FTSE Global Markets

SECURITY VERSUS SENTIMENT IN EUROPEAN REAL ESTATE

ISSUE 57 • DECEMBER 2011 / JANUARY 2012

The big squeeze on money market funds Can Form PF make hedge funds better?

Risk reduction in ETF fund administration Why there is still life in Europe’s covered bonds

20-20 ALL STARS:

Malaysia’s central bank takes the lead in Islamic finance THE FAST-SLOW BURN OF TRANSITION MANAGEMENT IN ASIA

NEW CHALLENGES. NEW SOLUTIONS.

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Global Pensions Transition Manager of the Year 2011 AsianInvestor Best Transition Management 2010 European Pensions Transition Management Firm of the Year 2011 Global Investor Middle-East Awards Transition Manager of the Year 2010 ICFA American Service Provider Awards Transition Management Provider of the Year 2011

To find out more about our transition management solutions, visit www.jpmorgan.com/transitionmanagement or contact: J.P. Morgan Worldwide Securities Services Duncan Klein, duncan.klein@jpmorgan.com or +65 6882 1127 Robert Calder, robert.a.calder@jpmorgan.com or +44 207 742 0257 Michael J Young, michael.j.young@jpmorgan.com or +1 212 622 0159 The products and services featured above are offered by JPMorgan Chase Bank, N.A., a subsidiary of JPMorgan Chase & Co. and its affiliates. JPMorgan Chase Bank, N.A. is registered by the FSA for investment business in the U.K. J.P. Morgan is a marketing name for Worldwide Securities Services businesses of JPMorgan Chase & Co. and its subsidiaries worldwide. Š2011 JPMorgan Chase & Co. All rights reserved.

OUTLOOK EDITORIAL DIRECTOR: Francesca Carnevale, tel: +44 [0]20 7680 5152 email: francesca@berlinguer.com SENIOR EDITORS: Ruth Hughes Liley (Trading); David Simons (US) CONTRIBUTING EDITORS: Art Detman; Neil O’Hara; Lynn Strongin Dodds CORRESPONDENTS: Rodrigo Amaral (Iberia/Emerging Markets); Andrew Cavenagh (Debt Capital Markets); Vanja Dragomanovich (Commodities/Eastern Europe); Mark Faithfull (Real Estate); Matt Lynn (UK Markets); Ian Williams (Supranationals/Emerging Markets) PRODUCTION MANAGER: Mariangel Gonzalez, tel: +44 [0]20 7680 5161 email: mariangel.gonzalez@berlinguer.com SUB EDITOR: Roy Shipston, tel: +44 [0]20 7680 5157 email: roy.shipston@berlinguer.com FTSE EDITORIAL BOARD: Mark Makepeace (CEO); Donald Keith; Imogen Dillon-Hatcher; Chris Woods; Paul Hoff; Jerry Moskowitz; Andy Harvill 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: Can Sonmez (Istanbul/Turkey) PUBLISHED BY: Berlinguer Ltd, 1st Floor, Rennie House, 57-60 Aldgate High Street, London EC3N 1AL Switchboard: +44 [0]20 7680 5151 www.berlinguer.com PRINTED BY: Headley Brothers Ltd, The Invicta Press, Queens Road, Ashford, Kent TN24 8HH DISTRIBUTION: Postal Logistics International, Units 39-43 Waterside Trading Estates, Trumpers Way, London W7 2QD TO SECURE YOUR OWN SUBSCRIPTION: Register online at www.ftseglobalmarkets.com Single subscriptions cost £497/year for 10 issues.

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

HIS END-OF-year edition positively seethes with the radioactive fallout of the eurozone crisis. While volatility in the equity markets has taken up most column inches in the popular press, equally swingeing effects of the crisis have been felt in the debt markets; in both the widening of spreads across the spectrum of debt securities, as well as a worrisome falloff in new issue volumes in the second half of the year. Our debt review covers the harrowing of the high yield, European covered bonds and pfandbrief segments.

It does not make for pretty reading.

Investor worries on this score have, as an example, seen spreads on the jumbo pfandbrief bonds of those German banks that have relatively high exposures to the debt of peripheral eurozone countries (sovereign and other) widen to 60-70 basis points (bps) over the mid-swaps benchmark in the secondary market. Those of institutions with less southern European risk are still in the 10bps to 20bps range however.

Moreover, investors have become pickier when it comes to credit risk. Sticking with the same thread: another factor that seems likely to exert an increasing influence on benchmark pfandbrief spreads is the composition of asset pools for mortgage-backed pfandbriefe, which now account for more than half the total annual issuance. Some core investors want to see a clear distinction between residential mortgages and commercial loans in cover pools, which they argue represent a different type of risk and should therefore command an appropriate differential in pricing.

Talking of risk, our Asian transition management roundtable focuses fairsquare on the issue of transparency and risk reporting. These will be recurrent themes through 2012 as various regulations come on stream, impacting for the medium term at least the way that banks conduct their asset servicing businesses. It is the least that banks can do to help rebuild confidence in an expensive and sometimes overwrought business segment that has sometimes failed to deliver on both the spirit and the actualities of its promises.

Our annual 20-20 review dominates the features section. This segment has, historically, been a mix of the sublime and the quirky. Perhaps it is the concern with which we approach the year end that has ultimately guided our choice of representatives of all that is individual, brave, innovative or dogged in the global markets through these challenging times.

As always in recent years, emerging markets are prominent in the selection, though we provide invariable nods to those innovators and brand leaders in securities trading in developed markets (where innovation still remains firmly rooted). Our emerging market nominations this year are highly varied. They range from the thought leadership in Islamic finance—one of the few consistently buoyant debt markets this year—provided by Bank Negara Malaysia’s specialist funding and regulatory arms, to the dogged consistency of service provided

by Egypt’s CIB despite a fundamentalist revolution upturning its client base.

It then moves on to the continuing innovation provided by RZB in central and eastern Europe and the untrammelled frontier investment marksman that is Mattias Westman of Prosperity Capital Management in Russia. We hope you enjoy the selection.

T

Francesca Carnevale, Editor, December 2011 / January 2012 Cover photo: Dr Zeti Akhtar Aziz, governor of Bank Negara Malaysia, Malaysia’s central bank. Photograph kindly supplied

by Lee Chun Chung / Light Frame Photography, supplied November 2011.

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

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CONTENTS COVER STORY

END OF YEAR REVIEW & 20-20 NOMINEES

......................................................Page 50 “Over time, we will see a network grow between smaller financial hubs in the developing markets that will support ... economic and financial flows and mutually reinforce one another in supporting growth. It is a new Silk Road and Malaysia has a definite role to play in that,” avers Dr Zeti Akhtar Aziz, governor, Bank Negara Malaysia in our annual 20-20 round-up. Do the other 20-20 nominees agree on the degree of change sweeping the global markets?

DEPARTMENTS

MARKET LEADER

NO END FOR THE BIG SQUEEZE ON MONEY MARKET FUNDS ........Page 6 Neil O’Hara on the bleak outlook for fund sponsors facing strong pressure on margins.

THE LESSONS FROM MF GLOBAL’S COLLAPSE

IN THE MARKETS

......................................Page 10 Should clearing houses transfer collateral accounts when an intermediary collapses?

THE BATTLE FOR CONTROL OF CEO REMUNERATION ....................Page 14 How Say-on-Pay is cutting down excessive corporate CEO remuneration.

SPOTLIGHT

THE IMPACT OF FORM PF ON HEDGE FUND REPORTING ............Page 18 This month’s round-up of investment market news.

WILL 2012 BE BETTER FOR DR ISSUES?

ASSET ALLOCATION

........................................................Page 20 DR issue volumes are in slow bake: though Asia and Brazil are still cookin’ —just.

PHYSICAL V SYNTHETIC ETFS: WHICH WILL WIN OUT? ................Page 24 Neil O’Hara examines the look and feel of the tussle for market share.

SECURITIES SERVICES FX VIEWPOINT

RISK REDUCTION IN ETF FUND ADMINISTRATION

............................Page 28 David Simons reports on the efforts of providers to service increasingly-complex product.

HOW TO SURVIVE ANOTHER YEAR OF PROFLIGACY & GREED ....Page 34 Erik Lehtis, president of DynamicFX, looks at what 2011 taught the FX market.

PRESSURE CONTINUES IN HIGH-YIELD SEGMENT

..............................Page 35 High-yield issuance is a fraction of what it was in 2010. Andrew Cavenagh explains why.

DEBT REPORT

THERE’S STILL LIFE IN EUROPE’S COVERED BOND MARKETS

........Page 36 Unlike most capital market debt, the outlook for covered bonds is quietly optimistic.

WHY INVESTORS STILL LOVE PFANDBRIEFE

..........................................Page 38 German covered bonds have maintained their safe-haven status.

2

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

CONTENTS

MANDATES

INDEX REVIEW

SECURITIES SERVICES: LATEST MANDATES ..................................................Page 39 A quick-fire selection of the current crop of custody and fund administration mandates.

THE LAW OF UNINTENDED CONSEQUENCES ............................................Page 42 Eurozone woes hold back growth.

FEATURES TRADING REPORT:

US EXCHANGES USE MERGERS AS A MEANS OF BUILDING MARKET SHARE ..........................................................................Page 42 US national stock exchanges have been in defensive mode all year; having to meet the competitive challenge of some 80 or so alternative trading systems that have captured as much as 38% of total market volume over the past few years. Ruth Hughes Liley looks at the problems and wonders at the long-term impact of the merger between Deutsche Börse and NYSE-Euronext. Is it really a match made in heaven?

SECTOR REPORT:

EUROPEAN REAL ESTATE: SECURITY VERSUS SENTIMENT ................Page 47 Although the value of commercial real estate largely follows the macroeconomic trends of the markets in which it is traded, a subtle disconnect has been evolving over the course of the financial crisis which looks set to crystallise in 2012. Despite their enormous problems, both Italy and Spain have largely retained investor and operator faith, while some of the other “Club Med” countries have been deserted. Conversely, although their stability has seen them perform strongly during the recession, neither Germany or France enter 2012 in quite the shape they started 2011. Mark Faithfull considers why market dichotomies are at play.

ROUNDTABLE:

THE FAST-SLOW BURN OF TRANSITION MANAGEMENT IN ASIA ........................................................................................Page 81 Adrian Teng, group treasurer at Jardine Matheson, says: “Corporations in Asia have slowly come up the curve with regards to managing transitions themselves and they do not always go out to a transition manager to do transitions, unless it’s a large and complex portfolio, such as moving a subsidiary’s plan into the corporate group plan. In addition, the current changes in the macroenvironment now forces one to be closer to your transition manager. They are used as a counsel, or an adviser, especially as plans become more complex with regards to new asset classes, ie private equity fund of funds, and hedge funds. In comparison, equities and fixed income are fairly straightforward. I think that is the value-add that transition management brings to the table.” Did everyone else on the roundtable agree with him?

DATA PAGES

4

DTCC Credit Default Swaps analysis ..............................................................................................Page 89 Fidessa Fragmentation Index ........................................................................................................................Page 90 Market Reports by FTSE Research................................................................................................................Page 92 Index Calendar ....................................................................................................................................................Page 96

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

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MARKET LEADER

MONEY MARKETS BEAR THE PAIN OF LOW RATES: BUT FOR HOW LONG?

During the 2008 financial crisis, frightened investors in the United States poured money into money market funds, boosting assets under management to a record $3.9trn in March 2009. As the panic receded, the money began to flow out again, and has continued to do so ever since. By October 2011, money market fund assets had fallen to $2.6trn, a level last seen in early 2007.

Even a flight to quality in the summer failed to reverse the trend. Assets leaked out notwithstanding the political shenanigans over raising the US debt ceiling, Standard & Poor’s downgrade of its US long-term debt rating and the European sovereign debt fiasco. For fund sponsors, who face intense pressure on margins, the outlook is bleak. Neil O’Hara reports.

Photograph © Yudesign / Dreamstime.com, supplied November 2011.

No end in sight for the big squeeze on US money market funds T APPEARS THE US money market segment can expect no relief from monetary policy in the immediate future. The Federal Reserve (Fed) has indicated it will not raise its overnight Fed funds rate from the current target of 0–25 basis points (bps) until at least mid2013. A recent auction of one-month Treasury bills sold for 0.5bps; three month T-bills yield a measly 1bps. At these levels, money market funds can barely cover their costs, let alone make a profit. In fact, sponsors have waived fees on many funds in order to report a positive yield to investors, further eroding margins that were already wafer-thin.

Persistent low short-term interest rates are not the only government policy

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culprit, however. Dodd-Frank extended unlimited federal deposit insurance on all non-interest bearing checking accounts through the end of 2012, while in July 2011 banks were permitted to pay interest on business checking accounts for the first time since the Great Depression. Brian Reid, chief economist at the Investment Company Institute (ICI), a trade association for mutual funds and other investment companies, based in Washington, DC, says these changes induced large institutional investors to move some cash balances from money market funds to checking accounts.

The switch shows up in Fed data on the money supply. This year, demand deposits shot up almost $242bn

through the end of October, from $504bn to $746bn, while institutional money market fund assets fell $114bn from $1.86trn to $1.72trn and retail money market funds assets (excluding those in retirement savings accounts) edged up $13bn to $718bn. Demand deposits pay no interest, but at today’s rates investors are willing to forgo a derisory yield in exchange for government insurance.

Anecdotal evidence suggests investors also pulled out of money market funds in the summer for fear of exposure to the European debt crisis and the implications of potential US default if Congress did not raise the debt ceiling. “Some of the money that left this year was related to uncertainties, but some was to take advantage of the new rules,” says Reid. “I can’t tell how much one or the other was.”

ICI tracks several different types of money market funds, including prime, government-only, Treasury-only and tax-exempt municipal. Fee waivers have become so deeply embedded in the government (Treasuries and agency debt) and Treasury-only sectors that managers have this year foregone almost twice as much fee revenue as they have collected.

In contrast, the prime sector, which invests in short-term corporate obligations as well as government and agency instruments, has collected 50% more revenue than it has waived this year. The tax-exempt sector meantime has evenly matched collections and waivers.

Portfolio managers operate within tight constraints that leave no room to reach for yield. Weighted average maturity must be less than 60 days, but most funds stay shorter and have brought the figure down in the past two years to around 40 days from 45 to 50 days.

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

Transition Management is about

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For over 25 years, Russell has led the way in setting standards for transition management globally. We approach transition management as a short-term investment management, making sure our clients enjoy the same care we offer our funds. Our pure fiduciary service and agency TM model is widely regarded as the most effective and consistent in delivering on-time, on-cost, risk-controlled results.

To find out how Russell’s award-winning team can help you gain 100 basis point advantage on your next transition visit: www.russell.com/asia/transitionmanagement

A saving in the range of 100 bps of each transition is based a conservative point with the range (60-180bps) of transition costs for inefficient transition management.

Source: Russell Investments, Don’t leave Basis Points on the Table, John Moore & Chris Briant, 2009. This document is published for information only and does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person. This document is issued by Russell Investment Group (“RIG”) Pte Ltd (Registration no. 199901513K) and is based on information obtained from sources believed to be reliable, but RIG does not make any representation or warranty as to its accuracy, completeness or correctness. RIG is part of Russell Investments (“Russell”). Russell or its associates, officers or employees may have interests in the financial products referred to in this information by acting in various roles including broker or adviser, and may receive fees, brokerage or commissions for acting in these capacities.R_AD_TransMan_Asia_FTSE_V1F_1111 MKT/ 2599/0710

MARKET LEADER

MONEY MARKETS BEAR THE PAIN OF LOW RATES: BUT FOR HOW LONG?

Managers cannot ratchet up risk, either; SEC rules permit money market funds to invest only in instruments that have minimal credit risk. “There is not much managers can do,”says Reid. “The most flexibility they have is in waivers, which is why you have seen so many.”

This year through September, ICI estimates that the industry has waived $3.7bn in fees and collected $3.8bn.

Investors have hair-trigger sensitivity in today’s nervous markets, which may cause managers to pass up opportunities dispassionate credit analysis would recommend. Steve Meier, chief investment officer, global cash management, at State Street Global Advisors (SSGA), has cut exposure to French banks in the firm’s registered money market funds even though he considers them—and BNP Paribas in particular—sound.“We have to be concerned about the optics of our holdings,” he says. “If investors see anything that could be a problem in a stable NAV fund they are more inclined to pull their money first and ask questions later.”

SSGA manages $450bn in cash balances around the globe. Clients run the gamut from risk takers who are willing to seize market anomalies such as cheap French bank paper (typically in separately-managed accounts rather than pooled vehicles) to scaredy-cats hunkered down in the most conservative commingled funds.“There are opportunities depending on your risk appetite, credit process and ability to take headline risk in a portfolio,”says Meier.

The ultra-safe government and Treasury funds suffer from a dearth of paper that has driven yields to unprecedented lows. T-bills have even traded at negative yields in the secondary market, albeit briefly, although Meier says the Fed is exploring whether it could tap negative yields at auction.

The flood of Treasury paper to finance the bloated US deficit is concentrated at the long end so that T-bills now represent just 15% of outstanding Treasury debt, the lowest proportion in 50 years.

Agency discount note issuance has dropped almost 50% over the past two

8

and a half years as well.“The Treasury is extending its liabilities,” explains Meier.

“To some extent, it is starving the short end of the yield curve.”

For most cash managers, preservation of capital is the primary objective, followed by access to liquidity. Only when certain of these two do investors look at yield relative to their investment guidelines, risk tolerance and market conditions.“It is rare to have a conversation about yield,”says Meier.“Clients ask what we are doing to preserve capital.

Are they at risk? How are we positioned from a liquidity standpoint?”

Downward pressure In theory, the Fed’s Operation Twist should take some downward pressure off short-term rates in the Treasury market. The central bank’s latest stimulus ploy aims to bring down long-term interest rates. It is restructuring its balance sheet by selling assets with maturities of less than three years and purchasing long-term bonds. The imbalance between supply and demand for short-term government paper is so acute that the programme has had no discernible effect on short rates, however.

“The demand for US government securities is still incredibly high,” says PeterYi, head of short-term fixed income at Northern Trust. “It has been a few weeks since Operation Twist got under way and we are not seeing any reaction at the short end.”

The relentless pressure on margins has prompted some sponsors to reassess their commitment to money market funds. Big players, including Fidelity,Vanguard, State Street and Northern Trust, have sufficient assets under management to hang tough even if low rates persist for several years. Economies of scale have become critical to success, though, and the entire industry faces higher compliance costs as a result of regulatory reforms.

In addition to economic pressures, sponsors must overcome investor scepticism about the safety of their products.

The US money market fund industry lost its virginity in September 2008 when the

Reserve Fund, the very first fund ever launched, was unable to maintain its $1 per share net asset value (NAV).

The psychological impact was so severe that the Treasury extended a temporary guarantee of the $1 NAV at money market funds to forestall a run, a programme that expired in September 2009. “People thought money market funds would never break the buck,” says Cindy Zarker, director of research at Cerulli Associates, a Boston-based research firm that specialises in the money management industry. “Investors have so much less confidence in money market funds today.”

Assets are gravitating to larger funds at the larger sponsors. In December 2000, half the industry assets were in funds that had $1bn to $10bn under management, but by August 2011 a similar proportion had shifted to $10bn to $50bn funds. The proportion in funds in excess of $50bn shot up from 3% to 22% over the same period.

Almost half of industry assets are held by the five largest sponsors; and 73% by the top ten. The process is continuing, as Yi attests:“The industry has lost roughly 6.5% in assets this year, but Northern Trust’s money market funds have actually increased assets about 7%.”He attributes Northern Trust’s success to its conservative investment strategy, expertise in credit research and the financial strength of the parent company, characteristics the other big players share.

The money market fund industry isn’t going away, after all. In fact, Reid points out that the pressures it faces today are not new. Whenever the Fed starts to lower interest rates, investors pile into money market funds to take advantage of the time lag before their portfolios adjust to the new rates, but once yields have equalised the money goes away again.“For the most part, the recent outflows are a traditional response to low interest rates,” says Reid. “If anything, the outflows have been weaker than our models projected given the extended period of low interest rates.”I

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

Gold market intelligence Responsible investment decisions require a solid understanding of assets and markets.

The World Gold Council offers investment professionals a unique resource through our investment research and marketing programme. We use a variety of media to provide the in-depth information and independent analysis that are needed to support gold investment. We are the world’s leading organisation for investor education on gold. www.gold.org/investment

The World Gold Council is the market development organisation for the gold industry. Working within the investment, jewellery and technology sectors, as well as engaging in government affairs, our purpose is to provide industry leadership, whilst stimulating and sustaining demand for gold.

We provide insights into the international gold markets, helping people to better understand the wealth preservation qualities of gold and its role in meeting the social and environmental needs of society.

World Gold Council 10 Old Bailey, London EC4M 7NG, United Kingdom T +44 (0)20 7826 4700 W www.gold.org

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IN THE MARKETS

MF GLOBAL COLLAPSE LEAVES COMMODITY MARKETS BRUISED

The lessons of MF Global’s collapse N LONDON the volume of trade in key base metals has almost halved since the collapse of MF Global, says Robin Bhar, commodities analyst at Credit Agricole CIB.“We are still waiting for the fallout to subside,” says Bhar, adding that trading has not been helped by the deepening of the eurozone debt crisis and the ongoing weakness in parts of the global economy.

In the US the worst affected markets were oil, natural gas and agricultural futures trading on the Chicago Mercantile Exchange (CME). Some people who have been hurt by the collapse are talking tough: “We are in a bankruptcy hearing and our money is being treated as if we were the company’s creditors, which we are not,” says John Mayer, board member of the Commodity Customer Coalition (CCC), a 7,000-member group of former MF Global clients which includes fund, commodity trading advisers and individual investors.

“My money has effectively been stolen and now I am told that I am free to open an account somewhere else. So that somebody else can steal my money too?”asks Mayer, adding that the resentment of commodity investors about the way they were handled in the wake of the company’s collapse has deterred a large number of them from coming back into commodities.

Andrew Lamb, chief executive of CME Clearing House in Europe, says that one of the key lessons to be learned is that clearing houses should have more legal power to transfer collateral in client accounts when an intermediary collapses and that clearing houses need to be ready for “military-style operations to marshal clients’ money.”

The first signs that there was something seriously wrong at the company emerged in the spring when US regulators noticed that the broker had removed some of the assets it had pledged as collateral on repo-to-maturity debt transactions. By August, the Financial

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Corporate bankruptcies are always messy, but what happened in the aftermath of the demise of US brokerage MF Global has left commodity markets so bruised that it will be an uphill struggle to restore investor confidence. It goes beyond clients of the failed broker getting their money back. Instead, it has a become a wider crisis of confidence within the commodities futures industry.

How can that confidence be restored in the wake of one of the biggest failures on Wall Street since Lehman Brothers? By Vanya Dragomanovich.

Industry Regulatory Authority had asked the firm to boost its capital levels because of its exposure to European debt.

The situation eventually boiled over after October 25th when the company reported rising losses in the third quarter. In quick succession its shares were sold down by over 50%. Ratings agency Moody’s Investors Service cut the company’s debt ratings to a step above junk. At the same time, MF Global began talking to a potential buyer; but those talks collapsed as it became apparent that there was a shortfall of money in the company’s accounts.

By October 31st the company had filed for Chapter 11 at the US bankruptcy court in NewYork, listing assets of $41bn and liabilities of $39.68bn. Within hours MF Global’s staff was barred from trading, including on the CME, where it carried its biggest exposure, and within days from the London Metal Exchange, the Intercontinental Exchange and a host of almost 30 other exchanges.

The worst fallout has been in the US where regulators found that there is

potentially more than $1.2bn missing from segregated client accounts. In Australia, a regulatory loophole, which is now likely to be addressed by Australia’s securities regulator, allowed MF Global to effectively pool client funds for hedging purposes, something that is forbidden under the UK or US regulatory regimes. “There has been no evidence of something similar in the UK,” says Monica Fiumara, senior spokesman at KPMG, the administrator for MF Global’s European operations. Regulators are still trying to piece together how the shortfall actually came about. The Commodity Future Trade Commission’s (CFTC’s) Scott O’Malia admits that “at this time, we have not identified the cause of the segregation shortfall”.

MF Global’s situation is unique in respect of missing funds from segregated accounts. There have been bigger bankruptcies in the past, notably Lehman Brothers, or the collapse of commodities broker Refco in 2005. However, client funds in segregated accounts were always safe and were eventually returned to their holders. “We always thought that the concept of segregated accounts was sacrosanct, that money from such accounts could never disappear. There have been bankruptcies before, but ever since the Chicago Mercantile Exchange was formed in 1870 nobody has ever lost a single penny from a segregated account. That certainty is now gone,”says Mayer.

What made the situation worse for commodities investors is that all futures accounts were frozen, leaving the markets to move against locked-in traders. Then when about 10% of the accounts were moved to other futures brokers by the CME, the margin deposits with MF Global were not transferred.

The exchange was in a bind, and could effectively only transfer the collateral it controlled itself.

Commodity investors have to deposit a level of margin with a broker to ensure

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

Your Strong, Canadian, Counterparty

As a top-ranked Canadian multi-prime in Global Custodian’s Prime Brokerage Survey1, CIBC deserves a closer look when you evaluate counterparty risk.

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What you have with CIBC Prime Services Group is a stable and strong partner with talent, technology – and capital strength, for when it matters. Either across the border – or across the pond – CIBC is your solution for Canadian multi-prime services.

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2011 Global Custodian Prime Brokerage Survey

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TSX and ATS Market Share Report, 2009-present (as provided by IRESS Market Technology): #1 in volume, value and number of trades

Services provided by CIBC World Markets Inc., a wholly-owned subsidiary of Canadian Imperial Bank of Commerce and part of Canadian Imperial Bank of Commerce’s wholesale banking arm which also includes other affiliates including: CIBC World Markets Corp., CIBC World Markets plc, CIBC World Markets Securities Ireland Limited, CIBC Australia Ltd, and CIBC World Markets (Japan) Inc.,: “CIBC” refers to the CIBC group of companies. CIBC World Markets Inc. is a member of the Investment Industry Regulatory Organization of Canada and the Canadian Investor Protection Fund.

IN THE MARKETS

MF GLOBAL COLLAPSE LEAVES COMMODITY MARKETS BRUISED

that they are able to pay for all their future transactions. Smaller investors frequently put up almost the maximum of their finances in the account to be able to leverage their trade.

With margin deposits still in MF Global, a lot of investors had no way of raising additional cash which they needed to deposit with a new broker, and they hastily closed out their accounts. On top of that, new brokers asked for a higher margin because of the risk involved. A total of $410m has been transferred; meanwhile some 5,000 accounts were placed with ten other clearing firms that trade on the CME. The CME thinks it has come under misplaced criticism for its handling of the fallout from the collapse. In a terse statement issued on November 17th, the CME said: “In response to inaccuracies reported yesterday, CME Group confirmed today that it followed CFTC requirements and CME rules and procedures in reviewing MF Global’s segregated funds statements and coordinating that review with the CFTC. CME was advised in the early hours of Monday, October 31st that there was an actual shortfall in the segregated funds account and was told the CFTC was advised concurrently. Shortly thereafter, CME Group discussed the shortfall in a conference call with the CFTC and other regulators. CME Group is confident that it complied with all its obligations as a designated self-regulatory organisation (DSRO) pursuant to the Commodity Exchange Act.” The CME’s Andrew Lamb says the exchange’s hands were tied on the issue and that the decision was made by the trustee, James Giddens, who handles MF Global’s accounts.“A clearing house can only transfer with client positions the collateral that it holds. If they are held at an intermediary, like MF Global, they are not accessible by the clearing house—the only collateral that can be ported is the collateral that it has possession of,” says Lamb. However, he notes that in future clearing houses should have more legal right to protect the clients’ money.

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An employee of the defunct trading company MF Global Inc. who identified himself as Pierre Yvan Desparois, vice president at the credit department, leaves the offices on Fifth Avenue in New York as the company is in liquidation Friday, November 11th, 2011.

Photograph supplied by AP Photo/David Karp, November 2011.

Those MF Global’s commodity clients that had open positions retrieved between 4% and 20% of the money they had with the company, depending on how much margin they had deposited with the broker, explains CCC’s Mayer.“I only got 5% of my investment back,” adds Mayer, who is a long-time commodities investor. “You can see how I would find it galling,”he says.

Clients who had no open positions but only held a cash deposit had no access to their money for the first two weeks but then the release of $520m was negotiated that will give cash clients around 60% of their money back. What will happen with the remaining 40% remains an open question.

In Europe, where the administration of the company’s assets has fallen to KPMG to handle, none of the clients’ money has yet been returned. When KPMG took over there were approximately 1.6m open positions across 30 jurisdictions. Since then, positions on most of the big exchanges have been liquidated, as have over-the-counter (OTC) positions in metals and plastics, while other positions have been moved to other brokers.

Richard Heis, KPMG’s joint special administrator, explains that the delay

in returning clients’ money stems from the sheer volume of accounting entries the administrators had to make and the fact that now that MF Global UK has been cut off from exchanges and clearing houses “a significant amount of book squaring needs to happen manually”.

The administrator has been discussing with the UK Financial Services Authority whether it would be feasible to distribute some money to clients but it has said that the final distribution won’t happen until all client risk positions have been liquidated or transferred and all claims have been validated.

However, a few companies stand to benefit from the demise of MF Global.

One of them is US broker INTL FCStone, which is said to be in the process of buying MF Global’s ring dealing seat on the London Metal Exchange (LME) and taking over the company’s metals trading team. MF Global had share holdings in the LME valued at around $8.05m and now that several exchanges have expressed an interest to buy the LME, those shares could shortly become worth much more.

Another part of MF Global’s operations that is likely to attract a buyer is the company’s over-the-counter diesel and fuel business, a lucrative but less visible part of MF’s energy operations. Even so, the winners are too few compared to the sea of traders who had their fingers burnt in the process and who point to exchanges, clearing houses and regulators as the ones who should have protected them from the fallout.

The soul searching has already begun and CFTC’s O’Malia says that the situation has highlighted areas that the commission should re-examine, including “the manner in which it ensures that intermediaries are complying with segregation requirements and its role in protecting customer positions and funds in the days leading up to and following the insolvency of an intermediary”.I

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

IN THE MARKETS

TYING CEO REMUNERATION TO PERFORMANCE

An Occupy Wall Street protester. Photograph © Arim44 / Dreamstime.com, November 2011.

The battle for control of CEO remuneration A Washington Federal Court in September overturned an SEC ruling that companies had to allow free access to “rebel” shareholders’ proxy statements. Nonetheless, the battle over chief executive officer (CEO) pay continues apace. The Occupy Wall Street movement is just one expressive tip of a volcano of resentment and may harbour change. The finance industry paid out $140bn in bonuses through the financial crisis and in the process focused similar attention on emoluments in the non-financial sector.

Ironically, Wall Street is more democratic and bonuses are spread more widely than in industry, where CEO pay is often much, much higher than that of his subordinates. Ian Williams reports.

HE BAD NEWS for chief executive officers (CEOs) is that cutting pay, pensions and jobs for employees while taking higher pay themselves now guarantees unwelcome attention. In the United States, the top 100 CEO packages run anywhere between $17m and $80m, and CEOs on average earn 342 times more than employees.

The United Kingdom is also jumping on the CEO pay bandwagon. In a strongly-worded submission to busi-

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ness minister Vince Cable’s review of executive pay, begun three months ago, the Institute of Directors’ (IoDs’), director general, Simon Walker, noted at the end of November, “with growing concern, the rapid rise in executive remuneration ... The pace of increase in executive pay is unsustainable”.

Research by the UK’s High Pay Commission found that between 2000 and 2010, the total earnings of all FTSE 350 executive directors went up by 108%,

while over the same period the value of their companies went up by just 8%. In light of this disconnect between pay and performance, among a detailed list of recommendations, the IoD calls for a “binding shareholder vote on executive remuneration policy”, as an answer to rampant growth in executive pay.

UK shareholders currently only have an advisory vote relating to pay decisions that have already been set.

It is hardly surprising then that both London and Washington now insist on capping compensation in companies, particularly in those which have received government help. In the US, the first year of “Say-on-Pay” has had some successes. While it remains to be seen whether the absolute amounts have been curtailed, corporate governance activists are claiming some success in ensuring that remuneration is tied to performance.

Even if shareholder votes are not binding, in these jittery times, the old insouciance of “Let them sell” does not apply. For example ISS, the proxy firm, had recommended a vote against a 2m stock option grant to GE CEO Jeff Immelt in 2010, and the company vigorously rebutted its arguments. Soon afterwards GE reported that after conversations with shareholders, they agreed that 50% of the options kick in only “if GE’s cumulative industrial cash flow from operating activities, adjusted to exclude the effect of unusual events, is at least $55bn over the four-year performance period beginning on January 1st 2011 and ending on December 31st 2014, and the other half would vest only if GE’s total share-owner return met or beat the S&P 500.”

In other instances, faced with only 39% support for its “Say-on-Pay” proposal, the CEO of Penn Virginia immediately stepped down. Others, such as Nutrisystem, Helix and Disney modified their packages to meet objections. Jon Lukomnik of Sinclair Capital, and long-time corporate governance activist, counts it as a qualified success: “Directionally, we’ve seen the beginning of an honest discussion. It forces

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

www.cibeg.com

ŠiStockphoto.com

IN THE MARKETS

TYING CEO REMUNERATION TO PERFORMANCE

companies to justify themselves. Directors should be exercising good judgement,” he says.

The problem is not greedy CEOs, he says, or even over-complacent boards, but a system overloaded with unintended consequences. Most compensation committees for instance want to pay their CEO above-average salaries which, of course, is its own inherent inflationary engine. He also questions the formula used to pay for performance. “[Let’s] admit that the quest of a perfect alignment is a fool’s game. It’s time for a U-turn.” Moreover, he points out that boards do not deal with CEOs as they do with other employees.“If you are hiring a General Counsel, then you wouldn’t hire someone who’s only slightly better than another candidate if he wanted three times as much salary,” he exclaims.

The missing element is “discretion,” he explains, adding:“We have created a system which disguises discretion as a scientific formula. Most long-term plans where the bulk of wealth transfer occurs [are] three to five years. By definition, you don’t know the economic conditions that far ahead or the challenges that the company faces.

[Everyone builds] allowances into their formula; [but] they build in more than they would if they did know.”

Long-time governance activist Robert Monks reminisces about Dennis Kozlowski, one of the most egregious cases of overcompensation. “I used to be a director of Tyco many years ago, so I have a somewhat different view of the depredations. Dennis certainly contributed his share, but the board would have given him everything that he took if he’d simply done the paperwork correctly. The sense that the CEO is the person in the venture who creates the value and is entitled to the money is very deeply seated in Tyco’s culture, which was why I got kicked off the board,” he notes wryly.

David Koenig, chief executive officer, The Governance Fund Advisors, points to Princeton Professor John Darley’s law: “The more any quantitative performance measure is used to determine a group or an individual’s rewards and punishments, the more subject it will be to corruption pressures and the more apt it will be to distort and corrupt the action patterns and thoughts of the group or individual it is intended to monitor.” Koenig adds: “We shouldn’t

blame Wall Street or individuals when it is systemic. The current form of stock options was designed to encourage CEOs to be entrepreneurial, but people didn’t realise that stock options do best with volatility. You incentivise CEOs towards risk, since there is no downside for them and there has been a failure to realise that.” He recommends opening up boards so they are less of a closed system, “but they are isolated.

They all want to validate each other.”

However, with public attention and resentment, and the Say-on-Pay votes exposing the issue regularly, he says: “People are paying attention to it now.

Boards are going to get smarter, and there should be greater transparency and awareness.” But there will be no quick fixes. “No time soon will CEO pay drop to a 60-to-one ratio. It is probably a generational change, maybe not even in my lifetime.” Even so, perhaps the market is beginning to add its own invisible hand to the momentum. Koenig is about to launch The Governance Fund, based on the principle that well-governed companies have less risk, badly governed ones have more.“We’ve back-tested it—and it works well,”he states. Perhaps more corporations can learn from it.I

THE TEN STEP PLAN TO ALIGN CEO PAY! MI, THE CORPORATE governance and ESG specialist blog portal, uses ten yardsticks to assess the S&P 500 companies’ adherence to best practice in the area of chief executive remuneration.

The ratio between the CEO’s pay and the median pay of the other named executive officers is 3X or less.

The CEO’s annual cash incentives rise or fall in line with annual performance.

The CEO receives no more than one annual cash bonus this fiscal year.

The CEO’s equity compensation reflects the company’s share price

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movement over the last five years.

The company only pays long- term incentives to the CEO for abovemedian performance against a peer group.

Annual and long-term incentives are based on diversified performance metrics.

The company’s dilution from equity incentives is 10% or less.

Unvested equity lapses when the CEO’s employment is terminated.

The CEO’s potential cash severance payment is capped at two times the level of annual cash compensation.

The accrued benefits for the CEO’s post-retirement income are within the typical market range for pension benefits in the S&P 500.

On this score, the companies they assessed ranged from an abysmal 12.5 to a top of the class 100, with a score of 40 putting over a fifth of them in the “high concern” category.

Somehow, it is not surprising that the low scoring companies were far more likely to attract negative votes in the Say-on-Pay resolutions.

However, to be fair, that meant that 30% voted against, not a majority.

These are early days however, and clearly with the economy showing few signs of improvement, a board and a CEO that ignores 30% of stockholders is cruising for a bruising. It is unlikely that the silent majority would fall on their swords to protect a greedy CEO.

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

SPOTLIGHT

On October 26th, the reporting requirement known as Form PF was adopted by the Securities and Exchange Commission (SEC). Form PF requires certain advisers to hedge funds and other private funds to report specified information—including leverage, investor types and concentration, liquidity, and fund performance—to the SEC on Form PF. The intention is that regulators can monitor systemic risk within the US alternative investment segment more effectively and, at the same time, improve transparency within hedge funds.

Form PF ups the ante for hedge funds THE FINAL RULES of Form PF have opened up a whole new era for hedge fund and private equity businesses, which will now be forced to disclose more information to the US government than previously required. As such, each entity must now plan how they will address the form’s requirements carefully, according to Kinetic Partners, a global professional services firm to the asset management, investment banking and broking industries.

Form PF applies only to private funds managed by registered investment advisers, registered commodity advisers and registered commodity pool operators. In particular, the three types of private funds that are covered include hedge funds, liquidity funds and private equity funds. Managed accounts and all related person accounts must be included in this calculation. Advisers not registered with the SEC or CFTC do not have to file Form PF. The introduction of Form PF implements Sections 404 and 406 of the Dodd-Frank Act, and requires SEC-registered investment advisers with at least $150m in private fund assets under management to file, on an annual basis, specified information to the SEC, so that its Financial Stability Oversight Council (FSOC) can monitor systemic risk within the US financial system.

