FTSE Global Markets by FTSE Global Markets

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NEW APPROACHES TO SECURITIES LENDING ISSUE 38 • NOVEMBER/DECEMBER 2009

Competition butts up to bulge bracket banks Order routers become even smarter Luxembourg basks in promise of UCITS IV New FTSE currency indices

CSAM’S VISION & STRATEGY MEETS OTHER 20/20 LEADERS LEGAL EAGLES TEST BANKRUPTCY PROTECTION POST LEHMAN BROS CLOSURE

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Outlook EDITORIAL DIRECTOR: Francesca Carnevale, tel: +44 [0]20 7680 5152, email: francesca@berlinguer.com, fax: +44 (0)20 7680 5152 SUB EDITOR: Roy Shipston, tel: +44 [0]20 7680 5154 email: roy.shipston@berlinguer.com CONTRIBUTING EDITORS: Art Detman, Neil O’Hara, David Simons. CORRESPONDENTS: Rodrigo Amaral (Emerging Markets); Andrew Cavenagh (Debt); Lynn Strongin Dodds (Securities Services); Vanja Dragomanovich (Commodities); Mark Faithfull (Real Estate); Ruth Hughes Liley (Trading Services, Europe); John Rumsey (Latin America); Paul Whitfield (Asset Management/Europe); Ian Williams (US/Emerging Markets/Sector Analysis). FTSE EDITORIAL BOARD: Mark Makepeace (CEO); Donald Keith; Imogen Dillon-Hatcher; Paul Hoff; Andrew Buckley; Jerry Moskowitz; Andy Harvell; Sandra Steel; Nigel Henderson. PUBLISHING & SALES DIRECTOR: Paul Spendiff, tel +44 [0]20 7680 5153 email: paul.spendiff@berlinguer.com EUROPEAN SALES MANAGER: Nicole Taylor, tel +44 [0]20 7680 5156 email: nicole.taylor@berlinguer.com OVERSEAS REPRESENTATION: Adil Jilla (Middle East & North Africa), Can Sonmez (Turkey) SUBSCRIPTION SALES: Marguerite O’Callaghan, tel: +44 [0]20 7680 5154 email: marguerite.ocallaghan@berlinguer.com DATABASE MANAGEMENT: Emrah Yalcinkaya, tel: +44 [0]20 7680 5154 email: mandates@berlinguer.com PUBLISHED BY: Berlinguer Ltd, 1st Floor, Rennie House, 57-60 Aldgate High Street, London EC3N 1AL Tel: +44 [0]20 7680 5151 www.berlinguer.com ART DIRECTION AND PRODUCTION: Russell Smith, IntuitiveDesign, 13 North St., Tolleshunt D’Arcy, Maldon, Essex CM9 8TF, email: russell@intuitive-design.co.uk PRINTED BY: Headley Brothers Ltd, The Invicta Press, Queens Road, Ashford, Kent TN24 8HH DISTRIBUTION: Air Business Ltd, 4 The Merlin Centre, Acrewood Way, St Albans, AL4 OJY. TO SECURE YOUR OWN SUBSCRIPTION: Please visit: www.berlinguer.com Subscription price: £497 each year (9 issues) FTSE Global Markets is published eight times a year. No part of this publication may be reproduced or used in any form of advertising without the express permission of Berlinguer Ltd. [Copyright © Berlinguer Ltd 2009. All rights reserved.] FTSE™ is a trademark of the London Stock Exchange plc and the Financial Times Limited and is used by Berlinguer Ltd under licence. FTSE International Limited would like to stress that the contents, opinions and sentiments expressed in the articles and features contained in FTSE Global Markets do not represent FTSE International Limited’s ideas and opinions. The articles are commissioned independently from FTSE International Limited and represent only the ideas and opinions of the contributing writers and editors. All information in this magazine is provided for information purposes only. Every effort is made to ensure that any and all information given in this publication is accurate, but not responsibility or liability can be accepted by FTSE International Limited and Berlinguer Ltd, for any errors, or omissions or for any loss arising from the use of this publication. All copyright and database rights in the FTSE Indices belong to FTSE International Limited or Berlinguer Ltd or its licensors. Reproduction of the data comprising the FTSE indices is not permitted. You agree to comply with any restrictions or conditions imposed upon the use, access, or storage of the data as may be notified to you by FTSE International Limited, or Berlinguer Ltd and you may be required to enter into a separate agreement with FTSE International Limited and Berlinguer Ltd.

ISSN: 1742-6650 Journalistic code set by the Munich Declaration.

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2009

N A NOD to the upcoming end of year season festivities we asked Art Detman to review the state of the California wine industry. Giant wineries that specialise in low-cost wines are basking in a bumper year. Meanwhile, high end, small family-owned wineries continue to struggle and things are likely to get worse before they get better. Onto more prosaic and perhaps grimmer developments, Neil O’Hara tables the thousand natural shocks that the bulge bracket banks have inherited since the summer of 2007, when BNP Paribas Asset Management first signalled that there was something rotten in the state of the US subprime mortgage-backed debt market. Leading securities houses have seen their market share decline and proposed new regulations could hack profit margins. In the last year and a half, some houses have cut proprietary trading to conserve capital and reduce leverage. In consequence, smaller, faster, niche players can now work to fill that gap. Is it a long term trend? Or are the bulge bracket houses merely playing for time while they refocus their resources on the main chance? We examine the changes the big players (which have a reputation for being survivors) are having to make. Elsewhere, the real estate market continues to provide the most accurate thermometer of the malaise in the financial sector. Obviously it has been a torrid time for the segment, yet despite some sorry tales from the UK and Germany, investor appetite for REITs as we close the calendar on 2009 appears suddenly quite ruddy again. Spain is working through the political mechanics of implementation of its own scheme and yet another UK property company is talking up its conversion to REIT status. So why the sudden enthusiasm? Mark Faithfull looks at the ups and downs of the European REITs landscape, while David Simons reviews the US market, which also displays some stirring signs. On an upbeat note, Paul Whitfield reviews the Luxembourg fund segment, newly invigorated by promises of impending regulations covering the crossborder selling of funds, otherwise known as UCITS IV. This latest iteration of the UCITS format could transform the fund management industry within the European Union, opines Whitfield, opening the market to more cross-border competition. Moreover, Luxembourg’s financial community feels it is particularly well placed to benefit from the changes more than rival financial centres such as London, Frankfurt, Paris and Dublin. While politicians and regulators are falling over themselves to eradicate the potent fin de siecle scent that still pervades the global financial markets, sensible market practitioner have long since girded themselves to continually changing market conditions. That’s the clear message of our new annual 2020 review, which highlights the achievements of those professionals and institutions that have been unduly prescient in their day to day business dealings and analyses their success against their particular market circumstances. It is by no means an exhaustive or comprehensive list (after all, we confined ourselves to only 20 nominations). We have not always chosen market leaders, but instead have preferred to concentrate more on rising hopefuls. Some entries will spur debate. Isn’t that what end of year reviews are supposed to do?

Francesca Carnevale, Editorial Director November 2009

Cover photo: Robert Parker, vice chairman, Credit Suisse Asset Management. Photograph kindly supplied by Credit Suisse, October 2009.

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Contents COVER STORY 20-20: NOMINEES FOR CHANGE & INNOVATION................................Page 58-80 Innovation and drive are not lacking in the global financial markets. In an inaugural annual section, we look at 20 financial institutions, funds and people which have initiated far reaching changes in their business segment. Some entries are inspiring, others expected, and others idiosyncratic. The coming year will provide new challenges and opportunities; the resulting cocktail of entries gives some important pointers as to how it might evolve.

DEPARTMENTS BULGE BRACKET BANKS BRACE FOR COMPETITION ..................Page 6

MARKET LEADER

“We are the new sellside, the next generation beyond the bulge bracket firm,” says Joseph Wald, global head of institutional electronic business at Knight Capital. Can the mainstream investment banks fight back? Neil O’Hara highlights the niche houses that appear to be giving the major investment houses a run for their money.

LEGAL EAGLES TUSSLE OVER COLLATERAL ........................................Page 14 Andrew Cavenagh reports on a court case that will impact on the fragile CDO market.

UNDER THE MICROSCOPE ......................................................................................Page 18

IN THE MARKETS

Giles Elliot, Standard Chartered, on the need for value in asset servicing.

CORPORATE ACTIONS: A WORK IN PROGRESS ................................Page 22 Solutions providers continue to tighten reporting and supply chain links. By David Simons.

THE SLOW UPLIFT IN US M&A ..........................................................................Page 27 Mark Faithfull looks at the varying fortunes of REITs across Europe.

..............................................................................................................Page 28 The sellers pipeline builds up, writes David Simons

THE REIT STUFF?

REAL ESTATE

................................................Page 32 REITs sprang back in the second half of this year. Can the good times last?

AFLOAT AGAIN, BUT FOR HOW LONG?

ALPHA IN ASIA MAJOR ............................................................................................Page 34 Simon Coxeter of Swisslake Capital Asia on multidisciplinary approaches to Asian real estate.

....................................Page 36 Art Detman on the best and worst of times for California’s wineries.

THE NEW THRIFT CAPS CALIFORNIAN WINE

SECTOR REPORT

..................................................................................................Page 39 Simon Watkins reviews the outlook for soft commodities.

THE SOFTER OPTION

......................................................................Page 42 Vanja Dragomanovich writes about the impending turnaround in the palm oil market.

CROSSING PALMS WITH SILVER

NOVEMBER/DECEMBER 2009 • FTSE GLOBAL MARKETS

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Contents FRB5 AND BETA..................................................................................................................Page 44

INDEX REVIEW

COUNTRY REPORT

FTSE Group and Record launch a new passive forward rate bias currency index series.

MIXED SIGNALS ..................................................................................................................Page 45

Simon Denham, managing director, Capital Spreads, is still bearish in outlook.

LUXEMBOURG – UCITS PROMISES AN EARLY SPRING ..............Page 46

Paul Whitfield looks at new regulations that could tip the tide in favour of Luxembourg.

FEATURES TRADING REPORT

DMA THE GREAT LEVELLER..........................................................................Page 49 The demand for ever faster electronic trading has sparked a technological war among trading venues that has slashed latency from seconds to milliseconds. The trend shows little sign of slowing. Paired with smart order routing algorithms that allow traders to tap multiple sources of liquidity in rapid sequence to capture the best available price, Neil O’Hara reports that direct market access enables traders to exploit the smallest, fleeting fluctuations in market prices.

ROUTERS ON THE MARCH ............................................................................Page 54

The complexity and velocity of routing orders have soared over the past few years, with Aite Group estimating that smart order router clients will next year pay up to $1bn for the technology. Clients everywhere are demanding faster trades and so on the buyside they want to know whether in the smart order router their broker uses is the most efficient way of accessing the market. Ruth Hughes Liley reports on the changes and challenges the ever improving technology brings.

ROUNDTABLE

SEEKING VALUE IN A RISK AVERSE CLIMATE ....................Page 81-89

Right now, beneficial owners are asking themselves whether they want to be in the business of securities lending. For those asset owners that have decided to remain in the market segment some regard it as an opportunity to revamp their lending programmes. Others have taken the view that risk control is of paramount concern. Regulators have taken, at different times over the last eighteen months, stringent controls on securities lending activity. What is all adds up to, say the participants in our fourth annual securities lending roundtable, is that it is more difficult to secure value in what sometimes appears to be a still adverse financial climate. Nonetheless, signs indicate that securities lending is once more building up steam.

DATA PAGES 4

Fidessa Fragmentation Index ................................................................................................Page 90 Market Reports by FTSE Research ......................................................................................Page 92 Index Calendar............................................................................................................................Page 96

NOVEMBER/DECEMBER 2009 • FTSE GLOBAL MARKETS

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Market Leader US BULGE BRACKET BANKS: THREAT TO MARKET SHARE AND PROFITS

Photograph © Christian Darkin/Dreamstime.com, supplied October 2009.

BULGE BRACKET

BANKS

UNDER SEIGE Leading securities houses in the United States have seen their market share decline and proposed new regulations could hack profit margins. Over the past 18 months, the major houses have cut proprietary trading in order to conserve capital and reduce leverage. That’s left an opening for smaller, faster, niche players to fill the gap. Is it a long-term trend? Or are the bulge bracket houses merely playing for time while they refocus their resources on the main chance. Neil O’Hara examines the changes the big players, which have a reputation for being survivors, are having to make. IG IS NO longer beautiful. The financial crisis debunked the notion that size implies safety; after all, it was bulge bracket banks that failed or were bailed out with government support. The major US securities houses are now under siege: their market share has declined and proposed new regulations could crimp profit margins long after the legacy toxic assets have run off their books. Regional brokers that never dabbled in exotic derivatives have been quick

to seize the opportunity to strengthen their research, sales and trading by picking up top talent orphaned in the wholesale reorganisation of the big Wall Street firms. Alternative trading venues that focus on high speed execution have siphoned business away from the majors, too. Today’s big firms are survivors, however, and they have a long history of adapting under stress. A world in which proprietary trading books attract higher

regulatory capital requirements will curtail the ability of bulge bracket firms to earn outsized returns and pay their staff a premium to what regional firms are willing to offer. In a sense, this will enshrine what has already occurred: over the past 18 months, the major houses have cut back proprietary trading in order to conserve capital and reduce leverage. “There is less differentiation today between large multi-sector regional brokers and the New York investment banks,” says William Jump, head of institutional sales and trading at Morgan Keegan, a regional broker based in Memphis, Tennessee. “The compensation scale has flattened and allowed everybody to bid for talent at the same rates.” A regional firm may not have to match pay dollar for dollar to attract talent, either. People sometimes

NOVEMBER/DECEMBER 2009 • FTSE GLOBAL MARKETS

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Market Leader US BULGE BRACKET BANKS: THREAT TO MARKET SHARE AND PROFITS

Commission’s (SEC’s) 2006 prefer to take a little less from rewrite of the rules governing a firm with a strong balance soft dollars. The new rules sheet than top dollar from a blessed commission sharing house that has been through arrangements that allow the wringer and may still face investment managers to an uncertain future. The allocate a share of their threat of caps on trading commissions to pay compensation at banks that for research produced by haven’t weaned themselves off government support also third parties. According to plays into the hands of figures compiled by Autex, smaller securities firms. Knight trades more volume Jump says research is critical in shares listed on the New to the business model of full York Stock Exchange or service regional brokers such NASDAQ than any other as Morgan Keegan. He securities house. “We are the acknowledges that the bulge new sellside, the next bracket firms still have an edge generation beyond the bulge bracket firm,” says Joseph if they are willing to commit Wald, global head of capital to facilitate trades, a institutional electronic service the regional brokers do business at Knight. not offer on a comparable A business model scale. Even so, the advent of to execution alternative trading venues has Ron Kruszewski, chief executive officer of St Louis, Missouri- dedicated enabled regional firms to tap based Stifel Financial. Kreszewski notes that research analysts at requires a huge investment in additional sources of liquidity its brokerage subsidiary Stifel, Nicolaus captured 14 awards in information technology to and compete on a more even the FT/StarMine World’s Top Analysts Survey for 2008, enough deliver the maximum access footing. “When you fortify the to tie for seventh place out of 192 firms.“That kind of to liquidity in the shortest research foundation of a performance has driven our flow business from buyside accounts time at the lowest cost. The regional firm, you drive that are looking to add alpha,” he says. Photograph kindly advent of dark pools and increased commission supplied by Stifel Financial, October 2009. electronic communication business over the trading networks has fragmented desk,” says Jump. “With the classes. Philip Gough, managing liquidity, too: less than 40% of trading unbundling of research and execution director, Knight Capital Europe, says in shares now listed on the New York that has occurred over the past few the financial crisis has accelerated the Stock Exchange takes place on the years, most buyside firms aren’t firm’s gains in market share, not least exchange. Knight’s trading systems making the distinction between bulge from customers who specifically cite a allow customers to tap all available of liquidity either bracket and regional firms that they desire to reduce their counterparty sources risk.“The market was reminded that a electronically or, for larger orders, with might have previously.” The brain drain from bulge bracket big bank doesn’t necessarily mean a the help of live traders using firms hasn’t all gone to US regional safer counterparty,” he says. “It’s not sophisticated algorithms to minimise brokers, however. Some big name the driving force behind our growth, the market impact.“Technology is the research analysts have launched but it hasn’t done us any harm.” bedrock of the organisation,” says independent research firms, while The reallocation of order flow Wald. “It’s one area where we have others have been lured to hedge enhanced the growth Knight was never taken our foot off the gas and funds. On the trading and operations already experiencing thanks to we don’t intend to.” side, firms including Knight Capital regulatory pressure on securities To Ted Oberhaus, director of equity have taken the opportunity to bolster houses to separate research from trading at Lord Abbett, an $85bn their already formidable execution execution. In the US, Knight benefited money manager based in Jersey City, capabilities across multiple asset from the Securities and Exchange New Jersey, the shift in order flow

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Market Leader US BULGE BRACKET BANKS: THREAT TO MARKET SHARE AND PROFITS

reflects a conscious effort to diversify counterparty risk rather than dissatisfaction with the service bulge bracket firms offer. When buyside firms enter into commission sharing arrangements, they build up unsecured cash balances at their brokers, which are not protected if a firm goes bankrupt. “People got burned when Bear Stearns and Lehman Brothers went under,” says Oberhaus. “If I pay $1m into a commission sharing arrangement the industry has not come up with a way to keep that money safe.” Lord Abbett and other long only managers have reacted by diversifying the number of counterparties they do business with to keep a lid on unsecured credit at any one firm. In doing so, they followed the lead set by hedge funds, which were even more exposed to counterparty risk at the bulge bracket firms. Clients fled the big independent prime brokers in droves after Lehman failed, but while the larger accounts ended up at major commercial banks such as UBS, `

Philip Gough, managing director, Knight Capital Europe, says the financial crisis has accelerated the firm’s gains in market share, not least from customers who specifically cite a desire to reduce their counterparty risk. “The market was reminded that a big bank doesn’t necessarily mean a safer counterparty,” he says. “It’s not the driving force behind our growth, but it hasn’t done us any harm.”

Deutsche Bank or JP Morgan, the shift created opportunities for smaller firms to capture new business, too. For Celadon Financial Group, a brokerage house headquartered in Chatham, New Jersey, that offers prime brokerage services, the financial crisis has been a gift that keeps on giving. Frank Magnani, managing director for sales and marketing, says the major prime brokers took a hard look at the revenue potential of their clients in the aftermath of the market meltdown and began to sever relationships with their less profitable accounts. “Smaller firms like Celadon are providing all the service and support to those clients,”he says.“This additional business enhanced our existing mini-prime business model.” As with other small firms, Celadon isn’t self-clearing; it acts as an “introducing broker” to two bulge bracket firms that handle trade clearing and settlement. It’s an agency outsourcing arrangement, however; all the client credit risk stays with Celadon, which also provides trading systems, reporting, execution, capital introduction and operational support. “We are getting a significant influx of new accounts ranging from $5m to $40m,” says Magnani. “Prime broker clients are looking for service first, followed by trading systems, other technology and easy interaction with the fund administrator. For these accounts, pricing is the last thing on the list.” In addition to a prime broker business that is growing rapidly from a small base, Celadon has seen an uptick in its pure execution service, which offers direct market access for domestic and international equities and options. The firm provides trading algorithms, too, including ones that handle spreads and pairs trading. “Anybody can do execution,” says Magnani. “The question is what tools

Ted Oberhaus, director of equity trading at Lord Abbett, an $85bn money manager based in Jersey City, New Jersey. Oberhaus thinks the shift in order flow reflects a conscious effort to diversify counterparty risk rather than dissatisfaction with the service bulge bracket firms offer. Oberhaus says: “If I pay $1m into a commission sharing arrangement, the industry has not come up with a way to keep that money safe.” Photograph kindly supplied by Lord Abbett, October 2009.

do you have and how much they cost. Price is the key driver for executiononly business.” As order flow has shifted to firms outside the traditional bulge bracket, Lord Abbett has followed because the firm prefers to route its orders through the broker that sees the most action in a particular stock. “We respond to merchandise,”says Oberhaus.“We will go to whichever entity controls the other side of a trade.”

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Market Leader US BULGE BRACKET BANKS: THREAT TO MARKET SHARE AND PROFITS

For small capitalisation stocks, Oberhaus says the regional brokers have always had an edge anyway. Regional firms typically handle smaller average order sizes, which may help an investor working a large order disguise the true scale of its interest. Traders at regional firms are willing to devote the time to handle smaller orders—25,000 to 50,000 shares—in less liquid names, too. “These regional firms know where the bodies lie,” says Oberhaus. “They put everybody into a small-cap name in the first place.”In effect, regional firms leverage their research prowess in small-cap stocks to deliver best execution through the trading desk. The symbiotic relationship does not extend to larger cap stocks that are widely owned for which more firms provide research coverage. A regional broker may still provide valuable research, but money managers no longer need to direct order flow through its trading desk to pay for it. “Commission sharing arrangements mean you can separate execution from research,” says Oberhaus. “You can go to the broker you feel gives you the best execution and steer a portion of the commission to the research provider.” The new dynamic reinforces the importance of research to full service regional firms. Ron Kruszewski, chief executive officer of St Louis, Missouribased Stifel Financial, notes that research analysts at its brokerage subsidiary Stifel, Nicolaus captured 14 awards in the FT/StarMine World’s Top Analysts Survey for 2008, enough to tie for seventh place out of 192 firms. “That kind of performance has driven our flow business from buyside accounts that are looking to add alpha,”he says. Although Stifel has taken advantage of the market dislocation to beef up its talent—it hired a middle-

For Celadon Financial Group, a brokerage house headquartered in Chatham, New Jersey, that offers prime brokerage services, the financial crisis is a gift that keeps on giving. Frank Magnani, managing director for sales and marketing, says major prime brokers took a hard look at the revenue potential of their clients in the aftermath of the market meltdown and began to sever relationships with their less profitable accounts. “Smaller firms like Celadon are providing all the service and support to those clients,” he says. “This additional business enhanced our existing mini-prime business model.”

market institutional sales and trading team from Bear Stearns, for example—Kruszewski does not see the redirection of order flow as a seismic shift in the structure of Wall Street. He points out that business migrates not only when brokerage firms fail but also when they merge. “The business is not additive,”he says. “Some of the combined revenue disperses to other firms.” The recent turmoil is similar to what happened when Drexel Burnham died in 1990 or Credit Suisse bought Donaldson, Lufkin & Jenrette in 2000, just on a larger scale. Kruszewski says Stifel has picked up business in the middle market where it has always done well, but he harbours grander ambitions to fill the void left by Bear Stearns and Lehman. “Which firms are going to be much larger and stronger in 10 years’ time?”he asks.“The two largest firms won’t grow fivefold in that period, but a firm like Stifel could.” It’s not an idle boast: Stifel’s revenues have already quintupled from $200m to $1bn in the past five years. Kruszewski isn’t gunning to displace Goldman Sachs or Morgan Stanley at the top of heap, but he foresees a day when Stifel or one of its direct competitors could start to appear in

the underwriting and merger advisory league tables. Celadon’s Magnani also believes the pecking order in the financial industry is likely to change as small and medium-sized brokers consolidate their gains at the expense of the bulge bracket firms. Prime broker clients who were shown the door won’t forget in a hurry, which creates an opportunity for new entrants such as Celadon to bulk up. Magnani foresees a repeat of the 1980s, when a relatively insignificant player—Drexel Burnham Lambert—parlayed its expertise in high-yield bonds into a huge presence in the merger market and created a whole new business for Wall Street that outlived the firm’s demise. The bulge bracket firms won’t go quietly into the night, of course. The strongest have already thrown off the shackles of government support and are demonstrating a renewed appetite for risk. Lord Abbett’s Oberhaus points out that the major houses have an enviable record of adapting to market conditions over time, too. “They are constantly reinventing their business models to keep themselves relevant to their customers,” he says. “In more than 20 years on the Street, I have learned never to count the bulge bracket firms out.

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In the Markets COURT CASE COULD SET PRECEDENT FOR RIGHT OF PROTECTION

LEGALS TUSSLE OVER COLLATERAL A legal action arising out of the Lehman Brothers’ collapse threatens to undermine a fundamental principle of securitisation—that it protects investors from the bankruptcy of other parties to the transaction. The outcome of the case could prove critical for the future of a market that is only just starting to recover from the unprecedented trauma that shut it completely in July 2007. Andrew Cavenagh reports. LEGAL DISPUTE following the collapse of Lehman Brothers centres on who has the right to the collateral in a Lehman-sponsored synthetic CDO (collateralised debt obligation) programme. The Dante programme had three special purpose vehicles (SPVs) that issued bonds to investors—Saphir Finance, Zircon Finance and Beryl Finance—and they all employed a structure common to such transactions. Under this typical arrangement, the issuing vehicle uses the proceeds from the bond sales to acquire highly rated liquid collateral (government bonds or similar instruments) to cover the SPV’s exposure under a credit default swap, through which the bond investors assume the default risk of the reference portfolio (of bonds and/or loans). The SPV then receives the coupon payments on the collateral and the premiums paid by the swap counterparty (for the protection it is buying) and passes both on to the investors [see flow diagram on page 24 for the Zircon Finance Series 20079 (Merimbula) issue]. The action threatens to undermine a basic principle of securitisation: that it protects investors from the bankruptcy of other parties to the

transaction. The outcome of the case could prove critical for a market only just beginning to recover from the unprecedented trauma of the financial meltdown in July 2007. The swap counterparty for the 12 bonds issued out of the Dante vehicles was Lehman Brothers Special Financing (LBSF), which ceased making payments under the swap after its parent filed for bankruptcy on September 15th 2008. As in most synthetic CDO structures, the trust deeds that govern the Dante transactions give the swap counterparty a priority claim over the collateral as long as it continues to pay the swap premiums. If it defaults on those payments, however, there is a provision in the documentation that subordinates the counterparty’s claim to that of the bondholders. Without this provision, the bonds would clearly have no protection from the bankruptcy of the counterparty and would not be able to secure ratings higher than that of the latter—one of the key benefits of securitisation. Nevertheless, lawyers acting for the bankrupt Lehman estate are challenging the legal validity of this all-important subordination arrangement in respect of the Dante vehicles.

Kevin Kendra, managing director at Fitch Ratings in New York, confirmed that if the final decision went in Lehman Brother’s Special Financing’s favour, it would impose a ceiling on the ratings of existing synthetic deals that relied on such subordination provisions.“You wouldn’t be able to rate those deals above their counterparty rating any more,” he said.“The ratings on such transactions would have to be capped at that of the counterparty without some further mitigating mechanism for counterparty default risk.” Photograph kindly supplied by Fitch Ratings, October 2009.

They are arguing that the provision contravenes two key stipulations of the United States Bankruptcy Code: that the interest of a debtor cannot be modified as a consequence of a bankruptcy filing, and that no third party can exercise control over the property of a company that is under the protection of US Chapter 11 bankruptcy proceedings. Counsel representing LBSF are trying to secure a ruling in the US Bankruptcy Court for the Southern District of New York (which is dealing with the Lehman Brothers insolvency) to this effect. They filed a complaint in June against the Dante bondholder

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In the Markets

Zircon Finance Series 2007-9 (Merimbula) issue CDS Counterparty Lehman Brothers Special Financing Inc. Reference Portfolio

COURT CASE COULD SET PRECEDENT FOR RIGHT OF PROTECTION

trustees, after the latter had initiated action against the collateral trustee (Bank of New York) to enforce the realisation of the collateral for the bondholders’ benefit. When Bank of New York declined to release the collateral, the bondholder trustees—Perpetual Trustee and Belmont Park Investments— commenced legal proceedings against it in the UK. They filed claims in the High Court in London because they considered it was important to determine the validity of the documentation under English law, on which the trust deed in the Dante vehicles were all based. A High Court ruling in their favour would greatly strengthen their hand in any US proceedings under the principles of comity (whereby courts in one jurisdiction are supposed to recognise the laws and legal decisions of another). One of the lawyers acting for the bondholders maintained that the argument put forward by LBSF, which joined Bank of New York as a defendant in the London action, defied logic.“It’s rather like saying you can take out an insurance contract, stop paying the premium, but still benefit from the cover.” While the case has not attracted great attention, some leading securitisation analysts have highlighted its severe potential consequences—mass downgrades of synthetic transactions on which the swap counterparties have US connections, large-scale unwinding of such positions by ratings-sensitive investors, and violent widening of spreads on the bonds involved. “A ruling against the investors would be hugely negative for the credit markets,” warned Atish Kakodkar, the senior strategist at the international research firm CreditSights who was formerly head of global credit derivatives strategy at

Guaranteed by Lehman Brothers Holdings Inc. (“A+/F1+”)

Premium

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Zircon Finance Limited Class A

Credit Protection

Series No: 2007-9

Class B

Note Proceeds

Class A (“AA”) Class B (“BBB”)

Note Proceeds

Lion Capital Management Limited

Collateral

(Portfolio Manager)

Source: Transaction documents for the Merimbula issue, 2009.

Merrill Lynch in New York. “In the medium to longer term, this outcome could represent a huge hurdle in restarting the securitisation market.” Kevin Kendra, managing director at Fitch Ratings in New York, confirmed that if the final decision went in LBSF’s favour, it would impose a ceiling on the ratings of existing synthetic deals that relied on such subordination provisions. “You wouldn’t be able to rate those deals above their counterparty rating any more,” he said. “The ratings on such transactions would have to be capped at that of the counterparty without some further mitigating mechanism for counterparty default risk.” It is certain to be several months at least, however, before there is a definitive court ruling on this question. The initial decisions by the courts in New York and London have ensured there will be further hearings in both jurisdictions, and the early signs are that the two judicial systems are leaning in opposite directions—a reflection perhaps of the difference in emphasis of the UK and US bankruptcy regimes. In early August, the New York court rejected a petition from Belmont to

dismiss the LBSF claim on grounds that the US was not the appropriate forum to hear the case. However, it was not due to open hearings on the LBSF complaint until the week beginning November 16th, and there are then potentially three levels of appeal—all the way up to the US Supreme Court. The UK High Court, meanwhile, handed down an initial judgement in favour of the bondholder trustees at the end of July. Sir Andrew Morritt, Chancellor of the High Court and senior judge in its Chancery Division, ruled that LBSF’s priority claim to the collateral in the CDO structures was clearly conditional on it continuing to meet its obligations under the swap agreement and “could never have passed on to a liquidator or trustee in bankruptcy free from those limitations or conditions”. Sir Andrew allowed LBSF and Bank of NewYork to appeal, however, and the Court of Appeal was scheduled to hear the case on October 12th. It could take some weeks after the hearing to deliver its judgement, and the losing party could then appeal further to the new Supreme Court of the UK, which came into being at the start of October.

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It seems probable at this stage that both parties will exhaust the appeals process as far they can and, if the case is allowed to go as far as the supreme courts in the two countries, this means the market might have to wait two years or more for a final decision. The prospect of contrary rulings in the US and UK courts at the initial stage also increases the likelihood of protracted litigation rather than a swift resolution. In the UK High Court judgement, Sir Andrew noted that Bank of New York “regards with apprehension the possibility that it might be faced with conflicting requirements by the US bankruptcy court and this court”, and the lawyer acting for one of the bondholder trustees said that in his view such an outcome was a“distinct possibility”. Brian Cain, the global knowledge officer for the finance practice group at law firm Baker & McKenzie in London,

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observed that it would be unusual for an American court to make a ruling that ran counter to one made in a British court—particularly in a case with such widespread implications for the global financial sector—but there was certainly an element of doubt. He said:“I think there’ll be a lot of people looking at what happens in New York with some apprehension.” If that was to happen, Cain said that, under the general rules of comity, the two judicial systems would then try to “mould their approaches” through the appeals procedure to avoid any serious disruption of international trade. “It would be highly unusual to end up after the appeals process with diametrically opposed views,”he concluded. How the market would react to such a decision remains to be seen. Commentators have pointed out that the lack of immediate panic may be

down to two factors. One is that the CDO sector is currently so bombedout that most bond ratings are below those of the swap counterparties on synthetic deals. The other is that the remaining US swap counterparties are highly unlikely to default, given the degree of government support they now enjoy. Bankers may also come up with new mechanisms in deal structures to mitigate such counterparty risk. However, investor confidence in the whole process would surely suffer. For if an assumption that had underpinned so much securitisation in the raging bull market up to mid2007 (and was never questioned in those good times) failed to stand up to legal scrutiny when times got tough, why should they believe it would be different with any new structures that the market devised to mitigate the risk?

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In the Markets SECURITIES SERVICES: SEEKING VALUE

A revived interest in achieving the highest value for money is driving everyone in the asset servicing food chain—brokerdealers, custodians and sub-custodians—to cut costs. Any player for which securities services is a peripheral rather than a core business is unlikely to have the appetite to continue investing, especially on the scale that will be required to meet client demands as investment markets becoming increasingly complex. Giles Elliott, global head of securities services, transaction banking, at Standard Chartered Bank, says the trend can only gain in intensity as market conditions return to normal. Giles Elliott, global head of securities services, transaction banking, with Standard Chartered Bank. Photograph kindly supplied by Standard Chartered Bank, November 2009.

ONSOLIDATION HAS LONG been a feature of the financial services world, and the securities services landscape in the late summer of 2009 looks very different from 10 years ago, when the single word “custody” could still be deployed. The great bout of consolidation that transformed custody in the United Kingdom in the 1990s has yet to be equalled in scale in continental Europe and in Asia, but the most recent major consolidation event—the merger of The Bank of New York with Mellon Corporation— reminded the world of what might still be possible. Fallout from the credit crunch of the past two years has given a new boost to mergers and acquisitions activity in international banking; but although it has yet to directly affect securities services, it will be interesting to see how BlackRock’s purchase of Barclays Global Investors impacts on the industry. Both houses are, of course, already large and successful transition managers, an area in which many major custodians are very active, and

UNDER THE MICROSCOPE the question of securities services provision will surely be raised in the integration process. Challenges tend to create opportunities, and those of the past two years are no exception. Asset servicing is likely to experience a twofold impact, one from the demand side as clients review their domestic, regional and international needs, the other from the supply side to respond to changing requirements. The revived interest in achieving the highest value for money is driving everyone in the food chain— including broker-dealers, custodians and sub-custodians—to cut costs.

Falling provision, intensifying competition Any existing player for which securities services is a peripheral activity rather than a core business is unlikely to have the appetite to continue investing, especially on the scale that will be required to meet client demands. Those demands can be expected to continue to grow in complexity and in international scope

once the flight from fear loses intensity and market conditions gradually begin to return to normal. While the number of providers is expected to fall, competition will ensure that the quality of service and value for money available in the market will remain intense. Invariably this will benefit clients, which now prioritise those risk management services provided by their custodians; and encourage them to plan contingencies should any of those custodians either cease to exist or exit from the market. A flight to quality in securities services is therefore perfectly possible, mirroring the flight to quality already seen in asset management. As traditional concepts of trust have taken a battering, clients increasingly ask questions they might not have raised before, relating, for instance, to how agents are chosen. They want to know how assets are held, how they are validated and revalidated, and what happens in the event of a custodian/depository default. Clients now question the very model of whether reliance on a single provider

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THE FTSE I WANT A LOW CARBON WORLD INDEX FTSE. It’s how the world says index. The FTSE Environmental Markets Index Series is the definitive benchmark for investors who want to be at the forefront of environmental markets. With the inclusion of renewable & alternative energy, energy efficiency, water technology and waste & pollution control companies, the FTSE Environmental Markets Index Series focuses on the companies that are shaping our future. www.ftse.com/environment

© FTSE International Limited (‘FTSE’) 2009. All rights reserved. FTSE ® is a trade mark jointly owned by the London Stock Exchange Plc and The Financial Times Limited and are used by FTSE under licence.

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In the Markets SECURITIES SERVICES: SEEKING VALUE

is prudent. Given the internationalisation of investment patterns and the extraordinary volatility in many markets recently, clients are examining the inherent risks more closely and investigating sound hedging alternatives. From a purely operational perspective, risk management is a key factor in the design of an optimal supply chain. Invariably nowadays, it goes way beyond: “Who do you use as correspondent banks?”

