedge funds have cut demand for the general collateral stocks the firm typically sells short more than supply has fallen. The costs associated with 130/30 programmes have nevertheless gone up because the credit crunch raised funding costs for the prime brokers, who in turn charge higher rates on debit balances used to finance the 30% incremental long positions. The effect may be short-lived, however.“We are already seeing solutions and pricing that, while not back to where it was before the credit crisis, is moving in that direction,”says Morgan.

At a time when relative price movements have forced institutions to take a hard look at rebalancing their broad asset allocations, active manager selection has taken a back seat and a preference for plain vanilla products has pushed 130/30 to the sidelines.“Pension plan sponsors are paralysed, except in extreme circumstances,” says Donna Wilson, head of client portfolio management at Invesco Quantitative Strategies US. “If a manager blows up, they will make a change but otherwise they are in a wait-and-see mode.”

Invesco tracks 25 competitors who offer 130/30 products, of which only eight beat the Standard & Poor’s 500 Index last year. Plan sponsors did not get what they wanted from 130/30 last year, but for all the talk about switching to passive investing, Wilson points out that successful active management remains the least painful way for pension plan sponsors to tackle funding deficits. The timing of 130/30 product launches together with less than stellar performance has left them tainted as a bull market phenomenon, but she remains optimistic for the longer term. Wilson says:“130/30 is a smarter way to run a traditional equity mandate. The premise of relaxing the long-only constraint to get the full benefit of our investment insight still holds.”

Morgan at UBS is even more emphatic. Through 2008, every one of the firm’s five 130/30 programmes has outperformed its long-only counterpart since inception and delivered a higher information ratio. “We are firm believers,”he says.“We have more products in the pipeline.

Our best alpha sources across the globe will have a 130/30 option for investors.”

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T H E 2 0 0 9 F X R O U N D TA B L E

FX TO THE FORE: RISK & RETURNS IN A POST CRISIS ERA

Attendees:

Top row from left to right

COLIN CROWNOVER, head of currency management, State Street

JOHN MURRAY, vice president, FX fund services (sales), BNY Mellon MOMTCHIL POJARLIEV, head of currencies, Hermes

Bottom row from left to right

THANOS PAPASAVVAS, head of currency management, Investec Asset Management BOB NOYEN, chief investment officer, Record Currency Management

THOMAS KRESSIN, senior vice president, portfolio management, PIMCO

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THE 2009 FX ROUNDTABLE

Left to right, Thomas Kressin, senior VP, portfolio management, PIMCO, Bob Noyen, chief investment officer, Record Currency Management, Thanos Papasavvas, head of currency management, Investec Asset Management, Francesca Carnevale, Colin Crownover, head of currency management, State Street, John Murray, VP, FX fund services (sales), BNY Mellon, Momtchil Pojarliev, head of currencies, Hermes

Overview: ROUGH WINDS SHAKE DARLING BUDS THANOS PAPASAVVAS: HEAD OF CURRENCY MANAGEMENT, INVESTEC ASSET MANAGEMENT:

Currency management was introduced back in the early 1980s out of the global fixed income business as another source of returns. For quite a long time equity managers tended to keep away from this asset class, but since the launch of the euro and the stock market corrections in 1999 and 2000, the focus has been much more to use currency management as a way of managing underlying risk and as another source of generating returns. The aim was to “unbundle” the currency risk from equity risk. More recently, and as the industry has moved towards alternative investments, currency management has been used to target absolute return strategies in an environment which allows long and short exposures. The investment into this asset class can be via segregated accounts or off the shelf pooled vehicles targeting differing levels of risk and return.

The preference among pension funds and consultants has been pooled vehicles, due to their limited liability. Over the past few years the industry’s performance has varied with the underlying managers’ differing styles, but has maintained an overall low correlation with other asset classes. We are seeing a continuing demand for currency management from the UK, Europe and the United States, which is coming round to favouring the asset class as another way of adding returns.

BOB NOYEN, CHIEF INVESTMENT OFFICER, RECORD CURRENCY MANAGEMENT:

We have noted a heightened awareness of the risks associated with currency. In 2008 we experienced levels of volatility unseen since 1973 and corporations and institutional investors now appreciate that currency is a tremendously risky asset class. Investors who passively hedge, particularly UK institutional investors, have found themselves having to fund large outflows from their passive

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hedging programs; this is particularly a problem for fund managers who are hedging relatively illiquid underlying assets. In addition to finding ways of settling loss-making currency contracts, they find themselves with all sorts of untended consequences such as the rapidly deteriorating credit quality of counterparties. If you are managing a currency mandate you now have to manage credit which up to that point was not an issue. There is growing institutional demand for active currency risk management to combat the risks associated with passive hedging; it turns out that even passive programs need to be managed by a specialist. It has created opportunities for us, particularly in the US. Unsolicited enquiries from the US now abound on currency strategies ranging from passive to more active approaches on currency overlays. As an industry, we continue to be acutely aware of risk, particularly systemic risk in the banking system. The currency market has survived relatively intact from the global financial crisis compared to other markets but we are not out of the woods yet. We have, for example, yet to see the longer-term impact of quantitative easing on the financial markets.

JOHN MURRAY, VICE PRESIDENT, FX FUND SERVICES (SALES), BNY MELLON:

There are many investors out there with a long-term outlook and currency hedging tends to be of short duration. There’s a conflict then in terms of how you support currency hedging. That simple fact will continue to influence clients now in terms of whether they need to change the strategies they have in place, be they active or passive. As a custodian we can support clients through analysis, management of passive strategies and through outsourcing services. For many investors, currency is not a core competence; however, currency management is very much more important to a lot of institutional investors than it was. It involves not only issues such as what cash means to them in real terms, and what strategies they need to employ to best manage those cash positions, but also there is market volatility to contend with. In that light, banks have seen huge turnover. But even

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if a lot of the money has left the market, it was at least directional, even if technically it might have been the wrong direction for many. Equally, there is no clear sign indicating when that money will come back into the market, or whether it will come back directly into the currency markets.

While currency and FX are sometimes regarded as a poor relation to the capital markets, when you talk about cross border investments FX plays a pivotal role in supporting those different markets. As a bank, we have certainly been challenged on credit and in a tight market the ability to conduct business in the first place is more difficult than it has been. Many institutions now impose much stronger credit conditions on clients, and clients in turn impose them on their counterparties, as the counterparty risk concerns have grown significantly since the second half of 2008.

MOMTCHIL POJARLIEV, HEAD OF CURRENCIES, HERMES:

The past 20 months were very good for currencies as an alpha class. I’m saying an alpha class and not an asset class because, from my perspective, it doesn’t matter if investors think currencies are an asset class or not. What matters is if they believe in your alpha generating capabilities in the foreign exchange market. Last year we saw a lot of black swans in the currency market. We saw five or six sigma type events, and the currency market had more black swans than any other. Moreover, covered interest parity, which is a fundamental arbitrage relation in international finance, broke down. The forward rates were pricing something completely different than the spot and interest rates; a lot of amazing things happened and this creates opportunity.

Now investors realise that currency risk is huge and could impact their performance in other assets. For example, sterling-based investors who invested in the Japanese stock market last year would have been flat because sterling depreciated so much against the yen that offset all the losses from the Japanese equities. On the other hand, Japanese-based investors would have had huge losses. We are still in an exceptionally good environment for risk takers, which is good for investors and they should use it.

THOMAS KRESSIN, SENIOR MANAGEMENT, PIMCO:

VP,

PORTFOLIO

What we are hearing around the table is that forex is a risk that needs to be managed by dedicated specialists. In this context we should discuss too, where the currency industry wants to place itself looking forward. Should active currency managers be considered as absolute return managers that compete against LIBOR? Or do we want to have a broader client base? forex might not be a separate asset class in the way we used to define asset classes. Nevertheless there are certain risk premia inherent in the forex market. Going forward, it is vital to create benchmarks for active currency management that are based on these risk premia. While this might be a challenging task, it should increase the overall interest and client base for the whole industry at the end. Let me add another point, which brings us back to the crisis last year. Interestingly enough, the forex market was one of the few markets, that did not (partially) shut down. During the crisis currency trades were initiated as proxy trades to

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hedge other risky asset classes that you couldn’t exit anymore. That is why some trends we have seen in FXspace were even more pronounced than they would have been otherwise.

COLIN CROWNOVER, HEAD MANAGEMENT, STATE STREET:

OF

CURRENCY

There are four important developments: first and foremost, we see a rotation towards specialist currency managers.

This does not have to be a currency boutique but just a specialist currency team within a multi-asset manager, perhaps with that particular expertise. Why? Well, many of our clients thought that the manager of their underlying international assets was taking care of their currency risk.

They found to their cost during the downturn that this was not the case. Two, we see a rotation geographically; there is an upsurge in interest from the US, where exposures to foreign assets were increased quite substantially over the last five to ten years, though perhaps not fully realising what could happen in a perfect storm. The same is true in Japan and we all saw its currency appreciate quite massively, for example, by 50% against the pound. Three, Thanos’s points about currency being a good source of alpha and it holding up well are exactly right; even so, we are still seeing a rotation from our clients out of active and into passive strategies. It is certainly not universal, but even in the active space we are seeing clients rotating away from absolute return leverage strategies into lower risk strategies and, in particular, strategies that may focus more on medium- to long-run fundamentals. Four, more attention is being paid to the distinction between what I could call beta exposure, even if it is exotic beta, versus pure alpha trade, and that the carry trade that Thomas brought up is a good test case for that sort of distinction. It is hard to argue that a lot of the carry trade is alpha; clearly, a good chunk of that is beta.

LIQUIDity: PRISONERS AND GLASS WALLS BOB NOYEN: From a very high level perspective, it is not

clear how the whole global financial market is going to evolve and it depends on whether or not we come out of recession in the next couple of years or whether we are going to muddle on, or perhaps deteriorate further. If we deteriorate, the pressure on the political class to start interfering and perhaps jolt the global economy into action may have a profound effect on financial markets. At the moment we have not seen some of the more extreme actions, such as protectionism, but the pressures continue.

Right now there is a “covert” beggar thy neighbour policy being played out. Every nation is doing its damnedest to maintain currency competitiveness because it is a convenient policy for politicians rather than protectionism and it is pretty cheap to do. I do not know how that will play out in the long term.

Coming back to the point about currency pricing, on certain days in the last six to nine months it was harder to justify

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The marketplace is more volatile because a lot of capital has been withdrawn – Bob Noyen, chief investment officer, Record Currency Management

the benefit of passive hedging if you factor in an ongoing implementation cost of a passive hedge combined with the need for an effective liquidity management programmes.

Now conditions have started to normalise, certainly in spot.

However, bank A still does not trust bank B and the moment the tenor is extended beyond two days, some of the spreads start to widen and while some of the measures the policymakers have taken give us confidence that the financial market will survive, it hasn’t been enough to date to fully restore confidence.

THOMAS KRESSIN: In the last couple of months we lost one important liquidity provider in Lehman through bankruptcy and other names through mergers. Going forward we will likely see more of that. This raises the question what liquidity in currency markets will look like in the future. In addition we have to deal with higher macroeconomic uncertainty too. In consequence I expect a higher volatility in currency markets than in the past few years. The question remains, what is the maximum return that you can reasonably target in such an environment?

Even when you have a manager with a successful track record and a high information ratio, when volatility is as high, as we have seen over the last couple of months, chances are high too that he will be wiped out of the market if he takes too much risk. All successful strategies will have losing streaks, it is inevitable. That means that even if a strategy proves to be successful in the long run, if you reach for too high a risk/ for a too high alpha target, you will with a high degree of probability inevitably be forced to leave the market. I expect the question of maximum alpha/risk targets for active forex managers to be raised more often in this kind of uncertain environment.

THANOS PAPASAVVAS: This is an opportune time for currency managers. We see demand for both absolute returns and risk management. The reason? As an industry, we have managed to generate respectable returns and respectable risk management in a very difficult environment. If the asset class or alpha class, or whatever you want to call it, adds value to the pension fund response, it will be in a very different vein that we’ll

be talking about currency management in five years’ time. We can bring to the table specific skill sets and show returns from those inefficiencies that exist in the currency markets.

THOMAS KRESSIN: I agree. What happened to the hedge fund industry in general might turn out to become an opportunity for the active currency management industry, in particular. Some hedge funds were pursuing strategies that were deemed to be pure alpha but, in fact, were nothing else than selling liquidity premia to the market.

When the systemic risk materialised last year, this became obvious and a lot of them blew up. The forex market on the other hand offers huge liquidity under normal circumstances.

And even during the crisis, FX-liquidity proved to be exceptionally well in comparison to most other asset markets.

This liquidity aspect and the fact the the forex market is open for 24 hours a day has lead to the wrong conventional wisdom that the FX market comes closest to what is called an efficient market.

Volume: LION’S PAWS AND SORRY SEASONS THANOS PAPASAVVAS: Actually, currency is an inefficient

asset class because a significant portion of participants are non-profit seeking. In other words, not everyone who participates in foreign exchange does so for profit; for example, foreign equities and bond purchases have to be cleared, global treasures need to hedge foreign currency exposures, central banks intervene to“guide”their currency as another monetary policy tool at their disposal. The majority of participants in the FX markets are not alphaseeking currency managers, so any attempt to regulate the market would be limited.

FRANCESCA CARNEVALE: Because of its OTC nature?

THANOS PAPASAVVAS: Exactly. I am not sure what the ratio is, but the latest survey of the markets is the BIS 2007, which is about just over $3trn and active managers are about 15% of that.

BOB NOYEN: There are several interesting developments. FX volumes have come down as a result of the implosion of the shadow banking system. Hedge fund strategies added liquidity and volume to the FX market and this volume has reduced sharply. To a large extent, the capital allocated to alpha-seeking strategies in currency as at 30th June, 2007 has gone. As a result, the proportion of profit seekers in the FX market has reduced, which means that the foreign exchange volume that is not profit maximising has increased as a proportion; this creates opportunity for alpha seekers.

Trading opportunities will exist in our markets as long as the industry is allowed to innovate and regulation stays on the periphery. Collateralisation is a case in point. It is relatively new and the banks are now offering it to those better corporate and institutional FX clients. This is a great innovation because it allows us to return to a commoditised FX market that does not require credit spreads or credit margins embedded into the FX pricing.

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However, if the US and the UK governments run their own banking systems, I do not know whether they will allow their banking systems to continue to innovate at the pace we have seen over the past 20 or 30 years. It could well be that the mindset that runs public utilities is going to run the banking system. I don’t know what impact that might have on the banking system.

COLIN CROWNOVER: I agree with the general point that the relative importance of profit maximisers in the currency market has gone down; in other words a larger percentage of the volume is for people who are just corporate or investor hedging, transactional volume and so on. However, we have not yet seen any evidence of volumes going down in the currency market. The Greenwich Associates study showed that last year currency volumes globally were up approximately 15% from 2007. While many of us think declining volumes will come, it certainly has not done up to now. It could be that in the increased volatility regime we find ourselves in, currency keeps enough incremental appetite for hedging strategies, so that we do not see a large decline in volumes. Second, while changes are afoot, they will look more like the collateralisation of the current forward market, as opposed to some exchange-traded solution. Exchange trade solutions do not work very well for FX, primarily because of all the wonderful customisation you can do for your clients in the existing OTC market, where I can pick a value date whenever the client wants cash flow. Therefore, I do not see sweeping regulatory changes to the FX market.

