FTSE Global Markets by FTSE Global Markets

ROUNDTABLE: OPTIMISING COLLATERAL MANAGEMENT

ISSUE 74 • DECEMBER 2013/JANUARY 2014

Will tapering help high yield? Investors shift out of macro funds Time for an equities rotation? EM corporates find cost of funds rises Small is best for fund admin

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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); 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 PRODUCTION MANAGER: Lee Dove – Alphaprint T: +44 [0]20 7680 5161 | E: production@berlinguer.com PUBLISHING DIRECTOR: Christopher Maityard T: +44 [0]20 7680 5162 | E: chris.maityard@berlinguer.com FTSE EDITORIAL BOARD: Mark Makepeace (CEO); Donald Keith; Imogen Dillon-Hatcher; Chris Woods; Jonathan Cooper; Jessie Pak; Jonathan Horton OVERSEAS REPRESENTATION: Can Sonmez (Istanbul/Turkey) FINANCE MANAGER: Tessa Lewis T: +44 [0]20 7680 5159 | E: tessa.lewis@berlinguer.com EVENT SALES: Sharron Lister: Sharron.lister@berlinguer.com | Tel: +44 (0) 207 680 5156 SPONSORSHIP SALES: Veena Mistry: Veena.Mistry@berlinguer.com | Tel: +44 (0) 207 680 5154 RESEARCH: Fahad Ali: Fahad.Ali@berlinguer.com | Tel: +44 (0) 207 680 5154 Adam Benchehou: Adam.Benchehou@berlinguer.com | Tel: +44 (0) 207 680 5151 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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S THE EDITION went to press US equities rallied to new records after the US Federal Reserve Bank announced the beginning of the end of its QE3 stimulus programme, with a modest $10bn first reduction in its $85bn monthly bond purchases in January and further measured steps expected in 2014. It was a welcome Christmas gift. The consensus outlook for 2014 is that economic growth will pick up relative to last year: good enough news in itself. The question is: what will be the fiscal drag exerted by the United States and Europe on global performance over the year? Although economists are more optimistic than they have been for some years, the reality is that neither the US nor Europe have tackled their structural debt problem. As this issue highlights equities and high yield bonds look to be favoured in a year when QE tapering begins; and about time too. However, as our overview of the 2013’s benchmark Verizon bond issue shows, investors need to be selective and should be prepared for continued market volatility and a trend towards emerging market equities outperforming US and European markets over the year. While a full rotation back to equities and into emerging markets will not likely happen at full throttle in the first half of this year, it is clear that emerging and frontier market will see something of a return to past form; though caution is advised on those BRIC markets with elections (always destabilising) and remaining structural imbalances (Turkey and Russia come immediately to mind). In any case, QE tapering will most likely continue to contribute to volatility in the emerging market segment in the first half of this year. These themes and more are writ large in this year’s opening edition. In our extended asset servicing segment it is clear that all service areas are preparing for change; mostly driven by regulation and the realisation that the economics of business have changed and continue to evolve. Ultimately a new world order is taking shape where banks properly price and structure risk and administrative processes: asset gatherers of any time will have to live with the consequences of this change—some of which are outlined in this edition, others in subsequent issues through the year. Additionally, important market changing themes will continue to dominate the intellectual agenda in the first half of 2014: one is T2S, the other is collateral management. We’ve collated the views of leading market practitioners in these fields in special roundtable sections. Trading technologies also gets the same treatment as the market slowly turns towards a long awaited though muted uptick in equity market trading volumes. The technology infrastructure is there: we thought we’d reassure you of that fact. In a difficult year (aren’t they all?) we’ve also highlighted those firms and people who’ve over-achieved. As always in our 20-20 selection it is a curate’s egg of the hopeful, the hope-giving and the idiosyncratic. As you know by now we don’t hand out awards, but we hope you enjoy this year’s nod to some of the outstanding professionals of the last 12 months. As the second iteration of the Markets in Financial Instruments Directive (MiFID II) looks to spearhead another round of upheaval in the European trading landscape, it is clear that the joint themes of regulation and risk management will continue to be the watchwords for 2014. The post trade landscape continues to undergo significant change, with EMIR, T2S and the T+2 settlement initiatives increasingly impacting on markets. Taking all that into account, the year ahead looks to be both challenging and revolutionary. With so much change in the air, the greatest risk in Europe is the spectre of another period of weakening growth, bringing political risks to the fore once more, erode the strength of credit fundamentals and the reforms underway in the financial markets. Clearly an interesting year ahead.

Francesca Carnevale, Editor COVER PHOTO: Aquis CEO Alasdair Haynes. Photograph kindly supplied by Alasdair Haynes, December 2013.

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

CONTENTS COVER STORY

20-20: DRIVING A YEAR OF CHANGE

....................................................................Page 58 The close of 2013 hopefully marked a transition from the dank years following the 2008 recessions into the dog years ahead. Change looks to be a constant in the post recessionary period. The question is: will the next round of change be good for the markets or mark a continuation more of the same?

DEPARTMENTS

MARKET LEADER

NEW DRIVERS OF OUTSOURCED SERVICES.................................................Page 6

SPOTLIGHT

THE RISING COST OF FUNDS IN EMERGING MARKETS ........................Page 10

Regulation changes the rules of the game in alternative fund administration.

Emerging market corporates feel the pinch of reduced bank lending.

THE GROWING REACH OF THE ACTIVIST INVESTOR .........................Page 16 Andrew Neil looks at the swing shift in corporate governance.

IN THE MARKETS

BRAZIL: INVESTORS UPBEAT DESPITE GROWTH CONCERNS .......Page 18 Foreign investors back Brazil even though growth remains constrained.

TIME FOR AN EQUITIES ROTATION .................................................................Page 22 Is this the year for equities to make a genuine comeback?

NEW RULES FOR THE NEW NORMAL .........................................................Page 24

REAL ESTATE

Mark Faithfull explains why real estate is worth a second look.

THE RETURN OF RUSSIA’S RETAIL SECTOR .................................................Page 31 Real estate pick-up driven by mixed retail/leisure projects.

ASSET ALLOCATION

THE GROWING APPEAL OF MULTI-ASSET FUNDS.................................Page 32 Lyn Strongin Dodds reports on shifts in investor fund flows.

WILL HIGH YIELD COME INTO ITS OWN POST TAPERING? ............Page 34 Neil O’Hara thinks it might, as long as investors do not look for high gains.

DEBT REPORT

TILL DEBT DOES US PART....................................................................................................Page 36 David Simons reports on the signs of a new thaw on Capitol Hill.

VERIZON TOPS A YEAR OF MEGA-BONDS ......................................................Page 38 Verizon’s $17bn bond issue set a benchmark: can it be repeated?

RISK OUTLOOK

MEASURING THE IMPACT OF LCR..............................................................................Page 40 Tyler Peterson looks at the meaning of the liquidity coverage ratio.

SMALL AND BEAUTIFUL FUND ADMINISTRATION? ................................Page 42 Lynn Strongin Dodds looks at the stresses on larger fund administrators.

ASSET SERVICING

GUNSLINGERS DON TUXEDOS ......................................................................................Page 44 Managing the expectations of investors in hedge funds.

THE TURNING CIRCLE..............................................................................................................Page 46 New age securities lending.

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CONTENTS ROUNDTABLE

NEW APPROACHES TO COLLATERAL MANAGEMENT

..........................Page 49 The requirement to centrally clear OTC derivatives trades looks to be a big step change both for clients and service providers, as OTC trades move onto exchanges and the demand for collateral escalates. This roundtable outlines the new roles and solutions in the new collateral management service set.

20-20 NOMINATIONS

THE NEW LOOK EXCHANGE BUSINESS .......................................................Page 58 Newby exchange Aquis has big goals. Can it deliver?

THE COMMODITIES PLAY ......................................................................................Page 60 Barclays continues to mine opportunities in the commodities space

THE SLOW STEADY BURN OF IPOS

................................................................Page 61 Goldman Sachs continues to beat the IPO drum: who is listening?

VANGUARD TAKES POLE ON ETFs ..................................................................Page 64 David Simons explains how Vanguard upturned the ETF applecart

INFLATION BEATS A RETREAT IN UGANDA ..............................................Page 65 How a frontier market beat inflation down from 18% to 5.%

FINADIUM: THE SECURITIES LENDING PROPHET ..................................Page 66 Why data and analysis are key for effective securities lending

WHY SGSS IS LOOKING SOUTH FOR BUSINESS ......................................Page 67 Andrew Neil explains why SGSS has spread into Africa

LGIM’S STEP CHANGE ..............................................................................................Page 68 The quiet evolution of Legal and General Investment Management

LEADING THE NEW ISSUANCE PACK

............................................................Page 69 Morgan Stanley has been quiet of late, except in leading IPOs

INTEROPERABLY YOURS ........................................................................................Page 70 Will Diana Chan set the pace in Europe’s post trade space with EuroCCP?

GOODBYE TO THE TOMORROW MAN ........................................................Page 72 Ibrahim Dabdoub, CEO, NBK retires. We look at his legacy

DEFENSIVE APPROACHES TO EMERGING MARKETS ..........................Page 73 Why First State Investments takes the cautious view

TIM HOWELL FINDS EUROCLEAR’S NEW MOJO ....................................Page 74 Can Euroclear set the agenda of post trade services growth again in 2014?

INFORMATION MOSAIC AND POST TRADE TECHNOLOGY ..........Page 76 How to effectively expand high tech solutions

NASDAQ EXPORTS TECHNOLOGY ..................................................................Page 77 NASDAQ shows how exchanges can evolve in the new world order

NSD: RUSSIA’S NEW POST TRADE PLAYER ................................................Page 78 Setting a new standard in corporate governance

THE STRATE APPROACH ..........................................................................................Page 78 Expanding the South African trading infrastructure

SIX FACES UP TO MARKET CHANGE ..............................................................Page 79 How a discrete exchange network views the world

THE LAMBENT APPEAL OF EUROBONDS ....................................................Page 80 Deutsche Bank maintains its Eurobond issuance crown

SEB AND THE NORDIC SUBCUSTODIAN ......................................................Page 81 What now for sub-custody in a changing market

DATA PAGES 4

Market Reports by FTSE Research ..............................................................................................................Page 82

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

MARKET LEADER

REGULATION ENCOURAGES OUTSOURCING BY HEDGE FUNDS

Photograph © Beliksk/Dreamstime.com, supplied December 2013.

NEW DRIVERS OF OUTSOURCED SERVICES Outsourcing is not a new trend in the hedge fund world, but the fallout from the financial crisis has raised it to an unprecedented level. Administrators have had no choice but to seriously raise their post execution game in order to stay in the match. This means not only offering a wider breadth of services at a reasonable cost but also keeping abreast of the moving regulatory parts to ensure clients stay one step ahead. Lyn Strongin Dodds reports. UTSOURCING IS NOT easy given the flood of new rules that have and continue to emanate from the US and Europe. It is a seemingly bottomless pit of alphabet soup acronyms ranging from the AIFMD (Alternative Investment Fund Managers Directive) and EMIR (European Market Infrastructure Regulation) to FACTA (Fair and Accurate Credit Transactions Act), which requires the disclosure of confidential information about US clients to the Internal Revenue Service and Form PF (private fund), the part of the Dodd-Frank Act that permits US regulators to carry out

stress tests on managers’ portfolios. It also reflects the magnitude of the information challenge as it requires funds with at least $150 m of private investment to deliver as much as 1,600 data points per fund comprising portfolio, performance, investor and risk data. Multiply the task across other rules and it is no wonder that the costs to meet these various regulations have been prohibitive. The Cost of Compliance, a global survey of hedge fund managers, by KPMG International in conjunction with the Alternative Investment Management Association (AIMA) and the Managed Funds Asso-

ciation (MFA), found that the industry has already shelled out $3bn on meeting the compliance requirements. Breaking it down, the average spend of at least $700,000 for small fund managers, $6m for medium-size fund managers, and $14m for larger firms. The survey which canvassed 200 hedge fund managers representing more than $910bn in assets under management in North America, Europe and Asia, also revealed that hedge fund managers were spending anywhere between 5% and upwards of 10% of their operating costs on compliance technology, headcount and strategy. Regulation though is only one, albeit significant part of the drive to raise the operational bar. The other motivating factor is the institutionalisation of the industry. The larger players now account for almost half of all new money flowing into the sector, which by the end of the second quarter stood at $2.4 trillion globally, according to data provider Hedge Fund Research. They are a much more demanding group than the hedge fund’s traditional high net worth constituency. “There is a lot of focus on the regulations but investors as well as consultants have been at the forefront and there has been a real shift of power,”says Phil Masterson, senior vice president and managing director of SEI’s Investment Manager Services division.“They have been leading many initiatives including the push for greater transparency and risk management reporting.” For example, the Open Protocol Enabling Risk Aggregation (OPERA), spearheaded by Albourne Partners, was a collaborative effort involving investors (BT Pension Scheme Management and Utah Retirement Systems), hedge fund managers (Brevan Howard Asset Management and DE Shaw), and service providers (Citco and State Street’s International Fund Services). The aim was to create a standardised template for collecting, collating and communicating market risks within their portfolios.

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

Post-trade made easy

MARKET LEADER

REGULATION ENCOURAGES OUTSOURCING BY HEDGE FUNDS

Pat Hayes, senior managing director and head of hedge fund services Europe at State Street, says,“Regulation has been one of the biggest catalysts but the changing investor profile has also created a new landscape because they are looking for the same visibility and risk management systems that they have in the long only world. OPERA is part of that movement and it has driven an element of standardisation. The larger administrators though are able to cope with these new reports and better align hedge fund managers’ interests with the institutional investment community.” Against this backdrop, it is not surprising that hedge fund managers have been looking to share the burden and are following the well-worn path of outsourcing taken by their more mainstream long only counterparts. The main focus is on the middle office functions which are the links between trade information between hedge funds, executing brokers and prime brokers as well as custodians. Services range from trade processing to confirmation and settlement, affirmations, reconciliations, securities pricing, derivatives processing and valuation, collateral management and foreign exchange. It marks a significant shift in an industry which preferred to control everything in house. The KPMG study showed that AIFMD and FATCA were seen as the most difficult and the highest in terms of cost, time and need for external support. This translated into over two thirds of the respondents polled looking specifically for outside help to meet these two pieces of regulation. “If you look at our business in 2008 and 2007, most managers were mainly looking at the basic model of outsourcing of fund administration and transfer agency but today over half of our clients are looking at the full middle office,” says Andrew Collins, head of business development for EMEA at Citigroup’s alternative investment services division. “One reason is performance has been down and

managers want to move from a fixed to a variable cost and the other is the enormous number of regulations. They are looking for a partner to help them with the post execution piece.” Stephanie Miller, global head of Alternative Investment Services, JP Morgan, agrees adding: “Fund administration has definitely moved up the food chain to compliance reporting, ancillary services such as tax reporting and middle office outsourcing. Hedge fund managers will now typically retain 1% to 3% of their administration staff for the oversight piece.” She is seeing increased interest for the bundled package instead of buying stand-alone components. “I think one reason is because under AIFMD, hedge funds need a prime broker, depository and administrator. There is an overlap of services and managers can be more efficient if they have one entity who can offer end to end services.” The prime brokerage industry underwent a radical shift after the demise of Lehman Brothers and Bear Stearns, with hedge fund managers spreading the counterparty risk across the prime broking units of multiple investment banks, to avoid being trapped if one of their counterparty failed. By the end of 2009, most hedge funds were using five or more prime brokers, some even nine. This is a far cry from six years ago when HedgeFund Intelligence research showed that Morgan Stanley and Goldman Sachs ruled the European prime brokerage with a combined 48% of the region’s mandates. Today, Morgan Stanley and Goldman Sachs are still leading contenders but they also share the stage with Credit Suisse, JP Morgan. UBS, Deutsche Bank plus Citi, Barclays Capital and Bank of America Merrill Lynch. The custodians have also made their mark in this field which has led to concern over the meshing of the two offerings. Fund administrators are divided as to the extent with most believing that they are two distinct services. “I do not see any blurring,”

says Serge Weyland, head of regional coverage for North America and UK at CACEIS.“These are two separate functions even if some prime brokers have their own fund administration groups. Typically a hedge fund will also want an independent service provider from their prime broker due to pressure from their institutional client base.” Hayes slightly disagrees, believing there is “some blurring but where is does exist, it is complimentary because we are not competing in the same space. We are not providing leverage but enhanced custody which has an element of financing. We help hedge funds generate finance by lending their fully paid-for long securities via securities lending.” In fact, overall, the landscape of providers has not really changed since the financial crisis demonstrated by the crop of league tables on the market. The industry is still dominated by both the fund servicing arms of custodial and investment banks and a few sizable independent administrators. One reason is because only the larger players have the balance sheet and pockets deep enough to invest in the necessary state of the art technology and offer a wide ranger range of services at a time when fees for their services are being squeezed. Anecdotal studies suggest they have sharply dropped from 15 to 18 basis points of assets under management five to six years ago to 12 bp today. Marina Lewin, head of sales for asset servicing in the Americas and global head of sales for alternative investment services, BNY Mellon, though believes the opportunities have never been greater.“The industry has changed the way it looks at fund administration. It used to be a narrow range of services but today it is much wider encompassing frequent valuation, data management and reporting as well as middle office functions. For full scale provider like ourselves, we are being looked upon favourably because we can provide the whole package or a combination of services.” I

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SPOTLIGHT

WHY EM CORPORATES PAY MORE FOR LOANS

Photograph © Kheng Ho To.