The rise and rise of contingency planning Some global custodians have already adopted a twin sub-custody strategy, while others do not view this as beneficial. Clients query the practical contingency measures in place and are increasingly scientific about doing so. This is not an overnight phenomenon, it is a clear trend, possibly a lasting one and one that is understandable. If investors trust you with assets worth hundreds of billions of dollars, they have every right to expect you to ensure those assets are protected in an optimal way. What should the right level of due diligence be, in the wake of the erosion of trust in rating agencies? How do you dig behind the ratings to get closer to the truth? Can you improve structures and processes to reduce risk? If your agent goes into default, how quickly can you get your assets back? Accessibility and segregation have quickly become key words in today’s much-changed market environment. The misuse of securities lending by albeit a few market participants also raised important questions. In particular, efforts to boost overall portfolio returns by ignoring valuebased lending in favour of more aggressive lending linked to cash collateral reinvestment have been revealed as inadequate.

Against such a backdrop, clients can hardly be blamed for re-evaluating how they buy securities services. Do they put all their eggs in one basket with bundled pricing or is it better to have more than one custodian? If they have a heavy dependence on one entity, are they compromising security in return for profitability? There are, after all, many different ways to buy securities services, not just from the traditional custodians but also from the band of emerging specialist providers; and after a period of over-concentration, people are looking at regional and local custodians as sound alternatives, not just as a back-up provider following the shift in focus to de-concentration but as a frontline supplier. Financial strength is important in a partner, as is the ability to ensure a mutually profitable flow of activity. Longevity and stability are central considerations, too: clients do not want to be left high and dry by a partner that cuts lines or reduces investment in securities services when the going gets a little tough. The rapid, wholesale commoditisation of securities services arguably blinded both clients and providers to the importance of these issues, but in times of crisis, fundamentals have a habit of reasserting themselves, sometimes violently. Anyone who doubted the importance of strong capital ratios because of the perceived negative impact on profit has been forcibly reminded of their attractions in ensuring an institution’s continuing independence, even its survival. In other words, the traditional emphasis on strong capital ratios is as valid today as it has ever been. Clients want a provider who is committed to the product for the long term. They need a provider committed to securities services as a core product, with a demonstrable track record of investing while others have cut or postponed spending.

The strength of the balance sheet is a primary point of focus and a deciding factor in whether or not providers offer a particular product line. Providers are not immune to loss, or averse to a challenge, and by and large do not enter new business areas or chase opportunities blindly. There is a high premium on transparency in any investments made, with a clear view of products and geographic goals. Some institutions, such as Standard Chartered, focus on steady and sustainable organic growth rather than rapid-fire growth by largescale acquisitions; others prefer different approaches.

Growing concern These are important considerations at a time a number of financial institutions have in effect been nationalised, or at least partially nationalised. The need for neutrality in the provision of securities services to pension funds, especially government-linked pension funds, is a growing concern, at least in Asia. This will undoubtedly create new opportunities for sub-custodians to pick up new business. In normal circumstances, such opportunities to dislodge incumbent providers are few and far between. Today’s abnormal circumstances mean that in a large number of cases regime change could take place much sooner than would have been expected. Any custodian worth its salt is surveying the market and its competitors. Everything has changed in the past few months. The competition to be the best, the need to be more costeffective and client focus on quality of service have all intensified. In such conditions, who would want to continue being a custodian? Only those institutions for which it truly is a core, long-term business and which are focused on exiting this downturn with an even greater market share.

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THE FTSE I WANT THE WORLD INDEX FTSE. It’s how the world says index. Global markets grow more complex and interconnected every day. To stay abreast, you need a comprehensive index that can slice and dice markets the way you do. The FTSE Global Equity Index Series was the first benchmark to cover the world seamlessly with a single consistent and transparent methodology. Because FTSE indices are independently verified by a panel of market practitioners, you can be sure that they will always be in line with investors’ needs. Wherever you invest, FTSE gives you the clearest view of how you are doing. www.ftse.com/invest_world

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In the Markets CORPORATE ACTIONS: TIGHTENING THE SUPPLY CHAIN

A WORK IN PROGRESS Corporate actions (CA) business has been brisk throughout 2009, as organisations increasingly used CA strategies in an effort to mitigate event-processing risk. Meanwhile, automation advocates and solutions providers continue to work to address persistent vulnerabilities in the reporting and processing supply chain. From Boston, David Simons reports. ESPITE A SLOWDOWN in m e rg e r- a n d - a c q u i s i t i o n s activity, an increase in corporate and debt restructuring as well as an uptick in reverse splits and optional dividends helped send corporate actions (CA) volumes through the roof. Though the complexity of Europe’s multi-market variants has typically put European Union firms ahead of their US counterparts in the move towards automation, recent market events have helped bring renewed interest in corporate actions projects stateside. Weak links in the corporate-actions lifecycle, including data that is inconsistent or disseminated too slowly between parties, continue to keep automation advocates busy. “That’s the reason why many organisations are double and triple sourcing information,” notes Amy G Harkins, managing director, global corporate events worldwide, BNY Mellon. “From our perspective, getting the data quicker, as well as scrubbing that data and trying to normalise [sic] it for the clients, are top priorities.” As has been the case in years past, efforts to improve corporate-actions efficiency continue to focus on the role of the issuer. As part of the “Issuer to Investor: Corporate Actions” initiative

Photograph © Dashk/Dreamstime.com, supplied October 2009.

launched last spring, in September the Depository Trust & Clearing Corporation (DTCC), SWIFT and XBRL US announced the formation of a stakeholder group designed to improve the corporate actions reporting and processing supply chain. In addition to

providing direct input, three subgroups representing issuers, intermediaries and investors will help determine if changes are required should issuers produce corporate actions messages in XBRL aligned with the ISO 20022 messaging standard.“We

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In the Markets CORPORATE ACTIONS: TIGHTENING THE SUPPLY CHAIN

feel that the technical document tagging functionality of XBRL, utilising the ISO 20022 global standard, can provide both a solution and a reason for issuers to become actively involved in the process of transforming paperbased information into electronic data,” says David Hands, director, product management, DTCC Solutions. The industry must also work to improve the communication of elections that are used to back up the CA chain from investor to issuer, says Hands. “It is particularly important that event ‘election options’ are presented clearly by all parties, thereby enabling investors to effectively communicate their same election intentions back to multiple parties.” Harkins says:“XBRL is better than a proprietary feed and BNY Mellon is more than happy to work with it. I am a supporter of it and I believe that it could be a very good way to get participants online and get things more normalised from a global perspective. And if XBRL is used properly, it certainly is capable of providing cleaner and less ambiguous data. My general concern is that it could become customised by region—we really don’t want an XBRL US version in addition to a global version XBRL because this is all about consistency of data.” Moreover, XBRL plans to be interoperable with ISO 20022, which is not yet a widely adopted standard in the marketplace, says Geoff Harries, vice president, investment services at Fiserv, a global provider of financial services technology. As such, anyone who wishes to implement corporate actions today must do so based around 15022, yet with the knowledge that a migration strategy will be necessary as they go forward, says Harries.“Bottom line, the magnitude of potential business interruptions warrants investment in corporate actions solutions today, rather than deferring to

some future innovation that may or may not be available.” Cynthia Weston, senior vice president, global product and strategy, at Northern Trust, says that a great deal of energy has been devoted to improving corporate-actions information capture, with particular emphasis on eliminating the interpretation that is often required. “We really want to ensure that there is accurate and timely scrubbing and receipt of data, and as a result we have invested heavily in that part of the corporate-actions lifecycle.” Like many of her peers, Weston sees XBRL playing a significant role in the effort to improve issuer cooperation. “An increase in XBRL adoption will allow us to look for those key bits of information that can properly translate information from a document into electronic data. That in turn enables us to immediately begin reconciling notices from multiple sources.”

Innovations Though mainly geared toward the developed markets, the Event Interpretation Grid (EIG), which clarifies the use of mandatoryvoluntary indicators and options across more than 60 event types defined in ISO 15022, is another tool that can help reduce the amount of hard-copy data processing.“Using a grid of data, rather than a document that needs to be scanned, is also a step in the right direction,” says Weston.“Obviously we want to see those kinds of innovations continue to move forward.” Additionally, it is pivotal that organisations look beyond the scope of basic corporate actions, says Weston. “In other words, we want to make sure that we’re gathering data as broadly as possible. The key benefit to the client is integrated data, but at the same time you’re also creating efficiencies internally, because you

Amy G Harkins, managing director, global corporate events worldwide, The Bank of New York Mellon.“From our perspective, getting the data quicker, as well as scrubbing that data and trying to normalise [sic] it for the clients, are top priorities.” Photograph kindly supplied by The Bank of New York Mellon, October 2009.

have multiple groups working off of the same data structure.” Factors driving corporate-actions projects have evolved in recent years, says Harries. Whereas efforts in the past have largely centered on using automation to boost operational efficiency, mitigating risk has leapt to the fore, “which is not to say that the risk component hasn’t always been there,”he says.“However, I think people are just more cognisant of risk today, which is due in part to much slimmer business margins.” As such, provisions against potential losses, as well as capital that is tied up to protect against those losses, have drastically altered the corporate-actions landscape. Having the ability to reduce provisions against losses obviously makes a compelling argument for implementing corporate actions solutions, says Harries.“Organisations that have better visibility and control

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measure it understand it apply it sĂZ ƌĞŵĂŝŶƐ Ăƚ ƚŚĞ ŚĞĂƌƚ ŽĨ ƌŝƐŬ ĞƐƟŵĂƟŽŶ ĨŽƌ ďĂŶŬƐ ĂŶĚ ĂƐƐĞƚ ŵĂŶĂŐĞƌƐ But a single VaR number is not the whole story D ƉƉůŝĐĂƟŽŶƐ Excerpt ĚĞůŝǀĞƌƐ͗ ^ŚŽƌƚͲƚĞƌŵ ĂŶĚ ůŽŶŐͲƚĞƌŵ sĂZ hƐĞƌ ĚĞĮŶĞĚ ƌŝƐŬ ĂƩƌŝďƵƟŽŶ ŽŵƉƌĞŚĞŶƐŝǀĞ ŝŶƐƚƌƵŵĞŶƚ ĐŽǀĞƌĂŐĞ ƌŽďƵƐƚ ƐƚĂƟƐƟĐĂů ŵŽĚĞů ĂƐǇ ŝŶƚĞŐƌĂƟŽŶ ŝŶƚŽ ǇŽƵƌ ŝŶǀĞƐƚŵĞŶƚ ƉƌŽĐĞƐƐ

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In the Markets CORPORATE ACTIONS: TIGHTENING THE SUPPLY CHAIN

of notifications to the decision makers are afforded a competitive edge, because once the process is automated, it means that the decision window can run that much closer to the market deadline, which is a major advantage for fund managers.” Daniel Simpson, chief executive officer of Cadis, a London-based data management provider for the buyside, agrees: “Firms who believe that investments in technology in the current climate are counter-intuitive need only calculate the true cost of their current CA process, including missed elections and the operational risks involved, to understand the money at stake. With the right process and technology, most firms will see return on investment in months with the added benefit of reduced reputational risk.” Cadis offers clients a corporateactions package that automates much of the time-sensitive work involved in collecting and validating corporate action data.“As there is no single ‘golden record’ available, clients are forced to use multiple data sources including Bloomberg, Reuters and FTID, all of which are provided in different formats,” says Simpson. “The challenge is to reconcile this data to that of the custodian or record keeper who may be supplying a message in ISO 15022, or in some cases a fax. Our technology allows clients to automate the collection process and view the disparate sources of information side by side, then applies rules to cross check the data, create the golden copy record and publish this to downstream systems in the format required, be it SWIFT, flat file or XML messages.” Flexible notifications are among the more recent additions to Fiserv’s corporate-actions product offerings. Organisations go through a data validation and cleansing process,

which allows them to relay information on corporate actions as it relates to their clients’ portfolios. Because this information is time sensitive, correlating and managing inbound decisions from managers is extremely important, says Harries, “Because whether they know it or not, those decisions could have a dramatic impact on the performance of the fund.” Back-office accounting continues to be a problem area, argues Simpson. Many systems have been in place for over 20 years and, therefore, are unable to properly handle complex cross-border, multi-currency corporate actions. “The back-office user is constantly wrestling with this dated technology and is forced to enter multiple journal entries to manipulate the corporate action. This manipulated corporate action becomes a nightmare to reconcile further down the line.” However, by using technology solutions to increase the level of automation, non-standard corporate actions can be manually checked and validated in a lower cost centre. “This allows local back-office staff to focus on the real exceptions rather than the noise, and provide oversight to the process,”says Simpson. Despite improvements, Simpson believes that the entire corporateactions process is still desperate for true automation. “The 1990s dream of STP seems to have passed corporate actions by,” he says. “The fact that a majority of data is still sent by fax and non-standard message formats continues to cause enormous headaches.” Additionally, the ultimate “utopia” of issuer- and market-agreed standards that can be translated into ISO 15022 or even XBRL appears to be a ways off, concedes Simpson. “In the meantime, the industry will likely be forced to use workarounds and manual processes.”The effort to build a better corporate-actions model goes on.

Geoff Harries, vice president, investment services at Fiserv, a global provider of financial services technology. As such, anyone who wishes to implement corporate actions today must do so based around 15022, yet with the knowledge that a migration strategy will be necessary as they go forward, says Harries. Photograph kindly supplied by Fiserv, October 2009.

Cynthia Weston, senior vice president, global product and strategy, at Northern Trust. Weston says that a great deal of energy has been devoted to improving corporate-actions information capture, with particular emphasis on eliminating the interpretation that is often required.“We really want to ensure that there is accurate and timely scrubbing and receipt of data, and as a result we have invested heavily in that part of the corporate-actions lifecycle.” Photograph kindly supplied by Northern Trust, October 2009.

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US M&A ON THE UP FTER A PROLONGED period in the doldrums, the outlook for US-based mergers and acquisitions may be improving. The trend towards increased M&A activity could continue well into 2010, think analysts, particularly as once-cautious stragglers scurry to get on board. Says Joe Berkery, president of Berkery Noyes Investment Bankers in New York, the turnaround is largely the result of strong demand from financially sound buyers finally breaking the resolve of reticent sellers. “Buyers—strategic players with strong balance sheets and financial buyers with plenty of investable cash—are still looking for growth through acquisition. The result is constrained supply of available acquisitions.” While the acceleration is likely to slow over the near term, Goldman Sachs analysts Daniel Harris and Jason Harbes expect a general continuation of the M&A upswing, particularly “as industry participants take note of deals in their sector and respond with additional transactions”. In a downward trajectory since early last year, M&A activity came to an abrupt halt in late 2008. Lack of leverage and a shaky economy kept buyers at bay for a good part of 2009. During the third quarter (Q3), total worldwide M&A valuations were nearly 5% lower than the same period a year before. However, the sudden spike in substantial M&A deals of late, covering a wide variety of sectors, in financial services, healthcare, industrials and

technology, has experts believing that valuations have finally bottomed. Going by past trends, an improving economy prompts sellers to enter the market in greater numbers. Given that yesterday’s over-valuations are well and truly over will help sellers to “let go of their inflated expectations and accept asset valuations that are strong by historical standards,” thinks Berkery. As buyers are presented with more viable acquisition opportunities, the supply/demand ratio will gradually reach equilibrium. Berkery expects a consolidation of the current trend through 2011,“with deal activity returning to the pre-bubble levels of 2005/2006”.

Growing confidence In financial services, the need to boost market share while keeping pace with the growing over-the-counter (OTC) derivatives market means buyers are seeking attractive small-firm acquisitions, says M&A group Jefferies Putnam Lovell in its recent assessment Winds of Change: First-Half 2009 M&A Activity in the Global Asset Management, Broker/Dealer, and Financial Technology Industries. “There’s growing confidence that the worst of the economic crisis has passed and would-be buyers are re-emerging,” noted Aaron Dorr, New York-based managing director at the firm. Deals such as Bank of New York Mellon’s investment in derivatives clearinghouse International Derivatives Clearing Group, and

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US MERGERS & ACQUISITIONS: IMPROVED OUTLOOK

A rise in corporate confidence and an increase in divestiture activity have prompted a surge in Stateside mergers and acquisitions over the past several months. If historical trends are any indication, a steadily improving economy will prompt sellers to enter the market in even greater numbers. David Simons reports.

interdealer broker ICAP’s effort to acquire European central clearing house LCH.Clearnet, are likely to grow in number, particularly as financial-services industry participants seek better solutions for the clearing, execution and processing of OTC derivatives. Risk mitigation and compliance fuelled deals such as SunGard’s acquisition of ICE Risk commodity trading solution and Broadridge Financial’s purchase of data-management services firm Access Data. Meantime, divestitures (accounting for more than half of all announced asset-management transactions during the first half of 2009) will play a significant role in the current M&A cycle, suggest analysts. Nick Colas, chief market strategist for BNY ConvergEx Group in New York, says the recent resurgence of M&A activity is good and bad news for the US. While rising stock indices have boosted corporate confidence, the subsequent increase in acquisitions could ultimately deal a blow to an already fragile labour market.“When A buys B, the purchase price almost always exceeds the cost of the ‘bricks and mortar’ business and the value of the current income stream,” says Colas. To make up the gap, the most common corporate action is to combine the workforces and reduce headcount—which, says Colas, “is a part of the M&A playbook to justify the cost of the acquisition.” As such, M&A may not be “the absolute boon that it more normally signifies to capital markets,” says Colas, particularly with US jobless figures already approaching 10%. “This is a concern, since it is that activity that signals the beginning of a decline in unemployment. M&A activity that drives incremental lay-offs will only prolong the wait for new job postings to provide fresh employment opportunities across the country.”

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Real Estate Report EUROPE’S REIT INDUSTRY: RIGHT PLACE, WRONG TIME

THE REIT STUFF?

Photograph © Julien Tromeur/Dreamstime.com, supplied October 2009.

Like most things European, accord and uptake of real estate investment trust (REIT) regulations have differed sharply across the continent, neatly illustrated by the two biggest property markets. The UK threw itself into the REIT arena with almost indecent haste once the chains were untied in January 2007 and the wreckage of the net asset values (NAVs) of those REITs is there for all to see. Germany ratified the legislation more slowly and has yet to create a meaningful REIT fund, yet for all that its real estate market may look more robust, it is stalled in a cat-and-mouse writedown cold war. Mark Faithfull looks at what next year holds for Europe’s REITs. HE CHEQUERED HISTORY of Europe’s REIT industry has so far been written in three acts. Act one—we’ll call it 2007—sees Europe’s two largest, most influential and prosperous real estate markets finally ratify REIT legislation and join a growing band of European countries, notably France and Italy, allowing companies to wrap their property portfolios up in a tax-efficient vehicle. The UK embraces the idea and has soon notched up double-digit REIT company listings while the Germans effectively derail their introduction at birth by placing residential property outside REIT status. This late political fix, based on concerns over upward rental pressures on German tenants, leaves a number of speculative international

buyers of multi-family residential units hung out to dry. Act two [2008] is largely concerned with watching Germany’s REIT market utterly fail to emerge while the net asset values (NAVs) of the UK’s REIT players plunge calamitously and loan to value covenants begin to creak under the unthinkable risk of breach. Meanwhile, the nearly-completed act three—this year—has been all about rights issues as REITs sought additional funds, they argued, to fund potential re-entry into the acquisition market but which in truth look much more like recapitalisation exercises. Despite the sorry tales from the UK and Germany, appetite for REITs as we enter 2010 appears suddenly quite ruddy again. Spain is working through

the political mechanics of implementation of its own scheme and yet another UK property company is talking up its conversion to REIT status. So why the sudden enthusiasm? In the UK, rights issues have undoubtedly provided temporary shelter, but questions remain about the major property companies’ strategies. Once loan-to-value ratios are breached, banks can rewrite loan terms with wider margins and arrangements fees to increase their profitability. The equity market is bullish and since the FTSE 100 Index low of 3500 on March 3rd this year, property shares are up 40%. Astonishingly, the sector’s market capitalisation has doubled to £21bn, of which £5bn has been fresh equity from shareholders.

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However, with the government capping its quantitative easing budget and the deluge of gilts, the gap between prime buildings let on robust leases at 7% and 10-year gilts at 4% is closing as a result of compressing real estate yields and rising gilt yields. Net asset values may be down for REITs but against fundamentals there is a distinct possibility that valuations are currently too optimistic. “There is more bad news to come and I question whether valuations are sustainable,” admits Martin Braun, head of capital markets in Germany for Cushman & Wakefield.“Stock markets are driven by momentum and psychological factors and I am not sure the fundamentals are in place,”he says. “Without market clarity it is impossible to know where the market is going or whether we have reached the bottom.” In Germany, open-ended funds continue to rule the roost and the power they wield and the consumer confidence they inspire has left neither room nor appetite for REIT growth. “IVG talked about it, then there were postponements and then the plans were cancelled,” recalls

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Sascha Hettrich, managing partner of King Sturge, Berlin.“To be effective, a company has to go out and acquire perhaps €1bn of property assets, yet the window to become a REIT is probably only four to five months. So in the current market a company would have to make those acquisitions and ride out the market while it was creating a suitable real estate vehicle to convert to a REIT.” Dennis Boergel, associate in corporate finance of Cushman and Wakefield’s capital markets group in Frankfurt, adds that while the German real estate market has proved innovative, it is also deeply conservative, especially when it comes to retail funds bought into by private individuals. “There is nothing to say about German REITs,”he adds. “The decision to omit residential from them at the beginning really killed the concept.” It is probably too early to brand the REIT model a flop in Europe but market sentiment has little to grab hold of, which has increased uncertainty.“The problem for the real estate sector is that it is all but impossible to call the market based on the very low transaction volumes,” stresses Chris Staveley, European director, European capital markets, at Jones Lang LaSalle (JLL). “Yes core and core-plus in London and Paris has picked up and we have seen yield Martin Braun, head of capital markets in Germany for Cushman & Wakefield.“There is more bad news to come and I question whether valuations are sustainable,” admits Wakefield.“Stock markets are driven by momentum and psychological factors and I am not sure the fundamentals are in place.Without market clarity it is impossible to know where the market is going or whether we have reached the bottom.” Photograph kindly supplied by Cushman & Wakefield, October 2009.

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2009

compression but these are established markets which have price corrected sharply and where investors can see value-added acquisition opportunities. However, we are seeing no knock-on effect for secondary locations and cities.” In the UK, the worry for REIT managements is the success of nonREITs in raising capital. Helical Bar set out its stall with a modest £28m equity raise at the start of 2009, issuing new shares at a 6% discount to share price. By contrast, the big REITs have all sold new shares at 50%-60% discounts, though admittedly on a much larger scale. There have also been a slew of non-REITs: Hansteen, which has recently affirmed plans to convert to REIT status, Development Securities and London & Stamford raised £527m at just 9%-11% discounts. “What the rights issues have done is help stabilise the businesses and attract a greater degree of confidence to some extent,” reflects JLL’s international director and head of

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Real Estate Report EUROPE’S REIT INDUSTRY: RIGHT PLACE, WRONG TIME

European capital markets, Tony Horrell. “However, it is important to note that while the first rights issues were pretty successful, some of the later issues did not attract the same degree of investor appetite.” Given that the UK is bedfellows with both Ireland and Spain in terms of the depth to which the property downturn has impacted its economy, it is perhaps all the more surprising that one of the triumvirate, Spain, is working REIT legislation through the upper house of its parliament. Spain could have its first REIT up and running by January but the introduction of the regime more than two years after Spain’s property crash began could prove a case of too little, too late.

Dennis Boergel, associate in corporate finance of Cushman and Wakefield’s capital markets group in Frankfurt. Boergel says that while the German real estate market has proved innovative, it is also deeply conservative, especially when it comes to retail funds bought into by private individuals.“There is nothing to say about German REITs,” he adds.“The decision to omit residential from them at the beginning really killed the concept.” Photograph kindly supplied by Cushman and Wakefield, October 2009.

Sociedades de inversión en el mercado inmobiliario (SOCIMIs) are being brought in to encourage investment in Spain’s embattled property sector. The government discussed their introduction almost three years ago but it has only been over the past year—as part of a multibillion euro rescue plan that included a €3bn package to kick-start development and bank lending—that the government has pushed forward its plans for the SOCIMI. However, unlike the REIT regimes in France or the UK, SOCIMIs will not be tax free. Instead they will pay an 18% corporate tax on income, but no capital gains tax. In a move clearly designed to address the greatest point of concern in Spain’s property market, there are rewards for those investing in housing—if 50% of a REIT’s investments are in residential lettings, 20% of the profits from it are tax free. Banks are expected to be the biggest beneficiaries and, unlike the UK, they will not have to pay an entry charge to become a SOCIMI. However, this approach has attracted a raft of critics, who question how the SOCIMI will help the real estate industry with its prevailing tax levels. Instead, some analysts in Spain are accusing the government of devising the scheme as a way to assist the banks with their property overload, with some structural concessions by the government to adapt it to a slightly more European model. The real rub for Spain though is that governments typically create REIT regimes to attract foreign investment—those in the US and Australia were largely formed to benefit flat real estate markets—but many investors remain unconvinced about Spain’s plans and are likely to continue investing through their own European funds instead, not least because in the SOCIMI structure an

Tony Horrell, international director and head of European capital markets, Jones Lang LaSalle. What the rights issues have done is help stabilise the businesses and attract a greater degree of confidence to some extent, notes Horrell. “However, it is important to note that while the first rights issues were pretty successful, some of the later issues did not attract the same degree of investor appetite,” he says. Photograph kindly supplied by Jones Lang LaSalle, October 2009.

investor must hold the asset in the SOCIMI for seven years. Spain, like the UK, needs less a recovery in REITs and more a recovery in the fundamentals of its real estate sector. With the latter, the fortunes of the former will inevitably rise. However, as at the beginning of 2009, the dawn of 2010 awaits with contradictory messages. HSBC speculated in a recent note that a double-dip drop in real estate prices would unfold over the coming year, while conversely Blackstone has confirmed a war chest of $12bn for real estate as it begins to call the market’s bottom. Whether the REIT sector has bottomed out remains to be seen.

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Spain is launching its own version of the Real Estate Investment Trust (REIT), to be known as Sociedades Anónimas Cotizadas de Inversión en el Mercado Inmobiliario (SOCIMI). A SOCIMI has to be a limited company with its sole purpose being the acquisition and development of urban real estate for lease activities, restoration works; the acquisition of shares in other SOCIMIs and collective investment entities or in foreign entities with the same corporate purpose and subject to the same dividend distribution requirements of a SOCIMI; or the acquisition of shares in qualifying subsidiaries. The legal framework is expected to be in place by the end of this year.

THE NEW REIGN IN SPAIN: SOCIMI RULES OCIMIs will be subject to detailed qualification requirements. For example they must be listed on a recognised European Union stock exchange. They will also qualify for 95% relief on transfer tax on acquisition of urban real estate for leasing and fully exempt from stamp duty on incorporation and capital increases. In order to qualify as a SOCIMI the following requirements must be fulfilled: The SOCIMI must be listed on a regulated Spanish or EU stock market; The minimum share capital must be at least €15m; The leverage cannot exceed 70% of the value of its assets; At least 80% of its assets must be qualifying assets (urban real estate for rent and urban land intended for development) or shares in qualifying subsidiaries; At least 80% of the income (not including capital gains from qualifying assets or subsidiaries) must derive from the leasing of urban real estate or from dividends distributed by qualifying subsidiaries; The qualifying assets or subsidiaries must be held for at least three years, or seven years if the property was developed by the SOCIMI. The SOCIMI must own at least three qualifying assets, any of which must not represent more than 40% of the value of the total assets at the time of their acquisition.

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2009

Photograph © Marvlada/Dreamstime.com, supplied October 2009.

Moreover, the SOCIMI must distribute to its shareholders as dividends at least 90% of profits obtained from rental activities, as well as from ancillary activities; at least 50% of profits derived from the transfer of qualifying assets which comply with the holding period (the remaining 50% must be reinvested in other qualifying assets or subsidiaries within three years of the date of transfer); and 100% of profits derived from dividends distributed by qualifying subsidiaries, as well as profits from income subject to general Corporate Income Tax (CIT) (currently 30%). At the corporate level, SOCIMIs will be subject to tax at a flat rate of 18% on income and gains derived from qualifying assets and subsidiaries. They will also qualify for 95% relief from transfer tax on any acquisitions of urban real estate for leasing and be fully exempt from stamp duty on incorporation and increases in capital. Shareholders which are either non-resident individuals or companies without a permanent establishment in Spain but which are resident in jurisdictions which have an effective exchange of information agreement with Spain, will qualify for an exemption from Spanish tax on dividends and capital gains derived from investments in SOCIMIs. However, the capital gains exemption will be capped at an amount equal to the difference between multiplying 10% of the price of acquisition by the number of years the asset has been held and the amount of the exempt dividends received during the holding period.

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Real Estate Report US REITS: ALL RIGHT OR ALL WRONG?

REITS AFLOAT AGAIN BUT FOR HOW LONG? Photograph © Romica/Dreamstime.com, supplied October 2009.

After spiralling out of control for a full year, real estate investment trusts (REITs) suddenly sprang to life during the second half of 2009, buoyed by pent-up investor demand and igniting a blast of initial public offerings (IPOs). David Simons asks whether REITs retain their vigour, or have they come too far too fast this time around? HILE MOST SECTORS have felt the impact of tighter credit measures over the past two years, it has been a particularly tough stretch for domestic real estate investments trusts (REITs). After soaring to unfathomable heights on the back of exceedingly low interest rates and unfettered lending practices, US REITs have, until very recently, been among the market’s lowest of bottom dwellers, stung by falling commercial and household real estate valuations, a stingy securities-lending environment and, above all, the broader market’s inexorable rush toward deleveraging. Continued liquidity concerns and deteriorating property fundamentals, together with a recessionary US economy and constrained real estate debt capital markets will continue to

pose challenges to US equity REITs throughout the remainder of 2009, according to Fitch Ratings in a new report. “Restricted access to real estate debt capital and lower transactional volumes will lead to uncertainties surrounding commercial real estate values throughout 2009,” says Fitch managing director and head of US REIT group Steven Marks. Equity REITs had rebounded in the second quarter, when equity REITs posted total returns of 29% (based on the total return FTSE NAREIT Index), versus a 15% gain for the S&P 500 and an 11% gain for the Dow over the same period. Then in July, REITs were down about 8%; the worst performing sectors being regional malls (-10.9%), industrial (-9.8%), office/industrial (-9.6%) and apartments (-9.7%) and up to the end

of July REITs were still down 19% and 43% over the previous year. Most companies have been shoring up balance sheets by raising cash through equity and asset sales, with the proceeds being used to pay down debt. There are some bright spots, however. While maintaining an overall negative posture, many analysts have reduced ratings downgrades on REITs during the final quarter of 2009, as narrowing credit spreads and improved lending conditions paved the way for more robust unsecured bond issuance, says Fitch. Other hopeful signs include the availability of REIT refinancing through the mortgage market, which has helped boost the fortunes of publicly-traded REITs. Though credit will remain tight and priced significantly higher than pre-crisis levels, REITs with sound balance sheets will likely continue to tap into the capital markets over the near term, suggests Morningstar analyst Todd Lukasik. Given the severity of the decline, a REIT rebound was long overdue. After

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peaking at just over 1200 in February 2007, the MSCI US REIT Index, which tracks a broad range of US REITs, plummeted 75% over the next 12 months as liquidity tightened and the bottom fell out of the housing market. Dividends, the feather in the cap of REITs, promptly tanked as rents and mortgage payments lost ground, sending fixed-income investors running for cover. Last spring, some good news: housing sales unexpectedly sprung to life, causing opportunistic investors to jump back into beaten-down REITs. Those investors have been handily rewarded for their bravery; as of September, the MSCI index had nearly doubled in value. The remarkable rally also breathed life into sagging REIT dividends, many of which are now paying in excess of 4%, or roughly double the average of dividendpaying S&P 500 companies. Meanwhile, REIT initial public offerings (IPOs) have surged as start-up investment firms attempt to cash in on the downtrodden commercial real

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estate market. Through September, equity REITs raised some $20bn in capital, including 45 common-stock offerings, according to Grubb & Ellis Alesco Global Advisors. Mortgage REITs, which invest in mortgages and mortgage-related interests, have accumulated some $1.3bn in IPO capital over the past several months. Have REITs come too far too fast? Analysts Andrew DiZio and Daniel Donlan of Janney Montgomery Scott believe that the substantial REIT gains over the past half year suggest that investors see a recovery in the making and are “looking ahead to potential earnings power”. A continuation of the recent REIT rally is possible, though profit taking is not out of the question, they add. But others such as BMO Capital Markets analysts Paul Adornato and Richard Anderson believe REITs are no longer undervalued as a result of the recent rally, particularly as fundamentals remain weak. They say: “It is possible that momentum

investors will fuel some additional upside. But we are content to book the healthy gain, while still on the lookout for names that could provide above average returns from here.” It remains unclear whether REITs will continue to gain favour within the equity markets. While REIT valuations appear to be on par with the S&P 500 during 2010, reduced growth could make REITs look more expensive by 2011, according to a recent UBS report. Looking ahead, increased capital costs due to anticipated interest rate increases, the potential implementation of LIBOR floors, in addition to substantial reductions in credit facility commitment amounts, may prove challenging for REITs, said Fitch’s Marks. “The expected reduction in commitment sizes will place increasing pressure on many REITs to maintain adequate liquidity, particularly if all-in rates in the senior unsecured bond capital markets continue to be uneconomic for most issuers.”

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

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Real Estate Report ASIAN REAL ESTATE: A MULTI-DISCIPLINARY APPROACH

Photograph © Alexander Kuznetsov/Dreamstime.com, supplied October 2009

ALPHA IN ASIA MAJOR Real estate in Asia has not been immune to the liquidity crunch in Europe and the United States. The so-called flight-to-quality taking place towards developed markets such as the United Kingdom, which now offer attractive yields without the perceived burden of emerging markets risk, has particularly impacted on capital flowing to private equity investment in the region. Bitter lessons have been learned on the interplay between liquidity, price discovery, and investment time horizons. Simon Coxeter, director at Swisslake Capital Asia, discusses the importance of a multi-disciplinary approach to real estate investment in Asia, and the long-term prospects for a global investor. PPROACHING REAL ESTATE investment with a cross-assetclass, multi-strategy capability enhances prospective returns and provides a more comprehensive array of risk management tools. This has been easy to overlook during the boom years but brutally apparent over the past 18 months. It is no particular revelation that shifting exposures between public and private assets at different points in the economic and market cycle may yield a more riskefficient portfolio, but some allocators still fail to capitalise on the opportunities of a multi-disciplinary approach to real estate investment. This failure is understandable because it requires the combination of, and cooperation between, investment professionals with very different backgrounds—creating a consistent investment philosophy across such a

team requires careful planning, open communication and rigorous discipline. Listed securities offer a few clear advantages over private investments and represent a key component of an holistic allocation to real estate. Listed assets offer obvious liquidity benefits over private equity or other direct investments. Although a secondary market for private equity interests exists in Asia, many investors have found it difficult to engineer an exit at palatable discounts. At times of financial and economic stress, the value of increased liquidity should not be underestimated; the lack of liquidity within the private investment sphere led to severe portfolio management challenges for institutional investors over the past year. This is not merely an issue of return of capital to meet liabilities, but also of managing exposures against strategic or

tactical benchmarks. This portfolio management reality makes nimble response to changing market conditions difficult with only a private investment approach. The ability to short specific securities and sub-markets makes it possible to profit from downturns and hedge out unwanted exposures, although Asia still has a long way to go to match the breadth and depth of physical market-related and listed security shorting options available to real estate investors in the UK. Accurately comparing valuations across private and public asset classes can be difficult at the best of times as the risks and value drivers are very different. Simply comparing current cap rates in the direct market with some form of implied cap rate in the listed market does provide a starting point, but other factors and necessary assumptions cloud transparent comparisons. Therein lie both the challenge and the opportunity, as value gaps between asset classes emerge across the cycle. Price discovery in private markets can be sluggish, which has resulted in convenient returnsmoothing for some but frustrating uncertainty for others. Price volatility in public markets can lead to extreme value dislocations. Contrasting value dynamics must be taken into account when identifying pricing anomalies. A simple example of a dichotomy between valuation drivers could be found in Singapore recently. Residential real estate has been resilient despite one of the worst economic backdrops in Singapore’s history, a mini-exodus of foreigners and foreign investors and a glut of supply on the horizon. The bull story relies on the large domestic savings pool and pent-up demand from domestic buyers wanting to upgrade from government-subsidised housing. The bull story certainly has some merit, but it was the lack of distress in

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the market on the part of both buyer and seller (developers as well as individual buyers and sellers) which buffered any marked impact on pricing in the direct market. In fact, developers have started to increase prices again after relatively modest residential price declines of 6.1% and 14.1% quarter-onquarter in the fourth quarter (Q4) of 2008 and Q1 2009, respectively. The public real estate securities market in Singapore was much quicker to respond to the macro decline, with large residential developers in early March 2009 trading up to 30% below book value and at larger discounts to direct market valuations. Between October 1st 2007 and March 31st 2009, private residential prices in Singapore fell by approximately 12.5%. During the same period, share prices of private residential developers and investors in Singapore fell by 60% to 90%. Of course, direct comparisons are simplistic given varying asset exposures, gearing levels, and liquidity characteristics of listed players, but the disparity in market pricing was nevertheless overwhelming.

