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CORPORATE ACTIONS: TOWARDS STANDARDISED MESSAGING

ISSUE 66 • NOVEMBER/DECEMBER 2012

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FTSE debuts Kenyan Sovereign bond index Why market quality counts How the buy side is managing collateral HFT takes the high road

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THE US FISCAL CLIFF: Can Republicans work with Obama in 2013? DRS IN THE DOLDRUMS: IS IT TIME FOR A CHANGE?

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Eds_Contents 66_. 15/11/2012 16:38 Page 1

OUTLOOK EDITORIAL DIRECTOR: Francesca Carnevale T: +44 [0]20 7680 5152 | E: 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); Dan Barnes (Derivatives/FX) NEW MEDIA MANAGER: Andrew Neil T: +44 [0]20 680 5151 | E: andrew.neil@berlinguer.com HEAD OF NEW MEDIA: Alex Santos T: +44 [0]20 680 5161 | E: alex.santos@berlinguer.com PRODUCTION MANAGER: Lee Dove – Alphaprint T: +44 [0]20 7680 5161 | E: production@berlinguer.com FTSE EDITORIAL BOARD: Mark Makepeace (CEO); Donald Keith; Imogen Dillon-Hatcher; Chris Woods; Paul Hoff; Jerry Moskowitz; Andy Harvill HEAD OF SALES: Peter Keith T: +44 [0]20 7680 5153 | E: peter.keith@berlinguer.com OVERSEAS REPRESENTATION: Can Sonmez (Istanbul/Turkey) EVENTS MANAGER: Lee Michael White T: +44 [0]20 7680 5153 | E: lee.white@berlinguer.com FINANCE MANAGER: Tessa Lewis T: +44 [0]20 7680 5159 | E: tessa.lewis@berlinguer.com RESEARCH: Lydia Koh: Lydia.Koh@berlinguer.com | T: +44 [0]20 7680 5154 Oliver Worsley Gorter: OliverWG@berlinguer.com | Tel: +44 (0) 207 680 5157 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. Multiple company subscriptions are also available FTSE Global Markets is now published ten times a year. No part of this publication may be reproduced or used in any form of advertising without the express permission of Berlinguer Ltd. [Copyright © Berlinguer Ltd 2012. All rights reserved.] FTSE™ is a trademark of the London Stock Exchange plc and the Financial Times Limited and is used by Berlinguer Ltd under licence. FTSE International Limited would like to stress that the contents, opinions and sentiments expressed in the articles and features contained in FTSE Global Markets do not represent FTSE International Limited’s ideas and opinions. The articles are commissioned independently from FTSE International Limited and represent only the ideas and opinions of the contributing writers and editors. All information in this magazine is provided for information purposes only. Every effort is made to ensure that any and all information given in this publication is accurate, but no responsibility or liability can be accepted by FTSE International Limited and Berlinguer Ltd, for any errors, or omissions or for any loss arising from the use of this publication. All copyright and database rights in the FTSE Indices belong to FTSE International Limited or Berlinguer Ltd or its licensors. Reproduction of the data comprising the FTSE indices is not permitted. You agree to comply with any restrictions or conditions imposed upon the use, access, or storage of the data as may be notified to you by FTSE International Limited, or Berlinguer Ltd and you may be required to enter into a separate agreement with FTSE International Limited and Berlinguer Ltd.

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INALLY, SOMEONE WITH a bit of regulatory sense: the US Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) have issued a notice stating that the January 1st 2013 effective date of Basel III capital rules will be pushed back. “Regulators have appropriately acted to give the industry more time to implement these new capital standards and ensure that each of their systems is updated to comply with Basel III,” notes an early November comment on the decision by the Securities Industry and Financial Markets Association (SIFMA). The regulators involved have not yet specified a new deadline, but stressed the urgency they had in resolving their concerns, stating that “as members of the Basel Committee on Banking Supervision, took seriously”the country’s internationally agreed timing commitments regarding the implementation of Basel III “and are working as expeditiously as possible to complete the rulemaking process.” “In light of the volume of comments received and the wide range of views expressed during the comment period, the agencies do not expect that any of the proposed rules would become effective on January 1st 2013,” the government agencies said in the statement. The move looks to have been on the cards for some time. The Federal Reserve noted in June this year, for instance, that many lending institutions would need to bolster their capital reserves to be ready for Basel III. At the time the central bank suggested that the 19 largest US bank holding firms would be $50bn short of their required funds at the beginning of 2013. Elsewhere Mark Carney, the governor of the Bank of Canada and the chairman of the Financial Stability Board, stated that the member nations of the FSB will require an additional six months to outline how the banks would divide assets in the case they became insolvent. It is to be hoped that other national regulators follow suit. It is not a panacea for the banking segment’s financial ills. The move will not cure the economic stagnation that many countries are experiencing; but it will take off some of the unnecessary pressure on banks (both large and small) if Basel III were knocked into the nearside long grass; at least until bank lending is of sufficient breadth and depth for it to have financial meaning once more. Mamma Cass once sang: the darkest hour is just before dawn. With that 1960s California spirit in mind, this edition is marked by a distinct whiff of opportunity. Even while the markets tank on both good news and bad, it is to be hoped that 2013 brings the first real shoots of new growth, new hope and renewed market confidence. Someone somewhere will and must make the dash for growth. Who will it be? If we stay on this current course, it won’t be high frequency traders; it won’t be the Hong Kong Stock Exchange, it won’t be the providers of execution consulting or prime broking or securities lending or whatever spectrum of asset servicing the market provides. In other words, all the people and segments which are at important tipping points in their particular fortune will be sucked into the global funk. If no one breaks for growth 2013 will be an even paler imitation of the palest imitation that was 2012 and 2012 was very pale indeed. That cris de coeur aside, there’s a plethora of goodies in the edition, if you like derivatives, clearing, securities lending and banking, which all hint of better days to come. Additionally, the Irish look to be continuing in fine fettle on refining their fund regulation, while Bill Hodgson looks at the long term stimulus to the capital markets provided by clearing and settlement architecture. Read and enjoy and dream of better days...

Cover photo: In this September 21st 2012, file photo Speaker of the House John Boehner, R-Ohio, leaves after meeting with reporters Capitol Hill in Washington as Congress prepares to shut down until after elections in November. Lawmakers will return in roughly seven weeks with a crowded list of must-do items, including averting the one-two punch of the fiscal cliff, expiring Bush-era tax cuts and automatic spending reductions that could drive the country into another recession. Two years of rancour and a divided government resulted in one of the least productive, least popular Congresses in history. Photograph by Scott Applewhite for Associated Press. Photograph supplied by PressAssociationImages, November 2012.

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2012

Eds_Contents 66_. 20/11/2012 11:14 Page 2

CONTENTS COVER STORY

CAN OBAMA & THE WORLD AVOID THE US FISCAL CLIFF

..................Page 4 With the US chief executive back in train, questions now arise about the ability of Barack Obama to bring together Democrats and Republicans to mitigate the impact of the impending confluence of budget cuts and the ending of tax breaks at the start of 2013. It is important they do so, not just for America, but for the world. Andrew Cavenagh reports.

DEPARTMENTS

MARKET LEADER

CAN DRS MAKE A COMEBACK NEXT YEAR? ................................................Page 10

SPOTLIGHT

FTSE GROUP LAUNCHES KENYAN SOVEREIGN BOND INDEX .....Page 14

David Simons claims the outlook is better than expected.

A round-up of market innovation and Russian clearing initiatives.

IRELAND’S CENTRAL BANK LEADS NEW FUND REGIME CHANGE ..Page 18 Ireland’s consultation on post-AIFMD non-UCITs fund regime.

CORPORATE ACTIONS: TOWARDS AN ISO STANDARD ..........................Page 21

IN THE MARKETS

Lynn Strongin Dodds looks at the search for efficiencies in corporate actions messaging.

REDESIGNED CAPITAL INTRODUCTIONS ....................................................Page 23 Prime brokers look at cap intro services in a new way. By Neil O’Hara.

A METRIC IN NEED OF A STANDARD ............................................................Page 26 Lee Hodgkinson explains how the buy side can ensure the best outcome for a trade.

TRADING POST

IS CENTRAL CLEARING A FORCE FOR GOOD?.........................................Page 28 Bill Hogdson looks at the impact on clearing on emerging countries.

CLEARING THE TABLE

DERIVATIVES

.............................................................................................Page 29 Dan Barnes looks at the capital requirements involved in central clearing.

DEVELOPING COST EFFECTIVE SOLUTIONS AT CCP LEVEL

...........Page 34

Why CCPs need to be at their best for the clearing of IR rate swap trades.

FACE TO FACE

DIN CHEN, CEO & CIO, CSOP ASSET MANAGEMENT .........................Page 36

FX VIEW

THE OUTLOOK FOR THE RMB.............................................................................Page 38

The lowdown on RQFII ETFs and the firm’s investment policy.

The impact of leadership changes on the timetable for RMB convertibility.

INTERNATIONAL INVESTORS ENDORSE US FCPA .................................Page 40

COUNTRY REPORT

Leading institutional investors welcome new guidelines.

SWITZERLAND TIGHTENS ITS FUND REGIME ...........................................Page 41 The Swiss fund industry is readying for more regulation of the asset management industry.

THE BEAR VIEW

TACKLING THE POST ELECTION MARKET BLUES...................................Page 43

SECURITIES LENDING

THE BUY SIDE COLLATERAL CHALLENGE ...................................................Page 44

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

David Simons looks at reliable collateral management strategies.

THE SHAPE OF THINGS TO COME..............................................................................Page 47 Why Saxo Markets is looking to a new generation of traders.

A DOWNWARD SPIRAL FOR HFT? ..................................................................Page 49

TRADING

Negative press and falling profits have beset high frequency traders. Can HFT regain its stride?

PROFILE: HKSE’S LONG TERM COMMODITIES PLAY ..........................Page 52 Lynn Strongin Dodds looks at the exchange’s global expansion strategy.

EXECUTION CONSULTING ......................................................................................Page 56 Ruth Hughes Liley looks at the new opportunities in execution consulting.

DATA PAGES 2

DTCC Credit Default Swaps analysis ..............................................................................................Page 60 Market Reports by FTSE Research................................................................................................................Page 61 Entrances & Exits................................................................................................................................................Page 64

NOVEMBER/DECEMBER 2012 • FTSE GLOBAL MARKETS

Eds_Contents 66_. 15/11/2012 17:16 Page 3

GM Regional Review 66_. 15/11/2012 17:09 Page 4

COVER STORY

WILL THE FISCAL CLIFF STRIP BARE THE US ECONOMY?

President Barack Obama calls Wisconsin volunteers as he visits a campaign office call centre the morning of the 2012 election, Tuesday, November 6th 2012, in Chicago. That call was a relatively easy one for the president. Tackling the crippling US budget deficit is arguably a much tougher one. Can he achieve the political consensus he promised as he started his first term in office this second time around? The world waits in anticipation. Photograph by Carolyn Kaster for the Associated Press. Photograph supplied by PressAssociationImages, November 2012.

COULD THE US FISCAL CLIFF DERAIL GLOBAL GROWTH HOPES? Superstorm Sandy may have devastated the US East Coast and caused more than $60bn of damage, but the so-called “fiscal cliff”, the combination of tax increases and Federal spending cuts that will drain up to $600bn out of the US economy next year, could represent a far greater threat to US economy. For unless Congress manages to enact emergency legislation to avert the automatic introduction of the measures from the beginning of January, they look certain to de-rail the US economic recovery and send recessionary shock waves across the world. Andrew Cavenagh reports. ULTIPLE QUESTIONS STILL rebound. Will the re-election of Barack Obama to a second presidential term presage more of the same political gridlock that have stymied efforts to re-ignite the US economy over the last four years? Did

America vote for the status quo? Or, do they now expect the Democratic senate majority and the Republican controlled House of Representatives to break through their posturing and really work together in common cause to mend a still-broken US economy?

In his victory address, the president, who won by 303 electoral college votes to the 206 secured by Mitt Romney, called on Republicans to join him in working to reduce the budget deficit, fix the tax code and reform immigration. The budget deficit will in the short term be the cause célèbre of 2013. The nonpartisan Congressional Budget Office estimates that if all the tax hikes and spending cuts come into effect as scheduled, they will pare at least $560bn from the Federal budget in 2013 and wipe some 4% off national GDP for the year; a shrinkage that would inevitably send the world’s largest economy back into recession. The American National Association of Manufacturers meantime estimates that a downturn of this magnitude would translate into the loss of six million jobs and see US unemployment rise to more than 11% by 2014. That nightmare scenario aside, the International Monetary Fund (IMF) has also highlighted a clear and present danger to the wider global economy in its recent annual review of the US. The IMF stated bluntly that fiscal tightening of such severity in the US would have “significant negative repercussions” for the rest of the world. Despite the obvious implications that these developments would have for corporate credit, the bond markets seem to have largely ignored the threat up to this point. As the search for yield continues to dominate the strategies of most fixed-income investors, issuance of investment-grade and high-yield corporate bonds in the US and Europe have remained at near-record levels through the second half of 2012 and spreads have continued to tighten. The extent to which demand for corporate paper is still outstripping supply was evident in the response to big issues from Italian energy utility Enel and Spain’s Intesa in the second week of October. Enel received €12bn of orders for the €2bn of debt that it sold, split evenly between 5.5-year and 10year tranches, while Intesa’s €1.25bn

NOVEMBER/DECEMBER 2012 • FTSE GLOBAL MARKETS

GM Regional Review 66_. 15/11/2012 17:43 Page 5

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GM Regional Review 66_. 15/11/2012 17:09 Page 6

COVER STORY

WILL THE FISCAL CLIFF STRIP BARE THE US ECONOMY?

Mike Riddell, who manages M&G’s international sovereign bond fund, says: “We think that US Treasuries are potentially very vulnerable, and across many of our bond funds we have reduced fund duration by going short of 10-year US Treasury futures in large size.” Photograph kindly supplied by M&G, November 2012.

of seven-year bonds attracted an order book of €4.7bn. The huge interest enabled both issuers from two of the high-risk eurozone countries to price their offerings well inside recent levels (270 basis points [bps] and 320bps over the mid-swaps benchmark for the Enel bonds and 315bps over for Intesa’s). “I think bond investors have concluded that it’s yield first and worry about the consequences later,” observes one senior fixed-income banker. Two considerations may be behind this apparent complacency in respect of the fiscal cliff. The first is probably an assumption that the politicians on Capitol Hill will avert the potential disaster at the eleventh hour, just they did in July last year when they passed the Budget Control Act (key provisions of which now a contributor to the impending cliff) to prevent the chaos that would have resulted from the Federal government running out of money.

In the event, Barack Obama romped to a second term.“The combination of an Obama win and divided Congress was our and the market's base case expectation and is therefore not expected to have a major impact on market sentiment. It does take away some uncertainty (risk of a dead heat and legal challenges, future of Fed policy under Romney), but keeps the uncertainty over the fiscal cliff negotiations later this year very much alive,” says Valentijn van Nieuwenhuijzen, head of strategy at ING Investment Management in reaction to the US election outcome. There are certainly plenty of leading economists who appear confident that Congress will approve another set of stop-gap measures before the tax hikes and spending cuts really start to bite, although that would simply put off (yet again)—until well into 2013 or even beyond—the increasingly urgent imperative to put a permanent policy in place to deal with the US Budget deficit. “We will see some very intense negotiations preChristmas around the budget deficit and the negotiating stance of the two parties will start off poles apart,” says Richard Lewis, head of global equities at Fidelity Worldwide investment. “After a lot of wailing and gnashing of teeth, we are hopeful of a budget agreement along the lines of the Bowles-Simpson proposal which is based on a ration of 3-1 spending cuts versus tax increases.” “One important source of uncertainty has now been removed, however. The probability that, in early 2014, Bernanke will be replaced by a new chairman who is intent on tightening sooner than later has fallen substantially. The effectiveness of US monetary policy rests crucially on the Fed's commitment to keep loosening until the real economy will have gained substantial traction. Hence, because of the Obama win, the credibility of this commitment remains very much intact,” adds van Nieuwenhuijzen.

Given the extent of political polarisation on those critical issues at the heart of the budget debate it is hardly surprising, however, that not all share this confidence. It is clear that Republicans remain insistent on spending cuts and no tax increases for the rich while the Democrats are adamant that the best-off in American society need to make a bigger contribution. Keith Wade, chief economist at Schroders, says he believes that the markets are being “a little sanguine” about the likely extent of the fiscal consolidation next year, because avoiding the full impact of the cliff would require the politicians in Congress to act with haste and exhibit some willingness to compromise. However, it must be said that the deliberations that have taken place on Capitol Hill over the past year hardly inspire a great deal of hope on either score. “With no discussions occurring preelection, the re-convening of the “lame-duck” Congress on November 13th this year will be the first opportunity to thrash out a deal ; a mere six weeks before the cliff is due to hit,” Wade explains.“The situation is further complicated by the disruption caused by the holiday season, with both Thanksgiving (November 22nd) and Christmas falling in this window. Finally, with the current Congress one of the least productive in history due to the ideological chasm separating the two parties, the omens for compromise and bipartisanship are poor.” Even so, the bond markets’ relaxed view over the massive potential upheaval is based largely on the presumption that the impact of the fiscal tightening measures will not be as immediate as the term “cliff” implies. While the tax hikes and spending cuts will no doubt erode GDP to the extent that the CBO has identified over the course of next year, the effects would be gradual and progressive rather than immediate. In other words, it will be more like a hill that becomes steeper the further you descend it than an actual cliff face.

NOVEMBER/DECEMBER 2012 • FTSE GLOBAL MARKETS

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GM Regional Review 66_. 16/11/2012 15:26 Page 8

COVER STORY

WILL THE FISCAL CLIFF STRIP BARE THE US ECONOMY?

This might mean that even if Congress fails to reverse the measures before the end of this year (and given the post-election Senate and House of Representatives will not be sworn in until January 3rd that has to be a real likelihood) the legislature could still pass the necessary measures before the end of the first quarter of 2013 to limit the damage. While bond investors may be playing down the risk, several leading issuers are clearly taking a more cautious view. The third week of October saw the issue of $26bn of investment-grade corporate bonds, as a number of large US companies—including the industrial conglomerate General Electric, software company Oracle, insurer United Healthcare, and mining group XStrata—refinanced debt that was due to mature next year well ahead of time just in case. Keith Sherin, GE’s chief financial officer, confirms that his company had issued its $7bn bond primarily to cover $5bn of debt falling due in February to avoid the risk of the possible turbulence in the markets at that point should the politicians fail to resolve the fiscal cliff problem. “If it’s choppy, we are prepared,” he explains. Many American companies are also cutting back on investment plans, including the hiring of more staff, in preparation for the hundreds of billions of dollars disappearing from the economy in 2013 (action that threatens to have a negative impact on GDP before the fiscal cliff is even reached). “It is prudent risk management, and an appropriate response to the uncertainty thrown up by the fiscal cliff situation,” holds Edward Marrinan, head of macro credit strategy at RBS Securities in Stamford, Connecticut. As with the economists, however, there is no consensus on the risk in the US corporate world, as others clearly believe that no real crisis will materialise in 2013. Four fifths of the respondents in a survey published in mid-October by the National Association for Business Economics—

MAIN ELEMENTS OF THE US FISCAL CLIFF Measure

Impact

Expiry of Bush-era income-tax cuts

$280bn

End of Obama’s payroll tax holiday

$125bn

Spending cuts in Budget Control Act

$98bn

Expiry of emergency unemployment benefits

$40bn

Source: JP Morgan

including economists from the Ford motor company, DuPont, and JP Morgan Chase among others—say they did not expect to see either severe spending cuts or tax increases in 2012 (and more than half thought the Bushera tax breaks would be extended for all taxpayers over the entire year). Whether or not Congress does what is necessary to avert the fiscal cliff taking effect next year, the bigger problem of the country’s budget deficit will remain. Moreover, time to address that without serious consequences for the economy is also running out. For the further postponement of a committed and enduring policy to rectify the ballooning deficit can only continue to erode the markets’ already waning confidence in the government’s ability to resolve the problem. It looks likely also to put the sovereign ratings of the US under greater pressure. While the Standard & Poor’s downgrade last year of its US sovereign rating from AAA to AA+ may have had no discernible impact on demand for either dollars or US Treasuries, if Fitch and Moody’s were to follow its example the risk that this could change would obviously increase.“The rating agencies are not going to just stand by idly, if the elected authorities in the US simply point fingers and do nothing,” comments Marrinan at RBS Securities. As Goldman Sachs chairman Lloyd Blankfein articulated in an interview earlier this month another failure to address the problem of the deficit would deservedly ratchet up the pressure on the US rating. It would be a sign to the financial markets that the country had a “dysfunctional government” that was incapable of managing

the health of the economy.“Who wants to lend money to dysfunctional government?”he asked.“The US is a major beneficiary of being the reserve currency, and I think people should start realising that that’s the real ticking time bomb.” It is difficult to see any near-term threat to the ultimate safe-haven status of US Treasuries or the dollar’s position as the global reserve currency, not least due to the absence of credible alternatives for either. However, the lack of decisive political action over the deficit in 2013 months could well have implications for the US Government’s cost of borrowing. There are already signs that bond investors are becoming wary of long-dated US Treasuries, on which current yields (1.8% on ten-year notes and 3% on 30-year debt) seem to be factoring in almost no possibility of interest rates returning to normal levels after 2015. Mike Riddell, who manages M&G’s international sovereign bond fund, said: “We think that US Treasuries are potentially very vulnerable, and across many of our bond funds we have reduced fund duration by going short of tenyear US Treasury futures in large size.” On balance, the probability must be that the Republicans and Democrats will bury their differences in the short term to avoid a scenario that could send the painstaking—but accelerating—recovery in the US housing, consumer and financial markets into reverse. Whether they can agree and implement the policies are needed to put the economy on a sustainable track in the longer term must be more open to doubt. The election result threw into bass relieve the two-nation political economy that is now the US. The thought line running through this piece then comes full circle. Can second term president Obama break the political deadlock that has stymied any real attempts to tackle economic stimulus. If consensus is not reached, the proverbial cliff could become a frighteningly steep and deep precipice indeed. n

NOVEMBER/DECEMBER 2012 • FTSE GLOBAL MARKETS

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GM Regional Review 66_. 15/11/2012 17:09 Page 9

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MARKET LEADER

DRs: LATE UPTICK IN ACTIVITY: BUT IS IT ENOUGH?

With IPO activity at a near standstill, depositary banks have toughed it out through most of 2012, salvaging the year with a respectable finish. The question remains: where do depositary receipts (DRs) go from here? What has to change? Dave Simons reports.