Cost of funds in emerging markets rises Cordiant returns bolstered by absence of Western banks from emerging markets: funds step in T USED TO be that in the late 1980s and early 1990s, bank’s increased the cost of borrowing for riskier markets through higher spreads over interbank lending rates, or through a capitalisation of risk through higher project prices. In the early 1990s for example, if you were involved in a Build-Own-OperateTransfer capital goods projects in selected markets (say Turkey or Indonesia) you might expect to see the costs of these projects increase by as much as a third over the typical cost of the same project in (for instance) the United Kingdom. These days, the perception of increased risk in lending to emerging markets (added to the ultra-conservative lending programmes now imposed on banks by Basel III) has

meant that spreads on lending to corporations in the emerging markets are still 30% higher than pre-financial crisis levels, according to Cordiant, the emerging market private debt fund manager. “The continued absence of Western banks from many syndicated loans in the developing world is driving an expansion of lending spreads at Cordiant,” concedes the lender in an official release. In its 2013 Annual Review, Cordiant says that the shortage of Western bank lending means it was able to achieve an average spread that was approximately 30% higher on new loans written by its CELF III fund during the last year, compared to the average spread on loans written by the fund manager prior to the credit crisis. The trend continues to an even greater

degree on loans Cordiant is writing for its CELF IV fund. Cordiant says that the supply of lending to emerging market corporates has been affected by the withdrawal of European banks in particular. The continued pressure from bank regulators in Europe means that many traditional lenders into the emerging markets still have to build up capital rather than increase lending. Only two of the Top 20 syndicated lenders to emerging markets in 2012 were European banks. Prior to the credit crunch, 11 of the Top 20 emerging market syndicated lenders were European banks. David Creighton, president and chief executive officer of Cordiant, says: “Many big Western banks, especially the Europeans, have been forced to step back from lending in emerging markets. This has reduced the supply of lending, while demand for medium to long term funding remains high. The loan spreads secured by Cordiant in recent years are a testament to how rewarding it can be for private lenders to step into that lending gap.”

Floating rate debt Cordiant adds that emerging market bonds, which until earlier this year had attracted record interest, have lost favour amongst investors as speculation continues over how rising global interest rates will impact fixed income debt. This turn in market sentiment has seen more investor interest in floating rate debt, like private debt, which provides a hedge against rising interest rates and inflation. Says Creighton: “A lot of institutional investors now feel that the balance of risk and return offered by emerging market bonds is no longer attractive for them. Yields were pushed too low by the bull market in EM bonds and, although yields have risen since May, investors see less volatility and more value in senior floating rate debt. This is one reason why we’ve welcomed a number of new investors to the class into Cordiant’s new CELF IV emerging

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

SPOTLIGHT

MOODY’S FRETS OVER DUTCH RMBS

market private debt fund over the past two years.” Cordiant reached a $250m first close on its CELF IV fund in April 2013, and is continuing to raise funds. Demand for lending in Cordiant’s target markets has been strong and that deployment of the fund is comfortably in line with its plans. Earlier this summer, asset manager announced loans to LOMC, a leasing business in Sri Lanka, and CAEPCO, the largest private electricity generator in Kazakhstan. A number of further deals have been finalised since then. Cordiant’s earlier CELF III fund wrote three new loans with a total value of $40m during the past year. At the end of 2012, the fund’s assets totalled $406m across 41 loans to 39 emerging market businesses in 18 countries and 17 sectors.

Moody’s concerns over Dutch RMBS market Dutch RMBS 60+ day delinquencies increase in September 2013.

LCH.Clearnet launches clearing for 187 single name CDSs Photograph © Kheng Ho To/Dreamstime.com, supplied December 2014.

Extension provides CDS portfolio margining benefits

UTCH RESIDENTIAL MORTGAGE-backed securities (RMBS) deals in the threemonth period ended September 2013 recorded a sustained increase in 60+ day delinquencies, according to the latest indices published by Moody’s Investors Service. On a year-on-year basis, the 60+ day delinquencies recorded an increase to 0.91% of the current balance in September 2013, from 0.71% in September 2012. The cumulative defaults increased to 0.35% of the original balance in September 2013, from 0.31% in September 2012. The cumulative losses remained stable, widening slightly to 0.08% in September 2013 from 0.06% in September 2012. As of September 2013, the Dutch RMBS transactions rated by Moody’s had an outstanding pool balance of £245.9bn. This balance represents an annual decrease of 14.7% compared with the outstanding pool balance of £288.3bn as of September 2012. Currently, the Moody’s-rated Dutch RMBS portfolio comprises 120 outstanding transactions. In terms of rating actions, Moody’s confirmed 18 notes, upgraded one

CH.CLEARNET HAS expanded its credit default swap clearing (CDS) service, CDSClear, to offer single-name CDS clearing. European members and clients can benefit from efficiencies through risk offsets between 187 single-names and existing index products through Monte Carlo Simulation Value at Risk (VaR) based portfolio margining. According to Bill Stenning, managing director, Clearing, Regulatory and Strategic Affairs, Société Générale, “Portfolio margining is a key benefit of clearing for us, so we welcome the extension of single-names to CDSClear’s already broad product set. The significant increase in the availability of European single name instruments eligible for clearing will undoubtedly be well-received by all market participants.” Gavin Dixon, global co-head fixed income clearing, BNP Paribas adds: “CDSClear’s launch, which delivers a wide array of single-name products, complements their existing index offering and provides our clients with the opportunity to clear their European CDS instruments on an individually segregated, portfolio margining basis.”

Investment strategy The diversification is integral to Cordiant’s investment strategy. “One of the most important ways we mitigate risk is by ensuring that none of our funds contain excessive exposure to a single sector or country. This is an important advantage that private debt investing holds over the bond market where, in general, only the largest corporates can afford the cost of issuance. The result of this is the range of corporates and sectors represented in the bond market are necessarily restricted, which hampers an investor’s ability to prudently diversify,” explains Creighton. However, Cordiant remains cautious about the margins offered by loans to businesses in the more developed emerging market countries. Its CELF III fund has made no loans to Chinese companies. Adds Creighton:“We have been underweight in China for several years. Not because we have any lack of faith in China’s growth—in fact we think that China is going to continue its amazing success story—but simply because China is so well supplied with banks and other funders that there weren’t the lending margins that we wanted.”

note and downgraded three notes in 11 Dutch E-MAC RMBS. In addition, Moody’s confirmed the ratings of E-MAC NL 2005-I B.V. notes following evidence of reduced counterparty exposure. Moody’s outlook for Dutch RMBS collateral performance remains stable. Moody’s forecasts a 0.2% increase in Dutch GDP for 2014, and the rating agency expects the unemployment rate to rise to 8% in 2014.

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

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SPOTLIGHT

MERCER RESPONDS TO UK PENSIONS CONSULTATION

‘Comply or explain’ approach to AMCs ensures better workplace pensions, says Mercer Government intervention on disclosure of charges and standard definitions is ‘positive’

Photograph © Norbert Buchholz/ Dreamstime.com, supplied December 2014.

ONSULTING FIRM MERCER has advocated a ‘comply or explain’ approach, combined with a 0.75% base cap, to Annual Management Charging (AMC) in the company’s response to the UK’s Department for Work and Pensions (DWP) consultation on ‘Better workplace pensions: a consultation on charging’. Mercer believes that other approaches mooted by the DWP, such as simply capping AMCs at 0.75% or 1%, risks putting more innovative products out of reach of schemes. The consultancy believes the flexibility that ‘comply or explain’ provides is needed to ensure that schemes can access products that increase certainty and improve outcomes for pension scheme members. According to Brian Henderson, Leader for Mercer’s DC and Savings

business,“Certainty, in terms of reducing volatility, is crucial. Solely focusing on an AMC cap will potentially undermine schemes’ ability to provide some degree of certainty to members. DC schemes, for example, have, in recent years, used diversified growth funds (DGFs) to gain access to broader active asset allocation, alternative investments as well as active management and allocation. DGFs tend to be more expensive than low cost passive arrangements which do not incorporate these features but they do contribute to increased certainty.” “Placing a cap on charges might push products like these out of reach of schemes to the detriment of savers,” he adds, explaining that in recent periods of market turmoil, DGFs have been successful in preserving members’ assets.“They are less volatile than equities. They may lag during bull markets but they are often much less affected by bear markets than equities. Longer term they should also improve the chances of avoiding poorer outcomes at retirement. Sometimes, it is simply worth paying for this sort of quality. We are urging the DWP to retain some flexibility and focus on value for money, not just cost,” he says. The UK government is also consulting on whether disclosure of charges is a positive step for the industry. Mercer strongly supports the use of standard and consistent definitions for terms such as the Annual Management Charge (AMC) and Total Expense Ratio (TER). “There should be full and complete disclosure of all charges to trustees, employers and governance committees,”says Henderson.“We do question the logic of extending such detailed disclosure to scheme members in default funds, however. If members become focused solely on cost and sideline other factors like value for money, then it could lead to greater levels of opt-out. As a compromise, the government might consider the provision of simple, visually creative

and succinct information—similar to energy ratings on electrical appliances. This would give consumers a clear guide but ensure that costs are not the only factor that is taken into account when making a purchase.” Mercer has also raised concerns over the timings proposed in the consultation. “The DC market is already stretched to capacity dealing with Auto Enrolment and with legacy schemes following the OFT’s review,” explains Henderson, “ If providers are asked to re-price thousands of DC plans, there is a risk that Auto Enrolment will not be properly implemented and existing arrangements will be put at risk. We therefore favour a longer and more phased transitional period.”

FATCA registration update IRS reminds financial institutions about registration procedures HE US INTERNAL Revenue Service (IRS) has released new guidance on the FATCA financial institution registration. The updated guidance reminds financial institutions of the different steps to take on the web portal in order to register and obtain a Global Intermediary Identification Number (GIIN), as well as the timeline, as originally announced in their Notice 2013-34. With regard to payees that are a Reporting Model I financial institutions, it is confirmed that verification of a GIIN is not required for payments made before January 1st 2015. As a consequence, such entities will not need to register or obtain a GIIN until on or about December 22nd 2014 to ensure inclusion on the IRS FFI list by January 1st 2015. In addition, it indicates that the IRS and the US Treasury Department anticipate publishing the final FFI agreement before January 1st 2014 and the final QI, WP and WT agreements in early 2014. I

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

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IN THE MARKETS

APPROACHES TO REMUNERATION & CORPORATE GOVERNANCE

Attitudes have moved on from the idea that corporate governance is a box-ticking exercise designed to placate clients or consultants, while actually achieving very little. If anyone still thought that way, last year’s Shareholder Spring showed the reality to be very different. Andrew Neil looks at the swing shift.

THE GROWING REACH OF THE INVESTOR ACTIVIST A

WAVE OF INVESTOR activism in the US and Europe, led by institutional shareholders, resulted in protests over pay awards for top executives at several big public companies, and in some cases overturned them. An unprecedented number of businesses were held to account for poor practice, mainly over salaries. Investors ousted a few chief executives, and board members also came under fire. Legal & General Investment Management (LGIM) emerged as a noted leader of the activist upsurge. Sacha Sadan, the firm’s director of corporate governance was often cited as the architect of the movement; his team opposed management resolutions at some 76 companies between April-May 2012 alone, voting against remuneration resolutions at 126 UK companies through the 2012 calendar year. One year on and signs are that firms look to be listening to activist shareholders. Recent surveys point to remuneration committees taking notice of the ever-increasing focus on executive pay. Nearly a third of FTSE100 companies have chosen not to raise basic salaries for directors so far in 2013, finds a recent survey by FIT Remuneration Consultants while the average pay increase was around 2.5%—roughly in line with inflation. Yet, in many ways, the success of the shareholder spring sowed a new misunderstanding. The misconception was that corporate governance was all

about pay, and the chance to make high profile stands against executive pay. In reality, the role of corporate governance has evolved and now has a wider remit than ever. “We think that corporate governance should act as a voice of sanity in an increasingly complex business environment,” says Sadan. “After all the progress, this does not make now a time to relax. The pressures that have led to greater political involvement and corporate readiness to engage are not going to fade. The role we play in corporate governance has changed enormously. “Obviously pay remains an important factor, a particular focus for us is linking director pay with performance,” he continues.“But companies have the best chance of growth by focusing on a number of key factors. There have been a number of real improvements across a range of areas.” Help now comes in many forms. Current engagement topics for Sadan’s team of eight professionals include diversity, environmental issues, succession planning, cyber security, auditors and regulation.“Investors want us to do more to improve company performance and, in general, companies want to engage and have more supportive shareholders,” he adds. “While we are not claiming that everything in the corporate world is perfect, there have been a number of real improvements across a range of areas, and we know that we can continue to work to improve the corporate landscape.” Perhaps the most crucial element of

all is board structure and effectiveness. A company is only as effective as its governing board, an issue which Sadan and his team have addressed one that bears repeating. “We have seen significant improvements in board diversity and engagement, but there is still further to go. We are increasingly focused on effective board reviews; improving the disclosure on reviews and greater transparency around how boards plan to tackle the action points highlighted by reviews,” he says. As well as being UK’s largest index fund manager, Legal & General also offers a boutique approach to actively managing equity portfolios, meaning it sits on two sides of the same coin when it comes to corporate governance. Passive managers are increasingly being urged to recognise a special responsibility to the index they track, while in the active equity business, corporate governance and engagement have traditionally been components of the investment process. “Investors’ perception of corporate governance is changing as the function continues to evolve,” explains Sadan. “In the past, investors used specific funds to filter or remove companies engaged in certain activities. What we find today, however, is that a majority of our clients want to know how companies’ activities can impact their main investment portfolios. Clients expect us to assess the risks and bring pressure on companies to change where necessary. The ultimate purpose is to enhance the overall long-term performance of our funds.” I

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

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

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ĂŶĂůǇƐŝƐ ŝŶƚŽ ĂĐƟ ŽŶ

IN THE MARKETS

BRAZIL REMAINS UNDER PRESSURE Economic meeting between Brazil and France. During his state visit to Brazil, President Franois Hollande and President Dilma Rousseff reinforce the strategic partnership between the two countries with the signing of several cooperation agreements. The Franco-Brazilian Economic Meeting was sponsored by the Federation of Industries of the State of Sao Paulo, at Avenida Paulista, west of Sao Paulo, southeastern Brazil, on December 13th 2013. Photograph by Nilton Fukuda/Estadao Conteudo. Photograph supplied by pressassociationimages.com, December 2013.

Investment inflows continue despite economic woes Having bounced off its July bottom, Brazil’s Bovespa index nevertheless remained under pressure during the latter part of 2013, as the country’s reduced growth expectations and persistent inflationary conditions weighed on equities. Surprisingly, the downturn has yet to have a measurable impact on foreign investment flows to the region. Will the trend continue into the new year? Dave Simons reports from Boston. OR YEARS LATIN America, and Brazil in particular, has remained a prime target for foreign investment flows, evidenced in part by consistently robust depositary receipt

F 18

activity (last year Brazil accounted for nearly three-quarters of all regional DR business, according to figures from JP Morgan). In recent times, however, changing market conditions have

weighed on core commodities such as coffee, soybeans, iron ore and crude oil, while lower growth, rising inflation as well as brighter prospects in the US and elsewhere continued to hamper Brazil’s forward momentum. This was particularly evident during 2013, which saw Brazilian equities beat a hasty retreat, sending the country’s benchmark Bovespa index down 35% mid-summer. In an effort to support the Brazilian real and shore up investor confidence, in July the government opted to lower the country’s so-called tax on financial transactions (IOF) to zero. In the past, inflationary concerns over foreign fund inflows have led to sudden and dramatic jumps in the IOF, including a tripling of the rate from 2% to 6% over a twoweek period. Simultaneously, Brazil’s central bank monetary policy committee, Copom, embarked on a tightening campaign that saw the benchmark Selic move from just over 7% to a high of 10% by year’s end. With inflation subsequently falling nearly 100 basis points in response, the government will likely begin to ease following one last possible hike in January, concurs Marcelo Salomon, a Barclays Capital economist. Even so, in December Barclays reduced its current-year and 2014 GDP expectations for Brazil to 2.2% and 1.9% respectively—a far cry from the 7.5% halcyon days of 2010. To many, a resurgent US economy, coupled with lower GDP in developing countries as a whole, poses perhaps the strongest threat to continued foreign allocations. As the US gradually moves toward a more normalised monetary environment, capital flows into Brazil and other emerging nations could conceivably taper in lockstep. An October estimate by the Washington, DC-based Institute of International Finance puts the privatecapital emerging-markets decline at $1trn for the coming year, down from $1.2trn last year. At a November discussion on the economic outlook for Latin America,

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

Lisa Schineller, managing director, sovereign ratings and Latin America economist for Standard & Poor’s Ratings Services, said that growth within Brazil as well as throughout the region will likely remain below pre-US recession levels in the coming years, consistent with the subdued forecasts for other emerging regions. Wider bond yields and depreciating currencies are expected to prevail, says Schineller, particularly as monetary policy in the US normalizes. The overriding message, says Schineller, is for “more volatility in-market.” Despite calls for a foreign-fund pullback, non-domiciled investors don’t appear to be heading for the exits just

yet: to date, inflows have actually outpaced last year’s levels, even in the face of negative market sentiment.“Bottom line, there is still a lot of investor interest in the market,”remarked Schineller. Historically, non-resident holdings of domestically issued central-government debt have tended to increase in response to improvements in local market fundamentals. This has been particularly noticeable in Brazil in the wake of the IOF tax elimination, says Schineller. While the market will undoubtedly experience further ebbs and flows, sustained non-resident investor interest could help offset any volatility, says Schineller, at least in the short term.