JOHN MURRAY: We saw this explosion of retail FX and now that has pretty much died. As a result, there are a number of providers and liquidity exchanges out there that have also maybe disappeared.You have also seen a more conservative view of the old traditional methods of execution returning and in terms of market regulation that will be tightened up going forward around certain types of participants rather than FX markets per se. That is because, as you have all said, they actually work very well. One of the changes you are seeing is that risk premium counts, that transitional cost has skewed slightly wider today, and that is a price many participants are willing to pay. They recognise it is a smaller market; their liquidity is not as deep as it may have been and it is a lot more conservative. Moreover, we have seen FX as more straightforward in terms of the collateral requirements we demand of our clients before we can do business with them. That actually imposes much more on our clients, particularly if they are trying to innovate. Equally, regulators are imposing much stronger conditions. We see a flight to quality and strength as a big institution; a lot of our clients come back to us because of our balance sheet quality.

Overall our business as a whole hasn’t changed too much.

We have seen a lot of outflows, the volatility quite rightly has been tremendous, and as a transactional business we know our counterparty. You may see some reshaping in terms of who clients would go to for their FX business in future, but the FX business itself is stable. It is probably a bit more costly today, but so is everything else.

THOMAS KRESSIN: Is it more profitable?

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JOHN MURRAY: Well, yes, that goes without saying but there is definitely a market sense that the risk premium attached to FX business has gone up; it is a given today. We definitely have seen a lot of clients come out of the market, to a degree; there is a lot less business being conducted right now than there has been.

BOB NOYEN: The foreign exchange market is now very much a two-product market: Interest rates and FX spot.

The FX banks aren’t yet set up in a way they can readily price credit risk. For example, they can’t really price an FX swap with their estimate of the underlying risk. How that is going to evolve, I do not know.

Volatility: SWART-COMPLEXION’D NIGHT OR SPARKLING STARS? BOB NOYEN: In the fourth quarter of last year we

experienced a period of exceptionally high currency volatility, five/six times greater than what we had come to expect as the “norm”. This “norm” period, between 2003 and 2007, exhibited exceptionally low levels of volatility, a result of monetary policy which created a weak dollar, relaxed attitudes towards risk, and created a bubble in all risky asset classes. Going forward, we will probably see volatility come down but unlikely to the abnormally low levels seen during 2003-2007.

THANOS PAPASAVVAS: Those famous last words, “policymakers have learnt”.

JOHN MURRAY: Remember, every time we had the finance ministers on the line they were talking about keeping volatility down; they just accentuated that. The results from that decision are clearly illustrated over the past two years.

Going forward, policymakers will not wish to bring volatility back to the lows we had.

THANOS PAPASAVVAS: We need to differentiate between two things: first the currency move per se and, second, how fast it moves within a defined period. Neither the ECB nor the Federal Reserve has a problem with a depreciating or an appreciating euro if the speed of the move is not excessive. What central banks are concerned about is excessive volatility. That is the issue here.

COLIN CROWNOVER: If it is a rupture in the market that hasn’t quite healed, then you might expect the transaction costs to stay at relatively elevated levels for the foreseeable future. If it really is more of a volatility issue—and we have done some analysis at my shop on this—it looks to us like most of the increase in transaction costs can be simply explained by the much higher volatility in the markets. It is rational for market makers to charge a higher spread if they are facing more volatility and a greater probability they are not going to be able to lay off that trade at a profitable price. I tend to think what we have seen is a temporary spike in transaction costs due to high volatility. The £20m question is does volatility come back down to something more normal? Moreover, will transaction costs normalise or do we stay at elevated levels? Is that the reason why maybe transaction costs will stay high in the future?

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managers, but a lot of managers I talk to find that relatively low to medium volatility environments are actually easier for them, even though the opportunity set is clearly lower in a more volatile market. They find it easier to predict movements and currencies in those environments because they respond more to institutional fundamentals that drive the markets, whereas in the experience that we have just had there were some days where we have all been challenged to figure out what exactly was driving the market besides panic.

That is an important distinction.

strategies: GREEN MEADOWS AND HEAVENLY ALCHEMY We need to leave our niche and become marketers – Thomas Kressin, senior VP, portfolio management, PIMCO BOB NOYEN: Have you done the analysis on the spot and

COLIN CROWNOVER: Spot spreads are completely what

the forward spreads?

you’d expect given the level of volatility, acknowledging of course we have not seen this level of volatility before, but you extrapolate from past events. The forward points was the one component of transaction costs where you could truly say they were higher than the underlying asset volatility would have indicated, but most of that happened in roughly the month following the Lehman Brothers bankruptcy. Since that point they seem to be consistent with the volatility of the underlying market. It is still very rich.

BOB NOYEN: The forwards took the brunt of the spread widening. This has to do with the illiquidity and volatility but it is primarily a function of the impaired interbank market.

THOMAS KRESSIN: The distortions in the forward market certainly had to do with financing needs and credit risk. During the climax of the crisis banks probably used it too, as a kind of mechanism to prevent new business with certain counterparties that they would not want business with.

BOB NOYEN: Because they didn’t want the business. They do not want any credit business because somebody from high up said:“Shrink the balance sheet.

THOMAS KRESSIN: Exactly. In general, this is a big issue for both our industry and the macro economy as well.

MOMTCHIL POJARLIEV: It is unfair to blame the policymakers about everything, especially for the high volatility. I’ve spoken to a couple of policymakers and they were not sure why volatility was so low. I think some market participants were responsible for the extremely low volatility by selling options, for example. If you are selling options and putting pressure on volatility, it comes down. Actually I am not complaining about high volatility at all, because it creates opportunities. In fact, many people complained between 2004 and 2006, because volatility was extremely low.

COLIN CROWNOVER: It is not the volatility of the currencies per se that creates a profitable or unprofitable environment but the amount of movement you can predict as a currency manager. I would not speak for all currency

THANOS PAPASAVVAS: I was having a discussion with a

consultant who asked does PPP really work? Until 2007 a significant number of market participants had left “valuation” on the sidelines, with even a few academic papers written specifically to support that. However, we have seen more recently that value has come back to play with a vengeance. Do we see different drivers affecting currency markets at different market environments?Yes we do as markets go through cycles and different factors impact investor behaviour and exchange rates.

THOMAS KRESSIN: In my opinion the critical point to watch for with respect to the potential currency impact of all the different conventional and non-conventional central bank easing measures around the globe will come, when the global economy gets traction again. Will central banks be able to take the excess liquidity out of the system without any major disruptions? Or how how much of this liquidity will stay there and become inflationary? PPP will be very quickly back on the agenda of currency managers, when inflation rates start to diverge. Looking at all the uncertainties with respect to the unprecedented policy initiatives, the potential for reregulation, protectionism and so on discretionary investment styles are likely to become much more important than they have been over the last ten years.

COLIN CROWNOVER: We have definitely seen an uptake in appetite for valuation-based currency strategies and, normally, after the level of volatility we have seen in the markets of late, you’ll see a lot of the extremist valuations completely eroded. Currencies have gone from being extremely overvalued, such as sterling was a little over a year ago, to being extremely undervalued.You can now play the opposite of the trade in an historically short period. We do think there is a lot of appetite there as some of the short-term strategies have been found out to be, at least partly, risk-creating beta trades. People are a little less concerned about making money every quarter and a little more concerned about their long run results because they have witnessed what a shorter investment horizon can do.

THANOS PAPASAVVAS: The question is whether, in this market you can survive as a pure PPP currency manager. It would need to be either a multi-strategy currency manager who combines different sources of alpha or a consultant

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who combines managers with different styles. Maybe one of the managers is underperforming for a given period of time, but the other managers are compensating for that.

THOMAS KRESSIN: Which means ideally, that you would diversify on your own and use different uncorrelated strategies.

THANOS PAPASAVVAS: There are different schools of thought. Some currency managers combine a multistrategy approach while others prefer to specialise on their own.

MOMTCHIL POJARLIEV: What is also very important is the sizing of the positions, not only the timing, because market timing is extremely difficult. You do not want to be stopped out exactly when you want to be adding to the position. The right calibration of risk is something very important. I had a feeling that until recently people were worried mainly about getting the direction right. Market timing is very challenging and you have to think hard about position sizing and calibration of risk, especially if you are a value manager.

THOMAS KRESSIN: It is certainly very credible, the idea of going forward to have a very clear distinction between alpha versus beta. The benchmarks can be decided, by the industry, or the consultant, or pension funds. That is certainly a very transparent way going forward. Will this put us very much in the same vein as the other asset classes which have had a similar experience, with the equities, the hedge funds, the commodities, because of the heavy beta assigned to that asset class? Should we, as currency managers, try to maintain our total return alpha mentality or shouldn’t we move down the road of the beta strategy and generating a return on top of that?

expansion: COMPARING APPLES, PEARS AND SUMMER DAYS THANOS PAPASAVVAS: It is certainly very credible, the

idea of going forward to have a very clear alpha versus beta and the benchmark can be decided, by the industry, or the consultant, or pension funds. That is certainly very transparent going forward. Will this put us very much in the same vein as the other asset classes which have had a similar experience, with the equities, the hedge funds, the commodities, because of the heavy beta assigned to that asset class? Should we, as currency managers, the currency management industry, try to maintain our total return alpha mentality or do we move down the road of the beta strategy and generating a return on top of that?

THANOS PAPASAVVAS: Right now we do have the differentiation between currencies as an asset class versus other assets? Do we move down and pick currencies as a beta class, as a beta style asset class, with some alpha on top?

COLIN CROWNOVER: We are already moving in that direction because many of the banks produce investable beta indices, whether it is carrier or value or momentum.

We are already heading in that direction. Prices will come down and, as they do, they may end up looking just like other beta products where you have fee compression and

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We have not yet seen any evidence of volumes going down in the currency market – Colin Crownover, head of currency management, State Street

you shouldn’t be charged much more than some notional value for the expertise. I would like to see us move to more like an equity or a bond world where you control the explicit risk factors. Of course, we do not have as wide a set of risk factors in currency, but we have some that we have already discussed.You control those and limit the exposure of those and then what you are left with is going to be much closer to pure alpha and we should be able to offer quite attractive fees that compete with the fees you’d get for alpha products across other asset classes.

THOMAS KRESSIN: Absolutely. To me, it is the only chance for this industry to grow out of its niche business. No institutional investor will allocate the majority of his/her capital to absolute return strategies. Active currency managers need to grow out of the absolute return universe and become some kind of beta manager too. In that respect it is key to discuss the economic rationales behind the notion that there are certain structural risk premia in currency space, just like in bond or equity space.

MOMTCHIL POJARLIEV: If we want to grow the industry we have to convince the investors there is beta in the market because, if you do not convince them, you cannot sell alpha. If they do not believe there is beta, they are not going to buy the alpha, or they are going to buy it but it is not going to be a huge business.

COLIN CROWNOVER: Momtchil, I have a question for your statement that you do not think you’ll be able to sell alpha without beta. I am curious because certainly there was a lot of popularity in market neutral equity strategies which, if executed correctly, should be zero beta, but provide alpha. Now, we know a lot of those managers weren’t doing what they were supposed to be doing but there were ones that did. I am curious: why couldn’t we have an analogue for the currency markets as well, where somebody might say, yes, carry has a risk premium in the

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long term and maybe I’ll get that from a beta manager relatively cheaply, but here’s a manager who has analysed what the risk premium should be in the carry trade, based on whatever factors they think relative versus what they actually receive, and making alpha trades around that.

MOMTCHIL POJARLIEV: In principle, you should be able to sell alpha without any beta; this is why I said currency is an alpha class. If you can prove you can generate alpha, that is enough, you do not need the beta. Unfortunately, if you look at the industry, you get the example of market neutral, long/short equity funds. Somehow we don’t have long/short frozen orange juice funds. There might be managers who might be able to generate alpha from frozen orange juices, but this alpha would be difficult to sell.

Investors are not sophisticated enough. So, if we want to move this industry to the same level where the equity market industry resides, then you have to try to promote the idea of beta. I believe that the concept of alpha and beta apply in FX. The return of any investment portfolio is a combination of alpha and beta return. Currency portfolios are not different. Investors should pay high alpha fees only for the alpha return, beta return could be obtained cheaply.

THOMAS KRESSIN: It is a good strategic goal for active currency management to reach the size of the equity market, but I doubt that we are going to accomplished in our working lifes. The investment case for currencies is intellectually very challenging: What are you actually investing in? What are the risk premia that you get paid for? In fixed income you lend money to someone and charge him with an interest rate. In equity space you even become part of one company’s owners and receive a claim on the company’s profits. But what do you do as an active manager in currency space? What do you provide in terms of economic utility?

BOB NOYEN: To say that “a market is volatile so we can generate alpha”, is questionable. You can generate alpha out of currency; by definition that is true, but it is not necessarily sustainable. Cumulatively alpha is a zero sum game regardless of volatility because for the positive alpha generated there is also negative alpha lost. Unless you can identify a participant who is willing to act as a risk or capital provider delivering some kind of utility to another participant, you do not have a sustainable source of alpha.

THOMAS KRESSIN: This brings us back to the question of the economic role of active currency managers. Certainly we are liquidity providers, but I would also suggest that active currency managers smooth currency volatility and promote market efficiency too. The currency market is the only market I can think of that is dominated by non-profit driven participants. And they are in most of the cases pure liquidity seekers. We are the ones providing risk capital, bidding against central banks or against the hedgers of the world and providing them with the counters.

MOMTCHIL POJARLIEV: On average, alpha is negative because you have transaction costs and management fees.

This is not just the case in currencies; this is the case for all asset classes. This is why the profession of an active

This is an opportune time for currency managers –Thanos Papasavvas, head of currency management, Investec Asset Management

portfolio manager is unique. The average active portfolio manager is completely worthless. This is not the case with other professions. For example, if you are sick, of course you want to go to the best doctor, but even if you go to the average doctor he’s going to do a fine job. But if you invest with an average active portfolio manager he’s going to cost you a fee without adding any value. It is difficult to generate alpha, to add value. This is the reason why alpha should be expensive, because only the best can deliver alpha. Therefore it is very important to know how to measure alpha properly.

JOHN MURRAY: Our clients come to us today looking very much at cost, asking what’s the cheaper option? They’ve gone back to basics. We have been through this cycle before, where it was very quiet, and clients start to look at their providers to ask, well, how much is it costing us?

Some have decided to move more towards a passive model which opens up providers in terms of custodians and other institutions being able to provide that service where there is a fee but it is a much smaller fee. Clients in this instance drive the model, telling the provider this is what we want you to do on our behalf and it is rules based. There is a small fee attached to that and it is really about currency maturity. They are trying to mitigate any exposure they have and in these conservative times clients may be opting out of riskier solutions for a period. That is not to say it is going to change in a very short space of time. Right now, institutional and pension players are more conservative because they have more basic concerns about cash and they’ve got to support these types of model-driven strategies and they’ve also been burnt of late.