DEPOSITARY RECEIPTS: BETTER DAYS AHEAD D URING THE FIRST half of the year $22.6bn in world-equity inflows were offset by $50.5bn in exiting US funds, leaving a net outflow of $27.9bn, according to data from Citi. Meanwhile macroeconomic pressures whittled away at IPO activity and with fresh capital in short supply total depositary receipt raisings plummeted 90% year-over-year, reaching an estimated $1.3bn as of mid-2012. As far as depositary banks are concerned, things could have been a whole lot worse. DR trading volume has held up reasonably well; mid-year, volumes stood at 75.4bn shares, only a marginal decrease from the 78.6bn recorded during the same period in 2011, according to Citi, as DRs continued to be a viable funding vehicle for foreign firms looking to secure a foothold in the global equity markets. Other numbers bear this out. BNY Mellon’s ADR Index revealed a modest increase of 1.86% YTD, while total sponsored and unsponsored DR programs eclipsed the 3,500 mark, up from 3,413 during the year ago period. Latin America topped the regional DR leaders list, with BNY Mellon’s Mexico ADR Index approaching 18% and Chile’s ADR Index exceeding 10% through the first half. Even with the markets as tight as they’ve been, depositary banks have been buoyed by some seriously sizeable business. One of the biggest kahunas to date was the $3.5bn secondary offering of Sberbank, Russia’s pre-eminent financial institution and BNY Mellon client since June of last year. And in October JPMorgan

became one of several firms to coordinate the launch of the Santander Mexico ADR, which, at $3.2bn, represented the largest offering of its kind on Mexico’s financial exchange. The blockbuster IPO was part of a flurry of activity to round out a relatively muted 2012 for DRs, remarks Dennis Bon, global head of JP Morgan’s Depositary Receipts business. “We have recently closed on a pair of GDR offerings, one out of Russia and another from Taiwan,” explains Bon. “At the same time, there were several other deals we anticipated that have since been postponed. There are a lot of solid companies with a strong desire to get into the markets, but have chosen to hold off for the time being in order to become even more attractive from a valuation standpoint. But then there are those like Santander that chose to access the markets right away. So while it may not be an ideal market for everyone right now, it’s still strong enough to allow some decent deals to get established.” As a segment of the US market, depositary receipts have marginally outperformed on both a volume and value basis.“It is the age-old argument about depositary receipts,” offers Anthony Moro, managing director and head of emerging markets for BNY Mellon’s depositary receipts business, “that is, companies with depositary receipts tend to have better track records than those that do not.” With DR volumes reflecting the ongoing effect of wholesale corporate de-leveraging, and the subsequent reduction in market volatility, growth

remains front and centre, says Moro.“If you have a strong growth proposition, now seems to be a particularly good time to come to the market.” While value plays such as financial services and industrials have generally not fared all that well in the current climate, the emerging markets have been the exception.“A staid industry in a growth market is still plausible, even if it’s not favorable in the Europe or the US,” explains Moro, “which is why you can have a retailer in South Africa, or a bank in Russia.” Non-US investors looking for a safe haven have been snapping up domestic equities at an impressive clip, and this stream of foreign capital is expected to maintain its present pace into the new year. “Right now the US appears quite favorable to the rest of the world—for many, it’s the best looking house on the block,”says Moro. Though fundamentals remain reasonably strong, a number of political and regulatory pressures continue to weigh on the depositary receipt business. The implementation of regulatory measures under Dodd Frank, as well as the aftermath of the impending fiscal cliff in the US could have far-reaching consequences for global investors, ADR participants included. “One of the bright spots has been the ability for certain US and non-US companies to offer dividend yields as high as 8%,” observes Moro. However, should dividends start getting taxed at a higher rate, for instance, things could suddenly look a lot less attractive from an investment point of view. This, says Moro, explains

NOVEMBER/DECEMBER 2012 • FTSE GLOBAL MARKETS

GM Regional Review 66_. 15/11/2012 17:09 Page 11

sĂZ ƌĞŵĂŝŶƐ Ăƚ ƚŚĞ ŚĞĂƌƚ ŽĨ ƌŝƐŬ ĞƐƟ ŵĂƟ ŽŶ ĨŽƌ ďĂŶŬƐ ĂŶĚ ĂƐƐĞƚ ŵĂŶĂŐĞƌƐ But a single VaR number is not the whole story D ƉƉůŝĐĂƟ ŽŶƐ Excerpt ĚĞůŝǀĞƌƐ͗ ^ŚŽƌƚͲƚĞƌŵ ĂŶĚ ůŽŶŐͲƚĞƌŵ sĂZ hƐĞƌ ĚĞĮ ŶĞĚ ƌŝƐŬ ĂƩ ƌŝďƵƟ ŽŶ ŽŵƉƌĞŚĞŶƐŝǀĞ ŝŶƐƚƌƵŵĞŶƚ ĐŽǀĞƌĂŐĞ ƌŽďƵƐƚ ƐƚĂƟ ƐƟ ĐĂů ŵŽĚĞů ĂƐǇ ŝŶƚĞŐƌĂƟ ŽŶ ŝŶƚŽ ǇŽƵƌ ŝŶǀĞƐƚŵĞŶƚ ƉƌŽĐĞƐƐ

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ĂŶĂůǇƐŝƐ ŝŶƚŽ ĂĐƟ ŽŶ

GM Regional Review 66_. 15/11/2012 17:09 Page 12

MARKET LEADER

DRs: LATE UPTICK IN ACTIVITY: BUT IS IT ENOUGH?

why many potential players have remained spectators during this turbulent period. “They want to see what things looks after the elections, the fiscal cliff, and the enactment of regulatory legislation before deciding to undertake capital raisings or other type of corporate activity,” asserts Moro. Bon agrees that current political events have given pause to a number of otherwise willing participants.“Not only are there concerns around the fiscal cliff and the EU sovereign debt situation, but there is also the prospect for slower growth in Asia and other emerging economies,”says Bon.“So you have all of these different macro factors that have injected uncertainty into the markets, which in turn has been weighing on equities in general and has resulted in the depressed activity that we’ve been witnessing for some time now.” With investors still desperately seeking yield, the Fed’s unprecedented QE3 rate lockdown theoretically points to increased equity activity over the long term. “For instance, we’ve seen assets under management at major private-equity firms continue to pile up,” says Bon.“Despite everything that has occurred these last few years, there is still a tremendous amount of interest in that particular asset class, simply because investors are searching for additional yield that they haven’t been getting on the fixed-income side. From our perspective, it means the equities story is still very strong, particularly with respect to emerging-markets participants. It’s the macro/political elements that have been acting as a counter-balance.” While experts bemoan the continued dearth of IPO activity, Edwin Reyes, global head of the depositary receipts business at Deutsche Bank, prefers to take the high road. IPOs represent only one of several key DR drivers, counters Reyes, and for the time being Deutsche Bank has shifted its focus toward non-capital raising strategies, as well as transfers (Deutsche Bank’s ADR division currently accounts for slightly less than

A o Anthony Moro, managing director and head of emerging markets for BNY Mellon’s depositary receipts business. “Companies with depositary receipts tend to have better track records than those that do not,” claims Moro. With DR volumes reflecting the ongoing effect of wholesale corporate de-leveraging, and the subsequent reduction in market volatility, growth remains front and centre, he adds. Photograph kindly supplied by BNY Mellon, November 2012.

Edwin Reyes, global head of the depositary receipts business at Deutsche Bank. Reyes says he prefers to take the high road. IPOs represent only one of several key DR drivers, he explains, and for the time being Deutsche Bank has shifted its focus toward non-capital raising strategies, as well as transfers. Deutsche Bank’s ADR division currently accounts for slightly less than half of all transfers undertaken this year, he adds. Photograph kindly supplied by Deutsche Bank, November 2012.

half of all transfers undertaken this year, according to Reyes.) Unlisted ADRs have figured highly in the company’s program, and DB has also sought to capitalise on sponsored conversions as well. “By shoring up our business in these areas, we’ll be that much better off once IPOs finally do come around,” says Reyes. In addition to securing available opportunities in Western Europe and related markets, Deutsche Bank, like others, has benefited from the wealth of ADR business emanating from BRIC regions like Latin America, Russia and Asia. This past spring, Deutsche Bank was appointed the depositary bank for the sponsored Level II ADR program of CorpBanca, one of Chile’s top five private banks; during 2012 the bank also secured Level I ADR programs for Brazil’s rental-car company, Localiza; Philippine-based infrastructure firm, Metro Pacific Investments; as well as UK-based oil and natural-gas exploration and production firm, BG Group; among others. Being able to put these companies in touch with a much broader base of investors remains one of the chief attributes of leading DR firms, says Reyes.“Particularly when you’re talking about a company that may be venturing out of its local market for the first time, that is a very essential element,” says Reyes. “You hear about all of this

money that is either parked on the sidelines or flowing from equities into competing asset classes, and we think part of that is due to investors not being totally cognisant of the full range of opportunities out there. So when you are able to break through those barriers and spread the word about these companies with great growth stories, then it's only a matter of time until investors latch on. So we obviously feel that maintaining this kind of proactive approach adds real value to the ADR service as a whole.” Actively working to help clients efficiently target pools of capital, while generating interest in prospective companies entering the markets through ADRs, will ultimately pay dividends, says JPMorgan’s Bon. After a period of stagnation, Bon and colleagues are confident that the coming year will bring with it a gradual return to normalcy. “There are a lot of companies out there looking to grow, and a lot of investors looking for a place to invest their capital,” says Bon. “It’s only a matter of time until they come together. I believe that conditions are looking favorable. We are already seeing clients beginning to tap into opportunities, and we think that momentum will carry over into the new year.” “It’s true, we have seen better days,” admits BNY Mellon’s Moro. “Still, it’s hardly the end of the DR world as we know it.” n

NOVEMBER/DECEMBER 2012 • FTSE GLOBAL MARKETS

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GM Regional Review 66_. 15/11/2012 17:09 Page 14

SPOTLIGHT

FTSE GROUP LAUNCHES SOVEREIGN DEBT INDEX FOR KENYA

A NEW SCRAMBLE FOR AFRICA FTSE Group and the Nairobi Securities Exchange launched the first independently calculated Kenyan sovereign debt index, underscoring increasing investor interest in Africa in early October. Jonathan Cooper, FTSE Group’s managing director for the Middle East and Africa talks through change in the African market and the benefits of the new index for investors keen to access Africa’s revitalised growth story. TSE GROUP AND the Nairobi Securities Exchange (NSE) launched the first independent benchmark index for Kenyan government bonds, the FTSE NSE Kenyan Shilling Government Bond Index, at the start of October this year. The launch comes, “as we see increasing demand from investors wanting to gain access to emerging market bonds and currencies,” says Jonathan Cooper, FTSE Group’s managing director for the Middle East and Africa. Government debt issuance accounts for over 90% of the country’s bond market, though issuance levels remain modest. Current outstanding government paper amounts to $8bn or so. Cooper says the index aims to help towards diversifying the country’s investment markets, providing the underlying index for a host of new investible products.“Mutual funds have tended to dominate investment in Kenyan government bonds, but this new index offers the opportunity to also create ETFs, structured products, or balanced mutual funds or ETFs that comprise both the equity and fixed income markets.” Although local government bond indices have been popular of late elsewhere, development in Africa is still at an early stage, says Cooper. Even so, the potential is immense.“International investors are looking for beta-type products that give them exposure to Africa. Fixed income portfolio managers in Kenya have been

using equity indices as a performance benchmark, because there wasn’t an appropriate index available that they could adopt. This new index aims to help fill that requirement,” he says. FTSE Group worked closely with Kenya’s securities exchange to launch the index, which it hopes will help deepen the country’s capital markets. The new FTSE/NSE index provides exposure to the performance of Kenyan sovereign debt, denominated in Kenyan shillings (KES). Sub-indices are also calculated for a range of maturities (from one to three years, three to five years, five to seven years, seven to ten year and over ten years). The underlying constituents of the index are based on Kenyan government securities quotes on the NSE, with maturities of over a year and with a minimum notional value above KES5bn. The index is likely to serve as the basis of financial products in the future, including ETFs, says Cooper. While onshore ETFs on the index will not be available in the short to medium term as Kenya has yet to finalise legislation for these products, “it would certainly open up possibilities for offshore managers over the immediate term,” he adds. The new index is also a logical development following the launch late last year of the equity based FTSE NSE Kenya Index series. That index series consists of two indices: one measuring the 15 largest stocks and the other the

Jonathan Cooper, FTSE Group’s managing director for the Middle East and Africa. Photograph kindly supplied by FTSE Group, November 2012.

25 most liquid stocks in Kenya’s equity market.“This work has to be seen in the context of the efforts by the Kenyans to deepen and improve the operation of the country’s capital markets,”underscores Cooper, adding, “The regulator, for instance, is currently working on measures that will support the launch of a derivatives exchange, alongside the stock market. Once implemented, it will provide a substantial infrastructure for investors to base their local investment strategies.” Even so, there are also wider panAfrican initiatives in play. The new sovereign bond index is the latest in a slew of index initiatives undertaken by FTSE Group in Africa this year. In August, for instance, JP Morgan and the FTSE/Johannesburg Stock Exchange (JSE) partnership developed a suite of risk-targeted indices linked to the FTSE/JSE Africa Top 40 index, which allocates weights to stocks according to volatility. Going forward, Cooper says that a partnership with the African Securities Exchanges Association will also result in the launch of a pan-African index launch by the end of this year, “a move which will help improve the visibility of African equities in ASEA’s 20 member exchanges. Some of the leading markets in Africa are evolving and working towards inclusion in global indices, which is a natural development as global investors seek exposure to the opportunities in these high growth markets,” he explains. “Right now, there is a visible commitment among the members of ASEA to work together to find ways to improve and strengthen the continent’s financial infrastructure.” n

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NEWS IN BRIEF OECD business start-up rates differ widely

Photograph © Jennbang/Dreamstime.com, supplied November 2012.

o add to the general air of uncertainty about whether 2013 will bring new growth or more of the same dull business environment that has characterised 2012, a new study shows that diverging patterns of business start-up rates are emerging across OECD economies five years after the sharp, synchronised falls recorded at the beginning of the financial crisis. Start-up rates remain below precrisis levels in most of the euro area economies for which data is available and in the United States. In France start-up rates were boosted in 2009 and 2010 by new legislation supporting auto-entrepreneurs. Start-up rates also began to recover or stabilise in Denmark, Finland, Germany, Italy, Spain and the United States in 2010. However, that small level of recovery has shown signs of petering out over the past two years with start-up rates trending downwards in most euro area countries and the US. Although latest data continues to show an upward trend in Spain, the rates remain well below pre-crisis levels. In Australia, Norway and the United Kingdom however start-up rates have

recovered strongly with trends continuing to move upwards since the nadir of the crisis. The trends are reinforced by the OECD latest release on composite leading indicators (CLIs), which are designed to anticipate turning points in economic activity relative to trend. According to the OECD, they continue to point to weak growth prospects in many major economies, but signs of stabilisation are emerging in Canada, China and the United States. Compared to recent months where the CLI has pointed to a deteriorating outlook, tentative signs of stabilisation are also emerging in Italy. The CLIS for Japan, Germany, France and the Euro Area as a whole continue to point to weak growth. In India and Russia the CLIs also continue to point to weak growth. However, the CLIs for the United Kingdom and Brazil continue to point to a pick-up in growth.

has trust issues with dark pools. Nearly seven out of ten survey respondents believe maintaining anonymity between high- and lowtouch trading is vital; 80% say their commission wallets are down or flat year-on-year, with over 60% saying their commission wallet goes to the top ten brokers.

TABB Group claims US equities market is due a shake-up

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

nstitutional equities trading in the US is about to be restructured, claims TABB Group in new research findings published in its paper, Institutional Equity Trading 2012/13: The Paradox of a New Paradigm, its eighth annual benchmark study. Among the study’s key findings: 60% of buy-side traders say offexchange activity is now impacting market quality but opinions vary over what should be done and by whom; two-thirds of the buy side

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2012

SIFMA and tech trade group challenge SEC over market data fees IFMA and the NetCoalition technology trade group claim the Securities and Exchange Commission (SEC) has failed to ensure “fair and reasonable” market data fees. Oral arguments in the case are scheduled to start in mid November. However, NYSE Euronext and NASDAQ OMX Group have argued that the court doesn’t have jurisdiction under their fee filings.

Guernsey plans dual regime for AIFMD uernsey is planning to have two parallel regulatory regimes for investment funds as a way to best meet client needs when the EU’s Alternative Investment Fund Managers Directive (AIFMD) comes into force. Fiona Le Poidevin, chief executive of Guernsey Finance has reiterated Guernsey’s intention to introduce a regime which is fully AIFMD compliant, while also maintaining the existing regulations for those investors and managers not requiring an AIFMD fund. It had been expected that the final Level 2 rules for the detailed implementation of AIFMD would be published in early autumn but now it is believed that this might not happen until December. The delay is fuelling speculation that the July 2013 deadline for the rules being transposed into local legislation may be put back but this remains unclear.

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SPOTLIGHT

RUSSIA ESTABLISHES CENTRAL SECURITIES DEPOSITORY

Photograph © Burlesck/Dreamstime.com, supplied November 2012.

Russia formalises new CSD infrastructure Regulator grants CSD status to Moscow Exchange Group’s National Settlement Depository HE RUSSIAN FINANCIAL markets regulator Federal Financial Markets Service has granted the Moscow Exchange Group's subsidiary National Settlement Depository (NSD) status as the country's Central Securities Depository (CSD). NSD is the depository of MICEX, the Russian exchange that completed a merger with peer exchange RTS in December 2011, creating Moscow Exchange Group. Over the course of this year, NSD has merged the operations of RTS's legacy depository, DCC, into its own. The decision has been expected for some time and a number of overseas CSDs have been lining up to help facilitate cross-border trading, clearing and settlement in the Russian market. The official blurb accompanying the announcement has it that the CSD is expected to enhance liquidity and lower settlement costs, while ensuring that all market participants operate on the same post-trading platform. Foreign central depositories are now opening nominee accounts the CSD, among them Euroclear and Clearstream.

Federal, sub-federal, municipal and corporate bonds of Russian issuers will be covered by the links with International Central Securities Depositories (ICSDs) by the end of this year. At some near point too, the NSD is expected to meet the requirements of Rule 17f-7 of the United States Investment Company Act of 1940, allowing US funds to invest directly in Russian securities. Eddie Astanin, chief executive officer of NSD says,“Client abilities to conduct cross-border transactions in accounts opened with our organisations means increased transparency and, as a consequence, improved attractiveness of the Russian market for global investors [sic]. We expect this step will have a positive impact on exchange activities of Russian issuers, where they will reach a greater pool of national and foreign investors.” “The CSD is a milestone event for Russia’s financial markets … one of the key elements of guaranteeing rights of both Russian and international market participants and providing comfort to all categories of investors given it is in line with international best practices,”says Alexander

Afanasiev, chief executive officer of Moscow Exchange Group. He adds: “The creation of a CSD is one the most important reforms the Moscow Exchange is executing in partnership with market participants, regulators and legislators. Other key reforms include changes to the listing rules, the introduction of settlement in T+N and creating a single family of indexes. These are the necessary elements of a modern, competitive exchange infrastructure and their implementation make [sic] the entire Russian financial market more attractive.” Both Euroclear Bank and Clearstream intend to open a direct account facility at the new Russian CSD by year end. Clearstream has maintained an active sub-custody link to the Russian market, via Deutsche Bank Ltd Moscow, since May 2006 and was the first ICSD to do so. Co-operation between NSD and Clearstream has gathered pace over the last year following the introduction of the new CSD law, which came into effect on January 1st this year and was given further impetus following the FFMS’s decision to include Clearstream in its select list of entities authorised to assume foreign nominee holder status. This new link now signals a significant improvement in the way Clearstream’s customers will be able to access the market. Once live, the new account at NSD will, says Clearstream, deliver an efficient means to hold fixed income assets — namely government debt instruments, municipal bonds and corporate bonds—in a safe and secure environment under a legally recognised nominee ownership structure exclusive to international central securities depositories (ICSDs). Mark Gem, head of business management at Clearstream and member of the firm’s executive board says,“We have been very positive about the creation of the NSD from the outset and fully support this development which is

NOVEMBER/DECEMBER 2012 • FTSE GLOBAL MARKETS

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part of broader plan to increase the appeal of the market to non-resident investors. We will also work with our partners on any future initiatives that provide non-resident investors the opportunity to hold a greater breadth of instruments with the clear advantages that the NSD will deliver in terms of legal safety and operational efficiency.” Separately, Euroclear Bank also has access to the Russian CSD for posttrade services for Russian OFZs, one of the most actively traded classes of Russian government bonds. Euroclear Bank will also be able to offer services for other Russian government and municipal bonds, corporate

bonds and securities issued by foreign entities. Euroclear Bank’s services for OFZs and other securities were dependent upon the NSD becoming Russia’s official central securities depository. Plans for Euroclear Bank’s OFZ and other Russian fixed-income securities services include cross-border transaction processing, asset servicing and collateral management. According to Frederic Hannequart, chairman of Euroclear Bank,“OFZ and other Russian fixed-income trades will be able to settle with Euroclear Bank; settlement risk should decline as settlement finality will be based solely on the National Settlement Deposi-

tory’s records. Working directly with NSD is the best way forward to achieve the levels of efficiency, effectiveness and operational risk control that our clients expect. We welcome the decision taken by the Federal Service for Financial Markets to grant Euroclear Bank access to NSD.” NSD has links with CSDs/ICSDs in seven countries. Russian onexchange equity market capitalisation increased by 7.8% in the first half of 2012, reaching the equivalent of $539bn. Total Russian debt outstanding is valued at $302bn of which 58% are government bonds, with the remainder in exchange bonds, corporate and regional bonds.

Optimising tradeoffs between expected returns, portfolio volatility and unexpected inflation A new report from Mellon Capital Management Corporation NEXPECTED INFLATION RESULTING from mounting debt burdens and easy monetary policy in developed nations could reduce the values of stocks and bonds, says a new whitepaper from Mellon Capital Management Corporation, the San Francisco-based multi-asset manager.“Since the onset of the financial crisis in 2008, both fiscal and monetary policies across the globe have been unprecedented,” notes Karsten Jeske, co-author of the report and senior research analyst at Mellon Capital. “The US especially has been troubled by persistently high deficits, with one trillion dollars added to its deficit each year since 2008.” In addressing the potential threat, Mellon Capital has unveiled a comprehensive program to help investors optimise the tradeoffs among expected returns, portfolio volatility and unexpected inflation. The program is detailed in its report,

Photograph © John Bigl/Dreamstime.com, supplied November 2012.

Unexpected Inflation Hedging: A 3D SUPER Approach. The report distinguishes between expected inflation and unexpected inflation, which it defines as the difference between realised inflation and expected inflation for the same period.“Past experience indicates that unexpected inflation is detrimental to both equity

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2012

and nominal bond returns, while some other asset classes such as commodities and commodity-sensitive equities can help alleviate this risk,” explains Anjun Zhou, co-author of the report, and head of multi-asset research, of Mellon Capital. “However, trying to anticipate unexpected inflation by moving into passive commodity indices would come at a cost, because these assets tend to have lower expected returns,” he adds. Mellon Capital extends Modern Portfolio Theory by establishing a three-dimensional efficient frontier surface, which it uses to help determine the optimal trade-off among expected returns, portfolio volatility and unexpected inflation. The Mellon Capital programs are designed to move the efficient frontier upwards with the goal of providing improved unexpected inflation protection that would not have to reduce expected return, the report says. n

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IN THE MARKETS

CONSULTATION ON NEW IRISH NON-UCITS FUNDS REGIME

Photograph © Patricia Fatta/Dreamstime.com, supplied October 2012.

Ireland’s central bank issues consultation on post-AIFMD non-UCITs funds regime The Central Bank of Ireland has released a public consultation proposing enhancements to its non-UCITS regime in preparation for the implementation of the European Union’s (EU’s) Alternative Investment Fund Managers Directive (AIFMD). The implementation of AIFMD will give rise to substantial changes to the non-UCITS funds industry. It is proposed that the current Qualifying Investor Fund (QIF) regime in Ireland will be replaced with a new Qualifying Investor Alternative Investment Fund (QIAIF) regime. For retail investors in non-UCITS products, a separate Retail Investor Alternative Investment Fund (RIAIF) regime will be created. OME FUNDAMENTAL CHANGES set out by the Central Bank of Ireland at the end of October in its consultation paper on the implementation of Europe’s Alternative Investment Fund Managers Directive (AIFMD) is designed to help strengthen Ireland’s attractiveness to international managers. Fearghal

Woods, chairman of the Irish Funds Industry Association (IFIA) explains, “the authorities in Ireland are making significant progress towards implementing a range of legislative and other measures to enable the broadest possible range of regulated structures for alternative investment managers of all types to coincide with the introduction

of the AIFMD directive and that will help maintain Ireland’s position as a leading funds jurisdiction.” Interested market participants have six weeks to let the central bank know their comments on the proposed changes. Usually open consultations of this kind are allotted 12 weeks, but given that the AIFMD rules come into force in July 2013, time is of the essence and the central bank has opted for a shorter consultation process. “The central bank is sending out a strong signal that it is aware of change in the non-UCITS world and this consultation not only reflects the changes that are happening but seeks to anticipate future changes,” explains Kieran Fox, head of business development at IFIA. Core to proposed changes to the country’s non-UCITS investment regime is the consolidation of the country’s regulatory book into a new single handbook covering all regulation for AIFMs. This consolidation will see the removal of countless minor regulatory requirements which have come into place over the years. “It is a game changer,” concedes Fox,“and it is clear that we have moved from a complex regulatory structure, that involves nonUCITS notice documents, and a dozen or so guidance notes and policy documents as well as an array of other ad hoc regulations towards it being brought into one handbook with appropriate chapters covering key market segments.” According to the central bank, these changes will result in a more efficient and streamlined regulatory environment for all types of alternative investment funds in the country. “The timing of this consultation process will allow managers to establish AIFMD compliant funds in time for the implementation of the EU directive in July of next year,” explains Eoin Fitzgerald, managing director, Morgan Stanley Fund Services, and a member of IFIA Council, which leads industry engagement. The central bank is proposing the redesign of its AIF regime to optimise

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its reliance on European regulatory requirements, or at least those set out in the AIFMD; the creation of a higher risk AIF option to UCITS for retail investors; the elimination of regulations on QIAIFs that are not substantially adding to the protection of investors as well as the application of the AIFMD depositary regime to all authorised AIFs, including those with AIFM below certain thresholds. Changes to share class rules, the issuance of partly paid units and the removal of existing property fund rules will make it more attractive and easier to establish both private equity and property funds in Ireland. IFIA chief executive Pat Lardner explains that with 40% of the world’s hedge funds serviced in the country, “Ireland is the leading global centre for the domiciling and servicing of alternative investments.” Recent figures, says the IFIA, show that asset managers are increasingly turning to Ireland and to the QIF, in anticipation of AIFMD, with the number of QIFs reaching an all-time high of 1,618 and assets reaching a record level of €211bn—up 19% in 2011, 35% in 2010 and 28% in the last 12 months. Ireland’s total non-UCITS figures have also experienced considerable growth in recent years, up 35% in 2010, 15% in 2011 and 11% in the first eight months of 2012, according to figures from the Central Bank of Ireland. Assets in domiciled non-UCITS funds are up from €200bn in 2010 to €262bn with the number of funds and sub funds reaching all time highs. “As we near the publication of the Level 2 measures and the implementation of AIFMD, the new regulatory regime being proposed today will serve to enhance Ireland as the domicile of choice for AIFs and AIFMs building on the record growth we have seen in Irish non UCITS funds,” says Woods. However, notes Fox, “The UCITS portion is still much bigger and is at least three times bigger than the nonUCITs segment, so there is a real

opportunity to see this segment grow in size.” The central bank regards the regulation of investment funds as a dynamic process. “Regulatory requirements are always being refined and adjusted to mitigate more precisely the risks that we aim to protect investors against. For example, in 2013 we propose to look at the question of lending by QIAIFs, which is currently prohibited,” notes the introductory blurb to the consultation paper. “QIFs can buy loans which have already been issued or structured in a certain way,” explains Fox. “They cannot originate the loan; but once made can acquire it. In 2013 the central bank will decide whether to allow QIAIFs to originate loans.” The central bank is now asking for views on some 16 separate recommendations. We provide a small sample here. “Primarily, the central bank is looking for input into its recommended changes that for the most part on are in AIFMD, and so it is looking for guidance as to whether these elements should be amended or removed from its rule handbook going forward. The EU directive allows for local fund requirements to be incorporated into the final regulations affecting each market where neces-

Kieran Fox, head of business development at IFIA. “The central bank is sending out a strong signal that it is aware of change in the nonUCITS world and this consultation not only reflects the changes that are happening but seeks to anticipate future changes,” explains Fox. Photograph kindly supplied by the IFIA, October 2012.

sary,” explains Fox. The central bank is proposing to eliminate its current fund promoter approval process and rely instead on the obligations placed on them by AIFMD, for example notes Fox. It is also proposing to elaborate in more detail to clarify the obligations of directors when an AIF gets into trouble.

