FTSE Global Markets by FTSE Global Markets

THE NEW EVOLUTION OF PRIME BROKING I S S U E 3 5 • J U LY / A U G U S T 2 0 0 9

New approaches to hedge fund replication Down but not out in London Securities services in the spotlight Why private equity buys into Cetip

FAST & FURIOUS:

CONVERGEX SPEEDS AHEAD

ROUNDTABLE: THE NEW US TRADING LANDSCAPE

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F T S E G L O B A L M A R K E T S • J U LY / A U G U S T 2 0 0 9

HE ALL-IMPORTANT cuckoo that signposts a financial spring (a very tardy one, admittedly) has been sought for high and low throughout the second quarter. It is actually the key theme of this issue. The surest indication of a solstice, marking a new season would under normal circumstances be a return to profit in the global banking market. However, the state of play is far from clear, particularly when the world’s bellwether—the United States banking market—is offering up contradictory signals. Ian Williams in our Market Leader asks whether the rush to repay TARP funds might not be as good an indicator of change as many reporters think. Luc De Clapiers, president of advisory firm New Dawn Advisors and previously long-time head of the NewYork operations of the French Caisse des Dépôts et Consignations (CDC), warns that despite the rush to pass the official stress test, laid down by federal agencies before banks can repay TARP funds, North American financial institutions remain in a parlous condition. Indeed, he considers the stress test to be a shoo-in. Moreover, the outlying economic financials are no better. De Clapiers explains: “They defined the criteria with unemployment at 10% maximum, the downturn for the duration of 2008/2009 and they anticipated strong growth for next year of 8% to 9%, and indeed even positive growth this year.” However, optimism is not necessarily just blowing in the wind. Keith Leggett, a senior economist at the American Bankers Association (ABA), thinks that lower LIBOR and a contraction in the LIBOR/OIS spread indicate a thaw in the credit markets. He highlights the fact that markets have also absorbed a huge injection of liquidity from central banks, and the Federal Reserve in particular. “Is the improvement in LIBOR a reflection of central bank intervention?”he asks.“Or is it an indication that markets have really corrected?” He’s optimistic it’s the latter, writes Neil O’Hara in his overview of the global credit markets, but nobody can be certain until governments curtail their support. In the emerging markets, it is apparent that the infrastructure supporting the securities industry is also in flux. Now comes the news that private equity is getting involved in the clearing and settlement space. The move by private equity firm Advent International to take a stake in Brazilian central depository Cetip looks like a shrewd one from the Boston-based group. Cetip enjoys a dominant position in its field in fixed-income and over-the-counter (OTC) derivatives, two markets with plenty of potential for growth in Brazil. Meanwhile, the US firm brings needed resources and expertise to an exchange traditionally too influenced by user-owners and dependent on their largesse to roll out innovative products. Will it be a marriage made in heaven? For better or worse? John Rumsey addresses the pros and cons of the union. If there is one signal of a wind change, it is perhaps the sale of UK football club Manchester United’s chief striker Cristiano Ronaldo for a paltry or eye-watering (depending on which club you support) £80m. It is not the first time an institution, in this instance Real Madrid, has thrown huge amounts of cash at a problem for an uncertain return at some time in the future. Equally, while the UK club may be nursing hurt that its golden boy Ronaldo doesn’t want to stay, it might just be that Man U has cashed in its Portuguese chips at precisely the right time.There’s a moral in there somewhere for the global financial community; at least I hope there is. For some weeks now, we have been receiving mail from readers asking us to profile the impact of the recession on this product or that; and we are always happy to comply. Feedback from readers is important to us. If you think that we need to cover certain aspects of the financial markets, or want to suggest ways in which we can improve the magazine to make it better suit your information requirements, we are always delighted to hear from you. By the way, we are in the process of finalising a revamp of our website. Now you can gain access to the entire archive of FTSE Global Markets, Emerging Markets Report, news stories and special reports on www.berlinguer.com.

Francesca Carnevale, Editorial Director July 2009

Contents COVER STORY COVER STORY: THE BRIGHT FUTURE OF CONVERGEX ........................Page 48

New York-headquartered brokerage ConvergEx is a precocious pretender to the broker/dealing big league. In some respects that’s because the make-up of New York’s leading trading league tables has changed irrevocably, as some of the larger houses have either disappeared or sunk in the volume rankings. In other respects however, the brokerage has consistently punches above its weight. Francesca Carnevale talks to Joe Velli, ConvergEx’s chief executive, about the firm’s long term plans.

DEPARTMENTS MARKET LEADER

WHY US BANKS ARE KEEN TO REPAY TARP FUNDS ....................Page 6

Ian Williams surveys the status of the US banking landscape.

LONDON: DOWN BUT NOT OUT ....................................................................Page 10 Lynn Strongin Dodds asks whether the city can survive an extended recession

IN THE MARKETS

DOES PRIVATE EQUITY LOVE SECURITIES DEPOSITORIES?........Page 16 It seems they do in Brazil. John Rumsey reports.

PENSION FUND POOLING: THE NEXT WAVE ..............................Page 22 Why pooling is de rigeur for the ultra-cost conscious. By David Simons

MANAGING PROCESSING RISKS ............................................................Page 26 By Ivan Nicora, director & head of investment fund product management, Euroclear

ALTERNATIVES

HEDGE FUND REPLICATION MAKES A COMEBACK ..............Page 29 Neil O’Hara assesses the sustainability of the uptick in hedge fund replication

GIVING HEDGE FUNDS A BIT OF GIPS ..............................................Page 33 Carl Bacon, chairman of StatPro, explains why GIPS makes hedge funds smarter.

THE 360 DEGREE SOLUTION......................................................................Page 35 Patrick Colle, head of BNPPSS’s UK operations explains his business approach

FACE TO FACE

....................................................................................Page 37 Mark Kelley, global head, asset gatherers segment, JPMorgan WSS, talks securities services

THE CHANGE FACTOR

......................................................................................Page 39 Andrew Gelb, head of securities & fund services, EMEA, Citi’s GTS, on innovation

CONSTANT INNOVATION

INDEX REVIEW COMMODITY REPORT REAL ESTATE

..............Page 41 Simon Denham, managing director, Capital Spreads, takes the bearish view

THE UK ECONOMIC TIME BOMB KEEPS ON TICKING

......................................................Page 42 Vanya Dragomanovich on the first wave of change in commodity trading

OBAMA SAYS, TIDY UP MESSY RULES

......................................................................................................................Page 45 Mark Faithfull on approaches to investment in tourist real estate and hotels

HOTEL VIEWS

..............................Page 81 Neil O’Hara asks whether easing in the credit markets will renew bank lending

MID WINTER THAW, OR GLOBAL WARMING?

THE DEBT REPORT

DATA PAGES 2

....................................................Page 84 Andrew Cavanagh explains the factors that hold back securitisation

HOW TO KICK START SECURITISATION

Fidessa Fragmentation Index ......................................................................................Page 87 Securities Lending Trends by Data Explorer ............................................................Page 89 ETF Data, supplied by Barclays Global Investors ....................................................Page 90 Market Reports by FTSE Research ..............................................................................Page 92 Index Calendar ..............................................................................................................Page 96

J U LY / A U G U S T 2 0 0 9 • F T S E G L O B A L M A R K E T S

Contents FEATURES PROFILE

SAXO BANK FLEXES ITS MUSCLES ....................................................Page 51

An unusual mix of the cerebral and the profane have marked Saxo Bank’s rise in the Danish banking sector. The founders and co-chief executive officers of Saxo Bank AS, Kim Fournais and Lars Seier Christensen, actively foster a staff culture based on “seven Saxo Bank values”, lifted from a novel by Russian-American writer Ayn Rand. The values stress the importance of individual thought, integrity and pride. Saxo Bank has printed 20,000 copies of Rand’s book, Atlas Shrugged. A copy is given to each new staff member. Paul Whitfield profiles a rising star.

ASSET SERVICING

IS CONSOLIDATION THE ONLY ANSWER? ..................................Page 55

There has long been talk of consolidation among asset servicers in Europe’s over-banked landscape but the financial crisis might actually kick-start the process, writes Lynn Strongin Dodds.

ASSET TRADING

THE RISE OF THE AGENCY TRADER ..................................................Page 60

Craig Lax, chief executive officer of ConvergEx’s G-Trade Services, has seen a resurgence in the agency model since the early days of the sub-prime crisis: “The third trimestre last year was an additional kick-start for the business. Over time, some customers had reduced the agency-only brokers on their list, but then they started to ask questions about the model and to be pure agency became a tremendous benefit. Now they are looking at their list and making sure they have one or two agency-only models on that list,” he says. Ruth Hughes Liley reports

THE US TRADING ROUNDTABLE ..........................................................Page 65

Andrew Nelson, senior trader, at TIAAA-CREF says, “Volatility is making it much more difficult to trade even ‘easy’ stocks. Second is innovation: just keeping up with the changes in the marketplace is a full-time job. I’m not just referring to technology, although that’s a large part of it. We also have to keep up with the non-technical changes in the marketplace as relationships evolve. The US trading market is setting a fast pace right now. Our team of experts analyse the trends

MARKET CROWDING: DUAL TRACK ALGOS................................Page 72

When algorithms first began to make their mark ten years ago, reports abounded that high-touch sales trading would disappear as the new world order took over, but, to paraphrase Mark Twain, reports of the death of the trader have been greatly exaggerated. A decade on, algorithms, rather than displacing the sales trader, have found their way into the toolbox of almost all trading desks and are moving in two different directions: faster, ultra-low latency, low-touch and traditionally slower, benchmark style, higher-touch. Ruth Hughes Liley reports.

BAIKAL: THE DEEP, DARK POOL ..........................................................Page 76

Nathan Tiefenbrun, Baikal’s commercial director, says: “I joined Baikal because I believed that neutral, exchange-led operating facilities would be winners. We are here for the long term and we want to create a new market.” Ruth Hughes Liley explains the dynamics

REMAKING THE PRIME BROKING MODEL ..................................Page 78

Demand from large institutional clients continues to shape the rapidly evolving primebrokerage model, forcing providers to re-examine what is profitable and what is not, what steps need to be taken in order to help clients improve clarity and risk management, and how to deal with the increasingly diverse and complex mix of asset classes within the alternative space. From Boston, Dave Simons reports

J U LY / A U G U S T 2 0 0 9 • F T S E G L O B A L M A R K E T S

Market Leader TARP: BANKS AIM TO GET THE FED OFF THEIR BACKS

Photograph © Ken To/Dreamstime.com, supplied June 2009.

Coming off the TARP Roundabout The United States Treasury Department has now cleared the way for at least ten of the country’s largest banks to begin repayment of Troubled Asset Relief Program (TARP) funds (essentially tax-payer fund aid). It is an important tipping point in the efforts by the Federal Reserve Bank, the US Treasury and other Federal government agencies to kick-start a still moribund banking system. The Bank of New York Mellon, has confirmed that it is among the first large banks to receive permission to repurchase the preferred stock purchased by the US government last October as part of the TARP capital investment programme. The Obama administration hopes the accelerated payback will show that its financial recovery programmes are working, even if the economy remains fragile. Ian Williams asks whether the rush to repay TARP funds might not be as good an indicator of change as many reporters think. HE NEWS THAT leading US banks will begin to repay TARP funds,“will be welcomed by our clients around the world as well as by American taxpayers, who have realised a very good return on their investment in our company. We appreciate the support that the US government provided to our industry and the overall economy at a critical time,” says Robert P Kelly, chairman and chief executive officer of The Bank of New York Mellon, which has raised $2.9bn toward the repurchase of the $3bn TARP capital investment in the company through a $1.5bn non-

guaranteed five-year and ten-year senior debt offering and the sale of $1.4bn in new common stock to the public. All in all, American banks are expected to return about $68.3bn to the Treasury Department, more than double the administration’s initial estimate of about $25bn in funds to be returned this year and around a quarter of monies outstanding. Repayments are also occurring well before the schedule laid down by Treasury officials. The timetable is also earlier than government officials originally intended, The Bank of New York Mellon, American Express, North

Carolina’s BB&T Corporation, Capital One Financial, Goldman Sachs, JPMorgan Chase, State Street and US Bancorp are expected to begin repayments, though early news reports by the leading US financial press also claimed that Morgan Stanley and Northern Trust have also received permission to begin repayments. “Repaying the government’s investment will give us greater flexibility to benefit significantly from future opportunities that will be available as we emerge from this recession,”BB&T’s chief executive, Kelly S King, said in a press release, after announcing it intends to pay some $3.1bn to buy back some of its preferred shares from the government. The banks are not entirely out of the woods however. They still need to redeem warrants giving taxpayers a share of the potential upside on their investments, which say some banking analysts, could top $4.6bn. Treasury officials have not disclosed how they plan to value and sell them. “These repayments are an encouraging sign of financial repair, but we still have work to do,” says Treasury secretary Timothy Geithner, in a statement.

J U LY / A U G U S T 2 0 0 9 • F T S E G L O B A L M A R K E T S

The move will also free up billions of dollars that can be redistributed to other troubled banks and companies without Treasury officials returning to Congress for more money. Not everything in the garden is rosy however.As a result of the payments, the government is foregoing up to $1.8bn in annual interest payments and is leaving its overall support programmes in place, even for those banks that repay TARP funds. While some banks will exit from the TARP programme in the foreseeable future, others, such as Citigroup, which has accepted $45bn in aid, might not be able to exit for some years to come. Moreover, US bankers continue to operate under contradictory mandates.

The Federal government wants them to pump money into the economy and has been force-feeding them billions to do just that. The banks want to make money and are not anxious to pour money into the same uncreditworthy causes that helped bring about the credit crunch. They also have to respond to the managerial imperative to get their businesses back to normal as soon as possible. Distributed Capital’s director of research Ulysses de la Torre elicits some sympathy for this predicament: “Put yourself in the shoes of a chief executive officer of Big Bank, USA. You want to show that your institution is financially sound, not only to keep your job, but

also to divert the spotlight away from yourself as soon as possible. You may not publicly phrase your goals that way, but that does not mean you are not thinking it.” Major US banks reported good first quarters, with a total $7.6bn profit. That, says James Chessen, chief economist of the American Bankers Association (ABA), means “banks are continuing to work through the problems presented by a difficult economy.”Moreover, he adds:“Two out of every three banks increased their assets in the first quarter.” Even so, in May, Fitch put nine key banks on a negative ratings watch. Additionally, the Federal Deposit

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F T S E G L O B A L M A R K E T S • J U LY / A U G U S T 2 0 0 9

Market Leader TARP: BANKS AIM TO GET THE FED OFF THEIR BACKS

Insurance Corporation (FDIC), which has over 305 banks on its watch list, is seeking extra financing to cover their anticipated losses. It is clear that while things are moving in the right direction for some of the country’s financial institutions, the problems for the US banking sector per se are not over. There are also other trends in play. At the end of May it emerged the banks were engaging in under-the-counter lobbying of the regulatory agencies to avert moves to make derivatives trading more transparent. Until the Wall Street Journal blew their cover, they were very careful not to say anything in public, since their massive marketing and trading in opaque derivatives helped propel the recessionary downdraft. Some firms had even enquired about whether they could bid at fire sale prices for their own toxic mortgage assets using government assistance—which has to be a working definition of chutzpah. The answer, unsurprisingly, was no. The rush to raise capital has exacerbated the banks’ reluctance to pass on Federal funding in the form of credit. They also may prefer to avoid accountability, since most of them are contracting lines of credit to their customers. That’s ironic given the need to inject liquidity into the economy was a key justification for public financing. The Wall Street Journal analysed treasury data and found that the largest recipients of TARP funding originated or refinanced 23% less in new loans in February than they did in October when TARP began: a figure sure to be cited if Congress is asked for new money. The failure to extend credit has been noticed in Washington, where it will add to the already strong reluctance to take bankers’ own figures too seriously. TARP is only one of the ways that bankers have benefited from taxpayer largesse. The government is underwriting $300bn in assets, which, if

Treasury Secretary Timothy Geithner testifies on Capitol Hill in Washington on Wednesday 20th May this year before the Senate Banking Committee hearing on the Troubled Asset Relief Program (TARP). Photograph by Manuel Balce Ceneta, for the Associated Press. Photo supplied by PA Photos, June 2009.

they were marked to market, would crash the banks and the financial system. The government’s flood of almost $200bn into AIG was recycled to all the financial institutions, domestic and foreign, that had invested in its credit default swaps and similar dubious instruments. Luc De Clapiers, president of advisory firm New Dawn Advisors and previously long-time head of the New York operations of the French Caisse des Dépôts et Consignations (CDC), warns that despite the rush to pass the stress test, US financial institutions remain in a parlous condition. Indeed, he considers the stress test to be a shoo-in since the Treasury did not want the possible panic and run on the banks that major institutions’ failure would entail. He explains: “They defined the criteria with unemployment at 10% maximum, the downturn for 2008/9 duration and they anticipated strong growth for next year of 8% to 9%, and indeed even positive growth this year.” He also questions the significance of the first-quarter results and the optimistic revenue estimates that they

have engendered. “This first quarter includes unrepeatable results, partly because the Financial Accounting Standards Board (FASB) changed the accounting rules. They all benefited by some billions from that, by using their own internal cash flow predictions and values for assets, instead of taking market prices. Now, of course there are distressed market prices, because there is no value. I would be surprised if the second-quarter results were as good, because, apart from the one-off of the accounting changes, with the number of bankruptcies in corporate America, they are going to report worsening results, and they have to contract their balance sheets. They have to get rid of leverage, to not renew a number of loans, which creates bottlenecks in the economy. That will contribute to a very anaemic recovery which means there will not be enough earning generation capacity, and then they will have to get investors at any price.” De Clapiers maintains it is a sectorwide problem. He points to 8,000 other banks across the country that

J U LY / A U G U S T 2 0 0 9 • F T S E G L O B A L M A R K E T S

profiles and essentially asks, ‘Suppose external conditions A, B and C; can Bank X handle it?’ This is a nice start. A nice follow-up for stress test 2.0 would be to say: ‘Here is what Bank X’s balance sheet looks like. What are the external conditions that would destroy it?’”says De la torre. It is possible that a premature rush to get out of TARP would be one of those external conditions. The bankers argue that at 5% before tax, TARP is more expensive, but that ignores the very salient detail that it is the government’s pumping of liquidity and other conditions and its guarantees that is keeping interest rates low. Without that support, who knows what kind of high interest rates depositors, bondholders and others would demand from the balance sheets the banking sector has contrived for itself? If banks fail after precipitately rushing out of TARP just in order to over-compensate their executives, how much popular support would there be for rescuing them? Investor adviser De Clapiers puts it bluntly: “I think long-term investors in banks are people who don’t understand what has happened. Investing in big financial institutions is something investors should avoid unless they are trading on volatility.”The banks will need life support from the government for some time to come, and they will have to accept the conditionalities and the regulation that come with it. Business as usual is not an option in such catastrophically unusual circumstances.

F T S E G L O B A L M A R K E T S • J U LY / A U G U S T 2 0 0 9

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are suffering, which is why the FDIC is raising its premiums. “Thirty-six banks closed this year, by the end of this year perhaps 500 or 1,000 small banks will be closed. It is not because they are losing deposits or that they use hot money, but because the amount of default they have on their books is much higher than they thought, and the capital markets are effectively closed so they can’t raise money by issuing stocks and bonds,”he notes. This is the extent of the collateral damage from the big crash’s effect on the economy, he points out. “This is the core economy. Although they are not as bad generally as the big banks because they were not doing any sub-prime lending, but even prime mortgages are defaulting at a higher rate than previous recessions and also have auto loans, credit card loans, going bad at a level that has never been seen before, so the historical default rate is no use to calculate. The third leg was the real estate sector, construction, mostly speculative, and property owners and developers. Now a lot of them are going belly-up.” De la Torre at the Distributed Capital Group also questions the stress tests.“There are at least two big issues that the stress tests, in their current incarnation, completely miss. One is the exposure any institution has to price volatility arising from hot money rushing in or out of a particular sector, asset class or even asset. Liquidity effects are undermining the validity of fairvalue pricing. “Second, the current stress testing looks at individual bank

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In the Markets LONDON: CITY FIGHTS TO KEEP ITS FINANCIAL STATUS

The UK capital’s reputation as a major financial services hub has taken a few hard knocks in the past few months but a series of reports shows London has not lost its position among the world’s leading centres. Tougher regulation, higher tax and the rise of Asia could threaten its long-term preeminence, though signs are London is well placed to hold its own. One of the big unknowns looming over the capital, of course, is whether the Conservative Party will win the next election and if so, reverse current tax and regulatory policies. Even if the Tories are successful, and change tack, it is inevitable that other burgeoning centres will chip away at the City’s lead. London’s real challenge will be to grab a bigger chunk of what many hope in the future will be an ever expanding pie of business. Lynn Strongin Dodds reports.

Photograph © Simon Gurney /Dreamstime.com, supplied June 2009.

Survival of the Fittest HIS IS NOT the first time that London’s reputation as a major financial services hub has taken a battering, but it certainly has been the worst. The severity of the crisis due to aggressive risk taking, bloated pay packets, a seemingly lax regulatory environment and quasi-tax haven status has hit the capital hard. A series of reports shows that London has not been knocked off its perch, although stricter rules and tax as well as the rise of Asia could threaten its long-term preeminent position. Jim Connor, director of European investment management services at Navigant Consulting, says: “We have been here before with the downturn in the 1990s and the introduction of the

euro when there was a view that business was going to shift to Frankfurt. While I am not being complacent, there are certain attributes that London has that are not duplicable in other regions. This includes the time zone and the ability to deal with Tokyo in the morning and San Francisco at night as well as the talent pool. The fact that English—the language of the financial services community—is spoken is also a plus. The Square Mile is also a relatively small place and all the tools that people in financial services need are readily available. It is easy to pull people together quickly if you need to. Even in today’s technological environment, there is still no substitute for meeting people face to face.”

Michael Power, global strategist at Investec Asset Management, notes: “The City may be feeling sorry for itself at the moment but so is everywhere else. The financial crisis has really been a rude awakening and I think what we will see is evolutionary biology—the survival of the fittest. It will be those species who can adapt and change that will be the most successful. I believe that although regulation will be tightened, London will surprise us and reemerge in remarkably good shape. It is important to remember that London is not just a banking centre but covers a majority of other services such as forex trading, international loan syndication (and not merely in

J U LY / A U G U S T 2 0 0 9 • F T S E G L O B A L M A R K E T S

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In the Markets LONDON: CITY FIGHTS TO KEEP ITS FINANCIAL STATUS

Michael Power, global strategist at Investec Asset Management. Photograph kindly supplied by Investec Asset Management, June 2009.

eurodollars), fund management, overthe-counter (OTC) derivative trading, foreign company IPOs and trading in foreign equities.” According to Power, other financial centres have their problems and will struggle to regain momentum. He believes that in the United States, New York will feel a heavier hand of legislation than London while in Europe, Dublin, whose lower backoffice costs were a main attraction, is now struggling with a stronger currency. By some estimates Dublin is 40% more expensive than London. Luxembourg, on the other hand, is no longer materially more competitive in terms of where to locate mutual and hedge funds due to underappreciated changes in UK law. This relates to the country’s new “tax elected funds regime”, which provides more favourable treatment to authorised investment funds. Meanwhile, the gloss has been taken off both Zurich and Geneva in the private banking sphere because of the compromises the Swiss authorities have been forced to make in light of the recent US tax scandals.

As for other regions, Power believes that Dubai is still shell-shocked from the financial crisis and reeling from widespread problems in its overheated property sector as well as tight liquidity conditions in its financial markets. Meanwhile, Hong Kong is under threat with the Chinese signalling that they want to develop Shanghai as their financial capital. While many market participants share Power’s view that other regions do not pose an immediate threat, some believe that the landscape will shift in time. John Donohoe, chief executive officer at investment consultancy Carne Global, says: “Things do not change that quickly and if you look at the current financial centres—London, New York, Tokyo—they are still domestically wealthy centres with established infrastructures. The stock markets in the Middle East, for example, are small and while they have tried to encourage companies to list, many are family-owned, private companies and have been reluctant to sell or list. Also, the Gulf region is relatively fragmented and there is no one centre that is coming to the fore to take the lead. Instead, Abu Dhabi, Qatar, Bahrain, Saudi Arabia and Dubai are competing against each other. However, in the future I expect the region will become more influential and develop into a larger global centre due to increased wealth.” Hirander Misra, chief operating officer of Chi-X Europe, also believes things will change in Asia. “One of the problems with Asia is that there is no common regulation like in [sic] the European Union and the US. There are inherent barriers to entry but over time these will be eradicated. For now, there is still a great deal of bureaucracy in countries such as China and India although things are changing. For example, last year we saw India allow direct market

access which is now seen as an essential tool and a way to further open the markets.” China is also on course to transform Shanghai into a major financial centre within the next ten years, although the general view is that the country is large enough to house two major financial hives of activity. A stumbling block could be the delay of further reform. The government recently announced plans to increase foreign investor participation in the mainland market and to allow foreign companies to issue A shares, although few details were given. Other requirements needed for a world financial centre such as a transparent regulatory and legal system may prove more challenging. Against the current background, it is no surprise that the top centres— London, New York, Singapore, Hong Kong, Zurich, Geneva and Chicago, as ranked in the latest Global Financial Centres Index (GFCI)—are likely to retain their positions. The most recent report published in March by the City of London and compiled by the Z/Yen Group think-tank canvassed 1,455 financial services professionals. It showed that all 62 centres lost points but that the leading six cities occupied the same positions that they did in September 2008. London and NewYork kept their edge as the world’s two truly global centres, with 781 and 768 points, respectively. London lost the upper hand as the number one banking centre but won plaudits for its professional services, insurance, asset management, government and regulatory regimes. The GFCI also revealed that the gap widened between the two leaders and the other four main contenders. For example, NewYork was 81 points ahead of Singapore compared to 73 last September. Overall, Singapore’s rating dropped by 14 points to 687, followed by Hong Kong, which slipped by 16

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In the Markets LONDON: CITY FIGHTS TO KEEP ITS FINANCIAL STATUS

points to 684. In addition, there was a greater divergence with those at the bottom of the chart as they experienced falls in scores four times greater than those at the top. In terms of winners and losers, Canadian cities Vancouver and Montreal were the biggest risers, each climbing five places to 25th and 26th, while Tokyo suffered the largest slide, falling eight places to 15th, followed by Sydney dropping six to the 16th rung. There were also new entrants, most notably Taipei grabbing the 41st place, two spots ahead of Bahrain. Kuala Lumpur also made its debut, in 45th place, displacing Qatar. Meanwhile Bangkok joined the rankings in the 50th slot, putting it just one place behind Mumbai, which, along with financial centres in the Gulf region, has become a popular destination for Western bankers switching to more far-flung centres. One of Bahrain and Qatar’s key rivals, Dubai, was unchanged in the rankings in 23rd place. Stuart Fraser, chairman of policy at the City of London Corporation, adds: “We have seen a retrenchment back from the Middle East to London and New York because at times of stress people tend to gravitate towards well-established financial centres. It is also important to remember that while London has had its reputation dented, it is not just a banking centre. It is also home to other parts of financial services such as insurance, law, accounting and support services that have not suffered as much.” Fraser is not alone in his concerns. Market participants fear that high tax rates announced in the last Budget coupled with stricter regulations will erode London’s premier standing over a period of time. According to research from PricewaterhouseCoopers, the increase in the top rate of income tax to 50% for those earning over £150,000 a year will place the UK as the second most expensive country in the G20 in

which to earn a living, after Italy. Britain will have higher personal taxes than the US, Germany and France. Some City flyers are already taking flight. Guy Hands, chief executive of the private equity company Terra Firma Capital Partners, has relocated to Guernsey while Crispin Odey is understood to be considering taking his Odey Asset Management, which controls more than £3bn, to a different tax jurisdiction. In addition, Peter Hargreaves, the co-founder of the financial advisory group Hargreaves Landsdown, has been quoted in recent weeks as considering a move to either Monaco or the Isle of Man, while Hugh Osmond, an entrepreneur who floated the Pizza Express restaurant chain, said he was considering moving his financial services group, Pearl Assurance, out of the UK. As Eli Lederman, chief executive officer of Turquoise, the pan-European trading platform, puts it:“The higher tax rates on individuals and enterprises are a significant issue, more than any increase in the severity of the regulatory environment, which people generally see as warranted. London has been a magnet for talent from all over the world and the tax situation will likely reverse that, as people and their businesses are so portable today.” The Ernst & Young Item Club, whose members include companies from a range of industry sectors, highlights these issues in its recent report, Rebalancing the economy: a long time coming. It warns the government that imposing tighter regulation or higher taxation than its competitors could damage London’s prospects. Andy Baldwin, industries managing partner for Ernst &Young’s European, Middle East, India and Africa financial services business, adds:“Over the next 20 years, the country needs a macroeconomic plan to encourage the development of high-value industries

Stuart Fraser, chairman of policy at the City of London Corporation. Photograph kindly supplied by the City of London Corporation, June 2009.

in services and manufacturing to rebalance the economy. Services account for 76% of the total of GDP and while financial services only contributes 10%, it generates a disproportionate amount, 28%, of all corporate tax revenues. The changes in the high rate of tax and on pension funds will make London less attractive and one question companies will start asking is whether I need to have my head office in the UK.” The government recognises the issues and the Financial Services Global Competitiveness Group, co-chaired by Chancellor Alistair Darling and former Citi chairman Sir Win Bischoff, has already concluded that the UK needs a more-effective system of regulation and must develop partnerships with overseas financial centres to be globally competitive over the next 15 to 20 years. More detailed proposals for strengthening and overhauling regulation were also be published in June in the wake of recommendations from Adair Turner, chairman of the UK’s Financial Services Authority, and meetings of the Group of 20.

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In the Markets BRAZIL CSD: AMERICA’S ADVENT TAKES STAKE IN CETIP

SECOND COMING FOR BRAZILIAN EXCHANGE The move by private equity firm Advent International to take a stake in Brazilian central depository Cetip looks like a shrewd one from the Bostonbased group. Cetip enjoys a dominant position in its field in fixed-income and over-thecounter (OTC) derivatives, two markets with plenty of potential for growth in Brazil. Moreover, the US firm brings needed resources and expertise to an exchange traditionally too influenced by user-owners and dependent on their largesse to roll out innovative products. John Rumsey reports.

DVENT INTERNATIONAL’S 8th May announcement that it was set to take a 30% share of Cetip, the largest central depository for fixed-income securities by private issuers and OTC derivatives in Latin America, should lay the ground for the Brazilian exchange to consolidate its leading hold in these two areas and invest in new, value-added offerings so that it can offer clients a broader array of products. The Boston-based firm has just four core areas of operation, one of which is investments in financial markets. The ethos is that by confining yourself to a limited number of areas, you get to know the industry profoundly and

One of the most exciting areas for new opportunities lies in the development of collateral management products. Federal legislation dating back to 2004 has clarified creditors’ rights and made it easier to enforce claims against borrowers when they stop repayments. Photograph © Norebbo/ Dreamstime.com, May 2009.

can add value, according to Martin Escobari, lead partner of the United States firm in the deal. Cetip was particularly attractive to Advent thanks to the very low penetration of fixed-income instruments in Brazil’s financial markets and thus its scope for growth. Globally, Brazil is one of the only large economies that is substantially underleveraged, says Escobari. The potential for growth in the fixed-income markets can be seen when comparing Brazil’s low debt to Gross Domestic Product (GDP) figures. Mortgages represent less than 2% of GDP for example and growth is in triple digits, says Escobari.

The Brazilian derivative markets are similarly under-developed: such markets in Brazil represent just 0.4 times GDP. That compares to four times GDP in Mexico and 26 times in the US, he notes. For Cetip, the transaction immediately provides a simpler, more coherent ownership structure. Like many of its peers, Cetip has been mutually owned. Small- and medium-sized banks and brokerage houses possessed 103m of the 221.9m shares with small distributors holding close to another 35m, leading to a highly fragmented ownership. As other exchanges have found, the interests of such owners can often be short term and they can be reluctant to

J U LY / A U G U S T 2 0 0 9 • F T S E G L O B A L M A R K E T S

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In the Markets BRAZIL CSD: AMERICA’S ADVENT TAKES STAKE IN CETIP

embrace change. Even where that is not the case, the parsimony of such a shareholder base does not typically provide a conducive atmosphere for long-term projects. In the case of Cetip, many of the owner-users had ceased to have an active role in the market, explains Jorge Sant’Anna, head of business development for the exchange. Many such shareholders have proven reluctant to provide enough cash to develop the exchange, he notes. The arrival of Advent allows these parties to monetise their shares and should remove the dead wood from the exchange. The new owners will also usher in some new management. Escobari will be one of two Advent professionals to gain a seat on the board and a new chief finance officer, Francisco Gomez, has already been appointed, hired for his depth of experience and as a recognised, respected name in the market place. The company is also set to appoint a new chief executive officer, who Escobari declined to name. Overall, Escobari does not see the need for substantive changes. Managers at Cetip have emphasised the development of technology and have worked well with the resources that they enjoyed over the past ten years, he says. In fact, he would like to see a beefing-up of human resources. The focus for capital investment will be technology in the short term and processes and IT over the medium term, says Escobari. Advent aims to extract efficiencies through this tactic and provide the platform for providing a broader set of services, as well as improving internal controls and enhance real-time reporting as well as the accuracy of calculating market values for clients. Cetip will need to be brought up to date and made more business oriented, believes Escobari. The exchange has had a not-for-profit

There is also the possibility that Cetip could get involved in equity markets in the future, says Sant’Anna. Currently, Brazilian legislation restricts companies from listing shares both on exchanges and OTC markets. Changes in legislation might enable Cetip to offer electronic trading platforms for equities, he notes. Photograph © Paul Fleet/Dreamstime.com, supplied May 2009.

mentality and Advent will be able to help in the transformation to a stronger business focus through new systems, alignment of management and shareholder interests. That does not mean the exchange will forget its public mission of helping develop capital markets, he says. The slowdown of the global economy as well as the tarnished reputation of derivatives and homegrown derivatives scandals may make this seem an inauspicious moment to be purchasing an exchange specialising in financial instruments that incorporate a big slug of derivatives. Some of Brazil’s top companies have been embroiled in scandals that have been costly, both to the bottom line and reputation, including food processor Sadia and paper and pulp company Aracruz. Sadia shareholders announced in April that they would sue Adriano Lima Ferreira, former chief finance officer, who they accuse of having a role in a BRL76m ($24m) loss. Shareholders in Aracruz, which settled a $2.13bn derivatives loss with banks in a deal that stretches repayment out to nine years, voted last November to sue former chief

finance officer Isac Zagury. The worst moment has passed and local media may have exaggerated the possible extent of the derivatives scandals, says Sant’Anna. He saw estimates of potential losses quoted in the media of as much as $80bn whereas his expectations are $15bn. Moreover, most of the derivatives trading was used for hedging currency positions by exporters, with only a small minority of firms using contracts in asymmetrical derivatives to make significant bets on the direction of currency movements. Furthermore, he notes, the market regulator is now insisting on greater transparency from listed companies on their derivatives exposure. Globally, there remains a lot of work to be done in qualifying derivatives and understanding their systemic risk profile, admits Escobari. He predicts that in the short term there will be higher demand for simpler derivative products. In this area, the Brazilian exchange has some significant advantages over others. The regulatory structure of the market is different from most of the rest of the world. Registration of trades at a central custodian is mandatory under Brazilian legislation.