STP: FREEDOM AND SWEET HOURS JOHN MURRAY: Technology affects the FX markets, or will do, and the technology is quite mature now in the multibank platform. For institutional clients, real money managers, it is a very mature market for foreign exchange.

From a bank perspective, the back-office infrastructure has

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matured as well. The larger banks, the big foreign exchange providers, have focused on that sort of processing capability in the last few years, their ability to provide straight through processing (STP) also counts. It is crucial, particularly for the gentlemen here. Bloomberg also has a big role to play; it is on the desktop and it makes perfect sense to branch out into the different asset types. Additionally, there is more competition in the data space, which is good. Some 80% of business from our clients is electronic and that is not going to change. The only change I would envisage is what the buyside technology requirement will bring. Banks, such as ours, will always have to bow to the demands of our clients in terms of how we service them. Right now, from a buyside perspective, I am not sure how much technology has changed. It may be just from the risk management perspective, the tools that are available to them and how much they have changed in the past few years. However, these guys are much more reliant on real-time, certainly real-time research and pricing.

BOB NOYEN: Straight through processing, making the administrative process less risky and more efficient, has grown apace. We are integrating our platforms with that of custodians to download exposures and send transactional information back; that works very well. There has been promise of an electronic execution engine that would do away with the need of the human element, but the events of the last six months have proven that they are not there yet. It has been a fantastic improvement in streamlining the admin but in terms of making the marketplace itself operate electronically, forget it. Another thing is that if you analyse data, you’ll see that the average transaction size in the interbank market has halved. At the moment $10m or $20m can be turnkey. I do not know if the electronic systems can cope with those evolutions in the way that the market clears, and I certainly believe that in the next couple of years things will keep evolving and that is why we are keeping our traders employed. They are extremely powerful in adding value and making sure that we do not get caught out by the odd feature of an overly systemreliant marketplace.

COLIN CROWNOVER: The biggest advantage from the growth in electronic trading is that it is more of an information flow, as opposed to a dealing benefit. As a portfolio manager, I can see real-time streaming dealable prices and FX Options allows some users to price a portfolio instantaneously. I can also do risk management looking at implied volatility; there are all sorts of fantastic things I can do with portfolios today that I couldn’t do five years ago. That said, we still do most of our dealing by picking up a phone and calling a couple of brokers, and then putting those trades into a multibank platform because of the STP advantages and its ability to allocate across multiple clients. Nowadays, it is critical, given the drying up of liquidity. As one of the largest currency managers our size is too big to effectively deal on those kind of platforms. Even for platforms that list the next best price and the next best price, I can’t see what I would

FTSE GLOBAL MARKETS • JUNE 2009

Currency management is very much more important to a lot of institutional investors than it was – John Murray,VP, FX fund services (sales), BNY Mellon

end up dealing with and I do not have enough people where I could have traders in there clicking all day trying to get a large trade done in clips of two, five, or ten.

THOMAS KRESSIN: Electronic trading has gained huge importance for us due the big chunk of our maintenance trades. It is very helpful for all this daily rebalancing and cash flow business, for example, as it serves two purposes.

One is you can prove that you do best execution. STP on the other hand enables you to deal with a much larger size of trades than in the past.. However, I agree, the big tickets in general are still done over the phone.

THE WAY AHEAD: SWEET LOCKED-UP TREASURE THOMAS KRESSIN: We need to leave our niche and become marketers. Our industry hasn’t been really good in marketing our business. We need to be more vocal in terms of opportunities and why there is money left on the table in currency markets. We also need to explain that investing in active currency strategies means adding another uncorrelated source of revenue. As long as you believe in Markowitz this is a valuable contribution as you move up the efficient frontier. We need to clarify why there are systematic risk premia in currency space, what they are based on in terms of economic background, and prove that our industry makes money in relation to certain benchmarks. That is then the beta that comes in, for as Momtchil pointed out, only a few managers really generate alpha and that would be a zero sum game. We

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THE 2009 FX ROUNDTABLE

I am not complaining about high volatility at all, because it creates opportunities – Momtchil Pojarliev, head of currencies, Hermes

need therefore to make sure that people are aware that there is a beta in the market, and there are systematic risk premia that you can exploit.

FRANCESCA CARNEVALE: How will banks work more closely with the FX industry to ensure that opportunities in generating alpha or in better risk management techniques, in managing currency exposure, are integrated into mainstream asset management strategies?

JOHN MURRAY: It depends on the level of sophistication of the investor. The bigger institutional investor will have already developed their own house capabilities and have the right guys, the right tools to make those decision. The smaller institutional investor will not see it as effective and may look at the more passive route; they may even outsource. This is a non-core function still, though increasingly they will see the value that currency has, but they might also see that there are banks that are maybe the better place to provide that level of service provision and analysis. However, there is room for everyone. Even so, when you look at a sophisticated institutional investor, they are going to formalise some FX strategy around the approach they are taking and in that regard we have noted a shift back to a more passive requirement. That in turn does play to custodians because they have all the information the client would use themselves to administer their risk. Why not?

We work, for instance, with clients who have to make their funds attractive to their investors. They will offer a hedged portion and an unhedged portion to clients, which is why we have seen a proliferation of hedge share prices. You’ll have funds that support both. Some investors want to be exposed to currency risk, others do not. We are seeing a blend there right now and that is not

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going to change dramatically. If anything, we’ll see this balance of currency active management, though passive for the moment, will return to prominence.

THANOS PAPASAVVAS: The key point is that the FX industry has to work hand-in-hand with consultants and pension funds trustees to make sure we can provide exactly what the trustees and consultants require. In other words, it is an educational process to make sure that the end user of our services understands why they are employing us. Are they employing us to manage their risk or to add a level of return? Moreover, we need to clarify what services we can offer. Some managers prefer to have passive and dynamic hedging mandates, whilst others only manage active. Of those active managers, some will have a bias towards beta, and so on. As the industry evolves and the various participants play to their strengths, consultants can work with the specialists over these regions to provide the end-client with the most optimal solution to fit their specific requirements.

COLIN CROWNOVER: The balance is more tilted to educating the clients or prospective clients. We find, for instance, two common misperceptions in the currency markets: one, liquidity equals efficiency, which it does not.

Two, is the zero sum argument.You cannot dispute that any relative asset class, such as currencies, has to be zero sum in aggregate. We can make arguments that, as managers, we have some positive alpha and there is some class of participants in the marketplace that have negative alpha, and many of us do exactly that. However, the misconception about zero sum is, again, with the relative asset class. If I just form my portfolio by throwing darts at the dartboard, of course the expected return will be zero, but that is irrelevant for an investor. If I am, say, a Japanese investor and I’ve watched the yen go from 300 in the 1970s to just below 100 today, try telling me that my currency is a zero sum game.

BOB NOYEN: It is absolutely essential for the FX market to be recommoditised. Over the last year we have had to become credit experts. We were not really obliged to before, but the people we indirectly hired to do the credit work, such as S&P’s and Moody’s, have arguably not done such a decent job. For the FX market to function in an efficient manner, we need to develop a mechanism that will align the interests of all participants and return confidence to the marketplace. One such a mechanism is two-way collateralisation, which can help to reintroduce competition back to the marketplace and reduce the cost of trading.

In terms of looking forward, we feel that one outstanding opportunity lies in the emerging currency world. I think that the trend of globalisation will continue to see new and successful nations participate in the global economy; the western world will become relatively poorer and the emerging world will become relatively wealthier. There are sound currency strategies that can exploit these trends and this means tremendous opportunity in the next couple of years.

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Seemingly caught in a cross-fire hurricane, MF Global continues to manfully combat a series of glitches that have stumbled and sometimes humbled the New York based intermediary, since its listing on the NYSE Euronext in July 2007. The firm, spun out as an independent broker by Man Group, has suffered a some time bruised reputation and cost the scalp of at least one senior executive. Now armed with an immensely popular and populist chief executive in the form of Bernie Dan, ex-chief executive of the Chicago Board of Trade (CBOT) prior to its immersion into the über-exchange that is now the (I believe it’s now part of the CME Group) Chicago Mercantile Exchange (CME), expectations of the firm are high once more. If anyone can turn around the fortunes of the seemingly star-crossed broker, Dan can, say market watchers.

Francesca Carnevale reports.

COVER STORY: THE RETAKING OF MF GLOBAL

BERNIE DAN LEADS MF GLOBAL’S FIGHTBACK

Photograph kindly supplied by MF Global, May 2009.

F GLOBAL, THE brokerage spun off from Man Group, the London-listed hedge fund, was ordered to pay as much as £20m in compensation in early May to Rajesh Gill, a day trader who ran a oneman investment fund, who claimed he was deceived about the value of his investments.

Mr Justice Flaux, presiding over the case, reportedly said the losses were a direct result of “deliberate and persistent” lies told by Mathew Bomford, Gill’s former

M

FTSE GLOBAL MARKETS • JUNE 2009

account manager at the brokerage, over a period of several months. MF Global denies that misinformation led to Mr Gill’s losses and has also questioned the amount of those losses and has indicated that it will take the decision to the UK Appeal Courts. MF Global is also expected to be ordered to pay Gill’s costs. The firm believes it has a strong case for appeal as, it holds that the damages awarded to the claimant are “greatly disproportionate to actual losses.”

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The fateful decision is among the latest in a series of hammer blows to the brokerage which have both sullied the firm and resulted in the departure last October of chief executive Kevin Davis in response to a 90% slide in the firm’s share price through 2008. Davis, who had been with the firm for just over 17 years resigned “to pursue new opportunities”. Under his tenure, the company has been rocked by a rogue trading incident and liquidity concerns.

MF Global Ltd is an intermediary offering customised solutions in global cash, derivatives and related markets. It provides execution and clearing services for exchangetraded and over-the-counter derivative (OTC) products as well as for non-derivative foreign exchange products and securities in the cash market. Europe accounts for 34% of MF Global’s net revenues, with another roughly 55% in the US and the remainder coming from Asia-Pacific.

By either luck or misjudgement, misfortune has fairly dogged the firm since its debut on the NYSE-Euronext in July 19th 2007 as the offspring of Man Group. In the event, the spin out turned out to be a sub-par send off. Just prior to the company’s debut, the credit markets suddenly came unglued, forcing Man to scale back its original float from a projected range of $36 to $39 per share, to $30 per share, resulting in a significantly more modest $2.9bn net.

Subsequently the share price fell to $25.

Despite earlier suggestions that the spin off would occur “subject to market conditions remaining favourable,”Peter Clarke, Man Group’s chief executive officer, was the first to admit that their timing was not perhaps the greatest.“We were trying to sell into an environment of weakness,” acknowledged Clarke, while maintaining that the reason for the float was“strategic, not financial.”

The Dooley impact However, through the summer and early autumn of 2007 the brokerage began to recover and climbed back up to a respectable $30 level. However, as soon as the firm thought it was safe in the water, things took a decided turn for the worse.

In early 2008, Evan Dooley, an MF Global employee, lost the company $141.5m in one evening playing with wheat futures. Equally dear was the blow to the firm’s reputation as a leader in risk management.

Either because by this time the market was becoming inured to bad news, MF Global’s share price took only a relatively modest dip after the Dooley debacle. Initially losing $7 on the news however the firm’s share price steadily fell below $20. Then came St Patrick’s Day ( March 17th), when a further 65% was wiped off the value of the firm’s shares following rumours about its liquidity (in the event, totally unfounded). MF Global suddenly found its shares trading at a historic low of $3.64.

Davis and his management team began looking for a scuttlebutt and approached private equity house JC Flowers to invest in the business. The buyouts firm subsequently ploughed $150m into the brokerage to help the firm meet payments on a bridging loan. While the investor relations team claimed the involvement of JC

Flowers was a“ringing endorsement”of the firm’s business; at the time, it largely fell on deaf ears. Probably because the rest of 2008 was looking poisonous, as the credit squeeze took its icy hold and an weakened OTC derivatives market began testing everyone’s endurance.

Whatever Davis did it seemed had minimal effect. Many market watchers agree that Davis was a chief executive of no mean stature, but he did not survive the year and with the firm’s share price continuing at its all time low, he was forced to fall on his sword in October. Enter Bernie Dan, who had joined the group four months earlier.

Gargantuan task A long term resident of Glen Ellyn, Illinois, Dan took on the role of chief executive armed with a surfeit of experience in the trading segment. Before his accession to MF Global, Ltd., he was the high profile president and chief executive officer of Chicago Board of Trade for five years; having introduced both efficiencies and reforms in the exchange and expanded its strategic product range and alliances, stretching out to China. In 2007, Dan was instrumental in the merger between the Chicago Board of Trade and the Chicago Mercantile Exchange, staying on in the role of advisor and ensuring the seamless integration of the behemoths into the world’s largest and most diverse exchange. Prior to joining the CBOT, he worked for 16 years in various operation positions at Cargill Investor Services, Inc. Aware of the gargantuan task ahead of him Dan is typically focused, concise and cuts to the quick to emphasise MF Global global credentials, “It remains a leading broker for exchange-listed futures and options, and maintains a presence in 14 countries with memberships on more than 70 exchanges, working across multiple asset classes. That combination makes this job interesting and challenging.”

Not a man to cut a Gordian knot with anything other than one blow of a sharp sword, his straightforward strategy is to “improve the positioning of the firm.”

The tactics are invariably manifold and include,“working hard to harness shifts in the OTC derivatives market, particularly in the area of clearing and settlement.” The move is an obvious one, given that in December last year US Federal regulators approved the International Derivatives Clearing Group LLC to begin clearing a form of financial derivatives that are traded off exchanges. The IDCG now serves as a centralised counter-party for interest rate swaps, an OTC derivative in which interest rate payments are traded for a fixed principle payment.

Additionally, the firm has begun to leverage its expansion into the Asia Pacific region. Shortly after going public, MF Global had acquired Sydney-based BrokerOne, Australia’s largest online futures and options broker, giving the firm a regional foothold while nearly doubling the company’s post-IPO Asia-Pacific based revenue. It also acquired FXA Securities Ltd., a provider of online foreign exchange products in Japan and subsequently rolled out FXA’s technology outside of Japan, with the goal of providing a retail OTC foreign exchange platform to clients in the Asia

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Pacific and Europe. Historically, some 10% of MF Global’s revenues come from the Asia-Pacific markets, and that number rising, a reflection of the company’s growing business prospects in locations. According to Dan, key elements in the firm’s growth strategy in the region involve increasing the firm’s retail footprint in Australia, Singapore and Indonesia and building its regional expertise in contracts for difference (CFDs) and cash foreign exchange.

A build-out strategy Dan hopes also to build out from its recent joint venture with Taiwan’s Polaris brokerage as well as expanding its staff numbers in Hong Kong and Singapore.“We are now 1,000 people throughout Asia and have been very aggressive in expanding our capabilities across the board.”

