FTSE Global Markets by FTSE Global Markets

ROUNDTABLE: T2S: MANAGING MARKET CHANGE AND REFORM

ISSUE 72 • SEPTEMBER 2013

CEPA-X & the future of Hong Kong The appeal of eurolira debt Zaghreb sets out its EU market stall

Euroclear’s new dawn: Leading the charge in Europe’s Post-trade landscape

www.ftseglobalmarkets.com

OUTLOOK EDITOR: 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) SENIOR EDITOR: Lynn Strongin Dodds CORRESPONDENTS: 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; Jonathan Cooper; Jessie Pak; Jonathan Horton HEAD OF SALES: Peter Keith T: +44 [0]20 7680 5153 | E: peter.keith@berlinguer.com OVERSEAS REPRESENTATION: Can Sonmez (Istanbul/Turkey) FINANCE MANAGER: Tessa Lewis T: +44 [0]20 7680 5159 | E: tessa.lewis@berlinguer.com RESEARCH MANAGER: Sharron Lister: Sharron.lister@berlinguer.com | Tel: +44 (0) 207 680 5156 MIDDLE EAST SECTION HEAD: Fahad Ali: Fahad.Ali@berlinguer.com | Tel: +44 (0) 207 680 5154 EVENTS MANAGER: Lee White | 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 US SALES REPRESENTATION: Marshall Leddy, Leddy & Associates, Inc. 80 S 8th St., Ste 900, Minneapolis, MN 55402 T : (1) 763.416.1980 E: marshall@leddyandassociates.com 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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FTSE GLOBAL MARKETS • SEPTEMBER 2013

S THE BARD would have it: summer’s lease has had all too short a date for the equity markets. Rising oil prices and bond yields and the threat of higher interest rates have bruised the equity markets as investors have worried that slow improving economies might lead central banks to begin to cut back on quantitative easing (or monetary stimulus for those Keynesians among you) in the autumn. Actually, it’s probably too soon for any central bank to take its foot off the printing pedal, just as Western economies look to be on a slight turn to the better. Assuming that’s the case, it is no surprise that UK fund managers that in the longer term equities are still worth a look. As Martin Walker, UK equities fund manager at Invesco Perpetual notes: “Economic growth underpins growth in company earnings and hence the improving economic outlook should prove positive for equity markets over the medium and longer term. It is also worth noting that the end game of quantitative easing is not deflation but inflation—and that equities (with share prices driven by nominal earnings growth) are a much better bet than bonds in an inflationary environment.” Even so, he marks his comment with caution.“There are three pillars to stock market returns—starting valuation, company earnings growth and investment of retained earnings. After such a strong run over the past few years combined with the recent rise in the risk free rate of return, equity markets are no longer as compellingly good value. But the latter two pillars are still very much in place, particularly in an improving macro-economic environment,”he says, adding. “In terms of constructing a portfolio to perform in this environment, the key, I believe, is that you need exposure to growth—which will mitigate against a rising risk free rate of return.” So, no grand rotation in sight as yet (bad news bears for broker-dealers and trading desks again); but at least the hope of a better cycle is in sight. Elsewhere, most of this issue is devoted to the post trade space which is evolving at an accelerated rate. There’s a long list of winners and losers respectively coming to terms with wholesale change (at least in Europe in the near term) that will redraw the relationships between central securities depositories and investment firms. In some ways, the role of intermediaries will become more important as Basel III, T2S, CSD Regulation, EMIR, AIFMD and the Securities Law Directive begin to impinge on markets in an increasingly coordinated pincer movement. The surprise of it all is the relative indifference of some markets (think the UK, Switzerland, Greece, Spain, Hungary and others) to the proceedings in train and the growing desire of non-European institutions (notably the Bank of Japan) to jump on the bandwagon. It’s a funny old world, isn’t it? The cover story, the market round-ups, the roundtable and the features either side of it dance to the new post trade music. Some institutions will undoubtedly benefit: Europe’s leading CSDs (Clearstream and Euroclear) look set to clean up as T2S comes on line and the continent’s smaller CSDs and sub-custodian providers struggle to find new business streams to compensate as post trade settlement is increasingly concentrated in fewer cross-border institutions; particularly those who can provide smart management of liquidity (and collateral). One thing never changes though. In my green and salad days as a cub reporter, my editorial director constantly admonished: “look to who controls the smart money; that’s the heart of the matter.”It’s as true today as it ever was.

Francesca Carnevale, Editor Front cover: Tim Howell, chief executive, Euroclear. Photograph supplied by Euroclear, August 2013.

CONTENTS COVER STORY

EUROCLEAR REDISCOVERS ITS MOJO

......................................................................Page 4 Some institutions look bruised by the impact of incoming regulation and market change. Others, like Euroclear, have been revitalised. What is the secret of the firm’s relentless energy in reaching out to build new strategic alliances and business models?

DEPARTMENTS

SPOTLIGHT

EMERGING MARKETS FUND FLOWS CONSTRICT .................................Page 10 Fund flows, trends and new platforms reshaping the global investment markets.

DOES CEPA-X HELP OR HINDER HONG KONG’S OUTLOOK? ........Page 18 The latest economic partnership agreement has far-reaching repercussions.

IN THE MARKETS

ALL UNDER CONTROL? AIFMD IMPLEMENTATION ................................Page 20 The latest economic partnership agreement has far-reaching repercussions.

OFFSHORE CENTRES KEEP THE FAITH ..................................................................Page 26 Re-regulation continues to impact on offshore markets: can they respond?

FACE TO FACE

WITH SERGEI SINKEVICH, HEAD OF DMA, OTKRITIE CAPITAL.....Page 28

TRADING POST

WHAT HAPPENS IN THE EVENT OF A CPP DEFAULT? .......................Page 32

The impact of market reform in the Russian capital and trading markets.

New columnist Amir Khwaja, CEO of Clarus Financial Technology analyses the swaps market.

EASTERN EUROPE: THE HUNGARIAN QUESTION .................................Page 36

COUNTRY REPORTS

Changes to Hungary’s constitution remain problematic.

TURKEY’S EUROLIRA MARKET GAINS TRACTION ...............................Page 52 Is there sustained appeal in the nascent Turkish lira denominated eurobond segment?

NEW SEC LENDING PLATFORM TESTS THE WATERS ..............................Page 34 What can SL-x offer a market already under strain?

ASSET SERVICING

SURVEY: MENA ASSET MANAGEMENT SURVEY RESULTS ................Page 38 Syrian crisis heightens investors’ fears of contagion.

T2S & THE €300BN LIQUIDITY CHALLENGE ....................................................Page 58 Will T2S really benefit the investor community?

ROUNDTABLE

T2S: MANAGING MARKET CHANGE & OPPORTUNITY ........................Page 61 How will T2S redraw the European post trade landscape?

ZAGREB: FROM MINNOW TO MINOR TO MAJOR....................................Page 71

TRADING

Vanja Dragomanovich review the options for the EU’s new exchange member.

RETHINKING EQUITY TRADING ....................................................................................Page 74 Ruth Hughes Liley talks to Instinet CEO Adam Toms about market change.

DATA PAGES 2

Market Reports by FTSE Research ..............................................................................................................Page 78

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

A SUSTAINABLE SOLUTION TO COMBAT THE GLOBAL COLLATERAL CHALLENGE The Liquidity Alliance is a partnership of market infrastructures that will deliver an efﬁcient and effective collateral management value proposition for the global industry. The founding partners – ASX (Australia), Cetip (Brazil), Clearstream (Luxembourg), Iberclear (Spain) and Strate (South Africa) – are combining decades of market expertise with world-leading collateral management technology to provide their customers with state-of-the-art services. The Liquidity Alliance partners look forward to integrating new members and to promoting links with international markets. The Liquidity Alliance: a global solution to a global challenge.

ASX Andrew White andrew.white@asx.com.au

CETIP Nelson Eduardo Pinto Pereira nelson.pereira@cetip.com.br

CLEARSTREAM Gerd Hartung gerd.hartung@clearstream.com

IBERCLEAR Teresa Castilla tcastilla@grupobme.es

STRATE Anthony van Eden anthonyv@strate.co.za

COVER STORY

EUROCLEAR: REDRAWING THE POST-TRADE LANDSCAPE

These are lambent days for Euroclear. The post trade service provider has rediscovered its mojo over the last couple of years; really ever since its urbane chief executive Tim Howell joined Euroclear from HSBC and gave it a much needed shot in the arm. Having a banker who walked the talk of investment services at the helm has brought a fresh and brisk perspective to the firm. Is it a case of the right man, at the right firm, at the right time? FTSE Global Markets spoke to Howell about the firm’s strategy and how it is leveraging its strengths at a time of transformation in the post trade space.

EUROCLEAR SETS A NEW PATH LEARLY 2013 STARTED with a bullet for Euroclear. The firm set off a cracking pace of change that really began at the tail-end of 2012. It’s moot what ultimately triggered the momentum for change. A raft of incoming regulations that will result in the redrawing of the investor services map in Europe is one driver. Others include the growing requirement to recast the post-trade landscape as new investor trading patterns evolve; demand from both the buy side and the sell side that post-trade services need to be harmonised across markets; and that more cost efficiencies have to be found. Moreover, leading international firms such as Euroclear, Clearstream and the DTCC, are well aware that to meet the challenges and demands of the new financial order they have to redefine themselves as service centres for both investors and issuers. It is a tall and broad-brush requirement. Sometimes it involves upgrading settlement, custodial, depositary, processing, technology and data services; and at other times managing collateral (or liquidity) pools, or combinations of the above. From this year’s raft of initiatives, and last year’s performance, Euroclear increasingly looks to be relishing the challenge; though it has not been entirely smooth sailing. Certainly, the value of securities held for its clients at the end of 2012 was a record €23trn, up

by almost one trillion euros on the previous year and in total a 4% uptick. That performance was set against an indifferent trading market (which compared to pre-crisis trading levels in 2007, was as much as 40% to 50% under par). No surprise then that turnover (or the value of securities transactions settled) was €541.6trn last year, a 7% decrease over 2011. Moreover, the number of netted transactions settled in the Euroclear group dipped by a slight 3% over the year (to reach €158.9m). Even so, Euroclear’s global Collateral Highway (of which, more later) mobilised €700bn of collateralised transactions each day by year-end 2012, over a period when the repo market contracted by a significant 14% (according to recent ICMA and the European Repo Council figures). Euroclear’s strategy, to the outsider, looks to expand business in five areas: expanding fund services; encouraging improvements in post-trade processing; expanding strategic CSD linkages and building out services that support the free movement of assets as collateral. Lastly, explains Tim Howell, Euroclear’s chief executive; “How do I make data work better?” One of the big ticket items that characterised Euroclear’s outreach strategy this year came in February with the delineation of Euroclear Bank’s posttrade services for Russian OFZs—one of the most actively traded classes of

Tim Howell, chief executive, Euroclear.

Russian government bonds. Via Euroclear Bank’s account with National Settlement Depository (NSD), Russia’s central securities depository, international firms trading OFZs can now settle their trades and deposit their OFZ positions with Euroclear Bank. The service kicked off servicing the over the counter segment, but was soon extended to stock exchange traded transactions. Essentially, “we and the Russian authorities launched the idea that Russian bonds should become ‘Euroclear-able’ to attract more foreign investors. On the Russian side, the agreement is an efficient way forward in the country’s efforts to increase inward investment. It is a clear example of there being significant opportunity in opening markets and expanding potential pools of collateral,” says Howell, explaining that, for instance:“OFZs held in safekeeping by Euroclear Bank are also eligible as securities collateral for securitised transactions where Euroclear Bank is the triparty collateral management agent.” At the time, the move was regarded as groundbreaking; but more was to follow. A game changer came in May with the agreement between Euroclear and the United States’ Depository Trust and Clearing Corporation (DTCC) to create a joint collateral processing service, which Howell says “will significantly increase efficiency, reduce risk and support the growing collateral needs of industry participants. As demand for collateral increases, both DTCC and Euroclear are each developing our own means to ease margin processing, collateral sourcing, mobilisation and allocation optimisation for clients, and together we will increase

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

COVER STORY

EUROCLEAR: REDRAWING THE POST-TRADE LANDSCAPE

significantly the STP efficiency and depth of this process. Euroclear’s global Collateral Highway is a key part of our strategy to deliver such an infrastructure.” Launched in July 2012, the Collateral Highway has been a key pillar of the firm’s efforts to be a leader in the provision of collateral-related services. Euroclear has been working hard to extend its market reach and relationships to cement this role as a centrifuge. In January, for instance, Euroclear Bank in collaboration with Citi launched a service, via the Collateral Highway, that allows mutual client assets held at Citi to be used as collateral through the triparty services of Euroclear Bank. Equity and fixed-income positions held within Citi’s proprietary custody network are now eligible assets that can be used as collateral when Euroclear Bank serves as triparty agent and manages the collateralisation process. Citi continues to hold the assets as custodian, while the securities move across markets and time zones via the Collateral Highway. Euroclear’s proposed service agreement with the DTCC on the other hand, will offer automatic transfer and segregation of collateral based on agreed margin calls relating to over-the-counter derivatives and other collateralised contracts. “It will significantly reduce settlement risk, increase transparency around collateral processing on a global basis and will provide maximum asset protection for all participants,” explains Howell, explaining that DTCC and Euroclear “will also establish mutual links, permitting firms to manage collateral held at both firms' depositories as a single pool. The joint service will be operated as an industry cooperative and will provide open and non-discriminatory access to all other collateral processing providers, including custodians, CSDs and ICSDs, that wish to link their services to the joint service.” While there is no direct year-on-year comparison data to make any pronouncements as to the success of the service, the number of firms signing up to the Collateral Highway is steady and includes institutions such as BNP

Paribas, Standard Chartered and Newedge’s MTS Agency Cash Management platform, among the client roster. Howell explains that,“Given the caution with which market participants are managing risk in the current environment, the Collateral Highway helps cash givers and receivers mitigate counterparty risk by easily collateralising credit exposures with diversified pools of securities on a segregated basis”. In numbers terms, in 2011, Euroclear Bank’s and Euroclear France’s triparty collateral management and Euroclear UK & Ireland’s delivery by-value services achieved the equivalent of €503bn per day; by 2012 the Collateral Highway was mobilising some €700bn and so far this year, the figures looks to exceed €800bn per day.

Fund services Services for funds are also a key service set. Two developments underscore Euroclear’s expanding role in facilitating cross-border investment through improved fund processing. In April, Europe began including some 50 or so products from BlackRock’s iShares ETF business on its FundSettle platform; the first ETFs in fact on the platform. Soon after, BlackRock and Euroclear Bank agreed that new iShares ETFs will be issued and settled for the first time in the international CSD, Euroclear Bank. Up to then, all cross-exchange listed ETFs in Europe, including iShares ETFs, were issued and traded on one or more national stock exchanges and settled in the national central securities depository (CSD) of the exchange where the trade was executed. According to Howell, this causes inefficiencies when ETFs are traded across borders because ETF settlement is so fragmented. By using a single European settlement location, the new international ETF structure will unlock the potential of ETFs in Europe, improve trading liquidity, ease cross-border ETF processing and help lower transaction costs for investors; also “enabling ETFs to continue their rapid growth. Access must be widened to encompass new investors

and operating simplicity must be delivered in the form of lower transaction costs.” Equally important, it brings Europe in line with the United States, where a single settlement location for ETFs has been in place for years.” Second, Cofunds, the administrative fund platform handling over £50bn in assets, began linking to Euroclear’s EMX Message System for electronic fund transaction order routing (for single or aggregated orders), enabling Cofunds to reach 95% straight-through processing (STP) with the fund managers it interacts with. According to Howell, these types of agreements enable the reduction of “operational processing costs and achieve processing efficiency. The wide scope of our service enables Cofunds to route their orders in an electronic way to an additional 25 fund issuers where previously they relied on less automated channels,” explains Howell. Not to under-estimate the work, Howell acknowledges a significant lead in time for these initiatives to mature. “We spent two years working with the Russian authorities and the impact of our new service has been more dramatic than we expected. We have witnessed an absolute reduction in OFZ yields. This success has meant that we have many more country administrations knocking on our door wanting to do business with us,” he acknowledges. Howell thinks that Euroclear’s time has come and underlines a clear business logic driving expansion. “Fundamentally in post trade, we are running a utility with high fixed costs and relatively low marginal cost, which gives us breathing room to expand our services.” Even so, there are limitations, he avers. “The reality is that we work with some profit constraints. We are not about maximizing profits. We are expected to provide a return on equity of 10%, which is a level that our shareholders think is appropriate for an organisation of this type and is viewed as an adequate level of return. It also gives us room to reinvest. However, it is a level of profit that is lower than our peer

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

COVER STORY

EUROCLEAR: REDRAWING THE POST-TRADE LANDSCAPE

group. Nonetheless, we have a strong balance sheet and a very high Tier 1 ratio of close to 50%. Moreover, we are immensely risk averse,”he explains. Nonetheless, he acknowledges that the firm is well aware of the momentum it enjoys.“We are back at pre-crisis profit levels. We have focused on costs and internal and market disciplines,” he concedes.“All in all, I would say we do our job very well. We have a lot of capital and we are willing to take others on; but on a level playing field. Ultimately, we have to remain relevant to our clients,”says Howell.“Clearly, there are significant opportunities around, but there are challenges as well. Much of the post-trade world is struggling with the competing demands of being a national champion and the need to be competitive in a changing, difficult and demanding marketplace. It’s a tricky balancing act,” he notes.

Powerful consolation Howell contemplates a future of powerful consolation as market evolution and regulation increasingly puts business in the path of post-trade institutions. In that regard, “I shouldn’t really care about competition. Most of the focus in the market is about finding the right product or service, at the right risk level and at the right price. T2S, for instance, will spur considerable competition and we are well prepared for it, though I say that from a parochial perspective.” T2S, which is discussed at length elsewhere in this issue and is not revisited here, will invariably redraw the European post-trade landscape over the long term. Howell is pragmatic about the impact that harmonisation will bring. He does envisage that over the long term the position of Euroclear and Clearstream will increase relative to Europe’s smaller CSD operations. The logic is relentless:“Costs are messy and to my mind, in Europe, the more you focus on quality of service the more you reduce risk. Those institutions that put that together with the right pricing structure will inevitably win business.” Howell also concedes that firms such

as Euroclear, DTCC and Clearstream, are increasingly becoming global players; an inevitable consequence of supporting the client. “Right now, country barriers are down and we are finding opportunities all over the place. If your utility is run properly, your marginal cost is very low. It reduces sensitivity to volume and in that regard we are in a good position to leverage change,” he concedes. At a recent international conference of CSDs in St Petersburg, the world’s post-trade infrastructure services providers were focused on data: what data they produced, what it meant and how it could be used or leveraged, either for business or regulatory reasons. Howell agrees that a fundamental task of post-trade institutions in the new world order is to provide so called “golden data”; in other words, meaningful analysis that will help regulators and markets effectively manage risk. Some of the efforts have been built around labelling, such as legal entity identifiers, which tell you which firm is doing what and where. Other initiatives are around aggregated data that indicates market trends; some micro, some macro. According to Howell, the efficacy of these efforts is a philosophical as much as a business equation. “What ultimately are you trying to control? What is the marginal benefit of a marginal control system?” he asks. Ultimately, he believes the effort is reductionist:“how do you make drivers more careful? You can eliminate all the risks that drivers face on the road, but you can’t always legislate against the pedestrian, who counter to logic, walks into an oncoming car. I can buy all the golden data I want and apply it down to sub-group level, but ultimately will it help me in a Black Swan event? I think we have still to define what we want and what we need from the data that is being generated; and we are all some way away from a true understanding about what it will mean for the markets.” For now, Europe remains Howell’s and the firm’s preferred focus.“By def-

inition, Euroclear is strongly bound and anchored in Europe where the financial markets are set against a background of (to date) limited growth. What we do see is a lot of opportunity around EMIR and Dodd Frank; which coalesced to build up a greater level of demand around collateral, and that will continue to define what we can and cannot do. However, we need to be conscious of a lot going on that links into Europe that is not necessarily European. There are a lot of foreign investors buying European paper which has given rise to opportunities,” explains Howell.

Business map That fact will continue to re-write the firm’s business logic. “Obviously, I will wait to see how the cards will fall. Our business map is not all in Europe; though clearly Europe is where there is a high level of activity for us,” he explains. “I see developing markets wanting to become financial centres, with the appropriate infrastructure. So there is a lot of work to do in partnership with those markets. We cannot escape the fact that all of the financial industry will be driven by economic growth and regulation. This involves breaking down traditional barriers (but which have been and remain stickier than people think),” states Howell; though he acknowledges that once you start working on a global basis you are invariably hostage to macro trends,“over which you have no direct control.” Three years into his tenure as leader of Euroclear, Howell has much to be pleased about. Three years ago the firm looked out of step with change; that’s all changed now and the firm has clearly rediscovered its drive. Howell clearly likes managing change and building out the firm’s strategic reach. He’s also extremely competitive; though like many chief executives he demurs at the word. Yet when asked what he wants from all the linkages and relationships he is setting in train, he stops, smiles and admits: “I want to be in the relationship that’s left standing.” I

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

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SPOTLIGHT

SOME UPTICK IN VOLUMES ON EURO-EXCHANGES: CAN IT LAST?

Exchange turnover up in Q2. Open interest down slightly Q2 sees a strong increase in turnover in investment certificates and leverage products on European exchanges Photograph © Satori13/ Dreamstime.com, supplied August 2013.

Just when we thought it was safe to go back into the water Variable investor fund flows into high growth markets UGUST’S FUND MANAGER Survey from Bank of America Merrill Lynch shows weightings to equities in the US, Eurozone and UK at multi-year highs. Meanwhile, investors remain stubbornly bearish on emerging market equities. Out of 229 money managers polled, a net 19% of global investors are underweight on emerging markets— the lowest exposure in 12 years, with majority viewing emerging markets as the biggest source of risk relative to the rest of the world. Andrew Neil reports. Despite the gloomy outlook, bearishness towards emerging markets could soon be turning the corner, as investor sentiment on Chinese growth and materials stocks ticked up modestly during the month. “While global growth expectations have risen very rapidly, the good news is that cash levels remain high. Out-of-favour emerging markets offer some enticing opportunities to deploy these balances,” says Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch Global Research. This year’s second quarter saw emerging equity and bond markets suffer from strong fund outflows and a decline in prices. A potential reduction of bond purchases by the US Fed, worries over China’s economy and concerns on emerging market dynamics on the whole turned market sentiment negative throughout May and June. The outlook on emerging markets deteriorated so

HE SECOND QUARTER this year saw a strong increase in turnover in investment certificates and leverage products on European exchanges, influenced in particular by the volatility of the region’s financial markets. At €27.1bn, trading volumes were up 8.7% compared with Q1, and rose by over 22% year on year for the quarter. The figures are based on the latest market data collected by the European Structured Investment Products Association (EUSIPA) from its members and were analysed by Derivative Partners Research AG. At around €13.0bn, the volume of investment products traded on the exchanges of member countries in the second quarter of the current year was up 8.3% in comparison with the first quarter. Investment certificates accounted for 48.1% of the total volume recorded by the exchanges of member countries at the end of June. Turnover in leverage products was also up in comparison with the previous quarter. Trading volumes grew by 9.2%, to €14.1bn. Turnover in leverage products accounted for 51.9% of the total turnover. At the end of the second quarter, exchanges in EUSIPA member

countries were offering 444,876 investment certificates and 616,525 leverage products. In comparison with the first quarter of the year, the number of products listed was down very slightly, by 0.1 %. The number of investment products listed was down 0.5% year on year, while the number of leverage products offered was up 16.4%. Banks listed 539,032 new products during the period from April to June of the current year. There was a quarter-on-quarter decrease of 2.7% in issuing activity. With 423,972 new structured products, the leverage products category accounted for 78.7% of new issues. New investment certificates accounted for 21.35%, at 115,060. Open interest on the exchanges in Germany, Austria and Switzerland at the end of June 2013 was €238bn. The market volume was down 3.6% compared with the previous quarter. Investment products accounted for a market volume of €224.7bn at the end of the second quarter of 2013, down 4.3% on the previous quarter. A total of €13.4bn was invested in leverage products, an increase of 10.6% as compared with the end of March this year.

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

SPOTLIGHT

MIXED FORTUNES FOR BRICS IN MID YEAR INVESTMENT FLOWS

much in July that profit expectations fell to their lowest level on record in the July edition of Bank of America’s survey. Naturally, many investors in the emerging markets are now interested in the question as to whether stock prices have now reached their bottom, both in absolute terms and in comparison to the developed markets. “Investors’ weak conviction towards global emerging markets is evident from their reported net 19% underweight in global emerging market equities,” notes the August survey. “This further weakening compared to last month represents the lowest level recorded in the survey in nearly two years, even though more than threequarters of specialist fund managers view emerging markets equities as undervalued.