J U LY / A U G U S T 2 0 0 9 • F T S E G L O B A L M A R K E T S

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In the Markets BRAZIL CSD: AMERICA’S ADVENT TAKES STAKE IN CETIP

That gives complete accountability and the regulator an almost real-time snapshot of the exposure of the economy to derivatives, says Escobari. This level of informational capture does not exist in either the US or European Union and regulators are working towards the kind of greater transparency already found in Brazil. Cetip is, anyway, not dependent on derivatives. It operates across the public and private fixed-income space, OTC derivatives and commodity derivatives, in custody and settlement, and offers trading platforms in government and private bonds. Although it dominates Brazilian derivates trading by acting as depository in 80% of trades, it is even more dominant in fixed-income transactions, accounting for 98% of trades. Often when one of the markets it operates in is weak, another one picks up the slack, says Sant’Anna.

Low volatility Indeed, despite the various crises suffered by Brazil since 1999, revenues have displayed low volatility. For example, Cetip’s revenues were relatively little affected when the dollar and bond yield spiked in the run up to Brazilian President Luiz Inacio Lula da Silva’s first election in 2002. It is Cetip’s range across different markets that smoothes out revenues, points out Sant’Anna. Indeed, revenues grew 89% between the first quarter of last year and the first quarter of this year despite the market downturn, he notes. The fixed-income markets should provide plenty of growth for Cetip. The Brazilian government traditionally crowded out private sector borrowers who were further deterred from issuance thanks to high interest rates. The dynamics both in crowding out and rates are improving as the government’s debt burden slowly falls and the Central Bank cautiously top

slices interest rates, a trend hastened by the global downturn.The Selic rate was cut to 10.25% on 29th April with the rate widely seen as falling to between 8.5%-9.5% by year-end. Just how fast the private fixedincome market will grow in the near term is hard to predict thanks to the global recession. Escobari says: “We don’t have lots of visibility in credit over the next six months, but we do have confidence in long-term trends.”In the meantime, the transition from floatingrate to more fixed-rate issuance by the private sector creates derivative demand, he adds. As fixed- and floating-rate issuance increasingly coexist, opportunities for derivatives to match differing liabilities is opened up. It is not only the organic growth of the fixed-income and derivative markets that attracted Advent to the Brazilian market. There exist many opportunities in product development and value-added products that will allow premium pricing. One of the most exciting areas for new opportunities lies in the development of collateral management products. Federal legislation dating back to 2004 has clarified creditors’ rights and made it easier to enforce claims against borrowers when they stop repayments. That clarity in legislation is allowing Cetip, with its established role as a depository, to develop a more significant position. The exchange will look to enhance services, for example with more automated calculations which allow the amount of collateral to be adjusted in line with changes in underlying prices as securities are marked to market. Developing more elaborate collateral management systems will require innovation, notes Sant’Anna. For users, the benefits are clear and include reductions to the amounts of capital tied up and lower costs, while more efficient management of collateral also

cuts systemic risk, adds Escobari. Securities lending is another area of possible opportunity in the future. In the fixed-income market, development will be focused on the breadth of products. Secondary market trading in Brazil has remained underdeveloped; as the whole market grows, that should start to change. There are also new areas of operation. For example, there are new types of agricultural lending that allows different types of collateral to be pledged.

Open to equities There is also the possibility that Cetip could get involved in equity markets in the future, says Sant’Anna. Currently, Brazilian legislation restricts companies from listing shares both on exchanges and OTC markets. Changes in legislation might enable Cetip to offer electronic trading platforms for equities, he notes. Escobari declines to be drawn on what Advent is anticipating for future revenues from Cetip. When asked whether Advent would like to list its stake on the stock market in the future, he replies that it is too early to talk about the firm’s eventual exit from its investment and says that there is plenty of time to ponder strategies as the company has a typical time horizon of four to seven years. Advent uses both strategic sales and listings as exit strategies. The conclusion of the acquisition by Advent of Cetip’s business comes just as financial markets are showing a rapid recuperation. Even if there is no repeat of the runaway markets of just a couple of years ago, the foundations for Brazil’s fixed-income market are solid and the volatility of the foreign exchange market means that, even if companies restrict themselves to plain vanilla instruments, they are not going to forsake the protection of derivative contracts altogether.

J U LY / A U G U S T 2 0 0 9 • F T S E G L O B A L M A R K E T S

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In the Markets PENSION POOLING: THE ONUS ON COSTS

POOLING

to Optimise Resources

Photograph © Mike Monahan/ Dreamstime.com, supplied June 2009.

By centralising administrative duties and reducing management costs, pooling has made it easier and more cost effective for multinationals to oversee plans that are scattered around the globe. With market conditions impacting the funded status of innumerable pension schemes, such attributes have recently become even more valuable. Dave Simons reports from Boston. ODAY’S CROP OF multinationals face increasingly stringent accounting rules, historically low yields on government securities, not to mention unprecedented risk-management concerns. Small wonder, then, that corporations by the score have come to view pension pooling as a powerful weapon in the campaign to optimise operational performance. By centralising administrative duties and reducing management costs, pooling makes it easier and more cost effective for multinationals to oversee plans that are scattered throughout the world. In addition to allowing companies to roll multiple managers into a single entity, the lower operating costs associated with pooling gives subsidiaries access to custodial services such as securities lending and commission recapture that might not otherwise be available. Custodians, meanwhile, continue to gain favour with large public-pension programmes eager to contain costs and reduce fees associated with defined-benefits plans. By making their pool of assets available

to the borrowing market through a low-risk lending arrangement, pension programmes have been able to significantly improve performance. Such attributes have, by all accounts, become even more valuable in recent times. “Some of these firms have some fairly hefty guarantees in numerous countries, they cannot just turn around and drop their definedbenefits plans the way they might be able to in the United States,” says Kerry White, head of multinational business and product development, BNY Mellon Asset Servicing. “It is a very slow ship to turn.” Accordingly, White says, there has been a clear reassessment of how pension plans should be managed going forward. “We have seen a lot of interest coming out of the Netherlands in particular which, of course, is where the parent companies of many large internationals are based.” Last year, a ruling from the US Department of Labor allowing multinationals to blend the Employee Retirement Income Security Act (ERISA) and non-US pension assets within a single fund,

gave a major boost to cross-border pension pooling arrangements, ostensibly increasing the opportunity for pooling multinationals to consider US-based assets and, at the same time, making it easier for US firms to engage in pooling programmes. Still, multinationals that decide to reap the benefits available through the pooling of assets have the responsibility to report to local regulators in each of the various jurisdictions. “If you are dealing with eight different countries and at least eight different regulators, you cannot just move your ERISA plan to Luxembourg and not be required to do your Form 5500 reporting any more—it just does not work that way,” explains White. “They are not trying to step away from their payment obligations; but instead are looking for a more economical way of covering these benefits, while perhaps at the same time improving their corporate-governance capabilities.” Public pension funds have themselves been severely hammered in recent months and, as a result, plan

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In the Markets PENSION POOLING: THE ONUS ON COSTS

managers are now looking for ways to increase transparency and boost flagging returns through various pooling programmes. In one particularly creative scheme, a consortium of public pension funds that includes the likes of the California Public Employees’ Retirement System (CalPERS) is apparently considering an investment pool dedicated to supporting state and local infrastructure projects. Nonetheless, still reeling from last autumn’s mammoth sell-off, plan managers are loath to reduce their exposure to certain alpha-generating investments, given the historical returns derived from alternative programmes in particular. “They really want to have their cake and eat it too,” offers White. “They want to do something about these opaque instruments they’ve been using by looking to get into some actively managed assets in the US, while at the same time possibly gain some economies of scale by merging those plan assets together with the assets of similar plans. So it is really a very new and challenging kind of balancing act.”

All or nothing As White points out, pooling need not be an all-or-nothing proposition. “It doesn’t necessarily have to cover all plan asset classes—for instance, if a plan has an immunised bond portfolio for 10 different countries, then they might consider doing all of their fixed income on a pooled basis. Compared to a NASDAQ-traded or NYSE-traded equity, there is potentially a big difference in terms of the kind of execution or pricing you can get through fixed income, particularly when looking at the longer end of the maturity spectrum.” Pooling can also provide smaller plans within a corporate pension programme the same access to certain specialised mandates normally

reserved for larger funds. Martin Campbell, vice president at Chicagobased Northern Trust, agrees that the value proposition for pooling among multinational clients remains strong. “We are currently working on projects with our clients to add over $4bn in new assets, mainly from pension plans, to existing pooling funds in 2009,”says Campbell, who is responsible for expanding and marketing Northern Trust’s cross-border pooling product. At least three new tax-transparent pooling structures will be launched during the course of the year, and two are already up and running, he says. “We’ve also gone to great lengths to assure that our pooling platform is able to provide Form 5500 reporting and the necessary information for partnership-tax reporting, so that all ERISA plan requirements are included.” Pooling assets from multiple pension plans into a single investment vehicle provides treasurers or chief investment officers with a degree of governance over the investment manager’s decision-making process. Making good on the cost benefits of pooling is paramount, and in the current capital-conscious environment, multinationals must carefully weigh the resources needed to establish, govern and administer a fund set up for pooling purposes, as well as how much of the investment can be offset by the potential savings. A PricewaterhouseCoopers report offered that pension-fund investors “should ultimately be no worse off as a result of pooling their investments than if they had invested directly in the relevant investments held by the vehicle on their behalf”. “That is all part of the cost-benefit analysis,” says Campbell. “A company might start by looking at the expected savings from investment-management fees. For example, if there are six different plans bringing their assets to the same manager, might they be

better served by establishing a pool with which to aggregate those assets in order to receive a more beneficial fee schedule?”

Co-mingled funds Similarly, companies with smaller plans that are invested in co-mingled funds but aren’t eligible for the withholding-tax treatment typically found under a double-tax treaty may benefit from a pooling arrangement, says Campbell. Securities lending is yet another area where savings may be realised through pooling, since the decision to lend securities is made at the pooled fund level, rather than on a plan-by-plan basis, adds Campbell. Moreover, investment managers and their institutional investors are beginning to understand the problems that can arise from investing in non taxtransparent vehicles, and are working to address the issue through the use of taxtransparent funds such as the Dublinbased Common Contractual Fund (CCF), as well as Luxembourg’s popular Fonds Commun de Placement (FCP). At the close of 2008, FCPs accounted for nearly 60% of all Luxembourgdomiciled funds, according to data from PricewaterhouseCoopers. How much of an impact pooling can have on any single pension program largely depends on the culture of the organisation and how its various subsidiary plans are governed, says Campbell. “One multinational may have a mainly hands-off approach, but sees the financial benefits of setting up a pooled fund. Whereas another multinational may already have a central group responsible for making decisions over investments managers for various mandates such as global equity. So in that sense, pooling is really a natural progression for the manager who is already at that level on the governance scale.”

J U LY / A U G U S T 2 0 0 9 • F T S E G L O B A L M A R K E T S

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In the Markets FUND MANAGEMENT: PROCESSING AUTOMATION A TOP PRIORITY

Heightened regulatory focus is expected both in mainland Europe and in the UK, which will also have an impact on how firms manage their processing risks. Infrastructure processing hubs are proven solutions; they are cheap and address many of the areas of concern for risk managers. By Ivan Nicora, director and head of investment fund product management, Euroclear.

Photograph © Blueximages/Dreamstime.com, supplied June 2009.

Cost-Efficient Fund Automation HE INVESTMENT FUND industry has gone through some stressful times recently. However, according to the European Fund and Asset Management Association (EFAMA), the combined assets under management in European investment funds fell by only 1.4% in the first quarter of 2009, with some funds posting net inflows of €22bn. While the green shoots of recovery are welcome, one factor remains which affects all asset managers and distributors, regardless of performance. This is the cost of processing fund transaction. Previously relegated as a back-office issue, fund unit processing is now highly topical and influential in gaining distributor support. Today’s economic climate has reinforced the need for fund promoters and distributors alike to pay closer attention to cost efficiencies and risk management procedures throughout the transaction life cycle. Many have turned to neutral, third-party processing solutions to achieve greater operational efficiency at the lowest possible price.

It is possible today to boost the levels of fund processing automation, but it is not as straightforward as you might imagine. In these economically challenging times, IT budgets are restricted and investments that have the potential to generate more business flows have the highest priority. With this and other considerations in mind, how can we convert the 50% of the fund industry that still links the sell and the buyside by email, fax and proprietary channels to the age of automation? The answer is to prove—to both sides—the tremendous value and cost savings to be gained through economies of scale and automated transaction processing. For example, firms with automated processing platforms today are able to make considerable savings in back-office costs with just enough headcount to feel safe in the knowledge that the selected straight through processing (STP) platform is able to handle spikes in redemption/subscription activity.

One of the biggest headaches that distributors face in not being automated is correctly calculating and receiving commissions—their raison d’être. When done manually, this is a painstaking rigmarole, as at any time distributors, fund promoters and others involved in the transaction need to know exactly who has bought what and held it for how long. Parameters such as these dictate the commission due to the distributor. Furthermore, as investment strategies go increasingly beyond domestic market funds, distributors often need to manage complex client account arrangements across different markets and time zones for commission calculation. In electing to use an automated processing hub, all of these commission-based reconciliation challenges disappear. The central hub automatically collects and routes orders from the fund distributor to the relevant fund promoter’s transfer agent (TA). Some processing hubs enable TAs that are linked into the hub to see precisely the portion of activity that has emanated from individual distributors for each and every fund for which the TA runs the books. Using such an automated infrastructure, TAs can accurately calculate commissions due and payments can be credited electronically

J U LY / A U G U S T 2 0 0 9 • F T S E G L O B A L M A R K E T S

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In the Markets FUND MANAGEMENT: PROCESSING AUTOMATION A TOP PRIORITY

and expeditiously to distributors in a matter of days. This is in contrast to delays of weeks, or sometimes months, in cases where the TA has to collect a stream of different reports from a variety of sources before being in a position to calculate commissions manually on a spreadsheet. Promoters are growing impatient, and rightly so. They are applying pressure, particularly given current financial market conditions, on distribution partners to embrace automation which will reduce errors and speed up commission calculations. Fortunately, many distributors are listening and making processing automation a top priority. Anything less and they will probably find themselves at a competitive disadvantage.

Efficient distribution Leading international fund promoters also recognise the benefits of automation in reaching all of their distributors at home and abroad. More efficient distribution channels equate to business growth, and potentially to a wider range of outlets where promoters can showcase their funds. Given the urgency for fund promoters to focus their attention on stabilising assets under management, while also locking in new investors, fund management companies are finding it easier and wiser to partner with efficient and automated processing providers. They are even willing to put their hands in their pockets and share the cost of automating distributors that lack the will and/or means to do so. For as long as any one link in the transaction chain remains manual, the fund promoter will never gain all of the benefits from automated transaction flows. For example, some fund promoters using the FundSettle platform recently teamed up with Euroclear to drastically reduce tariffs charged to distributors that are willing to process transactions

in their funds on the platform, and scrapped all safekeeping fees. Together, some of Europe’s leading fund promoters have made automation a short- and long-term commitment, delivering savings of up to 85% on fund-transaction post-trade costs. While cost savings to distributors are an economic necessity, an equally important driver for promoters is to be able to process transactions in their funds in the safest and most efficient environment possible—a definite winwin situation for all. Asset management, by definition, entails risk, both of a financial and operating nature. A critical factor for successful asset management is therefore the ability to identify, analyse and manage these risks before they transform into actual losses. PostLehman Brothers, there is a renewed sense of urgency across markets to know precise levels of exposure, their duration and how to protect against the event of a counterparty defaulting. Equally vital is to understand how open transactions and pledged cash/securities are managed. By having access to all settled and pending fund unit transactions, via its own or a third-party infrastructure hub, the asset management firm can perform its own risk evaluations and controls. Settlement risk is easily sidestepped by using a provider that integrates order routing with efficient settlement and safekeeping services.The UK is a case in point, with investment fund processing automation taking hold of what used to be a very fragmented, manually intensive and, therefore, risk-prone market. The UK market is progressively shifting from the norm of “cheque-inthe-post payment” to “fully-secure electronic T+4 book-entry settlement”of units and cash. Settlement risk is greatly decreased because there is no manual intervention from the moment a fund order is placed

by IFAs or fund supermarkets using the EMX Message System for order routing, to the moment settlement of the redemption/subscription order occurs at Euroclear UK & Ireland. Furthermore, reporting and exception management is handled in a fully electronic way via the central processing hub. The fact that fund units can be sold and cash recouped within four business days makes for a very attractive proposition for investors that may not have considered buying into a fund due to the cumbersome and timely exit periods, should they need to realign their investment strategy quickly.

Regulatory focus Operational headaches are commonplace in any organisation with a high dependency on manual intervention. During periods of market prosperity, firms may be willing to take the occasional financial hit as a direct result of manual processing lapses. Today, there is little, if any, tolerance for unnecessary losses in the back office. Heightened regulatory focus is expected both in mainland Europe and in the UK, which will also have an impact on how firms manage their processing risks. Calls for better risk management in our industry have been heard over and over again. These calls have become impossible to ignore, partly because there is regulatory power behind them. Thus, we are seeing wider recognition that our industry would be better protected through automation. Infrastructure processing hubs are proven solutions; they are cheap and address many of the areas of concern for risk managers. The financial crisis has shown that the unthinkable is conceivable. How much more of a warning does the fund market need to engage in processing automation and standardisation? Infrastructure processing hubs have passed the test.

J U LY / A U G U S T 2 0 0 9 • F T S E G L O B A L M A R K E T S

Alternatives

RATIONAL

INVESTMENT AST YEAR’S MELTDOWN exploded the myth of absolute returns—the HFRI Fund Weighted Composite Index fell 18.4% in 2008—and now the replicators are getting serious attention. Until now, neither high net worth individuals nor institutional investors in hedge funds paid much attention to a growing body of academic research suggesting

that hedge fund returns could be explained in large part by broad movements in the financial markets rather than the managers’ skill. “People want to believe that hedge funds produce alpha,” says Philippe Schenk, head of the global business development team for alternative beta products at Credit Suisse in New York. “Replication shows that in some of

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HEDGE FUND REPLICATION: A NEW APPROACH

Photograph © Andrea Danti/Dreamstime.com, supplied June 2009.

About three years ago, money managers, led by Goldman Sachs and Merrill Lynch, brought hedge fund replication to the institutional market in vehicles designed to mimic the performance of the hedge fund industry using futures, exchange traded funds (ETFs) and other highly liquid instruments. Although the products attracted enough assets to stay in business, the concept never captured the imagination of investors. People preferred to believe in the mystique surrounding hedge funds: that the managers were smarter than ordinary mortals, financial wizards who could deliver outsized returns uncorrelated to those on other asset classes no matter what happened to the markets. Successful replication models do not depend on some mad genius sitting behind a computer, says Bill Fung, visiting research professor at the London Business School (LBS) and one of the architects of State Street Global Advisors (SSgA) Premia Fund, a hedge fund beta-based product. Instead, they try to mimic the way portfolio managers behave in real life. Neil O’Hara reports. the more liquid and mature strategies most of the return is beta and investors can get that cheaper.” Hedge fund replication bears no relation to investible hedge fund indices or funds of hedge funds, both of which invest in actual hedge funds subject to all the usual risks and restrictions on liquidity. Replication vehicles rely on linear regression

Alternatives HEDGE FUND REPLICATION: A NEW APPROACH

techniques to find the best fit between the monthly returns on a benchmark hedge fund index and various factors that reflect financial market conditions at the time. For example, the Merrill Lynch Factor Index (MLFI) attempts to replicate returns on the HFRI Weighted Composite Index using futures on four equity indices— the Standard & Poor’s 500, the MSCI EAFE, the MSCI Emerging Markets and the Russell 2000—a US dollar index and the BBA One-month USD LIBOR index. Each factor is assigned a certain weight, which may be long or short, based on a rolling 24 months of hedge fund returns, and the weights are rebalanced every month as new data becomes available. Successful replication models don’t depend on some mad genius sitting behind a computer, according to Bill Fung, visiting research professor at the London Business School (LBS) and one of the architects of State Street Global Advisors (SSgA) Premia Fund, a hedge fund beta-based product. Instead, they try to mimic the way portfolio managers behave in real life. He says: “We don’t just throw in a whole bunch of factors and hope for the best. The key is to be able to associate a rational investment process with the model’s behaviour—you have to be able to differentiate a paradigm shift from noise. Otherwise you are likely to be severely tested when the next turning point comes along.” Peter Little, head of portfolio management and implementation for alternative beta products at Credit Suisse, says that while most replication products aim to track returns for the hedge fund industry as a whole, Credit Suisse has taken a more granular approach. The firm launched an index to track long short equity returns in May 2008, followed with a global macro replicator index in March 2009, and plans to offer additional indices in the future.

Credit Suisse focused its development efforts on the sectors that contribute most to industry performance. Although the numbers vary over time based on market conditions and asset flows, Little estimates that long short equity contributes about 70% of industry performance thanks to its relatively high volatility and large asset weighting. Global macro accounts for another 20% of performance. He says: “Throw in event-driven and the percentage is in the high 90s. The majority of assets are in those three sectors and they are where the majority of the volatility lies as well.” Hedge funds conjure up an image of rapid-fire trading, but Little says aggregate exposures are less volatile than people think. Individual managers may change their positions

compared to 2% of assets and a 20% performance fee for direct investment in hedge funds. Replicators offered by reputable firms ensure that investors need not worry about bad publicity if their chosen hedge fund manager ends up on the front pages like Bernie Madoff, either. Hedge fund replicators can’t match the returns of the best-performing hedge funds, but they don’t pretend to. Yonathan Epelbaum, a managing director responsible for equity structured products at BAML, says the idea is to isolate hedge fund beta and offer it to investors in a cheap, liquid form. In three years of live trading, the MLFI has achieved more than 90% correlation to the returns of its benchmark, a level the model met in back tests to 2000 as well. Epelbaum says:“The correlation shows there isn’t `

Hedge fund replication allows investors to adopt a coresatellite portfolio model to manage their exposures, a strategy that appeals to Kevin Burrows, a senior analyst at Nedgroup Investments, the $600m London-based offshore investment arm of South Africa’s Nedbank. frequently, but many trades offset each other. In a diversified group of hedge funds, exposure drifts up and down like a gentle swell—which is just as well for replicators, whose backward-looking models may need time to reflect sudden shifts. For investors burned by hedge fund managers who put up the gates and suspended redemptions, the daily liquidity and complete transparency replication products offer is an obvious attraction. Michael Heraty, director, equity structured products at Bank of America Merrill Lynch (BAML) in New York, points out that replication vehicles also have low fees—around 1% of assets per year,

a lot of secret sauce for some hedge fund strategies. The MLFI is our bestselling and most compelling product to date.” BAML offers other products that replicate specific strategies, including volatility arbitrage and foreign exchange arbitrage. Investors use the MLFI for liquidity if they want exposure to hedge fund beta and as a cheap alternative to funds of hedge funds. Fees range from 50–100 basis points depending on the size of an investor’s commitment, a far cry from the 1% management fee and 10% performance fee funds of hedge funds typically charge on top of fees levied by the underlying hedge funds. Epelbaum says investors have used the

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MLFI to offset their exposure to hedge funds that have put up gates, too. He says: “It’s so liquid and transparent investors can go long or short.” Heraty argues that the debate about whether hedge fund replicators are superior to picking individual managers is misplaced. BAML’s experience suggests that investors see the products as complementary, not substitutes. Investors are still looking for alpha in individual hedge funds, but managers won’t always accept all the money an institution wants to invest. Replicators have no capacity constraints, and daily liquidity has become far more important to investors when the markets for so many assets have dried up.

Hedge fund replication allows investors to adopt a core-satellite portfolio model to manage their exposures, a strategy that appeals to Kevin Burrows, a senior analyst at Nedgroup Investments, the $600m London-based offshore investment arm of South Africa’s Nedbank. The firm already separates alpha and beta in its long only portfolios and has started to do the same in its fund of hedge fund products. Burrows says:“If 75%-80% of hedge fund returns can be identified through beta exposures, we would like to access that through a hedge fund replicator. It allows us to concentrate our efforts on picking hedge fund managers for direct investment who provide us an

outsized opportunity to add alpha.” Burrows evaluates the various hedge fund replicators against the investible HFRX Equal Weighted Strategies Index (HFRX) “just to make it a fair fight”. The non-investible HFRI indices tend to run higher than their investible counterparts due to the inclusion of high-fliers that are closed to new investors and the effect of survivor bias. The replicators beat the HFRX in 2008, in some cases by a substantial margin. For example, the HFRX fell 21.9%, but the Goldman Sachs Absolute Return Tracker index dropped only 14.6%. “The drawdown in hedge funds was due in large part to widening liquidity premiums,” says Burrows. “Hedge fund replicators use

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

Section

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Investment

1995, achieved

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.

F T S E G L O B A L M A R K E T S • J U LY / A U G U S T 2 0 0 9

a member of the

Group of Companies

Alternatives HEDGE FUND REPLICATION: A NEW APPROACH

liquid instruments that didn’t suffer the same evaporation in liquidity.” That hedge fund replicators beat their benchmarks last year came as no surprise to Fung at the LBS. The question isn’t so much why they outperformed—liquidity was the key— as whether it was by a sufficient margin. In a research paper published in 2008, Fung and his co-authors demonstrated that hedge fund alpha can reach double digits in good years, which implies that replicators can underperform by a similar amount. Fung says:“To cushion for the potential underperformance in an exceptionally good year, replicators should outperform hedge fund peer group averages by a comparable double digit amount in bad years like 2008.” Even though the replicators haven’t yet attracted much capital, Fung says they are already having an impact on hedge fund fees and how incentive fees should be structured. Institutions are pushing managers to accept separately managed accounts, which allow investors to retain control of their assets and offer full transparency. Investors are also questioning whether hedge fund fees are justified if a fund does not beat the performance of beta-only products. He says: “They have brought back rationality to an industry that had an untenable pricing structure.” Widespread adoption of replicators by institutional investors could pose a serious threat to funds of hedge funds, so it’s no surprise that Judy Posnikoff, a managing director and co-founder of $9bn fund of funds manager Pacific Alternative Asset Management in Newport Beach, California, is not a fan. In her view, the whole point of hedge fund investing is to find managers who can deliver alpha, the core expertise that funds of funds offer—and which replicators don’t even claim to provide. If replicators use market

indices to track hedge fund returns, so-called hedge fund beta is nothing more than a package of other betas anyway. Posnikoff asks: “Why try to get hedge fund beta exposures? If you want beta exposures, just trade the indices.” Proponents of replication argue that beta is precisely what most hedge fund investors get in practice. Adam Patti, chief executive officer of IndexIQ, a $75m asset management firm dedicated to replicating alternative investments based in Rye Brook, NY, says that in the early days of the hedge fund industry—say 25 years ago—a few talented managers were able to extract alpha, charge high fees, lock up capital and provide little transparency. Patti says: “That was okay, because they were getting results. Today, we have 9,000 managers and the market inefficiencies are diversified away. Investors are paying alpha fees for beta performance.” IndexIQ uses only Exchange Traded Funds (ETFs) to replicate the performance of hedge funds, a process it calls “democratising alternatives” to make them available at low cost in a form that even retail investors can understand. It launched a mutual fund, the IQ ALPHA Hedge Strategy Fund, in June 2008, added three separately managed account products last December and in March this year unveiled the first US ETF designed to track the broad hedge fund industry. Each product consists of a package of ETFs, which means the latest launch is in effect an ETF of ETFs. Unlike mutual funds, ETFs cannot sell other ETFs short, which means the new fund has to use inverse ETFs when the model calls for short exposure, a potential red flag for investors worried about the notorious tracking error of some inverse ETFs. Salvatore Bruno, chief investment officer of IndexIQ, says it’s

Peter Little, head of portfolio management and implementation for alternative beta products at Credit Suisse. Photograph kindly supplied by Credit Suisse, June 2009.

less of a problem for the broad based ETFs IndexIQ uses—and the weightings tend to be small for any short positions the model requires. Correlations to IndexIQ’s benchmarks vary by product, running as high as 8590% for its long short equity tracker down to 60-65% for global macro. The broad industry model performed well in the second half of 2008, however. Bruno says:“We were short on the long short equity strategy for most of 2008. That drove a lot of the relative performance in the second half.” The sponsors of hedge fund replicators don’t harp too much on last year’s outperformance, however. In theory, a replicator shouldn’t beat its benchmark, so they prefer to make their case based on liquidity, transparency and low cost. No doubt these products deserve a second look, but investors lured by hopes of sustained outperformance at a discount price would do well to remember that last year’s liquidity crunch isn’t likely to recur any time soon.

J U LY / A U G U S T 2 0 0 9 • F T S E G L O B A L M A R K E T S

Alternatives HEDGE FUNDS: DEADLINE FOR DISCLOSURE

GIPS Aim to Smarten-Up Hedge Funds Global Investment Performance Standards (GIPS) are intended to ensure transparency, full disclosure and ethical standards in the hedge fund industry, writes Carl Bacon, chairman of StatPro, the portfolio analytics and data solutions provider.

EDGE FUNDS—OUT of ignorance, or simply because they could not perceive any benefit—have largely ignored Global Investment Performance Standards (GIPS), ethical standards for investment performance presentation to ensure fair representation and full disclosure of an investment company’s performance history. Until recently, with investors blind to the potential pitfalls, hedge fund managers have been able to pick and choose their investors, charging high asymmetrical performance fees and denying transparency. GIPS were initially born out of the frustration of pension fund trustee’s inability to differentiate between good and bad asset managers in the mid1980s. Without standards, it appeared that all managers were above-average performers. The standards not only benefit prospective clients but also good asset managers who are allowed to differentiate their performance, products and services on a level playing field. Marketing departments of asset managers would sometimes “cherry pick”good-performing accounts, choose

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

particular time periods, highlight important caveats in the small print and self-select return and valuation methodologies to ensure good but nonrepresentative performance. Globally, the standards have been so successful that, for traditional asset categories managers, presentations are now assumed to be a fair and honest representation of past performance. In reality they risk being too successful. Collectively, pension fund trustees have short memories and are perhaps becoming complacent; the abuses of long-only managers 30 years ago are largely forgotten, and the benefits of GIPS compliance not fully understood. Recent problems with hedge funds are a useful reminder for investors in all asset categories. GIPS is about to complete its third re-write. The public comment period ends on the 1st July, 2009. While asset managers, country sponsors, consultants, verifiers and software providers are expected to be major contributors, the people for whom the standards are written are likely to be not quite so responsive.

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For hedge funds, compliance with the standards is beginning to gain momentum. In the UK, the Hedge Fund Working Group (HFWG) states: “The Global Investment Performance standards (GIPS) provide a standardised approach to performance presentation to communicate investment results to clients and prospective clients … The HFWG welcomes the initiative of GIPS to review the applicability of their existing principles to hedge funds.” The G20’s resolve to increase regulation in the form of the Financial Stability Board for hedge funds will add further pressure. Although not specifically mentioned, the GIPS standards are exactly the type of unified code of best practice the G20 is looking for. In the past there has been the perception that GIPS is not applicable to hedge funds. Currently, there are no specific provisions for hedge funds. The core of the standard is the grouping together of portfolios of similar strategies into composites to avoid selection of the better performing accounts, not particularly relevant for hedge funds.

Alternatives HEDGE FUNDS: DEADLINE FOR DISCLOSURE

The standards have always been applicable to hedge funds. In the early development of the standards, the GIPS committee decided that all the users of performance information should benefit from fair and honest presentations, including institutional and private clients as well as investors in mutual or other collective funds. The standards are also intended to cover all asset categories. The GIPS executive committee has established a working group on alternative investment strategies to address issues impacting hedge funds such as side pockets, master-feeder structures, grossing-up of performance fees and other issues. The working group is expected to present its suggestions this year with the aim of ensuring any performance returns presented are truly representative of the underlying performance of the fund. While it is the company, not an individual hedge fund, that must claim compliance to the standards, there is no barrier to single hedge funds being unique members of their own composite. The advantage to investors if a hedge fund is compliant with the standards is the consistency in the application of calculation methodologies and valuation procedures, comparability of performance presentations and a commitment to ethical, representative presentations to all prospective clients. The prospective version of GIPS effective from 1st January, 2011 is expected to require fair valuation of assets within the fund. A hierarchy must be incorporated into the valuation process when determining fair value. There are five levels of valuations involving various market prices or marketbased inputs other than quoted prices, down to unobservable inputs, depending on what is available, in identical or similar investments in the markets.

Valuations must use objective, observable, unadjusted quoted market prices in active markets for identical investments on the measurement date. If not available, funds must use objective, observable quoted market prices for similar investments in active markets. If they are unavailable, funds must use quoted prices for identical or similar investments in markets that are not active (markets in which there are few transactions for the investment, the prices are not current, or price quotations vary substantially over time or market makers).

Pricing investments In turn, if not available, funds must use market-based inputs other than quoted prices which are observable for the investment. If not available, funds must use subjective, unobservable inputs for the investments where markets are not active at the measurement date. Unobservable inputs should only be used to measure fair value to the extent that observable inputs and prices are not available. Unobservable inputs reflect the funds own assessments of assumptions that market participants would use in pricing investments and must be developed based on the best information available at the time. Investment firms are also recommended to disclose if investments are valued using subjective unobservable inputs that are material; describe any material change in the valuation as a result of a change in valuation methodology; disclose the key assumptions used to value investments, and obtain fair values from a qualified independent external third party. The consistent application of valuation procedures makes it much more difficult to massage returns and in particular to hide volatility and hence improve risk-adjusted returns.