Expansion of its retail business also continues apace. By the end of 2007 the firm had acquired ChoiceOdds, a UK-based financial binary trading firm and a player in the online retail market for binary products. The acquisition allows clients to trade OTC products in place of listed equivalents using a single dedicated platform. A major proponent of streamlined trading solutions, MF Global’s move into binary products reflects the general evolution of the capital markets toward a more balanced playing field opposite retail market participants, one that requires less capital-intensive strategies while offering greater opportunities to profit.“We have some $4bn of retail assets on our books,”holds Dan,“and we intend to build this systematically up to $5bn, then $6bn.”

A fourth element is the rise of the fixed income business.

“Given the new levels of sovereign debt, we have been keen to capitalise on the trend.”

MF Global’s revenue, reported in late May, net of interest and transaction-based expenses (net revenue), was $256.7m for the fourth quarter of 2009 versus $407.9m for the same period last year; full year 2009 net revenues were $1,426.3m versus $1,636.3m in the prior year. GAAP net loss was $111.7m (or $0.98 per diluted share) for the fourth quarter compared to a net loss of $83.1m (or $0.69 per diluted share) for the same period last year. GAAP net loss for the full year 2009 was $48.6m versus a net loss of $69.5m for the same period last year. Additionally, as of the end of March this year, 2009, the company had $2.5bn in long-term capital.

Client payables at the end of March 2009 were $11.8bn.

The past year has been one of change, acknowledges Dan. Nonetheless, he is adamant that: “our focus on continuous improvement has strongly positioned the company for the future.The governance model we instituted has strengthened our risk management function, increased the efficiency and flexibility of our operations and improved our allocation of capital, all of which will serve to introduce scale, enhance profitability and drive long-term growth.”

“Similar to every other financial services company, we were tested by the difficult business environment including nearzero interest rate levels and global declines in volumes; but our diversified, predominately agency model continues to differentiate MF Global as we navigate the challenges of the macro environment,” he noted in the financial report.

FTSE GLOBAL MARKETS • JUNE 2009

However, he stresses that: “In recent months, we have increased our share of client assets and attracted some of the industry’s top talent to our company. We expect to leverage these positive developments to continue to build momentum with our clients, employees and shareholders alike.”

“In the last year, we significantly strengthened our company’s financial position,” noted Randy MacDonald, MF Global’s chief financial officer in the end of year statement. “Our capital planning initiatives have been successful, and for the first time, MF Global does not have any short-term re-financing risk.” In late March this year MF Global completed its cash tender offer to purchase any and all of its $210m outstanding 9.00% Convertible Senior Notes due 2038 at a purchase price equal to $640 per $1,000 of the principal amount. Then, in April, the firm notified its administrative agent of its intent to pay back a $240m unsecured term loan facility ahead of its maturity date of July 2010. MF Global financed the repayment from available cash, which was recently augmented by $250m in excess regulatory capital distributed to the company by one of its regulated subsidiaries.

“We have reduced our balance sheet by approximately 40% in the last fifteen months, while also ensuring that MF Global’s regulatory capital and liquidity remained robust.

As we work to execute our strategy and enhance our client offering globally, we remain committed to maintaining our financial discipline as well as our current risk profile,” acknowledged MacDonald.

Overarching history While agreeing that the firm has had disappointing results of late, Dan remains focused on what has to be achieved going forward. “Risk management is of course a key element of the operational landscape and we are committed to that expertise being a key differentiator for MF Global going forward,”highlights Dan. He believes that the overarching trend of history goes with him in this regard.“While it is difficult to see the exact changes in store for the markets, after all, the futures industry is now traded electronically on global networks; though more rules and regulations will likely be the norm.”

Two elements provide the backdrop for Dan’s optimism.

The first is the new management structure through the firm, which is “similar to that instituted at the CBOT: no one worries about titles, but rather is focused on achievement.”

Well known and regarded as a“team player,”Dan’s inclusive management style is popular and infectious. “It is vital to bring everyone’s ideas into play, but once decisions have been made, everyone has to stick to them and it has to be rolled out throughout the company. Clarity of purpose and transparency are watchwords,”he acknowledges.

The second is a continued commitment to customer service, through a flexible working structure “The firm has structured a global framework that will help to enhance client satisfaction and retention, ultimately leading to greater revenue opportunities.“ It’s a countdown approach that all of us will be watching.

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TECHNOLOGY: FIRING UP THE TRADING ENGINE

MOTIVATIONS TO INNOVATE

What is all the fuss about trading technology? Is it really about speed to market, aggressive trading algorithms and smart order routers? Do buyside trading desks really care, knowing they can access the markets via established brokers? Does innovation really help the buyside get the most from its trading desk? Ruth Hughes Liley goes in search of some answers.

EAR, GREED AND regulation are the three catalysts for innovation in electronic equity trading and the last year has seen all three, according to Rob Flatley, global head of Deutsche Bank’s electronic trading business, Autobahn Equity.“Fear of losing market share; greed because there is a lot of market share to capture and regulation because, as we saw with the Markets in Financial Instruments Directive (MiFID), it can change a competitive landscape overnight.”It is driving the search for speed through technical advance.

Portfolio trading algorithms, for example, are being launched now with exquisite timing for trading in volatile times, but have been in development for much longer. Take

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Photograph © Beka/Dreamstime.com, supplied May 2009.

Dynamic Implementation Shortfall, a portfolio trading algorithm from ITG. It appears to be just the job for buy-side traders in a trading world where annualised volatility reached 100% in the third quarter of 2008 and is still high at 40%50%. However, it was built and launched in the United States in 2007, when volatility levels were much lower.

“Volatility has been rising for over four years and there is a bigger need for risk management,” says Rob Boardman, head of electronic trading, ITG Europe. “The bigger the basket, the bigger the risk in volatile times, but these are large complex programmes and take longer than one year to develop,”he says.

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“Innovation is about continual evolution, not just a big bang approach,”agrees Mark Goodman, managing director, Direct Execution, UBS, which is rolling out its own portfolio trading algorithm, Portis. “Portis was originally developed for unwinding risk internally, but through discussions with clients, we have leveraged it as part of our direct execution offering and are now live with a number of clients. We are continuing to develop Portis based on client feedback with the aim of creating a complete suite of portfolio trading services over the year. Our whole philosophy is to go to market with a functional product but allow our clients to direct the development from there,”says Goodman.

Innovation in algorithms goes back to Credit Suisse’s Guerrilla, which set the benchmark for algorithmic trading at the end of 2004. Chris Marsh, head of AES trading and development, Europe, says that it was built with the simple goal of trading when liquidity materialised while minimising signals to the market. “Guerrilla has evolved since then and is far, far more complicated than it used to be. Markets and the world are more complicated and all algorithms evolve. Even the humble iceberg order has become quite sophisticated.”

Algorithms have become more sophisticated as trading conditions have become tougher with the downturn in volumes and drying up of liquidity. They also allow traders to cope with the quest for ever faster trades. Arguably, one of UBS’s most useful innovations in the last two years has been the liquidity-seeking algorithm Tap. It aggregates liquidity across displayed and dark pools and has five levels of urgency. Launched in 2007 in the US, it now accounts for 80% of UBS’s algorithm flow there. Rolled out in Europe before the introduction of MiFID, its true value is clear in the post-MiFID landscape, says Goodman. “We have continued to develop it based on changing markets and feedback from clients. This ensures it stays relevant and we are seeing usage of Tap grow to one third of our total European business in the last eight months.”

MiFID changed the competitive landscape; the abolition of the concentration rule, where trading no longer had to be conducted on primary exchanges, saw the arrival of multilateral trading facilities, pan-European exchanges, and the consequent fragmentation of trades across venues, spawning a raft of liquidity-seeking algorithms.

Deutsche Bank’s Stealth is one such algorithm. It essentially allows the trader to hedge against a spike in price or changed market conditions with minimal information leakage. ITG’s Raider algorithm was launched in the US in April 2009. This aims to seize arbitrage opportunities over perhaps a two-second window in highspeed markets. It finds the opportunity, goes in and trades and then pulls back to avoid causing market impact.

The sellside is innovating in cross-asset trading where fixed income and foreign exchange is increasingly electronic. Goldman Sachs, for example, has a suite of multi-asset algorithms and in March announced three new algorithms for trading advanced options including the facility to auto-hedge options orders.

FTSE GLOBAL MARKETS • JUNE 2009

Chris Marsh, head of AES trading and development, Europe, says that it was built with the simple goal of trading when liquidity materialised while minimising signals to the market.“Guerrilla has evolved since then and is far, far more complicated than it used to be. Markets and the world are more complicated and all algorithms evolve. Even the humble iceberg order has become quite sophisticated.” Photograph of Chris Marsh from the Berlinguer photo archives, supplied May 2009.

“In cross asset trading, everybody wants a one stop shop,” says Marsh. Credit Suisse recently launched a foreign exchange (FX) “trade-along” algorithm which matches and mimics the trade rather than waiting to settle at the end of the day and risk opportunity cost. “This is non-risk FX trading. It is a fixed rate commission and we trade the FX along with the equity or future fills so that traders can interact with the markets as much as they like.

It also preserves anonymity in the FX space because you are doing it in a locked-down system.”

With globalisation of trading, algorithms can now also be tailored for individual regional markets, such as new algorithms offered in the Middle East by Credit Suisse or customisable algorithms for Brazil and Mexico by BNYConvergEx. Progress Apama has designed a custombuilt “Complex Event Processing” platform for the fragmented Australian market. Apama customers are given access to out-of-the-box algorithms and tools to enable them to modify strategies to their individual needs.

A new suite of products from Execution, an agency-only brokerage house, allows buyside clients anonymously to use 32 algorithms from four bulge bracket brokers. It has an order management system provided by Fidessa, and

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Tony Nash, Execution’s head of execution services, says that it offers a complete execution and settlement service to clients.

“We believe we have chosen the brokers with the most sophisticated and highly regarded algorithms in the market. Our clients will be able to access the algorithms through us in a completely anonymous environment. The brokers do not know who is using their algorithms, but the buyside know the name of the banks and the names of the algos,”says Nash.

“The buyside is taking more control,” agrees Flatley of Autobahn Equity, which has just introduced real-time services through co-location at the Australia Securities Exchange (ASX). “The opportunities to arbitrage might only be there for a thousandth of a second and if it takes 800 milliseconds to get from New York to Australia, that is going to take away your opportunity to profit.” Deutsche has placed its servers next to those of the ASX to reduce latency and eliminate the time gap.

“Brokers used to facilitate the clients’ trading. Now we facilitate their access so they can trade themselves, and we have also created technology to help them trade on their own,”says Flatley.

Innovations are putting power into the hands of the buyside. UBS has a new real-time transaction cost analysis tool, Fusion, launched in the US in September 2008 and in Europe in March 2009. The innovation puts paid to one of the big grumbles of the buyside—lack of transparency through the trading process—and allows clients to analyse their orders while they are executing and still be able to affect the order’s outcome. Previously, post trade analysis was sent to clients at the end of the trading session, day or month.

Real-time intelligence has also been built into Quod Financial’s latest upgraded smart order routing (SOR) technology. Adaptive Smart Order Router version 2, allows traders to capture fragmented liquidity and selects the ideal venue and execution mechanism for every trade through real-time statistical analysis of pre- and post-trade execution data. It includes an audit trail showing why trades are made in relation to earlier trades.

“SOR is now an essential tool to navigate liquidity and the next generation needs to get smarter,” says Ali Pichvia, chief executive of Quod Financial. A recent paper from the company, “The Second Age of Smart Order Routing”, says that in Europe, SORs have to be able to handle multiple criteria including price, cost, preference and immediacy in order to find the right execution, so they need to be able to adapt intelligently rather than simply be a basic routing technology.

Increased volumes of data and the quest for low latency have themselves led to innovation in data provision.

Thomson Reuters launched its Data Feed Direct, claiming sub-millisecond data feed handling more than three years ago, and in April 2009 announced an upgrade to the architecture to cope with peak and forecast market data volumes. It claims to be the industry’s fastest market data

Mark Goodman, managing director, Direct Execution, UBS, which is rolling out its own portfolio trading algorithm, Portis.“Portis was originally developed for unwinding risk internally, but through discussions with clients, we have leveraged it as part of our direct execution offering and are now live with a number of clients. We are continuing to develop Portis based on client feedback with the aim of creating a complete suite of portfolio trading services over the year. Our whole philosophy is to go to market with a functional product but allow our clients to direct the development from there,” says Goodman.

Photograph kindly supplied by UBS, May 2009.

solution giving “ultra-low latency full-tick feeds, direct from exchanges, ideal for algorithmic trading programmes and other high-speed machine trading applications”. In tests, the upgraded technology demonstrated an eight-fold improvement in throughput and a four-fold improvement in latency, Thomson Reuters said.

However, Marsh describes a different trader:“If you are a statistical arbitrage fund, yes, speed is the new black; but if you are a traditional fund manager, then really, what’s the difference between 30 and 20 milliseconds? A large number of the buyside do not understand why we focus on speed. The world is getting faster, but everyone is focusing on cost and efficiencies; how to make trades cheaper and more efficient.”

At a time when many are cutting spending on research and development (R&D), ITG claims to have more people working in the area compared with last year. Rob Boardman believes it is down to ITG being an agency-only house without the distractions of proprietary trading or huge losses: “We are continuing to innovate strongly and are hoping to win by the quality of our R&D in the downturn. For us it is business as usual.”

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Against a blood-strewn financial backdrop, worthy of any Shakespearean tragedy, Phil Allison, a rising star at UBS Investment Bank, has been getting his feet under the table in his job in charge of European equity client trading. UBS has taken a significant battering of late, and many of its business departments have been decimated. Its equity trading operations remain a cornerstone of the UBS investment bank’s return to growth. Allison’s particular story is that of a wise old head on still young shoulders. Is that enough to lead the investment bank back to halcyon days? Ruth Hughes Liley reports.

HIL ALLISON’S BOYISH good looks belie his seniority. At just 33, he is in charge of European equity client trading and execution at UBS Investment Bank, leading a team of around 140 people.

When he took on the job, a touch above a year ago, the impact of the credit crunch and economic downturn was still a vague prediction. As the financial storm continues to wield its corrosive power through bulge bracket investment banks, UBS has made its equities trading business a key part of its business growth strategy.

At the annual general meeting in Switzerland in April this year, Oswald Grübel, who came out of retirement from Credit Suisse to be UBS AG’s new chief executive, stressed the paradigm to attendees. “In investment banking we want to return to the more traditional business model, with manageable risks and clear earnings potential. We will build on our already strong positions in equities … At the same time we will continue to reduce our balance sheet and risk-weighted assets. We want to focus our trading activities on client business,”he noted.

P

FTSE GLOBAL MARKETS • JUNE 2009

Successful client business is how Allison measures a good working day:“There are few things that make me feel better than meeting with an important client and have them say that we are doing a good job; they like the people they deal with; they like the execution we achieve for them.

