FTSE Global Markets

THE EMERGING ROLE OF CCPS IN SECURITIES LENDING

ISSUE 62 • JUNE 2012

Threats and opportunity in block trading strategies Defining market quality Middle East asset management survey update The buy side banks on disintermediation

THE DTCC LOOKS OUT

Helping define the new financial world order COMPARING GREEK AND ARGENTINE APPROACHES TO DEBT MANAGEMENT

OUTLOOK EDITORIAL DIRECTOR: Francesca Carnevale, tel: +44 [0]20 7680 5152 email: francesca@berlinguer.com SENIOR EDITORS: David Simons (US) Neil A O’Hara (US) Ruth Hughes Liley (Trading) EDITORS AT LARGE: Art Detman; Lynn Strongin Dodds CORRESPONDENTS: Andrew Cavenagh (Debt Capital Markets); Vanja Dragomanovich (Commodities/Eastern Europe); Mark Faithfull (Real Estate); Ian Williams (Supranationals/Emerging Markets) PRODUCTION MANAGER: Lee Dove at Alphaprint, tel: +44 [0]20 7680 5161 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) Luke McGreevy (Middle East) +971 (0)4 391 4398 email: luke.mcgreevy@dubaimediacity.com 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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FTSE GLOBAL MARKETS • JUNE 2012

n my green and salad days, our old geography teacher used to tease us schoolgirls with the chestnut: you cannot cross mighty chasms with tiny steps. He invariably put the emphasis on ‘mighty’. It is a meaty word, which learned men seem to favour. It is a word I think of frequently nowadays as I see more and more pressing news bites on the eurozone financial crisis.

It is a mighty and thorny problem that doesn’t seem to be in any way impacted by the myriad tiny steps undertaken by euro-politicos that my old tutor cautioned against.

The eurozone crisis is being revisited again and again in these pages, simply because it exerts such mighty pressure on every aspect of global investment. More firms are adopting more defensive asset allocation strategies.

Percival Stanion, head of asset allocation and chairman of the Strategic Policy Group at Barings explains, for instance:“The prospects for an agreed path for resolving the ongoing sovereign debt crisis in Europe look unlikely ahead of the next Greek election and with the electorate increasingly vocal and opinionated across the continent, the outcome looks even more uncertain.

We hadn’t been expecting much from Europe but even our expectations relative to the consensus seem overly optimistic today as the strains on the European financial system grow, particularly in places like Spain. In light of this view, Barings’ multi asset team has maintained its support for the US dollar and adopted a more cautious approach to equities, particularly to economically-sensitive areas such as materials and industrials, whilst concurrently upgrading defensive sectors such as healthcare.”

It clearly cuts to the reasons why equities trading volumes are down; why financial markets technology software vendors are now gearing up their sales efforts in intermediate rather than developed markets, and why the provision of asset services is undergoing structural change.

All these topics and trends receive a significant airing in these pages and all evince a common theme: that the events we are all dealing with and treating in the international investment markets these days are mighty and cannot be overcome with small steps. Instead, they require bold brushstrokes, strides and stripes.

We’ve taken a bit of a breather from regulation in this edition, though given our cover story of incoming DTCC chief executive Mike Bodson, the erstwhile regulatory engine that is Dodd-Frank is never far away from the underlying discussion. The DTCC is a mighty organisation, clearly rooted in the US, but faced with huge opportunity on a global scale. Current regulations could create in the DTCC a global game changer; if it has a clear vision of where it can add value and depth. Certainly, Bodson looks to have his hand on the right pulses at home and abroad. But while he might be able to read the changing market temperature, the question is whether other countries see the value of an international (read global) rather than domestic solution to the new emerging trade repository and clearing equation. Globalisation has, for the time being, taken something of a detour (with diversions such as LEI now beginning to take up time and precious resources). There is still uncertainty in the markets as to when it might get back on track; and timing, as you know, in the international investment markets at least, is almost everything.

In terms of country coverage, we take another look at Argentina and how it managed to overcome the limitations of a post-default economy (though in this instance, we are talking high growth economy). The lessons of Argentina are not pretty; and while market participants talk loosely about a so-called Grexit; if Argentina with all its resources; its cynical and nationalistic leadership; and its natural wealth still encounters petty and persistent problems ten years on from its default, what chance Greece? It’s another mighty, mighty problem that cannot and will not be solved by mincing words and steps.

I

Francesca Carnevale, Editor, June 2012

Front cover: Michael C Bodson, who will become DTCC president and chief executive officer in July this year. Photograph kindly supplied by the DTCC, June 2012.

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CONTENTS COVER STORY ..........................................................................................................Page 4 With a new chief executive and, simply because the new financial order demands it, a heightened role, the DTCC looks to be poised on the brink of what? Greatness?

Well that depends. Francesca Carnevale spoke to incoming chief executive Mike Bodson about his vision for the DTCC and its possible futures.

THE DTCC LOOKS OUT

DEPARTMENTS

SPOTLIGHT

PRIVATE EQUITY RULES AND OTHER STORIES...............................................Page 10

MARKET LEADER

THE BUY SIDE BANKS ON DISINTERMEDIATION ....................................Page 14

SURVEY UPDATE

MIDDLE EAST ASSET MANAGEMENT SURVEY UPDATE..........................Page 18

Market highlights in review: why insurance companies still love alternative investments What now for the sell side, as all too often the buy side is doing it for themselves?

Global sentiment worsens, but local outlook still strong says survey update

......................................................................Page 21 Bill Scrimgeour of HSBC Securities Services explains why.

AIFMD COMES UNDER SCRUTINY

SECURITIES SERVICES

........................Page 22 David Simons reports on the restructuring of business approaches in emerging markets.

THE LOCAL VIEW: EMERGING MARKETS CUSTODY

..........................Page 26 JP Morgan explains the new dynamics in asset servicing. Are you ready for change?

THE NEW SECURITIES SERVICES INFRASTRUCTURE

GREXIT: HOLDING THE EURO FORT, BUT AT WHAT COST? ........Page 29

DEBT REPORT

COUNTRY REPORT INDEX REVIEW

Andrew Cavanagh explains the repercussions of current efforts to keep the euro afloat.

ARGENTINA: THE LESSONS OF DEBT MANAGEMENT ......................Page 33

Vanja Dragomanovich on the limitations of the Argentine post-debt default growth story. ................................Page 36 Incoming legislation will strengthen the country’s financial services sector.

ALL CHANGE FOR TURKEY’S CAPITAL MARKETS

SOMEHOW, WE’VE BEEN HERE BEFORE, HAVEN’T WE? ..............Page 40 Simon Denham, managing director of Capital Spreads, takes the bearish view.

WHY THE BUY SIDE LOOK FOR MARKET QUALITY ..............................Page 41 Neil A O’Hara reports on the search for market quality.

TRADING REPORT

......................Page 45 David Simons reports on the impact of new rules on trading strategies and volumes.

CANADA: NEW RULES BRING MORE TRANSPARENCY

..........................................................................Page 50 Ruth Hughes Liley looks at the threats and opportunities in block trading strategies.

BLOCK TRADING ON THE BLOCK

SECURITIES LENDING DATA PAGES 2

..............................................................................Page 54 Neil A O’Hara explains why central clearing will increasingly be a feature of securities lending.

TO CLEAR, OR NOT TO CLEAR?

DTCC Credit Default Swaps analysis ..............................................................................................Page 58 Fidessa Fragmentation Analysis....................................................................................................................Page 59 Market Reports by FTSE Research................................................................................................................Page 60 Index Calendar ....................................................................................................................................................Page 64

JUNE 2012 • FTSE GLOBAL MARKETS

COVER STORY

DTCC LOOKS OUT ON A NEW, GLOBAL FUTURE

Michael C Bodson, who will become DTCC president and chief executive officer in July this year. Photograph kindly supplied by the DTCC, June 2012.

CAN BODSON & THE DTCC RISE TO THE CHALLENGE OF MARKET CHANGE? Michael C Bodson inherits the crown at the Depository Trust & Clearing Corporation (DTCC) in July; at a time of substantial market change and market volatility. Moreover, he takes over at a critical juncture where the roles of trade repositories and clearers are under scrutiny and placed centre stage in the effort to minimise systemic risks in the global financial markets.

Bodson has a tough steer. He must hone the DTCC through an operational landscape that is in flux and (at the same time) develop a consistent global business outlook that is viable at home and exportable overseas. Can it be done? Is the DTCC an organisation that can grab its destiny and run with new ideas and processes to meet the demands of the newly-emerging financial order? Or, buffeted by regulations and contradictory business trends, will it end up mired in processes and bureaucracy? Francesca Carnevale spoke with Bodson about the challenges and prospects.

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UCH IS EXPECTED of Michael Bodson.

His appointment, according to Robert Druskin, DTCC’s executive chair, is part of the DTCC’s long term leadership succession strategy; and on the surface is a natural progression on from outgoing chief executive Don Donahue. “His decade-plus of experience with the DTCC, both as an industry board member and more recently, as a senior DTCC executive for the past five years, [gives] him a strong understanding of DTCC’s operations, systems and risk management strengths and the critical roles they play in the financial markets ... The board

M

JUNE 2012 • FTSE GLOBAL MARKETS

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COVER STORY

DTCC LOOKS OUT ON A NEW, GLOBAL FUTURE

has great confidence in his ability to lead DTCC.” Bodson joined DTCC in 2007 as executive managing director for business management and strategy, following a 20-year career with Morgan Stanley, having managed its retail and asset management operations. By 2010 he had become chief operating officer of the DTCC and three of its subsidiaries (the DTC, NSCC and FICC), with enterprisewide responsibility for IT and operations. He has overseen the firm’s Trade Information Warehouse for over the counter (OTC) derivatives and EuroCCP, DTCC’s European clearing and settlement organisation and been a board member of New York Portfolio Clearing (NYPC), a joint venture with NYSE Euronext for clearing futures.

That CV has particular resonance for the DTCC as it attempts to export its capabilities even further around the world to Asia’s emerging financial centres. The infrastructure that the firm is building, particularly for the global OTC derivatives market is a cornerstone of this outbound strategy.

According to Bodson, over the last few years, the DTCC has been actively reaching out to “Asian regulators, officials, infrastructure organisations and market participants to make the case for a single global repository to house OTC derivatives data”.

The unique selling points of this strategy are, says Bodson, manifold and include helping regulators manage systemic risk by “providing near real time access to OTC derivatives data worldwide from a single, comprehensive source, while at the same time helping firms to better understand counterparty exposures”.

Actually, it is a bold and a big ask; expecting conservative Asian regulators to overcome national predilections to enable reporting requirements in multiple jurisdictions, utilising one system and enabling public disclosure of aggregated data to clarify market trends and movements. “There is also the cost consideration,” nods Bodson,

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acknowledging the years of investment and strategic planning that have underpinned this significant (of priority) business strategy.

Last year, he explains, the DTCC won industry mandates to build OTC derivatives repositories for three asset classes: interest rates, foreign exchange and commodities, in additional to its ubiquitous services covering credit and equity derivatives.

The logical next step then became the Global Trade Repository that will house global data sets across multiple asset classes, “with a single point of connectivity, backed up by geographically dispersed centres of data collection. For this repository to mitigate systemic risk effectively and on a global basis, it must capture data from all the major markets, including those in Asia, so that regulators have access to global aggregated data needed for effective systemic risk oversight. It is clearly in the best interests of regulators, the industry and the general public to avoid the creation of multiple infrastructures and the resulting data fragmentation,” adds Bodson.

Interest rates and FX derivatives He thinks the project is not only possible, but inevitable. “Several Asian markets are significant players in OTC interest rates and FX derivatives and the value of contracts in those asset classes dwarfs values in the credit default swaps market,”explains Bodson.

To reinforce the point: according to a recent DTCC corporate newsletter, as of June last year, outstanding contracts for interest rate derivatives reached $553.9trn, of which 12% was denominated in yen (equivalent to $65trn, double the value of the US-European CDS market).

He also points to the fact that many Asian economies are in the middle of substantial market reform. “A priority is to bring greater transparency and risk reduction to OTC derivatives markets. In fact, it is being driven

globally and across all elements of the trade process. You are seeing this in initiatives such Legal Entity Identifiers (LEI), as well as regulations emanating from Dodd-Frank in the US, EMIR in Europe and various directives from other non-governmental organisations. This was amply expressed by the Committee on Payment and Settlement Systems (CPSS) of the Bank for International Settlements (BIS) in conjunction with the International Organisation of Securities Commissions (IOSCO) in January this year, for instance,” stresses Bodson,” which stressed the need for central collection, maintenance and dissemination of OTC derivatives data by trade repositories to improve market transparency and help protect against market abuse.”

A number of wins are already in place. In March this year DTCC presented its Asia strategy at an OTCC Derivatives Regulators’ Forum. Japan’s Financial Services Agency has proposed legislation allowing foreign trade repositories. Hong Kong meanwhile has opted to build its own repository, “but agreed to use DTCC’s Global Trade Repository as an agent to send and receive data, thereby adhering to global data collection principles while still maintaining local data control,” says Bodson.

This cuts to a critical issue for Asia’s financial market authorities: whether the Global Trade Repository will guarantee them access and control over their country specific data. In particular, if there were moves in the historically skittish North American or European markets to limit data access for one reason or another, Asian regulators will want assurances that they can retain unfettered access to their own data. In this regard, privacy and data disclosure are natrally sensitive areas. “We are working on governance and oversight models for Asia that will protect data and ensure the independence of repositories, sharing standards and best practice,” holds Bodson.

JUNE 2012 • FTSE GLOBAL MARKETS

Innovation and change management DTCC’s breadth of vision in its Asia strategy has taken the market by surprise, concedes Bodson. “Innovation and the ability to compete on a global basis are not attributes traditionally associated with the DTCC,” noted Bodson in an internal paper in December last year. “We’ve always had a strong reputation for safety, soundness and execution capabilities in our core space, but the industry has not always recognised DTCC for breaking new ground,”he conceded.“I would say that now we are a much more fast-paced and globally-oriented company.”

It is a view he still holds six months on.“The industry has tended to underestimate the spirit of innovation that exists here. We have been quietly innovating for years, but post-2008 we shifted to high gear in response to the industry’s more acute demand for innovative solutions, driven by the regulatory environment and changing economics in the financial sector. The initiatives around repositories and LEI are cases in point,” he avers. He also points out that DTCC’s Trade Information Warehouse, which houses data on OTC credit default swaps, predated the Lehman’s crisis. In fact, he says: “We used information in the Warehouse to reduce concerns and uncertainty about the level of CDS exposure.”

He also highlights the DTCC’s com-

FTSE GLOBAL MARKETS • JUNE 2012

petitive drive in the acquisition of Avox, a player in the global reference data industry as an example of the multilayered approach to data collection, management and usage that characterises the firm’s tactical growth over the last few years. “The Avox deal was timely and opportunistic,” acknowledges Bodson.“By talking to people in the data management, regulatory, legislative and academic communities, we saw the LEI initiative coming. We knew the industry and the regulators’ need for accurate reference data on securities and legal entities to strengthen transparency and systemic risk management would be critical. Avox, which we felt was a best in class provider of counterparty reference data was, in that regard, an ideal acquisition target,” he adds.

It is a high-fallutin’ imperative, but with a practical end:“Right now, data is drinking from the waterhose and it is overwhelming. We have to put in place platforms and services that help filter the right data for regulators to help them and the market have a more accurate view about what is going on.

It is about data to information to understanding and ultimately to wisdom,” holds Bodson. “In a complex world, it is ultimately about pulling together the right data to allow people to do their jobs properly.”

In that context, Bodson views the evolution of strategy at DTCC as part of a wider market process whereby all

major financial market utilities and institutions are repositioning and refining their remit to meet changing market circumstance. An advantage for the DTCC is that as a principal market utility, it is a centralising force (enjoying almost monopolistic market share) and lives in peculiar territory which gives it hyper legitimacy (as a market authority) and freedom of action (as a market entity). Though Bodson believes that the DTCC does not always have its own way in the world,“We are still very much subject to competition; we are certainly not insulated. Look at it this way: the downside of monopoly is the concentration of risk and in a vertical situation you invariably end up bundling price. In that context, it is inevitable that the market will evolve and work towards greater efficiencies and innovation.

That’s why we can never rest.”

“Everyone has their day in the sun,” concedes Bodson, and in terms of its own particular zeitgeist, the DTCC is proving itself as a market driver in “improving the marketplace and refining the global trade repository concept.

Look, we are far from being all-seeing, all-knowing; but I venture that we are really good at what we do. We have astute and demanding board members who constantly ask: what have you done for me lately?”

In that regard, he views his current tenure as guardian of the flame: “I see

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COVER STORY

DTCC LOOKS OUT ON A NEW FUTURE

no need right now for a radical reworking of our overarching strategy.

The focus is on efficiency, economy and priority projects such as our Global Trade Repository. If nothing else, it will show we can execute large scale projects very effectively. At the other end however, is the expansion of the utility space in a fast evolving market. Will it all result in another Big Bang? No. Much will continue to look the same; but it will be the quality of the post trade processes that will have been upgraded significantly. It must give the markets and regulators heart.”

Ultimately, Bodson thinks the future for the DTCC is writ large in the mandate that lies at the heart of US

financial market regulation, as evinced most latterly by Dodd Frank which highlights the question: what does it mean to regulate a marketplace?

“Within that question lies a host of possibilities for the DTCC: servicing regulators in terms of the quality of information that they can have at their fingertips to ensure they can help manage and mitigate risk effectively.

Right now, everyone must go through this process of establishing what their role is in the new order of things and the DTCC is very clear in its role as trade and data processor, serving both the commercial and regulatory side of the business.”

Yet, it is clear that the DTCC’s ambi-

tions are global rather than domestic and that brings a new resonance to its role as depositary and clearer; particularly as they are at the cornerstone of much that is domestic regulation of high risk derivatives and securities trading. It is a conundrum that Bodson roundly acknowledges. It is in no way easy right now, he avers.“In some ways we are dealing with those that unrealistically want a riskless world. It is a struggle in that the question is constantly raised: whose money is at risk precisely? That is a very pertinent question. Even so, there is a realisation that a riskless world is not possible; but what is possible is proper consideration of risk and appropriate return.” I

DTCC URGES RESTART OF THE FEDERAL PILOT PROGRAMME THAT TARGETED CYBER ESPIONAGE HE DTCC IS calling for increased public-private information sharing to protect the capital markets from cyber-attacks. The company testified in early June before a Congressional subcommittee that federal agencies and the financial sector must expand information sharing on cyber threats to more effectively protect the capital markets from attack. DTCC also called for restarting the Government Information Sharing Framework (GISF), a successful but nowdefunct pilot programme that targeted cyber espionage as part of this information sharing effort. Mark Clancy, DTCC Managing Director and Corporate Information Security Officer, told the House Capital Markets and Government Sponsored Enterprises Subcommittee during a June 1st hearing that the termination of the GISF programme in 2011 eliminated a critical source of threat data and analysis for the financial sector.

“While financial institutions have robust information security programmes in place to protect their systems from cyber threats, they are not foolproof,” Clancy noted at the time. “A critical resource the industry relies upon to help safeguard the system is information sharing between federal agencies and the financial sector. DTCC strongly supports restarting the GISF programme, removing its pilot status and expanding its reach within the financial sector to ensure that all resources are working in concert to protect and defend the capital markets from cyber-attack.”

The GISF programme kicked off back in 2010 as a collaboration between the Department of Defense (DoD), the Department of Homeland Security (DHS) and The Financial Services–Information Sharing and Analysis Center (FS-ISAC), the primary group for information

T

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sharing between the federal government and the financial sector. It allowed for the sharing of advanced threat and attack data between the federal government and 16 financial services firms that were deemed capable of protecting highly sensitive information. The programme was expanded over time to include the sharing of classified technical and analytical data on threat identification and mitigation techniques.

The DoD effectively terminated the GISF programme in December 2011, and information sharing through DHS, which was expected to continue, also ceased that month. Since then several organisations in the financial sector have experienced threat activity from actors first identified to the industry through GISF reporting. A recent FS-ISAC assessment found that these threats will continue to increase in the years ahead.

“Information sharing … represents the most critical line of defense in managing and mitigating cyber risk today,” Clancy said. “GISF drove innovative new initiatives in the industry and helped reshape the sector’s approach to assessing cyber espionage risks while prompting pilot firms, including DTCC, to revise best practices for managing threat information. It also spurred financial institutions to make significant additional investments in threat mitigation and detection capabilities that otherwise could not have been easily justified due to the lack of understanding of the risk to the sector.” Clancy added that while GISF was successful in many aspects, it should be expanded to include a broader group of financial institutions because the pilot programme’s reach and impact were too limited and did not scale to the depth and breadth of the sector.

JUNE 2012 • FTSE GLOBAL MARKETS

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SPOTLIGHT

WHY INSUERERS STILL LIKE PRIVATE EQUITY

Insurance companies remain committed to private equity says Preqin study

Some 60% plan to make new commitments in 2012.

New regulations have on a limited impact on allocations.

Photograph © Binkski/Dreamstime.com, supplied June 2012

Almost two-thirds of insurance companies are planning to make new private equity investments before the end of 2012, according to the latest Preqin research.“Insurance companies represent an important source of capital for the private equity industry, accounting for 9% of all capital invested in the asset class. Regulations such as Solvency II are likely to impact upon the level of exposure some of these investors will have to the asset class.

However, over three-quarters of insurance companies have so far been unaffected by impending regulations and the majority of insurance companies will continue to allocate capital to private equity in order to meet their long-term investment objectives,” explains Emma Dineen, manager, Private Equity Investor Data.

The survey results show that despite impending Solvency II regulatory changes, the vast majority (79%) of insurance companies have not altered their levels of exposure to private equity. Moreover, nearly one-

10

third (30%) of insurance companies are currently below their target allocations to the asset class, and 88% plan on maintaining or increasing their allocation to private equity over the longer term. According to the research 60% have over $250m allocated to private equity, while 60% of firms polled intend to make their next commitments to funds in 2012. Only a marginal 2% intend to invest in 2013 and 16% not before 2014, while 22% remain unsure on exact timings.

According to the research, small to mid-market buyout funds are viewed as the most attractive fund types, with 49% of respondents seeking to invest in these types of funds over the next 12 months.

Some 46% of respondents are actively or opportunistically seeking co-investment opportunities alongside fund managers.

The results, say Preqin, are generally positive for fund managers coming to the crowded fundraising market with new vehicles, as 85% of insurance companies will consider forming some new GP relationships over the next 12 months. Also positive for fund managers is that 79% of insurance companies have not changed their exposure to private equity as a result of new regulations.