Optimism rules ok Richard Titherington, who manages JPMorgan’s Global Emerging Markets Income Trust, believes that there are many reasons to be optimistic. “At the moment there is a lot of talk about emerging markets correcting, with developed markets like the US and Japan leading the charge this year. But all the factors supporting the continued success of emerging markets are still there: positive demographic factors and the emerging middle class are still themes that will play out over many years, regardless of what short-term GDP numbers look like in China. And with valuations on emerging market stocks falling to levels that are in many cases pretty cheap relative to history, we feel the opportunity in these markets is very attractive at present.” A recent global outlook by Raffeisen Capital Management provides a more downbeat view. “Emerging market growth dynamics remain weak with few signs of a strong recovery in the quarters ahead,” says the bank’s Emerging

Market Global Overview. “The likely revival of the US economy combined with the euro area’s emergence from recession should be beneficial for economic activity in emerging markets, but the effect could turn out to be quite modest. There are some indicators and factors which seem to suggest stock prices have not bottomed out. Investor sentiment is not yet pessimistic enough (and nowhere near rock bottom).” The report adds that this does not, however, mean another plunge in emerging market share prices is bound to happen. But at the moment, it does not appear that this current weak phase has reached its end, and a renewed upturn in share prices lasting several years may not occur for a while yet. Asian markets have been hit hard by recent sell-offs driven by ongoing discussions about QE unwinding and, most recently, deteriorating macro data in both Thailand and Indonesia. Some positive emerging market stories stand out from the BofA Merrill Lynch survey. In particular, Korea (broadly referring to South Korea's Kospi Index) has seen a notable turnaround in sentiment since last month. Emerging market specialists now rank the market one of their top picks (alongside China and Russia), from a net 21% underweight in July. Teera Chanpongsang, portfolio manager of Fidelity Emerging Asia Fund, shares his current views and positioning: “These markets certainly aren’t easy,” he says. “Within the ASEAN region, Indonesian equities are a bit oversold now but I am still conscious of government actions and remain underweight the country. I have concerns about weakening consumption in Thailand but I continue to hold some telecommunication companies. I remain underweight Malaysia— interestingly, the market has shown

resilience in previous emerging market sell-offs but this week we have seen some strong selling.” Chanpongsang’s largest country overweight exposure is to the Philippines but with the market closed recently due to heavy floods, it could be vulnerable when it reopens. He also finds interesting stock opportunities in China, which is in the middle of the reporting season with a slowing GDP growth and mixed data.

Moderated growth In July, the IMF released its world economic outlook. Entitled Growing Pains, emerging markets added to the overall subdued picture, with lower growth forecast for China, Brazil, Russia, India and South Africa. The IMF predicted growth in emerging market and developing economies to moderate to 5% in 2013 and about 5½% in 2014, some ¼ percentage point lower than projected in the April. Elsewhere, Citi has recently cut 0.1% off its emerging market growth forecast for both 2013 and 2014, with its emerging market growth forecasts generally below consensus, notably for all four BRIC countries. The bank was positive on Europe. “We believe that investors have made too much of slowing growth in emerging markets,” says Rob Drijkoningen, co-head of the emerging market debt team (EMD) at German asset manager Neuberger Berman. Contrary to some views, Drijkonigen and his unit anticipate an economic resurgence backed up by the global recovery in the developed markets, which should partially offset China’s slowdown. While the team’s outlook is cautious for the second half of 2013, Neuberger Berman’s EMD managers and strategists anticipate that overall emerging market economies could achieve growth of over 5% this year—after first-half growth of 4.8% and 2012 growth

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of 5.2%. In 2014, the team believes that EM economic growth could exceed 6%. Emerging market debt has suffered from negative returns so far in 2013, reflecting a rise in US treasury yields and increase in emerging market spreads. Despite this, Gorky Urquieta, also co-head of the EMD team, says: “We believe the structural case for emerging market debt remains strong, as investors increasingly recognise the economic significance, improved credit quality, and depth of EM economies and markets.” Allianz Global Investors is another house which has provided an outlook on emerging market debt. The team has beefed up its emerging market team following recent development of its infrastructure equity, infrastructure debt and regional Asian bonds capabilities. Andreas Utermann, cohead and global chief investment officer at AllianzGI, says: “With the secular rebalancing of global growth from OECD markets towards emerging economies, emerging market debt is becoming an increasingly significant and attractive asset class for long term investors. The superior growth rates will be sustained through higher rates of investment, much of which will be debt-funded.” For the year-ahead, QE exit plans look set to continue causing volatility in emerging markets. A recent survey of fixed-income investors by Fitch shows over two thirds of European investors expect QE concerns to drive volatility in emerging market bond fund flows for the remainder of the year. About a fifth say flows will decrease due to greater concerns over political risk. Although the ratings agency believes that an improvement in credit fundamentals over the last decade should make emerging markets more resilient to a liquidity shock than in the past, some

emerging markets are more vulnerable to volatile capital flows and higher interest rates due to factors including large external financing requirements, low foreign reserve buffers and high leverage. “All in all, emerging markets resemble a lottery at the moment but with no big winners,” adds Alastair Winter, chief economist at Daniel Stewart & Co. “The shadow of Fed tapering looms over all of them.”

Once more into the breach! SEC/FDIC push for greater control of risk in the ABS market, again

Photograph © Vladislav Kochelaevskly/ Dreamstime.com, supplied August 2013.

EC COMMISSIONER LUIS Aguilar says both the US Securities and Exchange Commission SEC), acting jointly with the Federal banking and housing agencies, are genuinely committed to achieving improved risk controls and transparency in the asset backed securities (ABS) market. The agencies combined late in August to state once more the need to formulate rules governing credit risk retention by ABS sponsors. The regulator has asked for market

comment on its intention to adopt robust rules requiring loan level disclosures in ABS offerings, which were originally proposed more than three years ago. “The failures evidenced in the ABS market caused untold damage and must be prevented from occurring again. Ultimately the Commission and other regulators must develop a comprehensive and effective approach to reform the abuses in this complex market, while preserving its potential benefits,” says Aguilar in a late August public statement. According to Aguilar, “Investors purchase such asset-backed securities based on the credit quality and expected cash flows of the underlying assets. By enabling banks and other lenders to free-up capital by selling the loans they originate, securitisation increases the availability of credit for consumers and businesses alike. However, when originators have the ability to securitise and sell their loans, the financial institution that makes the credit decision does not have to bear the risk of default or delinquency. To the contrary, the ‘originate to distribute’ model incentivises volume over quality, as the lender pockets the origination fee but passes the credit risk, like a hot potato, to the ABS market.” Risk retention, says the SEC commissioner,“can help repair the broken incentives of the securitisation market, by making sure that the securitiser (or, in some cases, another party with the capacity to perform meaningful due diligence) has enough ‘skin in the game’ to promote effective underwriting practices.” Under the new proposals, unless an exemption is available, the securitiser will have to hold a qualifying 5% economic interest in the credit risk of the securitised assets.“The retained interest is measured by fair value, as determined in accordance with GAAP, so

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US REGULATORS TIDY UP ABS RISKS

securitisers have an incentive to make sure that the risks of such assets are fairly priced,” says Aguilar. In both 2010 and 2011 the SEC proposed revisions to existing rules for ABS transactions. However the months have passed with no concrete developments and investors are still waiting for the regulator to address meaningful concerns regarding transparency, loan level disclosure and shelf registration requirements in the ABS market. It will be interesting to see how far this latest initiative carries.

Trade slowdown sends out worrying signal Merchandise trade slowed in most major economies in Q2

economies: in Germany (by 1.5% and 2.0%, respectively), France (by 3.1% and 0.5%), Italy (by 3.8% and 3.1%), Japan (by 3.0% and 0.4%), Canada (by 1.1% and 0.3%), the Russian Federation (by 4.6% and 1.8%) and India (by 4.5% and 8.1%). The trend was replicated in high growth markets, with a definite bias towards imports outrunning exports. Imports grew and exports contracted in China (by 1.4% and minus 3.4% respectively) and in Brazil (by 0.2% and minus 4.6%). In contrast, exports increased and imports contracted in the United States (by 0.5% and minus 1.7%, respectively) and in South Africa (by 3.8% and minus 2.9%). The United Kingdom was the only economy with some, albeit moderate, growth in both imports and exports in the second quarter of 2013 (0.1% and 1.4%, respectively).

Philippine retail fund market remains tough to crack Regulatory inertia weighs, but there is some hope for asset managers on the institutional front Photograph © Eprom/Dreamstime.com, supplied August 2013.

ERCHANDISE TRADE SLOWED in most major economies during the second quarter (Q2), according to end of August figures from the OECD. Compared with Q1, the value of merchandise imports and exports for the total of G7 and BRICS countries fell by 1.4% and 1.8%, respectively over the period. In fact, merchandise imports and exports contracted in Q2 in most major

FTER EXPANDING BY more than 40% in 2012, growth momentum in the Philippines' retail fund industry continued into 2013. By the end of June, assets under management (AUM) in unit investment trust funds (UITFs) had reached PHP385bn ($8.9bn), while AUM of mutual funds had breached PHP200 billion for the first time. Cerulli Associates says the Philippine retail fund industry is still in its infancy and remains restricted, not helped by bouts of regulatory inertia.

However, there have been some positive leads. For instance, the Philippine Stock Exchange is now accepting listing applications for exchange-traded funds (ETFs) following approval by the Securities and Exchange Commission on the final component of ETF guidelines, paving the way for their long awaited debut. In the UITF segment, feeder funds and funds of funds (FoFs) received the green light from Bangko Sentral ng Pilipinas in September last year. Although gaps between policy announcements and execution in the Philippines are generally prolonged and Cerulli does not expect any UITF feeder fund to make its debut in 2013, the advent of new products signals a readiness for the retail fund market to become more open. “Distribution networks and brand awareness are keys to gaining significant marketshare in the Philippines. Local knowledge, networks, and a physical presence are areas in which regulators and investors measure the commitment of foreign managers to regional markets,” says Ken Yap, head of Asia-Pacific research at Cerulli. On the institutional side, the Government Service Insurance System (GSIS) is currently considering relocating assets abroad. Also, although the Social Security System (SSS) has always been managing its assets-which are 100% local-in-house, moving toward foreign investment is necessary due to limited market capitalisation in the Philippines. As such, advisory services will be needed, and mandates are likely to be handed out to foreign managers. “The institutional segment could potentially provide avenues for external managers to build a track record and create awareness before the retail distribution landscape truly opens up,” adds Yap. I

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IN THE MARKETS

CHINA & HONG KONG SIGN CEPA X

China and Hong Kong Special Administrative Region (HKSAR) signed the 10th supplement to the Closer Economic Partnership Arrangement (CEPA X), at the end of August which covers measures to foster tighter cooperation in the financial services sector. What will it mean for the Hong Kong financial services sector? Will it change the fundamentals of Hong Kong’s asset management industry for better or worse?

Redefining the role of Hong Kong as a financial hub EPA, THE ARRANGEMENT between the mainland and Hong Kong, is essentially a free trade agreement that offers Hong Kong products, companies and residents preferential access to the mainland market. The measures in this latest agreement will come into force at the beginning of 2014. Hong Kong financial secretary John Tsang and Chinese vice minister of commerce Gao Yan signed the 10th supplement to agreement at the end of August. Tsang say among the supplements made since the signing of CEPA in 2003, Supplement X contains the greatest number of measures. Some 28 business sectors have already been partly liberalised for Hong Kong exporters and services providers, including (among many others) construction, real estate, market research, banking, securities, transportation, freight forwarding, and trademarks. Companies in some 18 service industries enjoy varying degrees of improved access. In some areas, the concessions go further than China’s commitments under its accession agreements to the World Trade Organisation (WTO). Under various agreements, provided appropriate rules of origin conditions are met, Hong Kong goods in some 374 separate tariff codes can be exportable to the mainland free of duty. Specifically, Supplement X to CEPA provides covers some 73 separate areas of financial and manufacturing services of which some 65 involve measures liberalising the operation of financial services and eight others which “strengthen co-operation in areas of finance and facilitate trade and invest-

Photograph © Eti Swinford/ Dreamstime.com, supplied August 2013.

ment “ between mainland China and Hong Kong. One of the more important elements in this 10th round is that the mainland has agreed to assess the value of mutual recognition of fund products between the mainland and Hong Kong. Under this latest agreement the mainland has agreed to study the efficacy of introducing mutual recognition of fund products between the mainland and Hong Kong. Up to now the impact of CEPA on the Hong Kong securities industry has been relatively minor. Under the terms of this latest agreement Qualified Hong Kong-funded financial institutions will be allowed to set up joint venture fund management companies in the mainland in accordance with local requirements. The shareholding percentage of these Hong Kong-funded institutions will now be able to exceed 50%. Hong Kong-funded financial institutions which satisfy the requirements for establishing foreigninvested securities companies will be also allowed to set up one full-licensed joint venture securities company each in Shanghai, Guangdong Province and Shenzhen in accordance with relevant mainland requirements. Moreover, Hong Kong-funded secu-

rities companies will be allowed to make reference to all the securities assets being managed by the respective group when applying for Qualified Foreign Institutional Investor (QFII) status.“We highly welcome the latest initiatives under CEPA X,” says Timothy Tse, chief executive at Value Partners, the Hong Kong based investment firm. “This marks another step of liberalisation in the mainland’s financial services sector. As China quickens its pace in financial reforms, investors can be the end beneficiaries and may enjoy a better offering of products and services,”he adds. Tse points out the potential size of a free market between the mainland and Hong Kong. “The average savings rate in China exceeds 50% of GDP, equivalent to around $4trn a year. For the mainland’s mutual fund industry, the total assets in funds, trust company products and insurance savings vehicles have grown to exceed $2trn in size.” To that should be added Hong Kong’s already strong asset management industry. According to the latest survey released by the Hong Kong Securities and Futures Commission, the combined fund management business in Hong Kong rebounded significantly to a record high of HKD12.6trn (about $1.62trn) as of the end of 2012, representing year-on-year growth of 39.3%. “The much-anticipated mutual recognition scheme of investment funds is considered to be a game changer,”says Tse. “Hong Kong’s fund products have a strong appeal and will likely catch the eyes of mainland investors, a huge potential client base given the size of the China market and the high savings rate on the mainland.”I

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

IN THE MARKETS

REGULATION WATCH: AIFMD

Photograph © Stockete/ Dreamstime.com, supplied August 2013.

All under control? Market implications of AIFMD implementation The reverberations from the 2008 global financial crisis have been widespread and its impacts continue to be felt, not only in economic but also regulatory terms as firms prepare to assimilate further change and respond to a whole raft of new and refreshed legislative measures. Brought in by European regulators to tackle the perceived regulatory failings of the past, these initiatives (such as Solvency II, Mifid II, IMD II and CAARP), well intentioned as they are, pose very real challenges for the businesses tasked with implementing them. By Sarah Boswell, senior counsel at law firm Bond Dickinson LLP. HE ALTERNATIVE INVESTMENT Fund Managers Directive (AIFMD) came into force in July and will have significant ramifications for firms raising capital or operating, managing or otherwise involved with fund structures. To date, these structures have been broadly referred to in

the UK as unregulated funds (as distinct from the largely retail and potentially regulated funds established under the framework of the UCITS Directives (UCITS)). Under AIFM any fund that is not a UCITS fund will be an Alternative Investment Fund, or AIF, and subject to

a completely new and onerous EU wide regime. As far back as 2011 there was an estimated €2.2trn worth of alternative investment fund (AIF) sector assets under management in the EU. This figure demonstrates not only the reason why the European Commission (the Commission) and the European Securities and Markets Authority (ESMA) have considered it essential to regulate this ‘shadow banking’ activity, but also the heavy impact of the changes it requires. In the UK alone, ESMA has recently noted the estimate of more than 2000 AIFs which would be affected by this legislation and in other jurisdictions there are significantly greater numbers. AIFMD has been implemented using the same levels structure as for such directives as Solvency II. Level 1 is the directive itself, Level 2 is the more detailed and substantive ‘delegated acts’ and Level 3 consists of the guidelines and recommendations developed by ESMA with a view to establishing consistent, efficient and effective supervisory practices. While not legally binding, market participants are expected to be able to demonstrate compliance with Level 3 material. AIFMD is a ‘maximum harmonisation’ directive which means that Member States have had almost no scope to deviate from and take their own interpretations of the directive’s requirements. With detailed guidance from the Commission and ESMA there is even less scope for interpretation by national regulators, except arguably where there are gaps and inconsistencies in the work done at the different levels of European supervision (a phenomenon noted between Commission and ESMA work in implementing AIFMD).

What is covered? So now AIFMD is here to stay (pending any changes on scheduled review in 2017) what does it require? AIFMD has very wide scope and applies to pretty much any kind of collective investment structure that is not a UCITS, notably

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

IN THE MARKETS

REGULATION WATCH: AIFMD

including private equity, hedge funds, investment trusts, listed funds and property investment vehicles. The key characteristics of an AIF are manifold. It is an undertaking for collective investment, regardless of its legal structure (for example, open or closed ended, including any investment compartments of such a structure), which raises external capital from a number of investors (even if there is only one at a particular time); and where the investors invest their capital with a view to it being invested to a defined investment policy for the benefit of those investors. Moreover, it is not a UCITS. Any structure which fits within this very wide definition will be an AIF. However, AIFMD does not regulate the AIFs, as such—this is left to national regulators—but rather the managers of those funds (AIFMs).

When is a manager caught by AIFMD? The core functions of managers caught by the directives are those who provide portfolio management and risk management services to AIFs. There are also a number of non-core functions that are listed in AIFMD and may also be performed by AIFMs, including administration (for example legal and accounting services) and marketing. Some of these functions may be delegated by the AIFM, but AIFMD is prescriptive about preventing too much delegation of core functions by the fund manager. Those who provide portfolio management and risk management functions to any AIF are required to become specifically authorised by their home state competent authority. They will also have to comply with a comprehensive set of conduct and prudential requirements, ranging from leverage requirements, capital reserves, reporting requirements, and disclosure to prospective and current investors, to custody of assets under management. AIFMD catches EU AIFMs which manage an EU or a non-EU AIF,

regardless of where that fund is marketed. However, the directive also impacts to a lesser extent non-EU fund managers managing EU AIFs and non–EU fund managers who market any AIF, EU or not, in the EU. An AIFM can either be an externally appointed manager or a self-managed AIFM, in situations where the AIF itself is also to be viewed as the AIFM. This distinction between internally and externally managed AIFs is an important one. Internally managed AIFs are not allowed to extend their remit beyond the internal management of the relevant AIF. However, the managers of externally managed AIFs are permitted to carry on certain additional activities as well as managing the AIF.

Exemptions There are a number of exemptions under AIFMD, the key ones being: insurance contracts; securitisation SPVs; holding companies and joint ventures. There is also a group exemption for AIFMs which are limited to managing AIFs for parents/subsidiaries of the AIFM entity (as long as the parent or subsidiary itself is not an AIF). A light touch regime is in place for AIFMs who manage AIFs where the assets under management are below certain thresholds (although these AIFMs must still register with the local regulator). As ever with EU legislation, the devil is in the detail and no reliance should be placed on any of these exemptions without consulting the specific and detailed requirements at each different Level (1-3) and in the local implementation. The question of when a vehicle is a special purpose entity so as to be out of scope has been particularly vexed and guidance is awaited from ESMA to help with this. A firm which manages an AIF or provides custody services to it as its depositary (see below) must be authorised by the local regulator before they can carry on these activities or market their AIF(s). In the UK, the concept of

an unregulated collective investment scheme (as now will become an AIF) has already required any firm which is based in the UK and which establishes, operates and/or manages such a scheme to seek authorisation. Such existing firms will not need to reapply but will need to vary their permissions to cover the new activity of managing an AIF. Once authorised, AIFMs can readily apply to the FCA to obtain the freedom, known as the ‘passport’, to provide AIFM services into other jurisdictions in the EU without having to seek an additional licence. Becoming and remaining authorised is subject to the AIFM ensuring on-going compliance with the extensive conduct and prudential requirements of the AIFMD (considered below). The AIFM must ensure that it meets the capital and leverage requirements imposed by the Directive. Internally managed AIFMs must have an initial capital of not less that €300,000 and for external AIFMs this requirement is €125,000. These amounts go up in increments based on the value of portfolios of AIFs managed above certain thresholds. The AIFM must also comply with the ‘four eyes’ rule, in ensuring that the business is managed by at least two people who are of good repute and experienced in relation to the investment strategies pursued by the AIF(s) it manages. There is a general duty to act honestly, with due skill care, diligence and in the best interests of the AIF and its investors, with appropriate procedures to manage conflicts and risk. All AIF investors must be treated fairly and regulatory requirements must be complied with. Remuneration rules must be applied to minimise risk (and risk taking) in the AIFM and its AIFs. Delegation by AIFMs is tightly restricted. Guidance on these high level rules is available in the Level 2 and 3 material issued by the Commission and ESMA, although currently ESMA’s guidelines on the key concepts in the AIFMD are far from exhaustive.

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

Remuneration, disclosure and leverage Specific remuneration practices and policies are mandated by AIFMD; a key objective is to minimise risk taking by ensuring that staff are remunerated in a way that rewards achieving specific objectives and with bonus payments being deferred. Detailed guidance on this area was given by ESMA earlier this year in its guidance on sound remuneration policies. An annual report should be prepared for each EU or EU marketed AIF managed by an AIFM and this document must be available on request to the regulator and to investors. Detailed financial and other disclosures are required, including the year’s financials and remuneration paid for the year, broken down by senior management and members of staff of the AIFM whose actions have a material impact on the risk profile of the AIF. Level 3 guidelines on these reporting and disclosure obligations are being consulted on in the autumn. Leverage limits must be applied to each AIF managed by an AIFM. The AIFM must be able to demonstrate that the leverage limits are appropriate and it must disclose them on a regular basis to both the regulator and the investors in the AIF. Under AIFMD an AIF must use a single bank as its depositary to receive and safe keep both cash payments and also investments acquired by the AIF. Depositary institutions have to face up to strict liability for the loss of any financial instrument to which the AIF is entitled. To avoid liability, depositaries will have to show that the loss was caused by an event outside their control and that they had taken all possible precautions to protect the asset in question. These steps include on-going close monitoring of the location of AIF cash and investments. The directive also restricts depositories from delegating their liability risks to sub-custodians. Since depositaries of AIFs will be subject to strict liability for any assets

FTSE GLOBAL MARKETS • SEPTEMBER 2013

firms will need to apply, although there is a one year grace period transitional for those who wish to rely on it. The FCA handbook changes have been brought in by a number of FCA Handbook instruments. The most significant is the removal of the existing Handbook for regulated/UCITS schemes (COLL) and its replacement with a new handbook entitled“FUND” which will combine both the rules for the UCIT funds (UK unit trusts or OEICs) and for the new AIFs.

Issues with AIFMD

Sarah Boswell, senior counsel at law firm Bond Dickinson LLP. AIFMD catches EU AIFMs which manage an EU or a non-EU AIF, regardless of where that fund is marketed. However, the directive also impacts to a lesser extent non-EU fund managers managing EU AIFs and non–EU fund managers who market any AIF, EU or not, in the EU, explains Boswell. Photograph kindly supplied by Bond Dickinson LLP, August 2013.

lost, this is already an area which is generating debate and which will promote change, as well as potentially increased costs for the AIF. In addition, where currently the role of prime broker and custodian are integral, going forward the brokerage function will have to be functionally separate from that of depositary (a move designed to prevent the kinds of losses which resulted in the Lehman insolvency from re-hypothecation of title transfer collateral). AIFMD has been implemented in the UK in two ways: through secondary legislation consulted on by the Treasury and new rules in the FCA Handbook. The new secondary legislation is the Alternative Investment Fund Managers Regulations 2013. The Financial Services and Markets Act has been tweaked to introduce the new regulated activity of managing an AIF, for which existing

The very nature of this directive is potentially problematic, as it seeks to impose a single framework on an enormously divergent (in nature and scope) market. Practical difficulties will invariably be caused where the requirements of the AIFMD (for example in relation to remuneration provision) are similar but not entirely akin to requirements of other European or member state domestic legislation. Change is particularly likely to follow in terms of custody and primer brokerage arrangements. Protection for investors is undeniably noble as an aim, but many have challenged the need for a ‘regulation revolution’ for the AIF sector. The cost of compliance with this new legal burden will inevitably mount up and it remains to be seen whether there will be a latent effect on the viability of certain areas of this sector. It is also possible that investors may be put off by the potential increase in cost and therefore decrease in the accessibility of these areas. It will be a real cause for concern if the involvement of entities such as private equities funds and venture capital funds in economic recovery by, for example, boosting the development and resurgence of SMEs through investment, is curtailed as a result of their efforts being diverted towards the burden of compliance. Time will tell whether, in the drive to avoid a repeat of the 2008 crisis, a full recovery of the financial sector is vitiated by this regulation revolution. I

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Established: April 2013, combining the former Istanbul Stock Exchange, Istanbul Gold Exchange, and Turkish Derivatives Exchange Shareholders: 49.00% Government of Turkey, 41.60% Borsa Istanbul, 4.10% Former TurkDex shareholders, 4.00% Brokers of former IMKB, 1.00% Union of Brokers, 0.30% Members of former IAB Chairman & CEO: Dr Ibrahim M. Turhan Markets: Equities, Emerging Companies, Debt, Foreign Securities, Futures and Options, Precious Metals and Diamonds Average Daily Traded Value (2012): Fixed Income US$15.1 billion; Equities US$1.4 billion; Derivatives US$0.9 billion Number of listings: 406 (as of 31st December 2012) Market Capitalisation: US$310 billion (31st December 2012) Web site: www.borsaistanbul.com Regulator: Capital Markets Board CCP: Takasbank (Istanbul Settlement and Custody Bank) CSD: MKK (Central Registry Agency)

management. Borsa Istanbul will merge all of its systems and markets onto NASDAQ OMX platforms. The majority of trading will move to the best-of-breed Genium INET trading and clearing platforms, while energy trading will be housed on a separate platform. Commodities and energy are growth areas for the region. Turkey is a big metals producer and prominent agricultural exporter. The bourse is working with the Chamber of Commerce to further develop its metals markets and also hopes to attract regional trading to its new integrated platforms. Advanced technology that enables efficient trading and clearing for all asset classes is the starting point to becoming a regional hub. But technology alone will not get the job done. An important element of the Borsa Istanbul-NASDAQ OMX partnership is knowledge transfer and joint product and business development designed to further develop the region’s capital markets. In addition to systems training, NASDAQ OMX will provide a structured knowledge transfer program incorporating

best practices for market operations and market structure, essentially sharing its own experiences as a market operator. The bourses will also work together to cultivate other aspects of the business, including providing additional services to listed companies and domestic brokers to help them grow. Supporting the development of capital markets in surrounding countries, with tools for exchanges, better technology and business development, is another area of collaboration. A key goal is to increase the overall presence of the Turkish capital markets and products internationally. Joint initiatives will also occur to attract additional liquidity as well as expanding with other NASDAQ OMX partners around the world. Borsa Istanbul is well positioned to lead market development across Eurasia and has ambitious growth plans. Recent Capital Markets reforms, the long term strategic partnership with NASDAQ OMX and the planned 2016 IPO are all important steps in establishing Istanbul as a world-class financial center over the next ten years. I

IN THE MARKETS

MIXED FORTUNES FOR OFFSHORE MARKETS?