IRELAND’S PROPOSED QIAIF REGIME AT A GLANCE • Removal of the long-standing promoter regime (which includes the related promoter approval and capital requirements) • Removal of specific additional prime broker and counterparty credit rating requirements • Provision for the fair as opposed to equal treatment of investors in different share classes • Provision for exclude and excuse share classes • All existing non-UCITS Guidance Notes, Non-UCITS Notices and Policy Documents issued by the Central Bank of Ireland will be replaced by a new single handbook covering all aspects of regulation for AIFMs, Qualifying Investor Alternative Investment Funds (QIAIFs), Retail Investor Alternative Investment Funds (RIAIFs), depositary and administrator requirements.

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REGIONAL REVIEW

CONSULTATION ON NEW IRISH NON-UCITS FUNDS REGIME

Equally, QIFs authorised under the existing regime are not subject to investment and borrowing restrictions. However, in order to avoid circumvention of the Irish regulatory regime, they may not invest more than 50% of net assets in a single unregulated investment fund. The central bank is not proposing to change this limit of 50, but it does want to tighten the regime slightly by adding a provision to prohibit investment in excess of 50% in unregulated investment funds which are identical in terms of management and strategy.“This element is really about the treatment of master-feeder funds in the non-UCITS segment,” explains Fox. “The directive talks of a 75% limit or threshold for the definition of a feeder fund to a master fund, whereas the central bank is looking at a lower level, but it is asking for input if there is agreement with this approach.” The central bank is also proposing to discontinue the Professional Investor Fund (PIFs) regime and in future, no new PIF structures will be authorised, though the central bank will consider allowing existing PIFs to establish new sub-funds. It is keen in this regard to garner stakeholders’ views concerning the grandfathering provisions which should apply to PIFs. As well, the proposed RIAIF Requirements allow for the creation of an investment fund which is subject to less investment and eligible asset restrictions than the UCITS regime but is more restrictive than the QIAIF regime. In particular, key limits on investment in unlisted securities, single issuers and other investment funds have been raised. Additionally, requirements applicable to fund administrators specify that the final check and release of each investment fund net asset value (NAV) is a core administration activity which must be performed by the fund administrator. The central bank is keen to establish whether there are measures which could be put in place to allow the central bank to allow fund administrators to publish a net asset value prior to final checks. n

A QUICK GUIDE TO AIFMD irective 2011/61/EU on Alternative Investment Fund Managers (AIFMD) sets out rules that will apply to all alternative investment fund managers (AIFMs) and come into effect on July 22nd 2013. It will be supplemented by detailed Level 2 measures and regulatory technical standards and guidelines issued by the European Securities and Markets Authority (ESMA). In Ireland, the AIFMD will be transposed into national law by means of secondary legislation. AIFMD provides that certain of its provisions should be subject to supplementary rules and empowers the European Commission to adopt delegated acts in this regard (Level 2 measures). As of the date of this consultation these have not yet been published. The Directive aims to: • Ensure all Alternative Investment Fund Managers are subject to appropriate authorisation and registration requirements • Provide a framework to monitor macro-prudential risks through regular reporting obligations • Ensure proper monitoring and limitation of micro-prudential risks • Provide a common approach to protecting professional investors in Alternative Investment Funds (AIFs) • Enhance public accountability of fund managers holding controlling stakes in companies • Develop a European single market for AIFs. The Directive will increase the amount of disclosure made by funds, both to investors and supervisors. It will also impose requirements on managers in terms of organisation, capital, depositaries and marketing of funds, including a marketing passport for third country managers and funds, which was a particular priority for the UK. Political agreement on the Directive has been reached and the Commission is now engaged in writing extensive EU implementing measures that will provide further details. This work is expected to take at least a year to complete. Member States now have to transcribe the terms of the directive into national legislation by the beginning of 2013. AIFMD includes in its scope all investment funds which are not Undertakings for Collective Investment in Transferable Securities (UCITS). UCITS are regulated instead under Directive 2009/65/EC. While AIFMD does not regulate investment funds directly, it does, through regulation of an AIFM, impose requirements applicable to them. A number of non-UCITS investment funds and investment fund managers are currently established in Ireland under domestic legislation which will be impacted by the AIFMD. The legislation requiring the non-UCITS investment funds to hold an authorisation includes the Unit Trusts Act (1990); the Companies Act (1990 Part XIII); the Investment Limited Partnerships Act (1994) and the Investment Funds, Companies and Miscellaneous Provisions Act (2005). Each of these laws assumes that the Irish central bank have set down conditions for the authorisation of investment funds. Up to now the central bank has published a range of non-UCITS Notices (NU Notices) which have set down conditions with which authorised non-UCITS investment funds and firms who provide services to these investment funds must comply. It has also issued guidance notes which explain and clarify the various aspects of the country’s investment fund regulatory regime.

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IN THE MARKETS

MARKETS KEEN TO MOVE TO ISO 20022 MESSAGING Although it may seem like an unglamorous activity, corporate actions have always managed to generate a heightened level of debate. Progress is being been made on the automation front but there are still several bumps along the road. This is particularly true with the lack of movement on the messaging side which is why several disgruntled industry participants have recently made their collective voice heard. GROUP OF the world’s largest data vendors, custodian banks, securities depositories and software firms led by Thomson Reuters penned an open letter to SWIFT in the run-up to Sibos at the end of October. They took the interbank messaging services provider to task for its policy of allowing member firms to use both ISO 15022 and ISO 20022 message types to communicate information and receive instructions on corporate actions. Firms including Brown Brothers Harriman, Depository Trust & Clearing Corporation (DTCC), Fidelity ActionsXChange, XSP and Information Mosaic called on SWIFT to “drive consensus” among its members on how they will all move to ISO 20022 message formats and retire the older 15022 versions.

The main advantages of ISO 20022 over 15022 are that it supports a broader range of processes than just post-trade settlement and reconciliation. It covers the entire lifecycle for distribution events, ranging from entitlements and payments to instructions. Other attributes include flexibility, both in terms of content and adaptability, XML syntax, allowing for easier processing and maintenance and greater straight-through processing (STP) capabilities. In addition, it offers enhanced data elements providing for greater accuracy and risk reduction. According to Tim Lind, head of legal entity and corporate actions, ISO 20022 may represent an upgrade over ISO 15022 but the initiative has thrown the future state of corporate actions stan-

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CORPORATE ACTIONS: MARKET CALLS FOR A SINGLE MESSAGING STANDARD

Photograph © Dreamstime.com, supplied November 2012.

dards into a troubling state of uncertainty. “The lack of consensus on how ISO 20022 will be adopted is invariably creating a state of fragmentation, ironically from the very process designed to create harmonisation. The situation puts us at a critical crossroads and requires an escalation on the debate regarding the potential co-existence of both standards.” Christopher Remondi, partner at Brown Brothers Harriman, also notes, “We have before us a corporate actions standard solution that can propel the industry toward increased end-to-end STP, improved client service, and reduced risk and cost. Let’s forge ahead with clearly defined migration dates. We don’t want to be struggling with the problems of today when the problems of the future arise. The time has come to rip off the band-aid. We must not let the capabilities of ISO 20022 be stifled by the constraints of ISO 15022.” Many market participants though are not optimistic that there will be a resolution in the near term. “At the moment, the industry has a conundrum. The original ISO15022 standard has been the market standard but is quite archaic and has a rigid definition of what information can be put in the message,”says Paul Kennedy, business manager, reference data, Interactive Data, a financial market data provider. “By contrast the new XML-based ISO20022 standard is much more flexible especially for complex corporate actions. The DTCC in the US is moving ahead but it has the advantage of operating in one single market. The problem for Europe and Asia is that the industry is a little bit battle weary between the market crash and responding to regulatory demands to move from the existing standard to the more modern one despite its benefits.” The result is that different solutions are being developed across regions. The DTCC, which launched its multi-year corporate actions reengineering initiative last year, aims to replace its proprietary, files with ISO 20022 mes-

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IN THE MARKETS

CORPORATE ACTIONS: MARKET CALLS FOR A SINGLE MESSAGING STANDARD

sages by 2015. Four leading financial services firms including BNY Mellon, Brown Brothers Harriman, JPMorgan Chase, and National Financial Services are participating in its pilot programme while another 15 are currently in various stages of adopting ISO 20022. The DTCC believes that the enhanced data, improved identification and representation of events embedded in the new format will mitigate one of the greatest risks attached to corporate action processing—the misinterpretation of data when it is transferred from one party to another. “There are definitely significant benefits,” says Rob Epstein, DTCC vice president, Asset Services. “For example, we see about 25% to 35% increase in the amount of data published in a structured format, which will increase STP rates. One of the challenges is that there is no global mandate to adopt ISO 20022—currently 15022 is the messaging standard throughout other markets. I do believe that it is only a matter of time before other markets realise the advantages. Ultimately, the client base will not want to have a fragmented process.” A large number of market participants believe that the catalyst in Europe will beTarget2Securities (T2S), the initiative from the European Central Bank that aims to harmonise the settlements across Europe by connecting certain CSDs to one centralised settlement platform. Initially slated to come into effect from 2013, the much-delayed project, which has indicated it will use ISO 20022 messaging, is now expected to be operational from June 2015. “In Europe, ISO 20022 is not yet commonplace and migration towards it for corporate action processing will depend on the arrival of T2S,”says Tom Debruyckere, a director in Euroclear’s product management division. “The impression I have is that most people will wait until T2S arrives, and there will be a period of coexistence between the two formats well after T2S. From our perspective, the major challenges

both for and beyond corporate actions are the changing regulatory and cost pressures in the current weak economic environment. Euroclear’s solution— EasyWay—was designed with ISO 20022-operation in mind. The aim is to simplify and take the pain out of the corporate actions process.” Easyway, which is set to be launched in November, is a new browser-based application Euroclear has developed with several clients including Deutsche Bank, Goldman Sachs and Northern Trust. It will enable them to monitor the status of their entitlements in real time, including necessary actions on security holdings. It also contains a warning system that highlights imminent corporate actions deadlines. Although it will initially cover corporate actions, the plan is to roll it out to include settlement, collateral management and other custody services. The objective is to provide clients real-time access to a single screen from which they can monitor, manage and act on holdings that are impacted by corporate events. Clearinghouses are not the only ones forging their own paths. Banks are also pursuing different avenues. For example, Deutsche Bank has partnered with Tata Consultancy Services’ in development of their BaNCS platform to deliver an advanced corporate actions solution, which they will in future integrate with the dedicated custody and cash elements of the system. This development is a webbased, multi-lingual, multi-entity, end-to-end solution that automates corporate actions processing, and increases STP rate. “What we have done with Tata is remove the manual processes and in one platform we can look at positions across all business lines,” says Nick Scott, managing director and head of global asset services at Deutsche Bank. “It has simplified the process because getting a singular view across as many markets as we operate in is a monumental challenge. The industry can achieve some consistency by getting banks together to look at

how the software and platforms are being developed.” According to Geoff Harries, global head of asset servicing at investment software vendor DST Global Solutions, “There are a number of different agendas but people are not waiting for some future market panacea such as ISO 20022. There is already the technology in the market place to solve many of today’s problems. The biggest challenge always sits in the manual nature of the processes and the errors that can occur. However, we are now seeing many successful corporate action processing projects being delivered.” A recent study conducted by financial market consultancy firm CityIQ in association with SWIFT confirms that advancements have been made. It showed that in the four years since the last poll, automation of corporate actions processes and functions continues apace with 90% of the 95 financial service canvassed having invested in automation. The primary areas of focus include outbound as well as inbound notifications, workflow, data capture and cleansing, receiving instructions as well as instructing on voluntary events. Around 27% of institutions still continue to rely on the manual route mainly due to competing internal priorities, limited return on investment and difficulty in building a business case. There were also doubts about attaining STP, lack of management buy-in and the cost of SWIFT messaging. The other major hurdle in the corporate action world is the inability to receive the so called golden copy or record of the event. The industry largely relies on vendors who source the information from issuers directly and then channel it to participants through a feed. The problem is that not all corporate actions are captured. Some slip through the net because they are complex or custom events and are unable to be automated while standards also vary depending on the market and the way information is disseminated. n

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Opportunities to invest in size and strategy Hedge funds are always looking for capital. Even funds that are nominally closed to new investors will make an exception if the money will diversify their capital base in a desirable way, perhaps geographically or by extending the expected average duration of their capital. Start-ups and smaller established funds are less discriminating; they take whatever capital they can get. Prime brokers tout capital introduction services in their sales pitches, but managers who sign up and expect investors to throw money at them willy-nilly will be sorely disappointed. Hedge funds still have to close the deal once the parties have met; capital introduction is no substitute for marketing. Neil A O’Hara reports. APITAL INTRODUCTION IS free, a marketing tool sometimes oversold by prime brokers anxious to attract new clients or build up relationships with existing clients. Ten years ago, prime brokers often did little more than organise “meet and greet” events at which managers and potential investors would mingle in the hope of finding a match. An investor interested only in US long short equity managers seldom found the right

contact amid all the investors and managers of other strategies in the room—it was like speed dating without any pre-screening for compatibility. “Meet and greets” are still part of the service, but prime brokers now host targeted groups: the managers run similar strategies in which the invited investors have indicated an interest. Capital introduction has come to encompass other services, too. Prime brokers organise road shows for hedge

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CAPITAL INTRO: A SERVICE TO WHOM?

Photograph © Marek Redesiuk/Dreamstime.com, supplied November 2012.

fund managers to meet investors in various cities, arrange one-on-one introductions and disseminate information about managers to prospective investors. The teams also talk to investors to develop a profile of which hedge fund strategies best fit their portfolio requirements. Robert Leonard, global head of capital services at Credit Suisse in New York, says the role has evolved into what he calls capital consulting—advising hedge funds what investors are looking for, which strategies or structures are in favour and where the cash flows are coming from. “We are not just the guys who book road shows any more,” he says. “We have elevated it to a partnership role. We are sitting at the table having a strategic discussion and trying to help managers formulate their long-term business development plans.” The 32 professionals in Leonard’s group provide feedback from around the globe, which enables the team to identify potential investors hedge fund managers might never find on their own. Investor feedback has become more important since the financial crisis, when even the largest funds that had been closed to new investors for years suffered redemptions. Managers of these funds subsequently re-examined their capital sources and many turned to capital introduction teams for help in diversifying their investor base. “Large funds may want to find out more about, say, Scandinavian pension funds, or family offices in Hong Kong,” says Leonard. “They are targeted in their approach to global investors.” The renewed interest from established funds has shifted the business mix at Credit Suisse: before 2008, Leonard estimates the team devoted 70% of its resources to new and emerging funds but the split is closer to 50/50 today. Successful capital introduction requires the team to delve into each hedge fund’s strategy to understand not only how it differs from other strategies but also from direct competitors—and to explain the differences to

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IN THE MARKETS

CAPITAL INTRO: A SERVICE TO WHOM?

potential investors. Robert Sachs, global head of capital introduction at UBS Investment Bank, says traditional volume-based“meet and greet”capital introduction died in 2008 and he does not expect it to come back. The function has been subsumed into the bank’s entire interaction with hedge funds— capital introduction reports to sales, which has the ultimate say over how the team’s resources are allocated. Sachs, a career buy-side man who joined UBS three years ago from a fund of hedge funds, has staffed his group mostly from the buy side. Asset allocators who have experienced the institutional investment process at first hand bring critical insights into investor behaviour. “We have a greater understanding of hedge fund strategies and investor needs,” says Sachs.“We know how the allocation process works and how investment committees reach decisions.”The knowledge allows UBS to tailor its efforts; it may perhaps make fewer introductions than its peers but those introductions have a higher probability of success. The evolution of capital introduction has put considerable pressure on third party marketers, who dominated fund raising for hedge funds when the industry drew mainly from high net worth investors. Some have disappeared, while others have broadened the services they offer beyond fund raising to consulting or outsourced business management. The economics have deteriorated, too—payments in perpetuity for as long as the money stayed with a fund have been replaced by caps in amount and time; a share of the fees on money raised up to $200m for five years, for example. Capital introduction does not guarantee a fund will raise money, a point Sachs is quick to emphasise to hedge fund clients. Managing expectations is key in a job where clients may not grasp the distinction between capital introduction and capital raising—and prime brokers sometimes promise more than they can deliver. “We manage expectations to reality,” says

Robert Leonard, global head of capital services at Credit Suisse in New York. Leonard says the role has evolved into what he calls capital consulting-advising hedge funds what investors are looking for, which strategies or structures are in favour and where the cash flows are coming from. Photograph kindly supplied by Credit Suisse, November 2012.

Sachs. “We tell managers, ‘Never assume you will raise money in this market.’“ In practice, UBS explains to both investor and manager why they are meeting, then uses feedback from the investor to determine whether it is worth the manager’s while to pursue the lead and how the manager can assuage any concerns the investor flags. “It’s fact-based feedback,”says Sachs. “A manager cannot argue if I tell him he won’t raise a dollar from a particular investor. He can choose to ignore me, but he is unlikely to get the money.” UBS tries to be constructive, however; rather than a simple “no,” it tells the manager why the investor isn’t interested. The volatility of fund returns may be too high, the returns may be too low, or it may be an untested portfolio management team that has not worked together before. Whatever the reason, the feedback helps UBS refine its target introductions for the spurned manager and its profile of the investor. Keith Johnson, global head of capital introduction at Newedge, tries to keep managers’ expectations in check by focusing on who makes the investment decision: the investor, not the capital

introduction team. Newedge has long focused on“topical research,”analysing the same data investors study when they evaluate hedge funds: returns, volatility, drawdowns, correlations and downside correlations.“We can put the right people in the right room at the right time,” says Johnson. “From there on it’s out of our hands. We just have to keep reminding managers of that.” The predecessors of Newedge (a joint venture between Société Générale and Credit Agricole) were known for their expertise in futures, which explains the prime broker’s historical focus on commodity trading advisors (CTAs) and global macro funds. In the past two years, Newedge has expanded into fixed income and equities although Johnson admits it takes time to build up the necessary relationships. Like Credit Suisse and UBS, the Newedge capital introduction team targets only institutional investors—pension funds, endowments, foundations, consultants, family offices, funds of hedge funds and sovereign wealth funds—which is where most of the new money flowing into hedge funds comes from anyway. Institutional investors demand high quality infrastructure before they will invest in a hedge fund today. In the early 2000s, two individuals with a good idea and a Bloomberg terminal operating from a garage could still raise money, but not any more. “Investors want to know the manager will still be around in five years’ time,” says Johnson. “We see startups now that have spent $1m setting up the company, hiring the right people and getting complete research teams in place.” Finding the best match between a manager and investors depends on size as well as investment strategy. The smallest funds—less than $50m—need seed capital, a resource that has become harder to find in recent years and may require the manager to discount its fees. The next tier—up to $250m—taps traditional investors who won’t back startups but don’t demand a break on fees. The $250m threshold opens the door to the largest allocators,

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Robert Becker, head of capital introduction at Jefferies. Becker says his team works with these emerging managers on everything from the contents of pitch books to building the business and inducing as many investors as possible to look at the fund. His five person team divides its time about equally among talking to prime broker clients, talking to institutional investors, and setting up conferences or other events to bring investors and managers together. Photograph kindly supplied by Jefferies, November 2012.

typically funds of hedge funds, which need to write big tickets but typically do not want to represent more than 10% of fund assets. Johnson says CTAs and global macro funds suffered disproportionate outflows in 2008 because they never put up gates to forestall redemptions. These funds trade interest rate futures and other instruments for which liquidity never dried up during the crisis, which meant funds of funds tapped them because it was the only way to meet their own redemption requests. When the dust settled, managers took a hard look at where their capital came from and wanted to reduce their dependence on funds of funds. “Funds that were closed reopened,” says Johnson. “They focused on attracting pension funds and endowments that have longer investment time frames and a more stable asset base.” Rebuilding or reorienting the capital base of existing clients is less of a concern at Jefferies, which has carved out a niche as prime broker to smaller

($50m–$500m) hedge funds, mostly running US equity long short strategies. Robert Becker, head of capital introduction at Jefferies, says his team works with these emerging managers on everything from the contents of pitch books to building the business and inducing as many investors as possible to look at the fund. His five person team divides its time about equally among talking to prime broker clients, talking to institutional investors, and setting up conferences or other events to bring investors and managers together. “We put a profile of the managers who will present at our conferences up on a Web site,” says Becker. “Investors can choose the managers they wish to meet one-on-one for 30 minutes. It doesn’t waste managers’ or investors’ time; it’s targeted and more effective.” While strategy and performance are important to investors, Becker echoes the need for solid infrastructure as well: reputable service providers and a robust management team including a chief financial officer or chief operating officer along with a chief executive and chief investment officer. If the operations side is demonstrably sound, investors can focus on the investment process without worrying about business risk. “Investors make an effort to get to know a manager,” says Becker. “They want to know he’ll be there if they stay with him for several years.” Becker joined Jefferies two years ago with a mandate to build up its capital introduction capability. Through midOctober, the team had organised more than 60 events in 2012, featured 120 of its managers and made more than 700 direct introductions of managers to investors. He believes capital introduction is critical for a firm devoted to emerging managers.“It’s a key factor in choosing a prime broker,” says Becker. “Can its capital introduction team help smaller funds get quality opportunities to meet investors who will invest in that size and strategy?” Since the onset of the financial crisis, hedge fund performance has varied

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Keith Johnson, global head of capital introduction at Newedge. Johnson tries to keep managers’ expectations in check by focusing on who makes the investment decision: the investor, not the capital introduction team. Newedge has long focused on “topical research”, analysing the same data investors study when they evaluate hedge funds: returns, volatility, drawdowns, correlations and downside correlations. Photograph kindly supplied by Newedge, November 2012.

considerably and the extent to which particular strategies and instruments have the potential to contribute to market-wide risks remains a concern among policy makers. How much of those concerns filters through to end investors in hedge funds is yet to be determined; and while pickings remain slim in many traditional investment segments, alternative investment funds remain a popular choice for any asset gatherers willing to allocate a portion of their funds to more aggressive hedge funds. In consequence, this has allowed capital introductions to be more nuanced and more mature in approach. In that regard, capital introduction has invariably become a more valuable service. Ultimately though, hedge funds can rarely forget that ultimately prime brokers and not themselves are the drivers of the process. It’s a win, win for them: for if the ultimate results fall short for the investor the hedge fund manager is responsible, not the capital introducer. n

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MARKET QUALITY

THE SEARCH FOR MARKET QUALITY

Photograph © Italianestro/Dreamstime.com, supplied November 2012.