As the name suggests, GIPS focuses on performance. Nevertheless, risk is increasingly a consideration. In the 2010 review, as part of the composite description, firms will be required to disclose sufficient information to allow a prospective client to understand the relevant risks of the composite strategy. In addition, firms will be required to disclose the three-year annualised expost standard deviation of the composite and benchmark. While standard deviation may not be the most appropriate risk measure for many (if not most) hedge funds, it is widely understood and easily calculated and allows for comparability between strategies and firms. Also, managers are recommended to disclose more appropriate risk measures consistent with their investment strategy. Investors should require that hedge funds claim compliance with GIPS; it is really a question of basic hygiene. If funds do not claim compliance either they do adhere or believe in the highest ethical standards; their controls and procedures are so weak they cannot achieve compliance, or they are ignorant of the standards or not yet convinced of the benefits. Whatever the reason, prospective clients should be cautious of any fund for which the firm does not claim compliance. The standards provide additional assurance in the form of independent verification giving an added sense of confidence in the fundâ&#x20AC;&#x2122;s claim of compliance. Verification tests the fundâ&#x20AC;&#x2122;s processes and procedures to ensure they are designed to calculate and present performance results in compliance with the standards. Anyone with an interest in performance presentations and who wants to comment within the public commitment period can obtain a copy of the latest draft at www.gipsstandards.org. Positive and negative feedback is equally valuable says the author.

J U LY / A U G U S T 2 0 0 9 â&#x20AC;˘ F T S E G L O B A L M A R K E T S

Face to Face PATRICK COLLE, UK HEAD OF BNP PARIBAS SECURITIES SERVICES

COVERING

ALL BASES There is a new determination in BNP Paribas Securities Services (BNP Paribas), as the bank’s commitment to 360 degree service provision is taking hold. Now, Patrick Colle, head of BNPPSS in the UK says the logical conclusion of that is for clients to concentrate their business with the service provider. HE BIG DRIVE,” acknowledges Colle,“is to extend the franchise with the largest UK fund managers.” The tactic took root early in the year, with the enlarged mandate the bank won from Henderson Global “ Investors, back in February. BNP Paribas is now the exclusive service provider for Henderson Global Investors’ investment operations and related banking services, excluding services for hedge funds. The Henderson group is one of Europe’s largest investment managers, and the end of 2008 had £49.5bn worth of assets under management. “The new contract with firms such as Henderson and Aberdeen Asset Management brings an added dimension to the traditional partnership between the buyside and ourselves,” notes Colle. In addition to providing a full range of investment operations services, and related banking services such as custody, securities lending, cash and foreign exchange. BNP Paribas will also enhance its global distribution contribution to Henderson’s products. The bank, says Colle, “now offers a single, strategic global operating model to support, for example, Henderson’s future growth and development”. In addition, Henderson will benefit from access to banking related services, which

“

include cash and treasury management, as well as foreign exchange services. It is a new found confidence by BNP Paribas, which is now, in terms of worldwide assets under custody lying in fifth place, after BNY Mellon, JPMorgan, Citi and State Street and is the largest European bank providing asset servicing and fund administration by a country mile. The bank has approximately €3.34trn (around $4.65trn) assets under custody as at year end 2008, with €565bn of assets under administration and close to 6,000 funds administered. While there is still some way to go to reach the zenith of four US houses in terms of volume, Colle thinks BNP Paribas is sitting pretty;“ having all the flexibility and innovation of the upstart pretender.” Colle has expanded the remit of BNP Paribas Securities Services UK business since he took it over just under two years ago. The core of the bank’s UK business largely stemmed from the acquisition in September 2002 of Cogent. Once the acquisition had been finalised, the bank moved quickly to establish its credentials in the UK space, with particular emphasis on fund administration, implementing a global STP hub in 2004 for its international investor services business. By so doing, it was able to reengineer its middle and

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Patrick Colle, head of BNP Paribas Securities Services in the United Kingdom. Photograph kindly supplied by BNP Paribas, June 2009.

back office, with a significant reduction in overheads as a result. It was a strong platform for growth. Colle has taken the franchise into much broader territory, aligning its UK growth strategy with the bank’s multi-stranded service approach to securities service provision that encompasses clearing and settlement and broker services in tandem with traditional custody and fund administration skill sets. At ground level, the tactics behind the bank’s business strategy are twofold. The bank is specifically positioning itself as a partner of choice for large acquisitions in the asset management space. Second, as evinced by the expanded mandate with Henderson Global Investors,“now we want all the business of our clients,” stresses Colle. “it is a very different approach to that of previous years, when we were more focused on winning outsourcing or fund accounting mandates. We’ve upped our game.” The raison d’etre behind the tactics are, of course, economic but the pragmatism inherent in the approach also reflects the growing complexity of the current relationship between asset service provider and the client. “The level of customisation and partnership, especially when our clients make complex acquisitions, means that we cannot really leverage the best for us and the client unless the partnership is solidly profitable,” acknowledges Colle. “In that sense it is a win-win. It also means we are turning down deals, in terms of asset size,if the deal now involves only outsourcing or middle office.”

Face to Face PATRICK COLLE, UK HEAD OF BNP PARIBAS SECURITIES SERVICES

In practice it means ensuring that every cog in the service machine contributes to creating overall profitability, while ensuring that it is the entire service engine that is for hire. The approach involves heartfelt and frank conversations with clients, acknowledges Colle. “I am saying to clients unapologetically: ‘How can I support your business adequately if its not profitable?’ It is changing the historic rules of the game, certainly, but we are spending time talking to clients, and consultants, explaining the approach and the advantages that accrue from a sustainable economic model. It is the only way in which to build a meaningful, sustainable partnership.”

Economies of scale Colle thinks that other asset servicing firms will follow the same pathway. “It makes sense and it is inevitable. The economies of scale, for example, in some outsourcing deals are simply limited. With each mandate you are constantly reconfiguring the numbers. You cannot proceed over the long term on this basis. The only viable way is for clients and even asset service providers to understand that all banking services have to be brought into the mix for the full service range to be brought into play to everyone’s advantage.” Additionally, the bank is establishing a strong beachhead in placing itself as a bridge provider of both buyside and sellside services for the investment community by providing post-trade services to market infrastructures. “We have been first mover in this regard,”notes Colle. The London Stock Exchange (LSE) in late April picked Fidessa, a trading technology and market data company, and BNP Paribas, as technology partners for Baikal, its planned block trading MTF platform (please refer to page 76 in this edition). The LSE’s Baikal dark pool will allow the

crossing of large sized orders without having to send them through a broker first. Baikal will use BNP Paribas Securities Services for OTC settlement, clearing services (where Baikal trades on other venues as part of its liquidity aggregation service) and back-office administration Earlier in the month, the bank launched clearing services on the LSE’s International Order Book (IOB). The services provided are part of the bank’s Clearsuite® solutions package. The IOB offers investors access to international markets via Depositary Receipts (DRs) from 46 countries. Trading on the IOB has grown rapidly since its inception. The introduction of a CCP for IOB stocks provides post-trade anonymity and improved settlement netting facilities in conjunction with the risk benefits achieved from exposure to a CCP. As Colle explains, “Clearsuite® clients benefit from a panel of products and solutions that simplify the access to all trading platforms and CCPs. It provides our clients with solutions for all their post-trade needs, allowing them to focus instead on their core expertise.” More latterly, the bank has been mandated to provide back-office outsourcing and settlement by Pipeline Financial Europe through Clearsuite®. The Clearsuite® range of services includes the Hybrid Clearing Model which allows both buy-side and sellside institutions to access Pipeline Financial’s MTF by offering the ability to operate both with, or without, a CCP. In practice, this means both the buy-side and sell-side firms can reduce counterparty risk exposure in the clearing and settlement cycle and associated costs and also maintain anonymity when trading block trades and algorithmic orders. Buy-side customers have the ability to settle across BNP Paribas’ settlement account in a so-called Model B arrangement. BNP Paribas provides counterparty risk

management by allowing Pipeline’s clients the security of a AA rated balance sheet. Sellside firms trading with Pipeline benefit from EuroCCP’s provision of Central Counterparty services, therefore providing risk mitigation of each trade through EuroCCP. “In addition to offering a lower risk model throughout the clearing and settlement lifecycle, the unique combination of a central counterparty with a buy-side settlement process offers sell-side users the potential for additional settlement netting benefits,”notes Colle.

Fast growing Pipeline Financial enables access to liquidity across 14 European markets covering over 5,000 stocks including all the main European indices as well as a range of ETFs. “It is a significant build out of capability,” highlights Colle, “We have had a similar relationship with NyFIX for a year. What is means is that we now claim to be the only player with capability across the whole spectrum of client solutions.” Pipeline reportedly intends to extend the model through the addition of more CCPs over the coming year. The rationale for the extension of the BNPPSS franchise in this regard is straightforward. “The new MTFs typically act as broker/dealers and as a quasi exchange. When they do that they need smart order routers to other venues to support the broker/dealer and therefore need to outsource the broker/dealer back office; which is an obvious capability that we offer. Second is the exchange platform clearing service which supports MTFs when they need to clear across multiple platforms. It is harnessing the skill sets we applied to asset managers and broker-dealers to this new and fast growing MTF segment. It makes absolute sense.”

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Face to Face MARK KELLEY, GLOBAL HEAD, ASSET GATHERERS SEGMENT, JPMORGAN WSS

LEVERAGING THE CLIENT CONTINUUM

Mark Kelley, global head, asset gatherers segment, JPMorgan WSS. Photograph kindly supplied by JPMorgan, June 2009.

ARK KELLEY IS a passionate advocate of the need for asset service providers being close to clients.“While asset service providers typically operate along the same process continuum and view their service offerings in the same way, clients are looking at banks quite differently these days. In some cases, they look for a strong balance sheet; in other cases it is about the way the bank runs processes. The commonality among our different outlooks is the fact that we both acknowledge there are larger perspectives, forces if you will, at play right now.” The landscape has changed irrevocably. “The asset management industry is driving change. Consolidation in the sector is rife and looks to continue for some time.There is a constant drive for cost and processing efficiencies in the sector, which is reinforcing that trend. Certainly there is compression in the number of funds out there. Additionally, those that remain are expanding both their product and geographic requirements. Moreover, there are higher expectations of transparency from regulators and

JPMorgan’s Worldwide Securities Services (WSS) team is readying for a changing securities services landscape. So says Mark Kelley, global head of the division’s asset gatherers segment. Kelley talks to FTSE Global Markets about the key drivers for change in the asset servicing segment and the ways in which the bank is responding to new circumstance. Consolidation in the asset management space, a renewed focus on risk management and transparency, and the rise of regional service requirements are the principal business drivers. A heightened awareness of regulatory issues, continuing reduction in operating expenses and a concentration of effort on enhancing returns, combine to form a multi-layered tactical approach that will ensure that the bank extends it business reach in the new world order. trustees,” says Kelley. “We continue to leverage the bank’s ability to package solutions across the full spectrum of services, through continuous investment in people and technology,”he holds. JPMorgan’s world view, highlights Kelley, is based on the understanding that: “There is tremendous pressure to save costs, and one of our primary objectives is to help the asset management segment move from fixed to variable costs, allowing space for them to introduce new product, meet changing regulatory requirements and opportunities and finally, introduce new technology. More and more we are seeing these challenges in the middle and back office. Our response is then to find ways to develop our processing platforms to help our clients achieve efficiencies in those processes that can be standardised, thereby freeing them to focus on their core competencies.” Even so, Kelley acknowledges that no two institutional investors are the same and therefore, “some customisation is required.”That distinction has governed the way in which the bank has built its systems capabilities so that, in Kelley’s terms, “valuable connection points” can

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be made with some clients. To achieve that layered service, the bank distinguishes between types of investment institutions through segmentation: “for example, pension funds have different needs and priorities than asset managers; they operate under different regulations and have a variety of investment strategies,” he lists as examples. There are also geographic considerations, with segments “broken down into regions and sub-regional groupings,”he adds. Inevitably, JPMorgan’s global footprint is highly useful in this regard. “That does not mean that innovation stops there,” stresses Kelley. “We are servicing clients in new geographies in new ways. We constantly review what the client is trying to achieve and find ways in which the client can leverage that footprint and processing machinery across any asset class.” Moreover, size at JPMorgan, is definitely a strength. We are cognizant of the fact that a number of our largest clients do business with us precisely because of that global footprint.” Globalisation is a key theme in Kelley’s own career trajectory and it is

Face to Face MARK KELLEY, GLOBAL HEAD, ASSET GATHERERS SEGMENT, JPMORGAN WSS

obvious that his international expertise in understanding cross-border investor requirements was a key consideration in bringing him on board. Kelley joined JPMorgan WSS back in 2006 and already had more than 20 years of financial services experience behind him, having held several key positions including that of managing director and regional business head of Citigroup’s Securities and Fund Services Europe, Middle East and Africa Division. Based in London, he managed Citi’s custody and clearing services, fund accounting and fund administration businesses, covering 24 countries. It makes him highly sensitive to investor concerns, particularly those operating and/or investing in frontier markets.“What the largest institutional investors are looking for in a global provider is principal protection and opportunity in the emerging markets. While the reality is that right now the percentage of flow into these markets is relatively low (US and Dutch institutions have retrenched significantly back into home base currency investments, for instance), and investors review their portfolio exposures, it is reassuring to have safehaven support,”stresses Kelley. He maintains that he expects flows into the emerging markets to quicken over the coming year and a half; “Moreover, we expect increased flow into non-traditional vehicles, including derivatives,” he adds. Interestingly, Kelley reckons that the floodgate of regulation that is likely to overflow into the global markets over the coming year will, in fact, “provide investors with a global purview, with a much greater level of comfort,”rather than stymieing the free flow of funds across borders. It’s a no-brainer, he says. “Emerging markets by their very nature are more volatile, more risky.” The bank also has a significant play in traditional markets. In April, the bank was named the top custodian

and fund administrator in Luxembourg, according to the latest figures from Lipper, the independent data firm. At of the end of last year, the bank’s Luxembourg assets under administration totalled a tad over $301bn and assets under custody were just under the $350bn mark. Actually, the bank has been the largest custodian in the domicile for almost a decade, though active in the market for more than 35 years. Business volumes, explains Kelley, exploded with the introduction of Undertakings for the Collective Investment of Transferable Securities (UCITS), a trend Kelley thinks the bank will continue to build on through the various iteration of the UCITS template; particularly “as the demand for derivatives continues to build.”

Prime services It also places more requirements on the service provider, stresses Kelley.“Now it is all about intra-day pricing and increased transparency across the array of assets.” He also thinks that the long term trend is pinching the historical gap between prime services and asset servicing, particularly in the 130/30 space and services covering long and short positions.” The bank has recently been awarded the moniker of Best Overall Hedge Fund Administrator by HFMWeek magazine in its 2009 Service Provider Awards.“A truly global administrator; JPMorgan was one of the few top credit-rated banks to take advantage of the flight to quality last year, offering the industry peace of mind at a time it needed it most,” claimed the official blurb announcing the award. More sedately Kelley acknowledges that the bank,“is one of the fastest growing hedge fund service providers.”The group now has around $66bn in alternative assets under administration. Key specialisations aside, Kelley

acknowledges that in future, institutional money management firms will become more discerning in the way that they interact with service providers and at the same time believes that the leading houses cannot take anything for granted, even their much vaunted duality: offering both global and in-depth country reach. There are wider forces at play, he holds. “From conversations with asset management shops, it is clear that there is a growing divide. People in general are looking for diversity and protection. “Two or more camps are emerging: those that think they are better off by splitting their business between two or more different shops. We have Lehman Brothers to thank for that.Then there is another camp, that does the homework, extensive due diligence and will plump for the provider that offers them precisely what they need and the right counterparty.” Not only that, the role of asset service provision is, he concedes, become more inclusive. “When we make presentations we are discussing ways in which we manage pricing conflicts, we are explaining the processes and schematics of our network protection policies and we are even at board meeting explaining how the DTCC works and the risks involved in settling trades. It’s a far cry from the past when you were talking solely of the quality of your network and how many funds you were administering.” Ultimately, Kelley believes that the evolution of asset service provision over the next decade is defined by,“the art of the possible.” In other words, he views custody and fund administration as a craftsman’s tools.“Technology is part of that toolbox, as is understanding the requirements of clients, but ultimately it is down to artistry and craftsmanship and elevating services to the best achievable level. In other words, the toolbox is only as good as the craftsman that wields it.”

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Face to Face

Some years ago the investment services game was all about volume and league table placings and a strung out debate over commoditised versus customised service provision. These days, innovation and client service is key with a comprehensive service offering that encompasses electronic execution through to fund administration, clearing and settlement with custody and highly customised and added value service extensions in multiple markets. The provision of these complex, integrated and (essentially) global solutions is widening the gap between the top four or five services providers and the rest. Andrew Gelb, head of securities and fund services in EMEA for Citi’s global transaction services, explains the dynamics of the new business model. ESPITE UNPRECEDENTED MARKET headwinds for the industry, the business remains a central focus for Citi,” says Andrew Gelb.“Our ability to support clients in difficult times has been tested and proven over the last three quarters— we stayed focused on our clients as well as a commitment to invest and deliver innovation.” Over the short term the industry has seen a downward trend with falling volumes and asset values, but this is beginning to turn around while the longer-term fundamental drivers remain strong. “After the recent turbulence we are seeing our client’s priorities shift”, says Gelb, “as they focus more and more on transparency, cost and risk management.” Those mainline trends play directly to the bank’s key strengths notes Gelb. “We believe Citi’s Securities and Fund Services business model, which offers solutions right across the entire investment value chain, is uniquely positioned. Our clients across all segments, banks, broker-dealers, investors and issuers, are looking for ways to streamline their operating model, create efficiencies and ultimately

move to a more variable cost structure. Delivering innovative solutions, such as general clearing member services and execution to custody, is central to remaining ahead of our clients needs”. The pace was set early last year when Citi opened direct custody and clearing (DCC) in five new markets, most recently the United Arab Emirates (UAE), taking its proprietary network (the largest in the world) to some 57 markets in total. Gelb notes that the addition of countries such as the UAE and Bangladesh to the bank’s network reflects the bank’s long standing mantra, “to meet the expanding needs of our clients and service them wherever they are doing business. As a consequence, we always invest in capacity,” he explains. “Although our ability to process business is scaled to a degree, we have and will continue to undertake new business without issue.” In September 2008, the custody and clearing product set was expanded to include General Clearing Member Only (GCM) Services. The service was developed as a direct response to the needs of banks and broker-dealers to efficiently access multiple trading venues and Central Counter-Parties

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ANDREW GELB, HEAD OF SECURITIES & FUND SERVICES, EMEA, CITI GTS

A NEW DEAL

Andrew Gelb, head of securities and fund services in EMEA for Citi’s global transaction services. Photograph kindly supplied by Citi, June 2009.

(CCPs) as a result of the emergence of multi-lateral trading facilities (MTFs) and the evolution of pan-European CCPs infrastructure. Citi’s GCM only solution is a multi-market, multiplatform solution that provides trading members with a single point of access to pan-European clearing houses. It allows them to de-couple clearing and settlement, giving them the flexibility to retain their existing settlement bank arrangements and at the same time simplifying the process by having a single GCM for a CCP. Moreover, says Gelb, the service has additional advantages of a single contractual agreement, consistent data feed with clearing data, the consolidation of margin at CCP rather than individual country level and the retention of existing clearing arrangements should an MTF expand into a new market. “The solution shields trading members from the development requirements of the CCP and from the complexity of contracting with multiple GCMs,”notes Gelb, who avers that Citi was the first custodian in the market to provide this solution. The bank has put a particular focus on servicing MTFs through its integrated clearing and settlement solution. Citi already has an approximate 70% market share in terms of servicing CCPs and of all the major MTFs launched, Citi supports nearly all of them with solutions ranging from execution services, clearing and settlement, cash management or middle office solutions.

Face to Face ANDREW GELB, HEAD OF SECURITIES & FUND SERVICES, EMEA, CITI GTS

The evolution of the trading, clearing and settlement industry and the resulting need for banks and investors alike to access markets quickly and efficiently led Citi to also develop Execution to Custody Services, launched in June last year when Citi signed an agreement with Austria’s Erste Group. The banking group chose Citi to provide a single integrated electronic execution and custody solution (combining Citi’s order to trade, to settlement automation platform and its proprietary custody branch network). Citi launched Citi ®Execution to Custody in the EMEA region that same month, targeting market intermediaries, banks and asset managers to address client demand for post-MiFID solutions. The Citi® Execution to Custody service provides a single counterparty to execute, settle and provide custody in all major execution markets worldwide. Through the linking of Citi’s capital markets and securities capabilities, it provides clients such as Erste with a service that, says Gelb, “removes any operational inefficiencies and risks that come from dealing with multiple providers. The product suite encompasses equity market executions, algorithms, DMA, smart routing trade processing/aggregation, global and domestic markets clearing, settlement, asset servicing, regulatory and position reporting, statements/billing and client support. In this context, says Gelb:“We continue with our commitment to remain a market leader in smart ordering and asset routing by acting as a single counterparty to execute, settle and provide custody in all major execution venues.” By the early autumn, Citi inked a further mandate in this segment with Banque et Caisse D’Epargne de L’Etat (BCEE), utilising the bank’s Lava Technology market access platform,

CitiConnect(SM) for Securities. Citi now provides BCEE with full-service trading and operational support in the US and Canadian markets through its platforms, while Citi® Execution to Custody gives BCEE a trading technology giving them access to liquidity pools, matching their trading and custody needs.

Alternatives Citi has also become more active in the alternative investments space, since the bank acquired the Bisys Group. The bank continues to promote its alternative investment services, though Gelb believes that there is increasingly greater cross-fertilisation of activity both on the investment provider and asset management side of the equation.“While many hedge funds are challenged right now, the concept of hedge fund investing is not going away. So there is a need for service providers to both manage risks and address the cost/efficiency equations. Moreover, completely aside from the crisis, we have found a huge degree of synergy between the alternative and traditional asset management space. As asset managers have taken on multi-strategy approaches, they are increasingly looking to buy a wider variety of services from providers. Nowadays it is all about ease of use.” Another innovation has been the development of the bank’s pooling solution which is designed to enable asset managers to achieve a common investment strategy across multiple investor products (for example. pensions, insurance, etc). It also supports the requirements of large multinationals that are looking to bring together the assets of their pension funds globally. Explains Gelb, “Citi’s solution enables clients to commingle the assets of multiple entity types on a common platform. This can provide improved administration, tax

efficiencies and greater asset diversification opportunities”. The evolution of the global financial markets are gearing towards the universal, global houses, with “deeper pockets to innovate,” he adds. “In today’s market you have to leverage your expertise across multiple product sets, such as securities lending, foreign exchange and execution. Therefore there are a lot of advantages to a securities services business that is part of a universal bank. In a crisis period, such as this, those advantages become even more pronounced.” Additionally, while the markets have witnessed substantial shrinkage in capital market issuance and bank lending over the medium term, reconstruction of economies and financial sectors, holds Gelb, is dependent on a massive upswing in debt raising. The bank is well prepared, he says. “That is where our issuer business comes into play. Moreover, the bank’s particular footprint, tapping both local and global issuance, enables our corporate trust business around the globe to leverage the upturn in new issuance volumes,”highlights Gelb. He holds that important risk management and regulatory developments aside, that may add a new complexion to the operation of the global investment markets, perceptions of the value of the investment services industry is at a watershed. “The custody industry was significantly strengthened by the Roosevelt New Deal era, which required the segregation of securities in custody houses to safeguard and protect them. Going forward, there will be a renewal or revisiting of this concept as the value of custodians and their role in safeguarding assets, managing collateral and so on begin to be seen as important once more.”

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Index Review STRUCTURAL WEAKNESS COULD UNDERMINE UK RECOVERY

THE TICKING TIME BOMB While the banking system has been the headline grabber, the UK’s future problems are really not much to do with the financial sector at all. The last 12 years of state spending has built up an enormous monolith of massive financial demands that it is becoming impossible to control. With everyone knowing that the long-term answer is to drastically slash the public sector, we have the edifying sight of both the major political parties playing chicken with the remainder of the economy in their childish insistence on getting the other to admit to spending cuts. Simon Denham, managing director of spread betting firm Capital Spreads, gives his bearish view. HE UNITED KINGDOM is the 22nd most populous nation and yet it boasts the second biggest employer in the world. The National Health Service (NHS) employs more people bar the People’s Liberation Army of China; yet few query the fact. Actually, political parties will go to almost any lengths to show that they will continue to increase expenditure in real terms in the NHS no matter what the economic situation. In dealing with this issue it is educational to discuss the destruction of GM and Chrysler in the United States. What killed the two companies was not the operational business model, it was the cost of healthcare and pensions for previous employees. The un-costed liabilities of not just the NHS but a significant percentage of the employees in Britain are reaching critical mass. The effort of pushing the bill ever further into the future (a favourite trick of Gordon Brown) is now beginning to impact current economic growth. Depending on how it is calculated, some 34%-38% of the working population of the UK is now employed by the state. With an ageing population and an increasing reluctance for personal pension provision, the UK has been building a time bomb for the future. The question is: has this future finally arrived? Taxes in Britain are already the highest in the G7 and we are still

suffering the worst budget deficit in history. Aside from Ireland, Britain now has the highest global per capita debt and little (realistic) way of reducing it. So how does this rather pessimistic outlook affect the markets? While the UK markets hit bottom at pretty much the same time as its counterparts abroad, the recovery has been halting in comparison. From the lows in early March (when the DAX briefly sank below the FTSE 100), the major European markets have bounced over 50% against a UK move of around a third. In absolute terms it is easy to be seduced by the undoubted fact that UK equities are a good deal higher now than in March but that would be without concentrating on comparatives. While the pound has recovered somewhat versus Euroland and the dollar, the currency is still considerably lower than this time last year so we can compound an underperformance in the equity markets with a decaying currency. For foreign investors this has resulted in something of a double whammy. The UK was following each move higher by the global indices (albeit reluctantly) until the last. The Dow, DAX, S&P’s, CAC, Nikkei etc., all rallied in the first week of June but the FTSE remained stuck. There appears to be heavy selling above 4500 and the fear is rising that this will prove to be

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

a step too far until definite information becomes available. With a negative savings rate, an ageing population, pressure on government funding and increased taxation temptations to move wealth abroad, the equation is not exactly favouring a continued rally in stock. Compounding the problems for the UK are the current US policies. The US is following an aggressive (but undeclared) weak dollar programme. Sterling is not an attractive proposition by any stretch of the imagination but at least it does not suffer from official neglect. The country needs a weak pound to generate growth but compounded with the public debt levels this is flirting (very dangerously) with a serious inflation problem. With the US following its weak currency programme, the UK can hardly try to follow an even weaker one. As most international business is priced in dollars, possibilities of increased growth in the UK will be badly impacted if Sterling recovers any further. The fact that growth in the UK has not been as weak as feared over the last few months is hardly surprising given the sums spent by the Treasury and Bank of England during the past six months. The problems will start when the spending stops, spending cuts finally make their appearance and the new (higher) tax rates kick in. I very much fear that what weak stirring of new economic activity that we are seeing now will wither and die in the glare. As ever ladies and gentlemen, place your bets.

Commodities CFTC PROPOSES TOUGH MEASURES FOR COMMODITIES

Tidy-Up Messy Markets, Says Obama Gary Gensler, the new chairman of the Commodity Futures Trading Commission, testifies at a Senate Agriculture Committee hearing in Washington, on Wednesday, February 25th 2009. Gensler is dogged by a decade-old debate with former CFTC Chairman Brooksley, born over whether to regulate private derivative contracts blamed in part for $1trn in global bank losses. Photograph by Ken Cedeno for Bloomberg News /Landov. Supplied by PA Photos, June 2009.

A drastic shake-up of the over-the-counter (OTC) commodities markets by its US regulator the Commodity Futures Trading Commission (CFTC) includes proposals for all derivatives positions to be reported to the regulatory body; setting aggregate position limits, or the total number of open contracts held both on and off-exchange; expanding the CFTC's enforcement powers over swaps; and stricter margin and capital requirements. HE NEW OBAMA administration badly wants to be able to look at financial markets and no longer see the financial mess that it has inherited. Instructions from the top to all in the market are pretty clear: clean up! This message has been read loud and clear by the United States commodity market regulator, the Commodity Futures Trading Commission (CFTC), and its brand new chairman Gary Gensler. Only a few weeks into his new job, Gensler is proposing a fairly drastic shake-up of the over-thecounter (OTC) market for

commodities, a market that is seen by onlookers as the culprit for sky-high commodity prices last year. The proposals on the table include requiring all derivatives positions to be reported to the regulator—something derivatives traders currently don’t have to do; setting aggregate position limits, or the total number of open contracts held both on and off-exchange; expanding the CFTC’s enforcement powers over swaps; and stricter margin and capital requirements. “Market transparency should be further enhanced by requiring that aggregated information on positions

and trades be made available to the public,” Gensler told the Senate agriculture committee in Washington shortly after being appointed. “No longer should the public be in the dark about the extensive positions and trading in these markets.” He added that derivative dealers should also be subject to capital requirements, initial margining requirements, business conduct rules and reporting and record-keeping stipulations. “Standards that already apply to some dealers, such as banks, should be strengthened,”he said. This is really act two of a standoff between the CFTC and the commodities market that started last year with oil and grains prices rocketing and causing public outcry in the process. At the time, the CFTC imposed limits on on-exchange oil futures positions both in the US and on London-based ICE Futures Europe,

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part of Intercontinental Exchange (ICE). There were also some nonbinding limits which have so far been politely ignored by a number of derivatives players. Gensler’s current proposals are fairly moderate compared to some others in Washington, which have encompassed a total ban on customised financial products and the abolition of OTC trading. Such a drastic outcome seems unlikely at this stage as it is being pushed by only a small number of public officials. What the administration does want to do, however, is force standardised derivatives contracts to be cleared through regulated exchanges. This would limit counterparty risks but would also make it easier for regulators to glean information on positions. If the data on positions is consolidated across exchanges such as the New York Mercantile Exchange (NYMEX), Intercontinental Exchange and in OTC market, it will almost certainly reveal that a number of participants are running positions far beyond existing limits. Needless to say, some market players in commodities are worried. There is still a relatively small group of banks dominating the market but these have invested intensely in their commodity trading operations in the last five years and have made handsome profits in the process. “With commodity prices continuing to benefit from improving sentiment … once again, the theory of prices being driven by anything but fundamentals has resurfaced, says a banker in London. “Non-commercial positions have risen significantly over the last few weeks, leading to speculators being pointed out as the culprits. No doubt hedge fund activity has increased sharply, but it would be wrong to argue that this has been the key driver of price strength.

“Any misguided regulatory policy may act against improving financial market conditions rather than proving beneficiary. As usual, a rounded explanation of commodity price movements needs to include fundamental developments rather than focusing purely on investment flows,”he adds. While market outsiders argue that the fast speculative investors such as hedge funds tend to add volatility and contribute to unrealistic price spikes, those within the trading community say that if regulation is too strict, some short-term investors and hedge funds will leave commodities. “Regulators want pretty draconian measures because it has gotten to the stage of the tail wagging the dog,”says Robin Bhar, metals analyst at Calyon Credit Agricole.“This may mean fewer hedge funds and speculators as they have had free reign to play with the market, but the upshot could be less trading volume and that ironically, could cause more volatility rather than less,”he adds.

Size is everything The OTC market is typically three to four times the size of its corresponding futures market. The two are typically closely interlinked both in terms of prices and in terms of volume. If a trading house takes up an OTC position it typically offsets some of that position in the exchange traded market. If the new regulation puts hedge funds and other speculators off trading commodities, the effect will be an overall loss of volume in both over-thecounter and on-the-counter markets. Frank Holmes, fund manager at US Global Investor, says that US funds may simply trade elsewhere if they start feeling that their local market is becoming too regulated. “It is just as easy for these funds to trade in Shanghai or in Singapore as it is in the

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US. A lot of them are already based in the Cayman Islands, including the California Public Employees’ Retirement System (CalPERS), and it would make no difference to them where they trade,”he says. CalPERS is the largest US pension fund, holding assets of $240bn. The fund said last year it plans on investing $7.2bn in commodities by 2010. In theory, the CFTC’s decision should be limited to US markets but global commodities markets are now so interlinked that it is impossible to isolate price effects in one from all the other markets. Although the UK is not technically bound to follow the CFTC’s lead there is likely to be some overspill if decisions are made in the US because the UK’s Financial Services Authority has been working closely with the CFTC over the last 12 months on a task force that is looking into increased monitoring of the market. The main appeal of the OTC market is that contracts are tailor-made. This means that a mining company can hedge its production of copper for any given price it chooses for any length of time. If the same company went out into the futures market and tried to do the same thing, it would have to choose a contract in three-month increments, for instance three, six or 12 months ahead. The banks that dominate this space in trading are banks that will typically also provide finance to the miners or oil companies and offer other financial services to boot. So who are the main players in this market? According to Greenwich Associates, a Connecticut-based research company, on the banking side Goldman Sachs and Morgan Stanley hold the biggest share of the OTC derivatives client base with JPMorgan and Barclays Capital close behind. BNP Paribas, Citigroup, Deutsche Bank and Société Générale are in the“third tier of up-and-coming dealers”. Another

Commodities CFTC PROPOSES TOUGH MEASURES FOR COMMODITIES

major group in the market are big producers and big end users of commodities who hedge their exposure to oil, metals and/or grains. Last year such companies hedged an average 55% of their exposure, up from 45% in 2007, the uptrend being driven by oil refiners. “For such companies the key benefit in going into the OTC market rather then futures is the flexibility in contract type and length. The reason why we are seeing a fairly small group of banks is that banks that provide lending lines to such companies will also provide forex hedging and commodity hedging to those companies,” says Andrew Awad, a principal at Greenwich Associates. He notes that in the last year or two the trend has been for over-the-counter clients to use more dealers to access the market, moving from on average of three top dealers to employing five or six dealers. This is partly because there are more dealers in the market but also because the credit crunch limited some of the available credit lines in many of the banks. The problem the CFTC faces in dealing with the OTC market, which alongside the big obvious companies is also populated by hedge funds and short-term speculative players, is trying to establish who is holding what and who might be trying to manipulate the market. Pension funds typically have less direct exposure to OTC market primarily because they are heavily regulated and are frequently not allowed to take up derivatives positions. The CFTC has no proper insight into what is happening in the market and, in its own words, it cannot distinguish between speculative and hedging positions because these two are now so intertwined. In the CFTC’s Staff Report on Commodity Swap Dealers & Index Traders published last year, the regulator said

Photograph © Staysis Eidiejus/Dreamstime.com, supplied June 2009.

that having examined index and swap trading on exchange and over the counter, it wasn’t able to establish how much speculative trading there was on the futures markets. It added that the current data received by the CFTC classifies positions by entity, as commercial versus non-commercial, and not by trading activity speculation versus hedging.These trader classifications have grown less precise over time, as both hedgers and speculators are engaging in both activities. In any case, unless the regulator starts moving much faster, the CFTC may have its work cut out trying to avert another upward spiral in trading. Commodity markets are on the rise again. Monthly returns of the commodity benchmark S&P’s GSCI surged 20% in May, the highest monthly increase since September 1990 and the first substantial rise in 10 months. Analysts predict that after a rapid rise early this year base metals are likely to trade sideways to lower for a brief period before starting another rally. In oil, forecasts are also for higher prices with potential spikes towards the end of the year. Soybeans and sugar are also set to move higher on the back of increased demand from China and problems with crops, while gold is likely to attract investors as an alternative to currencies in an increasingly inflationary environment. Marcus Grubb, managing director of the World Gold Council, says:“This is a

different kind of crisis to any other we have seen in the last 30 years.” Unprecedented wealth destruction, recession and the printing of money, particularly the dollar, will make gold hugely appealing to investors as an inflation hedge and as an alternative currency, he added. Investors are returning to commodities with a vengeance. After a metaphorical market draught late last year there is a sense that they are ready to will the markets higher even if the fundamentals in all cases don’t yet justify the size of the latest rally because there is an expectation that a recovery in demand across a range of commodities will kick in later this year or early next year. Why does that matter? Since last June the CFCT has been thinking of ways to regulate the market and has come up with one set of decisions affecting futures trading. In the same period the OTC commodities market went from being worth $8trn to $13trn and back to $4.4trn, all in response to price moves. Unless the CFTC comes up with a decision fast, the market will continue trading the same way as last year likely creating sharp spikes followed by equally sharp falls. If that happens, it will be left with once again pointing the finger of blame at the market and missing the opportunity of coming up with a constructive solution that actually might be useful.