Looking regionally, some 51% of insurance companies view Europe as an attractive area for private equity investment even in the current economic climate, while 45% view North America as attractive, while 16% see Asia as appealing. Around 31% of insurance companies polled already invest in emerging markets, and a further 29% are reportedly considering the opportunity.

BlackRock report highlights a record month for fixed income ETPs Economic uncertainty sparks a flight to safety that yielded a record setting month with ETPs attracting $11bn in net flows Government bond ETPs attracted record breaking inflows of $5.6bn driven by flows of $4.4bn into US Treasury bond products. The previous monthly high for government ETPs of $3.6bn was set in June 2010. Broad/aggregate and investment grade corporate bond products attracted $1.6bn and $1.7bn respectively. Meanwhile, high yield bond ETPs saw monthly outflows of $1.3bn, the first month of redemptions since November 2011.

Emerging markets equity ETPs drew $3.3bn, with flows of $8.3bn into two new Chinese equity funds outweighing outflows of $5bn from a broad range of other emerging markets products. The two new Chinese equity funds seek to replicate the performance of the China Securities Index 300 which tracks 300 stocks traded on the Shanghai and Shenzhen stock exchanges. These are the first cross-market ETFs to be listed in China.

In developed markets equities, DAX German equity funds swung back with strong flows of $4.3bn in May on the heels of ($5.1bn) outflows last month.

Japanese equity ETPs also had a strong showing in May, garnering $3.6bn.

JUNE 2012 • FTSE GLOBAL MARKETS

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SPOTLIGHT

GUERNSEY BANK DEPOSITS HIT BY MARKET DOWNTURN

Global economic conditions hit Guernsey bank deposits The value of bank deposits in Guernsey fell £6.5bn (6.1%) in the first quarter of the year.

The total value of deposits held by banks in Guernsey was down to £101bn at the end of March 2012, a decrease of £11.8bn (10.5%) year on year. The quarterly report on banking sector activity from the Guernsey Financial Services Commission (GFSC) said that the overall fall in value of deposits was the result of both declining volumes and exchange rate factors.

In particular, sterling strengthened against the US dollar and euro but weakened against the Swiss franc, which had a negative effect on the level of deposits expressed in sterling.

The overall currency mix shows that the proportion of deposits in sterling is 25.7%, US dollars is 47.2%, euro deposits 19.1% and Swiss franc deposits 3.3%.

Fiona Le Poidevin, deputy chief executive of Guernsey Finance – the promotional agency for the Island’s finance industry, says: “It is disappointing to see this further decline in the value of deposits held by banks in Guernsey. Some of the fall was due to exchange rate factors but there was also a material drop in volumes as a result of the global trend of banks deleveraging in the face of uncertainties surrounding the eurozone, capital adequacy pressures and weak economic growth.

“Due to current conditions, we continue to experience an unprecedented low interest rate environment which has a significant negative impact on the attractiveness of having funds on deposit in a bank and as such, investors are moving capital into other higher yielding

12

products,” continues Le Poidevin.

“However, on a more positive note, there have recently been more inquiries from banks which have expressed an initial interest in establishing operations in Guernsey.

It is still very early days but it is encouraging news and of course, comes in the wake of the announcement by HSBC that it will be consolidating its Channel Islands private banking operations in Guernsey,” she adds.

“In addition, one of the great strengths of Guernsey’s finance industry is its diversity. Latest figures show that the value of investment funds being managed or administered in Guernsey was up nearly £9 bn in the first three months of the year. Also, during the first four months of the year, there has been net growth of 44 licensed international insurance entities, taking the total number to 731 at the end of April. Therefore, we can see that, in broad terms, Guernsey’s finance industry is performing robustly in what are difficult global economic conditions,” she continues.

Macro gains offset by equity losses Hedge funds post declines in volatile May; systematic macro post gains on fixed income Hedge funds posted decline in May, with the HFRI Fund Weighted Composite Index posting a loss of -1.6%, says Hedge Fund Research, Inc., the indexation, analysis and research provider for the global hedge fund industry. This marks the third consecutive monthly decline, reducing the year to date gain for the index to 2.5% through May. “During the volatile month of May, investors reacted to increased

European bank and sovereign bond risk and weakening U.S. economic data by aggressively moving portfolios toward less risky exposures,” explains Kenneth J Heinz, president of HFR.“This risk-off response adversely impacted certain areas of equitysensitive hedge fund exposures, while benefitting strategies tactically positioned to insulate portfolios and produce gains resulting from the strong trends and volatile environment which materialised.

In the current environment, at some level, every hedge fund is a Macro fund.”

Mirroring trends across financial markets, hedge fund performance during May was widely divergent across strategies, with macro funds posting their best monthly performance since April 2011, while equity hedge posted its largest decline since September 2011. The HFRI Macro Index gained 1.7% in May, bringing YTD gains to 1.9%, with significant contributions from systematic strategies and positions in fixed income, commodities and currencies, with limited aggregate exposure to equity market volatility.

The HFRI Macro: Systematic Diversified Index gained 4.1% in May and has gained 2.9% year to date.

The HFRI Equity Hedge Index posted a decline of -4.1% in the month, paring its year to date gain to +1.8%, with declines across growth, energy and emerging markets strategies only partially offset by short bias funds, which gained over 7%.

Event driven strategies fell by -1.4%, paring year to date gains to 3.1%, with weakness in activist, distressed and equity special situations funds.

Falling yields and increased volatility failed to offset the impact of credit weakness as Relative Value Arbitrage funds posted a decline of -1.3%, the first decline for this strategy in 2012, narrowing year to date gains to 3.1%, for the global strategy.

JUNE 2012 • FTSE GLOBAL MARKETS

RBC Dexia/Accenture report says change is due in Spanish investment industry The shape of Spain’s asset management industry is set to change dramatically according to a report by RBC Dexia and Accenture.

Photograph © Michael McDonald/ Dreamstime.com, supplied June 2012.

The RBC Dexia/Accenture report predicts further concentration of Spain’s asset management industry into fewer, more specialised managers and a stronger focus on improving efficiency and performance. Improvements in technology will also be vital to success, with outsourcing high on the agenda. José Maria Alonso-Gama, managing director of RBC Dexia in Spain, sets the scene, explaining that: “Spanish fund firms are concentrating on bottom-line indicators such as fund performance and increased assets under management. They recognise the need to restore credibility and investor confidence by showing they are delivering on their performance promises.”

The report is based on a survey of 33 asset management firms in Spain in the first quarter of 2012 by RBC Dexia Investor Services and Accenture. Some 33% of respondents have more than €1bn in assets under management (AUM), 46% have between €200m and €1bn in AUM and 21% have less than €200m in AUM.

FTSE GLOBAL MARKETS • JUNE 2012

Although the industry is dominated by a small number of firms, with the top three managers accounting for 45 percent of assets under management, the average size of funds in Spain is only €57m.

This compares with an average of €300m in Switzerland and €262m in the UK. The total number of funds in Spain has been contracting (down by about 20% to 2,500 in the past three years due to industry consolidation) and the report expects this trend to continue with,“The evolution of larger and more specialised companies with rationalised fund ranges”.

Also according to the report, of the 33 investment companies surveyed, 95% of local managers and 91% of foreign managers cited increased assets under management as a key indicator of success over the next two years. Fund performance was cited by 91% and 73% respectively and increased service quality by 86% and 45%. When it came to development of new products, 36% of foreign managers cited this as important but only 9% of local managers.

Over 80% of independent managers in Spain believe that the Undertakings for Collective Investment in Transferable Securities IV (UCITS IV) directive will make it easier to distribute investment funds abroad by creating a common regulatory environment. However, 70% of local managers were also concerned that it would lead to increased competition from overseas funds while independent managers were worried it would result in increased reporting obligations.

More than two-thirds of respondents cited improving technology as the most important factor in increasing efficiency. Most managers (90% of foreign managers and all local Spanish managers) expected an increase in the number of fund managers outsourcing certain functions in coming years. And 90% of those surveyed said there would be an increase in the diversity of functions outsourced in coming years.“The increased risks control imposed by new regulations and cross-border distribution opportunities that they also create, require increasingly sophisticated technology,” says Diego López Abellán, of Accenture’s Capital Markets practice for Spain.

“Outsourcing can play a pivotal role in enabling continuous technology upgrades while avoiding costly investment.”

Old Mutual completes £1bn return to shareholders Old Mutual has completed a return of approximately £1bn to shareholders following the sale of its Nordic business in March this year.

A Special Dividend of 18p per share (or its equivalent in other applicable currencies), amounting to approximately £1bn in aggregate, was paid to shareholders alongside the final dividend for 2011 of 3.5p per share (or its equivalent in other applicable currencies), which amounted to approximately a further £194m in aggregate. The special and ordinary dividends were paid by reference to the company’s shares in issue before the seven-for-eight share consolidation that took effect on April 23rd. I

13

MARKET LEADER

THE BUY SIDE FIND THEIR FEET IN THE NEW WORLD ORDER

Moderating the buy side/sell side infrastructure

Photograph © Deviney/Dreamstime.com, supplied May 2012.

As the global financial markets morph into different shapes as regulation, recession and restructuring take their toll; it was inevitable that the nature of the relationship between the buy side and the sell side would change accordingly. How that relationship will evolve across securities services will be the basis for a number of features and studies in the magazine over the coming months. For the purposes of this edition, Lynn Strongin Dodds looks at the growing disintermediation between the buy side and the sell side in the equities trading markets.

HE CHANGING RELATIONSHIP between the buy and sell side is not a new theme but it has intensified in the wake of the financial crisis and the ensuing onslaught of regulation, restructurings, market volatility and uncertainty. Both parties have been forced to re-evaluate the nature of their ties.

Disintermediation though can be traced back to the dot.com crisis with fund managers questioning the validity of broker research. Although this triggered legislation to unbundle services, the bonds between the two ironically strengthened as market conditions dramatically improved and trading

T

14

became more complicated. Not only were stock markets booming but MiFID ushered in a new era of alternative execution venues; plus investment managers became more adventurous adopting new instruments, asset classes and geographies.

The sell side were their first port of call to help navigate the new world and brokers eagerly stepped up the plate with a sharper suite of front office tools ranging from execution management systems to transaction cost analysis tools, direct market access and algorithms. The turning point of course was the demise of Lehman in 2008.

It not only unleashed a raft of legisla-

tion but also sent investors clamouring for greater transparency and accountability. Regulators began to seek greater insight into both the different types of investments undertaken, as well as the operational infrastructures that supported investment managers’ trading activities.

The buy side in turn began to cast its net wider for solutions and there was a more fundamental shift in the relationship between service providers and their traditional buy side clients. Kathy Perrotte, New York based managing director of in-memory analytics firm Quartet FS, says,“Traditionally, the buy side relied on the sell side for many of

JUNE 2012 • FTSE GLOBAL MARKETS

their technological needs but the global financial crisis led to call-off action for all participants. There is pressure from regulators to be much more transparent and implement tighter risk controls. The buy side is responding to this by moving away from the sell side, and taking control of technological developments in-house.

In part, this development has been driven by regulation and changes in technology, which support a stronger buy side. In part too, it has been an inadvertent result of the growing complexity in the securities markets.

Ironically, the sell side thought that complexity would result in growing dependence of the buy side on the sell side; in reality though a different trend is in play.

As Robin Strong, director of buy side market strategy at trading software vendor Fidessa explains: “The sell side had always been ahead of the game because they had to invest in technology to manage risk. This was not the case with the buy side that would often rely on manual research and spreadsheets to do their calculations.

However, the landscape has become much more complex with the fragmentation of liquidity, new instruments, a greater use of derivatives and much more regulation. This has forced the buy side to take greater control and make their own decisions about their trading tools.”

Moreover, fund managers no longer want to rely solely on their broker for their trading tools and strategies, according to Gavin Little-Gill, global head of asset management products at solutions provider Linedata. “As firms are focusing on managing their counterparty risk, they are increasingly adding additional brokers. In addition their business is getting more complex.

As a result, they’re looking for more robust tools and that is leading them to adopt solutions from companies where technology is their only business.”

Mal Cullen, head of Eagle ACCESS and Canadian operations for Eagle Investment Systems, the technology

FTSE GLOBAL MARKETS • JUNE 2012

Mal Cullen, head of Eagle ACCESS and Canadian operations for Eagle Investment Systems, the technology subsidiary of BNY Mellon adds, “We are seeing disintermediation. I believe it is partly based upon the technology solutions the buy side are choosing and they have a much greater breadth of choice today. Based on their connectivity needs, proprietary applications and dedicated lines, they are looking for intermediary services and gateways into sell side systems.” subsidiary of BNY Mellon adds, “We are seeing disintermediation. I believe it is partly based upon the technology solutions the buy side are choosing and they have a much greater breadth of choice today. Based on their connectivity needs, proprietary applications and dedicated lines, they are looking for intermediary services and gateways into sell side systems.”

Even so, most market participants agree: independent action in today’s complex world is only for the larger, richer and more sophisticated firms.

As Bradley Wood, partner at Greyspark Consultancy, points out, prop desks that have spun out of investment banks preparing for the Volker rule are “moving technology and tools that were once the province of the sell side into their new hedge funds. There are also existing tech savvy hedge funds who are building the platforms themselves and are only using brokers for low touch services such as straight execution. The more traditional long only asset management firms, on the other hand, tend to rely more on the sell side.”

Cost pressures mount for all The buy side also are not the only ones calling the shots. Brokers have come under their own cost pressures and are rethinking their business model as well as product offerings.“In the past, many sell side firms gave away execution products hoping that they would capture the order flow,” says Tom Driscoll, managing director, global, at technology group Charles River Devel-

opment.“However, they can no longer afford to give away their products.

Volumes are down, commission rates are extremely low and there are equity crossing networks such as Liquidnet or Charles River Brokerage where the buy side can find liquidity.”

Although the global players will continue to hone and develop their trading wares to service their buy side clients, smaller to medium sized firms are retreating from the equity arena. For example, earlier in the year, Royal Bank of Scotland withdrew from investment banking and cash equities while other banks such as Credit Suisse, Nomura and Morgan Stanley are thought to have pared back their operations.

The numbers say it all. Research by Morgan Stanley and Oliver Wyman last year forecast that margins in cash equities for the top five players would stand at 15% to 20%, with the next tier facing just 5%. “Wall Street firms constantly have to re-invent themselves and move up the food chain and have historically done so successfully. Since the 2008 financial crisis the ability of banks to reinvent themselves and move up the food chain has yet to be seen,” says Scott Sullivan, senior analyst at IT consultancy Celent.“Regulation, particularly the upcoming implementation of Basel III, will squeeze return on equity (ROE) margins through increased capital requirements. The greatest affect will be seen in sales and trading across fixed income, currency and commodities (FICC), placing headwinds on future revenue.”

As some brokers scale back, tech-

15

MARKET LEADER

THE BUY SIDE FIND THEIR FEET IN THE NEW WORLD ORDER

nology vendors are ramping up their efforts. Even so, the buy side is still looking for a more holistic service set and that means everyone will have a share of the pie, though for some it will be smaller than in the past. Strong of Fidessa believes “It has been a natural progression. In the past, the buy side delegated all aspects of the trade to brokers via care orders. Then they started to use DMA to control the timing of each trade, followed by broker algorithms to automate more complex trade execution. Buy sides are increasingly looking to automate aspects of trade execution under their own control, usually to free up resources to focus on harder trades that may have significant customer or market impact. There is no one size fits all solution but they do need a vendor that understands their needs, who can integrate and customise the different components.”

Dan Pagano, vice president of strategic alliances at Linedata, agrees adding, “The buy side do not just want to deal with vendors but want total solutions that cover OMS, EMS, compliance and accounting. It is no longer just about the software but the total solutions that a vendor can provide. What we are seeing is that fund managers are adding technology on top of their broker tools such as transaction cost analysis (TCA) and algos but they want a central console to manage across all their applications.”

In some cases, the larger fund management houses are developing products that could put them in direction competition with their brokers.

For example, BlackRock, which has $3.5trn in assets under management, has created a buzz with its plans to launch an internal trading platform for corporate bonds, mortgage securities and other assets. It would be offered to around 46 clients— including sovereign-wealth funds, insurance companies and other money managers and while the company has said the aim is not to marginalise the investment banks, the

16

fees are lower than Wall Street firms they could be cut as the middleman in the credit markets.

Although this type of IT investment is the preserve of behemoth groups like BlackRock, many fund managers are developing their own home-grown technology solutions to slot into a platform. This is particularly the case with TCA which provides asset managers with information on trading behaviour, costs and performance. Once seen by many industry participants as a basic monitoring tool for compliance, TCA has risen in the ranks due to a combination of regulatory changes and the fractured trading environment.

In-house trade performance measures?

According to a recent study by Aïte Group, two thirds of buy side firms are building their own technology for assessing trading performance due to “inherent mistrust”of the analysis provided by brokers and vendors. The report which was based on interviews with buy side firms accounting for $7trn in assets noted that buy side firms did not value the sell side tools as much as the broker thought they did.

This is because the analysis is subjective and brokers could manipulate the input to produce results that favour the execution that they provide. Low level of satisfaction was also due to the continued confusion regarding the data used to feed the model.

The problem is exacerbated in Europe where there is no standard benchmark for measuring the average price of a stock traded over a set period due to the lack of a consolidated tape.

This makes it almost impossible to gain a clear view on their trading prowess but also to compare the performance of their brokers.

Looking ahead, the adoption of technology may depend on the particular needs of a buy side firm but all agree that the cloud will become an even more important part of the offering. The main stumbling block has been concerns over security risks which

have been exacerbated by high-profile cyber attacks on Amazon and Gmail over the past year. According to a survey of IT leaders by International Data, security topped the list for 68% of the respondents followed by data control for 57%. Vendors such as SunGard, Fidessa, Charles River and other vendors have been hard at work to ensure that their clients’ data is safe and secure which explains why so many fund managers are opting for private and not public clouds.

“There has been a lot of energy and time gone in to make the cloud less challenging in terms of security and we are seeing the technology gaining traction,” says Paul Compton, head of asset management strategy at SunGard. “Some of our biggest customers are on our or their own private cloud which we helped to develop, so it’s not just the smaller to medium sized customers. One of the main advantages is cost reduction and the transfer of operational risk. Fund managers can develop their own solutions but they do not have to hire a whole IT team to support it. They can outsource the maintenance to a company like SunGard.”

Driscoll also sees cloud computing gaining ground.“In many ways it’s just a new word for the dynamic computing capacity of many hosted solutions and part of the larger outsourcing trend.

One of the main drivers is expense and the cloud enables fund managers to scale their business up and down according to their requirements. In many cases though, clients are choosing the private clouds because it gives them more comfort about the security of their data,” he says.

“The bottom line with all these trends though is that the buy side wants to lower their costs and simplify their lives. It is not just about the functionality and architecture anymore; whoever can deliver reliable hosted systems with integrated data that meet their needs at a reasonable price will be the most successful,” concludes Driscoll. I

JUNE 2012 • FTSE GLOBAL MARKETS

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MIDDLE EAST SURVEY UPDATE

MENA ALLOCATIONS INCREASE, BUT RISK OUTLOOK WORSENS

LOCAL ALLOCATIONS INCREASE AS GLOBAL OUTLOOK WORSENS In issue 60 we kicked off a year-long review of the Middle East asset management industry and its risk outlook for 2012/2013. The year long survey, which comprises polling of a cross section of investment firms located in the region mixed with more informal comment, has three aims: to describe the current investment outlook of a diverse range of asset management firms in the Middle East region; to assess the perception of political/economic risk within the region and to outline current thinking among the asset management industry as to what infrastructure is important to the proper functioning of their businesses. Three months on from the first survey (please refer to issue 60, page 56) set the underlying scene. Subsequently, we spoke to 47 out of the original 79 respondents to see whether the risk outlook for the region had altered. We will provide a further update in the October edition. This short snapshot concentrates on the way that institutional investors in the Middle East and North Africa region view political and economic risks.

IVEN CONTINUING MARKET uncertainties and the still bubbling pool of civil discontent in selected markets in the Middle East and North African region continue to exert a negative influence on investment patterns and the investment outlook of our survey respondents.

The survey was conducted between May 21st and June 7th 2012. Some 79 firms were approached for information of which 47 responded, either by phone or fax. From these returns we have extrapolated the analysis in the survey. This presentation is a prĂŠcised overview of the full survey, which will be made available from the end of June online and in hard copy.

Utilising the same respondent pool for this update ensures consistency in the underlying data, though we were somewhat disappointed at the relatively modest response rate. The survey focuses on a diverse universe of asset gatherers/managers, to achieve the widest possible response from a broad brush of market participants to ensure a suitably wide cross-section of opinion. The survey involves sovereign wealth funds, mutual funds, dedicated funds, and private equity and real estate funds. While future surveys may take into account

G

18

dedicated funds investing in the Middle East domiciled in other jurisdictions, this survey is entirely focused on funds domiciled in the countries surveyed.

As with the first survey, the asset management segment, as defined by the remit of this survey encompasses firms with a minimum $25m under management, with no upper limit.

While the geographical remit of the survey originally encompassed North

Africa and the Middle East, investment firms from a number of countries declined to participate, leaving the survey concentrated on seven countries: Abu Dhabi, Dubai, Bahrain, Saudi Arabia and Kuwait in the GCC and Egypt in North Africa and Lebanon in the Levant. Any limitations on the applicability of this survey keep this fact in mind.

In terms of outlook, the responses to the survey fell almost neatly into

DOMICILE OF RESPONDEES ABU DHABI BAHRAIN DUBAI EGYPT SAUDI ARABIA KUWAIT LEBANON QATAR

1 8 15 7 4 3 9 0 47

TOTAL

WILL YOU INCREASE OR DECREASE YOUR ALLOCATION TO THE MENA REGION OVER THE NEXT 12 MONTHS INCREASE DECREASE STAY THE SAME NO ANSWER

17 3 18 9 47

% 36.2 6.4 38.3 19.1 100.0

Tunisia and Morocco look to be popular new investment destinations for respondents, with seven out of the 47 mentioning them as potential investment targets.

JUNE 2012 • FTSE GLOBAL MARKETS

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MIDDLE EAST SURVEY UPDATE

MENA ALLOCATIONS INCREASE, BUT RISK OUTLOOK WORSENS

RISK OUTLOOK FOR THE MENA REGION AND LEADING MARKETS Of the 47 firms spoken to eight refused to comment and 38 gave their views on the following Bahrain Egypt Iraq Jordan Kuwait Lebanon Oman Qatar Saudi Arabia Syria UAE Asia Europe North America South America Africa

9 9 18 5 10 1 9 17 21 0 28 10 0 11 28 32

18 20 17 23 21 23 25 20 20 7 15 22 6 21 14 10

two halves. Some eight firms refused to answer questions about their international or domestic investment focus, while nine refused to comment on whether they intended to increase or decrease their allocation to the MENA region. There was a wide degree of variation in the responses to questions on risk outlook for the next twelve months, and these responses should be read in the context of the personal opinion of the respondent, rather than as any indication of their future investment plans.