The best measure of market quality In today’s challenging European markets, how should the buyside ensure the best outcome for a trade? The answer could increasingly lie in the measurement of market quality. Lee Hodgkinson, NYSE Euronext, gives FTSE Global Markets his thoughts on why he believes market quality is so important. N SPITE OF abundant independent post-trade data, reliable market quality data is hard to come by and the buyside often have to compare apples with oranges as they look at their transaction cost analysis (TCA) and other pre- and post-trade indicators. In January, research and advisory firm TABB Group produced a report calling for a more standardised approach to the measurement of market quality. In “European Market Quality: A Metric in Need of a Standard”, TABB principal Laurie Berke says: “Brokers are increasingly granular in their post-trade TCA analysis and are trying to come up with metrics that

will differentiate the quality of liquidity and trading results in one venue vs. the other.” Lee Hodgkinson, head of sales and client coverage EMEA and APAC at NYSE Euronext, says it’s easier to say what market quality is not: “It’s not just about market share, which is how most multilateral trading facilities (MTFs) measure themselves. The standard view is that platform X, Y or Z is good because it has so much market share and therefore liquidity. But market share is a different metric from quality. Furthermore, although many SORs do factor in market quality metrics, other factors such as pricing or

rebates—which can inflate a venue’s market share—can potentially cloud the influence that quality has on their routing logic.” For the past year, NYSE Euronext has been publishing monthly data from independent data analysis firm TAG Audit. In their reports, they measure market quality by venue using a number of metrics including percentage of presence time at the European Best Bid and Offer (EBBO), tightness of spreads and market depth. Hodgkinson says: “Much of the liquidity on MTFs is based on being inside the European Best Bid and Offer for a fleeting moment. Fleetingly tighter spreads alone are not sufficient for quality.You have to be there for a longer period of time.” The percentage of NYSE Euronext’s presence time at the EBBO increased from 65% to 85% between January 2010 and April 2011 on its key blue chip indices stocks - those that belong to the AEX-Index, AMX-Index, BEL 20, CAC 40, PSI 20, and SBF120 indices. Since then it has fluctuated and in September 2012 was 72% compared with an MTF average of 35% of the time. The TAG Audit figures are published monthly at www.nyx.com/marketquality, and are based on a snapshot of the European electronic order book, taking quotes from various venues based on one time stamp. A daily market quality indicator of a security is based on the average of the indicator for each millisecond. The figures look at the indices that are on the exchanges owned by NYSE Euronext and compare NYSE Euronext’s performance with BATS Europe, Chi-X Europe, Equiduct and Turquoise. Hodgkinson says: “Our figures are fully transparent and independently verified and we are prepared to live by the results. The results have been evolving over time but we are happy with them as they demonstrate our diverse community. Other regulated markets may also come out quite well because they share the same deep characteristics as us.”

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This ‘diversity of community’ Hodgkinson refers to—the more types of participants in a pool – tends to generate better market quality, he explains. “The more diverse a client base, the greater likelihood of a higher quality market. We have material diversity in our client base, both in terms of user profile and geography. ” To get an even broader picture, LiquidMetrix Research’s Battlemap of the Exchanges looks at eleven European indices comparing spreads, depth of book, market share of volume and best prices from the main exchange order books. So for example during August 2012, Deutsche Boerse’s Xetra performance on the DAX had the average tightest spreads at 5.03bps compared with other venues active in that index. While brokers produce data, it is generally proprietary and not publicly available. Hodgkinson admits: “As an exchange we can judge execution quality because that’s the key benchmark we can assess from our data set. We don’t have access to end client data or knowledge of their individual strate-

gies and intentions. Everybody can benchmark themselves against public data but it’s difficult to benchmark against other proprietary data.”

A new world demands new rules Currently legislation or guidance for market quality is piecemeal. In 2007 MiFID, the Europe’s Markets in Financial Instruments Directive, set out an obligation on brokers to have a policy for best execution of client orders. In addition, Europe requires annual quality statistics from markets. Meanwhile, according to TABB Group figures, 51% of the buyside in 2011 was ‘heavily’ reliant on TCA reports and venue analysis to measure and compare their dark executions. Hodgkinson says: “Current regulation allows intermediaries to adopt broad based policies, as long as they are transparent to clients. We would like to see a tighter definition of best execution in MiFID II. We think it is in the interests of everybody in the community, particularly for the end investor.” “In the great scheme of things, the

Market quality against market share on CAC 40 Equiduct

Turquoise

Market share: 2% Market quality: Presence time at EBBO: 21% EBBO with greast size: 0% Spread: 32.19bps Displayed Market Depth: €13 094

Market share: 6% Market quality: Presence time at EBBO: 46% EBBO with greast size: 0% Spread: 11.76bps Displayed Market Depth: €12 597

BATS Europe Market share: 4% Market quality: Presence time at EBBO: 34% EBBO with greast size: 0% Spread: 18.69bps Displayed Market Depth: €11 275

Chi-X Market share: 21% Market quality: Presence time at EBBO: 72% EBBO with greast size: 5% Spread: 7.62bps Displayed Market Depth: €22 234

NYSE Euronext Market share: 67% Market quality: Presence time at EBBO: 76% EBBO with greast size: 42% Spread: 6.35 bps Displayed Market Depth: €51 493

Data showing April-Sept 2012; Market share data and market quality data source: TAG Audit.

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2012

Lee Hodgkinson, head of sales and client coverage EMEA and APAC at NYSE Euronext.

introduction of MiFID I is a recent event and the proliferation of electronic trading in Europe is still relatively new. We are now in an environment where institutional investors are asking: ‘How do I assess quality and ensure I am getting the best performance when my orders are routed to the market?’ There’s a greater and growing awareness out there.” Execution sizes have fallen significantly over the past 15 years. Hodgkinson says: “An order for half a million shares in a blue chip equity in the late 1990's needed little more than 15 to 20 executions, whereas today a broker needs more than 150 order book executions to complete the order. Limiting market impact has become much more difficult in today’s challenging trading environment. Fragmentation of markets has led to tighter spreads and lower explicit costs but with the consequence of much higher implicit costs. In this environment, all market participants need to care about market quality when deciding where to trade.” As firms have fought for first place in terms of market share, Hodgkinson believes that the next battleground will be on quality. “Institutional investors want to know their business will be protected and that they can trade with minimum market impact. It is challenging in the current environment for firms to ensure their trading strategies are implemented to maximum effect. Part of the solution could be real-time market quality metrics built into broker’s order routing logic—and ideally a standardised way of measuring quality across Europe.” n

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TRADING POST

THE IMPORTANCE OF CAPITAL MARKETS INFRASTRUCTURE

Most of us are focused on the large changes being made to the OTC derivatives markets in Europe and the US. However, when you look at the total system required to support market infrastructure from trading down to settlement, recreating that framework in a new country from scratch is an enormous undertaking. I don’t mean just computers and software, but the legal framework, the settlement infrastructure, risk management and importantly the knowledge to bring it all together, much of which isn’t freely available and carries a high price by those that can provide it. If central clearing delivers trust in the post-trade environment, and the spread of market knowledge, then I argue that it is a force for good, and should been seen as a new enabler for the development of emerging economies, more than aid or loans. By Bill Hodgson, consultant, the OTC Space.

Is central clearing a force for good? A

S COUNTRIES DEVELOP they have to engage with capital markets technology and import some or the entire capital markets framework into their economies to become competitive and attractive to outside investment. Developing a national capital market firstly relies upon law. This entails a well defined insolvency framework that recognises the rights of users of the capital markets to settle a bankruptcy in an orderly manner and preferably with netting of obligations within asset classes. Law enabling the delivery of securities as collateral must be in place, and of course there needs to be a corresponding securities lending market and a depository, to complete the foundations. Once this is in place, the infrastructure for the effective movement of securities is needed. Most countries develop a depository to enable an equity or bond market, and if settlement delays are to be avoided, will want to provide a clearing function to enforce predictable settlement and derisk the post-trade environment. Without clearing the depository can only use fines to enforce good settle-

ment behaviour, or block firms from participating in the markets at all. The next step is development of traded products with central clearing. That needs technology for pricing and risk management, something that is harder to import or acquire than legal expertise. Vanilla products with observable prices such as interest rate futures, commodity futures or bond futures can be managed by reference to historic market data. Pricing though becomes more complex once options are introduced onto an exchange. Not only must the exchange be able to price options to calculate safe margin levels, but participants must have the ability to quote option prices, and become market makers to kick off the flow of trading activity. Built on pricing technology is that of portfolio risk management and techniques such as Value at Risk (VaR) or the well used Standard Portfolio Analysis (SPAN). Pricing a single option is something you can do online; but pricing a whole portfolio of hundreds or thousands of trades and simulating the behaviour of markets to calculate margin levels is a higher order problem.

Bill Hodgson, independent consultant, The OTC Space. Photograph kindly supplied by The OTC Space.

Computer hardware is cheap so acquiring the processing power needed to carry out the calculations isn’t a barrier, but the intellectual problem of making sense of the data cascading out of the calculations is harder. The reality is that portfolio risk management relies upon a deep knowledge of statistics, plus the traded products themselves. Most people left behind statistics at high school and the number of people who have the expertise to apply this knowledge in the context of central clearing is limited. Without this depth of knowledge and experience the central clearing structure is unlikely to stand strong against the economic instability it is meant to protect against. What good is all this for a developing nation? By introducing clearing for bond and equity markets, the margin and strict settlement requirements would (in theory) reduce credit risk in the secondary markets and attract more sources of capital, both on-shore and off-shore. Providing hedging products for risks such as interest and exchange rates would enable firms to transfer risk via a trusted counterparty (the CCP) and manage exposures proactively, rather than suffer from unpredictable and adverse rates making their business more costly and uncompetitive. By adding a CCP and bringing ‘trust’ into the capital markets, firms are enabled to grow and attract inward investment into an organised and safe market. n

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DERIVATIVES

Central clearing for the over-the-counter (OTC) derivatives trades is beset with challenges. Proposed as a solution to the underlying failing of the financial markets which triggered the ongoing crisis, central clearing mitigates counterparty risk which can trigger systemic risk should a big bank fail and expose other firms to a default. The solution was mandated by the G20 in September 2009 at its meeting in Pittsburgh, when it dictated that standardised OTC derivative contracts be traded “on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest” with any that are not centrally-cleared subject to higher capital requirements and all contracts reported to trade repositories. Dan Barnes reports. ITHOUT CERTAINTY ON the final rules, the market is undecided whether the costs of central clearing will balance with the benefits. The rules which will determine how the G20 principles affect market participant directly are still being put in place across all jurisdictions and as such there is no certainty over the long term. “I don’t think anybody knows how this is going to play out,” warns Jane Lowe, director,

markets, for UK buy-side trade body the Investment Management Association (IMA). These are significant changes to the existing operational model for OTC derivatives trading. Although contracts can still be agreed bilaterally many must now be exchanged or confirmed on a platform of some description, with central counterparties (CCPs) sitting in between the firms on each side of a transaction. CCPs require a strict level

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REFINING THE RULES ON CENTRAL CLEARING

Clearing the table

of collateral to be posted as margin in case one of the counterparties defaults. That collateral is used to cover any loss in the event that the CCP has to take over the positions of a firm that becomes bankrupt. “The bulk of the OTC market lies in interest rate swaps in major currencies, and thanks to electronic trading; much of this is already standardised, making clearing easier,” Olivier Laurent, director for Alternatives Investment at RBC. “That said, whilst difficult to give a number, we expect that some transactions will continue to exist outside of the clearing requirements.” Paul Rowady, senior analyst at TABB Group says, “In our recent ‘The new GRTM’ report, I estimated that the clearly unclearable portion of the market is about 20% and the potentially clearable component is about 40%. During this transformation to clearing, market participants will need tools to monitor exposures in both cleared and uncleared domains, in addition to the introduction of new ‘futurised’ and hybrid swap products. This bifurcation or ‘trifurcation’ of the global risk transfer market proposes numerous complexity risk and cost evaluation challenges.” “I see the market bifurcating quite severely between standardised and non-standardised products,” says Eric Litvack, head of regulatory strategy at Société Générale. “The proposals are still to be finalised but non-standardised OTC will be under very serious constraints from an operational pointof-view and due to the requirements for confirmation and reconciliation but probably more damagingly by the proposals on margining.”

Money on the table The margin demanded by CCPs will be in excess of that required by firms trading on a purely bilateral basis for several reasons: firstly, initial margin is required to cover the value of a position, which was often not a requirement when trading bilaterally; secondly, variation margin, which

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REFINING THE RULES ON CENTRAL CLEARING

accounts for changes in the value of the contract, is required to be paid on a daily basis under the CCP rules where it was commonly paid on a quarterly basis bilaterally; thirdly, the quality of assets demanded by a CCP is far higher than that required by sell-side firms or their counterparties. “I’m fully alongside the notion of mandating universal variation margin, with the exception of the categories of counterparties identified by IOSCO for which such an arrangement clearly couldn’t work,” says Litvack. “To push beyond variation margin in order to cover gap risk with systematic bilateral initial margin segregated to a third party pushes the requirement for additional security up to a much higher level. My concern is that the amount of margin that mandatory bilateral and segregated IM would take out of the financial system is enormous and very likely way out of proportion to the risk that it would mitigate.” He continues, “There is a legitimate question of gap risk. If you owe me $50 and you pay me $50 but you then default and in the time that it takes to unwind our transaction there’s another one or two points lost, it would be helpful if you’d previously put $5 in an account somewhere so I could draw down on it, but at the end of the day it is probably not crucial that you do so. The sum of your $5 and my $5 and everybody else’s on each transaction without the benefit of risk-offset is a very large number. Taking that mass of cash or collateral out of circulation and trapping it by imposing segregation and non-reuse effectively adds up to a liquidity drain which and monetary contraction which according to some calculations is a multiple of the liquidity affected by Basel III. On top of the slowdown already observed in collateral in circulation, and the collateral demands which are due to result from current regulatory reform, that really is a dramatic form of quantitative tightening.” By removing the freedom of firms to make arrangements with trading partners as they wish, regulators will restrict

for more collateral and so costs will go up. Collateral management operations will have to be strengthened so firms are clear as to what collateral is needed, where they will get it from and how much it will cost them. Initially the impact will be increased capital expenditure but as firms develop they will become more efficient.”

Making a choice without any options

Paul Rowady, senior analyst at TABB Group.

the ability of players to identify methods for reducing costs. Lowe says, “At the moment you can choose how to deal with counterparties by putting together groups of trades so that cash flows are netted off. You won’t be able to do that going forward so bifurcation is an issue over the short to medium term.” Nonetheless the rules which determine central clearing obligations such as Dodd-Frank in the US and the European Markets Infrastructure Regulation are not the only driver of cost. Laurent observes,“We have to keep in mind that the regulatory clearing obligation goes along with incentives for banks in terms of capital charges under Basel III. Cleared trades will cost less than non-cleared trades. Non cleared trades will also be subject to mandatory collateral.” It is really this issue of cost that firms must come to terms with says Richard Turrell, head of market infrastructure, at BNP Paribas Securities Services. “In terms of operating two processes it’s not that big a deal, firms are collateralising bilateral trades today, and a certain percentage of those will become a central relationship so there is an efficiency gain in an operational sense,”he says. “The issue categorically comes down to collateral. There will be a need

There are other risks, and potentially costs. The process of change itself requires suppliers to prioritise certain decisions ahead of others, although a haltering pace of progress during the US regulatory process is making this hard. For example market participants in the US have to register as either a swap dealer/security-based swap dealer (SD), a major swap participant/major security-based swap participant (MSP) or as eligible contract participants according to the amount of trading activity they undertook over the previous 12 months. Firms are considered an SD if the value of swaps they traded was over $8bn, or $400m for security-based swaps other than credit default swaps; they have a two-month window for registering once the $8bn threshold has been crossed. MSPs are identified as having, amongst other characteristics, daily uncollateralised positions of between $1bn for rates and $3bn for rate swaps, with tests conducted quarterly. Any other firms wishing to engage in the swaps business must register as eligible contract participants. Each firm’s further obligations such as reporting trades are determined by their category. Yet the term ‘swap’ was only formerly defined on July 11th this year. Moreover, there are 19 other rules that were dependent on this definition which must be delivered by the end of 2012. Numerous deadlines have been moved from October 2012 to January 2013 by the regulators in order to ease the transition, but not all. As of October 12th, 60 days after the rules

NOVEMBER/DECEMBER 2012 • FTSE GLOBAL MARKETS

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DERIVATIVES

REFINING THE RULES ON CENTRAL CLEARING

were published in the federal register, swap dealers and MSPs became subject to swap data reporting and recordkeeping requirements. All communications, all swaps and transactions must be recorded, for counterparties and clients as well, with a clear audit trail available. As Lowe notes, “It’s a pity about Dodd-Frank because it is taking up people’s attention but not because they are implementing, rather it’s because they are trying to work out what they are supposed to be doing. Under CFTC rules, firms are under notice that as of November 1st they will have to deliver a report in May, but without knowing exactly what is required. So all this information will have to be gathered and held in anticipation.” The shift of trading from a bespoke service to a larger volume business will see the prioritising of change becoming an issue for smaller firms that will find themselves lower down the chain of importance. “The market for highly-liquid and standardised OTC derivatives will see trades run through an OTF then a clearing house, which should ultimately result in a market which is more transparent and less reliant on bilateral credit risk exposure. My concern is that implementation will take longer and be more complicated than many observers expect,”says Litvack.“All the banks which are futures commission merchants (FCMs) need to set up clients, which is expensive and time consuming. Most FCMs are concentrating on the clients they can extract most revenues from—the high volume clients. So if I am a low-volume client under the clearing obligation I'm not sure I will have an easy time getting an FCM to prioritise my file.”

Fragmentation or diversification? There is also a potential risk that the growth in the number of market infrastructure providers that are seeking to service this market could increase the market complexity and thereby increase costs or risks.

“Yes, the market will be fragmented, but not nearly as much as is currently expected,” says Rowady. “CME, LCH and ICE are the primary global CCPs for swaps. Given the operational complexities, it will be very difficult to expand this list. Plus, there is solid operational precedent from listed markets to accept trades for clearing from multiple trading platforms. The real challenge is on the end-user side: how to choose which product on which platform clearing through which CCP?” Although there are moves to create competition between the various trading venues and counterparties that offer derivatives trade processing, the issues of intellectual property and effective risk management are holding things back at present. Laurent observes that all major existing clearing houses are currently developing capabilities to support OTC contracts and that some competition is needed between CCPs, but in order to avoid fragmenting the market too much, leaders will emerge on a product or asset class basis. “It is important to build strong connectivity with them through clearing members, as well as consolidated views of positions,”he says.“Netting effect between products from the same asset class and collateral optimisation will however allow for lower margin costs and liquidity fragmentation.” Nevertheless concerns have been expressed about the failure to provide adequate competition between trading venues in the derivatives markets. Although the delivery of new contracts that will require electronic confirmation could conceivably drive a growth in trading volumes on new venues, such as the London Stock Exchange Group’s Turquoise market, the connection of clearing houses with incumbent trading venues will mean that by trading on the same venue/clearing house for both exchange traded and OTC derivatives offers firms a greater opportunity to offset margin across all trades. Currently trading venues are

able to prevent clearing houses from cross margining the contracts traded on their markets with the same contracts traded on rival markets. Christian Krohn, managing director of the equities and prime services divisions at sell-side industry body the Association for Financial Markets in Europe says,“Turquoise can’t really get its derivatives offering off the ground. Even though it offers far lower trading prices for the exact same FTSE 100 contract as is traded on LIFFE, because of clearing arrangements between LIFFE and the LCH Clearnet, the clearing house, the derivatives trades would have to be cleared in two separate margin pools so they could not be offset against each other. That makes the costs for clients of Turquoise much greater. That is a game killer as far as Turquoise is concerned.” Lowe concurs with this noting that, “The flipside of fragmentation is access. Because there aren’t trading venues for most of the market in terms of what will end up being centrally cleared, there is every chance that a new, useful trading platform or model could be created on an exchange or trading facility. What our members didn’t want was to found out that they then effectively couldn’t use it because the venue is denied access to clearing.” The revisions of MiFID and MiFID II and its sister regulation MiFIR are expected to deliver competition in the post-trade space by providing a levelplaying field for access to the clearing houses. "MiFIR should do something about that because Article 28 gives exchanges a right of access to CCPs,” says Krohn. “That gets around the failing of EMIR to mandate interoperability between CCPs. We support that Turquoise be given access to LCH Clearnet on a non-discriminatory basis as LIFFE has. Clearing remains concentrated but competition would be enabled at the trading level. Fragmentation is the wrong word in this case, it should be diversification. Rather than putting all of your eggs into one basket you are spreading them around.” n

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DERIVATIVES IR SWAPS

WILL CCPs REMOVE SYSTEMIC MARKET RISK

Developing cost effective solutions at CCP level Central counterparties (CCPs) have become the hinge on which the derivatives markets swing. Their ability to process the highly complex risk valuations for interest rate swaps (IRSs), the largest OTC derivative category by notional outstanding value, is critical for funds seeking to combat low liability discounts. Interest rate derivatives offer investment managers cost-effective management of interest rate risk, but only if central clearing works effectively. ANAGING INTEREST RATE (IR) risk is a significant challenge for pension and insurance funds in the current climate low interest rate environment making their ability to use interest rate products effectively, of key importance to their hedging strategy. Although the swaps are able to provide a hedge against interest rate movements at a low cost compared to long-dated bonds, the derivatives have become subject to increased scrutiny after the financial crisis, when they were shown to potentially pose risks to the whole financial system if traded unsupervised. Politicians have determined that CCPs will be the policy tool for reducing systemic risk in the derivatives markets. Where previously trades were fixed bilaterally and stayed that way, now once a deal is booked, a CCP is required to sit between the two parties so that it is hit in case of default. The policy was set first by the Group of 20 (G20) countries at its 2009 summit in Pittsburgh, where it mandated that,“All standardised over-the-counter (OTC) derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end2012 at the latest. OTC derivative contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements.” This has since been set into legislation under the Dodd-Frank Act in the US and the European Markets Infrastructure Regulation (EMIR) which are

intended to come into effect next year. The need for checks on counterparty exposure were brought into focus in the financial crisis after US insurer AIG effectively took a giant directional bet on the positive health of the US mortgage market, which was promptly revealed to be unwell. AIG wrote out almost $60bn of credit default swaps for asset-backed securities underpinned by sub-prime mortgages. When those subprime loans were defaulted on, AIG required an $85bn credit facility from the Federal Reserve to keep it functioning. The G20’s model of using CCPs will not prevent a financial institution from going bankrupt by taking excessive positions, but it will mean that the firm’s counterparties are not all exposed to the default. “The major risk is default; the potential domino effect with one player bringing others down and eventually the entire system,” says Renaud Huck, head of UK institutional investor relations at Eurex Clearing.“So this is why our IRS OTC clearing solution is very much buy-side oriented because the buy-side is putting up the collateral. That’s why we offer a fully-segregated model. We have come up with this solution, where we ensure that the protection of collateral and position for the buy-side clients in the case of default of a clearing member.” A CCP requires the counterparties for every trade cleared through it to provide it with assets to be used as collateral. These are used to counterparty’s position if it defaults, known as ‘initial margin’, and further collateral is

required to account for daily movements in the price of the derivative, referred to as ‘variation margin’. Under this model the CCP is able to step in and cover a firm’s obligations to the market if it collapses, thereby reducing systemic risk. However calculating the right level for margins is no mean feat. “IR swaps are relatively complex; the way that they are valued, using a yield curve, is very different to other derivatives, such as futures,” says Michael Davie, chief executive officer of SwapClear. “They tend to be instruments of longer duration; our average swap is over ten years in duration and our average size on SwapClear is well over £100m,” he adds. New regulations make CCPs responsible for valuing and measuring risk on these instruments at a higher rate that has been required before and with a greater volume of instruments. “These are fairly risk sensitive instruments,”he continues. “I think that when it comes to clearing them there are a number of things to lock down. When you are setting up margin calls you need to construct your yield curves, value your trades, look at the existing portfolio and layover incremental trades, you need to have all of that process off pat multiple times a day and intraday.” The caveat is: some IR swaps have been clearing for 12 years and there are plenty of products that are more exotic and complex. Nevertheless, SwapClear has its work cut out. It sets valuation curves multiple times a day, in 17 different currencies, for up to 50 years. More than two million trades

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have to be valued every day. “We've cleared over £4trn in notional client business,” says Davie. “Although the notional value doesn’t affect the volume of trades being processed it does matter from a risk perspective. If I'm clearing a £5bn notional trade then if I'm not valuing that very precisely whoever is posting margin, whether VM or IM, is going to be upset.”

their collateral and help them establish a new relationship with a new clearing member,” says Huck.“In the meantime they become a clearing member of the exchange with the legal documentation in place, so that they are a registered client. We know what they are doing and how they are doing, they receive a certificate of deposition so it’s a much more transparent image of the business in the case of a default event.”