There are lots of ways to measure success, but if the feedback from the client is right then that means we are getting a lot of things right.”

Up to now, Allison is making the right calls. In its firstquarter results, issued on 5th May, 2009, UBS announced that the equities trading desks reported revenues of CHF1.37bn, up from CHF231m in the fourth quarter 2008.

In the latest Thomson Reuters Extel pan-European survey, UBS ranked top in equity and equity-linked trading and execution as well as best direct market access (DMA) provider, best execution in portfolio trading and best overall services in electronic trading.

His previous role as head of automated trading took him to the US but his new role is solely focused on Europe and includes the portfolio trading desk, sales trading and cash

EQUITY TRADING: ALLISON STEERS UBS BACK TO THE BIG LEAGUE

TRADING INTO A NEW FUTURE

Photograph © Kirsty Pargeter/ Dreamstime.com, supplied May 2009.

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as well as retaining the electronic trading brief. Allison says he has to have good teams in place to “get it right. The basis of our success is the team. If you have good people in the right place, going in the same direction, then that gives you confidence to react to any challenges that are thrown at you.”

When he first took over his role, he decided that it was important to help the different functions to understand each other so that clients would have a more seamless experience. “We needed to be more flexible in providing clients with the service they want. Clients frequently like having their sales trader, for example, but they execute and therefore pay down the electronic pipe. This merging of the business mix was one of my early priorities,”says Allison.“In fact all the different execution methods are changing in why clients use them [sic], but there has been a natural tendency for each execution team not to realise the strength of the whole platform. So that needed addressing.

“The electronic business has matured and now most clients are using it. In the same way portfolio trading and sales trading have changed and become more sophisticated, so clients are demanding a different type of service,”he adds.

The teams working with him have not, however, escaped swingeing redundancies at UBS—a move forced by recorded writedowns of $50bn last year. From a record high of 83,000 employees across the group in March 2008, a newly announced set of redundancies will reduce the figure to 67,500 by 2010. The investment bank will be left with 14,500 people, down from 17,000 at the end of 2008. Personnel changes have gone right through the investment bank and in April 2009, chairman and chief executive officer Jerker Johansson resigned after just a year in the job, to be replaced by joint heads Alex Wilmot-Sitwell and Carsten Kengeter.

Allison, who has worked for UBS since he graduated from Cambridge University in 1997, sees two additional reasons for the reduction in the size of the cash equities business: “Our client base is always changing. Hedge funds, a minority of our business, are clearly a lot less active at present. Second, as we have continued to invest in technology, we have been able to find productivity gains in the trading area.” That has not impacted on the essential client focus, highlights Allison:“We have reduced the size of the team, but maintained our client facing people.”

Along with redundancies—formal transition management was one of the areas exited by UBS—another consequence of the credit crunch has been record high levels of volatility in the markets and all the risks associated with wider spreads. Oswald Grübel’s pledge to reduce risk falls to Allison in the area of cash equities in Europe and Allison also sits on UBS’s equities global risk committee, responsible for the overall risk in the equities business.

Moreover, Allison has cut back the cash equities portfolio to reduce exposure to bigger swings in the market, as bigger portfolios bring greater risk and are more difficult to manage.“With higher volatility and wider spreads, we are typically running a much smaller portfolio,” he explains,

Phil Allison, head of european equities trading execution at UBS Investment Bank. Photograph kindly supplied by UBS, May 2009.

adding:“As for balance sheet, the cash equities business is a very light user; our risk positions are mainly short duration and result from client trading.”

UBS is a member of the consortium of nine banks that clubbed together to provide liquidity to Turquoise, the multilateral trading facility or pan-European exchange, which launched in September 2008. Allison is a director of Turquoise and sees the arrival of the MTFs on the trading scene as good for business.“Competition is healthy for the European cash market structure. It has started to create innovation in trading functionality as well as price, both of which ultimately lead to better execution for our clients,”he says.

On the flip side, Allison holds that the arrival of the MTFs has demanded more investment in technology:“Almost every month we are connecting to a new venue but substantial investment was made in our new execution infrastructure a couple of years ago and this is paying off. So while the pressure on technology is a challenge for the whole industry and particularly for the sellside, our technology platforms have improved and become more efficient, so we are getting more productivity per dollar spend.”

From time to time UBS has been ahead of the field in new algorithms. Nonetheless, he admits: “We have been more focused on building high quality algos rather than on how to market them but we have made enormous strides to address that and our products are now much better known about than they were.” One example is UBS’s liquidity-seeking algorithm, Tap, which now constitutes up to 80% of algorithmic trade at UBS in the US, while in Europe it makes up a third. Allison says a lot of work has also gone into the development of UBS’s new portfolio trading algorithm, Portis.

The emergence of smaller execution houses such as ICap and Execution has been regarded as challenging to the large brokers and Allison says:“They are a more significant part of the trading landscape. Our relationship with clients has remained stable over the last few years and clients see us as long-term partners with a commitment to meet their need. UBS is strong around the globe in research and sales as well as execution—that is a breadth and depth that our clients value.”

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In the Asia Pacific region, the reigning sub-custodian champions are Citi, HSBC and Standard Chartered, and this is likely to remain so. Each may have their own value add, but they all share the support of a large parent as well as experience and in-depth knowledge of the region’s different markets. Photograph © Drzzd/Dreamstime.com, supplied May 2009.

Before the recent financial turmoil, Asia scored high on the list of top ten emerging market destinations. Over the past few years, investors rushed in to capitalise on the booming growth stories but as with almost every investment strategy, enthusiasm has been tempered. This is likely to be a temporary phenomenon as the long term drivers behind countries such as China and India have not disappeared. The difference today in custodial circles is that firms might not only think twice before setting up shop in a country but they are also likely to become more selective in their sub-custodial relationships. By Lynn Strongin Dodds.

FTSE GLOBAL MARKETS • JUNE 2009

SECURITIES SERVICES IN ASIA

THE NEW DARWINISM

HILE THERE ARE no concrete figures, anecdotal evidence suggests there has been a flight to quality reflecting the general trend in the financial services industry. Clients are looking to conduct business with highly rated, sound organisations. Colin Brooks, the Hong Kong based global head of sub-custody and clearing of HSBC, notes, “The flight to quality in the region started ten years ago as a result of the Asian financial crisis of the late 1990s. The beneficiaries then, as now, were the regional providers given their strong and well established networks.”

Mark Kerns, head of investor services at Standard Bank, adds:“In emerging markets, the criteria has always focused on the financial standing of the bank, operational risk,

W

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quality of service, range of capabilities, credit position and geographical coverage. I think the criteria and selection process has been tightened over the past 18 months.”

Pierre Jond, head of global sales and relationship management financial intermediaries at BNP Paribas, comments,“Overall, organisations have had to think again about the banks they use. In some cases, the ones that were considered safe and secure have disappeared and this has made some people wary about relying on third party providers. As a result, the double A plus rated organisations will be seen as safe havens and are likely to attract additional business.”

In the Asia Pacific region, the reigning sub-custodian champions are Citi, HSBC and Standard Chartered, and this is likely to remain so. Each may have their own value add, but they all share the support of a large parent as well as experience and in-depth knowledge of the region’s different markets. Kevin Smith, managing director of global network management at The Bank of New York Mellon notes, “In Asia Pacific (ex Australia and Japan) we have a strong sub-custodial network through our primary Asia partner, HSBC. We made the decision to consolidate our sub-custodial relationships as far back as 2003 for the primary reason of service—we insist on delivering high levels of service in all of our chosen markets. Having fewer sub-custodial partners makes it easier to manage our local sub-custodians and deliver on our services expectations.

We applied the same strategy in Latin America with Citi and in parts of Central and Eastern Europe with ING.” Andrew Osborne, senior vice president, global head of network management at Northern Trust, says,“In the AsiaPacific region, to a large extent, global custodians have migrated away from indigenous relationships to the welcoming arms of the larger players who can provide multijurisdictional products. We have seen several local players exiting the market over the past few years due to this demand for a regional solution the increased challenges in offering a financially viable sub-custody product in a single location. In Northern Trust’s case we use a broad range—HSBC, Citi, and Standard Chartered as well as a couple of indigenous providers. Each one is handpicked and our main priorities are and have always been their creditworthiness, quality of service, commitment to business and cost effectiveness.”

There are concerns, though, that some local providers might not have the resources to survive the current climate or offer multi jurisdictional solutions and more complicated products to meet client demands. As Giles Elliott, Global Head of Products for Securities Services at Standard Chartered, notes,“Clearly, no one can predict how long this financial winter will last but the investment industry is definitely looking to cut costs. This in turn will put pressure on the supply chain. Custodians want to ensure that they are using committed players who are looking to expand their capabilities despite the challenges around revenue.

For those firms where custody is a peripheral activity, then we may see some exiting the business as they look to concentrate on core banking activities.”

`

Over the past year, Standard Chartered, which is in about 10 markets across Asia, has made significant investments in its sub-custody and clearing business in the region over the past year. The UK-based bank scored several firsts with its Swift proxy-voting initiative, derivatives clearing service in India, and third-party custody in the Philippines for government securities.

Over the past year, Standard Chartered, which is in about 10 markets across Asia, has made significant investments in its sub- custody and clearing business in the region over the past year. The UK-based bank scored several firsts with its Swift proxy-voting initiative, derivatives clearing service in India, and third-party custody in the Philippines for government securities.

Brooks of HSBC also points out, it is an expensive proposition to “establish a network and tailor it to the local market, find the right people, deal with the myriad of regulations, put in the regulatory oversight and corporate governance structures. Also, sub-custody tends to have a significant fixed cost element and in times like these when assets are falling I think we might see more outsourcing than in-sourcing of these functions. We offer sub-custodial services across 17 markets in the region and spend a great deal of time and effort ensuring that the high quality of services and products we provide in larger markets are replicated in smaller markets in Asia as well as in other regions.

There is no doubt that the cost of setting up shop has deterred many of the global custodians from entering the sub-custody market. Osborne sums it up by saying,“Subcustody is a high volume, low margin business although each market has its nuances. It is a capital intensive business and to make it viable you need to push through large volumes to make it attractive. This is not our business strategy as we are global custodians.”

Other firms such as BNP Paribas and Société Générale are pursuing strategic investments. Jond says,“Our model is that we provide services where we are on the ground but use sub-custodians where we do not have a presence. In Asia, the bank is developing its local business and our group is rolling out its technology and setting up subcustody networks in Singapore, Hong Kong and India. Our goal is to build our local expertise and harmonise the services we provide as much as possible across the geographical locations.

Where we do not have a presence, the criteria we look when choosing a sub-custodian is the resilience of the infrastructure and technology. For example, can the systems handle the spikes in volumes that we have just experienced? The quality of the people is also important.

They are not a commodity and it matters whether they are

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client driven and knowledgeable. Finally, we want a committed player who sees sub-custody as one of their core business areas.”

Société Générale Securities Services is following a similar strategy to its French rival in that it is pursuing a double prong strategy. Ramy Bourgi, head of emerging markets for SGSS says,“Over the past few years, we have moved from being a domestic bank to a European and now international player.

We are not in every market but we will establish a presence if clients’demands and volume justify it. We think diversification will remain a strong theme across markets, currencies and asset classes because neither cash nor houses are as safe as investors had thought. Although Asia has been affected by recent events, the region is more resilient than others due to the long-term growth potential of its economies and populations. For example, the Indian market dropped by 30% compared to Russia which has fallen by 60% year to date.”

Greenwich study A recent study conducted by Greenwich Associates reiterates this view by revealing that European institutional investors trimmed their allocations to domestic equities to just 14.7% of their total assets in 2007 from 15.9% in 2006 and more than 16% in 2005. By contrast, they used the spare cash to raise their exposure to emerging market equities to 2.3% of assets in 2007, up from 1.6% in 2006.

Looking ahead, nearly a third expects to significantly increase their allocations to emerging markets equities by 2011, while only 2% predicted significant reductions.

To this end, SGSS established a joint venture last year with State Bank of India (SBI) called SBI SG Custodial Services.

SBI and SGSS will hold 65% and 35% respectively of the equity in the new company, which will offer a range of services to both foreign and domestic investors including

custody, depository, and fund administration, registration and transfer agent services. We hope to be up and running by 2009,”says Bourgi.“China is the next country in Asia that we are looking at. We decided to partner with a domestic player which has a deep local knowledge and expertise. Otherwise it would take at least a year for us to come to market.”

In general, we believe that investments are important even in an economic downturn. Whether assets under custody may go up or down, our job is to cater to our clients. We all know this is going to be a tough time but we are not changing our business plan. We will continue to invest in growing the business to ensure that we are generating the fee income that will offset the decline in activity such as proprietary trading.”

As for the products that are being offered, sub-custody in Asia is still a traditional game consisting of safekeeping and clearing of securities, income collection and tax services, corporate action and proxy services, clearing services for remote brokers, securities lending depending on the market and SWIFT reporting and information services. More recently, though, in the wake of the financial meltdown there has been an increasing demand for real time information, performance measurement and analytics.

Elliott also notes that each market is different. “If you look at the larger and more mature markets such as Hong Kong, Singapore and Japan, the infrastructure is generally more sophisticated and there are fewer regulatory restrictions. The next layer is China, Indonesia, Korea, Taiwan, Malaysia and Thailand where regulations are increasingly being liberalised and this is leading to a greater breadth and depth of product range. There are immense opportunities in this developing layer for service providers who have local infrastructure and develop rapid solutions for investors as this liberalisation occurs.”

Don’t work in the dark, who knows what you might find Emerging Markets Report provides a comprehensive overview of the principal deals, trends, opportunities and challenges in fast-developing markets. For more information on how to order your individual copy of Emerging Markets Report please contact: Paul Spendiff Tel:44 [0] 20 7680 5153 Fax:44 [0] 20 7680 5155 Email:paul.spendiff@berlinguer.com

FTSE GLOBAL MARKETS • JUNE 2009

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BE SAFE, BE SURE! In the choppy waters that are today’s financial markets, being on top of the latest independent comment and analysis covering the world’s equity, debt and alternative investment markets can be a life-saver.

That is why FTSE Global Markets is valued by market professionals (both buy side and sell side) who are active in the global capital and investment markets.