Respondents to the question of whether they would increase or decrease their allocation to the MENA region could not be directly correlated with the responses to the risk outlook segment, as investors that responded to one set of questions did not necessarily answer subsequent questions in detail.

The breakdown of responses is clearly shown in the tables. We have provided absolute numbers in the interests of transparency. Clearly from the sum of the tables published a number of trends are clear. The numbers of respondents from the UAE, particularly Dubai dominates the survey results, and the researcher noted that on the whole respondents from the UAE were the most

20

15 10 2 11 5 18 7 6 0 31 0 9 35 11 0 0

5 8 10 8 11 5 6 4 6 9 4 6 6 4 5 5

47 47 47 47 47 47 47 47 47 47 47 47 47 47 47 47

transparent in their replies. This might be a reflection of the general sense of a positive outlook for the prospects of the UAE for the remainder of 2012 and beyond; or it may be happenstance.

As with the March survey, of notable interest is the wide variations between countries, particularly in terms of the way that investors perceive political, economic and investment risk (both in the region and outside). Perhaps a reflection of the zeitgeist, Europe outstrips even Syria as a bringer of marked political and economic risk into the investment equation. Even so, the concentration of negative responses towards Europe must give everyone pause for thought.

As with the previous survey South America and Africa outpace Asia as providers of a positive investment environment in the year ahead. Within the GCC it is the UAE that is viewed most positively by investors along with Qatar, Iraq and Saudi Arabia.

For the most part however, respondents tended to posit that 2012 is a continuation of the unsteady market conditions that marked the second half of 2011. What is equally clear from the responses is a keen sense that international macro-factors continue to exert a strong influence on

investment decisions both at home and abroad. Equally, there is a growing sense that regional and international investment expertise is becoming increasingly important as both a keystone of each firm’s own understanding of its own strengths and brand identity. Only three respondents said that they were sufficiently underwhelmed by local investment opportunities to justify a decrease in asset allocations to investments in neighbouring MENA countries; remaining respondents fell into almost two neat halves: with 17 claiming to be increasing their allocations to the region and 18 maintaining their current allocation.

With a plethora of industrial, real estate and infrastructure projects across the entire Gulf region estimated by the World Bank to total almost $1trn over the coming decade, there must be no surprise that overall the investment outlook for the region remains positive. Juxtaposed against the worsening outlook for most of Europe in 2012/2013, it should come as no surprise as well that Middle East investors are casting further afield in Africa and South America as potential investment destinations; and even if they are not in the near term, they are watching these markets closely.

As with the March survey, the largest segment of responses came from those firms which invest in equities. Seven of the firms are dedicated equity firms and will not change their strategy in 2012; of the remaining respondents eight refused to signal any change in their allocation to the segment, with three of these respondents saying their approach was flexible.

FOR MORE INFORMATION ON THIS SURVEY: This is a concentrated overview of the overall survey results, which will be available courtesy of the Qatar Financial Services Authority (QFC). If you would like to have a copy of the full surveys, please email francesca@berlinguer.com; or alternatively visit: www.ftseglobalmarkets.com, to download a copy. I

JUNE 2012 • FTSE GLOBAL MARKETS

SECURITIES SERVICES

AIFMD COMES UNDER SCRUTINY

Latest rules on AIFMD come under scrutiny The European Commission’s draft rules for the AIFMD have been questioned by the hedge fund industry, including fund administrators and custodian banks. Bill Scrimgeour of HSBC Securities Services explains why.

NCERTAINTY CONTINUES TO surround the Alternative Investment Fund Managers Directive (AIFMD), the latest development being the release in April of the European Commission’s (EC) nearfinal “level 2 implementing” rules.

Hedge fund managers and other industry participants are disappointed that the EC decided not to accept all of the advice given to it by the European Securities and Markets Authority (ESMA) in several key areas. These areas include the roles and responsibilities of depositaries, co-operation arrangements with regulators in nonEU countries, using and calculating leverage, professional indemnity insurance, appointing prime brokers, and calculating assets under management.

The industry is also unhappy with the EC’s intention to implement AIFMD through a Regulation rather than a Directive. As a Regulation the rules will come into effect sooner, with national regulators having no flexibility to implement them differently; as a Directive the rules could have taken up to two years to transpose into national laws, with member state regulators interpreting them differently. The industry would have preferred a Directive, to give firms longer to prepare and to allow for local differences, but is now resigned to the fact that it will be a Regulation.

The Alternative Investment Management Association (AIMA) has, however, published an analysis of the rules and asked the EC to make amendments. Andrew Baker, AIMA’s CEO, said the rules, if implemented

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FTSE GLOBAL MARKETS • JUNE 2012

in their current form, “will have a major impact on the EU and global asset management”.

The EC has defended its position.

Michel Barnier, the Commissioner for Internal Market and Services, in a letter to the City AM newspaper, wrote that the draft rules do not alter the substance of the directive’s “level 1 principles”, and pointed out that “these measures are still work in progress and no final decisions have been taken”. He explained that the Commission has largely followed ESMA’s technical advice” but that in drafting rules it “must translate technical recommendations into legal language which is sufficiently clear to ensure legal certainty”.

One area of contention is how the rules define the responsibilities of depositaries, which will typically be created and run by major custodian banks. The AIFMD requires every alternative investment fund manager (AIFM) to ensure that, for each alternative investment fund (AIF) it manages, a single depositary is appointed for the safekeeping of assets, replacing the current practice of appointing a prime broker for this purpose.

The industry was already apprehensive about ESMA’s advice to the EC that depositaries could be held liable for the loss of financial instruments kept by sub-custodians, even though depositaries have no control over sub-custodians. The industry was hoping the EC’s draft rules would not impose this liability— but they do. The rules also increase the

Bill Scrimgeour, Global head of regulations and industry affairs for HSBC Securities Services

scope beyond that recommended by ESMA of a depositary’s liability for any AIF losses caused by external events, such as bad investment decisions by AIFMs. Depositaries will therefore have to police the behaviour of AIFs, AIFMs and non-affiliated sub-custodians over whom they have no control; even worse, if those sub-custodians lose assets, the depositary will have to make good the losses to investors and risk heavy penalties from the regulator too. The consequences for depositaries could be serious— unlimited liability, complicated administration and high costs—and they may have to exit certain markets.

How the European Commission will eventually respond to these complaints—not just about the rules on depositaries, but others too— is unclear. What is clear, though, is that the alternative investment industry will continue to press hard for changes. I

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SECURITIES SERVICES

EMERGING MARKETS CUSTODY: THE VALUE OF BEING ON THE SCENE

Photograph © Mariobrioschi/Dreamstime.com, supplied June 2012.

DOWN & DIRTY: THE LOCALISED VIEW OF CUSTODY Though the challenges facing global custodians in emerging areas such as Africa and Latin America may vary, there have been a number of overarching themes. With regulations constantly in flux, those strong enough to stay in the game have done so in part by working with governments, stock markets and regulators to help shape the agenda and encourage best practice at the local level. Still, questions remain: in an era when counterparty risk mitigation is paramount, is it really all about network management?

Furthermore, how do providers compensate for the regulatory differences that may exist between markets, sometimes within the same general area? Dave Simons reports from Boston.

T IS WIDELY expected that global growth will slow to less than 3% annually into the foreseeable future, well below the pace set during the last several decades. This figure, however, obscures the significant growth disparity separating the developed and developing worlds. For instance, this year alone emerging economies, despite shedding an estimated 0.7% growth on average, will still likely expand at a 5.6% clip.

With that in mind, it is no surprise that investors are poised to plunder available opportunities not only in the BRIC regions, but less developed areas as well. This activity is having a considerable impact on firms that act as service providers for these investors across a wide range of markets. The

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challenges facing custodians and their networks vary from region to region; nevertheless, there have been a number of overarching themes. The marked increase in transactional volumes has led global custodians to continually invest in their networks, while compelling those at the local level to beef up technology and systems to avoid being the weak link.

Those still strong enough to stay in the game have done so in part by weathering an unprecedented rise in service expectations. In many emerging areas global institutions now comprise a majority of the investor base; even when a local market infrastructure is underdeveloped, the demands on custodians as intermediaries are often anything but. Keeping investors molli-

fied is only half the battle, however; with regulations constantly in flux, custodians play a key role not just in terms of reporting changes to their clients but also working with regional governments, stock markets and regulators to help shape the agenda and encourage best practice. The ability to demonstrate this expertise has helped many firms build out their franchises in regions such as Latin America, Eastern Europe, Africa, the Middle East and Asia. Moreover, in spite of an increase in global convergence, the persistence of regional distinctions should continue to favour those with a keen understanding of local customs and nuances.

A diverse landscape The reality is that although many of the leading providers lay claim to being global players, not all have ubiquitous strengths. Additionally, expertise is as much evinced by the extent of local relationships as in-house service excellence. For example, looking at five of the key custodial regions—Latin America, Africa, Europe, the Middle East, and Asia—a clear picture of the division of labour by provider type inevitably emerges. Much depends on the makeup of the region itself, notes Beth Fortier, managing director, Network Management at JP Morgan.

“For instance, in Latin America and the Middle East, there tend to be a limited number of providers, particularly within the smaller markets, and these are often multinationals,” says Fortier.

While a strong regional economy has often been the impetus for indigenous banks to seek a bigger piece of the action, even more so is the opportunity to assert themselves on a global scale, remarks Beatriz Molina, head of Global Network Management, BNY Mellon.“As these banks become more internationally exposed, they have the ability to attract foreign investors in greater numbers, rather than simply maintain a local client base,” explains Molina.

On the other hand, Molina has seen a different pattern emerge in Africa,

JUNE 2012 • FTSE GLOBAL MARKETS

where the custody business has largely been the domain of global and regional firms. “There certainly hasn’t been the same degree of local-single market participation that we have seen in other emerging regions,” says Molina. This might be due in part to local banks having a different profile and size, as well as less global exposure, says Molina. While growth within many of these countries has been among the strongest worldwide,“of course we are also talking about much smaller markets on a comparative scale,” adds Molina.

The stark contrast between the overly ripe and still maturing market segments in Europe has accounted for the enormous range of providers found within that region. “You have globals, regionals and locals [sic]—there really is no single class of provider that is more dominant,”says Molina.“It really is a perfect mosaic in which everyone has a different way of approaching the service offerings.”

Whether or not that continues in light of streamlining initiatives such as TARGET 2 Securities (T2S) remains to be seen. To many, T2S, which has the capacity to facilitate direct access by custodians to Eurozone CSDs, will almost certainly lead to increased disintermediation of the sub-custody space. “It certainly does raise the question as to whether it will be possible to remain a single-market provider in a multi-market/single infrastructure environment going forward,” admits Molina.

Perhaps even more so than in Latin America, the Middle East has proven to be a hotbed of global and regional custodian activity, with the number of participants increasing exponentially over the last three years. Meanwhile, Asia has ranked second only to Europe in terms of custodial diversity, though with a higher concentration of regional names, says Molina.

Cherie Graham, senior vice president and global head of Network Management for Brown Brothers Harriman (BBH), agrees that international players

FTSE GLOBAL MARKETS • JUNE 2012

have garnered the lion’s share of the pre-emerging/frontier markets, such as in the Middle East and Africa. Japan remains an exception, however, says Graham,“as local players are predominant with good credit ratings and standard product offerings.”

If international players typically have had the advantage of a strong credit rating and a standard product offering, by contrast local banks often bring to the table local expertise and strong relationships with regulators. However, “even this should be taken with a grain of salt,” says Graham, “as international players themselves are becoming increasingly successful at forging these kinds of relationships.”

Still, local players should always be considered as a viable alternative when selecting a custodian in any given market, notes Etienne Deniau, head of Custody Trustee Services for Société Générale Securities Services. “The SGSS strategy has been to build on Société Générale group’s local retail banking network in areas such as the Czech Republic, Egypt, and Morocco, Romania, or Russia,” says Deniau, “with the goal of being a strong lobbyist with the local authorities and to be part of the network of a major international player.”

Know your network Network managers continue to play a key role in the effort to mitigate counterparty risk and ensure that proper due diligence is performed.

“Network managers, along with credit, compliance, legal and operational professionals, must maintain a realtime snapshot of exposures at all sub-custodian banks,” says Graham.

“In addition, the policies and practices used to measure counterparty risk must be continually challenged and refined in order to stay in step with the changing environment.”

When it comes to network management, custodians remain focused on sharpening their risk-mitigation skills at the behest of their institutional clientele.“It is critical that we seek to provide

Cherie Graham, senior vice president and global head of Network Management for Brown Brothers Harriman (BBH). Graham agrees that international players have garnered the lion’s share of the pre-emerging/frontier markets, such as in the Middle East and Africa.

Japan remains an exception, however, says Graham, “as local players are predominant with good credit ratings and standard product offerings.” Photograph kindly supplied by BBH, June 2012.

detailed information on a market-bymarket basis,” says Fortier, “including whether risk is related to settlement or infrastructure, or is perhaps due to the local regulatory environment. Furthermore, we find it helpful to rely on our own in-house expertise for monitoring credit- as well as country-related risk. By pulling all of these resources together, we are able to achieve a much clearer view of the overall market covering a wide range of issues, as well as having a game plan for how to respond to potential risks in the making.”

For their part, investors have been taking an increasingly active role in their relationships with global custodians, says Graham, including maintaining regular schedules for conducting on-site due diligence and submitting annual due-diligence questionnaires to global custodians. Though the global custodian has typically been chiefly responsible for the selection and monitoring of its sub-custodians, “investors are now much more aware of the sub-custodian network, and are

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SECURITIES SERVICES

EMERGING MARKETS CUSTODY: THE VALUE OF BEING ON THE SCENE

frequently asking questions about the specific providers.” To wit, investors may want to review policies and procedures used by the bank to monitor the overall performance of the appointed sub-custodian, adds Graham.

According to Deniau, investors may also consider requiring both global and local custodians to be ISAE 3402-certified, or maintain similar qualifications. (Drafted by the International Auditing and Assurance Standards Board, ISAE 3402 seeks to be the globally recognised standard for assurance reporting on service organisations.) To further indemnify themselves,“investors may wish to use two different global custodians in order to diversify the risk and get the best of both worlds,” adds Deniau.

In an era when counterparty risk mitigation is vital, is it really all about network management? Or are there other elements involved as well?

Though cash and securities custodian networks are paramount, other arrangements may be considered as well, says Deniau, including subscription/redemption into funds and transfer-agency accounts, FX monitoring and benchmarking, as well as derivatives clearing and securities lending.

Providers clearly compensate for the regulatory differences that may exist between markets, sometimes within the same general region. According to BBH’s Graham, the provider has a number of strategies at their disposal.

“Often times, a sub-custodian bank has a single platform that provides services throughout an entire region and is flexible enough to customise for specific market requirements,” says Graham. The provider could document any deviations from best practices, and subsequently draft policies and procedures to address these gaps. “Most important, the provider can also drive regulatory changes in each of the markets in order to align with international best practices and to harmonise the structures.”A good example of this is in the Middle East, where a unique account structure exists throughout the

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region that includes slight variations based on local regulations. “Several years ago in the UAE and Qatar, lobbying efforts resulted in the introduction of an automatic override feature for accounts opened with a custodian,” says Graham.

Emerging—and evolving From JP Morgan’s standpoint, the operative term when discussing the emerging markets continues to be “presence,” explains Fortier. “Historically when we have thought about sub-custodian selection specifically in the smaller, less developed markets, we might actively consider a local bank that may have been able to offer a closer tie to the indigenous market players, and therefore were likely to have an edge in navigating the regional infrastructure.”

Given the considerable headwinds that firms such as JP Morgan continue to face, that line of thinking has since evolved. “Particularly when looking at sub-custodian selection, financial strength is now the overriding factor,” says Fortier. “As a result, it is more likely that we may choose to in-source through our own direct custody and clearing infrastructure, or, should the option be available, use a multinational provider instead.” The decision to “go direct” is typically made on a case-bycase basis (and includes such variables as local regulatory landscape and market complexity, financial factors and alignment with the firm’s international expansion plans). Where direct custody and clearing does not make sense, seeking outsourced firms with the widest possible coverage area that can also offer local market expertise has become the most attractive approach throughout the industry, affirms Fortier.

With the number of players jockeying for position on the global stage on the rise, many with capital reserves to burn, there is a question whether the up and coming upstarts stand a chance.

Actually, a lot depends on the wherewithal of the upstart, not to mention the business case the newcomer is able to present in times where banks are

Beth Fortier, managing director, Network Management at JP Morgan. Market providers say expertise is as much evinced by the extent of local relationships as in-house service excellence. For example, looking at five of the key custodial regions—Latin America, Africa, Europe, the Middle East, and Asia—a clear picture of the division of labour by provider type inevitably emerges. Much depends on the makeup of the region itself, notes Fortier. “For instance, in Latin America and the Middle East, there tend to be a limited number of providers, particularly within the smaller markets, and these are often multinationals.”

Photograph kindly supplied by JP Morgan, June 2012.

streamlining businesses and focusing on their key business areas. Regardless, observers such as BNY Mellon’s Molina do not believe that there will be a sweeping trend in which locals everywhere are completely vanquished by global providers with deeper pockets.

“I have been in many situations where a local firm has announced its intentions to enter the business by carving out a niche for itself, and I’ve thought, ‘Really? There is still room for yet another player?’ But given the differences that we know exist between the various markets and their participants, as well as the different client segments needs, I’ve learned that you can’t always make these kinds of universal assumptions about what the outcome will be,” says Molina. I

JUNE 2012 • FTSE GLOBAL MARKETS

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SECURITIES SERVICES

THE NEXT ITERATION OF GLOBAL SECURITIES SERVICES PROVISION

A streamlined approach The European asset management industry has grown considerably over the last ten years. Assets under management (AUM) stood at €3trn at the end of 2001, and had reached €7.89trn by the end of the second quarter (Q2) 2011. This growth, which will support the savings and retirement of a large portion of the European population, means asset managers have an enormous responsibility to their end clients.

By Ann Doherty and Brian Coughlin, JP Morgan Worldwide Securities Services (WSS).

T IS INEVITABLE that asset managers want to retain their investment gains by reducing uncertainty and risk from their activities as much as possible and increase straight through processing (STP) and transparency, particularly in today’s volatile environment. One way to achieve that is to use a custodian that can provide all of these benefits through a streamlined product offering to help reduce both costs and risks while keeping up with the everchanging regulatory environment.

The objectives of asset managers present their own challenges, particularly with a regulatory reform agenda framed by G20 commitments, which culminated in the Dodd Frank Wall Street Reform Act and the European Market Infrastructure Regulation (EMIR). Since 2008, regulation has been constantly evolving and expanding. In addition to those two regulations, investors also have to adjust to the second iteration of the Markets in Financial Instruments Directive (MiFID II), UCITs IV, AIFMD, FATCA, Basel III and Solvency II. To understand and execute on what regulators expect from them, asset managers today look to their service provider for help with the provision of an industry-leading global custody and securities services offering with innovative technology to meet their daily requirements; seamless execution to increase STP and reduce risk; thought leadership to help them understand how regulation and potential market

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events could affect them (as well as their end-clients) and provide appropriate and timely data analysis.

Inevitably, the most sophisticated asset managers want to work with a securities services provider that can provide global reach and which has sufficient resources of capital to invest in industry-leading systems and technology. That means all of their requirements are met in one place.

Investors then benefit and can have confidence in the fact that whatever complexity is injected into the market, whether by unexpected market events or by regulators, their custodian will be able to manage it.

Next, asset managers want seamless execution to help them eliminate risk and costs. Recognising the important role that asset managers play in the savings and pensions industry, regulators are putting pressure on them to provide their end clients with transparency and as little risk as possible. To do that, fund managers must tighten up the chain in their post-trade activities.

For their part, custodians have been moving into more consultative tech-

nology-driven services for years, which asset managers and other users of custodian and related securities services have greatly benefitted from. Increasingly, these users of securities services are looking to their providers to move even closer to their front office, even coming just after the trading and investment decision.

In the past, using one firm’s investment bank to execute trades and using the same bank’s custodian arm might have raised concerns about whether this one-stop-shop provided the best execution and cost in the market.

Regulations, particularly MiFID, have removed that uncertainty.

Finding a provider that can tick the first two boxes as well as provide the critical consultative thought leadership all asset managers look for to keep up with regulatory and market changes, isn’t easy. Asset managers look to their service providers to provide information about changes arising from the rapidly evolving regulatory environment, to ensure that new requirements are understood and prepared for. Large international firms that are present in multiple jurisdictions are best placed to have a view of regulatory changes and to adapt their services to new requirements on a global basis.

Lastly, asset managers also rely on service providers to help them provide up-to-date and transparent data analysis, which is a critical reporting requirement to regulators, governments, trustees and other stakeholders, and is part of their own internal risk reviews.

This means asset managers want detailed information about their

Moving closer to execution Fixed Income Equities On Exchange Derivatives

Execution

Clearing

Prime Brokerage/ Prime Custody

Custody

Dodd Frank and EMIR will require the “moving closer to execution” process, which is currently used for on-exchange instruments, be replicated for OTC derivatives over the next few years.

SOURCE: JP Morgan, June 2012.

JUNE 2012 • FTSE GLOBAL MARKETS

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SECURITIES SERVICES

THE NEXT ITERATION OF GLOBAL SECURITIES SERVICES PROVISION

transactions, securities held, and breakdown of the core characteristics of those assets. They also want this data delivered in a fast and efficient manner, which requires a strong STP framework. This presents a challenge and an opportunity for service providers as it is not an easy task pulling together different sets of data and presenting it in a format that asset managers can consume and customise.

To meet all of these requirements, a service provider has to continuously invest in technology, and have regulatory experts who can quickly analyse new regulations and understand how they will fit and potentially impact exist-

ing regulations with which asset managers are already complying. This requires a delicate balance between investing in business enhancements and people, while maintaining required capital levels. Large global custodians with the capacity to invest in its technology and systems are more able to make these investments than smaller firms.