Overnight indexed swaps For variation margin SwapClear has adopted the overnight indexed swap (OIS) curve to use for discounting; OIS rates are based on federal fund rates, rather than the London Interbank Borrowing Rate. To ascertain the level of the initial margin required, SwapClear tests itself against the simultaneous default of its two largest members and their clients. A substantial default fund also sits on top of the initial margin. "We are constantly looking at whether our IM is set correctly and never more so than at the moment; we have a multi-generational, if not all-time, low in interest rates and incredibly flat yield curves and that gives rise to various anomalies in traditional valuation-atrisk approaches,” says Davie. “We do make sure we don’t step over the limit of inefficiency because we want the collateral approach to be efficient; we want to reassure the buy-side community and the trading community at large about how serious we are in our collateral approach.” Investment firms also need to know that their funds will be safe with the CCP in the event of default and Eurex Clearing is offering a segregated account structure for buy-side clients to provide maximum security. A tri-partite agreement is established, setting up a relationship between the clearing member, the end client and the clearing house. “In the event of a credit event we cut the relationship with the defaulting clearing member, we therefore have no relationship with the administrator and we establish a bilateral relationship with the buy-side client in order to place

Collateral protection “Unlike other clearing houses Eurex will not liquidate the collateral of the client,” he continues. “We consider the approach of collateral protection to be very important, so neither the collateral nor the position will be liquidated. Other clearing houses liquidate collateral in a stressed market, at a low price. Once liquidated the marginal percentage of the initial collateral that is in cash will not be enough to buy new collateral and so the client will have to buy it back at a very high price.” A significant aspect of cost for the investment funds is the collateral required to be posted as margin with the CCP. The assets that are eligible for collateral vary from one CCP to another but have to be of high quality and must be liquid enough to be tradeable in the event of default. “With the implementation of EMIR during 2013, we had to look closely at what the new landscape would be for collateral,” says Huck. “We decided to take the best benchmark, the eligible list of collateral published by the European Central Bank (ECB), which has five tranches. The fifth is asset backed securities which we decided not to take, instead we will take the first four tranches of collateral: gold certificates; corporate bonds; and cash. Using our reduced version of the ECB list it does present about 25,000 items which are accepted. On bonds we do not accept more than 25% of any issuance and on cash we don't accept more than 5% of any free float.” For a pension fund that invests primarily in equities but holds a few gilts

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2012

to offset interest rate risk, finding collateral that fits the bill can create additional costs. Central clearing is not 100% mandatory—pension funds have a three-year exemption to centrally clear trades under European rules— but as per the G20 instructions, capital requirements for banks shouldering OTC positions without a CCP are high. Where there is a choice, firms must weigh up the advantages of clearing against the costs. Numerix is a software house that assists market participants in evaluating the risks and costs inherent in their positions and thereby deciding whether or not they ought to centrally clear a trade. “We're working with a lot of clients where the pre-trade analysis required is becoming more and more critical from a funding perspective,”says Jim Jockle, senior vice president of marketing at Numerix. “It comes down to a very Shakespearean decision; to clear or not to clear.” Despite the higher capital charges that regulators are imposing on noncleared trades, the accumulation of additional costs under the central clearing model can be prohibitive he warns. “There are elements of profitability,” O’Hanlon says. “What does this trade cost me over a lifetime? In a centrally cleared world I've got: initial and variation margining; buy-side participants face very disparate costs passed on by futures commission merchants (FCM); there's the cost of infrastructure; the cost of clearing with a CCP based on its default fund requirements. Against this firms have to consider that they might face a higher capital charge but that may not create the same impositions as initial and variation margin.” However Amy McCormick, executive director of market risk management at CME Group, believes that there are significant potential risks for firms that avoid central clearing. “Counterparty risk is always top of customers' minds, and uncleared OTC IR swaps require customers to have open bilateral exposure for long periods of time,” she says. n

GM Regional Review 66_. 20/11/2012 10:23 Page 36

REGIONAL FACE TO FACE REVIEW

DING CHEN, CHIEF EXECUTIVE OFFICER & CHIEF INVESTMENT OFFICER, CSOP ASSET MANAGEMENT

FTSE Group has licensed the FTSE China A50 Index to CSOP Asset Management as the basis of its first Renminbi (RMB) Qualified Foreign Institutional Investors (RQFII) ETF, which is now listed on the Hong Kong Stock Exchange. RQFII ETFs provide investors with direct access to the mainland A-share market. For the first time, foreign investors are able to invest in physical A-share ETFs. Previously, they could only get exposure to the Chinese mainland stock market via synthetic products; or the QFII scheme which was only available to a very limited number of foreign institutional investors. In this regard, RQFII ETFs are a breakthrough in A-share investing to the international investment community. Ding Chen, chief executive officer and chief investment officer, at CSOP Asset Management, China’s largest RQFII asset manager, talks to FTSE Group about the initiative and the continuing potential of the Chinese market.

RQFII’s long term promise TSE GM: FTSE Group has licensed the FTSE China A50 Index to CSOP Asset Management as the basis of its first Renminbi (RMB) Qualified Foreign Institutional Investors (RQFII) ETF, which is now listed on the Hong Kong Stock Exchange. Can you please tell us a little about the ETF initiative and the thinking behind it please? DING CHEN: Mainland regulators have utilised RQFII as a channel to introduce foreign capital to the Chinese market. Equally, from the overheated response of global investors to our product, it is not difficult to see that the A-share market represents vast investment potential. To Chinese asset managers like us, RQFII ETFs serve as the bridge between ourselves and the global market. As the first Chinese manager to set up offshore operations four years ago, CSOP Asset Management has launched a series of China-focused fund products for global investors. We have also become more familiar with foreign investors and we are delighted to see that more foreign investors are becoming comfortable with investing in China through us. The successful launch of the CSOP FTSE China A50 ETF is another example of this. FTSE GM: What are your views on the prospects for the RQFII ETF? What do you hope for it? DING CHEN: I am very optimistic about the prospects of the RQFII ETF. First, with the rising importance of

Ding Chen, chief executive officer and chief investment officer, at CSOP Asset Management. Photograph kindly supplied by CSOP Asset Management, November 2012.

emerging markets, led by China, it is expected that global investors will continue to increase their allocations into A-share investment. Second, Chinese regulators continue to make our market more open, transparent, and welcoming for foreign investors. At CSOP we need to make the necessary adjustments to leverage this change. Take our product CSOP FTSE China A50 ETF as an example. The listing of the ETF on August 28th this year was a great success but we are not resting on our laurels. We have plans to make the

ETF more appealing to a broader scope of investors, including introducing financial derivatives and a dual currency listing, for example. FTSE GM: The ETF marks a milestone in RQFII development. Can you please say why? DING CHEN: The launch of the RQFII ETF allows foreign investors to invest directly into physical China A-shares. It enriches the variety of the products under the RQFII regime and enables offshore RMB to flow back into the China A share market in a direct, effective and transparent way. FTSE GM: How effective is the FTSE China A50 Index as a route into the A-share market? DING CHEN: The FTSE China A50 Index comprises the 50 largest companies in China. With their combined market capitalisation, these companies represent a major part of the A-share market. The assets under management (AUM) of the FTSE A50 China Index ETF account for about 78% of the total AUM of HK-listed A share ETFs, despite the sharp increase in the number of A share ETFs on the exchange from eight at the end of 2009 to 24 right now. The market reaction has already told us all we need to know about the representativeness and tradability of the index. FTSE GM: How was the ETF received in the primary market? DING CHEN: It has been very successful as the original quota of RMB5bn was fully subscribed in a very short

NOVEMBER/DECEMBER 2012 • FTSE GLOBAL MARKETS

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period of time during the IPO. We subsequently applied for an additional RMB2bn quota in order to cope with heated market demand. FTSE GM: What do you expect of the ETF in secondary market trading? DING CHEN: We expect our ETF will account for a major part of the turnover of the five RMB listed products on HKEX. We believe the trading volume of our ETF will surge when market sentiment improves and investors acquire a better understanding of the RQFII ETFs. CSOP FTSE China A50 ETF is also the largest RQFII ETF in terms of the AUM and the highest in terms of average trading volume, among all three RQFII ETFs that are currently trading in HKEX. We are delighted to see the secondary market’s support for the CSOP A Share ETF, which is also a strong indication of the value that investors place on our product. FTSE GM: Can you tell us a little of CSOP’s investment approaches. ? DING CHEN: We believe that choosing the right investment strategy is the basis for our sustained development. Our investment strategies include: prudent investing, with an emphasis on risk management, pursuing sustainable return; value investing, where we emphasise the analysis of the internal value of listed companies and seek to invest in underpriced securities; and long-term investing, where we trade infrequently to avoid short term volatility, or chase a temporary heated market. We are also research-oriented. Our research is based on macro economy, sectors, listed companies and security markets as well as company visits to avoid credit risks. FTSE GM: How might this approach evolve over the coming year? DING CHEN: We think the rise of the RMB as an international currency has just started and there will be more exciting products along the way. Please stay tuned. FTSE GM: How will the ETF market in China evolve, do you think? DING CHEN: We believe the ETF

market in China will continue to evolve quickly with the support of the regulator and market participants. The penetration of ETFs in Asia and China is still relatively low, especially if you compare the ETF market size and product variety to that of more developed markets, such as the US. Investors in China are very familiar and comfortable with ETF investing, so the market potential here is huge. FTSE GM: How might CSOP help along this evolution? DING CHEN: Continuing internationalisation of the RMB and the growing importance of investments in China in the portfolios of global investors will help along this evolution. We also believe that we will continue the success of our CSOP FTSE China A50 ETF through the management of secondary trading liquidity and tracking error. Of course, we also want to make CSOP Asset Management more familiar to global investors. FTSE GM: What do you think are the most important influences on the global investment market right now? DING CHEN: Personally, I think political issues are exerting a powerful influence on the market right now. The world is following closely the repercuussions of both the US presidential election and leadership change in China. Any major political shocks over the coming year will likely continue to add to market volatility. FTSE GM: Where do you see opportunity in the Chinese market? DING CHEN: China’s market is undergoing an adjustment phase, with the A share segment falling off 60% from its high in 2008. Although China’s economic growth is slowing down temporarily, growth rates in the range of 7% to 8% in such a big economy will still offer great investment potential to global investors. Second, China’s export and import performance is now much more significant globally and the volume of transactions settled in RMB is growing steadily. Investors will inevitably place a higher proportion of

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2012

their global portfolio in China when investment access becomes easier for them. FTSE GM: This has been a challenging year: what obstacles have you had to overcome? DING CHEN: This is a challenging year for the global economy as the repercussions of the credit crisis in Europe have spread across the world. China’s economy is also undergoing structural adjustment and many small companies are facing difficulties. In my view, investors have over reacted to the slowdown in China’s growth and underestimated the country’s long-term potential. Meanwhile, mainland regulators are taking measures to restore investor confidence and to attract more long-term, institutional investors to the market. We believe market confidence will return and expect the market to respond positively soon. FTSE GM: What other initiatives might emerge in the near future? DING CHEN: Asset allocation to the China region has been steadily increasing in international investors’ portfolios, and offshore RMB deposits have also been accumulating. We foresee there will be further development of more offshore RMB products that offer direct access to China’s financial markets. FTSE GM: Can you please tell us about some of your own impending initiatives? DING CHEN: I am delighted that CSOP is the largest RQFII fund manager. We will continue to strive to maintain our leading position by dedicating our experienced product development and investment teams to designing and managing more successful products, to meet global demand. This could include more passive ETF products with beta exposure to China, tailor-made index products that focus on dividend yield or sector exposures, actively managed products with exposure to China’s fixed income market (including onshore high yield bonds market) and investment advisories or discretionary account management services to QFII investors. n

GM Regional Review 66_. 20/11/2012 10:25 Page 38

FX VIEW

RMB OUTLOOK AS CHINA USHERS IN NEW LEADERS

China began to usher in a new era in mid November as Xi Jinping took his place as the new leader of China’s communist party. Early local commentators noted that the make-up of the country’s seven man politburo were from the politically conservative arm of the party; perceived reformers having failed to win promotion. The new leaders will not take up their positions for a few months, as the presidency of Hu Jintao will not come to an end until March next year. What will be the likely impact on further economic liberalisation and the movement to full convertibility of the RMB?

China’s new leaders likely to take a conservative path HINA’S INCOMING POLITBURO will determine the country’s economic programme for the next five years. At first glance, it appears that the make-up of the seven-man standing committee, the innermost ring of power, marks the coming of a cautious period in China’s economic evolution. Certainly, cyclical weakness is expected to dominate the near-term outlook, with growth projected at 7.7% for this year, according to the World Bank. Moreover, it says Chinese policy makers will have to balance support for growth with concerns of a rebound in housing prices—a balancing act that is and will continue to reduce their ability to take more forceful stimulus steps. On a more positive note, the World Bank says recent economic data for China suggests a rebound, albeit modest, while recent efforts to step up investment project approvals could support the recovery in investment in the coming quarters. The bank expects growth in China to pick up to 8.1% next year, as the impact of stimulus measures kicks in and global trade rallies. China’s external terms of trade will therefore likely improve as import prices, which are dependent on commodities prices, continue to decelerate by more than export prices (which are dominated by manufactures). The exchange rate appreciation of the RMB is therefore expected to slow

Photograph © Guangliang Hug/ Dreamstime.com, supplied November 2012.

as long as the weak external environment continues to weigh on export volumes and prices. China’s current account surplus is projected to increase slightly to 3% of GDP this year and between 3% and 3.3% in 2013, according to the World Bank. With trade volumes expected to recover somewhat in 2013, it is no surprise that increasing numbers of reports out of China say that the markets should expect further widening of the currency band. In China’s foreign exchange spot market, the currency is allowed to rise or fall by 1% from the central parity rate each trading day. Further widening the trading band for China's currency is a policy option that the central bank may adopt in the future to better reflect modestly improving market conditions. China’s central bank had tweaked the trading band this April to allow the currency to rise or fall as much 1% from

a mid-point every day, compared with its previous 0.5% limit. The currency steadily strengthened through November to 6.2920 against the USD in early November, setting a six month high, though investors no longer appear to be betting exclusively on its continual appreciation. Continued weakness in the euro and expectations of a slowdown in China has meant that the currency has been more volatile this year, though it is now well off its July 2012 lows. The question is now whether the incoming administration will speed up the movement of the currency into a freely convertible global currency, or will continue to keep on the brakes to full convertibility. External factors as well as internal influences will have a say in the final calculation. The financial crisis and European debt woes have, to some extent, undermined the status of the euro and the US dollar giving the RMB an opportunity to grow into a global currency one day. Beijing has been trying to strengthen the global clout of its currency by promoting the use of the RMB in cross-border trade and investment. It has also signed a series of bilateral currency swap agreements with foreign countries and added new currency pairs in onshore market trading. However, many economists still say it will be a long time before the RMB can become a global reserve currency. n

NOVEMBER/DECEMBER 2012 • FTSE GLOBAL MARKETS

GM Editorial 64_. 03/09/2012 14:03 Page 51

GM Regional Review 66_. 20/11/2012 11:29 Page 40

COUNTRY REPORT

US, UK, EUROPEAN, INVESTORS WELCOME GUIDANCE ON FCPA

A leading group of global investors, representing more than $3trn in assets under management appear to have endorsed the United States’ new guidance on compliance with its Foreign Corrupt Practices Act (FCPA). The group of investors have engaged with the US Department of Justice (DOJ) and Securities and Exchange Commission (SEC) to voice concerns about potential dilution of the law, and issued a formal statement in early November, detailing their support for rigorous enforcement Act.

INVESTORS TALK TOUGH ON US FCPA RULES NSTITUTIONAL INVESTORS FROM around the world have joined to endorse US efforts to curb corruption through the Foreign Corrupt Practices Act. In an unprecedented level of support for regulation, the investor group has tried to offset efforts by parties such as the US Chamber of Commerce, to relax enforcement of certain key provisions of the Act. Any move to relax the terms or tenor of the law will have deleterious effects on shareholder interests, says the group. “We believe that poor control of corruption and bribery can be an indicator of future risk at global corporations and can thereby negatively impact longterm shareholder value,”says the official release from the investor group. Adam Kanzer, managing director and general counsel of Domini Social Investments LLC, the lead author of the investor statement explains that: “A significant coalition of global investors has come together to make a very clear statement—bribery and corruption is bad for society, bad for business and bad for our investments. Our statement details the very significant risks presented by these activities, from legal consequences to impacts on economic development and the realisation of human rights.” The guidance, published by the DOJ and SEC last week, provides information for companies on the DOJ’s and SEC’s policies and practices on civil and criminal prosecutions under the FCPA, the 35 year-old anti-bribery law that first set the stage for extra-territorial prosecution of overseas corruption of public officials. Following decades during which the United States led international efforts to prosecute cor-

ruption cases against US and non-US companies, the UK passed the UK Bribery Act two years ago.“The current state of the global financial system demonstrates that neglect of governance indicators can lead to long-term value destruction on a systemic scale that far exceeds the short-term benefits that might arise from engaging in highrisk behaviour,” posits Karina Litvack, director, head of governance & sustainable investment, F&C. “As investors, we continue to be concerned about the impact of bribery and corruption on individual company performance and the capital markets at large,”Litvack adds. A high incidence of bribery and corruption has been demonstrated to cause significant deterioration in the overall investment climate, says the group, driving up risk premiums and severely depressing investment returns on a like-for-like basis. Companies that are exposed to such markets through their operations and investments, and exacerbate the incidence of bribery and corruption through weak internal controls, thereby compromise long-term value creation and undermine efforts to drive reform that can benefit shareholders and the wider society, they add. “Given the wide reach of the FCPA and the US authorities’ aggressive enforcement record, all companies with operational or capital markets exposure need to be fully apprised of the legal and financial risks they face from failing to comply with this legislation. We therefore wholeheartedly welcome the DOJ and SEC’s determination to set clear and consistent standards, and to provide this much-needed guidance to affected companies,” says Litvack.

The FCPA and the various anti-corruption efforts it has engendered around the world impose prudent compliance requirements and the risk of costly enforcement actions on corporations. “We believe that these actual and potential costs are dramatically outweighed by the benefits provided by commercial activity free of bribery and corruption to individual firms, the capital markets, and local and national economies. Bribery and corruption present significant barriers to long term sustainable economic activity,”says the group release. Recent allegations of an alleged extensive bribery scheme by Wal-Mart de Mexico underscore the seriousness of this point. The announcement of the bribery scandal caused the share price to drop by 5% the next day and although short-term fluctuations in share price can reflect a wide range of factors, many believe the company is still at risk of fall-out from these revelations, particularly as they raise questions about the ability of the company to maintain its growth momentum in light of its historic reliance on allegedly illegal means of securing permits.“We are concerned that Wal-Mart de Mexico’s activities, if proven to be true, may have placed the company’s law-abiding competitors at a significant disadvantage,” says the investor group release. Wal-Mart shareholders—in particular those not directly connected with the management or controlling Walton family—voiced their disapproval of these practices by voting in significant numbers against key members in management and on the board and the company now faces a lawsuit from shareholders. n

NOVEMBER/DECEMBER 2012 • FTSE GLOBAL MARKETS

GM Regional Review 66_. 20/11/2012 10:25 Page 41

SWITZERLAND TIGHTENS INVESTMENT RULES

The Swiss asset management and fund industry will be subject to major regulatory changes over the next two years. Switzerland remains an important domicile for private equity and hedge funds and these new laws are designed to bring the country in line with EU directives on collective investment schemes and AIFMD. The new regulations are more onerous than the local fund management industry is used to and marks the beginning of a substantive change in the Swiss regulatory environment. As of 2013, any type of foreign collective investment scheme will be subject to prudential licensing and supervision.

SWISS TIGHTENS INVESTMENT REGIME HE CURRENT REGULATORY environment for asset managers in Switzerland is still light compared to other European jurisdictions. Up to now asset managers have not been tightly regulated. By and large they have been subject to supervision for purposes of anti-money laundering and for the prevention of terrorist financing. In this regard, they have been subject to supervision by the Swiss Financial Markets Supervisory Authority (FINMA). Either that or they have functioned under the auspices of a FINMA recognised self-regulatory organisation for anti-money laundering purposes. At the end of September this year, the Swiss parliament passed amendments to the Swiss Act on Collective Investment Schemes (CISA) with 128 yes votes, 58 nos and nine abstentions. CISA was originally adopted back in 2006 to help bring Swiss legislation in line with European UCITS rules, and provide transparency and protection to retail fund investors. This round of revisions to the Act covers the management, distribution and custody of funds and specifically affects local and foreign collective investment schemes in the country. However, this is only the first phase in a comprehensive review of the regulation of financial services and the creation of an overarching Financial Services Act (FSA) which will govern the Swiss investment industry going forward. The CISA amendments then should be seen as part of a work in progress and the first draft of the new,

Photograph © Vladitto/Fotolia.com; supplied November 2012.

planned, overarching legislation is expected sometime in 2013. Focusing on the now, the intervening period between the passing of the amendments in September and January 17th next year, is a designated interregnum in which interested parties may apply for a referendum if they wish to challenge any part of the amendments. However, given the detailed technical nature of the new law, say Theodor Härtsch and Markus Affentranger, in the wealth management team of international law firm Baker & McKenzie, in a comment paper, a referendum is not likely. If the amendments remain unchallenged in their present form the new law will come into force in February next year as planned. Looking at the main elements of the amendments, Swiss regulations and licensing requirements for asset manager have been strengthened in line with international regulatory develop-

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2012

ments (in particular Europe’s AIFMD). The key changes are detailed and include much more onerous reporting requirements and disclosure rule of all costs charged to end investors. Under the amendments, the distribution of foreign non-regulated funds such as private equity funds and hedge funds in Switzerland has also become significantly more difficult and the scope of private placements exemptions is more constrained. Equally, a larger number of Swiss asset managers will now fall under the supervision of FINMA and the delegation of functions in collective investment schemes are more strictly regulated. Further, due to an associated change in the country’s pension fund law, as of 2014 asset management services to Swiss pension funds will as a rule only be provided by FINMA supervised institutions. Under the new rules, any type of collective investment scheme distribution has to be regulated, though the kind of licence it will receive depends on who the end investor is (inside or outside Switzerland, for instance). If a collective investment scheme is promoted or sold to non-qualified investors, for instance, the scheme will still need FINMA approval (as it does today). It must also be represented by a FINMA licensed collective investment scheme representative, and it may only be distributed by a FINMA licensed distributor. As a fundamental conceptual change, the new law in principle subjects any offering and marketing of

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COUNTRY REPORT

SWITZERLAND TIGHTENS INVESTMENT RULES

collective investment schemes to the requirement of a licence from FINMA irrespective of whether such offering is to be considered public. This includes Swiss domiciled asset managers and Swiss branches of foreign asset managers, which will only be granted a licence if they are supervised by FINMA or an equivalent foreign authority. In the case of foreign asset managers this supervision must be equal to that of Swiss law. However, individuals and cooperatives (Genossenschaften) are not eligible to apply for a licence as a Swiss asset manager of collective investment schemes.