To secure your personal copy of FTSE Global Markets either call our subscription hotline on + 44 207 680 5151 or email us at priority@berlinguer.com. We look forward to hearing from you.

www.berlinguer.com

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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: October 2008 through May 2009 (Europe only). (â‚Ź) October

November

December

January

February

March

April

BTE/BATs

12,912,601

1,692,679,055

3,117,405,897

4,790,110,404

5,600,695,181

8,284,331,344

11,739,665,480

May (to 22nd) 9,535,112,492

CIX/Chi-X

106,153,062,152

55,474,806,309

37,565,687,908

46,712,279,892

44,287,264,624

57,055,170,476

64,549,417,670

53,532,023,640

CPH/Copenhagen

9,799,125,787

5,627,172,892

3,169,443,325

4,658,766,694

4,781,868,780

4,172,100,968

5,376,242,856

4,282,783,206

ENA/Amsterdam

58,477,575,182

29,515,979,897

23,377,293,076

28,998,109,764

28,228,747,464

33,374,484,823

33,930,345,328

27,537,550,103

ENB/Brussels

10,689,261,202

5,618,466,860

5,525,054,653

6,557,604,579

6,677,562,065

7,285,738,551

6,777,175,877

6,290,023,617

ENL/Lisbon

4,105,636,725

2,613,601,564

1,781,804,343

1,942,925,835

1,699,902,475

2,192,516,989

2,611,463,853

2,358,407,515

ENX/Paris

158,687,540,849

83,259,044,929

65,223,182,965

68,569,494,159

62,176,825,878

71,521,595,572

72,615,015,403

51,997,186,176

GER/Xetra

206,777,148,040

86,619,580,417

67,500,746,934

65,531,679,523

58,938,123,381

72,362,496,131

70,827,752,529

54,161,794,245

HEL/Helsinki

19,248,238,567

10,391,280,842

6,544,928,692

8,018,556,502

7,630,785,531

8,002,261,708

9,739,066,277

6,040,700,395

LSE/London

218,235,697,409

128,535,134,938

88,925,334,643

98,676,987,434

90,529,113,476

113,505,101,306

98,894,191,343

75,370,351,463

MAD/Madrid

86,557,745,208

47,772,645,094

38,385,030,437

43,520,648,521

37,123,194,201

45,141,078,254

47,509,757,990

36,039,871,316

MIL/Milan

69,520,744,329

40,577,825,970

27,355,375,071

33,878,620,775

33,642,167,059

40,867,417,146

51,081,732,593

54,930,883,951

NEU/Nasdaq-OMX

45,339,983

138,799,631

290,807,724

603,441,883

487,436,557

489,152,477

938,987,188

1,862,347,155

STO/Stockholm

34,318,445,867

20,077,565,709

15,283,216,874

18,432,301,605

20,449,832,829

21,258,141,925

23,114,786,824

16,074,430,179

TRQ/Turquoise

27,088,688,572

19,577,155,245

15,473,634,349

26,311,426,009

29,084,346,493

23,016,525,997

13,975,420,771

12,693,535,742

VTX/SWX

86,469,471,856

45,647,116,803

35,217,759,178

39,198,800,982

41,645,468,998

42,750,059,854

41,180,202,240

31,165,827,097

Monthly Total

1,096,186,634,329

583,138,856,156

434,736,706,069

496,401,754,564

472,983,334,994

551,278,173,520

554,861,224,224

443,872,828,293

EUROPEAN TRADING STATISTICS

THE FIDESSA FRAGMENTATION INDEX (FFI)

Market share by venue in electronic order book trades in major stocks: October 2008 through May 2009 (as a percentage) (Europe only) October

November

December

January

February

March

April

May (to 22nd)

BTE/BATs

0.00%

0.29%

0.72%

0.96%

1.18%

1.50%

2.12%

2.15%

CIX/Chi-X

9.68%

9.51%

8.64%

9.41%

9.36%

10.35%

11.63%

12.06%

CPH/Copenhagen

0.89%

0.96%

0.73%

0.94%

1.01%

0.76%

0.97%

0.96%

ENA/Amsterdam

5.33%

5.06%

5.38%

5.84%

5.97%

6.05%

6.12%

6.20%

ENB/Brussels

0.98%

0.96%

1.27%

1.32%

1.41%

1.32%

1.22%

1.42%

ENL/Lisbon

0.37%

0.45%

0.41%

0.39%

0.36%

0.40%

0.47%

0.53%

ENX/Paris

14.48%

14.28%

15.00%

13.81%

13.15%

12.97%

13.09%

11.71%

GER/Xetra

18.86%

14.85%

15.53%

13.20%

12.46%

13.13%

12.76%

12.20%

HEL/Helsinki

1.76%

1.78%

1.51%

1.62%

1.61%

1.45%

1.76%

1.36%

LSE/London

19.91%

22.04%

20.45%

19.88%

19.14%

20.59%

17.82%

16.98%

MAD/Madrid

7.90%

8.19%

8.83%

8.77%

7.85%

8.19%

8.56%

8.12%

MIL/Milan

6.34%

6.96%

6.29%

6.82%

7.11%

7.41%

9.21%

12.38%

NEU/Nasdaq-OMX

0.00%

0.02%

0.07%

0.12%

0.10%

0.09%

0.17%

0.42%

STO/Stockholm

3.13%

3.44%

3.52%

3.71%

4.32%

3.86%

4.17%

3.62%

TRQ/Turquoise

2.47%

3.36%

3.56%

5.30%

6.15%

4.18%

2.52%

2.86%

VTX/SWX

7.89%

7.83%

8.10%

7.90%

8.80%

7.75%

7.42%

7.02%

Monthly Total

100.00%

100.00%

100.00%

100.00%

100.00%

100.00%

100.00%

100.00%

FTSE GLOBAL MARKETS • JUNE 2009

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EUROPEAN TRADING STATISTICS

TRADING DATA FOR EARLY MAY 18TH-22ND MAY 2009 (EUROPE ONLY) Venue turnover for the week 18th-22nd May 2009 Venue

Trades

European Top 20 Fragmented Stocks for the week 18th-22nd May

Turnover € 000’s

Share %

TW

LW

1

-1 -17

London

2,932,438

21,955,087

18.60%

2

Xetra

761,342

15,631,137

13.24%

3

Milan

930,386

15,289,363

12.95%

4

-48

Chi-X

2,559,248

14,502,826

12.29%

5

-8

6

-51

7

-6

Paris

1,315,413

12,991,407

11.01%

Madrid

492,420

10,464,405

8.87%

8

-15

SWX

393,738

7,073,249

5.99%

9

-27

Amsterdam

604,464

5,928,013

5.02%

10

-13

Turquoise

584,829

3,380,860

2.86%

11

-62

Stockholm

219,979

3,119,138

2.64%

BATS

538,836

2,827,196

2.40%

Brussels

251,325

1,501,619

Helsinki

118,073

1,497,479

12 13

-69

14

-25

1.27%

15

-30

1.27%

16

-3

17 18

-7

19

-32

20

-28

Wks

Stock

Description

37

RDSA.L

RDS 'A' 'A' ORD EUR0.07

31

ULVR.L

UNILEVER ORD 3 1/9P

3

CKSN.L

COOKSON GRP. ORD 100P

2.09

5

LOG.L

LOGICA ORD 10P

2.08

14

BA..L

BAE SYS. ORD 2.5P

2.06

3

RIO.L

RIO TINTO ORD 10P

2.04

27

KGF.L

KINGFISHER ORD 15 5/7P

2.03

3

EMG.L

MAN GROUP USD0.03428571

2.02

5

HEN3.DE

HENKEL AG+CO.KGAA VZO

15

IMT.L

IMP.TOBACCO GRP ORD 10P

1.98

1

EN.PA

BOUYGUES

1.97

1

PFC.L

PETROFAC ORD USD0.025

1.97

3

IHG.L

INTERCON. HOTEL ORD 13 29/47P

1.97

4

SAB.L

SABMILLER ORD $0.10

1.97

2

ALO.PA

ALSTOM

1.97

25

RDSB.L

RDS 'B' 'B' ORD EUR0.07

1.96

4

LAND.L

LAND SECS. ORD 10P

1.96

11

RBS.L

ROYAL BANK SCOT ORD 25P

1.96

5

SU.PA

SCHNEIDER ELECTRIC

1.94

12

BATS.L

BR.AMER.TOB. ORD 25P

1.94

FFI 2.21 2.1

2

Index market share by venue for the week ending 18th-22nd May 2009 Primary

Alternative Venues

Index

Venue

Share

Chi-X

Turquoise

Nasdaq OMX

BATS

Copen.

Amst.

Paris

Xetra

AEX

Amsterdam

72.03%

17.15%

2.74%

0.40%

3.06%

-

-

4.27%

0.16%

Helsinki

-

BEL 20

Brussels

56.35%

9.82%

2.18%

0.81%

1.86%

-

-

28.07%

0.12%

-

CAC 40

Paris

66.62%

17.95%

3.42%

0.97%

3.19%

-

7.04%

-

0.20%

-

DAX

Xetra

77.02%

15.00%

2.54%

0.65%

3.82%

-

†

0.02%

-

-

FTSE 100

London

72.23%

17.57%

5.44%

0.83%

3.93%

-

-

-

-

-

FTSE 250

London

81.79%

13.79%

2.05%

0.29%

2.08%

-

-

-

-

-

IBEX 35

Madrid

99.76%

0.17%

†

†

-

-

†

-

0.03%

-

MIB 30

Milan

94.56%

4.15%

0.48%

0.02%

0.73%

-

†

†

0.04%

-

NORDIC 40

Stockholm

49.38%

7.91%

2.64%

0.13%

0.23%

11.91%

†

-

1.03%

26.73%

PSI 20

Lisbon

99.27%

-

0.73%

-

-

-

-

-

†

-

SMI

SWX

89.19%

7.25%

3.25%

0.10%

0.21%

-

-

-

-

-

† market share < 0.01%

COMMENTARY 1.5 1.4 1.3 1.2 1.1

r

ay M

ar

Ap

Fe b

M

c

n Ja

De

t

ov N

p

Oc

Se

l

g Au

Ju

n

1

Ju

When we reported on fragmentation in the last issue, we looked at why it was appearing to flatten across the main European indices. In April and May volume and market share across all the MTFs rose steadily. One of the reasons for this lies with the original market-making obligations of investors in Turquoise, which expired in March, with much of the liquidity that these activities created expiring with them. Since then, however, Turquoise has replaced this “artificial” liquidity with real passive or resting liquidity. This is much more valuable as traders will always gravitate towards where they think passive liquidity resides. This then increases match rates which further increases passive liquidity, and so on.

Other MTFs, including BATS Europe and NASDAQ OMX Europe, have also seen greater volumes, although this has been driven by price cuts targeted at specific market sectors, for example the CAC40.

As a result, the FFI of the CAC40 has risen by more than 15 per cent in the past two months.

FTSE 250

Another interesting aspect to the data is how many of the top twenty most fragmented stocks have now breached the statistically significant barrier of having an FFI of 2.0 or more. Once this happens, liquidity in that stock is deemed to have fragmented to the extent that it no longer belongs to its original venue. The number of such stocks has more than tripled in the past two months. Even more startling is the increasing rate of fragmentation in mid-cap stocks, such as the FTSE 250, as illustrated on this graph.

The consequence of all this is that brokers who specialise in these stocks will need to think hard about their smart routing technology and whether leaving smart routing to the big broker dealers will still make sense in the future.

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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$1,000

# ETFs 1,800 1,600

$800

1,400 1,200

$600 1,000 800 $400 600 400

$200

200 0

$0 ETF Assets Total

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Jan-09

Feb-09

Mar-09

$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

$711.0

$658.8

$593.0

$633.1

ETF Commodity Assets ETF Fixed Income Assets ETF Equity Assets

$0.8

$1.1

$2.3

$5.3

$8.2

$17.6

$39.6

$0.0

$0.1

$0.3

$0.5

$1.2

$3.4

$6.3

$9.9

$11.0

$12.4

$12.8

$0.1

$0.1

$4.0

$5.8

$23.1

$21.3

$35.8

$59.9

$104.0

$106.7

$109.0

$116.4

$74.2

$104.7

$137.5

$205.9

$286.3

$389.6

$526.5

$729.9

$596.4

$540.4

$471.1

$503.3

$15.6

$28.1

$45.9

$53.2

$59.5

$68.5

$73.0

ETP Assets Total

# ETPs # ETFs

3

3

4

21

21

31

33

92

202

280

282

336

23

70

134

271

274

274

277

461

714

1171

1590

1,602

1,603

1,634

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

ETF LISTINGS BY EXCHANGE (As of End March 2009) Region Listed

Country

Exchange

Asia Pacific Australia China Hong Kong India Indonesia Japan Malaysia New Zealand Singapore South Korea Taiwan Thailand

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

Americas Brazil Canada Mexico US

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

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

Grand Total

Wiener Borse Euronext Brussels Helsinki Stock Exchange Euronext Paris Deutsche Boerse Boerse Stuttgart 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

# Primary ETF

# Total ETF

AUM ($bn)

20 Day ADV ($m)

160

213

46.51

912.04

3 3 2 11 2 9 1 6 56 3 6 6 39 11 2

19 3 2 23 2 9 1 6 58 3 6 29 39 11 2

0.79 1.34 1.69 13.45 0.42 0.22 0.00 8.20 15.18 0.28 0.26 0.87 2.29 1.45 0.05

8.91 268.93 113.52 229.00 0.00 2.11 0.00 103.38 78.22 0.01 0.12 6.00 71.17 30.34 0.34

783

918

450.10

85,776.08

4 83 6 48 4 638 -

4 83 141 48 4 638 -

1.13 14.91 3.90 15.38 64.05 350.72 -

5.07 750.47 135.74 13,915.78 772.07 442.63 788.65 265.67 810.36 20,289.41 26,498.33 0.00 0.00 21,101.89 0.00

691

1,725

136.53

2,080.95

1 1 1 191 269 0 1 1 1 14 14 4 6 1 1 19 9 7 21 0 6 123 -

21 1 1 344 430 50 1 1 1 14 265 78 6 1 1 19 25 7 132 18 6 303 -

0.04 0.04 0.12 34.81 58.82 0.00 0.07 0.01 0.00 0.06 1.13 0.35 0.39 0.00 0.00 0.93 2.07 1.59 11.29 0.00 0.11 24.69 -

0.38 0.27 3.10 348.51 651.83 10.33 0.18 0.13 0.00 0.13 263.84 44.42 62.00 0.00 0.00 7.84 8.97 121.88 102.31 5.17 20.18 265.87 16.43 147.19

1,634

2,856

633.14

88,769.07

EXCHANGE TRADED FUNDS: LISTING & DISTRIBUTION

Worldwide ETF and ETP Growth

Assets US$ Bn

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 March 2009 Number of ETFs

Total Listings

AUM ($bn)

% Total

North America - Equity 474 Fixed Income - All (ex-Cash) 171 Emerging Markets - Equity 240 Europe - Equity 354 Asia Pacific - Equity 135 Global (ex-US) - Equity 60 Commodities 49 Fixed Income - Cash (Money Market) 15 Global - Equity 96 Mixed (Equity & Fixed Income) 27 Currency 13 Total 1,634

643 306 479 748 226 65 94 31 225 27 13 2,856

$275.71 $104.21 $73.95 $65.07 $44.90 $34.12 $12.82 $12.20 $9.60 $0.28 $0.28 $633.14

43.5% 16.5% 11.7% 10.3% 7.1% 5.4% 2.0% 1.9% 1.5% 0.0% 0.0% 100.0%

Region of exposure

Fixed Income Cash (Money Market) Global - Equity Commodities

1.9%

1.5%

2.0%

Currency

Global (ex-US) Equity

0%

5.4%

Mixed (Equity & Fixed Income)