Asset managers are looking to securities services providers to act more strategically then ever before. By using one bank for all activities following the investment decision, asset managers are recognising their ability to cut potentially weak links from their post-trade chain, and rationalise the

number of providers they use. This coordinated servicing effort across a firm, usually a bank, enables the large and fully-integrated players to really understand an asset manager’s needs, requirements, product and geographical expansion plans. This support across many distribution channels helps fund managers reduce cost, outsource the risk by leveraging operational capabilities, risk management capabilities and therefore offers a much better and broader value proposition. Today, a service provider must have all the necessary tools in the tool box and be willing and able to use them. I

FTSE & CÜREX GROUP LAUNCH FX INDICES Global index provider FTSE and Cürex Group, a developer of intellectual property and technologies that link institutional foreign exchange with global capital markets, have the FTSE Cürex FX Index Series, a new range of independently calculated, 24/5 streaming, executable spot FX benchmark FIX for currency pairs and currency baskets. “The new index is designed to provide a better benchmark for managing currency risk and performance, and will likely support a wide range of passively managed FX currency funds and strategies,” holds Mark Makepeace, chief executive officer, FTSE Group. he FTSE Cürex FX Index Series provides the next generation of FX valuation and performance benchmarking for global capital markets. By establishing real-time bid and offer spot FX indices on 192 currency pairs (FTSE Cürex FIX), from multiple independent contributors and at multiple depths of liquidity, global capital markets benefit from improved clarity when viewing previously opaque foreign exchange pricing. William Dale, chairman and chief executive at Cürex Group explains that the new index series “represents a step forward in the evolution of the global foreign exchange marketplace [and] enables … both buy side and sell side leaders seeking to provide more competitive products and liquidity to the world’s capital markets.”

New executable benchmark currency baskets include the flagship FTSE Cürex USD/G8 Index, an equally weighted, real-time index designed to provide an improved valuation of the US Dollar. The index consists of seven major currencies representative of global finance and commodity trading, plus the Chinese Renminbi—the most important emerging Asian reserve currency. These new benchmark FX Indices also can be used to measure the performance of active currency strategies, and provide new tools for investors seeking to express a ‘risk on / risk off’ trade.

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New proprietary and patented technologies have been developed by Cürex Group specifically to connect previously fragmented foreign exchange market liquidity with investment products linked to FTSE Cürex FX Indices.

These technologies, say FTSE Group, allow asset managers and their service providers to build custom FX Indices from proprietary or third party asset pricing models for both analytic and product development purposes.

Cürex Intellectual Property will enable a new generation of both exchange-traded and OTC financial products that are linked to FTSE Cürex FX Indices and utilise Cürex technologies designed to directly link institutional foreign exchange liquidity to financial products tracking FTSE Cürex FX Indices. This new capability will allow passive asset managers to reduce tracking error and liquidity providers such as Delta One desks to improve their hedging and risk management practices.

Benchmark Execution (BE) and Benchmark or Better Execution (BOBE) models can now be employed by thirdparty electronic and voice brokering FX platforms via principal transactions or STP to the FTSE Cürex FX Index liquidity pool. These new benchmark FX Indices also can be used to measure relative performance of active currency overlay strategies. Investors seeking to express a ‘risk on / risk off’ trade can alsouse these indices to implement this trade.

JUNE 2012 • FTSE GLOBAL MARKETS

DEBT REPORT

THE PROS AND CONS OF GREECE LEAVING THE EUROZONE

Greece: the final frontier

Sofia Sakorafa, SYRIZA MP, during the presentation of the party’s economic proposal for Greece. Alexis Tsipras, leader of SYRIZA (Coalition of the Radical Left), holds a press conference to present the party’s economic proposal. Tsipras stressed that more misery and austerity would inevitably lead to Greece’s exit from the eurozone and a euro collapse. Alexis Tsipras presents SYRIZA’s economic manifesto. Photograph by Nicholas Giorgiou, for Demotix Press Association. Photograph supplied by PressAssociationImages, June 2012.

Greece’s continued membership of the eurozone—and probably the future of the single currency—came as close as it has yet to breaking point in the first week of May. The failure of the country’s general election on May 6th to produce a majority government and the dramatic gains by the Syriza Party, which opposes the terms of the EU financial rescue package, led to a run on deposits at Greek banks that threatened to precipitate widespread defaults before the country had the chance to hold its second election on June 17. An €18bn infusion from the European Financial Stability Fund (ESFF) for four of the leading Greek banks on May 23rd may have averted that immediate risk, but uncertainty over the future of the single currency has reached new heights. How long can Greece last in the eurozone? Andrew Cavenagh reports.

FTSE GLOBAL MARKETS • JUNE 2012

EPORTS FROM THE European summit later on the same day that the EFSF provided its bolster for the Greek banks that EU officials were advising the other member states to make preparations for Greece leaving the euro did little to allay a mounting sense of alarm over the closing days of May. Little over a week earlier, German Chancellor Angela Merkel had raised the possibility of a Greek exit for the first time. “The growing fear of Greece exiting from the eurozone continues to increase market anxiety,” says Andrey Dirgin, head of research at the foreign-

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DEBT REPORT

THE PROS AND CONS OF GREECE LEAVING THE EUROZONE

Cypriot President Dimitris Christofias makes his statement to the media at the presidential palace in Nicosia, Cyprus, on Friday, June 1st 2012. The president says he has tasked officials to draw up plans on how the country would deal with Greece’s possible exit from the eurozone. Christofias told a news conference that conditions would be “chaotic” if debtdrowned Greece quits the euro and that the impact of such a move would be felt not only by all other countries using the currency, but all of Europe. Photograph by Petros Karadjias, for Associated Press. Photograph supplied by PressAssociationImages, June 2012.

exchange brokerage Forex Club.“If such fears come true, the consequences will be wide-reaching and much broader than some analysts forecast. Once Greece has been shown the door, it will set a precedent for any other country wishing to leave the eurozone.”

The increasing likelihood of a Greek exit almost immediately revived concerns about the contagion that would inevitably result, and this led bond investors and traders to take renewed

30

fright over the outlook for Spain. Yields on Spanish ten-year bonds hit 6.5% in the third week of May, widening their spread against comparable German bunds to 481 basis points (bps). Spain’s prime minister Mariano Rajoy warned over the UK’s extended Jubilee weekend that the country was in imminent danger of being locked out of the markets by “astronomical” borrowing costs and that its banks were in dire need of $40bn in balance sheet support.

The now very real prospect that Spain would follow the example of Greece, Ireland, and Portugal and seek an EU bailout inevitably cast fresh doubt over the viability of the single currency.“Spain is not a viable country to rescue,” maintains Marc Ostwald, senior bond strategist at Monument Securities. “If Spain has to be rescued, the whole euro project has failed.”

The developments over the first half of May thrust Greece to the top of the agenda at the G8 summit at Camp David on May 19th as the US (along with the leading emerging market economies) have become all too aware of what an implosion of the eurozone is likely to mean for their own growth prospects over the next decade.

Unsurprisingly, the meeting came to the unanimous conclusion that Greece should remain in the euro. That is because despite all the efforts to improve the transparency and riskresilience of the global financial system since 2008, the fallout from a Greek exit remains a dangerous unknown.

“Financial regulators and governments are not on top of what the tail risks would be,” insisted Ostwald at Monument Securities. “You just have to look at JP Morgan’s recent disclosure that it had lost more than $2bn on derivatives trading to see that.” [JPMorgan would not confirm whether the bank is advising the German government on the consequences of German withdrawal from the eurozone. If true, a devastating spin

JUNE 2012 • FTSE GLOBAL MARKETS

on Germany’s current opposition to anything regarding support of its southern neighbours].

The cost to the eurozone—never mind the rest of the global economy— of Greece having to revert to the drachma is largely a matter of conjecture, but few doubt that it would be severe. UBS recently put the all-in direct cost to European taxpayers at €225bn, a big enough figure in itself but one that takes no account of the possible contagion in other eurozone countries [even including Germany].

Laurence Boone, European economist at Bank of America Merrill Lynch, has meanwhile suggested that overall European GDP could shrink by at least 4% as a consequence of a Greek exit.

Despite these dire predictions, however, there is still fundamental disagreements between Germany, which will ultimately have the key say over the fate of single currency, and virtually all other members of the G8 (and the wider G20) over how best to avoid such an outcome.

Notwithstanding the clear evidence that EU-imposed financial austerity measures have sent the GDP of Greece into a terminal tail-spin, provoking ever more serious civil unrest, Angela Merkel and her government remain adamant that the country has no alternative but to stick to the prescribed programme of fiscal and structural reform. It is an increasingly redundant position. While the other European leaders back the demand for Greece to carry through necessary structural changes to its economy, in the wake of François Hollande’s election to the French Presidency in April the German stance that austeritydriven reform on its own is the only solution for both Greece and other impaired eurozone countries has become increasingly isolated.

The main emphasis elsewhere in the G8 and beyond—while still recognising the requirement to control and reduce fiscal deficits—has switched to the need to stimulate economic recovery.

The final communiqué from the Camp

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David summit, for example, stressed “the imperative to create growth and jobs”; and you can’t do that by austerity and budget cutbacks.

Inflexibility and the Germans Just how inflexible the German position really is will be put to the test after June 17th. While polls suggest that the majority of Greeks still want to remain in the euro [and even the Syriza Party is not advocating an exit at this stage] the government that emerges from the upcoming election (whatever its composition) is certain to demand some “renegotiation” of the terms of its bailout package. This will undoubtedly involve more time to achieve the specified deficit-reduction targets and probably some further financial assistance in the short-to-medium term.

Given the unquantified but certainly astronomical cost of the alternative, most close observers believe the German government will acquiesce to some relaxation of the terms of the Greek rescue package. “I think they probably will back off a bit,” says Graham Neilson, chief investment strategist at credit asset manager and advisory firm Cairn Capital. “There is clearly been a decrease in dogmatism on the issue, and EU officials seem to be rallying round the idea that the Greece is still wanted in the euro.”

The problem is that any such easing of the terms will simply buy a little more time until the next funding crunch arises, given that the target of the reforms is to reduce the country’s gross sovereign debt to 120% of the country’s GDP by 2020. This will still be an unsustainable level of debt for the Greek economy to support, and much more radical measures across the eurozone will be necessary for Greece and some of the other countries to remain part of the single currency in the longer term. “The one constant about Greece over the last two years has been its painfully predictable path to economic and political implosion,” explains Neilson.“In order to move on from here, there needs to be compro-

Graham Neilson, chief investment strategist at credit asset manager and advisory firm Cairn Capital. “There is clearly been a decrease in dogmatism on the issue, and EU officials seem to be rallying round the idea that the Greece is still wanted in the euro.” The problem is that any such easing of the terms will simply buy a little more time until the next funding crunch arises, given that the target of the reforms is to reduce the country’s gross sovereign debt to 120% of the country’s GDP by 2020.

Photograph kindly supplied by Cairn Capital, June 2012.

mise in the near term but also far broader policy imagination in the longer term.”

Large scale financial support To give Greece and the other embattled eurozone countries a realistic chance of retaining the currency, Neilson said the EU would need to contemplate largerscale financial support, more debt write-offs or restructuring (including obligations to the official sector), larger buffers for the country’s banks, further extension of the European Central Bank’s Long Term Refinancing Operations (LTRO), and the issue of common eurobonds. “If they’re serious about holding the single currency together, [all] those will be necessary at some point,” he concluded.

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THE PROS AND CONS OF GREECE LEAVING THE EUROZONE

Measures of this magnitude may well prove, however, to be beyond the ability of any German government to deliver (even if the politicians were prepared to contemplate them). One important consideration is the legal barriers that such initiatives would need to overcome. The constitution of the European Central Bank (ECB), for example, prevents it from acting as a lender of last resort (by printing money) in the same way that the US Federal Reserve and Bank of England have done over the past three years. It could only legally assume such a role if its constitution was changed, and the prospect of all the euro member countries agreeing to that within a timescale that would make a difference is remote, to say the least.

The German constitutional court may well also outlaw the Eurobond concept, for which there was widespread support from most other countries at the European summit on May 23rd. In September 2011, the court ruled that the German government could not sign up to financing mechanisms that (among other considerations) would enable the actions of foreign governments to trigger German sovereign guarantees. While the focus of that ruling was the European Stability Mechanism (ESM), the proposed permanent successor to the EFSF, it is difficult to see how the proposed Eurobonds could fail to foul of this judgment.

Even in the unlikely event that the constitutional issue could be overcome,

there is real doubt that German voters would support any government that tried to commit them to underwriting the debts of southern Europe, as all recent polls have indicated that most German taxpayers view their Mediterranean neighbours as financially irresponsible profligates who have only themselves to blame. If the political pressure on Germany from the G8 and elsewhere to bail them out then became intolerable, it is quite possible that the prime mover of the single currency would decide the project is no longer worth the candle.“Everybody is always talking about the peripheral countries being forced out, but no one ever considers the possibility that Germany would leave,” said Ostwald at Monument. I

SPAIN ASKS FOR MONEY: COST OF FUNDING RISES PAIN MANAGED TO raise almost €2.5bn of medium-term debt on May 17th but had to pay sharply higher yields, as heightened fears over a possible Greek exit from the euro compounded further bad news about the country’s economy and banks.

According to the Bank of Spain, the Treasury sold €372m of three-year bonds at an average yield of 4.375% compared with 2.89% for a similar sale on April 4th. In a separate auction, it issued a further €1.024bn of three-year debt at a yield of 4.876% against 4.037% on May 3rd, and finally €1.098bn of four-year bonds at 5.106%, which was up from 3.374% at the last comparable auction on March 15th. While the sudden surge in borrowing costs was largely down to the developments in Greece, recent official figures on the economy also increased concerns that Spanish government would not be able to meet the commitment it has made to reduce the budget deficit to the agreed EU limit of 3% next year from its level of 8.5% in 2011.

Data from the National Statistics Institute (INE) have showed that the Spanish economy, which is the fourth-largest in the eurozone, shrank by 0.3% in the first quarter of 2012, with unemployment hovering at just under 25%. Investors are meanwhile becoming increasingly worried about the state of the Spanish banking system, as recession aggravates the impact of the housing-market collapse in 2008 that has left the country’s banks with over €140bn of impaired loans.

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The Moody’s rating agency downgraded 16 Spanish banks—including Santander—on May 17th, while shares in Bankia (over which the government had assumed control a week earlier to allay concerns about the bank’s solvency) plunged nearly 28% on reports that clients had withdrawn more the €1bn of deposits over the previous week. Spain now needs some €40bn to prop up its debt-laden banks.

The problem for Spain is one of timing, as well as funding. The ECB, which has been relatively quick up to now to provide liquidity into the markets is reportedly in no mood to address Spain’s immediate concerns, given that anxiety is building up over the eurozone’s fast deteriorating economic outlook.

However, if help for Spain is to come from somewhere it will be the ECB. Outside of Europe’s central bank there is sparse sympathy. Spain’s request for help comes just as the EU is about to unveil plans to stop taxpayer money being utilised to bail out failed banks; though any initiative in this regard is unlikely to come into force much before 2014, if at all. As well, the growing concern at the still deteriorating situation in Greece is, for the moment, throwing Spain to the market wolves. Germany for one is in no mood to help, particularly as seven German banks were downgraded on the likelihood that continuing meltdown in the eurozone would erode the prospects for the German banking system.

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COUNTRY REPORT

WHY ARGENTINA REMAINS CUT OFF FROM INTERNATIONAL FINANCIAL MARKETS

Argentina’s President Cristina Fernandez delivers a speech during a ceremony to announce new investments in YPF in Buenos Aires, Argentina, Tuesday, June 5th, 2012. The chief executive of the newly state-controlled Argentine energy company YPF Miguel Galuccio announced a five-year plan that includes an investment of up to $7bn annually to expand exploration and boost production. Photograph by Natacha Pisarenko, for AP Photo. Photograph supplied by Press Association Images, June 2012.

TEN YEARS ON FROM DEFAULT: THE AFTERMATH In the hubble and bubble in the press around Greece and Spain, some commentators have lately drawn comparisons with Argentina, suggesting that is the way forward. Humbly, we suggest they might be wide of the mark. Greece will exit from a currency union; Argentina has its own currency and can set its own interest rates. In other ways too, the countries are way different and drawing comparisons between them is not helpful to Greece or Greek bondholders. Vanja Dragomanovich explains the long term impact on Argentina of its latest default (back in 2001) and what, if any, lessons might be drawn from that debacle and the long term impact on the Argentine financial markets.

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S GREECE EDGES closer to political and economic immolation, market watchers have been in a flurry, casting around for examples of how a country could survive leaving the eurozone and a hard default. One example being touted around the markets is Argentina, which went through a spectacular default ten years ago but managed to follow it up with a decade of fast growth, a boom in commodity exports and a golden period in banking. Argentina’s finances are in relatively good shape. At $185bn, the country’s total debt load last year equated to just 41.3% of GDP. That’s better than both Spain, whose debt-to-GDP ratio stands at 70%, and Italy, which is saddled with an eyepopping 120% burden. Moreover, with GDP growth at 4% and funds avail-

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WHY ARGENTINA REMAINS CUT OFF FROM INTERNATIONAL FINANCIAL MARKETS

able from central bank reserves, pension funds and YPF’s coffers, Argentina has ample cash.

Argentina’s expansion was fuelled by two things: liberal policies and a sharp rise in the prices of commodities. Argentina is one of the world’s largest exporters of wine, soy, corn and wheat and China is its enthusiastic buyer. And while Greece may try to emulate the policies component of the Argentina story, unless the Chinese take to drinking retsina and cooking with olive oil it will have difficulty replicating the Latin American country’s recovery.

Argentina has also come good on almost 93% of its initial debt obligations, but to this day has not been able to return to international financial markets. In large part this is because of an ongoing dispute with two hedge funds. The bulk of the outstanding amount is owed to the Paris Club, a total of $6.4bn.

“Technically, Argentina is not locked out of international markets the way it was in 2001 and 2002 when nobody would lend them money. In theory they could try to raise money but in practice they can’t go back because they would risk a seizure of assets while the [legal] cases are pending,” explains Michael Henderson, emerging markets economist at Capital Economics in London In 2001 the country defaulted on $100bn of its sovereign debt. Four years later, Argentina’s president at the time, Nestor Kirchner, offered to swap the defaulted bonds for new ones worth 70% less, in a similar deal to what Greece is hoping for. Around three quarters of the bondholders agreed. The process was repeated in 2010 by current president Cristina Fernandez de Kirchner who said at the time that this was the final deal being offered to remaining bondholders.

Two distressed-debt hedge funds opted for litigation in US courts while a group of Italian bondholders asked for an arbitration award at the World Bank’s International Centre for

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So where does this all leave Argentina? Over the years it has been turning increasingly inwards for solutions. The government’s tactical arsenal has included printing money, dipping into central bank reserves, seizing the assets of pension funds, controlling imports and exports to tweak its trade balance and privatising pension funds.

Settlement of Investment Disputes.

The US courts are still pondering the issue. Initially the courts ruled that NML Capital Fund, one of the funds suing Argentina, was entitled to a repayment of $1.6bn, including the payment of interest, only for this to be overruled this spring. Now the remaining debt holders are collectively appealing to the US Court of Appeal with the case due to be heard in mid-June.

While this is going on, not only is Argentina not in a position to issue bonds, it has also little hope of raising loans from major international institutions as the United States is actively blocking the country’s loan applications on the grounds that it is a recalcitrant debtor. In September last year the US, which holds a 30% voting share in Inter-American Development Bank, voted against a $230m loan to the country.

Of the remaining debt, $6.4 billion is still owed to the Paris Club of official creditors and Argentina has yet to reach agreement with the Club on how to reschedule the repayments.

“For that Argentina would need to get the approval from the IMF and that is not likely to happen as they have a strained relationship,” says Henderson. He argues that that would mean that Argentina would have to let the IMF carry out a health check on its economy and in the process the government would have to admit that the country’s official statistics have been doctored. Just how far the country’s figures have been massaged was made clear by Carlos Maria Regunaga, a former adviser-in-chief to the Argentina’s secretary of

commerce and a director at Menas Argentina. Regunaga cites the fact that although consumer price inflation in 2011 was around 22%, “the government denies this and insists that inflation is only 9.5%.”

So where does this all leave Argentina? Over the years it has been turning increasingly inwards for solutions. The government’s tactical arsenal has included printing money, dipping into central bank reserves, seizing the assets of pension funds, controlling imports and exports to tweak its trade balance and privatising pension funds. Moreover, both Kirchner presidents have been fuelling growth by heavy public spending. Despite some questionable actions, the economy has grown.

Again, according to official statistics, economic growth came in at over 8% in 2010 and 9% last year.

Even so, growth has come at a price and the high public expenditure is now a major problem, says Regunaga.

“Historically, the public sector represented an average of 30% of GDP. The Kirchners have increased it to a level of 45% of GDP,” leading to a financial shortage in the public sector, he says. In 2011, for instance, 70% of public sector spending has been financed by printing more pesos and reaching into central bank reserves.

Government raids The government has been raiding what there is to raid in the country. In April it said it would borrow almost $3bn from the state-run bank Banco de La Nación to cover its funding needs, $2.36bn in 12 instalments and the rest as a lump sum. Argentina also

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regularly issues bonds directly to pension fund agency Anses, which operates the bulk of Argentina’s pension money after the government nationalised all private pension funds in 2008.“There are no signs that the government will go back any time soon on the nationalisation of pension funds. Why would it?” says a Buenos Aires banker who did not want to be named. “The move has achieved two major objectives: not only did it give the government access to a large sum of money but also major stakes in top companies and seats on their boards of directors,” the banker adds.

This and other political decisions such as strict exchange controls, import and export restrictions and the recent nationalisation of oil company YPF, formerly majority owned by Spanish oil producer Repsol has alienated Argentina from foreign mutual funds and private equity investors. Julio Lastres, managing director at Darby Private Equity, part of Franklin Templeton Investments, explains: “In order to make an investment you have to see how the local capital market has been developing, to see if you can fund the company in the local market and exit through an IPO. And then you typically have the growth of local pension funds that fuel the growth of the local market. But what we hear in Argentina makes it challenging to take a long term view and invest there. You have better places to invest in Latin America.”

Argentina has some presence in the international financial markets through GDP warrants, which were issued as part of two debt restructuring instalments (one in 2005, the other in 2010) to sweeten the deal for bond holders caught out by the country’s default on $100bn of debt in 2001.

The warrants are structured in such a way that the government will pay investors as long as the GDP grows by 3.3% per year, based on the annual GDP. Although initially there

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was little appetite for these GDP warrants in the open market, as the country’s economy grew so did niche investors’ interest. “We had very good volumes on Argentina’s GDP warrants, hedge funds in particular like them,” says Gabriel Sterne, director at frontier markets investment banking boutique Exotix.