In their latest survey on company incorporation activity in the major offshore markets, Appleby, the offshore legal, fiduciary and administration services provider, reports a decrease of 3.6% in the second half of 2012, compared with the first half of the year, indicating the impact of uncertain global economic conditions across the majority of the offshore markets.

GUERNSEY & BERMUDA KEEP THE FAITH PPLEBY’S LATEST On the Register Report analyses incorporations in offshore centres such as the British Virgin Islands (BVI), Cayman and the Channel Islands, comparing with financial centres such as the UK and Hong Kong. Appleby says there are grounds for optimism in 2013 as Bermuda reports a 7% increase and the comparative market of Hong Kong also shows an increase in new company registrations.“There are signs that 2013 will be a watershed year in terms of seeing a universal return to pre-2009 activity levels across the offshore jurisdictions,” says Farah Ballands, partner and global head of fiduciary & administration services at Appleby. BVI continues to dominate the volume of new company incorporations offshore. The trend in the formation of companies in the information, technology, natural resources, mining and extraction sectors continues, with heightened activity in telecommunications and global project and infrastructure work in the robust markets of Africa, Canada, Latin America, Mongolia and Australia all of which is driving demand for BVI vehicles. Overall growth rates in new company incorporations for the majority of jurisdictions stayed at minimal levels last year, which proved to be a year of consolidation following large increases in new incorporations between 2009 and 2011. “Continued uncertainty in some markets and the shift in focus from China/Asia to Africa for jurisdictions like Mauritius and the Seychelles are preventing a speedy return to the numbers

of company formations recorded prior to the global economic crisis,” says Ballands. In consequence, “it’s hard to be surprised at the company registrations barometer struggling to improve quickly but we are seeing growth in some markets,”adds Ballands. The story is similar for the total number of active companies, with most jurisdictions showing little movement from the previous year as new company formations cancelled out the numbers leaving the registries. Hong Kong saw a 9% increase in the total number of active registered companies, with the local register there breaking through the one million mark for the first time. The Mauritius and Cayman registries are steadily returning to their prerecession peaks experiencing a 3% and 1% rise respectively. The report finds that overall volumes of new offshore companies being registered were 11% lower in the third and fourth quarters of last year (Q3/Q4 2012) than the preceding six months. After a busy first half of the year, jurisdictions including the Isle of Man, Mauritius, Cayman and the British Virgin Islands were approximately 10% down in the latter half. BVI dominates offshore new company registration activity by volume, maintaining a six-fold lead ahead of its nearest comparator, the Cayman Islands.Year on year, Guernsey is the only offshore jurisdiction revealing growth in new company registration activity with a 1% increase between 2011 and 2012, while Mauritius is the offshore economy witnessing the greatest growth rate in total

number of companies on its register, with a 3% increase between 2011-2012. The UK and Hong Kong in comparison continue to show signs of recovery. Hong Kong was the only jurisdiction indicating real growth between Q1/Q2 2012 and Q3/Q4 with a 7% increase in registrations. Both Hong Kong and the UK are back to registration levels well above those recorded in 2009. Guernsey’s 27 AIFMD agreements: The Guernsey Financial Services Commission (GFSC) has signed bilateral cooperation agreements with 27 securities regulators from the European Union (EU) and the wider European Economic Area (EEA), including the United Kingdom (UK), France and Germany. The cooperation agreements provide a set of arrangements for the on-going supervision of alternative investment funds, including hedge funds, private equity and real estate funds. Non-EU jurisdictions, such as Guernsey, are considered ‘third countries’ and are not required to implement AIFMD. However, for third country AIFMs to continue accessing EU markets post 22nd July 2013, their home jurisdiction must either apply measures equivalent to AIFMD or adopt provisions which will enable them to continue to market into the EU through existing National Private Placement (NPP) regimes, which will remain until at least 2015 and potentially to 2018. Consultation is expected shortly on the full AIFMD equivalent opt-in rules which Guernsey will introduce in due course. These rules should allow bilateral marketing of an AIF product to certain EU Member States prior to the implementation of a third country passport regime. The European Commission is expected to implement the full passporting regime for non-EU managers of alternative funds (AIFMs) in July 2015. However, in the meantime, Guernsey managers will continue to be able to access the EU markets under the NPP regimes as a result of the cooperation agreements that have been signed. I

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

FACE TO FACE

SERGEI SINKEVICH, HEAD OF DMA, OTKRITIE CAPITAL

The Moscow Exchange’s February public offering marked a new tone and tempo in Russia’s efforts to establish a more modern and open financial market. Broker-dealers operating in the Russian market, which have so far enjoyed a monopoly on providing a gateway to the country’s lucrative growth story, have undergone a step change in operations, technology and services to meet the requirements of a broader brush of clients keen to achieve direct market access (DMA). Francesca Carnevale talks to Sergei Sinkevich, head of DMA services at Otkritie, about the opportunities and challenges presented by Russia’s new market order.

Lessons in leveraging Russia’s investment potential NTIL RECENTLY RUSSIA’S securities market was the preserve of pioneer investment firms with specialised interests and specific emerging markets investment expertise. Something of a step change has happened in recent years as the government underscored its intention to establish Moscow as a global financial centre and local regulators have introduced refinements and changes to the legislation governing the ownership and trading of securities. A watershed of sorts occurred when the Moscow Exchange (an amalgam of two exchange operations) floated a secondary offering of shares, in the domestic market, in February this year. The importance of the event was reflected in the make-up of its main shareholders: the European Bank of Reconstruction and Development (EBRD), the sovereign wealth fund China Investment Corporation (CIC) and a number of leading, global emerging market funds. The largest block of shares however remains in local hands. The Russian central bank, in combination with other state-owned entities, holds (in aggregate) some 46% of the exchange’s shares. Soon afterwards, the central bank, now led by Elvira Nabiullina, was empowered as Russia’s financial ‘super-regulator’, with overarching responsibility for the operation and safety of the Russian capital markets and investment regime.“In Russia it is

Sergei Sinkevich, head of DMA/electronic trading at Otkritie Capital in London. Photo kindly supplied by Otkritie, August 2013.

important who is driving through change,” explains Sergei Sinkevich, head of DMA/electronic trading at Otkritie Capital in London. “It really matters how change is carried forward. In terms of market knowledge, of course, there remain some lessons to be learned; but you cannot question the drive for change,” he avers. The creation of the centralised superregulator ensures that any and all future capital markets regulation is both centralised and consistent, explains Sinkevich. Moreover, the move is designed to make the market more

attractive and“reassure investors (both local and international) that the government is committed to market reform and change,” he adds. In support, a subsequent series of market reforms was implemented, including the establishment of a central securities depositary, the opening up of the bond market to Euroclear and Clearstream, and the upgrading of the settlement of Russian securities to a T+2 settlement cycle. Once this is completed, in early 2014, it will involve the phasing out of the practice of 100% prepayment when trading the most liquid securities on the Moscow Exchange. From September 2nd this year all stocks, RDRs, sovereign bonds, mutual fund shares, and private investment unit shares will move to T+2 settlement. Other bonds and repo trades will remain on T+0 until the end of the year or early 2014. Clearly, the lines are being redrawn to strengthen the trading infrastructure and the relationship between investors and the broker-dealers operating in Russia. “Liquidity will gradually move from T+0 to T+2, but all in all, that is not the most significant element of the reforms. The ultimate goal is to turn Moscow into a liquidity and price discovery centre,” states Sinkevich. With so much change in place, the impetus for Russian companies to list in either London or New York to gain access to international investment dollars is certainly expected to dimin-

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

ish. In turn, Russian brokerages could now broaden their operations and articulate a convincing story that opportunities in the sometimes raw, skittish and bureaucratic market were growing. The range of services offered by them has expanded and implemented across multiple assets: moves now reflected in a diversified trading offering from the Moscow Exchange, which now offers trading across stocks, bonds, derivatives, foreign exchange and other instruments. Furthermore, the exchange has not been backward about coming forward. In May the exchange launched its BlueChip Index, which Sinkevich says should further incentivise investors to move liquidity from London to the Russian capital. The index, a benchmark to track the performance of the most liquid and highly capitalised securities of 10 Russian issuers,“was a step in the right direction for the exchange, as it encourages investors to buy Russian shares”. There’s still some way to go however: for instance, some ambiguity remains over the operation of ETFs, to ensure transparent construction of ETFs and the functioning of an ETF trading market; though Sinkevich expects clarifications will be in place before year end. Then, in August the exchange launched options on USD/RUB FX futures with monthly settlement alongside existing quarterly contracts. The new contracts will broaden members’ choices in rolling out the expiration date and is a step forward in developing the options market. The new contracts were live mid-month on the exchange’s Derivatives Market; and are regarded by market watchers as a signal indication of the growing sophistication of the range of securities and product offerings now available to investors active in Russia. There are macro-trends to contend with too. Historically, the Russian securities play has always been around energy and of course, with the rise of shale oil discoveries and exploitation, crude oil prices are expected to decline.

FTSE GLOBAL MARKETS • SEPTEMBER 2013

While frustrating for those players anxious to promote the benefits of investing in Russia, in some ways it is a good thing, as the temperature of the market’s attractiveness will increasingly be measured factors other than the price of crude.

Growth figures Even so, expectations for the country’s year end growth figures have been muted of late (early year expectations put 2013 growth at 3.6%; now the forecast is around 2.4%). There are also continued considerations, such as residual uncertainty over policy reforms, economic performance and the volume of securities traded. Certainly, volumes have been up and down this year. In February foreign investors were taking money out of the market. Since then, the exchange has seen a rebound, a further correction soon after followed by muted volumes typical of summer seasonal trading patterns. Although unsettling, the trends ultimately play to the strengths of the broker-dealers experienced in the vagaries of trading in Russia. The perception remains that Russia is a tough market and therefore the reliance on the brokers-dealers and their overseas operations (mainly set in London and Hong Kong, though increasingly firms are eyeing the potential of the Americas) remain strong. The value traded across all Moscow Exchange markets in July 2013 totalled RUB 43,978bn, a 21% increase over the same period in 2012. Total trading in corporate and government bonds (OFZs) rose only marginally over the year to RUB 1,046bn. Corporate bonds meanwhile posted the largest trading value growth, at 13% year on year. Debt issuance also looked lively. In July a total of 26 bond issues, equal to a combined value of RUB 194bn were placed on Moscow Exchange. It is something of a positive shift, particularly given the skittishness of investor fund flows for part of this year. Sinkevich’s view is that early in the year, the market was perhaps over-

priced and better returns were available in other markets, tempting away investors. Even so, he stresses, there is still value to be had and he points to the lively market in trading in Russia’s key equities (including Gazprom) in the IOB market through the summer as an indicator of the market’s continuing appeal. Ultimately though, concedes Sinkevich, the United States remains the investors’ choice and any market, including the Russian market, has to measure its strengths and market infrastructure against that benchmark. Even so, the prospects remain upbeat.“Now that the infrastructure is in place, there are more important changes that have to be faced,” explains Sinkevich.“More transparency and better corporate governance are increasingly important to investors and Russia has to respond. Certainly, the government’s efforts to fight corruption looks to be genuine; but it is not an easy task and we have some way to go. ” However, infrastructure isn’t the only thing that creates a recipe for success, thinks Sinkevich. “It is important to have a domestic investor base that plays a significant role in Russia’s stock market. The stock market should start performing its required role in the economy: to provide equity capital to enterprises, which elect to go public and create long-term investment vehicles; that is, shares of Russian companies. Captive domestic money will make the market less volatile and liquidity deeper,” he says.

Reform teeth Sinkevich cut his reform teeth at the Moscow Exchange, where he headed up the primary market and globalisation task-force, and as such has credentials as a merchant of change. Under his tenure the exchange significantly improved its position in the international markets; expanded communication with and the education of international dealers on developments in Russian capital markets; increased the share of foreign investors on the

FACE TO FACE

SERGEI SINKEVICH, HEAD OF DMA, OTKRITIE CAPITAL

stock exchange from 28% to 38% (“at significant effort and with the help of FTSE” adds Sinkevich); and also increased the number of international dealers trading in stocks, futures and currencies on the exchange. Moreover, Sinkevich worked closely with global custodians, investment banks, and potential issuers to have the NSD recognised as Russia’s central securities depositary, and was instrumental in the reform of the listing system in order to encourage the growth of the primary stock market in Russia. He joined Otkritie Capital in January this year to oversee the development of electronic trading. He was tasked with attracting new client segments and increasing turnover. “DMA development and electronic trading have traditionally been areas where Otkritie Capital has performed strongly; but given the current fierce level of competition and rapid developments in the field, we cannot remain where we are,” noted Otkritie‘s chief executive officer Ruben Aganbegyan at the time. Sinkevich puts the evolution of the brokerage’s client infrastructure in perspective.“Historically Otkritie has had a sophisticated value proposition for the high frequency trading (HFT) community. The high frequency trading segment has established a significant foothold in the Russian trading market, a natural extension of activity and one that developed off the back of lessons learned in the West. “Unusually though,”he explains,“the regime developed by the Moscow Exchange has been generally supportive of the role of high frequency trading, and therefore is more in tune with the segment than many other markets. Some 30%-40% of the transactions traded in the cash equities market is now related to high frequency traders, mainly foreign firms, which generate higher liquidity.” As an example Sinkevich points the exchange’s efforts to improve its messaging policy and technology. “It really helped the order to transaction ratio,” he adds. The brokerage’s other client segment

is the sell side: “The service set is designed to help the sell side and their clients gain access to the Russian securities markets. We have just started to work with non-Russian hedge funds and we are beginning to design products which will provide them with the tools they need. As regards long only business: in Russia, we do work with this segment, but frankly it is a thin market. In the West, we have not really started to define a service set for long only investment firms, but this will come,” he states.

Value proposition Since Sinkevich’s arrival the brokerage has expanded its service offering and its trading reach. He acknowledges that “the Otkritie business outlook is in flux and we continue to evolve our value proposition. We think it is important to diversify into all the segments mentioned above. We have been rewarded with some very good contracts, of a good size. However, we cannot just focus on these four segments, to do that would make us vulnerable to market shocks. We need more diversity and we will continue to strive to expand these client groups and the offering that we provide for them. Lots of news will be coming out towards end of this year.” In mid-August the brokerage announced a new access point, via the LD4 Data Centre of co-location provider Equinix to widen its reach to some the world’s leading exchanges. This is the brokerage’s third “point of presence” states Sinkevich, adding to the firm’s existing capability. This latest access point, he says, increases clients’ connectivity by linking them directly to 80 or so exchanges and trading platforms in 30 European markets inside Equinix’s LD4 (which handles around 25% of all European equity trades), enabling low latency trading between hubs in the States and Europe. The move, says Sinkevich, “increases our order processing speed. We are now providing the lowest latency channel at 38.35 milli-

seconds. It helps us make global markets investment opportunities even more accessible to our Russian and foreign clients. This new development is part of our ongoing commitment to improve and adapt our services to our clients’ needs and we aim to expand our footprint in the world’s major data centres, including on other continents.” Earlier in June the brokerage elevated its head of repo and treasury to chief executive officer (CEO) Otkritie Capital Group of which Otkritie Securities Ltd is a part, in an effort to restructure the firm to meet what is expected to be “growing demand for Russian instruments linked to efforts to modernise the country's equity capital markets,” explains Sinkevich. As CEO, Nikolay Katorzhnov oversees investment banking and institutional brokerage business and has been instrumental in growing the broker on the Moscow Exchange, where it has become a leader in repo transactions. Around the same time Konstantin Tserazov was appointed head of fixed income, having joined from rival firm Sberbank CIB, formerly known as Troika Dialog, Sberbank's investment banking division. He now leads the brokerage’s fixed income, repo and treasury businesses for Otkritie. Additionally, Georgy Mirel has taken on the role of head of equities, having moved up from his job heading up the firm’s equity derivatives and equity financing operations. “We have now gathered an A1 world-class team and are ready to give our clients the best service possible across all asset classes and geographies,” explains Sinkevich. “Our shareholders are completely behind us. Our agenda is to create value for our shareholders. If we can help drive revenue and at the same time help regulators and other relevant market organisations bring forward reforms, we are doing our job well. We will continue to participate in a number of working groups and our broader agenda is to align our operations with the Russian market.” I

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

TRADING POST

AGENCIES OUTLINE DISASTER RECOVERY OPTIONS: ARE THEY RIGHT?

Three different organisations in recent weeks have published papers on ways to strengthen the allocation of assets to cover losses at a central counter party (CCP), should a member default. The International Organisation of Securities Commissions (IOSCO) and the Committee on Payment and Settlement Systems (CPSS) a component of the Bank for International Settlements (BIS) in Basle published a paper Recovery of Financial Market Infrastructures in August, prior to that in April the Bank of England published a paper Central counterparty loss-allocation rules and finally the International Swaps and Derivatives Association (ISDA) published the paper CCP Loss Allocation at the End of the Waterfall also in August. Bill Hodgson, independent consultant at the OTC Space outlines the options.

Over the waterfall in a very safe barrel EFORE EXPLAINING THE significance of the papers outlined above, it is worth recapping the typical loss waterfall at a CCP. The first losses including portfolio hedging and funding uncovered variation margin payments would be the Initial Margin belonging to the defaulted member. This first pool is subject to much debate in relation to the holding period over which the losses might occur, for OTC products this is typically five days, and for exchange traded products (ETPS) one or two days. The initial margin pool for a member must allow time for the CCP to unwind or auction the positions, and also fund outgoing payments to other members, plus any hedging costs preceding an auction. The next pool would be the Default Fund contribution of the defaulted member. This pool is measured on a wider macro basis to cover the losses caused by the default of the one or two of largest members in many cases, and the contribution of an individual member assessed in proportion to their initial margin. The possibility that the losses for an individual member would exceed both their initial margin and their default fund contribution is unlikely (but not impossible), but in this case the next pool to be

drawn on is the capital of the CCP itself. The reason for this is to connect the quality of the CCP risk management approach with the CCP itself, sometimes referred to as ‘skin in the game’. Commonly the next pool of assets are the Default Fund contributions of members who have survived and not in default, but will have deposited assets with the CCP. Drawing on this pool begins to mutualise the losses by sharing them with the other members of the CCP, providing more linkage to the quality of the CCP risk management and engagement of the members in governance groups such as the risk committee. Should the losses in default consume all the above, we would be in uncharted territory regarding the magnitude of such a situation—it may well be that a catastrophic event has occurred in the wider capital markets. Even so there are still asset pools to cover further losses, which is where the three papers above begin to discuss new possibilities. The additional asset pools that the papers identify are the Initial Margin belonging to non-defaulting members, the variation margin gains of members and clients. The IOSCO paper points out that the CCP holds a huge balance of IM on its books which could be

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

drawn on in a default. CPSS/IOSCO suggests this is a capped amount— once the IM pool is exhausted the drawdown stops. CPSS/IOSCO points out that once IM is drawn-down each member must replenish their own IM contribution back to the level required by the CCP risk management calculations. Theoretically this drawdown could continue unabated. Another consideration is whether the initial margin of clients is also included as a pool of assets, mutualising the loss coverage even further. Variation margin gain haircutting (VMGH) is discussed in all three papers, and propose that gains in the market value of positions following the event of default be withheld to fund losses by the defaulter, which should almost always offset any VM losses by the defaulter (given they take the other side of each paired contract). The proposals all mention the possibility of the VM haircut being applied to Client trades, and suggest that whilst the CCP would haircut the VM to the clearing member (CM), the CM would have the freedom not to pass through the VM haircut to a client if they choose. Taxpayers would welcome the inclusion of these additional tools for a CCP to manage a default, but these three papers approach the problem with quite different agendas, and different interpretations of the consequences of these tools on netting, capital and bankruptcy. I would bet that in time either of these tools is introduced by CCPs on a voluntary basis, or even mandated given the enthusiasm regulators have for changing the capital markets. Politicians are certain to support such moves, as there isn’t any chance they would fund future bail-outs should a CCP find itself in a tight spot. I

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

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SECURITIES LENDING

NEW ELECTRONIC SECURITIES FINANCE PLATFORM

SL-x, a new electronic securities lending platform, is gearing up to go live in the final quarter of this year. Designed to offer automated matching, negotiated trades and CCP access for securities lending participants, the system has been in development phase for two years and, subject to regulatory approval, will initially launch in Europe before turning its attention to the US. Essentially a securities lending exchange, the firm says its CCP clearing method will achieve regulatory capital savings and increased market efficiency for its users. Andrew Neil reports.