Alexander Gorra, senior strategist at BNY Mellon’s ARX asset-management division in Rio de Janeiro, has also witnessed a rise in foreign participation in Brazilian domestic debt. “Even with the presence of the IOF tax, the level of involvement has more than tripled, from a 2007 rate of 5.1% to 16.9% in 2013.”Key to this trend, says Gorra, has been the government’s changing attitude toward foreign direct investment flows.“There was a time when the need just wasn’t there,” says Gorra, referring to the country’s prolonged period of accelerated GDP. Rising account deficits, higher inflation and, above all, lower growth projections have reduced Brazil’s capacity to remain largely self-

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FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

IN THE MARKETS

BRAZIL REMAINS UNDER PRESSURE

sufficient. “As a result, the country is now very much dependent on having these financial flows in order to maintain stability,” says Gorra. While further turbulence may lie ahead, given the existing economic outlook investors are not likely to run afoul of sudden IOF spikes any time soon. “Some of the measures in the past were partly in response to overarching trends in the global economy,” says Gorra.“However, given the importance of equity and fixed-income flows and issuance in particular post-IOF, I think the government understands the importance of re-building credibility among investors. So I think those kinds of moves will not be an impediment going forward.” Despite the recent turmoil, from a micro perspective Brazil seems to be taking things in stride—the odds for a second term for President Dilma Rouss-

Alexander Gorra, senior strategist at BNY Mellon’s ARX asset-management division in Rio de Janeiro. Gorra ways he has a witnessed a rise in foreign participation in Brazilian domestic debt. “Even with the presence of the IOF tax, the level of involvement has more than tripled, from a 2007 rate of 5.1% to 16.9% in 2013.” Photograph kindly supplied by BNY Mellon, December 2013.

eff appear strong at this juncture, with other centrist parties yet to gain any real traction.“Some of this has already been built into the financial markets,” acknowledges Gorra.“While we are cer-

tainly looking at a relatively lowergrowth, higher-inflationary picture moving into 2014, that still doesn’t mean a blanket negative for the markets and specific sectors as a whole.” I

HOW BRAZIL COMPARES WITH OTHERS: G20 GDP GROWTH PICKS UP TO 0.9% IN Q3 2013, SAYS OECD

UARTERLY GROSS DOMESTIC Product (GDP) in the G20 area grew by 0.9% in the third quarter of 2013, up from 0.8% recorded in the previous quarter, according to preliminary estimates. Among G20 economies, China recorded the strongest growth at 2.2%, compared with 1.9% in the previous quarter, followed by India where GDP growth accelerated to 1.9%, compared with 1.0% in the previous quarter. In Indonesia and Korea GDP growth was unchanged at 1.3% and 1.1% respectively. In the United States, the United Kingdom and Canada, GDP growth accelerated to 0.9%, 0.8% and 0.7% respectively, compared with 0.6%, 0.7% and 0.4% in the second quarter. In Mexico, GDP grew by 0.8%, rebounding from a contraction of 0.5% in the previous quarter,

while in Italy, GDP was unchanged on the previous quarter, after nine consecutive quarters of decline. Economic activity in Brazil by comparison remains challenging. As measured by the central bank’s IBCBR index, the economy contracted by more than expected as 2013 closed, and despite a late surge at the end of the year in retail sales, the country’s hopes of a modest recovery in the economy by year end were dashed. The economy won’t be helped either as the central bank is expected to keep on raising interest rates to keep a check on inflation. GDP growth has slowed but remains robust in Turkey (0.9%) and slowed marginally in Australia (0.6%). In Germany and Japan, quarterly GDP growth retained the relatively erratic profile seen in recent quarters, slowing down to 0.3% in

the third quarter from 0.7% and 0.9%, respectively, in the second quarter. Similar volatility continued in South Africa, where GDP rose by 0.2%, down from 0.8% in the previous quarter. In Brazil, GDP contracted by 0.5% in the third quarter of 2013, the first contraction since the first quarter of 2009, which may in part reflect the outstanding growth (1.8%) recorded in the previous quarter. Also in France, GDP contracted by 0.1%, compared with 0.5% growth in the previous quarter. Compared with the same quarter of 2012, GDP for the G20 area expanded by 2.9% in the third quarter of 2013, up from 2.5% in the previous quarter. Among G20 economies, China recorded the highest growth rate (7.8%) and Italy the largest contraction (minus 1.8%). I

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

IN THE MARKETS

US STOCKS IN HIGH GEAR: BUT FOR HOW LONG?

Undeterred by political discord, changing monetary policy and various other pressures, US stocks closed out the year in high gear, as the major indices registered their biggest gains since the gogo late ’90s. Will positives like rising real-estate valuations and increased IPO activity continue to support equity inflows? Dave Simons reports from Boston.

TIME FOR AN EQUITIES ROTATION? HAKING OFF A bond-bruising rise in interest rates as well as a self-inflicted financial wound stemming from October’s government shutdown, the US equity markets lurched forward during 2013, a year that saw the Dow tack on some 3000 points year-to-date. While perhaps a bit too early to call it a full-fledged fixed-income rotation, more money has been moving into equities than anytime in the recent past, with the potential to continue the trend into the new year, according to some observers. Entering the final two weeks of 2013, US equity benchmarks had gained nearly 26%, its best showing in 16 years. Re-adjusted price-earnings multiples, a reflection of the market’s overall consistency and base of economic support, has been a primary driver during the current run, suggests Boston-based MFS Investment Management. Cyclical earnings have generally outpaced those within defensive sectors, says MFS, consistent with an economy in expansion mode.“Furthermore, the trend of weak revenue growth accompanied by decent earnings has started to improve on a year-over-year basis.” Returns in 2014 are likely to remain positive—if somewhat subdued by 2013 standards—however the pace of earnings needs to continue in order for the markets to sustain their current trajectory, particularly as the Fed begins to taper, says MFS. To some, the arrival of millennium year number 15 signals a good time to reap rather than sow. Others, however, see a continuation of the supportive elements that took the Dow across 16,000 and believe there may be more to gain than lose in the months ahead. After a three-year pullback, global

growth is likely to accelerate in 2014, says Simon Webber, lead portfolio manager of global and international equities for Singapore-based Schroder Investment Management, who sees full-year global GDP cresting at around 2.9%. “We expect this improvement to be driven by Western economies, with Europe and the US both growing faster than in 2013,”says Webber. Particularly as the growth and policy environment begins to stabilise,“markets will naturally lengthen their investment horizon and should therefore increasingly focus on companies’ long-term growth prospects,” reasons Webber. Additionally, the level of market resilience and breadth of economic recovery makes it less likely for macro shocks to unhinge equities, adds Webber. “Note the far more muted market response to the US budget and debt ceiling crisis in 2013, compared to 2011,” he says. Despite the numerous upward indicators, many watchers still perceive some signs of skittishness. Commenting on November’s Bank of America Merrill Lynch Fund Manager Survey, Michael Hartnett, chief investment strategist for the firm’s Global Research division, calling the current crop of domestic investors“reluctant bulls.”Said Hartnett:“Who would have thought alltime highs in US stock prices would coincide with high cash levels?” Webber offers a similar assessment. As a percentage of GDP, gross fixed capital formation remained relatively muted for much of the year, a sign that consumers and businesses were not yet totally sold on the economic recovery. Continued corporate cautiousness means that “companies have been reluctant to invest, despite the fact that large company balance sheets are generally still very healthy,” says Webber.

Nicholas Colas, chief market strategist at ConvergEx Group, the New York-based global brokerage firm, says that the ghosts of 2007-2008 are at least partly to blame. “Want to know why Google searches for the terms ‘investing’, ‘stocks’ and ‘business news’ are at five-year lows even as the US stock market is at all-time highs? Because the intense pain of that tumultuous period lingers in the memory of individuals who would otherwise have made excellent returns by staying invested in the market which had hurt them so badly. Once bitten, twice shy— once bitten really, really hard—a thousand times shy.” Though not nearly the factor it was earlier in the year, the timing and level of Fed tapering remains a key driver of activity as 2014 unfolds, says Christopher Kearns, deputy chief executive officer for BNY Mellon’s depositary receipts business. “Clearly we are looking at the beginning of the end of the QE movement, and that will bear watching going forward.” Even so, the most recent round of economic data—including November’s unusually strong non-farm payroll report, which saw US unemployment drop to a five-year low of 7%—has helped give companies the courage to start putting their cash back to work, remarks James Slater, head of securities finance for BNY Mellon’s Global Collateral Services business.“This most recent [4th] quarter marked one of the more resurgent periods for IPO activity,” says Slater. “While there haven’t been many actual announcements yet per se, already we’re hearing about firms working with their clients in preparation of potential M&A deals in the making. Whether or not all of this actually materialises remains to be seen” I

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

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REAL ESTATE

A BETTER FORM OF MARKET POLARISATION

Photograph © Michael Brown/Dreamstime.com, supplied December 2014.

New rules for the new normal While caution may remain the watchword, there is little doubt that the global real estate investment industry goes into 2014 in considerably better shape than it entered this year. Polarisation continues to be an ever-present issue—those holding prime Grade A offices, industrial, residential and retail in the hottest locations are sitting pretty; those with tertiary assets in low or downward growth geographies may only ever see their investment values decline. Global opportunities are less black and white. A host of emerging markets beyond the BRIC countries could be the next generation of major growth drivers, while cross-border transactions are also fuelling pancontinental alliances, says Mark Faithfull. N THE NEW normal, nothing is quite as it was. Industrial real estate —once the unglamorous property backwater—is now being sexed up by the unfaltering growth engine of e-commerce. Not for sheds the competition between bricks and clicks, but an agnostic world where whether the space requirement is from an online retailer or an omni-channel one it is all space incremental. In the new

normal, people are talking about Africa, not India. In the new normal, the key cities are as likely to be Stockholm, Istanbul and Jakarta as they are Beijing, Moscow and Rio. In the new normal, some unexpected sectors and locations could catch next year’s headlines. Olaf Schmidt, global sector head of retail, real estate and hotel investments for IFC (World Bank Group) points to a

huge rise in global middle classes and massive urbanisation as the key factors transforming economic opportunities around the world and influencing these future trends. “We see the most dynamic opportunities around urbanisation in Latin America, the MENA region and sub-Saharan Africa,” he says. “We have identified the best countries for doing business based on transparency and demographic trends and in our research we already count 45 countries ahead of the BRICs regarding these factors.” Dr Ira Kalish, chief global economist at Deloitte, also points to some largely sidelined markets as those offering strong promise. “Mexico is back,” he says, pointing to the Central American country’s economic reforms and its proximity to the United States in terms of low cost manufacturing and supply chain potential. Kalish also cites the Philippines (notwithstanding recent events) as a country offering strong fundamentals. “The country was expected to grow rapidly after the Second World War but failed to deliver, but we feel it is now in a very strong position,” he says. Yet real estate opportunities are not only about the new world. In Europe, Moscow and Istanbul dominate the development pipeline for planned new space. Yet this year both cities have given jittery investors pause for thought. Most notably, the riots and protests in Turkey and the hardline stance taken by the government spooked some investors and despite the undoubted potential in the country, Turkey has not been a major success for a number of incoming businesses already, with strong local investment acting as a barrier to expansion. What property investors have been keen to avoid is risk, and the fact that it was the decision to turn Gezi, the only green park in central Istanbul, into a shopping mall and luxury apartment complex that triggered the ongoing revolt will not have gone unnoticed by those looking to set up shop in the country.

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

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REAL ESTATE

A BETTER FORM OF MARKET POLARISATION

For that reason Western Europe has remained an investment safe haven, although investors have been prepared to take decisive action. The INREV Fund Termination Study 2013 analysed 179 closed-end funds originally due for termination between 2007 and 2015, which together have a gross asset value (GAV) of €70.8bn. Approximately one third (€23.1bn) of the total GAV belongs to funds that are in extension already or will extend after 2013. But the study also showed that the location of assets held by investors is an important factor affecting termination decisions, with investors demonstrating a strong preference for Western Europe. Just four countries—the UK, France, Germany and Belgium—account for 57% of the assets of funds in extension. By comparison 52% of the assets being liquidated between 2007 and 2015 are in Southern Europe. “While most investors are still waiting for funds to recover from lacklustre performance during the economic downturn, our study shows that more investors are opting to liquidate poorly performing assets,” says Casper Hesp, director of research and market information, INREV. “There is a clear

preference for retaining assets in the stronger European markets.” The pick-up in European asset sales has provided an unprecedented inflow of capital from American buyers shifting to Europe to pick up distressed assets. Australian and Canadian pension funds have also increased their weight in European real estate assets and that trend looks set to continue in 2014. By contrast, Middle East watchers could be forgiven for feeling a sense of déjà vu at the current situation. This year, emirate Dubai has announced a flurry of projects reminiscent of the heady days of the mid-2000s. These include Mohammed bin Rashid City, which will include more than 100 hotels, a theme park and the world’s largest shopping mall, as well as a new artificial island valued at $1.6bn in construction costs alone. The announcements came amid a double-digit increase in passenger traffic through Dubai’s airport, taking the total number of travellers to more than 58m. Meanwhile, 19,000 new hotel rooms are expected to be added to the emirate’s stock over the next few years.

Photograph kindly supplied by Mark Faithfull, November 2013.

Dr Ira Kalish, chief global economist at Deloitte. Kalish points to some largely sidelined markets as those offering strong promise. “Mexico is back,” he says, pointing to the Central American country’s economic reforms and its proximity to the US in terms of low cost manufacturing and supply chain potential. Photograph kindly supplied by Deloitte, November 2013.

Neighbouring emirate Abu Dhabi has a similarly grandiose vision, which it is in the process of aggressively enacting. And Qatar has become increasingly vocal about its plans, as hosting the FIFA World Cup bolsters its infrastructure requirements, despite the justifiable controversy surrounding summer football and construction-site health and safety. Yet this phase of real estate expansion is happening with little outside money. While this is in part because of the incumbent wealth in the region, recent research by Mohammed Salem and colleagues from the School of the Built Environment at Liverpool John Moores University found that while there is a widespread perception that the region offered excellent demographics, high population growth, good GDP growth and a huge need for residential, retail and office real estate,“Their decision to invest in the region is affected by lack of transparency, finding local partners and lack of knowledge and research of GCC markets.”

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REAL ESTATE

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Related’s chief executive officer Ken Himmel. He says investors looking to follow Related’s lead need to be aware of the wide differences between local markets in the region. “There are very different things going on in different markets,” he says. “Dubai and Abu Dhabi are similar but have adopted a different approach to development. Kuwait and Bahrain have their own challenges. And Saudi Arabia is totally different.” Photograph kindly supplied by Related, November 2013.

One investor that has overcome these barriers is the US developer Related Companies, which formed a joint venture with Gulf Capital, a locally-based venture capitalist, under the banner of Gulf Related. It has just completed The Galleria luxury mall on Al Maryah Island in Abu Dhabi, and it will shortly begin work on an even more ambitious project, the 2.5m-sq ft Sowwah Central mixed-use scheme in Abu Dhabi. This will feature a 1.6 million-sq ft super-regional shopping mall alongside hotels, offices and residential. Related’s CEO Ken Himmel says investors looking to follow Related’s lead need to be aware of the wide differences between local markets in the region.“There are very different things going on in different markets,”he says. “Dubai and Abu Dhabi are similar but have adopted a different approach to development. Kuwait and Bahrain have their own challenges. And Saudi Arabia is totally different.” Instead, a number of investment houses have turned their attention to the sub-Saharan chunk of Africa largely ignored until now. Retail has led the development and funding pipeline, albeit at modest levels, and Michael O’Malley of Johannesburg-based RMB

Westport stress that there are significant opportunities in Africa, with its first development fund focused on Ghana, Nigeria and Angola. A second, $500m fund has been placed and they expect it to complete by the end of 2014, providing an investment chest of $1bn. “The first fund was primarily backed by US and Middle Eastern investors but there is a stronger European element for the second fund,” says

O’Malley. “We have six schemes coming out of the ground and Africa is a huge opportunity.” Persuading the international community comes back to risk. In the US that risk comes from the prospect of its recovery ending quantitative easing and inching interest rates upwards. Such moves would see money leave real estate for more traditional asset classes. In Europe risk profiles are moving away from the North-South divide and becoming more asset specific—which has been to the gain of Spain and Ireland in recent months— while in the emerging world this year’s Arab Spring has been a reminder of the uncertainty that political tensions and upheaval bring to long term development and investment. Was the bottom called during 2013? Almost certainly. Global real estate recovery is fraught with uncertainties and the market is not robust enough to brush off another serious economic jolt, but cross-border money flows and the ongoing urbanisation of the world population have encouraged mild confidence. Twelve months ago 2013 was called as 2012 part two. It has probably been a little more positive than that and may well have laid the foundations for a long overdue recovery.

Photograph kindly supplied by Mark Faithfull, November 2013.