This is also about to change as falling commodity prices and heavy government spending are catching up with Argentina’s economy. While the government predicts that growth this year will be 6% Henderson at Capital Economics forecast that the number will be closer to 2.5%. “Our belief is that Argentina is headed for a recession, most likely next year,” says Henderson, particularly if the global economic backdrop deteriorates over the next year, which could possibly lead to a more disorderly

adjustment. With Argentine state accounts under pressure, it would be handy not to have to pay warrant holders. But that might do no favours to Argentina’s already rocky investment reputation. For now, warrant payments are hanging in the balance. Ultimately though, while Argentina has some mounting troubles, it is a story of rich resource management and a deep economy; very different from that of Greece.

Greece’s economic recovery may also not be as certain as in Argentina’s case as it cannot devalue and does not have such a strong export market to boost its coffers. So if Greece is looking for a blueprint for the exit from the euro and a default it might be better looking somewhere other than Argentina. Or perhaps better yet, try and avoid the default in the first place. I

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COUNTRY REPORT

TURKEY UPGRADES ITS CAPITAL MARKETS INFRASTRUCTURE

Photograph © Rolffimages/Dreamstime.com

All change in the race for growth It’s all change in Turkey as the government embarks on a new round of privatisation and its regulators draft up important new regulations that will upgrade the country’s capital markets infrastructure, bringing its financial markets regulations more in line with neighbouring Europe.

The moves will cement Turkey’s rising profile in the international markets and support its efforts to establish its credentials as a regional financial hub. Francesca Carnevale looks at the some of the changes in train.

URKEY IS BASKING if not in lambent times; then days where the business outlook is significantly better than all its near neighbours. With the eurozone tottering into chronic recession (and the CEE not that far behind), corporations and investors in Europe and the Middle East are looking to Turkey for growth opportunities; and there are plenty of them.

The country has big ambitions: having embarked on a substantive programme of financial market reform going back to 2001, the government is keen to establish the country as a regional financial hub that can compete with the world’s global financial centres. It sits prettily at a natural crossroads between east and west and enjoys growing trade, cultural

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and linguistic ties with the richly resourced and still emerging CIS states, such as Azerbaijan.

In order to build on these opportunities, Turkey has been working hard since 2001 to develop a diversified financial market that can meet the demand of an emerging savings economy and investors (both local and international. The continuing dominance of the commercial banking system, and absence of a vibrant corporate bond market, was identified by the World Bank back in 2003 in a study Turkey Non-Bank Financial Institutions and Capital Markets Report, which covered a broad range of issues, including a suggested regulatory framework for capital markets; the mobilisation of savings; the operation of the government bond market, which has been a

defining element of the domestic capital markets in Turkey for many decades and a heightened role for nonbank financial institutions (NBFIs, such as insurance companies and pension funds) and the potential for the emergence of a rich domestic corporate bond market.

These elements are still in development; however the government has implemented a hefty slug of the recommendations enshrined in the World Bank report. A private pension system was launched in 2003; the country’s Capital Markets Board (CMB) has been strengthened; and market infrastructures for capital markets are now well underway. The Istanbul Stock Exchange is well established and TURKDEX, the derivative exchange, started its operations in 2005.

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The country has now embarked on a new round of regulation that will upgrade its capital markets infrastructure further and give more teeth to the CMB to regulate the issuance of securities, provide enhanced investor protection and improve corporate governance (please refer to the box: In

harmony with the EU: proposed capital markets regulation for a detailed explanation of elements of the draft capital markets law).

In March this year CMB released a draft of a revised Capital Markets Law for review by the public, professionals and practitioners, and a finalised law is

expected to come into force by year end. The country’s current Capital Markets Law (which has been in force since 1981) is outdated and other than some small amendments made in 1992 relating to public disclosure and in 1999 (relating to secondary markets) the law has not undergone major revision.

IN HARMONY WITH EUROPE: PROPOSED TURKISH CAPITAL MARKETS LEGISLATION CHANGES Underlying much of Turkey’s Capital Markets Board’s (CMB’s) efforts to modernise Turkey’s capital markets infrastructure is a need to heighten investor protection and encourage market liquidity. Equally, the CMB is keen to align the country’s capital market rules with those of its near neighbours in the European Union. If the country is to attain its promise as a fast growing marketplace for cross-border investment and financing flows and meet its ambition to become a regional financial hub, the upgrading and harmonisation of its financial and capital markets regulations is an important milestone. here are a number of new elements to the draft law.

Among them, capital markets instruments need no longer be registered with the board before public offers.

The draft law introduces a system through which only the prospectus regarding the offering need be submitted for board approval, which shall be valid for all offerings made within 12 months of the date on which an issue’s prospectus is published.

Investors will be entitled to revoke their demands of purchase, provided that any revocation occurs within two days of the date on which any changes regarding the prospectus are published. CMB may permit offerings of equity securities below their nominal value, to the extent that the market value or book value of the security is below the nominal value. This will allow issuers with financial problems to increase capital and raise funding from the public.

The new draft law proposes that all privileges existing in relation to a company must be disclosed to the public during the initial public offering of its shares. All privileges must be cancelled by a general assembly resolution if a publicly held company’s financial statements indicate loss for five consecutive years.

Under existing legislation, once a company has reached 250 shareholders, it can be regarded as publicly held. This has been increased to 500 shareholders under the draft law. In addition, the draft law obliges companies to apply for listing on the stock

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exchange within two years if the total number of its shareholders reaches 500. CMB will no longer determine the dividend payment principles for publicly held companies; instead, responsibility will lie with the shareholders for each public company. However, the board reserves its right to determine principles with respect to certain sectors and companies.

Investors’ right to sell their shares to a publicly held company and companies’ squeeze-out right (introduced with the new Commercial Code) are mentioned for the first time, and tender offers will be regulated in detail.

Equally, publicly held companies will be able to redeem their own shares based on the principles set forth by the CMB, without being precluded by the limitations set forth by the Commercial Code. This is likely to be a target of criticism by legal scholars, since the Commercial Code acts as the basis for all regulations regarding companies.

The draft law introduces the concept of public disclosure documents. It also mentions the liability of those preparing such documents in cases where information is missing, misleading or inaccurate for investors. In return, investors are granted the right to seek compensation in case of a loss arising from these documents. Many of the proposed rules are also enriched with corporate governance principles which supplement those recently updated by the CMB through a recent communiqué.

The draft law stipulates the creation of a compensation centre for investors that will collect contributions from investment institutions (formerly intermediary institutions) for distribution to investors that suffer from such institutions’ default of cash payments and delivery of securities, similar to the savings deposit insurance schemes established for banks.

Capital markets crimes are listed extensively (including new types of crime, such as transfer pricing), with penalties tailored to each type of crime. The existing law envisages blanket penalty norms for all type of crime, ranging from monetary fines only to imprisonment of between two and five years.

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Meanwhile, the country’s Commercial Code, which is over 50 years old, will be replaced by a new code on July 1st this year. This new code is important, as its remit underpins much of the country’s capital markets regulation.

The board’s supervisory and audit powers over capital markets institutions and publicly held companies have been strengthened. The CMB is also authorised to issue secondary legislation regarding the accounting and financial reporting requirements of publicly held companies, based on Turkish Accounting Standards and prepared by the Accounting Board, in line with International Financial Reporting Standards.

Significantly, the draft law acknowledges the deepening of the country’s financial markets infrastructure and enshrines definitions of new capital markets institutions, such as

central clearing institutions, central depositary institutions and data depositories. Many of these are already in place, but are retrospectively recognised. However, an important feature of the draft law is that it favours function-based regulation, rather than regulation based on institutions.

Therefore, institutions such as the Capital Markets Association, the country’s central depositary, Turkey’s clearing house and CCP are designed as being ‘self-regulating’.

There are some concerns around this and other elements in the draft law covering capital markets agents (brokerage houses and banks), which are referred to as ‘intermediary institutions’. They are designated ‘investment institutions’ under the draft law. Commentators think that this might be misleading or lead to confusion, since these institutions do not directly make

the investments, but rather act as agents for the investors.

Despite the changes in train, there are still substantive areas where regulators and the government still need to do work, particularly in the Turkish bond markets. There is, for instance, a perception that the public sector continues to crowd out the domestic bond market; the dominance of the banking system in the financial markets continues and there is a lack of a highly liquid sovereign yield curve beyond 22 months. More significantly perhaps is a continuing limited investor base.

Moreover, alternative sources of investment funding for the corporate sector remains very limited outside of trade finance instruments, and the corporate sector has substantial net exposure to foreign currency. Banking sector loans at the end of May 2011 were TL571.3bn, according to central

TURKEY ON THE PRIVATISATION HIGHWAY Photograph © Miloushek/Dreamstime.com, supplied June 2012.

Turkey has embarked on a new round of infrastructure investment and privatisations. Until recently, privatisation in Turkey has been a stop start affair.

Since the country began its sell-offs of state owned enterprises back in 1986, the country has sold off some 200 enterprises, with a combined value of some $43.1bn. Last year was a less than banner year in this regard, with a mere $1.4bn of state sales on the block; though this year has promised much more with some $6.8bh (around TYR12.5bn) of assets up for grabs.

The country’s grand sounding Supreme Board of

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Privatisations (ÖYK) approved the sale of 10.32% of Petkim, Turkey’s petrochemical major to Socar Turkey Enerji Corporation and Socar International (the international arm of the state oil company of Aizerbaijan) for a reported $168.5m. Socar itself owns 51% of the firm.

In one of those curious historical twists, Petkim was one of the first companies part slated for sale back in 1987, and ultimately one of its production complexes in the north-western province of Izmit was sold off for some $60m in 2001. Other parts of the company have been put up for sale and then withdrawn between 2001 and now; though 34.5% of the firm was hiked off in a public offering in April 2005. Some 38.68% of the company’s shares are now traded on the Istanbul stock exchange.

Tenders for two of the country’s largest infrastructure and privatisation projects, the building of a third bridge over the Bosphorus/Istanbul Strait and the transfer of operating rights of a number of toll roads are underway.

The final application date for firms interested in the highways and bridges privatisations and the final bidding for the building of the third Bosphorus Bridge was April 15th. The building of a third bridge over the Bosphorus as part of the North Marmara Highway project was put out to tender twice, after the initial size of the project was scaled down to around $2.5bn from the original $6bn estimated.

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bank figures, of which almost a third were FX loans. The corporate sector is also exposed to rollover risks due to maturity mismatches. Even so, the overall leverage ratio of the corporate sector is in line with other major emerging market countries.

In addition, there are signs that continuing reform is supporting domestic bond market growth. Initial government measures such as the issuing of guidelines by BRSA for banks to issue local currency bonds, the levelling of tax rates on capital gains from secondary market trading between corporate bonds and government securities and allowing shelf offerings has contributed to steady growth in corporate bond issuance. A number of larger blue chip issuers are coming to the market and overall annual issuance volumes are steadily rising. At the end of 2009 the corporate bond market was worth

TYR481m, for instance, this jumped to TYR1.4bn at the end of 2010 and TYR4.3bn in 2011.

There are other issues to tackle. The total investor base in Turkey still remains small given the scale of the economy. At the end of 2010, according to the World Bank, the total investor base of Turkey amounted to TYR61bn, equivalent to around 5.48% of GDP. Mutual fund companies are the largest component, followed by insurance companies and private pension funds (1.6% of GDP).

Although the size of the investor base in Turkey is much smaller than the average in middle income countries, especially East Asian countries, the potential for growth is good given Turkey‘s demographic (young population) profile.

Moreover, non-bank financial institutions (NBFIs) continue to play only a

The first two Bosphorus Bridge projects were won by Japanese and Italian led consortia in the late 1980s.

Among the bridges and highways that will be privatised this year as a single package are the two current bridges (the Bogaziçi and Fatih Sultan Mehmet bridges) over the Bosphorus together with their network of so called ‘ring motorways’; the Edirne-Istanbul-Ankara Motorway, the Pozanti-Tarsus-Mersin Motorway, the Tarsus-AdanaGaziantep Motorway, the Toprakkale-Iskenderun Motorway, the Gaziantep-Sanliurfa Motorway, the Izmir-Cesme Motorway, the Izmir-Aydin Motorway and the Izmir and Ankara Ring Motorways. Final bidding for these specific projects was dated to close in late May, but has now been pushed back to late June. Five consortium bidding groups have emerged: Koç Holding, Gozde Grisim Capital, UEM Group (Malaysia); Limak and Vinci (France); Alarko, Fiba, Nurol and MV Holding; Akfen Holding, Autostrada D’Italia (Italy), Thurs–Dogus Holding, which owns Garanti Bank, and Makyol Construction; and finally, Cintra, IC and STFA Holding. Unicredit and Deutsche Bank are reportedly advising the government on the toll road privatisations.

There’s a significant commercial interest in the highways sector in Turkey. The two existing Bosphorus Bridges and their associated ring network generate approximately $600m in turnover each year. Moreover, there is potential for successful firms to leverage local business opportunities; in particular a projected 200km of additional road

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limited role in Turkish financial markets. Their growth has been stunted by macroeconomic instability in the past and the dominance of the banking system. The NBFI industry remains fragmented creating high transaction costs of between 3 to 4 percent of the value of assets under management, depressing returns and discouraging private savings. There is a clear need to increase the role of the NBFIs in Turkey‘s financial markets to create an alternative funding source for the Government and the corporate sector; though the draft capital markets law perhaps does not go far enough in this regard to help the sector in the near future. It may be that parallel reforms are needed in the NBFI sector to ensure it plays a key developmental role in the country’s efforts to enhance its capital markets sector. I

construction (adding 10% capacity in and around Istanbul alone. The city has in fact one of the largest toll road networks in Europe). As well, there is the opportunity to add gas stations, hotels and commercial property along all highway and motorway routes, thereby increasing revenue.

Prosaically, according to ÖYK, the high level of interest in the privatisation sell off is based on the fact that Turkey now enjoys a “Highly significant geopolitical location, situated across continents; [and is an] important industrial and trade hub owing to increasing trade relations with surrounding countries. Moreover, says the privatisation agency investors will benefit from “Constantly increasing traffic averages,” including an annual 5.7% increase in vehicle/km on the highways network and a 12% increase on motorways in the country between 2002 and 2010, compared with a 0% increase in the European Union overall over this period; some 350m vehicles on the road in 2011 and the “high potential for an increase in the number of vehicles per capita (compared to developed countries).”

Curiouser still ÖYK mentions Turkey’s continued candidacy and “expected accession to the EU,” in its official documentation. More seriously perhaps, on a cumulative basis, the sale of the highways is one of the largest sales of state owned assets to date in the country and the combined value of the highways and bridges sell off could eventually top $6bn.

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INDEX REVIEW

MARKET RALLIES ON ECB LTRO EXTENSION

BEEN THERE, DONE THAT: LTRO? ROUND WE GO AGAIN Markets enjoyed a relief rally in early June as investors became more optimistic that Europe’s central bankers are going to get the money printing machines going again. In the event, the ECB announced nothing more than an extension of the LTRO program without an attendant new round of liquidity provision, yet investors kept buying equities as ECB President Mario Draghi said that “officials will act as the euro area’s outlook worsens”. What next? Simon Denham, managing director of spread betting firm Capital Spreads, ponders the outlook.

T APPEARS THAT Germany might look favourably on a Spanish rescue from the EFSF/ESM funds which can then be used to recapitalise Spain’s ailing banks. Although opposed to Spanish banks obtaining direct access to Europe’s bailout funds, Germany might permit the FROB to receive cash which can then be redistributed to those banks that require recapitalisation. Berlin is now waiting on Spanish bank audits (due by month end) and an upcoming IMF report on the sector to understand just how deep the hole really is before making a decision.

Equally, the ECB’s early June interest rate announcement offered the markets very little in the way of positive measures to stimulate growth and prevent contagion. Officials left the interest rate at 1%, although this was not a unanimous decision with some members reportedly seeking a cut in the benchmark rate. ECB president Mario Draghi suggests the ECB thinks that the worst was over for the eurozone, even while downside pressures still remain; a marvellous case of double-speak.

Actually, given the circumstances, the markets have reacted relatively benignly as the Spanish treasury brought €2.1bn to market at a touch over 6% (6.044% in fact) in early June; above the 5.743% of its last foray but well below the 6.7% reached in the previous week. After the government part-nationalised Bankia,

I

40

worries of a contagious default or a massive EU bailout pushed the Spanish risk premium to record levels; at a smidgeon over 500 points over Bunds; but following the bond issue the risk premium fell to a, only slightly more reassuring, sub 480 number.

Readers might be curious as to who the buyers of the new Spanish debt were. It is not as if there is a lack of the stuff out there already and one would have thought that this type of extreme risk profile was not something that financial institutions needed more of right now. Speculation is rife that much of it was picked up by the Spanish banks and then just flipped into the ECB. In any case, the‘successful’ placing was squashed later in the day by Fitch downgrading Spanish debt by fully 3 steps to BBB (with a negative watch) which has put holders into an immediate loss/conundrum.

While most people now take a much more critical view of ratings agencies this does not get away from the fact that a vast array of investment funds across the world have ‘minimum quality’ rules; rules which are rigidly enforced. If Moody or S&P follow suit then the number of potential buyers of such debt will fall substantially just as the markets are deluged by the splurge of liquidating portfolios.

Whilst even Germany’s Angela Merkel has realised that something

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

must be done about Europe and fast, investors should remember that volatility will continue to make trading conditions rather difficult over the summer. Just when you think the market is about to make a more concerted move in one direction it turns around and heads off in another.

Neither bulls nor bears seem to know where the next big move is going to be and it is making trading conditions somewhat treacherous. Any negative news, such as the bad NF payroll figures out of the US, is enough to drag down any and all leading indices.

The world now awaits the next rinkydink piece of accounting/political flannel that will attempt to save Southern Europe without (nominally) drawing an explicit guarantee from Germany. So far we’ve had four ‘decisive solutions’ which have proved to be of the gaffer tape variety; good for a bit but merely masking the problem. All that has happened is that the lack of political courage to actually force electorates to take the foul tasting medicine has merely built the crisis to its current, probably, insoluble level.

Much now depends on eurozone politicians to finesse a situation that could very easily turn into chaos.

Whether they can do or have the will to do so remains moot.

As ever, Ladies and Gentlemen ....place your bets. I

JUNE 2012 • FTSE GLOBAL MARKETS

MARKET QUALITY

Photograph © Skypixel/Dreamstime.com, supplied May 2012.

COMPARING EXECUTION QUALITY ON DIFFERENT VENUES In an increasingly fragmented market for European equities, trading venues are fighting to attract order flow any way they can. Some trumpet statistics boasting of their prowess, whether in market share, tight spreads, low latency or whatever else shows them in the best possible light. For brokers and the buy side, though, the data deluge does little to facilitate cross-venue comparisons. No industry standards exist for measuring market quality, which is in any case a moveable feast—the optimum venue for an urgent active order may be the worst place to execute a patient passive order. Buy side firms are clamouring for information that will allow them to judge execution quality on different venues on a consistent basis—an opportunity and a challenge the trading venues are now beginning to address. Neil O’Hara explains why quality counts.

ROKERS ALREADY DEVOTE substantial resources to venue analysis in the development of better trading algorithms and smart order routers. Their methodologies are proprietary, however, and the results not comparable from one broker to another. Meanwhile, a trading venue that attracts more high frequency traders than its peers may not want to advertise the fact for fear of alienating institutional investors who consider such liquidity toxic.“The buy side is frustrated that one market’s

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FTSE GLOBAL MARKETS • JUNE 2012

premier benchmark isn’t even available from another,” says Laurie Berke, a principal at TABB Group, a New York- and London-based financial services research and consulting firm. “There is a need for standard metrics published on a regular basis to help compare across venues.”

NYSE Euronext took a step in the right direction last year when it began to publish for its own exchanges and competing venues monthly statistics compiled by the Transaction Auditing Group (TAG), an independent

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MARKET QUALITY

firm that has provided execution quality analysis for US trading venues since 1996. TAG developed its own indicators to eliminate any bias in the results but NYSE Euronext still won out, particularly for measures that reflect depth of book.

The report for April 2012 shows that NYSE Euronext and Chi-X were neck and neck (76% versus 75%) for the proportion of time they matched the best bid and offer for all the stocks in the CAC 40 index. They weren’t far apart on the average bid-offer spread—6.91 basis points (bps) versus 7.77 bps—either. For anyone trying to trade size, though, NYSE Euronext was the clear winner. The average value available on the bid and offer was €49,583 versus just €24,680 on Chi-X, and it displayed both best bid and offer and the largest size 37% of the time versus 7% on Chi-X, its closest competitor.

The result is the same for stocks in the AEX, BEL 20 and PSI 20 indices, too. Simon Gallagher, chief of staff, European cash and listings at NYSE Euronext, admits that regulated exchanges enjoy a natural advantage in depth of book over multilateral trading facilities (MTFs).“There is an element of quoting ourselves,” he says, “but the figures are based on neutral measures of liquidity.”

A similar pattern exists on European exchanges that are not part of the NYSE Euronext stable. Intelligent Financial Systems, a London-based independent provider of historical and real time market data services, publishes statistics for some of these venues on its LiquidMetrix Web site. For example, in London during the week of May 7, although Chi-X had the narrowest average spread (7.36 bps against 7.78 bps on the LSE) and showed the unmatched best price more often (7.10% against 3.66% of

Laurent Fournier, head of business analysis and statistics at NYSE Euronext, says ticket size did decrease after the MiFID regulations took effect, but the value available at best bid and offer has not changed—it simply trades on multiple tickets instead of a single execution.

Photograph kindly supplied by NYSE Euronext, May 2012.

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the time), the LSE snagged a higher market share (54.62% versus 30.11%) based on its deeper book (€232,200 against €134,400 within 10 bps of best bid or offer).

One unexpected by-product of the TAG data was a rebuttal of claims that lower average ticket size has reduced available liquidity. Laurent Fournier, head of business analysis and statistics at NYSE Euronext, says ticket size did decrease after the MiFID regulations took effect, but the value available at best bid and offer has not changed— it simply trades on multiple tickets instead of a single execution. At the opening auctions on NYSE Euronext exchanges, 25% of the volume consists of orders valued at €100,000 or more, too. “To say that falling trade sizes mean liquidity is diminishing is completely erroneous,” says Fournier.

TAG collects additional statistics NYSE Euronext does not publish, including some that speak to the nature of market participants on a particular venue. Fournier says that while Turquoise displays the best bid and offer for the CAC 40 stocks 46% of the time, it is the first to set that price only 5% of the time—and has a 5% market share.

Turquoise is known to attract high frequency traders, who supply passive liquidity that follows price changes rather than initiating them. By contrast, NYSE Euronext, which draws a broader range of investors, has the best bid and offer 76% of the time, sets the price 65% of the time and has a 65% market share. “Diversity is important for us and valued by any participant,” says Fournier.