Core strategic allocation The investment case for Asian real estate is compelling, with unprecedented economic and demographic tailwinds. The long-term fundamental drivers for Asian property should not be understated. The positive backdrop for economic growth in Asia has been welldocumented, with blossoming domestic consumption and the emergence of a sizeable middle-class. However, demographic changes in some Asian countries will have a particularly profound effect on real estate. Take China as an example. In a recent study by the McKinsey Global Institute, Chinaâ&#x20AC;&#x2122;s urban population is forecast to grow by 350m over the next 15 years. That is equivalent to the entire populations of Germany,

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France, the UK and Russia all moving into Chinaâ&#x20AC;&#x2122;s urban environment. The real estate implications of such a demographic shift are enormous. According to McKinsey, 5m new buildings may be required by 2025, 50,000 of which could be skyscrapers, in itself equivalent to ten New York cities. For a global real estate investor, positioning the portfolio to leverage on this historical opportunity could be a key driver of long-term returns. The relatively inefficient pricing mechanism of listed securities in Asia, combined with the secular trend towards larger allocations to the region within international institutional portfolios, makes for a particularly attractive story for listed real estate securities in Asia. Pricing anomalies are more frequent and of greater magnitude than in European or US markets. Greater retail participation in the Asian markets amplifies both volatility and information asymmetry, expanding the opportunity for sophisticated investors to generate alpha. The general increase in risk aversion and heavy redemption-led selling caused a steep fall in listed real estate equity prices throughout Asia in 2008, implying an overly bearish view of prospects for the underlying assets. Large-cap Hong Kong property landlords, for example, traded down between 25% and 40% of net asset values (NAVs) towards the end of 2008. Peak to trough, share prices fell 50%-85% between 2007 and late 2008. Of course, NAVs are moving targets and just as relying on cap rates in the direct market would provide little investment insight without a partnering assumption on prospective income and capital values, discounts to current NAV must be viewed in the context of prospective NAV declines. In the case of Hong Kong, this is where a clear distinction could be

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drawn between office, retail, and residential assets. Office real estate, heavily exposed as it is to the financial sector, is justifiably undergoing a sharper correction than residential and retail real estate, which has been supported in part by a large pool of mainland Chinese home-buyers. Although large-cap developers and landlords clearly represented excellent value in early 2009, the velocity of the recent rally has been surprising, with many stocks already doubling from the lows. This rapid narrowing of discounts to NAV contrasts with a slower narrowing over a period of 18 months as we emerged from the Asian financial crisis of the late 1990s. Tactical opportunities exist among lesser-known small and mid-cap stocks, following the broader rally over the past few months. Moreover, a longer-term strategic allocation to the small and mid-cap space offers the potential for superior returns across the market cycle for a specialist real estate investor.

Growth prospects Within the small and mid-cap universe, we are still able to identify compelling opportunities for outsized returns; that is, companies trading on 40% to 50% discounts to NAV with manageable gearing levels, sizeable low-cost land banks and healthy growth prospects. Companies with solid cash-flow characteristics and the ability to make opportunistic investments when distress impacts upon more highly-geared competitors have appeal. However, caution is advised on office exposure within the Greater China markets of Hong Kong, China, Taiwan, and Singapore. Selective residential and retail exposure in those markets, playing more directly to the domestic consumption and liquidity theme will most likely prevail over the coming decade.

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Sector Report US WINERIES: AUSTERE TIMES FOR CALIFORNIA

Photograph © Richard Hoffkins/Dreamstime.com, supplied October 2009.

THE NEW THRIFT CAPS WINE SALES For California wine producers, it is the best of times and the worst of times. Giant wineries that specialise in low-cost wines are having a record year, while small family-owned wineries that specialise in high-end wines are struggling. For them, things are likely to get worse before they get better. Art Detman, with a glass of North Coast Shiraz at hand, reports from California. HE PRICE OF chicken wings tells what is happening in the storied and once thriving California wine industry. The average price across the USA in September was $1.48 a pound against only $1.21 for the more desirable skinless and

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boneless chicken breasts. The reason was simple: upscale restaurants, which are major buyers of chicken breasts and also account for a disproportionate amount of high-priced wine sales, had cut sharply their chicken orders because their revenues were down. Meanwhile,

the low-end restaurants and bars that feature cheap eats were ordering more wings than the poultry industry could supply. Just as Americans have traded down in restaurants, they have traded down in wines. “In November 2008, the market for more expensive wines fell off a cliff, as it did for many upscale consumer products,” says Barbara Insel, president of Stonebridge Research Group in Napa, the heart of California’s high-end wine country. “Consumers went into shock.” The sales slide shadowed a decline in business at white-table restaurants. “Starting in late 2008, the full-service restaurants really started struggling. About 20% of all wine sales by volume and probably 40% by dollars are made through restaurants. Many makers of expensive wines focus their marketing on high-end restaurants because that helps build brand recognition.” Like nearly all other businesses, upscale wineries have fallen victim to the “new thrift” that Americans have embraced and which has decimated sales of luxury goods in almost every category, from cars to clothes to cabernets. Insel and other experts say that wine drinkers have traded down decisively. “People who were drinking wines at $80 or more a bottle traded down to $40 wines, and all the people who were drinking $30 to $50 wines traded down to $15.”Many of those who had paid $12 to $20 a bottle are now drinking wines priced in single digits. “Wines under $8 have had their best year in a decade,” Insel says. “The $8 to $15 segment is holding its own because a lot of consumers are trading down into that range. So a lot of high-end producers, which tend to be the North Coast wineries and some of the Central Coast wineries, are having a very difficult time.” California has a dozen or more distinct viticultural regions, with more than 100 grape varieties grown by nearly 3,000 wineries. These range from

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behemoths like E&J Gallo Winery and Bronco Wine Company, which produce tens of millions of cases annually, to small boutique wineries that produce just a few thousand cases. The North Coast region—just north of San Francisco and including Napa and Sonoma counties—is the premium growing area and its wines rival or better those produced in the finest appellations in France. The Central Coast region, roughly between San Francisco and Los Angeles, also offers upscale labels. The South Coast region includes Los Angeles and San Diego counties and the inland counties of San Bernardino and Riverside are where many lower cost wines are produced. The huge Central Valley is known mainly for low-priced red wines. Although California ranks only tenth in wine acreage in the world, so bountiful are its soils that it ranks fourth in production after France, Italy and Spain. Last year it produced nearly 546m gallons of wine, 88% of all the wine produced in America. At retail, competing against both domestics and imports, California wines accounted for 62% of all US wine sales—$18.5bn worth. The industry dates to Spanish colonial times, when the so-called Mission grape was grown to provide wine for church services. After 1850, a merchant wine industry was created mainly by Italian and German immigrants using French grapes. Prohibition devastated the industry and only a few wineries survived, again producing wines for religious use. After repeal, Ernest and Julio Gallo borrowed $5,000, from Ernest’s mother-in-law, to establish a winery in Modesto, in the centre of Central Valley. They sold in barrels to taverns, whose customers brought glass jugs to be filled (hence jug wines). Then, the Gallos began bottling dessert wines and after World War Two introduced so-called specialty

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wines, such as Thunderbird, Boone’s Farm and Ripple. Oenophiles recoiled, but sales grew rapidly. The company acquired vineyards, signed long-term contracts with growers, expanded bottling capacity, built a formidable national distribution system, relentlessly launched new products, and established its brands through advertising. In the 1960s it introduced Hearty Burgundy, a jug wine that rivalled the quality of competitors’ varietals and became a favorite of the cognoscenti.

Moving upscale In 1974, Gallo introduced its first varietal wine.“They didn’t make a big deal of varietals until the late 1980s or early 1990s,” says Jim Gordon, editor of Wines & Vines, a California-based trade publication. Methodically, Gallo expanded its offerings of varietals, moving upscale with brands such as Turning Leaf. Today, Gallo produces brands ranging from jug wines such as Carlo Rossi, and under-$10 wines including Barefoot and Bella Sera to uber-luxury brands such as the 2004 vintage of Clarendon Hills Astralis Vineyards Syrah, marked down on Gallo’s website from $325 a bottle to $217. Gallo [family-owned and close-mouthed] will probably ship close to 80m cases of wine this year, the vast majority of which will be low-priced varietals produced at any of seven California wineries, of which 15m or more cases will be exported to 90 countries. Gallo’s happy prosperity is duplicated at other mass producers of low-priced wines, notably Bronco and the Wine Group. Founded in 1973 by Fred Franzia, a nephew of Ernest Gallo, most of Bronco’s vineyards are also in the Central Valley. Bronco is the owner of the Charles Shaw label, a cheap wine made famous through distribution by

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the Trader Joe’s chain of specialty stores, where it retails for $1.99 a bottle in California and is affectionately known as“Two Buck Chuck”. In other states it is “three buck Chuck” or “four buck Chuck”, to reflect the additional cost of transportation. Fans of its red wine are known to buy one bottle, open and taste it in the parking lot, and then go back into the store if the quality warrants additional purchases. The wine is produced from purchased grapes from a constantly changing mix of vineyards and so the taste varies from lot to lot. The Wine Group, meanwhile, which comprises mainly lower-priced brands such as Corbett Canyon and Glen Ellen, has responded with a $1.99 wine of its own, Bay Bridge, which is sold through supermarkets. Altogether there are no more than a dozen wineries that produce a million cases or more a year. The largest of these is NewYork-based Constellation Brands Inc (STZ). Publicly traded, Constellation is a highly diversified beverage company, owning the Robert Mondavi and Clos du Bois wine labels, among many others, as well as hard-liquor brands such as Black Velvet and Svedka and beer brands including Corona and St Pauli Girl. Gallo ranks second, followed by The Wine Group and Bronco.“The biggest commercial wineries are shipping record amounts of wine every month,” says Jon Fredrikson, a principal at Gomberg, Fredrikson & Associates, a consulting firm based in Woodside, California. “Lower priced wines are growing rapidly. Wines at the higher end of the spectrum are declining. It’s a dream market for American wine consumers right now because you have got wines from around the world and around the nation being sold at discounted prices in stores, in restaurants and direct by the winery. Everyone who is selling luxury products is crying the blues.”

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Sector Report US WINERIES: AUSTERE TIMES FOR CALIFORNIA

“The low-priced wines are up 5% to 10% in sales while some of the highpriced wines are down 10% or 15%,” says Robert Nicholson, a principal of International Wine Associates, a financial and marketing consultancy based in Healdsburg. He believes that as the recovery from the recession gains momentum, higher priced labels will rebound but not necessarily to their prerecession levels. “Certain consumers have recognised that they have been able to acquire nice wines for reasonable prices, and they will go back to spending large amounts of money for a bottle of wine only for special occasions.” Meanwhile, most growers of those high-end wines were caught in a bind as autumn harvesting approached. Faced with bleak prospects for selling their wine, they could leave the grapes to rot on the vines, or they could pay to have the grapes harvested, turned into wine and stored for sale later. Because growing wine grapes is a cash-flow business, the latter choice requires bank financing, something increasingly hard to arrange.

Renegotiate prices Wine makers, too, face some tough choices. Those that don’t grow all their own grapes usually have fixed-price contracts to buy grapes from growers. But those prices were determined last year, when prospects for high-end wine sales weren’t as bad as they are now. Some are trying to renegotiate prices, while all are desperately hoping to renew institutional credit lines. Not all succeed. Eric Flanagan, a highly successful hedge fund manager, put his 120-acre boutique winery on the block in September for $8.5m. He opened his winery in 2006, after spending millions to construct it to the latest standards. But his $100-a-bottle cabs and syrahs found few buyers as the economy slid into recession. He wasn’t encouraged when a nearby

property was marked down to $1.5m from $2m. Meantime, Havens Wine Cellars found no sellers and was liquidated after its lender, PNC Bank of Philadelphia, placed a lien on the assets of its owner, Billington Imports of Virginia. Billington had purchased the winery from its founders, Michael and Kathryn Havens, in 2006. Now, the Los Angeles-based Great American Group, which liquidated the assets of Mervyn’s and Circuit City, is selling Haven’s assets, which include grapes on the vine as well as trademarks, licenses and contracts. No central record of winery failures is kept, so the exact number is unknown. “Small wineries are failing all across the country, not just in California,” says Gordon of Wines & Vines. “Some of them close so quietly that hardly anyone notices.” Insel of Stonebridge Research isn’t entirely sympathetic. She says:“I think that the people who have been in business for 20 or 30 years and who have patiently grown their brands are not going to struggle, but there are an awful lot of people who have come in during the last decade and said,‘I want to make my $120 cab, which will just roll of the shelves at wine stores’. They are in for a shock. If you are a small and unknown brand that is trying to make a case for one of these incredible prices for your wines, you’re in trouble. It’s much easier to make wine than it is to sell it. The number of people who come into this industry without recognising what is involved in selling wine and understanding the market constantly amazes the rest of us.” Once the economy has reached its pre-recession output, will the high-end wines of California bounce back in sales? “That’s the $64 question,”says Professor Robert H Smiley, director of wine studies at the University of California, Davis. “I asked that question of 25 industry chief executive officers and they were roughly

“In November 2008, the market for more expensive wines fell off a cliff, as it did for many upscale consumer products,”says Barbara Insel, president of Stonebridge Research Group in Napa, the heart of California’s high-end wine country.“Consumers went into shock.” Photograph © Elena Ray/Dreamstime.com, supplied October 2009.

split. I feel that the labels that sell for over $50 and have a good relationship with their customers and a sound basis for what they ask in price are going to return. But there are a number of high-end labels that will never again see their previous highs in sales, and those labels will be in some difficulty.” It’s likely to be a year, perhaps longer, before consumers again feel like spending big bucks on wine, no matter how many stars the experts may award it. During that time, another harvest or two will be completed, more banks will refuse to roll over loans, and distributors will continue to reduce the number of brands carried. In short, it will be a very tough time for California’s world-class wineries.Yet you can be sure that right at this moment some wealthy money manager or software developer or biotech entrepreneur is thinking of starting his own boutique winery. He envisions the Tuscan architecture of the main building, complete with a bell tower.A wine cave extends deep into the side of a hill, where nature keeps his casks of fine cabernets and syrahs at the ideal temperature.The reviewers shower stars on his offerings, and they feature on the wine lists at the nation’s best restaurants. This time, he assures himself, it will be different.

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SOFT COMMODITIES: THE FINAL FRONTIER

Photograph © Dashk/Dreamstime.com, supplied October 2009.

THE SOFTER OPTION

Although Bernanke’s ITH RARELY A day comments temporarily passing without depressed the price of corn mainstream news (the biggest US crop, valued items touching on the price of at $47.4bn in 2008) as the US oil, and “hard” commodities dollar rallied, the price has such as gold and other rebounded on speculation precious metals, a weight of that freezing weather new money from smaller investors ($120bn to $150bn The re-emergence of oil and precious metals forecasts for the US Midwest estimated in the past couple of as a financial asset class has produced the side in the next month or so will years via pension and mutual effect of boosting interest in “soft” end the growing season for funds) has flowed into these commodities—including coffee, cotton, corn, immature plants. Corn prices received a commodities’ markets to add wheat and pork—with many investors to that of the previously allviewing the soft options as offering greater, further boost as the US powerful hedge funds. longer-term potential than their “heavier” department of agriculture reduced its estimate of the This rebirth of such counterparts. Simon Watkins reports. area sown with corn to commodities as a financial asset class, as part of portfolio September, as legendary investor 86.4m acres, from 87m, and predicted diversification strategy, has started to Warren Buffet stated that the US demand will rise to a record of fuel greater interest in the “soft” economy “has hit a plateau at 13.03bn bushels this year. Rain in commodity cousins (such as coffee, bottom”, and Federal Reserve October put further pressure on cotton, corn, wheat and pork), chairman Ben Bernanke added that prices as the harvest slowed and underlines Jorge Parente, director of “the recession is very likely over”. reduced sales by farmers, boosting Call it a function of market cash premiums for immediate JPM Fund Management in London. “Over the past year or so, there has sentiment, call it investor perception— delivery of the grain, according to been a pick-up again in exchange- or as Groucho Marx once said:“Call it a Chad Henderson, a market analyst traded fund (ETF) volumes in soft banana” – either way, Parente thinks for Prime Ag Consultants in commodities, and we expect this to that soft commodities can be regarded Brookfield, Wisconsin. continue,” Parente says. This notion as offering greater, longer-term upside Henderson thinks that only about received a further boost at the end of potential than either oil or gold. 10% of the crop had been collected as

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Sector Report SOFT COMMODITIES: THE FINAL FRONTIER

of October 4th, compared to the previous five-year average of 25% by that date. Reports from MDA EarthSat Weather in Rockville, Maryland, and the US National Weather Service, have predicted possible drier, warmer conditions in the Midwest at the end of October, firming muddy fields for harvest equipment. In broader terms, there has been a broad-based downwards retracement in the pricing complex of oil and the hard commodities in recent months. The previous surge in these prices has served to highlight the close relationship between hard and soft commodities, with prices for staple foods increasing globally by 55% from June 2007 to June 2008 as US light crude oil hit a high of $147 per barrel and gold traded above $1,000 per ounce. In addition, in March 2008 the price of rice (which accounts for around one fifth of all calories consumed in the world) went up by 87% and corn futures prices peaked at a record $8.26 per bushel; more than double their level in mid-2007. Soaring oil prices accounted for an increase of $3 per bushel, according to a recent study commissioned by the US Farm Foundation, as the input costs for corn production (such as fertiliser, propane and diesel) increased in tandem with the cost of petroleum. An additional $1 of the corn price increase was attributable to an ethanol subsidy that boosted biofuel production and spurred demand for more corn in the US, according to the same report. This said, the relationship between hard and soft commodities’ prices and volatility is not quite as straightforward as might be gleaned from the above examples. To begin with, explains Naheem Majid, managing director of Sinaco Global Trading in London, bad weather is, naturally, a key driver of crop costs: “The UK’s chief grain marketing body, the Home-Grown

“With the UK’s chief grain marketing body, the HomeGrown Cereals Authority, having said at the beginning of this year that a good crop was required to boost global stocks, which have been declining for all but one of the past eight years, wheat prices almost doubled in Europe after Canada, the world’s second-largest exporter, announced its output could be a fifth less than last year’s levels,” says Naheem Majid, managing director of Sinaco Global Trading in London. Cereals Authority, said at the beginning of this year that a good crop was required to boost global stocks. These have been declining for all but one of the past eight years, [and] wheat prices almost doubled in Europe after Canada, the world’s second-largest exporter, announced its output could be a fifth less than last year’s levels.” Excessive rainfall this summer in Germany, the UK and France (Europe’s largest supplier), and Australia—one of the world’s largest exporters of agricultural produce—is likely to further reduce supplies, he adds. Against this backdrop is a huge uplift in demand: Egypt (the largest importer of wheat in the world) increased its order by 250% this year and Morocco upped its demand by 300%. Food prices will invariably continue to rise over the longer term, thinks Parente. If nothing else, the world’s population is increasing at a rate of around 80m every year, to add to the 6bn people inhabiting the planet now. The apotheosis of this notion is evident in ever-increasing food consumption in China. For example, its denizens consume seven times more pork as those of the US and, according to the US department of agriculture, the level of Chinese pork consumption rose 22% between 2002 and 2006. Aside from the effects of an expanding population, pork prices

spiked 68% between April 2007 and April 2008 as a result of the Sichuan earthquake, almost unprecedented snowfalls and an outbreak of swine disease. Moreover, “The problem of disease in China is going to get worse, for two reasons,” says Parente. “First, peasant farmers, who account for around 70% of hog production in the country, are leaving their farms behind and moving to the cities for better jobs. Second, factory farms in the country are plagued by polluted water and overcrowding in the hog sheds.” The same rationale applies to the prices of other softs, he adds. Similar increases in China’s consumption of coffee [currently less than 50 times that per person than in Germany] or sugar, is likely as disposable incomes in the republic continue to rise. In the case of coffee, for example, the bullish underlying message is further underpinned by technical factors, which show that coffee has been in a major unbroken uptrend since 2000. Another key factor driving prices of soy, sugar, corn, and palm oil, in particular, says Sinaco’s Majid, is the trend towards fuel sources other than oil, such as the production of bioethanol and bio-diesel. “India’s demand for energy per capita is 5% of South Korea’s and Japan’s, while China’s demand is only 10%,”he says. “With the population of China and

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India totalling 2.3bn and declining oil supplies, significant growth in demand for such fuel is inevitable over time.” The UK government has announced it wants 5% of all fuel sales to be biofuels by 2010 (20 times present levels), and the US government has stated it wants to cut dependency on oil 20% by 2017 (mainly through a fivefold increase in the use of renewable fuels). The coalescence of these factors, holds Majid, is likely to produce the sort of“supercycle”for the soft commodities sector that had been evident in the oil and hard commodities markets for some time. In fact, he believes that in the coming few months and years it will be sufficient to redress the performance imbalance between the hard and soft sectors of the past. In this respect, for example, in 2007 oil increased around 41%, natural gas 58%, and zinc 50%, while soybeans and wheat rose 10% each in value, and cattle and coffee 3% each.“Its primary drivers will be the continued industrialisation of the world’s largest country, China, and an industry that faces unprecedented supply issues as a result of changing investment goalposts,” he underlines. This combination, he believes, is set to drive the “stronger for longer” theme for a number of years, although there will be inevitable pauses along the way. “Recent pullbacks in wheat and corn prices, for example, represent just such pauses, exacerbated by the recent investor concern about the US and global growth outlook for the remainder of this year and possibly next, despite Bernanke’s comments, but I think these fears will be outweighed by technical factors, and that a transition in the growth mix is under way.” So, what are the best ways to benefit from such an upturn within an overall balanced portfolio? From a broad-based equities perspective, if, as

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Photograph © Dashk/Dreamstime.com, supplied October 2009.

seems entirely logical, the“supercycle” of growth in the agricultural and food sector continues as it has done overall, there is no reason whatsoever, thinks Majid, why associated stocks should not be viewed as true-growth stocks, rather than cyclical ones, as they generally are now. “As the market in softs broadens and deepens, in line with the way markets develop as a rule, you can expect to see a convergence between the type of earnings per share multiples upon which softs-related companies trade, and those of more mainstream growth stocks,” he highlights.“With the World Bank estimating that global grain production will have to climb by nearly 50% and meat output by 85% between 2000 and 2030 to meet the projected global demand for food, I think it’s pretty obvious that this tactic is a good bet,”adds Majid. He highlights companies at the forefront of the agricultural seed market offering cheap food without gas-guzzling long journeys to get it, and palm oil producers (including REA Holdings in Indonesia, and MP Evans in Australia, which also has cattle).

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Investors can now access a broad spectrum of ETFs and exchangetraded commodities (ETCs) that track a range of agricultural goods, including sugar, corn, cattle, and coffee. ETCs, like exchange-traded funds, match the performance of a particular index and investors can trade them during the day in the same way as ordinary shares, and can also choose a basket ETC that tracks a number of different products, which also allows risk to be lessened (a grains ETC, for example, will track corn, wheat and soybeans). An interesting development in this respect is the announcement at the end of September that the S&P GSCI, intends to launch an index that would exclude US commodities. Impending US regulations are led by the Washington-based Commodity Futures Trading Commission (CFTC) to help rein in speculation in energy and commodity trading, which some blame for sending food and oil prices to record highs last year. The move is intended to assist clients concerned about new US market regulations, suggests Michael McGlone, director of commodity indexing at S&P. He says: “We had started looking at different types of commodities indices ex-US over two years ago, though we have certainly accelerated our development, per client request.” The US-free commodity index could possibly be launched“early next year,”he adds. The most popular European hard commodity futures with global investors include the UK Brent contract for crude oil, copper, aluminium, lead, nickel, tin, and zinc (traded on the London Metal Exchange). In terms of softs, such as cocoa, coffee and sugar (available on the UK’s LIFFE), Mclone concludes that the only problem thus far has been ensuring adequate liquidity for foreigners to invest in, but he would consider any futures as long they passed liquidity constraints.

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Sector Report PALM OIL: INVESTORS HOPE TO REAP PROFITS

Photograph © Ignat Leved/Dreamstime.com, supplied October 2009.

CROSS MY PALM WITH SILVER The fortunes of the palm market are about to turn as the harvest comes in. It is used as a generic vegetable oil, but is also a key ingredient in all sorts of products from soaps to shampoos and chocolate to lipstick. It is used on a large scale in the metals industry, in the production of leather and in recent years in the manufacture of biodiesel. With investors in Europe and the US increasingly getting the taste for all things commodities, interest in palm oil is picking up, reports Vanya Dragomanovich. HAT DOES PALM oil have to do with anything? A lot, it turns out, particularly if you are Unilever, Johnson & Johnson, Nestlé, Colgate-Palmolive, Cargill Agricultural Group, The Body Shop or Cadbury. This rich and heavy oil derived by crushing the fruit of the palm tree appears on supermarket shelves as a generic vegetable oil, but apart from its most obvious use it is also a key ingredient in all sorts of products such as detergents, soaps, shampoos, KitKat bars and lipstick. It is used on a large scale in the metals industry to polish special steels, in the production

of leather to soften it and in recent years in the manufacture of biodiesel. Most frequently it is used as an inexpensive frying oil, particularly popular in developing countries because it is abundant and affordable. “Would you have palm oil to fry your chips? Yes, you would. Would you put in on your salad with a splash of vinegar? No, you wouldn’t. It is too heavy for that,” explains Chris Sanda, analyst at Daiwa in Singapore. Although Europe is the third largest user of the oil after India and China, until recently, trading palm oil as a financial instrument has been an allAsian affair with futures actively

traded on Bursa Malaysia, the single biggest platform for trading palm oil, and the Dalian Commodities Exchange in China. On Bursa Malaysia more than 20,000 palm oil contracts are traded every day. European buyers appeared on the spot market buying cargos of actual oil for use in manufacturing of all sorts of cosmetics and food products, but in terms of investment the only players in the markets were a few specialty commodity hedge funds such as USbased Kerr Trading and Aisling Analytics from Zug, Switzerland. However, with investors in Europe and the US increasingly getting the taste for all things commodities, interest in palm oil is picking up. Recently, the Chicago Mercantile Exchange (CME) bought a stake in Bursa Malaysia and is now offering palm oil futures on its Globex platform. This means that instead of trading in Malaysian ringgits or yuan, palm oil futures can be traded in the US in dollars. Bursa Malaysia has launched three new FTSE Bursa Malaysia Palm Oil Plantation Indices which track Asian liquid and large-cap listed palm oil companies such as Singapore-listed Wilmar International and Golden Agri-Resources. Palm oil is a fairly volatile future to trade. In the past two years prices have see-sawed wildly between around $410 and $1,280 and settled around $615 in early October. Prices are heavily dependent on seasonal factors—with the harvest in the third and fourth quarter of the year, prices traditionally fall to their lowest in November and December, then rise to a peak in the spring—and on prices for other vegetable oils such as soybean, rapeseed and sunflower oil. Dips can happen at other times of the year, particularly when soybeans are harvested in major producing countries such as Argentina and Brazil.

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Prices this year had an unexpected boost after Argentina ran into problems with its soybean crop and had a 40% lower harvest than last year. Although palm oil and soybean oil are not fully interchangeable in terms of end use, they are aligned close enough so that when soybean prices rise, buyers substitute the oil for palm oil where they can. In the meantime, Argentine production of soybeans has recovered and latest forecasts indicate a record crop next year. Also, with the harvest season almost in full swing in Asia, prices are expected to remain under pressure until at least the year end. Doug King at Aisling Analytics says: “We are fairly bearish about palm oil at present; there will be a lot of it around with the harvest.” Daiwa’s Sanda echoes this view, estimating that prices will decline to around $525 in the medium term. He adds: “While on the one hand you have higher demand generated by fiscal stimuli which create more demand particularly in countries including China, you have normalisation of yields, a peak harvest season coming up and normalisation of planting in South America.” The outlook for palm oil prices for next year is somewhat mixed. On one hand, Argentina is expected to produce some 51m tonnes of soybean oil compared with 30m tonnes this year. This will bring soybean oil prices down and does not bode well for palm oil either. On the other hand, the El Nino weather pattern which is caused by the warming of the eastern Pacific, could bring extremely dry weather to parts of Asia and hurt farming output. There is some evidence of the El Nino this year with India’s sugarcane crop decimated by one of the worst droughts in years. Malaysian producers estimate that they will produce a record amount of palm oil

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to the tune of 17.7m tonnes but that level could drop by between 5% and 15% if the El Nino effect asserts itself. However, after a dip those levels are expected to continue to increase. While Malaysia may have a limited amount of land on which to expand its production, it has the capacity to increase its yields and has in the past stated that it will aim to up productivity by about 50%. “In a lot of cases framing practices are outdated and less then disciplined. You have a lot of small farms that produce about 18 tonnes per hectare. In comparison very professional farmers that use satellite imaging and more fertilisers can produce 24 tonnes per hectare,”says Sanda.

Glacial issue Looking more long term, the food aspect of palm oil demand in developed economies is expected to change fairly little. “Demand is a glacial issue; you will have the same demand tomorrow as you did yesterday,”says Sanda. This will not be the case with emerging markets where population growth and changing tastes in food which involve more meat consumption and less use of the traditional grain staples will dominate the picture. People in China and India are already eating more meat than they did a decade ago and as this trend continues more grains such as soybeans will be diverted to feed cattle and other livestock and away from human consumption. It is estimated that six times as much land is required to raise a pound of meat as a pound of grain. All of this will have a trickle-through effect on palm oil. “Population grows at a geometrical rate but soy and corn yields cannot grow at the same pace,”says Sanda. In Europe, demand for biodiesel will be the main factor of growth in the continent’s overall demand. Demand from biodiesel producers at

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2009

present makes up 31% of the total European Union market but this number is expected to come down. Industry analyst Vito Martielli of Radobank notes that “imports to the European Union will continue to grow although at a slower pace than in the past.“ This market grew by 40% between 2002 and 2008 but the pace of growth will slow to 8% by 2015 with total demand reaching 800,000 tonnes, according to Martielli. Most of the European biodiesel is produced from rapeseed, which grows abundantly in Europe. Soybean oil and palm oil hold a much smaller share of the market and make up roughly the same amount of biodiesel demand. Martielli expects the demand for soybean as biodiesel feedstock will start shrinking because rapeseed, which is normally costlier than soybean, is relatively cheap in Europe. Palm oil demand, however, is likely to hold because it is by far the cheapest oil. In a much more long-term view, European regulation could work against palm oil. The new EU renewables directive is strict about how the raw material for biodiesel is produced and the fact that large swathes of Indonesian rain forest are burnt down to raise palm trees will work against it being considered the main alternative to petrol. The same will be the case with soybean oil. Rapeseed oil will be one alternative until 2017 when regulation will tighten again and after which only sunflower oil will comply with EU targets for green biodiesel feedstock. For investors entering into this market, the immediate option would be to enter on the short side. Longer term, there will be factors that will work in favour of palm oil but this may be more than another harvest away. In the meantime the two main factors to watch will be weather in Asia and South America and European clean energy regulation.

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Index Review NEW INDEX: FTSE LAUNCHES PASSIVE FORWARD RATE BIAS INDEX

LEVERAGING CURRENCY MANAGEMENT Index provider FTSE Group launched passive, forward-rate bias (FRB) currency indices in late September, in conjunction with specialist investment manager Record plc. The indices offer the volatility of bonds and the returns of equities without being correlated to either. EIL RECORD, CHAIRMAN and chief executive of Record, explains the rationale behind the new FTSE Currency Forward Rate Bias (FRB) index series. “The currency forward-rate bias is a fundamental and sustainable return stream. We believe this is the beginning of a transition from an ‘alpha’ to ‘beta’.” With the trend in mind, Record says there is scope to develop more currency indices following the launch of the initial indices, as “investors around the world… develop new currency investment management products,”. FTSE Group’s latest launch allows investors to access alternative beta within FTSE’s existing range of alternative indices. It is a timely development. According to Imogen Dillon Hatcher, executive director of Global Sales at FTSE Group: “The foreign exchange market is the largest market in the investment world, allowing for both retail and wholesale investment. FTSE is committed to offering investors a complete suite of index products to measure and analyse all facets of the investment landscape. The FTSE Currency FRB Index Series will allow clients to access the currency market and has been created in response to market demand.”

The new indices, known as the FRB5 indices, will be calculated on a fullyinvestable basis and published daily by FTSE (both excess return and total return) and are the first in a range of currency indices that FTSE and Record will work together on. These indices can be used for portfolio construction, indextracking management and including within financial products such as exchanged-trade funds (ETFs) and benchmarking active currency strategies. The FRB5 indices utilise the five most widely-traded currencies (US dollar, euro, Japanese yen, sterling and Swiss franc) in a forward rate bias (also referred to as“carry”) strategy. Forward rate bias is the tendency of higher interest rate currencies to outperform lower interest rate currencies. This outperformance is captured through a series of rolling onemonth forward contracts, equallyweighted across all ten currency pairs. The currency market is one of the world’s largest markets with around $3trn traded daily, allowing both retail and institutional investment. Interestingly though only a small proportion of the market, around 5% is used for investment purposes, with the majority of trade being of a transactional nature. The nature of the market and its structure is therefore ripe for expansion, with the arrival of these indices opening

up access for investment, claims a FTSE Group spokeswoman. This potential coupled with the widespread disruption seen across the asset classes over the last two years has created a long-term interest from institutional investors in such alternative betas, she adds. The FTSE Currency FRB5 indices come at a time investors are increasingly looking at opportunities for diversification. Research from Record shows that FRB“provides a fundamental and sustainable return stream that rewards the risks associated with holding higher interest rate currencies”. With a low long-term correlation to other asset classes such as equities and bonds, the indices allow investors access to a pure source of alternative beta in currency markets.“Based on market spot and forward prices going back to 1978, the index series is the only one to demonstrate a long-term return over 30 years that is comparable to that of global equities and superior to that of global bonds, with volatility comparable to bonds and lower than equities,” notes Record research. The annualised return of the FTSE Currency FRB5 total return index in US dollars is 9.7% a year, backtested to 1978. “The FTSE Currency FRB Index Series will enable investors to develop new diversification strategies as the series returns show low correlations with established asset classes such as equities and bonds,” notes Record. “Taken together with the scalability inherent in the currency markets, and the universe of investable managers, this should help the investment community recognise the currency forward rate bias as an alternative beta,”he adds. Record says the first index in the launch includes five main currencies, the smallest of which will be the Swiss Franc. The indices use a rules-based system based on the Libor interest rate in order to determine which currencies to go long and short.