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REAL ESTATE

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CROSSING BORDERS: FIVE IN THE SPOTLIGHT US/European tie-up: TIAA Henderson Global Real Estate In the summer TIAA-CREF and Henderson Global Investors announced the launch of a new global real estate investment management company, TIAA Henderson Global Real Estate, which will consist of TIAA-CREF’s European real estate business, Henderson’s European and Asia Pacific-based real estate businesses and a new global distribution and client service organisation. The combined total of real estate assets under management for TIAA-CREF and the new venture is $63bn. A joint board of directors will oversee the management team. TIAA-CREF will hold a 60% interest and Henderson a 40% interest in the new venture. The transaction is expected to close in the first quarter of 2014. In addition, Henderson was appointed as investment manager to AustralianSuper, the AUS60 billion Australian superannuation fund, which provided a mandate for its emerging UK retail property strategy. The mandate is part of a wider global strategy for AustralianSuper, which recently announced a direct international programme which aims to significantly grow its global property investment portfolio over the next five years. Growth platform: CBRE Global Investors In 2011, CBRE acquired substantially all of the ING Real Estate Investment Management (ING REIM) operations in Europe and Asia from Netherlands-based ING Group, as well as Clarion Real Estate Securities (CRES), its US-based global real estate listed securities business. The acquired operations have been merged with the company’s existing real estate investment management business, and the combined

business now operates as CBRE Global Investors. After two years of amalgamating those businesses, CBRE Global Investors has been appraising its portfolio and acquiring new assets and is likely to become an even big player in retail especially during 2014. Europe to the US: Norwegian Pension Fund Global In February, the Norwegian Pension Fund Global made its first real estate investment in the US, buying almost 50% of five office properties owned by TIAA-CREF. The fund bought a 49.9% stake in the properties, based in New York, Washington DC and Boston, valued at $1.2bn. As part of a joint venture with TIAACREF, the Norwegian fund will look to acquire additional office properties primarily in the three cities. “This is the fund’s first real estate investment outside of Europe and is in line with our strategy to build a high-quality, global property portfolio,” said Karsten Kallevig, chief investment officer for real estate at Norges Bank Investment Management at the time of the deal. “As the world’s largest real estate market, the US will be an important part of the fund’s longterm property portfolio. We will initially seek to invest in key eastcoast cities.” The fund made its first real estate investments in 2011 in office and retail properties in London and Paris. It is mandated to hold 60% in equities, 35-40% in fixed income and as much as 5% in real estate. US into Europe: Blackstone Blackstone Group’s real estate unit is restructuring Dutch retail specialist Multi Corp and having taken full ownership of the debt-laden European mall developer in October, will use it as an engine for European growth. Blackstone, the biggest

manager of private-equity property funds, amassed more than 90% of Multi’s €900m of corporate debt and a similar share of its equity, despite resistance from the Multi board, before the takeover. The New York-based firm bought the rest of Multi’s loans and stock from a German lender and Blackstone plans to forgive the debt and use Multi to acquire shopping malls and other retail properties across Europe. Blackstone believes Multi is in a position to capitalise on a wave of retail property sales triggered by Europe’s ongoing economic issues and Multi would also give Blackstone exposure to the Turkish market. African emergence: Atterbury Atterbury operates as a joint-listed fund and as a developer and as the latter the first mega-mall in South Africa will open in late 2015 or early 2016 with two levels of retail, five African-themed zones and the first H&M in the country. The 120,000 sq m Mall of Africa is the largest single phase mall to be developed in South Africa and has been financed by Nedbank Corporate Property Finance. The new super-regional Mall of Africa will be the heart of the ambitious Waterfall, a new city situated in the busy channel between Johannesburg and Pretoria. The two-level mall forms the hub of Waterfall Business Estate, a 1.6m square metres large mixed-use commercial development undertaken by Atterbury, and the most ambitious commercial development yet undertaken in southern Africa. Atterbury is also one of a host of South African developers opening up new malls in other parts of Africa, as an emerging middle class and ambitious South African retailers have encouraged the creation of shopping centres around the continent. I

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

RUSSIA: SHOP TILL YOU DROP N THE FIRST nine months of 2013, 30 shopping centres opened across 22 cities in Russia, adding a cumulative 787,000 square metres (sq m) out of the 3m sq m that were due to be opened according to original development plans. In contrast with last year, however, most of that space will be delivered albeit with slight delays. In particular, a small decrease in new shopping centre delivery in capital Moscow during 2012-2013 will be more than compensated by some very distinctive openings in 2014, including Avia Park Shopping and Entertainment Centre, which will become the largest mall in the world outside Asia when the 225,000 sq m Gross Lettable Area (GLA) project completes in the fourth quarter of 2014. Meantime, Amma development’s four-level shopping centre is being constructed by Turkish-based Renaissance Construction in Khodynskoe Pole, between two major Moscow highways: Leningradsky Prospect and Zvenigorodskoe Highway. It will include French hypermarket Auchan, home-furniture store Hoff, German electronics store Media Markt, German DIY store OBI and a flagship Debenhams from the UK. Also to open in Moscow in 2014 is Vegas Crocus City. The 108,000 sq m GLA scheme is located at Crocus City close to Moscow’s densely populated north-western district, which includes Mitino, Strogino and Severnoye Tushino, as well as the city of Krasnogorsk and the developing neighbourhoods of Krasnogorye and

Spassky Bridge. The total area of new housing in this area exceeds more than 1.5m sq m. The International Crocus Expo Convention and Exhibition Centre is also located in the vicinity. Julia Gordeyeva, senior analyst, Sberbank Investment Research, notes: “Russia’s commercial real estate market has staged a healthy recovery since the crisis, enjoying two years of record investments as foreigners, including specialist funds, have returned to the market in search of yield and inflation protection. Real estate assets continue to offer higher yields than deposits, high-grade Russian corporate bonds and sovereign bonds.” She also notes that Russia’s publicly listed real estate stocks performed well last year, with yields advancing by around a third on average, outperforming the RTS Index and European peers since the beginning of 2012. “Unsurprisingly, it is Moscow that still accounts for the bulk of investment flows,” she says. Fuelled by a population of 140m, it is currently Russia’s domestically driven economy that is providing the engine for growth. Gordeyeva adds: “We are seeing increasing numbers of opportunities to optimise low penetration investment levels across the sector.” While much of the finance for Russian real estate is incumbent, Russia is also beginning to attract outside investment again as international confidence returns and it is one of the core markets for Austrian-based Immofinanz Group, which says that the country has always offered good

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

RUSSIAN RETAIL COMES IN FROM THE COLD

Russia was undoubtedly hit by the loss in investor confidence post-2008 but for the past 12 months there has been a distinct change in the air. Projects that had been put on ice were mobilised and put back into construction, with definitive and real completion dates attached, and more schemes came to market. The stand-out sector has been retail, says Mark Faithfull.

investment opportunities.“Our investments in Russia have proven to be strong cash-yielding assets and have been very resilient, even in the crisis. And we do believe that the Russian market will keep evolving further—of course, depending on how the global and European economies develop,” says Immofinanz chief executive Eduard Zehetner. Immofinanz’s assets in Russia represented 16.3% of the company’s total portfolio as of the end of January and included six properties (five standing investments and one development) with a value of €1.71bn. Golden Babylon Rostokino in Moscow, with a GLA of 168,000 sq m, was opened in November 2009 and is the most profitable shopping centre in Immofinanz’s portfolio.

Mixed schemes Mixed retail and leisure schemes are also beginning to emerge as confidence returns to Russia. At the beginning of this year, the Regions Group signed an exclusive license agreement with DreamWorks Animation to build the largest indoor theme park in Europe. DreamWorks theme parks will appear in St Petersburg, Moscow and Yekaterinburg and the first is projected to open as early as 2015. Each one of the DreamWorks theme parks will be part of a huge complex also comprising a multi-functional movie and concert hall, a multiplex with an IMAX theatre, a shopping mall, a hotel, an area with gardens and parks, and 11,000 parking spaces. However, Gordeyeva says that despite such grand plans the investment and opportunity picture is not consistent across Russia, with some regional markets, such as Kazan and Samara, reaching average European saturation levels, limiting the scope for new projects to be successful. She reflects of the current situation: “Moscow’s retail and industrial markets represent the best value for now thanks to tight supply and low vacancy, while other areas, such as the office market, remain oversupplied.” I

ASSET ALLOCATION

MAC FUNDS: WHAT ARE THEY GOOD FOR?

Uncertainty over interest rates and the paltry returns from traditional government bonds has spawned a new collection of multi-asset credit (MAC) strategies and funds. Even the most conservative investors are hopping on board although there are limits to the chances they are willing to take. The good news is the current crop comes in many different risk-adjusted flavours. It is easy to understand why MAC funds have captured the imagination. Investors have been on a prolonged hunt for yield and these dynamic strategies search across the credit spectrum for higher returns and downside protection. Lynn Strongin Dodds reports.

THE GROWING APPEAL OF MULTI-ASSET FUNDS HE TREND TOWARDS multiasset credit strategies is “definitely accelerating mainly due to concerns over rising rates, duration risk and low yields,”says Craig Scordellis, senior portfolio manager for loans at multi strategy asset management firm CQS, which launched a long only multi credit strategy in February. “Today, there is a much a much broader opportunity set versus vanilla credit giving investors the ability to access different asset class liquidity profiles over time,” The other driver is the need for flexibility. For example, the recent threat by the US Federal Reserve in May to start tapering its overly generous $85bn bond monthly buying programme revealed how unprepared investors were for a potential interest rate spike. As Fraser Lundie, co-head of credit at Hermes Fund Managers put it, “There are structural reasons behind the increased demand for multi asset credit strategies but the sell-off in May and June demonstrated to some traditional fund managers that they were not as well equipped with the prospect of rising rates as they thought. One of the main problems is that their mandates were too narrowly focused and they didn’t have the right tools to manage.” Another is that many “institutions had looked at credit through separate silos whether it was government bonds, investment grade or high yield but today there is a much broader focus,” according to Richard Ryan, alpha opportunities fund manager, M&G Investments. “It is dangerous to think about them separately and people are beginning to look at what value can be

including credit default swaps, for hedging of market directional risks.”

Diversification

Photograph © Spillarkscz/ Dreamstime.com, supplied December 2014.

extracted from a multi-credit strategy.” Not surprisingly, there are several variations on a theme although many funds aim to combine exposures to high-yield bonds, leveraged loans, mortgage and asset-backed debt securities, emerging markets debt and distressed debt. Some also have a generous sprinkling of investment grade and infrastructure debt or hedging tools if they need a more protective stance. “It depends on the institution’s requirements, but broadly speaking, we see two kind of strategies on the marketplace—total return which is yield driven and absolute return which is more defensive,” explains Roel Jansen, head of European investment grade credit at ING Investment Management International, which recently launched a multi credit strategy portfolio. “The common thread is that they use benchmarks only as references but the funds are not based on them. They also use the same asset classes but there is a different mix. For example, our total return fund would put more into high yield and emerging market debt, while our absolute return strategy would allocate more to investment grade instruments and uses more derivatives,

Nick Adams, head of the fund manager's EMEA institutional business at Henderson Global Investors, adds, “Clients are looking to benefit from diversification and reduction in duration exposure. We launched our MAC strategy last summer and already have almost £300m of assets under management. One of the main aims is to offer better protection against the possibility of rising interest rates (duration risk) by including exposures to floating rate instruments, and we are looking more at the liquid end of the spectrum including bank loans, asset backed securities and secured high yield." Ross Pamphilon, co-chief investment officer and portfolio manager at ECM Asset Management, an independently run arm of Wells Fargo Asset Management, note, “investors could decide to go farther down the credit spectrum to chase returns but this usually involves taking more risk; alternatively they can choose an unconstrained MAC fund which allows us to generate similar returns with a relatively lower risk profile. We make asset allocation choices based on an assessment of economic factors, the credit cycle, market technicals and valuations. Fundamentally driven research provides the opportunity to add alpha through stock and sector selection.” The group, which has been running these strategies since 1999 and has €4.75bn in MAC strategies, also relies on its research team to find and share their

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

best ideas. Last December, it rolled out a dynamic credit fund, a Ucits version of an existing MAC strategy and next year it is looking at introducing a higher yielding 6-8% global strategic fund.“We expect the dynamic fund to generate between 3 to 4% net of fees next year, for example, compared to investment grade corporate credit which we expect to generate just 2% to 3%.” Insight Investments also adopts a quantitative and qualitative approach using a three month tactical and 12 month strategic view for its Absolute Insight Credit Fund. It identifies idiosyncratic credit opportunities and exploits pricing anomalies across the credit spectrum. “The first thing is to make a distinction between multicredit and fixed income strategies because they are two very different things,” says Alex Veroude, head of credit.“For example in our UCITS multi credit strategy we use a wide range of assets including investment-grade and high-yield corporate debt, assetbacked securities (ABS), loans and cash instruments, along with a full range of derivatives.”

Scordellis is also an advocate of strong research.“There is a requirement to have technical understanding of the markets but the most important element is to conduct fundamental credit analysis to determine how they will react to pieces of information and where they are in the economic cycle.” The firm’s CQS CMA fund which has already amassed $800m in its long-only strategy, aims to return between 4% and 5% over LIBOR over the course of its investment cycle by tactically investing across the credit spectrum in loans, high-yield debt and asset backed securities (ABS). Lisa Coleman, head of Global Credit at JP Morgan Asset Management (JPAM) also believes in “taking the best ideas across sectors and geographies. Investors do not simply want asset allocators but people who can conduct the research and put the different components together in an integrated fashion. We are seeing more interest from institutional clients who had not previously been in this area.” JPAM launched a global credit Ucits bond fund three years ago which com-

prises two thirds investment grade and one third high yield including emerging market corporate debt. “I view this as the first generation of products and we are currently thinking about the next generation. It has to be the right vehicle and that may not necessarily be another UCITs fund.” The asset gatherer will not be alone as there are other fund managers busy at their credit drawing boards, devising new plans. However, investors should do their own homework on the different credit strategies on the market. They need to ensure that the providers have the specialist knowledge and flexibility to move between the different credit instruments. As Ryan at M&G Investments notes,“In the last dash for yield investors need to be more careful that they are not locked into private assets or strategies and not being rewarded for the illiquidity over the long-term. Managers must be able to select the assets and take advantage of the opportunities but also have the courage to sit on the side lines and put the portfolio into cash when they are no longer being rewarded for risk.” I

MACRO FUNDS LOSE THEIR APPEAL

ECENT SURVEYS HIGHLIGHT changing investor preferences in the hedge fund segment. Signs are that investors are moving away from macro funds with their largest monthly redemptions since December 2008, according to the latest eVestment Hedge Fund Asset Flows Report. Macro and managed futures fund redemptions were the primary reason hedge fund flows were negative in as 2013 came to a close, the first monthly outflow in the last six months. Even so, the industry still took in $22.3bn in Q4 and $71.9bn in all of 2013. Performance added $190.1bn to industry assets under management (AUM) in 2013. When combined with investor inflows there was an overall increase of $262bn, or 10.1%, the

industry’s biggest asset increase in three years. Total industry AUM ended 2013 just below its all-time peak of $2.94trn set in June 2008. Performance increased industry AUM to an estimated $190.1bn, the equivalent of asset weighted returns near 7.2%, well below the industry’s equal weighted 9% return, indicating outperformance by smaller funds through the year. Equity flows surpassed credit in Q4 for only the second time since Q1 2010. During the hedge fund industry’s high-growth phase of 20032007, investors overwhelming preferred equity strategies to credit. However, in the twenty-five quarters since Q3 2007 credit strategies have either gained more or lost fewer

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

assets than equity strategies in all but six. The high-growth phase led by equity allocations coincided with the last multi-year stretch when US treasuries ten-year rates were either steady or climbing since the late 1970’s/early 1980’s. Activist strategies led event driven/distressed flows and performance in 2013. Event driven and distressed strategies reportedly took in a combined $14.9bn in 2013. Activists, which had the segment’s best average returns in 2013, accounted for a disproportionately large amount of the segment’s flows. Of the 70 activist strategies tracked by eVestment, accounting for over $66bn in AUM, the group had an estimated inflow of $4.97bn last year. I

DEBT REPORT

FED TAPERING NO THREAT TO HIGH YIELD

The widely expected Federal Reserve move to taper its monthly bond purchases foreshadows higher Treasury interest rates, a big red flag for most fixed income investments. Even so, it is likely that short-term rates probably won’t tick up until 2015. US treasuries, a risk-free pure play on rates, are the most vulnerable, while the credit spread in investment grade corporate bonds will cushion the blow. For high yield bonds, credit quality is the principal risk— literally and figuratively—so provided Fed tightening reflects a stronger economy corporate cash flow will be robust and default rates should remain low. In fact, high yield could be the 2014 star performer in fixed income. Neil O’Hara reports.

Will high yield come into its own post tapering? APERING IN ITSELF will not push interest rates higher at the short end of the yield curve, where the Fed has signaled no change to its present near-zero target.“The Fed is far away from raising rates,” says Gershon Distenfeld, director of high yield investments at AllianceBernstein, a $446bn New York-based money manager.“The key factor keeping high yield defaults low for the next couple of years is that most companies have ample liquidity.” Not that investors can expect significant capital gains in high yield. The Bank of America Merrill Lynch US High Yield Master II Index stands about 103, which means most high yield bonds (around 70%) are trading above par. Duration is short in high yield bonds—four years on average—and calls are typically at par plus six months interest so today’s market hovers around the average call price. “It’s an asymmetric return profile,” says Distenfeld.“The upside is capped but you can still lose a lot if defaults increase.” Fixed income investors worried about rising interest rates often reduce duration to protect against capital losses—and high yield is no exception. Investors are piling into high yield floating rate bank loan funds and the pre-financial crisis market standard terms for high yield bonds—ten-year maturity with a five-year non-call

period—has given way to seven-year maturity/four-year non-call or fiveyear maturity/three-year non-call, sometimes with a 10% annual prepayment option during the non-call period. Matthew Eagan, a fixed income portfolio manager at Loomis Sayles, does not believe short duration is an effective defence in high yield, however. “If defaults rear their head investors will get hurt no matter where they are on the yield curve,” he says. “It’s akin to picking up nickels in front of a steamroller—investors could get run over.” Liquidity in high yield bonds is so poor that active trading undermines performance—witness the high yield ETFs, which have all lagged their benchmarks. The better way for high yield managers to alter portfolio composition is through reinvesting cash flows, which run 20%–25% of portfolio value per annum. “Managers get more cash flow from calls, tenders and maturities than from coupons,” says Distenfeld. “We try to reposition that way to avoid high bid-offer spreads.” Investors counting on a return of principal at the earliest call date could be in for a surprise, though. Paul Karpers, a high yield bond portfolio manager at T Rowe Price, points out that some issues rated B came to market with coupons less than 5% early this year—and fell 10 points or

more below par during the April/May rout. The issuers will not likely see such low rates again any time soon, if ever, and have little incentive to refinance. “Those bonds will probably be museum pieces for the companies,” says Karpers. “If they printed a deal at 4 5%/8% they will leave it out as long as they can.” When interest rates begin to rise, issuers will be more inclined to leave older bonds outstanding rather than call them at the first opportunity, effectively lengthening the average duration of high yield bond portfolios. The negative convexity so prevalent in today’s market will erode, but while investors may have to hold bonds longer a strengthening economy should boost corporate cash flow and forestall any increase in defaults. Investors also benefit from improved overall credit quality in the high yield market. The lowest quality CCC-rated bonds, which have exponentially higher average default rates (>15%) than BB (1.5%) or B (5%) paper, represent a smaller proportion of the whole than in past cycles. Expected returns on high yield may be lower—like every other asset class—but the probability of earning the return is higher.“Before the crisis, a successful company that migrated up in credit quality might provide a total return of 15% through the first call date,” says Karpers. “Now, it’s closer to 8%. That is still competitive against other fixed income investments.” A continuing slow but steady improvement in GDP growth next year could create a near-perfect environment for high yield bonds. While Eagan at Loomis Sayles will not rule out technical hiccups like this year’s April/May sell-off he does not expect a significant uptick in the default rate provided growth stays above 1%. “The right recipe for high yield is not too fast and not too slow,” he says. “Then investors can just clip coupons, which will be a good result in a period when Treasuries will struggle with rates moving against them.” I

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

DEBT REPORT

MANAGING US DEBT STOCKPILE US President Barack Obama delivers a speech in the State Dining Room of the White House in Washington DC, the United States, October 17th 2013. Barack Obama noted at the time that political brinkmanship in the last few weeks inflicted unnecessary damage to the economy. Photograph by Xinhua/Zhang Jun for XINHUA /LANDOV. Photograph provided by pressassociationimages.com.