“Investors are afraid to trade on a venue dominated by one type of liquidity.”

The desire to attract different liquidity sources lies behind the “opportunity reports” BATS Chi-X Europe publishes on its web site. For liquidity takers, the data shows the average notional amounts available, how much is at or better than the best bid and offer and the average bid-offer spread for the major European equity indices. On the liquidity provider side, BATS lists the stocks for which it had the greatest unsatisfied demand, showing the liquidity sought for which BATS did not have the other side, the unfilled value of partially filled orders and the value routed to other venues.“Agency brokers who tap our market for liquidity want to know how good the book is in different sectors,” says Paul O’Donnell, chief operating officer of BATS Chi-X Europe.“The market makers want to know how many liquidity takers are showing up. They don’t want to sit in a queue of bids or offers if no one is there to hit them.”

In addition to publishing data, BATS does its own analysis to identify gaps in its liquidity and touts the results to market makers as a business opportunity. Venues can also attract more flow through pricing incentives. At the moment, BATS is making a determined assault on the Spanish equity market, which has not fragmented as much as other European markets. “We have a pricing program designed to bring new participants to different parts of the liquidity spectrum to make the market function on our platform,” says O’Donnell. “It will be for a limited time,

JUNE 2012 • FTSE GLOBAL MARKETS

Michael Krogmann, head of institutional equity at Deutsche Börse, notes that they are not the sole determinant of market quality. A trading venue must also maintain the integrity of its order book—not favouring one group of market participants over another, for example—have clear procedures for handling bad trades and deliver effective market supervision. Photograph kindly supplied by Deutsche Börse, May 2012.

Paul O’Donnell, chief operating officer of BATS Chi-X Europe.

“The market makers want to know how many liquidity takers are showing up. They don’t want to sit in a queue of bids or offers if no one is there to hit them.” Photograph kindly supplied by BATS Chi-X Europe, May 2012.

until the market can sustain itself.” It’s a tactic BATS has employed to good effect elsewhere.

Although quantitative measures are important, Michael Krogmann, head of institutional equity at Deutsche Börse, notes that they are not the sole determinant of market quality. A trading venue must also maintain the integrity of its order book—not favouring one group of market participants over another, for example—have clear procedures for handling bad trades and deliver effective market supervision. It has to have fast and reliable infrastructure, too. “If a venue shows the best quote but traders cannot execute because the system is backed up they will never receive a fill on what they have identified as the best market on a pre-trade basis,” says Krogmann.

“Trading venues need all three elements to deliver the highest value to market participants.”

According to LiquidMetrix, Deutsche Börse’s Xetra platform is the consistent market leader in German equities, offering the tightest spreads, greatest depth of book and the best prices at touch and in size more often than its competitors. A recent study based on FSA Market Cleanliness Statistics by Michael Aitken, a professor at the University of New South Wales, found that, over the past five years, Deutsche Börse also had the smallest run up in prices ahead of price sensitive announcements, an indication that the market is less susceptible to insider trading activity than other European venues.

“Institutional investors in particular face the danger that other participants may detect their size on one side of the book,”says Krogmann.“The higher the market integrity the more it will appeal to institutional investors. Market impact plays a big role in transaction costs for large orders.”

Deutsche Börse uses pricing to induce traders not only to participate on its platform—qualified liquidity providers can trade free of execution, clearing and settlement costs, for example—but to offer tighter spreads and larger size.

The exchange tries to create functional inducements to improve market quality, too. In November, it introduced a new “top of the book” order type, which automatically enters an order one tick better than the then-existing best bid or offer provided it does not create a crossed market.

Some market participants have embraced the new order, and while it is too soon to tell what effect it has had on market quality Krogmann expects that over time it will contribute to narrower spreads.

On the infrastructure side, Deutsche Börse has invested in colocation and other technology enhancements to speed up access to the order book, a critical factor for market makers. “Quoting prices in an open order book is a risk,” says Krogmann. “Certain traders need to be able to adapt their quotes in a very short time. If market conditions change, they have the wrong price and get taken before they can amend it, it hits their profitability.”

Traders need accurate information about which venues

FTSE GLOBAL MARKETS • JUNE 2012

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Jarod Hillman, head of real time data at the London Stock Exchange, does not expect to see final regulations in place before 2015. Data vendors may pre-empt the regulators, however—several firms, including Thomson Reuters and NYSE Euronext, have announced plans to create a pan-European tape. Photograph kindly supplied by the London Stock Exchange, May 2012.

Simon Gallagher, chief of staff, European cash and listings at NYSE Euronext, admits that regulated exchanges enjoy a natural advantage in depth of book over multilateral trading facilities (MTFs). “There is an element of quoting ourselves,” he says, “but the figures are based on neutral measures of liquidity.” Photograph kindly supplied by NYSE Euronext, May 2012.

have liquidity in a particular security to determine where they should route their own orders. While both regulated exchanges and MTFs provide reliable, timely and accurate post-trade data captured directly from the electronic processing feed, other venues rely on contributors to report transactions, which can lead to delays, errors and double counting. In addition, trades executed over-the-counter (OTC) need not be reported until three minutes after execution, a delay that gives brokers who commit capital to facilitate large OTC trades time to hedge their exposure.

in Europe except for the regulators,” says Hillman.“The US single tape systems are cumbersome and have had recent resiliency issues. Europe has a far more complex set of users and requirements.”

From a technical standpoint, data vendors have no difficulty in compiling a consolidated tape from multiple feeds using different data protocols—a core competency.

Provided time stamps are accurate, regulators could obtain the single audit trail they want from a third party vendor while others could buy only the data they need.

“Different investors have different requirements,” says Hillman. “Some people want real time feed in just one name, while professional investors, who have the most sophisticated requirements, may have a huge book of sectors and markets.”

As currently proposed, the tape will show only trades, not the state of the order book on various venues at the time the trade was done. “People want tags that will tell them whether the order was a hedge against an option or convertible, or part of an OTC trade. They want to know whether a particular print contributed to liquidity they could actually access,” says TABB’s Berke. “This tape isn’t going to be all it is cracked up to be.”While it will create an audit trail and facilitate transaction cost analysis, the European tape will do little to advance the debate over market quality at different trading venues. For help on that score, the buy side must look to the venues themselves. I

Finally … a consolidated tape The quality of post-trade data should improve when the MiFID II regulations come into force, which will introduce a consolidated tape for European trading venues and are expected to reduce the delay in reporting OTC trades.

Implementation is some way off; Jarod Hillman, head of real time data at the London Stock Exchange, does not expect to see final regulations in place before 2015. Data vendors may pre-empt the regulators, however—several firms, including Thomson Reuters and NYSE Euronext, have announced plans to create a pan-European tape.

Whether the regulators will mandate a single tape or permit multiple tapes remains unclear, but most market participants would prefer multiple choice.

“It is highly unlikely that anyone has a working requirement for real time price data for every single stock

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JUNE 2012 • FTSE GLOBAL MARKETS

CANADIAN TRADING

THE IMPORTANCE OF BEING SEEN Canada’s financial markets have long been structured to favour trade transparency over cloaked activity and an enhanced regulatory framework set to take effect this fall seeks to keep an even tighter lid on dark trading by giving preference to visible orders while raising the standards for unlit price improvement. What impact might these new rules have on both dark and lit trading volumes in Canada? Are the regulations too draconian, as some suggest? Or will participants be better served in the long run? David Simons reports.

ITH THE US equity trading markets fast approaching maturity, dark-pool providers have been quick to seek opportunities in other locales. Lured by the prospect of strong growth within Canada’s equities market, last August Goldman Sachs Electronic Trading announced the launch of its SIGMA X Canada matching system for dark-pool traders of listed securities on the Toronto Stock Exchange (TSX). GSET’s entry expanded a list of unlit newcomers north of the border that also included the likes of Alpha IntraSpread, a dark pool marketed by Canadian ATS Alpha Group, as well as Instinet’s Canada Cross, comprising twin dark pools (the pre-market VWAP along with the algo-based Instinet BLX).

When TSX’s share of total market volume subsequently dipped to a low of 60% during the latter part of 2011, many believed that liquidity fragmentation within Canada’s financial markets was finally at hand. It was not to be. By April of this year in fact, TSX volume was moving in the other direction—approaching 70%—while, perhaps not coincidentally, that same month Goldman Sachs abruptly announced the closing of its Sigma X dark pool, barely seven months after hanging out its shingle.

For years, Canada has remained steadfast in its belief that staying visible is the key to staying out of trouble, and accordingly, Canada’s financial markets have long been

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FTSE GLOBAL MARKETS • JUNE 2012

structured to favour trade transparency over cloaked activity.

New regulations set to take hold this fall which, among other things, would disallow smaller unlit orders unless significant price improvement is provided, could force certain providers to revamp their spread-capture structures or run the risk of becoming non-compliant.

Meanwhile, those who prefer life in the fast lane are likely to feel the effects of Canada’s new message-based costrecovery fee model (which imposes a charge on messages in addition to trades), further eroding Canada’s already flagging high-frequency trading volume.

An enhanced regulatory framework, unveiled in April by the Canadian Securities Administrators (CSA) in conjunction with the Investment Industry Regulatory Organisation of Canada (IIROC) and set to take effect in October, seeks to keep an even tighter lid on unlit trading by giving preference to visible orders while raising its standards for ‘meaningful’ price improvement. Additionally, the agencies may consider the possibility of establishing a minimum-order threshold for dark operators at a later date, should conditions warrant.

According to CSA and IIROC officials, the new guidelines are intended to provide a clearer pathway for institutional participants attempting to execute large trading blocks, while at the same time offering adequate price improvement for small investors who trade unlit securities. While recognising

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CANADIAN TRADING

the benefits of using dark liquidity for healthy price discovery, Susan Wolburgh Jenah, IIROC president and chief executive officer, says that the aim of the proposals is to ensure that “Canadian equity markets continue to evolve in a fair and competitive manner that strengthens market integrity and investor protection.”

Canada’s historical emphasis on full and fair access, requiring that the entirety of the country’s capital markets be open to all participants, has gone a long way towards restricting the growth of so-called “club” models that have been prevalent elsewhere, says Thomas Kalafatis, head of Prime Services Group for Toronto-based CIBC. Additionally, these rules stipulate that meaningful price improvement must be achieved in order for unlit trading to remain viable.

“Furthermore, the notion that quotes must be accessed at a certain visible price point compels venues to take into account all of the different types of marketplaces that exist within Canada as part of the routing decision-making process,” says Kalafatis.

Given these factors, it is easy to see why Canada’s darkpool market share, though incrementally higher than the year-ago period, remains relatively muted. While dark venues like Match Now, Liquidnet Canada, Instinet’s ICX and Alpha’s Intraspread have continued to thrive despite the regulatory pressures (helping unlit trading reach an estimated 4.5% of total volume through early 2012); others have not fared nearly as well. Three years before Sigma X took an early exit, in 2009 Perimeter Financial was forced to shutter its BlockBook ATS after an ultimately unsuccessful four-year run.

However, as the new IIROC rules merely seek to close existing loopholes that could lead to non-complying USbased models to enter the Canadian markets, Kalafatis doesn’t see any drastic changes to the regional market structure over the near term. “It just keeps things the way they are,”he says,“and ensures that all investors are afforded the same unfettered access.”

HFT patrol on point Like dark pools, high frequency trading (HFT) has struggled to gain traction in Canada, and to date accounts for roughly one-third of Canadian trading activity, compared to 60% HFT in the United States. Maintaining a more measured approach to electronic trading has allowed Canada’s investors to weather the pronounced shifts in market volatility better than some of their major-market counterparts, suggest some industry observers, and to that end, the new CSA/IIROC regulatory framework serves as an“imprimatur around high-frequency activity,”says Kalafatis, by specifying what is and what is not acceptable in terms of forms of access within the Canadian marketplace.

Rubrics such as reduced ETF volumes associated with HFT strategies, as well as lower overall message rates and reports of lengthened order dwell times, suggest a pullback in Canadian HFT, says Joel Goodwin, senior equity trader for State Street Global Advisors (SSgA). While the IIROC’s new message-based cost-recovery model could potentially lead

46

Robert Young, chief executive officer of Liquidnet Canada, a dark-pool operator and provider of block liquidity to the buy side, expects to see greater consolidation over the next 18 months, fueled by regulation, lower volumes as well as natural market forces. Photograph kindly supplied by Liquidnet Canada, May 2012.

to lower volumes on the TSX, it has also resulted in narrower spreads and a reduction in overall messaging traffic. This not only points to reduced HFT activity but also the potential for a higher-quality order book,“since order messaging largely contributes to ‘noise,’” says Goodwin.

By interacting with dark pools and HFT order flow in an informed way, it is possible to protect one’s order from outside manipulation from HFT or toxic dark pools, says Goodwin.“It is important to note that the original purpose of dark pools was to connect orders between buy side participants and minimize market impact and trading costs by removing broker intermediation. While there are many more participants in dark pools today, liquidity begets liquidity and at SSgA, execution costs remain the overarching factor we consider in how, where and when we execute.”

Still, regulators must proceed with caution in order to avoid policy decisions that could have unintended consequences, says Kalafatis.“We realise that it is a difficult job regulating this kind of activity, and yet the details are critical, because if not properly managed, you could wind up losing market share.”

Kalafatis suggests that some regulatory easing may be in order so that Canadian institutions can remain competitive.

“For instance, in the United States if two broker-dealers want to trade together, they are allowed to do so by contracting risk-management to each other,” says Kalafatis. “We would like the same kind of arrangement to be made available in Canada. Having duplicative risk filters isn’t really necessary—if the risk filters are not implemented properly, there could be a reduction in the quality of risk monitoring.

In other words, by trying to raise the bar using a single

JUNE 2012 • FTSE GLOBAL MARKETS

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CANADIAN TRADING

benchmark for the entire industry, you actually run the risk of lowering the bar instead.”

As in other major markets, overall volume in Canada has been trending downward; in April, trading activity dropped some 22% following a lacklustre first quarter (Q1). Hence, while the markets may be able to support the current profusion of lit and dark pools, in all likelihood some sacrifices are in order. Robert Young, chief executive officer of Liquidnet Canada, a dark-pool operator and provider of block liquidity to the buy side, expects to see greater consolidation over the next 18 months, fueled by regulation, lower volumes as well as natural market forces. “Regulators have taken a leadership role in market-structure development in Canada,” says Young, “moving proactively on unnecessary intermediation and on high-frequency trading.”Dark markets that trade in small quantities just inside the quote may find themselves on the wrong side of the new dark trading rules, forcing them to adopt a large- and/or mid-point model—a space already dominated by Liquidnet, notes Young.

Globally depressed volumes, along with a reduction in natural, non-derivative related block liquidity in Canada, will likely promote further dark-pool consolidation, says SSgA’s Goodwin. “There is the potential for increased volumes should a Canadian/US dollar divergence occur, as this could increase arbitrage-related cross-border transactions in duallisted issues,”notes Goodwin,“however, our view appears to be supported by Goldman Sachs’ decision to cease operations of the Sigma-X product.”

Market factors continue to contribute to the overall lowvolume environment in lit pools as well, says Goodwin. The market and trading environment has changed substantially since the onset of the financial crisis and was exacerbated by the “flash crash,” with the net result being lower volumes globally due to a number of factors including unforeseen macro risks, a smaller pool of natural participants, and structural changes due to changing regulations.“Also important is the outright loss of the retail investor, as trust in the financial markets has eroded and investors continue to be uncertain over the pace of financial reform.”

A defining moment Although the various barriers to entry may be off-putting to some, new opportunities are readily available for those that can demonstrate an ability to provide a unique value proposition to Canadian investors. “The ATS rules are such that new marketplaces can be created, assuming that participants have something substantial to offer,” maintains Kalafatis. “The whole notion of creating fragmentation for fragmentation’s sake is no longer appealing to investors.

There was a time when it was perceived that increased competition could actually lead to reduced trading costs; however, we’ve since witnessed a shift from variable-trading costs to different types of costs associated with fixed-data, connectivity, routing and other technologies. As a result, investors are skeptical as to whether costs will actually recede as a result of fragmentation, particularly in this kind of multi-market environment.”

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Canada’s historical emphasis on full and fair access, requiring that the entirety of the country’s capital markets be open to all participants, has gone a long way towards restricting the growth of so-called ‘club’ models that have been prevalent elsewhere, says Thomas Kalafatis, head of Prime Services Group for Toronto-based CIBC. Photograph kindly supplied by CIBC, May 2012.

From his vantage point, Young sees buy-side traders focused primarily on two key issues—dwindling liquidity and transparency of order-handling. Despite having fewer large cap (and ostensibly more liquid) issues at their disposal, traders have benefited from Liquidnet’s 20% liquidity discovery rate in Canadian equities, not to mention a comparatively robust banking sector that has shown itself willing take on positions in an effort to service clients.“These have helped mitigate—if not negate—the impact of dwindling liquidity,” says Young.

Canada’s longstanding reliance on trade (or broker) attribution—whereby the executing broker’s identity is included with the trade—has helped keep the order-handling process relatively transparent. But as the buy side begins to differentiate the quality of contra liquidity, Canadian equities traders worry about the possible impact on order handling over the near term. In Canada, the potential exists for brokers to ship orders in the various US-interlisted stocks across the border, exposing Canadians to different players and market structures and subsequently creating a whole new set of challenges in terms of managing institutional-order exposure. As Young explains, “It is becoming increasingly apparent that the benefit of additional, US-based liquidity comes with an increasing cost in complexity.”

To Young, the current situation represents “a defining moment” for Canada, as participants and regulators focus on shaping a better market, “one with reduced HFT, lower fragmentation, better transparency and clearer competition than many other markets in the world.”If all goes according to play adds Young, it is the type of market that, in the end, stands to benefit investors and issuers alike. I

JUNE 2012 • FTSE GLOBAL MARKETS

SPONSORED STATEMENT: EUREX EXCHANGE

Delivering innovation with Eurex Exchange’s new trading architecture

With its new trading architecture, set to go live in December 2012, Eurex Exchange is again demonstrating its commitment to providing its customers with cutting edge technology. According to Wolfgang Eholzer, Head of Trading System Design at Eurex Exchange, innovation was the watchword—the guiding principle in the development of the exchange’s new trading architecture. He explains, “When we set out to design a completely new trading architecture, we took steps to encourage out of the box thinking. We felt strongly that in order to push the envelope with our new architecture, we needed to free ourselves from legacy constraints and really encourage our staff to think creatively.” Importantly, he adds, “We compromised none of our legendary reliability in the design [of the new architecture]. At the end of the day, bells and whistles don’t mean a thing if our exchange is down.” Eholzer further explains that among our peers, this reliability factors prominently in the exchange’s appeal. “One of the differentiators between Eurex and our competition is our proprietary trading software and network, which is based on a very robust design to ensure maximum availability.”

The next generation in exchange trading systems n terms of the appeal of the new trading architecture, Eholzer is confident that it really is a trail blazer in the industry. With enhanced functionality, platform independence and enhanced processing speed, the particulars of the new trading architecture have been well received by Eurex Exchange participants.

Eurex delivers a completely new trading platform, which allows for greater flexibility and quicker time to market for new functionalities and products going forward, ultra-low latency trading using state-of-the art technology including Linux servers, a new partitions concept for better scalability, throughput and separation of failure domains, a new direct messaging concept for high throughput that eliminates the need for a message broker and more.

Eholzer talks about introducing ‘real innovation’ in terms of the Eurex Exchange matching engine when asked to highlight stand-out features of the new system. Instead of the legacy setup in which the exchange maintained three separate matchers with three different sets of code, going forward the new trading architecture maintains one set of code for the matching of all products. The system will also feature more allocation schemes including the previously available price-time and price-pro-rata allocation schemes but also a new price-time/pro-rata allocation scheme as well.The advantages of this streamlined code are substantial according to the chief designer, “When we introduce changes to our core matching to further improve latency and, products matched according to all allocation schemes will benefit immediately so time to market is significantly reduced.” By implementing these types of smart design principles to maximize efficiencies customers and the exchange both benefit.

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Integral customer involvement Given that the exchange has engaged in intensive contact with market participants over the previous six years as part of its ongoing technology planning, which it refers to as its “Technology Roadmap”, developing the specifications for the new system was a seamless, organic process. Select customers were involved in the review process in a conversation-like process, which facilitated the design process and helped maximize efficiency. Eholzer explains, “This way, we drafted a blueprint and presented it to customers. And if we discovered that we were heading down the wrong path, we weren’t wasting resources.” Such interaction with

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customers is mutually beneficial for the exchange and customers in terms of getting expectations and software to match.

Eholzer clarifies that important changes had been implemented throughout the previous releases, but some things were impractical to implement in the legacy system. “The unencumbered design of the new trading architecture gives us much more freedom in the implementation of both major and minor changes. This will allow us to speed up the release cycle for exciting new products and features, and something that will benefit our customers in the rapidly changing financial markets.”

A major release: managing complexities The introduction of the new trading architecture ranks as the biggest single change that Eurex has yet implemented. While the 1998 cross-border merger of DTB (Deutsche Terminbörse) and SOFFEX (Swiss Options and Financial Futures Exchange) was admittedly a monumental undertaking, trading, market data and clearing volumes at that time were much smaller. As Eholzer succinctly puts it, “What we’re doing now is an order of magnitude larger.”

When Eholzer was asked “what keeps you up at night?” he answered, “The complexity of what we’re doing. Not only do we have a new trading architecture, but we also interface with other complex internal systems, customers and software vendors.”

Preparing customers for the introduction of the new trading architecture is foremost on the exchange’s priority list. In fact, to manage the migration, Eurex has dedicated transition teams in place, has already held customer information sessions and inperson consultative sessions.This proactive customer interaction is supported by a migration website and extensive documentation.

Additional educational initiatives including on-demand video and webinars are planned.

When asked to provide closing advice for Eurex Exchange participants undertaking the migration process, Eholzer’s stresses the power of the strong relationships that he and his team have built with exchange participants, “If you need help at any point during the process, ask. We’re available, flexible and hands-on. Our job is to ensure that you’re up and running in December.” I For information on Eurex Exchange’s new trading architecture, visit: http://www.eurexchange.com/nta Wolfgang Eholzer, Head of Trading System Design Wolfgang.Eholzer@eurexchange.com

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Photograph © Marilyn Volan/Dreamstime.com, supplied May 2012.

BLOCK TRADING

Block trading on the block?