NEW SEC LENDING TRADING PLATFORM TESTS THE WATERS ARIOUS ELECTRONIC SECURITIES lending platforms have been tried in the past; some successful, such as EquiLend, others less so. In 2011, SecFinex, for instance, a securities lending multilateral trading facility (MTF), closed its doors. At the time, a statement said that an electronic service, backed by a central counterparty structure (CCP-based model) would be a ‘long-term market goal’ but would ‘not be a priority for the banks until there was a determined regulatory push’ and Basel III started to impact capital requirements. “There have been earlier attempts to transition the market to a centrally cleared model, but these attempts were flawed” argues Peter Fenichel, SL-x chief executive and co-founder. He should perhaps know, Fenichel was the former chief executive officer at SecFinex from 2007-2010. “You could argue the timing wasn’t right and make a case for regulatory issues not being crystallised—I believe it’s far more complex. “Previous front end systems, which were price driven and anonymous, failed to meet the needs of the securities lending market. It’s a business which is largely ‘flow-driven’ and about relationships. What we now have with SL-x is a front end system built with a

relationship-based market model containing social networking concepts. Deals can be completed electronically without relationships breaking down.” Second, and more importantly, Fenichel says SL-x is working with the right clearing partners.“Going back to the old models, in my opinion the CCP partners didn’t provide a full service. Now, in Europe, we have signed a deal to clear with to a leading European clearing house which has a full service offering and a product for securities lending that works.”Fenichel adds that SL-x will launch in five European markets (Germany, Switzerland, France, Holland and Belgium) by the end of this year. In the UK, the firm applied to the financial markets regulator, the Financial Conduct Authority (FCA, formally the FSA) in February. Fenichel says he’s optimistic that an MTF license will soon be granted. Meanwhile, in the US, the firm is about to apply for a brokerdealer license with SEC which should take around six months. Talks with clearing houses OTC and DTCC are on-going. Fenichel remains tightlipped on plans for Asia. In the run up to its commercial launch, SL-x has named a former global co-head of global equities at Citigroup, Robert DiFazio, as its first

Peter Fenichel, SL-x chief executive and cofounder. Fenichel was the former chief executive officer at SecFinex from 2007-2010. “You could argue the timing wasn’t right and make a case for regulatory issues not being crystallised— I believe it’s far more complex.” Photograph kindly supplied by Sl-x, August 2013.

chairman and Richard Dellabarca, formerly of Chi-X Global Holdings as its new chief financial officer. The firm also completed its pre-launch funding with a substantial investment by Palamon Capital Partners, a mid-market private equity company. Hank Mlynarski and Nazaar Molokhia make up the rest of the management team. Mlynarski joined the SL-x team in December 2010 and served as the senior adviser to the DTCC on the creation and build of New York Portfolio Clearing (NYPC) while Molokhia Nazaar is a co-founder of SL-x and former chief technology officer of SecFinex. US-based DiFazio believes that SL-x will prove to be a game-changing capital markets business. “The global stock lending market needs userfriendly innovation, and the SL-x platform epitomises that,”he says.“My immediate focus is to make contact with senior management of major players in the securities lending market; there has been great interest. Sl-x is a neat and efficient way to transfer the market to an electronic platform, mitigate risks and free-up capital. It’s an adaptable platform with the end user in mind and I believe the market will recognise these benefits.” “Counterparty risk reduction is a

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

it’s important. It has to deal with lowinterest rates and looming capital problems. That being said, I’m sure the market can foster growth.” India: ICICI Prudential Life leads first sec lending deal following IRDA’s easing of rules for insurers: At the end of July, India’s Insurance Regulatory and Development Authority (IRDA) agreed to let local insurers generate extra yield on the securities held in their custody by lending securities through the country’s official securities lending and borrowing (SLB)mechanism, but only in equities. Lenders have to adhere to position limits prescribed by SEBI and the Indian stock exchange and can only lend up to 10% of their funds. ICICI Prudential Life Insurance with

major benefit of the CCP clearing route,”adds Fenichel.“Also, under Basel III, the capital charge when using a CCP decreases significantly. We now have a platform which will improve capital utilisation, lower operational costs, and improve beneficial owner yields by facilitating the transition of the current OTC based global marketplace to a centrally cleared model. At the same time, the system does not disrupt the relationship driven ‘flow based’ transaction model employed by prime brokers and agent lenders. For the securities lending market as a whole, Fenichel is optimistic. “I believe there will be an uptick in volumes but this is a middle distance run, not a sprint. This market is big and

Edelweiss Securities are the first firms to take advantage of the ruling, according to company statements. Puneet Nanda, executive director of ICICI Prudential Life Insurance notes,” Life insurance companies are long-term investors and the new [IRDA] regulation has opened up an avenue to generate additional yield. This, we believe, will enable us to provide even better risk adjusted returns to our policyholders.” According to Vikas Khemani, chief executive of Edelweiss Group adds: “For SLB to take off in India, it needed the participation of large institutional players.” ICICI Prudential Life Insurance is a joint venture between ICICI Bank, and Prudential. I

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FTSE GLOBAL MARKETS • SEPTEMBER 2013

COUNTRY REPORT

HUNGARY’S NEW CONSTITUTIONAL ROUNDS

Aside from the torrid days of the euro-crisis, the EU has had to contend with a government in Hungary which, on the surface, looks to have introduced retrogressive legislation in the form of a new constitution. Another round of changes is expected in the autumn, some of which will be passed next month to constitution, often called the ’Basic Law’, such as the planned merger of the National Bank of Hungary with the financial markets watchdog, have been welcomed by the EU. Others are not. What does it all mean in practice and will Hungary upend the EU project by default?

Hungary: EU refocuses on member policies N LATE JULY over a 190 investors piled into Hungary’s summer watershed bond issue, turning the government’s plans to raise some €500m bond issue. In the event investors pledged to buy €2.9bn of securities, nearly six times the amount the government initially planned to raise for general financing purposes. Citigroup and ING bank were lead managers on the deal. The offered yield on the €1bn bond was 6.75% on a five year maturity, more than the 5.9% Hungary has had to pay on existing Eurobond exposure, which is due to mature in the spring next year. However, the coupon is significantly higher than the 3.5%-4% coupon it paid on a bond offering last year. Hungary was hit hard by the global crisis and was the first European nation to receive financial aid from the EU and the IMF. Even at a higher price, the transaction marked something of a shift in investor appetite for Hungarian risk, which took a pounding in recent months on the back of a worsening economic performance and a discernible shift to extreme right wing politics. As the outlook as improved, particularly for the country’s banks, the driver of refocused investor appetite is an improvement in systemic risk, as the government has reiterated its pledge to cut spending by Ft1.3tr (US$6.7bn) within two years and raise taxes, helping to meet payment obliga-

tions on some €20bn of international loans. Clearly, Hungary is looking to refinance itself in the market rather than going cap in hand to supranationals. The question is will the funds suffice to see the government through to planned elections in 2014? Hungary’s government has had form in this regard; having halted loans talks with the IMF over the tactics it has employed in trying to control the country’s budget. The IMF (and the EU) reacted with dismay as it imposed windfall taxes on already overstretched banks. The government has insisted it will not accept foreign influences on its policy making; a difficult position perhaps given the changes running the European market this year and next. Some accommodation is likely: it will help in the elections and the government is keen to reduce overall public debt (at 80% of GDP) and there are monies still outstanding on loans from both the EU and the IMF. With that in mind, it is understandable that any private sector money will not come cheap. Hungary still has some way to go, as it will have to raise around €4bn or so this year to meet its debt obligations and refinance loans falling due between now and May 2014. Parliamentary elections are expected in either April or May, possibly at the same time as elections for the European Parliament in 2014. At the end of

Hungary’s Prime Minister Viktor Orban arrives for an EU summit in Brussels on Friday, June 28, 2013. After late night budget talks, European Union leaders are turning their attention away from their financial troubles Friday and toward embracing once-troubled Balkan countries. (AP Photo/Yves Logghe).

August, the Hungarian government announced a new round of amendments to the country’s constitution which it hopes will dispel some of the concerns voiced in the EU who have charged the government with trying to concentrate too much power in its own hands; in particular its management of the central banks has come in for much criticism; even from within the bank. A deputy governor resigned in the spring charging that the central bank was a puppet of the government. In August the central bank cut its base rate for the 13th time in a row, this time by 20 basis points. It has already cut rates by 195 basis points this year. To stimulate economic growth, Hungary's central bank embarked on an easing cycle in August last year, cutting rates each month by 25 basis points for a total reduction of 320 basis points. Last month the bank said it would change the pace or extent of policy easing in light of the significant cuts already executed and muted global and regional growth projections. I

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

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MENA SURVEY

In this latest iteration of our half yearly survey of asset managers in the Middle East and North African (MENA) region, we find that the respondent pool has grown larger. Some 104 asset managers responded to this latest survey, the largest pool of respondents to date, managing a reported $1.2trn in investible assets. The survey takes in a broad brush of investors. Common among them are concerns about the potential fallout from the Syrian civil war into the wider region. Equally important to them is the revitalisation of the region’s IPO market: something which will depend on a successful resolution of the Syrian crisis, sooner rather than later.

MENA investors cite heightened political risks and patchy market liquidity as key concerns The main trends HE HALF YEARLY survey of the asset management industry in the Middle East and North Africa region has three aims: to describe the investment outlook of a diverse range of asset management firms in the Middle East region; to assess the perception of political/ economic risk within the region and to outline current thinking among the asset management industry as to what infrastructure is important to the proper functioning of their businesses. These elements still remain core to the findings in each quarterly survey. Even so, each has its own character: in part determined by macro-issues; in part determined by the range of respondents. As the markets in the MENA region have taken on widely different characteristics as political unrest heightens in Egypt and the Levant, investors look to be increasingly sensitive to shifts in political risk. As far as possible the survey tries to reflect some of the differences in outlook among investors in different sub-regions. For this purpose, the markets are divided into three segments: The Middle EastLevant, comprising Lebanon, Jordan, Syria, Palestine and Iraq and now Turkey; the Gulf Cooperation Council (GCC) countries comprising the UAE —essentially Abu Dhabi and Dubai, Bahrain, Oman, Saudi Arabia, Kuwait, and Qatar; and North Africa, comprising Egypt, Libya, Algeria, Morocco and

KEY SURVEY FINDINGS 1. Heightened political risks in the region remain a key concern among the majority of investors 2. Investors cite overall ease of doing business is the most important factor in deciding where to locate in the region 3. A strong and continued concentration of assets in the GCC, but there is a discrete tendency for a greater allocation of funds out of the region, to Asia and Africa in particular in 2014 4. The United Arab Emirates are reemerging as regional leaders 5. Respondents are increasingly positive about the investment prospects in Iraq 6. The need for more regulation supporting good corporate governance and market transparency is an equally important requirement 7. The need to encourage market liquidity and revitalise the region’s IPO market remains an important concern for investors 8. Asset management within MENA becoming increasingly sophisticated 9. End-investors still require education to deepen their appreciation and knowledge of the investment products in the region 10. NBK is voted best overall provider of investment banking services

Tunisia. All in all, the survey recorded 104 responses, the largest block to date. Overall, with slightly over 60% of the responses, the survey remains dominated by the outlook of asset managers in the GCC sub-region. Compared with the last half year survey, this iteration is peopled by a wider range of respondents outside the GCC (40%, compared with 25% in the last survey). Within this subgrouping, as in previous surveys Dubai dominates in terms of asset gatherers and asset managers; although many of the funds surveyed have a lower volume of assets under management (AUM). Three sovereign wealth funds responded to the survey but some were unwilling to tell us the exact value of assets under management. The 104 respondents claim to manage just over $1.2trn worth of assets, a massive uptick from the last survey (almost ten times the assets). The GCC is clearly the largest aggregator of assets with reporting funds saying they hold just over 93% of the total. The survey shows a continuation of high growth market (HGM) to high growth market capital flows (East to East), with Asia and Africa marginally but increasingly popular among investors. The survey also supports the emergence of financial hubs in the region, most strongly defined in Saudi Arabia right now; though over the longer term it looks like the UAE will give the Kingdom a run for its money,

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

Chart 1: Survey respondents by country Abu Dhabi Tunisia Bahrain Turkey 2% Saudi Arabia 3% 4% 12% 8% Qatar 8% Oman 2%

Dubai 19%

Morocco 5%

Chart 3: Current investments by country versus planned investments in 2014 Egypt 10%

Chart 2: Assets under management by number of respondents and by region Middle East - Levant 1%

North Africa 5%

GCC 93%

FTSE GLOBAL MARKETS â&#x20AC;˘ SEPTEMBER 2013

Percentage of Respondents

2013

2014

50 40 30 20 10

i Sy ria Tu nis ia Tu rke y Ot he rU AE Afr ica As ia Eu r So uth ope Am e No rth rica Am eric a

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with rising confidence in the Emirates a marked feature of this survey. Respondents cite a popular list of attractions in Saudi Arabia: slow but continuing market liberalisation; diverse real estate investment opportunities; opportunities in downstream industrial infrastructure; the availability of a young and still growing population. While a large number of investors allocate funds to the country, a number expressed informally, a wish that market liberalisation would speed up in the Kingdom. The rising fortunes of the UAE meantime, according to respondents, is based on the re-establishment of Dubai as an entrepĂ´t centre, its attractiveness as a destination to locate business and improving real estate values. The Dubai residential property market, which was adversely impacted in 2010 and 2011 from a supply-demand mismatch continues to rise in value.

Kuwait 10%

Jordan 2%

Lebanon 15%

The return to form is reflected in the performance of the Dubai International Financial Centre (DIFC), a bellwether of inward investment into the emirate, which in September reported a 7% uptick in active registered companies in the centre (with 979 firms now registered) in the first half of this year, with retail space occupancy in the centre now at 99%, up 1% on year end 2012. An increasingly diversified economy in both Dubai and Abu Dhabi, continued population growth and well run infrastructure is, according to respondents, expected to have a continued positive impact on retail, hospitality and the residential markets.

Location

However, of all the recent iterations of the survey over the last two years, this one has thrown up some interesting, subtle but discernible trends. Iraq looks to be growing in popularity among investors; Asia, Europe and the United States look to be more popular investment destinations in 2014. The survey shows subtle but clear shifts in asset allocation towards markets outside the wider region. Chart 3 looks to be an early indication of a number of cross trends. One a return of confidence among MENA investors in traditional markets, such as Europe and the United States. Two, growing confidence in Iraq as a potential investment destination and continued focus on the main financial centres in the GCC. The low levels of investment in countries such as Syria (a no brainer given current circumstance perhaps), Jordan, Libya and Lebanon look likely not to change in the near term. But clearly the smaller Emirates (such as Sharjah), Asia, and Africa continue to build a steady constituency among investors in the region. It does not seem to presage a massive shift in asset allocations, because not all respondents answer this segment and therefore we interpret the overall consistency of investment patterns in the region to indicate that substantive funds will remain concentrated in the region for the foreseeable future. This latest survey comes at a time when the markets have been marked by a number of cross trends, which for the most part are defined by three influences. The first is the possibility that the US Federal Reserve Bank will, after

MENA SURVEY

Chart 4: Changes in asset allocation in 2014 by region (all respondents)

Chart 5: Respondents’ global risk outlook versus their investment intentions in 2014

Middle East 80

2.48%

Bonds

Decrease

0.39%

Money Markets

Increase

4.59%

Sovereign Debt

Increase

6.74%

Equities

60 40 Risk

Decrease

20 0 -20 -40

North Africa

-60 i ba Du

Private Equity

ya roc co So Turk uth ey Am er Ot ica he rU AE Om an Afr ica As ia Ab uD ha bi Sa ud i Q No rth atar Am eric a

4.20%

Ira

Islamic Funds

Increase

Lib

1.00%

Equities

Increase

Bonds

3.39%

in Tu nis ia

3.53%

Increase

rop

Decrease

hra

Money Markets

1.00%

eria Jo rda n

Decrease

Risk outlook

Money Markets

Equities

3.00%

3.52%

Increase

Alg

Increase

-80 yp

Bonds

2.54%

Increase

Sy ria

Derivatives

1.00%

Decrease

Planned investments for 2014 (%)

Country/Region

GCC

its September 18th policy meeting, decide to begin to taper quantitative easing. Syria’s civil war is another driver, which has cast a pall on both the Levant and the global investment community: that’s clear from the effect the conflict is having on oil prices and investment flows into emerging markets. Another key trend influencing global investment money flows is obviously China which is undergoing some market corrections following years of unprecedented growth. All these trends have had resonance in the survey region. Although investment flows from emerging markets have generally been outflows rather than inflows, the fact that issues such as fears that the US economy faces higher taxes, oil prices and interest rates in coming months, has meant that investment decisions are determined (in the short term at least) by hair triggers, such as potential punitive action by the US in the Syrian conflict. Investment flow monitoring agencies report that in excess of $8bn has been pulled out of emerging markets by western investors over the summer period, with bond funds a particular casualty. Investors continue to respond to the better data coming out of Europe, with Europe Equity Funds on course to extend their longest inflow streak since early 2006, while selected emerging markets such as India, Indonesia, Korea, Taiwan and Brazil report continuing net inflows, though some are very modest indeed. Foreign investor approaches to the Middle East and Turkey have hardened over the summer, in large part due to the widespread unrest in the North Africa region (think Egypt, of course, but to a lesser extent Libya too) and the ever present threat of contagion from Syria’s poisonous

civil war. Turkey Bond Funds have stumbled lately, with over 6% of AUM redeemed since the final week of August. To gain a more accurate view of investor intentions we overlaid two separate lines of enquiry. One was investor intentions in 2014, the other our regular risk outlook. The overlay threw up a number of interesting anomalies. According to the results, MENA investors remained open minded on countries such as Egypt, Lebanon and Iraq, while the popularity of Saudi Arabia and Dubai comes across much more clearly in this analysis. Anecdotally, most respondents voiced serious worries about the impact of the Syrian conflict on neighbouring markets and, perhaps as an indication of the nervousness in the immediate region, the usually voluble Lebanese survey respondents were much more muted than usual and a number requested that we pass on their views at this difficult time. This iteration of the survey has not sought to actively measure the impact of changes in regional investment flows. We will keep that in reserve for the next survey. However, clearly events in the sub-region will continue to influence intra-MENA investment flows. Already a number of respondents have indicated that investments have been withdrawn from Egypt, for instance; but equally over one third of respondents say they will remain open minded and if the opportunity presents itself they will invest in the country. Tragically, Egypt is now viewed as the next worse risky market after Syria, with one respondent writing off the market for “possibly the next 20 years.” However, as with the last survey the rise in extremist religious movements across the region continues to worry investors, with at least 15 respondents say they are watching the situation closely, particularly in countries across the North African region. An important consideration in 2013/2014 is how far instability might spread and what continuing impact it will have on cross border asset flows in the region. Will it increasingly concentrate assets in the GCC markets? Or, as this survey begins to suggest, will those assets be spread across a different geography? The global risk survey in this iteration threw up no surprises. However, the United States performs particu-

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

MENA SURVEY

larly strongly in this survey. Whereas previous surveys threw up informal interest in countries such as Australia, Indonesia and Argentina; this survey has thrown up a strong concentration of positive views about the US market. Most respondents expect US economic performance to pick up over the coming year and investors show a willingness to allocate assets accordingly. In line with previous surveys Saudi Arabia and Qatar perform strongly in terms of risk outlook, Dubai however again performs particularly well in this iteration. In the GCC region, Bahrain continues to lose ground, largely to the benefit of Dubai, which has seen an influx of investment firms that were previously located in Bahrain. Despite having one of the region’s strongest investment legislation the kingdom has suffered in the last two years from low level but consistent unrest and dissatisfaction among minority religious groups with the ruling administration, which is seen as being a puppet administration of the Sunni Saudi government. Equally clear is a small but marked change in the function/role of post trade institutions which will increasingly propel them to the forefront of effective capital management in asset management firms in the region. At this stage, the Middle East and North African region is still for-

mulating its overall post trade landscape; though in large part the end result will mirror structures that are emerging in developed markets. This has major implications for asset management firms in emerging markets; elements of which are beginning to be highlighted by the survey. CSD and CCPs and new, expanded CCP business models will become important pillars in local and international financial markets related activity. Virtually all respondents mention the growing importance of regulation and regional regulatory ‘harmony’. This desire for regional regulatory and process harmonisation looks to have gained further momentum in this iteration of the survey. With so much flux in the international investment markets, and the continuing challenge of a global economy still reeling from the aftershocks of the 2008-2009 financial crises, the asset management sector in the Middle East is clearly at a watershed. The evolution of the market is finely tuned: immense potential mixed with equally immense (and rising) political risk. Nonetheless, the survey continues to highlight that whatever the outcome (and it will be different in each country), if any nation wants to develop as a top ranking financial market in this century, then a significant strengthening of the asset servicing and asset management industry will form part of any meaningful strategy. In this survey we wanted to look more closely at the way the different regions within the overall survey area differed in their approaches to asset allocation. While the results show a propensity to diversify asset allocation across multiple asset classes, equities clearly dominates the investment landscape, closely followed by bonds and then fixed income securities. However, breaking the results down by region, the larger funds in the GCC countries have clearly skewed the results somewhat. The Middle East region (Lebanon, Turkey, Jordan, Syria, Iraq) meanwhile continues to focus on bonds, with investments concentrated in government issues. Compared with previous surveys, investors continue to show a tendency to diversify routes to market. While traditionally investors in the Middle East have concentrated on

Chart 7: Asset allocation preferences by sub-region

Chart 8: Investment products offered by investors

Chart 6: Global Risk Outlook: Syria and Dubai at the extremes 80 60

Risk Score

40 20 0 -20 -40

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A fr

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-60

Country/Region

Percentage of Asset Allocation

70 60

Equities Bonds

Mutual funds

Fixed Income Money Market

Private Equity

Real Estate Islamic Products

Structured Products

Middle East

North Africa

Bonds

Commodities

Islamic Funds/Structures

Money Markets

GCC Debt Instruments

Derivatives

Equities

Private Equity

Sovereign Debt

Real Estate

MENA sub-regions

Aggregate Fixed Income

Derivatives

Number of respondents

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

MENA SURVEY

Statement

Chart 9: Working with the end-investor Clients are well educated about investments Clients need to be educated about investments Clients prefer to invest in the local market Clients prefer to invest internationally Clients prefer to invest in the Mena region Clients have unrealistic expectations about ROI Clients have realistic expectation about ROI Clients are prepared to invest long-term Clients are prepared to invest short-term

0 Unsure

20 False

Number of Respondents

True

real estate, private equity, bonds and equities as mainstay asset allocation strategies, investors are showing a marked tendency to adopt more flexible and encompassing investment strategies. Money market funds, futures, hedge funds as well as Shari’a compliant investments are an increasing feature of the market. However, a majority of respondents state that this diversification continues to be constrained by the limits on usage of derivatives and that governments in the region should open up to risk management instruments. For the time being, respondents continue to offer local end-investors a traditional array of investible product, with equities dominant (please see Chart 8). Again, a number of respondents indicated that the region would benefit from the introduction of more derivatives based products, which they said would improvement the management of investment risk across a broad range of securities. Interestingly, demand for Islamic or Shari’a compliant investment product remains muted among survey respondents. No surprise then, that, as in the previous survey (please see Issue 68, page 53) a number of investors mentioned that they hope that local governments will try to revitalise interest in the IPO market, which they feel is a pre-requisite for a more vibrant equity market. A continuing frustration for investors is the lack of liquidity in the stock markets of the region, with the exception of Turkey (as it relates to this survey). Trading volumes remain muted and the challenge in the GCC, as elsewhere is how to kick start a wholesale return by the buy side to equity trading.

Chart 10: Investor requirements Increased Competition Less Regulation More Regulation Increased Market Harmonisation Increased Market Liberalisation More Risk Management Services More Islamic Investment Products Portable Cross Border Investment Products Lower Political Risks More Liquidity in Local Stock Exchanges A Better Clearing & Settlement Infrastructure Fund Adminstration Service A Greater Choice of Custody Provision s

30 Don’t Know

50 No

60 Yes

In this survey we asked the asset management firms questions about the way they interact with the end investor to try to understand how the investment industry has evolved. Clearly from the survey results, the end client has a strong preference in investing in the local market. It clearly places the requirements by asset management firms for a stronger local market infrastructure and greater harmonisation of market regulation across the region in a much clearer context. Managing the expectations of end investors in the region seems to be something of a challenge, as over half the respondents polled agree that end investors have unrealistic expectations of the returns they should achieve from handing over their money to a fund manager. It is a view perhaps supported by the clear preference for local investors for short term investments, which say respondents, investors want to deliver high returns in short order. Clearly there is some way to go for asset managers to educate their clients as to the realities of the post recessionary investment world. Turning these questions on their head, we asked respondents what their expectations were. The requirements of the asset management firms polled in the survey are clearly outlined in Chart 10. As with the last survey results investors are consistent in their requirement for improved liquidity in the region’s trading markets and a lessening of the political risks which blight the wider MENA region’s clear economic potential. In this survey a growing desire for increased market harmonisation and liberalisation are an indication perhaps of the frustration among the investment community that more can be done by governments in the region to encourage the deepening of the local investment markets. There is clearly a desire by investors to move freely between markets and enjoy the same rights and investment infrastructure in as many markets as possible within the region. Something for local governments to consider perhaps. Larger asset gatherers cited the need for local regulators to allow derivatives and more risk management products into the region; though many acknowledged that this was difficult for both cultural and religious reasons. A signal indication of the changes in investor approaches is rising awareness that the infrastructure supporting the growth of the region’s investment and capital markets also requires further strengthening. Interestingly, investors look to institutions that provide improved infrastructure and market safety, such as the establishment of effective central clearing and settlement arrangements, rather than encouraging direct regulation. In previous surveys investors talked of the region becoming ‘competitive’ measured against other investment destinations. In contrast, investor responses were more muted in this survey and the focus was more on the need for improved market infrastructure. A call for more ‘safety’ perhaps in a region marred by political unrest. Approaches to the provision of custody services varied widely. Among the larger firms, concerns over the extent of

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MENA SURVEY

Chart 13: Some of the investment themes of 2014

Chart 11: What investors want when they set up operations

Statement

Elements to Consider

Trasportation links Available office space Ease of access to local distributors Depth of local retail investment market Ability to attract expatriate staff Telecommunication links Size of the local capital markets Liquidity in the local stock exchange Size of the local high net worth commnity The local regulatory environment Ease of setting up operations in the country Low political risk Quality of local staff Ease of doing business in the country

Number of respondents

The global investment climate will improve in 2013 Investments in bric markets will reduce this year More asset manager in Mena are investing in Asia More asset manager in Mena are investing in Africa The US now offers attractive investment opportunities Europe will continue to be high risk in 2013 The Mena investment industry is becoming more complex There is increased competition from foreign firms in Mena Mena asset management firms are now more sophisticated

20 False

back and middle office support was strong; however smaller firms said that local banks helped them manage their back office requirements more than adequately. Interestingly investors tend to gravitate to local rather than foreign banks for these services (of which, more later).

Setting up operations in MENA—what investors rate The survey looked at the requirements for investors looking to set up operations in the region (please see Chart 11), highlighting those factors which governed the choice of domicile. Compared to previous surveys investors now look to be considering the overall package offered by individual jurisdictions when deciding where to locate in the region. Ease of doing business in the country, the quality of local staff and lower political risks topped the requirement league table. In this context, liquidity in the local market and size of the jurisdiction’s capital markets were of less concern. The availability of a substantial local high net worth market segment is much more to the fore in this survey than in previous surveys; a reflection perhaps of the growing pool of investment products offered by asset management firms in the region which require a more sophisticated endinvestor pool. The retail investment market, once a mainstay of the asset management firms and brokerages in the region has, in this survey taken a more of a back seat.