TILL DEBT DOES US PART As the Obama administration works to reduce the existing deficit stockpile, will ongoing ideological squabbling continue to get in the way? Or is the recent budgetary accord signs of a new thawing on Capitol Hill? From Boston, Dave Simons reports. N THE EFFORT to extricate the US from the mountain of debt largely accrued during the previous administration, President Barack Obama has counted on at least a partial return to the cooperative spirit that not too long ago was the hallmark of America’s two-party system. Unfortunately, such kinship has been in short supply during these ideologically challenged past five years. When the acrimony culminated in a 16-day, Republican-led government shutdown in October, many in the financial world struggled to understand the logic: unemployment was down, market indices were in record territory and

growth indicators suggested a recovery in full swing. If the objective of shutdown advocates was to blow a hole in America’s tires, they were at least partially successful: by the time the quagmire had ended, Standard & Poor’s set the estimated hemorrhaging of revenue at around $24bn. Time will tell if the shutdown episode serves as a catalyst for clearerthinking Republicans to finally wrest control from the more disparate elements of the right wing. Indications are that such movement has already begun to take place. In a rare display of bipartisan agreement, earlier this month the House signed off on a two-

year Federal budget plan that reverses a portion of the previously mandated across-the-board sequestration spending cuts, while achieving an estimated $23bn in deficit reduction. More importantly, the accord spares Congress from yet another shutdown showdown. Not that congressional members deserve any special recognition for finally coming to terms with the most basic of economic realities—that despite a 150 percentage point rise in the Dow and an equally impressive 30% drop in unemployment over the last five years, today the US is far less fiscally stable than the numbers would imply. In a report issued shortly after the October congressional impasse, Fitch Ratings placed the US, including all outstanding sovereign debt securities, on Rating Watch Negative (RWN), with the warning that further confrontations could“have some detrimental effect on the US economy.” Paradoxically, Fitch also maintained its AAA rating on the US, due in large part to the halving of the Federal budget deficit since 2010. Fitch cited “significant fiscal consolidation” under the 2011 Budget Control Act, along with additional revenues from to the passage of January’s American Taxpayer Relief Act, as key to the debt reduction effort. Based on current trends, Fitch sees the Federal gross debt settling in at around 72% of GDP for the remainder of the decade. Still, debt levels are such that the US remains“vulnerable to adverse shocks,” said Fitch, and will likely experience a rise in debt in future years unless significant new budgetary agreements are achieved. Given the role of US Treasuries within the global markets, a continuation of the heavily partisan tone in Washington could lead foreign governments like China to take evasive action. In a recent New York Times opinion piece, Menzie D Chinn, professor of public affairs and economics at the University of Wisconsin and co-author of Lost Decades: The Making of America’s

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Debt Crisis and the Long Recovery, said that while it is unlikely that China would begin dumping Treasuries in response to the repeated crises in Washington, the ongoing ideological chasm “will only solidify the Chinese government’s determination to diversify its holdings away from dollar-denominated assets.” That members of Congress would consider allowing a debt default to occur “understandably makes foreign investors uneasy,” says Chinn, and gives advocates of economic reform in China “an argument for accelerating the policy shift that de-emphasises exports and promotes domestic private consumption to shrink China’s trade surplus.”

Dealing with debt Digging out of the debt hole requires at least a basic understanding of how we got here in the first place. A bar graph depicting fluctuations in Federal deficit levels post-1980 tells a good deal of the story: significant jumps during the government opposition party (GOP) reign of Reagan-Bush-Bush; a downward slope lasting through much of the two-term Clinton presidency. While the 300% bull run of the 1990s was certainly key to the budget surplus that President Clinton bequeathed to his successor, President George W. Bush, in 2001, it was Ronald Reagan who managed to turn an equally impressive

quadrupling of the Dow during his own presidency into a simultaneous doubling of the deficit by the time he left office in 1989. The chart clearly illustrates the sharp differences in fiscal policy that have increasingly separated the two parties during the last several decades. The common thread linking the economic agenda of all three GOP administrations: sizeable income-tax revenue reductions, combined with increases in deficit spending. Though historically better at managing debt, Democrats aren’t without their faults; President

Based on current trends, Fitch sees the Federal gross debt settling in at around 72% of GDP for the remainder of the decade. Obama’s recently announced ten-year deficit-reduction plan includes $1trn in tax-revenue generation, yet also seeks in excess of $500bn in funding for new programs through the same period. The President assumes Congress will ultimately agree to further tax increases on America’s wealthy, but earlier this year was forced to settle for a bill that raised the threshold on joint filers from $250,000 to $450,000 annually. In reality, the ongoing US debt dilemma isn’t so much about divergent

US federal debt held by retail investors Percentage of gross domestic product

120 100 80 60 40 20 0 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 Source: The US Federal Reserve, December 2013.

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

ideologies as it is total lack of unity. Using the president’s Affordable Care Act as a wedge, since 2009 Congressional opponents have forged the longest stretch of legislative inaction in recent history. A web timeline depicting key moments of Congressional togetherness since 1787 courtesy of Washington’s Bipartisan Policy Center puts the problem in stark relief: not a single click follows the 2009 Obama inauguration. “The repeated brinkmanship…dents confidence in the effectiveness of the US government and political institutions, and in the coherence and credibility of economic policy,” concluded Fitch in its October report. While the December budget accord proved that members of Congress, when pushed, have it in them to move beyond the partisan stonewalling that has kept the US from achieving timely fiscal reconstruction, going forward the consequences could be dire if lawmakers fail to build upon this inkling of bipartisanship. Not least is the impact on the country’s internal capital markets. It has been clear to market watchers, for instance, that 2013 will see another year of negative performance in the wounded municipal bond segment. Investors have steadily moved away from the segment, which has contracted for three straight years now. If the Feb scales back its QE stimulus program and political tensions remain taut through the first half of 2014, debt issuance in the $3.7trn market will continue to shrink sending more investors into other asset classes, even as yields are expected to rise on the confirmation that the Fed will start tapering in Q2 next year. Sales of refunding bonds are running 30% lower than in 2012 while analysts expect total municipal issuance could drop to $349.5bn billion next year, down from $367bn this year according to the Securities Industry and Financial Markets Association's (SIFMA) recent survey of underwriters and dealers. I

DEBT REPORT

VERIZON’S BOND $49bn BOND ISSUE DISSECTED

It’s been a year of mega-bond issuance, particularly in the US where records were busted in the second and third quarters in terms of volume by a single issuer. In mid-September, Verizon Communications completed a record-setting $49bn bond offering involving eight tranches, each of which came in at the midpoints of guidance ranges that were established as much as 75 bps above comparable secondary-market indications. The biggest single tranche, worth $15bn of new long bonds set a new record, rivalling the previous $17bn record-setting bond deal from Apple in late April (though that was across six tranches). By David Varano, EVS portfolio analyst, Interactive Data.

Verizon tops a year of mega-bond issuance FTER A TUMULTUOUS summer, during which US fixed income markets sold off sharply in May and June, benchmark interest rates finally appeared to stabilise nearly +100 basis points (bps) higher as the third quarter was coming to an end. The US Federal Reserve, which most now believe sparked a historic exodus from bond mutual funds with talk of a QE tapering, took centre stage. Although the Federal Open Market Committee (FOMC) ultimately surprised market participants by voting in favour of continued full-throttle stimulus at their mid-September meeting, the apprehension and cautious tone leading up to the decision appeared to influence the execution of Verizon’s record corporate bond offering. On September 11th,Verizon sold $49bn of new debt to help finance its $130bn acquisition of the remaining stake it did not own in Verizon Wireless. Of this,

Exhibit 1. Verizon Deal Focused on Longer Maturities

Exhibit 2. Verizon New Issue Concession Widened Since Initial Pricing

Verizon Bond Offering – Sept 2013 g Size ($ bn) 16 14 12 10 8 6 4 2 3yr

relationship has actually widened further to 57 basis points, suggesting that the new bonds remain at a hefty discount to the old. During the week leading up to the placement, investors were net sellers of old Verizon debt to the tune of $617m, according to FINRA TRACE reported data. In comparison, investors actually net purchased $129m of AT&T debt over the same period. This would suggest that traders may have either been seeking safety in a peer credit until the supply was sold, or were taking advantage of more attractive spreads on a related telecom name that may have widened in sympathy with Verizon. However, in the weeks following the initial deal placement, AT&T ten year debt has actually underperformed both old Verizon and new Verizon paper. As of December 9th, average evaluated spreads for new and old Verizon ten year bonds have tightened by -22bps and -33bps respectively, while comparable AT&T

$45bn came in fixed-rate coupons, while $4bn was sold as floaters. The offering was staggered across the maturity spectrum but was clearly structured for longevity, with a full $32bn coming due in 10 years or greater (Exhibit 1). Due to the retrospective poor timing of the transaction being in close proximity the FOMC meeting and its enormous size, Verizon deemed it necessary to offer quite a substantial new issue concession to attract adequate demand. However, anecdotal reports from underwriters have alluded to very strong participation across the globe and an order book that was significantly oversubscribed. Examining the benchmark ten year offering as a proxy, it appears that investors were treated to an additional 45 bps of yield above the average existing Verizon bonds available in the secondary marketplace (Exhibit 2). In fact, since the initial pricing, this

VZ New Issue Concession Eval Spd (bps) 80

At Pricing

Current

40 20 0 -20 -40 -60

5yr

7yr

10yr

20yr

30yr

3yr

5yr

10yr

20yr

30yr

Source: Interactive Data, December 2013

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Exhibit 3. Verizon Outperformed AT&T Following Record Issuance Verizon Peer Comparison (10yr) Avg Eval Spd (bps) 200 190 180 170 160 150 140 130 120 110 100 90 80 9/12

AT&T Old VZ New VZ

9/26

10/10

10/24

11/7

11/21

12/5

Source: Interactive Data

issues only managed to narrow -3bps over the same time period (Exhibit 3). For example, while yields for the new two Verizon bond fell by 59bps (versus only 33bps for two year US treasuries), the new 30 year Verizon bond yield declined by a smaller nominal 44bps. However, relative to the 3bps increase in 30 year US treasury yields, the outperformance on the long end is quite apparent. Thus it appears that buy-andhold investors have been rewarded for participating in the largest US corporate bond offering of all time, while in retrospect, Verizon may have left money on the table due to the sheer size of the issuance as well as the timing coinciding with Fed uncertainty. I

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RISK OUTLOOK

THE IMPACT OF THE LIQUIDITY COVERAGE RATIO

LCR and its impact

US Federal Reserve (Fed) chairman Ben Bernanke, former Fed heads Alan Greenspan and Paul Volcker, vice chairwoman and incoming chairman Janet Yellen attending the US Federal Reserve centennial commemoration at the Federal Reserve building in Washington DC on December 16th 2013. The US Senate confirmed Janet Yellen as the next head of the Federal Reserve on January 6th 2014. She will replace outgoing Fed chairman Ben Bernanke whose term ended at the end of December. Photograph by Zhang Jun for the Xinhua/Landov new agencies. Photograph supplied by pressassociationimages, December 2013.

Since the recent financial crisis the Federal Reserve has sought to improve the liquidity and capital structures of systemically important entities in financial markets in order to decrease the likelihood of systemic failures. The Federal Reserve has implemented new rules to conform to Basel III capital standards and, in October, issued a proposal to implement a quantitative liquidity requirement that meets the Basel III liquidity coverage ratio, (LCR) standard. Under the proposal, US firms will begin the LCR transition period on January 1st 2015, and would be required to be fully compliant by January 1st, 2017. Tyler Peterson reports. HE LCR SEEKS to improve firms’ liquidity risk profile and to increase resilience in times of economic and financial stress. It is defined in an October press release issued by the Fed in this manner, “Each institution would be required to hold liquidity in an amount equal to or greater than its projected cash outflows minus its projected cash inflows during a short-term stress period. The ratio of the firm’s liquid assets to its projected net cash outflow is its “liquidity coverage ratio,” or LCR.” Governor Daniel K Tarullo stated:“Since financial crises usually begin with a liquidity squeeze that further weakens the capital position of vulnerable firms, it is essential that we adopt liquidity regulations to complement the stronger capital requirements, stress testing, and other enhancements to the regulatory system we have been putting in place over the past several years.”

The LCR and Net Stable Funding Ratio, (NSFR) are likely to increase cost for banks that provide maturity transformation services, with the LCR penalising short-term deposits, and the NSFR forcing constraint on lending. These upward pressures on cost could negatively impact securities lending. The Financial Stability Board, (FSB) is considering the utilisation of a system of haircuts and margin requirements to discourage excess leverage in securities finance transactions, (SFTs). In this arrangement, margin requirements are variable dependent on collateral asset classes and are believed to bind at the security level, thus making their effect difficult to evade. This situation is unlike that for the NSFR that does not bind for intermediaries and is subject to evasion through disintermediation. The focus of regulators on raising capital and liquidity standards is

driving increased demand for High Quality Liquid Assets, (HQLA). The securities that qualify as HQLA and which firms prefer to hold in light of the new regulatory environment, along with changes in the repo and OTC derivatives markets, are making it harder for MMFs and other cash lenders to source eligible securities. New regulation and changes in market structure are fostering an environment, through which, banks are encouraged to hold HQLA, but apart from contemporary regulatory compliance, there are other issues driving firms to increase their holdings of HQLA. A partial list includes: concerns over future increases in liquidity requirements, self-sustainability (in terms of liquidity), and firms’ individual assessment of the market. These additional influences are serving to further limit the supply of available HQLA not sourced directly from the Fed. The Fed has also expressed concerns with regard to ensuring that premiums for liquidity risk are equally binding in secured funding markets between dealer-as-principal and dealer-asintermediary types of SFTs. The LCR, for example, requires very little collateral for SFTs and is thought to bind unequally amongst counterparties, especially in the case where dealers run a matched book transaction. These types of regulatory mismatches require continued scrutiny from the Fed. An increased focus on liquidity risk regarding counterparties involved in SFTs is predicted by the Fed to reduce complacency towards risk in tri-party repo, and other SFTs. A clearer liquidity picture helps inform market participants on the issue of counterparty risk, and, as a result, is likely to reduce externalities in the event of fire sales.

Fire sale externalities Fire sale externalities can result from the maturity transformation activities of broker-dealers. A potential pitfall to using short-term funding to finance longer-term investments is the continual need for renewed funding. If these

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dealers lose access to financing they could be forced to unload securities at a reduced price, subsequently reducing the collateral value of these securities and the ability for others to borrow against them. Furthermore, this contagious effect could snowball if lenders demanding repayment cause a dealer to default. In this situation, lenders could be left with collateral that they are unable to handle efficiently and could be forced to sell those securities at depressed prices; further exacerbating the problem. The threat of fire sale externalities has been partially mitigated due to new capital and liquidity requirements, but inequalities with regard to internalising risk could cause dealers to act inefficiently. Governor Stein remarked at a Federal Reserve Bank of New York workshop in October:“Because brokerdealers generally do not internalise the externalities that arise in these cases, they may use more than the economically efficient level of shortterm funding.” Solutions to these types of problems are often technology driven and the possibility to exploit the data generated by the use of these technologies is driving structural changes in the securities finance industry.