Asia Pacific Equity

0%

7.1%

Europe - Equity

11.7%

Emerging Markets - Equity

North Americas Equity

10.3%

43.5%

Fixed Income - All (ex-Cash)

16.5%

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

TOP 25 ETF PROVIDERS AROUND THE WORLD: ranked by AUM, as of end March 2009 March 2009 PROVIDER

iShares State Street Global Advisors Vanguard Lyxor Asset Management db x-trackers PowerShares ProShares Nomura Asset Management Van Eck Associates Corp Bank of New York Nikko Asset Management Credit Suisse Asset Management Zurich Cantonal Bank Daiwa Asset Management EasyETF Nacional Financiera Direxion Shares Hang Seng Investment Management WisdomTree Investments Commerzbank BBVA Asset Management ETFlab Investment UBS Global Asset Management XACT Fonder Credit Agricole Structured AM

YTD Change

# ETFs

AUM ($bn)

% Total

# Planned

# ETFs

% ETFs

AUM ($bn)

369 102 38 115 104 143 64 29 19 1 8 8 4 23 58 1 16 3 50 50 8 22 8 10 35

$296.80 $103.55 $44.15 $29.93 $24.61 $21.53 $21.37 $13.24 $6.38 $5.32 $5.23 $5.06 $4.47 $4.46 $4.15 $3.09 $2.97 $2.91 $2.79 $2.39 $2.01 $1.95 $1.89 $1.83 $1.76

46.9% 16.4% 7.0% 4.7% 3.9% 3.4% 3.4% 2.1% 1.0% 0.8% 0.8% 0.8% 0.7% 0.7% 0.7% 0.5% 0.5% 0.5% 0.4% 0.4% 0.3% 0.3% 0.3% 0.3% 0.3%

9 29 5 3 0 36 88 0 13 0 0 0 0 1 8 0 114 0 64 0 0 0 0 0 1

8 4 0 0 6 1 0 0 3 0 0 0 0 0 4 0 2 0 0 0 0 12 0 0 11

2.2% 4.1% 0.0% 0.0% 6.1% 0.7% 0.0% 0.0% 18.8% 0.0% 0.0% 0.0% 0.0% 0.0% 7.4% 0.0% 14.3% 0.0% 0.0% 0.0% 0.0% 120.0% 0.0% 0.0% 45.8%

-$28.05 -$42.45 -$1.00 -$3.31 $0.55 -$0.75 $1.05 -$1.69 $1.93 -$1.37 -$0.96 -$0.89 $1.17 -$1.60 -$0.32 -$0.55 $2.04 $0.09 -$0.44 -$0.21 -$0.07 -$0.57 $0.49 $0.31 -$0.10

% % Market AUM Share

-8.6% -29.1% -2.2% -10.0% 2.3% -3.4% 5.2% -11.3% 43.4% -20.5% -15.5% -14.9% 35.5% -26.4% -7.2% -15.1% 217.6% 3.3% -13.5% -7.9% -3.4% -22.7% 35.2% 20.3% -5.3%

1.2% -4.2% 0.6% 0.1% 0.5% 0.3% 0.5% 0.0% 0.4% -0.1% 0.0% 0.0% 0.2% -0.1% 0.0% 0.0% 0.3% 0.1% 0.0% 0.0% 0.0% 0.0% 0.1% 0.1% 0.0%

Source: ETF Research & Implementation Strategy, Barclays Global Investors, Bloomberg. All data supplied March 2009.

NOTES At the end of March 2009 the ETF industry had 1,634 ETFs with 2,856 listings, assets of $633.14 billion, from 87 providers on 43 exchanges around the world. Assets fell by 11.0%, which is less than the 12.5% fall in the MSCI World index in USD terms. The number of ETFs has increased 2.8% YTD. The average daily trading volume in US dollar has increased by 10.4% to US$88.8 billion YTD. European ETF AUM has fallen by 5.0% while the MSCI Europe Index is down 15.8% YTD. In Europe net sales of mutual funds (excluding ETFs) were positive $16.6 billion while net sales of ETFs domiciled in Europe were positive $10.4 billion during the first two months of 2009 according to Lipper FMI.

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.

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Number of Securities

Value of Securities (US$ Bln)

176,489

6,419

28,227

1,261

Securities Available for Lending Securities On Loan Securities Transactions

1,990,413

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 303 separate asset classes in the data set.

Security Type

Lendable Assets (M)

Balance Balance vs vs Cash Non Cash (M) (M)

Total Utilisation Balance (%) (M)

SL Fee (Bp)

Daily SL Return (K)

Daily RI Return (K)

All Securities

6,418,818

749,354

511,582

1,260,935

All Bonds

3,500,799

409,398

321,424

730,822

Corporate Bonds

1,752,973

59,210

40,568

Government Bonds

1,683,511

346,865

All Equities

2,908,699

Americas Equities

Total Daily Revenue Return Share from (K) SL (%)

SL Return to Lendable Assets (Bp)

Total Return Lendable Assets (Bp)

SL Tenure (days)

16.27

38.20

60.0

13,380.2

21,016.8

19.41

5.14

29.8

1,043.3

6,058.1

63.66

5.02

9.31

103

17.22

0.94

6.10

99,779

5.17

10.84

36.03

300.5

122

998.6

30.09

0.55

1.99

280,083

626,948

34.75

4.18

28.77

139

727.7

5,010.9

14.52

1.35

10.51

339,955

189,873

529,828

12.53

83.82

120

101.6

12,336.5

14,958.3

82.47

9.95

13.20

1,750,102

208,663

29,717

238,380

11.09

76

92.31

119.30

6,112.4

7,899.7

77.37

9.48

13.15

Asian Equities

324,733

27,649

29,981

57,630

59

11.61

82.13

94.78

1,314.7

1,517.3

86.65

8.09

10.34

European Equities

687,736

68,810

126,130

96

194,939

16.39

83.51

91.68

4,521.9

4,964.3

91.09

13.16

15.48

Depository Receipts

80,715

15,818

95

1,946

17,764

13.33

62.44

80.90

308.1

399.2

77.19

4.66

8.72

Exchange Traded Funds

45,574

18,056

46

1,134

19,190

18.23

-4.49

12.31

-23.9

65.6

-36.44

0.91

7.98

45

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

Equities

Equities

Top 10 by Total Balance

Top 10 by Increase in Balance (Balance > 10 Mln Euro)

Rank

Stock description

Rank

Stock description

1

Total Sa

1

Novo Nordisk A/S

2

Hsbc Holdings Plc

2

Crh Plc

3

Sanof i-Aventis Sa

3

Astellas Pharma Inc

4

Mizuho Financial Group Inc

4

Citigroup Inc

5

Roche Holding Ag

5

Tdk Corp

6

Eni Spa

6

Mitsui & Co Ltd

7

Nestle Sa

7

Nintendo Co Ltd

8

Bayer Ag

8

American International Group Inc

9

Novartis Ag

9

Imperial Oil Ltd

10

E.On Ag

10

Standard Chartered Plc

Corporate Bonds

Corporate Bonds

Top 10 by Total Balance

Top 10 by Increase in Balance (Balance > 10 Mln Euro)

Rank

Stock description

Rank

Stock description

1

Goldf ish Master Issuer Bv (4.721% 28-Nov-2099)

1

Bnp Paribas Sa (4.125% 24-Jan-2011)

2

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

2

Sw edbank Ab (3.625% 02-Dec-2011)

3

Canada Housing Trust No 1 (2.7% 15-Dec-2013)

3

Caisse De Ref inancement De L’Habitat (4.1% 25-Oct-2015)

4

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

4

European Investment Bank (4.375% 15-Apr-2013)

5

Canada Housing Trust No 1 (4.65% 15-Sep-2009)

5

Bayerische Landesbank (2.75% 23-Jan-2012)

6

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

6

Bank Of Scotland Plc (3.25% 25-Jan-2013)

7

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

7

Bank Of Montreal (4.25% 23-Jan-2013)

8

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

8

Cm-Cic Covered Bonds (4.75% 17-Jul-2012)

9

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

9

Morgan Stanley (2% 22-Sep-2011)

10

Canada Housing Trust No 1 (3.95% 15-Jun-2013)

10

Depfa Deutsche Pfandbriefbank Ag (4% 15-Mar-2013)

SECURITIES LENDING DATA by DATA EXPLORERS

KEY PERFORMANCE EXPLORER STATISTICS as of 25 March 2009

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, 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.

Data Explorers Limited www.performanceexplorer.com

FTSE GLOBAL MARKETS • JUNE 2009

info@performanceexplorer.com © Copyright Data Explorers Limited March 2009

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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 FTSE GWA Developed Index r-0 9

FTSE RAFI Emerging Index

Ap

Oc t-0 8

r-0 8 Ap

Oc t-0 7

r-0 7 Ap

Oc t-0 6

r-0 6 Ap

Oc t-0 5

r-0 5 Ap

Oc t-0 4

0

r-0 4

Index Level Rebased (30 April 2004=100)

600

Ap

MARKET DATA BY FTSE RESEARCH

Global Market Indices

Table of Total Returns Index Name

Currency

Constituents

Value

3 M (%)

6 M (%)

12 M (%)

YTD (%)

Actual Div Yld (%pa)

FTSE All-World Index

USD

2,790

179.60

9.9

-2.5

-39.1

0.4

3.57

FTSE World Index

USD

2,361

423.12

9.3

-3.3

-38.8

-0.3

3.61

FTSE Developed Index

USD

1,944

169.60

8.0

-4.7

-38.7

-1.6

3.59

FTSE Emerging Index

USD

846

416.31

27.5

18.8

-41.9

19.4

3.46

FTSE Advanced Emerging Index

USD

417

392.33

28.1

18.5

-40.8

20.0

3.87

FTSE Secondary Emerging Index

USD

429

479.36

26.7

19.3

-43.4

18.6

2.84

FTSE All-World Indices

FTSE Global Equity Indices FTSE Global All Cap Index

USD

7,506

286.34

10.4

-2.0

-39.2

0.9

3.47

FTSE Developed All Cap Index

USD

5,845

272.57

8.5

-4.2

-38.7

-1.0

3.47

FTSE Emerging All Cap Index

USD

1,661

547.88

28.3

19.8

-42.3

20.1

3.46

FTSE Advanced Emerging All Cap Index

USD

874

527.37

29.4

20.1

-40.9

21.1

3.85

FTSE Secondary Emerging Index

USD

787

602.52

26.7

19.4

-44.3

18.6

2.87

USD

714

170.98

-1.3

5.5

0.8

-5.0

2.71

FTSE EPRA/NAREIT Global Index

USD

258

1640.88

7.9

-11.9

-51.0

-6.0

6.34

FTSE EPRA/NAREIT Global REITs Index

USD

178

549.41

4.5

-18.2

-51.9

-10.2

7.96

FTSE EPRA/NAREIT Global Dividend+ Index

USD

228

1159.14

8.3

-11.6

-49.7

-5.3

7.13

FTSE EPRA/NAREIT Global Rental Index

USD

215

619.98

5.7

-17.4

-51.1

-9.0

7.49

FTSE EPRA/NAREIT Global Non-Rental Index

USD

43

746.83

14.0

6.3

-50.4

2.7

3.38

FTSE4Good Global Index

USD

666

4569.66

9.8

-6.1

-39.6

-1.9

4.11

FTSE4Good Global 100 Index

USD

103

3905.59

7.8

-10.2

-39.9

-4.1

4.40

FTSE GWA Developed Index

USD

1,944

2572.90

14.5

-0.7

-39.3

2.7

4.14

FTSE RAFI Developed ex US 1000 Index

USD

1,017

4421.08

15.1

2.6

-39.8

3.1

5.35

FTSE RAFI Emerging Index

USD

363

4519.11

30.8

21.0

-37.3

20.4

3.63

Fixed Income FTSE Global Government Bond Index Real Estate

SRI

Investment Strategy

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

92

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

Index Level Rebased (30 April 2004=100) Ap r-0 4

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 r-0

8

FTSE RAFI US 1000 Index

Ap

Oc t-0

8 r-0 Ap

7 Oc t-0

7 r-0 Ap

6 Oc t-0

6 r-0 Ap

5 Oc t-0

5 r-0 Ap

Oc t-0

4

50

Table of Total Returns Index Name

Currency

Constituents

Value

3 M (%)

6 M (%)

12 M (%)

YTD (%)

Actual Div Yld (%pa)

FTSE Americas Index

USD

805

560.74

8.2

-6.4

-35.7

-0.1

2.73

FTSE North America Index

USD

669

617.18

7.5

-7.3

-35.1

-1.1

2.68

FTSE Latin America Index

USD

136

710.63

23.2

18.5

-44.1

23.3

3.48

FTSE All-World Indices

FTSE Global Equity Indices FTSE Americas All Cap Index

USD

2,646

255.37

8.8

-5.7

-35.7

0.5

2.60

FTSE North America All Cap Index

USD

2,446

246.26

8.2

-6.7

-35.2

-0.5

2.55

FTSE Latin America All Cap Index

USD

200

990.81

23.5

19.0

-44.2

23.4

3.51

FTSE Americas Government Bond Index

USD

157

186.37

0.2

6.1

7.2

-1.9

2.87

FTSE USA Government Bond Index

USD

140

183.16

0.0

6.0

8.2

-2.0

2.84

FTSE EPRA/NAREIT North America Index

USD

114

1871.05

7.3

-20.7

-50.1

-10.7

6.83

FTSE EPRA/NAREIT US Dividend+ Index

USD

90

1038.33

7.1

-21.5

-50.1

-12.0

6.79

Fixed Income

Real Estate

FTSE EPRA/NAREIT North America Rental Index

USD

111

633.33

7.6

-20.5

-48.4

-10.2

6.72

FTSE EPRA/NAREIT North America Non-Rental Index

USD

3

236.16

-6.5

-30.1

-81.7

-32.3

10.60

FTSE NAREIT Composite Index

USD

113

1890.61

7.5

-18.3

-47.1

-10.2

7.41

FTSE NAREIT Equity REITs Index

USD

98

4550.27

7.9

-20.1

-48.2

-10.7

6.65

FTSE4Good US Index

USD

138

3680.71

11.1

-9.2

-33.5

-0.8

2.74

FTSE4Good US 100 Index

USD

101

3534.21

10.8

-9.8

-33.8

-1.2

2.73

SRI

Investment Strategy FTSE GWA US Index

USD

615

2277.55

11.0

-7.5

-37.4

-0.1

2.81

FTSE RAFI US 1000 Index

USD

1,000

3844.69

14.5

-4.8

-35.1

2.4

2.70

FTSE RAFI US Mid Small 1500 Index

USD

1,490

3553.92

22.0

-1.0

-29.8

7.7

2.80

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

FTSE GLOBAL MARKETS • JUNE 2009

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5-Year Total Return Performance Graph FTSE Europe Index FTSE All-Share Index

400

Index Level Rebased (30 April 2004=100) Ap r-0 4

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 Ap

r-0

8 Oc t-0

8 r-0 Ap

7 Oc t-0

7 r-0 Ap

6 Oc t-0

6 r-0 Ap

5 Oc t-0

5 Ap

r-0

4

FTSE GWA Developed Europe Index Oc t-0

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)