Unlike Form ADV, the information reported on Form PF will remain private and not in the public domain.

However, there is another big difference, says Kevin Duffy of financial advisory firm Kinetic Partners: “This rule has been promulgated to satisfy a law’s

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Photograph © MinervaStudio / Dreamstime.com, supplied November 2011.

requirement and not to satisfy the SEC itself.”

The data required by the SEC includes security positions, derivative positions, leverage, counterparty exposure and beneficial ownership.

While the rules of Form PF require managers to disclose more information to the commission, the final rules also make it easier for them to report earnings than outlined in the original rules. Advisers will also now have a 60-day reporting deadline as opposed to the 15-day deadline that was initially proposed. In addition, Form PF will also take effect later than originally intended with advisers with over $5bn in assets under management (AUM) the first to be affected, having to report in the middle of 2012.“The filings for hedge funds must complete within 60 days of the end of the quarter for large investors and the deadline for large private equity fund advisers has been expanded from 15 days to 120 days,” explains Duffy. “The deadline for smaller private fund advisers has been expanded from 90 days to 120 days.”

He adds: “Although imperfect, the newly revised Form PF does provide each fund with ample time to comply

with the legal directives now being administrated by the SEC and CFTC.” The size of a fund matters, says Duffy. Large private fund advisers, those with at least $1.5bn in AUM, are required to file the form quarterly, while smaller registered investment advisers can file annually.“It is clear that the commission is trying to identify and monitor the largest market participants to avoid another LTCM-type problem. That was only a $3bn fund, not ridiculously large, but it was leveraged at almost 50-1 and when it got caught in a bond squeeze, the fallout was tremendous.

You have also to remember that most of the leverage in the United States hedge fund segment comes from the UK via the banks. It is clear the SEC wants to watch those leverage amounts, who the large traders are and how leverage is working,” explains Duffy.

While the SEC is challenged in being able to both aggregate and segregate data to achieve its ends, challenges also are created for advisers and hedge funds alike in having to develop systems to address classification and aggregation of the data required by the regulator.

Advisers will need to understand numerous aspects of Form PF, including issues regarding related persons and the difference between reporting for individual funds and reporting for fund structures (master feeder, mini-master, parallel, etc).

According to Duffy: “It is imperative that each fund’s manager takes the time to seek professional advice to make sure that the initial filings are letter perfect and conform to the regulator’s expectations.”

Form PF will have long-term consequences for the hedge fund

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

sector, which traditionally has been one of the more discrete segments of the global financial markets.

However, Bernie Madoff appears to have changed the hedge fund disclosure landscape as effectively as Richard Read, the shoe-bomber, has forever forced air travellers to show everyone what type of socks and stockings they are wearing. Duffy says: “After Madoff people realised that a regulator’s hand was required to bring honour and integrity back into the business.”

Form PF comes at a watershed for hedge funds, concedes Duffy.

“Markets are so unsure of what is happening that no one is taking on much risk right now. Because of uncertainty in Europe, the United States and even China, which has slowed, some hedge funds have started to deleverage. It is possible that some hedge funds will bow out.

Look at Soros, he has bowed out and is now running his own money, which does not require reporting through Form PF.” Duffy does not think that the introduction of Form PF will be too onerous for the alternative funds industry. After all, he notes: “Although the introduction of regulation has been piecemeal, Form PF has been sitting on the table since February. It would have been hard to miss and consultants and advisers to the industry should be well prepared for its requirements.”

A key question is whether the implementation of Form PF will introduce true rigour in the efforts of regulators to reduce systemic risk.

Duffy thinks it will only go part way and that the SEC has missed a trick by not introducing reporting requirements similar to those which will be required on an upcoming structured products form. If the SEC was serious about monitoring market risk, “Why has Form PF failed to include a self-identification mechanism like they will on a Swaps Form?” he asks rhetorically. I

AFME releases new high-yield guidelines AFME has updated its 2008-recommended disclosure guidelines to promote best practices in high-yield debt transactions.

NEW DISCLOSURE GUIDELINES have been published by the Association for Financial Markets in Europe (AFME), in response to investor concerns regarding structure and disclosure in highyield transactions.

The guidelines provide disclosure recommendations for issuers of non-investment grade debt and will provide additional transparency to investors in Europe’s high-yield sector. They have been developed after consultations between investors and high-yield syndicate teams at the major European investment banks.

The guidelines cover four areas of best practice. The first is disclosure of debt documentation such as intercreditor arrangements, including any amendments and waivers; all of which should be publicly available. Two, offer memoranda should include an org chart, and indicate where each material debt facility is located in the issuer’s corporate structure as well as outline the company’s debt exposure and debt profile, payment terms, financial covenants, definitions and ratios. Three, the issuer of noninvestment grade debt securities should promptly disclose to the same extent and in substantially the same manner as its initial disclosure when a triggering event happens, such as a material change to the issuer’s corporate legal structure.

Finally, AFME is also keen to remind issuers of non-investment grade debt securities of their recurring and special reporting obligations under the indenture or trust deed and the listing rules of the exchange on which the securities are listed. Any financial reports or other disclosure given

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

after the initial issuance of noninvestment grade debt securities should be consistent with the reports and disclosure given in connection with the initial issuance.

AFME also outlines detailed requirements for ongoing reporting.

Gary Simmons, director of AFME’s leveraged finance division, says: “Revising our disclosure guidelines and providing a platform for continued discussions between our investor and sell side members form part of AFME’s ongoing commitment to fostering dialogue between market participants and encouraging our members in the use of best practices.”

Ongoing discussions will continue via the High Yield Investor Issues Committee set up by AFME’s leveraged finance division. The committee will help to maintain a dialogue between buy side and other market participants, including the banks’ high-yield and loan syndicate teams, and will also monitor and debate key industry issues that are uppermost in the minds of investors.

European leveraged finance issuance (leveraged loans and highyield bonds) totalled €20.3bn in the third quarter of 2011, a decline of 53.2% and 23.8%, respectively, over the second quarter of the year (€43.3bn) and compared with the third quarter in 2010 (€26.6bn).

During the first three quarters of 2011, leveraged finance issuance reached €109.3bn, compared to €76.4bn during the first nine months of 2010. Simmons remains optimistic about the prospects for the segment, notwithstanding the market stresses impinging on issuance volumes right now. I

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ASSET ALLOCATION

ASIAN DRS: FOURTH-QUARTER SLOWDOWN; BUT GOOD PROSPECTS IN 2012

New Asian DR issues down.

Will 2012 be any better?

Against the current backdrop of an unresolved eurozone crisis and slowing global economy, it is not surprising that the depositary market across the spectrum has grown quiet. Asian companies along with Brazil still account for the bulk of global DR issuance but like many they are waiting and watching for events to unfold. Lynn Strongin Dodds reports.

CCORDING TO GREGORY Roath, head of Asia-Pacific for BNY Mellon’s depositary receipts (DR) business, it is“fair to say in respect to capital raising, which includes initial public offerings of depositary receipts, there has been a general slowdown. It has affected the plans of issuers who were considering issuing in the third and, potentially, in the fourth quarter.

There is still a healthy pipeline but in terms of timing, they may want to wait until the first or second quarter of 2012.”

Kenneth Tse, Asia Pacific head of JP Morgan’s depositary receipts group, adds: “There has been a great deal of global uncertainty with Europe in the middle of it. However, although flows to emerging markets have slowed, the Asian economy and the BRIC countries in particular have been more resilient. The one major trend that we have seen this year is the return of Russia, which was totally absent last year.”

According to Edwin Reyes, managing director and global product head of depositary receipts at Deutsche Bank, there were 166 new depositary receipt deals and follow-ons in 2010 with Asia accounting for 70%, Europe at 17% and Latin America at 10%. So far this year, the total has been 96, with Asia contributing 53%, Europe at 28% but staying roughly the same as in 2010 in terms of the number of deals, and Latin America at 13%.

The bulk of activity happened in the first half with BNY Mellon figures

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showing 79 new sponsored programmes from 19 countries compared to 64 programmes from the same period in 2010. Australia led the way with 13 followed by 12 from India and nine each from Russia and China.

Brazilian and Mexican issuers were also busy with four each. In terms of capital raised, issuers from Russia accounted for nearly half of the total $11.7bn in the first six months with financial group VTB’s $2.8bn followon offering being the most notable as the largest DR capital raising. Meanwhile, China and India executed the largest number of transactions at 12 and 11, totalling $2.6bn and nearly $200m respectively.

The BNY Mellon report noted that the New York Stock Exchange and NASDAQ remain the most popular venues for listings, accounting for almost 86% of all DR trading value worldwide. In total, 65.1bn US-listed DRs, valued at $1.66trn, traded on US markets during the first half of 2011 with the most active being China’s most popular online search engine, Baidu, Brazil’s Petrobras and industrial metals and mining firm Vale, the UK’s BP and Israel’s Teva Pharmaceuticals.

“The US continues to be the most popular for the Chinese private sector because that is where their peer group is,”explains Roath.“Investors understand start-up companies and their business models.” Tse echoes the sentiments.

“China prefers the US markets because the internet and e-commerce industries

are more developed in the country than in Europe. Russian companies though like the London Stock Exchange because it is stronger in mining and commodity related businesses.”

While fears over the eurozone debt crisis and slowing economic growth are making participants nervous, they are not the only reasons holding Chinese and Indian companies at bay. Accounting scandals in both countries have also made investors wary. There have long been suspicions that Chinese companies listed overseas do not adhere to strict accounting standards plus there are concerns over the Chinese government prohibiting US regulators from examining China-based auditing firms.

Reporting irregularities In September, these issues came into sharper focus when the US justice department announced it was investigating accounting irregularities at Chinese companies on the US exchanges. Although the names of companies have not been revealed, it has been reported that it is looking at both civil proceedings as well as criminal charges. The minute the news hit the wires, American DRs of some Chinese companies such as Baidu as well as Weibo, which runs a service similar to Twitter, fell sharply.

The charges came after a review conducted earlier in the year by the US Securities and Exchange Commission (SEC) into accounting problems at foreign-based stock issuers. It was looking into the resignations of auditors and book-keeping irregularities at dozens of China-based companies. For example, Deloitte Touche Tohmatsu CPA in May resigned as auditor of Chinese software company Longtop Financial Technologies, because it said it found falsified financial records and

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

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ASSET ALLOCATION

ASIAN DRS: FOURTH-QUARTER SLOWDOWN; BUT GOOD PROSPECTS IN 2012

bank balance confirmations. Valentina Chuang, head of depositary receipt services for Asia at Citi, says: “Although market conditions are the main reason why there has been a slowdown in issuance from Chinese companies, the scandals have had some impact. It has made investors more cautious. They are asking more questions and looking more closely at the companies’ corporate governance structures.”

In some ways, the scandals have had a positive impact in that it is forcing Chinese companies to raise their game.

They not only have to strengthen their corporate governance standards but also their disclosures to the US regulators.

As for India, the Securities and Exchange Board of India (SEBI) banned seven companies from raising fresh capital, after investigations revealed they manipulated share prices after issuing global DRs (GDRs). The regulator also barred ten entities, including a foreign institutional investor (FII) and sub-accounts, from dealing in securities market.

A recent study conducted by Crisil Research, which is part of the Standard & Poor’s Index Services Group, analysed 40 GDRs issued by Indian companies in 2010 and found that investors lost money in 85% with four out of five issues giving a negative return of 35% or more.

Looking ahead, while no one is brave enough to predict when the markets will recover, participants are hopeful that there will be a crop of issuance from India and China in the first and second quarters of 2012. ”One of the key challenges is the slowdown in some markets and that there is not the same level of deals coming through,” says Reyes.”However you have to be competitive and ready for when the markets improve. You also need to be able to provide more than the basic services. Issuers are looking for valueadded capabilities such as support with their investor relations programmes.

In this case we adopt a more consultative role and help them with identifying new investors.”

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Local markets such as Hong Kong and Taiwan, albeit hit by the current turbulence, are also expected to rebound. They are increasingly attracting foreign companies on the back of the Asian economic growth story.

Taiwan has been a favourite with repatriated companies although it is gaining traction from firms that do not have the same domestic connection. For example, in May, Hong Kong-listed companies NewOcean Energy Holdings, a vendor and distributor of liquefied petroleum gas in China and New Media Group Holdings, an investment holding company, filed to list troubled debt restructurings (TDRs).

HK draws luxury brands Hong Kong too is popular, particularly with foreign luxury brand names which want to tap into mainland China’s burgeoning middle classes and wealthy consumers. Handbag manufacturer Coach, which announced in May its intention to list on the Hong Stock Exchange, was hoping to make its debut in early December. It follows Italian fashion house Prada and US luggage manufacturer Samsonite International, which raised $2.5bn and $1.25bn respectively in June. Coach, like other luxury brands, is targeting China’s newly-affluent consumers and says it plans to open 30 stores in China next year.

The handbag maker says in a filing to the Hong Kong Stock Exchange that it will issue up to 293.6m Hong Kong depositary receipts “by way of introduction” rather than a public offering and said no new funds would be raised. “China is our largest geographic growth opportunity, given the size of the market, its rate of growth, and our increasing brand awareness,” the company says in the statement. Fashion IPOs are also having a knock-on effect on their Chinese suppliers. One of Coach’s major Chinese suppliers, handbag maker Sitoy Group, is also due to list in Hong Kong in December.

Hong Kong is also a magnet for natural resource companies that want to forge closer links with resourcehungry China. For example, Swiss commodities trader Glencore International raised $20bn through a dual listing in Hong Kong and London in May. There are also stirrings in the frontier markets of Mongolia, Indonesia and Vietnam which are looking towards Hong Kong as a way to raise their profile in China. Tse says: “Although BRIC will continue to dominate GDRs, we are seeing interest from stateowned enterprises for example in Mongolia. The firm recently organised the first Capital Raising Options for Mongolian Companies workshop where participants worked with the government to educate companies on how they can raise funds through a listing in Hong Kong. Vietnam has also seen a small number of GDRs below the $50m mark and I expect to see larger deals in the next two to three years.”

Aside from new countries entering the local DR game, different structures are also expected to appear. In June this year, Barclays Bank’s listed nine of its iPath exchange-traded notes (ETNs) on the Tokyo Stock Exchange via a Japanese DR. It was noteworthy for being the first ever ETN listing in Japan as well as the first listing of non-Japanese securities in a format of a JDR. We see this as a very interesting development,” says Chuang. “One of the main reasons for the listing is to attract liquidity and we now are seeing more ETF and ETN providers hoping to replicate the process in Japan. As for the growing importance of the renminbi (RMB) market, DR players do not see it as a threat but as a complement to equity issuance.

“RMB issuance is a growing sector in some bond markets and we would expect this to continue once markets stabilise “says Roath. “In time we believe that equity RMB issuance will follow. However, it depends on the financing needs and structure of the company as to whether debt or equity is preferable.”I

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

ASSET ALLOCATION

HIGH NOON FOR PHYSICAL VERSUS SYNTHETIC ETFS

The sovereign debt crisis has become a gigantic stress test for synthetic exchange-traded funds (ETFs) that may well determine whether they can compete against physical ETFs or will survive only as niche products used in markets where physical replication is impractical. Synthetic ETFs make up about half the market in Europe, though only a handful exist in the United States where current regulations limit the ability of registered investment companies to replicate index performance using derivatives. Market participants have long debated the relative merits of physical and synthetic ETFs, but now investors are voting with their feet. Neil O'Hara reports.

Can synthetic ETFs continue to compete?

T FIRST GLANCE, a physical ETF, which owns the components of the index it seeks to track, is a less risky investment than a synthetic ETF, which delivers the return on the benchmark index through total return swaps. Appearances can be deceptive, however. Most physical ETFs offset part of their expenses through securities lending, a bilateral transaction that introduces the same collateralised counterparty credit risk a swap entails. If the counterparty defaults, a physical ETF must sell the collateral and use the proceeds to replace the securities lent out, just as a synthetic ETF would use collateral to replace its swap exposure.

Except for commodity ETFs that own the underlying asset rather than futures contracts or swaps—the precious metal ETFs, for example—and a few early US ETFs such as the SPDR, the original ETF that tracks the Standard & Poor’s 500 index, physical ETFs do lend the securities they own. “The early ETFs were unit investment trusts, which have no investment discretion,” says Townsend Lansing, head of regulator affairs at ETF Securities in London.“The physical replicating ETF structures evolved to permit securities lending. Both synthetic ETFs and physical ETFs that engage in securities lending have similar counterparty

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credit risk.” For the vast majority of ETFs, the debate over the relative credit risk of physical versus synthetic vehicles is moot, at least in theory.

ETF Securities is an independent sponsor of about 150 ETFs with $28.3bn under management. It specialises in commodity ETFs, typically structured as debt instruments backed by collateral, which is held by an independent trustee to buttress investor protection. The products mimic the legal framework of UCITS even though they do not qualify under rules that preclude UCITS funds from holding commodities.

The credit risk in a collateralised ETF product is the difference between the collateral value and the market price of the underlying asset after the counterparty fails, not the entire principal amount. Townsend says investors have three primary concerns: the quality of the collateral, how closely the collateral is correlated to the underlying asset, and how fast the fund can take possession of the collateral. “Those three issues apply equally to a physical ETF that does securities lending and an ETF using swaps,” he says.

Investors today enjoy greater transparency about the collateral backing a synthetic ETF than for the securities lending collateral in a physical ETF. In

response to concerns that arose after Lehman Brothers failed, the leading synthetic ETF sponsors began to post on their websites daily updates about the collateral supporting the swaps in each product. Credit Suisse even posts the serial numbers and identifying marks for the individual bars held in its precious metals ETFs. Physical ETFs may even have greater credit exposure than their synthetic siblings, depending on the collateral guidelines applied to their securities lending programmes. The prospectus for a physical ETF discloses that the fund may engage in securities lending, but sponsors neither identify the counterparties to whom they lend nor give any information about the collateral received. In addition, the broker dealers who borrow the securities and lend them on to hedge fund clients often re-hypothecate the collateral they receive, which ratchets up broker dealer leverage and the credit risk associated with securities lending.

UCITS restricts the maximum residual credit exposure to the sponsor of a synthetic ETF sponsor to 10% of fund net assets, but the leading sponsors have adopted lower thresholds: a 5% target for db-X-trackers and zero at Lyxor. Simon Klein, head of ETFs Europe at Lyxor, notes that synthetic

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

Photograph © Vlastas / Dreamstime.com, supplied November 2011.

Lyxor’s Klein says the largest physical emerging markets ETF in the US underperformed by more than 6% in 2009 and outperformed by the same amount the following year. “An ETF cannot hold Indian stocks,” he says. “It has to use sampling to replicate the index performance.

The physical structure can be very inefficient in many instances; emerging markets, for example.”

ETF products survived a trial by fire during the 2008 financial crisis, too.

“All the swaps were settled,” he says.

“There was no problem in ETFs.” Lyxor manages $38.6bn in ETFs, all of which are synthetic. Created under French law, Lyxor ETFs must hold at least 75% of the collateral in European assets, although in practice the proportion is usually higher—in early November, it was 90% European, 6% UK and 4% US. Unlike some of its competitors, Lyxor holds the collateral in the ETF itself rather than in a pledged account at a third party, a structure that should enable Lyxor to act more quickly if disaster strikes. “It is a similar risk, but with a pledged account the manager has to move the collateral into the fund. It is already there in our structure,”says Klein.

Credit risk is a bigger concern for investors in exchange-traded notes (ETNs), which offer the return on a

benchmark just like an ETF. Legally they are quite distinct, however: ETNs are unsecured obligations of the issuer, typically a major bank or securities house. Most ETNs enjoy collateral protection, but the issuer has considerable discretion over the type of collateral and may retain possession of it.“Some ETNs have ring-fenced collateral,”says Phil Mackintosh, global head of portfolio strategy and ETF research at Credit Suisse.“You have to look at notes products case by case.”

Investors do not appear to distinguish between sponsors affiliated with major securities houses, which use a single swaps counterparty—Deutsche Bank for db-X-tracker ETFs, Société Générale for Lyxor ETFs—and independent sponsors such as ETF Securities, which have multiple counterparties and could cut their exposure to a particular firm if its creditworthiness came into question. Synthetic ETF

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

sponsors now follow risk management practices long used in the securities lending market, including daily mark to market valuations and adjustment of the collateral amount. “Most ETFs are run by managers who are conscious of the risks and try to minimize the exposure,”says Mackintosh.“The credit risk in synthetic ETFs is not as high as people think.”

Another critical risk in any ETF is tracking error, the extent to which fund returns differ from those on the benchmark it purports to mimic. Synthetic ETFs have the edge here. A total return swap delivers the exact return on the index, which limits tracking error to fund expenses plus the cost of index replication through swaps, including adjustments to the principal amount as fund assets wax or wane. A physical ETF bears similar costs, although the market impact of trading securities rather than adjusting the swap principal amount is higher, particularly in less liquid securities. A physical ETF may incur tax costs related to the dividends it receives, too.

In addition, physical ETFs do not hold every security in the underlying reference index. A broad benchmark may have so many components, including some in countries where foreign ownership restrictions prevent an ETF from owning the correct weighting in each stock that it would be impractical to rebalance the fund whenever assets fluctuate or the index components change.

For example, the MSCI World Index, which has about 1,600 components, goes through a major revision every year that sometimes adds or removes as many as 300 names. Physical ETF sponsors use “optimised sampling”, whereby the fund typically owns only the largest and most liquid index components, which cuts trading costs but raises tracking error.

The error can be significant. Lyxor’s Klein says the largest physical emerging markets ETF in the US underperformed

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ASSET ALLOCATION

HIGH NOON FOR PHYSICAL VERSUS SYNTHETIC ETFS

by more than 6% in 2009 and outperformed by the same amount the following year. “An ETF cannot hold Indian stocks,” he says. “It has to use sampling to replicate the index performance. The physical structure can be very inefficient in many instances; emerging markets, for example.”

The synthetic ETF structure enables investors to access asset classes they could not easily hold in physical form, such as commodities, currencies or hedge funds. Mackintosh at Credit Suisse points out that some US ETFs now offer“factor exposure”to portfolio characteristics. For example, a volatility ETF may go long technology or airlines, which exhibit high volatility, and sell short consumer staples or other industries less susceptible to market swings. “Some funds are long-short baskets from which the manager extracts some attribute other than beta,” Mackintosh explains. “It is hard to do that in a physical ETF. If it is not a swap- or note-based product the ETF has to manage loans.”

US Securities and Exchange Commission (SEC) rules preclude most synthetic ETFs in the United States except for some grandfathered leveraged and inverse products, which are among the most controversial ETFs on the market. They work as advertised on an intraday basis, but rebalance every day and make no claim to track the reference index over longer periods. They are trading chips designed for professional investors— but also available to retail investors who may not understand the risks.

Inverse ETFs carry extra credit risk, too. If a counterparty fails, most markets will go down, inflating the defaulted swap value to the ETF—and the risk that collateral may not cover the full replacement cost of the swap.

Critics of synthetic ETFs argue that in specialised niches the fund could outgrow liquidity in the underlying assets. In practice, the creation and redemption mechanism embedded in every ETF ties the liquidity of the fund to liquidity in whatever index it tracks.

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Patricia Little, a senior research analyst at Mercer. “An endowment doesn’t want to lose donors by having assets in the fund that will upset people. Why worry about something if you don’t have to and it doesn’t have a significant cost?” she says. Photograph kindly supplied by Mercer, November 2011.

Townsend Lansing, head of regulator affairs at ETF Securities. “The physical replicating ETF structures evolved to permit securities lending.

Both synthetic and physical ETFs that engage in securities lending have similar counterparty credit risk,” he says. Photograph kindly supplied

by ETF Securities, November 2011.

“People have to hedge, even in a swaps-backed ETF,” says Lansing at ETF Securities.“The real concern is on the other side, if you get a run on the fund—but that can happen with any investment, not just an ETF.” Investor preferences between synthetic and physical ETFs depend on cultural factors and perceptions as well as hard analysis. For example, an endowment fund must disclose its investments to the university administration and donors in its annual report.

Whenever derivatives are blamed for an unforeseen event, the portfolio manager can expect faculty and donors to carp at the risks the fund is taking if it trades these instruments.

“An endowment doesn’t want to lose donors by having assets in the fund that will upset people,” says Patricia Little, a senior research analyst at Mercer, an investment consulting firm.

“Why worry about something if you don’t have to and it doesn’t have a significant cost?” Portfolio managers may prefer physical ETFs rather than take flak from key constituents who believe synthetic ETFs are too risky.

The credit risk in either swaps-based ETFs or physical ETFs that lend their securities only comes home to roost if a counterparty goes bust, of course.

Memories of the Lehman Brothers collapse are still raw, however, and the demise of MF Global is a timely reminder that, although rare, bankruptcies do occur among financial firms—and with little or no warning.

“Counterparty failure has a low probability, but it doesn’t creep up,” says Little. “It hits you smack in the face.

Given current financial uncertainties, why should investors take that risk?”

According to figures compiled by Deutsche Bank, investors have pulled money from synthetic ETFs and switched into physical products as the eurozone debt crisis intensified in recent months.

Lyxor has suffered the largest outflows— €5.6bn year to date—amid concerns about the exposure of French banks, including Société Générale, to Greece and other troubled Eurozone countries.

Synthetic ETFs today face a tougher test than in 2008 that could determine whether they will play a leading role in the future or merely a bit part.I

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

SECURITIES SERVICES

ETF FUND ADMINISTRATION: A DEEPENING SKILL SET

Photograph © Skypixel / Dreamstime.com, supplied November 2011.

Risk reduction in ETF fund administration At more than $1trn in US assets under management (AUM) and climbing, the market for exchange-traded products (ETFs) appears to have plenty of room to move. For fund administrators, the rise in ETF popularity is an opportunity in the making. To make a go of it, however, firms must be able to reckon with increased ETF product complexity, confront challenges associated with crossborder ETF activity, while having the scale to stay profitable in a sector known for its low-cost ratios and razor-thin margins. From Boston, David Simons reports.

NICHE MARKET at best a decade ago, today exchangetraded products (ETFs) encompass a wide range of strategies covering numerous indices and markets, offering a comparatively low-stress approach to working with familiar benchmarks as well as fixed-income products, commodities and various other

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innovations. At more than $1trn in US assets under management (AUM) and climbing, ETFs as a product appear to be very much in their infancy.

Due to their low cost and tight margins, ETFs haven’t always been the most lustrous target for fund administrators. However, the tremendous flows into these products, along with a

marked evolution in ETF product structure, have compelled administrators to reassess the benefits of supporting ETFs. “Many argue that the ETF structure is the proverbial ‘better mousetrap’ in terms of an improved fund structure, principally due to things like transparency, low cost, and tax efficiency,” says Shawn McNinch, senior vice president, global head of ETF services for Brown Brothers Harriman.

For a fund administrator to have at least a marginally successful business foundation, versatility and scale are critical attributes. Administrators need to offer clients a diverse base of revenue-generating solutions; they must also be able to deal with the significant pricing pressures that are unique to the ETF space, such as costs related to providing multiple NAV data streams for cross-listed ETFs (as is the case in Europe and other cross-border environments). Given the low-cost nature of the business, above all administrators require efficient, automated solutions in order to make the economics work for all involved.

There is also the expectation that administrators will continue to preside over the same tremendous rates of growth that have propelled the ETF space over the past several years. This in turn is driving firms into less mature regions in hopes of maintaining the heady pace of ETF profitability in the months and years ahead.

Jeffrey McCarthy, global ETF product head at Citi Global Transaction Services, says that ETF fund administration can be a very labour-intensive operation, with margins perpetually being squeezed.

“Obviously having proper size, as well as the means to create efficiency through leading-edge technology, is essential for a fund administrator to maintain a footprint in this segment.”

However, the notion that ETFs are not nearly as profitable as traditional fund management is a misconception, says McCarthy. “The things that make ETFs low-cost vehicles do not necessarily impact an administrator’s business model,” he says. “When you look at

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

SECURITIES SERVICES

ETF FUND ADMINISTRATION: A DEEPENING SKILL SET

compensation before a fund administrator’s responsibility for net-asset valuation, financial reporting and the like, I think it is fairly consistent with what you would expect to find in comparison to a long-only fund.”

Administrators are typically responsible for providing a single NAV at the ETF’s base currency; however, in the case of ETFs in the European Union or Asia that are cross-listed on multiple exchanges with varying underlying currencies, administrators must disseminate information to multiple parties. This can result in additional costs, due to the need to develop supplemental data streams.

“Ideally, you want to have some consistency in the way these sources receive their data, but of course, that isn’t always the case,”says McCarthy.

In that sense, further customisation may be required in order to achieve the desired level of transparency per recipient. This in turn has led to the growth of organisations that have been able to build a business around price dissemination on behalf of the asset manager. In the US, groups such as the Depository Trust & Clearing Corporation (DTCC) and its subsidiary, the National Securities Clearing Corporation (NSCC), act as a central point of broadcast to the primary market liquidity agents.“In the absence of a single counterparty in Europe, data providers such as Markit, Interactive Data Corporation (IDC) and others like them have the wherewithal to get this data across, irrespective of who the service provider is,”says McCarthy.

Offering clients a comprehensive suite of services covering different types of asset classes is imperative, says McNinch, including support for both physically-backed as well as synthetic ETFs. “BBH has been fortunate enough to work with a wide variety of ETF sponsors to support launches of equity, fixed income, currency, commodity, leverage/ inverse, and active ETFs. Physicallybacked products require additional effort on the custody side of the business given the settlement of the underlying securities. For synthetic ETFs, there is more effort on services focused on managing

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Jeffrey McCarthy, global ETF product head at Citi Global Transaction Services. “A strong presence in collateral management is absolutely essential in synthetic swap-based ETFs. This allows us to deliver a robust automated and scaleable solution on behalf of the asset manager,” he says. Photograph kindly supplied by Citi Global Transaction Services, November 2011.

Shawn McNinch, senior vice president, global head of ETF services for Brown Brothers Harriman (BBH). “Using our ETF product knowledge and global network expertise, we are able to partner with our clients in order to assist in designing and implementing their ETF distribution plan across the globe,” he says. Photograph kindly supplied by BBH, November 2011.

and safekeeping the collateral tied to derivative/swap contracts.”

When it comes to dealing with the price disparities that can exist between various asset classes, leading fund administrators have often played a key role. “A strong presence in collateral management is absolutely essential in synthetic swap-based ETFs,” suggests McCarthy. Rather than creating a whole new vertical set of technologies, however, administrators such as Citi have been able to simply draw upon pre-existing skill sets.“This allows us to deliver a robust automated and scaleable solution on behalf of the asset manager,” he adds.

Having joined the fray slightly later than some of their peers, Citi was able to watch and learn as early adopters developed their ETF-based processes through trial and error. “Some of these models have worked, while others warranted further attention,”says McCarthy.

“Using this information, we were able to step back and identify all of the synergies that existed between asset classes and come up with a single system that took into account the specifics of an equity, fixed income, futures contract or swap, while also integrating all of our other firm-wide capabilities as well,” he says.

Citi believes it has benefited by using technology that leverages its existing platforms across the global transactional banking space and create processes that can effectively automate specific ETF components. Says McCarthy: “We felt we needed to take our time in order to get it right, particularly as these products became increasingly sophisticated as a result of the trend towards emerging, frontier and other esoteric markets.

Therefore we’ve emphasised putting our technology into automating straightthrough processing of pricing around these complex asset classes, or construct-

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

SECURITIES SERVICES

ETF FUND ADMINISTRATION: A DEEPENING SKILL SET

ing ETF portfolio composition files, improving the pipeline for central clearing, and so forth.” This has had an enormous impact on risk reduction around ETF daily pricing and the settlement of the creations/redemptions basket, adds McCarthy.

What makes the ETF space particularly attractive for early adopters, such as BNY Mellon, is the ability to offer support to even sophisticated investment managers who aren’t yet familiar with the lie of the land.“It allows us to become much more engaged in a consultative manner on behalf of both prospective and existing clients,” observes Joseph Keenan, managing director, BNY Mellon Asset Servicing.

“So no matter what they may have on the drawing board, we are able to get in the lab with them so to speak in order to help with initial product design.”

While the gestation process for ETFs (exemptive relief can run anywhere from six months to two years) has often led to a logjam in new sponsorship, the waiting period gives ETF architects such as BNY Mellon ample time to engineer the product, from ETF construction and distribution, to visibility, sales and the like.

“It allows us to get in the door, add value and hopefully develop long-term relationships with the client,” says Keenan.

Providing value to clients Having a keen understanding of various market practices and requirements, including tax implications and regulatory issues, is also key to providing value to clients, adds BBH’s McNinch. In Ireland, for example, local laws did not initially take into account issues related to shareholder-register maintenance, whereby shares are registered for sale in a number of different jurisdictions.

“Using our ETF product knowledge and global network expertise, we are able to partner with our clients in order to assist in designing and implementing their ETF distribution plan across the globe,” says McNinch.

Speaking before a Senate sub-committee meeting in October, Noel Archard, managing director for leading

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Joseph Keenan, managing director, BNY Mellon Asset Servicing. “Clients are driving us to these markets. As a result, we’re now really focused on ramping up our capabilities to support locally registered and cross-listed products, particularly in these emerging areas,” he says. Photograph kindly supplied by BNY Mellon Asset Servicing, November 2011.

ETF provider BlackRock, argued that exchange-traded products based on derivatives “should not be labelled ETFs” due to their complexity and high levels of risk. Archard’s remarks echoed sentiments expressed earlier in the year by the International Monetary Fund (IMF), which held that such esoteric ETF products have been partially to blame for the degree of turbulence within Europe’s financial markets.

Though ETF growth in the US is expected to remain strong, further regulatory tightening may constrict the flow to some degree.“Particularly in the active space, the SEC has been reluctant to green light anything that isn’t fully transparent,” observes Keenan. While many have welcomed this kind of inquiry, particularly as ETF activity continues to mount, others see a direct impact on the amount of innovation that can be reasonably employed within the exchange-traded arena.

“There are those who suggest that anything other than a pure passive product should not be called an‘ETF’,”he says. Competing on price cannot benefit the markets in the long run, says Keenan, hence the attraction of continuing to develop active-type products as well as those with fundamentals- or performance-based benchmarks.

“Regardless of whether they are simple or complex ETFs, the onus is on administrators, as well as their assetmanagement clients, to ensure that investors stay informed.”

For example, while ETFs as a whole have been extraordinarily tax-efficient, not all products offer the same types of advantages; the tax treatment of some derivatives- or futures-based ETFs is often markedly different from vanillatype products—much to the surprise of some investors who took the plunge without necessarily studying the prospectus beforehand. “To some degree, the catch-all acronym ‘ETF’ has done a disservice to the more sophisticated products, including listed partnerships requiring retail K1s and the like,”contends Keenan.“So it really is a buyer-beware type of situation.”

Rather than eliminating product sophistication altogether, observers such as Keenan believe that education is a much better strategy.“By and large, I think that firms have done a good job of articulating what these tools are used for, and under what circumstances they may not be the standard buy-and-hold type of instrument.”

While reaping the benefits of ETF growth in North America and EMEA, administrators must also be on the lookout for other opportunities in the making—in part by simply listening to their clients. “I’d like to say that we’ve been prescient, that we just show up in a region like Asia or Latin America and wait for the demand to arrive,” says Keenan. Even so, he adds: “Clients are driving us to these markets. As a result, we’re now really focused on ramping up our capabilities to support locally registered and cross-listed products, particularly in these emerging areas.”I

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

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FX VIEW

HOW TO SURVIVE ANOTHER YEAR OF PROFLIGACY AND GREED

The continuing need for drastic action After 12 long and dramatic months, it is December on the calendar yet again in this, the Year of the Tweet, and that means we’ve all survived another year of profligacy, greed, and impatience—indeed, the common qualities among traders, and none more than those found in the FX market. So that we can best hope to leverage these signal talents in the year ahead, Erik Lehtis indulges in that hoariest of journalistic practices—the year in review and what’s in store for the ensuing 12 months.

F WE DON’T learn from the lessons of 2011, we are of course doomed to repeat them. So rather than inflict my same columns on you next year, rebranded like an American sedan, I’ll quickly summarise the main themes.

I began the year harping relentlessly about Pure FX and the implications of an interbank FX market that refuses to give up the notion that it is somehow entitled to a special class of access and liquidity by virtue of being banks.

Regulatory hell awaits those who, especially in this environment, seek to take price discovery and order execution behind closed doors. While the much-rumoured brand Pure FX gave up its purely presumptive ghost, reports of the death of the spirit of opacity and entitlement that comprises the worst of the banking world appear to have been premature.

We can expect to see an instantiation of this fever dream of those Too Big To Fail sometime in 2012. May it meet the fate it deserves (which I leave you to ponder).

While several months’ columns were consumed by the explication of this theme, I did eventually manage to distract myself to the subject of the strong Swiss franc and the value of central bank intervention in the FX markets, and from that point global events continued to lead the way and we landed smack in the middle of the debate over the viability of the common currency known as the euro.

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To me, the euro is Pure FX writ large. The human traits I listed in my opening paragraph transpose to the institutional level very handily, and are in fact rewarded far too often.

Just as banks have always sought, with a herd-like mentality, the protection of market share via regulation (or deregulation) and sometimes via legislation, so too did the countries of Europe pursue relief from difficult fiscal and political decisions under the umbrella of a single monetary authority—the European Central Bank (ECB).

Unwilling to ride out the economic impact of the choppy peaks and valleys of a freely-traded currency, the nations of Europe chose, as the millennium approached, to abdicate control over monetary policy in exchange for a collective fate in the FX market; even if it meant that they would no longer have the benefit of localised currency fluctuation.

However, they did not reckon on how the impact of this loss of insulation would be felt by remaining markets, and now the vultures have come home to pick at the carcasses of their sovereign debt. Had the PIIGS retained their individual currencies, the intense pressure being felt directly by their bond markets would have been filtered through their currencies’ values, and the prices of their bonds would have suffered far less in local terms.

Erik Lehtis, president of DynamicFX Consulting. Photograph kindly supplied by DynamicFX Consulting.

So what does all this mean for 2012? To start, we will see how the latest heroic efforts (by the time this goes to press, I am confident there will be a whole new set of such) to save the patient will work, but my view remains that the fundamental lack of alignment between monetary and fiscal policy in Europe will continue to be battered by market dynamics. The euro was born fait accompli amid an atmosphere of false economic optimism fuelled by deregulation, the dotcom boom, a real estate bubble, and then severe geopolitical distraction (9/11). It is only now being tested by conditions often described as a perfect storm, but which could in fact have been inevitable once the convergence honeymoon ended.