The value of data Regulatory pressures due to systemic financial threats are causing institutions to realise the value of data. New technologies and greater awareness is helping to drive the exponential growth of data collection in investment markets, with each entity, seemingly, having their own data collection and analytics capabilities. Institutions that can manage data most efficiently will have an advantage over others who manage data less efficiently. And, those who are able to utilise a diverse set of data sources effectively will enjoy further advantage. Proprietary data collection and analytic programs are increasingly focused on liquidity profiles. The dissemination of this information coupled with the ability of other market actors to receive

and analyse it will serve to better inform investment decisions with regard to liquidity risk exposure amongst counterparties. Data collection and analysis continues to evolve and grow, however, there still appears to be gains to be made in terms of integrating data across systems. The data compiled by financial market participants and government entities should aid firms in staying solvent and aid regulators in formulating less restrictive and more precise targeted and effective regulation. For the time being, the economics forecast looks stable. The Fed has recently held short-term rates to near zero in an effort to support their dual mandate of maximum employment and would like to see unemployment somewhere below 6.5% with the best sustainable target rate between 5% and 6%. Janet Yellen’s nomination, and likely confirmation, as Federal Reserve Chairman will not likely cause radical changes to the Fed’s monetary policy. The Federal Open Market Committee, (FOMC) is likely to continue its Large Scale Asset Purchasing (LSAP) program that continues to buy agency mortgage backed securities at a rate of (now) $35bn per month (down $5bn a month since the December 18th announcement that the Fed would cautiously begin taper). The FOMC is also buying longerterm Treasury securities at a rate of $40bn per month in order to continue to put downward pressure on long-term rates. Logically, the Fed had to make this move as the unemployment rate closed on near 7% and inflation hovers around 2%, although economic recovery is far from complete. As outgoing chair Bernanke notes: “if jobs gains continue as expected, the bond purchases would likely continue to be cut at a“measured” pace throughout next year. Richard B Hoey, chief economist, BNY Mellon and Dreyfus, says of Janet Yellen at the Fed: “We believe that she is likely to hold the Fed funds rate at zero even after the unemployment rate hits 6.5%.”With the lack of inflationary concerns in the near future, Hoey

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

expects monetary policy to be “supportive of economic expansion in 2014, 2015 and 2016, with truly restrictive policy postponed until 2017 or 2018, after the Presidential election of 2016.”

Unemployment rate The unemployment rate is predicted by the Fed to continue falling and inflation should remain well controlled and not likely to cause serious concerns until 2017 or later. This economic environment and the gradual tapering QE, coupled with, a growing demand for high quality assets and the potential for a liquidity shortage in the face of new capital requirements and other market influences, is spurring the Fed to search for additional vehicles to add liquidity to the market. One idea under consideration is a new reverse repurchase agreement (repo) facility. According to Fitch Ratings, such a facility could receive positive attention from Money Market Funds, (MMFs) and others, who are looking for a supply of eligible shortterm securities that are limited in the current economic environment. The Fed envisions the new repo facility as a fixed rate, overnight facility that will allow MMFs and others to lend cash to the Fed. These transactions are collateralised by securities held by the Fed and as such, are considered low risk. As a result, rated MMFs would be exempt from Fitch’s normal counterparty limits. Once the Fed begins to allow interest rates to rise, the proposed repo facility could enable this process by providing another vehicle for the Fed to lend securities and reduce cash reserves. Clearly, the continually changing regulatory environment and the current economic climate call for flexibility in the securities finance market. Those firms that can generate and consume data efficiently are likely to increase the gap between them and those can’t. The markets intense focus on liquidity risk exposure will help to illuminate counterparty risk and these types of assessments are becoming increasingly more data driven. I

ASSET SERVICING

ALTERNATIVE FUND ADMINISTRATION

Photograph © Neil Lockhart/Dreamstime.com, supplied December 2014.

IS SMALL BEAUTIFUL ONCE MORE? In the boom years, small may not have always been beautiful for the larger fund administrator but times have changed since the collapse of Lehman. Competition and cost pressures have meant that many of the global and larger independent firms have become more accommodating. They may not look at the minnows with $5m to $10m of seed money but will target those shiny new starts-ups that have the capabilities to become the next superstars. Lynn Strongin Dodds. TART-UPS “MAY not typically have been our sweet spot but they are definitely part of our business now,” says Pat Hayes, senior managing director and head of hedge fund services Europe at State Street. “We are seeing a great pool of talent coming from the new breed of hedge fund managers being spun out of prop desks and incumbent hedge funds. They want us to do the whole gambit— business strategy, planning and infrastructure—and we look at their potential of becoming the next multibillion dollar fund.” “Serge Weyland, head of regional coverage for North America and UK at

CACEIS Bank, agrees that there are opportunities to be exploited. “Global custodians are under pressure with revenues shrinking from the long only space as well as related services such as securities lending and foreign exchange. As a result they are putting greater emphasis on the business opportunities that can come from the alternative space such as hedge funds as well as private equity and real estate funds.” The hedge fund industry has been a particularly fertile breeding ground with prop desk traders looking to make their own way thanks to the tougher regulatory environment of Dodd Frank.

They are being joined by a wave of managers breaking away from their existing companies in search of their own fortune. The peak was reached in 2010, with a record 1,184 hedge funds making their debut, a hefty 51% hike from 2009. The pace has since slowed but the latest figures from the HFR Market Microstructure Industry Report shows that there is still a healthy flow. A total of 288 new hedge funds were launched in the second quarter of this year which represented a slight decline from the 297 funds in the previous quarter but a year on year increase from the 245 funds introduced in the second quarter of 2012. Despite the welcome sign, not every small alternative manager will be able to walk through the door of a large or global administrator. One of the biggest challenges is to spot tomorrow’s winners which is not that simple. After all, it is not that easy to generate alpha without a strong infrastructure and support network of an investment bank or am established hedge fund group. “We look at every future possibility and do not have a minimum asset level, the theory being many asset managers start small but can grow significantly,” says Mark Mannion, head of business development and relationship management EMEA for alternative investment services, asset servicing, BNY Mellon. “However, we conduct our own forensic analysis and look at the calibre of the managers and their plans for asset gathering. The institutionalisation of the investor base has heightened the need for enhanced due diligence prior to entering into a commercial relationship.” Pete Townsend, chief operating officer of BNP Securities Services Ireland operations and head of hedge fund solutions “We will definitely take a chance with a sub-$100m launch, but managers need to have the right pedigree and track record. However, it is a two way street and alternative fund managers will also conduct their own due diligence on the provider in

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terms of their own pedigree, price and service levels. They will typically talk to three to five providers before making a decision. If we are selected, we take a consultative approach and help new managers set up the right middle office infrastructure.” The days when a hedge fund such as Caxton Associates—widely regarded as top in its class—could enter the world on shoestring budget of $3,000 from its founder’s credit card are long gone. Now anecdotal evidence suggests that hedge fund managers should not get out of bed unless they have at least $50m in the banks. Many enter the world with less but finding an administrator who can help them quickly achieve that target has become imperative. “These smaller hedge fund managers are not only facing the same regulatory requirements and investor pressure for transparency as the larger houses but once they get to a critical size above $100m they want to get on the radar screens of larger institutions,” says Phil Masterson, senior vice president and managing director of SEI’s Investment Manager Services division.“As a result, they are looking for providers that have the scale and capabilities who can evolve with their expectations.” Rahul Kanwar, senior vice president and managing director, alternative assets, SS&C Technologies, adds, “In the past smaller alternative funds would gravitate towards smaller administrators but that is changing because these firms have found it difficult to grow at the right levels to support their clients. They want the brand fund administration names now because it will make it easier to raise capital. This is particularly true of hedge funds because many very large private equity and real estate mangers still do their administration in-house although this is changing. Today it is all about the scale and processes.” Mid-tier and boutique players may not have the capability to grow with the business or offer best-in-class technology that can streamline an alternative manager’s business operational

processes while also coping with the on-going rigorous demands of existing and pending regulations. It is also an expensive proposition to provide the end to end services that many hedge funds are interested in. “Fund administration is only one part of the offering,” says Hayes. “In many cases they want a relationship in the wider context and can come to an organisation like State Street to get a bundled solution which includes the depository function required under the AIFMD, risk management, custody and risk reporting.”

Service bundling Liam Butler, head of hedge fund services group at Northern Trust also notes that “from a fee perspective it is more advantageous for the client to have services bundled together versus buying them on a component basis. Smaller hedge funds have the same reasons—to lift the administration burden—as their larger counterparts for outsourcing back and middle office services. However, it is a very competitive market out there and clients are looking for value for money.” Given this background, it is easy to see why the behemoth players continue to have a lock on the business with the same firms dominating the league tables over the past year. For example, according to a recent poll form research group eVestments, the rankings remained unchanged for the first half in 2013 from the previous six months last year. Overall, assets under administration in the single hedge fund industry jumped 13.3% to $3.411trn as of June 30th from December 31st, 2012. State Street’s alternative investment solutions group once again topped the chart among the 38 singlemanager administrators surveyed, with $682bn in assets under administration (AUA) as of June 30th, up 8.7% from December 31st. Citco Fund Services was next on the list at $532bn, with a 5.35% rise followed by BNY Mellon Alternative Investment Services, $445.75bn, a

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

25.56% hike. SS&C GlobeOp was at $395 bn, a 20.43% increase while Citi Hedge Fund Services was $243.48bn, up 15.41%. Morgan Stanley Fund Services, Northern Trust Hedge Fund Services, HedgeServ, SEI Investments Co and JP Morgan Global Fund Services rounded out the top ten. This trend is not expected to change and in fact some consultants believe that over the next three to five years 95% of the hedge fund administration arena will be dominated by between six and eight players. Consolidation has already taken hold and over the past two years, the industry has seen a spate of notable transactions. These include SS&C’s £572m purchase of GlobeOp as well as State Street’s $550m acquisition of Goldman Sachs Administration Services, bringing its hedge fund AUA to $700bn making it the largest global fund administrator, usurping former leader Citco. “As new super-sized’ administrators get going they will be looking to expand,” says Ed Gouldstone, head of hedge Fund Products Strategy at Linedata.“Rather than compete headto-head on existing business, administrators may look to emerging managers as a way to gain market share. After all, administration fees are charged on assets, so to a large extent it’s about who has the biggest book of assets under administration”. This though does not ring the death knell for the smaller firms. They have their advantages and may be better placed in the micro end of the market for funds that are under the AIFMD threshold. They are also well positioned to provide bespoke services such as customised reporting, quality web access and strong client support. “In the end it comes down to service,”says Brian McMohan, managing director, alternative investor services, business development at BNY Mellon. “For example, a private equity manager may have started out with one strategy but has broadened its spectrum. They could need a provider who can work with those different strategies.” I

ASSET SERVICING

HEDGE FUNDS IN THE MAINSTREAM

Photograph © Lorna/ Dreamstime.com, supplied December 2013.

Gunslingers don tuxedos Hedge funds took a hit during the financial crisis—along with everything else—yet many were quick to bounce back. Industry assets under management now total $2.5trn, up from $1.5trn five years ago, growth that has come despite mediocre performance relative to market benchmarks in recent years. The institutional investors that plough money into hedge funds take the long view and expect them to outperform bear markets (as they did in 2008/2009), not bull runs. Are expectations out of whack with reality? Neil O’Hara reports. EDGE FUND MANAGERS once posed as nimble gunslingers, but most institutions prize their steady long-term return streams, not their ability to shoot the lights out. Successful managers have abandoned the cowboy swagger for a veneer of respectability, as if the revolver that once dangled at Billy the Kid’s hip has been replaced by the discreet automatic in a shoulder holster under James Bond’s tuxedo. Hedge funds have a symbiotic relationship with their investors, of course. In the past ten years or so, the industry asset base has shifted away from high net worth individuals toward institutions who take a more sophisticated approach to monitoring investments. Funds had to beef up their infrastructure

to handle demands for more and better information from both investors and regulators, while the flood of new money crimped the outsized returns earned in the 1980s and 1990s. The sales pitch began to change, too. No longer did funds claim to beat the market year in and year out; instead they harped on the power of compounding long term low volatility returns. Institutional attitudes to hedge funds have evolved, too. Once viewed as a separate asset class despite the obvious differences between strategies, hedge funds are increasingly seen as an extension of the assets they own—a credit relative value fund belongs in the fixed income allocation, for example. Peter Hill, head of liquid alternatives manager research at Hewitt Ennis

Knupp, a Lincolnshire, Illinois-based investment consultant, finds clients value the reduced volatility associated with certain strategies that nevertheless deliver attractive returns.“It is dangerous to call hedge funds an asset class,” he says.“Some managers can generate return streams that meet expectations, but others are less successful or don’t do so at all. Manager selection is key.” For Rocaton Investment Advisors, a Norwalk, Connecticut-based investment advisor, hedge funds are just one more vehicle available to meet clients’ investment objectives. Roger Fenningdorf, a founding partner and head of manager research, says the firm’s overarching goal is to reduce risk and raise the Sharpe ratio for client portfolios.“We don’t decide we want 10% in hedge funds,” he says. “We are more opportunistic. In the long term we expect similar returns from hedge funds and traditional asset classes but hedge funds offer the potential to lower absolute risk. They substitute for part of the allocation to the underlying asset class.” Instead of using hedge funds to diversify traditional investments (as they have in the past), Steve Vogt, chief investment officer of Mesirow Advanced Strategies, says institutions are beginning to use the flexibility of hedge funds to address specific portfolio needs. One popular move today, when the imminent end to quantitative easing could push interest rates higher: assemble a portfolio of low-volatility (5% or less) hedge funds to replace a significant portion of the fixed income allocation and thereby reduce interest rate risk.“These low volatility portfolios tend to be more diversified across managers to minimize idiosyncratic risk,” says Vogt. “They are long/short credit relative value oriented, with perhaps some market neutral equity. They avoid directional strategies like long-biased hedged equity.” The low volatility tactic works best for pension plans that are fully funded or close to it. Plans that face a substantial funding shortfall often take a

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

different approach, using more aggressive hedge funds to help narrow the gap. In many cases, these plans need to boost returns but cannot tolerate the equity market volatility seen over the past five years. They will tolerate 7% to 9% volatility, giving up some equityonly performance for greater stability in returns. “Pension plans apply part of their equity allocation to hedge funds, but without introducing so much equity volatility into the funding ratio,” explains Vogt. Mesirow has also found opportunities to exploit structural changes in the economy following implementation of the Dodd-Frank Act and the Volcker rule, which prohibits banks from proprietary trading. Banks in both the US and Europe are shedding illiquid assets and buyers are scarce for certain maturities, particularly in the two to five year range. Hedge fund managers do buy these assets, but liquidity constraints limit their capacity for a trade that not only benefits investors but also reduces systemic risk because ownership shifts from banks leveraged ten times to credit funds leveraged no more than twice, if at all. Mesirow pools capital from clients able to tolerate the lack of liquidity and offers managers the chance to increase their exposure to these assets through a dedicated co-investment vehicle—in exchange for a break in fees. “They don’t need a big management fee because they are already managing the position in a co-mingled fund,” says Vogt. “It’s an add-on. We pay them on the back end through a healthy incentive fee provided the return exceeds a hurdle rate, which aligns the incentives for both parties.” The unusual fee structure is symptomatic of a move among hedge funds away from a monolithic pricing model. The pressure on fees derives in part from indifferent performance in recent years. Broad hedge fund indices have delivered only single-digit returns, and while fixed income strategies have generally done better than equity-oriented funds (until this year) consistent double

digit returns are the exception rather than the rule. If a fund that earns 8% gross charges a 2% management fee and a 20% incentive fee the investor receives only 4.8% net—acceptable perhaps, but not a sure-fire winner. From the managers’ viewpoint, the financial crisis was a wake-up call to an industry that had grown too large on an inappropriate capital base. Investors were typically locked in for the first year, but were then free to redeem at least every quarter on 60 days notice. Meanwhile, fund assets often could not be liquidated to meet a large redemption request except at a discount, or in some cases at fire-sale prices. In 2008/09, many managers invoked gate clauses to restrict redemptions, which infuriated investors.

Fee cut When the dust settled, managers recognised the need to narrow the mismatch between the duration of their assets and liabilities. To do so, they adopted pricing already commonplace among mutual funds and traditional asset managers: a discount for size. “The most common thing we see is a cut in management and performance fees in exchange for longer lockups,” says Fenningdorf at Rocaton. “Managers want a pool of capital that has staggered redemption dates and longer lockups.” Some managers have taken the concept one step further and adopted a sliding fee scale modeled on separately managed accounts, where economies of scale have long justified progressively lower fees on assets greater than specified thresholds. Pressure on fees is not universal, however. The most successful managers are closed to new investors, which makes existing investors reluctant to redeem for fear they will not be able to get back in later. These managers do not need to offer discounts—the capital is already more stable than it appears—and if they do, it is only to attract money from underrepresented investor types who will further diversify their capital base.

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

A preference for large funds among institutional investors also mitigates pressure on fees. Hedge fund assets are becoming ever more concentrated at the biggest funds, which have robust infrastructure and (usually) longer track records. They have staying power, too. Every year hundreds of small funds go out of business; they fail to attract enough capital, do not generate the returns investors expected, or a seed investor pulls out and the business model is no longer viable. “It’s not to say there isn’t a case for using smaller firms,” says Hill, “but investors have to understand the extra business risk involved.” At the strategy level, Aon Hewitt has seen increasing interest in credit hedge funds in recent years, including managers who focus on less liquid instruments like direct lending, asset-backed securities, residential mortgage-backed securities and structured credit. Equity long short remains popular, too, although long-biased rather than market neutral, where poor performance derives in part from low interest rates, which have eliminated income from the stock loan rebate. The imminent end of quantitative easing is already affecting hedge fund strategy allocations at Rocaton, where allocations are focused on long/short equity and credit strategies.“We expect interest rates to go up,” says Fenningdorf. “Significant net long exposures may not do well under those conditions. If rates go up fast, it could have a significant impact on highly leveraged funds such as certain fixed income arbitrage strategies for that reason.” Hedge funds have exhibited a remarkable ability to adapt to change whenever they have encountered unfamiliar market conditions, the demands of institutional investors or new regulations. The switch to rising interest rates will no doubt weed out some managers, but the industry rests on a stronger foundation than ever before. The gunslingers may have concealed their weapons but they have not lost their creativity. I

ASSET SERVICING

SECURITIES LENDING OUTLOOK 2014

Photograph © Eteimaging/ Dreamstime.com, supplied December 2014.