Chart 12: Respondents voting for best overal provision of banking services to investment firms in the MENA region NBAD

EFG Hermes

Qatar National Bank

Emirates NBD

National Bank of Kuwait

Number of respondents

30 True

Number of Respondents

We then turned to the provision of banking services in the MENA region. We asked the survey respondents which local banks they ranked in terms of provision of services to asset management firms. While investors ranked individual banks for particular services such as research and foreign exchange, there was a surprising level of concentration in the description of the region’s current leading banks. We give the top five and the number of votes they received. National Bank of Kuwait emerged as a clear regional leader with almost 35% of the vote. Meanwhile, EFG Hermes, NBK, Emirates NBD and NCB were ranked the top four banks for provision of research (banks had to achieve at least 16% of the overall vote to be included in this and all other rankings). NBAD, NBK, Al-Rahji were ranked the top three banks in the provision of custody services to the investment banking industry. While NBK and Emirates NBD were the top ranked in terms of fund administration, foreign exchange, investment advice and funding. Ahli United ranked top in terms of overall service provision in the GCC region and topped the Bahraini market ranking. CIB top the rankings for the North Africa region. A detailed list of the rankings will be published on the www.ftseglobalmarkets.com website in the final whitepaper based on the findings of the survey which will be published at the end of September. In summary, we asked investors to tell us what they thought of the overall investment outlook for the MENA region and the overall risk outlook for 2014. Some 57% of respondents expect the global investment outlook to improve in 2014, though Europe is expected to remain problematic as an investment destination. Survey respondents were asked to respond true or false to a number of statements. In follow up surveys we will refine this part of the study further. For the purposes of this iteration the responses broadly support the findings elsewhere in the survey. Of note is the statement that local firms are increasingly aware that the region will become (current political unrest aside) a target market for specialised emerging markets firms anxious to better leverage the region’s overall positive growth story. In that regard, calls for greater market harmonisation tally with global trends for smart investment money to want to move freely between markets.

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

MENA SURVEY

MENA ASSET MANAGEMENT SURVEY: TERMS AND CONDITIONS T HE SURVEY WAS conducted between June 2013 and end of July 2013. The research period was punctuated by year end and religious holidays. Some 375 firms were approached for information of which 104 responded, either by phone or fax. From these returns we have extrapolated the analysis in the survey. This presentation is a draft of the full survey, which will be made available from midFebruary this year online. A précised version will be published in the September 2013 edition of FTSE Global Markets. The research honed in on a diverse universe of asset gatherers/managers, to achieve the widest possible response from a broad brush of market participants. This was thought to be particularly useful as all segments of the asset management business are represented, and which we hope provides a suitably broad crosssection of opinion. The survey involves sovereign wealth funds, mutual funds, dedicated funds, and private equity and real estate funds. This survey update is marked by the introduction of respondents from Turkey. Twenty-four respondents were entirely new to the survey. While future surveys may take into account dedicated funds investing in the Middle East domiciled in other jurisdictions, this survey is entirely focused on funds domiciled in the countries surveyed. We do acknowledge however that many funds that service the region are domiciled outside the region in jurisdictions such as Guernsey,

Luxembourg, Bermuda, the British Virgin Islands, the Cayman Islands, the United Kingdom and the United States. The asset management segment, as defined by the remit of this survey encompasses firms with a minimum $5m under management, with no upper limit. In previous surveys we had approached firms with a minimum $25m in assets under management; but ultimately we felt that the value of funds under management in no way reflected the ability of asset managers to provide us with comment and/or market analysis. In that regard, size (we felt) did not matter. The end results show a wide variance in the value of funds under management in different firms; and this was equally applicable whether the firms invested in multiple assets or in particular asset classes, such as private equity or real estate. While in subsequent surveys we may refine the value of assets under management (AUM) that qualify a fund for inclusion in the survey, we felt at this stage it would be more useful to be as inclusive as possible. While three sovereign wealth funds participated in this update, unfortunately not all of them acknowledged publicly the value of their assets, which has resulted in a reduction in overall reported asset values. Variable responses to the survey obviously curtail the effectiveness of the overall results. With that in mind and with an emphasis on transparency at all time, all data presentations are either in

actual numbers or if presented as ratios or percentages, the calculated are precisely shown, so as to highlight the relevance of the data. However, it should be noted that while many funds were reticent about the value of assets under management, as the survey progressed an increasing number of asset managers were responsive to particular questions (particularly the ratings questions involving branding/operations/and risk. While no discrimination was imposed on whether firms were domestically or internationally focused, what has become apparent from the responses is a keen sense that international macro-factors continue to exert a strong influence on investment decisions both at home and abroad among respondents. Moreover, the definition of international is (outside of the larger asset gatherers) regionally biased. It seems that in the Middle East, while the spread of investments is rising across the region (albeit slowly); the globalisation of investment dollars is still some way off. Equally, there is a growing sense that regional and international investment expertise is becoming increasingly important as both a keystone of each firm’s own understanding of its own strengths and brand identity; as well as an acknowledgement that the Middle East asset management industry is increasingly confident about its ability to invest cross-border across a variety of investment vehicles and utilising a broader range of securities. I

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The Agent Lender continues to arrange loans as well for any CCP eligible transactions and uses its established market expertise and operational links with the securities lending flow providers or trading platforms. As a result of Eurex Clearing’s dedicated risk management process that enforces a high level of safety for all counterparts, a wider range of Borrower counterparts can enter into transactions backed by the Lending CCP. There is no longer a requirement for multiple legal agreements and no limit on the Borrowers that a Beneficial Owner can transact with.The Lending CCP can effectively protect the Beneficial Owner from the risk of the Borrower defaulting. The strong advantage and distinction between Eurex Clearing’s Lending CCP and other models is that for a pure Lender using the Specific Lender License, there is no requirement • to clear through a (third party) General Clearing Member, • to pay margin or • to contribute to a default fund. Prerequisite for this is a collateral pledge model using the services of a connected TriParty Collateral Agent. All of these innovative features have been received positively by Agent Lenders as it enables their existing arrangements and structures to remain in place and lets them benefit from the advantages of the CCP.As part of the core service offered, Eurex Clearing’s Lending CCP—after novation— becomes the guarantor of the loan and collateral securities and such is offering the protection from counterparty default—the exact same purpose of the current indemnification against the Borrower defaulting offered by Agent Lenders. The lessening of such an indemnification over time will enable the Agent Lenders to offer a more efficient and cost-effective service to Beneficial Owners, in combination with Eurex Clearing’s risk mitigation.

FTSE GLOBAL MARKETS • SEPTEMBER 2013

Integrated risk and collateral management services Securities lending transactions are incorporated into Eurex Clearing’s risk management methodology that provides a robust and safe environment leading to an overall reduction in systemic risk for the market.The CCP undertakes near-time intraday risk calculations to ensure coverage of mark-tomarket exposure and in case of collateral shortfalls intra-day margin calls are initiated. In addition, we have included the services of two Tri-Party Collateral Agents into our offering: Clearstream Banking Luxemburg and Euroclear Bank. Both of these specialist service providers are connected to the Lending CCP in order to manage the collateralisation process for non-cash collateral on behalf of the counterparties. This enables users of those Tri-Party Collateral Agents to optimise their collateral usage to a further extent by adding CCPnovated loans. A wide range of equity and fixed income securities is accepted as loan collateral by Eurex Clearing whilst the Lender will still be able to define its own collateral eligibility (as a subset of the CCP’s collateral universe). Eurex Clearing will instruct the Tri-Party Collateral Agent with the total amount of exposure to be covered on the Borrower side, while the Tri-Party Collateral Agent determines suitable collateral out of the selected subset of collateral taking into account eligibility criteria, haircuts and concentration limits of Eurex Clearing. The Lender can re-use the non-cash collateral securities received according to the rules and regulations of the Tri-Party Collateral Agent and the Borrower has the ability for substitution.

through process that is able to capture and manage the processing of the re-rate, recall, and loan return information (that is currently undertaken by the individual market participants) and as such is able to increase significantly the operational efficiency for its users. An integrated solution to support the management of voluntary corporate actions is another key component of the Lending CCP. Automated processing of mandatory corporate actions, dividend compensation proceeds, as well as the calculation and movement of lending fees and rebates is also included within the service.The service also comprises full reporting for the Clearing Members either directly or via the specialist service providers. A fully integrated solution for trading, clearing and settlement Eurex Clearing has integrated both electronic markets and OTC bilateral transactions within its CCP service, and provides a central gateway to the ICSDs, CSDs, TriParty Collateral Agents and payment banks for securities, collateral and cash movements. Hence, Eurex Clearing’s Lending CCP delivers a fully integrated solution for the trading, clearing and settlement of its customers’ securities lending business. Overall, Eurex Clearing has introduced an innovative offering of clearing services for loan transactions in equities, ETFs and fixed income securities servicing the needs of the entire market place and ready for further extension to keep you clear to trade. I

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COUNTRY REPORT

MIXED FORTUNES FOR THE LIRA AS DEBT ISSUANCE RISES

In its August monetary policy committee meeting the central bank decided to leave the oneweek repo policy rate unchanged at 4.5%. The borrowing rate remains at 3.5%, while the lending rate has been increased from 7.25% to 7.75%t, to prevent further slide in the lira. The lira is down as much as 9% against a rising dollar over the past few months. An archive photo of Turkey's central bank governor Erdem Basci as he speaks during a press conference at the Meeting of Central Banks and Monetary Authorities of the Organisation of Islamic Cooperation (OIC) Member Countries in Kuala Lumpur, Malaysia, in November 2011. Photograph by Lai Seng Sin, for Associated Press. Photograph kindly supplied by PressAssociationImages, August 2013.

THE RISE OF THE EUROLIRA ISSUE The outflow of funds from specialised high growth emerging markets country funds picked up pace over the late summer. According to fund flows monitor EPFR Global, the latest outflows from emerging markets equity funds saw a number of country fund groups hit hard. Philippines and Mexico equity funds both set weekly outflow records week ending August 28th, Korea equity funds had their second worst week year-to-date and redemptions from Turkey equity funds hit an 11 week high. Dedicated country funds might have suffered from investor withdrawals, but Turkish corporations (particularly banks) have been the beneficiaries of growing foreign investor interest in debt capital markets issues, with Turkish lira eurobonds the current flavour of the year. T THE END of August the European Investment Bank (EIBs) issued TRY40m in Turkish lira denominated bonds, maturing in April 2018. The bonds, lead managed

by Nordea and TD Securities were listed in Luxembourg and were issued at 90.125 of face value and carry a coupon of 5.75%, bringing the EIB’s overall issuance in Turkish lira to

around TRY330m this year; one indicator of the growing appeal of both Turkish lira and other emerging market currency denominated debt. The EIB is not alone, Turkish issuers hunt in packs and this year lira denominated eurobonds have been the preference du jour, since Akbank launched its debut TRY bond at the start of this year. It all kicked off with Akbank’s debut issue of a Turkish lira denominated eurobond by a domestic borrower raising TRY1bn (around $532m) in February, with a five year maturity and priced at 7.5% in a benchmark deal which set a new low price for medium term debt on a lira bond issued by a Turkish entity. That deal was soon trumped by Sberbank, which raised a lira denominated bond worth TRY550m, at a coupon of 7.3%, in support of the operations of its Turkish subsidiary Denizbank. Sberbank bought Denizbank from Belgium’s Dexia last year for $3.87bn; the first Russian bank to invest in Turkey’s banking segment. As foreign investors have become more comfortable with Turkish risk (the summer dissent over the gradual Islamisation of the country’s politicaleconomy aside), lira denominated securities offer higher yield. It is the latest option of a debt diversification trend in fund raising for both Turkish banks and corporations in recent years and routes and products issued to the market have been increasingly diverse. Originally bound in the one year syndicated loan market, issuers have now broken well free of those constraints, in terms of both the currencies of the debt issued and the maturity of the securities. Two years ago the predilection of the year was asset backed securities and dual currency eurobonds; this year the ticket has expanded to Turkish lira denominated debt issues, with tenors now going out as far as seven years and foreign investors have been keen buyers. According to an Akbank spokesman, foreign investors bought 99% of its

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

COUNTRY REPORT

MIXED FORTUNES FOR THE LIRA AS DEBT ISSUANCE RISES

benchmark eurobond, with US investors taking up 38% of the allocations, while British asset management firms snapped up some 46% of the issue. Over 90% of the buyers of the bond were however banks rather than pension funds or insurance companies, which together only bought around 7% of the issue. There’s a lot to buy. As international investors have opened up their portfolios to include Turkish risk, 2011 and 2012 each set a benchmark for bond issues, particularly by Turkish banks. Turkish bank foreign borrowings doubled last year; with issuance volumes this year set to match last year’s blistering pace; with analysts expecting non-sovereign issuance volume this year to top $25.2bn. A fillip to the eurolira market came in May as the Export Import Bank of India debuted a $100m bond in the eurolira market (almost at the same time it also issued debt in Mexican peso). Turkey’s private sector’s long-term foreign-denominated debt has almost quadrupled in recent years, standing at some $143bn. Some $84bn of that is corporate debt. No surprise then that given the weakening of the lira in foreign exchange markets, the appeal of domestic lira denominated debt is rising. It is a trend others hope to capitalise upon. In March Borsa Istanbul began talks with Euroclear to open trading in Turkish debt to foreign investors. No firm action has been signed, though both parties expect an agreement to be in place by year end. If it does come to fruition, it will be a large fillip for both parties. Euroclear set a similar deal in place in February with the Russian CSD; but Turkey’s sovereign debt stock stands at something like at $290bn, almost double that of the value of Russian sovereign debt stock.

The safety factor The attractiveness of Turkish lira denominated debt to domestic issuers is obvious. Funding is cost effective, currency fluctuations are no longer a

problem, and banks can avoid mismatches between assets and liabilities. It is a significant gain for Turkish banks whose ability to manoeuvre is sometimes stymied by the extremely short term structure of retail deposits (which are either demand deposits or short term fixed time deposits, with an average maturity of around 70 days). Longer term lira funding eases to some degree the banks’ reliance securing short term deposits, but realistically until the central bank has inflation under control this won’t change much, particularly as retail deposit strategies are unlikely to change much either in the short term. As the latest statement from the central bank’s monetary policy committee states: “Capital flows have weakened since May due to increasing uncertainty regarding the global monetary policies. Yet, loan growth continues to hover above the reference rate. The Committee has indicated that tightening the monetary policy stance under these circumstances will support financial stability.” As the magazine went to press , the lira continued under pressure in foreign exchange markets as the suggestion that the US Federal Reserve will begin to taper quantitative easing in the fall gains ground and investors are lured back to traditional markets. While almost all leading emerging markets are under pressure as September opens, Turkey remains vulnerable because of its large current account deficit, and (unusually for such an export focused country) relatively low foreign exchange reserves. Borrowings are running high to match an increase in loan growth that is double central bank’s expectations. In part the move to eurolira borrowing has offset some of the vulnerability to adverse currency movements that that would create as lenders have financed expansion of their loan book through foreign borrowing. Investors have sat back and waited as the central bank continues to tighten monetary policy and keep

interest rates elevated to support a weakening lira. In its August monetary policy committee meeting the central bank decided to leave the one-week repo policy rate unchanged at 4.5%. The borrowing rate remains at 3.5%, while the lending rate has been increased from 7.25% to 7.75%t, to prevent further slide in the lira. The lira is down as much as 9% against a rising dollar over the past few months. Clearly, the central bank has opted to fight further depreciation by tightening liquidity rather than spending reserves (the central bank has already defended the lira to the tune of $6.6bn this year). Over the medium term it is hard to see how this dovetails with the government’s desire to loosen monetary policy in the run up to a new round of elections in 2014. Premier Erdogan is keen to avoid any hint of a slowdown. However, as an indication of how far Turkey has come, interest rates averaged 60.60% from 1990 until 2013, reaching an all time high of 500% in March 1994. The lowest they have ever been was in May this year, at a record 4.5%, but political dissent over the summer and the promise of a reemergence of the US and European leading economies is encouraging investors to stay closer to home and Turkey, like its peer BRIC markets has witnessed a significant outflow of foreign investment funds. To date the outflow is around 11% (see page 10).

New infrastructure bond A new benchmark was set in August with the issue of Turkey’s first ever infrastructure bond, worth a combined $450m, with a $79.5m participation by the EBRD, launched by Mersin International Port (MIP), the private operator of the port of Mersin, on the Mediterranean coast in southern Turkey. The debut bond will be used for refinancing an existing loan facility as well as to fund part of the capital investment programme for the port. Mersin is the country's largest multipurpose port by tonnage and import/export container throughput –

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

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COUNTRY REPORT

MIXED FORTUNES FOR THE LIRA AS DEBT ISSUANCE RISES

Turkish riot police fired tear gas and rubber bullets to disperse hundreds of anti-government protesters in Istanbul, Turkey, on on Saturday August 3rd, 2013, leaving many injured. Ten people were injured and dozens arrested, in fresh protests which broke out near Taksim square, the epicentre of violent demonstrations which rocked the country in June. At least three journalists, including an AFP photographer, were injured by rubber bullets during the clashes. Photograph by Halim Derres for ABACAPRESS. COM. Photograph supplied by PressAssociationImages, August 2013.

is operated by a joint venture between Turkish diversified conglomerate, Akfen Holding, and PSA International (formerly the Port of Singapore Authority), one of the world's largest port operators. Some 85% of Turkish international trade is seaborne, and developing Mersin port is important for the economy and will also support growth in the wider region. The financing will enable the port to accept larger vessels and cater for increases in throughput in the longer term, as Turkey’s rapid economic growth continues to generate the need for ever-improving infrastructure. The bond is listed on the Irish Stock Exchange and is provisionally rated investment grade by both Moody’s (Baa3) and Fitch (BBB-). It has a seven year maturity. According the managing director of the port Hakkı Tas, MIP’s managing

director, “We have received broad based investor support from a diverse range of accounts in Asia, the US and Europe.” Mersin could be the high point of the year suggest local analysts. Although there are a number of high profile debt issues tabled . in the autumn (think Coca Cola Içecek and Türk Telekom), both banks and corporations are now expected to mute their issues while the interest rate environment looks volatile. It makes sense to see whether the markets will settle down towards the end of the year. Equally, the disturbances of the summer have not entirely gone away: coverage in the foreign press has given way to soulsearching over Syria; but most Turkey watchers expect local dissent to bubble through the coming year and pick up again as elections loom in 2014. The gloom that currently looks to be

settling on the leading emerging markets is also likely to affect Turkey as efforts by the central bank to cool internal demand for credit and the less than sparkling growth outlook for the country bites into investor appetite for Turkish risks. Banks too expect local loan growth to taper through the autumn. Vakıfbank and Garanti Bank recently raised funds through private placements, which might set an autumn trend, though banks will still require competitive funding rates. Turkey’s largest bank Įsbank registered its intention with Borsa Istanbul to raise $550m in September. After an unsettled summer, with still simmering tensions in the country’s polity, it will be an important litmus test of the depth of the Turkish capital markets and the ability of its leading institutions to weather seasonal and political blips. I

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

CALCULATING THE BENEFIT OF T2S

Clearstream and PricewaterhouseCoopers (PwC) have undertaken a detailed study on the benefits of TARGET 2-Securities, including a look at how T2S can provide relief from Basel III capital requirements. Francesca Carnevale spoke to PwC’s partner Thorsten Gommel and Philip Brown, executive board member at Clearstream, about the main strands of the research and their views on the way that T2S will change, forever, the European asset servicing landscape.

T2S and the €300bn euro liquidity gap

impact that a market changing ATHER THAN PROinitiative such as T2S will have VIDING a solution to on both the European and global lower cross-border settlelandscape. In this regard, the ment costs, T2S should be survey means to highlight both seen as a core element to any the structural market changes financial institution’s review that will follow T2S and its of their operating models ‘benefits’ to market participants. which prepare them to meet the Both Clearstream and PwC requirements of the new think the articulation of the European regulatory order. This repercussions of T2S are relevant is the overarching premise of a to a large audience and timely. new study undertaken jointly by The design and development of Clearstream and PwC that looks the migration process, for at the way leading financial insti- Photograph © Orlando Florin Rosu/Dreamstime.com, supplied instance, is already defined and tutions are approaching the im- August 2013. migration to the platform kicks plementation of T2S and the impact of its diffusion across the European financial landscape. off in 2014. Longer term, T2S has the potential (they believe) There are three key findings. T2S, they say, will help banks to become a global, rather than just a singular European inimake up some of their collateral shortfall (up to 11% of the tiative. This view is increasingly shared by non-European inapproximately €300bn collective tier 1 capital gap that, stitutions, such as the Bank of Japan, which have reached out according to the OECD, is expected from Basel III capital to the T2S platform providers to see how they can link to its adequacy requirements at Eurozone banks. Two, T2S should infrastructure and benefit from its operation. help reduce risk in custody supply chain as that chain contracts; a development that they say is also good for both Survey group depositories and global custodians in helping them deal The survey has focused on four groups: broker/dealers more effectively with their liabilities under AIFMD. Three, T2S offering broking and investment banking services; global will help participants manage their collateral positions better custodians (which focus on asset safekeeping, transaction and assist in meeting requirements under the EMIR directive. processing, , fund administration, liquidity management and The findings emerge from two separate research strands. facilitation of settlement and collateral services); multi-local The first is a massive number crunching exercise by sub-custodians who essentially provide local agent banking Clearstream which highlights some of the salient trends in services as well as asset servicing in a number of markets; cross border transaction flows and which relate any emerging and nationally focused or domestic banks (with strong patterns or trends in this data to the impact that T2S will have retail/merchant and/or commercial banking expertise). Each on those institutions servicing settlement and fund services. of these segments will be directly impacted by T2S and the In tandem, PwC conducted a series of in-depth market inter- research explains the effects on each. views, with leading proponents in key market segments to The survey also looks at both the macro trends and regugarner their views and direct experience of implementing lations that have a direct impact on the evolution of the measures that will make them compliant with both T2S and European (and extra-European) financial landscape. In parother relevant market regulations and initiatives. ticular it looks at the minutiae involved in financial instituFrom the resulting data and analysis both firms have made tions migrating to the T2S project as it dovetails with other a number of projections that they think reflect the direct important and contemporary regulatory and fiscal initia-

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

tives (think Basel III, MiFID II, AIFMD, UCITS V, EMIR, the fearsome European Financial Transaction Tax (FTT), CRD IV and the lesser known but influential CSD Regulation and the Securities Law Directive).

Market pressures The implementation of T2S is happening simultaneously with this plethora of regulation, which is clearly putting fearsome pressure on financial institutions in any number of ways, “with a varying degree of impact, depending on their business model and the market segment in which they are active,” explains Philip Brown, Clearstream’s executive board member. Brown enumerates some of the significant elements: Basel III and its European version the Capital Requirement Directive (CRD IV) require financial institutions to increase their capital and will lead to a significant change in the way that they conduct business in order to maximize their capital and minimize their obligations in this regard. As a result, he notes, riskier assets are already more expensive in the capital markets. Equally, regulatory initiatives associated with the financial crisis have exerted strong pressure on all margins and will put additional cost pressure on all institutions in the financial industry. Some of these issues are onerous. For example, liability, as it will be imposed under AIFMD and UCITS-V, is a problem in itself, since assets held in custody are often huge compared to the custodians’ capital bases. In addition, such liability risks feed back into the Basel III balance, where they must be backed with tier 1 capital,“making it potentially more expensive for custodians to cover those risks,”explains Brown. Hope however, is at hand. “T2S can bring relief here by offering an option to establish consolidated CSD connectivity,” he explains, “to become direct with all assets held without the need to establish business relations with all CSDs in all of the current 23 T2S markets”. That in a nutshell is the presentational format of the research results. Pose a scenario, extrapolate the consequences of the problem and then explain how T2S does or does not provide relief.