For Europe, it is almost de rigueur now to repeat the mantra that things will get worse before they get better, but unfortunately that alone doesn’t mean they won’t. The economy in the United States is starting to show signs of turning around, and as long as Europe manages to keep things from going straight in the tank, the US could become an engine for growth in the months ahead.

Nevertheless, immediate prospects aren’t appealing, and the temptation may be to reminisce about Christmases past rather than look ahead to Christmas yet to come. The need for drastic measures is never easy to contemplate, but with regard to the euro, putting off the inevitable will only exacerbate the pain when the correct decision is the only remaining option.I

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

DEBT REPORT

The risk-aversion mentality that seized investors in the third quarter of 2011—as continuing failure to resolve the sovereigndebt problems in the eurozone threatens to plunge Europe back into recession—has had a predictable impact on the high-yield bond markets on both sides of the Atlantic. By Andrew Cavenagh.

IGH-YIELD NEW issuance is a fraction of the levels seen in the first half of 2011, while secondary-market prices have collapsed as cash has deserted high-yield funds on a massive scale. “Some funds have seen 35% redemptions in the last three months,” claims Patrick Bawlf, a credit desk analyst at Nomura in London. A recent survey of Dutch pension funds’ investment intentions, published in the first week of October, confirms the trend. Only 16.7% of the respondents said they were making tactical allocations to high yield. A year ago the number was 57%.

The US is the largest and most resilient high-yield market, but only $7.8bn worth of bonds ($6.8bn of them from companies) came to the market in September, compared with $50.4bn in the same month of 2010. Third-quarter issuance was a mean $35.5bn, following a miserly $5.9bn of issuance in August.

Compare this with the $100bn-plus totals that were recorded in all four preceding three-month periods.

Market fears have contributed to selling pressure; with the Barclays Capital US Corporate High Yield Index losing 4.2% over the month to register an 8.4% drop for the quarter, much to the chagrin of all those yield-chasing investors who had favoured the sector over US Treasuries at the start of the year.

In Europe, an unprecedented surge in primary issuance in the first half of the year came to an abrupt halt at the end of July. After sub-investment-grade companies raised €3bn from bond investors that month, nothing came to

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Photograph © Iconspro / Dreamstime.com, supplied November 2011.

the market in August as worrying developments in the eurozone once again caused investor enthusiasm for risk to evaporate. Three companies, Heidelberg Cement, Fresenius Medical Care, and Peugeot, did manage to issue €1.2bn of debt between them in September. However, the price they were obliged to pay did little to suggest that other companies would be queuing up behind them for choice.

Heidelberg, a stock that has minimal direct exposure to the eurozone risk and has real emerging-market growth potential, priced a €300m bond with a seven-year maturity and a 9.5% coupon on September 30th at 99.3% of par to offer a yield of 9.625%; although the bonds broke back through par in subsequent trading to reduce the yield to

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

HIGH YIELD: INVESTORS ON THE RUN?

Pressure continues in high-yield segment

9.35%. These figures can be compared with the 6.75% coupon and an initial yield of 6.875% on the €650m of debt the cement producer issued in June 2010. Peugeot’s latest €500m issue, offering a coupon of 6.875%, priced to yield 7%.“Unless you really have to come to the market, this isn’t the market to test,”observes Gary Jenkins, head of fixed-income research at Evolution Securities. “Having de-coupled from sovereign debt earlier in the year, high yield has now re-coupled with a vengeance and is trading as the market is generally,” he adds.

This situation seems unlikely to change over the next six months or more. However, the story is not all bad. Default rates among high-yield companies are still declining, although that would obviously change if the eurozone’s problems do send Europe back into recession. Moreover, current spread levels offer the potential for substantial gains—again provided the EU’s politicians can devise and implement a credible solution to the sovereign debt crisis and its implications for the European banking system. “If the eurozone comes to a quick resolution and there is stability and a return of confidence to the capital markets, then US high yield will quickly rebound and there will be opportunity to make possible great return in a relatively short period of time,” says Harley Lank, the portfolio manager of the US high-yield fund at Fidelity Investments Funds in Boston.

Chris Brils, co-head of global high yield at F&C Asset Management, says the market is broadly undervalued on the basis of fundamentals, because current high-yield spreads (between 850bps and 900bps) are pricing in a severe recession.

Although European high-yield debt offers the best opportunities on a longerterm (five-year) horizon (because they are the most oversold), Brils says continued uncertainty in the eurozone means that F&C is favouring the debt of US companies at present.“In the short term, we remain cautious on Europe.”I

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DEBT REPORT

COVERED BONDS: QUALIFIED OPTIMISM

The outlook for European covered bonds, unlike most capital market debt, must be one of qualified optimism. Although the instruments have clearly not been immune from the worsening sovereign crisis in the eurozone over the second half of 2011—which predictably saw primary issuance fall to a fraction of the record levels seen over the first six months of the year—key fundamentals remain firmly in the market’s favour. Andrew Cavenagh reports.

Europe’s covered bond pipeline still in sway ROVIDED EUROPE’S POLITICAL leaders do what is necessary to restore market confidence in the sovereign debt of the eurozone’s peripheral states and avert the financial Armageddon that would result from a disorderly breakup of the euro, the primary market for covered bonds in 2012 should at least match this year’s total. Heiko Langer, senior covered bond analyst in the credit research team at BNP Paribas in London, thinks that, with the allimportant proviso that the EU authorities manage to stabilise the sovereign situation, European banks could issue as much as €190bn of euro-denominated covered bonds next year and a further $30bn of dollar-denominated instruments. This figure is a slight increase over the projected figure for 2011.

Société Générale Corporate and Investment Banking (SGCIB) meanwhile says it expects to see €185bn of euro issuance and the $29bn of dollardenominated deals out of Europe with another $27bn targeted at US investors from issuers in Canada and Australia.

These forecasts are impressive, given the year-end figure for 2011 and the sharp decline in issuance in the second half. The total was in fact slewed by an unprecedented surge in issuance in the first quarter of the year; some €60bn of covered bonds was sold in the first six weeks of the year alone.

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The reason for such confidence in the new issue pipeline, is that, all things being equal, in key respects covered bonds are now an even more attractive proposition for both issuers and investors than they were in January and February 2011.

The relative security of the instruments is the leading consideration. The surge of investor interest in the first quarter of this year was largely a response to proposals at EU and national level for bail-in provisions to ensure that senior unsecured bondholders will share the pain of any future bank rescues. Because covered bonds are structurally immune from such provisions, their appeal has widened beyond their traditional investor base as even hedge funds (hardly natural buyers of such safe and stable securities) have looked to exploit some startling pricing mis-matches that have arisen.

If the bail-in provisions strengthened the standing of covered bonds against that of banks’ senior unsecured debt at the beginning of the year, subsequent macro developments in the eurozone over the course of 2011 have enhanced their status even more dramatically relative to a great deal of sovereign debt.

For the prospect of losing principal on holdings of sovereign bonds—historically the lowest-risk assets off which all other instruments in any given jurisdiction price—has become a certainty in the case of Greece and an

increasing likelihood for a growing number of other eurozone countries.

This has created the intriguing possibility that covered bonds are seen as a safer investment than their sovereign debt. In essence, this is a bet on whether struggling Greek, Italian or Spanish consumers are likely to pay their mortgages ahead of their taxes.

“You could construct a scenario where covered bonds continue to look like a sound investment relative to their host sovereign,” says Tim Skeet, managing director in the financial institutions group within the debt capital markets division at Royal Bank of Scotland.

Skeet thinks that covered bonds may well have already achieved that status for many investors in the peripheral eurozone.“If you’re going to hold anything in those countries, they’re probably the best thing to hold,” he avers. Then again, while some covered bonds have frequently traded tighter than their comparable sovereigns on a swap-spread basis over the past two years, it still remains to be seen whether a primary issue can actually launch inside its sovereign spread.

“Obviously you have to distinguish between pricing and trading, but I would not completely exclude it,”says Langer at BNP Paribas. “I think there is a small group of investors who see more value in covered bonds than sovereigns.”

An additional source of reassurance for investors has come from the second covered-bond purchase programme (CBPP2) that the European Central Bank (ECB) launched in the first week of November, under which the central bank will buy at least €40bn of bonds by the end of October 2012. In fact, many believe it is likely to increase the scope of the programme before then.

CBPP2 is a further affirmation of the financial authorities’ support for the instruments. On top of their favourable treatment they will receive under the proposed new regulatory regimes for financial institutions, the programme is also designed to help banks in the struggling countries access long-term funding.

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

Spread difference covered bonds vs senior unsecured bonds of some of Europe’s banks

The ECB is expected to spend more of CBPP2 in the primary market than it did with its first €60bn programme that ended in July 2010 (about a third) and will also accept instruments with single ratings as low as triple-B minus so as not to block access for institutions whose ratings are dragged down by sovereign downgrades. Given the ECB cannot buy up an entire issue, however, the success of the programme in this respect will still depend on such banks being able to find other investors for their paper as well.

The appeal of covered bonds may well be further reinforced—particularly for bank treasurers—if, as expected, the final version of the EU Capital Requirements Directive upgrades the instruments from Level Two to Level One assets for key purposes such as liquidity cover ratios. From the issuers’ perspective, meanwhile, covered bonds have become an even more compelling source of funding over the course of 2011 than they were at the start of the year. The relative spreads on banks’ senior unsecured bonds has continued to widen, a process that has accelerated markedly as the uncertainties over the eurozone sovereign situation intensified from July onwards.

Negative headlines The differential between the spreads of senior unsecured and covered bonds of banks that have been subject to negative headlines, such as Lloyds Banking Group in the UK and Société Générale in France, have increased from around 100 basis points (bps) to 200bps over the past four months [see graph], while even those of an institution deemed to be as solid as Spain’s Santander have shot up from single digits to around the 100bps mark.

There are no convincing reasons why these differentials should narrow next year. Not only will the ECB purchasing programme help to keep the spreads on covered bonds tight by restricting net supply, but any negative news on either individual issuers or on the sovereign front that causes covered-bond

220

bp

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EURHYP/CMZB 2015

SANTAN 2015

SOCGEN 2013

LLOYDS 2015

INTNED 2016

SEB 2015

140 100 60 20 -20

Sep 2010

Nov 2010

Jan 2011

Mar 2011

May 2011

Jul 2011

Sep 2011

Nov 2011

Source: BNP Paribas, supplied November 2011.

spreads to widen is almost certain to have a more dramatic impact on senior unsecured spreads.

European banks have consequently raised considerably more from covered bonds in 2011 than senior unsecured issues, which are expected to total around £120bn for the year.“There has been a distinct shift towards coveredbond issuance, and that’s quite logical given the savings in funding costs,” explains Langer at BNP Paribas.

The credit team at SGCIB expects the volume of senior unsecured debt that European banks issue to fall much more sharply in 2012 to just €50bn, despite the fact that €250bn of senior bonds are due to mature in the course of the year, along with €19bn of subordinated debt and €83bn of government-guaranteed bonds.

For many European banks, of course, the senior unsecured market no longer offers a source of funding at viable cost.

“Credit institutions that are not highly rated cannot issue senior unsecured,” said SGCIB’s covered-bond analyst José Sarafana.“The only funding option they have is covered bonds.” While the outstanding market for senior unsecured bank debt will shrink considerably over the next 12 months, that for covered bonds will consequently grow. European covered-bond redemptions will fall from €115bn this year to €96bn in 2012 and, even allowing the mitigating impact of CBPP2, the anticipated levels of issuance should see the total outstanding volume of bonds increase by around €50bn.

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

Again assuming that there is not a sovereign disaster in the eurozone, French banks will make the biggest contribution to this growth in the market. They are expected to issue €50bn of fresh debt next year against just €15bn of redemptions. UK institutions will come next, with €18bn of new issuance and €3bn of maturing debt.

Meanwhile, issuers will continue to merge from new jurisdictions, with Belgium expected to join the market for the first time in 2012.

Europe’s banks clearly cannot meet all their funding requirements from the covered-bond market. There are legal limits on the level of assets they can assign to the instruments in some cases, and over-collateralisation and collateral eligibility requirements under all legal frameworks for the instruments. This fact should not present a problem in the near term as financial institutions continue to reduce their balance sheets.“I think everyone’s well within their limits,” confirms Skeet at RBS. “That’s certainly not a clear and present danger, although it may be a concern for the future.”

While it would be naïve to think that covered bonds could continue to flourish in the financial meltdown that would follow a collapse of the eurozone. There is every reason to believe they will be the last to go in such a scenario. As Skeet observes: “If that happens, everything else is going to slide as well, and covered bonds will remain the most resilient and resistant to change.” I

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DEBT REPORT

PFANDBRIEF SPREADS REMAIN STABLE

Investors remain keen even as pfandbrief issue volumes fall German covered bonds (pfandbriefe) largely maintained their safe-haven status with investors through the deteriorating financial environment in the second half of 2011, despite an inevitable dramatic slump in primary issuance as markets took fright at developments—or lack of them—in the eurozone.

What now? Andrew Cavenagh reports.

ITH JUST €1.5BN of jumbo pfandbrief issues since the end of June, and none since Eurohypo’s €1bn deal at the end of August, the primary market this year will fall way short of the €87bn recorded in 2010. Verband Deutsche Pfandbriefbanken (VDP), the association of German pfandbrief banks, now reckons the final figure for this year will come out at around €65bn, against its earlier forecast of €90bn, on the back of the €47bn of bonds that were sold in the first six months, including €19.8bn of jumbo transactions.

Pfandbrief spreads have nevertheless remained relatively stable, compared with most other classes of capital market debt and covered bonds elsewhere.

While the differential between pfandbriefe and German sovereign debt (bunds) may be approaching historical highs at around 120 basis points (bps), average spreads are still only about 30bps over the mid-swaps benchmark as those on most other covered bonds are well into three figures. “Flight to quality has prevailed, and the pfandbrief has confirmed its benchmark position in the covered-bond market,” maintains a VDP spokesman.

This spread stability looks set to endure through next year. For even if EU authorities take the measures necessary for the bond markets to resume normal functioning, the overall pfandbrief market will continue to shrink, which will tend to support the current spread levels. In the jumbo sector of the market, for instance, most banks

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are forecasting that primary issuance will be around €26bn while redemptions, although lower than the €44bn this year, will still total €38bn.

Investor confidence in the market received a further boost on November 23rd, when the Moody’s rating agency raised its base-case timely payment indicator for mortgage-backed (hypotheken) bonds issued under the Pfandbrief Act from “probable high” to “high”. The agency cited the strong legislative and regulatory support for the pfandbrief regime as the reason for its decision, including recent amendments to the act.

These require issuers to maintain a socalled liquidity buffer of at least 180 days in respect of their pfandbrief commitments and enhance the powers of a cover-pool administrator in the event of an issuer insolvency. The pfandbrief market is nevertheless facing significant challenges over the next 12 months and beyond, which could yet alter the historical perception—which German banks and financial authorities are keen to maintain—that the instruments trade almost as an homogenous asset class.

The increasing emphasis that both the rating agencies and investors are placing on the link between issuers and their covered bonds is certainly threatening to create a great deal more discrimination in the market, particularly in the present environment where individual banks’ sovereign exposures are under the microscope.

Moody’s decision to place UniCredit’s covered bonds on review for downgrade a week after it announced

it was reviewing the bank’s senior debt rating was a recent example of such linkage. Moreover, the trend could clearly see the spread spectrum in the asset class widen significantly from historical norms. Timo Böhm, portfolio manager and member of the covered bond team at Allianz Pimco in Munich, says the mounting concern over banks’ exposure to the sovereign debt crisis has led to a more pronounced linkage between the spreads on an institution’s covered bonds and those on its senior unsecured debt. “That link to the seniors and the sovereigns is much tighter now, and therefore everybody is looking at what could be the worst case here,” Böhm explained. “Even if the covered bond is rated triple-A, its spreads will widen on these concerns.”

“From our point of view, covered pools should be split,” says Böhm. He points out that banks now price their commercial property loans to reflect the different degrees of risk involved, and that it was not unreasonable for bond investors to require the same consideration. However, issuers continue to oppose the need for such a move. They say the pfandbrief legal framework offers investors adequate protection while the transparency of the cover pools allows them to choose the type of investment that most closely meets their requirements.

“They can decide themselves what kind of strategy suits them best,” says the VDP spokesman. He points to mortgage pfandbriefe backed 100% by residential mortgages:“If you like to take entirely residential mortgage risk, you find such bonds, too,”he says. While that is clearly the case, it is equally evident that issuing banks that have high concentrations of commercial loans in their cover pools are going to have to pay progressively more for the privilege. I

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

MANDATES

DATE

MANDATE/ VALUE

WINNING FIRM/ CONTACTS

CLIENT/ CONTACTS

COMMENTS

3rd November 2011

Technical services related to investment limit reviews in the client's depositary banking business/ administration for special fund assets/€1.4bn

BNY Mellon/ BNY Mellon Service KAG

Hamburger Sparkasse AG (Haspa)

According to Grünewald: "There are a number of ways in which depotbanks can meet additional regulatory requirements that have recently been imposed, and one compelling option is to outsource individual processes and services to a specialist institution."

Global custodian mandate.

NT will provide additional record keeping for private equity and infrastructure fund and investment risk and analytics tools/ £1.5bn

Northern Trust

10th November 2011

11th November 2011

Carston Hoever, division head Thomas Grünewald, managing director, BNY Mellon Service KAG

Doulgas Gee, head of sales for institutional investor group UK

Quintillion

14th November 2011

Custody and settlement services for the bank's Italian and foreign securities and financial instruments.

14th November 2011

The mandate encompasses custody and transfer agency services, fund administration, fund factsheets and foreign exchange solutions for SIG’s UK-based fund, Skandia Investment Management Ltd

15th November 2011

Fund administration for Odey's UCITS funds, involving daily dealing fund accounting, administration, and transfer agency services to the umbrella fund.

Fund solutions for a suite of global funds via BNY Mellon's Derivatives 360 (D360) offering. The mandate covers derivatives in Spain and Mexico/ €23bn.

This is a reappointment with an extended mandate. SAUL is keen to reduce admin costs, and improve internal governance and thinks NT can help the fund.

Penny Green, trustee

Fund administration services supporting IQS's high volume trading strategy.

14th November 2011

The Superannuation Arrangements for the University of London (SAUL)

IQS Capital Management

IQS Capital Management will trade the assets of the fund using the IQS Diversified Programme, which trades a diversified portfolio of futures contracts utilising objective computer programmes.

Société Générale Securities Services (SGSS)

Bank of Bologna

SGSS says it won the mandate on the basis of its technology and client support capabilities.

Citi

Skandia Investment Group (SIG)

Citi currently provides trustee, custody including cash management, and transfer agency services, fund administration as well as foreign exchange solutions for Dublin-based Skandia Global Funds and will now manage their fund factsheets and Key Investor Information Document (KIID) disclosure. Skandia has consolidated its fund ranges in pursuit of cost efficiencies.

Alan Doyle, senior manager

Andrew Gelb, EMEA head of Securities and Fund Services

Marc Bulstrode, chief operating officer.

Citi now has $12.5trn assets under custody.

Bulstrode explains that the wider group (the parent company is Old Mutual) will also be able to utilise Citi's global operating platform.

Capita

Odey Asset Management

Paul Nunann, managing director Capita (Ireland)

Tim Peary, chief finance officer

BNY Mellon

BBVA Asset Management (BBVA)

Patrick Tadie, global head of business, Derivatives360.

Odey has just launched the Odey Odyssey Fund, one of the first UCITS IV funds authorised by the Irish central bank. Another sub-fund, the Odey Giano European Fund, is also launching.

The mandate covers middle office, OTC trade affirmation and confirmation, third party valuation, lifecycle event management, portfolio reconciliation and collateral management and custody.

Also Frank Froud, head of Europe, Middle East and Africa at BNY Mellon Asset Servicing.

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

39

MANDATES

DATE

MANDATE/ VALUE

WINNING FIRM/ CONTACTS

CLIENT/ CONTACTS

COMMENTS

15th November 2011

Middle and back office outsourcing of Bridgewater's diversified alpha and beta strategies, which will be placed on BNY Mellon's OnCore platform.

BNY Mellon

Bridgewater Associates

Tim Keaney, chief executive officer.

This is a lift out of Bridgewater's data warehouse, trade processing, portfolio accounting and derivatives processing.

BNY Mellon has been providing custody and fund administration services to Bridgewater since 1994.

Some 100 software experts, business analysts, accountants and other employees will move over in the lift out.

Calypso Technology Inc

BM&FBOVESPA

17th November 2011

21st November 2011

To register and manage OTC derivatives and cash risk assessment and lifecycle management.

Private equity fund administration services to the GC Equity Partners Fund II, a late stage fund/more than $500m Investors in the fund include global and well-known regional sovereign wealth funds. The client was established in Abu Dhabi back in 2006 with a capital base of some $330m.

29th November 2011

Settlement agency services in the Euronext market.

Charles Marston, chairman and chief executive officer JP Morgan Worldwide Securities Services (WSS) Brian Coughlin, asset managers and alternative investments markets manager.

1st December 2011

Under-one-roof pensions service, involving actuarial services, consultancy, scheme secretariat services, investment consulting, scheme administration, pensioner payroll and fund accounting.

Global custody mandate.

Deutsche Bank

Muhannad Qubbaj, head of business development, private equity

Gulf Capital Equity Fund Associates Muhannad Qubbaj, head of business development, private equity.

Capital Hartshead

Southern Housing Group

Malcolm Pearce, consulting and operations director

Alene Wilton

BNY Mellon

Fortune SG Fund Management Co Ltd QDII Fund - a joint venture between HWABAO TRUST Co (a subsidiary of China's Baosteel Group) and Lyxor Asset Management (a subsidiary of the Société Générale Group).

Chong Jin Leow, head of Asian securities services

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Gulf Capital one of the largest Middle East private equity firms

Timothy Peters, general manager of JP Morgan's Abu Dhabi office.

Savinder Singh, global head of trust and securities services (TSS) and Michael Aschauer, head of global sales and relationship management, Direct Securities Services.

1st December 2011

Marcelo Marziero, chief products and customers officer.

In Brazil, OTC trades are officially registered so that the intraday mark-to-market value of each trade can be tracked.

GC Equit Partners Fund II was the first regional private equity fund to derive income from international markets in North America, Europe and Asia.

Scalability was important to GC in this mandate. At the same time GC also awarded its FX settlement agency services to Deutsche Bank a few days earlier.

Gulf Capital is one of the largest private equity firms in the Middle East, focusing on late-stage control buyouts, growth capital, real estate developments and credit businesss.

The firm is incorporated in Abu Dhabi.

The contract runs for five years.

Capita Hartshead initially evolved from a team set up in 1974 to administer the UK local government pension schemes on behalf of water authorities. It is now a FTSE 100 company.

The new Fortune SG S&P Oil & Gas Exploration & Production Select Industry Index Fund is Fortune SG's third QDII fund and the second QDII fund that uses BNY Mellon.

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

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INDEX REVIEW

EUROZONE WOES HOLD BACK GROWTH

Tall tales of the woes of the eurozone have dominated the year in view. The tragedy in those tales is that at the end of the year, the problems loom as large, and the solutions are as far from clear, as they were at the beginning. Politicians appear keen to have the last word on this matter and through the mechanism of the ECB these will almost certainly be “Print more money”.

The telling is no better outside the eurozone, where clouds continue to gather. Growth is proving elusive in virtually all OECD nations and even the BRICS look to be slowing from their breakneck pace. Simon Denham, managing director of spread betting firm Capital Spreads, tells an ultra-bearish story.

Simon Denham, managing director of spread betting firm Capital Spreads. Photograph kindly supplied by Capital Spreads.

The law of unintended consequences OVEREIGN DEBT HAS finally taken the banking sector off the front pages and may at some point refocus minds on who was really the cause of the ongoing financial crisis of 2007-2009. Yes, there was no doubt that banks have displayed greed in abundance but that is what bankers are supposed to be about. In reality the really big problems were caused by the massive growth in sovereign liabilities across the entire developed world.

Politicians (most of whom have no grounding whatsoever in finance or fiscal matters) started to spend, not just today’s revenue, but also the next day’s and the next’s. The desire to be re-elected swamped all reason and compliant economists, wittering on about the “end of inflation” or even history itself, outweighed the sane voices of more pragmatic commentators (and there were a lot of Cassandra’s out there if you cared to look for them).

In the near term, political agreements will be cobbled together to try to force the eurozone into a tighter fiscal region, but one does wonder how on earth this is actually going to be policed. Independently, countries occasionally do need a stimulus or a cooling. In the straitjacket of a fiscal union this would be impossible (especially if it does not suit Germany!) and the one clear Achilles heel of the whole

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framework, workforce mobility, would not be solved at all. The only truly successful forced fiscal union of recent centuries is the US (which at least had a common language) and even this ended in Civil War. One does wonder if grasping the nettle now might be the better option. Spending ever-larger sums trying to keep a lid on the sovereign debt issues may well be just building the problem from being a crisis into a truly global disaster. Coupled with this is the fudge over Greek debt where 50% of the value is being written off but, somehow, without triggering a default. This sounds great to a politician as it interferes with hedge funds trading Credit Default Swaps (CDSs). The problem is that now no one can protect themselves against a sovereign debt haircut which “lo and behold” suddenly meant that both Italian and Spanish debt went into freefall as holders just dumped it. This may yet come back to haunt the markets as every piece of bad news causes huge swings in yields.

Oddly enough this is not a bad time for equities. The fiscal position of many companies has never been better with large cash piles abounding (admittedly interspersed with some private equity-backed companies weighed down with massive IOUs). Private and corporate borrowing rates are, in many cases,

far lower than rates asked of the Southern European nations which, as far as I can see, apparently makes me a better credit risk than Italy!

The waves of bad news seem to be having less and less impact on markets. This can clearly be seen by looking at the original effect of the Greek crisis of early summer which took the FTSE down into the 4700s while the far more serious implication of 7% yields in Italy could not get the index below 5100.

With protection of value seemingly being the prime mover of many investors, the purchase of solid equity assets may finally be coming back into play.

We are seeing more buying to hold on dips in the markets and more selling on rallies in gold and other “alternative” investments. Absolute levels of wealth are likely to suffer in coming years as income and growth lag and inflation bites. Returns on safe haven bonds are so sparse that investors in these areas are guaranteeing negative returns. We may find that in the absence of any credible alternatives, selected equity sectors start to come back into favour.

Unfortunately for banks this is unlikely to include the financial sector as over-regulation and vengeful politicians continue to weigh on prospects.

As ever ladies and gentlemen “place your bets”.I

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

US TRADING VENUES Photograph © Skypixel / Dreamstime.com, November 2011.

US EXCHANGES WALK THE SAME ROUTE TO MARKET SHARE National stock exchanges have been busy defending their territory in recent years. In the United States, many of the traditional exchanges (if they haven’t been bought out) are having to meet the onslaught of competition from the estimated 80 alternative trading systems (ATSs) that have captured 38% of equity volume over the past five years, according to the Boston Consulting Group. Exchanges have fought their ground in four ways: through takeovers and mergers, building new exchanges, partnerships or simply by widening their offerings. Ruth Hughes Liley reports on the main trends.

HE PLANNED MERGER of NYSE Euronext and Deutsche Börse has thrown up an interesting conundrum. Rather like a set of Russian dolls, Deutsche Börse owns 50% of ISE Holdings while ISE Holdings owns 31.5% of Direct Edge. Thus the merger will draw Direct Edge into the same company as its exchange competitor, NYSE Euronext. The transaction also highlights the now global search for market share among the US’s traditional exchanges, as their domestic market is increasingly constricted by competitors.

Since 2007, the world’s two largest stock exchanges, NYSE Euronext and NASDAQ OMX, have often opted for the takeover route, competing on the world stage to acquire a bigger slice of the pie. NYSE in 2007 bought European stock exchange group Euronext and the following year NASDAQ finalised its purchase of OMX. This left each exchange with

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FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

a footprint in Europe: NYSE on the Atlantic fringe countries of Portugal, the Netherlands, France and Ireland; and NASDAQ in the northern Baltic and Scandinavian countries.

Deutsche Börse’s merger with NYSE Euronext will create a mega-exchange with a market capitalisation of $9bn and the bulk of the market cap of listed companies worth $14trn, according to Boston Consulting estimates. The final decision regarding approval of the merger is expected in January 2012.

Ron Quaranta, Thomson Reuters’, global head of trading analytics and head of exchange trading, The Americas, says: “It comes down to ‘buy or build’ and scale economies. What do these exchanges get out of their expansion? It’s interesting that these days we don’t talk about US-based exchanges without talking about some kind of globalisation component.”

Joe Mecane, NYSE Euronext’s co-head of US listing and cash execution, agrees:“Scale is a very significant part of the

43

US TRADING VENUES

priority of a global exchange. Customers are looking for ease and simplicity of connectivity so they can connect at one location. In the US many of our customers have gone multiproduct and in the trend to globalisation, they are looking for multi-geographical reach too.”

Mecane explains that competition emanating from the US is spilling out and influencing the development of market structure abroad:“There is a US equity market evolution and we’ll see the same thing play out in Europe. We are better prepared for it in Europe than we were in the US when there was a lot more uncertainty over the introduction of Reg NMS. In Europe we have been able to anticipate the direction and the way things would go.”

While some fear the power of large mergers, TABB Group principal Miranda Mizen points out:“Just because you are big doesn’t mean you are anti-competitive. There’s no global regulator, but regulators are working together more than ever before. There’s a convergence of regulatory thought.”

While the NYSE Euronext/Deutsche Börse tie-up seems to be forging ahead, albeit with concessions over derivatives trading and clearing by selling their overlapping businesses and giving open access to Eurex clearing, others have failed: a proposed merger between the London Stock Exchange (LSE) and the Toronto Stock Exchange (TSE) failed as did a proposal to merge the Australian (ASX) and Singapore (SGX) stock exchanges.

Steve Grob, director of group strategy, Fidessa, says:“One of the problems with these sorts of transactions is that they get caught up in a lot of nationalistic politics. It’s quite hard to explain to the guy in the street why his national stock exchange should fall into the hands of an overseas buyer.“In these days of global financial markets, the concept of a national stock exchange that has a divine right to trade the stocks that are listed on its venue is pretty much dead,” he says.“One of the things that have driven the globalisation of stock exchanges is that their domestic market has been disrupted by the smaller, more nimble alternative venues. Because their domestic market share is being eroded, they are having to look beyond their national boundaries. Newer alternative venues have provided much of the innovation in markets in terms of products and pricing. They have also attracted the HFT community that can exploit different maker-taker price models,”he adds.

The newcomers on the US exchange scene, BATS Global Markets and Direct Edge, have each built up market share in the region of between 10% and 12% in the US, jostling for third place after NYSE and NASDAQ. In 2007, BATS represented around 15% the size of NASDAQ. In 2009, it represented around 55%.

Direct Edge has increased its market share through clever strategy. The International Securities Exchange (ISE) bought the 31.5% stake in Direct Edge in 2008, as the holdings of Knight, Citadel and Goldman Sachs were reduced to just less than 20% each. As part of the same deal, Direct Edge took operational control of the ISE Stock Exchange, increasing its market share to 12%. Then in March 2010, the SEC approved the conversion of Direct Edge’s two ECN platforms, EDGX and the low-cost EDGA, into licensed stock exchanges.

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Bryan Christian of Direct Edge. “The barriers to starting a marketplace are low and it is not too expensive to set up a matching engine and to buy services from an exchange. In this environment of increased competition, the marketplaces that are going to survive are those that differentiate by being adaptive and innovative,” he says. Photograph kindly supplied by Direct Edge, November 2011.

Like NYSE and NASDAQ, Direct Edge and BATS Global Markets are also expanding overseas. BATS’ acquisition of Chi-X Europe will give it a firm foothold in London, presenting a serious challenge to the London Stock Exchange in the United Kingdom. BATS has also gone into partnership with Brazil’s Claritas Asset Management and law firm Freitas e Leite, with the aim of setting up an exchange in the country.

Direct Edge, too, has turned to Brazil as it looks outside the US for the first time. Its new entity, Direct Edge Brazil, aims to build an all-electronic equities exchange platform in Rio de Janeiro, Brazil, where there is little fragmentation, but a large market. Launching in the fourth quarter of 2012 pending regulatory approval, Direct Edge Brazil will operate a single stock trading platform using Direct Edge technology and architecture customised to the Brazilian market. It will offer trading in all Brazilian equities, ETFs and depositary receipts.

“The Brazilian economy is among the fastest growing in the world and we believe that a second stock exchange will spur even greater investor participation through competition that drives innovation and price improvement,” says William O’Brien, Direct Edge’s chief executive officer. Some estimates count around four ECNs, 28 ATSs and 14 “medallions” or extensions to exchanges, such as NYSE’s Arca or NASDAQ’s Boston Stock Exchange. Many of the dark pools exist within investment banks: for example Credit Suisse’s Crossfinder or Goldman Sachs Sigma X. However, the numbers change and Quaranta points out: “Like any cyclical market place, some come in and then some are bought out or consolidate. But the differentiator between the successful and non-successful will be the cheaper, lower-cost, technology, and cross-asset capability. Existing ECNs don’t just appear and then sit still.”

Quaranta does not believe that the US market has reached a maturity.“I think we will continue to see parsing and frag-

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

Joe Mecane, NYSE Euronext’s co-head of US listing and cash execution.

“Customers are looking for ease and simplicity of connectivity so they can connect at one location. In the US many of our customers have gone multi-product and in the trend to globalisation, they are looking for multi-geographical reach too,” he says. Photograph kindly supplied by NYSE Euronext, November 2011.

Ron Quaranta, Thomson Reuters, global head of trading analytics and head of exchange trading, The Americas. “It comes down to ‘buy or build’ and scale economies. What do these exchanges get out of their expansion?

It’s interesting that these days we don’t talk about US-based exchanges without talking about some kind of globalisation component,” he says.

Photograph kindly supplied by Thomson Reuters, November 2011.

mentation with new ECNs and dark pools popping up, although maybe not at the competitive rate that they were doing over the past five years. It is technology which will be the differentiator: they will be talking about sub-millisecond execution and whether one is faster than another.”

Owain Self, global head of algorithmic trading at UBS, has counted up to 53 different pools of liquidity in the US, 13 being lit venues in the majority, owned by only a few corporate entities: NYSE Euronext, NASDAQ-OMX, Direct Edge and BATS Global Markets.“But they operate multiple books and if consolidated into one venue, the market share of a combined book would likely be less than the sum of the separate books. They attract different types of liquidity to the market place, via different matching functionality, pricing models and fee structures etc. If they consolidate into one venue, you don’t have differentiation and choice. With multiple venues you get more choice,” he says.

Bryan Christian of Direct Edge agrees: “At the end of the day, the reality is that in any consolidation, one plus one equals one and a half, not two.”

Direct Edge has 40 routing strategies, more than other exchanges and another example of how innovation is critical, says Christian.“The barriers to starting a marketplace are low and it is not too expensive to set up a matching engine and to buy services from an exchange. In this environment of increased competition, the marketplaces that are going to survive are those that differentiate by being adaptive and innovative. We are listening to our customers to tailor solutions that add value in a fragmented market.”

In fact, he goes further.“We are out there to be disruptive in the exchange space while supporting the broker-dealer community. They are our customers. While there are a lot of regulatory changes ahead in 2012 that will impact exchanges and broker-dealers, the only thing we can plan for is to keep

our systems nimble and responsive, while looking out for opportunities for strategic growth,” Christian says.

One of the things which helped the development of ATSs was Reg NMS, through its“trade-through”rule where orders must be passed on for best execution, regardless of where the order is placed. In addition, NASDAQ-OMX changed its rules so that ECNs could integrate into its system.

Setting up a matching engine is one thing, but drawing liquidity to the venue is quite another, although partnerships help, as Fidessa’s Grob explains: “It is through partnerships that exchanges can build volume by cross-listing products that have already been successful elsewhere or in other time zones.”

Technology companies such as Fidessa are increasingly partnering with exchanges to leverage its global community. Partnerships between venues include Liquidnet, the buy side-tobuy side crossing network, which enhanced its global liquidity pool through a link-up with SIX Swiss Exchange in July 2011.

Indeed, with volumes low throughout 2011, US venues have had to resort to a range of methods to raise liquidity levels, and NYSE’s Mecane says:“Market volumes are cyclical and it points to why scale is important. When volumes are low you need diversified revenue streams. Differentiation is a major theme in a hyper-competitive environment where if you don’t want to compete on price, it’s the best way to deliver value to the market place.”

Quaranta adds: “We don’t really talk about cash equity exchanges any more. Venues are differentiating themselves one from another through cheaper pricing, better and faster technology, providing cross-asset capabilities or simply by being easy to connect to.”

Diversifying revenue streams beyond trading volume is important to market participants when flows are reduced: exchanges benefit from a slice of income from the US consolidated feed; venues, including Direct Edge, sell packaged

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

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US TRADING VENUES

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Miranda Mizen, TABB Group principal. “When times are tough, you need to have a fresh and innovative business model. If you are a niche player and good at what you are doing, that’s fine, but being in the middle and mediocre is a dangerous place to be. It comes down to who is going to draw liquidity: what is going to make people trade with you?” she says.

Photograph kindly supplied by TABB Group, November 2011.

Owain Self, global head of algorithmic trading at UBS. “The venues attract different types of liquidity to the market place, via different matching functionality, pricing models and fee structures etc. If they consolidate into one venue, you don’t have differentiation and choice. With multiple venues you get more choice,” he says. Photograph kindly supplied by UBS, November 2011.

data products and connectivity services; multi-asset trades in securities, futures, commodities as well as spin-off companies such as NYSE Technologies also add to the mix.

NASDAQ-OMX technology, for example, is used by around 70 exchanges in 50 countries.

Meanwhile, BATS Global Markets has filed with the SEC to provide a primary listing service to companies from December, creating another revenue stream. Responding to the challenge, in November 2011, NYSE Euronext was planning to attract more small and medium sized enterprises (SMEs) in Europe by making it easier for them to access capital markets. Over six years, 181 companies, including several in the US, have raised €2.6bn on its SME market, NYSE Alternext.

Mizen says: “When times are tough and margins are so thin and companies are not flooding to markets, you need to have a fresh and innovative business model. If you are a niche player and good at what you are doing, that’s fine, but being in the middle and mediocre is a dangerous place to be. It comes down to who is going to draw liquidity: what is going to make people trade with you?”