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Index Review

MIXED SIGNALS E ARE A few more hundred points higher on the FTSE and hammering away at the 5200 level, but worryingly the good news of midsummer is starting to peter out as the storm clouds of winter approach. The Far East seems to be clambering out of the downturn but Europe is still struggling with continuing aftershocks of the financial crisis. The overhang of debt and high costs is not going to just disappear. Although the FTSE 100 with its weighting of global mining, oil and pharmaceuticals may continue to perform, the same should not be expected of the many domestic components of European indices. Of particular concern are August’s truly dreadful industrial production numbers, which should have risen by a paltry 0.2%. In the event they showed a fall of 2.5% to crown a year-on-year drop of 11.2%; much worse than the predicted 5.5% fall by the end of the second quarter. Moreover, while M4 money numbers appear a healthy 12.5%, this hides the underlying surge towards the end of last year and the first few months of 2009. The past six months’total is a miserly 1.2% and it is

only this high because August showed a blip up. If we exclude the huge injection from the Treasury, this number would make grim reading indeed. On the other hand, when the mighty Tesco reports a return to more normal buying patterns from its clients, we cannot just throw this information out as irrelevant. It might be that a two-tier economy is emerging: those in employment, who are more confident of retaining their jobs and have resumed their usual daily buying patterns, though stopping short of big ticket purchases; and the unemployed, who are “out of sight and out of mind”. Although unemployment is up from 4% to 9% over the past year, that still leaves 91% versus 96% still in employ and sad to say but, as with all recessions, the ones who feel the majority of the pain will be those at the lower end of the social scale. Recovery has to start somewhere. However, it won’t take hold until business lending is on the rise. While confidence is cautiously improving, it must reach a sustainable level soon, otherwise the crude attempts to reduce the huge public debt liabilities

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INDEX REVIEW: IS IT THE END OF THE DOWNTURN?

Commentators are calling the end of the downturn and from a purely technical view they might be right. GDP in the UK may well have turned tentatively positive in Q3 but the emphasis is on “tentative”. As GDP watchers know, growth must approach 1.5% before any real benefit is felt at street level. Productivity increases, particularly due to improved technology, rarely result in an uptick in overall wealth or employment prospects. Much of the bounce over the past half-year/quarter result from interest rates at 0.5% (making debt management easier), rather than employees feeling safer because the UK Treasury pumped £175bn into the banking system! That means any numbers from the Treasury can only be described as “mixed”. Simon Denham, managing director of spread betting firm Capital Spreads, surveys the outlook.

Simon Denham, managing director of spread betting firm, Capital Spreads, September 2009.

from the incoming administration after the next election will snuff out any small flickering of recovery. However, next year, tax increases and spending cuts are likely to cut demand dramatically. The increase in high end tax to 50% appears popular, but why? Very high income households will cut expenditure and a good percentage of the real cost will fall on gardeners/cleaners/local shops/unskilled workers etc. As well, the Inland Revenue may lose income from the highest earners as these tend to be able (legally) to divert income to more favourable locations. The Tories and Labour appear to be outdoing themselves on “hair shirt” programmes for the taxpayer. We may well find that the next UK general election is fought on the grounds of who is the meanest “hood on the block”. Shades of Lady Thatcher perhaps? Unfortunately the eventual outcome will almost certainly be a lower standard of living for many over coming years, calculating what might be left after hefty tax rises and cost-push inflation. As UK ex-pat retirees have discovered, their average income compared to their Euroland neighbours has already fallen by some 25% over the past two years. Worse perhaps is that this reduction might be the middle rather than the end, as many commentators expect sterling to fall further. A grim commentary this time but, as ever ladies and gentlemen, “place your bets”.

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Country Report LUXEMBOURG FUNDS: NEW EU RULES WILL BRING MAJOR CHANGES

Photograph © Vassjozsef/ Dreamstime.com, supplied October 2009.

UCITS IV PROMISES AN EARLY SPRING New regulations to be introduced for the cross-border selling of funds, UCITS IV, could transform the fund management industry within the European Union, opening the market to more crossborder competition. Luxembourg’s financial community feels it is well placed to benefit from the changes more than rival financial centres such as London, Frankfurt, Paris and Dublin, and some even think the opportunities created by the regulations will spell the end of the economic downturn as far as the Grand Duchy is concerned. Paul Whitfield reports. HE DAYS MAY be shortening as winter advances, but among Luxembourg’s outsized fundsservicing industry it feels like spring is in the air. The sentiment in the tiny financial centre is that the fallow days of the financial crisis are in the past. The green shoots of recovery are found in the return of fund inflows but it is more than just the cyclical return of investors that has bred confidence that the Grand Duchy is gearing up for a new growth spurt. Incoming regulations governing the cross-border selling of funds, the Undertakings for Collective Investment in Transferable Securities (UCITS) IV, promise to recast the

landscape of fund management in the European Union. This will open the market to increased cross-border competition, sparking a concentration of funds in a handful of servicing centres. Luxembourg, according to locals, stands to be a big winner. “We have had some dark days recently, along with the rest of the world,” says Marty Dobbins, senior vice president and managing director at State Street in Luxembourg.“People are cautiously positive now because we are seeing a difference in the markets and Luxembourg is well positioned to benefit from the changes ushered in by UCITS IV.” If Luxembourg seems a little more

upbeat than some rival financial centres it may also have something to do with the fact that it has less reason to lament the woes of 2008. A mixture of more restrictive labour rules, limited exposure to the investment-banking sector and higher-risk fund management sectors served to protect workers in Luxembourg’s financial sector from the worst of the mass layoffs that afflicted London and Dublin. Luxembourg’s fund servicing business has also benefited from its relative mobility. It is less reliant on its domestic market than near-neighbours such as Frankfurt or Paris. That has meant the larger operations have been able to reallocate resources from the slumping European market to regions that have proven more resilient to the financial crisis. The Asian market, which has been propped up by China’s continued strength, and to some extent South America, provided a silver lining even in the midst of the financial storm. Some 75% of all funds marketed in Hong Kong are Luxembourg domiciled. Michael Ferguson, partner and asset management leader at Ernst & Young in Luxembourg, says: “Luxembourg has weathered the crisis reasonably well. There have been job losses and fund closures but not on the same scale as other financial centers.” That is a blessing that cannot be discounted. About 28% of Luxembourg’s annual GDP comes from its funds and financial sector, making it more dependent on the fortunes of its finance sector than any other country in the world. Luxembourg hasn’t bounced back from the crisis unscathed. Funds domiciled in the country had assets under management of between €2.2trn and €2.1trn before the crisis struck. That amount tumbled more than a third to about €1.4trn during the depths of the downturn. More

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recent figures suggest that the value has risen to €1.7trn as asset values rise and, more importantly, as the balance of fund flows turns positive. Luxembourg saw a net positive inflow of €33bn in September, according to figures quoted by Ernst & Young. It was not only Luxembourg’s headline assets under management figure that was drastically altered by the financial crisis. The investment mix also changed, with significant consequences for the bottom line of the fund servicing industry. “Investors fled anything that looked or sounded like it was associated with risk,” says Ernst & Young’s Ferguson. “This caused a significant shift from fixed income and equity products to the lower margin cash and money market products.” The shock of mass redemptions, the sharp shift in asset allocation and the lack of new equity for start-up funds will continue to be felt in the sector for many months. “We saw a lot of fund rationalisation,” says Dobbins. “There were a lot of funds that were seeded [with capital] before the crisis and never took off, others lost enough capital that their future had to be reassessed. A lot were merged or liquidated.” One fallout from that has been an uptick in competition among asset servicing operations. There have been claims that some administrators and custodians are pitching for business at loss-making levels in the expectation that what may be unprofitable now will reap rewards as assets grow in the future. The state of flux into which Luxembourg’s fund industry has been plunged is not about to ease. The expectation is that whatever consolidation has been forced on funds by the financial crisis is likely to prove a footnote to the change that will be wrought by the adoption of UCITS IV. That may be a wearying thought for

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some, but most in Luxembourg’s closeknit fund management sector are relishing the upheaval. UCITS IV is the latest iteration of a directive designed to create a standardised regulatory framework for funds and to simplify cross-border sales. It was adopted by the European Parliament in January 2009 and the council of the European Union in June 2009 and will come into force across the EU by July 2011, which is the deadline for all EU countries to adopt the directive. The new rules will tweak the regulation for cross-border distribution of funds, introducing a simplified notification procedure that will reduce red tape. More importantly, and the reason for much of the glee among Luxembourg’s funds community, it will simplify the procedure for acquiring or merging funds and establish a specific scheme that allows investment companies to operate feeder funds in a centralised location.

High expectations It is not the first time that expectations have been high ahead of a new UCITS directive. Since the introduction of the first UCITS regulations in 1985 there have been predictions of mass consolidation of the fund management industry. The changes have so far been rather more incremental. Yet there is good reason to believe that UCITS IV may well be game changing. “At the moment if you want to establish a fund that has local flavour and local tax benefits, it is necessary to set up different funds domiciled in different countries,” says Philippe Seyll, head of the investment funds activities at Clearstream, the clearing house owned by Deutsche Böurse AG. “That has meant replication of funds in different locations, which isn’t very efficient. UCITS IV will sweep that away by introducing the master/feeder concept.”

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2009

Marty Dobbins, senior vice president and managing director at State Street in Luxembourg, says: “We have had some dark days recently, along with the rest of the world. People are cautiously positive now because we are seeing a difference in the markets and Luxembourg is well positioned to benefit from the changes ushered in by UCITS IV.” Photograph kindly supplied by State Street, Luxembourg, October 2009.

The upshot of the new UCITS regime is likely to be a wave of consolidation. Regional funds will, so the theory goes, be merged into monolithic master funds, which in turn will be located in whichever financial centre offers the most attractive mix of talent, infrastructure and cost efficiency. That should be good news for Luxembourg. “We in Luxembourg’s fund services sector have an infrastructure that is geared to support cross-border marketing and management of funds,” says Dobbins. “We do that day in day out here and there is already the knowledge of tax regimes, the infrastructure, the talent and the knowledge in place.” There is certainly plenty of scope for consolidation. Some 65% of all UCITS funds have less than €50m of assets under management, according to figures produced by analysts at PricewaterhouseCoopers. About 30% of all UCITS funds have less than €10m. Some of those funds justify their existence by their niche focus or particular investment strategies that are best suited to smaller sizes. Others are seed funds that are expected to grow in the future. Yet many will simply be failed or, at least, undersized funds that

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Country Report LUXEMBOURG FUNDS: NEW EU RULES WILL BRING MAJOR CHANGES

are too small to compete with larger rivals and will be closed or acquired. Yet Luxembourg for all its bullishness is not the only centre likely to benefit. Dublin, London, Paris and Frankfurt will also fancy themselves as potential winners. “The management company passport is both an opportunity and a threat,”says Ernst & Young’s Ferguson. A survey of 40 chief finance officers, chief executive officers and heads of product development carried out by Ernst &Young identified five key criteria that will determine where companies will place their management company. They are: costs (including taxation); potential impact on distribution; regulator quality; government policy and support for fund industry, and overall country perception. “Luxembourg scores pretty well on most of those criteria,” says Ferguson. However, he warns there is still work to be done, particularly on ensuring that cost, which has emerged as the main criteria according to the Ernst & Young study, can be minimised. Other studies also suggest that Luxembourg, which has about 75% of the current cross-border fund distribution traffic, cannot afford to rest on its reputation. The city ranked third in Europe, behind London and Frankfurt, but ahead of Dublin and Paris in a recent survey conducted by researchers Z/Yen that rated financial centres on the basis of competitiveness, infrastructure and market access. Clearstream’s Seyll says: “I do think that UCITS IV is an enabler for competition, but I believe that the infrastructure in place like Vestima [Clearstream’s straight through processing solution for funds], which isn’t available anywhere else, our experience and the multi-lingual services that we provide means Luxembourg has more to gain than to lose.”

New regulations could also offer Luxembourg the opportunity to go on the attack in attracting alternative asset managers, a sector of the fund management community that it has been notably week in wooing in the past. This time it is not UCITS IV but the draft directive on alternative investment funds that is providing the catalyst. The directive, which is still in consultation, will seek to implement, among other things, new reporting and liquidity standards and a European marketing passport. Crucially, to qualify for the passport, funds are likely to have to prove that their domestic regulator meets so called reciprocal standards, i.e., are subject to regulatory standards equal to those established by the EU. In practice, that will force funds currently domiciled in foreign tax and regulation havens to either close their European operations or adopt an EU domicile. Ferguson says: “The opportunities arising from the AIFM Directive are threefold: attracting the AIFMs [alternative investment fund managers] and the AIFs [alternative investment funds] to domicile themselves in Luxembourg and attracting the servicing of AIFs domiciled in Luxembourg and elsewhere.” The keys to attracting these alternative funds and fund managers will be the usual culprits of cost and infrastructure, but also the ability of financial centres to ease the onerous processing of adopting EU compliant structures. Luxembourg’s specialised investment fund structure, an existing vehicle for alternative funds, would seem to be ideal for housing the incoming regulatory refugees. Once again Luxembourg will have a fight on its hands. Dublin, which is already the centre of the EU-domiciled alternative fund universe, will fancy its chances of scooping up any wave of incoming funds. London, which is

Michael Ferguson, partner and asset management leader at Ernst & Young in Luxembourg, says: “Luxembourg has weathered the crisis reasonably well. There have been job losses and fund closures but not on the same scale as other financial centers.” Photograph kindly supplied by Ernest & Young, Luxembourg, October 2009.

already home to the offices, if not the assets, of many alternative fund managers, will also have its hat in the ring. French politicians have also posited that the new directive could open the door for Paris to grab a greater share of the alternative fund market. For all the bullishness of Luxembourg, such competition is evidence of an uncomfortable truth. The homogenisation of Europe’s fund market may make funds more able to choose their domicile—but at the same time will serve to make that choice less important. The big winners in the coming regulatory shake-up are likely to be those fund management companies with international networks that can service clients wherever they may be located. “Companies like Caceis, BNP Paribas and RBC Dexia combine the local European flavour with international reach through hubs to service global clients,”admits a senior executive at a fund servicing operation. “They will be able to go head to head with the larger established groups.” Luxembourg has created its dominant position by being exceptional, both in its response to new trends and in its ingenuity in overcoming regulatory hurdles. Remove those hurdles and you strip out much of the need for ingenuity. In that case Luxembourg’s attractiveness could be diminished rather than enhanced.

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DMA: The Great Leveller The demand for ever-faster electronic trading has sparked a technological war among trading venues that has slashed latency from seconds to milliseconds and shows little sign of slowing. Paired with smart order-routing algorithms that allow traders to tap multiple sources of liquidity in rapid sequence to capture the best available price, Neil O’Hara reports that direct market access (DMA) enables traders to exploit the smallest, fleeting fluctuations in market prices. IRECT MARKET ACCESS (DMA), which lets investors route orders to the exchanges and electronic communication networks (ECNs) without going through a broker’s trading desk, has loosened the sellside stranglehold on order flow. Traders at asset management firms who are willing to spend the time can now control where and how their orders are executed while clearing and settlement are still handled by a broker. For traditional buy and hold asset managers, it’s an option that saves them money on the easy orders, but a new crop of high-frequency traders depends on DMA for its very existence. While some argue these firms disrupt the markets, proponents see DMA and the investors who use it as a benign force that puts small investors and the major securities houses on a more equal footing. The demand for faster electronic execution has triggered a technology arms race among trading venues that has

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already slashed latency—the delay between when an order is entered and when it reaches the electronic order book— from seconds to milliseconds and shows little sign of slowing. Paired with smart order-routing algorithms that allow traders to tap multiple sources of liquidity in rapid sequence to capture the best available price, DMA enables traders to exploit even the tiniest, fleeting anomalies in market prices. Traders can afford to exploit the opportunities, too, because electronic execution costs are a fraction of the commissions charged on conventional orders. The combination has driven exponential growth so that highfrequency trading now accounts for 61% of trade volume in the US equity markets, according to Laurie Berke, a principal at TABB Group, a financial markets research and advisory firm with offices in New York and London. That high-frequency volume isn’t all DMA, however.

DIRECT MARKET ACCESS: GOING WITH THE FLOW

Photograph © Rolffimages/Dreamstime.com, supplied October 2009

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use DMA (with or without Berke notes that DMA algorithms) through the provides a pipe to Knight Direct platform or exchanges and ECNs, but to give orders to a live not to crossing networks— body on its trading desk. either the brokers’ internal Knight’s sales traders may ones or the anonymous be able to find a natural dark pools—that account buyer or seller to take the for an increasing opposite side of a trade, proportion of trading but they also have access volume. High-frequency to the same formidable traders nevertheless electronic technology the dominate DMA volume, as firm provides directly to its traditional hedge funds customers. The goal is to and long-only asset deliver the best execution managers increasingly use for the client using algorithms and smart order whatever works best for a routing, accessing both lit Jeffrey Bell, executive vice president of the clearing and technology group particular order. Wald says: and dark venues, to at Wedbush Securities. He says: “I don’t hear people talking about what “Traders have to have manage their flow. happens if proprietary trading desks had a problem with their trading access to this technology Although hedge funds, systems. We have become comfortable with firms like that doing it. in order to do their job market makers and What’s the difference?”Wedbush is a leading sponsor of DMA, which effectively.“ proprietary trading desks has propelled the Los Angeles firm’s ascent to become the top liquidity To the uninitiated, one all engage in highprovider on both NASDAQ and the New York Stock Exchange. electronic platform looks frequency trading, Berke Photograph kindly supplied by Wedbush Securities, October 2009. much like another—but attributes about two thirds of the volume to independent trading shops. These outfits appearances can be deceptive. Economics of scale play a typically try to go home flat at the end of the day and critical role in a business that requires a huge investment in pursue statistical arbitrage or momentum strategies information technology up front and on a continuing basis designed either to extract money from bid-offer spreads or to deliver fast, cost-effective execution. Fierce competition to capture“maker-taker”rebates paid to liquidity providers ensures a constant struggle to keep customers coming back by exchanges and ECNs. “High frequency traders are not for more.“You have to offer superior technology, innovative looking to maintain exposure or carry positions overnight,” products and services,” says Wald.“You have to know your says Berke. “They take advantage of minute mispricing in customers well, meet their needs and help them to do their assets or markets relative to one another.” In some cases job more effectively.” In an effort to compete against dark pools and other they trade even knowing they will lose money on the spread because the maker-taker rebate is enough to turn alternative trading venues, the exchanges and ECNs offer colocation services, which allow buyside firms to install servers the loss into a profit. Traditional money managers use DMA as well, but they in data centres adjacent to their electronic order processing are marginal players: TABB Group estimates that they route facilities in order to reduce latency. To gain an edge measured less than 10% of their order flow directly to exchanges or in microseconds or less, buyside firms used to fight for ECNs. Algorithms that tap into dark pools as well as optimum placement within the data centres: as close as exchanges account for another 25% to 30%, but the possible to the trading venue hardware. The exchanges and majority of conventional buyside business still goes to ECNs have begun to harmonise access so that everyone has broker desks where sales traders handle the orders. The the same length cable no matter where their server sits. Even high-touch service comes at a price. In 2008, commission though latency has plummeted in the past couple of years, rates for conventional execution averaged 2.95 cents per the race towards zero continues.“As long as you have price share against 0.77 cents for DMA and 0.88 cents for and time priority, latency is still a huge factor, either to get an algorithmic trading. The differential is well worth it to execution, or to cancel an order,”says Wald. money managers who value the market intelligence a Advocates of high-frequency trading argue that it sellside trader can bring as well as research, access to initial provides additional liquidity and enables other market participants get their orders filled faster and at more public offerings (IPOs) or other support. Electronic trading, whether through DMA or using favourable prices. Critics claim the plethora of small bids algorithms, has propelled the rise of firms like Getco and and offers is toxic liquidity, more akin to noise than real Knight Capital that focus on execution and market-making flow other investors can depend on, however. A trader but do not provide research or investment banking. Joseph trying to work a large order who taps this liquidity early on Wald, global head of institutional electronic business at may tip his hand, scare away the other side of the trade and Knight, points out that customers can choose whether to end up with inferior execution as a result.“Traders have to

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be vigilant about order BNY Mellon (Sonic), and placement to get the best Citigroup (ColorBook). execution for their client,” DMA trades still go says Wald. through a broker—the Complaints about toxic investors do not become members of the liquidity cut no ice with exchanges—but the Frank Troise, head of global broker takes a passive role, equities electronic product monitoring orders from a at Barclays Capital. The risk management and various trading venues compliance perspective have rules to which all although taking no part in market participants must how or where they are adhere and traders executed. Some market understand that if participants question someone can find a whether traders who are legitimate way to gain an edge they will surely do so. not governed by the rules “Within the defined rules that apply to brokerof the market it is up to dealers will follow proper David Easthope, an analyst at Celent, a New York-based research and market procedures, while market participants to consulting firm focused on information technology in the global financial others worry about the determine their best services industry. Photograph kindly supplied by Celent, October 2009. havoc that would ensue if strategy for accessing liquidity—just as it has always been,” says Troise. That a computer went haywire and entered orders the trading doesn’t stop people from spending the money to create a firm could not fulfill. The wacky computer concern doesn’t impress Jeffrey technological advantage as long as they abide by the rules. In a sense, it’s no different from a trader in the pre- Bell, executive vice president of the clearing and technology electronic days getting faster execution by routing orders in group at Wedbush Securities. He says:“I don’t hear people IBM to the broker who has better access to the IBM talking about what happens if proprietary trading desks specialist post on the stock exchange floor. had a problem with their trading systems. We have become Troise sees high-frequency trading that depends on comfortable with firms like that doing it. What’s the DMA and algorithms as an additional liquidity source and difference?”Wedbush is a leading sponsor of DMA, which complementary to traditional order flow. A world where has propelled the Los Angeles firm’s ascent to become the electronic trading has a significant and growing market top liquidity provider on both NASDAQ and the New York share leaves plenty of business flowing through manned Stock Exchange. As a leading liquidity aggregator, Wedbush qualifies for trading desks, and it will never go away. “There are many situations where clients want to work with traditional the maximum available price discounts from the trading high-touch brokers,” says Troise. “For example, they may venues in which it participates, an advantage it uses to want immediate execution on a block of stock and look for attract new clients that would not qualify for the full a broker to commit capital on the trade. They may not want discount based on their own volume alone. Bell says:“Every to be subject to market risk by piecing out a large ‘parent client has a different pressure point in what they are looking for on pricing. To the extent we help them reach the order’ into hundreds of ‘child orders’.” High-frequency players avoid small and mid- top tier for better pricing we can share in that with them.” Wedbush won’t offer DMA to just anyone who asks, capitalisation stocks, too, where best execution typically involves a broker tracking down natural investors to take though. The firm is at risk if a DMA client can’t stand up to the other side of a trade.“The vast majority of traders do not its trades, so it has a rigorous due diligence process to make use DMA—they don’t need it,” says David Easthope, an sure that a potential client follows sound risk management analyst at Celent, a NewYork-based research and consulting practices and has sufficient capital to withstand any firm focused on information technology in the global problems that may crop up. As an early mover in highfinancial services industry. The few who do generate huge frequency trading and later DMA, Wedbush has a wealth of trading volumes, which explains why brokers are willing in experience it can apply to help clients improve their business effect to give these investors the keys to their car: they make models and adopt best practices, too. The proof is in the up in volume more than what they lose on the commission pudding: Bell says Wedbush has never suffered any losses rate. Major securities houses that offer DMA include associated with either high frequency trading or DMA. Bell says: “Sponsored access is a great improvement to Goldman Sachs (REDIPlus), Morgan Stanley (Passport), Credit Suisse (Pathfinder), Barclays Capital/Townsend market structure that levels the playing field. It allows Analytics (RealTick), Banc of America Securities-Merrill buyside firms to compete more directly with the bulge Lynch (InstaQuote), JPMorgan (Neovest), UBS (Pinpoint), bracket houses.”

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ROUTERS ON THE MARCH The complexity and velocity of routing orders have soared over the past few years, with Aite Group estimating that smart order router (SOR) clients will next year pay $1bn for the technology. Clients everywhere are demanding faster trades and on the buyside they want to know whether the SOR their broker uses is executing their trade in the most efficient way. Ruth Hughes Liley reports on the changes and challenges the everimproving technology brings. INDING LIQUIDITY IN today’s fragmented European markets is like navigating a cargo through the Nile Delta. Using a smart order router (SOR), you can pick your way along the channels and rivulets to make your preferred way—splitting up your order and taking it along several different routes at once, choosing a number of routes in advance and going straight there, or making decisions as you go along about which route to take. The complexity of routing orders to pockets of liquidity

has increased since competition was introduced into European equity markets in November 2007 by the Markets in Financial Instruments Directive (MiFID). With the London Stock Exchange dipping below 60% of FTSE 100 market share, having a technology system that can not only find the best place to execute an order but also get there fast and efficiently is crucial for brokers. Aite Group has estimated that smart order routing clients are paying $772m for access to SOR technology and next year the figure will rise to more than $1bn, 95% spent with sellside brokers. While big money is spent on smart order routers, it is a challenge for the buyside client to know whether the smart order router their broker uses is executing their trade in the most efficient way. Scott Cowling, Barclays Global Investors’ head of equity trading, Europe, says: “Every institution has a bestexecution policy as do our brokers and, as such, they are obliged to give a high level of information to show their commitment to best execution. There’s some legal comfort in that. However, the devil is in the detail.”

Photograph © Jan Kaliciak/Dreamstime.com, supplied October 2009.

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One of the fears is that brokers use their order routers to trade on the cheapest venues which may also offer rebates for posting liquidity rather than to find the best price for their client. Richard Balarkas, chief executive officer of agency broker Instinet, says you just have to look at the way the multilateral trading facilities (MTFs) expect to see changes in market share in response to changing their fee structures. “They clearly think that brokers are going to redirect flow based on cost of trading to the broker,”he says.“If true, SORs are calibrated to take charges into account, but to what extent does that take precedence over quality of execution? It’s a conflict of interest. Chasing rebates doesn’t lower clients’ costs because they are charged on a fixed commission, but it may increase a broker’s margins.” Smart order routers are becoming more sophisticated but Rob Maher, European sales head of Credit Suisse’s Advanced Execution Services, says: “There are different levels of sophistication. The first level is basic routing to a venue; the second intelligently probing venues and the third providing liquidity for others to probe. Under the first two you get an immediate response and so know if you have done something wrong, but under the third you run the risk that if you are wrong you have wasted inordinate time and subjected the client to unwanted market and trend risk. The best SORs will strive to perfect this functionality and this is where we concentrate most of our efforts.” Bill Capuzzi, president of ConvergEx’s G-Trade Services, agrees there are huge differences in smart order routers and, like many others on the sellside, is spending more time answering buyside questionnaires about his router. “I have responded to ten in the past month or so, asking me questions about how it works, whether it sends data, uses indications of interest (IOI), how we guard client confidentiality and what anti-gaming measures we have in place. It’s a very difficult thing for the buyside. They have to read the information and have to trust their brokers are doing the right thing.” Capuzzi adds: “SORs are all different—there are the haves and the have-nots. For example, some route orders to all venues simultaneously, while others route sequentially. If you have a router going from A to B and `

In the US, the “trade-through” rule under Reg NMS requires brokers to run orders through all markets in order to trade at the best price. Not surprisingly, this regulatory environment has contributed to 67% of SOR customers being located in the US, according to Aite Group. Europe has no such rule, although compliance with best execution rules under by the Markets in Financial Instruments Directive (MiFID) has encouraged the growth of use of smart order routers.

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER

Scott Cowling, Barclays Global Investors’ head of equity trading, Europe, says: “Every institution has a best-execution policy as do our brokers and, as such, they are obliged to give a high level of information to show their commitment to best execution. There’s some legal comfort in that. However, the devil is in the detail.” Photograph from Berlinguer Photo Archive, supplied October 2009.

then to C, I am going to beat that router every time if I hit A, B and C all at the same time.” Smart order routers are getting more specific in what they can do. Goldman Sachs Electronic Trading, for example, is upgrading its SIGMA smart order router for its clients who trade stocks listed on US and Canadian venues, seeking the best prices while taking into account real-time foreign exchange rates, allowing for single currency settlement. As smart routers develop and deal with more specific events—such as Goldman Sachs SIGMA taking real-time foreign exchange rates into account—many believe customisation of smart order routers is the biggest change to have occurred in the router market over the past two years. Ian Salmon, head of liquidity solutions, Fidessa, says: “The biggest difference is that we have moved away from a one-size-fits all approach to differentiation for each customer.”He adds:“We are opening the lid on how SORs work so that users, including the buyside, can influence the way they are used. Customers want to move beyond the SOR as just a best-execution tool and are increasingly using their SOR as a key part of their intellectual property. We’re seeing more buysides influencing the way SORs are used and have implemented our SOR at ten different brokers and seen it operating very differently at each one.” Many believe that that level of customisation in building and maintaining a smart order router is a game which can only be played by big brokers with the money; indeed, most global brokers build their own SORs and have dedicated technology teams.

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Over at Credit Suisse, Notwithstanding the Maher agrees: “As more grip by the large people rolled out SORs investment banks, Simon they started reacting with Nathanson, chief executive officer of one another more. The Stockholm-based global challenge is to stay on top, agency broker and based on what other software supplier Neonet, people’s SORs are doing. sees a trade-off between At first it was manual order being in control of the flow; now it is much more system and the cost of automated and our developing it.“We develop competitors are using all our technology similar technology. You get ourselves and what is more efficient markets interesting is that as the when routers can react to world becomes more and one another.” more advanced everyone Balarkas agrees that the realises you can’t build best prices can be missed. these by yourself. It takes “It’s very difficult for a client Rob Maher, European sales head of Credit Suisse’s Advanced Execution to figure out what they’ve time, several years and Services, says: “As more people rolled out SORs they started reacting missed. Years ago, when costs a fortune. with one another more. The challenge is to stay on top, based on what prices moved every three “Things go so fast with other people’s SORs are doing. At first it was manual order flow; now minutes, you could see new MTFs popping up, new it is much more automated and our competitors are using similar dark pools, new trading what was going on, but technology.You get more efficient markets when routers can react to one strategies, if you want to be now you really have no another.” Photograph kindly supplied by Credit Suisse, October 2009. in control, the cost would be objective measure. Take a enormous. It’s important for everyone to be connected mid-cap stock with a wide spread: the broker’s post-trade everywhere so you either go through an intermediary, build results show you bought at the offer, or perhaps even slightly the system yourself or you outsource the IT.” inside the spread, so you should be pleased. But the postAlthough sellside firms have the lion’s share of the SOR trade report won’t tell you that you could have traded at the market at 95%, technology providers have 4%, estimates mid in one of the dozen or so dark venues that exist.You don’t Aite Group, and of that market, 84% of its customers are discover these opportunities unless you look for them.” In the US, the “trade-through” rule under Reg NMS broker-dealers. With Europe a growing market for smart order routers, third-party providers are expanding their requires brokers to run orders through all markets in order offerings and many now provide multi-asset class to trade at the best price. Not surprisingly, this regulatory coverage, collectively more than broker-dealers, according environment has contributed to 67% of SOR customers to Aite Group. SmartTrade offers equities, fixed income, being located in the US, according to Aite Group. Europe futures, options and foreign exchange; FlexTrade offers all has no such rule, although compliance with best execution rules under MiFID has encouraged the growth of use of but fixed income. However, Balarkas believes that third-party providers smart order routers. Capuzzi of ConvergEx says:“Brokers in Europe can dictate cannot be relied on by anyone who wants to be in division one.“The reality is that the market changes so quickly that how true best execution is achieved. There’s no requirement unless you are at the coalface, you can’t hope to do the best to connect to all multilateral trading facilities or to dark pools job. Smart order routing is a combination of technological and no interlinking of markets as in the US. So unless you skills and frontline trading skills, and third-party vendors are dealing with counterparties linked to every point, you are not necessarily assured of best execution. Also, with no are too removed from this.” Nonetheless, with European fund managers the fastest requirement as a broker to connect to all points of liquidity, growing group of users of SORs, Nathanson foresees a how do you prefer one venue over another?” Nathanson believes a solution to prices being missed will greater understanding among them of the value of routers in getting the best price.“In the boardrooms they will say, come as technology advances: “More and more people will ‘We are not trading at the best price and we don’t get best be connected to more and more venues either by themselves execution—make sure we achieve this’. It’s a Catch-22 or through someone else. Anything else is impossible.” situation. To move liquidity, the venue needs support from While the US and UK are aware of the issues, Nathanson a number of players, otherwise liquidity will never be there. sees a lag in adoption of smart order routers in France, At the same time that the members are placing orders, it is Germany and the Nordic countries, although the latest Nordicnecessary for everyone to have an SOR or they won’t see based MTF, Burgundy, is forcing change in his region.“When it the best price.” comes closer to you, you are forced to change,”he says.

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The need for speed has created a new competitive dynamic and is one of the issues forcing change as more firms are co-locating their servers next to exchanges to shave fractions of seconds off transaction times. For example, the Tokyo Stock Exchange (TSE) offers colocation for servers. For 750,000 yen per rack per month, plus fees for power and cooling and network charges, firms can place their servers at the exchange and from January 4th 2010, can connect to Arrowhead, the TSE’s “next generation”trading system. Similarly the London Stock Exchange has offered colocation since September 2008, In October 2009 it spent $30m buying Sri Lankan technology company MillenniumIT, enabling it to replace its platform, TradeElect. It will vastly increasing the speed of its platform and enable it to provide clients with sub-millisecond transaction speeds and multi-asset class trading when it is introduced by the end of next year. It will also provide the LSE with a“footprint”in Asia. Interestingly, high frequency, statistical arbitrage traders represent only 1% of the SOR market according to Aite Group. This is because they can transact their trade faster by going straight from A to B and by co-locating their servers at the exchanges, believes Capuzzi. “For the nonstat arb traders, smart routing has replaced direct market access (DMA) and unless a client specifies they don’t want it, I will always use an SOR.” However, Max Palmer, director of algorithmic solutions at technology provider FlexTrade, says: “While most high frequency traders are co-located, not all co-located firms are necessarily high frequency. The users of smart order routing technology are people who want to access liquidity simultaneously and in parallel at multiple market centres and are, by and large, not co-located. Smart routing is not as fast as co-location for accessing liquidity, but it saves traders from having to enter six orders in sequence if six markets are bidding or offering. So it can be fast enough to access the liquidity at all of the markets as opposed to individually-generated orders, which create signalling and leads to the cancellation of the remaining bids or offers by the time the trader has entered the third or so order.” Certainly the new breed of smart order routers is giving firms the ability to access dark and lit venues at speed. Fidessa’s new online Fragulator tool, which launched in October on the Fidessa Fragmentation Index website, enables users to calculate the trading pattern of a stock over any time period across both lit and dark venues as well as systematic internalisers and over-the-counter (OTC) trades. Although the amount of dark pool or non-display trading is still small at around 5% of equity trading in Europe, it is growing. Agency broker Instinet, for example, claims 30% of its trades on one large trading day in October were executed on dark venues at the mid-price. “The ability to intelligently access both dark and lit venues is where I see most potential in future smart order routers,” says Salmon of Fidessa. “We are seeing more customers reporting huge increases in volumes in dark

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Richard Balarkas, chief executive officer of agency broker Instinet, believes that third-party providers cannot be relied on by anyone who wants to be in division one. He says: “The reality is that the market changes so quickly that unless you are at the coalface, you can’t hope to do the best job. Smart order routing is a combination of technological skills and frontline trading skills, and third-party vendors are too removed from this.” Photograph kindly supplied by Instinet, October 2009.

venues. It’s challenging, but it’s an opportunity and we are already seeing a rise in the block approach.” Baikal’s smart order router launched this year links to 17 displayed and non-displayed venues across 14 countries and will also route to brokers’ internal crossing networks. At the same time as the number of venues creates complexity and larger amounts of data, the number of order types is a headache for any SOR developer. Additionally, SORs will have to carry even more data in future: 60% of firms questioned by Aite Group are planning to build in other data such as economic indicators. BGI’s Cowling says: “Better post-trade reporting is important for us to help us better analyse our trading, but with fragmentation of data, it’s a difficult exercise to build a good picture.” Smart routing is both a cause and a consequence of the globalisation of equity trading and as an example Credit Suisse has opened up its smart order router to the Japanese market. “The core technology in our Asian SORs is the same as Europe. However, every market is unique and the SOR’s must be tuned for their individual microstructures,” says Maher. Palmer at FlexTrade agrees:“It’s still early days in Europe. The European Union doesn’t have a consolidated tape and until these issues are clarified and the infrastructure improves, it may never reach the proportions as in the US, where fragmentation is a decade-old issue.” Fidessa’s Salmon says the buyside now has a confusing choice:“The markets quickly evolved beyond a simple bestexecution approach and skilled brokers now have the ability to add value to the buyside by customising execution strategies across the plethora of dark and lit venues on a consultative basis. This ‘broad touch’ approach to SOR, where technology and trading skill are optimally combined, has become the main differentiator to trading in a fragmented marketplace.”