SICAAS & depositary banks There are also onerous clauses regarding the delegation of investment decisions to foreign asset managers by Swiss investment firms. This will only be allowed if there is an agreement regarding the cooperation and exchange of information between FINMA and the competent foreign regulator(s) unless FINMA grants an exemption. Further, a foreign investment fund reserved for qualified investors will need to appoint a Swiss paying agent as well as a Swiss representative if the fund is distributed in Switzerland. The tasks of such representative are limited, though. However, there are several exceptions mitigating these rules. For instance, the parliament decided that only the distribution of collective investment schemes to non-qualified investors will be subject to the requirement of a licence. Moreover, investment firms are granted a two years’ transitional period to achieve compliance with the new provisions and for the filing of the application for a licence provided they notify FINMA within six months as from the entry into force of the new CISA amendments. Under the new amendments, foreign collective investment schemes that are distributed to qualified investors may only be distributed by financial intermediaries who are subject to prudential supervision either in Switzerland or at

their foreign domicile. The important definition of“qualified investor”has also been modified. Qualified investors includes regulated financial intermediaries such as banks, securities dealers, fund management companies, assets managers of collective investment schemes and central banks; regulated insurance institutions; public entities and retirement benefits institutions with professional treasury operations and companies with professional treasury operations. However, whereas today, a high net worth individual/investor is automatically deemed a qualified investor, under the proposed rules wealthy individuals will have to explicitly declare their readiness to be treated as qualified investors and in addition, the possibility of opting in would be subject to those investors fulfilling certain conditions, such as providing evidence of investment expertise. Under the new rules, closed collective investment schemes in the form of a Société d'Investissement à Capital Fixe (SICAF) will always have to use a depositary bank. KGKs continue to be exempted from this obligation (as only qualified investors may invest in a KGK). In line with this new approach, even open-ended collective investment schemes [but only those in the form of a Société d'Investissement á Capital Variable (SICAV)] can be exempted from using a depositary bank by FINMA under certain conditions. These include the provision that the SICAV is only open to qualified investors; provided the execution is done by prime brokers being under equivalent supervision; and provided that the prime brokers or the competent foreign supervisory authorities supervising the prime brokers provide all information and documents to FINMA. Depositary banks are permitted to delegate the custody of the funds to third parties in Switzerland and abroad. The new rules state that such delegation may only be made provided that the delegation is in the interest of an adequate custody and provided scheme

representative and a paying agent (Zahlstelle) is appointed for the collective investment scheme. The collective investment scheme representative also has to periodically review whether the foreign fund management company and the custodian are subject to prudential regulation that is equal to Swiss regulation, whether there is an information exchange agreement between the foreign regulator and FINMA and that there are no grounds for ‘confusion or deception’ in the designation of a collective investment scheme The liability of depositary banks has now been increased significantly, as depositary banks delegating custody will be liable for any damage caused by third parties unless they can prove that they were acting with due care when choosing, instructing and supervising the third party custodian. In other words, Swiss depositary banks will in future have to supervise any third party to which they delegate custody. Equally, the amendments say that investment decision competences should not be delegated to the depositary bank of a collective investment scheme or to companies with interests that could conflict with the interests of the fund management company or investors. In all these instances, the investment firm will be liable for the conduct of those mandated persons to which it delegated asset management services. An important question for regulators now in Switzerland is whether this road is ultimately for the benefit of the local investment industry. There have been concerns that the path that Swiss legislators are on will not strengthen the country’s competitiveness. The changes inherent in the amendments to CISA will involve increased costs for investment firms which will be an additional burden on an industry already beset by indifferent capital markets. However, many firms have been preparing for change and remain sanguine about the implications of continued change in the country’s regulatory infrastructure. n

NOVEMBER/DECEMBER 2012 • FTSE GLOBAL MARKETS

GM Regional Review 66_. 20/11/2012 10:25 Page 43

THE BEAR VIEW

POLITICS TRUMPS HOPE – AGAIN! EFORE THE US elections, the omens for the market were not good. Initial trading activity following a US presidential election has tended towards the negative. The immediate post election period in eight of the last twelve presidential US elections witnessed market declines. However the post election market falls following President Obama’s two victories (the last in 2008) have been particularly bloody; a fall of 25% in the S&P 500 in the two weeks following his 2008 success and the markets are off some 5% in the first week alone this time round. Nowadays history is often described as bunkum; but equally often has a distressing habit of repeating itself. In that regard, no doubt investors hope that markets take a more sanguine approach this time around. The fact that a Democrat rather than a Republican was voted in into the arguably the world’s most powerful job, is widely ascribed as a/the reason for the market’s seemingly bilious reaction. Actually, though I don’t think the response would have been any different to a Romney win. There is always a huge amount of vitriolic hot air spouted during election time, but the differences between the two candidates (and their wriggle room should either win) was always miniscule. Without looking into the minutiae, most recent elections seem to corroborate the theory that whoever gets in

causes a ripple of negative sentiment: what might be termed a ‘Presidential plunge’. In other words, the audacity of hope turns almost immediately into a dose of fiscal reality, thereby causing US indices to slide. In fact, two things the market clearly dislikes are audacity and hope, preferring instead steadiness and certainty. As economics has become increasingly divorced from fundamental company valuations we continue to see global markets driven increasingly by politics and sentiment. The US elections, of course, are simply a good illustration of this but this situation has been the case for some considerable time now. The upshot of this long term trend is that we are living in a world where equities are ludicrously cheap. As the corporate bond bubble continues its incremental swell, and interest rates continue to look set to lag inflation for some time yet, the logic is that we will witness a flow of money into equities at some point. The problem is that hope does not necessarily translate into reality. In a global economy fuelled by macro fears and skewed beyond all recognition by QE and bail-out packages propping up what are frequently called zombie countries, we no longer live in logical times! Markets remain understandably nervous on both sides of the Atlantic. The fiscal cliff looming on the US side, while protestations of ECB Pres-

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2012

WHY DOES THE MARKET LANGUISH IN POST ELECTION DOLDRUMS?

The US election outcome has thrown up more questions than answers. Does second term President Obama look more or less likely to solve US Medicare issues, show fiscal probity and reignite the more or less standstill US economy? Or will it be more of the argumentative same? Simon Denham, managing director of spread betting firm Capital Spreads, gives us his ultra-bearish insights.

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

ident ‘super’ Mario aside, the eurozone juggernaut rolls on. With unemployment still rife throughout Europe and (in reality) likely to get worse the economic prospects remain challenging. This is stifling any prospect of a pick-up in demand as those in work or businesses that are actually surviving are deleveraging or hording their cash anticipating even worse times ahead. Expectations are that Spain will succumb eventually and request a formal bailout in either 2013/2014. If the eurozone can keep a steady flow of bailouts then there may be a route through the crisis but the longer they put it off runs the risk of running into the next one (Italy?, France?) and so the more nervous investors may become. The 10 year bond yields on Spanish and Italian government debt are once again creeping higher and while European markets are trying their best to show some sort of life, an overriding problem is that market bulls are reluctant to jump in just in case assets are measurably cheaper in just a matter of days. Here’s the rub. Equities are cheap and we should see buyers on any rational level. However, in an irrational world, no longer driven by fundamentals, the prevailing view is that they can always get cheaper, and therefore what should go up, keeps coming down. As ever, ladies and gentlemen, place your bets. n

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MANAGING COLLATERAL Photograph © Sureshr/Dreamstime.com, supplied November 2012

THE BUY SIDE COLLATERAL CHALLENGE For buy side firms, the inexorable march towards central clearing puts added emphasis on the accurate monitoring of CCP-held collateral, as well as the ability to extract and report on any relevant position at any given time. In this climate, advantage goes to those with the most reliable collateral-management strategies at their disposal. Dave Simons reports from Boston. ITH AN ELECTION year behind us, 2013 could (hopefully) mark the beginning of the end of the regulatory inertia that has kept the markets hamstrung for so long. As the ink finally begins to dry on Dodd Frank and other initiatives, the new regulatory landscape will further impact the manner in which collateral is utilised within the global financial markets. Specialised methods for OTC derivatives processing, in addition to the proliferation of newer collateral types, require increasingly sophisticated valuation tools capable of tracking securities held in numerous locations across non-synchronised settlement cycles and asset-protection regimes. Though central counterparties (CCPs) bring the likes of guaranteed settlement and other risk benefits to the table, other solutions include triparty repo mechanisms, which, among other things, have proven effective in handling the collateral needed to cover margin calls. Additionally, so-called “enterprise-wide” CM models allow firms to monitor and manage collateral across numerous product lines on a global basis. Going forward, the onus is on market participants to obtain the necessary skills to manage their collateral exposures in a still-evolving marketplace. Along the way, concerns have risen over the financial impact of CCP-required margins and the associated costs of managing collateral in this altered environment. As such, buy-side clients are seeking partners to help them deal with their specific collateral complexities, using a menu of services that include the handling of collateral agreements, collateral optimisation options, and more. In what ways are providers structuring services to reflect the increased utilisation of collateral among global investors?

Along with tri-party models, what other strategies are helping to streamline the collateral process? Additionally, what features should clients prioritise when sizing up a prospective clearing agent?

Emphasis on optimisation Much of the current discussion continues to focus on the anticipated increase in collateral requirements; recent research from TABB Group, for instance, sees collateral reserves approaching $2.6trn over the near term. Even a portion of that figure would still be a fairly hefty amount, affirms John Rivett, global product head for Securities Collateral Management, JP Morgan Worldwide Securities Services. The real issue, says Rivett, is the manner in which that collateral is utilised going forward.“On the OTC markets today, collateral is basically settled on a T+1 basis. With a cleared market, however, you have the CCP making the margin call at 9am, and wanting to be covered within an hour or so. So in effect we’re moving from a one-day turnaround, to a cycle that encompasses all of 60 minutes. Obviously that is a significant challenge for many participants—hence the demand for solutions that can help them meet these requirements.” Optimisation of collateral is absolutely essential, maintains Rivett, both on a pre- and post-trade basis.“If you’re going to use your collateral, you need to know where to put it in order to achieve the best value while fully meeting your obligations. This means determining which CCPs might be able to offer the best netting position, lowest possible collateral requirement, and so forth.” The requirement for an enterprise-wide platform that simultaneously covers a number of different elements—

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including F&O, OTC, securities lending, tri-party repos and more—continues to gain favour. By using this “virtual long box,”says Rivett, providers can monitor a client’s various obligations without actually taking custody of their assetst. “In other words, we can remain ‘custodian-agnostic’ and still help our clients carve out the most optimal route.” In the realm of collateral “transformation” and “optimisation,”some functions offer more intrinsic value than others. The ability to reclaim excess collateral that has been posted to cover margin calls in one such benefit. “For instance, a client that gets a margin call of $1 million might be inclined to post $2m instead, with the idea that they’ll be ready once the next call comes in,” says Rivett. Under a single-CCP scenario, however, this strategy not only increases one’s risk exposure but, should collateral requirements rise as expected, clients will no longer be able to park unutilised collateral in different venues anyway. With operational complexity on the rise, “from a risk perspective this is an area that is becoming increasingly important to clients,” says Rivett. Providing the most accurate depiction of clients’ collateral in real time has become compulsory for industry participants. Running reports overnight may have sufficed in the past; however the speed with which businesses went bust back in 2008 has changed all that. “As a result, you really need to know where you are at right now,” says Rivett, “rather than where you were at the close of business on the previous Friday. Hence, from our perspective it is imperative that clients have online tools that allow them to see their realtime cash and non-cash positions.” Clearstream, a leading European supplier of post-trading services, has worked to establish new routes to liquidity and financing through the development of its Global Liquidity and Risk Management Hub, a system that delivers integrated securities lending, borrowing and collateralmanagement services in cash, fixed-income, equities and investment funds to connected counterparties such as central banks, CSDs, CCPs and others. Non-cash collateral in particular will play an increasingly pivotal role for global investors, asserts Jean-Robert Wilkin, head of collateral management and securities lending products at Clearstream. “Those in collateral-management services should be prepared for significant changes affecting access to collateral locations, asset classes, as well as counterparties using the same provider /infrastructure.” When assessing a prospective clearing party, clients should focus on areas such as creditworthiness, the CCP’s expertise in the clearing/collateral management field, the ability to efficiently mobilise collateral as well as re-use collateral received upon transfer of the ownership legal structure, says Wilkin. “Portability of client exposures and related collateral to another clearing member is also a must,”adds Wilkin. In fact, says Wilkin, a greater likelihood for risk stems from the limited number of clearing members offering access to central clearing as a service, rather than with the CCP itself. This underscores the need for clients to have adequate transparency into these clearing members.“Asset segregation and reporting will be key to the protection of their collateral,”maintains Wilkin.

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Jeffrey Alexander, vice president, Global Securities Lending at Torontobased CIBC Mellon, sees a continuation of the trend toward outsourced collateral-management or tri-party arrangements. “In the tri-party model, plan sponsors retain bilateral relationships with the preferred counterparties. A collateral agent is responsible for valuations, margin call calculation, and processing the movements of collateral on behalf of their buy-side clients, while the custodian executes on the transactions and transfers of cash and securities.” Photograph kindly supplied by CIBC Mellon, November 2012.

The solutions spectrum Technology plays a key role in collateral management and can be viewed as a core feature of any collateral-management program, offers Mat Gagne, managing director, product development for Boston-based securities-lending agent eSecLending. Whether creating an internal system or outsourcing software solutions, says Gagne, “collateral service providers are investigating the appropriate tools for the level of sophistication they feel is appropriate for their clients. As this market is developing, custodians, clearing members, third-party collateral managers and tri-party agents are considering enterprise-wide, open-ended technologies that are based on a modular approach. This flexibility has several benefits, including the integration of collateral management tools with existing systems, the ability to implement certain modules to complement current needs, and the potential to employ an enterprise-wide collateral solution.” Offerings range from basic to complex, and include the likes of inventory management, collateral allocation, and optimization. “Investors will have varying needs of sophistication across this spectrum,” says Gagne,“from those that have high CCP usage to others who are simply trying to optimise collateral usage across internal business silos. The technologies and services being developed exhibit a significant number of common denominators, which suggest that the basic needs of the investor are being addressed. However, there is enough variation to warrant a disciplined approach in choosing a systems solution or a collateral service provider to best fit an investor’s needs.” Jeffrey Alexander, vice president, Global Securities Lending at Toronto-based CIBC Mellon, sees a continuation of the trend toward outsourced collateral-management or

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MANAGING COLLATERAL

tri-party arrangements. “In the tri-party model, plan sponsors retain bilateral relationships with the preferred counterparties. A collateral agent is responsible for valuations, margin call calculation, and processing the movements of collateral on behalf of their buy-side clients, while the custodian executes on the transactions and transfers of cash and securities. The outsourced solution enables asset owners, investment managers and counterparties to focus on executing investment strategies, while leaving the operational, regulatory reporting and transaction requirements around collateral management to the custodian and collateral agent.” As companies continue to assess the changing regulatory and operational landscape, the scope and importance of collateral has become more evident, says Gagne. In addition to using outside solutions, firms are looking to create opportunities from within by combining activities for mutual benefit. Adopting a holistic view presents opportunities to allocate collateral internally across departments“as a primary optimisation tool on a local level prior to implementing a full-scale strategy on a global basis,” says Gagne. Whether using tri-party collateral agents to help streamline an initial process or engaging third-party collateral managers to provide a corporate optimisation strategy as a first step toward a global strategy, integration among a firm’s departments—from securities trading and treasury/financing to derivatives/OTC—in order to transform collateral is a logical first step in the creation of an effective strategy, adds Gagne.

Clarity a must Transparency will continue to be an ongoing priority for investors when selecting clearing members, asserts Gagne.“As the calculation and guidelines for initial and variation margin will remain the responsibility of the CCP, the ability for a clearing member to provide a ‘window’ into collateral requirements will provide a level of transparency to assist the investor in optimising its collateral,” says Gagne. The ability to run scenarios that indicate compliance with CCP/CM needs as well as potential netting effects may be integrated into the investor’s collateral management program, says Gagne. This could be managed internally, outsourced to a thirdparty collateral service provider, or even handled directly by the clearing member itself. “Without transparency, the investor is limited to the unidirectional requirements of the clearing member to cover collateral needs under its optimal allocation methodology without the potential for delivering alternative, acceptable collateral to the clearing member that may have some benefit to the investor.” Looking ahead, the influx of new regulation has the capacity to create trillions of dollars in demand for highquality collateral, offers CIBC’s Alexander. “There are limited forms of acceptable collateral based on regulatory or counterparty requirements,”says Alexander.“In Canada, for instance, market conditions have put downward pressure on the returns of government bonds, leading to much greater demand for Canadian sovereign debt. “Collateral transformation is essentially a matter of

Mat Gagne, managing director, product development for Boston-based securities-lending agent eSecLending. Whether creating an internal system or outsourcing software solutions, says Gagne, “collateral service providers are investigating the appropriate tools for the level of sophistication they feel is appropriate for their clients. As this market is developing, custodians, clearing members, third-party collateral managers and tri-party agents are considering enterprise-wide, openended technologies that are based on a modular approach.” Photograph kindly supplied by eSecLending, November 2012.

turning something that is a good investment into acceptable collateral,” says Alexander. Changes to collateral requirements, including an increase in underlying capital being held by the collateral agent, have lead to greater focus on where the collateral is located and who is administering it, says Alexander.“Choosing a good administrator to manage the segregation of assets across various portfolios and legal entities reduces the risk in a client’s own infrastructure; the administrator is aware of with the impacts of emerging regulation and assists the fund in meeting risk management best practices. These factors make outsourcing collateral management attractive for institutions who desire robust collateral processes without dedicating substantial intellectual capital to the issue.” At present, indications are that the buy side may still be in the early stages of readiness, having been significantly outspent by the sell side in terms of collateral-based IT investment. Experts such as Rivett attribute the reticence in part to the buy side’s need for greater clarity into regulatory initiatives in the making. It has become quite clear, however, that any client that is transacting a large number of derivatives or swaps on a regular basis and doesn’t yet have sufficient internal capabilities will likely need the assistance of a qualified partner from here on out. “Many clients had been waiting to see when these changes would take effect and whether or not they may be exempt,” says Rivett. “At this point however, I think there’s a feeling of inevitability. So while there may be some slight nuances here and there, clients have begun moving forward and are beginning to put the processes in place that will enable them to manage their collateral prior to the advent of central clearing.” n

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PROFILE: SAXO MARKETS

THE SHAPE OF THINGS TO COME?

Photograph © Rolffimages/Dreamstime.com, supplied November 2012.

Small developments here and there which are slowing adding up to a gradual disenfranchisement of banks or traditional stock exchanges as distribution agents look to be underway. So what are we to make of the change? “Opportunity,” says Torben Kaaber, chief executive officer, of the recently launched London operations of Saxo Markets. Francesca Carnevale goes in search of tomorrow’s financial markets. “

HE DAYS OF traditional pension funds are numbered,”avers Torben Kaaber, chief executive officer of Saxo Markets in London. Before any number of corporate pension fund professionals go hunting for the best situations vacant website, Kaaber concedes he is taking the long view. Nonetheless, he clearly holds that time is on his side of the argument and that firms such as Saxo Markets are designed for tomorrow’s financial markets today. If you have stared in disbelief at the implications of Kaaber’s statement, you need only look elsewhere. Even in Egypt Islamic finance, which is resurgent in the country right now, has the touch of the zeitgeist on its shoulder. The first Shari’a compliant crowd online funding service, Shekra.com, was launched in early November. Crowd funding allows large numbers of investors to become shareholders in a project by contributing very small amounts of money, without going through a stock exchange or distribution agent, such as a bank. The founds of Shekra.com believe that their platform is a viable and more flexible alternative to traditional Shari’a compliant funds and that it offers a cheap and easy alternative to invest in viable local projects.

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The principle has been working for some years, particularly in the angel financing space, where professionals with cash on their hands can invest their money, often in high risk/high reward investments, such as new business startups. Investors put in a minimum amount and accept all the investment risk and avoid introduction and fund management fees associated with putting their investment dollars in traditional private equity funds. Up to now the investment method has been particularly suitable for smaller ticket projects; especially those that need up to $500k. In the case of Shekra.com, projects are evaluated before being presented to a network of investors who agree to maintain confidentiality. A joint venture is then built around ideas which are deemed attractive. Projects are required to obey Islamic principles, including bans on the payment of interest and on pure monetary speculation. Investors take an equity stake in the project and gain returns based on a profit-sharing formula; such formulas are common in Islamic finance, which relies on earnings from real assets rather than pure debt. While Saxo Markets is operating on an entirely different business model, the principle is the same. The firm is part of

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PROFILE: SAXO MARKETS

a new wave where firms build their business around new platforms for bringing higher net worth investors to the market without the need for traditional funds. Saxo Markets is among those firms leading the application of modern investment methods in more sophisticated markets. Kaaber acknowledges that the growth of exchange traded products, such as ETFs will fuel tomorrow’s investment world. He says the product offering right now is a blend of the old and the new. “Although we feel we have a product suite for a new generation, in practice we operate as a traditional bank with an online multi-asset offering that can be accessed by a wide range of clients, individual investors among them.” The brand kicked off in 1992, arrived in the UK in 2006 and has now been exported globally, with 23 offices around the world and key offices in Singapore, London, Zurich, Paris, Tokyo and Hong Kong. Together with Saxo Bank, its parent company headquartered in Denmark, Saxo Capital Markets serves an increasingly globalized base of experienced institutional and retail clients who seek self-directed online trading technology, products and services Contracts for difference, foreign exchange, futures, bonds and options are available for trading on Saxo Markets’ platform. Around half of the firm’s London staff work on the platform, on which securities in some 30 countries can be traded. While the firm’s strategic sights are firmly set on a growing number of high income professionals who are bypassing traditional institutions and setting their own investment goals and preferences. Equally Saxo also works hand in hand with global broker/dealers.“We have relationships with the ten biggest banks and use their infrastructure to trade on exchanges,” adds Kaaber. The business splits almost evenly down the middle with almost 50% being bank to bank and almost 50% handling private self-directed trades. The balance is taken up by hedge funds and white labelling operations (for example Citi FX Pro is white-labelled to Citibank), where the infrastructure is rented out. Each asset segment appears to have developed its own business characteristics. For instance, the firm reports a high level of high frequency trading activity in its FX segment, “but hardly any is visible in the equity segment,”says Kaaber. “The most important element of the service is to give clients as much choice as is economically possible and in that regard, the multi-asset character of the platform is a vital element,” avers Kaaber. The business is predicated on the emergence of a new generation of investors,“who are way different than we are. They think that funds are an old-fashioned product and they want something where you can see the price of your invested assets at any time through the day,” says Kaaber. It is also about time to market, he explains. “With funds you have to commit to a particular investment strategy for a fixed period and within that time frame any number of market developments has made the strategy outdated or redundant. The time to market of the platform is way faster and we believe we are part of a process that involves the democratisation of the investment process. It has to come and

Torben Kaaber, chief executive officer of Saxo Markets in London. “The days of traditional pension funds are numbered,” avers Kaaber. Before any number of corporate pension fund professionals goes hunting for the best situations vacant website, Kaaber concedes he is taking the long view. Nonetheless, he clearly holds that time is on his side of the argument and that firms such as Saxo Markets are designed for tomorrow’s financial markets today. Photograph kindly supplied by Saxo Markets, November 2012.

we are part of that change.” Kaaber points to the US, Denmark and Germany where there are well heeled professionals who are increasingly taking charge of their individual investments and who are avid consumers of market intelligence and research to help them make investment decisions. It is this rising class of professionals in the UK market that Kaaber is currently seeking. Moreover, he says that the markets have been evolving in this direction for some time. “You only have to look at the massive growth in the ETF space and how is has diversified for you to see the potential changes running through the global investment markets,”says Kaaber.“You can step in and out of ETFs as diversified as gold, energy and financial products and modify your investment portfolio to suit your individual investment preferences or market conditions. Increasingly individual investors are looking for more control of the investment process and financial products and securities and platform providers such as ourselves are changing our approaches to suit this rising demand.” “In this regard it is clear that we are looking to be the market player. It is clear we are hoping to be the entity that is helping to drive this change and become a serious competitor to traditional providers of investor services. The platform is modern, global, and multi-asset giving investors’ immense flexibility in designing and applying their investment strategies; and all on one platform,” says Kaaber. Ultimately, the natural evolution of the pension fund market may help Kaaber do his job. According to pension consultancy firm Mercer, the final salary pension funds of FTSE 350 companies owed £42bn more than they owned at the end of September this year. The obvious long term trend is for individuals to rely less on traditional vehicles such as pension funds to cushion their retirement years and rely more on their own laurels. n

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HIGH FREQUENCY TRADING Photograph © Andreus/Dreamstime.com, supplied November 2012.

Following a year's worth of negative press and falling profits, high-frequency trading proponents will likely continue to seek workable regulatory solutions in order to help the industry regain its composure. From Boston, Dave Simons reports.

A HEADSTART FOR HFT; OR A DOWNWARD SPIRAL? S HURRICANE SANDY barreled up the Northeast corridor late last month, the impending devastation was such that even that stalwart of American institutions, the New York Stock Exchange, chose to remain shuttered for two consecutive trading days, the longest weather-related closure in nearly 125 years. Just prior to the storm’s arrival, NYSE officials indicated that trading would continue on its Arca electronic platform. Though the vast majority of daily market activity is currently handled through such electronic means, plans to run a fully unmanned market—with data centres also exposed to Sandy’s fury in nearby Mahwah, New Jersey— were quickly scuttled by industry heads. What seemed like a prudent change of course also revealed an ongoing uneasiness following a year’s worth of computer-related mishaps, most of them linked to the world of high-frequency trading—a consortium of firms with a knack for reaping major profits in a matter of seconds, and, on occasion, creating unspeakable damage almost as quickly.

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The algo-instigated unhinging of Facebook’s IPO in May, followed three months later by the $440m kneecapping of New Jersey market-making firm Knight Capital, helped bring the debate over the merits of HFT to a head during 2012. Much of the focus has centred on establishing workable solutions for monitoring HFT activity and containing accidents in the making. Also at issue is the rise in HFTbased price quotes, which, despite relatively flat trading volume, have exploded of late. Even before the Knight fiasco of August 1st this year— apparently the result of a trading-software upgrade gone awry—the once guarded HFT community had become increasingly vocal, with leaders pointing to the merits of their methodology and the role of HFT in the smooth operation of the equities markets. Such openness hasn’t always worked out so well, however; just two months prior to that long day at Knight, Thomas Joyce, Knight CEO, sought to assure officials at a meeting of the Commodity Futures Trading Commission (CFTC) that high-speed computers, dark pools

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HIGH FREQUENCY TRADING

and other technology driven trading strategies were “not the problem,” but “the culmination of competition” that has helped reduce the cost of trading for global investors. The increased visibility comes as HFT profitability continues to wane. New York-based agency brokerage Rosenblatt Securities recently forecast HFT revenues from US equities to settle around $1.25bn by year’s end, more than a third lower than last year’s take and only a quarter of the $4.9bn accrued three years ago. HFT market share is expected to close the year in the 50% range, some 10 points lower than in 2009.