Earlier in the year it was reported that Citigroup would launch a new dark ATS called Citi Cross in Q4 2011, which would allow retail flow to cross with high-frequency trade.

High-frequency flow represents between 60% and 70% of daily market volume in the US, while Citigroup has an enormous amount of retail flow—the bank boasts 200m customer accounts.

Citi also has plans for LavaFlow, an ECN, which as a technology company was integrated into Citi’s platform in 2006 and now has an average daily volume of more than 90m shares. John Procopion, head of transaction services, Citi, and

president of LavaFlow, wants to see the ECN grow in 2012 from its current 1.25% market share to 3%-5%. It has a lit component as well as non-display order types. Procopion says:“Price, speed and liquidity are the three factors that are most important to a platform, followed by stability, reliability and functionality. People always want to talk about size, although what is most important is specific to the native liquidity that can be accessed.”

Nonetheless, in volatile times, Quaranta sees what he calls “a flight to quality”. Between May and August and since, he witnessed order flow moving to the standard exchanges. “The NYSEs, the NASDAQs and the LSEs of this world,” he says. “The liquidity moved to the ‘safer’ liquidity pools. The ECNS and dark pools in particular also need to address information leakage. Firms use dark pools for minimum information leakage—but is that happening?”

Indeed, Pipeline was recently fined $1m by the US regulator, the Securities and Exchange Commission (SEC), for failing to disclose that orders were being routed to an associated firm.

Issues like this, on top of multiple venues, give extra work to brokers. Grob points out: “One of the key challenges lies in access to liquidity across the lit dark spectrum. This has become much more complex from a workflow perspective and brokers have to work harder to keep up with it all—they are dealing with more complicated workflows at a time when they are not necessarily seeing any more order flow in through the front door.

However, it’s the buy side which has the real problem as it has to penetrate this ever-thickening fog of fragmented liquidity and try to make sense of it.”I

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

REAL ESTATE OVERVIEW

German retail real estate is being buoyed by strong domestic demand and unprecedented levels of international interest. Photograph © Metro Group, supplied November 2011.

Paris is second only to London as a target for international retailers in Europe, with retailers such as Uniqlo opening large flagships.

Photograph © Uniqlo, supplied November 2011.

Milan’s retail is currently city-based but by 2015 Westfield will have opened its latest mega-mall. Photograph © Geox, supplied November 2011.

SECURITY VERSUS SENTIMENT: A TALE OF THREE MARKETS Although the value of commercial real estate largely follows the macro-economic trends of the markets in which it is traded, a subtle disconnect has been evolving over the course of the financial crisis which looks set to crystallise in 2012. Despite their enormous problems, both Italy and Spain have largely retained investor and operator faith, while some of the other “Club Med” countries have been deserted. Conversely, although their stability has seen them perform strongly during the recession, neither Germany nor France enter 2012 in quite the shape they started 2011. Mark Faithfull considers why market dichotomies are at play.

INCE THE ONSET of the economic crisis, the German property market, Central London and Paris, have been viewed as Europe’s safe havens. Comparatively strong economic performance and healthy occupier markets have given investors the comfort they are looking for in both France and Germany, while London has developed as a city-market at odds with the UK’s wider problems.

By contrast, prospects for the “Club Med” nations have looked bleak indeed and the real estate markets in Greece and Portugal have been decimated by the ongoing eurozone crisis.Yet amid the ashes of the current situation, both Spain

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FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

and Italy have retained some investor confidence and relative lack of supply for prime commercial sites has continued to attract inflows of capital into their real estate markets.

Indeed, one of the greatest issues for Germany is that demand has hiked prices. Yields are hitting record lows as investors compete for the same prime products and as a result the market has become polarised, with strong demand only for core properties or the limited supply of distressed assets.

The gap between prime and secondary properties has widened again thanks to the most recent jitters on the

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world’s financial markets. This is most clearly evidenced in the booming German retail property market—seen as a recession-proof category in part because German consumers have remained metronome-like in their expenditure come the good or bad times and, also in part, because restrictive planning continues to squeeze supply.

Retail investment in Italy and Germany jumped in 2011; in Italy representing over 58% as a proportion of deals, with retail in Germany at a 52% share, according to agent Savills.

The firm says the figures represent a year-on-year rise of 70% in Italy and 50% in Germany. Despite this, its research indicates an overall decline in average retail investment from 34% of total volumes to 25% in Q3 2011. However, Savills suggests this reflects a lack of prime opportunities rather than a loss of interest from investors, as illustrated by average yield compression of -22 basis points (bps) for shopping centres and -2bps for retail parks.

Giles Wilcox, head of European cross-border investment, adds:“There has been increasingly strong investor appetite for retail stock across Europe, especially in large, core liquid markets. However, the year has been a tale of two halves with more opportunistic demand in the first half and a very much more cautious approach in the second as the eurozone crisis continues to influence decision-makers and finance providers.”

Germany: retail soars If the past three years of European real estate have been largely about Germany, in Germany it has been all about retail. By the end of the third quarter of 2011, a total of €7.87bn had been invested in retail real estate, putting this category of property far ahead of all others for 2011. Office real estate came in a distant second in terms of commercial transaction volume, at approximately €4.77bn, according to agent Colliers International.

“In the first nine months of the year, retail properties accounted for nearly 47% of the total commercial transaction volume in Germany,” reflects Andreas Trumpp, head of research at Colliers International in Germany.

Strong performance has attracted a host of investors, with Union Investment one of the latest fund managers to increase its allocation to retail. In June, it launched a €750m European shopping centre fund targeting the key eurozone economies. German fund manager Realis has also turned to retail despite operating principally as an office investor and it surprised the market when in May it bought Hamburg shopping centre Hamburger Meile for €250m, reflecting a 5.5% to 6% yield.

As a result of surging demand, yields are being squeezed by both international and domestic investors. RREEF is in discussions to sell the 60,000 sqm PEP shopping centre, located in a suburb of Munich, to US pension fund Teachers, which outbid Allianz Real Estate, Union Investment, Corio and Deka and pulled the yield from an expected circa 5% down to 4.6%.

A month earlier Irish investor Signature had acquired the Neumarkt Gallerie, beating bidders for the €135m asset from Barclays Capital, which had taken it over from Quinlan

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Private at the end of last year after the Irish investor missed a loan payment. Opportunistic buyers such as Orion had been interested too, as well as core investors such as German shopping centre giant ECE. Similarly, the Canadian Pension Plan Investment Board bought a half share in the 150,000 sqm CentrO shopping centre in Oberhausen for around €700m, reflecting a 4.7%4.8% yield. The Canadians outbid established players such as Henderson and Allianz Real Estate.

Meanwhile, smaller, opportunistic investors have been the main beneficiaries of greater liquidity. One such example is Activum SG Capital Management, which closed its second fund, raising €238m, more than two times oversubscribed. Its first fund was launched with €56m of equity in early 2009 and in autumn 2011 Actvium began the process of selling assets from the fund, which is expected to deliver an internal rate of return of over 28%.

Banks have so far held back from large portfolio sales, choosing to ignore loan-to-value breaches in a so-called “pretend and extend” strategy. However, Royal Bank of Scotland (RBS) is currently in talks with investors about selling German loans, as RBS looks to sell debt it provided to Goldman Sachs to buy the €1.7bn, 190 building-strong Charlotte portfolio in 2008. “About half of the capital invested in the first nine months of 2011 came from two groups of investors: open-ended and special real estate funds invested about €2.14bn in retail properties, while risk-oriented opportunity and private equity funds invested about €2.04bn,” adds Trumpp.

France: Paris office over-supply worries banks The arrival this summer of New York-based Northwood Investors could yet provide the much-needed catalyst for investment for French capital Paris which has been impacted by uncertainty over rents and a preference for prime.

Northwood in August bought a 75% stake in Défense Plaza from Beacon Capital Partners in what is only France’s second example of a syndication deal since the 2008 crisis.

It involved Morgan Stanley taking half of Aareal Bank’s €210m original loan on the property and Morgan Stanley is now expected to syndicate the €105m among French and France-based banks. Last October the US bank was sole arranger for a €120m acquisition loan on another Défense office property, CB16, and in that deal asset manager Hardstone paid €180m for the tower to Aberdeen Degi; Morgan Stanley, Crédit Foncier and Aareal, each taking around €40m. The US bank then syndicated its €40m.

Elsewhere in France, finance for JP Morgan’s and Constructa Asset Management’s Docks de la Joliette scheme in Marseille is to be provided by Germany’s Pfandbriefbank with a €143m facility. Banks continue to offer loan-to-value ratios typically in the 60%-70% range but insurer-lenders remain noticeable by their absence and the usual domestic and German financial institutions continue to drive finance.

In March, Aareal, Crédit Foncier and Landesbank HessenThüringen completed the refinancing of Benson Elliot’s prime Paris property portfolio for €138m.

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

The deal was the first refinancing of securitised debt in France since the credit crisis. More recently, the SCPI Notapierre investment vehicle, owned by Union Notariale Financière and managed by B&C France, acquired an office complex in the Antony Parc II business park for just over €100m from Iceland-based Askar Capital, financed by Pfandbriefbank.

Yet there is an increasing dilemma for banks operating in the Paris market as the number of towers being redeveloped and refurbished has made it difficult to predict accurately future rental levels in and around the city.

Office rents have typically averaged around €550 per sqm but with so many new schemes under construction in other areas of Paris and at levels as low as €300 per sqm, one of the city’s key business areas risks falling foul of the current situation. At La Défense, many of its projects are not due to complete until 2013, while rival Vinci Construction has announced it is to develop a phased, 133,000 sqm office scheme near the Stade de France in Saint-Denis, with French telecommunications company SFR confirmed as the first tenant on a nine-year lease.

“Paris is by far the most active market in the eurozone,” says Allianz chief executive for France, Olivier Wigniolle.

“What we are seeing is that rents are stable and incentives are increasing. So it’s active, but it’s difficult.” Wigniolle expects a rental decline of between 5% and 10% for the year and he reflects: “When you see assets at yields of 4.5%, we do not consider that there is room for growth.”

Italy: retail opportunities despite the crisis A relatively mature if highly bureaucratic market, Italy’s real estate sector had been feeling the heat even before the government’s collapse. Although figures from agent CBRE show that Italy saw the strongest growth (69%) in real estate investment in Q3 compared with the previous quarter, this sharp increase was largely down to the low level of investment activity in Q2 and one or two large deals completing in Q3.

Notable retail deals in Italy included WP Carey’s €300m acquisition in September of a fund that owns 20 Metro cash-and-carry stores. Nonetheless, a dramatic fall in available bank financing over the summer has virtually halted real estate investment in Italy, with the ongoing political and economic crisis pushing the country soaring up the risk curve.

Yet, as ever, Italy remains a country of contrasts. Its retail real estate stock is currently the strongest performing of the commercial sectors and its heritage in retail, apart from the lack of international brands, continues to persuade investors of the potential for the market.

A world-class luxury goods producer with a famous textiles industry, the country’s fragmented domestic retail sector means that there are few dominant players. And despite its famous cuisine, the big five grocers account for a relatively low proportion of the total food market, while a north-south divide remains in market penetration and development activity.

Despite the political and economic turmoil which is keeping investors out of the country, fund manager

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

Phare is a distinctive office landmark planned by Unibail-Rodamco at La Defense, Paris. Photograph © Morphosis / L’autre Image Production, supplied November 2011.

Henderson Global Investors is just one of the companies which remains focused on retail centres worth between €20m and €50m across the country.

“We will keep trying to invest in Italy,” says Mario Pellò, Henderson’s head of portfolio management in Milan.“In Italy we are mainly focused on retail. We have some offices but no residential or hotels and have stopped looking at logistics.”

Henderson owns three shopping centres, five retail parks and three outlets in the country. Pellò says the firm is now looking at all centres in the north of Italy and some in the south.

One positive of the background to the latest round of austerity measures is that Italy has been working hard to stabilise its economy for some years and since the late 1990s consumer price inflation has been in a moderate range of around 2%-3%. Analyst Planet Retail points out that with Italy, one of the less wealthy markets within the EU (compared with powerhouses such as Germany and the UK), consumers still have some catching up to do, particularly in the south of the country with its underdeveloped and underfunded structures. As a result, private consumption has been among the key growth drivers over the past decades, as in most years private consumption grew slightly faster than GDP. An ongoing obstacle to short-term growth is the country’s economic division into two halves, with the largely saturated (albeit not strongly consolidated) north and the far less developed south, where it is hard to operate profitable large-scale operations because of the local spending power. However, retail opportunities will be boosted next year. Italy currently has 394,000 sqm of retail under development.I

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END OF YEAR REVIEW

LET THE GAMES BEGIN If 2011 has taught us anything, it is that politics and finance are an uneasy mix. From the moment that Lehman Brothers and Bear Stearns disappeared into a vortex, a powerful and sometimes heavy political hand has exerted growing influence on the global capital markets. The question at the start of 2011 was: can politicians fix the problems in the financial markets? While many tried, few have been able to provide either a consistent or coherent answer to that dilemma. More piquantly perhaps, the question being asked as 2012 dawns is: can politicians save the financial economy? Finding a meaningful answer to that conundrum will continue to reverberate through the first half of 2012; particularly as fewer people are convinced that politicians are the right people to fix the wrongs in the system. Francesca Carnevale sums up some the problems and the prospects.

HE NEWS ISN’T good, whichever way you look at it.

Simon Smith, chief economist at FXPro, expounds: “The level of the purchasing managers index (PMI) readings being seen in the eurozone suggests that a recession is more likely than not over the turn of the year.

The manufacturing reading in the provisional November data was below the 50 level [for] the third consecutive month in a row. On top of this, we are also witnessing a credit crunch in the eurozone as banks aggressively de-leverage to meet impending revised capital requirements, adding to the likely duration of the upcoming slowdown, which will likely last at least until the middle of next year.

At the same time, adds Smith: “PMI readings in China have increased concerns that we are likely to see a more synchronised global slowdown. This is probably more a shortterm fear than one that holds up on the wider view. While the G7 contracted in the 2007-2010 period, most emerging markets powered ahead, having reduced their reliance on foreign capital (Asia especially), avoiding the worst pitfalls of the credit crisis.”

Smith believes that this still largely holds true for the current period,“but China needs to navigate its soft landing first”. He continues:“As for the euro (struggling after a break below 1.3500), the PMI data has weighed only marginally, with the softer tone on the back of reports that France could well shoulder more of the cost of the Dexia bailout, something which it can ill-afford and further pressures its triple-A sovereign rating.”

Smith’s analysis cuts to a number of threads running though the financial markets at year end. Cross-border financial flows have contracted and liquidity remains scarce, two trends which have stripped ahead of countrybound politicians’ efforts to either control or stimulate them. Then again, although emerging markets have reduced their reliance on foreign capital, they continue to rely on demand in western markets for their goods. While that demand was unfettered, it floated all boats and although everyone talks of a growing east-east financial axis, it is (feasibly) some years away and the problems of the West continue to upturn growth expectations in advanced emerging markets.

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It is hard to see how Smith’s bearish outlook can be refocused over the next 12-month period. The key to change is perhaps not as politicians would have it, in government policy or regulation, but instead to be found in their ability to reflate their economies while cutting government spending and, at the same time, give bankers back their mojo. Right now it looks as though ideas are few and far between on the first, and the second is not in their sights at all. Understandably perhaps, it is not an easy sell to an already tired electorate. After all, bankers have been effective whipping boys for sovereign fiscal profligacy, so why should they be the ones to get things back on keel? Even so, the electorate would do well to remember that while the banking segment has cost the West a pretty penny, it adds up to peanuts in comparison to the monies needed to bail out Europe’s incontinent national treasuries. A case of the blinder leading the blind perhaps.

An end seems nowhere in sight, at least not in Europe. As Herbert Stepic, chief executive officer of Raffeisen Bank International, notes: “The EBA in London is now asking all European banks to increase their capital to 9% over the next eight months, at a time when the capital markets are moribund. What chances do European banks have? They have no option but to deleverage and that means further deceleration of economic growth. Loans will become more expensive for both sovereign borrowers looking to finance infrastructure and the corporate sector. This measure, which seems very logical, carries an enormous price. The same end could have been achieved through a Basel III-style accommodation over an agreed period in which the banks could feasibly meet approved levels of capital adequacy. It is a critical period to say the least.”

It might be that bankers in Europe will have to take a leaf out of the book of banking in Turkey, which faced similar problems in 2000/2001. Turkish bankers are cooking now; but they weren’t baking then. It took a thorough review of lending practices, a refocus on profitable businesses, inviting in foreign shareholders with new ideas and a good dose of provisioning and capital building over a period of two to three years before they could start standing tall in the kitchen once more. It was certainly painful at the time, but Turkey clearly shows it can be done.

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

Diversification Based Investing: Expanding into Emerging Markets A Q&A with James Norman, President, QS Investors, LLC FTSE and QS Investors recently expanded the FTSE Diversification Based Investing (DBI) Index Series to include Emerging Markets.

Can you explain the basic concepts behind DBI? Diversification Based Investing (DBI) seeks to apply the principles of portfolio diversification across asset classes to international equity markets. Research has shown that investors often become overly excited by the growth opportunities of countries, currencies, and industries and allocate too much capital to them while undervaluing other parts of the market.

This leads to concentration risk, which builds and collapses in traditional market-cap weighted indices.

DBI seeks to mitigate concentration risk by building groups of countries and industries that have been highly correlated to each other over the last five years, and then equal weighting these “risk clusters” or themes in the market. This creates a diversified portfolio across both countries and industries.

What makes DBI compelling in Emerging markets right now?

Similar to Developed markets, we have found that Emerging markets are subject to momentum and sentiment effects at the country and industry level, which lead to concentration risks that build and collapse. In addition, we see that diversification opportunities abound in Emerging markets due to the large differences between Emerging country economies. For example, some countries are commodity exporters, some importers, some are very technology and consumer export oriented, others are more diversified, and of course the political environments and currencies are extremely varied.

Emerging markets have struggled this year. How has the FTSE DBI All Emerging Index performed?

Year to date, the FTSE DBI All Emerging Index has outperformed its cap weighted counterpart, the FTSE Emerging Index, by over 4% through the end of October. This can be attributed in part to the fact that the FTSE DBI All Emerging Index is currently lower weighted in the worst performing industries, such as Basic Materials and Financial Services, and higher weighted in the best performing industries, such as Telecom and Consumer Goods. The DBI index was also lower weighted in the BRIC (Brazil, Russia, India and China) countries, all of which were all in the bottom half of country performance in the cap weighted FTSE Emerging Index.

FTSE DBI All Emerging Index vs. FTSE Emerging Index 250 200 150 100 50

FTSE DBI All Emerging Index

FTSE Emerging Index

Au g20 11 No v20 11

Fe b20 11 M ay -2 01 1

Au g20 10 No v20 10

Fe b20 10 M ay -2 01 0

Au g20 09 No v20 09

Fe b20 09 M ay -2 00 9

v20 08 No

g20 08 Au

ay

-2 00 8

-2 00 8 M

Fe b

v20 07 No

g20 07 Au

M

ay

-2 00 7

-2 00 7 Fe b

No v20 06

0

Source: FTSE Group as at 31 October, 2011

For further information about the FTSE Diversification Based Investing Index Series, please visit: www.ftse.com/Indices/FTSE_Diversification_Based_Investing_Index_Series All rights in the Index vest in FTSE and QS Investors, LLC. “FTSE®” is a trade mark of the London Stock Exchange and the Financial Times and is used by FTSE under licence. The FTSE DBI Index Series is calculated

by FTSE International Limited (“FTSE”) or its agent. FTSE, its licensors and QS Investors, LLC do not sponsor, advise, recommend, endorse or promote this product and are not in any way connected to it and do not accept any liability (including in negligence or otherwise) to any person in relation to the product’s issue, operation or trading or as a result of an investment in the product.

END OF YEAR REVIEW

Equally, the next few years will reduce the ability of politicians across Europe to spend taxpayer’s funds without thought or consequence for the future. Already precedents are being set in Europe with the replacement of democratically-elected government by functionalist technocrats with a limited mandate to push through fiscal consolidation.

Who can blame Italy for taking this route? The country is peachy keen to discard the corruption (both moral and fiscal) of the past decade, and now with the Sarkozy-Merkel axis beginning to determine long-term eurozone policy and skittish ratings agencies looking to downgrade Europe’s sovereigns wherever possible, who is to say they did not make the right decision? Rome has done it before.

According to Natixis, it is the zeitgeist. “Whatever the budgetary rules that eurozone countries may introduce (the golden rule etc), investors will now require countries to be fiscally solvent at any moment. This means that the primary fiscal surplus—excluding interest payments on the debt— must at least be equal to the product of the public debt ratio by the differential between the longterm interest rate and nominal potential growth,” says Patrick Arbus, head of research at Natixis in Paris.”As long

as this primary fiscal surplus is not reached, the fiscal policy of the eurozone countries in question will remain restrictive, with the resulting slowdown in growth amplified by the fact that restrictive policies are being conducted in many countries simultaneously.”

Arbus is equally bearish as to when this imposed fiscal probity will bear fruit:“We believe that eurozone growth will be weakened for at least three years.” That’s good news then, I thought it might be a lot longer.

Thinking about it, it seems rather measly to throw brickbats at year end at people with genuine concern for the future of capitalism and the financial infrastructure that supports it in the West. If it is not easy to limn the exact arc of change that the West must now undergo it is perhaps because while we know where it begins, we simply do not know where it must (perforce) end. There is a surfeit of political-economic prognostications about the future. After all, we all know that China will one day become the world’s largest economy, with the attendant political and economic mobility it endows. We know too that burgeoning economies, such as Turkey, Russia, Brazil, Argentina, and Australia (even perhaps Poland) will at some point come

US MARKETS REGULATION: ALREADY IN A FUNK? The 2,319 pages of the Dodd-Frank Wall Street Reform and Consumer Protection Act was a milestone of sorts in process of bringing order to the US financial markets. Backed by popular appeal, the act has proved to be resilient against attacks by Republican presidential candidates.

Even so, the act appears bogged down by its verbosity and detail. According to law firm Davis Polk, regulators have already missed the legally mandated deadlines for over 163 rules that the act requires, writes Ian Williams.

HESE BUREAUCRATIC SNAFUS in fact mask some major wins that have been achieved by the DoddFrank act. This includes “Say-on-Pay” votes, the mandatory publication of executive pay and its ratio to other employees for example, not to mention cutting charges to retailers for debit cards. It is indicative of the popular mood that when the banks proposed charging the customers instead for using the cards a combination of political pressure and consumer outcry forced many of them to reconsider.

One quibble is that the act did not set out to centralise and coordinate regulatory policy consistently across the US financial markets; which some say is an opportunity lost. Wharton’s Lauder Institute director Mauro Guillen avers: “Dodd-Frank could have gone one step further to merge the SEC, the OCC, and

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other regulatory agencies, leaving perhaps the FDIC separate. As we know, the Fed wanted more power over systemic risk, but Congress did not want to give it that power.”

Even piecemeal however, Dodd Frank does coalesce authority around regulators and adds a resolution regime to take orderly care of bankrupt financial companies. It protects consumers. The problem, adds Guillen is that: “We have made little progress with implementation [Moreover] the Republicans managed to pass legislation in June to delay implementation of many provisions until September 2012.”

Rules governing derivatives, particularly OTC derivatives trading, appear to be evolving on schedule.

However, observers’ hopes that wholesale protection of investors would be enshrined in this particular segment

were roundly dashed as Commodity Futures Trading Commission (CFTC) chair Gary Gensler moved to allow firms with as little as $50m in capital to enter the clearing house business.

The wisdom of Gensler’s position was immediately thrown into question when MF Global, one of the companies vociferously arguing in support of the chair, failed soon afterwards. Even so, to be fair, size is no protection against failure. Indeed large failures carry equally large systemic risk.

Everyone appears, in fact, to want a say in this profitable business segment. No less than 13,000 comments came in to the CFTC’s requests for comment on commodity position limits. The proposed position limits would cap the amount of futures contracts that a single trader or firm can hold on 28 commodities, such as

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

knocking on the door and start to redefine the old and cosy grouping that was the G7.

What will happen though, as the century advances, to the ability of the one-time leaders of the industrial age to continue to set the agenda of change? In one sense, it doesn’t matter so much, because of the power that the collective accumulation of capital in the West (in pension funds, mutual funds, hedge funds et al) exerts on the fortunes of the world. In that regard, the West is still in top gear. Although sovereign wealth funds and pension funds in many advanced-emerging and emerging markets are accumulating and investing in assets in some pretty innovative ways across the globe, it is not yet of the magnitude of the combined investment power of, say, the US pension fund segment. That advantage, however, will not last forever.

The current polemic would have it that as one segment rises across the world, the other must decline. That might be missing the point. The issue is more likely how the West can accommodate the emergence of so many relatively-wealthy players given the limited resources available in the world at any one time to share between them. Then again, there are more fundamental questions to answer. What kind of

oil, wheat and corn. Existing rules only capped nine items. Similarly, the commission resisted industry blandishments to allow many physical futures to go unregulated.

Among the myriad rules awaiting clarification is the Volcker Rule, restricting proprietary trading and thereby conflicts of interests in banks and encouraging a separation of retails and investment banking business. The SEC outline for comment comes in at 530 pages, asking for opinions on 394 distinct questions by January 13th 2012.

It then hopes to have finalised the rules

by July, With thousands of interested parties expected to enjoin talks, holding one’s breath is not advised.

Sal Gilbertie, president of Teucrium Trading, which sells a line of commodity-based ETFs, laments: “The regulations are well intentioned, but often quite onerous and increase costs of all companies. If you increase costs for traders, you increase them for the public. The costs of monitoring and reporting requirements, across these multinational organisations that actually work directly in the commodity supply chain will add directly to the cost of everybody’s bowl of cereal.”

country/society/culture will define the West in the years ahead? What will be the mainstays of revenue? How are the capital markets changing form? How will the global equity markets evolve? Can global banking survive in its current form? Which currencies will dominate the FX and trade finance markets and what will that mean for other currencies? How will advances in technology continue to change the way business is conducted? How different will the world be in the next five, ten or even 20 years, and how should investors meet that change? As a magazine, we will be spending much of 2012 pin-pricking people who matter for their ideas in this space.

All this is leading up to our selection from 2011 of our 2020 nominations. As always it is a medley of the sublime and the workaday, simply because that is the way that the markets work. The selection honours hard work and forward thinking, as well the ability to leverage existing business tools and structures to best effect. Always, we hope, we highlight rigorous commitment to results and achievement, sometimes in the face of market difficulties; sometimes in the face of civil conflict. We hope you enjoy and celebrate this past year’s crop. I

Gary Gensler, chair of the Commodity Futures Trading Commission (CFTC), speaks at the Securities Industry and Financial Markets Association annual meeting, Monday, November 7th, 2011 in New York. Photograph Mark Lennihan/AP/Press Association Images, supplied November 2011.

He adds: “They don’t just handle corn but a variety of commodities, and they have dozens of traders across the world who have to fulfill the requirements, so the Dodd-Frank monitoring requirements add an immense layer of bureaucracy across these operations. The reporting requirements are already being

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

implemented over the next few quarters.

Next year they will be in place and tested for immediate effect. The position limits will be implemented in the first quarter of next year for the legacy contractors on agricultural commodities, with the monitoring, adding costs that will be felt on almost any commodity user.”

Guillen agrees. He says: “Of course, regulation increases transaction costs and paperwork. It reduces the ability of the markets to function unhindered.

Regulation is meant to prepare us for the day on which something bad happens.

There is a trade-off then between keeping costs down and protecting us from systemic risk. It is a difficult balance and we need to learn how to live with it.

It remains to be seen whether the financial industry does indeed learn to live with what could be seen as a compulsory insurance policy.

Certainly, even if there were no Republican successes in the 2012 elections, giving a free ride to the institutions that brought about the biggest financial crisis since the Great Depression is not going be much of a vote winner. It would be unwise to short Dodd-Frank just yet!

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END OF YEAR REVIEW

US DOLLAR STILL THE MAINSTAY: BUT FOR HOW LONG? In a paradigm-busting trend, the US dollar continues to strengthen. Given moves by the Federal Reserve to update and toughen its stress tests for banks to include 13% unemployment by 2013, it is astounding. Then too, the allegedly bipartisan supercommittee tasked with solving the Federal deficit gives itself a pink slip and goes home without a plan. How long can markets ignore what is going on before them? By Ian Williams.

HE UPWARD TRAJECTORY of the US dollar is reminiscent of the punch line of that hoary joke: Crime in multi-storey car parks? It’s wrong on every level. On fundamentals alone, the dollar should be tanking. However, the US is still the motor of the world’s economy, and investors react to bad news about it in a seemingly perverse way. They run to the dollar because “the environment is dominated by fear, and with authorities clamping down on speculation people go for safety,” explains Luc De Clapier, former New York head of Natixis Capital Markets Inc, and now president of New Dawn Advisors.

“When the Fed announced a few weeks ago that they were buying $400bn in long-term Treasuries and selling the short term, you’d have expected investors to collect short term bonds because the price of long terms would come down,” continues De Clapier. “In fact, the intensity of the crisis in Europe and extreme fears in the US during August and September of a recession led to the inverse effect.

Long term should have gone down.

They went down initially by a few basis points [but] then they went back up. It’s not that the Treasury was not buying, but international investors felt that with all the problems [elsewhere], they bought in [the] US rather than Europe, bringing down long bond yields.”

Professor Mauro Guillen, director of the Wharton School’s Lauder Institute, posits a broader brush perspective. “We are seeing the end of the post-World War II era. We know things will be

T

54

different, but there is so much uncertainty, not least because no one knows which way things will go from here. With confidence being such a big issue, these are strange times. So, for example, despite the US balance of payments, the deficit and the political uncertainty, and the low interest rates, people are still buying the dollar, because there is nowhere else for them to go.”

Despite its very visible downside then, the US dollar, it seems, is still the only reserve currency in town, the denomination in which most global trade is still valued, and indeed in which most other countries value their own reserves. As Guillen explains: “The nearest thing to a viable alternative is the euro, and of course, its current problems stop it being an alternative.

On the other side, although China is set to be the world’s largest economy, the renminbi (RMB) is not convertible, so it can’t replace the dollar.”

Guillen suggests that there is no room for complacency for the US, certainly not in the longer term.

“People are looking for alternatives, as the Swiss franc and yen testify, but the Swiss economy is too small to play the role, and even Japan, apart from its own banking problems, is not really large enough to substitute.” In fact, sterling is a bigger reserve currency than the yen, representing between 4% and 5% of world reserves, while the Swiss franc is less than one per cent.

Actually, there are dangers in having a reserve currency without the economic heft to back it up. Both the Japanese and Swiss are spending a

lot of money to stop their currencies becoming safe havens, since their exporters and all those who depend upon them would not appreciate too much appreciation. Even the Australian dollar is being forced up.

De Clapier points to the delicate balancing act in Beijing, where the authorities are clearly thankful the RMB is not convertible. “Because their economy is so exposed to exports, they are trying to find a proper balance, so they will not do anything to precipitate. They will try to stop appreciation of the RMB, because of its effect on trade, although everyone tells them to continue to revalue. But the Chinese obviously feel frustrated, witnessed by the growth of bilateral deals and barter agreements with trading partners [such as] Brazil to bypass the dollar.”

Even so, Guillen thinks that over the longer term the US dollar will be on a gentle downwards slide. “For the next two years or so, the dollar will hold its own, but it will definitely weaken as confidence in it ebbs and people work out alternatives. It’s unlikely to be a catastrophic Argentinean style meltdown. It is more likely it will drift down by, say 30% or so, over five to seven years. At the moment Asian countries with a hard or soft tie to the dollar are waiting to see what happens, but eventually they will likely loosen it,” he suggests.

Despite its current problems, a long-term threat to the dollar dominance might yet come from the euro. De Clapier suggests it is the “elephant in the room”. Even if, he says, “the crisis results in a massive devaluation, then you will have a cheap euro, making the eurozone a good investment”. In turn, he says, the markets could see a big change in the dollar. He predicts a crunch period in 2014 or 2015, as the current policy of debasing the currency comes home to roost and the Fed finds it more difficult to sell bonds.

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

20-20: DR ZETI AKHTAR AZIZ, GOVERNOR, BANK NEGARA MALAYSIA

Last year Malaysia accounted for 72.5% of total sukuk issued globally. The trend continues unabated this year though the country still has some way to go to become a truly international hub. Nonetheless, it has become a singular entity with clear prospects, based on a robust regulatory infrastructure, a buoyant domestic issuance market and related institutions, which have set a consistent and enviable run of benchmarks for sukuk issuance. The success of Malaysia in establishing a pre-eminent position in Islamic finance is not happenstance. It has taken years of hard, detailed work, led by Bank Negara Malaysia, the central bank, and its governor Dr Zeti Akhtar Aziz.

Dr Zeti Akhtar Aziz, governor Bank Negara Malaysia. Photograph by Lee Chun Chung / Light Frame Photography, supplied November 2011.

SETTING THE BENCHMARK IN SUKUK ISSUANCE G IVEN MALAYSIA’S LONG-standing commitment to the deepening of the Islamic finance market, it seems appropriate that the 19th Meeting of the Council of the Islamic Financial Services Board (IFSB), the international standard-setting organisation, was held in Kuala Lumpur in November 2011. Malaysia is now a clear regional leader in Islamic finance and has set new benchmarks in Shari’a-compliant sukuk issuance; both in terms of issuance volume and as an innovator in Shari’acompliant financing structures.

The year has seen a number of innovative transactions, led

by Khazanah Nasional, the investment holding arm of the Malaysian government. Two transactions typify the trend. One is Khazanah’s recent ground-breaking CNY500m three-year renminbi-denominated sukuk, priced at 2.90%. It is the first Emas (Malay for “gold”) foreign currency sukuk issued in Malaysia, and the first sukuk denominated in renminbi.

The sukuk was issued under the Malaysia International Islamic Financial Centre (MIFC) initiative, and highlights Khazanah’s support of the expansion of Islamic finance through innovative securities structures. The sukuk was issued via a Malaysian incorporated special purpose vehicle, Danga Capital, under its official multi-currency Islamic securities programme and was listed on both Bursa Malaysia

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

(in its Exempt Regime segment) and on the Labuan International Financial Exchange (LFX).

The second is Khazanah’s inaugural issue of five-year and ten-year sukuk, worth a combined SGD1.5bn. The deal was a milestone for a number of reasons. It was the largest and longest-termed Singapore dollar-denominated issue by a foreign issuer in Singapore under the same multi-currency securities programme registered in Malaysia. The transaction came in at the tightest end of price guidance, at 2.615% for the five-year sukuk and 3.725% for the ten-year sukuk, ultimately drawing demand of 4.3 times book size, enabling Khazanah to up the deal size from SGD1bn to SGD1.5bn.

At the time of the issue, Dr Zeti Akhtar Aziz, governor of Bank Negara Malaysia and chairman of the executive committee of the Malaysia International Islamic Financial Centre, noted: “This is a further step forward for our MIFC initiative to evolve Malaysia into a multi-currency issuance platform for sukuk.”

Also through 2011, the Kuala Lumpur-based International Islamic Liquidity Management Corporation (IILM), in which the central bank enjoys a founding role, which launched in autumn of 2010, has steadily prepared itself for a sustained issuance programme of short-term Shari’a-compliant paper beginning in 2012. IILM will facilitate more efficient liquidity

55

20-20: DR ZETI AKHTAR AZIZ, GOVERNOR, BANK NEGARA MALAYSIA

management for institutions offering Islamic financial services and help support a growing number of cross-border transactions between them.

After a small pilot issue scheduled for early 2012, the IILM is likely to issue regularly in batches of $2bn short-term paper in multiple currencies, enhancing the ability of Islamic institutions to match their liabilities and meet the demands of global trade flows.

A pivotal role Dr Zeti is a central figure in international Islamic finance initiatives, chairing special taskforces for the IFSB, the executive committee of the MIFC, and is also the chair of the governing board of the IILM and chancellor of the International Centre for Education in Islamic Finance (INCEIF), in Kuala Lumpur.

Her keen grasp of the complex Islamic finance segment has been honed over a 25-year career at the central bank, where she entered as a research analyst in 1985. Prior to joining the bank, Dr Zeti was attached to the South East Asian Research and Training Centre (SEACEN)—between 1979 and 1984—as a research economist specialising in financial policies and reform in the Southeast Asian region.

Dr Zeti held a number of positions at the central bank before she was appointed assistant governor responsible for economics, reserve management, foreign and money market operations and exchange control.

She took over as acting governor of the bank on September 1st, 1998 during the height of the Asian financial crisis and led the Bank Negara Malaysia team to successfully introduce and implement selective exchange controls and a fixed exchange regime, which was subsequently lifted in 2005. During the Asian financial crises, Malaysia was faced with numerous challenges. “We had a very fragmented market with more than 75 financial institutions, many with multiple subsidiaries. There was a clear gap between the strength and quality of our domestic banks and their international peers,” she explains.

The crisis has provided Malaysia the opportunity to undertake institutional reforms that enabled the country to better withstand the recent financial crisis. Bank Negara Malaysia, she says, encouraged market-led consolidation by increasing capital funding requirements, discouraging certain financial activities and instigating new regulatory and reporting standards.“We wanted to refocus the financial sector away from the purely financial sector and refocus it on the main economy, diversifying the financial market into insurance and asset management as well as supporting the growth of Islamic financial institutions,” she adds.

Market liberalisation encouraged the entrance of foreign players, and helped to build up the local financial institutions segment, as well as institutionalise a more robust financial infrastructure. These have been key building blocks in creating a stronger and more dynamic financial marketplace, backed by a flexible exchange rate regime, holds Dr Zeti. Her success in stabilising the ringgit, and in introducing key financial and currency reforms and deregulation, made her appointment as permanent governor in the spring

56

Photograph by Lee Chun Chung / Light Frame Photography, supplied November 2011.

of 2000 a shoe-in. Now into her 12th year as governor, she is a consistent and driving force behind Malaysia’s leadership in the development of Islamic finance globally.

In that regard, Malaysia’s circumstances are now very different to what the central bank faced in 1998. Malaysia now has one of the most developed financial sectors among emerging economies. There have been obvious benefits flowing across both retail and business borrowing: “There has been no credit crisis here in Malaysia with a steady flow of credit to both the household sector and SMEs. Also, sukuk yields have tight spreads and often experience oversubscription than their conventional equivalents as the pool of potential investors is wider comprising both conventional and Shari’a-compliant parties while drawing comfort from the robust regulatory system governing capital raising in Malaysia,” she says.