When floor traders at the Chicago Mercantile Exchange (CME) staged a walk-out on April 12th this year, they were protesting against a large block trade that had been negotiated and conducted away from the pit, shutting them out of the picture, they said. While this block comprised eurodollar contracts being rolled forward, electronic block trading is growing in asset classes other than cash equities as electronic tools have developed to cope with the demands of different types of trading. However in the equity trading markets, block trading might just have run its course in some segments; though the buy side still show signs of wanting to have the facility to trade in blocks. Ruth Hughes Liley reports.

ESEARCH GROUP, AÏTE’S Howard Tai says: “For old-school end-users of FX options, the time has come to embrace the evolution of electronic FX trading, especially in today’s environment, where establishing audit trails through electronic footprints on financial transactions is vital.”

That may be so, however, in the equities space, where block trades have traditionally been defined as a single trade of more than 10,000 shares, the trend is determinedly down as algorithms chop up blocks to trade them and as regulators are demanding less over-the-counter (OTC) trading [a traditional heartland of block trading]. In addition, low volumes are also taking their toll on block trading and the cost is being counted across the globe. For instance, on May 24th Chi-East ceased trading. It was a joint venture between Singapore Stock Exchange and Chi-X Global and offered a non-display block trading platform for Japan, Singapore and Hong Kong. While it promised much; Chi-East is the latest casualty of indifferent markets. Somewhere, somehow it seems, something had to give.

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“Unfortunately, the launch of Chi-East directly corresponded with a period of slower market volumes globally.

Although trading volumes were improving, they were still short of expectations,” acknowledged Ned Phillips, chief executive officer, in a telling statement on Chi-East’s website.

Just how far volumes are off is illustrated by Rosenblatt Securities, which tracks data of average daily volume in dark pools. Rosenblatt points out that by the middle of 2010 the average execution size in the US was 433 shares. That figure has been falling gradually ever since to reach a mere 226 shares in January 2012. In that context then it is no surprise that Kieron O’Brien, managing director, Rosenblatt Securities in Europe speaks of the demise of block trading. “Dark pools were set up so larger sizes could be traded, but if we look at the average execution order size, it is now very close to the lit market. The original intention for those dark pools has been adapted and dark pools have become just another liquidity point to consider.”

Dark pools it seems have not always met one of their original justifications: that they were a black hole for infor-

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mation leakage, a cornerstone of effective trading. As O’Brien explains,“Trading is about management of information leakage, and if I can go to a pool and post 500 shares and get some indication from the other side as to the level of interest, I am surely going to do that, rather than post a more risky 50,000 shares. The ability to garner information can be achieved with a much smaller chance of leakage. Hence one reason for the decline in sizes traded in dark pools,”says O’Brien.

Rob Shapiro, global head of trading, at Bloomberg Tradebook agrees: “One could argue: why trade a block when you could work an order over a period of a few hours and get a better price. Trading size is about speed and convenience, but also about the stock price. The value of trading a block and the efficiency of electronic trading has changed over time. There’s a whole new generation of traders who are younger and don’t remember the heyday of block trading.

The truth is, in that period, if you traded a block, a sales trader would send you a little trophy!”

Horses for courses While Rosenblatt puts the bulge bracket houses top of the list when it comes to volumes traded in their in-house dark pools, it is a different story when looking at the size of trades. So Credit Suisse Crossfinder, for example, which grew 53% in its average daily volume traded between March 2011 and March 2012, and sees daily trade of €599.1m, has an average trade size of just €4,713. At the other extreme, Liquidnet, whose average daily volume traded in March was just €89.4m saw an average trade size value of €900,375, putting it top of the block traders.

O’Brien makes the point:“The attractiveness of the size of trades in a pool depends on what you are trying to achieve and whether you are buy side or sell side as to what makes sense for you. The key is choice.”

Liquidnet is a buy side to buy side matching engine and its chief executive, Seth Merrin, says its average trade size of 50,000 shares has been “stable for several years, even throughout the financial crisis.” Other block trading platforms include ICAP’s Blockcross, ITG’s Posit, Pipeline and New York Block Exchange (NYBX), which launched in January 2009 as a joint venture between NYSE Euronext and alternative trading system, Bids Trading. Within six months NYBX was reporting an order fill rate of 48% according to Rosenblatt. Meanwhile, broker-dealer consortium-owned Bids Trading has grown its ADV from around 45m shares to 80m shares in Q2 2012 and has an average execution size of more than 26,000 shares, according to its own figures. Block orders constitute 58% of its total volume.

NYBX chief executive Tim Mahoney says its strength lies in giving client’s choice and providing a large range of order types on one trading system and one matching engine.

Moreover, he holds that block trading has an advantage in the US.“No matter what venue you trade in, it is reported to a consolidated tape immediately, for all intents and purposes. This is a benefit to block trading because the most important thing is the last price where a stock traded, not the

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NYBX chief executive Tim Mahoney says its strength lies in giving client’s choice and providing a large range of order types on one trading system and one matching engine. Moreover, he holds that block trading has an advantage in the US. “No matter what venue you trade in, it is reported to a consolidated tape immediately, for all intents and purposes. This is a benefit to block trading because the most important thing is the last price where a stock traded, not the venue where the stock traded nor the bid or offer. In Europe this is different because there is no consolidated post trade reporting.” Photograph kindly supplied by NYBX, May 2012.

venue where the stock traded nor the bid or offer. In Europe this is different because there is no consolidated post trade reporting.”

However, consolidated price data may not make much difference in Europe as one trader puts it: “When you are trading a block you are trading outside the bid-offer spread, so I don’t see why one tape will help, although it makes it easier to aggregate and do transaction cost analysis (TCA) and get a picture of total liquidity.”

Merrin believes it is in the instinct of institutional traders to want to trade large blocks.“If you have a personal trading account, investing $50,000, you are not going to buy one share at a time. Institutional trading is no different from that; it just plays with larger amounts of money. Institutional investors will never want to implement orders at 250 shares at a time, which is the level that the lit and dark venues are down to these days.”

Andrew Morgan, head of Autobahn Equity Europe, Deutsche Bank, says that the definition of a block trade has changed with the onset of fragmentation.“As average order and fill sizes become smaller the definition of a larger, market moving trade has changed. Most traders would think about block trading in terms of making a risk price to a client for that size of stock. Dark pools are a significant venue for unwinding that risk.”

The impact of market conditions A year ago, risk appetite was higher and Dealogic figures pointed to $12.2bn worth of block trades in just the first quarter of 2011. However, as everyone knows, the world (and trading volumes) went to pot since then. Morgan explains

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the trend: “For the last couple of years it has been more difficult to find someone to transact a big block of stock. It’s a challenge because of the combination of low volumes, high volatility and the credit crisis.”

Merrin says that a skewed supply and demand imbalance does not help.“For every £1m of demand, there’s just £1,000 of supply. There is so little supply on exchanges which is then exacerbated by the brokers and their algos, resulting in a decline in execution sizes all around the world. It isn’t that the buy side doesn’t want to trade blocks. They do but market conditions on most lit and dark venues don’t allow it.”

Despite the problems running through today’s markets, most market participants agree that the buy side still has a desire to see block trades and some firms are beefing up their algorithms to cater for this demand. Credit Suisse’s Blockfinder allows participants to dictate a minimum level of trade size to interact with. Blockfinder will then search multiple dark venues for an appropriate ‘block’. Meanwhile Liquidnet Dark is an algorithm that allows buy side firms to specify minimum size of trade on most of the external dark pools in Europe. Liquidnet Dark claims to be trading $40m a day in Europe.

Other firms are creating ‘smart’ block trading platforms.

Tony MacKay, founding CEO of Chi-X Europe, is aiming to launch a block exchange by the end of the year which will use social networking principles, allowing participants to prioritise their orders. Additionally SpreadZero, a new firm on the block (no pun intended!), is gathering clients before it launches in September and will provide direct desktop access to institutional clients for block trading of government bonds and other investment grade securities. It will also allow instant messaging for private and anonymous negotiations.

Also in the pipeline, former head of connectivity at Fidessa, Chris Gregory, is also launching a ‘solution’ for block trading which he hopes to launch by the first quarter of next year.

Gregory, now managing director of new firm Squawker, explains his commitment to the segment and holds that block trading can save traders money:“Month on month, the average trade size falls by 3%. But there are still large block orders coming from managers. When these are loaded into an algo and traded in bits, every single piece has a fee and you are racking up these fees all the time. Doing it now as a block is still much cheaper.”

Tony MacKay, founding CEO of Chi-X Europe, is aiming to launch a block exchange by the end of the year which will use social networking principles, allowing participants to prioritise their orders. Photograph kindly supplied by Tony MacKay, May 2012.

it doesn’t give management control, says Gregory); some providers actually project a rosy future for block trading: “In Europe, the regulators are aware of the problem and the organised trading facilities (OTFs) and swap execution facilities (SEFs) point to something beyond MTFs and order books. The fact that 15-20% of value is still not done on order books shows that it is up for grabs,” says Gregory.

The importance of market structure Market structure is significant for how effectively blocks can be traded. Deutsche Bank’s SuperX is a Broker Crossing Network (BCN), rather than a multi-lateral trading facility (MTF), which means it can allow participants some freedom of choice about who they interact with in the pool. SuperX saw volumes grow 380% in the year to March 2012, according to Rosenblatt. Its dark pool aggregator, SuperX Plus creates a heat map of liquidity on the 38 dark trading

The end of OTC traded blocks?

With around 15% of block trading done over-the-counter (OTC) as brokers pick up the phone to search for the other side of a trade, Gregory says it is regulators who are also signalling the end of OTC-traded blocks: “OTC is part of the problem as it has few audit controls and compliance managers can’t control it. So the management end in a lot of firms discourages people from dealing over the phone: telephone based OTC is being squeezed hard and with it block trading,” explains Gregory.

Nonetheless, in spite of lit and dark trade sizes declining and the continuing struggles in the OTC segment (because

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Seth Merrin, chief executive officer, Liquidnet. Merrin says its average trade size of 50,000 shares has been “stable for several years, even throughout the financial crisis.” Photograph kindly supplied by Liquidnet, May 2012.

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BLOCK TRADING

Also in the pipeline, former head of connectivity at Fidessa, Chris Gregory, is also launching a ‘solution’ for block trading which he hopes to launch by the first quarter of next year. Gregory, now managing director of new firm Squawker, explains his commitment to the segment and holds that block trading can save traders money. Photograph kindly supplied by Squawker, May 2012.

Andrew Morgan, head of Autobahn Equity Europe, Deutsche Bank, says that the definition of a block trade has changed with the onset of fragmentation. “As average order and fill sizes become smaller the definition of a larger, market moving trade has changed. Most traders would think about block trading in terms of making a risk price to a client for that size of stock. Dark pools are a significant venue for unwinding that risk.” Photograph kindly supplied by Deutsche Bank, May 2012.

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venues in Europe. Morgan explains that: “It brings liquidity together in dark pools in the same way that a smart order router brings liquidity together for lit venues.”

However, some shy away from aggregation on the basis of information leakage. It’s a serious concern for the buy side that when they place a large order others might spot the trade and front-run the block.

Mahoney says: “Non-displayed or dark venues are a valuable tool when there is high information content in a trade that would drive the value in the market. Another potential user of dark liquidity might be portfolio trading desks, which are often very passive. If you are not in a rush to trade those stocks, if there is a low sense of urgency, and the correlation among stocks has gone down, then a dark pool is a good place and a trader might use non-displayed liquidity. If there’s a high sense of urgency, you are going to trade in a displayed market where you can see the stock on your screen.”

While MIFID has led to fragmentation of stocks and smaller stock sizes, other regulation is in the wings which could also affect block trading, the most prominent being Basel III capital requirement rules and Dodd-Frank in the US, in which the Volcker Rule will prohibit banks from trading on their own account where it would not benefit their customers.

These could have an effect on how much money banks are willing to set aside for risk trades, believes Merrin: “When volume is light, the investment banks tend to buy portfolio trades. They will bid very aggressively and give a good price for the entire portfolio. But I think that will decline in the investment banks. It was a tactic used by them to generate a lot of trades, but we still have to see how Basel III and the Volcker Rule turn out.”

Merrin believes that after recent losses suffered by JP Morgan, the rules are more likely to be implemented more stringently:“If there is less capital available to the buy side to push those large trades, if they want to own or dispose of stock, they will increasingly need to execute on institutional trading networks like Liquidnet.”

Nonetheless dark block trading is still a tiny proportion of total trade: Liquidnet’s business is 0.13% of total consolidated turnover in Europe, while Credit Suisse’s Crossfinder amounts to 0.89% (according to a March 2012 paper by Rosenblatt).

Ultimately, says Liquidnet’s Merrin, it all comes down to market dynamics and any mooted end to block trading is just too pessimistic a view; there will always be room for the trading approach:“There have been outflows from equities.

Investors have been pulling money out of mutual funds and long-only have been losing assets; these dynamics have created challenges for the buy-side. The two biggest issues for our participants are getting best execution and paying bills. We continue to gain market share but the buy side could use our liquidity pools more. I do believe our market share will continue to grow, however they will still continue to use broker-dealers so they can gain access to the other services they offer.” I

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SECURITIES LENDING

To Clear or Not to Clear?

Photograph © Cornelius20/Dreamstime.com, supplied June 2012.

Securities Lending:

Central clearinghouses have never been so popular among regulators and legislators. By the time the Dodd-Frank Act and the European Market Infrastructure Regulations come into full force, the vast majority of OTC derivatives trades will be cleared, permitting regulators for the first time to see who is trading with whom and in what size. Regulators are now debating whether to extend the clearing mandate to securities lending, another business conducted primarily on a bilateral OTC basis.

HE INTRODUCTION OF CCPs in securities lending is part and parcel of a change drivers in the financial services industry. Those drivers include increased attention to counterparty risk, tougher regulatory requirements in terms of capital allocation and use of balance sheets, a heightened sense of risk and the increased costs of risk mitigation to beneficial owners involved in securities lending. Finally, of course, regulators are attempting to control systemic risks per se in the international financial markets and increase overall market supervision. They are by now familiar themes.

CCPs are now taking centre stage. However, their role is circumscribed. According to a recent study by TABB Group, “despite the demanding and product specific requirements of securities lending, CCPs are able to deliver the fundamental benefits for which they are designed, namely counterparty risk mitigation and improved operational efficiency. Optimisation of the CCP model in securities lending will require significant industry consultation and flexibility in application”.A recent report from the Financial Stability Board (FSB) suggests that regulators may be less concerned about credit risks than the pro-cyclical effects of securities lending and the role it plays in the shadow banking system. In lending transactions backed by cash collateral, securities

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can be called back at a moment’s notice while cash is reinvested in instruments of longer duration. This maturity and credit transformation is precisely what money market funds in the United States do, an industry with a bull’s-eye on its back ever since the Reserve Fund“broke the buck”in 2008— an event that forced the US Treasury to offer a temporary industry-wide guarantee to forestall a catastrophic run on assets. Although central clearing has no effect on cash reinvestment programs, it would give regulators transparency into a business that is notoriously opaque; though transparency is more in line with trade repositories than necessarily central clearing.

Even so, market participants will soon be able to clear securities lending trades in Europe no matter what the regulators decide. Eurex Clearing and Pirum Systems signed off a Connectivity Agreement in late May to facilitate access to Eurex Clearing’s Lending CCP. Market participants will be able to leverage Pirum’s automation platform to transmit bilaterally negotiated transactions to Eurex Clearing.

Pirum Systems is an expert in automating post-trade processes for the securities finance industry. The direct connectivity between Eurex Clearing and Pirum’s automation platform allows market participants to “make use of their existing Pirum interfaces to feed bilaterally agreed trans-

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actions to Eurex Clearing for CCP novation and downstream processing, via an API,”explains Jonathan Lombardo, global head of sales at Pirum.

“Leveraging Pirum’s existing connectivity will significantly simplify access to Eurex’s securities lending CCP Service; providing clients with seamless integration for CCP transactions using the same business processes and system interfaces that are already used for bilateral transactions,”explains Lombardo, and is the first partnership “to offer the safety and efficiency of central clearing to the large bilateral-organised securities lending market. Fully introduced, it will cover European markets for loans in equities, ETFs as well as fixed income securities and will provide significant improvements to the current market structure.” However, adds Lombardo, by year end he expects the platform will be able to accept securities broader than equities.

The clearing house will act as single counterparty to all trades and therefore will reduce counterparty risk exposure and eliminate the need for multiple credit evaluations. Thus, users can achieve a significant reduction in capital allocation associated with bilateral transactions. In addition, the new service is able to support the existing relationship between agent lenders and beneficial owners by introducing a unique member model for beneficial owners. Eurex Clearing also intends to further expand the range of its Lending CCP Service by leveraging internal solutions.

The project has been maturing for some time: Eurex and Pirum established the basis of the new clearing service as far back as 2009 and together have spent the last three years developing the service in conjunction with specialist consultation with major market participants, including borrowers and lenders which have committed to use it after the anticipated launch this summer. Essentially it is a gateway, explains Jonathan Lombardo, which will feed bilaterally agreed trades to the central clearer, “via an API; extracting transactions on a five to ten minute interval, which is in turn transmitted to Eurex. Eurex then validates and novates the trade; sends confirmation back to Pirum, which then books the trade.”

Gerard Denham, head of client and market relations for securities lending at Eurex Clearing, nursed the project through the development stage and expects the new service to gain traction because it benefits both sides.“Bringing in a central counterparty minimizes credit exposures and counterparty risk for lenders,”he says.“For borrowers, it minimizes the regulatory capital requirement—a big advantage.”

Eurex will guarantee the return of securities to the lender and collateral to the borrower in the event that either party defaults. It will introduce operating efficiencies to securities lending, too: more automation and straight-through processing (STP) of recalls, returns, re-ratings, marks to market and corporate actions as well as the calculation and payment of lending fees. The Eurex platform does not require anonymous trading so participants will retain the flexibility to choose their trading partners just as they do in a bilateral arrangement. The model was designed to disturb existing relationships as little as possible—and to minimise costs.

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Nicholas Bonn, head of securities finance and portfolio solutions at State Street thinks that: “Risk sharing doesn’t work in a market with too few participants. I would rather manage my own risk exposure to Lehman than share it with 13 of my closest friends.” Photograph kindly supplied by State Street, May 2012.

Previous attempts to promote clearing for securities lending have foundered in part because they required the lenders to put up collateral at the central counterparty instead of taking in collateral from the borrowers. The new system permits a beneficial owner to acquire a license from Eurex under which the borrower’s non-cash collateral is pledged to a tri-party account, which frees the lender from any margin requirement. “If the lenders take our specific license, margin will not apply if they are taking non-cash collateral,”says Denham.“This removes the biggest concern to date for clearing securities lending—that the lender has to put up margin.”The central counterparty will treat cash collateral the same way agent lenders do now, passing it on to beneficial owners for reinvestment.

The attempt to accommodate existing market practices as much as possible may help Eurex avoid the fate of SecFinex, a European securities lending trading platform that closed down at the end of 2011. SecFinex had struggled to attract business and its major shareholder, NYSE Euronext, did not foresee any change until regulators require market participants to clear these trades and/or the Basel III capital framework kicks in.

Trades on SecFinex were cleared by either LCH.Clearnet or SIX x-clear, depending on the country in which the trade took place. SIX x-clear wants to stay in the game, but Thomas Kindler, head of clearing relations, says the firm may reposition the service toward higher margin business.

At today’s low interest rates, the plain vanilla securities lending SecFinex handled delivers a return of just 1.5 basis points (bps), too low to support the cost of clearing. By comparison, collateral swaps—a longer-term form of securities lending—yield 40bps to 70bps. “Have we been in the right segment?” asks Kindler.“We see more potential in the area of collateral upgrade trades.”The advent of OTC derivatives clearing will create enormous incremental demand for collateral transformation.

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SECURITIES LENDING

In the United States, clearing of securities lending transactions has been available on a limited basis for many years. The Options Clearing Corporation (OCC) has offered dealer-to-dealer clearing to its members since 1993, a service it developed at their request to help dealers reduce the capital requirements on options positions hedged through a short sale.“We novate the trade and stand in the middle as lender to the borrower and borrower to the lender,”says Joe Pellegrini, head of securities lending at OCC. “With that program, we guarantee the return of the securities against the collateral.”

In 2009, the OCC expanded its service through a partnership with Quadriserv, which operates a trading platform for securities lending called AQS. It’s an anonymous screenbased system that allows banks and brokers to arrange trades and send them to the OCC, which breaks the trades into two halves, inserts itself in the middle and hands the novated trades off to DTCC for settlement. “With that program, we not only guarantee the return of securities and collateral but also rebates and any corporate actions related to cash dividends,” says Pellegrini. Participants must be either clearing members of the OCC or sponsored by a clearing member.

The AQS platform got off to a slow start, in part because it requires participants to abandon ingrained habits in how they arrange securities lending trades. Volume has picked up in recent months, however: Pellegrini says the aggregate notional value of cleared trades on the OCC’s internal system and the AQS platform nearly doubled over the eight months through April 2012 to $28.4bn while the number of transactions grew by 34%. Market share data is not available—nobody tracks what trades are eligible to use the services—but it’s a small blip compared to the $700bn U.S. securities lending market.

Agent lenders are not opposed to central clearing in principle but they do question whether the purported benefits outweigh the incremental costs. Keith Haberlin, head of securities lending at Brown Brothers Harriman in London, sees a central counterparty primarily as another channel through which his clients could lend out their securities. If the clearinghouse guarantee induces lenders to trade with counterparties they avoid on a bilateral basis and borrowers to seek the capital relief available on cleared trades, the overall market could expand.

Haberlin nevertheless points out that, unlike risk management using OTC derivatives, securities lending is a discretionary activity. Clients like the flexibility to choose their counterparties, set individual credit limits, establish collateral guidelines and manage the risks themselves. A central counterparty would change all that—and may require them to put up margin as well. “If a model is imposed which results in clients having less control over the parameters of the program, they may decide the returns are no longer worth the risks and exit the business,” says Haberlin. “We would support central clearing counterparties as an option on a commercial basis, but we would not want to see regulators mandate their use.”

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Keith Haberlin, head of securities lending at Brown Brothers Harriman (BBH) in London. Haberlin sees a central counterparty primarily as another channel through which his clients could lend out their securities. If the clearinghouse guarantee induces lenders to trade with counterparties they avoid on a bilateral basis and borrowers to seek the capital relief available on cleared trades, the overall market could expand. Photograph kindly supplied by BBH, May 2012.

Haberlin also questions whether the credit diversification benefit of central counterparties even applies to a securities lending market that survived a monumental stress test when Lehman failed. If the regulators want visibility into securities lending participant exposures, a trade data repository could satisfy their requirements without imposing the costs of a central counterparty on a market that may not need one.