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ROBERT PARKER • CREDIT SUISSE ASSET MANAGEMENT

It is always something of a struggle in assessing the relative merits of one institution over another in the area of financing and investment. After all, these things are largely subjective. One fund manager’s ace fund administrator, for example, is another’s prosaic eight of spades. In these uncertain days, when traditional paradigms that have described the global markets are changing forever, any signs or portents of the times to come can be quite useful. That is the thinking behind this inaugural 20-20 segment; the obvious wordplay of clear vision set against a limited number of nominations. We do not pretend that these entries are the best in their class. What we do say is that these 20 people and/or institutions have exhibited no small degree of prescience in their business dealings and that, intentionally or otherwise, they have made more than the best of the hand they have been dealt. We anticipate that the application of their business strategy will outlast some of those past paradigms now past their sell-by date. The choice of entrants is varied, sometimes idiosyncratic. Being interesting is as useful (we hope) as being right. Honestly, our selection, like Donald Rumsfeld before us, is limited by knowing what we don’t know of the changing global markets, as much as by what we do. Moreover, some nominee eliminations were easier than others. Institutions, such as the rising Chinese banks, for instance, still remain too closely married to national policy (and sometimes direct or indirect subsidy) to warrant nominations for groundbreaking innovation. Even so, we found a plethora of innovation and forward thinking out there. This is just a reflection of some of it. We hope you enjoy and are enlightened a little by our selection and that it provides encouragement that 2010 will be a lot better than we expect.

BEEN THERE, DONE THAT While the financial crisis has prompted many asset management groups to rethink their strategies, Robert Parker, vice chairman of Credit Suisse Asset Management (CSAM), had set the wheels in motion long before Lehman collapsed. His prescience kickstarted a root and branch restructuring of the group he helped found in 1982. The recession may have accelerated the move but jettisoning CSAM’s long only traditional business and strengthening its alternatives and emerging markets presence was always part of the longer-term game plan. Lynn Strongin Dodds reports. LTHOUGH HE WOULD not profess to have predicted the severity of the financial crisis, Robert Parker, vice chairman of CSAM says the warning signs had been flashing.“All of us were getting nervous at the end of 2006. That is one of the main reasons why Credit Suisse, which has had its knocks, has navigated the crisis relatively well. The investment bank was not the owner of high levels of toxic debt and on the asset management side, we decided to undertake a review of our business model in early 2007. It was becoming clear then that there was an investor barbell emerging with demand for higher risk products that offered a greater scope for alpha such as alternatives at one end of the spectrum, and index and enhanced index products at the other end. It is the middle ground of traditional fixed income and equities that was being squeezed out.”

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Robert Parker, vice chairman of Credit Suisse Asset Management (CSAM). Photograph kindly supplied by Credit Suisse, October 2009.

There are of course challenges, according to Parker. He notes that while savings pools in many emerging countries are substantial, partly because they function to offset the relative lack of welfare systems, their large size relative to the local capital markets can pose a problem. In addition, there is still room for improvement in the development of local regulatory frameworks. However, other related issues such as technology and liquidity have developed relatively well. The firm was an early mover in China, making history, by being one of the first asset management companies to enter into a joint venture—ICBC Credit Suisse Asset Management—initiated and held by a commercial bank. The deal, which was struck in 2005, involved Industrial and Commercial Bank of China, the world’s largest lender by market value, taking a 55% stake with Credit Suisse Group holding 25%. China Ocean Shipping has the remaining chunk, which it recently put up for sale. It is too early to determine whether ICBC or Credit Suisse will be the buyer. In the Middle East, Credit Suisse has increased its stake in its local joint venture, Saudi Swiss Securities [since renamed Credit Suisse Saudi Arabia], which offers the full gamut of investment banking, private banking and asset management services. Parker says: “Our objective is to become market leaders in Asia, Latin American and the Middle East. We are also focusing our attention on Japan, which tends to get overlooked when Asia is mentioned.” Over the past year, the firm has hired some 18 senior executives to bolster its global institutional distribution group, which collaborates with the newly formed investment strategies and solutions group, to offer clients a coordinated and strategic approach across the spectrum of asset classes and investment styles. Explains Parker, Mark Bourgeois (managing director and head of distribution for asset management) has been busy“upgrading our sales team because the line between sales and client advice is blurring.”He adds:“Investors want to speak to people who are sophisticated, experienced and fully understand their needs.”

CSAM: PRESCIENT ASSET ALLOCATION

The conclusion was to exit the traditional long only equity and fixed income business but not to totally sever links with its roots. CSAM found a willing cohort in Aberdeen Asset Management, which last year bought the majority of the $65bn Global Investor business in Europe, the US, and Asia Pacific for about £250m.The Swiss-based group retained a 25% stake plus a seat on the board of Aberdeen. Parker explains:“We realised that the traditional business needed greater scale and that the only way was to bulk it up or change it. We felt that the best thing to do would be to partner with another industry player.As a result, we do not see the deal as a straight sale but instead a swap of our Global Investors business for equity in Aberdeen. Keeping a stake also means that it is in our and our clients’ interest to help Aberdeen succeed plus it also acts as an insurance policy just in case we were wrong about our strategy.” Going forward, Parker notes that the main focus will be on strengthening the higher growth areas of alternatives, multiasset class solutions, emerging markets as well as advisory services. Under CSAM’s banner the alternatives group, whose latest value comes in at roughly $138.5bn, is defined with a broad brush. It covers the gamut of asset classes including private equity, hedge funds, the fund of funds business for each of these categories, products tied to its CSTremont hedge fund index, real estate, infrastructure and commodities. While the financial crisis initially dampened investor appetite for riskier assets, Parker says investor enthusiasm is returning.“What happened given the extent of the crisis is that investors did move into money market and short duration bond funds, but they then realised that they would not be getting a return for a year. We are now seeing a steady and slow return to riskier assets.” Lessons have been learnt, though which Parker believes will be translated into less leverage employed and a more discerning investor base. For example, take the hedge fund industry. In the post-Madoff world, he sees a greater demand in terms of liquidity and pricing, especially in “stressed” scenarios, which should in turn help drive improvements in investment processes, transparency and risk management across the industry. He adds:“There is no doubt that 2008 was a difficult year for hedge funds, with up to 50% having closed, mainly due to performance failure. Only the fittest are surviving, which makes me less negative about the industry because it means that the ones who are left have proven and talented managers who can generate alpha.” Parker points out that opportunities are already presenting themselves in the hedge fund space particularly in the event-driven funds arena on the back of increased mergers and acquisition activity; convertible arbitrage funds thanks to a cheaper convertible market as well as emerging market equity and bond funds due to the fast growing economies such as China and India. Overall, emerging markets will be a big push for CSAM particularly in Asia, the Middle East and Latin America. “We estimate that the developing world will grow four times more than the developed economies over the next five years and we expect to see investment flows to increase to both emerging market debt and equities.”

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JOHN LITTLE • BNY MELLON ASSET MANAGEMENT

THE LITTLE BOUTIQUE FACTOR Who better to help orchestrate the eclectic collection of boutiques that make up BNY Mellon Asset Management (BNYMAM) than Jonathan Little, a man who once harboured ambitions to be a professional musician? Based in London, the vice chairman of BNYMAM oversees the firm’s non-US business, which has grown from a paltry $300m under management in the late 1990s to $200bn today. The stable of asset managers runs the gamut from Dreyfus, the venerable US equity mutual fund complex that has become the group’s retail brand worldwide, through fixed income specialists Standish and Alcentra to currency overlay manager Pareto and funds of hedge funds EACM and Ivy. Neil O’Hara looks at Little’s strategy. SSET MANAGEMENT DOESN’T generally get better when it gets bigger,” says Little, “We think smaller, more focused firms perform better than large supermarkets.”He believes talented portfolio managers prefer to work in small teams in which ideas flow freely around the firm rather than a big bureaucracy, an environment he experienced first hand earlier in his career at JPMorgan and Fidelity. BNYMAM also remunerates its people based on how each boutique performs so that managers who do well see a direct reward in their bonus check. The boutique concept does not extend to passive strategies, however, which benefit from economies of scale: index tracking involves fixed costs best spread over the largest possible asset base. Cash is another exception. “Short term cash management needs to be done once in scale with industrial strength risk monitoring and operations,”says Little,“Doing it five times in five different parts of an organisation makes no sense.” In effect, BNYMAM handles scalable activities at the corporate level but leaves each boutique to focus on what it does best. As part of this strategy, Little has centralised marketing efforts outside each manager’s home turf so that BNYMAM’s local office acts as the representative for the entire stable.“Scale does help in distribution,”he says,“It is hard to hire good people. You don’t want to do it 19 times in Tokyo and 19 times in Sydney.” The cluster approach has been applied by a few other asset management firms—Old Mutual and Affiliated Managers, for example—but BNYMAM has done it for longer than most and with demonstrable success. “We constantly refine the model,” he says, “That is why we give a wry smile when a competitor talks about moving to a boutique model. It will probably take them 10 years to get it operating correctly.” BNY Mellon came through the financial crisis in better shape than most banks in the United States—Standard &

John Little, vice chairman of BNY Mellon Asset Management. Photograph kindly supplied by The Bank of New York Mellon, October 2009.

Poor’s actually raised its rating one notch in June 2008.That fact has helped the asset management arm attract new business, a halo effect that continues not only in the US but also in certain other countries where reputation is often the deciding factor in awarding investment mandates. Even so, Little says the firm has conducted a thorough review of its operations to make sure that each product line fits within its overall strategy.“We’ve learned to stop doing hobbies,”he says,“The things that bite you are not the things that you are really focused on. It’s the things you forgot you were doing or the activities someone was doing off the corner of their desk.” Little sees the asset management business evolving toward a more complete separation of alpha and beta. Clients will demand either inexpensive passive products, active strategies that can beat the benchmark by a wide margin or uncorrelated absolute returns. He also expects a move away from productoriented marketing in favour of identifying a client’s particular needs and then assembling the products that best achieve the desired result.That’s why Little is so excited about the pending acquisition of Insight Asset Management, which will bring a market leader in liability driven investing into the BNYMAM fold.“We can ask, ‘What does this client need to do over the next 50 years with their pension plan?’”he says,“We can work back to a portfolio from there.”

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TESCO’S REAL ESTATE PLAY

Sir Terry Leahy, Tesco’s chief executive officer. Photograph kindly supplied by Tesco, October 2009.

Grocery retailers used to want to own their stores but of late have switched to own-and-lease strategies. The company innovating most in that field is Tesco, which has proved itself a formidable property strategist across Europe and beyond. Mark Faithfull examines its property power play. ESCO IS THE UK’s biggest retailer, Europe’s second largest and the globe’s number three. That probably does not tell you anything you didn’t already know. It is less likely you know that Tesco is Europe’s largest retail real estate owner It is larger even than French/Dutch shopping centre giant Unibail-Rodamco or UK REIT colossus British Land. Tesco has played its property card more aggressively than just about any other supermarket group since embarking in 2006 on a targeted, six-year £5bn sale of its property assets. Tesco Property Finance was set up to achieve its ambitious target and got the ball rolling in a series of joint-venture sale and leaseback deals with British Airways Pension Fund in December 2006, British Land in March 2007 and Prupim, M&G Group’s real estate investment arm, in February 2008. By October of this year Tesco had raised £1bn in two sales of commercial mortgage-backed securities (CMBS) by stripping down the complexities of the deal and turning it into something buyer-friendly. Normally, debt is sliced into several notes of varying risk and returns but Tesco opted to sell one portion of 30-year bonds backed by guaranteed lease payments from two separate packages of supermarkets and distribution centres. Michael HampdenTurner, a structured credit strategist at Citigroup, says: “There is no need for complexity at the moment and you don’t need leverage to get decent returns.” Also in October, Tesco agreed a £400m purchase and leaseback deal with DTZ Investment/Clearbrook venture Index-Linked Properties as the base of its £1bn inflationlinked, closed-end fund. supermarket property has never been a better bet, particularly for cautious investors.Yet Tesco was caught by a surprise backlash in the summer when a number of analysts questioned where the payback would come from building debt to finance constant national and international expansion. They accused Tesco of being impulsive.“Tesco understands the importance of ownership,” counters John Strachan, head of retail at agent Cushman & Wakefield.“It gives it a huge degree of control over its future.” With debt difficult to find Strachan notes that selling limited tranches of property portfolios has become an attractive way of raising money. “Quite a few of Tesco’s deals have involved the creation of 50/50 joint ventures,”he

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adds. “That option means they don’t lose control of the properties.” Even so Tesco’s debt ratios are at record levels and Moody’s Investors Service recently cut the firm’s credit outlook to “negative”, endangering its A3 credit rating. Tesco had already pledged to cut net borrowings (of £9.6bn) by £1bn this year and next. Numan describes the criticism of Tesco as“idiotic”, adding the retailer’s detractors are overlooking the robust nature of its business and its intentions to pay down debt. Tesco has not been shy about realigning its strategy in the face of business reality. In 2005 Tesco and French chain Carrefour confirmed an unusual store swap deal, enabling Tesco to exit troubled operations in Taiwan and bolstering its position in two equally troublesome European markets for Carrefour. Large retailers rarely enjoy performing in markets in which they are not dominant and the deal gave both retailers an out. The deal originally involved 11 Taiwanese stores for Carrefour’s while Tesco snapped up 11 hypermarkets in the Czech Republic and four in Slovakia. However, Slovakia’s anti-monopoly office banned Tesco from acquiring the Carrefour stores because the transaction “would boost Tesco’s dominant market position and leave it without relevant competition”. Carrefour eventually concluded a deal with two locally-based retailers. “In Central and East European markets the supermarket chains want to be number one or number two,”says Jonathan Hallett, managing partner of Cushman & Wakefield, Czech Republic and Slovakia.“Planning has not been a big issue in most markets, and finding and developing sites has been fairly straightforward. It’s all about critical mass.” Similarly, Tesco’s £958m acquisition in South Korea last year neatly encapsulates Tesco’s opportunism. By buying 39 hypermarkets in the country, it also notched its largest acquisition and showed where it believes future profits lie.Tesco bought the stores from E-Land, a South Korean company, that in turn bought them from Carrefour for £1bn two years earlier and which had last year set a selling price of over £1bn.“What Tesco is doing is to determine that it can afford to realise property assets in a structurally mature market in order to buy in new, high-growth markets,”says Numan.“As those emerging markets mature, it will be able to do the same again,”

TESCO: SHOPS EUROPEAN REAL ESTATE

TESCO

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MARK KELEHER • MELLON TRANSITION MANAGEMENT

WILL FORTUNE FAVOUR THE BRAVE? In the spring of this year, when transition management underwent a massive contraction, Mark Keleher, global head of Mellon Transition Management boldly hired the entire UK transition team from Citi, after it reoriented the transition management business pulse out of New York and Sydney. It was a massive investment in people and cost and risky, because the Citi approach to transition management was quite different; a sellside rather than buy-side offering. Did Kelleher read the runes correctly and get his ‘super-team’ into place in time to leverage the upturn in business that began in the second half of this year? Art Detman reports. RANSITION MANAGEMENT IS changing as clients demand global capabilities, access to liquidity across asset categories, and, perhaps most importantly, accountability and transparency. All this suits Mark Keleher, chief executive of Mellon Transition Management (MTM), who expects the number of transitions to set a record in the second half of 2009. Institutional investors watched with dismay as their assets shrank sharply over the past two years or so. Some changed fund managers but many others held back, fearful of making a switch in a market where prices moved 4% or 5% a day. With less volatility, more big investors are now switching managers, which is good news for MTM, the San Franciscobased transition management arm of Bank of New York Mellon. Keleher says his firm responded to pre-trade inquiries involving $10bn during August alone.“August is a very slow month,” he notes. BNY Mellon doesn’t break out MTM’s results but Keleher expects revenues to grow 30% or even 40% this year. He says: “It doesn’t make sense to change managers for 100 or even 200 basis points but when the disparity in performance becomes four or five times that much, they want to make a transition.” Keleher thinks the difference between the best and worst performing managers was probably no more than 4% from 2004 through 2007. He adds:“Last year it was 17%.” In October, a set of voluntary guidelines for European transition managers was introduced. The so-called T-Charter is intended to allow client companies to better compare

Mark Keleher, chief executive, Mellon Transition Management. Photograph kindly supplied by The Bank of NewYork Mellon, October 2009.

competing proposals. Keleher both welcomes the code and condemns it as not going far enough.“In its present form it requires disclosure only of how a transition manager earns its money. It does not require full disclosure of exactly how much a manager makes, or how much its affiliates make. I support a document that requires complete transparency as to the total amount of revenue generated by a transition manager and the amount earned by a TM’s affiliated trading arms.” Keleher’s hard-line stance is no surprise. Since taking command at MTM in 2001, he has built a reputation for fiduciary responsibility and transparency.“Clients have come to realise they need a fiduciary protecting them, someone who can step in as an interim manager and take on longterm management of distressed assets. We take full responsibility for the management of assets during the transition period and manage the entire transition, all the operational details, from start to finish. We substitute our client’s interest for our own.” One result of this approach has been a slew of industry awards. Global Pensions named MTM Transition Manager of the Year in both 2008 and 2009. A more tangible result has been MTM’s steady growth. Earlier this year Keleher acquired Citigroup’s entire London transition management office, which included seven professionals. He has added staff in Australia and has more than 50 people in offices around the globe.“We’re looking to add people here in the US,” he says. What if BlackRock decides to move San Francisco-based Barclays Global Investors to New York after the acquisition is completed?“We’ll be glad to talk to any of BGI’s people who want to remain in San Francisco, I can tell you that,”he says. Keleher says MTM has been gaining market share and much of it has come at the expense of broker-dealers in Europe, the Middle East, Africa and Asia. “Broker-dealers have dominated these markets but many of them are under such terrible financial pressure that they are shutting down their transition operations or severely curtailing their headcount in transition management. At least six brokerdealers actually left the business in practical terms last year. “If anyone has benefited from the financial crisis, it is the fiduciary transition manager,”Keleher says.

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N SEPTEMBER THIS year, China’s state council gave the go-ahead to phase one of the projected Shandong Haiyang nuclear power station complex. Ultimately, two nuclear power generating units will be built, each with an installed capacity of 1.25m kilowatts (KW). The China Power Investment Corp. and State Nuclear Power Technology Corp, the project sponsors, expect both plants to come on-stream by March 2015 at the latest. The nuclear power plant will use so-called AP1000 technology, a type of the third-generation nuclear power reactor designed by US-based Westinghouse. The government is hoping to utilise state of the art nuclear technology to tackle both air pollution in the republic and increase the proportion of new energy provision to meet 10% of total energy consumption by 2010 and 15% by 2020. Says Richard Lockwood, director at New City Investment Managers, some 24 nuclear plants are now either in construction, or near construction in the republic. The uptick is that the dual trends of climate change and long-term waning natural resource supplies are coinciding to encourage greater use of uranium as a source of economic and clean energy in both emerging and developed markets. In this context, holds Lockwood, it’s time for the Geiger Fund to come into its own. When the fund was set up in 2006 it was a time of contrasting attitudes to the whole nuclear issue. “At one meeting I lost the audience’s attention in minutes, literally. In fact, some people were downright hostile,” concedes Lockwood. Three years later, he notes: “The proverbial penny has dropped. People are becoming clearer on the facts, such as 80% of France’s energy generation is down to nuclear power.” In an increasingly geo-strategic world, it provides a serious alternative to the West’s extensive dependency on carbon-based fuels, he holds. The fund, which is listed on the Channel Island’s Stock Exchange, invests only in uranium production and exploration companies. In part, that focus derives from the fact that much of the leading nuclear power construction industry is state-owned. Areva, the specialist French nuclear power construction firm, is 94%-owned by the government, for instance. “It is always difficult to buy ownership,” notes Lockwood. In part, the Geiger Fund’s investment strategy is guided by the particular nature of the uranium industry.“Only 5% of supply is sold on a spot basis,” explains Lockwood, with the bulk (95%) sold through pre-agreed offtake agreements directly to power station sponsors or owners. Even so, supply remains vulnerable. “As Olympic Dam illustrates, it’s a sensitive time in the industry. Moreover, with so many power stations coming on stream, particularly in Asia,”notes Lockwood,“it would appear that now is the time to buy into uranium production as competition for supply can only intensify, at least in the medium term.” There are significant sub-trends in play, adds Lockwood. “The real challenge will surface in two to three years as

Photograph © Peterdenovo/Dreamstime.com, supplied October 2009.

THE NUCLEAR OPTION BHP Billiton declared force majeure at its Olympic Dam copper, iron ore and uranium mine, crippled by a runaway skip that took its Clark shaft out of operation on October 6th. The incident is expected to result in the loss of 70,000 tonnes of copper and, more importantly for this entry, 1,500 tonnes of uranium. The incident will significantly eat into uranium supply from the world’s biggest known deposit of the power plant fuel. Olympic Dam’s crisis is grist for the mill for Richard Lockwood, director at New City Investment Managers, part of CQS, who manages the innovative £40m Geiger Fund Limited. The fund, whose net asset value increased 18% over the three months up to September 30th this year and 38% since its launch in June 2006 is the only listed specialist uranium fund in the world. Francesca Carnevale reports

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LEVERAGING LIMITED URANIUM SUPPLIES

THE GEIGER FUND LIMITED

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THE ADVANCED TECHNOLOGY INVESTMENT CO more nuclear power stations come on stream, and supplies remain concentrated.” Interestingly, Lockwood believes that the future of nuclear power lies squarely in the newly minted emerging markets.“Nuclear plant construction is a rich man’s game,”he notes wryly.“Now there are very real discussions in some countries as to whether they can afford to build nuclear plants, which involve set-up costs of anywhere between $5bn and $10bn,”he explains. Then there are complex geo-political issues in the mix that will invariably concentrate the debate around supply. While RTZ, for instance, owns the bulk (around 70%) of the mighty uranium producing Rossing mine in Nambia, the Iranian government no less owns the rest. In this regard though Lockwood is keen to downgrade speculation: “The mine has been operational since the 1970s and the Iranians have been at pains to remain remote partners in the venture.” Even so, there are new nuclear players standing in the wings which, at some point, might rise to complicate matters, or at least put pressure on demand for uranium. The Kingdom of Saudi Arabia was recently reported as commissioning a report on the viability of nuclear power reactors, for example. Then again, China is known to be trying to secure additional offtake agreements, though few if any suppliers are acknowledging these new supply contracts. “Major uranium suppliers, such as Paladin, with mines in Namibia and Malawi, have not reported any changes in offtake contracts. It is a bit of a mystery,” says Lockwood. Already, there are efforts at diversifying supply. The US, for instance, whose principal supplier is Canada, buys additional uranium from Russia for its nuclear power stations, as Russia decommissions its nuclear missiles. Lockwood agrees that the fund, ultimately is leveraging these conflicting and, it has to be said, worrisome pressures. He firmly believes, however, that the winds of change are firmly propelling the fund’s future. From an initial £12m in commitments at launch, the fund is now worth £40m, though Lockwood says he thinks the fund will be and should be much bigger. Lockwood’s rationale for preferring uranium is based on three precepts: one that nuclear power has moved on exponentially since the 1980s. “Excepting the Wild West that was Chernobyl, nuclear power is actually very safe,”he asserts. Second, while uranium is ubiquitous, concentrated supplies are few and far between.“There is a real chance of physical shortage, which could push up prices by a factor of five or six, at least,”he explains. The third consideration is the zeitgeist. “We are not out to change the world,” he concludes. “[We are] simply providing a vehicle to secure investment in a rising trend that we are enthusiastic about and which is at the heart of the matter on a key debate; that of securing reliable and clean energy.” Natural questions remain, such as: where will all that nuclear waste be stored? Moreover, will someone come up with a fund that will invest in safe and clean answers to that particular problem?

CORNERING MARKET SHARE Abu Dhabi’s technology sovereign fund threatens to change the semi-conductor industry’s balance of power via organic growth and strategic acquisitions. In its latest deal, the Advanced Technology Investment Co. (ATIC) is paying (all-in) $3.9bn to acquire Singapore’s Chartered Semiconductor Manufacturing Ltd. The acquisition follows hot on the heels of the recent joint venture GlobalFoundries, which ATIC owns together with Advanced Micro Devises (AMD). Can it build market share as market leading Taiwanese companies grapple with their own problems? By Francesca Carnevale. bu Dhabi’s Advanced Technology Investment Co. (ATIC) will soon close its $3.9bn acquisition of Chartered Semiconductor Manufacturing Ltd, which brings with it an 11.3% global market share. ATIC will merge Chartered’s operations into its Sunnyvale, California-based acquisition GlobalFoundries, giving it a substantial Asian footprint. The deal is part of a total investment of more than $10bn by ATIC to establish a beachhead in semi-conductors. Chartered meanwhile will get faster access to leading-edge manufacturing capacity (via Global Foundries) and long-term capital investments promised by ATIC. In turn, Chartered brings six fabrication plants and some starry clients to the party. In 2002, the company began working with IBM, and licensed the silicon-on-insulator (SOI) process used by IBM and AMD for their microprocessors. Chartered however has struggled to turn a profit and reports a cumulative loss of $952m against net profits of $177m between 2002 and 2008. ATIC’s plans won’t be easy to achieve. GlobalFoundries is less than a year old and has limited experience in making chips for companies beyond AMD. The integration of Chartered will be a big and expensive task. The industry is scale-sensitive and companies must continually make capital investments in new technology and operations. Moreover, it will be difficult for the integrating operations to gain ground on first movers and industry leader Taiwan Semiconductor Manufacturing Co. Ltd and, second ranking United Microelectronics Corp. However, despite enjoying a rebound in the first half of 2009, Taiwan’s semi-conductor industry is also being tested. Demand from China helped the upswing, but that demand is prescribed; mostly chips for mobile devices (laptops etc). Then again, inventory building, which spurred the global chip industry is, for the time being, coming to an end and will be replaced by actual consumer and industry demand. Moreover, while Taiwan’s chip makers are keen to expand in China, regulations currently limit Taiwanese inward investments in the segment. Does all this play to ATIC’s game plan? ATIC chief executive officer Ibrahim Ajami is bullish about the overarching trend of rising global demand for semiconductors which, he says, will be driven by “billions of new mobile phones, cars, televisions, computers and other devices.”

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MOULDING STRUCTURED FINANCE Sarah Breeden is one of those senior central bank figures who few, if any, high fliers in commercial banking would have probably have come across even two years ago. That’s changed as the Bank of England has had to provide an unprecedented level of support to the UK’s banking sector since September 2007. The extent of that help is now clear: Bank of England governor Mervyn King told a meeting of Scottish businessmen in mid-October that the total was “not far short” of £1trn. Breeden, the Bank’s head of risk management, has become a key figure for senior executives at all those banks that are stuck with huge portfolios of asset-backed securities (ABS) they cannot sell and that are relying on Threadneedle Street for their liquidity. Andrew Cavenagh reports. ARAH BREEDON IS now probably known to every single person in the structured-finance market,” explained a former securitisation specialist at one of the big US banks in London. “What the Bank of England will or will not do over the next year will be very important for the future shape of the capital markets—particularly structured finance.” Breeden was heavily involved in the design and implementation of the emergency programme that the Bank of England launched in April 2008 to prevent more large British banks collapsing like Northern Rock. The Special Liquidity Scheme (SLS) offered banks and building societies life-saving liquidity by allowing them to exchange higherquality (triple-A rated) illiquid assets originated before December 2007 for Treasury bills (or gilts) for a period of up to three years at an appropriate discount (haircut) and for a fee. When the drawdown period for the scheme closed at the end of January 2009, the Bank had swapped gilts with a nominal value of £185bn for such collateral. Most of it comprised residential mortgage backed securities and covered bonds backed by mortgages with a face value of £287bn, although the Bank valued it at £242bn; a discount of 16% to par. Although the scheme closed to new entrants at the start of the year, it will remain a significant risk-management exercise for Breeden and her team potentially well into 2012, by which time all the swaps must be reversed. To protect itself from potential losses in the event of a SLS counterparty defaulting, the Bank has to monitor regularly the market value of the assets it has acquired and call for additional collateral if their haircut-adjusted value falls relative to that of the gilts for which they were swapped. The Bank has since embedded features of the SLS into the Discount Window Facility that it launched in October 2008, which will allow eligible banks and building societies to

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2009

People rest on steps across from the Bank of England in the City of London, Thursday, September. 10th 2009.The Bank of England had held interest rates steady at 0.5% for the sixth consecutive month that Thursday and pledged to continue its programme to boost the money supply despite gathering signs of an economic recovery. Photograph by Sang Tan, for Associated Press. Photograph kindly supplied by PA Photos, October 2009.

borrow gilts against a wider range of collateral than the SLS accepted on a permanent basis. In January 2009 it extended the period (for a fee) from the usual 30 days to up to 364 days. As the Bank also needs to monitor changes in the valuation of assets pledged under the DWF, an unprecedented expansion of its collateral management capabilities is under way to enable it to manage a much greater volume and range of assets than it has had to do historically. This exercise will involve a continuing investment in people, processes and systems—some of which will be outsourced. Responsibility for managing the risks associated with these vast programmes of support for the financial system represents the latest step in an upward progression for Breeden. From October 2007 until she took on her latest role, she was responsible for the Bank’s involvement in the rescue of Northern Rock. Prior to that, her role as head of the risk management division covered the Bank’s financial market operations and the UK’s official foreign currency reserves. She joined the Bank soon after graduating from Cambridge with an economics degree in 1990, but left five years later to obtain an MSc in finance from the London Business School (sponsored by the Bank). She considers the qualification was important to her career development in improving confidence in her technical skills and the knowledge that she would be going back to the Bank enabled her to focus her studies.“I knew what job I’d be applying the knowledge in when I returned,”she posits. On her return, she held the number two position in each of the Bank’s Markets divisions (sterling and foreign exchange) and also served as assistant private secretary to former governor Eddie George.

SARAH BREEDON: THE BANK OF ENGLAND BANK BAILOUT

SARAH BREEDEN • BANK OF ENGLAND

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SUSAN EBENSTON • JPMORGAN

THE LANGUAGE OF COMPONENTS Despite, or perhaps because of, a still challenging investment environment, definitions of fund administration appear to be steadily expanding. Funds look to administrators for extended valuation and reporting capabilities as well as greater middle office functionality, collateral management, risk reporting, and compliance services. In turn, administrators are broadening their client search, servicing a greater range of funds and investment styles. Set against this dynamic backdrop, the quality of the operations team and its supporting technology is paramount. That is why Susan Ebenston, JPMorgan’s head of Global Fund Services, has set it as a priority. T IS ALWAYS something of a struggle in assessing the relative merits of one institution over another in the area of asset servicing. After all, these things are largely subjective; one man’s ace of spades fund administrator is another’s measly four of clubs. According to Ebenston, the segment has “room in the market for four to five key players and we are all different in our own big ways.”Some elements of JPMorgan’s strength lies in its “universal banking model,” suggests Ebenston, to which must be added the“strength of our balance sheet.” That financial strength has allowed JPMorgan time to redefine its internal technology and hardwired communications links, “breaking it all down into smaller boxes that can fit together and talk to each other. We use a software that essentially connects islands of functionality. It has been a big task; more deconstructing than constructing, but it has massively increased the capacity of our technology and has upgraded our front-end service offering to clients,”claims Ebenston. Against that backdrop the bank has developed what Ebenston refers to as a “componentised” business offering. This has involved “reimagining ourselves to ensure that the elements of our service offering are mixed and matched together to provide the exact required service for our clients. It is particularly apt,” she holds, “as increasing numbers of hedge funds pour money into UCITS. The bulk of the business remains vanilla. Mutual fund flows, for example, are now being outstripped by ETFs, which are relatively simple.” In this regard, the bank has finely balanced its drive to standardise as many outsourcing functions as possible on a common technology platform while simultaneously offering a bespoke service to each client. This balance is

Susan Ebenston, JPMorgan’s head of Global Fund Services. Photograph kindly supplied by JPMorgan, October 2009.

often not as difficult to achieve as it first appears, contends Ebenston, as clients are usually willing to review some of the complexity inherent in their own operating model. She adds: “The challenge in fund administration is balancing the need to support product innovation on an end to end basis with keeping prices simple and transparent.” It is a development that is being embraced along the client spectrum, she adds. “At one time, only hedge fund managers were paid for performance. Now the practice is appearing in the traditional space.” Even so, notes Ebenston, the asset management sector is increasingly embracing simplicity. “Some of our latest deals are with hedge funds that are taking on characteristics of long only investors. We must all recognise that the appetite for opaque products has dissipated. Asset managers have discovered there is a lack of appetite for complexity in the market. However, a hub and spoke approach is also gaining ground,”she explains.“We have definitely noted an appetite at the edges to chase alpha. Our capability must at least match our clients’as they develop new strategies,”says Ebenston. The direction of regulation is a key risk for the asset servicing industry these days. “There are a lot of papers coming out of the European Commission,”she notes. While she welcomes any moves that encourage good governance and market transparency, Ebenston warns against the potential harm from “the unintended consequences of regulation. Certainly the regulators would like us to be responsible because of our function in the value chain. However, there are a number of people in the value chain, including investors, which have to be responsible for their own functions.You can’t just move responsibility to the end of the value chain and say, ‘You have unlimited responsibilities’. There are market conventions and legal structures that give custodians and depositories protection. However, expectations are that custodians and depositories are standing behind these liabilities, and that is perhaps a step too far. The decision to invest in certain markets and certain assets remains with the investor.” Elsewhere, Ebenston is looking to a near term future full of promise for the asset servicing industry in Europe as UCITS IV legislation comes on stream. “It will be great for the fund administration industry and those asset managers looking for distribution of funds globally. It is such a huge topic, with immense geo-political implications, as people in different countries allow their assets to move either onshore or offshore.”

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THE STRATEGIC PLANNER The gap between the top four global custodian providers and the next tier in terms of funds under custody is wide; by a factor of three. Arguably, it is the battle for the next two to three slots that have fired contenders such as BNP Paribas and, for the purpose of this segment, HSBC Securities Services (HSS), to overhaul their operations to keep them on an upward trajectory. However, HSS is less concerned with league table positions than with positioning itself within a new world order in investment servicing. “

E DEVELOPED A strategic plan four years ago, that has directed our operational mandate, remains in place and has guided the business through the financial crisis.” says Tim Howell, global head of securities services at HSBC. While the bank has no footprint in the low-margin US market, it does have operational width in the Middle East, Asia and Latin America. Asia is of particular interest, because of its growth and because “its demographics are favourable. Moreover, its risk-reward profile is attractive” says Howell, adding, “While some Asian countries bring their own unique challenges there remains a premium that is paid for local knowledge.” In focusing on core competencies, the bank is realistic in letting some businesses go. In October, for instance, HSBC France agreed to sell its mutual funds custody operations and the fund administration operations of its subsidiary HSS France SA to CACEIS SA, an asset servicing banking group of Credit Agricole dedicated to institutional and corporate clients. HSS France carries with it €39bn in assets under custody and a further €56bn of assets under administration, two thirds of which related to HSBC France’s own asset management funds. According to Howell, pure asset servicing does not get the heart racing; it is the value added in the business. Instead, HSS is harnessing a growing pool of clients that put more store in safety of assets than leverage. It is a dash of sorts towards prime services, “due to the focus on asset security we have clients who want us to look after their assets on a segregated basis. Additionally, we have no need to rehypothecate client assets for our own funding purposes due to the Group’s balance sheet strength and liquidity ”explains Howell. It is a proactive and still evolving approach that cuts to the gradual absorption of prime broking specialisms within a traditional custody and fund administration infrastructure. According to Howell, “Typically the first product a client will ask us to transact is Foreign Exchange (FX). We will hedge their FX exposure and we prove best

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2009

Tim Howell, global head of securities services at HSBC. Photograph kindly supplied by HSBC, October 2009.