Dr Zeti is quick to dispel the idea that Malaysia’s successes can be laid at the door of any one individual.“Take the MIFC initiative for example. The MIFC executive committee draws membership from key government ministries and agencies as well as the country’s Islamic financial institutions and other key regulators such as the Securities Commission with the objective to promote Malaysia as an international Islamic financial centre. It is about moving forward together in a sustainable way and creating an enabling the environment for Islamic finance activities to thrive. Certainly, without the central bank and the Securities Commission, there would be no regulatory structure to permit sukuk. However, without other government institutions undertaking seminal benchmark issues, or the exchange providing a venue for listing of sukuk, or the local Islamic banks supporting secondary trading of sukuk and a distribution capability, then it would all be for nothing. Everyone has a key role to play.”

Nonetheless, Dr Zeti has made a strong personal contribution to the establishment of specialist institutions that provide an infrastructural backbone for the Islamic finance industry. Contributing towards the creation of the IFSB, for example, remains one of Dr Zeti’s proudest achievements.

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

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20-20: DR ZETI AKHTAR AZIZ, GOVERNOR, BANK NEGARA MALAYSIA

Based in Kuala Lumpur, the organisation was officially inaugurated on November 3rd 2002 and began operations on March 10th the following year. It serves as an international standard-setting body of regulatory and supervisory agencies that have vested interest in ensuring the soundness and stability of the Islamic financial services industry, which is defined broadly to include banking, capital market and insurance. In advancing this mission, the IFSB promotes the development of a prudent and transparent Islamic financial services industry through introducing new, or adapting existing, international standards consistent with Shari’a principles, and recommends them for adoption.

To this end, the work of the IFSB complements that of the Basel Committee on Banking Supervision, the International Organisation of Securities Commissions and the International Association of Insurance Supervisors. As at November 2011, the 189 members of the IFSB comprised of 53 regulatory and supervisory authorities, eight international inter-governmental organisations and 128 market players, professional firms and industry associations operating in 42 jurisdictions. Malaysia, the host country of the IFSB, enacted a law known as the Islamic Financial Services Board Act 2002, which gives the IFSB the immunities and privileges that are usually granted to international organisations and diplomatic missions.

The private sector perspective Equally, Dr Zeti highlights the role of the private sector in complementing official structures: both in the context of Islamic finance and the country’s traditional debt capital market.“The Malaysian market is one of only three (the others being Australia and Hong Kong) where private bond issuance exceeds that issued by the government or state institutions.

The imminent award of two mega Islamic bank licenses is another indicator that Malaysia is keen to see the private sector’s role to expand even further, not only domestically but also internationally,” she says. It is a clear acknowledgement that both Islamic finance and the conventional financial system are now developing side by side in the country.

Dr Zeti explains that the mega Islamic banks will have primarily an overseas mandate and will not compete with the domestic institutions. Instead, they will leverage on expertise developed domestically and seek out international opportunities. Non-Muslim institutions (both public and private sector) have been forthcoming to issue sukuk in the country. There is precedence which suggests the strategy will work: Tesco, Shell, Nomura and even the World Bank have successfully issued sukuk in Malaysia, highlighting the growing price competitiveness of sukuk structures. There was perhaps a time, she admits, that there was a commercial disadvantage with Islamic banking and finance over conventional products. Sometimes this manifested itself in having to pay higher yields on sukuk or perhaps it meant fewer and more restrictive banking products. That is no longer the case and if anything Dr Zeti thinks it has reversed.

Malaysia has fortuitously found its natural niche in Islamic finance; and because of it enjoys a growing voice on

58

the international stage. Trying to compete with the global financial centres is extremely difficult, holds Dr Zeti, not least because of the head start that places such as London and New York enjoy.“They have a critical mass which takes many decades or in some cases centuries to establish. With Islamic finance, however, it is a much more level playing field. We are all starting from the same place and if anything we have an advantage as a predominantly Muslim country located in Asia.”

Dr Zeti also anticipates that continued change in the financial markets will also play to Malaysia’s strength. “Already we see emerging markets becoming the anchor of global economic growth. Trade between emerging economies will soon begin to rival that between developed and developing nations. You can already see the massive growth in trade between countries such as Brazil and China or Russia and India, or between the large economic surpluses in places such as the GCC and the infrastructure investment requirements of somewhere like Indonesia. It doesn’t make sense any longer to direct those flows via centres such as London. Over time, we will see a network grow between smaller financial hubs in the developing markets that will support these economic and financial flows and mutually reinforce one another in supporting growth. It is a new Silk Road and Malaysia has a definite role to play in that,” she avers.

Malaysia certainly seems to be charting a more stable path than most with third-quarter growth rates of 5.8% and GDP growth rates of at least 5% predicted for 2011 and 5% for 2012. Nonetheless, Dr Zeti dismisses the idea that Malaysia is immune to any global slowdown.“We are a relatively open economy and so we are likely to be affected. However our stable domestic demand is likely to insulate us from the very worst.” She credits much of the current stability not to recent changes but to those that took place much earlier. “Policies need to be anticipatory not reactive. If you have to make changes or put regulation or structures in place to counteract a particular issue then in all likelihood it is already too late. The damage has often already taken place and all you can do is try and mitigate its impact. If however you can assess the likely risks and weaknesses ahead of time then you are more likely to be able to stop them.”

With four-and-a-half years still to run of her current fiveyear term, Dr Zeti gives little indication that she is ready to slow down her efforts. She thinks there is huge opportunity for even greater regional financial integration as well as the continued efforts in the development of Islamic finance.

“We are not in competition with each other, we need to work together to make the pie bigger.”

The link between Islamic finance and the real economy is one that Dr Zeti continues to emphasise. “The support for Islamic finance in Malaysia has never been about financing for financing sake. It is about providing support and finance for real companies and real jobs. This and the very nature of Islamic finance with its link back to the underlying asset, makes it much more sustainable in the medium to longer term. “I

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

20-20: GOLD

European investment in gold has reached record levels. Fears of high inflation, uncertainty in the sovereign debt markets and the choppy performance of equities have driven investors towards the classic safe-haven asset. At a time when competing investments offer mediocre returns and sovereign debt is no longer considered risk-free, the glister of gold is likely to catch many an investor’s eye for the foreseeable future. By Neil O’Hara and Vanja Dragomanovich.

GOLD IS ALL THAT GLISTERS W HAT IS STRIKING is that European bar and coin demand was at 118 tonnes, the largest in the world, says Marcus Grubb, managing director for investment at the World Gold Council (WGC), following the release of its third-quarter 2011 report. “If you take into account that ETF demand was 77 tonnes and that this was roughly equally distributed between the US and Europe then this was really a stellar quarter for Europe,”says Grubb.

Even so, global investment demand for gold rose by over 30% in the third quarter of 2011 compared with the same period in 2010. The drivers of demand are manifold: high ETF inflows; gold is increasingly being accepted as collateral by major exchanges such as the Chicago Mercantile Exchange; and jewellery purchases, particularly in India, China and the Middle East, continue to burgeon. There is also a shift in central bank attitudes to gold, which has also played its part in propelling prices. Gold is up almost 40% for the same period when compared with the third quarter of 2010.

After the 2008 financial crisis, European central banks, which had been selling gold for years, drew in their horns.

Sales dropped from 350 to 500 tonnes per year to seven tonnes in the 12 months through September 2010 and just one tonne the following year.

Industrialised nations that framed the Bretton Woods agreement still hold a significant proportion of their foreign exchange reserves in gold—more than 70% for the United States, Germany, France and Italy, for example. In contrast, the newly cash-rich BRIC countries and other emerging markets typically have between a relatively modest 1% to 10% of their reserves in gold. Those same emerging markets have stepped up their buying to boost the gold weighting in their reserves portfolios and as a hedge against the debasement of fiat money in the developed nations.

James Steel, precious metals analyst at HSBC in New York, explains: “The heavy sales in the 1990s and early 2000s occurred because the Europeans did not need to hold so much of it as geopolitical risk had fallen.”

Grub says: “If you look back it was mainly western banks that were doing the selling [of their gold reserves]. Western banks tend to hold a much higher proportion of gold as part of their reserves, something in the range of between 50% and 60%, whereas economies that are in surplus tend to hold only about 2% to 3%.”

Since the late 1990s, European central banks and the IMF have coordinated their gold sales under the Central Bank Gold Agreements (CBGAs), which capped their collective annual sales at 400 tonnes from September 2000 to

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

Michael Widmer, a metals analyst at Bank of America Merrill Lynch.

Photograph kindly supplied by BofAML, November 2011.

Natalie Dempster, head of government affairs at the WGC. Photograph kindly supplied by the WGC, November 2011.

September 2004 and 500 tonnes in the subsequent four years. In addition to satisfying increased demand for gold from private investors and jewellery manufacturers, some of that metal went to central banks in China, Russia, India, Mexico and other emerging markets. The current CBGA, which expires in September 2013, sets a 400-tonne limit, although it is no longer relevant now that the Europeans have stopped selling.

Steel attributes the change in European attitudes to longterm structural weakness in the US dollar, particularly after the 2008 financial crisis. The decade-long bull market in gold may have prompted second thoughts about selling, too.

Whatever the reasons, the end of European sales has had a profound effect on the balance of supply and demand. “It is just as important that the Europeans have stopped selling as that the emerging markets have started to buy,” says Steel.

“Scrap has now replaced official sector selling as the second largest source of gold supply.”

In 2011, Mexico’s central bank alone bought 100 tonnes of gold, taking total central bank purchases in the year to around 348 tonnes. “This trend will only continue in the future as central banks of economies that are in surplus continue to attract foreign exchange, which makes the proportion of gold in their reserves smaller and prompts them to buy yet more gold,” he adds. The WGC expected central banks to buy another 100 tonnes of gold before the end of 2011.

Central banks invest in gold not least because it is one of the few assets they are permitted to hold. Equities are generally off limits and the sovereign debt of certain

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20-20: GOLD

advanced nations once considered safe beyond question is now under a cloud. Michael Widmer, a metals analyst at Bank of America Merrill Lynch in London, says:“Initially, the emerging markets increased their gold reserves as an insurance policy, but then export-driven growth and pegged exchange rates caused a massive increase in their reserves.

For some countries, the weighting of gold in their portfolios has declined even though they have been buyers.”

A study Widmer and his colleagues conducted of efficient frontiers for central bank investment portfolios made the case for an 8%-10% portfolio weighting—more than double the current level for many emerging markets countries. “It still makes sense for emerging markets central banks to increase their holdings from an asset allocation perspective,” he says.

The appropriate weighting varies by country, though. Countries such as China that already have large gold holdings should settle for a lower threshold to ensure that the sheer quantity will not overwhelm the market if they ever have to sell.

Natalie Dempster, head of government affairs at the WGC, explains that reserve asset managers at central banks altered their investment strategies after the 2008 financial crisis.“They used to be focused on yield, but now it is all about risk management and liquidity,” she says.“Gold does well during fattail events, and quantitative easing has led to fears about the value of fiat money.”Like Widmer, she emphasises that central banks have few alternatives to gold if they want to sell other permitted investments—such as European sovereign debt.

The WGC expects emerging markets central banks to remain net buyers of gold for the foreseeable future, given the current economic environment. In the third quarter of 2011, the World Gold Council estimates that central banks bought a net 148 tonnes, led by Thailand, Russia and Bolivia.

“Deposit rates will become more negative as inflation picks up,” Dempster says. “Gold should also do better as the sovereign debt crisis reaches breaking point.”

Her reserve optimisation models for emerging markets central banks recommend 3%-30% in gold, depending on what other assets they own and their risk tolerance. It’s a wide range, but in most cases well above current holdings.

Central banks are the third-largest players in the gold market, after jewellery and private investment, but the shift from average net sales of 440 tonnes per year before 2008 to substantial net purchases will be felt for years to come.

The question now is can gold make any further progress in terms of prices beyond $1,800/oz and analysts believe that in the short term this is not very likely. Saxo Bank’s senior commodity strategist Ole Hansen says it is worrying that gold has failed to break above $1,800/oz as investment in ETFs rose strongly during November and is now at the record levels seen in August 2011. If prices continue to go down, especially below $1,700/oz, there could be a deeper correction, he says. Looking ahead however, the prospects for a price rise look fairly positive. In an environment where real interest rates are negative and the US equity risk premium is high, “our strongest conviction trade remains long precious metals and specifically gold,” says Michael Lewis, commodity analyst at Deutsche Bank. I

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20-20: CNH – THE OFFSHORE RENMINBI

CNH: WHAT’S IN A NAME? The news in early December 2011 that CME Clearing will accept offshore renminbi (CNH) as collateral for futures trading shows how far the unofficial currency of the China has come. You can open an account in CNH; you can issue bonds and securities in CNH, and now you can open collateral accounts in CNH. It is the rookie of the year that threatens to jump to the head of the class and which enjoys great expectations. The obvious question is left hanging: just how far away is full convertibility of its official counterpart, the RMB? ME GROUP SAYS it will include offshore renminbi (CNH) in the range of instruments to meet performance bond requirements on all exchange futures products cleared through CME Clearing, effective January 2012. HSBC Hong Kong will serve as CME’s first Far East clearing custodian in Asia, holding CNH deposits from CME Group clients and use those deposits as collateral. In part, according to Kim Taylor, president, of CME Clearing, the CME Group is looking at ways to provide services that fulfil the needs of its increasingly-diverse customer base.

The agreement also cements HSBC’s leadership in the development of the CNH market, says Diane S Reyes, global head of payments at the bank, noting the agreement between the two institutions is“the first of its kind”.

Razzmatazz aside, the real story is the about the fastmaturing kid on the block, the offshore renminbi, best referred to as CNH. Although the Chinese government began promoting the development of offshore RMB in 2004 through the encouragement of the use of RMB in cross-border transactions, it wasn’t until 2011 that the currency caught the spotlight. In part, it has benefited from the belief that China is the heir apparent to the global economic throne—that coveted number one slot atop the G20. That alone would and should underscore its growing popularity; and by extension appreciation in its value.

Now comes the clever bit: to support and protect Chinese exporters; to limit imports to mainly industrial components and resources that feed Chinese industry and construction, the Chinese maintain non-convertibility and set an official exchange rate which maintains the country’s competitiveness despite inflationary pressures and growing demand for its currency.

In part, too, CNY has benefited from the clarification mainland China has provided to the multi-strand RMB

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DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

The renminbi currency. Photograph © Zoom-zoom / Dreamstime.com, supplied November 2011.

regime—an official currency (RMB), an offshore currency (CNH) and a trade finance currency (CNY). It keeps a tight lid on the conversion value and usage of each. This really came to the fore in July of 2010 when China and Hong Kong signed a revised Settlement Agreement on the Clearing of RMB Businesses. It was an important stepping stone for the take-up of the offshore RMB. Equally, CNH has benefited from escalating competition between Singapore and Hong Kong to become the Asian financial centre of choice and a centre of offshore RMB. Ultimately, those ambitions must fade to grey as Shanghai waits in the wings for its time in the sun, when the RMB finally becomes convertible and there is a clear and easy path for investment monies in and out of the mainland; but for now, while CNH usage gains momentum, there is still substantive business to play for.

Right now, Hong Kong is winning hands down. RMB trade settlement conducted through banks in Hong Kong in the first four months of 2011 amounted to RMB445bn, as compared to RMB369.2bn in 2010. In the first quarter of 2011, 86% of mainland’s RMB trade settlement was conducted through banks in Hong Kong, showing that Hong Kong is the prime platform for RMB trade settlement.

Moreover, RMB deposits in Hong Kong continue to grow apace. In 2010, RMB deposits increased from RMB60bn in January to RMB310bn in December, and further to RMB510bn as of end-April 2011, according to the Hong Kong Monetary Authority. According to more recent figures from the Financial Services and the Treasury Bureau, by the end of October 2011, RMB deposits in Hong Kong nearly doubled from the start of the year, to RMB618.5bn (just over $97.2bn), now some 10% of the total deposits in Hong Kong.

Concurrently, Hong Kong has become the largest offshore RMB bond market. The total amount of RMB bond issuance in Hong Kong increased from RMB16bn in 2009 to RMB35.8bn in 2010. In the first five months of 2011, the amount of RMB bond issuance exceeded RMB28bn. In the first ten months of 2011, 71 entities issued CNY92.6bnworth of RMB-denominated “dim sum” bonds, compared with RMB36bn in 2010.

An important function of the Hong Kong offshore RMB business centre is to provide an efficient market and financial platform to allow the effective circulation of RMB funds. This includes “outer circulation; that is the circulation of RMB funds between Hong Kong and the overseas market, and “inner circulation”, in other words, the circulation of RMB

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

funds between the Hong Kong offshore market and the mainland onshore market,” says a recent HKMA report.

Just how far the HKMA has succeeded is illustrated by the following facts. Hong Kong conducted 86% of RMB trade settlement in the first quarter of 2011. This is evidence that many financial institutions in Hong Kong are providing RMB settlement service for overseas corporate clients, says the HKMA. “Hong Kong also has an edge in promoting the outer circulation of RMB under non-trade account. Currently, more than 40% of Hong Kong’s deposits are held by non-resident institutions or individuals. Among the RMB deposits held by institutions, 16% are held by overseas institutions. Therefore, RMB funds flowing to Hong Kong are in effect being circulated among international individuals and corporations,”it adds. In that sense, the trend can only deepen.

In September 2011, China’s central bank, the People’s Bank of China (PBOC), said it would begin trialling RMB Qualified Foreign Institutional Investor (RQFII) trials, allowing RMB funds raised in Hong Kong to be invested in the mainland’s securities markets.

Despite the relatively conservative quota of less than RMB20bn, the RQFII quota is expected to build; particularly as RMB deposits in Hong Kong are soon likely to top $1trn, and are looking for returns. Right now, Hong Kong investors have very limited options open to them to invest in mainland securities and are mainly confined to buying RMB denominated bonds. The RQFII programme will broaden the channels for RMB in the offshore market to flow back into the mainland.

The RQFII programme is part of the central government’s measure to build Hong Kong into an offshore RMB centre, said Vice Premier Li Keqiang at a forum on the nation’s 12th Five-Year Plan (2011-2015) which included discussion of cooperation between the mainland and Hong Kong, also last September.

Another milestone came early in November 2011 as an RMB100m convertible bond issue by Hong Kong juice company, Garden Fresh Fruit & Vegetable Beverage (Garden Fresh), came to market. The transaction was lead managed by Sun Hung Kai Investment Services Limited, which in turn was advised by international law firm Simmons and Simmons.

Although in deal size it is a relative minnow, it did manage to break new ground as the first ever issue of convertible bonds in the offshore renminbi market. The convertible bond offering is a pre-IPO offering, which the issuer hopes to complete within three years.

For now, bond issue volumes will continue at a sustained pace, in part propelled by foreign firms with RMB exposure and the Chinese ministry of finance, which has come to market three times this year with just under $10bn-worth of issues in CNH, to help cement Hong Kong’s position as the premier offshore RMB centre. That position can only get stronger in the near term.

The question now is: how long before the CNH market finally gives way to a fully convertible RMB. In early 2011, most analysts estimated a date around 2015. However, as the range of CNH financial instruments grows and usage escalates, that date looks increasingly toppy.I

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20-20: MATTIAS WESTMAN, CEO, PROSPERITY CAPITAL MANAGEMENT

Mattias Westman, chief executive and co-founder of Prosperity Capital Management (PCM), sees parallels between his own company and the Russian companies he invests in. “In 1996 we were just a bunch of guys setting up in an office in Moscow. We were fairly young and didn’t have much experience in running a fund management company. Now we are more corporate and institutional and efficient. In that respect we identify with some of the entrepreneurs who lead the new companies in Russia.” Ruth Hughes Liley reports.

CREATING VALUE IN HIGH-GROWTH RUSSIA WEDISH-BORN MATTIAS Westman, 45, and two colleagues began investing in Russia in 1993 when massive internal change was transforming the country and when $5 privatisation vouchers to be exchanged for shares in formerly state-owned factories and shops were being put into the hands of 150m ordinary Russians.“These newly-privatised companies didn’t know how to create value,”says Westman.“Companies are now becoming more profitable and efficient and doing the things that turn a factory production unit into a company. Also, the process of consolidation is rolling up the sectors to achieve economies of scale. In the beginning however there was massive fragmentation; every single shop and every factory became a company after the end of communism.”Westman says there are still efficiency gains to be made in Russia, as many companies are still poorly run. In fact he says most profit growth comes from simple productivity increases through efficiency gains following restructuring and consolidation.

It is this potential for company growth from greater efficiency which saw Prosperity Capital Management (PCM) assets under management grow to $5bn by mid-2011. The recent global downturn has knocked off $1bn, but Westman still believes the fundamentals of investing in Russia and the former Soviet Union countries are sound.“The markets are volatile, but the earnings of companies are not nearly so volatile. Earnings don’t change much.” He points to 2008 when the price-earning ratio in PCM’s flagship Russian Prosperity Fund collapsed from over 10 to 2.5, while its earnings per share (EPS) fell only fractionally from around $25 to $21. Today, EPS in the fund stands at $48. “Russian companies have lived through a lot of volatility. They don’t like being leveraged. Plus the Russian government is largely debt-free and individuals too have very low levels of debt, so they have a bigger disposable income, providing a strong growth base,” he adds.

Westman says that PCM’s success is due to its long-term investment philosophy to “own parts of companies, not just a piece of paper or share certificates someone might pay more for tomorrow”. He adds: “Even in 1998, when share prices were close to zero, companies were still producing; they were still pumping oil from Siberia; no debt meant very few companies went bankrupt.” With 30 employees (half in Moscow, a quarter in London and the Cayman Islands and

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Mattias Westman, chief executive and co-founder of Prosperity Capital Management. Photograph kindly supplied by PCM, November 2011.

one in Tokyo), PCM meets regularly with management of the companies in their funds. They are often the largest minority shareholder, regularly holding between 5% and 10%. Energy investment is a significant component in the firm’s overall strategy: PCM, for instance, is the secondlargest shareholder in TNK-BP and helped to negotiate its recent conflicts.

The firm is also good at seeking out sometimes arcane opportunities: it is the second-largest shareholder in Manas air base in Tajikistan; the staging post for US Air Force planes on their way to and from Afghanistan. “It is a small investment but it gives a good dividend yield, makes a good profit so why not?” shrugs Westman. PCM does not get involved in direct management of its companies, but with a minimum investment horizon of three years, Westman talks with companies about what is expected in terms of corporate governance. He has an advantage: during his 18-month spell in the Swedish military, he learned Russian and was taught interrogation techniques, useful in negotiations, he understates.“Corporate governance is the greatest risk and in 1996 it was appalling, so if you can be an active shareholder you can add value. It’s the most complicated part of the whole story. So one of our primary jobs is to avoid bad situations, to resolve them, by increasing education among the management,” he explains.

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

20-20: MARK WIEDMAN, GLOBAL HEAD, ISHARES

After the 2008 crisis, the Russian government decided to turn Moscow into an international financial centre and PCM is at the heart of corporate governance discussions. Chief investment officer Alexander Branis heads up a corporate governance sub-committee and is also chairman of the ten-year-old Investor Protection Association. In fact Westman believes Branis is one of the key reasons for the company’s success.“Hiring ‘Sasha’ was the best decision I made in all 15 years.”Branis was 19 at the time and still brings a fresh eye to corporate governance discussions.

The international financial centre project will help PCM, believes Westman. “International investors don’t like to think that things are different [sic], so when Russia makes the financial system work the same as everywhere else, that will be very helpful. That, coupled with the privatisation programme, corporate governance work, [and a] big effort to create more long-term domestic pools of capital to decrease volatility—all these are important steps to help the market to maturity, and with a PE at less than six, which is less than half other emerging markets, [Russia is] attractive. Once all these institutional reforms are executed, these discounts will decrease significantly which is beneficial to those already invested.”

Since 1996, the Russian Prosperity Fund (RPF) has grown to 20 times its original value. Westman keeps funds concentrated so maximum benefit is derived from any growth. In the RPF, for example, ten companies comprise 73.5% of the fund, while the top ten companies in the Prosperity Russia Domestic Fund make up 71%.

In others of the nine funds, the proportion is less, but rarely less than 50%.

In the next five years, the Russian government is planning to raise a further $10bn through another wave of privatisation. On October 28th 2011, for example, a 75% stake in Russia’s Freight One rolling stock company was auctioned for $4.2bn. The programme will give PCM more companies to choose to invest in, something which will appeal to its growing and varied customer base. The Norweigian sovereign wealth fund is the largest investor. Finland also ranks high. A growing interest from Asia and the growth in trade between Russia and China, Japan and Korea, has led to the opening of an office in Tokyo.

Westman traces an upward curve starting from the low point of inefficiency and low value of the old Soviet “production units” through the industrials and power utilities, which PCM’s fund Prosperity Quest Fund invests in, on through the more consumer-based industries such as retail and consumer goods, oil, investment services, which lie at the heart of the Russian Prosperity Fund, and finally to the transition to a western-style company.

With this progression, does Westman see Russia as the new US? “It’s on its way to becoming a new economy.

You can make parallels between the new financial industrial groups in Russia and the Robber Baron industrialists in 19th century US, but there’s a long way to go.” I

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

TURNING BLACKROCK’S ETF FORTUNES Mark Wiedman’s appointment as global head of BlackRock’s iShares brand is a concerted effort to sharpen the focus of the consortium of exchange-traded funds launched by BGI in May 2000 that combines index fund-style diversification with the liquidity of stock trading.

To date, iShares accounts for roughly half of the estimated $1.1trn in US-based ETF assets. While AUM continues to grow at a steady clip, competitors have gradually whittled away at the company’s domestic market share (currently around 43%). Can Wiedman buck the trend?

David Simons reports.

URING A RECENT earnings conference call, Laurence Fink, BlackRock’s chairman and chief executive, likened the recent run-up in ETF product innovation to the pre-crisis market for mortgage-backed instruments.

BlackRock, said Fink,“needs to be very assertive as a firm” in order to prevent “a lack of disclosure on these products”.

To help address issues such as transparency—while also Mark Wiedman, global head of enhancing its ETF product BlackRock’s iShares brand. line—BlackRock in September Photograph kindly supplied by 2011 announced it had tapped iShares, November 2011.

Mark Wiedman, managing director in charge of corporate strategy, to serve as the new global head of iShares, the ETF provider acquired by BlackRock as part of the 2009 buyout of Barclays Global Investors (BGI). Wiedman succeeds Mike Latham, who will continue as iShares chairman. Having served as an adviser to global financial institutions on balance-sheet issues at the height of the crisis, as well as heading up corporate strategy for BlackRock, Wiedman got a “crash course” in understanding clients’ problems and mobilising BlackRock’s capabilities in order to solve them.“I worked closely with iShares throughout the BGI integration and on iShares strategy work, so I stepped into the role with some familiarity with the businesses and the terrific leadership team,” says Wiedman.

ETFs appear to be still in their infancy, and have benefited from factors that include greater use of fixed-income and

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20-20: MARK WIEDMAN, GLOBAL HEAD, ISHARES

commodity-based products, increased uptake among feebased advisers, as well as new product launches within the major exchanges. These conditions will likely pave the way for larger ETF fund allocations over the near term. Wiedman claims:“ETFs are one of the top two or three socially productive financial innovations of the past 40 years, with a value proposition that speaks to a galaxy of clients, from sovereign wealth funds to retail investors. ETFs deliver efficient exposure to global markets using the most democratic, transparent, and liquid vehicle yet devised.”

From the perspective of iShares, key growth drivers over the near term include fixed-income ETFs (which currently represent only a fractional amount of total outstanding bonds within the US), as well as equity income. Meanwhile, the potential for across-the-board ETF uptake exists in nearly every market around the world, says Wiedman.

Unifying US and foreign ETF platforms was a priority for BlackRock following the acquisition of iShares, and the ability to offer both US and European product lines to investors around the globe has been one of iShares’ greatest strengths to date. “Some 15% of the assets in domestic ETFs are currently held outside the US and in Europe in 2011, we’ve seen over 15% organic growth, in part driven by buyers from Asia. As we look forward, our UCITS-compliant European product line could possibly become the de facto global standard,” says Wiedman.

The rise in ETF fund flows has coincided with a marked increase in product complexity, and, in some instances, has sparked concerns over opacity. For its part, the SEC continues to take a dim view of derivatives-based ETF products, compelling many providers to back away from such offerings.

Wiedman notes:“We would call products that trade on an exchange ‘exchange-traded products’ or ‘ETPs’ while reserving the label ‘ETF’ for a sub-category that meets certain agreed standards of simplicity and transparency, including backing by underlying securities, rather than derivatives.

We understand that regulators around the world will have different views. However, we believe that a standardised classification system could help regulators develop appropriate rules in each jurisdiction.”

The proliferation of so-called“cheap beta”ETF products— or, in some instances, ETFs that are totally commissionfree—has had a dramatic impact on the business as a whole.

Rather than attempt to compete on price, however, iShares has instead turned its attention toward product development, including active ETFs, which mimic the performance of hedge funds at a fraction of the cost. In August 2011, the company sought the SEC’s permission to launch a set of actively-managed equity ETFs, each based on proprietary BlackRock benchmarks.

“If there is a one thing I learned from my past experience at BlackRock, it’s that iShares will succeed by doing what we do best—not by playing on others’ terms,” offers Wiedman.

“We are the sole global player competing against regional players in every market. No one can match our global presence, scale, or brand. Capitalising on that unique position is where our future lies.”I

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20-20: HISHAM EZZ AL-ARAB, CEO, CIB

CIB: CAPTAINS COURAGEOUS CIB was borne in a cross-fire hurricane this year as the Arab Spring found form in Egypt with all the gusto of a force ten gale.

Despite the pouring rain of rubber bullets, tear gas and dissent, CIB kept at its job.

Like many chief executives in highstrung/high growth markets, Hisham Ezz Al-Arab, CIB’s chief executive officer, walks a tightrope between high finance and high politics. Right now, it is a brave fellow who puts his head above the parapet in Cairo. In a heartfelt polemic on the hopes for change, Ezz Al-Arab shows how the staff of CIB are made of stern stuff.

N FEBRUARY 11TH 2011 Hisham Ezz Al-Arab, CIB’s chief executive officer was being interviewed by Bloomberg’s Margaret Brennan. As the interview went to air, the news came that President Hosni Mubarak had resigned. “Four days later at our board meeting we all agreed: it would be a rollercoaster ride so everyone would have to fasten their seat belt and enjoy it,”says Ezz Al Arab.“In practice, what this meant was that whatever was happening outside our doors, we had to remain focused. That focus kept us sane, it kept us in business and all the success we have enjoyed this year is build on that clear focus,” he adds.

The current troubles that blow through Egypt are not of the making of the so-called Arab Spring, suggests Ezz Al Arab. “It goes much further back, to before 2009 or even 2008. In the event, we firmly believe that change it is a good thing and forces us, as a country, to ask important questions of ourselves. Of course, in the run up to elections, there are and will be a lot of political games; and we reckon that it will be a good four to five years before everything settles down and we finally move along the right track. In the interim, we will continue to provide that focus to our clients and to our staff.”

For Ezz Al Arab, the strength to carry on as normal in the midst of apparent chaos is a mindset; and one that he has worked hard to instil in the day to day working culture of CIB“We are the only bank in Egypt where staff have not gone on strike. We work hard to align our business culture both with our shareholders and our staff; we look after them as we would a family. In consequence we think the culture here at the bank is healthy and very strong,” he says. He explains that this cohesion has been built up over years and has involved some degree of ruthlessness. “Most failures are down to

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DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

Hisham Ezz Al-Arab, CEO, CIB. Photograph kindly supplied by CIB, November 2011.

having the wrong people in place and you are shy of changing them; we have no such qualms at the bank.”

All business sectors in Egypt have been affected by the aftermath of the collapse of former president Hosni Mubarak’s regime, particularly the country’s banking sector, which in recent years has worked hard to improve liquidity, introduce tighter monetary regulations and adopt various reforms. Although in general terms Egypt remains underbanked (only around 15% of the population have bank accounts); over the last decade the sector has undergone substantial consolidation, and the number of banks has decreased from 57 to 39. Both private and public banks were closed during the 18-day uprising that toppled Mubarak, then closed again for a week due to workers’ protests demanding wage parity. CIB was the exception.

Moreover, at the height of the crisis, on February 1st, CIB staff came into work to ensure that customer salaries were processed as normal. “We brought in our own security companies, to ensure that people needing cash could get it. The staff came in and secured our buildings over the worst of the crisis; it wasn’t a drill, but one of the best stress tests we could have had. It showed we could operate in the most uncertain of times. I am proud to say that the staff had the courage to do it.”

The crisis has been tough on the bank as most lending is for corporate business; with mortgages and car loans still a discrete business. “Most of this business is based around payroll and rolls through cards and personal loans,” says Ezz Al Arab, adding that: “the business was launched back in 2009. After the shutdown, the business came through at expected limits; so we cannot complain. The corporate side is a very deep culture at the bank and goes back to our Chase Manhattan days. We are still strongly committed to the cash flow based credit models that we adopted decades ago, and most players in the region followed later on.”

This year the banking segment has also had to work towards adopting Basel III requirements which, in practice,

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

means banks have had to adopt broader measures of risk and demonstrate that they adhere to sound risk management practices that are publicly disclosed. Basel III also solidifies the definition of capital and calls for stronger conditions for managing liquidity. The banking segment was set to conclude the final phase by this summer, but further reforms may be delayed due to the current circumstances.

Even so, several banks continue to raise their capital reserves.

What this means explains Ezz Al-Arab is capital adequacy running at 15%, double that of banks in the United States or Europe. We also run a loans/deposit ratio of around 50%, giving us the opportunity to grow. The financial strength of the bank surpasses Basel requirements; but we continue to be penalised by country ceilings.

Whatever the outcome of impending elections in Egypt in mid December 2011 (it appears to be a closing tie between the Muslim Brotherhood and the rising Noor Party), the challenge for any incoming government will be to integrate the official and the grey economy, tackle political corruption and lay the groundwork for economic prosperity. If the country is lucky, it will go down a similar route to Turkey where an Islamic governing party adheres to pragmatic capitalist principles; with all the attendant opportunities that this will provide for the Egyptian banking segment.“If the government insists on collections and paying of duties and the processing of these payments electronically, then obviously the banks will benefit,”explains Ezz Al Arab.“Traffic fines, car licences, etc all have to go through the banks; at the same time it will cut petty corruption and the grey economy. In Egypt the grey economy is at least equal to the GDP; in some ways it is good, because it employs the sometimes unemployable. In other ways it is bad, as the government misses out on substantial tax revenue.”

For Ezz Al Arab, the business of integrating political changes, of lessening corruption and creating conditions for growth centres around trust: “which must operate at every level of society,” he states.

For the time being CIB is focusing on doing more of the same: “We will have opened five branches by the end of December in new urban areas and we are planning for more branches in 2012, with further growth on the loan book and deposits,” says Ezz Al Arab. Up to now the policy has been working; the bank claims a growth of 10% in market share overall, backed up by growth of 8.4% in the bank’s loan book and 7.19% growth in deposits up to September 1st, despite the introduction of some impairments which impacted on overall profits for the year. “The important thing in this regard, is that the bank did it by the book. That was important for us,” he says.

Ezz Al Arab, remains optimistic about the long term:“Our focus is Egypt and we are sure that political changes will bring the accountability that the market needs and we believe this will all be in place within the next three to four years. When you are accountable it changes everything; because everything is done properly, by the book and business is about what you know, rather than who you know. That has to be a good thing.”I

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20-20: BRIAN LAMB, CEO, EQUILEND

THE NEW WORLD ORDER IN SECURITIES LENDING During a FTSE Global Markets interview at the end of 2010, Brian Lamb, chief executive officer of New York-based EquiLend, a provider of trading and operations services for the securities finance industry, suggested that the most successful beneficial owners are the ones that consistently allocate resources and apply professional investment-management processes and approaches to their programmes—because, said Lamb, “as history has often shown, one can’t afford not to be educated”.

OR THE BETTER of the past decade, securities lending was a perpetual wellspring of revenue for beneficial owners and, not surprisingly, a sense of complacency ultimately took hold. Then came the fall of 2008 (literally), and owners quickly assumed a defensive posture, some exiting sec-lending altogether, others finding few plausible alternatives and ultimately returning, albeit with a renewed sense of urgency and a need for full transparency.

While the market psyche may have changed for good, EquiLend is seemingly none the worse for wear. It is ten years since its incorporation (the platform went live in 2002), and chief executive officer (CEO) Brian Lamb has watched EquiLend’s business grow out from an initial ten-member ownership group to a roster comprising 70 or so different global financial organisations. It has obviously been a source of satisfaction for Lamb. “It’s certainly a proud moment to reach this milestone and to have things going so well at the same time,”he remarks.“The fact that the business continues to grow at this pace is tremendously important to us, as we see ourselves as a cog in the wheel of the securities-finance business, one that can continually bring more efficiency to the entire marketplace.”

EquiLend’s operational model is such that if there’s big volume, business is good—no matter which way the markets are moving. Not surprisingly, the most recent round of high volatility is reflected in EquiLend’s year-to-date stat sheet; through September 2011, total borrowing and lending transactions were up 16%, and in 2011 the platform experienced its ten largest trading days ever, including 28,000 transactions processed during a single day in August 2011. Volume has only been part of the story. Through 2011 EquiLend added 15 clients, a record for a single year, including newcomers such as Prudential Investment Management, Kellner DiLeo & Co., and RBC Dexia Investor Services. Backing Equilend are some of the world’s top global financial institutions, among them BlackRock, Goldman Sachs, JP Morgan, and Bank of America Merrill Lynch.

Key to EquiLend’s recent spate of success is innovation wherever possible, says Lamb. EquiLend’s post-trade offerings are ripe for investors seeking plausible risk-mitigating strategies.

Additionally, a new trading-optimisation programme enables clients to pool long and short assets and includes limits based on existing bilateral relationships.“Our goal is to optimise these securities transactions to the fullest extent,”says Lamb.

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Brian Lamb, chief executive officer, EquiLend.

Photograph kindly supplied

by EquiLend, November 2011.

While the EquiLend platform has always been able to accommodate fixed-income securities, it wasn’t until recently that investors on the bond side began to truly embrace the EquiLend concept, he adds. The firm launched BondLend, a fixed-income and repo-trading/post-trade services platform designed to boost liquidity and reduce risk using a single point of entry to the non-equities sector. “Of the roughly 20,000 trades that we handle daily, roughly 2,000 come from the fixed-income side,” says Lamb. “We see that number growing pretty significantly over the near term. Let’s face it— the world as a whole has a lot of debt, and is in need of tremendous financing. So in terms of notional size, we’re looking at a market that is much bigger than equities.”