The groups T2S affects It is clear that T2S will have far-reaching effects on the market that will add to the different strands of change that are motored by the effects of the financial crisis, changes in investor preferences, a heightened aversion to risk from both regulators and investors and the mass of regulation that is being implemented. In the firing line are custodians, which have often borne the brunt of the more complex demands on their capital and resources in the new world order. Safeguarding the risk profile of custodians is paramount in a world where“AIFMD creates new risk positions and Basel III makes it potentially more expensive to maintain those positions,” explains Thorsten Gommel, partner at PwC in Frankfurt. Others too have been and will be impacted by change. Assets under custody have decreased for both global custodians and local custodians since the crisis and are recover-

FTSE GLOBAL MARKETS • SEPTEMBER 2013

ing only at a moderate pace. They also face growing cost pressure from customers and downstream market participants who often have adopted tough price standards/limits. T2S only solves part of their problem, concedes Brown. The sub-custodian in particular faces important challenges in the post T2S landscape. The confluence of regulations such as AIFMD, UCITS V and EMIR enforce strict liability clauses for assets held in sub-custody. The issue of liability will gain even more prominence under the currently proposed UCITS V rules, since these are even stricter than under AIFMD. In addition, as the UCITS market is much larger than the AIF market, solutions to reduce liability will be critical” he specifies. “From the multi-local sub-custodians’ point of view, the current environment threatens the margins of traditional custody products,” he continues,” intensifying the potential for further consolidation in this sector. After T2S goes live, settlements will be considered a commoditised product more and more, sub-custodians will have to add new services to their portfolio to maintain the profitability of their business model—which is already happening in areas such as collateral management.” T2S will only feed that trend rather than dilute it. The impact of change and T2S will be felt across the board, underscores Gommel. “Sell-side firms are also now faced with increased borrowing costs and are therefore looking for ways to reduce this requirement.”The broker dealer segment will nod in bitter-sweet acknowledgement of this particular development; it has come under severe strain as commission income has decreased as investors, reluctant to trade despite rising stock markets, have opted for deposit products. This risk aversion among investors and heightened market risk associated with the European sovereign debt crisis has ultimately helped constrict the number of securities transactions in the market. Any number of broker-dealers will tell you volumes remain a shadow (50%-60% of the watershed volumes enjoyed back in 2007).“The challenge in this environment has been to generate sustainable revenues while not absorbing too much of the valuable capital,”says Brown. There are other stresses too to contend with. EMIR for instance, introduces a mandatory central clearing obligation (either directly or through a clearing broker) for standardised OTC derivatives and trades must be reported to a trade repository.“This causes major process changes and often introduces new players into the value chain, such as clearing brokers, collateral managers, adding cost to market players who had not had to factor in these elements in the past,”says Gommel. (Though Gommel also concedes that these new service providers also will enjoy new business opportunities in the new post trade landscape.)

Bringing relief? So, how does T2S affect the mix? T2S brings relief, as it offers “the possibility to pool liquidity for settlement in the T2S zone via a single central bank money cash account,” explains Brown. He explains that the survey suggests that while“market participants are starting to consider the effects

GM Editorial 72_. 06/09/2013 08:53 Page 60

CALCULATING THE BENEFIT OF T2S

of a pooled cash account in T2S on their balance sheet, they are still struggling to quantify the impact. With that in mind, we used Clearstream’s own and anonymised [sic] settlement data on customers transacting cross-border to assess the impact on their own liquidity requirements of using a single central bank cash account in T2S. The figures speak for themselves. We find that it will reduce, on average, 15% of their daily cash or credit consumption during peak settlement periods (usually the overnight cycle),” he adds. Moreover, “Looking at settlement volume in the wider euro zone, we calculate that under Basel III rules this could translate into savings of as much as €33bn of tier 1 for all eurozone banks (equivalent to 11% of the shortfall estimated by the OECD using 2011 year end positions),” says Brown. Comfort all round then, but those effects won't materialise automatically and banks have to look individually how they can their custody chain to this new world. There are other effects that may benefit the market, he adds. For one, T2S facilitates the shortening of the custody chain. In recent months, many of Europe’s central securities depositaries (CSDs) have signalled their intention to provide direct access to another, allowing market participants to hold their assets directly in T2S through one CSD without having to open up business relations with all of them. It means that commercial banks can be partially disintermediated from the custody chain for both securities and cash transactions. “They still have a very important role to play because local market relations need to go far beyond settlement and safekeeping, but we see increasing demand for agent services that are structured as account operator models for large clients alongside the traditional sub-custody model,” explains Brown. In other words, establishing direct connectivity with a CSD will become much less cumbersome than it was in the past—at least for those markets that form part of T2S. This will, in part, be supported by some CSDs’ plans to establish mutual links with each other and to enable increased centralisation of the safe keeping of assets across a reduced number of CSD locations in combination with the demand for an account operator model to continue to access the extended services of an agent bank. Good news for CSDs perhaps and also for large multi-local agent banks with flexible IT infrastructures, but more difficult for smaller players.

Collateral at a premium Most importantly perhaps, in the constrained European environment of the last few years, available collateral remains at a premium, especially for derivative trading and the funding of trades. In the short term, this will only get worse, rather than better. “Following EMIR and the end of unsecured interbank credits, the need for high-quality collateral has increased massively,” says Brown.“Sourcing collateral is now a major challenge, in particular for brokers and dealers; another is providing it at the right time and place: collateral management, mobilisation and optimisation are key business elements right now. What is important is that

T2S might be a solution to this challenge due to its facilitation of cross-border settlement,” he says. “Liquidity is the key resource in today’s markets”expands Gommel, “Collateral is particularly required by the EMIR directive, with its obligation to collateralise bilateral, OTC-derivative trades and to centrally clear standardised OTC-derivative trades, which again is only possible if sufficient collateral is mobilised at the right time and place.” The survey, says Gommel clearly shows that respondents think that next to risk reduction, sourcing and managing collateral is the most important area of focus for financial institutions, and are expending efforts to improve its availability and optimise its usage.“T2S creates additional opportunities in this space not only through the liquidity savings, but by also improving the mobility of collateral to where it is needed,” adds Brown.“By internalising settlement and harmonising processing cycles across 23 markets, T2S will remove much of the cost and labour associated with moving securities cross-border, eliminating some of the fragmentation and over-collateralisation that characterise the market today. This will be a critical improvement in an environment where EMIR and Dodd Franck are expected to create additional pressure on collateral availability, and will introduce some buy-side institutions to the requirement for the first time to source and deliver margin collateral to a clearing broker or CCP.” T2S will speed up the mobility of collateral.“Securities in all T2S markets are technically held on the same platform, and bookings within T2S can be executed in real time. This means that if a bank needs collateral in one market and that same bank only has the securities eligible for such collateral in another market, then only one T2S internal booking needs to be executed to transfer the corresponding securities to where they are needed. Today, with separate settlement systems being involved, this is a lengthy and expensive procedure and the issue will not go away,” adds Thorsten Gommel,“Collateral is the name of the game when we talk about priorities under T2S, Basel III and EMIR,” he states.

Preparedness for T2S Various informal surveys that Clearstream has undertaken at its own seminars on T2S as to the readiness of the market for the change show that the majority of market participants in more advanced markets, such as Germany, are in a state of readiness for market change. “In many cases, the measures currently receiving highest priority were due to internal programmes, like cost-cutting or the overhaul of their IT systems, though through the survey we found out that Basel III and AIFMD/UCITS V are the most important topics for decision-makers these days due to their influence on the risk positions held by market participants,” says Gommel. However, there is still some work to be done. Gommel concedes,“the positive effect T2S will have on liquidity and on the capital needed under Basel III is significant in our opinion and, as far as we could observe during the market study, not sufficiently appreciated by the market participants in their strategies with respect to T2S.” This study should help. I

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

THOUGHT LEADERSHIP ROUNDTABLE

SECTION NAME

T2S: Transforming the European post-trade landscape

ROUNDTABLE PARTICIPANTS (from left to right) ALAN CAMERON, HEAD OF GLOBAL STRATEGIC UK BROKER-DEALERS & BANKS RELATIONSHIP MANAGEMENT, BNP PARIBAS KARLA AMEND, HEAD OF T2S GOVERNANCE TEAM, CLEARSTREAM PAUL BODART, NON-CENTRAL BANK MEMBER OF ECB T2S BOARD DIANA DIJMARESCU, MANAGING DIRECTOR, JP MORGAN GRAHAM RAY, DIRECTOR, GLOBAL PRODUCT MANAGEMENT, DIRECT SECURITIES SERVICES, DEUTSCHE BANK

FTSE GLOBAL MARKETS • SEPTEMBER 2013

ROUNDTABLE

WHO AM I AND WHERE AM I GOING? T2S AND BUSINESS PLANNING ALAN CAMERON, BNP PARIBAS: BNP Paribas is a large local custodian across Europe and we undertake about 50m settlements a year, most of them in Europe and most of them in T2S markets. In that regard, T2S is very important to us and we are working hard to get ready for it. You can divide our work into four categories: First, we are active in the many working groups in the local markets to ensure that T2S provides good pan-European harmonisation that also fits in with local market practices. This work has been going on for many years and will continue way after T2S goes live. Second, we are working to ensure that our clients achieve real advantages in settlement from T2S. Actually, T2S comes with some quite cool functionality; allowing prioritisation, linking and auto-collateralisation, for example. We continually update our systems to make sure that we can pass these advantages on to our clients. Third, as T2S brings in harmonisation we have to ensure that we achieve economies of scale and process simplification. In practice, this means building up our settlement capabilities through our international operating centre in Lisbon, although asset servicing remains a much more local functionality. Finally, (and this is what takes up a great deal of time) we are working with some of our key clients to help them find ways to take more control over settlements, but still receive the benefits of using agent banks to provide asset servicing. We have a specific service for this we call ‘sponsored access’. We have spent a lot of time working with clients on developing this service and we can all see what might be possible. Though frankly, clients are finding it hard to come to any final decisions about implementation, because the pricing of the various options is still unclear at this point mainly because we do not know how the CSDs will charge postT2S. There’s still a great deal of work to be done, so it is a work in progress. DIANA DIJMARESCU, JP MORGAN: At JP Morgan, we have a number of businesses that will be impacted by T2S. We are a global custodian; we are also offering direct custody and clearing services, collateral management, and prime brokerage services, among others. We trade on our own behalf and on behalf of our clients. We manage our own treasury and are a direct member of the Target2 system. We are a large asset manager. All these businesses and functions will be impacted by T2S. As such we have been very involved in the project from its launch back in 2006 and we have been represented in the governance of the project. We continue to be a member of the T2S advisory group and in a number of related working groups, for instance. The relevant project management teams in the bank continue to look at the impact of T2S on the bank’s various businesses and how we and our clients will benefit from the system once it goes live. Right now we are accessing these markets via a network of local custodians. We are interested in the directly connected participant solution and, as such,

Paul Bodart, non-central bank member of ECB T2S Board.”In the CSD world today we have more or less a monopolistic situation and I think that is going to change. You will see more competition among the CSDs over time. The caveat is that I believe it will take a long time, but we should see the number of CSDs reduced,” says Bodart. Photograph © Berlinguer, August 2013.

we are part of an informal group of banks that are in talks with the various central securities depositories to try to better understand their offering. We continue to assess the changes that this will involve and how we might respond. We are also looking at the options of perhaps concentrating our access via one depository, or a selection of depositories, or alternatively buying services in bulk or unbundled from one of the agent banks that we are using today such as buying asset servicing from an agent while self-settling. As you can imagine, it is a long and complex process, where all parties have been involved in regular dialogue spanning the last three or four years. Although the project is well advanced, and the ways forward are clearer, we are still some way from finalising our decisions. A key objective is to provide our clients flexible, efficient access to T2S and the benefits it brings, while maintaining high service standards for asset servicing. GRAHAM RAY, DEUTSCHE BANK: I represent the Direct Securities Services business within our Global Transaction Bank. T2S is pivotal and at the forefront of our DNA. One of the main key objectives of T2S is to ensure our diverse client base fully understands the opportunity that it provides, not just looking at the headlines that focus on the efficiencies that T2S will bring in cross-border settlement but also analysing the different components of the new operating models that will result and supporting the future proofing of our and our clients’ businesses. I can categorise our work with our clients into a number of streams. Some involve looking at the account opportunities and account structures that can be leveraged from T2S and other initiatives within the European space; others involve the functionalities of T2S, whether they involve the core functions listed in T2S, or whether they involve the functions that can be created from new operating models. We are also very engaged/co-chairing the forum around T2S connectivity. From our perspective, connectivity is very important (particularly as we are one of the main sub-cus-

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todians across the T2S landscape). We have decided that we will centralise some of our connectivity and functionality into what we consider to be a T2S hub, which will come from our home market of Germany via DBAG Frankfurt. This hub will be complimented and serviced by our on the ground expertise, local Deutsche Bank market presence. The last element is for us to leverage the experience we have gained so far from T2S and look at its potential application across the product management footprint in both the cash and collateral worlds. Certainly, we look to find the opportunity for our clients to find efficiencies either through the management of collateral or the utilisation of liquidity via various netting, consolidation or distribution opportunities. KARLA AMEND, CLEARSTREAM: The Clearstream group represents two CSDs, as well as an ICSD in Luxembourg. The CSDs are clearly impacted by T2S and will outsource settlement to the joint T2S platform. At Clearstream, we consider T2S as an opportunity, for our clients and for us. The initiative sits at the heart of our strategy. We have a vital interest in making it all happen. We have been involved in the project since the very beginning, helping define the system jointly with the euro system, the market and other CSDs in various working groups to help us all work together effectively and to come closer together. The end goal is of course efficient settlement across the eurozone. To get to that point we have worked intensively in all the relevant groups covering governance structures and ensuring that everything is working towards the introduction of market improvements to ensure efficient settlement in the future. In reality we have put T2S at the core of our business strategy and have been in a process of adapting our business model to meet T2S requirements. Therefore, we are rephrasing and optimising our network and services to ensure seamless operation across the various CSDs. In addition, we are upgrading our other services, such as collateral management, cash services and other related offerings to ensure that we optimise and enhance our participation in a new post trade landscape.

DEFINING TOMORROW’S POSTTRADE WORLD: WHY T2S IS A GAME CHANGER PAUL BODART: In the CSD world today we have more or less a monopolistic situation and I think that is going to change. You will see more competition among the CSDs over time. The caveat is that I believe it will take a long time, but we should see the number of CSDs reduced. The other thing that will happen is that the functional boundary between infrastructures, such as CSDs and, on the other end, banks and intermediaries, will blur. You will see CSDs offering services that are very similar to what the custodian provides and, as we have seen recently, you will see some banks becoming CSDs. This is a significant shift of responsibilities. We should be looking at T2S as a platform. I think a good

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Diana Dijmarescu, managing director, JP Morgan. :We are also looking at the options of perhaps concentrating our access via one depository, or a selection of depositories, or alternatively buying services in bulk or unbundled from one of the agent banks that we are using today such as buying asset servicing from an agent while self-settling,” says Dijmarescu. Photograph © Berlinguer, August 2013.

analogy is that it is like an electricity grid, where CSDs will provide electricity on that grid and then all the market players, the bank, the broker, the investor, the issuer, will use the electricity to power the service that can fulfill their requirements. Now, Alan and Diana have implied, and this is important, that the way the CSD services operate today is going to change as well, because to date, when you contract with a custodian, you give them everything. The contract includes settlement, asset servicing and so forth. With T2S you will have the option of settling yourself on the platform. That will in turn tempt the CSDs to offer more on the asset servicing side, I think. Particularly as investors will be looking to ensure that they get the right services for their transactions. The big players (banks and asset managers) are looking for a flexible service model that will allow them to connect directly with T2S, and do the settlement itself. This will be possible and they will be able to service the client’s assets as best as possible. This is another important change coming from T2S. FRANCESCA CARNEVALE: Graham, are you and your clients prepared for these relationship shifts? GRAHAM RAY: Most definitely. We recognise the word transformational that’s being used around T2S. The project is transformational and is widely understood as such. Even so, the journey for T2S will be quite long, and therefore it will take time for all parties to actually understand what this transformation will mean to their business models. Moreover, this understanding will continue to evolve, just as T2S will continue to evolve. From a market perspective, T2S isn’t just an isolated component; it will create opportunity, which fundamentally creates competition. During that journey, and the recognition that it will be transformational which, is taking the end-to-end process and unbundling it into components, you have the dynamics of what that will mean to different client segments to play with. What is becoming very clear to clients, is the expertise a sub-custodian delivers through its knowledge of the local

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markets and the continued value, importance this has even with the introduction of T2S, once you’ve unbundled the components, you find particular components are still really dependent upon that expertise. That continues to require massive investment, Deutsche Bank has invested significantly to T2S to ensure that from a technology platform and from a resource platform, we comply and actually deliver tangible benefits to our clients in a post T2S landscape. Deutsche Bank engages with a diverse client base and it is our focus to ensure that each of these diverse market segments fully understand the implications of T2S. I think many segments have made the effort to understand T2S, though there’s still some debate about how best to optimise the solutions T2S will provide. However, our role is to ensure that we partner effectively with the client to help them understand the various options open to them. The repercussions of unbundling have still to be fully quantified; but I would say that one of the key things that the local subcustodian still offers to the community is the ability to look for the complimenting component opportunities that can come from unbundling the end-to-end chain. DIANA DIJMARESCU: I would say that we probably had much greater expectations in terms of the transformations that T2S will deliver at the start of the process than we do now. I think now, seven years down the road, after all the work that Paul and Karla alluded to, we realise that it’s much more complicated to reach the level of harmonisation required that would enable real market transformation. In that regard I agree that any significant change in the environment in terms of the CSDs and their service offering, in terms of the global custodians changing their business models will take time Certainly, it won’t be a big bang. There is of course an analogy to be made with MiFID; but only up to a point. It was much easier to establish new trading platforms and new CCPs than it is to change the infrastructure of the posttrading environment when substantial cross-border legal harmonization is yet to happen. In part, that is because T2S only addresses the settlement piece. Moreover, we now know very well that it involves significant work in sourcing all the other components that go into providing comprehensive securities services, beyond settlement. It will take a lot of time, a lot of effort and many years. ALAN CAMERON: I think it worthwhile to remembering why we’re all doing this. Clearly, the real reason is that companies need to be able to finance themselves through the capital markets rather than just through banks. That need has become even clearer since T2S began and it’s generally thought that one of the stumbling blocks preventing this is the structure of the post-trade world in Europe, which is expensive and somewhat difficult to navigate. Therefore, T2S is an important step is changing things, but it’s just a step along this road and one among many. Previous progress includes immobilisation, dematerialisation, CCPs, netting and the introduction and shortening of settlement cycles. Stuff happened before T2S and we will need more stuff to happen after T2S.

However I would suggest that T2S will have significant impact on safety; it will make settlement safer. It will bring in more harmonisation and finally, which I think is probably the most difficult one to achieve, it will bring about cost reductions. Our belief is that it will bring cost reductions if we all adapt our processing to take advantage of it,, but this may not be as immediate as some of us had hoped. KARLA AMEND: I think it is valuable to focus on the objectives of T2S; its contribution to the integration of the European markets and, in this instance, the post trade infrastructure. On the one hand it is an end-goal; on the other hand it is the beginning of a much larger round of harmonisation. It has a dual function and out of the T2S infrastructure, we can image a host of new opportunities where the whole business of the capital markets can then change and deepen over time; but, as we keep saying, it will take time. The practical question is how much will costs be reduced by the exercise. I can speak only from the Clearstream perspective, as we are one of the biggest CSDs and one of the cheapest CSDs (in settlement only). We pass on the ECB’s fee of 15 eurocents to our customers without adding on an additional margin. Can standardisation of costs be achieved on a panEuropean basis? It is too early to say. But it is certainly an important goal. The introduction of harmonised T2S processes will lead to a unified infrastructure.

WHO WILL DO WHAT AND WHEN? REDEFINING SECURITIES SERVICES PAUL BODART: First, I’m not sure that the impact is bigger on the banks than on the CSDs quite honestly. A bank could very well limit the system change or business change to a minimum and continue to work with a custodian or directly with CSDs. I think for the CSD the change is neutral. However, if a custodian wants to be successful and benefit from T2S, there they will have to put in place significant changes. In that regard, there will be winners and losers in this game. And we should never forget that the post-trade custody is a scale business, so you have to be big just to be successful, or more accurately survive. I believe that JP Morgan, BNP and Deutsche Bank with their multi-market infrastructure will probably be among the winners, while the sub-custodian that have been active only in one market will probably suffer. We are already seeing changes in this segment. The UK is a good example. There are no more UK custodian banks, so consolidation in the custody business has happened. There were about 50 custodians in the US ten years ago. There are only six or seven surviving today. I think the same will happen in Europe.You will see a much smaller number of custodians playing mostly in a multi-market approach and the smaller players will gradually disappear. The CSD space will also have to consolidate; but I honestly think that that will take much longer; though over the long term, it is inevitable. ALAN CAMERON: I’d agree with Paul absolutely that

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transaction banking is all about scale and it’s becoming increasingly so, but that’s been the case for a number of years. T2S will make this clearer and more pronounced. The skill will be to exploit scale and manage to keep the high quality that you have around asset servicing, because there’s very little point in saving cents per settlement if you lose millions in corporate actions. Some banks will consider becoming CSDs, but I think that’s driven much more by regulatory changes and collateral and the banks that are considering it are probably more famous for collateral and issuing services than they are for European settlement services. The CSDs? Well, yes, they are in a difficult situation. What we really need is a consolidation of CSDs, but we seem to be looking at a proliferation of them. The worst thing would be if they were all to believe that they could become global custodians, because Europe has been a graveyard for global custodians over the years and those that had built up a business based on local client groups have all failed, because they cannot get the scale that’s required. The best thing would be if the CSDs would consolidate. The worst thing would be if they were all to try and become global custodians and ultimately pass the expense of this on to the clients who have to use them for monopoly services still. So there is change ahead for the CSDs; I think it will take some time and I think we all know what we would like to see. KARLA AMEND:Yes, for the CSDs, it’s the biggest burden for the time being. The reality is that T2S is clearly representing new opportunities for CSDs at a time when many of them are thinking intently about their business model. T2S will provide those CSDs capable of working across multiple markets with a real opportunity to build up links with a range of market participants. But then, there is the realisation that some of the opportunity is not for them; why would a CSD really want to become a global custodian, for example? Nevertheless, CSDs will have to redefine their services. Then again, if you look at the 23 CSDs in Europe, there are only a few who currently have experience in linkage and this kind of business. So what happens to the rest? Some of the CSDs are monopolistic, state institutions that serve a dedicated function. It will be a challenging market for them. Others are more private market institutions and they will definitely face competition, but also enjoy more freedom of movement. Consolidation may make sense for some of these; in some markets talks are already underway and it has happened in others (in some of the Nordic markets, for instance). DIANA DIJMARESCU: What everyone agrees on is that we will see a re-drawing of local sub-custody services and of local CSD services. It is unlikely we will see a redrawing of the global custody offering as a result of T2S. As Paul has said, the global custodians could do nothing, stay as they are today, just tweak connectivity a little and continue to use their agent bank network to access T2S markets. Most of the global custodians are looking at optimising their access, but the sub-custodians will definitely have to reassess their business model, particularly the single market providers. Multiple-market providers will be in a

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Graham Ray, director, global product management, direct securities services, Deutsche Bank. in creating a T2S landscape, we have created a competitive landscape, which still has a period of time to be bedded down and that time is still a lengthy period. So even in two years’ time, the pure benefits of T2S will not totally be realised,” says Ray. Photograph © Berlinguer, August 2013.

much better position and they already have quite a strong product offering. I also agree with Karla, it’s true that the larger CSDs will develop links, build their investor services, and by doing so they will at best compete with their local sub-custodians for a domestic client base. There are only one or two CSDs, which are of a decent size, who will be really able to target a multi-country client base. So what we expect to see is a number of domestic CSDs building a multi-market offering that will be targeted at their local audience, which are already direct members in that CSD. Obviously, we will see over the coming years both winners and losers in the CSD space. ALAN CAMERON: The thing to remember about the global custody world is that it is under intense price pressure. Margins are very thin and to make money out of it, you have to have a whole range of ancillary services— most of which involve taking on a degree of risk, so the important thing here is that if CSDs want to get into this business, they have to have the risk-taking businesses separated from the CSD businesses. KARLA AMEND: Absolutely and that’s coming up also on the CSD Regulation initiative. Even with this separation, I would say that the larger CSDs do have the capacity to be a CSD, offer investor services and be T2S compliant. That will set a benchmark of sorts. GRAHAM RAY: We all recognise that there are a number of CSDs who potentially can redefine themselves in a T2S landscape and provide functionality that the market participants will require across the T2S landscape. However, in creating a T2S landscape, we have created a competitive landscape, which still has a period of time to be bedded down and that time is still a lengthy period. So even in two years’ time, the pure benefits of T2S will not totally be realised. Therefore, we will all have to be honest in the interim who will win and who will not win in the new landscape: we have at least 23 participants coming to the opportunity of T2S; not all will be able to take full advantage of it over the long term.

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With that in mind, Deutsche Bank has a strategic approach to what T2S really means to us and our clients. We have to acknowledge that a component of the end-to-end service chain has become commoditised and potentially moving away from the services we were originally providing. We all continue to redefine our business models and Deutsche Bank is fully committed to the success of T2S and the integration of such a momentous infrastructure development across the European landscape; but in redefining it means you need to also find value in what your clients require. T2S is not a one-size fits all for your end clients, so actually in redefining and finding the tangible value that you can add to each client, you have to start categorising what that means to different client segments.