HSBC: THE QUIET PERFORMER

TIM HOWELL • HSBC

execution. We would then move on to other value added products like equities and futures.” This has achieved significant traction over the last few months as funds look forward with more certainty. Earlier in the year, funds have simply been trying to survive events.” The bank is also leveraging the natural cross trends that emerge at times of market volatility and, at this particular time, substantial market changes.“It involves a significant pipeline of business in Asia and the Middle East, but also Latin America, and specifically Ireland and Luxembourg, where we are conduits for dollar and euro funds into those emerging market regions.”HSBC’s long standing and encyclopaedic knowledge of the Asian market are useful skills in this context, where the bank is leveraging its local tax and regulatory expertise to assist clients working in frontier markets. The denudation of asset values that has occurred over the last eighteen months has played to HSBC’s strengths as more asset owners try to tap opportunities in high growth markets. In today’s investment services universe, “unless you can offer value-added services over the long term and across limitless borders,”you should not be in the business, states Howell. He cites the post trade world as a microcosm of the changing financial landscape, where liability profiles are better understood and where true product pricing is the rule rather than the exception. NAV-lite models must be consigned to the dustbin of custodial history, thinks Howell, at least at HSS as it refocuses on high end business where transactions are ineffably tied to underlying cash flow. It is a vision of a highly polarised world of investment services, with HSS intent on positioning itself in the product-priced right lane.

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JACQUES D’ESTAIS • BNP PARIBAS’ CORPORATE AND INVESTMENT BANK

STEERING SAFE PASSAGE BNP Paribas has probably had as good a financial crisis as any European bank. While other lenders paid for the greedy mistakes of their investment divisions, France’s largest bank capitalised on its relative strength, and rival’s collapsing valuations, to expand into new markets. The purchase in May of much of the retail and fund management operations of Fortis propelled BNP Paribas to the number one spot in Europe in terms of retail bank deposits. Standing at the centre of much of this action is Jacques d’Estais, head of BNP Paribas’ corporate and investment bank from December 2005 to March this year. By Paul Whitfield. IN HIS NEW role as head of investment solutions Jacques d’Estais is in charge of the integration of Fortis’s asset management divisions into BNP. The job swap— d’Estais exchanged roles with the former head of investment solutions Alain Papiasse—will bring the“benefit of a fresh eye” to both businesses, BNP Paribas chief executive officer Baudouin Prot reasoned when he announced the move in February this year.” Although there are a different set of disciplines in investment banking, much of my experience at the head of the investment bank is applicable across the board,” explains d’Estais.“In addition to the‘fresh eye’… the swap really reinforces our‘one bank’approach to financial services.” D’Estais is a 25 year veteran of the bank. While a onebank career is rare, d’Estais says it is an advantage for a senior manager. “Over the years I have built a close relationship with managers and employees across the bank that enables us to act as a tight team—when decisions are needed they can be made quickly,”he says.“Having a good knowledge of the bank’s inner workings helps us to understand both the opportunities and the risks.” “My philosophy [at CIB] was that to become a globally recognised investment bank, half the battle was motivating our people to look beyond boundaries. I tried to encourage our bankers to talk, discuss, challenge each other and to be as entrepreneurial as possible,” says d’Estais. “We developed a series of internal slogans such as ‘push and pull’ and ‘dare and share’ to reinforce this behaviour. I will be applying much of this philosophy to the investment solutions business, where there are real opportunities for the business to work even closer together.” BNP Paribas’conservative approach to banking is also one that d’Estais acknowledges, though he makes no apology for that. “What we have shown is that taking a measured

Jacques d’Estais, head of BNP Paribas’ corporate and investment bank.

approach [in terms of risk] pays off handsomely,”he says.“I think many people would be quite surprised if they were to add up investment banking profits over the past couple of years—we would be out in front despite being smaller than some of our competitors.” Nonetheless, BNP Paribas did not escape the crisis unscathed. In the last days of December 2008 d’Estais’ CIB unit unveiled losses of €1.6bn, most of which occurred in the proceeding two months. Those losses, and the changed reality of investor demands, led to changes at CIB. The units risk profile was reined in and plans to expand further into derivatives were dumped. Yet unlike its rivals, the changes felt like tweaks rather than a complete overhaul. Significantly, the changes little altered the balance of BNP Paribas operations at a global level. “The board is committed to our balanced business mix operating across three poles, as we call them: retail banking, investment banking and investment solution,”says d’Estais. With Crédit Agricole’s decision to scale down its CIB operations and Société Générale’s effective sale of is asset management operation, BNP Paribas is now the only French bank to pursue growth across the three major banking pillars. The recent job swap means that d’Estais, like Papiasse, has now headed two of those three sections. Despite the very different nature of those units, d’Estais sees significant crossover in terms of the management challenge and in terms of the operations themselves. d’Estais also notes that many of the challenges to bank operations in the coming years are likely to come at an industry level, as governments and clients demand significant change to discredited practices and as lower profit margins drive consolidation. In dealing with those sorts of challenges, a broad knowledge of banking is likely to be more valuable than narrow expertise.“We are at a period of industry introspection and the decisions we make on important topics such as retail and institutional distribution, product expertise and remuneration need to be very well thought through,”says d’Estais.“They will impact on investors for many years to come.

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LARRY KANTOR • BARCLAYS CAPITAL Though small to mid-size research firms continued to gain ground during 2009, their stalwart bulge bracket counterparts—which garnered more than two-thirds of buyside research spending over the past year—do not appear ready to hand over the keys just yet. Things seem particularly rosy over at Barclays Capital, the investment-banking unit of Barclays Bank. A year after acquiring the North American division of Lehman Brothers, Barclays has embarked on a vigorous hiring campaign. David Simons reports.

BULKED UP RESEARCH Larry Kantor, head of research, Barclays Capital. Photograph kindly supplied by Barclays Capital, October 2009.

HE CONSOLIDATION OF Lehman and Barclays Capital’s respective research teams, which saw 165 Lehman and 80 Barclays analysts pared down to a crew of 160 at the start of the year, was accomplished within four months of the acquisition. Larry Kantor, head of research for Barclays Capital, spent many a night holed up in his New York office in order to ensure a seamless transition. He recalls: “Comparatively speaking, it went remarkably well but we really felt that moving quickly was key to having the integration be a success.” Since then, Barclays Capital has added hundreds of new research and M&A staff. “We’re investing where we see opportunities,” says Kantor. “What Barclays had lacked was a strong US cash-equities presence, which we felt was necessary in order to properly serve our clients. At the same time, clients are narrowing their list of counterparties—they are continually reminding us that it is really difficult to follow research and talk with analysts at upwards of eight different firms. Our objective is to be a top-three counterparty for all our important clients.You

can see this type of consolidation reflected in the numbers—the market share of the top five firms has really grown.” At a time when a majority of firms have been scaling back on research in order to cut costs, Kantor says Barclays Capital, “wanted to be one of the few firms that could continue to provide clients with real content and value. We’ve always been a client-focused firm, and as such we’ve taken an integrated approach to our research offerings”. Kantor explains that there is often a disconnect among research analysts, resulting in clients receiving contradictory information from a number of different sources within the same company.“Let’s say the focus is Mexico. You might get one report from the emerging-markets analyst about the Mexican economy, another from the FX specialist discussing the peso, and still another from the energy analyst concerning Mexico’s oil situation. And more often than not, they are all completely inconsistent with one another! So one of the things we have done is to have our analysts collaborate across regions and product areas, which is invaluable for clients.” With the markets becoming more interrelated and clients increasingly viewing the world in a holistic manner,“there needs to be even more cooperation between the various parties—the expertise needs to be leveraged in order for the research to meet clients’ expectation,” says Kantor. At Barclays, for instance, the firm’s commodities experts when calling on clients are often accompanied by the emerging markets team. He adds: “Clients find this kind of synchronised approach very impressive and I believe it is one of the reasons why we’ve been successful.” Latin America figures prominently in Barclays Capital’s research expansion plans. “At present we have around 20 equity-research professionals in Brazil, covering over 60 companies in 10 different sectors. Long term, our goal is to cover up to 150 companies in Brazil alone. Obviously there continues to be a lot of economic growth and financial development coming from the emerging markets, so naturally we see a lot of opportunity in those regions.” Additional growth prospects in the coming year include areas such as Hong Kong, China, Korea, Taiwan and India. Barclays Capital continues to increase its equity coverage in Japan, where there are presently 45 equity research analysts, and plans to add Singapore and emerging Europe to the list during 2011. Even the best intellectual content can be squandered if not leveraged properly, says Kantor, particularly as the electronic era continues to evolve.“If your clients aren’t reading your research or talking about it with the analysts and strategists, then it is useless,” says Kantor. Such was the impetus behind Barclays Capital Live, a web-based portal for information and electronic trading launched earlier this year. Combining Lehman’s research and analytics capabilities with Barclays Capital’s BARX Fixed Income multi-asset class electronic trading service was no easy task, says Kantor.“From an IT standpoint it was a huge job—trading systems needed to be integrated, there were all sorts of compliance and legal issues to deal with. And yet in the end we were able to create a website that combines the best of the two previous platforms, get all of the clients properly migrated and improve navigation as well.”

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THE ISLAMIC IMPERATIVE Despite several challenges and difficulties, Islamic finance and investment has surfaced as a safe and secure alternative to conventional assets. The steady growth of Islamic finance across countries and asset classes is squarely represented by Kuwait Finance House (KFH) which, since its inception in 1978, has become a dominant force in the segment. The bank is now focused on building its international remit through innovative real estate investment approaches in the United States and beyond, which underscore the new geography of crossborder regional investment flows in the Islamic investment sector. By Francesca Carnevale.

Mohammad Sulaiman Al-Omar, chief executive officer, Kuwait Finance House. Photograph kindly supplied by KFH, October 2009.

HE UNITED STATES is once again a focal point for KFH’s international real estate investment strategy. KFH has entered into a joint venture with real estate investor UDR Inc to acquire high income-producing residential properties in major cities. The bank had already built up a number of separate real estate investment portfolios in the US, which it liquidated prior to the global credit crunch. This latest venture signals the bank’s commitment to a new strategic drive in North America and indicates KFH’s preferred route in its geographic expansion programme, via strategic alliances with major companies. KFH’s holds a 70% share in the venture, with UDR’s holding the balance. The joint venture will buy high income residential real estate in major US cities, with an aggregate initial investment value of up to $450m. The venture will target class“A”assets with a minimum value of $20m that are less than seven years old, noted the bank’s chief executive officer Mohammad Sulaiman Al-Omar, at the time of the transaction. The venture will be fully invested over a two year investment period and is targeting an internal return rate (IRR) of 12% to 14% annually. The bank continues, meantime, to look for new investment opportunities.“We have obtained an investment banking licence in Saudi Arabia and are executing real estate development projects in the eastern areas, as well as other cities in the Kingdom,”notes Al-Omar. Asia is an important market for this bank in this regard. The bank’s Asian real estate investment fund, realised a profit of 40% over a threeyear period, after which the $100m fund was closed. (The fund offered 6% as capital profits before being liquidated.) The Asian Real Estate Fund was established to develop the largest residential and commercial complex in Malaysia, called the Pavilion, located in Kuala Lumpur. KFH also manages the $1bn Al-Nebras 2 Fund (offering 8% annually)

which invests in the Iskandar City development, one of the largest real estate projects in Malaysia, worth some $15bn. This success is now being repeated in Turkey, where KFH has extended the operating period of its KD15m real estate fund which provides an annual return of 10%. The fund rents out 60,000m² of warehouse space, near Ataturk Airport which is then rented to logistic companies for a minimum of five years. Moreover, KFH’s Kuwaiti real estate portfolio, which was established in the second quarter of this year with some KD50m in capital, is expected to deliver a 6% quarterly profit this year. The five-year portfolio consists of 70 commercial and investment real estate that are distributed among various areas in Kuwait, which allows diversification in revenues. KFH is one of the few banks that weathered the worse effects of the global financial crisis. Earlier this year, the bank reported total profits of KD379.35m for 2008 with assets increasing to KD10.54bn and deposits of KD6.612bn. KFH paid out a 40% cash dividend and a 12% stock dividend to shareholders for the 2008 financial year. The bank’s growing pre-eminence in Islamic finance across the board is exemplified also by the recent mandated awarded to the bank by the International Finance Corporation’s (IFC’s) recent $100m sukuk. Other lead managers included DIB, HSBC and Liquidity House.“KFH has now become a symbol for the Islamic finance industry in Kuwait, as well as around the globe,” said Al-Omar during an Global Finance award ceremony in Istanbul at the October 2009 IMF meeting. KFH picked up the Best Islamic Bank in the Middle East award. Al-Omar meanwhile won Best Banking CEO from CEO Middle East magazine in the autumn because of his work in Islamic finance. It appears to be a question of right bank, at the right time, in the right places. As Al-Omar says: “It is now time to reinforce the role of Shariah-based transactions.”

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2009

20-20: EXPANDING THE REACH OF ISLAMIC FINANCE

KUWAIT FINANCE HOUSE

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ABDUL HAMID SHOMAN • ARAB BANK

STRENGTH IN DEPTH Being a successful bank in a rich Middle East country is one thing; being a successful Middle Eastern bank, with a home market blessed with few natural resources is another. Even so, the Arab Bank Group, Jordan’s largest financial institutions, has managed the greatest geographical spread of any Middle East financial institution (spanning more than 500 branches in 30 countries) and is still expanding its reach. More than 80% of the bank’s revenues now come from overseas, and while still steeped in a traditional and conservative banking tradition, the bank typifies the new breed of global banks emerging from the MENA region, with a strengthening international franchise. N SEPTEMBER THE Arab Company for Shared Services FZ LLC commenced Arab Bank’s Gulf and Yemen back-office operations at the Dubai Outsource Zone (DOZ), the special economic zone dedicated to the outsourcing industry. As a subsidiary owned entirely by Arab Bank Plc, Arab Company for Shared Services will handle the back office transactions of the bank for the United Arab Emirates, Qatar, Yemen and Bahrain (with an estimated 300 employees to be based at DOZ). The DOZ-based back-office operations will centralise and standardise core business processes tailored to the needs of the GCC market. Business processes include back-office related transactions. AB Capital meanwhile, the banking group’s investment arm, has received approval from the Capital Market Authority (CMA) in Saudi Arabia for its license application of Al Arabi Capital Saudi Arabia. Headquartered in Riyadh, AB Capital Saudi Arabia will offer investment banking and asset management services. According to Abdul Hamid Shoman, Arab Bank’s chairman and chief executive officer,“Negative market conditions due to the global financial crisis has given us an opportunity to reassess and further strengthen our existing portfolio, processes and infrastructure and realign our business strategies in the MENA region to complement the changing needs of our clients and the market as a whole.” These moves underscore the “strength in depth” approach that Shoman is seeking in the MENA region, and the growing importance of the Saudi market to the bank. In this regard, a new post of executive general manager has been established. The bank has just hired Nemeh Sabbagh,

Abdul Hamid Shoman, chairman and chief executive officer, Arab Bank. Photograph supplied, October 2009.

ex-chief executive officer of Saudi Arabia’s Arab National Bank, who will take up the new post in mid January 2010. Shoman explains that during 2009, Arab Bank has focused on enhancing liquidity and capital adequacy and intensified efforts to maintain the quality of credit and investment portfolios so as to be ready to confront any unexpected developments that might emerge as a result of the global financial crisis.The rise in non-performing loans has however, impacted on the bank’s short term outlook. In October, the bank posted a 25% fall in nine-month net profit to $500.9m and increased provisions for bad loans. The bank put aside $54.6m in provisions for non-performing loans in the third quarter bringing total provisions for the year to date to $742m, up from $647.5m in the same period last year. In June the bank conceded that it was exposed to troubled Saudi Arabian groups Saad and Al Gosaibi but, Shoman says that that this exposure will not affect its financial position overall. He points to the rise in the bank group’s assets, which rose to $49.56bn in the first half of the year against $45.63bn at the end of last year (and $48.5bn at the end of June), while deposits increased to $30.9bn at end of September against $28.58bn at end of 2008. The bank’s“conservative policy and emphasis on maintaining ample liquidity has helped us weather the storm better than most,”says Shoman.“Of course we did see a slight decline in revenues and profits; however if you compare the first half of 2009 to that period in 2008 you will notice there has only been an 8% drop in revenues. Our customer deposits are stable and well-diversified. Our liquidity is at very comfortable levels and strong, with 47% of our total assets made up of cash and quasi-cash.” Shoman noted that the drop in the net income, as compared to the same period last year, is mainly attributed to a nonrecurring gain of $37m booked in 2008 as a result of selling the bank’s branches in Cyprus. The bank has also booked a net additional provisions of $56m against non-performing and watch list credits. Moreover, the bank has gone the extra mile to provide customer care through adding provisions to voluntarily compensate clients who invested indirectly through Arab Bank Switzerland in funds managed by Madoff. Over the medium term, the bank continues to “adopt a prudent wait and see mode, hoping that the worst is over. grow organically,” highlights Shoman. “Our core focus will remain in the MENA region and to further develop our business between other countries and the MENA region. Moreover, growing our retail banking segment is something we are now focusing on. We have historically been a commercial bank and new we are diversifying our client base to include consumer banking.”

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NEW AGENT FOR CHANGE Suzan Sabancı Dinçer was appointed as chairman and executive board member of Akbank in March 2008. As Turkey has grown in confidence as a player in the global financial markets of late, Sabanci Dinçer has been at the forefront of broadening intellectual debate on Istanbul’s role as a regional financial centre. Sabanci Dinçer is part of a growing band of emerging market business leaders promoting thought leadership in the banking segment as well as the role of global bankers as polemical intermediators. HE RISE OF change agents in key emerging markets is exemplified by the growing new breed of emerging market business leaders making their mark on the global financial landscape. In another topsy turvy year where developed markets often have had to defer to the growing opportunities in high growth markets (aka emerging markets), a new crop of bankers and business leaders are beginning to exercise new found influence. Just over a year after taking the reins at Akbank, Suzan Sabanci Dinçer decided to make the leap and establish the bank’s International Advisory Board; a platform to discuss and evaluate global and local economic developments and their strategic implications for Turkey in April this year. It is a well worn path—in this regard, Sabanci Dinçer is following in the august footsteps of Ibrahim Dabdoub, chief executive officer at the National Bank of Kuwait (NBK), who has long promoted the role of bankers as polemical mediators and thereby meaningful agents for change. Nonetheless, it is a marked signal of faith in the growing strength and regional influence of the Turkish financial sector. Turkey’s heightened role in the new emerging financial order is a cause dear to Sabanci Dinçer’s heart. No accident then that Sabanci Dinçer is on the same Institute of International Finance Emerging Markets Advisory Board as Dabdoub and also serves on NBK’s own International Advisory Board; the Citigroup International Advisory Board, the Chatham House Panel of Senior Advisers and the Forum Istanbul Honorary Advisory Board. No accident either, that at the latest IMF meeting in Istanbul, Sabanci Dinçer’s principal polemic was the establishment of Istanbul as the premier financial centre in a new geographic business arc that encompasses the Black Sea states, eastern Europe and the Levant. Sabancı Dinçer also initiated a new discussion called “Istanbul Consensus”at the IIF’s Emerging Markets Advisory Council (EMAC) meetings held in October, in Istanbul. She

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2009

Susan Sabanci Dinçer, chairman, Akbank. Photograph kindly supplied by Akbank, October 2009.

underlined the importance of enhanced cooperation and more systematic sharing of crisis experiences between emerging markets and developed nations as a more effective means to combat the economic downturn at a time when emerging market countries enjoy increased power in the global economy. From Akbank’s viewpoint, the development of this change agent role is logical. For the fifth consecutive year the bank has won Global Finance’s award as the best bank in Turkey, for its business in emerging markets and central and eastern Europe, which covers a business range of some 22 countries. That tally is growing steadily, with Dubai scheduled to be the next destination on the bank’s global expansion plans in the last quarter of 2009. The bank has also begun to modify the country’s historical dependence on American and European commercial banks for its international capital raising. A trend that other leading financial houses in the country, such as Garanti Bank, following with alacrity and which have all been diversifying their sources of funding this year. It is a trend underscored earlier this year, when in March, the bank agreed a €100m 8year loan agreement with the European Investment Bank (EIB) to finance its SME lending, under an agreement by the European Union Commission to support European Union candidate countries. In June, Akbank broke further with tradition to sign a loan agreement with the Export Credit Bank of China for $100m to finance Turkey’s growing trade with the republic. Interesting questions are now whether Turkey will ever make it to full membership of the EU; and whether if it does or does not, Europe will influence the growth of Istanbul as a major financial capital. According to Sabanci Dinçer, the growth of Istanbul as a major financial sector is only“a matter of time.” As for membership of the EU, Turkey has all the benefits of membership (preferential trading terms with other EU countries) and suffers none of the strangulated bureaucracy that has hobbled the pace of financial harmonisation and reform throughout the Union. Moreover, the country’s diverse trading relationships that encompass Israel, Russia, the US, China, South Africa, the Black Sea states and Europe demonstrate a Byzantine political complexion that gives it free rein to exploit any and all opportunity without any political shackles.That gives its business leaders immense polemical scope and one that Sabanci Dincer and other Turkish banks are increasingly keen to exploit.

AKBANK: WORKING TOWARDS A NEW TOMORROW

SUSAN SABANCI DINÇER • AKBANK

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PETER SANDS • STANDARD CHARTERED

ASIA IN MIND AND FOCUS Emerging markets have been at the core of this year’s modest upswing in confidence. Few institutions have been as well placed as Standard Chartered, which takes 90% of its profits from emerging markets to leverage that trend. Lynn Strongin Dodds reports. TANDARD CHARTERED, HAS received a green light from India’s central bank to list on the Mumbai Stock Exchange; the first foreign company to list in Mumbai utilising Indian depositary receipts, under new rules issued in July this year. The bank will likely also list in China, following HSBC (said to want to list in Shanghai), thereby establishing a new roadmap for foreign banks planning to grow in Asia. While a rising star, Standard Chartered does not earn brownie points across the entire span of its business. A structured investment vehicle it ran went into receivership and loan impairment losses across the bank rose to $1.09bn in the six months ended June 30th 2009 from $465m a year earlier as corporate and retail customers in Korea and the Middle East, among others, had trouble repaying loans. Consumer banking was also badly hit, down 57% in first-half year pre-tax operating profit to $348m, although this was offset by a strong showing in wholesale banking. Overall though, pre-tax operating profit rose 36% to $2.25bn over the half year and the bank beat analyst expectations with a net profit of $1.88bn, up from $1.79bn a year earlier. Group chief executive Peter Sands is set on positioning the bank for further growth, with Asia firmly at the forefront.“We do see this crisis as a strategic opportunity to deepen our relationship with clients, to win market share and to transform our competitive position,”he noted some weeks ago. To this end, the bank recently tapped the market for $1.7bn on top of the $2.65bn it had raised last autumn. The share placing—equivalent to 4% of Standard Chartered’s issued share capital—raised the bank’s core tier-one ratio, a key measure of strength, from 7.6 % to 8.4%. The proceeds will be used to provide a cushion against any further shocks and to finance organic growth and continued small-scale acquisitions. Sands said the bank was in talks about small acquisitions in China and India, which would cost in the“low hundreds of millions of dollars”; opportunities that were said to include Royal Bank of Scotland’s assets in China. Actually, the deal is now dead because RBS reportedly wanted more

Peter Sands, group chief executive officer of Standard Chartered, photographed in Hong Kong. Photograph by Kin Cheung for Associated Press. Photograph provided by PA Photos, October 2009.

money than Standard Chartered was prepared to commit. [RBS’s retail, wealth and commercial businesses in Taiwan, Singapore, Indonesia and Hong Kong and the institutional businesses in Taiwan, the Philippines and Vietnam have been snapped up by the ANZ Group, while RBS’s Pakistan unit was sold to MCB Bank.] A signal of Sands’ policies in Asia came early in 2009 when Standard Chartered Bank (Hong Kong) bought Cazenove Asia, the Asian equity capital markets, corporate finance and institutional brokerage business, from JPMorgan Cazenove. It was an obvious move, noted Mike Rees, chief executive officer of wholesale banking, “especially in Asia where we expect markets to grow faster than in the West”. The bank is leveraging opportunities to offer clients additional services in distribution, advisory and institutional equity brokerage. Invariably, this has involved new hires. Zhu Wei, the former senior managing director for China at private equity firm CVC Asia Pacific, in September joined Standard Chartered’s private equity team. Additionally, Tim Andrew and David Murray, formerly of Deutsche Bank, are expected to join Standard Chartered as global head of cash equities and global head of equities research, respectively. The bank has also projected an additional 2,000 hires over the next 12 months to expand its Indian operations. Moreover, there have also been important shifts in the roles of senior executives. Ray Ferguson was recently appointed chief executive of Standard Chartered (Singapore) in addition to his role as regional chief executive of Southeast Asia, taking over from Lim Cheng Tek who became executive vice chairman and chief executive of the bank’s business in China. Elsewhere, Standard Chartered is expanding the coverage and range of its services. It has also been supporting clients with its balance sheet to provide liquidity and capital. Then again, in July, Standard Chartered won the mandate to provide electronic fund transfer services and settlement processing for transactions on the Singapore Mercantile Exchange; the bank’s strong transaction servicing capability apparently swinging the deal.

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THE GALLERY PLAY While some trace the Chicago Mercantile Exchange (CME) story back to 2001 when the exchange took on corporation status, the real step up came in 2007 when it finally bought the Chicago Board of Trade and rapidly moved on to bring in NYMEX into its fold. “The CBOT merger laid the ground work,” says Duffy, “Once the world saw that CME could consolidate exchanges that helped the NYMEX transaction go through.” Since then the exchange has secured further strategic acquisitions and relationships that, it hopes, will redraw the future of on-exchange derivatives trading. HE CME GROUP faces some still fierce truths. Despite its massive size, it faces stiff competition from an over-the-counter futures markets that is up to five times larger than its on-exchange counterpart. Second, the Group still only controls (after a series of mergers and strategic alliances) 15% of the global commodities trading segment; a fact, perhaps, that explains the CME’s relatively easy ride among the anti-trust regulators when it acquired NYMEX. With those exigencies in full view, the exchange has built a substantive body of strategic stakes in Bursa Malaysia, the Korea Exchange and BM&FBovespa in Brazil, and thereby secured some of the world’s key derivatives and commodities benchmarks (essentially a draw for new trading volume on its mighty Globex trading platform). Commodities markets have enjoyed the influx of a heavy chunk of money in recent years, from both passive investment vehicles, such as mutual funds and exchange traded funds (ETFs). While politicians and regulators worry that the trend has pushed commodity prices higher, the notion doesn’t hold water in a risk transfer market that is by definition a zero sum game. To Terry Duffy, CME Group chairman, the money simply deepens the liquidity pool and allows commercial participants to hedge their exposures more cheaply and faster than they could otherwise. Futures exchanges came through the financial crisis in better shape than any other part of the financial markets; in part because of sound risk management. Even the failure of Lehman Brothers, a major CME clearing member, did not disrupt the futures markets. “We mark the positions to market daily,”says Duffy,“It’s a time-tested system that has never had a customer lose a penny due to one of our clearing members defaulting.”

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2009

CME: THE EXCHANGE THAT DID

TERRY DUFFY • THE CME GROUP

Terry Duffy, chairman, CME Group. Photograph kindly supplied by CME Group 2009.

That unblemished record has stood for 110 years and Duffy is determined to keep it. He supports US government plans to encourage central clearing of OTC derivatives contracts through higher capital requirements on uncleared trades. In principle, the proposed new regulations should benefit CME Clearport, the group’s derivatives clearing platform that is keen to add other asset classes to the energy, electricity and agricultural contracts it already handles. Duffy is wary of the mandates for clearing derivatives that some legislators have put forward; history suggests they will only redirect business to alternative foreign venues that play by different rules. In any case, some contracts are not suitable for clearing because they are one-off customised transactions or too illiquid for a clearing house to be able to manage the risk. “We cherish the integrity of our clearing house,”Duffy declares,“We are not going to jeopardise that just because people think every product ought to be cleared. You cannot clear every product.” In early October, rumours emerged that the CME Group was in unofficial talks with the Chicago Board Options

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Exchange (CBOE), long held to be an acquisition target for the exchange. If ultimately successful (and remember it took almost seven years of charm offensives and informal discussions to secure the acquisition of the CBOT), it would seriously redraw the remit of the exchange. It would certainly suffice to compete directly with the remaining US options exchanges. Whether the CME Group can fly in the face of an underlying and global trend for trades to be executed off-

exchange is still moot. Certainly, on-exchange trading of derivatives plays to the regulatory gallery; a fact that Duffy has not been slow to emphasize in his various visits to Washington. Additionally, as the exchange expands globally, there remains the question of whether its hub and spoke strategy has long terms legs in an increasingly fragmented global trading market. In other words, in five years time, will the CME still have the same (relative to the OTC markets) market share?

BREVAN HOWARD ASSET MANAGEMENT

COMPASS POINTS Brevan Howard Asset Management made money last year partly because it correctly anticipated lower interest rates and steeper yield curves across government debt of different maturities. The firm follows global macro and relative value strategies trading mainly in G7 country government debt and currencies, and to a much lesser degree, in the equity and credit markets. Lynn Strongin Dodds reports. he latest Financial News poll of European hedge funds reveals that this year Brevan Howard extended its lead as the region’s largest hedge fund manager. Sitting at the top of the table with $24.2bn assets under management, its asset only fell by 8%, against the 20% drop at computer-driven rival AHL, owned by Man Group. In addition, the Brevan Howard Master fund—the firm’s global macro flagship fund worth close to $20bn—generated more than 20% last year, net of fees. This compares with an average loss of 19% for the hedge fund industry and a 40% drop in global stock markets, according to respective figures published by data provider Hedge Fund Research and the MSCI World index in dollar terms. Foreign exchange and bond markets helped lift Brevan Howard’s performance, but its success is based on its prediction in early 2008 that credit markets in the US and Europe were likely to freeze. Brevan Howard then shifted the bulk of funds under management (roughly 85%) into cash and reduced the company’s exposure to derivatives by more than half and cut exposures in all markets that were becoming illiquid. Brevan Howard made money last year partly because it anticipated lower interest rates and steeper yield curves across government debt of different maturities. The firm follows global macro and relative value strategies trading

Photograph © Svetliana Tatarnikava/Dreamstime.com, supplied October 2009. mainly in G7 country government debt and currencies, and to a much lesser degree, in the equity and credit markets. The firm also reined in its resources and limited its liabilities, conserving capital and core trading strategies, which revolve around rates, government bonds and foreign exchange. Although the firm cut jobs, it retained a high proportion of risk managers (16 risk specialists for just over 50 traders, a ratio of one risk specialist per three traders). Despite the lay-offs, Brevan Howard has taken advantage of the talent on the market and made strategic hires to bolster its teams. This has included Fabrizio Gallo, the former head of proprietary trading and global equities at Morgan Stanley and his colleague Richard Chau, who was head of equity structuring at the US bank. Danny Bernheim, formerly a trader at Merrill Lynch, has also come on board. The firm has also ventured into the mainstream world in the hope of attracting new and more conservative investors. Last year, it hired Philippe Lespinard, former deputy chief executive at fixed-income specialist Fischer Francis Trees & Watts, to help lead the charge. The firm has already launched an Undertakings for Collective Investments in Transferable Securities (UCITs)-compliant absolute return fund, which is an actively managed fixed-income fund focusing on high liquidity and capital preservation with minimal credit exposure and a cash target of +3.5 % (net) returns.

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LEVERAGING GLOBAL CROSS TRENDS Among the winners in the global trading market, following the collapse of Lehman Brothers in 2008, Credit Suisse has enjoyed growth across a swathe of the trading markets. Its dark pool CrossFinder, for example, is ranked among the world’s top three alternative execution venues. Moreover, the firm has helped create innovation in other dark electronic trading venues (including exchanges) creating enhanced execution performance to the benefit of its clients. Now the bank has expanded into high growth markets (emerging markets and other asset classes) to leverage its first-mover brand. CONSISTENT FIRST first ranked house in algorithmic trading, Credit Suisse’s Alternative Execution Services (AES) business has won awards for both client service and its direct market access services globally . Moreover, its dark pool, CrossFinder, is now the largest alternative trading system in the US, followed by Knight Link and Goldman Sachs’ Sigma-X. Broker-run dark pools have grown because they’re fast, cheap and open to algorithms (computerised trading programmes), especially during volatile periods such as last year’s crash. Credit Suisse has enjoyed something of a first mover advantage in this regard, with its groundbreaking Guerrilla algorithm, which has subsequently undergone a number of upgrades. “Algorithms are becoming smarter and more intelligent,”notes Naseer al-Khudairi, co head of cash trading and head of Credit Suisse’s alternative execution group in the EMEA region. “We have been nimbler than the rest in this regard. Moreover, we make it a point to be one of the first to link to and trade on new venues as they emerge.” Market structure, particularly in the United States and Europe, has changed substantially in recent years. Brokerowned and market-maker sponsored venues will continue to dominate and modify the nature of dark pool trading and off-exchange trading venues by offering ultra-fast, cheaper, more innovative algo-friendly venues. In that regard, the larger trading houses are becoming more powerful market forces or drivers. “If you look at the US market, approximately 30% of trades are on the NYSE. In the UK,

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Naseer al-Khudairi, co head of cash trading and head of Credit Suisse’s alternative execution group in the EMEA region. Photograph kindly supplied by Credit Suisse, October 2009.

the London Stock Exchange now has a 60% market share, but the US is a good indicator as to where Europe will likely end up. The market will continue to evolve.” Nonetheless, al-Khudairi is aware of the evolving regulatory landscape. “We need to make sure that we are engaged and well positioned to evolve products to meet individual country/regional requirements that result from regulatory changes.” With regulation and moves towards greater market clarity in mind, the bank is stepping up its efforts to increase transparency in the post trade space. In this regard,“Having a consolidated tape is beneficial for the market, and having a strong price formation process built upon both pre and post trade data that we and our clients can leverage is key,”notes Al-Khudairi. The bank has also been active in expanding its global reach and leveraging its first-mover brand in high growth markets.“It’s one pillar in our growth strategy this year,”says Al-Khudairi. In April AES launched electronic trading in Abu Dhabi, Dubai, Egypt, Israel and Turkey in what is a significant move into the emerging markets by the Bank’s algorithmic trading platform. The move built on the bank’s existing emerging markets capability in India, Indonesia, Poland and Mexico, which it entered in 2008. In each market, Credit Suisse has rolled out a sub-set of its algorithmic trading strategies which are tailored to each country. “As markets evolve, we evolve as well,” says Al-Khudairi,“adjusting our global offering to suit clients and individual markets.” Al-Khudairi sees demand for electronic trading continuing to expand with opportunities arising in the multi-asset space, “including futures, options and foreign exchange. Foreign exchange in particular has made a big impact in Europe this year.”In practice this will mean that in future, trading desks will “multi-task, mixing specialists with people who can handle more than one asset class. We will need to balance it carefully though in order to continue to innovate.”However, he notes, the move away from complexity in investment strategies is also impacting trading and it is unclear what the longer term implications will be. “More complex Delta One strategies are less apparent these days, from buy-side trading desks”says AlKhudairi,“as many clients have gone‘back to basics.’”

20-20 CREDIT SUISSE: BROKER POWER

NASEER AL-KHUDAIRI • CREDIT SUISSE AES

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DARYL BOWDEN • ICAP Daryl Bowden, co-chief executive officer, equities at ICAP. Photograph kindly supplied by ICAP plc, October 2009.