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Real Estate

Room for Growth?

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HOTEL INVESTMENT: ARE RESERVATIONS ON PROSPECTS UNFOUNDED?

The world’s hotel industry has been in the frontline of the global downturn, with less people travelling for business or pleasure and guests typically choosing to trade down as they look to save money. With investment capital for development all but non-existent, the major hotel chains have been forced to turn their attentions to conversions and asset management rather than expansion and, with that, the dynamics of the sector are set to change still further. Mark Faithfull reports.

HE PAST 18 months could have hardly been bleaker for the globe’s hotel industry. The fall in occupier numbers and the dramatic switch to value rooms for both personal and business use have rocked an industry which had been booming in more buoyant times. Low room rates have replaced occupancy levels as the chief area of performance concern and lack of debt funding has also slashed development plans. After a year mostly notable for its wreckage, 2008 has been followed by a more complex picture in 2009. Most of the global chains have posted at least first-quarter results and what a mixed bag they have been. Yet amid the restructuring, rights issues and retrenchment there are undoubtedly the first signs of some level of recovery. Reporting its figures, the world’s thirdlargest chain—Marriott International, often cited as the bellwether for the US hotel sector—produced bad but betterthan-expected results. The company said that the rate of decline in revenue per available room (revpar), the industry’s financial benchmark, will probably begin to recover in Q3, albeit that revpar in North America could still decline between 22% and 25% before that bottom is hit. However, unlike many of its competitors Marriott still expects to open 30,000 rooms in the year. In 2010, new openings will still be more than half the level of 2009, with fallouts from new development being replaced to some extent by conversions. Hot on the heels of Marriott’s cautious optimism came a pronouncement by Starwood—the eighth-largest hotel group—that the hotel industry is no longer in freefall. Chief executive officer Frits van Paasschen admitted that revpar will remain under pressure and as insurance the company has renegotiated its debt position so that the leverage covenant is

Real Estate HOTEL INVESTMENT: ARE RESERVATIONS ON PROSPECTS UNFOUNDED?

now 5.5 times rather than 4.5 times. It believes it will be able to access its $1.9bn revolving credit facility even in the toughest scenarios and has also sold $500m of bonds. For Choice Hotels International (the sixth-largest group), chief executive officer Stephen Joyce cited a gap in the upscale full service business and admitted he would like to target brands in the 3.5 to 4-star range.“This would offer a conversion opportunity because I think the full service new-build business is probably going to be pretty tough for a long time,”he added. Second-largest global operator Wyndham was also bullish about development prospects and it expects conversion opportunities to increase in the current environment. Already, only about 20% of total gross openings for Wyndham are new build. Timothy Lloyd-Hughes, vice chairman, real estate, gaming and lodging, Deutsche Bank, believes that conversions will now dominate real estate management. He says: “Transaction volumes will be very low in the next 12 months—the buying market is effectively closed. The relationship between investor and hotel owner has moved back towards the investor.” Rather than continue searching for debt to develop new sites, LloydHughes believes that hotel chains will instead rebrand and asset manage. “You have to look at the economic cycle,”he says.“Is this the right time to be developing new hotels, or is there more value to be achieved from asset management and conversion? At the moment, the figures favour the latter.” Christopher Day, managing director of business agent Christie + Co, concurs: “There is something of a stand-off—there are very few distress sales and an appetite for good quality hotel product. But transaction volumes have fallen off a cliff and yields have

moved out from lows of 5%.” Indeed, according to Jones Lang LaSalle Hotels (JLL Hotels), in the first quarter of 2009 global hotel transaction volumes fell to just $1.9bn, their lowest level since the first quarter of 2002. The rate of decline is, however, slowing.“This suggests the global hotel transactions market could be hitting a bottom, laying the groundwork for increased activity towards the later part of 2009 when more distressed assets are expected to come to market,”says JLL Hotels global chief executive officer Arthur de Haast. By region, EMEA was the most active market in this quarter, recording approximately $813m, or 42%, of all hotel sales within the period. The Americas, which has historically been the most liquid region, recorded only $556m of hotel sales in comparison, followed closely by Asia Pacific at $531m. Most deals were undertaken in major gateway cities including London, Paris, New Delhi, Washington DC, Boston and New York. “There is a question whether there is a hotel real estate market at the moment,” reflects Derek Gammage, managing director of CBRE Hotels for EMEA. “There are still people who would like to invest but my sense is that equity has been somewhat arrogant. It believes that there will be train-crash prices and so none of the equity holders want to be first mover, in case they miss a better deal.” Yet the industry is beginning to wind up for a greater flow of distress sales. Accor, Europe’s largest hotelier, plans to set aside €100m a year to buy hotels put up for sale as a result of the global downturn, the group’s chief financial officer, Jacques Stern, has affirmed. He sees acquisition opportunities in the next two years as the market bottoms out. He says: “In terms of development capex, we could dedicate an amount of €400m a year to the expansion and within this envelope

Peter Gee, head of hotels and leisure at King Sturge, a leading supplier of commercial property and related services.“It certainly looks like a bath-shaped market cycle but it may be a very long bath,” says Gee.“A lot of groups are discounting room rates. I like the strategy of discount groups like Whitbread and I think investors will continue to back operators which show they are doing everything they can to maintain their hotels.” Photograph kindly supplied by King Sturge, June 2009.

we will commit around €100m for hotel acquisitions.”The company sold a €600m bond in April to help finance its expansion. Accor’s strongest performance has come for the budget end of its hotel brands and this sector is extremely bullish. Whitbread may be a comparative minnow in the global hotel sector (28th by hotel rooms) but chief executive Alan Parker declared at the end of April: “Economy lodging has come of age.” He based his conclusion on research which found budget brand usage by business travellers in the UK is ahead of midmarket and upper full service brands for the first time, as he affirmed an “attack” on the full-service corporate market and a new campaign for the leisure market.

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Puneet Chhatwal, senior vice president and chief development officer at The Rezidor Hotel Group, believes that the greying margins between the mid-market and budget sectors mean that the dynamics of the market will change.“There is a huge opportunity to rethink how the industry operates. It is very labour intensive—are all the people needed? In the good times we have tended to ignore costs,”he says.“I feel the middle market has really been neglected over the past 10 years but the budget sector may also be reaching saturation in Europe. The middle market may need to look at its offer, possibly reducing food and beverage.” Gammage agrees and question whether the budget sector is “as resilient as people believe”. Instead he points out that while room rate cuts by middle rank hotels will impact revpar, deep enough discounts will see occupiers switch away from budget to the perceived better quality of major brands. “The ability to adjust rates is actually a strength of the sector,” he says. “It will take time, but when the market improves, the middle market operators will gradually be able to shift their rates back up.” The extent of the devastation the recession is wreaking on trading at luxury and upscale hotels has been revealed in the first quarter results of three key players: Strategic, Orient Express and Host. The three sets of

responses are similar: raising funds, asset sales and drastic cost cuts in an attempt to shore up covenants. At REIT (real estate investment trust) Strategic Hotels & Resorts, revpar was down 24.1% in North America and 29.3% in Europe. At Host, the world’s biggest hotel REIT, which is more focused on upper-upscale than luxury, revpar fell 19.8%. And at Orient Express, the owner and operator of probably the most luxurious chain of significant size, revpar was down 26%. Orient Express has already taken the plunge in terms of a share offering, raising $141m through a share offering of its class A shares. Yet luxury growth has not stalled altogether.The luxury Mandarin Oriental Hotel chain has unveiled its plans for its first five-star hotel development in Moscow, while Dubai-based hotelier Jumeirah and Dutch property company MAB have teamed up to develop a fivestar hotel in Frankfurt. Jumeirah has signed a lease for a 219-room hotel as part of the PalaisQuartier mixed-use scheme in the city. “It certainly looks like a bath-shaped market cycle but it may be a very long bath,”reflects Peter Gee, head of hotels and leisure at King Sturge, a leading supplier of commercial property and related services. “A lot of groups are discounting room rates. I like the strategy of discount groups like Whitbread and I think investors will

Can Buy Me Love... IM-LISTED JAPAN Leisure Hotels (JLH) intends to raise £50m to fund acquisitions of Japan’s famous hourly-rate “love hotels”. The Guernseybased company plans to exploit the weak Japanese property market and funding difficulties among wouldbe consolidators of love hotel chains to more than quadruple its present room total. With five ‘Bonita’ hotels, JLH has made steady inroads into a fragmented industry which turns over £31bn annually but lacks a dominant player. In a

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continue to back operators which show they are doing everything they can to maintain their hotels.” He cites Holiday Inn as a good example. “The company has reengineered its offer and is now very competitive. It will probably start with good sites in provincial cities with that offer.” He also feels that locations continue to provide opportunities and picks out Russia, Poland, Ukraine, Georgia and Libya as examples of emerging markets that are still under-developed as hotel sectors. Timothy Lloyd-Hughes adds:“What type of hotel to buy? It is easy to see the budget sector as attractive because it is less volatile. But luxury could also be good, providing the price is right. However, at the moment there is no debt available.” Jochen Schäfer-Surén, head of hotel and leisure fund management, Invesco, reflects: “Despite the current economic climate, the hospitality sector will remain a growth industry in leisure and business.” Gammage agrees, pointing out that this recession has not hit the sector has hard as that of the early 1990s: “An awful lot of people have bought into the hotel sector without understanding the risk, yet hotels are a good real estate option. Whatever the current issues, hotels have become a much more mainstream investment class.”

society where young people often live with their parents into their 30s and where bedroom walls are paper-thin, the hotels provide discreet escape at prices based on average visits of about 90 minutes. Annual occupancy rates across JLH’s 242 rooms were 250%—with each room used at least twice daily. Steve Mansfield, director of JLH asset manager New Perspectives, predicts visits may even increase. He said: “Life gets miserable in a recession and you are going to find people deciding to spend their ¥6,000 (£40) to take themselves to a leisure hotel and just enjoy the fantasy for a couple of hours.”

CONVERGEX STREAKS UP THE TRADING LEAGUE TABLES 48

Photograph © Dan Collier/Dreamstime.com, supplied June 2009.

HIGH BROW HIGH SIGHTS HIGH SOCIETY New York headquartered brokerage ConvergEx is a precocious contender to the broker/dealing big league. A mere toddler, in relative terms (it was only spun out of The Bank of New York in October 2006), the firm is streaking up the dealing league tables. In some respects that’s because the make-up of New York’s leading trading league tables has changed irrevocably, as some of the larger houses have either disappeared or sunk in the volume rankings. In other respects however, the brokerage has consistently punched above its weight and over its short life has made a seemingly indelible mark on the landscape. Has its meteoric trajectory still got legs? Francesca Carnevale talks to Joe Velli, ConvergEx’s chief executive, about his long term vision.

ONCE DESCRIBED Joe Velli in these pages as a semilegendary banker. When we met for this article, it was the first thing he teased me about: “Only semilegendary?”he laughed. Since legends tend to be well and truly dead and Velli is very obviously alive, the description is apt. His demagogic status is built on two pillars. The first is recent history, in which he has led the firm through an albeit spatchcocked business landscape into the echelons of the top five brokerages in the city. The second, rests in a more distant and benign past in which Velli was part of a four man team that redefined The Bank of NewYork in the late 1980s from a discrete, commercial and trade finance focused local bank into the global securities services behemoth that it is today. ConvergEx was established back in October 2006 from the combination of the Bank’s brokerage business (then known as BNY Securities Group) and Eze Castle Software,

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“with the primary purpose to cross sell into BNY’s sub client base,” notes Velli. While still at The Bank of New York , Velli says he was certain of two things: “One that we had an entrepreneurial mindset that gave us flexibility and two, that we could react faster than other brokerages to market events.” Initially keen to seize the day in the rising alternative segment, Eze Castle’s client base (of which more than 70% were in the hedge fund segment) made it a logical acquisition target in the bank’s plans to build out the brokerage firm. “Eze Castle said no, but stressed it wanted to work with us and we talked through possibilities for some 18 months before we spun off the brokerage,” says Velli. Equally, The Bank of New York did not want to exit the brokerage business, but “realised the size of the investment in technology that was involved and was more ready to take a strategic rather than controlling stake,” adds Velli. “The bank continues to get fair value from its association with us,” he stresses, “as the final deal was accretive to the bank.” The relationship with private equity firm GTCR—Golder Rauner, one of ConvergEx’s largest shareholders, was also something new. According to Velli, “We worked on developing the relationship, and wanted to work with a house that bought into the concept that they would work with the management, but not get involved in the day to day running of the firm. We wanted to be independent Joe Velli, chief executive, ConvergEx. Photograph kindly supplied by ConvergEx, operationally, but wanted a relationship June 2009. with a firm that could raise finance when required. They’ve done everything they’ve said. The upshot One provider, though differentiating ourselves in niches.” Among these, Velli lists ADR Direct, a smart router, called is that we have created a new hybrid.” ConvergEx began to establish itself as a provider of TACTEx; its own dark pool, named VortEx; block crossing via investment technology solutions and global agency brokerage ConvergEx Cross and a suite of global algorithms,“all servicing services, based on global and multi-asset class trading the growing complexity in the trading markets,”he adds. The build out is accretive, acknowledges Velli, pointing to capabilities. Its key selling point was the mix of the firm’s sophisticated technology, a consultative approach to client the fact that the firm is constantly refining its product mix. In care and “a culture of extraordinary client service,” highlights March, the firm announced that it had rolled out a complete Velli. “It was obvious the brokerage business was changing set of optimised algorithms for both the Brazilian and Mexican and technology was becoming much more important; clients markets.“As a truly global firm,”he says,“developments such were seeking empowerment through technology and hedge as these algorithms show our commitment to product funds were in the ascendant. Key to this was providing differentiation and quality. Moreover, it was important to build upon our access to the Bovespa and the Mexican Bolsa and optimal efficiency along the workflow chain.” The diverse suite of products offered by the ConvergEx keep on staying ahead of the markets.” Through it all, Velli stresses that the key differentiator is entity includes order management and related investment technologies, a full suite of global electronic, portfolio and sales that ConvergEx is an agency-only house.“We are an agent. trading capabilities, global transition management, There’s no odd-balling, no proprietary trading desk, no commission recapture, commission management and prime broking services. That’s deliberate and a key strength independent research. “Our goal,” holds Velli, “is to be a Tier when it comes to customer accretion.”

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CONVERGEX STREAKS UP THE TRADING LEAGUE TABLES 50

Today, the company has three core business lines: liquidity and execution management, investment technologies and intermediary and clearing services. According to Velli,“Market volatility supports sales trading and we have leveraged the fact that the market increasingly requires a high touch model.” Our traders utilise a mix of voice and electronic trading methods,“or a combination of both. It is a hybrid model, which is all supported by stateof-the-art technology.” Leveraging its Chicago-based options business, LiquidPoint, the brokerage offers execution and routing for options. “In many respects, the options business is more complicated than the equities business because the same security can trade on several exchanges and have multiple strike prices, requiring complex routing and massive market data requirements. Plus, the trading rules at each exchange are constantly changing,” highlights Velli. “Because of the advanced capabilities we provide, we now handle some 25% of options volume in the US market.” Although options volume is still a rising tide, ConvergEx’s boat has floated higher and more quickly than most. In late April, the brokerage announced its options volume was up 55.28% over the year, compared with an increase of 15.2% over the same period for the options industry as a whole.“We are quickly becoming recognised as the leader in multi-exchange cross functionality, whether it be facilitation or solicitation, large block orders or small. Moreover, our crossing volume has contributed nicely to our overall growth over the last few months.” Looking ahead Velli thinks that technology rollout is key.“It is a huge focus for us, and key to us helping clients get the best out of the workflow.”In June, ConvergEx built on this premise by rolling out a fully upgraded version of its order management system, the Eze OMS. This marked another significant evolution in order management systems and ensured ConvergEx’s clients had access to some of the most sophisticated investment technology available. “Real-time and accurate price and risk assessment tools are essential elements of the traders’ armoury in these markets for any trader. Again, it goes back to providing efficiencies along the workflow chain, and providing clients with access to powerful, yet easy to use tools.” As to the firm’s future plans, expansion and market build will continue to be key elements of its forward strategy. From experience, Velli is not wedded to edifices or a tactic of scaling up. He prefers alliances and acquisitions. Most of those, supporting the firm’s ambitions in leading the market in trading technology, will be in areas including “technology and risk management, with applications throughout the industry.” A recent example of the firm’s strategy in this regard is the relationship with an affiliate of inter-dealer broker BGC Partners. Through the agreement, BGC Partners now offers its customers access to ConvergEx’s full suite of electronic, portfolio and sales trading services across various asset classes, including equities, fixed income and US options.

The success of the firm’s multi-layered strategy is clear. By October last year, albeit in a straightened trading market, the brokerage set down a significant marker. It was ranked number one broker on the NYSE Euronext Broker Volume Top 10 for a three week run from the first to the 21st of the month. Now the firm ranks consistently in the top five positions in the NYSE Euronext broker volume rankings; although the market share of the exchange is depleted from its heyday of a decade ago and now accounts for between a quarter and a third of local trading volume. Nonetheless, Velli is adamant that the ConvergEx product mix is at the heart of the firm’s success. “The rapid increase in volume on the exchange can be attributed to the firm’s agency model, which we believe puts our clients first. The offering is one that has global appeal right now, not just on exchange trading, but also across the large majority of our businesses. Clients realise that the model allows us to focus solely on their investment objectives and in that light positions us well to be their partner for the long term.” As for Velli himself, his future is firmly at the brokerage. “Actually I’ve never been one to jump around very much,” he avers, pointing out that he served at least 23 years at The Bank of NewYork before he made the leap into ConvergEx. “You know,” he adds,“I don’t even have an exit strategy. I have thought that we might take the firm public in the next two years, when markets stabilise once more, but it is not a pressing concern right now.” He concedes however that managing the brokerage has left him a changed man.“Look, in my banking days I was managing a block of 6000 people across multiple business lines. It is a totally different set of parameters. It is very different to the kind of focus, hardcore business that is ConvergEx. However, I believe in empowering management: they run their own profit and loss account, and can hire and fire and develop their business development tactics: of course within the context of our overall business arc.” Velli is not a man of excesses, and that is applied across the business mix. That means, the business focuses on function: “in that environment, you learn not to have too many employees or too many grandiose buildings,” he notes. Velli is as close to a liberal minded manager that a focused entrepreneur can be. In part that comes from mix of the benign and the hard-nosed culture that he engendered at The Bank of NewYork. And grown up men, like leopards, rarely change their spots. However, as Velli himself acknowledges, the ConvergEx business is a particular mix of the innovative with ultimately, a processoriented business, delineated by state of the art technology and the ultimate variable, market change.“It is limiting and liberating at the same time,” concedes Velli, “and therein lies the intellectual challenge: finding opportunity that marries our growth to market developments and changes in client requirements. It’s a heady mix if you get it right.”

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The founders and co-chief executive officers of Saxo Bank AS, Kim Fournais and Lars Seier Christensen, actively foster a staff culture based on “seven Saxo Bank values”, lifted from a novel by Russian-American writer Ayn Rand. The values stress the importance of individual thought, integrity and pride. Saxo Bank has printed 20,000 copies of Rand’s book, Atlas Shrugged. A copy is given to each new staff member. Paul Whitfield reports.

LOBAL BANKS DON’T tend to be young. They do not typically start out with just $100,000 of capital put up by a pair of friends, and they do not often grow revenues at a rate of 50% year-on-year. In short, they don’t tend to be anything like Danish upstart Saxo Bank AS. The Copenhagen-based bank, which traces its roots back to the 1992 launch of a financial trading group called Midas, and which received its European banking license as recently as June 2001, has in a very short time muscled its way onto the global banking scene. The driving force behind the bank is its founders and co-chief executive officers Kim Fournais and Lars Seier Christensen. The pair of Danish nationals formulated the idea for an online foreign exchange trading platform while working as bankers in London in the late 1980s. The first incarnation of the system, which would eventually evolve into Saxo Bank’s core trading platform SaxoTrader, was launch in 1998. Called MITS, it allowed investors to execute foreign exchange trades online, and was, according to Fournais, the first of its kind. “Back then there wasn’t much talk about internet based trading,”says Fournais.“The businesses that did exist relied on phone trading and we saw an opportunity for a business that put control in the traders hands without the expense of systems such as Reuters or Bloomberg and without the need to establish credit lines.” The focus on simplicity and low cost dealing has underpinned Saxo Bank’s subsequent growth as it has

BANK PROFILE: SAXO BANK AS

Atlas shrugs and Saxo muscles in on the world’s banking scene G

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Photograph © Dreamstime.com, supplied June 2009.

BANK PROFILE: SAXO BANK AS 52

expanded from its FX base to offer trading in bonds and equities across most major markets as well as a handful of more exotic products, including contract for differences (CFDs), exchange traded funds (ETFs), oil, gold and energy futures and forex, gold and silver options. The bank is not alone in offering trading across a range of investments, but it is one of the few that offer access from a single platform that requires nothing more than a savings account as its foundation.“Our key difference is that we do all our business on the internet on one platform, which certainly wasn’t, and still isn’t, the norm amongst more established banks which tend to operate numerous silos,” he says. “Setting up from scratch was and an advantage in that respect was we had a white board on which to plan and no expensive legacies to disassemble.” The bank has evidently struck a chord with customers, which are split roughly equally, in terms of revenues and profit, between partners that adopt Saxo Bank’s technology and repackage it as their own, known as“white-label partners”, and direct clients. Operating income at the Saxo Bank Group level topped DKr2.5bn in 2008, up 60% from the DKr1.56bn ($290m) the bank took in 2007, which in turn marked a 56% improvement on the 2006 figure of DKr1bn. Kim Fournais, founder and co-chief executive officer, Saxo Bank. Photograph kindly “Historically we have been able to compound supplied by Saxo Bank, June 2009. our revenues by 50%,” says Fournais. “The numbers are now getting bigger and that is says Fournais.“Investors like the idea of transparency and becoming a hell of a lot more difficult to maintain.” The group also has an enviable reputation for turning a that is generally something they don’t have in common profit. Since 1997 it has only dipped into the red once, in with the banks they may currently be with.” Fournais believes that one of the fallouts from the crisis 1998 after the bank launched its international expansion programme. Last year it posted net profit of DKr339m, up will be a desire among investors to take a more direct role in their portfolio’s management. This, he claims, will be 23% from DKr275m the year before. The figures may be modest on a global banking scale but particularly true for those who have been stung by the there are not a few other European banks that would have poor performance of hedge funds and other alpha-seeking gladly accepted a profit of any sort in 2008, let alone a 20% managed funds. His suspicions are based on more than a hunch.“We have plus increase in their bottom line. The financial crisis has certainly not dented Fournai’s never seen as many new customers,”he notes.“The growth enthusiasm for the future of Saxo Bank, nor has it had a of our assets under management has been phenomenal.” The bank claims clients in about 180 countries, though it noticeable effect on business, at least in the short term. An uptick in trading activity as markets collapsed in late 2008, remains heavily skewed towards Europe, which accounts for even served to boost some revenues. “October was our 54% of its clients, and Asia, which accounts for a further 33%. Saxo Bank has not escaped the banking crisis and best month ever in terms of client trading, though volumes ensuing economic downturn completely unscathed. have fallen since then,”says Fournais. He is also confident that the crisis will provide a longer- Deposits at the bank shrank in 2008, falling to DKr6.8bn, term opportunity, playing to Saxo Bank’s strengths, down 4% from DKr7.1bn in 2007. At the same time, namely providing individual investors with the means to provisions for bad debt rocketed, increasing fivefold to an trade directly in products that have traditionally been admittedly still modest total of DKr13m.“The value of our margin assets (AUM) was more or less unchanged,”notes accessed through managed funds or brokers. “The general trust of the public and the credibility of Fournais,“ from 2007 to 2008 it stayed around DKK8.6bn trading banks has been damaged and we have benefited,” to DKK8.7bn. They are now above DKK11bn.”

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There was never much chance that Saxo Bank would be significantly exposed to the worst excesses of the banking crisis. Its focus on facilitating trading for clients means that unlike traditional savings banks it does not run a traditional loan book, so has no exposure to the stressed mortgage and consumer credit markets that have bedeviled both European and US lenders. It also has no proprietary trading arm, meaning that it does not take positions in the investment market on its own behalf. It was this practice that exposed retail lenders with investment banking divisions to toxic assets and which led to the multi-billion dollar write-downs that punctuated late 2008 and early 2009. Saxo Bank can even stake some claim to have seen the worst excess of the crisis coming. In January 2008, it published its now annual“outrageous predictions”note, in which it speculated on the possibility of extreme, if unlikely events, in the coming year. Among the ten predictions were claims that the UK’s growth would turn negative and that the S&P’s 500 would fall 25%. The note also tipped Ron Paul to be elected as President of the US, proving that Saxo has no crystal ball.

“Lars and I are entrepreneurs and we recognised that we were not necessarily the best people to fine tune a business, so we brought in people that could do it for us,” says Kim Fournais, co-chief executive officer, Saxo Bank AS.

Despite its relative insulation from the crisis, Saxo Bank took up an offer from the Danish government to underwrite its obligations, an insurance that was afforded to all Danish domestic banks and which will remain in force until October 2010. Adopting the guarantee cost the bank DKr4.5m and means that it cannot pay dividends or implement a share buyback programme, neither of which will pose considerable hardship on the closely held group. According to Fournais, the support for domestic banks was “not really an option to avoid as every bank in the Kingdom more or less had to be involved, as all clients in a Danish bank hereafter had the Danish State guarantee. This means that Saxo Bank has the same credit rating as the Danish State, at AAA. To be outside the scheme was not really an option.” There have been tougher decisions to make in the past year. Last September, the bank announced plans to lay off about 340 employees as part of a restructuring of its operations aimed at cutting costs. The final number of job losses was 309, and Saxo insists that it worked closely with unions and was generous in its treatment of those it let go, but the incident did attract rare negative headlines in the Danish press. The situation was not helped by the bank

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noting on the same day that the market turmoil of the preceding weeks had massively boosted its trading volume, prompting Fournais to tell Reuters that the month had been“quite fantastic…the best we have ever had”. The restructuring was overseen by a new management team, which was installed by the joint-chief executive officers as they took a step back from the day-to-day running of the bank in August. “Lars and I are entrepreneurs and we recognised that we were not necessarily the best people to fine tune a business, so we brought in people that could do it for us,”says Fournais. They appointed Eric Rylberg as chief executive director, a position tantamount to head of operations, and Karsten Poulsen to the role of deputy chief executive director. Rylberg and Poulsen, are a well established pairing, with a weighty reputation in the Danish business community. They had worked together at Danish facility management and cleaning business ISS, as chief executive officer and chief finance officer respectively, before both left in 2006, briefly joining Danish property developer Keops, before they again moved on together to Saxo Bank. If the appointments of new operational managers were evidence of an admirable admission of limitations on behalf of Saxo Bank’s founders, they were also evidence of recent errors. “In the second quarter of 2008 we brought in a new senior management committee and soon discovered that it was not very efficient,”says Fournais.“We added a layer of decision makers in 2006 and 2007 that served to slow down decision making and at the same time were growing costs as fast as revenues.” The appointment of Rylberg and Poulsen coincided with the jettisoning of the management committee, some of whom left the company less than a year after joining. Following the upheaval, Fournais and Seier Christensen remained co-chief executive officers at the top of the organisation but have made it clear that they want to focus on“long-term strategic decisions”. In practice, that seems to amount to pondering and executing strategies to expand the banks operations into new territories and products. It is little co-incidence that the founders’decision to step back from day-to-day operational management has coincided with a new willingness to augment organic growth through acquisition. That parallel approach has been evident in the past year. In May, Saxo Bank Japan KK was incorporated, while in September the group bought its way into the French market with the acquisition of its former white-label partner Cambisite, a French online brokerage firm, which became Saxo Banque France SAS. Saxo Bank took another significant strategic step this year when it moved into the wealth management and asset management arenas with the acquisition in January of Danish stockbroker and asset management group Fondsmæglerselskabet Sirius Kapitalforvaltning. That was followed on June 10 with the acquisition of two Danish fund managers, Capital Four Management

BANK PROFILE: SAXO BANK AS 54

Fondsmæglerselskab, a specialist in European corporate bonds, and Global Evolution Fondsmæglerselskab, which operates primarily in emerging market fixed income and FX. The deals underpin a vision to expand the bank’s investment platform, in effect establishing Saxo Bank as a one-stop investment shop. That goal does not come without risk for Saxo Bank. Fund management is a notoriously crowded market and has a reputation for opacity in terms of process and charges that is at odds with the pioneering spirit and the simplicity and clarity of products that has won Saxo Bank fans. “Active investors have always been the focus but if you look at 100 investors you will find people that want to take a less active role but still have a keen interest in accumulating wealth,” says Fournais. “Mutual funds, because of the human element of management in the pursuit of alpha, are less transparent. But we are happy to help our clients access the funds because if we don’t they may seek the opportunity elsewhere.” The fund management acquisitions are targeted at two principal markets: Saxo Bank’s “whitelabel” partners who want to offer broader services to their own clients and high net worth individuals who bank directly with Saxo. That desire to build operations servicing high The founders and co-chief executive officers of Saxo Bank AS, Kim Fournais and net-worth individuals has, Fournais admits, Lars Seier Christensen. Photograph kindly supplied by Saxo Bank, June 2009. necessitated the adoption of new tactics. “If you think of the client space as a pyramid, then the Banco Espirito Santo paid a reported $1.26m for a 4.9% stake lower half cannot afford the expense that comes with in early 2008, while a 4.7% stake was handed to shareholders human contact so they are serviced by the platform of Swiss lender Synthesis Bank as part payment in its operation,” says Fournais.“But further up the pyramid you acquisition by Saxo Bank in December 2007.“We have a lot of have very affluent investors who have historically never our own net worth tied up in the bank and we don’t want to hold on to that position forever,” says Fournais. “We are used a platform and are used to personal service.” The drive to be accessible to high net-worth clients has always willing to consider new investment in the business underpinned much of the banks geographical spread over where it is provided by the right partner at the right price but recent years. An office was opened in 2007 in Marbella, we are not actively in the market place looking to sell.” The reluctance to cash out of the business is no surprise. Spain to tap the wealthy expat community, offices in Paris and Milan followed and more recently Saxo became the first Saxo Bank may be emerging from its entrepreneurial Danish bank to install itself in the Middle East when it phase as Fournais and Seier Christensen take a less active role in day-to-day running, but the imprint of the owners announced plans to open an office in Dubai. Fournais and Seier Christensen can long since count still rests heavy on the organisation. Nowhere is this more themselves among that coterie of high net-worth evident than in the staff culture they actively foster and individuals that their bank is now chasing. The pair own which is based on“seven Saxo Bank values.” The values, lifted from a novel by Russian-American 61.7% of the bank, a stake that is worth about DKr5.8bn, based on a per-share valuation of DKr159.15, which was writer Ayn Rand, stress the importance of individual used in January when Saxo Bank issued new shares as part thought, integrity and pride. Saxo bank has printed 20,000 copies of Rand’s book, Atlas Shrugged, in which she outlines payment for its acquisition of Sirius. Selling up is not something that the partners are her individualistic laissez-faire philosophy. A copy is given considering, though Fournais says they could be tempted to each new staff member. Maintaining those values, and the entrepreneurial spirit to reduce their stakes by the right offer. To date, the partners have invited only three significant that has so far driven the bank’s success will become harder investors to join them in the project. General Atlantic, a as Saxo Bank grows.Yet for the time being the Danish upstart Greenwich, Connecticut, private equity firm, paid a reported remains a bank unlike its international rivals—and is DKr728m for a 22% stake in the bank in 2005, Portugal’s probably stronger for it.

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TO MERGE Photograph © Shock 77/ Dreamstime.com, supplied June 2009.