“It is not clear to me what problem we are trying to solve with a central clearing counterparty,” says Haberlin.

“Mandating a central counterparty is taking a sledgehammer to crack a nut. It doesn’t address the problem we had in 2008, which was the reinvestment of cash collateral.”

Central clearing may not be the universal panacea some regulators and legislators seem to believe anyway. In a global securities lending market dominated by four big custodian lenders (BNY Mellon, JPMorgan Chase, Northern Trust and State Street) and perhaps 10 significant prime broker borrowers, a central counterparty offers limited scope for credit risk diversification, the most widely touted benefit.

“Clearinghouses do a good job of managing risk in a market like equities where there are thousands of participants,” says Nicholas Bonn, head of securities finance and portfolio solutions at State Street. “Risk sharing doesn’t work in a market with too few participants. I would rather manage my own risk exposure to Lehman than share it with 13 of my closest friends.”

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Thomas Kindler, head of clearing relations at SIX x-clear says the firm may reposition the service toward higher margin business. At today’s low interest rates, the plain vanilla securities lending SecFinex handled delivers a return of just 1.5 basis points (bps), too low to support the cost of clearing. By comparison, collateral swaps—a longer-term form of securities lending—yield 40bps to 70bps. “Have we been in the right segment?” asks Kindler. “We see more potential in the area of collateral upgrade trades.” Photograph kindly supplied by SIX x-clear, May 2012.

Joe Pellegrini, head of securities lending at OCC. The Options Clearing Corporation (OCC) has offered dealer-to-dealer clearing to its members since 1993, a service it developed at their request to help dealers reduce the capital requirements on options positions hedged through a short sale. “We novate the trade and stand in the middle as lender to the borrower and borrower to the lender,” says Pellegrini. “With that program, we guarantee the return of the securities against the collateral.” Photograph kindly supplied by OCC, May 2012.

The existing bilateral arrangements for securities lending have survived numerous financial crises without a hitch, too. From the failure of Yamaichi Securities in 1992 to Baring Brothers in 1995, Lehman Brothers in 2008 and MF Global in 2011, agent lenders were able to sell non-cash collateral and use the proceeds—or apply cash collateral directly—to repurchase the securities lent out and return them to the beneficial owners. The borrowers still had the original securities (or had lent them on to their clients) and got back any collateral not used to pay for the repurchase. Markets generally don’t go up when a big broker fails—the only assets that do appreciate are the high quality sovereign bonds often used as non-cash collateral in securities lending transactions, so credit protection tends to improve in a crisis.

“We managed the Lehman default and came out fine,” says Bonn.“We may have lost a little hair, but our risk structures held up, the collateral was sound and our processes worked.”

A central counterparty would leave an agent lender holding less collateral than it now enjoys, too. In a bilateral trade, State Street and its peers take in collateral from the borrower equal to either 102% or 105% of the market value of the securities lent. Introducing a central counterparty to face both sides puts the agent lender in the opposite position: from the clearinghouse point of view, the securities a lender puts up are more risky than cash, so it will apply a haircut to the collateral

it hands over to the agent lender. The haircut supports the clearinghouse guarantee to return the securities to the lender if the borrower fails, but lower collateral balances translate into lower revenue for the agents, who would also have to pay clearing charges.“If the regulators mandate clearing for securities lending, it will cost me more to do business,”says Bonn.

“I hope they don’t try to fix a problem that doesn’t exist.”

Despite the agent lenders’ reservations, clearing is likely to play a bigger role in the securities lending market even if the regulators don’t impose a specific mandate. Basel III lumps securities lending together with OTC derivatives and repo: the regulatory capital assessment will be 2% if the trade clears through a recognised central counterparty, vs. at least 10% (and potentially much higher, depending on counterparty credit quality) in a bilateral arrangement, a difference borrowers cannot afford to ignore. Kindler at SIX x-clear argues that lenders would derive credit risk benefits, too; he notes that the big Swiss insurance companies have up to 100 different lending counterparties, not just the four major agent lenders. It may still take a push from regulators to get the ball rolling, though.

“Everybody agrees it makes sense in principle,” says Kindler, “but when you ask market participants whether they would consider a central counterparty the most common reply is, ‘Only if I have to’.” I

FTSE GLOBAL MARKETS • JUNE 2012

57

DTCC CREDIT DEFAULT SWAPS ANALYSIS

Top 10 number of contracts (Week ending 1 June 2012) Reference Entity

Republic of Italy Federative Republic of Brazil Bank of America Corporation Republic of Turkey United Mexican States Russian Federation Kingdom of Spain JP Morgan Chase & Co. Morgan Stanley MBIA Insurance Corporation

Sector

Market Type

Net Notional (USD EQ)

Gross Notional (USD EQ)

Contracts

DC Region

Government Government Financials Government Government Government Government Financials Financials Financials

Sov Sov Corp Sov Sov Sov Sov Corp Corp Sov

354,292,544,245 164,657,310,967 89,766,519,272 142,885,391,585 124,454,326,414 113,208,459,623 189,309,871,790 84,817,048,441 84,285,225,998 85,792,515,300

21,424,627,929 18,419,706,121 5,325,590,117 5,961,150,007 8,667,382,621 4,273,845,277 14,265,826,198 4,319,389,008 5,003,046,235 3,179,645,277

11,524 10,405 10,304 9,500 9,047 8,949 8,876 8,791 8,644 8,133

Europe Americas Americas Europe Americas Europe Europe Americas Americas Americas

Top 10 net notional amounts (Week ending 1 June 2012) Reference Entity

French Republic Republic of Italy Federal Republic of Germany Federative Republic of Brazil Kingdom of Spain UK and Northern Ireland Japan General Electric Capital Corporation People’s Republic of China United Mexican States

Sector

Market Type

Net Notional (USD EQ)

Gross Notional (USD EQ)

Contracts

DC Region

Government Government Government Government Government Government Government Financials Government Government

Sov Sov Sov Sov Sov Sov Sov Corp Sov Sov

156,447,200,827 354,292,544,245 127,397,934,914 164,657,310,967 189,309,871,790 71,414,594,892 83,663,357,896 94,912,801,903 65,568,751,788 124,454,326,414

22,841,952,015 21,424,627,929 20,607,737,251 18,419,706,121 14,265,826,198 11,287,099,523 10,744,898,018 10,079,622,952 8,719,657,051 8,667,382,621

7,579 11,524 4,814 10,405 8,876 4,609 8,046 7,227 7,276 9,047

Europe Europe Europe Americas Europe Europe Japan Americas Asia Ex-Japan Americas

Ranking of industry segments by gross notional amounts

Top 10 weekly transaction activity by gross notional amounts

(Week ending 1 June 2012)

(Week ending 1 June 2012)

Single-Name References Entity Type

Gross Notional (USD EQ)

Contracts

References Entity

Corporate: Financials

3,364,252,452,774

472,724

Sovereign / State Bodies

2,914,564,894,848

219,300

Corporate: Consumer Services

1,841,476,694,412

Corporate: Consumer Goods

1,824,072,137,328

Corporate: Industrials

1,171,429,474,319

206,875

Ireland

2,520,211,565

160

933,287,346,048

157,904

Federative Republic of Brazil

2,303,193,000

155

Corporate: Telecommunications Services 876,329,548,023

138,326

UK and Northern Ireland

2,054,050,000

123

Corporate: Utilities

123,221

Portuguese Republic

1,713,507,092

57

Corporate: Basic Materials

Contracts

Republic of Italy

5,670,651,818

255

Kingdom of Spain

3,668,094,401

440

318,966

French Republic

3,616,737,578

213

305,380

Hungary

3,085,705,794

244

Corporate: Energy

532,404,854,953

96,799

Republic of Poland

1,613,850,000

182

Corporate: Technology

379,620,501,424

68,809

Federal Republic of Germany

1,591,448,924

81

Corporate: Health Care

348,642,884,861

62,206

Corporate: Other

143,313,647,612

16,499

CDS on Loans

51,896,576,106

13,895

Residential Mortgage Backed Securities

44,693,261,146

8,483

Commercial Mortgage Backed Securities 12,904,286,589

1,363

Residential Mortgage Backed Securities*

7,993,064,934

516

CDS on Loans European

3,914,464,480

623

Muni: Government

1,211,700,000

119

Other

843,702,377

61

Commercial Mortgage Backed Securities*

562,917,162

50

Muni: Utilities

63,293,153

12

*European

58

733,765,807,419

Gross Notional (USD EQ)

All data © 2012 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

JUNE 2012 • FTSE GLOBAL MARKETS

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 25th May 2012 INDICES

VENUES FTSE 100

INDICES FFI

Europe

Amsterdam BATS Chi-X BXE BATS Chi-X CXE Berlin Burgundy Deutsche Borse Dussefdorf Equiduct Frankfurt Hamburg Hanover LSE Munich Nyse Arca Paris SIX Swiss Stockholm TOM MTF Turquoise XETD

CAC 40

DAX

OMX S30

SMI

2.40

2.20

1.99

2.20

2.01

5.90% 30.80%

2.32% 4.39% 25.80%

3.68% 24.08% 0.01%

5.83% 23.93%

5.19% 22.91%

3.01%

0.11%

US

1.62%

VENUES

0.27% 66.44%

62.58% 0.03% 6.46% 0.00%

7.31%

5.19%

INDICES

4.87

12.03% 5.04% 0.44% 0.73% 5.58% 9.61% 23.68% 4.58% 2.44% 0.48% 20.08% 0.07% 15.26%

11.70% 4.71% 0.48% 0.52% 4.89% 8.74% 25.90% 3.99% 1.88% 0.41% 21.61% 0.10% 15.26%

FFI

1.07

5.19%

INDICES

INDICES

S&P TSX Composite

FFI

2.13

2.19

19.36% 13.78% 1.56% 1.05% 2.23% 62.82%

20.29% 15.44% 1.72% 0.87% 1.45% 60.43%

Canada*

Alpha ATS Chi-X Canada TMX Select Omega ATS Pure Trading TSX VENUES

INDEX

Chi-X Japan JASDAQ Nagoya Osaka Sapporo SBI Japannext Tokyo

1.19 3.17% 0.00% 0.00% 0.00% 0.00% 5.19% 91.64%

VENUES

INDEX

FFI

Japan

S&P TSX 60

NIKKEI 225

INDICES

INDICES S&P ASX 200

4.65%

VENUES S&P 500

INDICES

Australia

0.01%

59.38%

5.29 BATS BATS Y CBOE Chicago Stock Exchange EDGA EDGX NASDAQ NASDAQ BX NASDAQ PSX NSX NYSE NYSE Amex NYSE Arca

0.00%

0.05% 0.01%

0.05%

DOW JONES

FFI

66.42% 0.01% 0.13% 0.39% 0.03% 0.01%

55.84%

VENUES INDICES

GLOBAL TRADING STATISTICS

Fidessa Fragmentation Index (FFI) and Fragulator®

ASX

96.42%

INDICES

HANG SENG

Chi-X Australia

3.58%

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/.

Asia

Hong Kong

100.00%

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 • JUNE 2012

59

Global Equity View 5-year Performance Graph (USD Total Return) Index level rebased (31 May 2007 = 100) FTSE All-World Index

FTSE Developed Index

FTSE Emerging Index

FTSE Frontier 50 Index

140

120

100

80

60

11

ay -1 2 M

Fe b-

11

11 N ov -

11

Au g-

10

M ay -

Fe b-

ov -1 0 N

10

-1 0 Au g

10

09

M ay -

Fe b-

09

09

N ov -

Au g-

M ay -

08

Fe b09

-0 8

N ov -

Au g

M ay -0 8

07

07

Fe b08

N ov -

Au g-

7

40 M ay -0

MARKET DATA BY FTSE RESEARCH

GLOBAL MARKET INDICES

Global Alternative/Strategy View 5-year Performance Graph (USD Total Return) Index level rebased (31 May 2007 = 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

120

100

80

60

ay -1 2 M

12 Fe b-

11 N ov -

11

11

Au g-

M ay -

11 Fe b-

N

ov -1 0

-1 0

10

Au g

M ay -

10 Fe b-

09

09 N ov -

Au g-

09 M ay -

08

Fe b09

N ov -

-0 8 Au g

M ay -0 8

Fe b08

07 N ov -

07 Au g-

M ay -0

7

40

Global - Across the Asset Classes 5-year Performance Graph (USD Total Return) Index level rebased (31 May 2007 = 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

ay -1 2 M

12 Fe b-

11

11 N ov -

Au g-

11 M ay -

11 Fe b-

ov -1 0 N

-1 0 Au g

10 M ay -

09

10 Fe b-

N ov -

09 Au g-

09 M ay -

-0 9 Fe b

08 N ov -

-0 8 Au g

ay -0 8 M

-0 8 Fe b

07

07 N ov -

Au g-

M

ay -0 7

0

Source: FTSE Group, data as at 31 May 2012

60

JUNE 2012 • FTSE GLOBAL MARKETS

USA MARKET INDICES USA Regional Equities View 5-year Performance Graph (USD Total Return) Index level rebased (31 May 2007 = 100) FTSE US TM Index

FTSE USA Index

FTSE All-World ex USA Index

120

100

80

60

11

11

11

Fe b12 M ay -1 2

N ov -

Au g-

M ay -

Fe b11

-1 0

ov -1 0 N

10

Au g

M ay -

Fe b10

09

09 N ov -

09

Au g-

M ay -

08

Fe b09

N ov -

-0 8 Au g

ay -0 8 M

07

07

Fe b08

N ov -

Au g-

M ay -0

7

40

USA Alternative/Strategy View 5-year Performance Graph (USD Total Return) Index level rebased (31 May 2007 = 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

Fe b12 M ay -1 2

11

11 N ov -

Au g-

11 M ay -

Fe b11

ov -1 0 N

Au g

-1 0

10 M ay -

09

09

Fe b10

N ov -

Au g-

09 M ay -

Fe b09

08 N ov -

-0 8 Au g

ay -0 8 M

07

07

Fe b08

N ov -

Au g-

M ay -0

7

40

USA - Across the Asset Classes 5-year Performance Graph (USD Total Return) Index level rebased (31 May 2007 = 100) FTSE Americas Government Bond Index

FTSE EPRA/NAREIT North America Index

FTSE Renaissance US IPO Index

160 140 120 100 80 60 40

12 M ay -1 2

Fe b-

11

11 N ov -

Au g-

11 M ay -

11 Fe b-

ov -1 0 N

-1 0 Au g

10 M ay -

09

09

10 Fe b-

N ov -

Au g-

-0 9

-0 9

ay M

Fe b

08 N ov -

-0 8 Au g

-0 8 M ay

-0 8 Fe b

07

07 N ov -

Au g-

M

ay -0 7

20

Source: FTSE Group, data as at 31 May 2012

FTSE GLOBAL MARKETS • JUNE 2012

61

Europe Regional Equities View 5-year Performance Graph (EUR Total Return) Index level rebased (31 May 2007 = 100) FTSE 100 Index

FTSE Nordic 30 Index

FTSEurofirst 80 Index

FTSE MIB Index

120

100

80

60

40

11

ay -1 2 M

Fe b-

N ov -

11

11

11

Au g-

10

M ay -

Fe b-

ov -1 0 N

10

-1 0 Au g

10

M ay -

09 N ov -

Fe b-

09

09

Au g-

M ay -

08

Fe b09

-0 8

N ov -

Au g

M ay -0 8

07

Fe b08

07

N ov -

Au g-

7

20 M ay -0

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 May 2007 = 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

M ay -1 2

11

11

Fe b-

N ov -

11

11

Au g-

M ay -

10 Fe b-

ov -1 0 N

10

-1 0 Au g

10

09

M ay -

Fe b-

N ov -

Au g-

09

09 M ay -

Fe b09

08 N ov -

-0 8 Au g

M ay -0 8

07

Fe b08

07

N ov -

Au g-

M ay -0

7

20

Middle East and Africa View 3-year Performance Graph (Total Return) Index level rebased (29 May 2009 = 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

12 M ay -

12 Fe b-

11 N ov -

11 Au g-

11 M ay -

11 Fe b-

ov -1 0 N

-1 0 Au g

-1 0 ay M

Fe b10

N ov -0 9

Au g09

M

ay

-0 9

80

Source: FTSE Group, data as at 31 May 2012

62

JUNE 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 May 2007 = 100) FTSE Asia Pacific Index

FTSE EDHEC-Risk Efficient All-World Asia Pacific Index

FTSE RAFI Developed Asia Pacific ex Japan Index

160 140 120 100 80 60

M ay -1 2

11

11 N ov -

Fe b-

11

11

Au g-

10

M ay -

Fe b-

N

Au g

ov -1 0

-1 0

10

10

M ay -

09 N ov -

Fe b-

09

09

Au g-

M ay -

08 N ov -

Fe b09

-0 8 Au g

M ay -0 8

Fe b08

07

07

N ov -

Au g-

M ay -0

7

40

Greater China Equities View 5-year Performance Graph (USD Total Return) Index level rebased (31 May 2007 = 100) FTSE China A50 Index

FTSE Greater China Index

FTSE China 25 Index

FTSE Renaissance Hong Kong/China Top IPO Index

200 180 160 140 120 100 80 60

11

M ay -1 2

Fe bAp r12

11

11 N ov M ar -1 2

11

Au g-

M ay -

N

Fe b-

10

ov -1 0

-1 0

10

Au g

10

09

M ay -

Fe b-

09 Au g-

N ov -

09 M ay -

Fe b09

08 N ov -

-0 8 Au g

M ay -0 8

07

Fe b08

07

N ov -

Au g-

M ay -0

7

40

ASEAN Equities View 18-month Performance Graph (USD Total Return) Index level rebased (30 November 2010 = 100) FTSE ASEAN 40 Index

FTSE Bursa Malaysia KLCI

STI

FTSE SET Large Cap Index

140 130 120 110 100 90

12 M ay -

-1 2 Fe b

Ja n12

1 c1 De

11 N ov -

Oc t11

11 Se p-

11 Au g-

l11 Ju

1

Ju n11

M ay -1

Ap r11

ar -1 1 M

Fe b11

-1 1 Ja n

De c10

N ov -1 0

80

Source: FTSE Group, data as at 31 May 2012

FTSE GLOBAL MARKETS • JUNE 2012

63

INDEX CALENDAR

Index Reviews May-Jun 2012 Date

Index Series

Early Jun Early Jun Early Jun 01-Jun 01-Jun 01-Jun 05-Jun 05-Jun 05-Jun 05-Jun 05-Jun 06-Jun

IBEX 35 Semi-annual review 29-Jun OBX Semi-annual review 15-Jun ATX Quarterly review 29-Jun S&P / ASX Indices Quarterly Review 15-Jun CAC 40 Quarterly review 18-Jun KOSPI 200 Annual review 08-Jun AEX Quarterly review 15-Jun PSI 20 Quarterly review 15-Jun BEL 20 Quarterly review 15-Jun FTSE MIB Index Quarterly review 15-Jun FTSE China Index Series Quarterly review 15-Jun FTSE All-World and FTSE Global Small Cap Middle East & Africa Review Annual review 15-Jun FTSE All-World and FTSE Global Small Cap Emerging Europe Review Annual review 15-Jun FTSE UK Index Series Quarterly review 15-Jun FTSE AIM Index Series Quarterly review 15-Jun FTSE European Index Series Quarterly review 15-Jun FTSEurofirst Index Series Quarterly review 15-Jun FTSE Italia Index Series Quarterly review 15-Jun FTSE ECPI Index Series Quarterly review 15-Jun FTSE JSE Index Series Quarterly review 15-Jun FTSE JSE All-Africa Index Series Quarterly review 15-Jun FTSE ASFA Index Series Quarterly review 15-Jun NZX 50 Quarterly review 15-Jun DAX Quarterly review 18-Jun Dow Jones Global Indexes Quarterly review 15-Jun FTSE EPRA/NARIET Index Series Quarterly review 15-Jun FTSE Bursa Malaysia Index Series Annual 15-Jun FTSE Shariah Index Series Quarterly 15-Jun TOPIX Monthly review - additions & free float adjustment 28-Jun FTSE Taiwan Index Series Quarterly 15-Jun FTSE Environmental Opportunities Semi-Annual 15-Jun S&P / TSX Quarterly review 15-Jun S&P Europe 350 / S&P Euro Quarterly review - shares 15-Jun S&P Topix 150 Quarterly review - shares 15-Jun S&P Asia 50 Quarterly review - shares 15-Jun S&P Global 1200 Quarterly review - shares 15-Jun S&P Global 100 Quarterly review - shares 15-Jun S&P 500 Quarterly review - shares 15-Jun S&P BRIC 40 Semi-annual review - constituents 15-Jun OMX C20 Semi-annual review 22-Jun FTSE Renaissance Index Series Quarterly 15-Jun FTSE Macquarie Global Infrastructure Index Series Semi-Annual 15-Jun FTSE EDHEC Index Series Quarterly 15-Jun FTSE GWA Index Series Quarterly 15-Jun OMX I15 Semi-annual review 29-Jun VINX 30 Semi-annual review 15-Jun OMX N40 Semi-annual review 15-Jun OMX S30 Semi-annual review 29-Jun OMX B10 Semi-annual review 29-Jun Russell Global Indices Annual consituent review / Quarterly IPO additions 22-Jun Russell US Indices Annual consituent review / Quarterly IPO additions 22-Jun

06-Jun 06-Jun 06-Jun 06-Jun 06-Jun 06-Jun 06-Jun 06-Jun 06-Jun 06-Jun 06-Jun 06-Jun 07-Jun 07-Jun 07-Jun 07-Jun 07-Jun 08-Jun 08-Jun 08-Jun 08-Jun 08-Jun 08-Jun 08-Jun 08-Jun 08-Jun 08-Jun 10-Jun 11-Jun 11-Jun 11-Jun 12-Jun Mid Jun Mid Jun Mid Jun Mid Jun Mid Jun 16-Jun 16-Jun

Review Frequency/Type

Effective (Close of business)

Data Cut-off 31-May 31-May 31-May 25-May 31-May 30-Apr 31-May 31-May 31-May 31-May 21-May 30-Mar 30-Mar 05-Jun 05-Jun 31-May 31-May 31-May 31-May 31-May 18-May 31-May 31-May 31-May 31-May 31-May 31-May 31-May 31-May 31-May 31-May 31-May 01-Jun 01-Jun 01-Jun 01-Jun 01-Jun 01-Jun 01-Jun 31-May 31-May 31-May 31-May 05-Jun 31-May 31-May 31-May 31-May 31-May 31-May 31-May

Sources: Berlinguer, FTSE, JP Morgan, Standard & Poor’s, STOXX

64

JUNE 2012 • FTSE GLOBAL MARKETS