COME IN BOATS NUMBER 3 & 6! (THE UK AND SWITZERLAND TO THE REST OF YOU) KARLA AMEND: Some 23 markets have signed up, which are mostly the eurozone countries, or countries with euro currency markets. FRANCESCA CARNEVALE: What is the impact on T2S if a major financial market, such as the United Kingdom, does not sign up to the platform? ALAN CAMERON: Well, one important aspect of T2S is that it is to be run on a cost recovery basis and in transaction banking we have all discovered that our fixed costs are much higher than we thought. The more transactions you have, the better the headline price. So with the UK and Switzerland not being in, volumes for T2S are likely to be lower than originally anticipated. And more transaction taxes are yet to come which will lead to lower volumes than we’d anticipated. So there is potential for a higher per unit charge than originally thought. FRANCESCA CARNEVALE: So will the lack of participation by the UK and Switzerland in T2S ultimately undermine its effectiveness? PAUL BODART: I think the more volume we have the better the economies as Alan said. The project is run on a full-cost recovery basis, so the project is fully funded by the eurosystem, but the eurosystem expects to completely recover its investment without making a profit, just recovering what it has put on the table. However, there is a gap between the projection that we made when we had to put a price for T2S on the table and the volume that we see today as a result of the financial crisis. So any market that joins us will help to close the gap and we have basically four options to try to solve the conundrum. The first one is that we reduce costs, but that will probably be tough. As Alan says, a project like this involves a lot of fixed cost. We are spending exactly what we anticipated to spend, which for a project of this size and complexity is quite remarkable. However it is probably not realistic to believe that we might significantly reduce the amount that we are going to spend going forward to complete T2S. Two, you can bring new volumes in T2S and thereby try to

convince other markets to join. I believe that some markets are waiting for T2S to be successfully launched and then if it works, will join. We are getting positive signals from some Eastern Europe markets for example. Some of the Scandinavian markets are clearly waiting and seeing what happens. The Norwegian and Swedish authorities have told us if T2S is successfully launched, they will sign up. Three, we can try to bring to T2S business that is today not done in central bank money. I’m thinking about Eurobond activity, or fund activity, or collateral management activity. Some of that could shift to T2S and bring new volume. The fourth option is to look at the recovery period. Originally we thought we would recover the investment within 8.75 years. We could change that. We can make it nine years, ten years, or 12 years. Remember that we started this project in 2006 and it will be launched in 2015. So it’s almost a ten year investment before it’s launched, so is 8.75 the right number? I don’t know, but it’s clearly something that we could decide. The Governing Council could decide that rather than amortising over 8.75 years, we amortise on ten and 12 years and then we will have more time to recover. The last option is always the possibility to increase price. We have that option in the contract. It will be looked at in 2018. We are taking any decision for the time being. We are just watching the markets and trying to convince more countries to join. We will try to bring new business in T2S and wait for a decision on pricing in 2018. GRAHAM RAY: I agree we need to deal with this dilemma, but from a sub-custodial perspective and definitely from a client perspective, if T2S delivers as now anticipated within the timeframe that we have set out and delivers the solution that is set for its objective, then I think we will see other markets want to join. We have to be pragmatic in dealing with the gap, as well as recognising if there is a success; people always want to join success, so other markets will want to play in the T2S landscape. It’s very important with all the complexities that we have going on with T2S and other such regulations like FTT and suchlike that can obviously have an impact upon volumes that we actually stabilise the objective of T2S and we deliver on T2S to then fundamentally create the opportunity to expand. DIANA DIJMARESCU: Looking at the impact on the markets which are not joining T2S, we think that there is a very clear concern that these markets will not be as keenly involved in the harmonisation process that is directly linked to T2S. That is a consequence of not having the whole of the EU joining the platform. Also for the ultimate participants and investors, having all the markets in the EU joining T2S would have really enabled to look at a single market and concentrate liquidity and assets on the same platform. Obviously this is not going to happen and we have the massive pool of assets represented by the UK being outside of the platform. ALAN CAMERON: I would say that we’re disappointed that the UK isn’t in it, but the flat pricing structure and the governance issues that the UK faced make it unlikely that that this will change. The addition of smaller Eastern

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European markets won’t help hugely on the pricing side. I’m not sure about the Asian expedition, so the best places to look for additional volumes must surely be the Eurobond market and funds. PAUL BODART: Another interesting question is the case of Switzerland, Romania and Hungary, because these three markets are joining T2S, but they are not joining T2S with their local currency. The question is whether we will see some of their local equities trading shifting from their local currency to the euro and then settle on T2S. Will it be easier for UBS, Credit Suisse, and Morgan Stanley to trade Swiss stocks in euro instead of in local currency because everything would happen on T2S? This may be another twist. We’re going to watch. We have no clear answer to that. We have mixed signals. We are working with Romania and Hungary to see whether they could rethink their initial not to bring their local currency in T2S, after both CSDs have decided to completely revamp their CSD platform. They’ve acknowledged that they have to make a change for T2S. Now, it’s probably easier to have that new platform operating the same way both for the euro and their local currency. We are in discussion with the respective central banks to see if the efforts of the CSDs could be facilitated by bringing the Romanian currency and the Hungarian currency into T2S as additional settlement currencies. This will be a plus. FRANCESCA CARNEVALE: Essentially what you’re saying is that because of these holes, T2S will have become much broader and multi-asset to compensate. PAUL BODART: Only in Europe. The idea of T2S may be exported but not the European version of T2S. We should never forget the legal and time zone issues.You can therefore not think that the European T2S could be used by an Asian CSD, or an American CSD, because of the legal and time zone issues, so that’s completely out of the discussion and something we are not even thinking about; though the concept of T2S may be exportable. DIANA DIJMARESCU: Or maybe foreign CSDs linking their platform to the T2S platform would allow, for example, Japanese securities to be settled in euros.

GOLDEN DATA/SEGREGATED DATA: WHAT IS IT? WHO HAS IT AND WHAT WILL IT MEAN? GRAHAM RAY: One of the interests around data is the risk element, we say golden data, but if we talk towards the element that the CSD plays in this component a client’s intention is focused on safety and liability, we are seeing more of a move towards account segregation. From a local sub-custodial perspective and other market participants, segregation of data is quite a complex process, quite a controlled process with multiple reconciliations in place to manage, so actually I look at the use of the word golden data with a little bit of hesitance and actually ponder do we understand the complexity when we use the word golden data and what it truly could mean. Do we recognise

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Alan Cameron, Head of Global Strategic UK Broker-Dealers & Banks Relationship Management, BNP Paribas. “I would say that we’re disappointed that the UK isn’t in it, but the flat pricing structure and the governance issues that the UK faced make it unlikely that that this will change. The addition of smaller Eastern European markets won’t help hugely on the pricing side,” says Cameron. Photograph © Berlinguer, August 2013.

that segregating data can be a function? However, it could also introduce a risk and if we don’t control the management of that segregation we actually implement into a complex value chain an anomaly that could actually be extremely dangerous as an industry and specifically the perception of the industry in the wider world. KARLA AMEND: It’s pretty essential to define what golden data means, and specifically what golden data means in a T2S environment. We already had interesting discussions in the market about how CSDs are making their positions transparent, via golden data on transactions in our local settlement infrastructure. Originally we had a huge debate that CSDs should or should not publish this data, because in part it is sensitive and in part highlights the risk positions or performance of market participants. Should this data be completely visible (or not); and who should see it? How secure should it be? Who does it ultimately belong to? Other considerations in play centre around the day to day practicalities of generating, presenting and analysing data: how secure is the data held? What does it cost to maintain? Again, who has access to it and why? How will it be used? Is it a good indication of performance? These are all important questions and there are no clear answers to all of them. There are still many areas we need to finalise around the definition and usage of data in the post trade world. PAUL BODART: T2S again is a platform and the data on that platform belongs to the client of the platform, so the data belongs to the CSDs. What you suggest Karla is correct: T2S will have a lot of information on transactional volumes, transaction settlement and on positions, but it will be the position of the client of the CSD, not the client of those clients, but it’s certainly a plus if a regulator wants to have an idea of who has no cash and who does. It was maybe an option, but we can only provide that information if we get agreement with the client of the CSDs. This data belongs to them and as Karla intimates some of them have strong

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banking secrecy, privacy rules that we have to respect, so we have to be careful in managing that. There is clearly an opportunity for T2S there, because issuers, so the ones that have issued shares or bonds, are extremely entitled to know who their shareholders are. In a domestic environment that works pretty well as each CSD provides this service. In the cross-border environment, it becomes much more complex and if T2S is successful, then you will see more investment made by investors outside of the country of the issuer. For the issuer to have a view who has both his stock, or who has both his fund share is very important. T2S has the information, could provide the information. It’s not on the radar screen for the time being. We have postponed that discussion, but in terms of shareholder transparency as we call it. T2S could be a plus, but it’s something for phase two. I want to be very clear. We have nothing planned for the time being regarding that. I repeat the data belongs to the CSDs.

MIGRATION TO T2S, WAVE UPON WAVE: WHERE ARE WE NOW? WHO IS STILL WAVING? PAUL BODART: Maybe I can give some feedback first on the way the waves have been defined. The T2S Board asked CSDs when they want to migrate and based on their initial feedback, we ended up with a three wave scenario: one wave on June 2015, with one big CSD (Italy) and then four smaller ones. Two other waves will occur in the second half of 2016. In the event, we realised the gap between wave one and wave two was too long and the concentration in the second semester in terms of number of CSDs per wave and volume in one wave was not acceptable. It was really too risky. So we had a very constructive discussion with the CSDs and we ended up with the four wave scenario. The first wave is unchanged; the second wave is in the first part of 2016; a third wave in the second part of 2016 and the last wave in February 2017. The biggest wave will be the third one, because Clearstream will be in that wave and Clearstream brings more volume. So that’s how we ended up and I think this balanced, so there is not too much volume in one wave. You don’t have too many CSDs. I don’t believe that this migration plan will change much. There is always the risk that when we start user testing, one CSD may say they are not ready. If that happens we will have to move it to another wave and look at what that will mean for subsequent waves. GRAHAM RAY: The impact of the waves to the different client segments is treated in a different manner, which brings complexity to the exercise. There’s recognition of where the volume comes in the various waves, but there’s also the importance of being ready for 2015 when T2S is implemented and starts. That brings us to another dynamic of the tangible benefits that a local sub-custodian provider can bring to their clients through T2S. The opportunities between the waves will be a definition of what T2S means to the underlying clients and

its implementation. Moreover, the risks that come with that implementation period are quite substantial, which brings opportunities for the sub-custodian to shield its clients. Deutsche Bank is on hand to help clients through this key initiative and any diversions that do arise from such a large implementation. KARLA AMEND: CSDs were not very happy with the original three wave approach; and we think the latest model is better. Of course, this has involved intensive work to help our clients balance it out and meet the requirements of the Eurosystem. It has also involved masses of internal work to ensure we can comply at any and all stages. In the first wave we look to have around 15% of the euro business and 23% in the second wave. This involves the euro markets and the Belgian market. Some 44% of the market will transfer in the third wave and 18% in the last wave, with some contingencies for those institutions which were perhaps not ready to move across in previous waves. Interestingly, and I agree with Graham on this point, I think everyone underestimated the impact of the whole migration programme on every client segment in the Euromarkets. As there are independencies between the links and sometimes complex interdependencies between various market players and you begin to understand the potential for something going wrong, or something not really being prepared for. It has put all of us involved in the project under immense pressure to ensure that all contingencies are covered both pre-migration and post migration. What we did not expect, but are now pleased to have, is the long preparation period, because every actor has to be ready and on board by February 2017 and in some cases will require a redrawing of historical relationships and practices. ALAN CAMERON: The implementation waves seem reasonable and well balanced to me. I think from the CSDs’ point of view, it’s hard to see there being a first mover advantage in this anyway. The benefits come from the cascading effect of everybody being in, but there may be important to financial institutions who want to consolidate their banking relationships to avoid going through multiple testing scenarios with different agent banks, etc. So that is the main impact that they may have.

THE NEW T2S LANDSCAPE: WHO WINS, WHO LOSES AND WHY? DIANA DIJMARESCU: For our clients, the main benefits of T2S are related to safety and risk reduction aspects. These are especially important in the post financial crisis environment. We should remember though that the T2S project was initiated before the onset of the financial crisis. Whereas at that time the focus was more on cost reduction and market efficiencies, today we are in an environment where the risk reduction is really uppermost in everybody’s mind, and having the opportunity to settle across Europe in central bank money is a key attraction of the T2S solution. Then, as we have discussed before, we all look towards the ability to reduce costs. That’s still on the table and we can

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achieve that by benefiting from any resulting low settlement fees, through the reorganisation of the way we do business and by changing the way we access the EU markets. These benefits should cascade along the investment chain to clients and end investors. Costs reductions will have to be balanced against the cost of adapting to T2S, the costs of migration to the platform and testing. Ultimately though, we should see at each level more savings and improvement in efficiency. Then, there are the significant opportunities from the concentration of liquidity, the pool of securities and collateral on T2S. This should ultimately result in more business coming to T2S due to the network effect. GRAHAM RAY: The opportunities are clear, irrespective of the client segment. Clients will enjoy better use of collateral, liquidity and cash and will work with an account structure that better meets their day to day requirements. The benefits of being able to take the end to end process and unbundle components are very clear. I’m going to probably steer away from the benefits of the fundamentals and focus on what I see as one of the key benefits to our end clients. T2S by default is actually driving an integrated partnership between clients and their local sub-custodians to find partnering solutions that are beneficial to the end clients, which is probably an anomaly that sometimes cannot be measured by purely looking at T2S. It is measured by the scale that the local sub-custodian providers have, like Deutsche Bank in the T2S landscape. I think my main focus is on creating more of an integrated market in a relationship between clients and their support infrastructure. ALAN CAMERON: The core benefits include improved settlement functionality and the better use of collateral. Equally, investors should also benefit from agent banks managing to build scale and passing on the economic advantages of that. Moreover, with post T2S CSD pricing unclear, the agent banks have to draw up fee schedules that include unbundled pricing. This may well be an advantage to some people, but the reality is that it can’t be an advantage to everybody. KARLA AMEND: Among the many benefits of T2S streamlining the asset servicing component is an important one. It allows investors to streamline their network, with all the attendant cost reduction activity on the other side. T2S is also enabling access to a wonderfully large collateral pool, this is important given changing regulatory conditions and a desire by regulators for a more secure market. Collateral optimisation will become more important. I think we have come a long way along the harmonisation route informally; what is now vital is formalising this harmonisation and what it means in terms of service level agreements and costs for investors and other market participants. PAUL BODART: The big change will be for the issuers that will have more choice to see who is going to support them when they want to issue bonds and money market instruments. They will not be forced any more to go to their local provider, but they will likely benefit from the competition brought by T2S. The fundamental benefit of T2S is that it

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Karla Amend, head of T2S Governance Team, Clearstream. “We recently undertook an enterprise-wide study in cooperation with PwC (please refer to page 69) around the cost of direct cash accounts (DCAs); the study, published in September this year found a clear 15% advantage or liquidity reduction by using only one DCA,” says Amend. Photograph © Berlinguer, August 2013.

settles cross border transactions at the same price, or the same cost, as domestic transactions. You should see issuers getting a broader range of investor buying their securities and that should probably reduce the cost of issuing debt and shares over the long term. You should also see investors investing more outside of their home market than they do today. We should never forget regulations such as CRD 4, EMIR and so on and what it means in terms of additional capital risk reduction. In addition T2S will allow you to pool all your liquidity on one account, or fewer accounts, to move collateral around much faster and more efficiently than today; and to use efficiently the collateral and the liquidity that you need to meet your post-trade commitments. Today we often forget the role that, for example, the sub-custodians play in providing the oil in the machine, in other words, how subcustodians provide liquidity for intraday settlement. By bringing everything onto one platform, T2S, and using a smaller number of cash accounts investors will need less cash, or less liquidity to settle their trades and less collateral to support the risk related to that activity. KARLA AMEND: Talking about that new cash/liquidity requirement, we recently undertook an enterprise-wide study in cooperation with PwC (please refer to page 58) around the cost of direct cash accounts (DCAs); the study, published in September this year found a clear 15% advantage or liquidity reduction by using only one DCA. That does not include additional advantages of netting; but it gives you an idea of what is possible.

NAVIGATING THE REGULATION JUNGLE: DOES T2S CLEAR OR HINDER THE PATH? PAUL BODART: I’d like to start by saying T2S is an infrastructure, it’s not a regulation. T2S is part of a wider programme around harmonisation of markets in Europe.

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On top of T2S, you have the CSD Regulation that describes the regulatory framework. Will the CSD Regulation be adopted in time? I believe it will.You have MiFID for trading, EMIR for CCPs and CSD Regulation for the CSDs, which are critical [infrastructure]. Infrastructures worked extremely well in the crisis, but I think that regulators have recognised that if an infrastructure were to fail, it would be a major problem. I therefore believe that a European-wide level playing field, a stronger risk management framework and stronger governance around CSDs, are good things and I think it’s required. In this regard the CSD regulation and T2S are complementary and not conflicting and will help to create, as Diana said earlier, a more integrated European financial market as opposed to a combination of 27, or 28 financial markets. DIANA DIJMARESCU: I would just make the observation that from a market participant perspective, the combination of a major infrastructure change at a time when we are heavily involved in implementation of a number of significant regulatory changes poses a challenge in terms of resources and (clearly) management. We view 2015 as a critical year when a number of regulatory changes will already be in place and in implementation phase, and then we will have the first wave of T2S to deal with. While I agree that many regulations do indeed complement each other and will, in fact, help T2S to deliver on all its opportunities, we have to acknowledge that the next few years will be very busy indeed, for everybody, and we will need to make sure that we have the resources in place to deal with this successfully and look at the combined effects of all these simultaneous changes. GRAHAM RAY: Most definitely there’s a complementary element in CSD Regulation and T2S. There are also challenges, as Diana noted, with regards to dealing with all this change. For T2S it is important that CSD Regulation comes in on time so that T2S can benefit and we can all optimise our responses to the new post trade infrastructure. However, I have to acknowledge that, looking at it from the point of view of the market participants, there’s an element of fatigue creeping in around T2S and some of the changes that follow. It might be time now to bed down some of the more important regulations and give them time to be implemented and see what the effects of the regulation are on the market community before we look to overcomplicate things with any additional regulatory developments or infrastructural changes. ALAN CAMERON: Two of the most important aspects of T2S are safety and harmonisation. Both would be improved with shorter and harmonised settlement cycles. To get the most out of T2S we need T+2 settlement to come in before it goes live. If we need CSD Regulation to get to T+2 then CSD Regulation is important. PAUL BODART: Of course, Alan is right. We definitely need T+2 implemented before T2S. However, if you do it at the same time, it might be a too complex project. The CSDs have decided to join in, so I am hopeful it will happen. Another question is whether T2S will be ready on time. We

don’t know. I think we are on track; though we still have two years of full testing ahead of us. Up to now the results are better than we anticipated for a project of this complexity. Soon we will start testing with the central banks, then in late summer 2014 with the CSDs and after that the CSDs will start testing with their users. Of course, surprises can happen, so we are preparing for that eventuality too. However, I want to make the point that the work and the mind-set around this work have changed. We are working together with CSDs across Europe and they are really constructive and all the work around testing is underway. I’m not nervous about the CSDs being ready. I think they will be. I’m a little bit nervous about whether (in each European market) the users of the CSDs will be ready. That is something we need to watch, but we still have two years in front of us and we know that a complex project like this may lead to some surprises. There’s nothing that’s telling me today that we will suffer any delays, or whether the results of our testing are better than what we expected. KARLA AMEND: I recently ran a T2S conference in Frankfurt where we surveyed attendees on their preparedness for and understanding of T2S. Interestingly, around 79% of the 130 customers that attended responded that their preparedness for T2S was more or less on schedule. We ran that same exercise last year and then only 40% of respondents said they were ready and preparing for T2S. In the intervening period then, there has been a substantial shift in attitude and commitment to the project and we have taken that response as a positive sign. At least I can say this is the case for the German market: I cannot be sure of the same in other European markets. T2S entails investments of several hundred million euros, not only for the eurosystem, but also for market participants across Europe. It is in all our interests to ensure that the numerous advantages offered by T2S actually become a reality. As the largest central securities depositary in Europe, we believe it is our responsibility to continue to offer the market (in Germany and beyond) the right services for a world with T2S. GRAHAM RAY: I think Karla hits a very salient point, market evolution within T2S for more mature markets, or higher-scale volume markets, is definitely tracking in line to the T2S plans. I suppose the complexity around it all is that there are still many steps involved in the process to ensure that all participants are ready for change. If you bring that back to CSDs, all of the adaptation plans for T2S are not delivered yet; but as long as everyone adheres to the principles of T2S to be ready by the date, from a sub-custodial perspective, with multi-market coverage, then our significant investment into T2S and our own multi-market coverage will begin to dovetail with each CSD. I really do believe that the dynamics of the impacts on the European sub-custody network will depend on what the underlying CSDs will do. In the meantime we will be dealing with specific issues, such as reform in the Spanish market, CSD adaptation plans for T2 and so forth. So there is a lot of work to do in between now and the complete implementation of T2S/all waves. I

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TRADING VENUES: ZAGREB EXCHANGE

Austrian chancellor Werner Faymann, right, welcomes Croatia’s prime minister Zoran Milanovic, left, and Slovenian prime minister Alenka Bratusek for talks in Graz, Austria, on Friday, August 23rd 2013. Photograph by Hans Punz for Associated Press. Photograph supplied by pressassociationimages.com, August 2013.

When Croatia joined the European Union on July 1st this year, the country’s main stock exchange in Zagreb became the new kid on the block, or rather, the new kid in a tough playground, where alliances are already formed and where going it alone may be the most difficult option. The rules of the game continue to change in Europe and the discrete exchanges are the ones facing the severest tests of their ingenuity and business acumen. Vanja Dragomanovich looks at the options open to Europe’s newest exchange member and assesses its outlook as a template for developments elsewhere in the European national exchange landscape.

The challenge of moving from minnow to minor to major A

S THE EMBERS of the financial crisis die down, it remains difficult for smaller exchanges to muster the volume and a broad enough interest from investors to remain profitable. The Zagreb Stock Exchange (ZSE) is no exception. Of all the central and east European exchanges Warsaw has been the most successful and remains a visible exception to the rule; but it operates in a market where the local population is almost tenfold that of Croatia’s modest 4.4m. Until now, previous EU newcomers, such as Prague, Budapest and Ljubljana were quickly bought up market hungry

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exchange groups, in this instance the Vienna Stock Exchange in 2008 and merged into the CEE Stock Exchange Group. The four together now have a market capitalisation on a par with the WSE. It is an indication of the problems at hand for national trading venues looking to secure market share at a time of seismic change in the European trading landscape. A fairly efficiently run and lean operation, the Zagreb Stock Exchange (ZSE) has a turnover of HRK17m (around $3m) and around 380 listed companies. It caters to a relatively small market. It uses the NASDAQ OMX X-stream trading system and as of July this year all stocks can be

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traded the same way as in the rest of the EU. However, even before Croatia joined the EU, the exchange looks to have struggled with profitability and there has been intermittent speculation about whether or not the exchange would/could continue forging its own path or become an acquisition target. We’ll soon find out: after all, the pool of potential buyers is relatively small with CEESEG, Warsaw and Borsa Istanbul seen as the frontrunners. When approached for comment, a spokeswoman for the CEE group says the exchange is not looking at Zagreb as an acquisition target. Warsaw and Istanbul, however, have not dismissed some form of co-operation. For the time being however, home markets look to be ruling supreme. Adam Maciejewski, president and chief executive of the Warsaw Stock Exchange, for instance, says that the Polish market has yet to be fully utilised and that the WSE will focus on that aspect of growth first. “But to be competitive we simply can’t ignore what’s going on outside Poland and ignore opportunities to create value for the company with external partners. We’re very active in looking for such opportunities,” concedes Maciejewski. When asked specifically about an interest in the Croatian Stock Exchange Maciejewski adds,“we’re interested in all initiatives strengthening economies and capital markets in CEE and (at the same time) creating value for our stakeholders.” Financially, WSE is certainly in a good shape. It reported revenue in the first half of the year of PLN 143.9m ($44.9m), up 7.4% year on year. In comparison, ZSE reported a loss of HRK3.47m ($0.61m) in 2012. Whether there is much financial logic in a medium sized exchange acquiring the ZSE is another question. “If a bigger bourse were to buy the Zagreb Stock Exchange it is unlikely that it would make a huge profit but it could make it work financially by running it as a lean operation by, for instance, centralising most of the services,” say Herbie Skeete managing director of Mondo Visione, an exchanges intelligence service. Instead of an outright acquisition there might be a softer version of co-operation on the cards. Although neither Zagreb nor the Istanbul stock exchange would comment on a potential link up, just a few weeks ago the Turkish exchange signed a deal to distribute data from Bosnia’s Sarajevo Stock Exchange. According to the deal Borsa Istanbul will be able to distribute Sarajevo Stock Exchange data in Turkey and in other countries from the beginning of 2014.“This is the first step. Our plan is to become a data distribution centre for the region. The Sarajevo Stock Exchange is the first one but we are also talking to other exchanges in the region,” says Serkan Zeytun in Borsa Istanbul’s marketing and sales department. The talks are in various stages of progress and Borsa Istanbul is currently not revealing which other exchanges it is talking to. The agreement with Sarajevo is a small piece in a much bigger plan by the Turkish government to turn Istanbul into a major international financial hub in the next three years, the Istanbul International Financial Centre project, which will include expanding the financial district and ambitions

for the country’s main stock exchange to play a bigger role in Europe. The agreement between the exchanges in Istanbul and Sarajevo also illustrates the growing acceptance that traditional trading services will not always be the main source of revenue for the exchanges in future. Securing control over traditional clearing and settlement businesses is one angle that exchanges look to be pursuing across Europe (the vertical trading model looks to be in the ascendant in this regard). Another key source of revenue will be data management and market analytics. The technology to capture market data is already in place. The question is: what data sets will the market require and are smaller exchanges the best sources of this ‘golden data’? A good example of what ZSE could expect as a part of a bigger group is the experience of the Ljubljana Stock Exchange, bought by the Vienna Stock Exchange in 2008 to become a part of the Vienna-Budapest-Prague-Ljubljana operation. Apart from the obvious benefits of integrating all of the ancillary services (such as compliance and infrastructure in a central hub) and allowing the smaller exchanges to focus on their core trade business, the biggest appeal is attracting a much broader base of investors to the home market. As Andrej Sketa, president of the management board of the Ljubljana Stock Exchange says,“What is especially important for smaller markets is access to foreign investors and promotion. We [Slovenia] are a small market and before we became part of the CEESEG it was impossible for us to, for instance, go on a road show in New York and attract foreign investors to Slovenian stocks.” As part of a bigger group of exchanges it proved much easier to get access to investors and remote trading members and indeed since Ljubljana became part of the CEESEG, the interest of international investors has increased significantly, adds Sketa. The point is underscored elsewhere in Europe. Michael Buhl, joint chief executive officer of CEESEG and Vienna Stock Exchange, agrees there has definitely been sustained high interest from international investors in the companies listed on the CEESEG with almost 30% from the US, just under 20% from Austria and 15% from the UK. “The share of US investors has decreased since 2012, but we are seeing inflows from other markets such as Mexico, CEE, the Middle East and Australia,” says Buhl.