N MANY WAYS, the asset servicing industry has gone back to the future. Never before has being a safe pair of hands mattered so much. While assets under administration have fallen, providers are taking advantage of the greater demand for risk management tools, outsourcing as well as the bread and butter custody. The challenge, though, is how to generate sufficient revenues to offset the higher margin businesses which have suffered in the financial crisis. Paul Stillabower, global head of business development for HSBC Securities Services’ fund business, says: “My view is that the credit crunch exposed the industry from a revenue perspective. Ad valorem fees are down due to market decline, securities lending revenues have dropped and net interest

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ASSET SERVICING: CHALLENGE OF THE CREDIT CRUNCH

THE URGE There has long been talk of consolidation among asset servicers in Europe’s over-banked landscape but the financial crisis might actually kick-start the process, writes Lynn Strongin Dodds

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Margaret Harwood-Jones, head of client segment, institutional investors of BNP Paribas Securities Services, echoes these sentiments.“We are seeing clients reviewing their list and asking themselves how many providers they need,” she says. Photograph kindly supplied by BNP Paribas Securities Services, June 2009.

income has fallen. In addition, leverage has come out of the market and clients have pulled money out of funds. In these types of markets, many players, but especially monoline providers and trust banks, will struggle to make a profit. The universal bank model is much better positioned to benefit from flight to quality and a broader product suite.” There has long been talk of consolidation among asset servicers in Europe’s over-banked landscape but the financial crisis might actually kick-start the process. According to John Robertshaw, principal, operations at consultancy Investit: “Going forward we will see the Darwinian theory of the survival of the fittest being played out. There will always be a place for the niche players but it will be the small to medium-size firms who will be under the most considerable pressure and not have the critical mass or ability to invest in new technology or products to compete. I think the larger players will only get larger.” This is because these heavyweights not only have the breadth of depth of products and services on offer but also the strong balance sheets and geographical reach that are needed to weather the storm. Equally as important, they can offer the personal touch, which has become more important in these turbulent times. The other crucial factor is the quality and scaleability of the platforms to cope with a new business climate and regulatory framework which will require greater reporting, accountability and transparency. Finally, their pockets are deep enough to scout around for opportunities. Jervis Smith, global head of client executive within Citi’s global transaction services, comments: “We have not seen the scale of consolidation in Europe as we have seen in the United States where there were at one time 51 players and now there are four to five major providers of custody and fund accounting. On the continent, many of the banks still have their processing operations and I expect to see more banks hand over the keys to the bigger players because of the capital commitments required.”

Nadine Chakar, head of EMEA, The Bank of New York Mellon Asset Servicing, says: “I think we will see more players examining their business models to determine whether asset servicing is a core activity or not. Although some can remain locally focused, I do not think it is sustainable over the long term because you still need the scale, resources to innovate and service to cater to a growing global and globalising client base.” Ramy Bourgi head of emerging markets at Société Générale Securities Services, notes: “There is no doubt in my mind that we will see consolidation among those banks that provide custody and administration at the local level in Europe They will no longer be able to keep pace with the investments that are needed in this business.” Margaret Harwood-Jones, head of client segment, institutional investors of BNP Paribas Securities Services, echoes these sentiments.“We are seeing clients reviewing their list and asking themselves how many providers they need. They are now choosing one or two global firms who have the strength and commitment to service their needs on a local and global level. The other catalyst is the inevitable focus on costs which the crisis has brought about. This focus brings a huge pressure on asset service companies as well, as they to look internally at how they will return value to their shareholders during a difficult period. For some it may even prompt a decision to exit the business.” Market participants also believe that being a safe haven should not be underestimated, especially in the wake of the demise of both Lehman Brothers and Bear Stearns. Counterparty risk is a main concern and fund managers like their brethren everywhere are carefully scrutinising the balance sheets, credit ratings and sustainability of their business partners. Harwood-Jones notes there has definitely been a flight to quality taking place.“Almost irrespective of how the global markets have performed, clients still need to have their assets kept safely in custody. The change we are seeing is that clients have gone back to basics. Before the

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Mathilde Guérin SGSS London

THANKS TO OUR INTERNATIONAL NETWORK, WE STAND BY YOU AS MUCH FOR PERSONALISED ADVICE AS FOR KNOW-HOW. “At Société Générale Securities Services, we don’t settle for simply providing technical expertise. More and more of our clients expect us to fulfil a genuine consulting role. They want to benefit from our industry analysis and expertise. This is where I step in. I help them to position themselves in this environment, identify their specific needs and propose simple solutions that will accompany them through the long term.” Mathilde Guérin, project manager. www.sg-securities-services.com

We stand by you

ASSET SERVICING: CHALLENGE OF THE CREDIT CRUNCH 58

crisis, they were more interested in the global reach, how many products asset service providers had, etc, and while that is still important, they are focusing much more on the security of their assets. We have definitely seen new client interest and are benefiting from our high credit rating and the strong balance sheet of BNP Paribas.” As Penelope Biggs, head of EMEA business development at Northern Trust, says: “The financial crisis has been a mixed blessing. The market value of client’s assets has definitely been impacted but on the positive side we are seeing new opportunities for our products and services. Clients are being much more thoughtful about their business models and are looking to save costs and gain efficiencies. Also, what was once considered a fairly dull service— custody—is now at the top of the radar screen. It has been a long time since prospective clients asked me if their assets were safe but that is now one of their main concerns and one of their main catalysts for considering changing custodian. Chakar adds: “The financial crisis was a huge wake-up call and it unquestionably caught people by surprise. It has been a double-edged sword for us. On the one hand, our client base’s order activity and asset values are down due to falling stock markets but we have emerged as a more focused and resilient player who can even better support our client’s

Francis Jackson, head of business development and relationship management in EMEA at JPMorgan Worldwide Securities Services, notes the fund managers are looking for asset services to provide a more advisory role on the risk management front. Photograph kindly supplied by JPMorgan, June 2009.

investment process. We also benefit from today being the highest-rated US bank and having passed the recent stress testing in the US as one of the fittest in the class. We have seen an uptick in transactions in April and May and I think we will benefit from new business because people clearly see us as a safe haven.” In terms of what products and services asset servicers are focusing on— risk management, performance measurement and reporting, transfer agency, fund accounting and transition management—are just to name a few. Ironically, many of these tools were left gathering dust on the shelf during the halcyon boom years. They have since been upgraded and enhanced but providers will not have to go back to the drawing board and start again. As Bourgi says: “These tools have been around for a number of years but now clients are putting more emphasis on risk than ever before. They are realising that they cannot rely on what the fund manager tells them so they are looking to the asset servicer to provide them.” Biggs concurs, adding: “There is a definite increased interest in risk management with clients asking for tools that not only provide transparency but also can monitor liquidity and performance on a daily basis. This type of risk management is particularly prevalent in areas such as fund of hedge funds but is across all asset classes, even cash. As a result, we are seeing

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an increased demand in off balance-sheet cash funds. Before the financial crisis, they thought they were anecdotally interesting to have but now they are the hot topic of the decade.” Francis Jackson, head of business development and relationship management in EMEA at JPMorgan Worldwide Securities Services, also notes the fund managers are looking for asset services to provide a more advisory role on the risk management front. “We have an electronic communication product called ACCESS, which provides information that is critical to their businesses and decision making processes (it offers stock and index prices and JPMorgan research, news flashes and headlines in a single screen). We launched it a couple of years ago and have added and enhanced functionality. What we are seeing now, though, is that clients also want us to work with them on a consulting basis to help them identify the risks in a particular area.” Smith of Citi believes that“one of the biggest challenges is to develop bespoke products based on a client’s particular requirements and unique risk profile. The fallout from the Madoff scandal and collapse of Lehman has made people more focused on the checks and balances they need to make. The value at risk-modelling tools has been tarnished and they are now looking at systems that provide independent valuations particularly on the more complex instruments.” The other notable and possibly lucrative trend sweeping across the asset servicing industry is outsourcing. Tim Caverly, head of State Street’s Investment Services sales and business development activities, EMEA, says: “Everyone has been impacted by lower assets under administration but I believe outsourcing will offer opportunities to grow market share and offset some of the decline. I expect to see increased demand from traditional fund managers as well as hedge funds.” The new wave, though, is expected to differ from past deals. The fortunes of outsourcing have ebbed and flowed in the past with back-office functions such as custody and fund accounting being the most popular. More recently, middle-office capabilities were targeted due to the rise of hedge funds and use of over-the-counter derivatives, which are difficult to process or value. In the not-so-distant past, asset servicers were criticised for their lacklustre services and products in this area but many have rectified the problem by heavily investing in new technology, valuation services, efficient processing, administration platforms and data warehousing. Smith says: “This is no surprise as fund managers are now having to tackle the fallout of sharp reductions in revenue. This is leading them to look at what products are core to the investment process, which ones are hobbies and what areas do they want to outsource.” Chakar is also witnessing an increase in interest.“We are not just seeing a greater demand from traditional fund managers in the UK but also from continental asset management groups. Each deal is different though and it ranges from a more ‘componentised’ approach—covering

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Jervis Smith, global head of client executive within Citi’s global transaction services. “We have not seen the scale of consolidation in Europe as we have seen in the United States where there were at one time 51 players.” Photograph kindly provided by Citi, June 2009.

specific functions such as fund accounting, transfer agency, valuations and custody—to clients handing the keys over to the back- and middle-office. Expectations on both sides are these days much more realistic, and we work very closely with the clients to develop a plan of action to ensure that we understand their objectives and can implement solutions in the best way possible.” In addition, Biggs is seeing activity from in-house managed pension funds. “Continental European pension funds in the Nordics and Netherlands are increasingly looking to outsource different components of their backand middle-offices. We have a product called Web Trade Services which had been ticking along nicely (it allows managers to selectively outsource various components of back-office post-execution processing for equities, bonds, and foreign exchange) and now we are seeing a significant increase in demand.” As for hedge funds, they are facing the inevitable tightening of regulatory screws and the ensuing need to comply with reporting, governance and risk management standards, including minimum capital requirements that have been proposed by the European Union. It is unlikely that these firms will want to build their own systems and asset service providers are more than happy to step into the breach. In addition, there is hope that the continued blurring between the hedge fund and long-only communities will also generate new sources of growth which will help offset the slowdown in the traditional hedge fund business. Jackson of JPMorgan says: “We are now seeing hedge fund managers entering the traditional space and hedge funds launching regulated UCITS products. In the past they gave everything to their prime broker but there are certain functions that they cannot do. Asset providers are well placed to offer a full range of services including infrastructure, safekeeping of assets, securities financing as well as the back- and middle-office functions.”

AGENCY BROKING: PULLING AWAY FROM THE PACK

EXECUTION-ONLY

IS ON THE UP

As agency trading has pulled away from the pack, a distinction has emerged between the different types of agency brokers. According to a report by strategic research and advisory firm Celent, the change in brokerage models is ‘Darwinian’ in its evolution. The agency brokerage model, with its straightforward system of commission payment for trades executed, has been a beneficiary of the turbulence from the credit crunch. Ruth Hughes Liley reports. ROKERAGE BUSINESS MODELS are being transformed in the wake of the credit crisis as the buyside takes a hard look at its trading costs and the way it conducts its trades. A beneficiary of this turbulence has been the agency brokerage model, with its straightforward system of commission payment for trades executed. According to strategic research and advisory firm Celent in a May 2009 report, the change in brokerage models is “Darwinian” in its evolution. It says stressed capital markets, a retrenchment in IT spending and a structural realignment of the industry has put brokerage business models in transition and “an empowered buyside is demanding increasingly targeted and customised solutions from brokers”.

Photograph © Brunosette/Dreamstime.com, supplied June 2009.

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As agency trading has pulled away from the pack, a distinction has emerged between the different types of agency brokers. Some firms are low-touch, best execution models where the buyside can dip in and execute quickly and efficiently. Others are crossing networks with huge liquidity such as Liquidnet and ITG, both of which saw more trade in 2008. There are execution-only brokerages such as Knight, and those that offer a broader service including research and sales trading, such as Execution and ConvergEx. Richard Balarkas, chief executive officer of Instinet, an agency broker founded in 1969 to launch the first electronic block-crossing capability for institutions, questions the definition of agency trading: “Agency is one of the most abused terms in the market. You can be an agency broker but it doesn’t mean you haven’t got a prop desk or risktaking capability. We are very purist about our definition of agency and here it means our only source of revenue is the agreed execution commission paid on the order.” As the buyside take more control of their own trading— adoption of low-touch channels by the buyside grew at an estimated 13% in the past year—they are also looking at their broker lists to see who they will trade with and whether to include more agency names.

Long broker list AXA IM, like other buyside firms, has a long broker list which has developed over the years to more than 100 names. Paul Squires, head of trading, says: “They include start up brokers, some of the new ones. It’s a large list, but we don’t remove names because a couple of times a year you might want to trade with them. Liquidity is absolutely key and you might have a clever smart-order router, but the best piece of liquidity might be to pick up the phone to a smaller broker who knows a particular stock.” There is evidence that broker list sizes will come down. In a recent TABB Group report, more than half of the buyside (51%) expected their lists to reduce this year. Squires, too, expects to see consolidation of names over the next year as agency brokers merge just as in the multilateral trading facility (MTF) space.“It’s a natural evolution,”he says. When the large investment banks were suffering at the height of the credit crunch, Philip Gough, European chief operating officer at Knight, said that the buyside sought to minimise its counterparty risk by spreading trading activity across several different brokers. “But an agency execution doesn’t give a buyside firm lower risk. The risk exposure is effectively the same, as the primary risk lies in the default of the executing broker,”he says. Craig Lax, chief executive officer of ConvergEx’s G-Trade Services, has seen a resurgence in the agency model since the early days of the sub-prime crisis: “The third trimestre last year was an additional kick-start for the business. Over time, some customers had reduced the agency-only brokers on their list, but then they started to ask questions about the model and to be pure agency became a tremendous benefit. Now they are looking at their list and making sure they have one or two agency-only models on that list.”

ConvergEx is an agency broker-dealer offering execution and trading technology services and while Lax believes the initial impetus towards agency trading came from counterparty risk following the collapse of Lehman Brothers and Bear Sterns, he thinks the rationale is now more that the only agenda for agency-only brokers is the customer’s best-execution interests, something he believes is powerful. “As dark pools grow, the agency-only agenda is becoming more and more important because customers can question why you are going to certain dark pools and not others. Our strategy is transparent. We are going to the best prices and trying to steer clear of grey pools which send out indications of interest and so on. Our entire agenda is best execution and we are not looking to make money on a prop book,”says Lax. Balarkas agrees that while counterparty risk concerned some traders, proprietary trading conducted on its own account by bulge bracket firms was another reason the buyside moved to the agency model.“That trend for ever more prop-trading hit a brick wall at 90 miles an hour. The credit crunch was a result of the fact that the bulge bracket was at heart prop-trading firms taking ever more excessive risks. In the new daylight, people are seeing that model is not primarily geared to the interests of their clients,”he says. An estimated 58% of buyside firms are redistributing their order flow following re-evaluation of counterparties, according to a TABB Group survey, European Equity Trading 2009: counterparties, capital and control. The lion’s share of commission, €2.6bn across major European markets, is still concentrated among the core brokers. Yet with volumes down as much as 60% in Europe and falling markets, commissions, which in Europe are calculated on value, have come down with them. TABB Group estimates that the fall in available risk capital will move from 19% daily traded volume in the UK in 2008 to just 5% in 2009.

Risk pricing “Banks are not prepared to make prices like they used to,” says Simon Brookhouse, chief executive officer, Execution. “They have less commission to enable them to pay risk prices, plus stocks are so much more volatile that banks are less willing to put up risk capital and give risk prices.” Over at Knight, which has a large institutional client base and uses capital to facilitate trades, huge volumes pass across its books, and it claims to have executed 109 trades every second in 2008. European chief operating officer Gough says: “We are an execution-only firm, but we’ll use our own capital to enhance liquidity for clients who are looking for immediacy in the execution of their orders—effectively assuming the execution risk for the client. A lot of firms are agency-only because they don’t have capital. Our advantage is that we provide clients with the choice to best satisfy their execution needs on a tradeby-trade basis.”

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Nonetheless, Squires of AXA IM has been disappointed with the performance of the agency brokers: “A recent monthly turnover report from one of my fixed-income traders summarised that agency brokers were failing to make the impact we expected, showing that banks have been more versatile than initially predicted. This is replicated in the equity agency space. Even the better agencies by nature are still not able to provide the capital commitment sometimes needed for execution.” Following the unbundling of execution and research in the UK, opinions differ among agency houses on whether unbundling has helped or hindered the agency model. Lax at ConvergEx says the unbundling of execution and research in the UK has helped the agency model: “It incentivises customers to trade execution-only and add on a research component. It gives customers transparency about how their commission dollars are used and it has become an important part of our business.” However, Balarkas thinks differently: “The biggest gripe about the market is the extent to which unbundling hasn’t happened. Many traders in the fund management industry would like to use us to execute, but the pressure is still on them to pay for the research bill.” Nick Finegold, executive chairman, Execution, which offers research, agrees: “Unbundling was a transparency issue and therefore one of the largest red herrings of all time. If you are paid exclusively through commission sharing-agreements, it can be difficult to capture the

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revenue due to you from another venue. I don’t want to trust somebody else to collect revenues on my behalf.” Where execution-only agencies have benefited is through the rise of white-labelled technology. Some firms will take the algorithms developed by a sellside provider and repackage them for their clients. Execution has gone one step further and is offering its clients the opportunity to trade with 32 algorithms from three investment banks and one agency broker and to know the exact names of the products they are using. Many see white-labelling as an opportunity for the smaller, more niche brokers who don’t have the resource to develop their own algorithms to raise their game. “People have been predicting the end of the small broker for some time, but the smart management teams figure out ways to add value. MiFID has made it harder for small brokers to compete because of the large technology investments,”says Lax.“If European markets are down 60%, that’s 60% less commission on the trade but you have to make a lot of investment to keep up with the technology. Transaction cost analysis is critical, a good smart-order router is critical.You can’t triple your price or you’ll lose customers so you have to be able to serve your customers and to grow market share. It’s the only way to offset the new expenses.” Partly in order to offset these constraints but also as a result of the credit crunch, agencies have also been broadening their offering, particularly into the fixedincome space as balance sheets of the large broker-dealers have shrunk an estimated 21%.

AGENCY BROKING: PULLING AWAY FROM THE PACK 64

Richard Balarkas, chief executive officer of Instinet, an agency broker founded in 1969 to launch the first electronic block-crossing capability for institutions, questions the definition of agency trading: “Agency is one of the most abused terms in the market.You can be an agency broker but it doesn’t mean you haven’t got a prop desk or risk-taking capability. We are very purist about our definition of agency and here it means our only source of revenue is the agreed execution commission paid on the order.” Photograph kindly supplied by Instinet, June 2009.

Celent’s report, Capital Markets 2: the future of institutional brokerage and market-making operations, states: “Although behind in electronification rates as compared to equities, fixed-income trading has been directed to greater agency flow due to capital constraints on the parts of banks and broker-dealers.” The banks have also pulled back on headcount as they have been forced to cut costs and talent has defected from the large investment banks to agency brokerages, especially since the credit crisis. This migration has created a different field of competition. “Previously, we were competing with the bulge bracket; now we are competing with other types of execution brokers,”says John Holl, who runs Knight’s cash equities institutional trading business. Paul Squires puts some of the migration down to brokers wanting to feel more in control of their own compensation, but it made life difficult for the buyside in the short term: “In the second half of last year we did a lot less business with the top ten brokers. We moved trades to two or three `

Nick Finegold, executive chairman, Execution, which offers research, agrees: “Unbundling was a transparency issue and therefore one of the largest red herrings of all time. If you are paid exclusively through commission sharing-agreements, it can be difficult to capture the revenue due to you from another venue. I don’t want to trust somebody else to collect revenues on my behalf.”

execution-only brokers because important contacts for us were moving. In the bulge bracket meltdown, we weren’t getting the service because people weren’t there any more and the level of quality wasn’t replaced.You can’t leave the phone ringing for five minutes. The execution-only guys were clearly very incentivised to do our business and we moved quite a lot of business in their direction.” Employee numbers at Execution have risen 15% over the past year to 140 globally with 100 in the UK. Many hires have been from big name houses such as Merrill Lynch and Dresdner, and Brookhouse says:“There are obviously a lot of people unemployed right now. There are fewer jobs around. It’s a great time to be hiring because people are more realistic. We want to hire people who want to be hired.” The question is: how long will the resurgence in agency broking last and Paul Squires says he has already moved work back to the bulge bracket firms as business has stabilised: “They still have big flows; they are showing a bit more capital commitment; they still have some good analysts and sales people. We’re not fully reversing back to the bulge bracket firms as before, but these are still major relationships.” In the same way, Scott Cowling, head of trading at Barclays Global Investors, has seen only a marginal increase in market share. “The jury is still out as to whether they will garner more market share. The question is: do they provide a service that the buyside want? And do they provide good execution? I am unclear whether they will get a vote of confidence in the long term on both of these.” Holl believes the big banks will respond:“They aren’t going to sit back and watch us grow and do nothing. Looking at it as someone who runs a business, these investment banks cut at the low point and then rebuild themselves as things get better. They will rebuild themselves.”

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T H E 2 0 0 9 U S T R A D I N G R O U N D TA B L E

CHANGING PLACES: The New Dynamic Between Buyside & Sellside Trading

Attendees

LAURIE BERKE, principal,TABB Group

ANDREW NELSON, senior trader,TIAA-CREF

Supported by:

JIM ROSS, vice president, NYSE Matchpoint

CHRIS MAXMIN, head of trading, Moon Capital

JOHN PALAZZO, MD North America, CA Cheuvreux

FRANCESCA CARNEVALE, Editor, FTSE Global Markets

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THE 2009 US TRADING ROUNDTABLE

STANDING: Chris Maxmin, head of trading, Moon Capital; John Palazzo, managing director, North America, CA Cheuvreux. FRONT ROW: Francesca Carnevale, editor; FTSE Global Markets, Andrew Nelson, senior trader, TIAA-CREF; Jim Ross, vice president, NYSE Matchpoint; Laurie Berke, principal, TABB Group.

THE STATE OF PLAY JIM ROSS, VICE PRESIDENT, NYSE MATCHPOINT:

Regulatory and legislative issues are central to today’s evolving market structure. Core to our concerns are the issues of transparency in our marketplace and the integrity of the platforms that are operating at ECNs, ATSs or MTFs. For investors to make informed decisions they must be able to independently ascertain how the market functions, what are the costs and quantify the value of trading in a particular market venue. LAURIE BERKE, PRINCIPAL, TABB GROUP:

I’m interested in the way that volatility has changed trader behaviour and how much more challenging it all is right now, in terms of the choices of venues and liquidity and the characteristics of liquidity in those venues. Then there is the ongoing debate about how to determine the best algorithm for a given order and understanding how to measure the success of those algos relative to the benchmark of that order. Moreover, there is the issue of how volatility has affected the overall relationship between the buyside and the sellside. Buyside traders are in a position where their responsibility is even heavier than it has ever been. In the last seven to ten years, we have been saying that the power of trading was shifting from the sellside to the buyside. Now that trader really sits in the hot seat. These days there’s a heightened responsibility for choosing the correct methodology for executing, for preserving every last ounce of alpha and rebuilding performance. Self-directed electronic trading can feel like trading in a vacuum of information when volatility is high. The buyside trader is looking to his sellside sales/trader therefore for help: whether it is help in understanding algorithms, or help in understanding which dark pools to trade in. Or, it is simply a sales trader on the other end of the phone who’s got some colour, insight and experience that can help the buyside trader. Because he’s trading and managing everything on his own, and to the extent that a sellside sales trader has the experience and the insight to help, that is sellside value-added. CHRIS MAXMIN, HEAD OF TRADING, MOON CAPITAL

I’m with an emerging markets fund, so for me, liquidity is paramount, getting funding in some of these markets

is next to impossible, and associated with that, obviously, is anonymity.

JOHN PALAZZO, MANAGING AMERICA, CA CHEUVREUX:

DIRECTOR,

NORTH

Right now we are focused going back to try to build partnerships with our clients and share technology with the buyside. The sellside is acting as execution consultant for the buyside, becoming almost a technology proxy to be able to help them source liquidity in areas where they may not be familiar or unknown. We try to align our clients’ investment methodology with their trading style. ANDREW NELSON, SENIOR TRADER, TIAA-CREF:

Two items: first, volatility is making it much more difficult to trade even “easy” stocks. Second is innovation: just keeping up with the changes in the marketplace is a fulltime job. I’m not just referring to technology, although that’s a large part of it. We also have to keep up with the non-technical changes in the marketplace as relationships evolve. You have to stay on your toes to keep track of what new services are available, and who’s emerging as a new player. The conventional wisdom of two years back was that regional brokers would disappear and you’d wind up with only bulge-bracket firms left standing. In fact, the bulge brackets were the victims and the regionals have flourished. They have changed their game, changed their style, come up with new products and services, and found new ways of adding value. They are an important force that the buy side has to keep track of.

LOSING CONCENTRATION & ITS IMPACT LAURIE BERKE: What we have found in the past year is that Lehman had such an extended impact on so many different players, including those buyside traders who only traded cash equities. The buyside had been narrowing and narrowing their executing relationships to the point where they were doing 70% or 80% of their US equity commission business with only 12 or 13 brokers. When Lehman went down, there were counter-party risks associated with their over-the-counter (OTC) transactions. Beyond that, now

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there was risk even in the listed security transactions that had not settled and the outstanding commission sharing agreement (CSA) cash balances that were sitting at Lehman. Any institution that did business with Lehman had been pooling this money for payment to research providers; and now that money is sitting on the books of a bankrupt entity and locked up until a court decides who has ownership of those assets. The result of all this is a renewed sense that concentrating order flow in a handful of relationships is no longer the right thing to do. You might have done that at one time to gain access to the technology, to get leverage, to get the first call, such that if you concentrated your relationships with a few brokers, you got all the top-tier services the broker provides. Now that story is no longer compelling in the face of the counterparty risk inherent in a high concentration of relationships. ANDREW NELSON: The drying up of the IPO calendar has also reduced some of the impetus to concentrate your business with leading houses. Regulatory changes have split off research; now very often you either write a cheque for it or use a CSA. In many cases, research been hived off into a separate company or the people have left and set up their own shop, so both the research and the IPO calendar have gone away, at least temporarily, as big drivers of concentration. CHRIS MAXMIN: You used to deal with the big shots because they had capital if you needed it and they could, smooth things over. They can’t do that anymore, or they only do it for a Fidelity or other really big firms. So now, for the rest of the market, the question is: why not trade with the smaller firm? I might even get a better service if they want the business. We use CSAs a lot because our broker list at one point was about 120, that’s just doing a factor in 42 countries, so you really have to deal with them. However, you cannot trade with everybody and get your job done; then CSAs came in and you still couldn’t write cheques to everybody. I mean, if you try to deal with Piper Jaffray, they don’t accept it. It’s like you want to rate research, you have to trade with us. JOHN PALAZZO: Right now, with everybody I’m talking to, the most heavily weighted thing is counterparty risk, which has already been mitigated, for the most part. The players left standing are the ones that are certainly in a good position. Then there is a move to appoint agency shops. I’ve heard that resonating more now than ever in the last three or four years. These themes are not new to the industry, they were just dormant for the last four or five years. It looks like we are going back to some very fundamental basics and it’s good to see. Now we can help clients with some of that counterparty anxiety. But it’s interesting that this is not new to the industry, and every few years it surfaces in a different form. Then there is the sobering consideration that I really do have to consider my counterparty risk; that plays an important role now. I do want to know if they are agency or not and what exposure they may have. Before, it didn’t matter because everybody’s balance sheet was flush; now I have to answer to my shareholders, so who am I really trading with?

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Laurie Berke, principal, TABB Group CHRIS MAXMIN: From a hedge fund standpoint obviously

we have prime brokerage. If I only have one prime broker, what am I going to do? We had multiple primes, we did from the start. Now though you really start to pay attention to evening out balances.You start looking around for places you didn’t look before. Fidelity is private, they’ve got a ton of cash. JPMorgan, all right, everybody’s going to be dead by the time they go under. I exaggerate, but that’s what you are looking for. Where is the closest thing you can get to stability that you don’t already have? Then you go and you try to get a relationship with them, and find they are much more discerning than they used to be. JIM ROSS: We now need to think a little bit about what is the next “bubble”? Where are we really vulnerable going forward? What are the things we don’t know? We spend a lot of time fixing things after they happen as opposed to wondering where are we really at risk and trying to prevent problems. It is a difficult balance between enabling business to flourish and protecting the marketplace from its own exuberance but it is a balance we must try to achieve for our investors and our economy. LAURIE BERKE: One of things that has come out of the credit crisis is the need for both buy and sellside firms to manage more effectively to the next systematic issue through robust enterprise risk management. That used to be a behind-the-scenes issue for compliance officers. Now however, what’s required is for any institution on the buyside or the sellside to be able to map any security and any investment of any kind; whether it’s private equity or it’s real estate or it’s futures and options or it’s securities or it’s debt. It is important to be able to map those entities to each other to determine aggregate exposure to that entity. Once you can do that, then you want to be able to map aggregate positions in those entities to every single customer that you do business with. We happened to be working on an enterprise risk project during the summer of 2008, and we were on the phone with global investment banks in Europe and the United States, and, across the board, they all said that between Friday night, 12th September and Monday morning, 15th September, there were about 65 hours to figure out every single exposure the bank had to Lehman Brothers globally on its own books

THE 2009 US TRADING ROUNDTABLE

Chris Maxmin, head of trading, Moon Capital

and through its clients, and it couldn’t be done. It couldn’t be done because they couldn’t map it, and if they couldn’t map it over a weekend, clearly the next issue would be to bring that capability up to speed to be able to map it within hours. And that’s really what the banks realised they had to do in order to be able to figure out what their aggregate exposure is at a point in time, to mitigate the overall impact of that event. CHRIS MAXMIN: The one unfortunate thing about that is, as a smaller shop is where we have to pay. I’ve lost almost ten traders that have covered me over the years that are good, solid traders and they all went to other places and I can’t trade with them because I don’t have enough commission dollars. I have enough agency business for one, but most of my commission list is offshore. So the guy I used to be able to trade with who could do my American depositary receipts (ADR) business, my Latin business and all that, he can now only do US business and I don’t have enough US business to give him. That means that basically my corporate knowledge is going out the door and now I’m left with a handful of brokers, maybe five, that I’ve dealt with over the years where I can trust the trade in any market. That’s the downside.

TOO MANY, TOO FEW VENUES? ANDREW NELSON: Fragmentation is not our problem

anymore. The technology supports arbitrage, so there can be many pools out there; an exchange doesn’t need to be the only place to trade. It’s very helpful to have different people trying to come up with new ways to trade. It keeps new ideas coming as people are scrabbling to draw flow to their system. I don’t see a problem there. Another thing is that anonymity is actually a very good thing. The“unique liquidity”argument is an interesting case because people come in the door and say,“You’ve got to use our system, we’ve got unique liquidity.” That liquidity falls into two different categories. One is that they have exclusive access to some retail pipe, you can have access to“dumb”retail flow – that is actually not as dumb as one might think. The other is access to program desks and transition desks who say that you can have an early look at their flow before it goes out and joins the broader market. If any of that flow turns out to be toxic, then you’re the first victim of a concentrated stream of poison. However, if you make the assumption that that is not what’s happening with this flow, then you still have an operational trade-off to make: Do I connect to all of these places that claim to have unique

liquidity in the hopes that they actually do have it, or, do I wait until they give up on all people that have directly connected to them and they send it out into the general market? At that point, I’m going to see it through any of my dark pool aggregators or the floor of the exchange. Liquidity needs to pool somewhere, and eventually the bulk of it is going become available. The question is, is it worth it to put in the effort to connect to all of these places and incur the opportunity cost of sending an order to each of these pools in the hopes that there is something there. That’s a big cost. Worse, you can’t leverage a dark-pool aggregator to defray those costs because the whole argument for the unique liquidity is that the aggregators can’t reach it. JOHN PALAZZO: In the United States there are in excess of 40 dark pools, and we’ve created a dark pool aggregating algorithm for clients and it’s driven by client demand. Clients ask: “How many pools can you connect to?” I respond: “Who do you want to be connected to?” It’s a collaborative effort with the buyside and it boils down to opportunity cost for each millisecond. I’m resting an order in a pool where I could potentially be getting an execution somewhere else and that creates an opportunity cost, a potential drag on performance. Therefore, for us, this is an ongoing cost, a rather frustrating one, but we do deliver it for the clients. Dark pool aggregation is necessary. The real game is that we continually look at the empirical data that suggests what might or is the value of the dark pools that we are staying connected to. Then again, when will some of these dark pools eventually consolidate? Hopefully we are going to see the dark pool phenomenon kind of work its way out and the strong ones will be standing or alliances will be made. They are a very valuable piece of the landscape and I just like that the competition breeds innovation, innovation breeds efficiencies and benefits to the end-user eventually. It seems we go through these processes all the time with these products; and really drill into them to find out where and when they are reasonable and/or meaningful or not. JIM ROSS: My view is why would any broker who’s got internal liquidity and has technology, not use it? There is a value to brokers to have this, they leverage it and they should use it. The question that does concern me is the massive opportunity cost that is incurred along the way while you are trying to find your contra-side among so many separate liquidity pools and broker systems. For the buyside trader, it is not only figuring out which technology costs you have to pay to connect; it’s also the process of finding a natural contraside while being pinged and probed in a highly sophisticated and quantitative market.. There‘s no doubt that algorithms are extremely viable and an important component to our marketplace. However, algorithms cannot fully resolve the problem of liquidity fragmentation…only a centralized and neutral exchange can address this issue. LAURIE BERKE: Competition, transparency and I’m going to add a third piece to that, and that’s the buyside trader’s expertise. When it comes to the relative value of a particular liquidity pool and its unique liquidity, one that thing that

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we found when we went out and talked to buyside folks is that they weren’t always fully informed about which dark pools their algorithms or the smarter order routers were talking to, with what types of orders, and under what trading circumstances. How is a dark pool, or an order, or any venue preferenced on a smart order router? Where does that router send the order first? Does it go to the consortium that the executing broker is a partner in? So the buyside really needs to ask for transparency from the broker. The technology exists to configure any client to connect to certain dark pools and to opt out of certain other dark pools. Buyside traders tell us that they want to be able to have that choice. They want to be able to choose the circumstances under which they might take advantage of a potentially toxic source of liquidity or take advantage of an electronic market maker, and enhanced liquidity provider (ELP). As a buyside trader, I want to be able to take advantage of that liquidity, but I don’t want to do that with this particular order. So that there is a lot of opportunity for increased transparency, increased control on the part of the buyside trader who does his homework and knows where these orders are being sent and under what circumstances. CHRIS MAXMIN: As a buyside trader, I’m not as concerned about where I’m getting executed but that I am getting an execution! I saw a couple of matrix that show that of the 40-plus dark pools available, about 85% of the volume goes through less than ten of these dark pools. Currently, none of the so-called aggregators can access all of them but the most popular ones can access most. We are all aware of the rebate/post versus take liquidity/third party routing. We have all gone through the pricing drill. Some of the costs turn into rebates, other costs top out at a mere ¼ of a penny/share. I’ll pay 25mils to execute a “liquidity challenged” stock if trades within the spread or my limit and clears with one of my primes. Do I care if BATS, Arca, NASDAQ or SIGMA X executes it? Not really. The margins are now so thin out there that we are once again focused on liquidity and to a lesser extent, gaming. JOHN PALAZZO: Just to add to that, show me something with some innovation. There is innovation going on except I’m realising now that some of these things are happening on an individual customer-by-customer basis and they may not be universally commercial just yet. A client wants to take advantage of a certain rebate model. Anybody who I give a volume weighted average price (VWAP) through cannot get that exposure so we spent about a month in development and am able to make my algorithm now so transparent that I can pass through the rebate model, the true hit, and take fees directly to that client in an algorithm. Is Cheuvreux ready to roll it out commercially yet? Maybe not. If it’s a really big client that wants it they are going to get it tomorrow but, right now, part of it is manual, part of it is relying on people we interact with getting the proper data. It’s really data reconciliation at the end of the month. Some of that is manual because it’s manual from the vendors we trade with—one of those 30-plus dark pools that’s not as highly automated as some of the other ones. Another innovative

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Jim Ross, vice president, NYSE Matchpoint

thing is if a client asks us: “Is there a correlation of effective stocks when I give you a list to trade? Do you just put these things through the same algorithm, the first half hour of trading?”A year ago we would have said:“Yes!”However, the client now wants to see the correlative effect and wants your dark pool sweep on all the mid-cap names for the first half hour, and then go into the marketplace. He wants your ladder on all the large-cap names because empirically you’ve proven good results with that and then asks you now to create correlations between the stocks. So he forces us to sit back on a global basis and think: wow, this is a much better way to trade a list or a basket of names instead of just on a marginalised basis,VWAP first 15%; don’t be more than 80% of average daily volume (ADV) and so on. FRANCESCA CARNEVALE: Are you saying that the buyside is much more interactive now in determining what is best execution? JOHN PALAZZO: That’s interesting. I’m giving you two examples of buyside clients that have made a decision internally that a collaborative effort with their broker partner is going to pay off. I’ve spoken to other clients, very similar clients, billion dollar funds, and I’ve had people stare me right in the face claiming that it won’t work, that this work is not going to ever bear out any empirical data and hold simply that it:“Could just be luck, John”. They may be right, I don’t know; I have no data to support that. However, I know I’m not lucky and that it really is up to the client. When you find a client that wants to take advantage of your resources they will build a partnership, you can create something that differentiates you from the other brokers that you are dealing with. More importantly, the client is really receptive because, like: “Wow, someone heard me!” Even if it didn’t bear out what they thought, the results were they now have data points that suggest their idea didn’t work. Now the majority of people are not ready for that sort of effort. Resources are tight, in this environment you are doing a lot more with less people so you’ve got to allocate your resources carefully but we see this as an exciting initiative and one that an agency broker like us is best positioned for. JIM ROSS: I’m not saying there’s no innovation on the service level. I guess my concern is more the market structure level. Again, when we are talking about destinations of liquidity.