THE TURNING CIRCLE: NEW AGE SECURITIES LENDING

With a new year comes new signs of hope for the securitieslending trade—greater need for integrated solutions, as well as an increase in demand for collateral-optimisation tools and services, to name a few. For lenders, then, the key to future success still revolves around the ability to offer a diverse and customised array of services that will suit new market conditions. Dave Simons reports from Boston. URING 2013 THE securitieslending business continued to deal with a bevy of nowfamiliar challenges, from lower turnover to more restrictive global regulatory measures. Lingering concerns over riskmanagement practices and collateral arrangements gave pause to various

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would-be beneficial owners; a mid-year poll of institutional investors conducted by consulting firm Thomas Murray’s networking group myInvestorCircle concluded that more than half were still waiting, rather than lending. Of all financial market segments, securities lending was the most

impacted by the financial crisis and showed that the operations of the securities markets was and is much more complex than participants gave it credit for. The last few years has seen the industry pretty much treading water, as macro conditions remained unconducive to both hedge fund investing and securities lending. Yes, various firms claimed that their volumes remained buoyant; but by and large agent lenders had to work in an environments where the suppliers of good quality securities were largely indifferent to the service. Securities lending needs a complex cocktail of market developments to work well: among them a buoyant M&A/corporate actions market; a healthy derivatives market where shorting is a plain vanilla instrument, rather than a suspected (only by regulators and nervous politicians) call to the dark side; a liquid and confident prime broking segment that serves a wide range of hedge fund strategies; interest rates that are north of zero and a buoyant repo market. It has not been easy to find the right confluence of these requirements through the last half decade or so. No surprise that the sector has been at best wan and at worst spectral over the period. By the end of 2013 however a new more optimistic mood has taken hold. With equities moving higher, opportunities for stock deals increases, which would bode well from a securitieslending standpoint; furthermore, lenders seem poised to benefit from the rise in demand for collateraloptimisation services, a byproduct of the new era in derivatives clearing and trade execution standards. For many, then, the key to future success still seems to revolve around one’s ability to offer an increasingly diverse and customised array of client services. The question is: is the business still securities lending; or is it a morphing into a more sophisticated array of diverse products that sometimes sit side by side with securities lending?

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

The answer, like most in these transient days, is still an uneasy but hopeful mix of both. Northern Trust, for example, picked up the IWA Forest Industry Pension Plan, involving some C$3.1bn in assets, in early January. The selection of the bank as lending agent came in a package which included custody, fund administration and various reporting services. In that regard, securities lending was not a sufficient priority for the fund to warrant a separate service agreement. The preponderance of these general mandates, reflects the fact that over the near past investor participation in general collateral remained relatively subdued. Even so, there are compelling arguments for an ‘all-in’ approach. First is addressing a compelling need for better integration and interconnection in critical functions such as risk management, compliance, finance, and technology. Who better to do that than a custodian lending operation? For beneficial owners, risk management and compliance will likely continue to priorities in the post regulatory period. In particular, the move towards comprehensive intra-day understanding of exposures and greater operational control in more technology-driven environments (such as securities lending, trading, collateral management and post trade services) will likely be a key goal. Better quantifying risk and reducing disruptive operational failures can mean better integration, better governance mechanisms, and more robust data and analytics. Considerable strides have been made by some firms, but there is more to be done. That in turn put the onus on agent lenders and securities services providers to continue to mine opportunities in intrinsic value lending including issues that trade “hot,” “warm,”or “special.”In these instances, full transparency is paramount, and providing as much detail into these trade processes reportedly remains in high demand. Accordingly, EquiLend,

the New York-based global provider of trading and operations services for the securities-finance industry, sees lenders continuing to prioritise investments in technology in an effort to achieve straight-through processing. Earlier this year, the company went live with DataLend, a customised securities finance market-data platform designed for lenders and prime brokers as well as institutional clients such as pension funds and beneficial owners. With the cost-savings and riskmanagement benefits derived from automation clearly evident within the cash markets for years now, the securities-finance sector has finally begun to take advantage of the trend as well, remarks Ben Glicher, EquiLend chief investment officer and head of DataLend.“From our perspective, there has been an evolution in automation that is already having a profound impact on lenders and borrowers alike,” says Glicher. As securities-finance platforms help to streamline general collateral, agents will find it easier to focus on loaning out more profitable special securities, explains Glicher. This in turn will lead to a subsequent rise in automation of specials as well, he adds.

Buy side engagement Despite a general sense of indifference among beneficial owners, intermittent engagement in securities lending has been a hallmark of the post-crisis lending era. In an improving market however, the pointers are that there are real opportunities for agent lending and service providers such as EquiLend for market penetration via reporting and performance-measurement solutions, says Glicher. It’s perhaps a sign of more competitive times, where beneficial owners are once more in a buyers’ market.“These kinds of products have proven invaluable in helping owners ascertain like-to-like comparisons of agent lenders against industry benchmarks,” explains Glicher. The inexorable march toward centrally-cleared OTC derivatives products—and the heightened margin

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

requirements therein—could help shape the direction of the industry going forward. Regulatory regimes like Dodd Frank and EMIR bring with them the likelihood of greater collateral need, training the spotlight on the importance of process integration. Recent research from Hartford, Connecticutbased consulting and technology services firm Accenture found that process inefficiencies have prevented financial institutions from fully utilising all available collateral, costing the global industry an estimated $5.4bn annually. This has led to initiatives such as Clearstream’s Global Liquidity Hub, which, among other things, has enabled global clients to optimise their collateral needs in part through the full integration of securities-lending and borrowing activities. As collateral accessibility becomes increasingly important to both buyand sell-side participants, the need for quality securities lending will become even more apparent. “The securities lending market has already shown itself to be a systemically important product for the capital markets,” notes RBC Dexia in its recent report Demystifying Securities Lending. Additionally, the relentless quest for transparency points to increased usage of securities lending and lending data among fund managers looking for ways to optimise the construction of their portfolios, improve the timing of their trades and more, concurs RBC Dexia.

Central clearing/regulation Central clearing of securities-lending transactions continued to gain favor during 2013. At year’s end, the Chicago-based Options Clearing Corporation (OCC) reported a 27% year-over-year increase in centrally cleared lending activity (including an 18% rise during November compared to the year-ago period). Along with its mainstay OTC Stock Loan Program, the OCC offers securities lending and borrowing central counterparty services through its five-year-old

ASSET SERVICING

SECURITIES LENDING OUTLOOK 2014

automated AQS alternative trading system platform. Meanwhile, the effect of new regulatory structures—a central theme for some time now—will likely continue to dominate sec-lending roundtables during the new year. In Europe, the ramifications of a Financial Transaction Tax (FTT) casts perhaps the longest shadow; if passed, the measure could conceivably rob EU’s lending business of nearly two-thirds of its current revenues, according to research from the International Securities Lending Association (ISLA). To the north, proposed rule changes by the Canadian Securities Administrators council (CSA) include reducing the current reporting threshold for “significant holdings of issuers’ securities” from 10% to 5%, as well as requiring notification of changes in securities ownership amounting to 2% or greater. If implemented, the rules could increase compliance costs by requiring firms to maintain separate reporting procedures for their securities-lending arrangements. “At the start of the year we were seeing a lot of roads still under construction, making it somewhat difficult to know exactly which way we were

headed,” offers James Slater, head of securities finance for BNY Mellon’s Global Collateral Services business. “While I think that is still the case—to some degree things have since opened up a bit and the information that we now have around collateral and financing in particular has been a big part of that change. Regulators are increasingly trying to make the world a safer place with respect to OTC derivatives by emphasising collateralised and margined activity. Additionally, the leverage rules that we’ve seen, while not completely done and dusted, point to a market with fairly broad balance-sheet constraints, which, from a financing standpoint, makes things a bit more challenging for certain banks and dealers going forward. This, in turn, creates opportunities for those with significant cash reserves that are perhaps looking for higher-yielding assets,” says Slater. The parade of big-name IPOs during 2013 was a significant bellwether during the outgoing year, and leading into 2014, the prospects for a pick-up in mergers-and-acquisitions activity would naturally be a real positive for the sec-lending arena as a whole. “Muted ‘specials’ and trade volumes,

James Slater, head of securities finance for BNY Mellon’s Global Collateral Services business. “To some degree things have since opened up a bit and the information that we now have around collateral and financing in particular has been a big part of that change. Regulators are increasingly trying to make the world a safer place with respect to OTC derivatives by emphasising collateralised and margined activity.” Photograph kindly supplied by BNY Mellon, December 2014.

along with a continuation in the lowinterest rate environment, contributed to the spread compressions that dominated lending during 2013,”says Slater. “A shift in market dynamics, particularly around finance, gives rise to the belief that spreads will begin to widen in the months ahead. Given the positive tenor of the general markets during the past 12 months, a rise in corporate activity seems imminent.” I

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DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

THOUGHT LEADERSHIP ROUNDTABLE

SECTION NAME

NEW APPROACHES TO COLLATERAL MANAGEMENT

ROUNDTABLE PARTICIPANTS (left to right) BRIAN STAUNTON, MANAGING DIRECTOR, BNY MELLON'S GLOBAL COLLATERAL SERVICES JOERN TOBIAS, HEAD OF COLLATERAL SERVICES EMEA AND GLOBAL PRODUCT MANAGEMENT COLLATERAL SERVICES, STATE STREET JEAN-ROBERT WILKIN, HEAD OF PRODUCT MANAGEMENT, GLOBAL SECURITIES FINANCING SERVICES, CLEARSTREAM MEYSAM RAHGOZAR, HEAD OF COLLATERAL MANAGEMENT ADVISORY, PWC CONSULTING FRANCESCA CARNEVALE, EDITOR, FTSE GLOBAL MARKETS (NOT PICTURED)

Sponsored by:

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

COLLATERAL MANAGEMENT

INTRODUCTION UCH HAS BEEN written about the emerging role of collateral in the new financial order, particularly as recent requirements for clearing OTC derivatives via clearing houses will increase the amount of collateral required by counterparties and put pressure on its management. Regulation and the resulting changes in market infrastructure continue to drive demand both for the utilisation and optimisation of collateral, balance sheet quality, capital and liquidity adequacy and improved risk management. In light of these trends, it is clear that the role of effective collateral management in monetising assets is growing in importance. It is clear from the following discussion that collateral management is crucial for optimising the use of and return on both capital and liquidity and requires the proactive management of all assets. We have brought together experts in the provision and management of collateral to discuss the key trends in the market and outline any inefficiencies that might arise. To put collateral in a global market context, the total value of securities being used as collateral in the global financial system is estimated to be worth more than $10trn, excluding cash. If you include cash, that figure rises to more than $12trn, a figure greater than the current estimated gross domestic product (GDP) of the United States. Even so, recent research, conducted by both Clearstream and advisory firm Accenture, suggests that internal fragmentation of the global collateral management market costs more than €4bn a year. External costs and potential savings are more difficult to estimate, given that they are dependent on additional regulation. This roundtable will explain what is required for an effective collateral management framework and helps delineate the roles of service provider and clients, to ensure that collateral is mobilised to meet business, counterparty and service provider requirements.

SETTING THE SCENE: DEFINING ROLES IN COLLATERAL MANAGEMENT MEYSAM RAHGOZAR, HEAD OF COLLATERAL MANAGEMENT ADVISORY AT PWC CONSULTING: We advise clients ranging from the Tier 1 sell-side institutions, market infrastructure organisations and the buy-side on a range of issues across the collateral lifecycle, front-toback. In the front office, work is focused around supporting clients with IM/IA modelling; collateral pricing and optimisation. In the back office it's more focused around regulatory or other issues that impact the day-to-day operations of collateral management. Over the last few years; there has been a lot of focus

around regulatory change, particularly in the derivatives space. As a consultancy, we have been helping our clients both in terms of revisiting their strategy; as well as translating their strategy into operating models that can succeed in this new environment. Our work covers solution design to a wide range of issues, for example around standardising back office systems and processes across all collateralised products, including any subsequent organisational changes that may be required. It is about supporting our clients with insightful advice and pragmatic solutions along the value chain. JOERN TOBIAS, HEAD OF COLLATERAL SERVICES EMEA AND GLOBAL PRODUCT MANAGEMENT COLLATERAL SERVICES, STATE STREET: Our focus is on the operational side, helping our buy side clients manage their collateral effectively. Within our global product department we continue to develop new systems and products and services around collateral management, collateral tracking and custody of collateral. BRIAN STAUNTON, MANAGING DIRECTOR, BNY MELLON’S GLOBAL COLLATERAL SERVICES, I’ve been in the financial industry for 22 years and for most of that time I’ve been in businesses where collateral plays a key role, whether that’s securities lending, repo or collateral management for derivatives. My role is to help clients, mostly on the buy-side, to navigate the regulatory changes impacting their business. We help them cope with this evolution and suggest solutions to the inevitable challenges that emerge around regulatory compliance. Clearly nowadays, the focus is very much on the changes relating to derivatives and OTC clearing in particular. JEAN-ROBERT WILKIN, HEAD OF PRODUCT MANAGEMENT, GLOBAL SECURITIES FINANCING SERVICES, CLEARSTREAM: Our services include collateral management, mainly tri-party collateral management services, as well as securities lending and borrowing services for both Clearstream’s ICSD in Luxemburg and CSD in Frankfurt. Acting on behalf of our clients, the task is to collateralise a number of exposures based on our triparty collateral management offering. More recently, we have started offering clients a back office outsourcing service and we will be much more active in OTC derivative clearing collateralisation. Until now, we have concentrated our efforts in the collateral space on servicing central banks. However, these days we are kept busy by central clearing collateralisation with CCPs, especially with the upcoming migration of a large part of the OTC derivative markets to central clearing. We play an important role in linking central counterparties with our clients, often also linking the clients of a direct participant with the clients of Clearstream as an international central securities depositary (ICSD) or CSD. At times, of course, we compete with our colleagues around this table; at other times our services are complementary. Increasingly, we see our role as providing the right tools, infrastructure and functionality that banks can leverage in their services to their clients.

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EVOLUTION OF THE COLLATERAL MANAGEMENT SERVICE SET BRIAN STAUNTON: Let’s take a step back and look at why collateral is important in the first place. Transactions that require collateral do so because there is a risk to at least one of the parties in the transaction. Collateral helps reduce this risk or, if you like, offers a form of protection to one or more of the parties in the event of a default. Collateral has always been important, but what has changed—and continues to change—is the way in which collateral is viewed and managed. The way it is used is becoming more efficient, technical even. Equally, collateral is now relevant to a greater range of transactions and in those trades collateral is being used in very specific ways. The requirement to centrally clear OTC derivatives trades is actually a big step-change for clients. Not only are they moving OTC trades onto exchanges, via a clearing broker, they are also facing an increased demand for collateral. Some clients potentially may be collateralising trades as much as twice a day. Collateralisation impacts all the points along the trading chain: the clearing broker, the CCP and so forth. This has been quite a challenge for the buy side in terms of managing their available collateral and the ensuing increase in business complexity. That’s where service providers can step in and help. JOERN TOBIAS: Brian’s right, everyone was always aware of collateral, but perhaps it was not used as effectively or as efficiently as it is required now. This change has been forced on clients; in the past everyone felt it was perhaps ‘optional’ or not necessarily required; or that the cost of collateral would make it prohibitive to use. In those days however, risk appetite among traders was much higher, certainly higher than the willingness to absorb the costs of collateralising trades. Even so, I have to say that banks have always been very professional in their use and application of collateral. In that regard, it is much easier for them today than it is for many players on the buy side. Nonetheless, we must acknowledge that in many cases the buy side is facing an administrative challenge and avalanche of regulation, due to the structure of the business; in fact, it is very fragmented. They have to deal with thousands of accounts, tens of thousands of agreements, so by definition they are facing a much more complex environment than other market players. It is causing some big issues. JEAN-ROBERT WILKIN: Regulation is clearly an issue, however the initial trigger for this wave of collateralisation was of course the financial crisis and the crisis of confidence facing the banking system. Inevitably, the number of participants in collateralisation agreements in a very broad sense, be it from funding, secured funding, OTC derivatives or even securities lending (which was already collateralised) will increase significantly. As a market infrastructure we have already been active in helping clients such as banks or very large customers in collateralised, mainly inter-bank functions. These are essentially very sophisticated market players, which have well established operational and back

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

Brian Staunton, managing director, BNY Mellon’s Global Collateral Services. “The core of collateral management is identification of assets, their allocation, monitoring and reporting. What we are finding now is the addition on top of that of the aggregation and optimisation of collateral, which although it has been around for many years, these days is increasingly important,” notes Staunton. Photograph © Berlinguer, December 2013.

office support for the collateral operations. Moreover, these days, however, many smaller players have been brought into the game as transactions are required to be secured. As a result, scale is the big issue that we are facing as a service provider. Some of these new players will outsource or use consultants to help them, but that is only a first step. The second step involves the selection of one or two service providers, even before issues around compliance with new regulation kicks in! Regulation is making things worse for some of these clients, either because it impacts on the speed with which they can transact or because of the cost. It has also added significant complexity, particularly as more than one set of new rules is coming into force more or less at the same time. Some of these rules are complementary; some frankly contradictory. Be that as it may, our challenge is to ensure that our clients are both prepared and cushioned by the services we offer to ensure they comply with the new rules as seamlessly as possible. The buy side in particular is certainly looking for a lot of guidance and advice at the moment. MEYSAM RAHGOZAR: Dealing with the regulatory driven complexity is the real issue here and it manifests itself differently for buy-side and sell-side clients. Integration is the single biggest challenge that sell-side institutions are grappling with, whereas for the buy-side clients, it is mainly around dealing with the enormity of the compliance tasks ahead.