Business drivers The pragmatic head of the ZSE’s board Ivana Gazicis is fully aware of the economic and overarching competitive environment which affects the Croatian Stock Exchange and the still extant trend for closer cooperation between smaller exchanges. She sees the way forward for Croatia as closer cooperation with countries of former Yugoslavia: Bosnia, Serbia, Montenegro and Macedonia rather than as a potential acquisition target. Gazicis took over at the helm of the exchange in 2010 in the midst of an economic crisis both globally and at home. At the time Croatia had (and truth be told still has) high debt

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and unemployment levels, its GDP has not been positive since 2008. Domestic demand remains weak and the foreign currency income depends heavily on tourism. Changes Gazicis implemented over the last few years have made the exchange a more cost effective enterprise.“We did a lot since then and we will continue to do so,” she says. Transparency and improved corporate governance are now important pillars in the exchange’s efforts to upgrade the quality of its listings. In addition, the exchange has begun trading structured products, which have proved popular with local buyers and improved their ability to manage market risks. As part of the process of upgrading the exchange’s operations, it has also started classifying stocks by sectors.“We brought in, among other things, new indices, we boosted the presence of market makers on the exchange and launched the first certified programme in Croatia to educate investor relations managers,” she says. Since the beginning of this year the exchange has introduced six new indexes, CROBEplus and five sector indexes, and is currently working on a CROBEX Total Return Index. All in all though, these innovations ultimate are designed to improve the attractiveness to other exchange operations, either as a business or strategic partner. Clearly,“The trend for consolidation is very pronounced and we are keeping a close eye on it but liquidity problems are making those processes harder,” acknowledges Gazicis. Clearly then, the challenges facing the smaller European exchanges are multifold. At the top of the agenda, attracting fresh investors is proving especially important now that interest in East and Central Europe from a lot of emerging market fund managers is waning in favour of BRIC countries and other high growth markets, especially in Asia. Specialised investors no longer regard Eastern Europe as an emerging market, namely a market with a high potential for return. Increasingly it is folded into the broader European context, with all the advantages and disadvantages that entails. In Europe’s increasingly competitive internal market, companies and exchanges have to work even harder to be seen. In a wider global context, it becomes more difficult to compete with low cost/high growth economies, as Europe’s smaller economies are bracketed into the eurozone whole. Added to the macro trends, the micro-circumstances of Croatia remain problematic too. Economically, Croatia is not on a strong footing. Kevin Koerner, analyst at Deutsche Bank, for one, says the short-term economic outlook for the country is bleak.“Croatia has been heavily exposed to the eurozone debt crisis, with about 60% of exports going to the currency block and almost 20% to Italy alone. The banking sector is foreign-dominated, with Italian parent banks holding almost all of the total assets.” The local currency kuna is informally pegged to the euro. About 70% of loans and more than 60% of deposits are either denominated or linked to foreign currencies which means that the central bank has little leeway to react to the financial crisis in the country with monetary or foreign exchange rate policies. Unemployment is at over 20%, public debt is close to 60% of GDP and expected to rise over the

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Ivana Gazicis, head of the Zagreb Stock Exchange board is cognisant of the economic and overarching competitive environment which affects the Croatian Stock Exchange and the still extant trend for closer cooperation between smaller exchanges. She sees the way forward for Croatia as closer co-operation with countries of former Yugoslavia: Bosnia, Serbia, Montenegro and Macedonia rather than as a potential acquisition target. Photograph kindly supplied by the Zagreb Stock Exchange, August 2013.

next few years. Two of the top three rating agencies have the country’s sovereign rating at below investment grade, which means that external refinancing costs are high. The country’s exports and foreign currency income depend on shipbuilding and tourism. Despite the bleak preamble, it’s not all bad. Membership of the European Union will bring in new money that will help strengthen the country’s discrete infrastructure. Croatia has gained access to the Cohesion Fund, the Structural Fund and the European Fisheries Fund and the total amount of funds approved for Croatia in the second half of 2013 total €655m, which is a shedload of cash for a small economy. As a new member Croatia will also receive €29m from the Transitional Facility and €75mfrom the Cash Flow Strengthening Facility. Total funds earmarked for Croatia, which still have to be approved by the European Parliament, will be €13.7bn although Croatia will have to contribute to the EU some €4bn, says Kroener. Those financial inflows should start reflecting the performance of the top stocks in the Croatian Crobex Index. Some of the companies in the 25-strong index are ports, infrastructure companies, food producers, telecoms and oil companies. “The interest of foreign investors has certainly picked up but we are still awaiting the full effects of that interest,” says Gazicis. Equally on the upside, now that the country is part of the EU, foreign investors can use “a single passport,” that is, have access to Croatian stock the same way they would with any other stocks traded in Europe. “The process of listing companies in both directions will also become easier, local companies will be able to list on European bourses and foreign companies will be able to list in Zagreb. Simplifying procedures and an easier flow of capital can only be a good thing for the market,” she says. I

PROFILE: INSTINET

Reality continues to bite in the broker-dealer segment. The challenge is to deliver cost effective execution services as revenues remain constrained. Fundamentally, the execution services set continues to be cut, refined and molded to suit changed market conditions. The agency broking business model has borne the brunt of change; unadulterated market offerings invariably do. To survive in the new trading order has required guile as well as trading expertise and the ability to continue to invest in technology. Going forward however, will it be enough? In a series of profiles of high visibility firms which highlight the varied, innovative and determined responses to straightened trading market conditions we look at the agency broking segment through the prism of Instinet, one of its leading proponents. Ruth Hughes Liley talks to Instinet chief executive Adam Toms about the vagaries of market change, and the firm’s and its clients’ responses to it.

RETHINKING THE FUTURE I NSTINET EUROPE MADE the most of the quiet month of August, moving its operations and trading desks from its offices from Canada Square, in London’s Docklands, to parent company Nomura Group’s headquarters in the City. The move is significant. It comes at a challenging time when brokers are consolidating and scaling back operations as the industry adjusts to ‘the new normal’ of low volumes and equally low commissions. In this environment, it might seem as though Japanese investment bank is consolidating its office spend and moving the Instinet business back under its own wing. It was only last September that it migrated its entire equity execution business outside Japan to its agency-only subsidiary, Instinet, as part of a $1bn cost-saving initiative. Now the same rationale is driving a very different response. But then the Nomura/Instinet mix has not been the most predictable of pairings. Most industry watchers originally assumed the bank would merge Instinet (which it bought for $1.2bn in 2007) into its own execution services business, which the Japanese bank had acquired from Lehman Brothers back in 2008. In the event, the bank did the opposite, keeping Instinet an independent entity within the Nomura Group but separately regulated. It then moved Nomura’s own execution business into agency broker Instinet, with Adam Toms at the helm. The migration carried the risk that clients would leave for pastures new. In the event, more than 90% of the group’s “priority clients” in Europe elected to remain and are now actively trading with Instinet, claims the firm. Its own figures record it has more than doubled its market share in both Europe and Asia ex-Japan and grown market share by more than 50% in the United States. The broker has also expanded its geographic footprint in Europe, adding an office in Frankfurt to those already in London, Zurich and Paris. The relationship between the elements of the group has also matured. Instinet and Nomura regularly use their wider market relationships to benefit each other. For instance: as the equities execution arm of the group, Instinet is the distribution mechanism for Nomura’s equity capital markets business, and earlier this year acted as selling agent on Barclays accelerated book-building and the initial public offering (IPO) of Bpost, Belgium’s postal service in June.

Then again, Instinet is also the preferred payment channel for Nomura’s research, on top of any additional discretionary flow it might receive as an agency broker. This is a vital and meaningful element, particularly at a time when the buy side is under the regulatory spotlight to ensure no conflict of interest exists between research and execution. In this regard, agency brokers can be seen as a clear-cut way to transact. Asset managers are being asked to assess their adequacy when purchasing research while trade execution firms need to be able to prove purchases are in customers’ best interests. The requirement does not look anything like a paper tiger; in fact, it is widely expected that the UK market regulator, the Financial Conduct Authority (FCA), will soon start to conduct checks to ensure the buyside is selecting brokers “correctly”. Adam Toms, who was moved from Nomura’s global cohead of electronic trading to become Instinet Europe’s chief executive officer in June 2012, explains:“Clients by and large have done a good job unbundling research from execution and managing conflicts through the use of Commission Sharing Arrangements (CSAs), but I would not be surprised to see some firms revisit policies and if necessary enhance them. Historically, any time that has happened, it has benefitted brokers [such as] Instinet [that offer] strong CSA offerings and high-quality trade execution.”

A new business outlook Even with the best will and expertise in hand however Instinet has been bruised by oncoming winds. With European volumes stagnant European trading operations have sometimes struggled to maintain profit levels. If UK Companies House figures are taken at face value, Instinet Europe Ltd reported an operating loss of £270,000 in the year to March 31st this year, compared with a profit of £351,000 in the previous 15 months. Globally, performance is harder to measure as Instinet’s revenues are only reported in aggregate (as part of the Nomura’s Global Markets group) and therefore meaningful comparisons cannot be made. The firm is sanguine however and marks it down to fundamental market shifts and is redrawing its business models to leverage the change over the medium term. To hold his own in Europe, Toms aims to move away from its 100% equities-only model in Europe next year towards trading

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

Andrew Bowley, Instinet Europe’s head of business operations and risk. Bowley says it is vital for regulators to get MiFID II right. “It will have taken nine years from the implementation of MiFID to MiFID II being enacted. That means that if we get it wrong with MiFID II—and all of us in the industry bear responsibility for making sure that’s not the case —we will potentially have to wait a considerable amount of time to rectify it.” Photograph kindly supplied by Instinet, August 2013.

equity options trading in Europe is over-the-counter (OTC), with just 25% on exchange. (In the US, which has 12 options exchanges, the figures are reversed.) However, with so much OTC trade reporting stored in banks on paper or Excel spreadsheets, regulators want the transparency of onexchange derivatives trading with central clearing. Indeed, the $40trn fixed income is going through similar changes to that experienced by the equity markets as trading becomes more standardised and moves on to order books to be traded electronically on exchanges. Toms is circumspect about other asset classes in his sights but notes:“While I certainly recognise that moving into any new asset class is a big undertaking, there could be a real sea-change in the amount of business executed electronically in several different products, fixed income in particular. And then all of a sudden the world of algorithms and smart routing and block-crossing—all the things that Instinet has done well in equities for many years—becomes relevant to a whole host of new areas.”

New thinking in technology equities futures and options. It has done so successfully elsewhere. The firm has traded derivatives in the US since August 2009, when it bought options-focused TORC Financial, at a swoop providing US clients with brokerneutral solutions for institutional derivatives trading. At the time, Instinet’s bosses talked of “moving Instinet to the forefront of electronic derivatives trading.” A year later the firm felt confident about the business flow and subsequently launched a dark pool for US options trading. Then in June last year Instinet set the scene for global expansion of multi-asset trading when it added support for Asian futures as it upgraded its broker-neutral execution management trading system (EMS), Newport 3. In the previous 12 months it had added derivatives-friendly features from exchange-traded futures calendar spreads to a better workflow for options spread trading. At the time Erin Sheehan, product strategist for Newport, commented:“Every facet of our business—from sales trading and liquidity sourcing to aggregation and commission management— now addresses derivatives. We’re committed to maintaining this focus and bringing the best possible multi-asset trading enhancements to Newport going forward.” Even so, Toms has his work cut out to introduce multiasset trading in Europe. First it will face competition from REDI, the newly independent, leading multi-asset execution management system (EMS) provider. After acquiring the firm in 2000 Goldman Sachs sold its majority holding in July 2013 to a consortium of investors including Bank of America Merrill Lynch, Barclays, BNP Paribas, Citadel and Lightyear Capital. Goldman Sachs is now a minority shareholder. “In this day and age, broker-neutrality is a pre-requisite for any buy side firm to consider an EMS,” notes Toms. “The spinoff of REDI is no doubt an effort to get there, but we are happy with where our offering is today and feel that neutrality is an attribute that Instinet has long been known for.” Another challenge is that currently three-quarters of

FTSE GLOBAL MARKETS • SEPTEMBER 2013

In June, research group Celent published a report on technology costs calling on mid-tier and larger brokers to “think the unthinkable” and embrace technology outsourcing to radically reduce cost structures in equities trading, which have “persistently low growth in revenues, stubbornly high costs, and capacity challenges.”Author and research director David Easthope says brokers should, rather like environmentalists, “reduce, reuse and recycle” their IT, including outsourcing infrastructure where possible to cloud technology and should reuse existing platforms to trade asset classes beyond equities. As with other technology-focused agency brokers, technology provision is becoming an area of income for Instinet as sell-side clients use its algorithm suite, its EMS or connectivity infrastructure and Toms says he is in discussion with other firms looking to outsource. “The ability to leverage our platform is something that’s appealing to many other brokers and in fact is one of our primary sales focuses at the moment. With our scale, we are able to offer economic terms that most others are not, making us a very intriguing partner to a whole host of firms.” While multi-asset trading and technology sales are two ways of meeting its challenges, Instinet is also facing upcoming regulation and using it as an opportunity for expansion. It is an area ripe for innovation. In a survey of 375 buy-side participants in March 2013, for example, the Professional Risk Managers’ International Association found that risk regulation was the buy side’s top concern. The fact that the buy side can no longer rely on paper records is spawning a new set of regulatory reporting platforms. Middle office solutions provider Viteos, for example, recently launched its own reporting platform covering SEC requirements in the US and AIFMD in Europe. Indeed, any technology that makes it easier to comply with regulation will become a growth area for brokers. This is particularly pertinent for Instinet Europe, which in 2010 was

PROFILE: INSTINET

fined £1.5m, discounted to £1.05m, by the UK regulator for breaches of transaction reporting rules. Today however, clients are using Instinet’s technology, for example, to formally separate payment for trading from research, improving transparency and helping fulfill client best execution and conflict management mandates. Clients can aggregate commission credits from executing brokers and manage their whole CSA budget in one account. In 2012, Instinet says it directed more than $325m in payments to 900 research providers worldwide on behalf of its clients. It is not all plain sailing: upcoming regulation could place a drag on Instinet and the industry overall as the months draw on and trading volumes remain depressed, even as the economic outlook starts to improve. As Toms concedes, the integers have an equation of their own: “When frictional costs of trading get higher, clients must reconsider the amount of turnover in their funds.” Since the financial transaction tax was introduced in France last August, TABB Group has reported that the country’s share of the total European equities market has declined by around 25% to 12.8% in July this year. Similarly in Italy, where a transaction tax was also introduced, volumes in July were half what they were at the start of the year. Also of concern is a possible restriction on high frequency volumes, which are estimated to make up 40% of the European market place. While Toms asserts that the conduct of HFT firms should be as carefully monitored any other market participant, he says individual tax regimes should not be used to penalise one group specifically.“Broadly speaking, HFT participants are just technology-leveraged market makers. If they are removed from the market place, the implicit cost of trading will increase substantially and it will be in large part the pension funds and other managers of retail money that bear the cost.” As European regulators set a new timetable for MiFID II for reaching agreement on the first stage by the end of the year, Andrew Bowley, Instinet Europe’s head of business operations and risk, says it is vital for regulators to get MiFID II right.“It will have taken nine years from the implementation of MiFID to MiFID II being enacted. That means that if we get it wrong with MiFID II—and all of us in the industry bear responsibility for making sure that’s not the case—we will potentially have to wait a considerable amount of time to rectify it.” Regulatory restrictions on dark trading under MiFID II could have implications for BlockMatch, Instinet’s dark MTF. Volumes on the platform have tripled since January 2012, from 2.72% of the overall European dark market in January 2012 to 7.09% in July 2013. After BATS Chi-X Europe and UBS MTF’s dark book (which enjoy a combined 50% market share), then POSIT and Goldman Sachs’ Sigma X (which together reportedly enjoy a fifth of the market), Instinet BlockMatch, Liquidnet and Turquoise together make up another fifth. Block trading has also become a competitive area as alliances and new entrants try to attract business: Deutsche Börse and Liquidnet have teamed up to launch a new block

Adam Toms, Instinet Europe’s chief executive officer. “Clients by and large have done a good job unbundling research from execution and managing conflicts through the use of Commission Sharing Arrangements (CSAs), but I would not be surprised to see some firms revisit policies and if necessary enhance them. Historically, any time that has happened, it has benefitted brokers [such as] Instinet [that offer] strong CSA offerings and high-quality trade execution,” claims Toms. Photograph kindly supplied by Instinet, August 2013.

trading service on Xetra MidPoint, allowing 240 Xetra members to trade directly with Liquidnet’s network of 700 asset management firms, while new entrants include Squawker, the social-media based inter-dealer block matching venue. Toms puts the growth of BlockMatch down in part to volume migration from Nomura’s NX MTF platform as part of the overall execution services migration, and also because of the introduction in February 2012 of its use of the European Best Bid and Offer (EBBO) waiver to claim pre-trade transparency. The firm compiles the EBBO using Instinet’s proprietary market data feed handling technology, referencing prices from the major European primary markets as well as BATS Chi-X Europe’s BXE and CXE, Burgundy and Turquoise. Another migration was Nomura’s high touch-trading business, which moved to Instinet in January this year. The team sits separately from Instinet’s electronic and programme desks—there’s been no cost-saving combination of desks as at some investment banks. “We think it’s important to be mindful that clients view both the high- and low-touch trader as specialists in their own right,”says Toms. “Generally speaking, they want someone on the high-touch side who knows how and when to source natural liquidity and provide market colour, and on the low-touch side someone who understands market structure and our electronic product on a deep and meaningful level. That’s not to say that some clients aren’t looking for a hybrid that can bridge those roles and in those cases we try to accommodate, but overall we view the generalist trading model as being suitable for only a small subset of clients.” “In many ways our high-touch model has us going back to the roots of cash sales trading, albeit with a very advanced technology platform that the traders are able to leverage. We’re happy with where the Instinet business is today and believe we are extremely well-positioned for the future.” I

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

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% 4.4 5.3

-0.3

23.7 25.4 6.7

3.8

22.4 14.8 23.9 7.4

5.5

1.4

COMMODITIES Brent Crude Oil Gold Copper Credit Suisse Commodity Index

4.6 2.1

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

7.5

-17.8 -9.0 -0.4

3.8

0.9 0.6 1.1 1.6

2.8

2.0 0.9

FX - TRADE WEIGHTED USD GBP EUR JPY

5.8

-4.9 1.3 0.2

19.2

5.5 7.5

-1.7 -0.6

-5

0.9

-5.5 -3.4 -0.5

-0.7

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

58.7

11.4

-22.1

-40

-20

EQUITY MARKET TOTAL RETURNS (LOCAL CURRENCY BASIS) Regions 1M local ccy (TR) 6.7

UK Europe ex UK USA Developed FTSE All-World Asia Pacific ex Japan BRIC Emerging Japan -0.3

-1

Regions 12M local ccy (TR)

5.5 5.3 4.7 4.4 3.8 2.5 1.4

7.9 7.5 7.4 7.1 6.7 5.8 5.7 5.5 5.3 5.0 4.7 4.1 4.0 3.4 3.1 3.0 2.5 2.0

0.3

-0.3

-2

10.6

Emerging 1M local ccy (TR) China Russia South Africa Brazil Emerging Taiwan Mexico Malaysia India Thailand Indonesia Turkey Chile -7.4

-8

-2

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

0.0

0.2

-10 0

58.7

31.4 28.7 27.0 25.8 25.7 25.4 24.6 23.2 22.7 22.4 21.2 19.7 17.9 17.7 14.0 10.8 9.7 9.3

10 20 30 40 50 60 70 80

Emerging 12M local ccy (TR)

-0.3 -0.9 -1.8 -2.9 -4.2

-4

14.8 7.4 3.8

Turkey Thailand South Africa Taiwan Malaysia Indonesia India China Emerging Mexico Russia Brazil Chile -12.1

4.2 3.3 2.3 1.8 1.4 1.2 0.6

-6

25.7 25.4 23.9 23.7 22.4

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

58.7

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

-15 -10

18.8 17.2 15.8 15.4 11.9 11.5 10.6 8.0 7.4 1.3 0.6 -3.3

-5

Source: FTSE Monthly Markets Brief. Data as at the end of July 2013.

SEPTEMBER 2013 â&#x20AC;˘ FTSE GLOBAL MARKETS

PERSPECTIVES ON PERFORMANCE Regional Performance Relative to FTSE All-World Japan Europe ex UK

US Emerging

Global Sectors Relative to FTSE All-World Oil & Gas Health Care Financials 130

Asia Pacific ex-Japan

130

Basic Materials Consumer Services Technology

Industrials Consumer Goods Telecommunications Utilities

120

110 110

100

90 80

70 60

80 Jul 2011

Nov 2011

Mar 2012

Jul 2012

Nov 2012

Mar 2013

Jul 2013

Jul 2011

Nov 2011

Mar 2012

Jul 2012

Nov 2012

Mar 2013

Jul 2013

BOND MARKET RETURNS 1M%

12M%

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

-0.7

UK (7-10 y)

-5.5 -3.4

0.9 0.6

Ger (7-10 y) Japan (7-10 y)

-0.5 0.9

0.7

France (7-10 y)

2.8

1.1

Italy (7-10 y)

19.2

1.6

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

2.5

Euro (7-10 y)

4.4 6.4

1.2

UK BBB

5.5

2.0

Euro BBB

7.5

0.9

UK Non Financial

1.8

Euro Non Financial

2.3 3.9

0.9

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

2.0

1.5

-1

-10

-5

BOND MARKET DYNAMICS – YIELDS AND SPREADS Government Bond Yields (7-10 yr)

Corporate Bond Yields

Japan

Ger

France

Italy

UK BBB

8.00

Euro BBB

8.00

7.00

6.00 6.00

5.00 4.00

5.00

3.00

4.00

2.00 3.00

1.00 0.00 Jul 2010

Jan 2011

Jul 2011

Jan 2012

Jul 2012

Jan 2013

Jul 2013

2.00 Jul 2008

Jul 2009

Jul 2010

Jul 2011

Jul 2012

Jul 2013

Source: FTSE Monthly Markets Brief. Data as at the end of July 2013.

FTSE GLOBAL MARKETS • SEPTEMBER 2013

MARKET DATA BY FTSE RESEARCH

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

130

125

120

115

110

105

100

FTSE US

Jul 2012

Oct 2012

Jan 2013

Apr 2013

Jul 2013

Jul 2012

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

Oct 2012

Jan 2013

Apr 2013

Jul 2013

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

FTSE UK

FTSE US Bond

160

145

130

FTSE US

115

100

Jul 2008

Jul 2009

Jul 2010

Jul 2011

Jul 2012

1M%

Jul 2013

FTSE USA Index

5.3

-5

Jul 2013

49.2

13.8

49.7

40.6

0.0

-4.3

Jul 2012

7.8

-2.7

-0.1

Jul 2011

5Y%

6.2

1.0

-2

Jul 2010

6M%

3.9

6.7

FTSE USA Bond

Jul 2009

3M%

FTSE UK Index

FTSE UK Bond

Jul 2008

29.3

-2.3

-5

Source: FTSE Monthly Markets Brief. Data as at the end of July 2013.

SEPTEMBER 2013 • FTSE GLOBAL MARKETS

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