THE 2009 US TRADING ROUNDTABLE 70

JOHN PALAZZO: It might be a misinterpretation. JIM ROSS: The concern that I have is, as I’ve said before, how

business interests are somehow being relied upon to be the driver of our market structure dynamic . Reguklators needs to take a more proactive though careful approach to evolving our market place as it matures with new innovations and new technologies. Regulations and laws on which investors and citizens rely have be able to adapt and evolve. Take a look at Ref ATS and NMS, for example. . Did these rules really want to promote the market gragmentation that we see today, the dimunition of price discovery and that over 50 dark pools could operate without any operational transparency? Not likely….It seems, especially I would say, in the dark pool environment, that there is an awful lot of catering to particular types of customers or certain types of liquidity, and how people trade in it. That is why we have such a segmented, segregated liquidity pool.Yet it’s become more about business than it has been about trading quality. And that’s what concerns me; we are looking at the dark market as some sort of market structure definitive when it merely reflects the various commercial and self interests of many new ATS providers.This is not necessarily the best way to evolve a market.

THAT OBVIOUS TECHNOLOGY FACTOR ANDREW

NELSON: A lot of the technology is commoditised. If people don’t have relatively low latency and access to the usual suspects of dark pools and all of the other stuff that everybody is pitching, then there’s no conversation in the first place. However, the distinction between six milliseconds and five milliseconds… well, I just wouldn’t see it. There’s not a lot of difference between all the people who are capable of showing up at the table and between and amongst them it becomes other factors that go into the trading decision. LAURIE BERKE: The US marketplace has evolved rapidly in the last decade. All of these advances in speed and low latency have happened since 1999 and it has transformed out marketplace to the core. Speed and access are no longer peripheral components of equity trading. The US markets have gone down the path to multiple alternative liquidity pools linked by high-speed connectivity. While Europe and Canada continued to see the exchanges dominate, now, postMiFID and the best ex rules in Canada, these markets would appear to be headed in the same direction. Although it is still early days, and alternative venues in these markets have captured only a small market share, they will likely follow a similar path as we’ve seen in the States, where it’s competition on liquidity, speed and the economics of the venue.There’s no question that aggressive pricing created new pools of liquidity. Will that be replicated in Europe?Yes, cheaper, faster, liquid. JOHN PALAZZO: You made a comment that all this started to change very rapidly since 1998 and it’s no coincidence that 1997 was when the National Association of Securities Dealers (NASD) and the Securities and Exchange Commission (SEC) adopted the limited order handling rules.

Andrew Nelson, senior trader, TIAA-CREF CHRIS MAXMIN: Europe is still a long way from where we are in the US and the emerging countries are worse. Look at all the countries that have “limit up” or limit down” trading. It just delays the inevitable. The stocks will move that same direction over the course of 2/3 days instead of 1. ANDREW NELSON: I would add that in Europe there seems to be, at least anecdotally, a big push towards regulating and using regulation to make markets never go down again. Well, one country tried it: they just said that you can’t sell a stock lower than the price it was yesterday. LAURIE BERKE: I like that. ANDREW NELSON: The danger of over-regulation is that technology will allow traders simply to trade somewhere else. The next generation of order-routing technology is “transformational” smart routers that switch between equivalent asset classes. So you can send an ETF to an algo and it will trade either a basket or a futures contract or the ETF, and return with fills on the ETF. You can trade interlisted stocks in a similar fashion. For example, you can send an order in the US flavour of a Canadian stock and the algo may decide that it is cheaper to trade in Canada plus the FX, while still returning a fill in the US kind. If the regulations come down in a way that it is too painful to the industry, people will take advantage of technology like that to trade away. Moreover, new regulations will actually increase the use of such algorithms, both by making it cost effective to use these transformational algorithms, and also because it will spur the innovation of outside markets to provide a way to trade it more cheaply.

TRADING MULTI-ASSET CLASSES ANDREW NELSON: You now hear more and more system sales people coming round, claiming “We are multi-asset class” and you are seeing companies such as Pipeline buying an options trading firm, 3D Markets. Everything is converging. But that is evolution. ETFs were sort of exotic a few years ago, and now they are 30% of traded volume. They are derivatives but nobody even thinks of them that way; they are just becoming virtually “plain vanilla” securities. Furthermore, we often use futures instead of an ETF or a basket of stocks. All of these things are becoming

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the standard way of doing business. Then you have convertible bonds and single-stock options. So all these different types of derivatives are melding into, from the equities side, what we consider the mainstream. Of course, it also works the other way. An options trader may find that he actually wants to trade the equity. Tools will exist, or are coming into existence, that allow trading in both directions. If you can transform an equity into an option you can certainly take an option and trade in the other direction. So, I see a big convergence process. LAURIE BERKE: From Andrew’s standpoint, the buyside trader has a choice of trading the ETF, trading the basket, trading the future, entering into an OTC swap, or some combination thereof. It’s a big job to understand exactly what all of the implicit and explicit costs are around these implementation choices, incorporating such “soft” factors such as operational complexity and liquidity risk. Moreover, there are all sorts of complexities related to transparency and pricing between the OTC and the exchange-listed markets. It would come down ultimately to a question of what is the most cost effective, most efficient implementation tool given the objective of the order and the strategy of the portfolio manager. CHRIS MAXMIN: Remember, though the US is the largest single market, we have to continue to think globally. Here technology doesn’t hold all of the answers … yet. We too trade futures versus ETF more often than not—they are cheaper and more liquid and can be used in multiple countries. Let’s also not forget the most liquid market of all—the FX market—whether we use it for a hedge or an asset class. Here technology is just hitting its stride in some emerging markets—though it’s still a very manual process in many others—and not just the frontier markets. There still remain many inefficiencies in these markets. JIM ROSS: This convergence will evolve in two ways. The first is increased efficiency through technology and

John Palazzo, managing director, North America, CA Cheuvreux

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software innovations. It’s the broker’s job to come up with that stuff and they are doing a great job in whatever exchange. The second is the relationships between markets, the regulators, market participants and issuers. All have a vested interest to make our markets as robust, liquid and effective as possible. Technology has enabled and will continue to move our market evolution forward but it requires a collective effort for us all to put the right structure together.

WHAT’S AROUND THE CORNER? JOHN PALAZZO: I’m a little bit more optimistic than

probably some of my peers; not in this room but people in the industry. Events like this remind me that there will be great, catastrophic events in the future. I know this because it has just happened to us right now. We seem stunned that we can’t prepare for it, when we have all the answers right in front of us. If a low level sort of risk control management stated that you should never have more than 15% of our gross commissions with any single broker, I don’t care who it is, then you’ve limited or mitigated some of your exposure. Moreover, these events allow us to deal with things that we normally wouldn’t deal with if things are going well. It really does encourage you to look at your firm, your offering, your clients and ask yourself: what core competencies should we focus on? It allows us to fine tune our offering, be an innovator, help to solve clients’ problems or get them to the next level, and re-focus on what we do well. While it’s been catastrophic—a lot of jobs have been lost, a lot of assets under management devalued—it also gives us the opportunity to realign ourselves with our clients and our industry. These times give us the opportunity to kind of wipe that slate clean and go back to some fundamentals. JIM ROSS: I look back five, ten years at how exchanges operated and it was very insular, some might call monopolistic. Beyond the kind of business approach of an exchange way back then is that they traded stocks that were only listed on their exchange in posts on the floor. Now we are dealing with a much broader global business community, and what we are starting to see at the exchange level is the relationship between the global demand and complex products. Right now, exchanges are coming into their own; and it is revolutionary for them and the markets they serve. It will also benefit investors and brokers alike that exchanges now are actively engaged with global partnerships and new efficiencies that can be found in those relationships Second is more choice. Trading is no longer a one trick pony. Moreover, choice is a critical dynamic that will create new opportunities for investors and brokers. That we need to be sensitive that not everyone wants to trade one way: there are portfolio traders and block traders, dealers and position traders, passive and active strategies and our market need to adapt to this diversity and accommodate the needs of all market participants. Ultimately, exchanges will play a prominent and leading role in the unfolding and future marketplace.

ALGORITHMIC TRADING: THE NEW GENERATION 72

New Strategies in a Crowded Market When algorithms first began to make their mark ten years ago, reports abounded that high-touch sales trading would disappear as the new world order took over, but, to paraphrase Mark Twain, reports of the death of the trader have been greatly exaggerated. A decade on, algorithms, rather than displacing the sales trader, have found their way into the toolbox of almost all trading desks and are moving in two different directions: faster, ultra-low latency, low-touch and traditionally slower, benchmark style, higher-touch. Ruth Hughes Liley reports.

HILIP SLAVIN, HEAD of sellside product technology at trading systems supplier Fidessa, sees a broader church in the application of algorithms.“Without trader intervention, algorithms could have gone into meltdown last year, with all the volatility. What we are seeing is an evolution towards a broad-touch trading approach, a combination of high-touch, traditional stockbroking skills supported by sophisticated analytics, low-touch algo trading and smart order routing, equipping the trader with the best tools for the trade,”he says. Some of the pressure to adopt the latest tools has come from the buyside’s own clients, as Damian Bunce, head of European equities electronic sales trading, Barclays Capital, explains: “When mandates are being awarded to investment managers, plan sponsors want to know that trading innovation and efficiency is an integral part of the investment life-cycle. In slower markets they have more time to plan how they are trading.”

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There is no doubt that the buyside has shifted order flow away from sales traders towards algorithms. Boston-based TABB Group estimates a 12% shift away in the past year as liquidity, risk capital and blocks have evaporated. A parallel 13% growth in low-touch trading occurred in the European markets as buyside traders took advantage of direct market access, algorithms and, more slowly, crossing networks, says Miranda Mizen, a TABB principal and author of European Equity Trading 2009: Counterparties, Capital and Control. She estimates buyside adoptions of low-touch trading will rise to 91% by 2001 compared with 81% this year. A key driver in the adoption of algorithms is the desire to lower costs, with anonymity a close second. Scott Cowling, head of trading at Barclays Global Investors, says commissions are lower on algorithmic trading:“You weigh up the options of whether you would get better implementation by using a sales trader at a higher rate of commission, but if you are not sure, you will use the lowertouch route at a lower rate.” For firms which have higher ticket volumes and higher price sensitivity, it is better to develop one’s own electronic platform and degree of automation, says Cowling. “Because we have been able to justify that we can extract value from the method of execution, it is worth the investment and we have seen an increase in the amount of trades we are doing electronically.” This client-led trend has seen greater customisation of algorithms by brokers to suit individual clients. As Owain Self, head of algorithmic trading at UBS, explains: “A lot of the original pressure to build algorithms is driven by internal demand. Now we spend more time customising algos for our clients. There is an extreme amount of customisation going on. We rarely produce a generic algorithm now. It’s the more popular route.” It has become particularly prevalent with the rise of multiasset algorithms, notes Vijay Kedia, chief executive officer of Great Neck, New Jersey-based FlexTrade. FlexTrade provides broker-neutral algorithmic trading platforms and execution systems for equities, foreign exchange and listed derivatives. “We are also looking to raise functionality across other asset classes to tap into changing trading desk requirements.” Kedia believes that the multi-stranded approach has legs for two reasons: “One is depth of service provision. The second in this post recessionary period, it is all about managing risk exposure, particularly in terms of hedging exposure across the entire multi-asset portfolio of securities.” There are also more straightforward trends at work. Unlike the early days of algorithms, when volume weighted average price (VWAP) was the main benchmark of choice, simple execution-style algorithms have evolved into those which deliver a service and solve problems such as liquidity-seeking algorithms. Many believe volatility has shifted trade away from the classic VWAP to implementation shortfall algorithms, which are front-loaded to trade more volume earlier even at the risk of some market impact. “We are now seeing adaptive algorithms,” says Paul Squires, head of trading, AXA IM.“These think more like a

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Philip Slavin, head of sellside product technology at trading systems supplier Fidessa. Photograph kindly kindly supplied by Fidessa, June 2009.

trader so might be aggressive for half of the trade and then tail off. They can mirror a trader’s actions but they are never going to do completely what you want them to.” Cowling says:“Brokers are very keen to offer customisation and clearly they will help if a client knows exactly what they want. The difficulty is identifying exactly what is required to enhance the execution on an ongoing basis.” “Algos do go out of date to a certain extent,”says Bruce Bland, head of algorithmic research, Fidessa.“They will always do what they say they will do but, when market conditions shift, they need to evolve rapidly.We have seen our customers’algorithmic teams carry out a lot of work on their implementation shortfall models recently due to high volatility and widening spreads.” However, customisation of algorithms for individual clients is often based on historical data, which can be thrown out of kilter by unforeseen external events. Slavin points to the extreme volatility at the height of the credit crisis when algorithms were stretched to their limits: “As volatility increased, the historic-based models moved outside their tolerance so any mean reversion-style model became sub-optimal. Paradoxically, people carried on using them, but became increasingly unsure of the execution quality they were achieving.” Volatility led to a 54% increased use of algorithms, according to TABB Group’s Mizen, as broker smart order routers and algos had access to the most accurate data and could react more quickly to market movements than a buyside trader. She also reports that volatility led to 42% changing their benchmark.

ALGORITHMIC TRADING: THE NEW GENERATION 74

Cowling says brokers’ Rob Flatley, global head of capacity to cross and use Autobahn Equity, Deutsche liquidity internally will grow: Bank’s electronic trading “Brokers have made the arm, says it is volatility which investment and the more they has driven people to move internalise, the less it will cost faster or slow down them in exchange fees. A algorithmic adoption, a second reason is that they trend he witnessed five years know it will give clients better ago in the US: “Now execution because they won’t volatility has slackened off have to cross the spread on there is more confidence in other venues as most crossing the volume profile of the takes place at the mid-market market. There will be a gradual expansion in the Scott Cowling, head of trading at Barclays Global Investors, says price. If they can net it off, it is amount of securities that the commissions are lower on algorithmic trading: “You weigh up the options better for them and their buyside traders are going to of whether you would get better implementation by using a sales trader clients.” Slavin of Fidessa, which trade electronically across at a higher rate of commission, but if you are not sure, you will use the European markets. In the lower-touch route at a lower rate.” Photograph from Berlinguer’s photo provides much smart order early stages they will trade archives, supplied June 2009. routing technology, says that he sees algorithms moving in more liquid stocks, but as four directions: programme algorithms become more intelligent and as the users become more knowledgeable, level algorithms, where models manage a portfolio of orders; they will trade more names and they will be confident execution level algorithms, where smart order routers are able to route aggressively and passively to both dark and lit because they will have seen the positive results.” The proliferation of trading venues following the venues; cross asset class algorithms from a single asset to a implementation of the European Union’s Markets in group of multi-asset instruments in multiple currencies; and Financial Instruments Directive (MiFID) and an estimated finally, algorithms which support pre-trade transaction cost growth of trade on dark pools rising by 1% a month in some analysis to determine which are the best order-level firms, has forced developments of ever smarter order routers algorithms to use.“There may be some merit in the warning to seek out the best prices. TABB Group has estimated that ‘Be afraid of the UK’s Financial Services Authority (FSA). We brokers spent €407.5m on internal software development last could conceive of a market regulated in a more sophisticated year and that this will grow at 3% over the next two years way so that traders need technology that not only monitors with larger brokers developing trading tools internally and risk and trading activity but can also prove it,”says Slavin. Fragmentation of liquidity has been steadily rising others relying on third party resources. Investment has also been made in internal crossing according to the Fidessa Fragmentation Index, which shows networks. In April 2009, CA Cheuvreux announced that it the average number of venues needed to be visited to achieve was using Smart Trade LiquidityCrosser as part of its internal best execution. FTSE 100 quoted stocks, for example, rose crossing strategy, matching retail, institutional, programme, from 1.3 in June last year to 1.84 on 29th May 2009. Fidessa algorithmic and direct market access flow into the firm. After says this shows that smart routers are continuing to spread client orders are sent through internal pools and crossed trading volume across different venues. Differences are emerging between smart order routers. against internal flow, duplicate orders are channelled into the The basic ones sweep venues and markets looking for open market but deleted if the order is first filled internally. Morgan Stanley in the US, for instance, is crossing an hidden pockets of fragmented liquidity. The newer models average of 100m shares a day in its US internal liquidity pool, incorporate algorithms which allow traders to specify MS POOL. Morgan Stanley, UBS and Goldman Sachs have criteria for their trades, critical in the future as traders look allowed each other reciprocal access to their internal crossing for increasing sophistication in their tools, but greater engines, MS POOL, UBS PIN, and SIGMA-X in the US and simplicity on the screen. Steve Wood, global head of Europe. Brian Gallagher, head of European sales and coverage, trading, Schroders, which does more than 50% of its Morgan Stanley, says: “This has kick-started interest in non- trading electronically, has sent out questionnaires to his displayed liquidity among the buyside and we’ve seen a brokers asking them about the quality of their smart order significant uptick in use of crossing engines and non-displayed routers. “We want to know does it do what it says on the liquidity pools to access internal and external liquidity. Clients are tin. Is it maybe biased towards one market? Does it touch looking for liquidity and aggregation in general so they are all markets that it says it does? There is a lot a competition increasing usage of these order types.We are seeing traders migrate in this area.” Perhaps the ultimate in customisation is the development to liquidity focused algorithms such as Night Owl that blend displayed venues like the exchanges and MTF’s with non- of Fidessa’s algorithmic trading solution, BlueBox. It allows traders to route single orders and lists to internally-hosted displayed liquidity pools.”

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algorithms and to control and monitor their algorithmic orders from their existing order management screens. While BlueBox is clearly labelled, the industry has seen a growth in white-labelled algorithmic products, with smaller banks buying electronic products from the sellside and repackaging them for the buyside, as many niche brokers want to maintain a reliable service without the cost of further investment, while the larger banks see it as a way to increase their own volumes. “If I was a tier two or three broker, I would white-label others’algorithms,”says Squires. “One of the healthiest moves in terms of transparency last year was when Dresdner told everyone they were using Goldman Sachs’ algos.” Execution is an agency broker offering algorithms from four top-tier brokers. Buyside traders know the name of the brokers and even the names of the 32 algos open to them, although brokers do not know who is using them. The main factor fuelling white-labelling is the increasing desire of clients to pay for services electronically, according to Bunce.“It is a significant and recurring investment to build an electronic trading product and offer it to your clients yourself. White-labelling is a popular alternative for small houses but for mid-tier brokers an obstacle to adoption has always been a fear of outsourcing market share and membership and the negative effects this might have to their other businesses. White-label deals vary enormously. Some are very transparent to the end user, they may even be given a list of brokers to choose from, while others are far more secretive.” Another significant investment is in low-latency technology as speed to execution becomes increasingly important. In 2007, buy and sellside firms spent an estimated $300m on low-latency infrastructure, according to TABB Group. “There has been a race to the bottom in terms of latency,” says Bill Capuzzi, president of ConvergEx’s GTrade Services.“The law of diminishing returns applies. The race has started and latecomers won’t benefit. There are three questions: how fast are you to market, how fast is your market data and how good is your co-location.” In the US, 40% of present-day trading volumes is highfrequency, statistical arbitrage trading and it could reach similar levels in Europe, says Capuzzi. “That’s not going to go away. There are models which are tuned in to flip positions in minutes to find the spread or the delta. They are not routed in fundamental analysis, they are routed in short-term profits.” Deutsche Bank’s Flatley agrees: “If you can be faster, why wouldn’t you always be? Even if your trading strategy has nothing to do with how quickly you execute, if you are trading billions, speedy access can impact your portfolio returns throughout the year. We talk about speed pretty much every day: dark fibre versus copper cables, co-location, highspeed routers, faster algo configurations.” As algorithms have evolved, they are increasing being used in asset classes other than equities. Over at UBS, Self, who as head of algorithmic trading in US and Europe oversees development of algorithms across all asset classes, says his focus for the next six to 12 months is making the current suite of algorithms into multi-stock and cross asset.

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Damian Bunce, head of European equities electronic sales trading, Barclays Capital, explains: “When mandates are being awarded to investment managers, plan sponsors want to know that trading innovation and efficiency is an integral part of the investment life-cycle. In slower markets they have more time to plan how they are trading.” Photograph kindly supplied by Barclays Capital, June 2009.

In May 2009, trading technology provider Orc Software launched Orc Spreader, a server-based, futures spreading product designed for low latency and high-frequency futures spread traders. It uses Orc’s server-based algorithmic trading engine and includes built-in futures spread trading logic designed for futures spread traders. Looked at from the buyside’s point of view it can feel like the sellside is pushing products on the market. However, Squires says:“We have one algo provider, Credit Suisse, and multiple strategies within it. We don’t need to extend our technology into multiple algorithm providers, but it’s amazing how most of them want you to talk about algorithms. It’s a crowded space and people have overanticipated the use of algos.” Wood sees a different future in algorithms: “We used to have two standalone engines with say five algos in each. Now we have gone broker neutral, it feels more like 50 brokers with 10 algos each. A challenge for us is the buyside is to be able to identify which algos are most suited to a particular trade. There are people out there looking at overlays of algos; algos which can pick out say the three optimal ones. This is a complex area and you start getting into the realms of artificial intelligence. It’s aspirational at the moment, but it will come.”

LSE GOES AHEAD WITH MTF PROJECT 76

Plans for the London Stock Exchange’s (LSE’s) project with Lehman Brothers to develop a multilateral trading (MTF) facility, Baikal, were put on hold when Lehman’s collapsed last September. The pair had announced a joint-venture partnership to create a pan-European MTF only 11 weeks earlier. Even so, the first trading facility to combine an innovative dark liquidity pool with sophisticated algorithmic trading functionality looks on track to secure regulatory approval by the end of June. Ruth Hughes Liley met with Natan Tiefenbrun, the venture’s commercial director, to discuss the implications of the launch of the ‘unique’ hidden liquidity gatherer.

BAIKAL IN THE SWIM DESPITE LEHMAN’S DIVE HEN LEHMAN BROTHERS collapsed on the 15th September 2008, it looked like disaster for the London Stock Exchange’s joint project to develop Baikal, a multilateral trading facility (MTF). Just 11 weeks earlier the two organisations had announced a joint-venture partnership to create a pan-European MTF, which, they said, would be the first to combine an innovative dark liquidity pool with sophisticated algorithmic trading functionality. It would also offer the service to both buyside and sellside participants. Those plans were put on hold when Lehman Brotherswent into administration,posingthe London Stock Exchange with a dilemma: should it drop the idea altogether,press on with a different partner, or go it alone with a different model? The exchange chose to go it alone and, in October 2008, announced John Wilson, a former Lehman employee, was to be chief executive of the pan-European non-display trading platform, Baikal, named after the deepest lake in the world, and located in Siberia. A former oil-field engineer with Shell and with 11 years in research at UBS, Wilson spearheaded the drive to launch Baikal by its new deadline of the end of June 2009. The rest of the senior team was announced earlier this year: LSE’s Chris Rennoldson as chief operating officer, Mark Ryland from SWX Europe as chief technology officer, and Natan Tiefenbrun, formerly of XConnect and Instinet, as commercial director.Tiefenbrun says: “I joined Baikal because I believed that neutral, exchange-led operating facilities would be winners. We are here for the long term and we want to create a new market.” The route to this new market creation begins as soon as regulatory approval is given with the roll-out of Baikal’s smart order routing capability, provided by Fidessa, giving a onestop-shop for navigating fragmented liquidity across Europe. By launching this first, Baikal claims it will have the time to set up the linkages needed for liquidity aggregation for its MTF, which will not be launched until autumn 2009. Wilson says:“We are making good progress towards a phased

roll-out of Baikal this year. We are delighted to be working with Fidessa to provide best-in-class order management and liquidity aggregation technology for our customers. With this service we are able to offer a Markets In Financial Instruments Directive (MiFID)-compliant best-execution service that shields customers from the complexity and costs of direct membership of multiple markets and central counterparties.” In order to provide this, Baikal Global Ltd, a whollyowned subsidiary of the LSE Group, has applied for status as an investment firm which would mean customers of Baikal would not themselves have to have membership of all venues. Approval is expected by the end of June. While the collapse of Lehman’s meant the loss of the bank’s prized algorithmic capabilities and a delay to the original launch planned for Q1 2009, Tiefenbrun says that it has ended up with Baikal being more independent and neutral. He says:“The market is generally welcoming a more neutral approach, so not to partner with a single bank is seen as an advantage. It’s a healthy change. Our technology costs are substantially lower than they would have been and Baikal is not perceived as being tightly associated with a single broker.” The fact that buyside traders will not have direct participation is a clear change from the original model as announced by the LSE in June 2008. Tiefenbrun’s first day at Baikal coincided with the first meeting of the Baikal Buy Side Advisory Group, a group of 18 leading buyside and hedge fund members. He says:“My own mind was firmly made up at the end of that day, but it has taken a while for us to fully get the message across that Baikal is not going ahead with direct buyside access. Our success is bound up with helping broker-dealers to reduce costs and give improved execution quality to their customer base.” Tiefenbrun adds:“The buyside we are trying to do meets their needs. At the same time, they are happy to continue to trade

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with their brokers who give a broad offering including research, capital and so on. For us, the smarter road to success is to leverage rather than to disrupt this relationship.” He refers to meeting a new demand:“We are not trying to play the same game as Chi-X or Turquoise or take market share from them or even the FTSE all share index platform SETS. We are trying to attract into the market types of orders which don’t reach the books of other venues by offering trading in larger size and at lower frequency. So it might be a small order in numerical terms, but if it is a relatively illiquid stock, that represents a large trade for that stock and it is this type of order where we expect Baikal to add most value. “Average order and average trade sizes are down 75% as a result of fragmentation and competition and they are still falling between 5% and 10% a month. That creates demand for new ways to trade in larger sizes. As we succeed we will create a new market opportunity.” Baikal’s offering is split into two: on one hand, the Baikal order book (BOB), a pan-European MTF for the execution of non-displayed orders, which will use the LSE’s TradeElect platform, to be launched in autumn 2009. On the other hand, a suite of smart routing and liquidity aggregation strategies will aim to route orders to best available displayed prices as well as searching out non-displayed liquidity. It will offer customisable strategies to enable sweeping and posting of orders on both lit and dark venues simultaneously, claims Baikal, benefiting best execution for immediate trades or orders specifically marked for external routing. It will also enhance block-trading opportunities through participation algorithms as and when blocks become available. In total, it will connect to more than 20 European venues. This onward routing of orders not matched in its own system has not faced difficulties, says Tiefenbrun.“We have had no difficulty in establishing relationships.” He adds: “The liquidity eco-system or routing framework will ensure that customers aren’t isolated in Baikal, but can choose to interact with other broker algorithms and other MTFs. We are trying to improve the certainty of execution by linking to other venues. The bulk of non-display trading happens in broker-dealer internalised crossing networks but we are operated by an exchange which doesn’t do trading on its own behalf. We are moving this trading from an‘over-the-counter’basis to an exchange basis, which improves transparency of trade reporting and is supportive of price formation.” The Baikal order book, the MTF part of Baikal, has adopted the “price referencing’” waiver in order to be a non-display venue, rather than one of the three other possible waivers which exempt MTFs from pre-transparency disclosure rules. By adopting the price referencing waiver rather than the “large-in-scale” waiver, Baikal has not restricted itself to trading only large orders. At launch, BOB will take its prices at best bid and offer from the various primary markets. However, Baikal’s order book aims to meet the needs of institutional market participants trying to trade large orders without information leakage. There are two types of crossing: continuous and random period mid-point matching. Resting

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orders will meet at the mid-point price at random times between 10 and 30 seconds apart and benefits traders who are happy to wait longer to get a fill. However, when a midpoint match is not under way, continuous trading will operate, allowing “immediate or cancel” orders to interact with resting orders. “The Baikal order book is fairly unique,” says Tiefenbrun. “It combines period call auctions with continuous trading so that patient traders can either interact only with other patient traders during the auction call periods, or, crucially, they can also choose to lower their guard and interact with continuous, high-frequency market flow, which may include smaller orders. That optionality is a big differentiator.” Baikal has invested heavily in anti-gaming technology to prevent market leakage. These include“well-formed market” checks, which are a series of tests to ensure that transactions only take place when both buyside and sellside are satisfied that the reference price is fair. Equally, the random nature of the matching function with its delay of up to 30 seconds makes it unattractive to high-frequency traders or those wanting immediate execution, especially when combined with the non-display nature of the order book. As such, it discourages fishing where traders dip in to a pool to see how much interest there is in a particular stock. Additionally, market surveillance system provider SMARTS will monitor activity on the non-display order book in real-time, developing the platform already used by the London Stock Exchange. Among the other technology providers, BNP Paribas Securities Services will provide integrated net settlement regardless of which venue executes the trade; CC&G, the LSE’s clearing house, will provide panEuropean clearing to the Baikal MTF; QuantHouse will provide high-speed market data. Baikal has not yet announced its liquidity providers, but it is expected that they will come from a range of investment firms. The Baikal board will be constructed in the light of investors, although discussions are still taking place about who will be in the chair, a position held by Clara Furse, who stepped down as chief executive of the LSE in May 2009. New LSE chief executive Xavier Rolet has a seat on the Baikal board, as does former Borsa Italiana board member, Raffaele Jerusalmi, the LSE’s new director of capital markets. Baikal, while it will operate as a separate company, has benefited from its connection with the LSE.“Having existing infrastructure allowed us to move more quickly after Lehman’s went into administration,” says Tiefenbrun. “But the real advantage to us has been in the LSE brand and reputation and its high level of integrity. This, and the relationship that LSE has with its market partners, is more valuable than anything else.” As to the phased roll-out, Tiefenbrun acknowledged that the technology team would enjoy a glass of champagne when the technology was fully up and running and out of testing. “However, I am responsible for product sales and marketing, so I will have my champagne when we start making money,”he laughs.

REMAKING THE PRIME BROKING MODEL

A New Face

Photograph ÂŠ John Kroninger/Dreamsti me.com, supplied June 2009.