ICAP: LEVERAGING FRAGMENTATION In early 2008, ICAP, the London listed interdealer brokerage, made clear it was intending a dual push in both cash equities and equity derivatives. On the equity derivatives side, its strategy was kicked off by the acquisition of Link Asset & Securities in an effort to see off smaller rivals such as Tullet Prebon and BGC Partners, which remain among the market leaders in Europe. On the cash equities side, the strategy was organic and centred around two key hires: that of Daryl Bowden, from specialist broker Execution, and Glenn Poulter, former head of European sales trading at Citigroup. ICAP was keen to leverage trends such as market fragmentation and unbundling, believing the buyside would increasingly opt for the non-conflicted agencyonly broking model. As market participants will tell you, things have moved on apace since then. Nonetheless, ICAP’s equity trading business has grown exponentially in only 18 months, driven by Bowden. Ruth Hughes Liley explains the dynamics.

CAP’s METEORIC RISE among the ranks of cash equities trading houses is, in large part due to the make up of the teams put in place by Daryl Bowden, the 40year-old co-chief executive officer of ICAP Equities. Launched in April 2008, the business has grown to 187 employees around the world, the bulk, about 100, based in London and some 45 traders in the US. “One of the hardest things to do is to build a global business from scratch. If you haven’t got a platform with all the connections, the offices, the infrastructure, it’s hard to gain global reach,” says Bowden. In that regard, he acknowledges the strength of ICAP’s infrastructure. The firm operates out of 50 locations in 32 countries and the strength of its existing electronic networks, particularly its foreign exchange and fixed income businesses, worked to his advantage. In parallel, ICAP’s equity derivatives business kicked off with the purchase of inter-dealer broker rival Link in April 2008 for up to £250m. ICAP Equities claims a client base of 450 worldwide. A veteran in equity trading, Bowden started out at agency broker Carnegie in London on Black Monday, October 19th 1987. By 1996 he was head of trading and sales trading and left to join Merrill Lynch to run EMEA sales trading for four years. In 2002 he left to co-found agency broker Execution and in January 2008 agreed to head ICAP’s equities business. Long-term experience and relationships count a lot for Bowden. He’s known his cochief executive officer Glenn Poulter for 15 years. While Poulter runs the client-facing side of the business, Bowden takes care of the day-to-day trading desks. Through the past 18 months, Bowden has hired extensively but favoured experience above all, taking advantage of redundancies and resignations from other banks. Inter-dealer brokers have an “entrepreneurial and hungry” culture, he maintains, and hopes he’s taken the best pieces of other cultures, other banks.“A huge amount of experience has been lost from banks, especially in equities. We were seeing fund managers with 20 years’ experience on one side of the wall and young, inexperienced brokers on the other. We deliberately chose people with experience an average of 18 years in the City with proven records of loyal, strong relationships.” “One man’s loss…” goes the old chestnut and Bowden acknowledges the downturn has been a “massive opportunity”to draw market share.“Since Lehman’s, many hedge funds have taken down risk and people are more focused on the traditional base, so there’s more competition. While many of the middle tier investment banks went out of business or were subsumed, there has also been an explosion in boutique brokers, so we felt it would be good to go up the food chain, not down. Our advantage was that ICAP was prepared to invest significant capital to get there and our ultimate goal is to be the leading global integrated agency broker.” Bowden highlights ICAP’s research team, where 12 out of the firm’s 14 analysts have been ranked in the top five in their sectors. He has deliberately kept the research team

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flexible and focused on alpha generation. Another highlight is the electronic trading team, run by ex-UBS portfolio trading head Phil Hodey. Bowden says: “We are waiting to get started on algorithmic trading. There’s a lot of expertise in this team and we are expecting clients to respond well.” There are larger forces at play right now, which are tending ICAP’s way. Sweeping changes to the European equity trading landscape have encouraged the buyside to take more control of trade execution, resulting in greater demand for direct access to liquidity sources. There are two pragmatic responses to this fact: to set up one’s own liquidity pool, and to increase equity trading services to the buyside. ICAP has not been slow on either count. ICAP is setting up BlockCross, a dark block-trading platform, which will be run by ex-head of equity trading at JPMorgan Chase & Co Daemon Bear, with around 70 members from both the buyside and the sellside. The pool will offer all the biggest stocks in Europe, except for Spanish and Greek equities, which will be included later. One of BlockCross’s attractions, says the firm, is that it links directly to buyside desks’ order and execution management systems, thereby integrating into the trader’s existing workflow. The buyside trader will be able to choose BlockCross in much the same way as they make other trading decisions. Clearing and settlement, or posttrade services, will be handled by ICAP Securities. Traditional exchanges in leading European trading venues have lost approximately 25% of their share to the plethora of multi-lateral trading facilities (MTFs) which set up in Europe post-Markets in Financial Instruments Directive (MiFID). On the equity trading side, as market structures fragment, Bowden stresses that he wants to be part of the price discovery debate, particularly as it relates to bestexecution for clients:“I am not sure that fragmentation is a good thing for price discovery and I think a strong London Stock Exchange is necessary for it. We want to be part of that debate.” Light or dark trading pools aside, Bowden places high value on voice broking. As Michael Spencer, ICAP’s chief executive, noted in the firm’s latest annual report:“In voice broking markets, competitive strength is a function of longstanding customer relationships, coherent asset class coverage and, increasingly, the speed and efficiency of straight-through-processing that is normally provided or facilitated by ICAP as a free ancillary service in conjunction with voice broking.” The marriage of technology and voice-broking is one of the reasons he joined ICAP, notes Bowden. “It’s coincidence versus creation,” he explains.“If you want to trade electronically, it’s coincidence if that liquidity is there. It doesn’t create liquidity, unlike a salesman or sales trader who might call you to say: ‘There’s this great piece of liquidity and it looks like it will suit your portfolio.’ That’s creation and the past 18 months have shown its value.”

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2009

COMPETITIVE SPIRIT The London Stock Exchange’s (LSE) plan to buy Turquoise is being undertaken for a patchwork of reasons; some related to Turquoise’s founding banks (which started Turquoise in response to the exchange’s high trading fees). One of those patchwork components—probably quite a big one—is the perceived need for the LSE to have a viable competitive response to Chi-X Europe, the current runaway winner of the post-MiFID European trading landscape. Ruth Hughes Liley spoke to Chi-X Europe chief executive Mark Howarth about his firm’s success to date and his long-term strategic vision.

CHI-X EUROPE: THE MTF LEADER

MARK HOWARTH • CHI-X EUROPE

Mark Howarth, chief executive, Chi-X Europe. Photograph kindly supplied by Instinet, October 2009.

N AN AGGRESSIVELY competitive move, Chi-X Europe, operator of the largest pan-European equity multilateral trading facility (MTF), launched its autumn pricing promotion in late August. Chi-X Europe participants that doubled their total Chi-X Europe trading activity (by value traded) in September 2009 versus their previous three-month average (June to August 2009) qualify for reduced trading fees; to 0.2 basis points (bps) for aggressive executions in October 2009. The promotion applies only to Chi-X Europe’s visible order types, and will be valid for trades in any of the 14 markets in which Chi-X Europe offers trading. Qualifying trading participants whose trading composition (for visible order types) is 50% aggressive and 50% passive in October 2009 will trade at no cost, while trading participants whose trading

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composition is primarily passive will continue to receive a net rebate. Mark Howarth, chief executive officer of Chi-X Europe, said on the launch of the initiative: “Participants can continue to take advantage of our proven panEuropean liquidity and price improvement opportunities, now at an even lower tariff … [which] should help to increase the efficiency of the European capital markets and lower the frictional costs of trading.” Chi-X Europe offers trading in component stocks of 20 indices across 14 major European markets, as well as ETFs (exchange-traded funds) and ETCs (exchange-traded commodities), providing access to a universe of more than 1,000 instruments for its trading participants. “We have been pleased to see the European equity markets hold their own with July and August remaining steady, despite the usual seasonal downturn. September [was] a very good month, as we recorded our third busiest month since launch,”notes Howarth.

Pause in expansion Relentless in its reach for market share as an arachnid is in capturing its prey, Chi-X has marked the autumn with a series of further initiatives designed to pull more business its way. In September, Chi-X Europe and Liquidnet Supernatural signed an agreement to interconnect. Collaboration is expected to enhance liquidity discovery opportunities for clients of both firms by bringing together liquidity sources whilst allowing anonymous trading with minimal market impact. Then in mid October, the MTF announced the launch of Chi-Velocity, a proximity-hosted risk management software layer located next to the Chi-X Europe primary matching engine that permits trading participants of Chi-X Europe to offer ultra-low latency Sponsored Direct Market Access (DMA) to their underlying clients. Chi-Velocity also offers a suite of configurable pre-trade controls, open exposure risk management controls, alerting functionality and a FIX order and trade feed that can be integrated with in-house risk management systems. Hirander Misra, chief operating officer at Chi-X Europe, notes: “Since launching two and half years ago, we have been keenly aware of our trading participants’need for ultra-low latency connectivity and the ability to pass this along to their end clients as sponsored direct market access.” Mark Howarth, who took over from its first chief executive, Peter Randall, in April 2009, has supervised these initiatives, reflecting his broad ambitions for Chi-X. Even so, his own role has to be finalised. Announcement of his permanent tenure is likely to be made by the Chi-X board on December 31st this year, the date the company will also move to a one-share, one-vote structure rather than the current block vote structure, with Nomura controlling the voting. [Nomura owns Instinet, the largest minority shareholder in Chi-X Europe.] “This was always planned. We were confident of success from the start,” says Howarth. Chi-X Europe has grown fast. In September it had an

average daily consideration of €3.9bn and claimed costsavings to clients of 2.01 basis points. Howarth believes the success of Chi-X Europe is partly because it had a seven month head start before MiFID (the Markets in Financial Instruments Directive) when Peter Randall was, in Howarth’s words, “evangelical”, traversing Europe marketing Chi-X and selling the concept of pan-European trading to customers. Randall is widely acknowledged to have been the heart and soul of the emerging Chi-X, and many practitioners were shocked at his departure. It’s a fact, however, that people who often have the drive and vision to launch a company are often not the people who take the company forward. That responsibility is now firmly in Howarth’s lap. Since Randall’s resignation, Howarth has been seen as a safe pair of hands to continue Chi-X Europe’s existing three-pronged strategy: geographical expansion into new markets, addition of new instruments and new customers to the platform. The addition of Ireland in Q4 to its market base will see a pause in Chi-X Europe’s geographical expansion. Meanwhile, Howarth claims to be adding three to four new customers a week to his current client base of 110. Half of his new clients are from firms not previously present in European markets. On the other hand, Howarth sees Europe itself as an untapped market with plenty of opportunity in Spain and Germany, for example, where regulatory structures have restricted full exchange competition. Howarth’s vision is for Chi-X Europe to offer 1,300 instruments and stocks by the end of 2010 coming from around 23 or 24 sets of indices—Chi-X currently trades in 20 indices in 14 markets. “There are 6,000-7,000 stocks in Europe and we could happily trade them, but whether we do depends on demand from our customers; this also moves into the area of clearing—clearers are reluctant to move down the liquidity curve,”he notes. Chi-X Europe launched on the same day as EMCF, the European Multi-Lateral Clearing Facility, and now Howarth is adding LCH-Clearnet and SIX x-clear to give customers greater choice. This distributes risk, he says, and reduces the instances of customers having to pay double margins. “If we can link trades together and net off the clearing costs, that’s a good thing,” he holds. “It’s a long process and very technical, but at the end of it, our customers will have a choice of trading platform—either us or other MTFs or the exchanges; and a choice of clearing platform. This interoperability will be a big theme in 2010.” Howarth likes competition and as MiFID is reviewed in 2010, he sees Chi-X Europe as primus inter pares (first among equals) among the MTFs leading the call to prevent what he calls “backsliding” by the incumbent exchanges retaking a larger monopoly position. “We are pushing for people to sit round a table and discuss mandating a consolidated tape, a European best bid and offer price and also common symbology and uniform tick sizes. Exchanges don’t mind discussing these last two, because they have clear customer benefits, but they are slower at wanting to come to agreement on a consolidated tape and pricing,”he explains.

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

Seeking value in a risk-averse climate

Attendees

Supported by:

SHARON WALKER, managing director, EquiLend Europe SARAH NICHOLSON, head of securities lending, Aviva

MARTIN TURNBULL, repo portfolio management, Aberdeen Asset Management

JOYCE MARTINDALE, head of investment operations, Railway Pensions Management & Investments (RAILPEN) SIMON LEE, senior vice president, eSeclending

FRANCESCA CARNEVALE, editor, FTSE Global Markets

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OVERARCHING TRENDS SIMON LEE (eSECLENDING): Right now, beneficial

owners, first and foremost, are asking themselves whether they want to be in the business, and whether it makes sense for them to participate in securities lending. For those that think it does not make sense, they may well have made a decision to pull out of the business, to suspend their programmes, perhaps permanently. For lenders that have made the decision to stay in the business, many will regard it as an opportunity to revamp their lending programmes. Obviously the awareness of the business has been heightened over the past 12 months or so, and lenders are now making decisions around how they actually want to participate in the business, and how they want their programmes to be managed; whether that means refining the type of collateral they will accept, or looking at alternative routes to market. Lenders have a far greater awareness of the business nowadays and a much better understanding of how they can manage their programmes than perhaps they would have before. SHARON WALKER (EQUILEND): We have seen real changes in the market, many of which have been driven by risk, that is, the need to contain, or control of, risk. We have also seen some regulatory changes come into play as well as a drive to get the best value from the underlying asset. In turn, we see more in terms of the trading that is executed via EquiLend for non-GC transactions. We are also being asked for more input by our clients with regards to collateral management. We have transparency on the counterparty side, because we are in a bilaterally-driven environment over EquiLend. We comply with the regulatory changes and more recently, in Europe, we now have agent lender disclosure. Overall, a continuing desire by our clients to ensure that they have risk mitigation, fully and well controlled. SARAH NICHOLSON (AVIVA): We have gone through a process of reviewing the business, the controls, and the risk appetite of clients, ensuring that they understand this business as we think they understand it. This comprehensive review of all of the practices within the business has ensured our approach is robust and that risk levels are appropriate for each individual client, properly managed and reported. Underlying clients have a need for more information, not only about market practices, but also on a day-to-day basis about the risks they’re taking, and the sort of positions they are running. There are also questions about the risk-rewards in securities lending. MARTIN TURNBULL (ABERDEEN ASSET MANAGEMENT): Two years ago Aberdeen had only a

couple of custodial schemes, which worked pretty well. In the last 18 months, we’ve done two quite large auctions. The opener was the first major third-party arrangement that Aberdeen entered into. You must understand, Aberdeen is extremely conservative and it looks upon these arrangements as added income, but only provided they are happy with the risk. In fact, the way we set it up has proven

SHARON WALKER, managing director, Equilend Europe

very robust through the Lehman’s crisis, and adjustments we have made to the firm’s custodial programmes are also seen working well. It has given Aberdeen a great deal of comfort that the firm took that really conservative approach.You hear horror stories about cash reinvestment, but participants these days are much more aware of the risks involved and that can only be a good thing. Recent events have underlined the fact that if you adopt a strict collateral profile you get a lot of protection, but perhaps not such a big income. That is a choice, however, that you have to make. We are looking to grow the business more, but not in a rush to do anything radically new and certainly nothing risky.

MINIMISING RISK MARTIN TURNBULL: Our fund managers look at the additional income they get from securities lending as very welcome, obviously, but they want the minimum risk, and also to maintain continuity in the day-to-day cash trading. It is very important that corporate governance is taken care of. Our clients and fund manager take their corporate governance responsibilities very seriously and insist on being able to recall to vote. It is important to a lot of our customers, that they feel their input is being observed, so you can’t compromise on that. Brokers come to me with ideas of doing synthetics. I usually tell them: “We can’t do that for a year, because what if we want to vote? You can’t get it back”. With securities lending, exclusives or a custodial programme, you can call back lent securities at any time. It is also important that reporting is transparent and clear. That’s one thing we’ve insisted on, and it’s worked for all our providers: they’ve managed to give us detailed reports as to exactly the collateral involved. Not the collateral you’re just expecting to get, but actually what you have got. There have been problems with that, not for

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us directly, but I understand that during the Lehman collapse some tri-party cash providers had all sorts of stuff that they weren’t anticipating placed as collateral. But if you actually see it reported it gives people comfort. Overall, there still seem plenty of borrowers out there. In our last auction, the actual results from July were pretty similar to the year before, and we had more participants and more winning bidders. SHARON WALKER: Externally, the regulatory framework has to be in place to allow this business to continue and the risk-reward ratio needs to remain. There’s been a lot of review around balance sheet use, and people have been watching very carefully their use of balance sheets. In managing the securities lending business, as resources have been cut in the last 12 months, probably to, in some cases, very, very lean numbers, that continues to drive the need for cost-efficient businesses. So, in order to make a sound return on the business, there has been a growing demand on people to run their business efficiently and with the resources that they have. So it’s a combination of factors, really: regulatory framework, the fact that the market is sufficiently buoyant with opportunities available, and that people can enter and maintain the business along an efficient and cost-effective path.

ROUTES TO MARKET MARTIN TURNBULL: It has to be a business decision in

the end.You have to look at what’s best for the fund, and if a custodian can do the best job (that you perceive at the time) then leave it with the custodian. However, if you can get significant extra value by doing, say, an exclusive oneyear auction, then this should of course be looked into. From the borrower’s point of view, there is no guarantee that they can have those securities for a whole year, but they calculate a value by using data such as turnover levels and bid accordingly. Our experience of the auction process has been positive; it’s worked very well for the funds we selected. All the recalls and corporate actions have worked. Potential routes to markets can be influenced by the size of the fund and its turnover. We don’t for example lend any small-cap stocks. Choosing a route to market it is actually about assessing what sort of value you’re getting, which can be difficult to quantify. Despite all the data that’s available, you’re not always comparing like for like.You can look at the data and it may show that someone’s got a higher income than you. However, are you both taking the same collateral? Was it the same amount? It is not always black and white. SIMON LEE: Custodians will continue to be the largest pool of supply for borrowers, given their captive client bases and the sheer number of clients that participate in the businesses. However, market dynamics have changed, and more lenders are looking at alternative providers to their custodian. That could be another custodial bank providing that lending service, but there are certain lenders who will be looking at other options. Custodial

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programmes are set up to provide a pooled product that serves a large client base, and for those clients for which that structure is suitable, they will most likely remain with their custodial lenders. The dynamic won’t change in that respect. For lenders that are better served outside of a pooled custody arrangement, it is a different story. Lenders that are more minded to look at alternative routes to market will be more inclined to do so now. SARAH NICHOLSON: What’s apparent right now is that there are a number of beneficial owners who are in programmes, would like to get out, but because of cash reinvestment and the potential of crystallised losses, are unable to do so. Over the next 12 to 18 months, we will see a lot of people coming through this and reviewing where they are and their provider. That’s not to say they’ll change, but they will go through the process, and the market will move ahead with an increased awareness and understanding among beneficial owners. Regarding Simon’s comment that this isn’t something that you just sign up to and receive a cheque every month: the decision to appoint a lending agent, whether it’s the custodian, a third party, or an in-house provider, is going to be a much more conscious decision. Actually, there is room for all of the routes to the market, because there is no one-size-fitsall. What I would say is that a lot of the very large programmes have tended to be run in a one-size-fits-all method, where you tick the box to choose the parameters

SIMON LEE, senior vice president, eSeclending

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you want. However, going forward, I do not think this will continue to be an appropriate model for a lot of people. In consequence, we’ll see a lot more bespoke, focused kind of structures coming in, and, off the back of it, more alternative routes to market and alternative lenders, or agent lenders, away from the custodial banks.

JOYCE MARTINDALE (RAILWAY PENSION INVESTMENTS—RAILPEN): It will depend on the size of

the beneficial owner. There will be small pension funds whose only option of coming to market will be through an agent lending programme, so it will still be there for them, as I don’t think the likes of eSecLending wants lots of small pension funds coming to auction. SIMON LEE: No, as we’ve said, lending for segregated accounts, utilising an auction tool, and lending via an exclusive route to market, does not suit all lenders, and smaller accounts holding assets that are in less demand could well be better suited to a custodial pooled programme. JOYCE MARTINDALE: Even for larger beneficial owners, if you use an exclusive route, you’re promising that you’ll have a relatively stable set of assets for a period of time. Now, it could depend on which asset managers you use, or

JOYCE MARTINDALE, head of investment operations, Railway Pensions Management & Investments

you may be planning some asset allocation changes, which you know might happen in a year’s time, so therefore you know you can’t actually enter into an agreement like that.

CHANGING RELATIONSHIPS SHARON WALKER: Certainly, we’re probably finding there’s

been some change there. Not a massive sea change, although we clearly like to think of ourselves as more of a partner, rather than purely a provider, because we ourselves are regulated in the marketplaces. We continue to stay very close to our clients. We have equity owners which represent some of our largest clients as part of the EquiLend consortium, and over and above that, we have another 40 or so clients globally. What we do continue to do is to encourage clients to talk directly with us, or through a number of groups and forums. Moreover, we try to stay abreast of such things as regulatory change, market dynamics and so forth. We always endeavour to be quick to respond to our clients, and the market, if we can, and we create releases and changes to our service on a regular quarterly basis. SIMON LEE: I don’t think securities lending is an overly complex business. It is an evolving business, and you can argue that the rate of evolution has increased over the last 12, 18 months, driven by market events, but the relative level of complexity hasn’t changed overtly. What has changed is that people’s understanding of the business has improved, driven by a need to know what’s going on in a programme, and what kind of business is being managed. That, in turn, drives an increased level of transparency, however I don’t think the overall level of complexity inherent in securities lending has changed fundamentally. Nor will it. SHARON WALKER: I agree insomuch as I don’t think the complexity has changed, but I do think the scrutiny, if you will, or the ability to look very, very closely into what’s going on has stepped up. Everybody now wants to know, exactly, why is that firm getting more than me, and I’ve got the same asset? Additionally, the focus around collateral is changing: the need to be very sure and confident about what you are holding, and that your business is in line with all the regulations; all that’s become very tight. So I would say it was the forces outside that are changing some of the behaviour in the business. SARAH NICHOLSON: I absolutely agree, and the relationship between the beneficial owner and their agent lender becomes more and more critical, because the beneficial owner is no longer happy to receive a report at the end of the month that says everything is fine, that there’s no need to worry. They want to see every scrap of information; they want somebody on the end of the phone who they can ask: “Why is this fund getting more than me?” Or: “Why am I not getting fair value for this?” The beneficial owner wants that level of engagement now, and so the relationship between the beneficial owner and the lending agent is becoming increasingly more important. SIMON LEE: …Which, from our perspective, is obviously a big positive, because it prompts questions about routes to market, it prompts lenders to investigate what programmes are available to them, and, it prompts lenders to look

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outside their existing providers. SHARON WALKER: Several of us were at a conference recently and one of the questions was: “What prompts people to look at different agents?” I think it was Joyce, actually, who may have come back with a response that at the end of the day it was about service degradation. It wasn’t necessarily about income. Actually, people would be accepting of potentially a lesser income, but they may not be accepting of a lesser quality of service. SARAH NICHOLSON: The interesting thing there is around the degradation of the service, and the fact that the income isn’t necessarily the most important thing. Historically it seemed that the key decision around who you appointed as your agent lender was simply who will make you the most money. Hopefully we will see that change, as too often in the past it’s just been whoever estimates the biggest number is likely to win the business. JOYCE MARTINDALE: I would expect custodians that don’t keep up with the spend in IT required for the need for transparency would end up being the losers. It wouldn’t be just a securities lending experience that makes you select your custodian, because you’ve got the custodian in any case to ensure the safety of your assets. That’s the key thing, above and beyond this area of business: securities lending is a nice addition to that, but it’s not the only factor. SARAH NICHOLSON: The unbundling of securities lending away from a custody service decision is a trend we are definitely seeing. In the US, it’s not seen in that way at all, and we’re increasingly seeing that more in Europe. You know all of the custodians, all of the big lending agents, and a number of newcomers to the market are in a position to be able to offer lending services, without having the custody, and so where the lending is undertaken becomes much more transferable and transient. For the custodians, undoubtedly, it will be a challenge, but as these increasing demands from beneficial owners come through, they’re going to have to deal with it. That’s not to say that they can’t deal with it now. I don’t have custody lending, so I don’t know what their services are like now, but absolutely, as the demands comes, they will have to meet it.

WHICH PORTFOLIOS SUIT AUCTIONS? MARTIN TURNBULL: Not every portfolio is suitable for auctions. The beauty of doing an auction is, usually, you get a much higher return, and you can demonstrate transparency. The competitive nature of the auction proves that you’ve gone for best execution. The post-auction data clearly demonstrates this. So if it suits the portfolio (and not all portfolios are suitable), those that are stable have relatively low turnover, we consider auctions a good route to market. SARAH NICHOLSON: Martin, I’ve got a question about the auction route: one of the concerns, I guess, is the concentration of risk. So when auctioning off a portfolio to a single counterparty, does it not concern you that you have that concentration of risk? MARTIN TURNBULL: Yes and no. We do get a 5% haircut in our favour, obviously, and its good quality stock (G7 debt

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BUSTING MYTHS AROUND SECURITIES LENDING JOYCE MARTINDALE: What might help, and this has been an age-old theme, is to get more transparency and more education for beneficial owners. SARAH NICHOLSON: What frustrates me is when you hear beneficial owners say: “Well, we participate in lending to cover some of the fees.” It is almost as if it is a no-risk aspect to the business. That is patently not the case. It needs to be seen, and it is increasingly being seen as an investment strategy. Now, clearly it is not the sort of investment strategy that you’re going to launch a fund around: it is a very much of a valueadd, overlay strategy. Nevertheless, it is an investment strategy, and should be seen as that. It has to be placed, as Joyce says, in the context of the overarching investment strategies pursued by fund managers, because that element delivers most of the performance. Securities finance can only ever add to that, it cannot drive the performance of the fund. Moreover, you do not buy assets to lend out, you only lend those assets you have already bought. It is very easy for people in the industry to forget the pecking order, almost, within a fund. JOYCE MARTINDALE: We should probably myth-bust on the “covering the fees”. The comment should be viewed in relative income terms. The returns from investment portfolios will have a bigger impact on your overall funding level than the income from your securities lending. The Railways Pension Scheme manages risk very effectively; though we do expect that the order of income would be something that will cover the types of fees that we incur in undertaking some of the investment processes. However, we are not expecting anything bigger, and that’s how we’ve designed our lending programme. SARAH NICHOLSON: I’m not suggesting that that’s an inappropriate approach, but you have a very conservative programme, and you’re almost designing it because you don’t want the additional risk, and that’s the purpose for being a participant in the industry, and obviously there’s a whole range of risk appetites out there. Therefore, the returns can be significantly higher than paying the fees, and generally should be seen as part of the performance of the fund. SIMON LEE: Going forward, the days of lenders giving their business to their custodian and collecting a cheque each month, and not really thinking about what’s happening behind the scenes are most definitely gone. However, because a lender runs a very conservative programme, to your point, Joyce: that’s an active decision that’s been made, to run a programme in that manner, and essentially, it’s an investment decision that’s been made, to run the programme in that manner. And that part of the business, I don’t think will go away for the foreseeable future.

only). Our risk department is always monitoring the process. We also monitor the counterparties ourselves, and, of course, you can always close off an exclusive. If you get uncomfortable with anybody, you forego the rest of the fee, and well, that’s a business decision. Concentrating the risk on one counterparty? The maximum for, say, Luxembourg Funds, the maximum you could possibly lend, is 50% of the value of the fund over the year, and in reality, it’s probably only a maximum 20%.

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agent lender, you may have some form of indemnity, which reduces your income. If you’re happy with that indemnity, and you’re actually clear what it gives you, you may not be as concerned with some of the concentration risks as you would otherwise have been. Moreover, there are various types of indemnity, and if you get one, you do need to make sure you know what it means, and you also need to make sure how many times the organisation giving you that indemnity has given something similar to other clients. However, as long as you understand that, then you may be willing to accept a little bit more concentration . It all rests though on the time and effort you put into your legal agreements up front. We were pleased with our securities lending agreements over the Lehman’s bankruptcy last year because we knew exactly where we stood. SIMON LEE: I’d say you were probably in the minority there, in that many lenders were not as well versed as you as to the legal terms of their indemnification policies. The Lehman event gave people a wake-up call, and caused many lenders to immediately move to review their legal contracts. MARTIN TURNBULL, repo portfolio management, Aberdeen Asset Management SARAH NICHOLSON: But having 20% in one place MARTIN TURNBULL: It does seem a lot, I agree. But that is

why you have quality collateral and it is conceivable to have just as much out to one borrower in a custodial scheme. SIMON LEE: It also important to make the distinction between principal lending and agency lending. Principal lending is when the beneficial owner of the securities contracts directly with the borrower, which is typically under an exclusive arrangement, and that’s where you have the level of concentration that Sarah’s referring to. Under an agency programme, whether you’re lending via exclusives, discretionary trading, or a combination of both, you do have the ability to diversify amongst a wide borrower base, and I’d make the point that the vast majority of auctions that eSecLending undertakes are awarded to a number of winning bidders, and that the lender achieves the diversification across borrowers through that route. I’d also say that, if you look at custodial programmes, probably preLehman’s, when the custodial business was very much run on a specials versus GC allocation type arrangement, the level of concentration that lenders had to the larger broker dealers probably outweighed the benefit of lending on a pool basis amongst a wide borrower base, as the likes of Goldman Sachs and Morgan Stanley, who were very, very big users of equity finance products, tended to get larger allocations of special securities, which was consequently reflected in larger GC balances. That would create a level of concentration that probably most lenders weren’t actually aware of at the time. That’s less the case, now, of course: the prime brokerage space has changed, there are more players and the business has been distributed more equitably. JOYCE MARTINDALE: Even going the agency route, depending on the agreement between yourself and your

COLLATERAL AND REINVESTMENT MARTIN TURNBULL: We don’t do any collateral reinvestment, it is as simple as that. As I said earlier, we run a conservative programme. We only take government G7 bonds as collateral. We used to take a mix of collateral on our custodial programmes but when the Lehman’s default happened, we changed all profiles to G7 only. Actually, personally I have no problem with cash reinvestment per se, as long as everyone’s aware of the risks. Yes, there have been some horror stories, it’s no comfort but some of the troubled programmes, were signed off on ten or 15 years ago, by people who no longer work in the business. So accountability and vigilance is very important today. SARAH NICHOLSON: We don’t do cash reinvestment either from the UK. We do take cash as collateral, but it’s all then reinvested through a securitised basis, so it’s all on a repotype structure. Cash reinvestment has had a bad press over the last few months, and I completely agree with Martin: it’s not a bad strategy. It just has to be recognised that it’s a higher and different risk than taking non-cash collateral, and with it comes a higher return, undoubtedly. I wonder whether some of the cash reinvestment mandates that have been around for three years or so are written as a blacklist of what you can’t take. It might be a bit extreme, but then CDOs come along and it’s not on the blacklist, so suddenly it becomes an eligible reinvestment. The guidelines need to be under constant review. Now, since Lehman’s, we’ve done quite a lot of analysis around different types of assets and how they reacted in the immediate aftermath of Lehman’s, and what might happen in the event of another default. From looking at volatility and liquidity, and taking those scenarios into account, we’ve changed some of our non-cash collateral parameters. Historically, we would have seen lending government bonds versus equity as probably one of the higher-risk trades, because you’d absolutely expect

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governments to go up and equities to go down after a major financial default. However, because of the margins that we take, and because of the ability to sell those equities very quickly in the market, we are now very comfortable with the trade. What we’re not happy with is long-dated corporate bonds as collateral, because, post-Lehman’s, if you talk to non-cash takers, the one issue that most will have shared is the difficulty in selling those assets at the price that you needed to sell them, in the timeframes you had. So, where we focused a lot at volatility, we are now looking equally at liquidity, in recognition that it’s about speed to market and speed of the restitution process. SHARON WALKER: From a trading platform perspective, we make no recommendation, nor do we lean one way or another: we handle trading with both cash and non-cash collateral. We don’t make any distinction about it and we accept trades that are covered either way. What we have seen is a greater use of tri-party. Again, that speaks to riskmitigation people seeking to use tri-party to better control their risk. What we also see is where more collateral is tending to change hands ahead of the settlement. We’ve had a request from our clients to be able to effectively compare and agree the collateral that’s moving ahead of time. We have responded to that request and provided a process that enables people to ensure that the levels of collateral they are receiving ahead of time are correct, and as you would expect them to be. SIMON LEE: Expansion of non-cash collateral is one area of the industry that moves relatively slowly. While there’s probably an opportunity for change to occur over the coming years with respect to a greater level of acceptance of equity collateral, I still think it would be a slow process. Intuitively, whilst lending equities against main equity index collateral can make sense, it’s still a relatively new product for most beneficial owners, and will take a long time to become more readily accepted. On the cash-side, what you will see is more specialist money managers coming into the securities lending reinvestment space, in recognition of securities lending cash collateral being a viable source of liquidity. This is illustrative of the idea of unbundling in the securities lending business and utilising a specialist lending agent to lend your underlying assets and a specialist money manager to manage your cash collateral.