Last of the high profits Like any rapidly maturing industry, HFT has likely seen the last of the outsized profits.“Margins are being squeezed, and firms are being forced to seek out new ways to make money,” offered Instinet’s Alison Crosthwaite in a recent commentary. A reduction in margins and market share will likely coincide with an increase in HFT consolidation as smaller firms unable to keep up with the higher costs of technology and regulatory compliance are gobbled up or forced out of the business altogether. (The HFT pullback may have had a hand in the shuttering of Eladian Partners LLC, the HFT outfit launched only a year ago by former Citigroup senior transaction-services executives.) With the industry in flux, some HFT firms have used their market-making agility as a gateway into the traditional investment world. In September, New York-based Virtu Financial announced it would acquire European ETF market maker Nyenburgh, furthering its expansion into the regulated market-making trade. Last month, Chicago’s Getco LLC secured a partnership with brokerage firm Mismi aimed at giving exchange brokers handheld access to the firm’s proprietary trading algorithms. Given their propensity for snapping up gains in the blink of an eye, high-speed firms haven’t exactly endeared themselves to the market mainstream. At a Senate committee hearing in September, David Lauer, HFT consultant for independent advisory firm Better Markets, remarked that “something is dreadfully wrong”when traders can drain the markets of half of its liquidity pool in a matter of seconds, “dramatically worsening” an already unstable situation. Commentators such as Lauer appear less than sympathetic to a market segment that up to recently appeared unstoppable profit machines, backed by superfast data and trading connections that few buy side trading desks could match. What, if anything, can HFT firms do about this measurable shift in fortune? And outside of sell side trading operations that have benefit from their flow, who else cares? Will the HFT segment have to work harder to show that it does have a positive role to fill in the trading markets and can work to the benefit of traditional market incumbents, such as buy side trading desks? Then again, if HFT firms cannot articulate solutions for themselves or the common weal is it then incumbent upon regulatory agencies to do the job for them, as Dennis Kelleher, Better Markets’ chief executive officer suggests.

According to Kelleher, “shockingly little” has been done to address the issues that led to 2010’s HFT-inflicted “flash crash. Hence, the possibility of a similar crash occurring “is quite high,” Kelleher adds. Some have been better than others at keeping HFT on a shorter leash. In Canada, for instance, HFT has struggled to gain traction; accounting for barely one-third of the country’s trading activity. This measured approach has enabled Canadian investors to absorb market shocks better than some of their peers. Enacted last month, an enhanced regulatory framework drafted by the Canadian Securities Administrators (CSA) and the Investment Industry Regulatory Organization of Canada (IIROC), which ostensibly seeks to keep a tighter lid on unlit trading activity, in effect serves as an “imprimatur around HFT activity,” according to Thomas Kalafatis, head of Prime Services Group for Torontobased CIBC, by specifying what is and what is not acceptable in terms of forms of access within the Canadian marketplace. However, for all its flaws, HFT isn’t exactly the root of all of the financial world’s evils, say a host of independent observers and affiliated proponents. “It is important to remember that HFT firms close out their positions at the end of each trading day,” notes Lisa Shalett, chief investment officer for Merrill Lynch Global Wealth Management. Unlike lingering broader market dislocations resulting from a serious underlying macro condition, the majority of HFT flare-ups, though inordinately painfully, have nonetheless been mercifully brief, observes Shalett. Such events, she says, are “scary enough without creating a bogeyman out of high-frequency trading.” Elsewhere, in their paper The Diversity of High Frequency Traders, Björn Hagströmer and Lars L Norden of the Stockholm University School of Business found that much of the risk associated with HFT was confined to certain opportunistic strategies, including arbitrage and momentumdriven HFT approaches. According to the authors, market makers accounting for upwards of 70% of HFT trading volume were more likely to have higher order-to-trade ratios as well as lower latency and lower inventory than their opportunistic peers. By labeling all HFT as “bad”, regulators run the risk of undermining the benefits that “good” HFT players bring to the markets. Earlier this year, Daniel Coleman, chief executive officer at Getco, told the House Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises that regulatory and operational initiatives that reflect the core values of HFT—including price discovery, efficiency, transparency and stability—will help investors “to believe in the soundness of our financial, banking, and capital market systems and trust the financial community with their hard earned investing dollars.” Regulators appear to be listening. Last month the SEC said it would authorise the use of so-called“kill switches,”an automated program that would systematically shut-off any firm that exceeded pre-set trading limits and would also serve as a secondary risk-management backstop. Speaking in support of the proposal before a Senate hearing weeks earlier,

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Chris Concannon,Virtu executive vice president, said that kill switches, as well as other safeguards such as pre-trade risk checks and real-time drop copies, could help protect participants from worst-case scenarios.“Kill switches have operated effectively on futures exchanges in the US for many years,” said Concannon, adding that the presence of a kill switch would have limited the damage inflicted upon Knight Capital.

Taming HFT If the speed with which Knight rebounded from its neardeath experience is any indication, traders remain generally nonplussed by HFT. In its October report, Knight revealed that September’s domestic equities market-making volume reached $19.4bn, a 55% improvement over the previous month. To date, many continue to question the wisdom of imposing hastily assembled measures aimed at curbing the flow of HFT. Still, in order for hedge funds and other investors to maintain confidence in the markets, regulations must be updated to reflect the rapid move towards algo-driven activity, argues Gary Gensler, chairman of the Commodity Futures Trading Commission (CFTC). “Regulators cannot assume that the algorithms in the markets are well designed, tested or supervised,”said Gensler at a public discussion on HFT last June. “Few participants believe that regulators ought to have direct oversight of algorithms via a safety control board for algorithms,” observes Adam Sussman, partner and director of research at research firm TABB Group. Efforts to slow the market or widen tick size have garnered modest support, while proposals that include a financial-transaction tax as well as an industry error account for algorithms have been less well received, says Sussman. As such, achieving regulatory consensus could prove challenging going forward. At the CFTC meeting, a proposal to

broaden the definition of HFT drew opposition from some members of the alternative community, among them Joe Saluzzi, co-founder of New Jersey-based brokerage Themis Trading LLC. Branding HFT “a form of automated trading” was casting much too wide a net, one that would ultimately “catch everybody”, claims Saluzzi. Even so, after a year’s worth of bad press and falling profits, Concannon and other HFT leaders will likely continue to do what is needed to help HFT regain its stride. “Let me be clear—our market is not perfect,” remarked Concannon, “it has flaws and unnecessary complexity. But despite its flaws, it is a market that has withstood the most unprecedented volatility and re-pricing of equity values in our lifetime, while still maintaining the same levels of pricing efficiency.” The inevitably query is that if trading volumes were at 2007 levels, would much of the brouhaha around HFT attract as many column inches in the press as they do today. Clearly, the equities trading market is undergoing wrenching change: institutions, traders, strategies and services are all under the gun as the market ekes its way into a new, as yet, not fully described future. That will be characterised by new institutions, new trading groups and those last remnants from a market that began to take on modern form as far back as deregulation in the late 1980s. For some of them, this testing period may yet be their last gasp. The question for HFT traders is whether their time now looks to be measured and they too must now give way to inevitable change; or, whether they have done enough to ensure that they remain an integral pillar of the trading community and will help design its evolution over the next ten years. Either way, the future for HFT will look very different from the past few years where the explosion of high speed trading seemed unfettered. Ultimately it all hangs on the return of liquidity to a volume-starved market. n

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PROFILE: HKEX

The Hong Kong Exchanges and Clearing’s (HKEx’s) recent £1.4bn purchase of the member owned London Metal Exchange (LME) certainly raised a few eyebrows. At 180 times trailing net income, it ranked as the most expensive of any bourse deal above $1bn since 2000, according to data compiled by Bloomberg. However, the HKEx has no doubts that it was the right move. In one fell swoop this staid domestic player has been catapulted into the global league of exchanges. What now? Lynn Strongin Dodd reports.

HKEX’S LONG TERM COMMODITIES PLAY words, Hong Kong has its own inHE 135 YEAR old LME, dependent legal and regulatory which put itself up for sale system based on English Common last year, was not an easy Law which is separate from prize to win. Competition was mainland China. fierce with around 15 contenders Equally as important, the HKEx vying for its hand. The HKEx, assured the LME that it will not which mainly derives its revenues make any immediate changes to the from trading in Hong Kong shares, structure or fee base for contracts warrants and stock index futures as well as initial public offerings, Archive photo of Hong Kong Exchanges and Clearing chief currently traded before January 1st 2015. As a result, traders will be able was not the most obvious choice. executive Charles Li during a news conference in Hong to continue to use arcane hand Its experience in commodity Kong Friday, June 15th this year where the Hong Kong signals to conduct open outcry trading was limited and there were stock exchange operator said it had agreed to buy the trading in copper, aluminium, lead, also fears over Beijing’s influence. 135-year-old LME for £1.4bn ($2.2bn) as it shifts into Moreover, it was up against for- commodities to capitalise on Chinese demand. Photograph nickel, tin and zinc across a circle of midable players such as the CME by Kin Cheung for Associated Press. Photograph supplied red leather benches The main appeal of the LME for Group which had in 2007 made by PressAssociationImages, October 2012. the HKEx is the foray it provides the headlines with what was then considered the priciest exchange deal—the roughly $11.9bn onto the world exchange stage and the platform to broaden its revenue base. The price paid might have been high but some acquisition of CBOT at a multiple of 66 times earnings. However, the Chicago based firm along with NYSE Liffe, industry experts believe it will make its money back in the the London based derivatives arm of NYSE Euronext were future.“There were some concerns that the Hong Kong stock both knocked out in May while the IntercontinentalEx- exchange had overpaid for the LME,” says Herbie Skeete, change (ICE) made it to the final stages before losing out to managing director of Mondo Visione. “However, I think the LME gives them a more diversified product range and puts HKEx this summer. While the US exchanges were thought to be in a better them in a stronger position with a more sustainable business.” The LME will give the HKEx control of about 80% of position to cut costs and modernise the London exchange, the opportunity to realise its potential in China made Hong global trade in industrial-metal futures at a time when the Kong the most attractive bidder. The country not only exchange’s main activities (trading and initial public consumes 40% of the world’s metals but China related offerings) look to be falling off. Overall performance is trading is estimated to account for only 20% on the LME. something of a short term worry: the latest second quarter The HKEx also allayed fears over the Chinese government’s figures, for instance, show a 21% drop in net profit to influence by stating that,“China does not own HKEx or have HK$1.07bn ($137.98 m) from the same period last year due management control. HKEx embarked on this transaction to continuing weak market conditions. Share-trading for its own sound commercial reasons and in the interests of volume was lacklustre for most of the first half, with average all of its shareholders. HKEx is a publicly listed company with daily turnover, a key determinant of exchange income, down a wide base of institutional and retail shareholders which is 23% from a year ago to about HK$56.7bn a day. The exchange has also suffered from the vicissitudes of an run with scrupulously high levels of corporate governance.” It also noted that there are various legal and institutional indifferent IPO market of late. Its IPO calendar has been safeguards in place such as Hong Kong’s Basic Law, which is marred by high profile names such as luxury jeweller Graff based on the principle of one country, two systems. In other Diamonds, pulling its Hong Kong offering in the light of poor

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investor sentiment. Recent offerings have also had a mixed reception. Shares of Shanghai’s Fosun Pharmaceutical (Group) Co Ltd fell as much as 12% on its debut in late October, underscoring weak investor appetite for new offerings. Fosun Pharmaceuticals $512m offering is the largest IPO to come to market in Hong Kong over the last three months and has been regarded in the local press as a temperature gauge for the exchange’s IPO pipeline for the rest of the year. November in particular looks to be a testing time for the exchange’s IPO calendar. The People’s Insurance Company of China Group (PICC) is the largest expected IPO this month, and is said to be worth up to $6bn. Also expected in November are Zhengzhou Coal Mining Machinery’s planned IPO, managed by Citic and Deutsche Bank, UBS and JP Morgan and reported to be worth $600m; CIFI Holdings ($300m), arranged by Citigroup, Morgan Stanley and Standard Chartered; and Horizon Hospitality ($800m or so), arranged by Standard Chartered and Bank of America Merrill Lynch. While China Railways $2bn is planned to debut by the end of this year (arranged by CICC, Citigroup, Credit Suisse, HSBC and UBS). Most of the deals to come to market this year have been block offerings that target selected numbers of institutional investors. The question is whether this institutional investor appetite for big ticket Chinese IPOs is sustainable with a sizeable number of deals planned to come to market before year end. The LME transaction is then clearly an indication of the exchange’s need to secure alternative revenue streams. If that is the case, then it might equally be that the exchange is moving between proverbial frying pans and fires. Certainly, some analysts believe that continuing buoyancy in commodities prices is no longer a given. There are two schools of thought. One believes that the super cycle of commodities which started on the back of the industrialisation and urbanisation of China and other emerging countries in Asia, Africa and Latin America has run its course. The rationale is that the combination of a slowdown in Chinese economic growth, the continuation of the eurozone crisis into 2014, ongoing uncertainty in the US economy and the arrival of fresh raw materials supplies

(after a decade of investment in new production) will inevitably begin to dampen prices for products ranging from crude oil to iron ore. Others however believe the cycle still may have legs. They argue that the death knell has been rung often in recent years only to ring hollow; as it did in 2008 and 2009 when the World Bank pronounced the end of the bull run in commodities. Prices then recovered sharply in 2010 after economic growth gathered momentum. The evidence supporting either argument this time around is mixed; adding to the overall tension around key commodity prices over the near term. Overall, the IMF commodities index for instance—one of the broadest and more complete measures of raw materials costs—has fallen from its record high of four years ago. Even so, it is still up 32% over the past five years and a hefty 220% since 2000. Right now, the exchange wallows in a quiet period and is unable to go on the record for this interview. However, exchange personnel agreed to speak on a background basis only. According to one HKEx spokesperson, “the strategic rationale for the acquisition is based on growth of the LME’s existing operations. Revenue synergies are expected to be realised in the long term from increased volumes in China and rest of Asia, the establishment of LME Clear and the introduction of new products. The LME also provides a platform for entry into a range of commodity asset classes as well as the development of RMB denominated products in fixed income and currencies that are attached to commodity flows. In addition, there will be opportunities for further geographical expansion, especially in emerging markets, by leveraging HKEx’s membership of the recently formed BRICS Exchanges Alliance.” The five member exchanges, including Brazil’s BM&F Bovespa, Russia’s MICEX-RTS, India’s Bombay Stock Exchange, HKEx, and the Johannesburg Stock Exchange (JSE) all joined forces in October 2011. A year later in March the participating members cross listed their benchmark index futures in order to give investors easier access to the BRICS index derivatives which can be used to hedge diversified portfolios. Although product development is important, The HKEx also plans to help the LME develop its market infrastructure.

Hong Kong Stock Exchange: 2012 Turnover and On-floor and Off-floor Trades [Year to date] [Main Board + Trading Only Stock] Turnover (HK$m) Month/Year Jan 2012 Feb 2012 Mar 2012 Apr 2012 May 2012 Jun 2012 Jul 2012 Aug 2012 Sep 2012 Oct 2012

On-floor Trading 3,107 4,322 3,477 2,197 2,744 2,533 1,924 2,603 2,302 3,393

0.31% 0.30% 0.25% 0.24% 0.23% 0.27% 0.21% 0.26% 0.22% 0.32%

Number of Trades

Off-floor Trading 995,331 1,427,852 1,409,500 899,233 1,200,546 947,040 909,133 1,002,889 1,043,271 1,042,415

99.69% 99.70% 99.75% 99.76% 99.77% 99.73% 99.79% 99.74% 99.78% 99.68%

Total 998,438 1,432,174 1,412,977 901,430 1,203,290 949,573 911,057 1,005,492 1,045,573 1,045,808

On-floor Trading 41,262 67,150 55,623 33,996 45,815 41,940 37,651 48,528 48,045 53,018

0.29% 0.34% 0.29% 0.26% 0.27% 0.29% 0.27% 0.33% 0.32% 0.34%

Off-floor Trading 14,166,484 19,558,067 19,289,576 12,962,663 17,241,704 14,420,621 13,746,897 14,746,906 15,104,881 15,618,566

99.71% 99.66% 99.71% 99.74% 99.73% 99.71% 99.73% 99.67% 99.68% 99.66%

Total 14,207,746 19,625,217 19,345,199 12,996,659 17,287,519 14,462,561 13,784,548 14,795,434 15,152,926 15,671,584

Source: Hong Kong Stock Exchange press release, November 2012

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PROFILE: HKEX

The varying fortunes of the Hong Kong Stock Exchange 2011/2012 IPOs by volume and value: the world’s top ten exchanges 01 Jan - 31 October Top IPO Exchanges Globally – By Deal Volume Jan - Oct 2012 Rank

Exchange

1 2 3 4 5 6 7 8 9 10

Nasdaq New York Tokyo Kuala Lumpur Mexican stock exchange Shenzhen - Chinext Shenzhen Shanghai Singapore Amsterdam Subtotal Total

Jan - Oct 2011

Deal Value ($m)

No.

Rank

22,653 21,525 9,880 7,529 5,363 5,276 4,914 4,266 3,987 2,946 82,112 103,139

58 69 6 11 4 70 50 22 13 2 303 652

1 2 3 4 5 6 7 8 9 10

Exchange

Deal Value ($m)

No.

26,307 24,284 17,573 12,529 12,337 10,341 7,575 7,229 5,281 4,174 117,583 145,357

54 46 13 33 91 110 51 8 2 10 417 1,126

Deal Value ($m)

No.

276 10,341 132 12,337 1,041 26,307 7,575 24,284 1,366 958 1,366 84,616 145,357

136 110 100 91 63 54 51 46 40 40 40 731 1,126

New York Hong Kong London Shanghai Shenzhen Shenzhen - Chinext Nasdaq Singapore Madrid Sao Paulo - Novo Mercado Subtotal Total

01 Jan - 31 October Top IPO Exchanges Globally – By Deal Activity Jan - Oct 2012 Rank

Exchange

Deal Value ($m)

1 2 3 4 5 6 6 8 9 10 11

Shenzhen - Chinext New York Nasdaq Shenzhen Hong Kong AIM - London Alternative Investment Market Australian Stock Exchange Shanghai Warsaw - NewConnect Jakarta KOSDAQ Subtotal Total

5,276 21,525 22,653 4,914 2,895 587 338 4,266 12 738 180 63,383 103,139

Jan - Oct 2011 No.

Rank

70 69 58 50 36 30 30 22 21 16 15 417 652

1 2 3 4 5 6 7 8 9 9 9

Exchange Toronto Venture Exchange Shenzhen - Chinext Warsaw - NewConnect Shenzhen Australian Stock Exchange New York Nasdaq Hong Kong India - National Stock Exchange KOSDAQ Bombay Subtotal Total

Source: Dealogic, supplied November 2012.

This includes the expansion of its warehouse network in Asia, including China as well as the progressive upgrade of its core platforms to drive business growth. In addition, the HKEx aims to utilise its data centre, established Asian infrastructure and market data hub in Shanghai to enhance distribution of market data to Chinese clients. In addition to the LME acquisition, HKEx introduced the first exchange-traded currency futures settled in RMB in September and will continue promoting the listing of RMBtraded products such as bonds, exchange traded funds and a real estate investment trust in its securities market. “We are also in the process of introducing hosting services and a clearing house for OTC derivatives, both of which are scheduled to be up and running by next year,” according to the spokesperson. Skeete believes that these developments will help the HKEx keep its edge over rival Shanghai Futures Exchange. “Hong Kong is perceived to be the gateway of China which used to be the role of Shanghai until the Communists took over. I think the rivalry will continue and although Shanghai would like to return to where it used to be I can’t see the Hong Kong Exchange being displaced in the medium term.”

For the HKEx’s part, it would like to collaborate rather than compete and has already forged links with the Shanghai Stock Exchange and Shenzhen Stock Exchange in June to create a joint venture in Hong Kong with an aim to develop financial products and related services as well as the franchising of index-linked and other equity derivatives products. The joint venture will also include the compilation of cross-border indices based on products traded on the three markets and the establishment of industry classification for listed companies, information standards and information products. Market promotion, customer services, technical services and infrastructure development will also be covered. According to the HKEx spokesperson, “the mainland economy’s continuing growth will result in more business for both stock markets. We believe that the Shanghai and HKEx markets are complementary; one is international and funds can be raised in a freely convertible currency; the other is mainly domestic in terms of investors and currency. With respect to other markets, HKEx has been competing with its overseas counterparts for investors and issuers for years. Hong Kong is relatively small (about 7m people) so HKEx has to seek growth opportunities at home and abroad.” n

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GM Editorial 66_. 20/11/2012 10:32 Page 56

EXECUTION CONSULTING

The meaning of life & execution consulting In October, a group of leading asset management firms’ heads of dealing gathered in London. Asked what execution consulting meant to them they gave a variety of responses. “It is transaction cost analysis, that’s all,” held one buy side trader. Another ventured: “I’m not sure what you mean.” A third dismissed the question with: “I don’t need help with algorithms.” There’s a hullaballoo of hype around execution consulting among the sell side: but with what justification? Is it all just a way to secure client stickiness at a time when trading volumes are merely a whisper of what they were in 2007? Or is it something more? Ruth Hughes Liley went in search of some answers. SURVEY IN JUNE 2012 by research and advisory firm Aïte Group found that almost nine out of ten (87%) broker-dealers believed execution consulting services were more important than the provision of core liquidity management services as their top differentiator. In The Next Generation of Execution Consulting Services, Aïte found that today’s execution consulting needs to provide not only a high-touch advisory service, but also trade and risk execution analysis and real-time tools for live insights. In other words, the service has expanded to fit new market conditions.

In part, it is a reflection of having to develop canny trading strategies in a much smaller liquidity pool. In part, it is a function of fundamental changes coursing through the industry, with new people entering the business armed with a predisposition towards detailed and sophisticated analysis. Laurie Berke, a principal with TABB Group, highlighted this trend earlier this year, in March in fact, when she wrote in an opinion paper that one head trader of a large global asset management firm had pointed out to her that all his new hires over the past five years had either been a quantitative

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analyst or a developer. “His ability as head trader to contribute to and preserve alpha is increasingly dependent upon his firm’s ability to quantify, customise and optimise its equity trading solutions,” she wrote. It comes as no surprise then that Stephane Loiseau, head of equity execution, Société Générale exclaims: “Execution consulting is not ‘one size fits all’. A big part is listening to the client’s strategy and what they are trying to achieve and guiding them in the process. This is not an easy thing to do to understand the portfolio manager’s objective, the trader’s objective and this is very dependent on the type of institution you talk to and the strategy. So for example, toxicity in a venue may not be important to a client who wants to execute as quickly as possible.” The definition of execution consulting was traditionally grounded in advice to buy side firms that need support with algorithms, or their customisation. As Berke explains, that client base continues to evolve both in terms of numbers and the demands they make on the sell side. Moreover, with high frequency flow or systematic traders now making up to 70% of liquidity in the US, there’s a need to service that segment of the market as well. In August 2012, UBS launched a new business area for hedge funds, Quant HQ. It combines the firm’s prime brokerage function with its direct execution services and is targeted at systematic or quant traders. The bank claims to offer “a la carte services combining human insight and expertise with cutting-edge technology”offering clients enterprise consulting, capital formation, market connectivity, co-location, risk management, trade execution and clearing. “Quantitative traders are a highly sophisticated segment of the global securities markets, and a major source of market liquidity,” explains Charles Susi, global co-head of direct execution at UBS. “They know precisely what they want from their service providers and have highly specialised needs. With Quant HQ we have organised ourselves to empower them to implement their innovative models and help them quickly seize opportunities for alpha, wherever they trade.” “Hedge funds have always been ahead in their use of information technology,” adds Jon Fatica head of analytics at technology firm, TradingScreen. “We are now finding that there are more hedge funds looking to deal with the same issues as traditional asset managers such as: what’s the algorithm doing to the order?” Loiseau agrees that within the institutional side of the business some are highly automated and sophisticated, but he says: “On the sell side, your vision of trading is the sum of all your clients’ activity. Execution consulting is regardless of sophistication although the degree of consulting will vary from thorough back-testing of customised algorithms on one hand to TCA at the other end. There is a degree of variation between different users, but all will need some form of execution consulting.” Kevin Tyrrell, head of execution consulting at Bank of America Merrill Lynch (BAML) holds: “It’s not long-only firms asking one thing and hedge funds asking another.