Initially used mainly for general-collateral or“low-touch” type transactions, over time investors have begun to reap the benefits of EquiLend’s automation processes for other kinds of trading. Today, some 20% of platform activity is specialistbased or otherwise non-GC—“which is a pretty significant number, and we expect that trend to continue, particularly as the markets fully embrace automated solutions in order to keep pace,” notes Lamb Given the uncertain nature of the financial landscape, Lamb is heartened by beneficial owners’ efforts to stay informed. He observes: “Events like the demise of MF Global serve as a reminder to all financial institutions that no one can afford to be complacent—you have to be diligent, applying sound financial modelling and market-tested principles in order to run your business successfully. [And] with leveraging down, capital allocation has become paramount, requiring that balance sheets are maintained more efficiently than ever before.”I

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

20-20: JOE RATTERMANN, CEO, BATS TRADING

When Joe Ratterman took over as chief executive officer of BATS in July 2007, he named his priorities as price innovation, including data for free, smart and fast technology, and good customer service. Within a few years he has taken BATS from a fledgling trading platform to a company which some value at $1.1bn, based on an upcoming flotation aiming to raise $100m.

Ruth Hughes Liley analyses the firm’s contribution to diversity in the global trading market as it reposes in a “quiet period” prior to its IPO.

BATS EXTENDS ITS REACH ECEMBER 2011 COULD prove a landmark for BATS Global Markets. During the month, the UK Competition Commission official was expected to ink its approval of BATS’ takeover of Chi-X Europe, Europe’s largest multilateral trading facility (MTF). The new BATS Chi-X Europe will be the largest trading centre in Europe in terms of market share and notional value traded. In the first quarter of 2011, Chi-X Europe accounted for €454.6bn traded while BATS own MTF, BATS Europe, traded €171.2bn. Chi-X Europe will add a derivatives offering to the combined company through an agreement with Russell Investments.

It was also a month in which BATS Global Markets was set fair to challenge NYSE Euronext and NASDAQ OMX with a new listings service on BZX. BATS operates two stock exchanges in the US, the BZX Exchange (BZX) and the BYX Exchange (BYX), which account for around 10% to12% of all equity trading in the United States on a daily basis. BATS Listings will be headed by Brian King, who has managed client relationships at BATS for four years.

Launched from a suburb of Kansas City, Missouri, onlookers were unsure about the success and direction of BATS at its launch in 2005. Started by a handful of people and still only employing barely more than 100 worldwide, in May 2011 it filed with the SEC to raise $100m in a flotation, which some estimates say values the company at $1.1bn. The flotation will fund acquisitions and provide an exit strategy for some of its original investors, which include Getco, Credit Suisse, Morgan Stanley and Deutsche Bank among others.

Chief executive officer (CEO) Joe Ratterman’s expansion plans for BATS—originally just a simple electronic communications network—have coincided with huge upheavals in the financial markets. In October 2008, in the middle of the fallout from the Lehman Brothers crisis, it launched a multilateral trading platform, BATS Europe. At the same time on the other side of the Atlantic, it also launched BZX. Work on the European platform was complete in six months with Ratterman saying at the time: “This is a testament to our focus and determination to move at ‘BATS speed’ and the drive to simply get things done.” The platform is headed by chief executive officer Mark Hemsley.

In 2007, BATS represented around 15% the size of NASDAQ. In 2009, it represented around 55%. Today its 12% US equities market share compares with NASDAQ’s 18%. For its other businesses, US equity options market BATS Options holds around 3.8% matched market share and BATS Europe just over 5% as of October 2011.

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FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

Not content with expansion at home and in Europe, BATS is also looking further afield. The firm has set up a partnership with Claritas, a Brazilian asset management firm, to work on creating a new stock exchange in the country, with attendant clearing and depositary services. Brazil is the fourth-largest market in the world, with opportunities to challenge the incumbent stock exchanges.

It is that “better place to do business” which has been BATS’ focus with Ratterman at the helm. BATS originally stood for Better Alternative Trading System and its logo incorporates the slogan “Making Markets Better”. “The last two years have been very exciting and rewarding as we took BATS from a napkin drawing to one of the fastest-growing market centres in the nation,” he told members then.

“Because our employees and investors come from the industry, we are well-positioned to help make the markets a better place to do business.”

While it is acknowledged that a listing business will add to BATS’ revenue, some believe they will find it harder to make a success of it than they did with their trading business; high-frequency trading provided a ready-made market for the trading business.

Ratterman bases his success on the technology which underpins BATS. It includes parallel routing strategies which aim to provide best execution more efficiently while accessing multiple market venues simultaneously. Several matching engines provide up to five times more capacity than required and it has kept latency low.

Ratterman has also implemented innovative pricing with BATS National Best Bid and Offer (NBBO) Setter programme, which rewards clients not just because of size but also because of actions which improve market quality. Ratterman says:“This has been such a hit on the BATS Options market that we have recently rolled it out on our two US equity exchanges as well.

It’s the first of many innovations to come from BATS based on a new paradigm shift in pricing models.”

Pricing has been used as a strategy to expand. An initial aggressive fee structure that lost money on every trade in order to attract customers was successful: the firm now claims more than 300 broker-dealer customers. In October 2011, the firm began to provide rebates for firms taking liquidity from the BYX Exchange order book for all securities priced $1 or above. Customer service is one of Ratterman’s original stated aims for BATS—in 2007 Ratterman told his members: “We are listening to you, our customers. We want to be your market.” I

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20-20: STEVE GARNETT, HEAD OF CASH EQUITIES AND DAN MATHISSON, HEAD OF ELECTRONIC

It’s party-time at Credit Suisse’s electronic trading team, which is celebrating ten years since its first algorithmic trades were executed internally in November 2001. The success of its electronic trading offering is useful, given revenues from Credit Suisse’s cash equities business were down CHF1.5bn between the first nine months of 2010 and the same period 2011 to CHF4.6bn. The firm’s Advanced Execution Services (AES) team handles around 10% of all US trades; Credit Suisse’s crossing engine, Crossfinder, has been ranked the largest dark pool in the world by Rosenblatt; and the firm is currently averaging 997m shares traded each day.

WHY CREDIT SUISSE’s AES SETS THE PACE OF CHANGE A T FIRST NICKNAMED internally as “The Liquidator”, because it “liquidated” positions, algorithmic trading at Credit Suisse was initiated by Dan Mathisson, head of electronic trading, and Steve Garnett, now head of global cash equities, but who at that time came from an eight-year background in programme trading at Salomon Brothers. Garnett has worked at the investment bank since 1999 when the firm’s electronic trading platform was simply for proprietary trading.

However, two years later in the first quarter of 2001, the climate changed in favour of electronic trading as new rules meant “decimalisation” of trades, when stocks were no longer quoted in fractions but in dollars and cents.

“The whole radical notion was that it traded by itself,”says Mathisson. Eight months later in June 2002, the electronic trader was launched to clients as the Advanced Execution Services (AES). It had an 18-month headstart over its nearest rivals, who appeared in late 2003. Says Mathisson:“Even that short amount of time gave us a significant first-mover advantage. When you move into a new area, it gives you time to improve the product.”

As the competition developed, so the team worked to innovate and keep it ahead. First, by Richard Balarkas, who was a significant figure as head of AES sales, ensuring client liaison and marketing campaigns hit the right spot, then after January 2008 by Manny Santayana, who took over the role. Mathisson adds: “We are in financial services so you can’t have a great product if it is not backed up with good customer service.”

The team is keen to reassure the bulk of its customers— many of them long-based mutual funds and pension funds— that it does not participate in high-frequency trading. Rather, with algorithmic trading reaching an estimated 22% market share by 2014 (Greenwich), the development of high-speed trading has challenged the team to build faster technology.“You need to use high-frequency techniques nowadays. We want to be able to trade a mutual fund and give our clients the same advantage that a high-frequency trader has,”says Mathisson.

Nearness to the action is critical in this regard and in summer 2008, Credit Suisse moved its electronic trading infrastructure across the Hudson River from Manhattan to the Weehawken data centre to co-locate with exchange servers and provide the same speed advantage as high-speed traders.

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Dan Mathisson, head of electronic trading, Credit Suisse AES. Photograph kindly supplied by Credit Suisse AES, November 2011.

The firm now counts eight standardised and more than 100 customised algorithms within the AES product suite.

During the recent volatility in early 2011, Mathisson says clients switched from the more passive algorithms such as VWAP and Inline to aggressive types, aptly-named Guerrilla, Sniper and Blast.“When you are in a highly volatile market, you might miss trades if you have to wait, so then your priority is to get the trade off and not obsess about every penny,” says Mathisson. “There’s always something in the suite that is good for a particular occasion.”

Company strategy has been to keep AES as standardised as possible around the world, although algorithms are customised for each country by local teams and quant developers. Mathisson says: “It is in 40 countries, including nine in Asia, but they have the same names around the world. We want to make it a standard experience so that when clients

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

TRADING, CREDIT SUISSE AES

use it, wherever they are, they understand it and are comfortable with it.”

Garnett sees a global convergence in his clients’ multiasset class-trading needs so has ensured that the firm’s algorithms are built to trade cross-asset wherever possible.

Credit Suisse now uses AES to trade more than 100 currency pairs, 80 futures contracts and US options including multi-leg order types traded on Bloomberg. The team rolls out the capability to trade a security or asset electronically whenever it meets certain criteria: real-time quoting and accurate data, capacity for electronic trading and clients using FIX Protocol. As derivatives move on to exchange and become standardised and centrally cleared, Mathisson is monitoring and watching.

AES is agency-based trading so the team sits behind an electronic Chinese wall to prevent information leakage and its business is independently audited by PricewaterhouseCoopers, which validates the information barriers. Indeed, Mathisson has witnessed programme trading develop alongside the long-term trend growth in passive indexing, where a fund tracks an index. “Passive indexing is very hot and is becoming a bigger and bigger part of clients’ assets under management. As that grows, there’s a trend to turn to the PT desk to manage the rebalancing trades.”

The pace of innovation has been Mathisson’s biggest challenge in recent years: “Electronic trading is an area where you have to overhaul your technology constantly and this is driven by speed. It’s a relentless challenge to upgrade your systems and servers. It’s important to stay very fast in this market so you don’t end up at a disadvantage. But as soon as you finish one roll-out you start planning the next one.”

Investment banks spend millions on technology upgrades and it is an advantage to be a big player with economies of scale—even more so as Credit Suisse announced it was to make CHF1.2bn-worth of cuts by the beginning of 2012. Nonetheless, AES handles around 10% of all US trades; Credit Suisse’s crossing engine, Crossfinder, has been ranked the largest dark pool in the world by Rosenblatt; and the firm is currently averaging 997m shares traded each day.

Credit Suisse technology connects to 75 exchanges with its Pathfinder smart order router. It also sells its algorithms to other Tier-2 investment banks and brokerdealers who“white label”it and use it themselves. Under a seven-year-old scheme called B-D Plus (Broker-Dealer Plus) the firm offers a low-cost, execution-only service for 300 broker-dealers.

Credit Suisse has exclusively used third-party software providers to distribute AES to clients. The firm has 80 deals with software providers who add in AES to their order management systems and execution management systems.“There’s no front end, no client-facing software.

Doing it this way relieves us of the burden of creating software, which allows us to do what we are good at— which is trading stock,” says Mathisson.I

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

20-20: ERIC BOMMENSATH, HEAD OF FICC, BARCAP

BRIO UNDER FIRE Basel III accords and the EU’s Capital Requirement Directive will oblige Barclays to adopt more of a risk-related asset model than it has in the past. The bank is still looking to make a return on equity in the range of 15%-20%; however, incoming regulations seem certain to penalise its FICC activities particularly severely. Barclays has historically relied on an economic-capital model that assigned relatively little capital to assets held in the investment banking subsidiary. Under Basel III that will no longer be possible, with serious consequences for future profitability.

IFE IS NOT getting any easier for Eric Bommensath, the head of fixed income, currency and commodities (FICC) at Barclays Capital. Since he returned to London in September 2010 from his job as head of fixed income and trading in New York to assume the wider remit (which also includes all trading within EMEA), Bommensath has had to preside over a sharp decline in the division’s revenues and profits as the worsening difficulties in the eurozone have taken their toll on activity across the capital markets.

The turnover at FICC in the third quarter of 2011 fell by 16% to £1.4bn, following a decline of 22% in the second three months of the year. Although these figures compared favourably with most of BarCap’s peers (the comparable operations at Deutsche Bank and Credit Suisse saw revenues drop by 37% and 76% respectively over Q2), it still represented a serious setback for a division that has historically accounted for around two-thirds of the turnover at Barclays’ investment banking arm.

Now it seems that Bommensath’s division is going to bear the brunt of the 1,400 further job losses that the parent bank is going to make, as it adjusts its structure to meet the demands of new, more risk-weighted banking regulations that will come in progressively from 2013 onwards under the Basel III accords and the EU’s Capital Requirement Directive.

A recent report by analysts at UBS argues that BarCap would never have made an economic profit if had been obliged to allocate capital in accordance with the Basel III provisions.

The analysts suggested that the bank would need to increase the capital allocations in the subsidiary by up to 50%.

Many of the FICC operations—particularly those that involve counterparty risk in fixed-income derivatives and capital-intensive businesses such as correlation trading and securitisation—will face a real struggle to meet the continuing ROE requirements under the new regime. There will not be the same degree of concern in BarCap’s less capital-intensive equities and IBD operations. Having seen the financial numbers in his division go into free fall during the first year of his tenure, Bommensath is facing the imminent prospect of seeing the same happen with the numbers of his staff. Can the strength of the franchise win through in a challenging 2012?I

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20-20: STUART HENDEL, MD AND GLOBAL HEAD OF PRIME BROKERAGE, BANK OF AMERICA MERRILL LYNCH

Expanding Bank of America Merrill Lynch’s hedge-fund business ranks high on global head of prime brokerage Stuart Hendel’s agenda. “Clients want to do business with us in this area, and so that has been a key focus during these past few months,” he says. Stock prices in the banking sector have been pummelled of late, forcing players such as BofA (whose own shares are off two-thirds since the start of 2011) to address operational redundancies and affect changes where needed. Hendel, however, remains resolute. “At the end of the day, firms need to have a solid return on the assets they use to support these types of businesses. We believe our business is differentiated by the size and strength of our balance sheet—and how we can put it to work for our clients.”

PRIME BROKING: BALANCE SHEET, FUNDING STRENGTH NOW KEY APID RESPONSE IS a keystone of Stuart Hendel, “As long as this kind of climate persists, deleveraging will global head of Bank of America Merrill Lynch’s (BoA’s) likely continue. In fact, market fundamentals appear to be prime brokerage unit. When he signed on for the job, the least important aspect in determining the health of early in 2011, from two years as head of UBS AG’s prime companies, sectors or valuations.”

One downside of the current environment and inherent brokerage division, he was certain that “anytime you join a new organisation, and particularly when it’s a global business lack of investing conviction is the effect on market liquidity. and platform, you start by learning the landscape internally”. Once clarity returns to the political, regulatory and economic He adds: “You also want to ensure that you have the right landscape, the market should become more liquid, which will people in the right seats and that they are supportive of the in turn benefit everyone. “Therefore, this is something that direction you want to take.”Most of all, says Hendel, you need needs to be addressed in order to preserve the well-being of both the alternative space and to act quickly, as you don’t the prime-brokerage industry always have the luxury of time “This is a sector that continues to over the long haul. We believe once you’ve taken the reins. that once Europe gets its house “This is especially true on deleverage, performance is down and in order and there is more the sell side—I made a number prime brokers are fighting for market clarity, that should help of key decisions within the share,” says Hendel. “We have some markets achieve some kind of first 60 days.” considerable headwinds to contend with.” foundation,” he says.

The ability to think on your From his vantage point, feet in a highly-volatile market is a business imperative and a lifeline of sorts to clients Hendel sees a much greater likelihood of consolidation under duress. Whether the news is good or bad is almost within the sell side than the buy side. “No matter what irrelevant, says Hendel, as there is only so much market tur- happens in Europe or with governments in general, we bulence that hedge fund managers can tolerate.“One day the believe there is going to be a real need for the best and news out of Europe is positive and the markets move accord- brightest to achieve superior returns on behalf of their ingly, then the next it is negative and all bets are off. clients,” he avers. “Certain investors are questioning the Therefore, the instinct is to just deleverage. Even funds actively-managed, long-only business, but we are still bullish focused on the macroenvironment can’t always handle being on the hedge fund space.”

Even then, Hendel says he is “flummoxed” by the perpetwhipsawed like that.”

A cool head is equally vital; particularly as the constant ually thinning margins on banks’ leveraged-based book of need for hedge fund managers to address counterparty risk, business.“Pricing eventually has to go in the other direction,” though positive for the industry as a whole, has ultimately says Hendel.“If it doesn’t, sell side firms may re-examine the kept the sell side from focusing on the job at hand—that is, returns being generated by the prime-brokerage business. In making money.“This is a sector that continues to deleverage, an environment where resources are scarce, all balance-sheet performance is down and prime brokers are fighting for businesses may be vulnerable, not just prime brokerage.”

Hendel believes that market-exacerbated balance sheet market share,” says Hendel. “We have some considerable weakness could ultimately threaten the existence of certain headwinds to contend with.”

Ambiguity surrounding political and regulatory prime brokerage businesses over the near term. “Balance solution—rather than the outcome of regulations them- sheet and funding strength are areas that we believe will selves—only exacerbates the trend. Even then, there is continue to be distinguishing factors for BofA—having a some upside.“As strange as it may sound, hedge funds react tremendous deposit base and excellent funding resources better to negative news than uncertain news,”says Hendel. will allow us to properly service our clients going forward.”I

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DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

20-20: JAY HOOLEY, CEO, STATE STREET

STATE STREET’S AMBITIOUS TURNAROUND Near the end of 2010 State Street unveiled a multi-year business operations and IT transformation plan aimed at boosting growth through process streamlining and enhancing research and development. State Street has predicted it can achieve annual pre-tax run-rate expense savings of roughly $600m through 2014, as well as $400m to $450m in pre-tax restructuring charges. If so, it will mark a substantive turnaround in the bank’s fortunes. David Simons talks to Jay Hooley, State Street’s chief executive, about the changes and the challenges in hand.

IVEN THE HEADWINDS we were facing, we needed to make sure that we were addressing the cost side of our income statement in order to create efficiencies wherever possible, explains State Street Global Advisors chief executive officer (CEO) Jay Hooley. Using technologies such as cloud computing will allow State Street to build out systems and deliver products faster and more effectively, he explains, while extending its service business to include better analytics and data processing.

From the upper reaches of State Street Corp’s headquarters overlooking Boston’s waterfront, on a clear day you can see all the way to the dunes of Cape Cod. Yet when Hooley first entered the CEO’s lofty office space in March, 2010, the outlook was anything but picturesque.“At that time it looked as if the storm clouds were going to be around indefinitely,” he recalls. Accordingly, the 25-year company veteran spent the better part of 2010 addressing various post-crisis issues while preparing the Boston-based financial services giant for the turbulence that lay ahead.

“Taking care of any remaining problems was a priority, as was repositioning the company’s balance sheet,”says Hooley, who spent two years as State Street’s president and chief operating officer before replacing former CEO Ronald Logue. “Coming into 2011, I felt we were in great shape in terms of the quality and integrity of our capital ratios, which, if things were to remain unstable, was an important area.”

Regulation continues to change the face of the global custody business, yet the need for greater custodial responsibility and reporting detail has worked to State Street’s advantage, says Hooley.“The Commodities Futures Trading Commission is determined to ensure that the lion’s share of OTC derivatives trades flow through a centralised clearing

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FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

Jay Hooley, chief executive officer, State Street. Photograph kindly supplied by State Street, November 2011.

service. That is something that has resonated quite loudly with our client basis; therefore we really want to be part of this transformation, particularly as new market structures continue to evolve.”

Meanwhile, Hooley continues to seek potential revenue streams from outside of the US, including usual suspects such as China, India and Latin America.“We are definitely looking to expand our footprint,” says Hooley. “Brazil’s capital markets in particular have shown tremendous growth, with some $230bn in hedge-fund assets alone. It’s been a very attractive market domestically, but inevitably there will be an increase in outside investment. It is something we continue to focus on as it represents a very significant opportunity for our shareholders.”

Hooley has resolved to build upon the strengths of State Street’s asset-servicing business. Greater focus on compliance and risk management has led to a surge of interest in State Street’s analytics and risk-based tools, not to mention its middle-office outsourcing capabilities. Recently, the bank announced a $300bn outsourcing deal with AllianceBernstein, with State Street providing a broad brush of services including institutional portfolio administration and performance measurement. Hooley acknowledges the deal is a game changer.

“Needless to say, outsourcing is key to the continued growth of our core business,” says Hooley. “Managers have been struggling to create more product against a backdrop of lower yields, and with a tsunami of regulation headed in their direction as well. Our platforms are built to withstand these kinds of adverse market conditions, and have already been installed on behalf of numerous clients.”

Earlier this year, State Street announced a stock buyback initiative while simultaneously raising its quarterly dividend from a penny to 18 cents per share. Approved by the Fed (which signed off on similar actions by JP Morgan and Goldman Sachs), the dividend increase was the first of its kind since the start of the financial crisis—a positive indicator by all accounts. Having passed the Treasury’s 2009 stress test with a Tier-1 capital ratio of over 15%, Hooley is confident the bank will once again reveal its underlying strength during the Fed’s upcoming round of testing. “Our business model is generally perceived to be low risk, and we continue to maintain high levels of capital as defined by the various Basel initiatives,” says Hooley. “Heading into these new tests, we feel pretty good about our ability to stress our business using capital on hand, and still be able to return capital to our shareholders. The business-model indicators would suggest that we’re still in a great position.”I

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20-20: JOSEF ACKERMANN, CEO, DEUTSCHE BANK

ACKERMANN LOOKS TO A NEW FUTURE The internal structure of Deutsche Bank’s DNA “completely changed under chief executive Josef Ackermann,” says Konrad Becker, an analyst at private bank Merck Finck & Co. Ackermann not only extended the bank’s geographical reach and products but it also became much more client facing. He also introduced a more Anglo-American corporate governance framework with a clear hierarchy. This was revolutionary at the time. By Lynn Strongin Dodds.

HE PAST FEW weeks have tested Deutsche Bank’s chief executive officer (CEO) Josef Ackermann. He unexpectedly withdrew his candidacy to become chairman of the supervisory board and police raided the bank’s Frankfurt offices and legal department. While headline grabbing, these glitches are not expected to diminish his legacy of transforming the one-time commercial bank into a global banking powerhouse and steering it through the market tumult of the last five years.

Historically, German corporate law shunned the idea of an American-style chief executive and an Anglo Saxon board where executives take responsibility for their own business lines. The preferred model was a Vorstand, a statutory managing board that promoted collective responsibility.

Ackermann struck a compromise, although at the time it was considered groundbreaking. He became CEO, shrank the Vortsand and created a 12-man group executive committee, which he chaired. The new structure gave the Vorstand a strategy-making role, while the group executive committee, on which Vorstand members also sit, run the bank’s day-today operations.

He also severed long-held industrial ties, raising $5.3bn in the process, including the sale of a €1.6bn stake in Munich Re. He eliminated 14,470 jobs (18% of the workforce) and cut costs by one-third by closing retail branches and outsourcing management of the bank’s computer systems and real estate, and built out the bank’s US business. The Bankers Trust $10bn acquisition in 1999 was key in this regard.

Although the purchase was not done on his watch (Rolf Breuer was chairman at the time), it provided a launch pad for Ackermann’s global investment banking ambitions.

“In the middle of the last decade, UBS was very profitable and it was the bank that Deutsche measured itself against, but then the financial crisis happened,” says Becker.

Deutsche Bank weathered the storm but did not escape unscathed. Ackermann often claims that the bank did not need a government injection of capital, but critics note that in fact the bank (along with others) received the equivalent of a back-door bailout from American taxpayers when the US government intervened to prevent the insurer American International Group from collapsing.

Moreover, the bank faces litigation in the US tied to residential mortgages and in Germany regarding the mis-selling of complex financial products to municipalities. Separately, Ackermann himself is also embroiled in legal wranglings involving a former client, the late Leo Kirsch, and in early November 2011 prosecutors raided the bank’s offices looking for evidence of attempts to mislead the court.

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Josef Ackermann, chief executive officer, Deutsche Bank, speaks during the German Economics Forum in Hamburg, Germany, December 2nd, 2011. Photograph Bodo Marks/DPA/Press Association Images, supplied December 2011.

Overall though, Ackermann has won plaudits for the way he has navigated the bank through extremely choppy waters over the past three years. Not everyone has been as happy. “The market capitalisation has more than halved since Ackermann and this has left a bitter taste in shareholder’s mouths,” says Michael Rohr, an analyst at Sylvia Quandt Research GmbH in Frankfurt, with the caveat: “This has more to do with market conditions. Ackermann has had a strategic vision to transition the bank into a more stable business and has done a very good job with its risk management.”

Recent strategy involves a retreat from the investment banking business which contributes roughly 70% of the group’s total pre-tax profit and a return to commercial banking, retail and private banking. Strategic acquisitions are also on the agenda, among them Deutsche Postbank and Sal Oppenheim, Germany’s largest private bank. The bank is now expected to divest its asset management division— except for its profitable DWS retail franchise in Europe and Asia. A sale could raise $4.5bn which would improve the bank’s capital position in light of impending regulation.

The strategy is widely regarded as being driven by CEOin-waiting Anshu Jain who, together with Jürgen Fitschen, will run the bank starting next May. Even so, Ackermann was not supposed to take a back seat in 2012; but now it looks as if he will retire. He was likely caught out by German law, which holds that a chief executive of a listed company may not become its chairman without a two-year cooling-off period, unless 25% of shareholders endorse the move. In a fickle move of fate, Ackermann may not have received the support he anticipated and was put in an untenable position.

Paul Achleitner, currently chief financial officer of insurer Allianz, is now mooted as the next chairman.I

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

20-20: JEFF TESSLER, CEO, CLEARSTREAM

Under Jeff Tessler, Clearstream continues at the forefront of post-trade services and global-led client solutions to reducing risk and costs in securities trading, securities finance and settlement. The firm’s leadership in the Link-Up Markets project, for example, was first mooted in April 2008 and is still outrunning efforts by the European Central Bank (ECB) to develop Target2-Securities (T2S) to streamline interoperability at the CSD layer. The ECB’s project continues as a moving target. As its parent Deutsche Börse now moves towards union with the NYSE Euronext, Clearstream stands at a crossroads: how far can it now travel in any direction? Lynn Strongin Dodds reports.

CLEARSTREAM MOVES UP THE VALUE CHAIN ments. Market participants can now secuLEARSTREAM HAS COME a long ritise their positions via the appropriate way from its roots as a Luxembourggrade or quality of assets to ensure an based provider of post-trade infraoptimal use of collateral. It also builds on structure for the eurobond market. Thanks Clearstream’s presence in the Asia-Pacific. to Jeffrey Tessler, who came on board as The alliance comes close on the heels of a chief executive officer (CEO) in 2004, the similar initiative launched with Brazilian CSD international central securities depository CETIP. Several domestic institutions are also (ICSD) has not only expanded its global in talks with Clearstream to construct similar reach, but also the breadth and depth of its arrangements. According to Tessler: “Our services and the asset classes it covers. collateral management service addresses the The company is part of the rapidly major industry concern to consolidate and expanding Deutsche Börse Group streamline collateral management activities. business set, contributing to over 30% of All users will immediately benefit from future the overall group’s pre-tax $1.2bn in system enhancements in line with market earnings in the first nine months of 2011. requirements and regulatory demand. We With almost €11trn in assets under will continue to grow this model with a custody, it ranks as one of the world’s strong partnership approach that incorpolargest settlement and custody firms for Jeff Tessler, chief executive officer, rates the needs of our strategic partners and domestic and international securities.

Clearstream. Photograph supplied by their underlying customer base.”

These days, Clearstream clearly carries a Clearstream, November 2011.

Closer to home, Clearstream has joined global remit; with widespread operations and boasting a global network of domestic links encompass- forces with Spain’s Bolsas y Mercados Españoles to form ing 52 countries. Its customer base is even broader, compris- REGIS-TR in response to increasing regulatory demand for greater transparency in over-the-counter transactions. The ing 2,500 financial institutions in over 110 countries.

Tessler, a 25-year Bank of New York veteran, has managed newly-formed entity collects and administers details of all Clearstream since 2004, seemingly at a clip. He launched a OTC derivative transactions reported by its users, giving multi-year strategic project in 2005 which transformed the market participants and regulators access to a consolidated company into diversified post-trade services provider. A global view of these positions. The service, which serves strong emphasis was placed on interoperability and strategic both financial and non-financial institutions, aims to partnerships. As he says: “Both elements have been the deliver flexible participation levels, which can adapt to the guiding principles of our strategy.” Tessler is keen to develop diverse profiles and needs of all stakeholders and actors in the OTC derivatives market. solutions “with and for the market”.

Looking ahead, the biggest news on the horizon is the While settlement and safekeeping of eurobonds is still bread and butter business, accounting for a significant slug impending mergers between its parent, the Deutsche Börse of Clearstream revenues, the firm has moved up the value Group and NYSE Euronext. Changes are already afoot, chain to offset the increasingly commoditised nature of the although nothing has been announced. It is clear that in a business. Cross-border custody, investment funds services, merged entity, Clearstream will gain a firm foothold in the global securities financing as well as collateral management US, and a stronger presence in Asia—20% of the Clearstream revenues come from this region already—on the services are now part and parcel of its offering.

Over the past year, Tessler has continued to forge partner- back of an enlarged and truly global customer base. As for ships. The most recent is with the Australian Stock Exchange the rest, watch this space. In particular, it will be interesting to develop an automated collateral management service to see what the repercussions of the merger will be in the that links directly to ASX-owned CSDs Austraclear and post-trade servicing segment. The global market has become CHESS. It offers market participants a more efficient means much more competitive than it once was in the post-trade of managing bilateral and central counterparty risk exposures space and the question is: how will a post-merger with non-cash collateral and short-term funding require- Clearstream navigate through these changing times?I

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20-20: HERBERT STEPIC, CEO, RAIFFEISEN BANK INTERNATIONAL

No other bank chief executive has been so closely in tune with the needs and aspirations of emerging Europe than Herbert Stepic, CEO of Raiffeisen Bank International (RBI). From the early 1980s, Stepic has been convinced that Central and Eastern Europe (CEE) is the growth engine of the continent; sentiment based not only on its economic prospects but also on genuine feeling for its people. He combines specialist banking expertise with charitable works across the continental heartland. Francesca Carnevale spoke to him about the vagaries of economic fortune and the consequences of market change.

TO RUSSIA, AND ALL CEE, WITH LOVE ERBERT STEPIC, RAIFFEISEN Bank International (RBI’s) chief executive, has always been a blend of acute business acumen and strong humanitarian feeling, and both these aspects of his character have fuelled a long-term love affair with CEE. As with all good love affairs, the relationship has been to the equal benefit of both.

Immediately following an interview for this profile, Stepic left for a charity event which raised nearly €106,000 to fund two homes for disadvantaged families in Ukraine. The H Stepic CEE Charity has realised numerous projects in seven countries in Eastern Europe and Southeastern Europe, targeted at the region’s poor.“There are segments of women and children in distress in the CEE. Not everyone has benefited from the transformation process. We work a great deal with orphans and other disadvantaged children, providing them with homes to live in with dignity and a special care, with the aim of integrating them into society. All the work is driven by our own staff and all funds raised are directed to projects—our staff work entirely for free.”

Stepic works on the basis that he asks no one to do anything he does not or will not do himself. “I try to set a good example. That is why I put my name to the charity, as a guarantee that promises will be kept.”

It is a philosophy that runs all the way through the bank.

“I am a strong believer in the human aspect of my job; ranging from knowing our customers to caring for my staff.

There are 43 nationalities of people working at the head office of this bank. Do you know how happy that makes me?

I believe each nationality brings something new to the bank and, speaking metaphorically, this mix is heavy yeast to make the best and tastiest cake,” he says.

The recipe has worked well for RBI, which has carved a unique and successful niche in providing banking services to emerging markets. RBI is a fully-consolidated subsidiary of Raiffeisen Zentralbank Österreich AG (RZB), which indirectly owns around 78.5% of the common stock in RBI, the remainder being in free float. In CEE, RBI operates an extensive network of subsidiary banks, leasing companies and a range of other specialised financial service providers in 17 markets. RBI is the only Austrian bank with a presence in both leading financial centres and in Asia, the group’s further geographical area of focus. In total, around 60,000 employees service about 13.5m customers through around 3,000 business outlets, the great majority of which are located in CEE.

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Stepic has always believed that Europe’s central and eastern heartland is the continent’s long-term growth engine and therefore remains optimistic about the outlook for CEE: “The assumption is logical,”he avers.“The transformation of the region is only halfway there. It will encompass two or more generations before they can catch up to current eurozone standards.”Even so, Stepic maintains:“All the CEE states are in a much better position than they were prior to the implosion of Lehman Brothers.”

While RBI looks to be sitting relatively pretty, compared to its other European counterparts, its current perch is one that Stepic has worked long and hard for. Moreover, it has taken a number of gambles at key points in its history which, in the way of most outrageous fortunes, has paid off. A key turning point for the bank was its IPO in 2005. The €1.1bn IPO was the biggest in Austrian equity market history. Such was the feeling for the bank’s ability to leverage emerging Europe that the IPO’s order book was 22 times over-subscribed. Even then, enthusiasm did not subside. The bank’s share price rose by 116% over the following 18 months.

Importantly for Stepic was that the IPO allowed the bank to build on its specialisations of trade finance, retail banking and SME lending and, at the same time, build market share through acquisition of asserts around the peripheral markets of the EU. Acquisitions in Ukraine (Bank Aval), Russia (Impex Bank) and the Czech Republic were all added to the mix. It was a heady time for the bank, and while the firm’s share price remained high, some naysayers were anxious that the bank was overstretching itself. Even so, it was clear that Stepic saw opportunity beyond the bank’s then-capacity to book business. While it was nerve racking at the time, it has paid off in proverbial buckets.

Stepic has always believed that diversity provides both risk mitigation and a vital business mix. This has come to the fore most recently as the downturn in Hungary is counterpointed by business growth in markets such as Russia. A vital business mix in that for the past decade the bank has been diversifying into corporate business in Asia.

Another turning point came in February 2010, when RZB disclosed that the group was merging RZB’s principal business areas— above all its business with Austrian and international customers—with those of Raiffeisen International. The merger combined Raiffeisen International’s expertise in the equity capital markets with RZB’s expertise in debt finance. At the same time it would strengthen Raiffeisen International’s status

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

Herbert Stepic, CEO of Raiffeisen Bank International (RBI).Photograph kindly supplied by Raiffeisen Bank International (RBI), November 2011.

as a universal bank in the CEE through the merger of Raiffeisen International’s distribution and RZB’s service range. The merger also involved a brand change, Raiffeisen International becoming Raiffeisen Bank International (RBI).

With the eurozone crisis in continual flow through the second half of 2011, Stepic views the future with a mix of trepidation and optimism. He points to the fact that most of the states in the CEE have drastically reduced their current account deficits to between 3% and 6% of gross domestic product (GDP). He also points to the restructuring of the sovereign debt profile of many CEE states that “used the window, following the collapse of Lehman Brothers, to issue mid- to long-term bonds to improve the overall maturity profile”. He adds:“Then again, with the exception of Belarus and possibly Hungary, we have seen the peak of inflationary pressures in all countries in the region. The upshot is that the level of foreign debt is roughly half that of the EU.” Moreover, he adds, several countries have also introduced wholesale pension reform:“Where did that happen in any of the EU markets?”

While the CEE, now RBI’s key business hinterland, remains replete with opportunity, Stepic feels there is less cause for optimism elsewhere. “We have witnessed the longest boom phase in history, with relatively few and small hiccups, and I include here the Russian crisis of 1998. That boom began in 1993 and lasted through to just before the collapse of Lehman Brothers,” he explains, adding: “This period was characterised by, among other developments, the transformation of Eastern Europe; long-term low interest rates, kept down for mainly political reasons; the inventiveness of investment banks to create derivative instruments that increased liquidity in the markets; and deregulation in Europe and elsewhere, that accelerated the circulation of money, thereby feeding growth.”

Now it is the reverse, he says, with markets witnessing an enormous deleveraging process that began in 2009, resulting from the failure of Basel II and ratings agencies to bring to book banks which were lending to states on a massive scale, without sufficient capital.“As markets react quickly to events and they see political leaders failing to find meaningful solutions to these problems, they have lost trust and are now over-reacting. The more you talk the eurozone problem down, the more it is feeding the problem; after all, you cannot finance state borrowing at 7%. In this regard, the European authorities are now landed with a huge problem.”

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

“Against the backdrop of a clear deterioration in the economic environment and the continuing crisis involving the eurozone’s peripheral states, we managed to post respectable results in the third quarter. This development is based on our sustainable business model and our broad diversification with regard to markets, products and customers groups,” says Stepic. RBI posted a consolidated profit (after tax and non-controlling interests) of €745m for the first nine months of 2011, a slight decline of 4.8% against the same period a year earlier. In contrast, RBI’s profit before tax rose by 3.5% to €1.032bn. However, income taxes rose by €128m year-on-year to €272m. This increase was primarily driven by higher earnings in the group units, but deferred tax expenses on valuation gains increased as well. Only a small proportion of deferred tax assets could be recognised to offset the losses in Hungary.

This led to a profit after tax of €760m, a decrease of 10.9% against the comparable figure for the preceding year.

Based on current economic developments, especially in CEE, RBI is aiming for a return on equity before tax of around 15% in the medium term, with the inclusion of the acquisition of Polbank. “This excludes future acquisitions, any capital increases, as well as unexpected regulatory requirements from today’s perspective,”says Stepic.

At the end of October 2011, the European Banking Authority (EBA) stipulated a requirement of core tier-one capital ratio of 9% for European banks. Like other banks, the RZB Group, of which RBI is the largest sub-group, must reach this target by June 30th next year. Stepic says: “Frankly speaking, this turns things upside down. The RZB Group expects its additional capital requirement to amount to approximately €2.1bn. The group, along with RBI, has established around 20 work streams that will contribute to reaching the target ratio by yielding between €2.5bn and €3.6bn. Around four-fifths of the measures for achieving the target ratio are not connected to the reduction of business activities, for example by not prolonging expired credit lines.”