REGULATORY CONSIDERATIONS MARTIN TURNBULL: When the short-selling ban came in,

Aberdeen took the decision to not lend any of the names on the list. Did it make any difference to the price of those shares? I don’t think so. The actual numbers of the shares in the market that were out was tiny. So I don’t think it had any effect on the market. SARAH NICHOLSON: If the objective of the short-selling bans was to prevent the price of the shares from freefall, it clearly failed as a strategy. MARTIN TURNBULL: Exactly. It just encouraged those that were selling it to give the market even more of a kicking. The regulators now recognise that short-selling is an important

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER

part of the market. It’s all part of business, but the regulators did what they thought was right at the time. It was a panic situation: there were perfectly healthy banks just getting trashed for no other reason than that the market could. SARAH NICHOLSON: What it did give us is an opportunity to analyse the market without shorting in it, and to see whether prices go down, despite there being no shorting. Clearly, it was not only fund managers dumping stock that was causing the price falls, but research suggests it was a big factor—which, I guess, from a defending the stock lending industry perspective, can only be a good thing. FRANCESCA CARNEVALE: Your view is tempered by your experience. However, if you were a beneficial owner or you were a trustee, would you have felt confused, or frightened in this really knee-jerk period? SARAH NICHOLSON: Absolutely. At the end of the day, the press have a lot to answer for here because in all of the newspapers it was all about these evil short-sellers and the Archbishop of York and Alex Salmond pointing fingers and it was an easy target, to blame this industry because of the short-selling. It made a good story. SHARON WALKER: Actually, it was the relatively smaller lenders which, because of the short-selling bans, pulled out of the market. They wanted to step back, calm down, regroup and then compose themselves. However, a number of funds have indicated that they are now coming back into the market. For EquiLend, of the four or five that withdrew from the market, they’re pretty much all now back in, with maybe only one or two funds that remain outside. The turmoil in the market has left everybody a little skittish, but I do think, in time, people will just go back to where they were. For the time being however, until a sense of equilibrium has been reached, people will continue to be very cognisant of the regulatory requirements, and have a keen awareness that they adhere to it. Some of the short-selling bans were criticised with being overly long. But for the most part, most of those bans now appear to have been lifted. JOYCE MARTINDALE: I thought that some of the more interesting comments, or maybe less well-informed comments, were indicative of the fact that, as an industry, securities lending is quite complicated. There are a lot of different parties involved, and it’s not very well understood. David Rule (formerly chief executive officer, ISLA) did a very good job, but ISLA was on the back foot at the time, given the coverage. I think you need to educate people in a time of calm, but who’s the best person to take a lead on that and who’s going to get that news out there? SARAH NICHOLSON: From ISLA’s perspective, education is the only way forward, and they will be taking a lead in educating regulators etc. Although it can be difficult because it can be seen as self beneficial PR for the industry SIMON LEE: Also, in periods of calm, I don’t think journalists are that interested in understanding or knowing. Nor is the average man in the street, because stock prices are rising, and everyone’s happy. That’s part of

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the issue: that it only becomes a story, and people are only interested in learning more, in times of crisis JOYCE MARTINDALE: There was such a barrage of negative comment last year so surely people realise that they’re going to have to push that education to regulators and the market in future. SHARON WALKER: People have also highlighted the fact that there hasn’t really been a spokesperson or spokespeople group for the industry. SARAH NICHOLSON: ISLA’s had a chief executive officer now for 18 months, so we’re in a better position than before; it’s the first time we’ve really had an independent spokesperson for the industry. More importantly, I was just going to comment on the evils of stock lending, and one of the things I quite like to point out to people is that a lot of funds are very pleased that they hedged their positions over recent months, and it’s worth remembering that they can only hedge it because there’s an active lending market behind it. So that’s one of the best safeguards anyone’s had over the last 12 months, and it’s been facilitated by stock lending. SIMON LEE: Something that summed up for me the lack of understanding in the media was the reporting of a pension fund that had hedged their currency exposure on their overseas investments, and being berated for selling sterling short—never mind that the fund was managing risk for the benefit of the investors. FRANCESCA CARNEVALE: OK, but that’s not always the whole approach is it? I was amazed, for instance, that the market didn’t actually throw its hands up in horror over the whole of the Porsche-Volkswagen affair. JOYCE MARTINDALE: That’s a far more marketmanipulating thing there, isn’t it? You couldn’t do that in the UK, I don’t think. You couldn’t build up such a long position in a company without having to declare it. Actually, you are right, no one was really upset at the shortsellers. In that case who did lose quite a lot of money there? There wasn’t a hue and cry then. SARAH NICHOLSON: Actually, Germany’s one of the few countries where it could happen.. It is not really a story for the vast majority of the population. It’s a carmaker in Germany, and their share price is being manipulated. That is not particularly applicable to a big, big part of the public. From a stock-lending perspective, the funds that loaned those shares were the winners. They got the revenue. The hedge funds that ultimately borrowed it were the ones that lost out, and the funds that weren’t lending would have got less of a performance on those assets. Weren’t they at one stage the most expensive company in the world? And at that point, lenders were getting a fee off the back of that value, without taking any extra risk or increased exposure on the asset itself, whereas the hedge funds that were running the trades, they’re the ones that took a bath. SHARON WALKER: What’s interesting is that the press picked up on the fact that the hedge funds lost money over it. That was interesting, not necessarily the underlying strategies and the sort of transactions involved. JOYCE MARTINDALE: But UK funds will have owned one

or both of those shares, and they should have been concerned about that: if you’ve got any European equity exposure, it will impact your pension funds and therefore you should be interested in that. MARTIN TURNBULL: It couldn’t happen in the UK because we haven’t got two public car companies, have we? [Laughter]

A NEW GROWTH SPURT? SARAH NICHOLSON:

From our business perspective, we are in a growth period, now. We have come through the last 12 months strongly, with huge internal support for our securities lending activities and the business is definitely into a growth cycle. From an industry perspective, all lending agents will continue to be challenged by the underlying funds. You’ll see more bespoke specialist lenders evolving and coming to market, and much more of a continued recognition of the investment strategy of lending. Make no mistake, it is a real challenge to the market, to continue to increase the transparency, increase the understanding, and really take the industry to the next level. SIMON LEE: If we just look at some of the key metrics in our business at eSecLending—additional client mandates, levels of exclusive fees being bid, and most tellingly, numbers of borrowers bidding on exclusive deals, all are up year on year, pointing to a more positive outlook than a year ago. MARTIN TURNBULL: I sense an air of optimism in the market in. One of the bigger players across the market held a customer meeting the other night at which they stressed they were having a big push to be top three in all markets globally. One the integral parts of their business was securities lending. Others have been in touch directly expressing a wish to do more in this area, and are constantly looking for more portfolios to value, and other ways to optimise what they’ve already got. Moreover, companies are hiring again, which has to be good. Not everybody, of course; there are some that are still struggling, and some organisations are being broken up. However, of those firms remaining in the market which are rediscovering their identity, they are looking to beef up their business. JOYCE MARTINDALE: I can just reiterate what everyone else is saying, and from the beneficial owner’s side, they’ll be looking to understand what they’re lending out, what the risks are, what collateral they’re going to take, and I suspect some people will become more conservative and remain so, in terms of collateral, for quite some time. It won’t be a three month or a six month: if people go more conservative, it might stay for a bit longer. Some other people, may go the other way. SHARON WALKER: We saw some dips in the volume of EquiLend trading volumes about September time, with a dip of about 15% to 20%. What we’ve seen through 2009 is a pick-up of those trading volumes, and interestingly, we’ve seen some of our peak numbers ever in August and July,

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executing in excess of 20,500 trades in one day, which is a significant number for us, with orders going through the system of many multiples of that. As we look forward, we will have to be extraordinarily aware of people’s need to be cost-effective. Everybody is extremely cost-conscious, us included. We are very aware that we need to be able to offer the best service, the best value, at the right price.

THE WAY AHEAD SIMON LEE: There is an increased awareness, among

beneficial owners, of the business, which will prompt more investigation into alternative routes to market, and alternative ways of managing their lending programmes, and an increased demand on service providers. Clients will be looking for customisation, for transparency, and so forth. The obvious challenge is whether service providers can step up to meet these requirements, and how quickly they can step up and provide the lenders what they are demanding. SHARON WALKER: We are seeing a growing interest in ETFs—generally with people using it as a shorting alternative. There’s been a 20% uptick in the issuance of ETFs in the 2007, 2008 space. Talking with some of the ETF issuers, they certainly believe that’s going to carry on. EquiLend already has some ETF trading across the platform in the same way as any other warm security. So flexibility, cost-effectiveness, staying and being aware of the regulatory demands of the business, that’s where our challenges will be. SARAH NICHOLSON: We’re definitely seeing a huge influx of new opportunities, not necessarily in new markets. Instead we’re seeing new strategies and new ways of doing business, and new considerations around the types of stocks you’re lending and the types of collateral you’re seeing, and the returns on that. With the diversification of broker dealers in the market, and everybody trying to find their places, there’s a lot of innovation going on, and a lot of increased understanding from that side of the market as to what the beneficial owner and the ultimate security holder is looking for. ETFs and convertibles are interesting, for example. I guess traditionally, we’ve always looked at a new market as the new opportunity. We have very little appetite to go into far-flung countries that we don’t have complete comfort in, though we do have an appetite for these new structures. Whereas once we might have told an underlying client about a new idea and the money we could make for them, nowadays the discussion is much more about risk assessment and analysis. SHARON WALKER: We are seeing more use of our trading services in Asia, and we like to think of it now as a very natural market for us given trading volumes. Traditionally it’s been a very manual market, so we are pleased to see more take-up of our services, and we are able to offer trading in a number of different guises. We certainly expect to see growth in the volumes traded over EquiLend in markets such as Japan, Hong Kong and Singapore.

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER

SARA NICHOLSON, Head Of Securities Lending, Aviva MARTIN TURNBULL: We don’t really do a great deal in emerging markets, but that can change in the future. Markets are always evolving, that is true of whatever market you’re in. Some of the points we have raised about due diligence and awareness have changed, and so you’d like to think you’d never have a situation again where the cash reinvestment was such an issue, or as painful as it has been for some people. Plenty of positives have come out of this period but there are still the negatives of people trapped in some securities lending schemes because they can’t get out, without crystallising a loss. However, as markets recover, they will hopefully be able to get out of them without too much pain, and re-evaluate what they’re doing. JOYCE MARTINDALE: I’d prefer more to answer the question: wouldn’t it be great if there is growth? Or when will there be growth in the market? Because that, by implication, means that there’s more liquidity, there’s more confidence in the market, and our supplies of assets to lend have gone up, which would be really good, from a pension fund point of view. I’m interested to hear what opportunities will be out there in securities lending, but if there’s overall growth in that market, it means there are other benefits for pension funds. SIMON LEE: Looking at next year, that growth will come from the abilities of lenders, and their agents, to best manage their lending programmes to meet both risk management requirements, and market demands. That may mean anything from looking at collateral flexibility to lending in emerging markets, or to engage in synthetic lending structures. Lenders that are able to evolve their programmes, and have a flexible approach to how they manage their business, will see that growth.

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EUROPEAN TRADING STATISTICS

THE FIDESSA FRAGMENTATION INDEX (FFI) The Fidessa Fragmentation Index (FFI) was designed to provide the trading community with an accurate, unbiased measurement of the state of liquidity fragmentation across the order driven markets in Europe. Liquidity is fragmenting rapidly as new MTFs have unveiled a range of low-cost alternative trading platforms. It is essential for both the buy and the sellside 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.

European Top 20 Fragmented Stocks TW

-30

-3

-44

-33

6 7 8

-47

-36

-45

-25

-7

13 14

-9

-2

16 17

-18

-34

-1

-37

FFI Across Major Indices

Wks

Stock

Description

TCG.L

THOMAS COOK ORD EUR0.10

2.95

PVCS.L

PV CRYSTALOX ORD 2P

2.87

SSE.L

SCOT.&STH.ENRGY ORD 50P

2.86

CPG.L

COMPASS GROUP ORD 10P

CCL.L

CARNIVAL ORD USD 1.66

2.69

HLMA.L

HALMA ORD 10P

2.66

CLLN.L

CARILLION ORD 50P

2.62

MRW.L

MORRISON (WM) ORD 10P

2.61

IGG.L

IG GROUP ORD 0.005P

2.61

HSX.L

HISCOX ORD 5P

2.61

IAP.L

ICAP ORD 10P

2.59

BATS.L

BR.AMER.TOB. ORD 25P

2.59

IMI.L

IMI ORD 25P

2.58

WPP.L

WPP ORD 10P

2.57

IMT.L

IMP.TOBACCO GRP ORD 10P

2.57

ANTO.L

ANTOFAGASTA ORD 5P

2.54

GFS.L

G4S ORD 25P

2.53

ISYS.L

INVENSYS ORD 10P

2.53

DGE.L

DIAGEO ORD 28 101/108P

2.52

KESA.L

KESA ELECT. ORD 25P

2.51

FFI

2.5

2.7

2.0

1.5

1.0 Oct

Nov Dec

DAX

Jan

Feb

AEX

Mar Apr

May Jun

CAC 40

Jul

Aug Sep

FTSE 100 October 2009

Wks = Number of weeks in the top 20 over the last year. Week ending October 16th 2009

COMMENTARY By Steve Grob, Director of Strategy, Fidessa The widening gulf in fragmentation between the London Stock Exchange and the other primary markets in Europe is hard to miss. The gap that started to appear earlier this year seems to have widened to the point that fragmentation on FTSE 100 stocks is now around 30 per cent higher than in either France or Germany. Given that the London experience of fragmentation has been played out in mainland Europe, too, it’s likely that NYSE Euronext and Deutsche Börse will be monitoring this situation carefully. Intuitively, you would expect fragmentation to be slightly higher in London as the MTFs are based here, but there may be other reasons behind this gap. BATS Europe has led the way in aggressive pricing against the primary exchanges and has recently been focusing these efforts directly against the LSE. As a result, BATS’ market share in FTSE 100 stocks has doubled since August. It’s not viable to apply these incentives over the long, or even medium, term so the real question is what happens to liquidity when the rebates are removed? Obviously, the MTFs can’t expect to hold on to all the flow they win in this way but maybe that’s not the point. These discounted pricing campaigns can act as an incentive to get the market focused on connecting to new, alternative venues. When the price incentives are removed some liquidity naturally shifts again but, by then, more trading firms are connected to the venue in question and confidence in their operating model is established. The primary markets will rightly argue, though, that the MTFs still aren’t profitable so have yet to prove the viability of their business models. As the MTFs creep towards break-even, however, this argument may carry less weight in the future. On this point, it’s interesting to note that Chi-X has announced the introduction of market data fees for non-trading users from the beginning of next year. If other MTFs follow suit then this could further squeeze the primaries as traders will be reluctant to accept the current market data fees from the primaries if they also have to pay the MTFs for the same thing. If this does happen it will reignite the whole consolidated tape issue and will also open up the debate as to who really “owns” this market data.

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Venue turnover in major stocks: February - September 2009 (Europe only). (€) February

March

April

May

July

August

September

BTE

5,608,054,977.00

8,293,478,409.00

11,760,455,327.00

12,273,094,621.00 19,819,573,785.00

June

17,136,125,014.00

14,571,686,219.00

22,569,010,036.90

CIX

44,478,000,689.00

57,302,171,842.00

64,890,793,940.00

67,426,563,518.00 76,420,127,929.00

73,902,822,016.00

71,551,307,518.00

84,046,791,321.19

CPH

6,065,736,542.00

5,769,670,820.00

6,870,911,751.00

7,383,968,635.00

4,870,382,666.00

7,089,257,770.00

7,147,826,212.47

ENA

28,155,384,745.00

33,344,383,457.00

33,930,334,077.00

32,867,006,758.00 30,976,601,902.00

31,385,199,230.00

30,691,910,028.00

37,393,454,265.25

ENL

1,699,902,475.00

2,192,516,989.00

2,611,463,853.00

2,971,813,173.00

2,070,066,025.00

2,485,993,487.00

4,261,559,944.59

ENX

62,176,825,878.00

71,521,595,572.00

72,615,015,403.00

64,756,243,571.00 65,114,762,913.00

60,333,614,213.00

59,636,097,679.00

77,685,773,333.81

GER

58,503,655,400.00

71,961,504,918.00

70,826,928,671.00

65,294,587,783.00 59,810,363,156.00

59,120,911,176.00

55,161,793,765.00

69,515,848,590.13

MAD

35,155,031,277.00

42,748,157,361.00

46,356,689,095.00

44,148,540,160.00 46,007,528,734.00

45,653,082,841.00

35,434,917,111.00

47,318,951,034.98

MIL

33,411,222,405.00

40,612,882,418.00

50,707,487,670.00

65,112,164,394.00 50,337,737,317.00

43,251,626,085.00

50,791,257,494.00

78,086,217,226.28

NEU

497,344,442.60

497,818,346.20

950,256,423.30

2,327,001,210.00

3,543,693,008.00

3,185,323,984.00

4,413,980,819.97

OSL

9,507,251,979.00

9,960,856,458.00

9,308,457,732.00

14,694,324,285.00 13,002,357,861.00

8,191,066,040.00

10,083,367,296.00

13,222,554,868.00

STO

21,156,243,299.00

22,366,913,852.00

24,478,052,974.00

21,101,128,524.00 19,326,314,013.00

18,390,750,978.00

20,842,988,551.00

23,529,554,732.68

TRQ

27,575,386,163.00

21,789,168,823.00

13,250,597,390.00

15,013,090,241.00 19,593,680,671.00

22,795,819,570.00

26,695,607,538.00

26,106,162,960.16

ENB

6,583,680,870.00

7,274,199,930.00

6,777,175,877.00

7,445,092,754.00

6,529,627,899.00

5,189,313,861.00

7,784,709,480.00

10,086,003,222.10

HEL

9,953,915,021.00

10,391,428,275.00

12,141,298,756.00

9,649,992,328.00

8,465,193,200.00

8,937,741,770.00

8,812,985,645.00

10,016,921,672.01

LSE

90,396,376,631.00

113,304,000,000.00

98,817,445,425.00

94,048,810,611.00 109,576,000,000.00 92,086,424,632.00

82,899,283,778.00

96,477,697,345.69

VTX

41,645,468,998.00

42,750,059,854.00

41,180,202,240.00

38,363,085,417.00 33,892,649,428.00

32,849,258,499.00

35,080,948,172.00

37,499,163,419.18

NAE

75,833,173.13

65,079,038.29

BRG

367,214,270.90

622,622,788.02

5,812,371,514.00

2,198,642,157.00

2,718,970,582.00

Index market share by venue: Week ending September 11th 2009 Primary

Alternative Venues

Index

Venue

Chi-X

Turquoise

Nasdaq OMX

BATS

Burgundy

Amst.

Paris

Xetra

Stockholm

AEX

Amsterdam

70.36%

17.08%

4.55%

0.81%

3.56%

3.37%

0.14%

BEL 20

Brussels

59.07%

14.30%

2.99%

0.54%

2.81%

20.05%

0.06%

CAC 40

Paris

67.30%

16.73%

5.16%

1.03%

3.51%

4.94%

0.13%

DAX

Xetra

74.16%

17.16%

3.61%

0.49%

3.52%

†

0.02%

FTSE 100

London

62.23%

22.12%

5.71%

1.99%

7.94%

FTSE 250

London

68.20%

20.08%

4.95%

1.44%

5.32%

IBEX 35

Madrid

99.29%

0.58%

0.02%

†

0.05%

FTSE MIB

Milan

87.52%

7.23%

1.04%

0.14%

3.99%

†

0.04%

PSI 20

Lisbon

97.20%

1.05%

1.57%

0.03%

0.13%

†

SMI

SWX

80.21%

12.05%

4.64%

0.72%

2.28%

OMX C20

Copenhagen

87.76%

10.43%

1.18%

0.22%

0.40%

†

OMX H25

Helsinki

79.25%

11.35%

50.3%

0.57%

0.79%

0.04%

0.24%

2.26%

Figures are compiled from order book trades only. Totals only include stocks contained within the major indices. † market share < 0.01%

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

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER

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5-Year Performance Graph (USD Total Return) Index Level Rebased (30 September 2009=100) Se p04 500

FTSE All-World Index

400

FTSE Emerging Index

300

FTSE Global Government Bond Index

200

FTSE EPRA/NAREIT Developed Index

100

FTSE4Good Global Index FTSE GWA Developed Index M

09 p-

FTSE RAFI Emerging Index

ar -0 9

08 pSe

ar -0 8 M

07 pSe

ar -0 7 M

06 pSe

ar -0 6 M

05 pSe

ar -0 5

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

2,763

232.83

18.2

45.4

1.2

30.1

2.55

FTSE World Index

USD

2,313

545.97

18.3

44.4

0.4

28.6

2.58

FTSE Developed Index

USD

2,022

217.51

17.7

42.9

-1.0

26.2

2.57

FTSE All-World Indices

FTSE Emerging Index

USD

741

584.64

21.6

65.5

20.3

67.7

2.44

FTSE Advanced Emerging Index

USD

291

547.51

25.2

65.1

20.6

67.4

2.89

FTSE Secondary Emerging Index

USD

450

683.06

17.3

67.0

20.4

68.9

2.02

FTSE Global Equity Indices FTSE Global All Cap Index

USD

7,341

372.73

18.6

46.6

1.6

31.4

2.46

FTSE Developed All Cap Index

USD

5,891

351.03

18.2

44.1

-0.7

27.5

2.47

FTSE Emerging All Cap Index

USD

1,450

774.06

22.0

67.1

21.5

69.7

2.40

FTSE Advanced Emerging All Cap Index

USD

621

736.67

25.3

65.8

22.0

69.2

2.81

FTSE Secondary Emerging All Cap Index

USD

829

870.12

17.9

69.8

21.4

71.3

2.01

USD

717

186.90

5.9

9.1

13.4

3.8

2.67

FTSE EPRA/NAREIT Developed Index

USD

259

2311.69

25.1

70.0

-10.4

32.4

4.46

FTSE EPRA/NAREIT Developed REITs Index

USD

177

771.03

33.6

71.0

-20.2

26.0

5.53

FTSE EPRA/NAREIT Developed Dividend+ Index

USD

203

1646.59

29.4

72.8

-11.5

34.5

5.21

FTSE EPRA/NAREIT Developed Rental Index

USD

215

872.07

32.8

71.0

-18.1

28.0

5.22

FTSE EPRA/NAREIT Developed Non-Rental Index

USD

1054.28

8.4

67.2

16.9

45.0

2.44

FTSE4Good Global Index

USD

660

5995.84

19.1

47.8

0.5

28.7

2.83

FTSE4Good Global 100 Index

USD

103

5072.60

17.6

42.4

-2.5

24.6

2.97

FTSE GWA Developed Index

USD

2,022

3430.67

20.1

57.3

4.9

37.0

2.69

FTSE RAFI Developed ex US 1000 Index

USD

1,005

6310.38

27.3

72.8

15.8

47.1

3.02

FTSE RAFI Emerging Index

USD

356

6321.85

22.6

68.2

24.7

68.4

2.12

Fixed Income FTSE Global Government Bond Index Real Estate

SRI

Investment Strategy

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

NOVEMBER/DECEMBER 2009 â&#x20AC;˘ FTSE GLOBAL MARKETS

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Americas Market Indices Index Level Rebased (30 September 2009=100)

5-Year Performance Graph (USD Total Return) 300

FTSE Americas Index

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 09 p-

ar -0 9

FTSE RAFI US 1000 Index

08 pSe

ar -0 8 M

07 pSe

ar -0 7 M

06 pSe

ar -0 6 M

05 pSe

ar -0 5 M

Table of Total Returns Index Name

Currency

Constituents

Value

3 M (%)

6 M (%)

12 M (%)

YTD (%)

Actual Div Yld (%pa)

FTSE Americas Index

USD

790

697.66

16.4

37.4

-4.9

24.3

2.07

FTSE North America Index

USD

666

760.20

15.8

35.5

-6.1

21.8

2.00

FTSE Latin America Index

USD

124

1052.17

24.7

73.9

20.6

82.5

2.95

FTSE All-World Indices

FTSE Global Equity Indices FTSE Americas All Cap Index

USD

2,547

319.65

17.1

39.1

-4.4

25.8

1.96

FTSE North America All Cap Index

USD

2,358

305.04

16.6

37.2

-5.8

23.2

1.90

FTSE Latin America All Cap Index

USD

189

1481.91

25.7

76.3

21.9

84.6

2.88

FTSE Americas Government Bond Index

USD

166

188.54

2.5

-0.1

5.8

-0.8

2.95

FTSE USA Government Bond Index

USD

152

184.73

2.3

-0.6

6.2

-1.2

2.92

FTSE EPRA/NAREIT North America Index

USD

114

2543.21

35.0

77.1

-26.9

21.4

4.08

FTSE EPRA/NAREIT US Dividend+ Index

USD

1385.29

34.9

76.5

-29.0

17.4

4.00

Fixed Income

Real Estate

FTSE EPRA/NAREIT North America Rental Index

USD

111

861.48

34.7

77.0

-25.2

22.2

4.06

FTSE EPRA/NAREIT North America Non-Rental Index

USD

311.39

45.7

85.2

-66.4

-10.8

4.92

FTSE NAREIT Composite Index

USD

117

2480.34

32.0

68.0

-25.6

17.8

4.92

FTSE NAREIT Equity REITs Index

USD

5963.97

33.3

71.7

-28.4

17.0

4.02

FTSE4Good US Index

USD

138

4621.71

16.5

39.5

-4.6

24.5

1.86

FTSE4Good US 100 Index

USD

102

4415.26

15.9

38.2

-5.4

23.5

1.88

USD

614

2886.75

17.6

45.3

-4.4

26.6

2.10

SRI

Investment Strategy FTSE GWA US Index FTSE RAFI US 1000 Index

USD

993

5267.23

27.1

62.9

6.3

40.3

1.51

FTSE RAFI US Mid Small 1500 Index

USD

1,474

5038.08

32.5

80.6

9.3

52.7

1.52

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

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER

GM EDITORIAL 38.qxd:.

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Page 94

5-Year Total Return Performance Graph FTSE Europe Index (EUR) Index Level Rebased (30 September 2009=100) Se p04

FTSE All-Share Index (GBP)

400

FTSEurofirst 80 Index (EUR)

300

FTSE/JSE Top 40 Index (SAR)

200

FTSE Gilts Actuaries UK Conventional Fixed All-Stocks Index (GBP) FTSE EPRA/NAREIT Developed Europe Index (EUR)

100

FTSE4Good Europe Index (EUR) FTSE GWA Developed Europe Index (EUR)

Se p-

9 ar -0

08 Se p-

8 ar -0 M

07 Se p-

7 ar -0 M

06 Se p-

6 M

ar -0

05 Se p-

ar -0

MARKET DATA BY FTSE RESEARCH

Europe, Middle East & Africa Indices

FTSE RAFI Europe Index (EUR)

Table of Total Returns Index Name

Currency

Constituents

Value

3 M (%)

6 M (%)

12 M (%)

YTD (%)

Actual Div Yld (%pa)

FTSE Europe Index

EUR

549

217.36

18.7

42.1

-1.6

27.6

3.35

FTSE Eurobloc Index

EUR

286

123.73

21.2

45.8

-0.5

25.7

3.69

FTSE Developed Europe ex UK Index

EUR

375

223.87

20.6

43.9

0.7

26.3

3.36

FTSE Developed Europe Index

EUR

490

214.87

18.5

41.5

-1.1

26.6

3.39

FTSE All-World Indices

FTSE Global Equity Indices FTSE Europe All Cap Index

EUR

1,581

339.13

18.9

43.1

-1.2

29.4

3.26

FTSE Eurobloc All Cap Index

EUR

781

365.90

21.4

46.6

0.1

27.1

3.61

FTSE Developed Europe All Cap ex UK Index

EUR

1,064

372.75

20.8

45.0

1.1

27.8

3.28

FTSE Developed Europe All Cap Index

EUR

1,461

337.28

18.6

42.5

-0.7

28.4

3.30

Region Specific FTSE All-Share Index

GBP

620

3404.36

22.4

35.7

10.8

23.4

3.33

FTSE 100 Index

GBP

102

3223.93

21.9

33.7

9.5

19.9

3.44

FTSEurofirst 80 Index

EUR

4661.81

20.8

45.0

-1.3

22.7

3.93

FTSEurofirst 100 Index

EUR

100

4067.11

17.6

40.3

-2.7

23.0

3.81

FTSEurofirst 300 Index

EUR

311

1403.79

17.9

39.9

-2.1

24.4

3.48

FTSE/JSE Top 40 Index

SAR

2510.81

13.3

22.1

5.4

17.1

2.40

FTSE/JSE All-Share Index

SAR

162

2791.42

13.9

23.8

7.7

18.6

2.64

FTSE Russia IOB Index

USD

823.98

24.8

66.3

-1.3

91.9

2.14

FTSE Eurozone Government Bond Index

EUR

234

169.72

3.1

3.5

10.6

4.4

3.52

FTSE Pfandbrief Index

EUR

375

205.51

4.8

6.5

12.5

7.4

3.60

FTSE Actuaries UK Conventional Gilts All Stocks Index

GBP

2335.13

3.1

1.7

11.2

0.9

3.75

FTSE EPRA/NAREIT Developed Europe Index

EUR

1769.82

29.7

55.1

-13.7

31.2

4.86

FTSE EPRA/NAREIT Developed Europe REITs Index

EUR

644.47

29.3

54.2

-15.5

29.2

5.41

FTSE EPRA/NAREIT Developed Europe ex UK Dividend+ Index

EUR

2194.48

33.4

51.9

2.8

37.0

5.38

FTSE EPRA/NAREIT Developed Europe Rental Index

EUR

690.79

29.5

54.8

-14.0

30.0

4.99

FTSE EPRA/NAREIT Developed Europe Non-Rental Index

EUR

572.07

34.9

64.1

-1.6

71.3

1.30

FTSE4Good Europe Index

EUR

264

4304.57

18.5

41.5

-1.0

26.8

3.45

FTSE4Good Europe 50 Index

EUR

3710.65

16.4

35.2

-4.6

21.0

3.64

FTSE GWA Developed Europe Index

EUR

490

3184.28

21.4

59.0

6.7

40.7

3.45

FTSE RAFI Europe Index

EUR

517

5151.56

27.1

66.1

11.4

45.4

2.63

Fixed Income

Real Estate

SRI

Investment Strategy

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

NOVEMBER/DECEMBER 2009 â&#x20AC;˘ FTSE GLOBAL MARKETS

GM EDITORIAL 38.qxd:.

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Page 95

Asia Pacific Market Indices FTSE Asia Pacific Index (USD) FTSE/ASEAN Index (USD) FTSE/Xinhua China 25 Index (CNY)

800

FTSE Asia Pacific Government Bond Index (USD)

600

FTSE EPRA/NAREIT Developed Asia Index (USD) 400

FTSE IDFC India Infrastructure Index (IRP) 200

FTSE4Good Japan Index (JPY) 09

Se p-

M ar -0

08 Se p-

8 M ar -0

07 Se p-

7 M ar -0

06 Se p-

6 M ar -0

Se p-

FTSE GWA Japan Index (JPY) M ar -0

Se p-

Index Level Rebased (30 September 2009=100)

5-Year Total Return Performance Graph

FTSE RAFI Kaigai 1000 Index (JPY)

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

1,290

270.32

15.5

49.4

14.4

37.2

2.49

FTSE Asia Pacific ex Japan Index

USD

829

528.14

22.4

64.7

26.5

64.5

2.65

FTSE Japan Index

USD

461

75.85

-1.5

18.3

-16.2

7.8

2.25

FTSE All-World Indices

FTSE Global Equity Indices FTSE Asia Pacific All Cap Index

USD

3,030

458.42

15.7

50.6

15.5

38.4

2.48

FTSE Asia Pacific All Cap ex Japan Index

USD

1,776

651.74

22.5

66.5

27.1

66.7

2.63

FTSE Japan All Cap Index

USD

1,254

241.16

-1.3

18.7

-14.8

8.2

2.24

Region Specific FTSE/ASEAN Index

USD

148

522.01

21.1

73.7

25.5

64.3

2.98

FTSE Bursa Malaysia 100 Index

MYR

100

8801.42

13.8

42.8

23.8

43.8

2.68

TSEC Taiwan 50 Index

TWD

6808.11

20.6

45.9

25.9

62.2

2.90

FTSE Xinhua All-Share Index

CNY

1,001

7735.04

-3.9

18.9

41.5

67.5

0.94

FTSE/Xinhua China 25 Index

CNY

22876.28

7.3

45.9

24.9

46.2

2.14

USD

239

142.84

8.2

11.1

21.5

1.8

1.26

FTSE EPRA/NAREIT Developed Asia Index

USD

2039.61

13.6

63.6

13.1

41.7

4.65

FTSE EPRA/NAREIT Developed Asia 33 Index

USD

1314.90

13.2

59.1

7.7

37.4

3.96

FTSE EPRA/NAREIT Developed Asia Dividend+ Index

USD

2125.93

20.9

69.9

18.6

54.1

6.39

FTSE EPRA/NAREIT Developed Asia Rental Index

USD

929.63

26.4

59.1

-4.1

34.2

8.23

FTSE EPRA/NAREIT Developed Asia Non-Rental Index

USD

1151.11

6.8

66.4

26.5

46.8

2.37

Fixed Income FTSE Asia Pacific Government Bond Index Real Estate

Infrastructure FTSE IDFC India Infrastructure Index

IRP

999.95

9.6

83.5

21.1

64.6

0.65

FTSE IDFC India Infrastructure 30 Index

IRP

1135.84

9.3

86.7

28.4

72.2

0.64

JPY

187

3645.37

-2.3

19.0

-17.9

7.7

2.46

FTSE SGX Shariah 100 Index

USD

100

5148.72

15.8

41.6

10.0

28.2

2.26

FTSE Bursa Malaysia Hijrah Shariah Index

MYR

10134.29

11.5

35.0

21.1

38.5

2.60

JPY

100

1032.09

2.5

22.4

-12.2

13.5

2.23

SRI FTSE4Good Japan Index Shariah

FTSE Shariah Japan 100 Index Investment Strategy FTSE GWA Japan Index

JPY

461

2707.67

-1.4

22.6

-11.0

16.3

2.32

FTSE GWA Australia Index

AUD

102

4052.99

23.8

38.4

9.3

35.6

4.32

FTSE RAFI Australia Index

AUD

6488.24

25.8

37.1

12.7

36.3

7.99

FTSE RAFI Singapore Index

SGD

7696.18

14.8

66.0

18.0

58.1

3.40

FTSE RAFI Japan Index

JPY

278

3716.60

-3.5

21.2

-13.7

9.5

2.33

FTSE RAFI Kaigai 1000 Index

JPY

1,011

4108.77

19.8

55.0

-6.7

44.1

2.41

HKD

6731.24

10.3

52.6

25.3

51.5

2.55

FTSE RAFI China 50 Index

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

FTSE GLOBAL MARKETS â&#x20AC;˘ NOVEMBER/DECEMBER

GM EDITORIAL 38.qxd:.

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Page 96

INDEX CALENDAR

Index Reviews November/December 2009 Date

Index Series

Review Frequency/Type

Effective Data Cut-off (Close of business)

06-Nov

TOPIX

Annual review (constituents)

27-Nov

30-Oct

14-Nov

Hang Seng

Quarterly review

05-Dec

30-Sep

16-Nov

MSCI Standard Index Series

Quarterly review

30-Nov

30-Oct

Mid Nov

Russell/Nomura Indices

Annual review

30-Nov

31-Oct

Early Dec

CAC 40

Quarterly review

18-Dec

30-Nov

Early Dec

ATX

Quarterly review

31-Dec

30-Nov

Early Dec

IBEX 35

Semi-annual review

02-Jan

30-Nov

Early Dec

OBX

Semi-annual review

19-Dec

30-Nov

Early Dec

S&P / TSX

Quarterly review

18-Dec

30-Nov

03-Dec

DAX

Quarterly review

18-Dec

30-Nov

03-Dec

FTSE Global Equity Index Series (incl. FTSE All-World)

Annual review / North America

19-Dec

30-Sep

05-Dec

S&P / ASX Indices

Quarterly review

18-Dec

07-Dec

TOPIX

Annual review (constituents)

30-Dec

30-Oct

09-Dec

FTSE/JSE Africa Index Series

Quarterly review

18-Dec

30-Nov

09-Dec

FTSE UK Index Series

Annual review

18-Dec

08-Dec

09-Dec

FTSE techMARK 100

Quarterly review

18-Dec

30-Nov

09-Dec

FTSE Euromid

Quarterly review

18-Dec

30-Nov

Quarterly review

18-Dec

30-Nov

09-Dec

FTSEurofirst 300

09-Dec

FTSE EPRA/NAREIT Global Rea Estate Index Series

Quarterly review

18-Dec

30-Nov

09-Dec

FTSE eTX Index Series

Quarterly review

18-Dec

30-Nov

09-Dec

FTSE Italia Index Series

Quarterly review

18-Dec

30-Nov

10-Dec

OMX I15

Semi-annual review

31-Dec

30-Nov

11-Dec

FTSE NAREIT US Real Estate Index Series

Annual review

19-Dec

28-Nov

11-Dec

FTSE NASDAQ Index Series

Annual review

19-Dec

28-Nov

11-Dec

NASDAQ 100

Annual review

18-Dec

30-Nov

12-Dec

S&P BRIC 40

Annual review

18-Dec

20-Nov

12-Dec

S&P US Indices

Quarterly review

18-Dec

04-Dec

12-Dec

S&P Europe 350 / S&P Euro

Quarterly review

18-Dec

04-Dec

12-Dec

S&P Topix 150

Quarterly review

18-Dec

04-Dec

12-Dec

S&P Asia 50

Quarterly review

18-Dec

04-Dec

12-Dec

S&P Latin 40

Quarterly review - shares & IWF

18-Dec

04-Dec

12-Dec

S&P Global 1200

Quarterly review - shares & IWF

18-Dec

04-Dec

12-Dec

S&P Global 100

Quarterly review - shares & IWF

18-Dec

04-Dec

Mid Dec

VINX 30

Semi-annual review

18-Dec

30-Nov

Mid Dec

OMX C20

Semi-annual review

18-Dec

30-Nov

Mid Dec

OMX S30

Semi-annual review

31-Dec

30-Nov

Mid Dec

OMX N40

Semi-annual review

18-Dec

30-Nov

Mid Dec

Baltic 10

Semi-annual review

31-Dec

30-Nov

11-Dec

FTSE Bursa Malaysia Index Series

Annual review

18-Dec

30-Nov

11-Dec

DJ STOXX

Quarterly review (components)

18-Dec

24-Nov

14-Dec

Russell US/Global Indices

Quarterly review - IPO additions only

18-Dec

30-Nov

18-Dec

FTSE MIB

Quarterly review - shares & IWF

27-Dec

17-Dec

24-Dec

NZX 50

Quarterly review

31-Dec

30-Nov

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

NOVEMBER/DECEMBER 2009 â&#x20AC;˘ FTSE GLOBAL MARKETS

GM EDITORIAL 38.qxd:.

3/11/09

10:15

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