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2012

Stephane Loiseau, head of equity execution, Société Générale exclaims: “Execution consulting is not ‘one size fits all’. A big part is listening to the client’s strategy and what they are trying to achieve and guiding them in the process. This is not an easy thing to do to understand the portfolio manager’s objective, the trader’s objective and this is very dependent on the type of institution you talk to and the strategy. So for example, toxicity in a venue may not be important to a client who wants to execute as quickly as possible,” says Loiseau. Photograph kindly supplied by Société Générale, November 2012.

We are getting demands from the entire client base and a lot are asking for high-tech solutions. They want to know: do we have the best tools at our disposal? Some clients want simple customisation, but then there are the more advanced clients who want to move into the heart of the algorithm— how it is responding to signals and so on. What they want is not necessarily to rewire it, but to bring the algorithm decision-making process closer to the initial strategy. That’s more complicated at our end, but brings results for the client.” Indeed, UBS’s execution consulting framework called Quant on Demand uses advanced technology to make quantitative capabilities scalable for clients. One tool, launched in April earlier this year, is the Quant on Demand Studio, an iPad app, which can be used to design new algorithms for quick deployment.“Our aim is to turn the process of product development and execution consulting on its head—making our platform client-centric and more immediate,” says Owain Self, global head of algorithmic trading at UBS. “UBS Quant on Demand will, over time, deliver a series of highly sophisticated and automated quantitative, consultative and personalised solutions to clients ‘on demand’. As Self implies, the term ‘execution consulting’ these days is a broad brush term covering detailed transaction cost analysis (TCA) at one end of the spectrum to macro research analysis at the other.

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EXECUTION CONSULTING

Definitions, definitions... Even TCA itself can mean different things to different people and FIX Protocol have created a working group with a highlevel sub-group headed by ITG and a second sub-group, developing formal definitions of price, time and cost headed by BAML. More than 100 members from 59 firms have signed up to the full working group led by Mike Napper of Credit Suisse representing the sell side and Michael Caffi of State Street Global Advisors, for the buy side. As if to illustrate the point, ITG splits its transaction analytics consulting, including cost measurement and suggestions for practical implementation of insights, away from its execution consulting, which teaches clients how best to reach liquidity, points out which algorithms are working well, whether clients are maximising their technology and where adjustments are needed. Tyrrell at BAML says the fact that execution consulting has moved on from its original focus on electronic trading has also had an impact on the way that clients interact with the service. Gone is the preoccupation with questions such as ‘where did you execute?’ and ‘how did my smart order router do?’These days the analytical requirements are much more nuanced.“It has expanded significantly and people are just starting to see the overall offering as more integrated between high and low touch,” explains Tyrrell. “Clients are now asking questions that are more wide-reaching. So if a client has traditionally come to talk to us about venue distribution, they are now also asking about orders they send to the high touch desk.” For many firms this means the skill set of the trading floor has accordingly expanded. Bloomberg Tradebook, for instance, has a structured programme of education for its 32strong cross-asset class execution consultants in 15 accredited courses including consultative skills, knowledge of smart order routing and global market structure. TABB Group points out that with asset management firms now executing 48% of their US equity order electronically, over 65 trading venues in the US alone, over 600 broker-built algorithms, thousands of smart order routing logic solutions and “more reams of post-trade TCA data than any analyst could ever learn to love”, buy side traders need knowledgeable sell side partners to help them interpret the data. With more to analyse in less time, much recent development in execution consulting has taken place in the area of real-time data analysis.“Real time means a lot of data, probably more than any system can take; so you need to do a lot of data analysis every couple of minutes,” says Loiseau. Furthermore, he explains that looking at the data in real time means different things for the manual trader than for the automated trader: “You have to be able to use the information in a meaningful way and in a format which is manageable. If it is a manual trade, you need macro level alerts that you can see. If it is an automated trade, the algo will need to be able to read the information.” To augment data management, providers of execution consulting continue to invest in technology to provide real-

Laurie Berke, a principal with TABB Group. Berke wrote in an opinion paper that one head trader of a large global asset management firm had pointed out to her that all his new hires over the past five years had either been a quantitative analyst or a developer. “His ability as head trader to contribute to and preserve alpha is increasingly dependent upon his firm’s ability to quantify, customise and optimise its equity trading solutions,” she wrote. Photograph kindly supplied by TABB Group, November 2012.

time tools. Abel Noser Solutions, for one, is planning to roll out a real-time TCA tool early in 2013, which will update post-trade analysis in real-time and show how much of an order is left and the likely costs for the rest of that order. Meanwhile, ConvergEx’s PerformEx system, released in August, allows traders to see a pie chart of where an order is being filled in real time. Yet the story does not end with the provision of real-time consulting tools. Each news event or change in a venue’s pricing structure, reaffirms the belief that today’s market micro-structure has a shelf-life of a couple of weeks. Indeed, continually reassessing market micro-structure has become the norm for execution consultants. Loiseau points out:“The mistake made post-Lehman was that we saw increased volatility which created issues for algorithms. There was a belief that if you invested in the technology, set it up, tested and off you go, that would work. But that is not the reality in today’s micro-structure. The environment changes so fast that being static is the wrong approach today. We look at toxicity levels intra-day with our Quality of Venue Measurement (QVM) tool, how a stock behaves before the trade and four or five minutes after. It is collating data in real-time and this is important because toxicity levels vary by venue, but also in one venue intra-day. So we adjust algorithms intra-day accordingly.” However, making continual reassessments and adjustments to compensate for this does not necessarily mean

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Kevin Tyrrell, head of execution consulting at Bank of America Merrill Lynch (BAML). “It’s not long-only firms asking one thing and hedge funds asking another. We are getting demands from the entire client base and a lot are asking for high-tech solutions. They want to know: do we have the best tools at our disposal?” explains Tyrrell. Photograph kindly supplied by BAML, November 2012.

Charles Susi, global co-head of direct execution at UBS. “They know precisely what they want from their service providers and have highly specialised needs. With Quant HQ we have organised ourselves to empower them to implement their innovative models and help them quickly seize opportunities for alpha, wherever they trade,” says Susi. Photograph kindly supplied by UBS, November 2012.

much more work or more expense. “It is often the same servers, the same data and often the same front end. TCA is not an end in itself. It’s a process and you need to look at it as much as your technology allows you. At least then you are a step ahead of the competition,” says Loiseau. At Société Générale, where 15 people on electronic trading desks are advising clients daily around the world, Loiseau says: “Everyone on the trading desk is spending more time on consulting and less time on execution technology. Technology issues are now quite well covered by technical teams so it gives more time to the sales traders on the desks to focus on client needs. It is everyone’s job to do execution consulting, and execution consulting function has become a bigger proportion of everyone’s mandate; as high as 75% in some cases.” Indeed, finding the people with the right skill set is no easy task and today’s execution consultants need knowledge of venues, of new regulation and different technologies and also operational and client relationship skills. Rather than find individuals who can fulfil each of these tasks, some desks try to combine skills with some people expert on the trading side and others with good knowledge of regulation, for example. Bringing people together in a team means skills are transferred. At BAML, much ‘cross-fertilisation’ occurs during weekly sales meetings and simple desk-side discussions. The firm expanded its execution consulting team at the end of 2010 adding consulting on different vendors’ order management systems and execution management systems to its

quantitative consulting, macro research and market structure reports. At the time, Lee Morakis, the firm’s head of execution services sales, said: “By combining these capabilities into one group we are better able to analyse information and leverage our expertise to offer clients a better service.” Add to this the ability to advise on multi-asset executions and the complexities increase further. More 60% of foreign exchange trades were conducted electronically last year, according to Portware and with it the demand for execution consulting, TCA in particular, in the FX arena has grown. Tyrrell at BAML has also noticed a growing demand for multi-regional advice. BAML has a team in US, Europe and Asia and he says: “We have had more requests to integrate performance across the US, Asia and Europe. A lot of requests are to do with regulatory issues, comparing and contrasting cross-border. In the US, for example, they want to know about the French transaction tax and MiFID II, and in Europe, clients are asking about US related structural issues. There has been a lot of cross-border collaboration among the execution consulting teams this year.” Such advice is vital as substantial sums are at stake: a daily saving of 20 basis points adds up to $400,000 on $50bn traded annually. Tyrrell concludes: “Clients’ main priority is that they are looking for best execution, which may involve assessing different trading styles and benchmarks. They are servicing their own clients by looking for something that will help them to know the markets better and be better traders.” n

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GM Data pages 66_. 15/11/2012 17:34 Page 60

DTCC CREDIT DEFAULT SWAPS ANALYSIS

Top 10 number of contracts (Week ending 2 November 2012) Reference Entity

Republic of Italy Federative Republic of Brazil Republic of Turkey Kingdom of Spain Russian Federation Republic of Korea United Mexican States Bank of America Corporation People’s Republic of China Banco Santander, S.A.

Market Type

Net Notional (USD EQ)

Gross Notional (USD EQ)

Contracts

DC Region

Sov Sov Sov Sov Sov Sov Sov Corp Sov Corp

384,245,988,748 158,448,608,790 144,757,295,746 205,067,246,640 115,183,691,633 82,775,496,834 121,177,185,462 70,786,011,899 74,452,128,130 63,822,602,376

20,338,476,005 16,889,991,095 6,804,128,100 12,594,280,013 4,812,412,178 6,947,572,461 9,370,010,058 4,578,654,886 9,345,771,058 2,365,433,518

12,641 10,115 9,902 9,831 9,551 8,955 8,748 8,199 8,079 7,985

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

Top 10 net notional amounts (Week ending 2 November 2012) Reference Entity

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

Sector

Market Type

Net Notional (USD EQ)

Gross Notional (USD EQ)

Contracts

DC Region

Government Government Government Government Government Government Government Government Financials Government

Sov Sov Sov Sov Sov Sov Sov Sov Corp Sov

384,245,988,748 173,461,978,697 158,448,608,790 150,958,171,222 205,067,246,640 79,352,805,149 121,177,185,462 74,452,128,130 80,990,111,326 71,087,928,934

20,338,476,005 18,250,278,807 16,889,991,095 16,710,815,320 12,594,280,013 11,587,225,346 9,370,010,058 9,345,771,058 9,165,703,896 8,930,759,980

12,641 7,415 10,115 5,841 9,831 7,730 8,748 8,079 6,497 4,670

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

Ranking of industry segments by gross notional amounts

Top 10 weekly transaction activity by gross notional amounts

(Week ending 2 November 2012)

Single-Name References Entity Type

Gross Notional (USD EQ)

Contracts

References Entity

Gross Notional (USD EQ)

Contracts

Corporate: Financials

3,149,933,792,069

448,746

French Republic

8,334,975,098

330

Sovereign / State Bodies

2,994,790,806,084

221,756

Federal Republic of Germany

7,286,433,412

351

Corporate: Consumer Services

1,755,946,577,037

311,389

Republic of Italy

5,886,946,523

338

Corporate: Consumer Goods

1,551,093,967,285

267,041

Kingdom of Spain

3,555,236,622

318

Corporate: Industrials

1,156,691,575,307

211,595

United Kingdom of GB and NI

2,533,369,252

263

841,873,651,508

144,632

Japan

2,208,218,200

243

Corporate: Telecommunications Services 784,113,981,035

127,059

Republic of Austria

2,182,762,970

123

Corporate: Utilities

656,642,753,283

111,985

Deutsche Bank Aktiengesellschaft

1,218,064,821

167

Corporate: Energy

488,284,215,464

89,607

The Royal Bank of Scotland plc

1,043,850,410

155

Corporate: Technology

328,482,985,209

62,611

RWE Aktiengesellschaft

1,030,915,200

172

Corporate: Healthcare

314,261,463,740

57,488

Corporate: Other

127,042,860,019

13,844

Residential Mortgage Backed Securities

34,039,967,427

6,459

CDS on Loans

26,989,641,257

7,324

Commercial Mortgage Backed Securities 11,333,751,704

1,236

Corporate: Basic Materials

Residential Mortgage Backed Securities*

7,244,833,270

440

Other

4,829,022,180

720

Muni: Government

3,422,144,390

269

CDS on Loans European

2,727,534,761

469

Commercial Mortgage Backed Securities*

721,431,010

400,000

Muni: Utilities *European

Sector

Government Government Government Government Government Government Government Financials Government Financials

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

NOVEMBER/DECEMBER 2012 • FTSE GLOBAL MARKETS

GM Data pages 66_. 15/11/2012 17:34 Page 61

MARKET DATA BY FTSE RESEARCH

ASSET CLASS RETURNS 1M% EQUITIES (FTSE) (TR, Local) FTSE All-World USA Japan UK Asia Pacific ex Japan Europe ex UK Emerging

12M% -0.3

11.2

-1.8

15.2 0.8 0.9 0.4 1.2 0.5

COMMODITIES Brent Crude Oil Gold Copper Credit Suisse Commodity Index

-0.9 8.7 8.1 12.6 8.2

-1.9

-1.1

-2.7

0.5

-5.5

-2.8 -2.2

-4.2

GOVERNMENT BONDS (FTSE) (TR, Local) US (7-10 y) UK (7-10 y) Germany (7-10 y)

-0.7 -1.0 -0.3

6.7 8.3 7.1

CORPORATE BONDS (FTSE) (TR, Local) UK BBB Euro BBB

1.0 1.4

FX - TRADE WEIGHTED USD GBP EUR

10.9 10.3

1.1

-0.5

3.5 4.4

1.2

-6

-5

-4

-3

-2

-1

-5.4

-10

-5

EQUITY MARKET TOTAL RETURNS (LOCAL CURRENCY BASIS) Regions 1M local ccy (TR)

-2

Regions 12M local ccy (TR)

1.2 1.0 0.9 0.8

Europe ex UK BRIC UK Japan Emerging Asia Pacific ex Japan FTSE All-World Developed USA -1.8

0.5 0.4 -0.3 -0.5

-1.5

-1

-0.5

0.5

15.2 12.6 11.6 11.2

USA Europe ex UK Developed FTSE All-World UK Emerging Asia Pacific ex Japan BRIC Japan

1.5

8.7 8.2 8.1 4.9 -0.9

-5

Developed 1M local ccy (TR) Australia Italy Hong Kong Spain Netherlands France Finland Switzerland Israel Canada UK Germany Japan Developed Norway Sweden Belgium/Lux Singapore USA Denmark Korea

-0.5 -1.2 -1.3 -1.4 -1.7 -1.8 -1.9

-4.7

-6

-4

-2

-10

5.7 3.8 2.7 1.8 1.7 0.5 0.4 -0.9 -0.9 -1.4 -2.8 -6.0

-10

-5

37.3 36.9

18.7 18.4 15.2 15.1 12.5 12.2 12.1 11.8 11.6 9.6 8.8 8.7

Emerging 12M local ccy (TR) Turkey Thailand South Africa Mexico Malaysia Indonesia Emerging China Brazil India Taiwan Chile Russia

10.3

4.0 3.1 3.0 2.9

-0.9 -3.5 -4.2

Emerging 1M local ccy (TR) Turkey China Indonesia South Africa Malaysia Mexico Emerging Chile Brazil Thailand India Russia Taiwan

Developed 12M local ccy (TR) Belgium/Lux Denmark Germany Switzerland USA Hong Kong Norway Sweden Netherlands France Developed Australia Singapore UK Canada Israel Italy Korea Japan Finland Spain

3.0 2.7 2.6 2.4 2.3 2.0 1.8 1.6 1.5 1.3 0.9 0.9 0.8

35.3 30.1 19.2 16.8 14.1 12.1 8.2 7.3 5.8 5.2 -0.2 -1.9 -4.8

-10

Source: FTSE Monthly Markets Brief. Data as at the end of October 2012.

FTSE GLOBAL MARKETS â&#x20AC;˘ NOVEMBER/DECEMBER 2012

GM Data pages 66_. 15/11/2012 17:34 Page 62

MARKET DATA BY FTSE RESEARCH

PERSPECTIVES ON PERFORMANCE Regional Performance Relative to FTSE All-World Japan BRIC

US Emerging

UK Europe ex UK

Global Sectors Relative to FTSE All-World Basic Materials Consumer Services Technology

Oil & Gas Health Care Financials 120

Asia Pacific ex-Japan

120

Consumer Goods Industrials Telecommunications Utilities

110

100 100 90 90

80 Oct 2010

Feb 2011

Jun 2011

Oct 2011

Feb 2012

Jun 2012

70 Oct 2010

Oct 2012

Feb 2011

Jun 2011

Oct 2011

Feb 2012

Jun 2012

Oct 2012

BOND MARKET RETURNS 1M%

12M%

FTSE GOVERNMENT BONDS (TR, Local) US (7-10 y)

-0.7

UK (7-10 y)

6.7 8.3 7.1

-1.0

Ger (7-10 y)

-0.3

Japan (7-10 y)

0.1

France (7-10 y)

4.0 11.7

0.3

Italy (7-10 y)

18.0

2.1

FTSE CORPORATE BONDS (TR, Local) UK (7-10 y)

0.4

12.2

Euro (7-10 y)

16.7

1.1 1.0

UK BBB Euro BBB

10.9

1.4

UK Non Financial

10.3 10.8

0.8

Euro Non Financial

9.1

0.9

FTSE INFLATION-LINKED BONDS (TR, Local) UK (7-10)

6.7

0.1

-2

-1

BOND MARKET DYNAMICS – YIELDS AND SPREADS Government Bond Yields

Corporate Bond Yields

US (7-10 y)

Japan (7-10 y)

UK (7-10 y)

Ger (7-10 y)

France (7-10 y)

Italy (7-10 y)

UK BBB

7.50

Euro BBB

8.00

6.50

7.00

5.50 4.50

6.00

3.50

5.00

2.50 4.00 1.50 0.50 Oct 2009

Apr 2010

Oct 2010

Apr 2011

Oct 2011

Apr 2012

Oct 2012

3.00 Oct 2007

Oct 2008

Oct 2009

Oct 2010

Oct 2011

Oct 2012

Source: FTSE Monthly Markets Brief. Data as at the end of October 2012.

NOVEMBER/DECEMBER 2012 • FTSE GLOBAL MARKETS

GM Data pages 66_. 15/11/2012 17:34 Page 63

COMPARING BOND AND EQUITY TOTAL RETURNS FTSE UK Bond vs. FTSE UK 12M (TR) FTSE UK Bond

FTSE US Bond vs. FTSE US 12M (TR)

FTSE UK

FTSE US Bond

115

120

110

115

FTSE US

110

105

105 100 100 95

90 Oct 2011

90 Jan 2012

Apr 2012

Jul 2012

Oct 2012

Oct 2011

FTSE UK Bond vs. FTSE UK 5Y (TR) FTSE UK Bond

Jan 2012

Apr 2012

Jul 2012

Oct 2012

FTSE US Bond vs. FTSE US 5Y (TR)

FTSE UK

FTSE US Bond

160

145

130

FTSE US

115

100

Oct 2007

Oct 2008

Oct 2009

Oct 2010

Oct 2011

1M%

Oct 2012

3.8

-1.8

-3

-2

-1

15.2

-2

Oct 2012

2.8

5.4

-0.4

Oct 2011

4.4

8.7

-1.1

-0.5

Oct 2010

5Y%

3.0

-0.7

FTSE USA Bond

Oct 2009

12M%

0.9

FTSE UK Bond

Oct 2008

3M%

FTSE UK Index

FTSE USA Index

Oct 2007

-1

47.7

4.5

42.8

Source: FTSE Monthly Markets Brief. Data as at the end of October 2012.

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2012

GM Data pages 66_. 15/11/2012 17:34 Page 64

THE LATEST MARKET HIRES & NEW BUSINESS BUILDS 64

ENTRANCES AND EXITS

ASIA BNY Mellon promotes Fred DiCocco to regional head of sales & relationship management, Treasury Services, Asia-Pacific. DiCocco will remain in Hong Kong and reports to Alan Verschoyle-King, global head – sales & client management, Treasury Services.

EUROPE Legal & General has appointed Paul Stanworth head up Legal & General Group’s Treasury & Investments operations. Paul will report to Nigel Wilson, Legal & General Group chief executive officer. Heading this newly formed group, Paul will be responsible for the overall asset strategy and financing of Legal & General’s balance sheet composing £40.1bn of assets across all shareholder interests, £16.4bn in participating funds and £3.3bn of Group borrowings. Citi has opened a securities lending trading desk in Dublin as part of its commitment to expand its OpenLend capabilities in key cities and regions around the globe. The Dublin desk will form part of an expanded EMEA (Europe, Middle-East and Africa) securities lending trading team that covers Global Equity lending, Global Fixed Income lending and multicurrency cash reinvestment. The combined (London and Dublin) EMEA trading desk will continue to be run by Gareth Mitchell, EMEA Head of Securities Finance Trading, who has over 26 years of industry experience. As part of this expansion, Gareth has relocated from London to Dublin. Reech AiM Group (Reech), the international asset management group specialising in real estate and managed futures, has appointed Gary Sher as finance director and Adam Mincer as head of operations and technology. Both will be based in London and report directly to Christophe Reech, Chairman and CEO, Reech AiM Group. Allan Cottam has left the DTCC and joined BNY Mellon. Cottam becomes business head for corporate and sovereigns in EMEA. Kevin Bowhay has become discretionary fund manager at Rowan Dartington, the wealth management firm. He joins from Lloyds TSB Private Banking. NYSE Euronext has hired Demetria O’Sullivan as chief risk officer of its new full-service derivatives Clearing House in London – NYSE Clearing. NYSE Clearing intends to launch a revamped NYSE Clearing platform in June 2013 to expand its existing clearing business. O’Sullivan worked most recently at Citigroup, where she was global head of risk for futures and OTC clearing.

Andrea Podesta has left Bank of America Merrill Lynch, where he headed up Southern Europe fixed income sales and has joined KNG Securities as managing partner and head of fixed income. Palamon Capital Partners has appointed John David as managing director, investment strategy. David joins Palamon’s pan-European team, all based in London, to advance the firm's thematic investment model which proactively identifies and partners high growth service businesses across Europe. Previously, David worked at Allstate Investments where he was global strategist and head of the London office. Erudine Financial says it is bringing its expertise from safety-critical industries to financial services markets. The firm is leveraging its Erudine system which was originally tailored to engineering practices in the aerospace industry to create secure automated financial systems. The new company has also recently acquired specialist consultancy Silverminute, a provider of bespoke software solutions The firm claims to be working closely with financial institutions to analyse their systems and transform infrastructures in as little as 12 weeks to meet existing and future business challenges.

AMERICAS The NASDAQ OMX Group, Inc says it will buy the index business of Mergent, Inc., including Indxis. Mergent is an index provider and supplier of business and financial data on global publically listed companies. Deutsche Bank Fund Administration Services has launched the industry's first App-based fund solution on Autobahn App Market. The App provides access to Deutsche Bank’s fund administration services as well as research and analytical tools in one place. SIX Financial Information and Numerix announce that they have signed a strategic partnership agreement to produce valuations for OTC derivatives. The new service complements SIX Financial Information’s proprietary pricing for fixed income products by expanding client’s options to value a wider range of their portfolio in a consistent and reliable manner. OpenLink, the transaction lifecycle management (TLM) software firm, has hired David Obstler as its new chief financial officer. Obstler will report to Mark N Greene, CEO Designate, and oversee all finance functions and selected administrative functions. MarketAxess Holdings Inc the electronic trading platform for US and European corporate bonds, emerging markets bonds and fixed-income securities, will buy Xtrakter Limited. The target is a regulatory transaction reporter, financial market data provider and trade matching services to the European securities markets. Xtrakter is a wholly owned subsidiary of Euroclear.

NOVEMBER/DECEMBER 2012 • FTSE GLOBAL MARKETS

GM Cover Issue 66 Impo_. 15/11/2012 17:05 Page FC2

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CORPORATE ACTIONS: TOWARDS STANDARDISED MESSAGING

ISSUE 66 • NOVEMBER/DECEMBER 2012

$341,796,560,585,702 isn’t just a big number. *

FTSE GLOBAL MARKETS

It’s more liquidity.

FTSE debuts Kenyan Sovereign bond index Why market quality counts How the buy side is managing collateral HFT takes the high road

swapclear.com

*SwapClear’s total outstanding notional as of October 24, 2012

ISSUE SIXTY SIX • NOVEMBER/DECEMBER 2012

SwapClear’s unrіvalled dealer volumes can mean better executіon prіces for buy-sіde clіents who clear theіr OTC іnterest rate swaps wіth us.

THE US FISCAL CLIFF: Can Republicans work with Obama in 2013? DRS IN THE DOLDRUMS: IS IT TIME FOR A CHANGE?