Demand from large institutional clients continues to shape the rapidly evolving prime-brokerage model, forcing providers to re-examine what is profitable and what is not, what steps need to be taken in order to help clients improve clarity and risk management, and how to deal with the increasingly diverse and complex mix of asset classes within the alternative space. From Boston, Dave Simons reports RIME BROKING, AS it once existed, is a thing of the past. The undoing of former stalwarts Bear Stearns and Lehman Brothers were obvious game-changers, while the Madoff scandal underscored the need for tighter regulatory standards and counterparty risk mitigation. In reality, the trend had begun much earlier, as opportunistic custodian banks, eager to gain a foothold in the alternative space, began offering prime-time services such as trading, leveraging and fund administration. Demand from large institutional clients continues to

shape the rapidly evolving prime-brokerage model, forcing providers to re-examine what is profitable and what is not, what steps need to be taken in order to help clients improve clarity and risk management, and, among other things, how to deal with the increasingly diverse and complex mix of asset classes within the alternative space. Furthermore, brokerage-shopping clients also want institutions to be well capitalised, conservatively funded and have significant liquidity. It is a supremely challenging environment for existing brokerages, to say the least. The use of historical data and other traditional metrics can no longer be trusted in todayâ&#x20AC;&#x2122;s fast-moving markets. As such, streamlining the trade-execution process is considered a major part of the effort to address cost pressures that did not exist only six to eight months ago. Recent trends have only increased the demand for smartorder routing and other advanced trading mechanisms within the buyside. All of this will implore the broker community to sharpen their skill sets as never before in order to provide more transparency and increased beta.

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“With the landscape and the dynamics of the markets changing so dramatically, it is now a requirement for managers to be able to track their brokers’decision-making capability in near- or real-time in order to make a proper performance assessment,” says Dhiren Rawal, managing director for Quod Financial, a global provider of multi- and cross-asset adaptive trading technology. “Once managers begin aggressively collecting and examining real-time market data, they need much more sophisticated tools on hand. As a result, I think we’re going to see those kinds of solutions being implemented sooner, rather than later.” The need to expand the range and depth of services to include such “extras” as intra-day-oriented metrics has compelled brokerages to boost investments in technology in order to maintain market share. Still, cost pressures must be reckoned with, and some are managing better than others, says Rawal. “Tier two brokers have seen a lot of the business come their way, however they’re often ill-equipped to service clients who want real sophistication. As a result, they now need to really invest to keep up with the increased volume.” Plummeting indices have effectively halved the size of the prime-brokerage market since the onset of the financial crisis, from around $2trn in assets pre-fall to an estimated $1trn today. “Not only that, but, due to the deleveraging trend, overall financing is considerably down as well,” says Jeremy Todd, director for Pershing Prime Services, the Bank of New York Mellon affiliate and provider of financial services outsourcing services solutions for broker dealers, independent registered investment advisers, asset managers and financial intermediaries. Concerns over counterparty risk have prompted many fund managers to move long and/or cash assets to the perceived safe haven of the custodial banks, says Todd.“As a result, bank custodians are benefiting from more traditional prime-brokerage revenue streams. So it is a confluence of forces that are working to alter the dynamics of the prime-brokerage industry.” How the shake up impacts on any one firm in particular largely depends on the structure of that brokerage, says Todd, not to mention its historical standing within the marketplace. “Our business profile has served us very well, since Pershing is a company that is considered to be a very safe, stable counterparty with a sizeable custodial client base and is able to generate the kind of revenue that might otherwise be lost through a more traditional prime-brokerage model.” Only a year ago, a trio of brokerage firms controlled some 60% of the market. Today, however, hedge funds, increasingly wary of counterparty risk, are no longer content to use any one broker to house the majority of their assets. “Though the multiple prime-brokerage model has always been in existence, now there is much more of an even distribution of assets among the various providers, which really means that the market share as a whole is being divvied up among a much larger group of players than it has been historically,”notes Todd. Using multiple primes also helps ensure that alternative investment firms receive the best trading support services

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Ajay Nagpal, head of prime services for Barclays Capital.“It is definitely working to broaden the landscape—fundamentally, the criteria that a client might use to select a prime broker has changed considerably. Before, simply having the support of the consulting community and the testimony of other clients was good enough. Not any more.” Photograph kindly supplied by Barclays Capital, June 2009.

available, says Rawal.“There has a been a much greater focus on understanding whether the algos from each of the brokers are working properly, as well as making sure that smart orders are being executed in the most efficient manner possible. And because there is less capital available now from each of the brokers, the objective is to achieve the same level of capital support that they were receiving before.” Smaller clients in particular have increased their efforts to diversify their prime-brokerage relationships, the result of both self-imposed and client-imposed pressure, says Ajay Nagpal, head of prime services for Barclays Capital. “It is definitely working to broaden the landscape— fundamentally, the criteria that a client might use to select a prime broker has changed considerably. Before, simply having the support of the consulting community and the testimony of other clients was good enough. Not any more.” All of which has helped bring about a major re-shuffling within the prime-brokerage space as clients continue to seek out incremental relationships. “The beneficiaries of this trend have primarily been the large commercial banking organisations, Barclays included, which have been

REMAKING THE PRIME BROKING MODEL 80

able to develop new relationships as a result,”says Nagpal. Furthermore, he adds, this diversification of relationships has taken place across multiple geographies.“While clients are working to spread the risk among different organisations, at the same time it also makes sense to think about organisations that have some kind of geographical dispersion, given that they want to have prime-brokerages who are each subject to different regulatory regimes and central-banking oversight.” While many funds have been busy expanding their list of prime providers in an effort to improve control and gain clarity, overly diverse clients have been paring their list of brokers in order to accomplish the same objective. Roy Martins, head of international prime services, Credit Suisse, says: “In other words, if a client who previously may have only had one prime broker and now has three, a client who had six brokers prior to the crisis likely now only has three brokers as well. What we’re seeing is a convergence around a set number of brokers that is perceived to be more practical from both a risk-diversification and operationalefficiency standpoint.” Whether increasing or downsizing, Credit Suisse’s Advanced Prime service programme, established in 2007, helps clients effectively navigate the multi-prime waters, says Martins.“It allows them to have a very consistent platform and process that they can work from in order to access the various broker relationships. We’ve made some strategic investments in that space in order to facilitate the growing demand.” The value proposition also ranks high among clients, and Martins cites securities lending and capital services as leading components of Credit Suisse’s prime-brokerage offering. He adds: “We’ve shaped our business around a much more execution-driven model on the capital side, where we have a group of people who can either do traditional capital introduction, or actually raise assets on behalf of the client for a fee.” Helping clients manage balance sheet and businessfunding issues related to complex structured products is yet another key offering among top brokers, says Martins.“We continue to invest in this heavily with the belief that it is the kind of differentiating, content-driven service that clients truly value.” Brokers also need to be able to provide clients with the highest-level of reporting services possible, adds Terry Ransford, senior vice president and head of fixed-income trading for Northern Trust Securities. “In addition to conventional custodian-like reporting, clients also want the flexibility to short sell and use derivatives—attributes that aren’t normally associated with a traditional, long-only trust and pension custodian.“ Manager-performance analytics, as well as attribution, distribution and commission analysis, are additional services typically provided by well-positioned custodians, says Ransford. This will ultimately lead to a truly integrated brokerage industry, one that combines the best of both traditional prime brokerage and custody (already evident in the likes of Bank of NewYork Mellon’s ConvergEx and Pershing groups). Among other things, this melding of

The use of historical data and other traditional metrics can no longer be trusted in today’s fast-moving markets. As such, streamlining the trade-execution process is considered a major part of the effort to address cost pressures that didn’t exist only six to eight months ago.

methodologies will help reduce the need for an assortment of brokerages, suggests Ransford. He says: “By using a tri-party agreement, for instance, collateral may be held with the global custodian while being pledged to the brokerage firm for the benefit of the money manager. This lessens the need to mitigate counterparty risk, because in reality, the assets aren’t really on deposit with the broker.” Based on their own research, Barclays Capital—which acquired the North American businesses and operating assets of Lehman Brothers for a tidy $1.75bn late last year— created a wish-list comprised of five key components: asset protection coverage, stable financing, infrastructure, differentiated content, and a capital markets approach. Says Nagpal: “Post-Lehman bankruptcy, every client is thinking very hard about the nature of the risk they take with the counterparty, especially when one considers that the client is lending the prime broker money on an unsecured basis. Given that, asset protection has really become an absolute requirement. Also, since clients now have a limited pool of capital resources as a result of the market decline first and foremost, they want a primebrokerage relationship with someone who can attack this issue from a multi-asset class perspective—hence the need for a focused capital-markets approach.” Stable financing has become a key selling point due to current liquidity constraints, says Nagpal, adding that while the ability to demonstrate a solid infrastructure helps allay fears related to control and risk management. Finally, clients that are seeking differentiated content will be drawn to brokerages that can provide unique intellectual capital, including riskmanagement framework and tools, market insight, capital raising and capital introduction, he says. “The prime broker is there to provide leverage, financing, risk management—it is a very high-end content kind of business,” maintains Martins.“It has a much different cost structure and dynamic than a pure custodial business. So from our perspective, when appropriate, we work to offer clients alternatives that help in the context of a broader overall prime-brokerage relationship. It really boils down to the nature of the client—if the main objective is to be essentially a long-only, un-levered fund, then that is really a job for the custodian, which really underscores the importance of doing a careful analysis in order to access a client’s level of risk, right from the start.”

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The drop in LIBOR is the best indication that the world’s major financial institutions are no longer afraid to lend to each other but even when banks do start to loosen the purse strings and the securitisation markets come back to life, credit will never be as easy as it was prior to the credit crunch. Neil O’Hara

Photograph © Paolo de Santis/Dreamstime.com, supplied June 2009.

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HE ICE AGE that froze the credit markets after Lehman Brothers failed in September has begun to loosen its grip. As fears of a systemic financial collapse leading to another Great Depression have receded, credit spreads have narrowed everywhere, from the short-term interbank market to long-term corporate bonds. The capital markets have reopened, too: Investors are snapping up new issues of both investment-grade and highyield corporate bonds. But banks are still tightening lending standards, the securitisation markets remain moribund except where the government has intervened, house prices keep on falling and the commercial real estate sector is on its knees. Do signs of life in the credit markets herald a brief mid-winter thaw or long-term global warming?

CREDIT MARKETS: A BRIEF THAW OR LONG-TERM WARMING?

IS THE END OF THE ICE AGE IN SIGHT?

CREDIT MARKETS: A BRIEF THAW OR LONG-TERM WARMING? 82

The drop in LIBOR is perhaps the best indication that the world’s major financial institutions are no longer afraid to lend to each other. John Calverley, head of research, North America, at Standard Chartered Bank, points out that it lowers borrowing costs throughout the economy, too, because so many bank loans and other credit products price off LIBOR. That stimulative effect may be muted by persistent tightening in bank credit standards, however. “The quarterly Federal Reserve senior loan officer survey has been misinterpreted,”says Calverley. “People said they were tightening by less than before. That means they turned the screw a little more in the first quarter, having turned it substantially last year.” He does not expect the banks to relax lending criteria until after the economy starts to grow again in light of their historical experience that loans still go bad in the early stages of an upturn. Jeffrey Rosenberg, head of credit research at Bank of America in New York, draws a distinction between eliminating the worst-case scenario and a return to credit expansion. After the Lehman bankruptcy, the LIBOR/OIS spread (the difference between LIBOR and the overnight index swap rates) blew out from about 100 basis points (bps) to a peak of 400 bps, but it has since narrowed to below 100 bps. “We have completely removed the crisis indication from the cost of financing private financial institutions,”says Rosenberg.“That is not to say it will lead to an immediate return to pre-crisis credit availability.” In fact, he expects banks and regulators to reassess what the appropriate level of credit for the economy should be, which will affect how much it costs in the future. Although Keith Leggett, a senior economist at the American Bankers Association (ABA), agrees that lower LIBOR and a contraction in the LIBOR/OIS spread do indicate a thaw, he notes that the markets have also absorbed a huge injection of liquidity from central banks and the Federal Reserve in particular. “Is the improvement in LIBOR a reflection of central bank intervention?” he asks. “Or is it an indication that markets have really corrected?“He’s optimistic it’s the latter, but nobody can be certain until governments curtail their support. Looking beyond the short-term money markets, Milton Ezrati, senior economist and market strategist at Lord Abbett, an $86bn money manager based in Jersey City, NJ, cites a revival in issuance of both investment-grade and high-yield corporate bonds as evidence that investors have begun to recover their appetite for risk. Weakness in the dollar and rising treasury bond yields confirm his view, too. “The dollar and treasuries received a tremendous inflow of funds in the period of greatest fear,” says Ezrati. “The money is flowing back out. That is a welcome sign.” Another indicator of returning health in the credit markets comes from high-yield bonds, which do not qualify for any of the government programmes now in place. Bimal Shah, an analyst at Fox-Pitt, Kelton, an investment bank that specialises in the financial services industry, notes that highyield spreads over Treasuries tumbled about 30% from 17% to 12% in April alone, a clear sign that investors are willing

Keith Leggett, a senior economist at the American Bankers Association (ABA), agrees that lower LIBOR and a contraction in the LIBOR/OIS spread do indicate a thaw, but he notes that the markets have also absorbed a huge injection of liquidity from central banks and the Federal Reserve in particular.“Is the improvement in LIBOR a reflection of central bank intervention?” he asks.“Or is it an indication that markets have really corrected?” He’s optimistic it’s the latter, but nobody can be certain until governments curtail their support. Photograph kindly supplied by ABA, June 2009.

to lend even to the riskiest companies. Investment grade spreads narrowed sharply, too, albeit not quite as much. Shah says that while the decline in LIBOR is important, the popular perception that banks are reluctant to lend is misconceived. Before the credit crisis hit, bank lending accounted for only 30-35% of total credit outstanding, with the rest supplied through the capital markets, including securitisation. The withdrawal of credit from the economy is mainly due to the collapse in securitised debt markets: New issue volume fell from about $700bn in 2007 to just $200bn in 2008.“Securitisation is the biggest piece missing in the lending equation right now,” says Shah. “Six to 12 months down the road bank lending will be much higher because banks will recapture some of that share even though it may be at a higher interest rate.” The banks won’t be able to fill the gap entirely, however. Even though the major banks moved quickly to meet the capital needs identified by the Federal Reserve’s stress tests, the industry has nowhere near enough capital to support the incremental lending needed to substitute for securitisation. Shah notes that activity has picked up in the asset-backed securities (ABS) market in recent months, but new issuance is concentrated in sectors that qualify for the Troubled Asset Lending Facility (TALF), like credit card and jumbo mortgage deals. “Securities that qualify for TALF have seen spreads narrow much more than Alt-A, subprime or other securities that do not qualify,”he says. The natural instinct among bankers to lend umbrellas only when the sun is shining has not deserted them. ABA members tell Leggett that banks are happy to lend to creditworthy borrowers—although the definition of creditworthy has tightened in the past year. New customers

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get raked over the coals more than existing ones, too. “Banking is a relationship business,”says Leggett.“Businesses that relied on the capital markets for their funding and only turned to banks when the markets froze up are subject to a lot more scrutiny. We are seeing lower loan-to-value ratios, wider risk spreads and more covenants for the borrowers.” Leggett doesn’t expect lower quality borrowers to have easier access to credit until the economy turns around. Many of these companies never had access to the capital markets anyway, and before the credit crisis hit, hedge funds had elbowed the banks aside to become an important source of credit through direct lending and participation in syndicated loans. Today, hedge funds are struggling to adapt to a capital base that has roughly halved in the past 18 months and have little appetite for illiquid assets like loans to weak credits. “Banks will pick up market share,”says Leggett.“For the next couple of years the banking model may resemble what we had 25 years ago before securitisation—banks holding on to loans in their portfolios.” Like Shah, Leggett notes that the securitisation market has recovered only for assets for which the government provides some guarantee, including agency MBS and securities eligible for TALF. Private label MBS issuance remains non-existent, and the obstacles to its revival extend to the political arena. Congressman Barney Frank, chairman of the House Financial Services Committee, has floated legislation that would require sponsors to retain a portion of the loans they securitise. The idea has populist appeal—as did Frank’s earlier support for increased mortgage lending to low income households that helped inflate the housing bubble—but in practice it undermines the economics of securitisation and could postpone or even forestall any rebound. Investors will have little appetite for private label MBS as long as house prices continue to slide. Standard Chartered’s Calverley estimates that 50%-75% of the bad debts in the banking system relate to residential mortgage debt, a proportion that is likely to rise based on his projection that the national Case-Shiller index of house prices will fall 40-50% before it hits bottom. The index is down 32% from the 2006 peak so far, but with the number of unemployed increasing by 500,000 per month at the moment, he sees no reason for house prices to stabilise until well into next year.“From this level we still have to fall another 20%,” says Calverley. “It’s an exponential curve, too. The first 10% fall doesn’t have much impact but each successive 10% decline triggers more defaults. It gets harder for lenders the more prices grind down.”

Undercapitalised It’s no surprise that Calverley believes US banks remain undercapitalised. In fact, the adverse case in the Federal Reserve’s stress test corresponds to Standard Chartered’s base case—and the banks would certainly need more capital if things turn out worse than that. In effect, Calverley says, the banks will operate with insufficient capital and an implied government guarantee until they earn enough money over time to restore their capital bases without having to pay the cost in the interim.“The US approach here is not dissimilar to the

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Japanese approach in the 1990s,” he says. “That is good for existing bank shareholders, but not necessarily for the economy because it means the banks will not be aggressively lending.” Bank of America’s Rosenberg argues that the stress tests were intended to counter the impression created by the bailouts of Bear Stearns, Fannie Mae and Freddie Mac that the government would not protect holders of equity in financial institutions, a policy intended to fight moral hazard. Investors got the message, but it scared them away from equity in financial institutions and left banks unable to tap the public markets to rebuild their depleted capital.“The stress test strategy has worked remarkably well,” says Rosenberg.“Confidence has returned. Equity capital can be raised in the private market now that investors know exactly how much capital the government thinks is needed.” Completion of the US stress tests has ratcheted up the pressure on European banks and bank regulators who have not conducted a similar exercise. Rosenberg notes that because European regulators never flagged their concern about moral hazard they don’t have the same need to shore up investor confidence—although he isn’t suggesting that European banks are in robust health.

Greatest threat In fact, Lord Abbett’s Ezrati sees European banks as the greatest threat to the global financial system at the moment. Not only are they more highly leveraged than the major US banks but they also have significant exposure to questionable credits.“It is not just that the European banks own so much of this garbage (US toxic assets) but they also own a great deal of debt in eastern Europe and Asia.We are not sure how well that will pay out,” says Ezrati.“I doubt they would pass stress tests on the criteria that (US treasury secretary Timothy) Geithner used.” US banks that had to raise additional capital after the stress tests had little difficulty getting the money they needed to meet the targets. Yet while the capital markets have reopened for business, Ezrati points out that US bank lending has not picked up at all, as if the banks will lend only to the best credits—which don’t need them. “People who can get credit from the banks either have a lot of cash—and there are firms with a lot of cash—or they are issuing debt in the public markets,” he says. For the vast number of companies too small to access the capital markets, banks are the only option—and they are in no hurry to lend to those borrowers. Even when banks do start to loosen the purse strings and the securitisation markets come back to life, credit will never be as easy as it was prior to the credit crunch. Rosenberg says the crisis revealed that financial institutions leveraged 30-40 times pose an unacceptable threat to the system, but the adjustment to a more prudent level has to take place over a long period of time in order to avoid an economic depression. “Credit availability from 2002 to 2007 was abnormal—excess supply and underpriced,”he says.“In future, credit will be less readily available and the cost will be higher.” The Ice Age is probably over—but the ice won’t melt for quite a while.

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In Need of

the Kiss Of Life ‘Now securitisation is a positively disgusting word,’ would no doubt have been the take of the fictional General Melchett from the highly acclaimed British television series Blackadder IV on the financing practice that precipitated the worst economic crisis since the 1930s. Six months ago, many investors, politicians and regulators would probably have shared this view, but most have since come to recognise that securitisation will have an important role in the long-term revival of a sound banking system, in which lending to consumers and businesses can grow at a sensible and sustainable rate once again. But resuscitating the corpse will not be easy. Andrew Cavenagh reports.

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

HERE ARE CERTAINLY huge challenges to address. Investors in the United States and Europe are sitting on $8trn to $9trn of securitised bonds that they cannot sell without sustaining serious losses. Those obliged to markto-market their assets have already made massive provisions on these asset-backed holdings over the past 18 months. The latest figures that the European Securitisation Forum published in May confirmed how depressed the market remains. Quoted secondary market prices—there is not enough activity to constitute genuine trading—for triple-A continental European residential mortgage-backed securities (RMBS) with maturities of three to five years ranged from 72% to 91% of their par value. This translated into spreads of 350 to 650 basis points (bps) over the Euribor benchmark—well into historical high-yield territory. Such unprecedented widening of secondarymarket spreads has obviously destroyed the economic rationale for further primary issuance.

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undoubtedly revived since Unless those securitising loans its launch. could increase the margins on the Chase Issuance Trust, the underlying assets JPMorgan subsidiary, filed a proportionately—which would prospectus with the Securities & mean hiking mortgage rates into Exchange Commission on May 4 the mid-to-high teens—the cost for a TALF-eligible issue of up to of funding such lending via $7.5bn, and total issuance under securitisation would far exceed the scheme for the month the margin that the originators exceeded $10bn. Most of the could charge their borrowers. In issues have paid margins of the current environment, the around 150% over LIBOR— chance of any lender raising its interest rates to this extent and Hans Vrensen, head of securitisation research at Barclays compared with secondary market retaining any business would be Capital in London. Photograph kindly supplied by spreads of around 600bps in nil. There is broad consensus in Barclays Capital, June 2009. January—which is clearly a low enough level to encourage repeat the securitisation industry that the dislocation of the market is so severe it has gone issuance. Ford Credit, which launched a $3bn issue backed beyond the point of self-correction. “The market will not by consumer auto loans in March, indicated it would come necessarily re-ignite itself for several reasons,” maintains to the market again before the end of the year. The Fed is also looking at extending the scheme to Rick Watson, managing director of the European commercial mortgage-backed securities (CMBS) and Securitisation Forum (ESF). High among them, he explains, was that the de- possibly even some RMBS, although it is safe to assume that leveraging of the global banking system had eroded the it will not include securities backed by sub-prime loans. There are few who believe that the European securitisation traditional investor base for asset-backed securities (ABS), particularly in Europe, where banks or their off-balance market can make a comeback without the support of a sheet vehicles previously bought two-thirds of all new similar initiative, given its greater exposure to the banking issuance and also cut the availability of funding for other crisis. Not only have the off-balance-sheet bank vehicles— conduits and structured investment vehicles (SIVs) — types of investor. The response of the US government, which oversees by disappeared as big investors in ABS, but new regulations far the largest and deepest securitisation market in the under both European Union legislation and revisions to the world (Europe accounts for just €1,700bn of the Basel II Capital Accords will impose higher regulatory-capital outstanding issuance in the two continents) has been to charges on such assets.The financial institutions will also face launch a massive scheme to support the issuance of new much more onerous obligations in respect of monitoring and asset-backed securities. The Federal Reserve’s Term Asset- reporting the performance of ABS investments. Most small and mid-size European banks will almost Backed Securities Loan Facility (TALF), which took effect in March, will lend up to $8trn to buyers of short-term (three- certainly reduce or outsource their ABS holdings as a year) triple-A securities that are backed by non-mortgage consequence of these increased due-diligence requirements, lending to consumers (portfolios of auto loans, student and several may well withdraw from the market altogether. “A lot of them have been questioning whether they should loans and credit-card accounts) and small businesses. While the Fed takes a haircut on the loans—which means bother,” observes Hans Vrensen, head of securitisation borrowers receive slightly less than their commitments— research at Barclays Capital in London. Watson at the ESF concluded: “Basically you have to they are non-recourse, secured only against the ABS investments for which they are used to pay. This virtually replace that bank investor base. You have to look at what eliminates exposure for the borrowers but still offers them non-bank investors will need to start becoming interested all the potential upside from the investment. The US in securitisation.” One pre-requisite will be a stable market that enables treasury is providing a facility of up to $100bn to cover any them to trade such investments at sensible prices that losses the Fed incurs under the scheme. While initial take-up of TALF was slow, with loan requests reflect the credit risk rather than disillusioned market of just $4.7bn and $1.7bn in March and April respectively, sentiment. The size of the spreads on what few small trades the programme has succeeded in kick-starting a resumption are taking place currently owes everything to the absence of primary issuance—if at only about 5% of the level of of any meaningful liquidity in the market—not concerns about the underlying credit in most cases. activity seen before the market froze in November. “You know you’re going to have to sell these bonds at a Despite continuing reservations about the programme among some investors—hedge funds, in particular, fear that discount if you need to offload them for your own liquidity the executive-pay curbs that apply to banks participating in reasons,”explains Jean-David Cirotteau, structured-finance the parallel Troubled Assets Relief Programme (TARP) will analyst at Société Générale Corporate and Investment also apply to the TALF—interest in US securitisation has Banking in Paris.

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SECURITISATION: BEYOND THE POINT OF SELF-CORRECTION

This lack of liquidity is preventing many real-money investors from seizing the investment opportunity of a lifetime. For while there is undoubtedly a lot of outstanding ABS that truly justifies the label “toxic asset”, there is a great deal more that is anything but, if assessed simply on the basis of its credit risk. Take the largest single type of bond in the European market—triple-A prime RMBS—as an example. Most of these bonds (some Spanish deals are the exception) will not default in even the most extreme scenarios that the more pessimistic economists have projected for the present recession, yet their quoted prices represent 88-90% of their face value. This offers the sort of return traditionally associated with junk bonds for a rock-solid investment. As long as the secondary market remains so illiquid, however, pension funds, insurance companies and fund managers will stay away. “A lot of investors are very comfortable with the credit risk of the underlying asset,” says Watson.“What they’re not comfortable with is whether or not they can sell it.” Some securitisation bankers feel that Europe needs to address the problem that investors face with the overhang of existing assets before looking at a revival of the primary market. “Most people are focusing on re-starting the primary issuance market, but is there no room to improve the situation for existing deals?”asksVrensen at Barclays Capital. The problem is that Europe does not have the combination of a single central bank and government treasury that can set up and fund a scheme like the TALF. The European Central Bank may have provided short-term liquidity for banks to issue ABS through its expanded repo programme, but this is a short-term fix that will not re-start the market—the securities involved have been structured specifically for this purpose and could not be sold into the market without being re-packaged and re-rated.

Furthermore, the measures that the EU has introduced this year to restore confidence in financial markets are likely to inhibit securitisation in the near-to-medium term. The Capital Requirements Directive, which will become law at the end of 2009 and take effect a year later, will impose the additional regulatory-capital costs and tighter reporting requirements on banks holding ABS, while the new EU regulation to govern the operation of rating agencies in the community can only make the process of rating ABS transactions more time-consuming and expensive. The ESF is consequently looking to persuade the leading European governments to set up appropriate initiatives. But given the number of imponderables involved, the organisation is not prepared to predict when a functioning securitisation market will return in Europe—just what needs to be done to enable it to happen.“We don’t have any specific time line, but we do have a set of conditions that are necessary for the market to come back,”says Watson. Ultimately, the way forward is signposted. “ABS investors are looking for the industry itself to make important structural changes,” highlights Scott F Posner, executive vice president and chief executive officer, corporate trust, at The Bank of New York Mellon. “We surveyed more than 250 participants at the Annual Global ABS Conference in London earlier this month, and the feedback was loud and clear: investors do not want to step in while secondary markets are dysfunctional and they can’t accurately assess the value of their portfolios. They are looking for more independent reports and analysis, an appetite that’s sure to influence the Trustee’s role. And that role’s going to emerge sooner. More than 80 percent of our respondents says the role of the Trustee has become more relevant—structurers and issuers both want to see the trustee on board at an early stage of structuring transactions.”

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Paul Spendiff Tel:44 [0] 20 7680 5153 Fax:44 [0] 20 7680 5155 Email:paul.spendiff@berlinguer.com

J U LY / A U G U S T 2 0 0 9 • F T S E G L O B A L M A R K E T S

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: November 2008 through June 2009 (Europe only). (â&#x201A;Ź) November

December

January

February

March

April

May

BTE/BATs

1,692,679,055

3,117,405,897

4,790,110,404

5,600,695,181

8,284,331,344

11,739,665,480

12,301,809,608

June (1-5) 7,966,699,687

CIX/Chi-X

55,474,806,309

37,565,687,908

46,712,279,892

44,287,264,624

57,055,170,476

64,549,417,670

67,015,814,749

30,257,762,922

CPH/Copenhagen

5,627,172,892

3,169,443,325

4,658,766,694

4,781,868,780

4,172,100,968

5,376,242,856

5,436,958,049

1,630,760,671

ENA/Amsterdam

29,515,979,897

23,377,293,076

28,998,109,764

28,228,747,464

33,374,484,823

33,930,345,328

33,811,464,108

12,840,670,067

ENB/Brussels

5,618,466,860

5,525,054,653

6,557,604,579

6,677,562,065

7,285,738,551

6,777,175,877

7,445,092,754

2,832,262,070

ENL/Lisbon

2,613,601,564

1,781,804,343

1,942,925,835

1,699,902,475

2,192,516,989

2,611,463,853

2,971,813,173

914,749,992

ENX/Paris

83,259,044,929

65,223,182,965

68,569,494,159

62,176,825,878

71,521,595,572

72,615,015,403

64,756,243,571

26,330,298,569

GER/Xetra

86,619,580,417

67,500,746,934

65,531,679,523

58,938,123,381

72,362,496,131

70,827,752,529

65,295,346,642

22,337,079,533

HEL/Helsinki

10,391,280,842

6,544,928,692

8,018,556,502

7,630,785,531

8,002,261,708

9,739,066,277

7,404,697,792

3,048,921,037

LSE/London

128,535,134,938

88,925,334,643

98,676,987,434

90,529,113,476

113,505,101,306

98,894,191,343

94,113,001,150

44,901,399,357

MAD/Madrid

47,772,645,094

38,385,030,437

43,520,648,521

37,123,194,201

45,141,078,254

47,509,757,990

44,325,704,359

17,731,663,334

MIL/Milan

40,577,825,970

27,355,375,071

33,878,620,775

33,642,167,059

40,867,417,146

51,081,732,593

65,550,350,346

19,738,248,104

NEU/Nasdaq-OMX

138,799,631

290,807,724

603,441,883

487,436,557

489,152,477

938,987,188

2,333,459,443

1,078,431,922

STO/Stockholm

20,077,565,709

15,283,216,874

18,432,301,605

20,449,832,829

21,258,141,925

23,114,786,824

19,718,479,803

8,054,649,101

TRQ/Turquoise

19,577,155,245

15,473,634,349

26,311,426,009

29,084,346,493

23,016,525,997

13,975,420,771

15,796,021,315

7,476,215,297

VTX/SWX

45,647,116,803

35,217,759,178

39,198,800,982

41,645,468,998

42,750,059,854

41,180,202,240

38,363,085,417

12,597,649,479

Monthly Total

583,138,856,156

434,736,706,069

496,401,754,564

472,983,334,994

551,278,173,520

554,861,224,224

546,639,342,279

219,737,461,142

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) November

December

January

February

March

April

May

BTE/BATs

0.29%

0.72%

0.96%

1.18%

1.50%

2.12%

2.25%

3.63%

CIX/Chi-X

9.51%

8.64%

9.41%

9.36%

10.35%

11.63%

12.26%

13.77%

CPH/Copenhagen

0.96%

0.73%

0.94%

1.01%

0.76%

0.97%

0.99%

0.74%

ENA/Amsterdam

5.06%

5.38%

5.84%

5.97%

6.05%

6.12%

6.19%

5.84%

ENB/Brussels

0.96%

1.27%

1.32%

1.41%

1.32%

1.22%

1.36%

1.29%

ENL/Lisbon

0.45%

0.41%

0.39%

0.36%

0.40%

0.47%

0.54%

0.42%

ENX/Paris

14.28%

15.00%

13.81%

13.15%

12.97%

13.09%

11.85%

11.98%

GER/Xetra

14.85%

15.53%

13.20%

12.46%

13.13%

12.76%

11.94%

10.17%

HEL/Helsinki

1.78%

1.51%

1.62%

1.61%

1.45%

1.76%

1.35%

1.39%

LSE/London

22.04%

20.45%

19.88%

19.14%

20.59%

17.82%

17.22%

20.43%

MAD/Madrid

8.19%

8.83%

8.77%

7.85%

8.19%

8.56%

8.11%

8.07%

MIL/Milan

6.96%

6.29%

6.82%

7.11%

7.41%

9.21%

11.99%

8.98%

NEU/Nasdaq-OMX

0.02%

0.07%

0.12%

0.10%

0.09%

0.17%

0.43%

0.49%

STO/Stockholm

3.44%

3.52%

3.71%

4.32%

3.86%

4.17%

3.61%

3.67%

TRQ/Turquoise

3.36%

3.56%

5.30%

6.15%

4.18%

2.52%

2.89%

3.40%

VTX/SWX

7.83%

8.10%

7.90%

8.80%

7.75%

7.42%

7.02%

5.73%

Monthly Total

100.00%

F T S E G L O B A L M A R K E T S â&#x20AC;˘ J U LY / A U G U S T 2 0 0 9

June (1-5)

EUROPEAN TRADING STATISTICS

TRADING DATA FOR EARLY MAY 18th-22nd MAY 2009 (EUROPE ONLY) Venue turnover for the week 1st-5th June 2009 Venue

Trades

European Top 20 Fragmented Stocks for the week 1st-5th June 2009

Turnover € 000’s

Share %

-5

London

3,024,986

26,140,633

21.23%

-1

Chi-X

2,856,869

16,926,817

13.75%

-22

Paris

1,474,043

14,455,146

11.74%

-16

-17

-47

-26

Xetra

652,624

13,318,906

10.82%

Milan

891,877

10,728,435

8.71%

Madrid

479,591

10,366,210

8.42%

-91

SWX

385,627

6,932,665

5.63%

-2

Amsterdam

611,670

5,820,233

4.73%

-34

Turquoise

781,403

4,490,292

3.65%

-28

-66

-25

-51

Stockholm

326,499

4,451,734

3.62%

BATS

810,664

4,380,653

3.56%

Helsinki

143,759

1,799,766

1.46%

-13

Brussels

230,919

1,341,780

1.09%

-92

Copenhagen

48,616

775,491

0.63%

-32

Nasdaq OMX

144,973

701,558

0.57%

-21

Lisbon

87,086

486,926

0.40%

-39

-12

Wks

Stock

Description

WKL.AM

WOLTERS KLUWER

2.29

FFI

RDSA.L

RDS 'A' 'A' ORD EUR0.07

2.27

RDSB.L

RDS 'B' 'B' ORD EUR0.07

2.19

REL.L

REED ELSEVIER ORD 14 51/116P

2.17

SDRC.L

SCHRODERS NV NON-VTG SHS ?1

2.17

VIV.PA

VIVENDI

2.13

SHP.L

SHIRE ORD 5P

2.13

WPP.L

WPP ORD 10P

2.11

MMB.PA

LAGARDERE S.C.A.