The challenge for banks such as RBI, with a strong focus on a prescribed region, is helping to create conditions in which the bank and its client countries can thrive. In the context of the CEE, this involves helping to establish viable capital markets.“In Russia, this process began five years ago and was focused around the corporate bond market. This type of process is at the very beginning in countries such as the Czech Republic. Institutions such as ours play a pivotal role in this regard. In Kosovo and Albania, for instance, we work together with the central banks to help build domestic money market operations,” explains Stepic.

Going forward, Stepic thinks that over the medium term, the“continuation of basic banking is still the most important service set”. He adds: “Just compare the ratio of banking assets to GDP in Europe (now around 360%) to that in the CEE, which ranges between 70% and 90%, and you have a fair indication of the work that remains to be done. This is potential business for us and there is ample space to grow by simply following supply and demand.” I

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20-20: ROBERT BARNES, CEO, UBS MTF

SETTING A MARKER FOR CHANGE On July 29th 2011, UBS MTF, the multilateral trading facility operated by UBS Limited, became the first MTF to offer full interoperability of two central counterparties (CCPs), EuroCCP and SIX x-clear Ltd, after which its ranking out of 16 European external dark venues jumped from 9th since launch in November 2010 to 2nd by September 2011 according to Thomson Reuters data, showcasing full interoperability as best practice. Full interoperability allows 100% predictability that a matched order will clear through the trader's CCP of choice. It enables users to consolidate clearing across markets with a choice of CCP that has best affinity with a user’s commercial profile without imposing switching costs on those members that wish to remain with the incumbent. Robert Barnes, chief executive of UBS MTF, who headed up this initiative, outlines the benefits.

BS LIMITED OPERATES UBS MTF as a segregated, non-displayed multilateral trading facility.

Executions completed in UBS MTF are reported post-trade in real time to the Markit BOAT trade reporting facility. In an automated world, UBS MTF’s implementation exemplifies how post-trade transparency contributes to pre-trade transparency for the next trade while avoiding pre-trade signalling risk.

UBS MTF is separate from UBS the broker and its discretionary mid-point crossing network UBS PIN. Designed as a MiFID-compliant external venue, UBS MTF is segregated by legal entity, line management, systems and physical separation. UBS the broker has the right to decline access to UBS PIN as it is a discretionary and selective process employed in furtherance of UBS broker’s best execution obligations. UBS MTF instead is non-discretionary and non-discriminatory which means all participants that satisfy UBS MTF public criteria can become members of UBS MTF by simple FIX connectivity. The beauty of this UBS MTF implementation is that UBS the broker can access UBS MTF as an additional external venue to enhance the spectrum of liquidity available to UBS clients while maintaining flexibility and selective offering of its internal crossing process.

Europe’s clearing silos multiply costs as fragmentation increases and order book trade sizes shrink. The all-in cost of trading has soared as an increasing proportion of the explicit costs relate to the number of fills cleared and settled relative to value executed. Post-trade optimisation has become a priority for the trading floor.

Regulators have by and large fed the slow trickle towards interoperability that allows market participants to net and crossmargin trades between clearing houses over the last few years.

UBS along with other proponents of interoperability have positive experience of its obvious benefits in reducing post trade costs and thereby providing a fillip to trading volumes.

Until July 2011, UBS MTF held a steady position as ninth largest out of the 16 broker-operated MTFs on the continent.

Once live with full interoperability, the platform then appeared to have captured the market zeitgeist that same month, securing a substantive slice of European share trading.

Thomson Reuter’s data shows the platform kept to the trend through September, executing over €4bn of business, making it the second-largest broker-operated dark pool behind Chi-

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Robert Barnes, CEO, UBS MTF. Photograph supplied by UBS MTF, November 2011.

X Europe by volume traded that month. Subject to approvals, UBS MTF plans to extend the number of CCPs. Progress in interoperability in Europe has had to follow prudent review by regulators long cautious to ensure that new arrangements do not introduce new risks to the equity capital markets. Even so, interoperability will become the rule rather than the exception in 2012 and we are delighted this institution is pivotal in bringing about change. Fostering innovation and choice is part of UBS MTF's core mission.

Our plan is to be an early adopter of interoperability as regulation makes investor choice more available; the value of the central counterparty model is designed to help clients mitigate risk and reduce settlement costs.

It is clear that interoperability unlocks further opportunity.

The puzzle solved in Europe is how to trade the same name in two or more countries and settle at home. For example, one can trade Daimler in Germany and trade Daimler in the UK and settle all into Germany. This is a real macro opportunity, with a global dimension. Right now, UBS MTF offers trading in some 15 countries around Europe. However, looking ahead, the model could be used outside of Europe as well; with attendant opportunities in high growth markets of Asia and elsewhere. Ultimately it is about the ability of equities to trade everywhere but settle at home in the same way that developed currencies can trade 24 hours and settle in one place.I

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

20-20: RAY TIERNEY, CEO AND PRESIDENT, BLOOMBERG TRADEBOOK

Ray Tierney, CEO and president, Bloomberg Tradebook. Photograph kindly supplied by Bloomberg Tradebook, November 2011.

Founded in 1996, Bloomberg Tradebook has come a long way in redefining the essential day to day service set in sell-side trading. Its particular journey time speeded up after the accession of Ray Tierney as chief executive officer and president. Previously global head of equity trading at Morgan Stanley high energy Tierney spent that time introducing new technology, upgrading systems and streamlining those processes which fire global trading desks. At Bloomberg Tradebook, Tierney has done the same and more; this time instituting the subtleties of sell side sales trading into the already high-octane Bloomberg culture as well as expanding its independent research services. It looks to be a high-value mix.

EXECUTION-EVERYTHING H ISTORICALLY, BLOOMBERG TRADEBOOK has provided trading tools and direct access to markets, and we are still focused on that, but we need to broaden our reach, which is why we went down the path to providing independent research,” explains Tierney, adding: “Our goal, to move from an execution-only broker, to execution-everything broker, means we need to provide research, execution consulting, commission management and research and development, all packaged together.”

Bloomberg Tradebook had to evolve; for varied reasons.

Historically, it was a product-focused organisation albeit highly service driven—a hallmark of Bloomberg products. In a world increasingly driven by regulation and the need to source liquidity, these days much more is required. In this regard, Tradebook’s particular positioning focuses on providing high level execution consulting, research, and helping clients achieve commission management efficiencies; a product suite that Tierney believes is finely tuned to today’s buy side trading requirements.

Moreover, the new focus hones in on current client needs: “Everything we do at Bloomberg Tradebook is driven by and for clients. Our model is to maintain a sharp focus on delivering an ever-improving product, backed up by unremitting attention to customer service and support,”says Tierney, explaining that: “The core competencies Bloomberg is built on—data, analytics and technology—is what puts us in a great position to deliver that service to clients”.

Independent research services, he believes is a keystone service set.“We try to give clients more value for their dollar in terms of the commissions that they spend. Our payment abilities are flexible, meaning clients can pay for independent research using hard dollars; they can pay the IRP with a check, or they can do it through a soft dollar commission sharing arrangement (CSA)-type of protocol, or they can trade through Bloomberg Tradebook and we maintain a customer’s credits.”

Bloomberg Tradebook’s customers can now use their Bloomberg terminal and (to) check their commission account balances in real time.“The client also controls how he wants to spend those dollars, whether it is on research, or execution feeds, and so forth,” adds Tierney.

The service set is a sign of the times. As commissions have fallen over the past year, agency shops continue to

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

look to increase revenues by finding new products and services through which to reach customers. No wonder then that Bloomberg is leveraging more than 100 research and development resources dedicated to Tradebook. Additionally, within that particular group, it has carved out a smaller set to work on initiatives that help solve client’s risk management related issues. Bloomberg is also building alpha-generating research content; though the firm, will reveal details about that at a later date, Tierney says.

It is not just a buy-side story. Like other agency brokers, Tradebook sees an opportunity to expand its broker-to-broker business as well. Tierney sees a lot of potential to offer services and tools to other broker-dealers, including sophisticated algorithms, direct market access, analytics and connectivity to Darkpools. Tierney is fired by the help it can provide smaller broker-dealers with advanced execution abilities they need to solicit business.“With multi-asset-class execution capabilities, Bloomberg can help these firms develop an all-encompassing trading solution,” Tierney holds.“This includes providing lowlatency market access, algos with cross-asset pairs strategies and global portfolio trading capabilities.”

Tierney finds confluence in both buy side and sell side requirements: “They need something on the edge that differentiates them, in terms of their execution performance,” he continues.

Advanced execution consulting is the name of the game in today’s market. It takes everything from pre-trade to posttrade and in between.“It’s understanding pre-trade analytics and creating a plan with your client to map out how to execute that transaction, or list of transactions, throughout the day,” explains Tierney, “being able to respond, in realtime, using data, technology and analytics to improve the outcome of the previous plan that you put in place. Then post-trade or TCA is to basically evaluate the transaction you did so as to improve the process for the next trade, or the trade that looks like that in the coming days.”

Tierney thinks execution consulting is no longer a strategic nicety, but a service imperative if the sell side and the buy side are to make sense of the seismic changes running through the global trading markets. It is a thought-leadership process, as much as a trading process, thinks Tierney.“Execution consulting is about bringing light to the dark world.”I

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20-20: GARRIT ZALM, CEO, ABN AMRO

It was never going to be simple but chief executive officer Gerrit Zalm had been making steady progress in turning round beleaguered ABN AMRO. The year 2011 started out promising with a strong first half but the eurozone crisis has put a question mark over whether it will return to the public markets by 2014. Despite the uncertainty, Zalm is seen as heading in the right direction. Lynn Strongin Dodds reports on the outlook for the bank.

CAN ABN AMRO STAKE A COMEBACK CLAIM? BN AMRO’S FALL from grace has been well-documented. The bank had become the symbol of the financial hubris of the pre-Lehman days with its fast past growth, high-profile takeovers and subsequent collapse.

By 2007, ABN AMRO was the second-largest bank in the Netherlands and the eighth largest bank in Europe by assets.

It had operations in 63 countries, with more than 110,000 employees and almost $63.9bn in revenue.

The moniker was set to disappear when Royal Bank of Scotland, Fortis and Santander split up its international assets between them in a €72bn deal that was ranked as the world’s largest banking takeover. The financial crisis exploded a year later and the Dutch government was forced to step in to rescue not only the domestic assets of ABN AMRO but also Fortis, at a cost of some €27bn.

The two banks were subsequently merged under the ABN AMRO name and Zalm, a former finance minister who earned a reputation as a fiscal hawk, was called in as chief executive in 2009 to oversee the integration.

His task is to get the bank’s income ratio structurally below 60% and to lay the foundation for a public listing in three years’ time. To this end, Zalm has been busy cutting the workforce by about 9%, bolstering key business lines and resurrecting its energy, commodities and transportation (ECT) operations. It had sold its ECT business to Fortis in 1997 and so it is back in the fold.

Integration is still under way and the goals include improving cost efficiency, rebuilding the bank’s franchise in commercial banking and increasing market share lost in the Netherlands. Zalm is also carefully developing an international presence in the bank’s core competencies such as ECT. It has re-established a foothold in the US oil and gas market by opening an office in Dallas, staffed by a sixperson team it lured away from UBS. Moscow and Shanghai are also on the list as cities where it would like to re-establish a presence.

Zalm has also returned the brand to the Dutch high street; a move which, says Claudia Nelson, senior director of Fitch, plays to the bank’s strengths. The combined entity is now the third-largest domestic bank behind rivals Robeco and ING with a market share of 15% to 25% depending on the product line, involving some 6.8m customers.

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Zalm has also strengthened the private banking franchise via the respected AMRO MeesPierson brand. The bank targets customers with wealth in excess of €1m and holds around €165bn of assets under management split equally between ABN AMRO, MeesPierson and a widely spread international network. The division is also known for its global diamonds and jewellery group, which specialises in providing lending, cash management, merchant banking and transaction banking services to small and medium enterprises in the industry. Zalm is a master of detail, evinced in his product diversification strategy: he has, for instance, introduced a special service for entrepreneurs both as a private individual and as a representative of their enterprise; while ABN AMRO MeesPierson has created a dedicated service advising a wide range of non-profit organisations.

Analysts remain optimistic about the bank’s prospects on the home front, but they are more circumspect about its global ambitions in the energy sector. The general consensus is that ABN AMRO could have difficulty in competing against French banks such as Société Générale and BNP Paribas, which have a lock on the field in Europe. In fact, ABN AMRO’s former energy team ended up at BNP Paribas after it took over part of Fortis during the demerger.

Analysts though are encouraged that Zalm appears on track to deliver the bank back to the public markets by 2014.

The first-half results in 2011 show net profits of €974m compared to €325m in the same period in 2010 while its core tier-one capital ratio was 11.4%. The cost structure had also been whittled down with expenses dropping to 63% from 75% a year ago.

With the eurozone crisis rumbling in the background, the bank’s third-quarter results showed it had taken a battering as profits were almost erased by a €500m writedown on Greek corporate loans.“Uncertainty as a result of the sovereign-debt crisis, and the impact thereof on the European economy, caused us to impair part of the €1bn Greek governmentguaranteed corporate exposures,”Zalm noted at the time.

Nelson says: “It is difficult to know what will happen because all banks in the eurozone will be affected. However, there has been some investor appetite for the Netherlands and there is still scope for ABN AMRO to continue to build up its business.” I

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

20-20: ADNAN BALI, CEO, ISBANK

Fitch Ratings says that the medium-term outlook for the Turkish banking sector is broadly favourable: a glimmer of good news in a less than stellar year marked by continuing unrest (political and economic) east and west of its borders. Within the sector, Isbank has continued on a serene growth path; led by CEO Adnan Bali, which has seen the bank’s total assets increase by 21% in the first three quarters of 2011, with loans rising by 33% and shareholder equity rising by 5%.

Adnan Bali, CEO, Isbank.

Photograph kindly supplied by Isbank, December 2011.

LEVERAGING REGIONAL OPPORTUNITY OU CAN BE forgiven for thinking that all the countries that ring the Mediterranean have had more than their fair share of problems in 2011. For all that, and its own spots and glitches, Turkey’s banks have been yar: quick to the helm and light of touch. As a result, the sector looks to be able to withstand the continuing euro storm better than most. Some reasons are obvious: banks in Turkey have very little exposure to eurozone sovereign debt.

Equally, they enjoy a relatively benign home market: the Turkish economy grew by almost 9% in 2010 (after contracting by nearly 5% a year); proving its ability to bounce back quickly after a crisis. In 2011 it fared even better, becoming the year’s fastest growing economy with an impressive 10.2% in the first half. That blessed run is unlikely to continue however, given external circumstance, says ratings agency Fitch, whose base case is that Turkish GDP growth will slow to 2.2% in 2012 before returning to 4.5% in 2013, close to potential.

Isbank, along with Garanti and Akbank, are the leading private sector Turkish banks. Together, they control a domestic market share of around 38%. Isbank has traditionally been the largest among its peers in terms of assets, equity and branch network size. While Akbank’s asset quality and capital ratios continue the strongest and Garanti displays the highest profitability ratios, Isbank progresses as best allround performer.

Even so, Turkey’s operating environment remains volatile, ultimately with the potential to bruise if not exactly batter the banking sector’s forward performance. According to Fitch, the sector is well capitalised, profitable, liquid, and moderate in size in relation to GDP. Non-performing loans are low, the loan/deposit ratio is 99.5% and there is minimal foreign currency lending to households. However, loan growth in the sector has been rapid, up 25% in the first nine months of 2011 and 32% in the whole of 2010. Isbank, like Garanti and Akbank, have all expanded lending, particularly to high margin retail and SME borrowers.

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FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

For much of 2011, Isbank supported this growth. Total lending by Isbank rose by 33% between January and the beginning of October (from TRY64bn at the end of 2010 to TRY85bn at the end of the third quarter 2011). Of this, 72% is commercial lending, which itself grew by 38% over the first nine months of 2011. Why that happened is easy to see.

Turkey’s export volume has risen, from below $100bn in 2009, to $114bn in 2010 and an anticipated $135bn in 2011.

The country’s current account deficit has also spiked to around 9% of GDP, due to the country’s rising energy bill and industry’s dependence on intermediate goods for re-export. Much of this deficit is through the rise of private rather than public debt. However, this level of growth looks to be constrained through much of 2012 with the continued slowdown in demand in some of Turkey’s largest export markets (including Europe).

While the general picture has been good, bankers concede that net interest margins are being compressed, reflecting among other things, heightened competition in the market and increased reserve requirements on deposits. Margins for the three banks tumbled to an average of 2.4% in the first half of 2011, compared to 4.2% for the whole of 2010, says Fitch.

Taking on the mantle of general manager in April 2011, after predecessor Ersin Özince moved to the job of chairman, just as the eurozone’s problems began to ripen, chief executive officer Adnan Bali was keen to take on any resultant pressures, at a clip. “The recent slowdown in economic activity in the developed economies and the fiscal challenges facing those nations has repercussions for all of us; creating uncertainty and volatility and therefore plenty of downside risk. The driver was and always has been: let us get on with the job.”

Bali symbolises the new crop of Turkish bank leadership which will take the sector into a more mature business phase, which concentrates as much on thought leadership as day-to-day business growth. This dual role is increas-

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20-20: ADNAN BALI, CEO, ISBANK

ingly important in a region which is struggling to develop a new identity in a modern, fast changing, sometimes unstable world. Bali is keenly aware that for Turkish bankers, there is much at stake. The country is keen to develop Istanbul as a regional financing hub; and Bali would like to see Isbank set firm centre in leveraging the new business opportunities this will bring. The strategy, if successful, will draw in high growth and resource-rich economies in Eurasia, ranging from the Black Sea states through to Kazakhstan and the northern zone of the Middle East.

Anxious to leverage growth in leading markets, the bank acquired Bank Sofia in Russia in April 2011, in a deal valued at $40m and has subsequently named it Isbank Russia.

Against this opportunity, Bali is also keenly aware of the growing impact of regulation on the banking segment per se. “We are being called to reconsider all things again. It might be a risk to do so, but we are moving at a fast pace towards a stricter regulatory financial system. We might as well imagine and prepare for what, realistically, this might mean for us all,” he avers.

There are also issues closer at home to take into account. According to Bali, in an interview conducted in 2011, there remain some residual concerns over liquidity for Turkish banks, as the increase in costs in the deposit market restricted growth in net interest income in the first half of the year. Equally, he added: “The flight of capital from emerging markets to developed markets due to the liquidity needs in global markets has resulted in pressure on currency rates and also increased the risks of doing business in emerging markets through the year.”

In consequence of a conservative business outlook: “We continued to set aside 100% provision for non-performing loans thanks to the bank’s strong financial structure. The bank has also managed to reduce its nonperforming loans by 10% as a result of a decline in nonperforming loan formation due to the positive effect of the economic conjuncture, as well as its effective policies in non-performing loan collections,” says Bali. Isbank’s non-performing loans ratio, which was 3.6% at year-end, decreased to 2.5% at the end of third quarter due to “these positive changes and the solid growth in performing loans,” he added.

Similarly,“cost management has become crucial due to the competitive structure in the banking sector and the increase in funding costs. The bank has followed a strategy, which aims to keep funding costs under control.

On the other hand, there has been 6% growth in Turkish lira savings deposits,” he said.

For the time being the bank is focusing on building both its commercial and retail lending business as well as cementing its position in the mutual fund segment.

The bank currently manages over TRY6.6bn in mutual funds, enjoying a leading 20% market share in Turkey; as well as some TRY17.4bn of fixed income securities under custody (accounting for an 18% market share).I

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20-20: ARUNMA OTEH, DIRECTOR GENERAL, SECURITIES AND EXCHANGE COMMISSION, NIGERIA

OTEH’S PILLARS OF REFORM Nigeria still stands at the crossroads, as the process of infrastructural reform continues under the president, Goodluck Jonathan.

Variously, central bank governor Lamido Sanusi and incoming finance minister Ngozi OkonjoIweala, have been honoured by NGOs this year for their work in leading reform in the country’s monetary system and still misshapen economy. Our own personal nomination is Arunma Oteh, who has been director general of the Nigerian Securities and Exchange Commission since July 2009 and has been a consistent standard bearer for change.

IGERIA’S SECURITIES AND Exchange Commission is moving apace with its Project 50 events commemorating a half century of regulation of the Nigerian capital markets. The project committee is headed by directorgeneral Arunma Oteh heralds a range of activities marking the role of the SEC in introducing good corporate governance and market rigour to the country’s financial markets activity.

Nigeria is expected to remain a fast-growing economy with an average GDP growth rate of 8.5% and rising real income growth. Oteh sees these trends as a real incentive for change.

“Ongoing financial sector reforms have engendered a better capitalised and more stable financial sector that is strong enough to provide robust financial intermediation and support Nigeria’s position as a preferred investment destination. With respect to the capital markets, the SEC has in the past 22 months invested significant resources in catalysing its transition to a world-class capital market. In the first instance, we undertook a diagnostic review of the capital market and have been implementing reforms in line with the recommendations of this review,”explains Oteh.

The SEC has addressed corporate governance with a new code introduced at the beginning of April 2011, which is comparable to internationally accepted codes, says Oteh. “In addition, we are facilitating a seamless transition to risk-based supervision and are working with publicly-quoted companies to ensure that they are able to transition to international financial reporting standards (IFRS) in 2012. These we believe will ensure adequate and timely disclosure of information, thereby promoting market integrity.”

To this mix should be added a new management team for the Nigerian Stock Exchange (NSE). Incoming chief executive Oscar Onyema has outlined a bold vision to build a credible market with five product ranges—equities, fixed income, exchange-traded funds (ETFs), options and financial futures— over the next five years. In September 22nd 2011 inaugurated an industry-wide committee to develop a strategy for the demutualising of the exchange. For now, the SEC is reviewing its internal structures to improve efficiency and service delivery.

Says Oteh:“We continue to invest in capacity-building initiatives for SEC staff, operators and the general public”.I

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DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

ASIAN TRANSITION MANAGEMENT ROUNDTABLE

WHY TRANSITION MANAGEMENT IS NOT LOST IN TRANSLATION

Photograph © FTSE Global Markets, supplied November 2011.

Attendees

Supported by:

(From left to right) JOHN MOORE, managing director for Russell Investments, Asia Pacific NICK McDONALD, principal, Mercer Sentinel JIM KARELAS, managing director and head of Asia-Pacific transition management, Convergex Group HEMAN WONG, executive director, Hospital Authority Provident Fund, Hong Kong DUNCAN KLEIN, head of transition management, Asia, JP Morgan ADRIAN TENG, group treasurer, Jardine Matheson

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

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a volatile mix of market growth and change DUNCAN KLEIN, HEAD OF TRANSITION MANAGEMENT, ASIA, JP MORGAN: When we talk about transition management in Asia, what gets a lot of attention are the twofold trends of increasing demand for the product and the growing complexity of many deals, particularly around fixed income and emerging markets, during these volatile times. These two asset classes by nature carry greater trading and operational complexity compared to developed market equity transitions, and therefore clients are starting to differentiate solutions and outcomes across the various transition managers in the region.

HEMAN WONG, EXECUTIVE DIRECTOR, HOSPITAL AUTHORITY PROVIDENT FUND, HONG KONG: At a time like this my focus is trying to preserve capital and performance in the portfolio. As a pension fund, we tend to be long-term investors; even so, volatility is inevitably unpleasant. Now and then if we are forced to make a change in our appointed managers, transition management is a tool that we often adopt. Other considerations for us include inflation, new products such as commodities and UCITS, and heightened risk.

JIM KARELAS, MANAGING DIRECTOR AND HEAD OF ASIA-PACIFIC TRANSITION MANAGEMENT, CONVERGEX GROUP: I have a dual-focused strategy right now which involves Asia and Australia separately. In Australia, we are looking to leverage the industry consolidation among super funds that is occurring at the moment. There is a high level of complexity and administration driving that process which offers us a lot of opportunities. At a wider Asia level, our process and scope is more educational. With the Asian customer base, there is still a bit of a learning curve with respect to transition management and a large knowledge transfer that must take place at the onset of building our relationship with them. So our dual strategy throughout the region involves a widely differing set of activities and objectives.

NICK MCDONALD, PRINCIPAL, MERCER SENTINEL: Transition management is a strong element in our service set in Asia, which involves consultancy services around investment operations and implementation. Right now, capital preservation for any asset owner has got to be key in a volatile market. Then it becomes a process of analysing the risk tools provided by transition managers and their ability to utilise them in different market conditions, not meeting the execution requirements of today.

ADRIAN TENG, GROUP TREASURER, JARDINE MATHESON: Uppermost in our thoughts is how to cope with increased volatility in the global market. What used to be a once in every three or five year occurrence is now happening on almost a daily basis; and you have to bear it in mind when you are managing a corporate pension plan. It is also a fine balancing act: safeguarding capital on the one hand and taking a risk to generate reasonable returns on the other for the benefit of our employees. It is a difficult tightrope to walk right now and, as Heman noted, in Hong Kong, rising

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inflation is not helping. In this context therefore, we look at transition managers no longer as service providers, but as partners in helping us mitigate these very real challenges.

JOHN MOORE, MANAGING DIRECTOR FOR RUSSELL INVESTMENTS, ASIA PACIFIC: Some of the biggest challenges are related to the sheer complexity of events around the industry. Pointedly, this is not about specific countries in Asia, but rather across the board.

Moreover, as Duncan notes, the focus on fixed income events and emerging markets, where liquidity is more of an issue, can present a challenge as well. Then, as everyone has mentioned, it is about volatility and how we deal with it during a transition. In that regard, it becomes very important how you put together a team that actually knows how to manage transitions in these dynamic times.

TWIN PEAKS: RELATIONSHIPS AND TRANSITIONS JOHN MOORE: Transitions in Asia are developing and evolving in the same way that they are in the US and Europe.

Outside of Asia, especially in Europe, we see people moving towards a fiduciary-type model and in time that will all evolve in Asia as well. Clients nowadays depend on the transition manager a lot more during the pre-transition stages; leaning on them for advice because there are more complex instruments being used. It is as much about process as the actual transition. It is important that clients really look at their transition managers, and see how they’re constructed as a team. For instance: when you’re dealing in both the physical market and the derivative markets, how well are the two teams handling these elements? How well are the teams connected? How do they integrate their expertise? It is important to do this analysis because if the transition manager is to deliver an optimal outcome for the client, it is really important that these teams work together effectively; particularly in these volatile times.

NICK MCDONALD: Transition management in this region is often overlooked; in fact, it is sometimes an afterthought. I’m sure the asset owners in the room would say having a transition manager in place or a panel of transition managers in place allows them to be flexible. Their decisions will depend on their particular asset requirements, or their desire to be able to respond to market volatility and be able to implement that change quickly. Or, it may simply be a process of wanting to change managers and having a clear process already in place. Either way, to get to that point you have to do a lot of due diligence to achieve that flexibility.You have to reach an understanding as to who are the transition managers in the market and how their expertise can be brought to bear on your requirements.

ADRIAN TENG: At Jardines, we tend to look at very longterm relationship management. The transition manager that we’ve used, is one we have used for close to three decades. The team knows our portfolio extremely well and I don’t have to explain anything whenever we do anything. It is a very easy process. Also in terms of evolution, corporations in Asia have

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

Duncan Klein, head of transition management, Asia, JP Morgan.

Photograph © FTSE Global Markets, November 2011.

slowly come up the curve with regards to managing transitions themselves and they do not always go out to a transition manager to do transitions, unless we’re talking about large portfolio shares; such as, for instance, one company into another’s group plan. The current changes in the macro-environment now forces you to be closer to your transition manager. They are used as a counsel, as an adviser and as plans become more sophisticated with regards to new asset classes, funds of private equity funds, and funds of hedge funds, which is always the most complex business. In comparison, equities and fixed income are fairly straightforward. That is the valueadd that TM can bring to the table. For plain vanilla transactions on the other hand, it is really not a difficult process.

NICK MCDONALD: It is also ensuring that your transition manager keeps up the pace with that as well.

DUNCAN KLEIN: The transitions that we manage are less about asset manager change and more about interim asset management solutions that by nature allow us to intensify, consolidate, strengthen and deepen our relationship with our clients. To that effect, the roles and responsibilities of the transition manager are not only to implement restructures in a timely, cost efficient and transparent manner. They must also ensure the client is fully convinced that their transition manager is delivering an optimised trading strategy in line with client interest and away from internal trading limitations. Increasingly, we see client and transition manager partnerships strengthen as clients engage us earlier in the restructure discussions. Additionally, in today’s volatile markets, clients are beginning to recognise the benefits in hiring a transition manager for short-term restructure implementation away from asset managers who manage their portfolios for the long term.

JIM KARELAS: My response is in two parts and that is only because I cover two distinct regions. Australia is definitely driven by the relationship between clients and transition managers. Australia is well-advanced with respect to transition management panels, and relationships are formed as a result. The clients treat transition managers like investment managers when it comes to appointing them to a panel. The appropriate due diligence and capability research is performed at a detailed level before any selection is made. What we’ve seen in Asia however, is that acceptance of this business and process, has been a lot slower. Even so, as clients start diversifying their plans, changing their asset allocation, changing their investment strategy and as a result reconfiguring their investment manager line-up, then the requirements of the transition manager become far more critical. Let’s take, for argument’s sake, a plan and it could be a sovereign wealth plan with traditional government bonds that are managed in-

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

John Moore, managing director for Russell Investments, Asia Pacific. Photograph © FTSE Global Markets, November 2011.

ternally. They might start looking at diversifying their investment strategy potentially to increase their alpha or modifying their return profile to match certain liability requirements. They start investing into equities, hiring investment managers, and all of a sudden they start realising that the road to implement that strategy becomes a lot more difficult. Discussions then begin with transition managers.

HEMAN WONG: A long-term relationship is useful. If you have a long-term relationship with a transition manager and they know what you need to do, and particularly if the contract agreement has been established, you don’t have to go through things over and over again. However, at a time like this when a lot of new challenges are in the market, complexity comes to the fore. If for instance you are investing in a group, like a specialist, there are legal restrictions and liquidity issues, which often require a very detailed discussion with a transition manager. The relationship is sometimes also driven by understanding and bringing new ideas or solutions to the table. In that sense you gradually build up confidence in the transition manager and the process. We appointed a new manager early in the year and the challenge for us is to bring the relationship together and look for natural fits with certain mandates. It is also important when you get into that relationship building that dialogue is frequent and detailed, even before a deal is contemplated.

That dialogue then ratchets up when a deal is being contemplated. That process gives you a lot of confidence.

JIM KARELAS: As Heman rightly points out, what clients get when they employ a transition manager is a market and portfolio implementation specialist. Clients get access to the firm and its resources. We find clients are utilising transition managers to also access value-add resources and to market expertise, market intelligence and market colour. Clients are not only looking for formal research, but also bespoke research and/or market trends that may be beneficial in assisting investment teams with their investment strategies.

COST CONSCIOUSNESS and CONSIDERATION NICK MCDONALD: The majority of Asian clients pay close attention to detail and to costs. Add to that a strong requirement for transparency. The more transparency that a transition manager gives to the client so that he can understand, for want of a better word, the numbers behind the strategy, behind the implementation, is key right now. Detail is king.

JIM KARELAS: Certainly clients in the region are a lot more focused on the accounting outcome pre- and posttransition. They like to drill down, as Nick says, into the detail

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and question particular prices. Having said that, I think it is important for a transition manager, before anything occurs, to set client expectations. You have to manage expectations by providing analysis of the client’s portfolio from a price and valuation perspective, and let them know that the execution in the market may vary slightly from the actual accounting valuation. This is particularly the case with fixed income. In saying that, even standard reporting will provide significant detail and clients appreciate the analysis resulting from an accounting valuation versus market price perspective because it breaks out all of the costs associated with the trade from a market sense.

JOHN MOORE: There was an email sent out from the chairman of the T-Charter to clients after one of the TCharter group’s recent surveys which called for more transparency. All clients want full accounting transparency around a transition. Moreover, I think that clients will want more going forward, in terms of having analysis around the track records of individual transition managers; a sort of independent audit, that perhaps goes back as far as five years. I think transition managers will be analysed and evaluated in the same way that investment managers are analysed and vetted on their historical performance record. Once that is in place, then I think it creates more trust with the transition provider, particularly when you’re going through the pretransition and the post-transition reporting processes.

DUNCAN KLEIN: Asian clients do not like surprises when a transition manager presents the post-trade cost analysis. To this point, as Jim touched upon, we need to highlight any valuation price that we view as “off market” compared to our pre-trade prices that better capture dealer appetite for the assets within the current market. Any significant difference needs to be presented and explained to the client prior to trading. This is especially noticeable for illiquid fixed income assets that are less frequently traded or when market volatility is such that some corporate bonds trade like high yield bonds. In these cases there are fewer market makers willing to provide two-way markets and therefore quote a one-sided market (bid only or offer only) to reflect their long or short position or their overall net portfolio exposure to that issuer.

HEMAN WONG: We have a small team. We don’t have an investment team and a finance team, it is always the investment team who’s looking after transitions. We are pretty good on the pre-transition due diligence. I’m a demanding type of boss. I ask my own team to run the numbers even before a consultant runs the numbers. I will make my own guesses and by the time I ask my transition managers to submit reports, I have some idea as to whether they are telling me the full story or not. Obviously everybody has their own model, but I think that preparation in-house is important and we don’t forego the responsibility. My members look at me for performance. Any shortage is a hit. That is the way I read it.

ADRIAN TENG: Our situation is similar. I manage the investment and the finance element of it. It all sits with me and so we execute as most efficiently, as cost-effectively as possible. We obviously try to do pre-work on our part before

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we engage with transition managers for their advice and counsel. Obviously, they may be more sophisticated with regards to the risk management tools which may then be a potential upside to our initial costings.

MEASURE FOR MEASURE: WHAT MAKES A GOOD TRANSITION? NICK MCDONALD: From a consultant perspective, part of our valuation is about performance, past performance and track record. It becomes particularly pertinent when you look at pre-trade versus post-trade performance. The more confidence we have in pre-trade, in cost discovery, the easier it is to then move forward with a transition. If that is not there, it is harder to proceed. You can see this enormous difference in the developed markets in the bell curve versus an emerging market bell curve, for instance. It is actually quite wide and that makes the whole process more interesting.

JOHN MOORE: Of course, there are different bell curves or outcomes for different transitions, but it is exactly the same with investment managers. Their outcomes around emerging market investments versus say US large cap are going to be widely divergent; but what does it all mean? It is comparing apples with pears.

HEMAN WONG: I look on transition management in the same way that I would if I started a war. Before you start a war, you had better have undertaken detailed simulations and developed a clear strategy for victory. It is a dramatic example, but I expect the same approach from a transition manager. A good transition manager should explain to the client what kind of events might fall upon the day you start that war. Something might happen, especially at a time like this when the market is throwing up so many challenges.

Having clear measurements, reports and analysis in place will give you the confidence and allow you to be prepared in the case of extreme market events coming on the day you started that war. Because once you press that button you can’t unwind part of that what you have done.

DUNCAN KLEIN: Once you start the transition it is nigh impossible to back track, but during the preparation stage you’ve got time to think about what might hit you and in today’s markets, it could be quite a few things—macro, micro, regional, political—you need to be ready for it.You need to consider the overall strategy you are presenting to your client in your pretrade. The quality of the execution is directly dependent on the quality of the preparation. It is thinking about all the different models to help achieve the client’s number one objective: and we’ve heard it both from Adrian and from Heman, that is, the protection of the value of their assets. That might involve considering hedging solutions to minimize volatility, if authorised by the client. Coming back to transparency, it is not just about the implementation shortfall standard, it is also looking at benchmarking the post-trade versus other execution benchmarks. If you’re in a situation where you’re buying and the market opens lower compared to the prior night’s close, you’ll always outperform your implementation shortfall benchmark.

Even so, you have to put that in context with what the market

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

Adrian Teng, group treasurer, Jardine Matheson.

Photograph © FTSE Global Markets, November 2011.

actually did during your period of trading and that is another level of transparency we need.

NICK MCDONALD: You are right Duncan. It is not simply looking at the implementation shortfall, it is the trading strategies behind the result. That is because you can still have an implementation shortfall calculation that looks good but the strategy behind it isn’t exactly up to par. That in turn goes back to how you’re managing that risk at transition. That is where a lot of people in this region can fall down if they’re not careful.

ADRIAN TENG: Key performance indicators (KPIs) have been broadly mentioned. There are fairly basic KPIs that one would measure, pre, post, cost, track record, level of service, level of research, market information and whether the transition manager is on the curve of new market developments, new asset classes. All of that forms the background of how we evaluate a longstanding relationship or a transition. Is there a right or wrong answer? I don’t know. As Heman said, if we feel comfortable that the transition manager understands our culture, what we’re seeking objectively, and that Jardines is a very risk-averse organisation, that is fine. If we think that a transition manager is putting risk on the table and something that is crazy in pursuit of a particular number, we will reject that outright. That is the important dynamic; not just numbers but the entirety of it. As someone said: it is an evolutionary process.

When Jardines first entered its transition management contract 30 years ago, would you have known that they would stick with them for 30 years? Who knows, right? Unless another compelling transition manager comes to the table and offers a real reason to change, then there is really no incentive to do so on our part. Having said that, as one’s asset volume increases, as one’s level of asset sophistication increases, there is then a merit of considering having another transition manager as a stopgap, as a check and balance.

JOHN MOORE: As plans become more complex, and the market presents different types of events than you would have seen 30 years ago—which results in multiple asset allocation shifts— you are seeing clients looking at panels, wanting to be ready for different types of events. Others have panels because of due diligence, ahead of time, in order to be ready for any allocation changes and move quickly in response to market events.

CLIENT-LED SERVICE EVOLUTION JIM KARELAS: Within Asia, some of the countries that only recently started to utilise the transition management product are starting to diversify their portfolios and are now looking for transition management expertise in terms of re-

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

structuring assets. In that sense, we are looking at a set of clients who are new to transition management. In terms of other changing demands, obviously with the level of sophistication that has occurred with new technologies in the space, clients now expect their transition managers to have access to advanced trading technologies, have the ability to scour its network of different markets and exchanges while sourcing liquidity across the globe and execute at competitive prices. Additionally, we’ve seen increased client demand for interim solutions for asset management and on the hedging side of the business. We have also seen an increasing demand for interim client exposure management solutions that not only utilise futures or currency overlays, but also include ETFs. DUNCAN KLEIN: What clients look for in the service is flawless project management as a transition requires coordination across numerous entities: the client, the transition manager, external fund managers (legacy and target) as well as the custodian. The role of the transition manager is therefore predominantly one of a project manager, ensuring clear communication at all stages to all interested parties.

They are singularly accountable for the overall delivery across the multiple entities. The complexity of managing and delivering on time within the objectives and time frame of the client is complex and demanding. These days market volatility, exacerbates the complexity of the mandate.