5.02

FTSE All-World Indices FTSE Europe Index

EUR

552

175.83

7.4

-7.8

-35.9

3.3

FTSE Eurobloc Index

EUR

1,985

98.77

8.0

-5.4

-37.0

0.4

4.39

FTSE Developed Europe ex UK Index

EUR

380

179.67

7.9

-5.7

-35.0

1.4

5.10

FTSE Developed Europe Index

EUR

492

174.16

6.7

-7.7

-35.2

2.6

5.09

FTSE Global Equity Indices FTSE Europe All Cap Index

EUR

1,631

273.35

8.0

-7.0

-36.1

4.3

4.94

FTSE Eurobloc All Cap Index

EUR

813

290.62

8.2

-4.9

-37.2

0.9

5.67

FTSE Developed Europe All Cap ex UK Index

EUR

1,109

297.61

8.1

-5.2

-35.4

2.0

5.06

FTSE Developed Europe All Cap Index

EUR

1,515

272.46

7.3

-6.9

-35.4

3.7

5.00

Region Specific FTSE All-Share Index

GBP

616

2758.43

6.1

1.9

-26.9

0.0

4.81

FTSE 100 Index

GBP

102

2616.09

3.9

-0.6

-27.2

-2.7

5.02

FTSEurofirst 80 Index

EUR

80

3729.04

7.5

-6.7

-35.9

-1.8

6.11

FTSEurofirst 100 Index

EUR

99

3303.86

4.9

-9.7

-35.5

-0.1

5.78

FTSEurofirst 300 Index

EUR

311

1143.74

5.6

-8.7

-35.4

1.3

5.08

FTSE/JSE Top 40 Index

SAR

41

2068.48

1.2

-1.4

-33.2

-3.5

4.59

FTSE/JSE All-Share Index

SAR

165

2291.16

1.6

0.1

-30.3

-2.7

4.73

FTSE Russia IOB Index

USD

15

609.12

53.7

5.8

-57.3

41.9

3.36

FTSE Eurozone Government Bond Index

EUR

235

165.02

2.7

6.4

8.9

1.5

3.69

FTSE Pfandbrief Index

EUR

389

193.55

1.0

4.1

6.0

1.2

4.52

FTSE Gilts Fixed All-Stocks Index

GBP

34

2266.49

2.6

7.6

10.6

-2.1

3.91

FTSE EPRA/NAREIT Europe Index

EUR

80

1370.70

7.1

-14.9

-46.4

1.6

7.13

FTSE EPRA/NAREIT Europe REITs Index

EUR

39

499.98

5.9

-17.9

-43.9

0.2

7.69

FTSE EPRA/NAREIT Europe ex UK Dividend+ Index

EUR

46

1652.04

3.3

-2.3

-36.6

3.1

7.43

FTSE EPRA/NAREIT Europe Rental Index

EUR

72

536.50

7.1

-15.2

-45.7

1.0

7.28

FTSE EPRA/NAREIT Europe Non-Rental Index

EUR

8

408.05

8.3

-3.3

-56.5

22.2

2.58

FTSE4Good Europe Index

EUR

270

3483.67

6.7

-8.9

-34.4

2.6

5.33

FTSE4Good Europe 50 Index

EUR

52

3043.02

3.5

-13.5

-34.7

-0.8

5.63

FTSE GWA Developed Europe Index

EUR

492

2478.52

15.6

-1.6

-34.5

9.5

5.61

FTSE RAFI Europe Index

EUR

524

3856.31

14.3

-3.0

-33.4

8.8

5.49

Fixed Income

Real Estate

SRI

Investment Strategy

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

94

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Asia Pacific Market Indices 5-Year Total Return Performance Graph

FTSE Asia Pacific 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 Ap

r-0

8 Oc t-0

8 r-0 Ap

7 Oc t-0

7 r-0 Ap

6 Oc t-0

6 Ap

r-0

5 Oc t-0

5 Ap

r-0

4 Oc t-0

r-0

4

FTSE GWA Japan Index

Ap

Index Level Rebased (30 April 2004=100)

FTSE/ASEAN 40 Index

FTSE RAFI Kaigai 1000 Index

Table of Total Returns Index Name

Currency

Constituents

Value

3 M (%)

6 M (%)

12 M (%)

FTSE Asia Pacific Index

USD

1,283

204.14

FTSE Asia Pacific ex Japan Index

USD

826

370.82

FTSE Japan Index

USD

457

69.86

YTD (%)

Actual Div Yld (%pa)

11.6

8.1

24.8

18.0

-37.7

3.6

3.53

-40.3

15.5

7.8

-2.4

4.12

-38.1

-0.7

2.77

FTSE All-World Indices

FTSE Global Equity Indices FTSE Asia Pacific All Cap Index

USD

3,033

343.82

11.8

8.7

-38.0

3.8

3.55

FTSE Asia Pacific All Cap ex Japan Index

USD

1,782

454.75

25.6

19.0

-41.2

16.3

4.16

FTSE Japan All Cap Index

USD

1,251

220.44

7.2

-2.2

-37.3

-1.1

2.75

Region Specific FTSE/ASEAN Index

USD

148

357.41

17.7

19.1

-38.1

12.5

4.59

FTSE Bursa Malaysia 100 Index

MYR

100

7039.43

13.5

17.0

-21.0

15.0

3.73

TSEC Taiwan 50 Index

TWD

50

5333.07

37.9

17.6

-29.7

27.1

6.59

FTSE Xinhua All-Share Index

CNY

976

6806.23

30.8

67.4

-30.0

47.4

1.19

FTSE/Xinhua China 25 Index

CNY

25

17564.51

24.2

28.9

-38.1

12.3

3.23

USD

246

128.43

-8.7

2.0

9.1

-8.5

1.39

FTSE EPRA/NAREIT Asia Index

USD

64

1407.35

7.2

-1.3

-50.3

-2.2

5.52

FTSE EPRA/NAREIT Asia 33 Index

USD

31

926.88

5.2

-4.3

-48.7

-3.2

10.83

FTSE EPRA/NAREIT Asia Dividend+ Index

USD

52

1409.21

8.5

4.4

-49.0

2.1

7.12

FTSE EPRA/NAREIT Asia Rental Index

USD

32

615.39

-3.6

-14.5

-54.3

-11.2

9.71

FTSE EPRA/NAREIT Asia Non-Rental Index

USD

32

815.15

14.7

8.2

-47.6

3.9

3.10

Fixed Income FTSE Asia Pacific Government Bond Index Real Estate

Infrastructure FTSE IDFC India Infrastructure Index

IRP

60

655.30

18.5

17.8

-51.3

7.9

0.91

FTSE IDFC India Infrastructure 30 Index

IRP

30

732.99

19.9

22.8

-48.9

11.1

0.94

JPY

189

3414.80

9.3

-3.8

-38.7

0.9

2.90

FTSE SGX Shariah 100 Index

USD

100

4072.59

8.3

1.4

-35.7

1.4

3.45

FTSE Bursa Malaysia Hijrah Shariah Index

MYR

30

8477.03

12.9

18.5

-23.6

15.9

3.80

JPY

100

932.43

11.1

-1.2

-37.3

2.6

2.97

2.94

SRI FTSE4Good Japan Index Shariah

FTSE Shariah Japan 100 Index Investment Strategy FTSE GWA Japan Index

JPY

457

2469.22

13.6

3.6

-35.0

6.0

FTSE GWA Australia Index

AUD

102

3111.95

9.7

-4.4

-29.2

4.1

7.18

FTSE RAFI Australia Index

AUD

65

5051.06

13.4

-2.8

-23.4

6.1

10.61

FTSE RAFI Singapore Index

5.51

SGD

18

5329.25

10.7

10.1

-33.6

9.5

FTSE RAFI Japan Index

JPY

278

3479.30

11.3

1.3

-34.3

2.5

2.97

FTSE RAFI Kaigai 1000 Index

JPY

1,020

3176.43

26.8

-2.6

-42.8

11.4

4.38

HKD

51

5073.91

25.1

24.4

-34.3

14.2

3.59

FTSE RAFI China 50 Index

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

FTSE GLOBAL MARKETS • JUNE 2009

95

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Page 96

CALENDAR

Index Reviews June – August 2009 Date

Index Series

Review Frequency/Type

Effective Data Cut-off (Close of business)

Early Jun Early Jun Early Jun Early Jun Early Jun Early Jun 01-Jun 03-Jun 05-Jun 05-Jun

ATX KOSPI 200 IBEX 35 CAC 40 OBX S&P / TSX DJ Global Titans 50 DAX S&P / ASX Indices TOPIX

30-Jun 08-Jun 30-Jun 19-Jun 19-Jun 19-Jun 19-Jun 19-Jun 19-Jun

31-May 31-May 31-May 31-May 31-May 29-May 30-Apr 31-May 29-May

10-Jun 10-Jun 10-Jun

29-Jun 30-Jun 19-Jun

28-May 31-May 09-Jun

19-Jun 19-Jun 19-Jun 19-Jun 19-Jun

31-Mar 29-May 29-May 29-May 29-May

10-Jun 12-Jun 12-Jun 13-Jun 13-Jun 13-Jun 13-Jun 12-Jun 13-Jun 13-Jun 13-Jun Mid Jun Mid Jun Mid Jun Mid Jun Mid Jun 12-Jun 19-Jun 24-Jun 07-Jul

OMX I15 FTSE UK Index Series FTSE Global Equity Index Series (incl. FTSE All-World) FTSE techMARK 100 FTSEurofirst 300 FTSE eTX FTSE/JSE Africa Index Series FTSE EPRA/NAREIT Global Real Estate Index Series FTSE Bursa Malaysia Index Series DJ STOXX NASDAQ 100 S&P BRIC 40 S&P US Indices S&P Europe 350 / S&P Euro S&P Topix 150 S&P Asia 50 S&P Global 1200 S&P Global 100 S&P Latin 40 VINX 30 OMX S30 Baltic 10 OMX C20 OMX N40 FTSE MIB Russell US Indices NZX 50 TOPIX

Quarterly review Annual review Semi-annual review Quarterly review Semi-annual review Quarterly review Annual review of index composition Quarterly review Quarterly Review Monthly review - additions & free float adjustment Semi-annual review Quarterly review Annual review - Emgng Eur, ME, Africa, Latin America Quarterly review Quarterly review Quarterly review Quarterly review

19-Jun 19-Jun 19-Jun 19-Jun 19-Jun 19-Jun 19-Jun 19-Jun 19-Jun 19-Jun 19-Jun 19-Jun 19-Jun 30-Jun 30-Jun 19-Jun 19-Jun 22-Jun 26-Jun 30-Jun

29-May 29-May 26-May 31-May 05-Jun 05-Jun 05-Jun 05-Jun 05-Jun 05-Jun 05-Jun 05-Jun 29-May 29-May 31-May 29-May 31-May 31-May 31-May 31-May

07-Jul 09-Jul Mid Jul

FTSE Xinhua Index Series TSEC Taiwan 50 OMX H25

30-Jul 17-Jul 17-Jul

30-Jun 20-Jul 30-Jun

Mid Jul 07-Aug

SMI Family Index TOPIX

31-Jul 19-Sep

30-Jun 30-Jun

08-Aug 17-Aug

Hang Seng MSCI Standard Index Series

Quarterly review Semi-annual review Quarterly review (components) Quarterly review/ shares adjustment Semi-annual review - constituents Quarterly review - shares Quarterly review - shares Quarterly review - shares Quarterly review - shares Quarterly review - shares Quarterly review - shares Quarterly review - shares Semi-annual review Semi-annual review Semi-annual review Semi-annual review Semi-annual review Quarterly review Annual / Quarterly review Quarterly review Monthly review - additions & free float adjustment Annual Review Quarterly & annual review Semi-annual review - consituents, Quarterly review - shares in issue Annual review Monthly review - additions & free float adjustment Quarterly review Quarterly review

28-Aug 05-Sep 31-Aug

31-Jul 30-Jun 31-Jul

10-Jun 10-Jun 10-Jun 10-Jun 10-Jun

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

96

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The New IPO Market A Q&A session with Kathleen Smith, Chairman, Renaissance Capital LLC, Melanie Hase, Vice President, Renaissance Capital LLC, and Jerry Moskowitz, President, FTSE Americas, Inc. Q: FTSE and Renaissance recently launched an index series that tracks the IPO market. Why track IPOs separately from other equities?

Kathleen Smith: The FTSE Renaissance IPO Composite Index adds IPOs at the close of the first day of trading. This early inclusion is well in advance of major U.S. equity indices, where newly public companies must wait up to a quarter or longer for inclusion. Thus, major indices miss early returns on newly public companies and underweight the new industries that typically manifest themselves first in the IPO market. For example, Visa, which went public in March 2008, gained 44% before it was included in the Russell 3000; the FTSE Renaissance IPO Composite Index captured this return.

Q: Given the general market turmoil, how are IPOs performing?

Jerry Moskowitz: The index has shown significant outperformance relative to major equity indices over time. IPOs have outperformed the broader indices for the past five year period ended December 31, 2008, and have generated strong returns year-to-date through April 30, 2009. By investing in IPOs on a float weighted basis, emphasis is placed on those companies with the highest unfolding liquidity and strongest performance, which enables this asset class to produce unique and superior risk-adjusted returns.

140 120 100

Return

80 60 40 20 0 -20

FTSE Renaissance IPO Composite Index

FTSE USA All Cap Index

08

07

20

20 S&P500

20

06

05 20

20

20

04

03

-40

RUS 3000

Q: You’ve also said before that IPOs perform better than more seasoned equities in down markets. Why is this?

Melanie Hase: Academic studies show that in weak stock markets characterized by low issuance of IPOs, only the strongest and most attractively priced companies are able to go public. These companies have historically produced superior long-term returns. Recent examples include Rosetta Stone, a provider of language learning software, which went public on April 16, 2009 and has traded up 66% through April 30, 2009. Similarly, Mead Johnson, a maker of baby formula and a spin-off of Bristol-Myers Squibb is up 18% from its February 2009 IPO, and online education provider Grand Canyon Education, which made its market debut in November 2008, is up 36% through April 30, 2009.

Q: It sounds like IPOs behave more like an alternative asset class than equities – is that so?

Kathleen Smith: Yes and no. Newly public companies are specialized equities with exploitable information asymmetries similar to alternative investments. Like private equity investments, IPOs have the potential for higher returns because of market inefficiencies caused by the lack of research, lack of trading charts, untested governance and the lack of an established shareholder base. Yet, IPOs possess far greater liquidity and transparency than alternative equities.

Q: How big is the IPO Market?

Melanie Hase: IPOs represent one-third of total equity capital raised. The market capitalization of the FTSE Renaissance IPO Composite Index has averaged $306 billion over the past six years, permitting significant indexing capacity. This is because the IPO market is not just limited to small cap companies, but includes companies from all sectors and sizes.

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.

GM EDITORIAL 34.qxd:.

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