2.11

FME.DE

FRESEN.MED.CARE KGAA ST

2.11

FP.PA

TOTAL

OR.PA

L'OREAL

2.09

HEN3.DE

HENKEL AG+CO.KGAA VZO

2.09

CPG.L

COMPASS GROUP ORD 10P

2.06

IMT.L

IMP.TOBACCO GRP ORD 10P

2.04

KPN.AM

KPN KON

2.03

ULVR.L

UNILEVER ORD 3 1/9P

2.02

KGF.L

KINGFISHER ORD 15 5/7P

2.01

RB..L

RECKITT BEN. GP ORD 10P

2.01

TSCO.L

TESCO ORD 5P

2.01

2.1

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

Alternative Venues

Index

Venue

Chi-X

Turquoise

Nasdaq OMX

BATS

Copen.

Amst.

Paris

Xetra

AEX

Amsterdam

68.30%

18.41%

3.29%

0.77%

4.77%

4.23%

0.12%

Helsinki

BEL 20

Brussels

56.70%

11.76%

2.29%

0.81%

3.67%

24.23%

0.07%

CAC 40

Paris

63.58%

17.46%

3.41%

1.35%

6.10%

7.00%

0.12%

DAX

Xetra

73.99%

15.87%

4.19%

0.88%

4.20%

†

FTSE 100

London

70.88%

18.07%

5.67%

0.49%

4.88%

FTSE 250

London

78.85%

14.76%

3.59%

0.19%

2.61%

IBEX 35

Madrid

99.79%

0.14%

†

0.02%

MIB 30

Milan

90.02%

7.58%

0.70%

0.04%

1.57%

†

0.06%

NORDIC 40

Stockholm

54.29%

11.14%

2.17%

0.14%

0.45%

9.46%

†

0.38%

21.95%

PSI 20

Lisbon

98.99%

1.00%

†

SMI

SWX

85.96%

7.48%

6.04%

0.12%

0.39%

† market share < 0.01%

COMMENTARY Looking at the FFI it is interesting to note that we are starting to see the rest of Europe “catching up” with what is happening in London. The graph below clearly shows how rates of fragmentation in the DAX and CAC 40 are converging with those of the FTSE 100. In some cases this is down to the very aggressive pricing models that MTFs such as BATS and NASDAQ OMX Europe are now offering. The basic idea is that the spread between their maker taker pricing models is structured so as to entice traders to post passive liquidity onto their venues. The real question is whether this shift in liquidity will remain once “normal” pricing is resumed. There is a distinction between attracting market share through deep discounting and really shifting liquidity permanently from one venue to another. Interestingly, when BATS applied the same pricing promotion in the US at the beginning of 2007, they were successful in keeping and growing the liquidity seeded in this way. Market share is one thing, but reaching profitability is quite another. The primary and alternative venues are all on different trajectories in terms of revenue/cost projections and each of the MTFs will attest to the deepness of their investors’ pockets. This looks likely to be put to the test as the current trend towards deep discounting to attract liquidity continues. Only when “normal” pricing has been resumed for a while will we be able to tell which sorts of liquidity are naturally aligned with which venues. Meanwhile, traders are basking in lower and lower trading costs but, if they don’t let the new venues make a reasonable return, they may find that there are fewer left to choose from.

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.

J U LY / A U G U S T 2 0 0 9 • F T S E G L O B A L M A R K E T S

Number of Securities Securities Available for Lending Securities On Loan Securities Transactions

Value of Securities (US$ Bln)

174,019

9,173

31,417

1,816

1,716,559

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

Lendable Assets (M)

Balance vs Cash (M)

Utilisation (%)

SL Fee (Bp)

Revenue Share from SL (%)

SL Return to Lendable Assets (Bp)

Total Return Lendable Assets (Bp)

All Securities

9,173,072

1,068,881

747,055

All Bonds

4,891,751

568,568

449,439

1,815,936

16.03

108.03

83.84

12.23

16.36

1,018,007

19.12

4.29

15.10

5.87

118

Corporate Bonds

2,480,221

86,282

54,080

Government Bonds

2,256,069

478,450,

394,055

140,362

5.00

8.48

24.05

1.93

133

872,505

35.77

3.56

13.05

10.53

All Equities

4,270,456

500,308

116

297,238

797,546

12.52

240.50

93.54

28.41

Americas Equities

2,567,646

293,110

42,242

335,353

10.56

98.81

79.53

13.35

457,645

30,215

33,418

63,632

8.92

78.43

85.74

7.79

112

1,032,320

135,056

215,967

351,023

18.95

406.49

97.94

77.55

118,858

24,130

2,218

26,348

12.66

383.60

95.92

20.74

65,196

16,127

2,127

18,855

16.43

20.34

47.34

47.57

8.50

Asian Equities European Equities Depository Receipts Exchange Traded Funds

Balance vs Non Cash (M)

Total Balance (M)

SL Tenure (days)

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

Equities Top 10 by Total Balance

Top 10 by Increase in Balance (Balance > 10 Mln USD)

Rank

Stock description

Rank

Stock description

Sanof i-Aventis Sa

Volkswagen Prf

Total Sa

Icade Sa

Nestle Sa

Centrica

E.On Ag

Bilfinger Berger Ag

Allianz Se

Crescent Point Energy Trust Unt

Muenchener Rueckversicherungs Gesellschaft Ag

Parker Hannifin Corp

Banco Santander Sa

Henkel Ag & Co. Kgaa

Rwe Se

Ses Ord

Basf Se

Panasonic

Nokia Qyi

Fresenius Se

Corporate Bonds Top 10 by Total Balance

Top 10 by Increase in Balance (Balance > 10 Mln Euro)

Rank

Stock description

Rank

Stock description

Goldf ish Master Issuer Bv (4.721% 28-Nov-2099)

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

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

Bank Of America Na (2.1% 30-Apr-2012)

Canada Housing Trust No 1 (2.7% 15-Dec-2013)

General Electric Capital Corp (1.8% 11-Mar-2011)

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

Caisse De Refinancement De L’Habitat (4% 25-Oct-2009)

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

General Electric Capital Corp (5.25% 19-Oct-2012)

Canada Housing Trust No 1 (4% 15-Jun-2013)

Bbva Leasing 1 Fta (4.17% 26-May-2031)

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

Host Hotels & Resorts Lp (6.75% 01-Jun-2016)

Canada Housing Trust No 1 (4.65% 15-Sep-2009)

Lloyds Tsb Bank Plc (4% 17-Nov-2011)

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

Sungard Data Systems Inc (9.125% 15-Aug-2013)

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

Electricite De France Sa (5.875% 18-Jul-2031)

SECURITIES LENDING DATA by DATA EXPLORERS

KEY PERFORMANCE EXPLORER STATISTICS AS OF 29th APRIL 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, 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

F T S E G L O B A L M A R K E T S • J U LY / A U G U S T 2 0 0 9

info@performanceexplorer.com © Copyright Data Explorers Limited March 2009

EXCHANGE TRADED FUNDS: LISTING & DISTRIBUTION

Worldwide ETF and ETP Growth

Assets US$ Bn $1,000

# ETFs 1,800 1,600

$800

1,400 1,200

$600 1,000 800 $400 600 400

$200

200 $0 ETF Assets Total

0 1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Apr-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

$710.7

$706.9

$6.3

$9.9

$13.0

$0.1

$4.0

$5.8

$23.1

$21.3

$35.8

$59.9

$104.0

$122.1

$0.8

$1.1

$2.3

$5.3

$8.2

$17.6

$39.6

$74.2

$104.7

$137.5

$205.9

$286.3

$389.6

$526.5

$729.9

$596.4

$571.2

$15.6

$28.1

$45.9

$53.2

$72.9

134

272

301

461

714

1,171

1,591

1,677

ETF Commodity Assets

$0.0

ETF Fixed Income Assets ETF Equity Assets

$0.1

$0.3

$0.5

$1.2

ETP Assets Total

# ETPs # ETFs

202

280

282

336

$3.4

Source: ETF Research & Implementation Strategy Team, Barclays Global Investors, Bloomberg. June 2009

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

Country

Exchange

Australia China

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

Asia Pacific

Hong Kong India Indonesia Japan Malaysia New Zealand Singapore South Korea Taiwan 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)

166

223

49.88

967

3 3 2 16 2 10 1 6 57 3 6 6 38 11 2

21 3 2 30 2 10 1 6 59 3 6 29 38 11 2

0.92 1.38 1.81 14.91 0.49 0.22 0.00 8.88 15.75 0.31 0.27 0.95 2.21 1.71 0.06

12.64 287.50 98.78 224.99 0.00 3.35 0.00 89.64 76.95 0.01 0.13 7.84 133.85 31.14 0.50

792

941

504.55

73,328.71

4 84 7

4 84 156

1.41 17.73 5.20

16.77

4 645

67.61 395.84

9.95 667.72 121.94 10,542.46 1,037.37 450.82 567.90 334.02 984.48 19,319.53 20,943.26 0.00 0.00 18,349.24 0.00

719

1,845

152.44

2,260.92

1 1 1 193 285

9 131

21 1 1 346 469 50 1 1 1 14 300 78 6 1 1 19 30 7 153 17 9 319

0.04 0.04 0.13 39.01 65.15 0.00 0.08 0.01 0.00 0.07 1.31 0.30 0.42 0.00 0.01 1.07 2.19 1.63 12.08 0.00 0.24 28.64

0.32 0.22 4.53 363.90 699.09 15.09 0.21 0.37 0.00 0.27 263.87 49.73 82.54 0.00 0.00 5.53 14.99 152.66 112.49 7.73 48.80 255.32 20.04 163.20

1,677

3,009

706.87

76,556.93

1 1 1 14 14 3 6 1 1 19 9 7 21

20 Day ADV ($m)

Source: ETF Research & Implementation Strategy Team, Barclays Global Investors, Bloomberg. June 2009

J U LY / A U G U S T 2 0 0 9 â&#x20AC;˘ F T S E G L O B A L M A R K E T S

Global ETF Assets by Type of Exposure, as at end April 2009 Number of ETFs

Total Listings

AUM ($bn)

% Total

North America - Equity 476 Fixed Income - All (ex-Cash) 183 Emerging Markets - Equity 246 Europe - Equity 365 Asia Pacific - Equity 141 61 Global (ex-US) - Equity 49 Commodities Fixed Income - Cash (Money Market) 16 98 Global - Equity 13 Currency Mixed (Equity & Fixed Income) 27 Alternative 2 Total 1,677

654 339 499 793 235 66 107 32 242 13 27 2 3,009

$306.61 $111.29 $90.14 $76.00 $49.18 $38.53 $12.96 $10.86 $10.69 $0.31 $0.30 $0.01 $706.87

43.4% 15.7% 12.8% 10.8% 7.0% 5.5% 1.8% 1.5% 1.5% 0.0% 0.0% 0.0% 100.0%

Region of exposure

Fixed Income Cash (Money Market) Global - Equity Commodities

1.5%

1.8%

Currency

Global (ex-US) Equity

5.5%

Mixed (Equity & Fixed Income)

Asia Pacific Equity

7.0%

Alternative

Europe - Equity

10.8%

Emerging Markets - Equity

North Americas Equity

12.8%

43.4%

Fixed Income - All (ex-Cash)

15.7%

Source: ETF Research & Implementation Strategy Team, Barclays Global Investors, Bloomberg. June 2009

TOP 25 ETF PROVIDERS AROUND THE WORLD: ranked by AUM, as of end April 2009 April 2009 PROVIDER

iShares State Street Global Advisors Vanguard Lyxor Asset Management db x-trackers PowerShares ProShares Nomura Asset Management Bank of New York Van Eck Associates Corp Nikko Asset Management Credit Suisse Asset Management Daiwa Asset Management EasyETF Zurich Cantonal Bank Direxion Shares Nacional Financiera Hang Seng Investment Management ETFlab Investment WisdomTree Investments Commerzbank Credit Agricole Structured AM UBS Global Asset Management BBVA Asset Management Claymore Securities

YTD Change

# ETFs

AUM ($bn)

% Total

# Planned

# ETFs

% ETFs

AUM ($bn)

381 104 39 116 105 143 64 29 1 19 9 8 23 58 4 20 1 3 24 50 50 36 8 8 57

$336.17 $110.14 $51.04 $33.34 $25.32 $24.19 $24.00 $13.47 $6.91 $6.32 $5.58 $5.61 $5.12 $4.58 $4.38 $3.83 $3.54 $3.51 $3.47 $3.15 $2.67 $2.49 $2.24 $2.13 $2.05

47.6% 15.6% 7.2% 4.7% 3.6% 3.4% 3.4% 1.9% 1.0% 0.9% 0.8% 0.8% 0.7% 0.6% 0.6% 0.5% 0.5% 0.5% 0.5% 0.4% 0.4% 0.4% 0.3% 0.3% 0.3%

18 28 4 3 0 37 106 0 0 13 0 0 1 8 0 114 0 0 0 64 0 0 0 0 10

20 6 1 1 7 1 0 0 0 3 1 0 0 4 0 6 0 0 14 0 0 12 0 0 3

5.5% 6.1% 2.6% 0.9% 7.1% 0.7% 0.0% 0.0% 0.0% 18.8% 12.5% 0.0% 0.0% 7.4% 0.0% 42.9% 0.0% 0.0% 140.0% 0.0% 0.0% 50.0% 0.0% 0.0% 5.6%

$11.32 -$35.86 $5.89 $0.11 $1.26 $1.91 $3.68 -$1.47 $0.22 $1.87 -$0.61 -$0.34 -$0.94 $0.12 $1.08 $2.89 -$0.10 $0.69 $0.95 -$0.08 $0.08 $0.63 $0.84 $0.05 $0.43

% % Market AUM Share

3.5% -24.6% 13.0% 0.3% 5.2% 8.6% 18.1% -9.8% 3.3% 42.1% -9.8% -5.7% -15.5% 2.6% 32.7% 309.1% -2.6% 24.5% 37.6% -2.4% 2.9% 33.9% 60.3% 2.2% 26.6%

1.8% -5.0% 0.9% 0.0% 0.2% 0.3% 0.5% -0.2% 0.0% 0.3% -0.1% 0.0% -0.1% 0.0% 0.2% 0.4% 0.0% 0.1% 0.1% 0.0% 0.0% 0.1% 0.1% 0.0% 0.1%

Source: ETF Research & Implementation Strategy, Barclays Global Investors, Bloomberg. All data supplied June 2009.

NOTES At the end of April 2009 the ETF industry had 1,677 ETFs with 3,009 listings, assets of $706.87 billion, from 90 providers on 43 exchanges around the world. YTD assets have fallen by 0.5%, which is less than the 3.0% fall in the MSCI World index in USD terms. The number of ETFs has increased 5.4% YTD with 109 new ETFs launched, while 27 ETFs were de-listed. The average daily trading volume in US dollar has decreased by 5.0% to US$76.6 billion YTD. European ETF AUM has risen by 6.0% while the MSCI Europe Index is down 4.7% YTD in USD terms. In Europe net sales of mutual funds (excluding ETFs) were positive $18.4 billion while net sales of ETFs domiciled in Europe were positive $9.2 billion during the first three 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.

F T S E G L O B A L M A R K E T S • J U LY / A U G U S T 2 0 0 9

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 -0 9

FTSE RAFI Emerging Index

No v08

-0 8 ay M

No v07

-0 7 ay M

v06 No

-0 6 ay M

v05

-0 5 M

v04 No

-0 4

Index Level Rebased (29 May 2004=100)

600

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

2,791

197.95

34.1

14.8

-33.9

10.6

3.23

FTSE World Index

USD

2,362

464.02

33.0

13.4

-34.0

9.3

3.27

FTSE Developed Index

USD

1,944

185.38

31.3

11.2

-34.0

7.5

3.25

FTSE All-World Indices

FTSE Emerging Index

USD

847

488.37

59.1

50.8

-33.3

40.1

3.09

FTSE Advanced Emerging Index

USD

418

448.64

58.4

49.9

-34.3

37.2

3.54

FTSE Secondary Emerging Index

USD

429

583.77

60.3

51.9

-31.8

44.4

2.45

FTSE Global All Cap Index

USD

7,500

315.55

34.6

15.7

-34.1

11.2

3.15

FTSE Developed All Cap Index

USD

5,838

297.79

31.8

12.1

-34.3

8.1

3.15

FTSE Emerging All Cap Index

USD

1,662

645.51

60.5

52.7

-33.2

41.5

3.08

FTSE Advanced Emerging All Cap Index

USD

875

605.09

59.8

52.3

-34.1

39.0

3.52

FTSE Secondary Emerging Index

USD

787

738.63

61.6

53.3

-32.0

45.4

2.45

USD

712

176.13

5.4

5.0

5.4

-2.2

2.91

FTSE Global Equity Indices

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

USD

258

1848.13

45.5

16.1

-43.4

5.9

5.70

FTSE EPRA/NAREIT Global REITs Index

USD

178

583.54

34.5

5.1

-47.9

-4.6

7.55

FTSE EPRA/NAREIT Global Dividend+ Index

USD

228

1285.23

43.3

16.1

-43.1

5.0

6.50

FTSE EPRA/NAREIT Global Rental Index

USD

215

663.30

35.1

6.2

-46.9

-2.6

7.06

FTSE EPRA/NAREIT Global Non-Rental Index

USD

951.17

74.8

45.6

-33.8

30.8

2.70

FTSE4Good Global Index

USD

666

5027.49

34.1

12.0

-34.0

7.9

3.63

FTSE4Good Global 100 Index

USD

103

4306.97

31.9

8.5

-33.9

5.8

3.87

FTSE GWA Developed Index

USD

1,944

2883.67

45.3

19.2

-32.2

15.1

3.47

FTSE RAFI Developed ex US 1000 Index

USD

1,017

5024.59

46.9

23.2

-31.9

17.1

4.55

FTSE RAFI Emerging Index

USD

364

5249.98

62.3

49.3

-28.9

39.9

3.17

SRI

Investment Strategy

SOURCE: FTSE Group and Thomson Datastream, data as at 29 May 2009

J U LY / A U G U S T 2 0 0 9 â&#x20AC;˘ F T S E G L O B A L M A R K E T S

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

Index Level Rebased (29 May 2004=100) M ay -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 ay -0 9

No v08

FTSE RAFI US 1000 Index

ay -0 8 M

No v07

ay -0 7 M

No v06

M ay -0 6

No v05

M ay -0 5

No v04

Table of Total Returns Index Name

Currency

Constituents

Value

3 M (%)

6 M (%)

12 M (%)

YTD (%)

Actual Div Yld (%pa)

FTSE All-World Indices FTSE Americas Index

USD

805

601.78

29.1

8.4

-32.6

7.2

2.46

FTSE North America Index

USD

669

657.83

27.6

6.5

-32.1

5.4

2.42

FTSE Latin America Index

USD

136

862.71

58.1

54.2

-37.9

49.6

3.09

FTSE Global Equity Indices FTSE Americas All Cap Index

USD

2,644

273.76

29.7

9.5

-33.0

7.7

2.35

FTSE North America All Cap Index

USD

2,444

262.14

28.3

7.6

-32.6

5.9

2.31

FTSE Latin America All Cap Index

USD

200

1202.84

58.3

54.6

-38.0

49.8

3.11

FTSE Americas Government Bond Index

USD

159

184.60

-0.2

0.9

7.1

-2.9

3.13

FTSE USA Government Bond Index

USD

142

180.78

-0.7

0.3

7.9

-3.3

3.10

FTSE EPRA/NAREIT North America Index

USD

114

1940.11

39.7

6.9

-48.6

-7.4

6.09

FTSE EPRA/NAREIT US Dividend+ Index

USD

1061.86

39.6

5.9

-49.1

-10.0

6.02

FTSE EPRA/NAREIT North America Rental Index

USD

111

658.11

39.7

6.2

-46.5

-6.6

6.06

FTSE EPRA/NAREIT North America Non-Rental Index

USD

225.67

43.2

83.0

-82.9

-35.4

7.32

FTSE NAREIT Composite Index

USD

113

1929.39

36.4

6.3

-46.5

-8.3

6.75

FTSE NAREIT Equity REITs Index

USD

4648.41

39.3

6.1

-47.5

-8.8

5.95

FTSE4Good US Index

USD

138

3873.87

29.6

5.6

-30.8

4.4

2.28

FTSE4Good US 100 Index

USD

101

3715.20

29.0

4.8

-31.0

3.9

2.29

Fixed Income

Real Estate

SRI

Investment Strategy FTSE GWA US Index

USD

615

2464.38

36.8

9.0

-32.4

8.0

2.37

FTSE RAFI US 1000 Index

USD

1,000

4163.39

40.6

12.5

-29.7

10.9

2.27

FTSE RAFI US Mid Small 1500 Index

USD

1,487

3771.03

47.1

20.5

-28.5

14.3

2.59

SOURCE: FTSE Group and Thomson Datastream, data as at 29 May 2009

F T S E G L O B A L M A R K E T S • J U LY / A U G U S T 2 0 0 9

5-Year Total Return Performance Graph FTSE Europe Index FTSE All-Share Index

400

Index Level Rebased (29 May 2004=100) M ay -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

ay -0 9

No v08

FTSE RAFI Europe Index

ay -0 8 M

No v07

ay -0 7 M

No v06

M ay -0 6

No v05

M ay -0 5

FTSE GWA Developed Europe Index No v04

MARKET DATA BY FTSE RESEARCH

Europe, Middle East & Africa Indices

Table of Total Returns Index Name

Currency

Constituents

Value

3 M (%)

6 M (%)

12 M (%)

YTD (%)

Actual Div Yld (%pa)

4.51

FTSE All-World Indices FTSE Europe Index

EUR

552

185.73

24.9

4.6

-33.3

9.1

FTSE Eurobloc Index

EUR

1,986

103.92

27.5

6.0

-34.6

5.6

3.95

FTSE Developed Europe ex UK Index

EUR

380

188.28

25.9

6.0

-32.8

6.2

4.48

FTSE Developed Europe Index

EUR

492

183.34

23.8

4.1

-32.4

8.0

4.58

FTSE Europe All Cap Index

EUR

1,629

288.85

25.2

5.6

-33.5

10.2

4.44

FTSE Eurobloc All Cap Index

EUR

812

306.23

27.5

6.8

-34.7

6.4

4.90

FTSE Developed Europe All Cap ex UK Index

EUR

1,107

312.50

26.2

6.9

-33.2

7.1

4.45

FTSE Developed Europe All Cap Index

EUR

1,513

287.04

24.3

5.2

-32.6

9.3

4.50

FTSE All-Share Index

GBP

616

2874.04

18.3

8.0

-23.7

4.1

4.57

FTSE 100 Index

GBP

102

2738.47

17.0

5.5

-23.7

1.9

4.76

FTSEurofirst 80 Index

EUR

3933.06

27.6

4.4

-33.2

3.5

5.23

FTSEurofirst 100 Index

EUR

3509.29

23.5

1.8

-31.8

6.1

5.12

FTSEurofirst 300 Index

EUR

311

1204.09

22.7

3.0

-32.6

6.7

4.60

FTSE/JSE Top 40 Index

SAR

2302.10

25.8

8.0

-28.8

7.4

4.13

FTSE/JSE All-Share Index

SAR

166

2527.87

24.4

9.0

-25.9

7.4

4.27

FTSE Russia IOB Index

USD

787.79

86.4

66.5

-53.1

83.5

2.60

FTSE Global Equity Indices

Region Specific

Fixed Income FTSE Eurozone Government Bond Index

EUR

231

162.70

0.3

1.1

8.8

0.1

3.96

FTSE Pfandbrief Index

EUR

384

194.32

1.0

2.4

7.5

1.6

4.51

FTSE Gilts Fixed All-Stocks Index

GBP

2244.23

0.2

2.0

11.1

-3.0

4.06

FTSE EPRA/NAREIT Europe Index

EUR

1384.40

17.8

0.8

-43.5

2.6

6.81

FTSE EPRA/NAREIT Europe REITs Index

EUR

503.65

16.5

-2.8

-40.6

0.9

7.36

FTSE EPRA/NAREIT Europe ex UK Dividend+ Index

EUR

1711.96

15.1

13.5

-33.0

6.9

6.88

FTSE EPRA/NAREIT Europe Rental Index

EUR

540.72

17.5

0.4

-42.9

1.8

6.97

FTSE EPRA/NAREIT Europe Non-Rental Index

EUR

438.24

28.0

17.4

-51.1

31.2

2.27

FTSE4Good Europe Index

EUR

270

3673.53

23.8

3.5

-31.0

8.2

4.73

FTSE4Good Europe 50 Index

EUR

3237.78

22.3

0.1

-30.3

5.5

5.04

FTSE GWA Developed Europe Index

EUR

492

2657.87

40.4

13.1

-29.6

17.5

4.56

FTSE RAFI Europe Index

EUR

524

4114.62

36.0

11.1

-28.7

16.1

4.50

Real Estate

SRI

Investment Strategy

SOURCE: FTSE Group and Thomson Datastream, data as at 29 May 2009

J U LY / A U G U S T 2 0 0 9 â&#x20AC;˘ F T S E G L O B A L M A R K E T S

Asia Pacific Market Indices 5-Year Total Return Performance Graph

FTSE Asia Pacific Index

Index Level Rebased (29 May 2004=100) M ay -0 4

FTSE/ASEAN 40 Index FTSE/Xinhua China 25 Index

800

FTSE Asia Pacific Government Bond Index

600

FTSE EPRA/NAREIT Asia Index

400

FTSE IDFC India Infrastructure Index

200

FTSE4Good Japan Index

ay -0 9

No v08

FTSE RAFI Kaigai 1000 Index

ay -0 8 M

No v07

ay -0 7

v06 No

M ay -0 6

v05 No

M ay -0 5

v04

FTSE GWA Japan Index

Table of Total Returns Index Name

Currency

Constituents

Value

3 M (%)

6 M (%)

12 M (%)

YTD (%)

Actual Div Yld (%pa)

FTSE Asia Pacific Index

USD

1,283

230.79

38.8

27.3

-29.7

17.1

3.19

FTSE Asia Pacific ex Japan Index

USD

826

427.07

52.7

45.4

-30.2

33.1

3.72

FTSE Japan Index

USD

457

74.76

20.6

9.3

-36.0

6.3

2.47

3.19

FTSE All-World Indices

FTSE Global Equity Indices FTSE Asia Pacific All Cap Index

USD

3,030

391.01

39.7

28.5

-29.6

18.1

FTSE Asia Pacific All Cap ex Japan Index

USD

1,781

528.39

54.8

48.2

-30.7

35.2

3.73

FTSE Japan All Cap Index

USD

1,249

236.35

20.4

9.1

-35.1

6.1

2.45

FTSE/ASEAN Index

USD

148

419.13

47.5

44.7

-27.7

31.9

3.91

FTSE Bursa Malaysia 100 Index

MYR

100

7483.35

18.8

24.0

-15.1

22.3

3.45

TSEC Taiwan 50 Index

TWD

6018.58

44.1

47.8

-18.3

43.4

5.94

FTSE Xinhua All-Share Index

CNY

974

7164.30

30.3

56.9

-19.9

55.1

1.14

FTSE/Xinhua China 25 Index

CNY

20343.89

48.7

40.3

-25.7

30.0

2.82

USD

245

132.08

2.2

0.9

14.3

-5.9

1.43

FTSE EPRA/NAREIT Asia Index

USD

1737.89

57.2

26.6

-35.6

20.8

4.97

FTSE EPRA/NAREIT Asia 33 Index

USD

1113.61

50.1

19.5

-35.5

16.3

10.94

Region Specific

Fixed Income FTSE Asia Pacific Government Bond Index Real Estate

FTSE EPRA/NAREIT Asia Dividend+ Index

USD

1721.20

55.2

30.3

-34.6

24.7

6.49

FTSE EPRA/NAREIT Asia Rental Index

USD

702.54

29.4

0.8

-46.4

1.4

9.56

FTSE EPRA/NAREIT Asia Non-Rental Index

USD

1051.14

76.8

45.7

-28.2

34.0

2.57

Infrastructure FTSE IDFC India Infrastructure Index

IRP

932.54

81.1

76.0

-23.4

53.5

0.68

FTSE IDFC India Infrastructure 30 Index

IRP

1060.52

85.9

85.2

-17.7

60.7

0.69

JPY

189

3661.30

22.6

11.6

-36.4

8.2

2.58

FTSE SGX Shariah 100 Index

USD

100

4433.83

28.9

19.3

-31.0

10.4

3.09

FTSE Bursa Malaysia Hijrah Shariah Index

MYR

8883.88

17.8

22.6

-19.8

21.4

3.60

JPY

100

993.04

20.5

11.9

-36.5

9.2

2.59

SRI FTSE4Good Japan Index Shariah

FTSE Shariah Japan 100 Index Investment Strategy FTSE GWA Japan Index

JPY

457

2667.05

27.0

17.6

-32.3

14.5

2.60

FTSE GWA Australia Index

AUD

102

3139.33

18.1

3.7

-28.1

5.0

7.02

FTSE RAFI Australia Index

AUD

5016.45

18.4

3.4

-24.2

5.4

10.62

FTSE RAFI Singapore Index

SGD

6720.28

53.0

40.5

-17.6

38.0

4.06

FTSE RAFI Japan Index

JPY

278

3748.83

25.8

13.8

-31.9

10.4

2.62

FTSE RAFI Kaigai 1000 Index

JPY

1,020

3433.11

41.9

17.5

-38.6

20.4

3.71

HKD

5982.94

52.2

39.9

-20.5

34.7

2.98

FTSE RAFI China 50 Index

SOURCE: FTSE Group and Thomson Datastream, data as at 29 May 2009

F T S E G L O B A L M A R K E T S â&#x20AC;˘ J U LY / A U G U S T 2 0 0 9

INDEX CALENDAR

Index Reviews July – September 2009 Date

Index Series

Review Frequency/Type

07-Jul

TOPIX

07-Jul 09-Jul Mid Jul

FTSE Xinhua Index Series TSEC Taiwan 50 OMX H25

Mid Jul 07-Aug

SMI Family Index TOPIX

07-Aug 17-Aug Early Sep Early Sep

Hang Seng MSCI Standard Index Series ATX CAC 40

Early Sep 28-Aug 02-Sep

S&P / TSX

Monthly review - additions & free float adjustment 30-Jul Annual Review 20-Jul Quarterly & annual review 17-Jul Semi-annual review - consituents, Quarterly review - shares in issue 31-Jul Annual review 18-Sep Monthly review - additions & free float adjustment 28-Aug Quarterly review 05-Sep Quarterly review 31-Aug Semi-annual review / number of shares 30-Sep Annual review of free float & Quarterly Review 18-Sep Quarterly review - constiuents, shares & IWF

03-Sep 04-Sep

FTSE Global Equity Index Series (incl. FTSE All-World)_ DAX S&P / ASX Indices

04-Sep 07-Sep

S&P MIB TOPIX

11-Sep 11-Sep 11-Sep 11-Sep 12-Sep 12-Sep 12-Sep 12-Sep

NASDAQ 100 S&P Asia 50 DJ STOXX DJ STOXX FTSE UK Index Series FTSE / JSE Africa Index Series FTSE Asiatop / Asian Sectors FTSE Global Equity Index Series (incl. FTSE All-World)_ FTSE techMARK 100 FTSEurofirst 80 & 100 FTSEurofirst 300 FTSE Euromid FTSE eTX Index Series FTSE Multinational FTSE Global 100 FTSE EPRA/NAREIT Global Real Estate Index Series FTSE4Good Index Series S&P US Indices S&P Europe 350 / S&P Euro S&P Topix 150 S&P Latin 40 S&P Global 1200 S&P Global 100 FTSE NAREIT US Real Estate Index Series FTSE NASDAQ Index Series S&P MIB Russell US/Global Indices DJ STOXX NZSX 50

12-Sep 12-Sep 12-Sep 12-Sep 12-Sep 12-Sep 12-Sep 12-Sep 12-Sep 12-Sep 12-Sep 12-Sep 12-Sep 12-Sep 12-Sep 12-Sep 12-Sep 15-Sep 15-Sep 16-Sep 23-Sep

Effective Data Cut-off (Close of business)

Annual Review / Japan Quarterly review/ Ordinary adjustment Quarterly review - shares, S&P / ASX 300 consituents Semi-annual constiuents review Monthly review - additions & free float adjustment Quarterly review / Shares adjustment Quarterly review - shares & IWF Quarterly review (components) Style review Quarterly review Quarterly review Semi-annual review

30-Jun 22-Jun 30-Jun 30-Jun 30-Jun 31-Jul 30-Jun 31-Jul 31-Aug 31-Aug 18-Sep

18-Sep 18-Sep

30-Jun 31-Aug

18-Sep 18-Sep

28-Aug 07-Sep

29-Sep 18-Sep 18-Sep 18-Sep 18-Sep 18-Sep 18-Sep 18-Sep

31-Aug 31-Aug 04-Sep 25-Aug 07-Sep 10-Sep 07-Sep 31-Aug

Annual review / Developed Europe Quarterly review Annual Review Quarterly review Quarterly review Quarterly review Annual review Quarterly review

18-Sep 18-Sep 18-Sep 18-Sep 18-Sep 18-Sep 18-Sep 18-Sep

30-Jun 31-Aug 31-Aug 31-Aug 31-Aug 31-Aug 30-Jun 31-Aug

Quarterly review Semi-annual review Quarterly review - shares Quarterly review - shares Quarterly review - shares Quarterly review Quarterly review - shares Quarterly review - shares

18-Sep 18-Sep 18-Sep 18-Sep 18-Sep 18-Sep 18-Sep 18-Sep

07-Sep 31-Aug 04-Sep 04-Sep 04-Sep 04-Sep 04-Sep 04-Sep

18-Sep 18-Sep 18-Sep 30-Sep 18-Sep 30-Sep

31-Aug 31-Aug 14-Sep 31-Aug 01-Sep 31-Aug

& IWF & IWF & IWF & IWF & IWF

Quarterly review Quarterly review Quarterly review - shares & IWF Quarterly review - IPO additions only Blue chip (annual review) Quarterly review

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

J U LY / A U G U S T 2 0 0 9 • F T S E G L O B A L M A R K E T S

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