FRANCESCA CARNEVALE: Are those requirements constant throughout the region; or do countries operate differently?

DUNCAN KLEIN: There is a relative inconsistency through the region with some clients systematically leveraging the skills set of a transition manager even for cash injection while others do not. I would say that across the region, clients have a better understanding of the concept and value of transition management but are still learning about the different execution models and levels of price transparency that the various transition managers are offering. With investments expanding into global markets across equities, emerging markets and fixed income, clients are engaging more transition managers by selecting panel solutions rather than appointing a single provider to cater to all asset classes as they recognise these differences.

JOHN MOORE: In terms of variations in Asia, it all hangs around local regulatory issues. Take Japan, for instance: if you compare Japan to Hong Kong, the way transitions are contracted is totally different than you would see here in Hong Kong. Moreover, as market complexity increases, transition managers, must now have global support and be able to manage their event live across the world, and able to pass things around the world with ease. When the financial crisis hit, some transition managers jumped out of this market and those tended to be operations without a strong global infrastructure. Asian clients are keenly aware that they also need global support when they do these types of events, particularly as you have more complex fixed income events involving swap and hedging strategies.

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NICK MCDONALD: We are looking at how transition managers manage across asset class exposure and across time zone exposure and the use of tools, either derivatives or ETFs, and from that perspective I see more complexity rather than less. Let’s take fixed income. Adrian said it is reasonably straightforward but I would say there are a lot of complexities in terms of the different styles or models that are out there between an agency and principal and they have different trading roles. Does that favour the broker/dealer or the agency model?

JOHN MOORE: Is that because the broker/dealers can’t put up any more balance sheets?

NICK MCDONALD: Perhaps one of the broker/dealers in the room might be able to elaborate…

DUNCAN KLEIN: Certainly, we enjoy the challenges that come with increasing complex deals, and as Nick notes, the necessity for a transition manager to adapt to client needs to ensure the best delivery. While John points to regulation, I would say each client is different. Some clients impose non-negotiable transition management agreements, others are more open to signing a transition manager’s agreement and you need to be able to adjust to the client requirements from a legal perspective. Some clients require you to contract under their local law whereas you’re delivering the transition out of a different jurisdiction. To have that flexibility within a global organisation is another opportunity to differentiate one provider from another.

FRANCESCA CARNEVALE: What’s important to the client side? Is it an agency-style model, or is it a custodian or proprietary structure, that appeals to you most?

HEMAN WONG: We segregate our assets into specific asset classes and we are more sophisticated than some other clients. So when we look for a transition manager, we have to ask ourselves a few questions. Obviously cost is one thing that probably very often comes up. But what about sophistication around a specific asset class? That is a key concern.

Now, people all say that they are good and everybody will tell you that they have cause of capability because their asset size is back-paid. You would expect the major players to be more or less the same, but it is not always the case. You might also expect that whoever gives me the cheapest quote will get my deal, but that is not always the case. We have to delve very deep into the process to decide what form of transition manager is right for us and when.

ADRIAN TENG: I always wonder, whenever questions like that are asked: does it really matter? All this marketing that transition managers spend on, does it really change the landscape? A bank is a bank. Who really cares what colour they are, as long as they can deliver and, in fact, more or less, by and large, services tend to be the same. Fundamentally banking and/or transition management is a people’s business and it is the relationships they have developed that count. It is the understanding of and the awareness between the client and the provider and by and large that is why, when someone moves to another organisation, the business goes with him or her and fundamentally that is how I see banking services.

However, I also agree with Heman. At the end of the day it is

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Heman Wong, executive director, Hospital Authority Provident Fund, Hong Kong. Photograph © FTSE Global Markets, November 2011.

the level of reach and expertise that a firm can bring to the table and it really needs to fit with the client’s profile. Not every client requires the same level of sophistication and secondly, I, like many others, are not spending hours in my day dealing with transitions. I don’t think there’s a right or wrong way of selecting a transition manager. Are you buying Chanel or Gucci? Who really cares? A shoe is a shoe and a handbag is a handbag. Yes there are nuances that you decide one way or the other and it is really that—it is nuances—but then it is really the relationship with the account manager that really drives the decision.

NICK MCDONALD: What you’re saying is that at the end of the day the objectives of a transition prior to doing it is the critical factor and everything else will fall into place after that.

It is setting those objectives upfront is key.

ADRIAN TENG: Yes, it is a combination of months of deliberation and finally, a community of 20 people have made a decision. Frankly, it is a real pain in my life, and then when everyone else is happy we pull the trigger and we go get a transition manager or a fund administrator or a custodian. Then it is about deciding which is the best way to execute the transition; we do not think it is the transition manager’s right to tell us how to do it; but we expect him to advise us about the best methods and minimizing costs. Hey, and if we can make money out of a transition, all the better. And there are some companies that maybe look into that as one KPI.

THE UNBEARABLE LIGHTNESS OF NEW OPPORTUNITIES JOHN MOORE: We’re seeing opportunities in Japan with clients starting to look at some of the major changes and starting to diversify a bit more than they traditionally have done. Around the corner, there are new regulations in train which will start allowing clients to transfer in specie assets into and out of trust funds. It will totally change the investment landscape there. That means real opportunity for some as the size of the pie changes, as does the way things are done in Japan. In Australia we are seeing a lot of funds consolidating, mainly smaller funds, either consolidating with larger or other funds for capacity reasons. Within Asia, the opportunities are really around clients putting more and more money offshore in a lot of the countries.

Here in Hong Kong it is probably a little different. People have been investing offshore quite a bit for a while, but in a lot of the Asian countries you’re seeing more clients putting more money offshore, whether it is in equities or fixed income or emerging markets.

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

JIM KARELAS: With fund consolidation there are multiple levels of complexity and the funds typically engage the transition manager early on in the process to come up with indicative cost analysis. The complexities and challenges for a transition manager are greater as there are typically changes from a custodial, administration, investment strategy and manager perspective. The landscape is changing for the smaller super funds and in order to survive, scalability becomes very important.

DUNCAN KLEIN: In Asia we’re seeing quite a few opportunities, as John mentioned, in clients starting to inject cash in global mandates. Hopefully over the next 12 months they will start leveraging the services of transition managers to implement the cash injections for them, especially when they start doing it across four or five different asset managers, because there is a huge benefit for them in understanding the cost of implementation of their full cash injection. The cost associated with half a billion to a billion invested could be significant, especially in volatile markets where we are often seeing more than 100bps of intraday volatility across assets and foreign exchange.

EXPANDING THE SERVICES SET IN TRANSITION MANAGEMENT JOHN MOORE: Whether it is the need for interim management, or the evolution of the transition manager into a trusted adviser, the fact is that clients are sharing more and more information with their provider. In fact, I would venture that transition management is becoming more and more of an asset management assignment. Similarly, I see the emergence of a closer relationship, maybe even a symbiotic relationship, between transition managers and specialist consultants. Say consultants that specialise in hedge funds or alternative investment strategies.You’re going to have portfolio managers that are working with the clients on their general strategies and then you’re going to have specialists below that, that are really helping them in fixed income and commodities, property events and those sort of things.

DUNCAN KLEIN: John highlighted the importance of a global team. It is critical to ensure that your team evolves alongside your clients’ requirements. In that regard it is vital that your team is capable of delivering services that meet this market complexity, while maintaining client confidentiality.

What you don’t want is a transition manager that does not have the skill sets within the team and starts leveraging other parts of the institution to overcome their internal TM shortfall. This breaks away client confidentiality and might introduce concerns around conflict of interest. Having a global, dedicated and segregated transition management team is increasingly important as clients’ mandates become more complex and global.

JOHN MOORE: That is a very good point. You hear these days that everyone is becoming an agent and that can be somewhat misconstrued. Maybe the contracting entity itself is an agent and acting as an agent, but they are in fact accessing other parts of the organisation. Where you start

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

Jim Karelas, managing director & head of Asia-Pacific transition management, Convergex Group.

Photograph © FTSE Global Markets, November 2011.

sharing information that is not used in an agency capacity and that has got to be clear. Clients need to be aware of how their information’s being used; that the team that they’re using is rowing with them and that the contract they have with the transition manager is being adhered to around the globe within that transition manager’s organisation.

FRANCESCA CARNEVALE: Is part of that ensuring that transition managers are adequately recompensed for their work, so that they are not tempted to find remuneration elsewhere?

JIM KARELAS: There was a time when clients essentially looked to transition managers to pay for their flow. A lot of those clients realised that they were not getting good execution and as a result clients have come full circle and understand that you don’t get something for nothing. Thus commissions have steadily increased and transition managers are being remunerated better than they were in those ‘zero to pay for flow days’, but there is still a long way to go. Along with that, transition managers have emphasised, particularly post-2008, the real difference between cost and risk. It is one thing to come up with an estimated cost based upon your commission, your tax, your spreads and your market impact. It is another to sit down and ensure that a client understands what risk is involved in that trade and the gain or loss that can arise particularly from the greatest marginal contributors to risk. As transition managers we’re not in the business of gambling with the clients’ portfolios. We must ensure that the client adequately understands the risk and that the risk can essentially become a cost. Then the derivation of an appropriate trading strategy, coupled with a firm’s ability to source liquidity and provide competitive pricing, means that clients are paying for specialist expertise. I think that clients are starting to realise that they need to adequately remunerate transition managers based on the level of work they do, but they also need to ensure that their transition managers are giving them the level of expertise, resources and knowledge applicable to that commission rate.

JOHN MOORE: More clients are becoming aware that it is not a free service, that you need to pay for it. However, this is not true across all parts of Asia. It is a work in progress. In some countries there is still that illusion that you can get things free. Ultimately it is about education.

Investment consultants play a very good role in that, in helping educate as well and bringing everyone up to kind of the same level.

DUNCAN KLEIN: It comes back to the fundamental question of transparency. Being transparent about your costs and ensuring that clients understand the remunera-

87

ASIAN TM ROUNDTABLE

tion you’re going to get from their flow. That has to be clearly distinguished versus a commission that might be imbedded in the bid-offer spread. As long as a client understands the remuneration side, they’re willing to reward the transition manager for that and that is a key element in a region where clients need to understand that there’s no transition that is free. It is about transparency and cost, and what’s the right word? Honesty.

NICK MCDONALD: Integrity. I think it is straight down to accountability, and accountability, in a lot of these organisations, needs to not only be on the direct cost side of things, in other words looking at commission rates and things like that, but the actual success of the transition and the performance of the transition. Now, that disconnect can happen quite easily where you’re dealing with a finance team versus an investment team. I’d be quite interested from our asset owners, how you connect both of those together and ensure that there is accountability.

HEMAN WONG: We talk about sophistication in terms of product, but we are also seeing more sophistication in terms of willingness to pay for services. In part, asset sizes are much bigger now and transition management is much more affordable. People also recognise that because of the large size of some transitions, the transition manager delivers very efficient implementation and that means cost-saving, which would not be achieved if they did it alone.

WHAT DO YOU WORRY ABOUT? EVENTS, MARKET EVENTS? ADRIAN TENG: Market evolution is beyond the controls of the transition manager themselves or the client. It is the market development that is pushing evolution. Markets have obviously become more connected, more volatile, there are macroeconomic developments that forces one to have to think a lot more proactively. Why would I put money in European equities for the next five years? That is not something I would want to do. Similar, pockets of US equities. And, even given all of that, why am I not putting my money in China? There are ways to try and capture the economic growth of China without putting my money there.

It is these developments that are forcing people to think more carefully. QDII or QFII will develop, but it is not the easiest way to invest right now. Is the transition manager able to support that kind of asset classes or that kind of transaction? Institutions and people at the top of the game or ahead of the curve, with execution transparency, will be the winners going forward.

NICK MCDONALD: The key thing is, as with any market event for a transition manager, risk management. Let’s use the example of European debt, which has moved markets 2% to 3% during a portfolio transition. It is the ability of your transition manager and the strategy and risk management tools that they have, to be able to manage these events, that is key. To me it is not necessarily the market event, it is how transition managers can manage that market event accordingly and us being able to assist in that.

88

Nick McDonald, principal, Mercer Sentinel.

Photograph © FTSE Global Markets, November 2011.

JIM KARELAS: Typically the events that drive transitions are investment strategy changes that result in asset allocation shifts and/or investment manager changes. I’d say in the next few months, if there are any particular investment managers that have been geared toward European sovereign debt and if those portfolios aren’t changed very quickly, then those investment managers will be “on the nose”, if they’re not already. If there’s going to be any particular market event, it’ll be investment managers that have been geared toward those particular markets, and those that haven’t shifted quickly enough.

That will trigger a transition event from a market-driven event. Otherwise it is fundamentals; this means bad performance, changes within the investment managers shop with respect to either personnel or investment process or maybe clients are looking to adjust their return profile by adjusting their risk profile.

DUNCAN KLEIN: Clients who are typically invested in AAA are not getting the yield that they need any more, so they’re looking to break away a little from AAA securities and start adding on a little more credit risk. The other thing that is really a hot topic in any transition is the foreign exchange volatility. With recent appreciation of their local currency versus USD, clients are holding back on their international investment exposure as they are concerned that the additional yield gained might be offset by the increasing strength of their based currency versus the non-based currencies.

HEMAN WONG: In a volatile environment that is not most ideal for transition management to be made. You typically will avoid those sort of days to start trading.

Now, if an event comes down to the fact that an asset owner must make a transition, the chances are often you have to move inactive management into passive management because you need a quick fix. You need quick action.

JIM KARELAS: That is a very good point in terms of looking at what those transition costs are to the outer cost performance of moving managers.

JOHN MOORE: We’re seeing more clients looking at breaking up their fixed income portfolios more into segments such as global fixed income, global government, global corporate and the like. They have a little more control over the risk management themselves and being able to allocate between the two directly and manage that risk versus allowing a single investment manager too to make those shifts in and out and have less control—as we continue to have debt issues in Europe—more and more clients are looking at those options, they have that flexibility in-house to make those asset allocation changes.

NICK MCDONALD: That is the new benchmark.I

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

(Week ending 18 November 2011) Reference Entity

Federative Republic of Brazil Republic of Italy United Mexican States Republic of Turkey Bank of America Corporation Russian Federation JPMorgan Chase & Co. MBIA Insurance Corporation Kingdom of Spain French Republic

Sector

Market Type

Net Notional (USD EQ)

Gross Notional (USD EQ)

Contracts

DC Region

Government Government Government Government Financials Government Financials Financials Government Government

Sov Sov Sov Sov Corp Sov Corp Corp Sov Sov

17,884,811,600 20,122,240,743 8,725,395,897 4,522,105,724 5,764,816,889 4,533,375,771 5,761,565,396 3,667,700,431 15,517,936,879 22,603,701,852

180,139,136,327 312,550,673,504 130,681,621,053 147,891,297,716 81,336,000,656 114,920,678,520 81,205,966,330 83,323,511,593 171,113,519,054 141,272,628,299

11,979 10,077 9,678 9,400 9,190 8,752 8,153 7,926 7,842 7,507

Americas Europe Americas Europe Americas Europe Americas Americas Europe Europe

Sector

Market Type

Net Notional (USD EQ)

Gross Notional (USD EQ)

Contracts

DC Region

Government Government Government Government Government Government Financials Government Government Government

Sov Sov Sov Sov Sov Sov Corp Sov Sov Sov

22,603,701,852 20,122,240,743 19,905,589,894 17,884,811,600 15,517,936,879 12,450,766,785 11,249,982,806 9,654,935,335 8,922,067,447 8,725,395,897

141,272,628,299 312,550,673,504 122,228,429,619 180,139,136,327 171,113,519,054 73,030,778,347 95,365,290,407 62,397,965,630 63,916,314,312 130,681,621,053

7,507 10,077 4,664 11,979 7,842 5,047 7,340 7,320 6,364 9,678

Europe Europe Europe Americas Europe Europe Americas Asia Ex-Japan Japan Americas

Top 10 net notional amounts (Week ending 18 November 2011) Reference Entity

French Republic Republic of Italy Federal Republic of Germany Federative Republic of Brazil Kingdom of Spain UK and Northern Ireland General Electric Capital Corporation People’s Republic of China Japan United Mexican States

Ranking of industry segments by gross notional amounts

Top 10 weekly transaction activity by gross notional amounts

(Week ending 18 November 2011)

(Week ending 18 November 2011)

Single-Name References Entity Type

Gross Notional (USD EQ)

Contracts

References Entity

Gross Notional (USD EQ)

Contracts

Corporate: Financials

3,377,052,186,483

449,261

French Republic

8,853,914,770

1077

Sovereign / State Bodies

2,916,307,308,888

220,646

Republic of Turkey

4,630,002,000

305

Corporate: Consumer Services

2,084,330,572,204

349,166

Republic of Italy

3,487,363,679

398

Corporate: Consumer Goods

1,610,831,092,459

259,543

Kingdom of Spain

3,225,223,659

295

Corporate: Industrials

1,275,262,998,286

219,486

Federal Republic of Germany

3,106,524,231

153

Corporate: Technology / Telecom

1,238,311,227,687

193,476

Federative Republic of Brazil

2,303,387,000

203

Republic of Austria

1,342,553,981

107

United Mexican States

1,257,517,000

125

Residential Capital, LLC

1,234,127,439

257

Unicredit, Societa per Azioni

1,160,143,226

191

Corporate: Basic Materials

983,674,991,012

159,688

Corporate: Utilities

765,935,644,927

120,692

Corporate: Oil & Gas

480,832,459,788

85,581

Corporate: Health Care

346,616,931,591

59,551

Corporate: Other

149,088,719,105

16,232

CDS on Loans

66,563,395,012

17,362

Residential Mortgage Backed Securities

57,723,031,475

11,186

Residential Mortgage Backed Securities* 15,402,220,824

1,066

Commercial Mortgage Backed Securities 13,952,911,386

1433

CDS on Loans European

4,593,184,016

663

Muni:Government

1,221,700,000

125

Other

1,005,758,610

83

Commercial Mortgage Backed Securities*

870,148,487

77

CDS Swaptions

101,399,250

1

Muni:Other

50,000,000

1

Muni:Utilities

36,600,000

11

*European

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

DTCC CREDIT DEFAULT SWAPS ANALYSIS

Top 10 number of contracts

All data © 2011 The Depository Trust & Clearing Corporation This data is being provided as is and can only be used by you pursuant to the terms posted on the DTCC website at dtcc.com/products/derivserv/data_table_i.php

89

GLOBAL TRADING STATISTICS

Fidessa Fragmentation Index (FFI) and Fragulator® The Fidessa Fragmentation Index (FFI) was launched to provide a simple, unbiased measure of how different stocks are fragmenting across primary markets and alternative lit trading venues. In short, it shows the average number of lit venues you should visit in order to achieve best execution when completing an order. So an index of 1 means that the stock is still traded at one venue.

Increases in the FFI indicate a fragmentation of trading across multiple venues and as such any firm wishing to effectively trade that security must be able to execute across more venues. Once a stock’s FFI exceeds 2, liquidity in that stock has fragmented to the extent that it no longer “belongs” to its originating venue.

The Fidessa Fragulator® allows you to query several billion trade records to get a complete picture of how trading in a given stock is broken down across lit venues, dark pools, systematic internalisers and bilateral OTC trades.

FFI and venue market share by index Week ending 11th November 2011 INDICES

VENUES INDICES

FTSE 100

CAC 40

DAX

OMX S30

SMI

FFI

2.55 7.42%

2.21 4.59%

2.05 3.76% 0.02%

1.93 4.62%

2.02 5.13%

31.42%

23.30%

3.67% 19.58%

23.25%

0.06%

1.73%

24.53% 64.97% 0.02% 0.01% 0.62% 0.04% 0.01%

Europe

BATS Europe Berlin Burgundy Chi-X Europe Deutsche Börse Dusseldorf Equiduct Frankfurt Hamburg Hanover London Milan Munich NYSE Arca Europe Paris SIX Swiss Stockholm TOM MTF Turquoise Xetra

52.86% 0.18%

65.93% 68.97% 0.09% 7.45% 0.00%

8.11%

4.72

BATS

12.63%

11.98%

BATS Y

4.28%

3.67%

CBOE

0.07%

0.04%

Chicago Stock Exchange

0.23%

0.18%

EDGA

5.19%

4.63%

EDGX

10.64%

9.67%

NASDAQ

24.22%

25.69%

18.89% 13.35% 1.37% 1.68% 2.42% 62.29%

Canada*

3.76%

INDICES

1.38%

FFI

NSX

0.52%

0.52%

NYSE

18.48%

22.58%

0.09%

0.23%

NYSE Arca

16.17%

15.68%

Japan

INDICES

FFI

1.01

Alpha ATS Chi-X Canada TMX Select Omega ATS Pure Trading TSX VENUES

S&P TSX 60

INDEX NIKKEI 225

Chi-X Japan JASDAQ Nagoya Osaka SBI Japannext Tokyo ToSTNet-1 ToSTNet-2

1.33 1.85% 0.00% 0.00% 0.00% 2.26% 88.91% 6.97% 0.00%

VENUES

INDEX

Australia

99.72%

INDICES

HANG SENG

Chi-X Australia

0.46%

FFI

1.00

Figures are compiled from lit order book trades only. Totals only include stocks contained within the major indices. *This index is also traded on US venues. For more detailed information, visit http://fragmentation.fidessa.com/fragulator/.

90

2.15

20.78% 11.66% 1.43% 1.81% 3.02% 61.34%

5.63%

S&P ASX 201

Australia

FFI

2.15

1.85%

NYSE Amex

INDICES

INDICES

NQPX

VENUES

5.32%

S&P TSX Composite

NASDAQ BX

INDICES

3.13%

VENUES S&P 500

5.19

FFI

5.83%

INDICES DOW JONES

INDICES

0.03%

59.26%

VENUES

US

0.07% 0.03%

0.12%

Asia

Hong Kong

100.00%

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

COMMENTARY

By Steve Grob, Director of Group Strategy, Fidessa

W

HEN THE MARKETS in Financial Instru¬ments Directive (MiFID) relaxed the concentration rule and opened up Europe’s capital markets to greater competition, many of the incumbent exchanges were caught off-guard whilst a number of alternative trading venues established a presence and wrested market share away from them. In contrast, the Australian Securities Exchange (ASX) has taken a more ro¬bust view of regulatory change and is embracing the idea of greater competition in the Australian market. With the transfer of market supervision from the ASX to the Australian Secu¬rities and Investments Commission (ASIC) in 2010, the Australian market supervisor appears to have calmly stepped through the difficult process of creating a multi-market infrastructure in an attempt to understand the big picture.

Following the recent launch of its first alternative trading venue, Chi-X Australia, the Australian trading landscape is embarking on a period of rapid transfor¬mation and realignment. With just one primary exchange and one alternative venue, Australia provides a particularly pure data set as it joins the global fragmentation experiment.

Chi-X Australia began trading on 31st October 2011 with a maker-taker fee structure and a soft launch covering just 8 of the constituent stocks of the ASX 200. In its first week of operation, the new kid on the Australian block achieved a market share of 0.75% in those 8 stocks and a 0.14% share in the S&P/ASX 200 as a whole (chart 1).

With Chi-X expanding its trading operations to cover all ASX 200 constituent stocks the following week, its market share in the domestic index rose to 0.53% (charts 1 and 2).

1. Lit value %, ASX 200 (1st week v 2nd week) 0.53% Chi-X Australia 116

0.14% Chi-X Australia 25

99.47% ASX 21,822

99.86% ASX 18,435

2. Chi-X Australia, ASX 200 50 45 40 35 30 25 20 15 10 5 0

1.60% Market % Value (m AUD)

1.40% 1.20% 1.00% 0.80% 0.60% 0.40% 0.20%

31 Oct 2011

01

02

03

04

07 Nov 2011

08

09

10

11

0.00%

Further signs of a promising start for Chi-X Australia appear when we look at the number of trades (market share above 1%) executed in its second week of operation (chart 3).

3. Chi-X Australia, ASX 200 25,000 Number of trades

20,000

Market %

15,000 10,000 5,000 0

31 01 Oct 2011

02

03

04

07 08 Nov 2011

09

10

11

4.50% 4.00% 3.50% 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00%

Despite the standardisation of tick size put in place by ASIC, Chi-X executed an average trade size of around one third that of the ASX, a figure that is entirely in line with its sister companies operating in other countries.

Chi-X appears to have made a good start in Australia, especially considering that the regulation currently allows market participants to comply with best execution obligations connecting to a single venue (which, for historical reasons, is more likely to be the ASX). It was almost six months post-launch before Chi-X Japan achieved the market share that its Australian counterpart achieved in a fortnight, but this was largely as a consequence of several restrictions imposed on PTSs operating in the Japanese market (chart 4).

4. Chi-X Japan (value %), Nikkei 225 3.50% 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00%

28/01/2011 1.23%

30 30 30 31 30 31 31 28 31 30 31 30 30 30 30 Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep 2010 2011

But whatever the early signs in Australia, it is too early to draw any really meaningful conclusions. The ASX has responded pretty robustly to the threat of competition, perhaps benefitting from going last in this game and seeing the impact that regulatory change has had on the market shares of other national stock exchanges. The exchange has recently opened an impressive new co-location facility, announced a new smart trading workstation (ASX Best) and adjusted its fees. It will be particularly interesting to see what happens following the launch of its new high-speed, lowlatency order book, PureMatch. And in any event, Australia will take its own path and I am sure that other alternative market operators will be studying its progress with interest.I

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 Fidessa’s fragmentation tools, please contact: fragmentation@fidessa.com.

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

91

Global Equity View 5-year Performance Graph (USD Total Return) Index level rebased (31 October 2006 = 100) FTSE All-World Index

FTSE Developed Index

FTSE Emerging Index

FTSE Frontier 50 Index

180 160 140 120 100 80 60

1

1

Oc t1

1

Ju l1

Ap r1

0

Ja n11

Oc t1

Ju l10

10

Ap r10

9

Ja n-

Oc t0

9 Ap r0

Ju l09

Ja n09

Oc t08

Ju l08

Ap r08

Ja n08

Oc t07

Ju l07

07 Ja n-

Ap r07

40 Oc t06

MARKET DATA BY FTSE RESEARCH

GLOBAL MARKET INDICES

Global Alternative/Strategy View 5-year Performance Graph (USD Total Return) Index level rebased (31 October 2006 = 100) FTSE RAFI Developed 1000 Index

FTSE Developed ActiveBeta MVI Index

FTSE EDHEC-Risk Efficient Developed Index

FTSE DBI Developed Index

FTSE All-World Index

140

120

100

80

60

1 Oc t1

Ju l1

1

1 Ap r1

Ja n11

0 Oc t1

Ju l10

Ap r10

10 Ja n-

9 Oc t0

9

Ju l09

Ap r0

Ja n09

Oc t08

Ju l08

Ap r08

Ja n08

Oc t07

Ju l07

Ap r07

07 Ja n-

Oc t06

40

Global - Across the Asset Classes 5-year Performance Graph (USD Total Return) Index level rebased (31 October 2006 = 100) FTSE EPRA/NAREIT Global Index

FTSE Global Government Bond Index

FTSE Global Infrastructure Index

FTSE StableRisk Composite Index

FTSE FRB10 USD Index

FTSE Physical Industrial Metals Index

250 200 150 100 50

1 Oc t1

1 Ju l1

1 Ap r1

Ja n11

0 Oc t1

Ju l10

Ap r10

10 Ja n-

9 Oc t0

Ju l09

9 Ap r0

Ja n09

Oc t08

Ju l08

Ap r08

Ja n08

Oc t07

Ju l07

-0 7 Ap r

-0 7 Ja n

Oc t06

0

Source: FTSE Group, data as at 31 October 2011.

92

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

USA MARKET INDICES USA Regional Equities View 5-year Performance Graph (USD Total Return) Index level rebased (31 October 2006 = 100) FTSE USA Index

FTSE All-World ex USA Index

140

120

100

80

60

1

1

1

Oc t1

Ju l1

Ap r1

0

Ja n11

Oc t1

Ju l10

10

Ap r10

9

Ja n-

Oc t0

9

Ju l09

Ap r0

Ja n09

Oc t08

Ju l08

Ap r08

Ja n08

Oc t07

Ju l07

07

Ap r07

Ja n-

Oc t06

40

USA Alternative/Strategy View 5-year Performance Graph (USD Total Return) Index level rebased (31 October 2006 = 100) FTSE RAFI US 1000 Index

FTSE DBI Developed Index

FTSE EDHEC-Risk Efficient USA Index

FTSE US ActiveBeta MVI Index

FTSE All-World Index

140 120 100 80 60

1

1

Oc t1

Ju l1

1 Ap r1

Ja n11

0 Oc t1

Ju l10

10 Ja n-

Ap r10

9 Oc t0

Ju l09

9 Ap r0

Ja n09

Oc t08

Ju l08

Ap r08

Ja n08

Oc t07

Ju l07

Ap r07

07 Ja n-

Oc t06

40

USA - Across the Asset Classes 5-year Performance Graph (USD Total Return) Index level rebased (31 October 2006 = 100) FTSE Americas Government Bond Index

FTSE EPRA/NAREIT North America Index

FTSE Renaissance US IPO Index

FTSE FRB10 USD Index

160 140 120 100 80 60 40

1

1

Oc t1

Ju l1

1 Ap r1

Ja n11

0 Oc t1

Ju l10

10

Ap r10

Ja n-

9 Oc t0

Ju l09

9 Ap r0

Ja n09

Oc t08

Ju l08

Ap r08

Ja n08

Oc t07

Ju l07

-0 7 Ap r

-0 7 Ja n

Oc t06

20

Source: FTSE Group, data as at 31 October 2011.

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

93

Europe Regional Equities View 5-year Performance Graph (EUR Total Return) Index level rebased (31 October 2006 = 100) FTSE 100 Index

FTSE Nordic 30 Index

FTSEurofirst 80 Index

FTSE MIB Index

140

120

100

80

60

1

1

Oc t1

1

Ju l1

Ap r1

0

Ja n11

Oc t1

Ju l10

Ap r10

9

10 Ja n-

Oc t0

9

Ju l09

Ap r0

Ja n09

Oc t08

Ju l08

Ap r08

Ja n08

Oc t07

Ju l07

07 Ja n-

Ap r07

40 Oc t06

MARKET DATA BY FTSE RESEARCH

EUROPE, MIDDLE EAST, AFRICA (EMEA) MARKET INDICES

Europe Alternative/Strategy View 5-year Performance Graph (EUR Total Return) Index level rebased (31 October 2006 = 100) FTSE RAFI Europe Index

FTSE4Good Europe Index

FTSE EDHEC-Risk Efficient Developed Europe Index

FTSE EPRA/NAREIT Developed Europe Index

FTSE All-World Index

120

100

80

60

40

1

1 Ju l1

Oc t1

1 Ap r1

Ja n11

0 Oc t1

Ju l10

10

Ap r10

Ja n-

9 Oc t0

Ju l09

9 Ap r0

Ja n09

Oc t08

Ju l08

Ap r08

Ja n08

Oc t07

Ju l07

Ap r07

07 Ja n-

Oc t06

20

Middle East and Africa View 3-year Performance Graph (Total Return) Index level rebased (31 October 2008 = 100) FTSE JSE Top 40 Index (ZAR)

FTSE CSE Morocco All-Liquid Index (MAD)

FTSE Middle East & Africa Index (USD)

FTSE NASDAQ Dubai UAE 20 Index (USD)

180 160 140 120 100 80 60 40

1 Oc t1

1 Ju l1

1 Ap r1

Ja n11

0 Oc t1

Ju l10

Ap r10

10 Ja n-

09 Oc t-

Ju l09

Ap r09

-0 9 Ja n

Oc t08

20

Source: FTSE Group, data as at 31 October 2011.

94

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS

ASIA-PACIFIC MARKET INDICES Asia Pacific Regional Equities View (Market-Cap, Alternatively-weighted and Strategy) 5-year Performance Graph (USD Total Return) Index level rebased (31 October 2006 = 100) FTSE Asia Pacific Index

FTSE EDHEC-Risk Efficient All-World Asia Pacific Index

FTSE RAFI Developed Asia Pacific ex Japan Index

200 180 160 140 120 100 80 60

1

1

Oc t1

1

Ju l1

Ap r1

0

Ja n11

Oc t1

Ju l10

10

Ap r10

9

Ja n-

Oc t0

9

Ju l09

Ap r0

Ja n09

Oc t08

Ju l08

Ap r08

Ja n08

Oc t07

Ju l07

Ap r07

07 Ja n-

Oc t06

40

Greater China Equities View 5-year Performance Graph (USD Total Return) Index level rebased (31 October 2006 = 100) FTSE China A50 Index

FTSE Greater China Index

FTSE China 25 Index

FTSE Renaissance Hong Kong/China Top IPO Index

450 400 350 300 250 200 150 100 50

Oc t1

11

Oc t1

1

Ju l1

1

1 Ap r1

Ja n11

0 Oc t1

Ju l10

10 Ja n-

Ap r10

9 Oc t0

Ju l09

9 Ap r0

Ja n09

Oc t08

Ju l08

Ap r08

Ja n08

Oc t07

Ju l07

Ap r07

07 Ja n-

Oc t06

0

ASEAN Equities View 18-month Performance Graph (USD Total Return) Index level rebased (30 April 2010 = 100) FTSE ASEAN 40 Index

FTSE Bursa Malaysia KLCI

STI

FTSE SET Large Cap Index

180

160

140

120

100

Se p-

1

11 Au g-

Ju l11

1

1 Ju n1

M ay -1

1 Ap r1

1 M ar -1

-1 1 Fe b

11 Ja n-

-1 0 De c

ov -1 0 N

Oc t10

Se p10

-1 0 Au g

Ju l10

Ju n10

-1 0 ay M

Ap r10

80

Source: FTSE Group, data as at 31 October 2011.

FTSE GLOBAL MARKETS • DECEMBER 2011 / JANUARY 2012

95

INDEX CALENDAR

Index Reviews December 2011 Date

Index Series

Review Frequency/Type

Early Dec Early Dec Early Dec Early Dec 01-Dec

OMX C20 OBX ATX IBEX 35 FTSE Global Equity Index Series (incl. FTSE All-World) BEL 20 PSI 20 AEX CAC 40 DAX S&P / ASX Indices FTSE MIB FTSE China Index Series TOPIX

02-Dec 02-Dec 02-Dec 02-Dec 02-Dec 02-Dec 06-Dec 06-Dec 07-Dec 07-Dec 07-Dec 07-Dec 07-Dec 07-Dec 07-Dec 07-Dec 07-Dec 07-Dec 08-Dec 08-Dec 08-Dec

09-Dec 09-Dec 09-Dec 09-Dec 09-Dec

FTSE JSE Index Series FTSE JSE All-Africa Index Series FTSE UK Index Series FTSEurofirst Index Series FTSE Italia Index Series FTSE AIM Index Series FTSE European Index Serries FTSE ECPI Index Series FTSE ASFA Index Series FTSE Bursa Malaysia Index Series FTSE Vietnam Index Series FTSE EPRA/NAREIT Global Real Estate Index Series FTSE Shariah Index Series FTSE Taiwan Index Series FTSE Environmental Opportunities Index Series FTSE Nasdaq Index Series S&P US Indices NZX 50 Dow Jones Global Indexes DJ Global Titans 50

09-Dec 09-Dec 09-Dec 09-Dec 09-Dec 09-Dec 10-Dec 12-Dec 12-Dec 12-Dec 12-Dec 12-Dec 13-Dec 14-Dec 23-Dec Mid Dec Mid Dec Mid Dec Mid Dec

S&P / TSX S&P Topix 150 S&P Asia 50 S&P Latin 40 S&P Global 1200 S&P Global 100 OMX I15 S&P BRIC 40 Russell US & Global Indices FTSE Renaissance Index Series FTSE EDHEC Index Series FTSE Infrastructure Index Series FTSE GWA Index Series Russell US & Global Indices FTSE Goldmines Index VINX 30 OMX S30 OMX N40 OMX B10

09-Dec 09-Dec 09-Dec

Effective (Close of business)

Data Cut-off

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

16-Dec 16-Dec 31-Dec 12-Jan

30-Nov 30-Nov 30-Nov 30-Nov

Annual review / North America Quarterly review Quarterly review Quarterly review Quarterly review Quarterly review Quarterly review Quarterly review - shares & IWF Quarterly Review Monthly review - additions & free float adjustment Quarterly review Quarterly review Quarterly review Quarterly review Quarterly review Quarterly review Quarterly review Quarterly review Quarterly review Annual review Quarterly review

19-Dec 16-Dec 16-Dec 16-Dec 16-Dec 16-Dec 16-Dec 16-Dec 16-Dec

30-Sep 31-Oct 31-Oct 31-Oct 30-Nov 30-Nov 25-Nov 05-Nov 21-Nov

29-Dec 19-Dec 19-Dec 19-Dec 16-Dec 16-Dec 19-Dec 19-Dec 19-Dec 19-Dec 16-Dec 19-Dec

30-Nov 18-Nov 18-Nov 06-Dec 06-Dec 06-Dec 30-Nov 30-Nov 30-Nov 30-Nov 30-Nov 25-Nov

Quarterly review Quarterly review Quarterly review

19-Dec 19-Dec 19-Dec

30-Nov 30-Nov 30-Nov

Semi-annual review Annual review Quarterly review Quarterly review Quarterly review Quarterly review - no composition changes only rebalance/shares/float changes Quarterly review Quarterly review Quarterly review Quarterly review - shares & IWF Quarterly review - shares & IWF Quarterly review - shares & IWF Semi-annual review Annual review Quarterly review - IPO additions only Quarterly review Quarterly review Semi-annual review Quarterly review Monthly review - shares in issue change Semi-annual review Semi-annual review Semi-annual review Semi-annual review Semi-annual review

19-Dec 19-Dec 16-Dec 16-Dec 16-Dec

30-Nov 29-Nov 08-Dec 30-Nov 30-Nov

16-Dec 16-Dec 16-Dec 16-Dec 16-Dec 16-Dec 16-Dec 31-Dec 16-Dec 16-Dec 19-Dec 19-Dec 19-Dec 19-Dec 16-Dec 19-Dec 16-Dec 16-Dec 16-Dec 30-Dec

30-Nov 30-Nov 02-Dec 02-Dec 02-Dec 02-Dec 02-Dec 30-Nov 18-Nov 30-Nov 30-Nov 30-Nov 30-Nov 30-Nov 13-Dec 29-Nov 30-Nov 30-Nov 30-Nov 30-Nov

Sources: Berlinguer, FTSE, JP Morgan, Standard & Poor’s, STOXX

96

DECEMBER 2011 / JANUARY 2012 • FTSE GLOBAL MARKETS