COLLATERAL MANAGEMENT

The regulatory requirement to centrally clear standardised OTC derivative trades for example drives a number of other requirements around the level of IM/IA commitments. Its segregation, eligibility, velocity, and reporting, which once combined across all products/divisions, demands an integrated approach from sell-side institutions. Therefore, many firms are finding it hard in terms of the level of investment that these types of integration exercises require, particularly with the sell-side institutions that had previously operated in silos and had not strategically invested in their collateral management infrastructure. Therefore, some of the key questions in play include: should organisations tackle multiple requirements that are driven by multiple regulations with a single solution or with multiple solutions? How can organisations best leverage the heavy infrastructure investment required in a way that allows for the introduction of new innovative service offerings to their clients?

REGULATION: ARE THERE MORE PROBLEMS THAN SOLUTIONS? JEAN-ROBERT WILKIN: Each regulation is probably well thought out individually. That's not the problem. The issue we are all facing now as service providers is providing clients with a consolidated view of all the regulations, regardless of whether they are in force or about to be implemented. Smaller, domestic firms may only concern themselves with those regulations that specifically impact their home market. Larger, international clients have a problem of a much larger magnitude: either regionally, if they are European; or globally, if they operate around the world. Each regulation has a different set of requirements and it is a challenge to meet them all. Although there is a significant degree of co-operation between regulators across the world, the rate of co-operation is not the same; the text and context in each country or region can be significantly different. This is a particular challenge for the larger global institutions that are dealing with nuances between regions or countries or regulators; they can sometimes be complementary or contradictory. It is a problem for market infrastructure providers like us. There is no hiding place for us and regulation impacts our business at all levels. It is exactly the same for large custodian firms. I have to add that in terms of regulation, we are only now beginning to understand where the stress points will be: where regulation in one segment conflicts with regulation in another. Let me provide some examples: banks will be affected by Basel III, CRD IV in Europe. There are requirements around liquidity buffers, leverage ratios and liquidity coverage ratios, these kinds of things. Nonetheless, it is becoming clear that because of all these requirements, banks will now have to fund their businesses at much longer maturities than they have done in the past. Similarly, large asset managers, buy-side clients or institutional investors are also affected by incoming regulation. For one, there will be more limitations on their securities lending

activities; it is also not clear whether some of the maturities of securities loan transactions will be able to match the longer funding maturities that banks will be forced to seek. Working on a secured basis over the longer term is costly and contradictory if banks require longer-term funds and funds that are limited as to how long they can lend securities. Clearly, there will be a need over time to iron out these inconsistencies. If that doesn’t happen then markets will cease to function properly and liquidity will dry up. This calls for detailed monitoring by regulators of the impact of their rules and a willingness to change or modify the rules if they do not work. JOERN TOBIAS: As Jean-Robert outlined there will be unintended consequences of regulation. I can just give one example where I feel already that there is a problem. If you have an equity fund or you have an emerging markets fund and you want to hedge and you’re forced into clearing, probably your fund, assuming it’s a UCITS fund, does not hold eligible collateral. UCITS per se are restricted from collateral transformation by UCITS regulations. Does this mean the fund cannot hedge anymore? Is this really the intention of the regulator, to expose the investor to unhedged risk? And so far nobody has come up with a solution to this conundrum. It think there is more to come, as well. FRANCESCA CARNEVALE: Meysam, obviously a lot of the dots aren’t joined. Is this causing regulators to reassess regulation? Or, is it creating opportunities for people to arbitrage the gaps? MEYSAM RAHGOZAR: It is probably a mixture at this stage. The period between the issuance of proposed regulation and its finalisation is an opportunity for market participants to actively work through the requirements and point out where contradictions or potential gaps exist. Post the finalisation of the rules and before reaching the set compliance milestones, market participants may identify further issues in the process of compliance. They tend to discuss these issues within their industry associations to identify common solutions. There may be instances where the implementation of such solutions may give rise to unintended consequences and therefore require the regulatory authorities to reassess their approach. FRANCESCA CARNEVALE: IOSCO and the Basel BCBS recommendations cover uncleared margin and there look to be renewed efforts by regulators to try and reach an accord to prevent regulatory arbitrage. Any firm that operates on a global level will want to actively seek regulatory arbitrage to their own benefit, even though it might not always chime with themes such as compliance. EMIR and Dodd Frank are a case in point. Is the industry working together effectively so that there are common standards between them? Are association working groups, such as ISDA onside? Otherwise implementation could be Jurisdictional and complex, plus there will be other crossborder issues coming through. BRIAN STAUNTON: This debate is interesting, particularly given we have different regulators overseeing different

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markets.You almost need a super-regulator of the regulators to make it all work seamlessly and to harmonise all the elements of regulation and their global implementation. The reality is we have a very complex tapestry of regulation to deal with, such as MiFID, CRD, FTT, AIFMD, Basel II, Basel III, and the interplay between each of them is equally complex. So individually we can figure out the impact of Basel II and Basel III on our businesses, but then if you add FTT into the mix how does this impact those other regulations? Invariably though, collateral is seen to be the solution to the problem of market risk, particularly when there’s been serious market dislocation, as a result of the recent financial crisis for example. The crux is that, while collateral has and continues to play a pivotal role, the key question we are trying to answer is ‘what is the optimal use of collateral’? Going forward, the demands on collateral will be greater and more varied, so we need a way of managing collateral efficiently. It isn’t just about how easily we can move collateral, it’s much more about how it is identified against a background where there is competition for the use of that collateral. Aggregating, allocating, monitoring and reporting are also key. Whilst this represents a challenge for both the buy and sell side, the sell side has historically implemented efficient collateral management procedures and systems and now the buy side is having to do the same. It’s a new world for them. FRANCESCA CARNEVALE: Clearly regulation is changing the way collateral is employed. Is collateral a market safeguard, or is it the lubricant that should make markets work more efficiently? Have regulators struck the right balance? BRIAN STAUNTON: As you rightly infer, regulators must do both. They are trying to ensure the market is efficient, safe, accessible and transparent, all those things—but as I mentioned earlier, collateral is seen as a solution to many of the problems in the market. What we’re finding now is that that regulation is placing a host of requirements on both the buy side and the sell side, and the apparent solution is an increased requirement for collateral. JEAN-ROBERT WILKIN: The G20 has made some very strong statements about what they want to achieve from this tsunami of regulation. The intention is very clear: to improve the integrity of the security and the reliability of financial markets. This is a fair objective. Now, I believe that translating that into regulation and implementing those regulations has proved much more complex than anticipated, either when regulation was first drafted or in trying to limit some of the worst unintended consequences of this regulation. Certainly, the design of regulation was to ensure that markets survive and that the damage of the financial crisis was as limited as possible. Right now, I would say the markets are in a period of adjustment as the implementation of regulation is taking much longer than we thought it would. However, while we continue this implementation, we have seen some success. We have witnessed a significant degree of deleveraging among banks (though this has also

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Jean-Robert Wilkin, head of product management, Global Securities Financing Services, Clearstream: “Ultimately, the driver for change and efficiency must come from the provider side. For clients, collateral represents bureaucracy and cost, not a revenue opportunity. It is an operational hassle, though it does mitigate some market risks.” Photograph © Berlinguer, December 2013.

had a detrimental impact on the economy as it has limited activity). Unfortunately, there is no immediate end in sight. For example, the ECB is already preparing to do yet another long-term financing operation to re-inject liquidity into the market for up to three or five years and so the implementation period will continue to be stretched out. From the initial articulation of the G20 goals to the end of the implementation period we could be looking at a time span in excess of ten years. I cannot see banks returning to fully financing businesses until this regulation has worked through the system, which will invariably impact long-term economic performance. All that is linked to the growing complexity of the market. BRIAN STAUNTON: On that point I was reading an article from the IIF, which was quite interesting, which was written in 2010, which suggested that only the implementation of Basel III would shave off 3% from GDP growth in the US and Europe in the five years preceding its implementation. That’s a hefty blow to the real economy, and these are the unintended consequences of some of this regulation. Let’s not begin to speculate on what the cost of the financial transaction tax (FTT) will be. FRANCESCA CARNEVALE: Recent reports suggest that right now the unregulated market has $3.7trn dollars’ worth of collateral in circulation, of which around about 80%-81% is cash. The majority being euros and then US dollars. If you consider all of the collateral in circulation in the market at the moment for uncleared OTC derivatives, collateral looks to

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have been used as an effective credit risk/counterparty credit risk mitigant for a number of years. Moreover, that value has increased exponentially (along the lines of 27% compounded over the growth rate since 1999). The introduction of central clearing, the uncleared margin rules, the excuse-me rules around the need for a standardised and resolute pro-active reconciliation process of OTC derivative trading, and dispute resolution of those trades and any breaks that are raised, look to go hand in hand. Are they really an extension to the best practices that we have in the market? Are regulators aware of the potential impact on market liquidity? BRIAN STAUNTON: When we talk about collateral, particularly in the way that we just described it, we have to think about collateral as not being a singular thing. For the most part the regulations specify the type, quality and amount of the collateral that would be needed, and in turn this feeds down into market participants such as CCPs, clearing brokers and banks’ own capital requirements. If you’re going to collateralise with them, you either need cash or you need high quality collateral. When we talk about collateral and its availability, for the most part we're talking about quality collateral: that’s the segment that is really in the spotlight. As you rightly ask, do banks, do market participants, have enough of these high quality securities to use as collateral? That's really the crux. Not whether they've got enough collateral, it's more about whether firms have enough of the right type of collateral to post to a CCP or their clearing broker, or whether banks have enough quality collateral for regulatory requirements. Additionally, any firm that wants a credit line, for example, needs collateral to support those credit lines for trading. Going forward, banks will be much more specific about the types of assets that they will want as a form of collateral when providing a line of credit. All in all, we believe the demand for high quality collateral will be huge. JOERN TOBIAS: Regardless what the additional demand for collateral would be as the outcome of the regulation—it could be two trillion, ten trillion—I would say at first instance these numbers are not really important because the problem is how does a market participant who needs the collateral at a certain time get that collateral? And that’s a big question. Even if that collateral in the market as a whole is available that doesn’t mean that a certain party will have access to that collateral at that point in time. And that’s what I tried to allude to at the beginning is that some market participants are even restricted by regulation to have access to that collateral and that poses the issues. As Francesca says, regulators have realised this effect because the IOSCO paper has factored in that liquidity squeeze. The paper is a second draft. However, I struggle to see how collateral will transfer at the right time to the right party. This is where we have conflicting regulation in particular which will even prohibit this and I believe that’s the real issue. The total numbers are not really the issue. I can understand that, for example, at Deutsche Bank their proprietary portfolio will be able to enter into lending transactions or go out to the repo market; but if you are an asset manager

with say 600 funds and you need to do little, tiny lending transactions, and you are not allowed to do that, or repo transactions to mobilise collateral, how will that sit technically? That’s a big, big, big challenge and this is what we’re all as service providers trying to help our clients to resolve that situation. BRIAN STAUNTON: Well, we started a year ago by bringing our collateral-related businesses together to form Global Collateral Services because we recognised there were very real benefits in bringing those activities together in one place. Our clients may want some form of tri-party repo collateral management, they may need collateral management for derivatives or for securities lending, margin segregation or collateral aggregation. They can now choose the specific components of collateral that they need. It might be that some clients need bespoke solutions to address their collateral requirements, and it may not be tri-party collateral management or derivatives collateral management but rather a combination of the above. By having one unified group we are better positioned to help our clients. FRANCESCA CARNEVALE: Jean-Robert, you launched the Liquidity Alliance: how does that work and how does it feed into the evolution of collateral management? JEAN-ROBERT WILKIN: The Liquidity Alliance is a group of CSDs around the world which have decided to co-operate and share, to some extent, the collateral management capabilities which we have developed at Clearstream. The Liquidity Alliance has an objective to not only share information and technology development among the CSDs, but also to facilitate cross-border mobilisation of collateral; a point which I think Jorn addressed. In other words, how do you ensure a client’s collateral is in the right place at the right time? The initiative arose because we wanted to ensure that our clients could invest in many different countries. This is the same for global custodians. Nowadays there is a subtle shift in our thinking, we need to help clients mobilise collateral, not just invest in one market and holding on to the securities, but mobilise collateral across multiple markets, wherever it is required. Essentially this business is non-cash collateral for securities. As you said Francesca, we now have a low volume transaction market; it has still not recovered. What happens if the flow of transactions increases again to pre-2007 levels? The other aspect is that we also have a very low interest rate at the moment, which is helping the markets temporarily, but what happens when the interest rates start rising again? Right now, any conundrums around the supply of collateral are easily solved by cash and if interest rates increase and the transactional flow increases, particularly in the derivatives market, cash will no longer be a first option, we will have to mobilise non-cash collateral. That is why the network is important: for linking settlement and to mobilise collateral across many markets. That’s the medium and long-term objective of the Liquidity Alliance. Up to now we have five CSDs that link up Brazil,

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South Africa and Australia. We have recently announced the launch of a partnership with the Singapore Exchange, which also runs the CSD in Singapore and which is entering into discussions with us to join the Liquidity Alliance. FRANCESCA CARNEVALE: With this kind of initiatives in mind, will banks have to work together more closely to create bigger collateral pools to meet demand? MEYSAM RAHGOZAR:Yes and no. As a first step, banks need to be smart in the way they manage their various pools of collateral and, to Brian’s point, that’s already happening. As an advisory firm, we have helped a lot of clients in terms of bringing those disparate pools of collateral together. There are challenges with doing that, both from the point of view of agreeing on how those pools come together as well as practical connectivity issues. Once this is in place, the next step is to consider broader joint venture opportunities that can enhance the organisation’s service offering. FRANCESCA CARNEVALE: In the evolution of collateral management, do you think that some banks will dominate this business: either because of their size or global reach; or simply their ability to gather assets through services such as custody? Are some institutions more adept at making hay from the growing demand for collateral than others? The limitation of re-hypothecation, for example, was confirmed in the new IOSCO paper (with acknowledgement that the market can at least one step re-hypothecate). All of these areas will require a concerted effort by the buy- and sell-side, the CSDs, the custodians, third party providers and the vendors to be able to reach an accord. Can it be done? JOERN TOBIAS: Yes, I think so, although I have to say that given the investment required it will be easier for larger companies to, basically, put the money on the table in order to create that interoperability and to create collateral velocity. As Brian outlined, at State Street we always had all exposures on one single platform organised globally in one single operation for our clients, but, for me, that's just the start. I would say that’s the minimum requirement. In order to create collateral velocity you now really need to have that connection to the various players in the market, to the ICSDs, CSDs, and other custodians in order to move collateral. Before we even talk about collateral transformation and liquidity, the first thing everybody should focus on how to increase collateral velocity because if you don’t have this anyway everything else we can discuss will not really remedy the situation. From that perspective, yes, I totally agree everybody needs to play together, while of course, competing in others. In terms of reducing operational risk and increased collateral velocity it just works together, but I would assume that for some larger players it might be easier than for smaller ones just to make the necessary investments. MEYSAM RAHGOZAR: When we look at the market participants and the level of investment that they traditionally have had in collateral management, you have some organisations that have invested heavily in collateral for quite a long time and are in a much better position to react and

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Meysam Rahgozar, head of collateral management advisory, PWC Consulting. “Clearly there are two tiers of buy side clients: ones that are already well versed in the application/use of collateral and others have never had to collateral a transaction before,” says Rahgozar. Photograph © Berlinguer, December 2013.

resolve some of these issues as a collective group. But you also have others who perhaps didn’t invest as much, or started a bit late and they are playing catch-up. There is therefore a two tier division between the market participants and how well they are reacting to these changes.

HOW WELL PREPARED IS THE BUY SIDE FOR CHANGE? JOERN TOBIAS: Overall, I would say the buy-side is prepared. In fact, some are really forerunners. To be fair though, it is not easy for everyone, many of them are coming to this new requirement for the very first time. Some have never had to collateralise a transaction. Second, some asset managers were held back by their investors, which perhaps did not want to spend the money required in collateralising transactions. The buy side is very active right now looking for outside help with new market requirements and we are kept very busy indeed. There are no unified solutions in this market. We cannot, for instance, create a single pool for their investments. Regulation ensures that is not possible: each fund is a separate legal entity and so you cannot take from one and hand it to another. It is prohibited. That’s step one, creating solutions with that reality in mind. Step two is then sound collateral optimisation for each single portfolio. Step three then employs, probably, collateral transformation/enhancement if and when allowed. Right now, a lot of players still struggle with step one.

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BRIAN STAUNTON: I’ve been to a number of conferences in the last six months where they've put up statistics about how well prepared the buy side is. Without going into the specifics, the general trend is that a high percentage of the buy side is not prepared at all. I tend to agree with Jorn in that you have to look at who the client is. Certainly, the big asset managers seem to have this compliance project very well organised. That’s not to say they don't need help, but they certainly have a view on how they can implement change. I would say that less prepared are the smaller mid-size asset managers and those pension funds that have a history of outsourcing the custodial function, asset management, fund administration, the mid and back office functions, for example. I don’t think it is in their DNA to necessarily think that they would or should build out a complete collateral capability for themselves. They look to their provider, whether that be their custodian, or somebody else, to help them. The conversations I’ve had with the buy-side have really been around helping this group get to grips with the regulations and implement a solution that works. FRANCESCA CARNEVALE: The market is clearly split then. Has that had an effect on the provision of services: say where larger clients get a more comprehensive set of services and others a more commoditised solution? One of the things that’s really hammered home, say commentators is the importance of having a clear responsibility to engage as many clients as possible, giving them regular updates as to the progression of the rules and interpretation of the rules and how the sell side can mechanically support them from day one. It is a huge responsibility for the sell side, to cover all bases right from the outset and engage at all levels with the client. Is everyone up to the job? MEYSAM RAHGOZAR: Clearly there are two tiers of buy-side clients: ones that are already well versed in the application/use of collateral and others who had never had to collateralise a transaction before. Our work with the former group of buy-side clients is around assisting them with the selection of their clearing brokers and supporting them through the required changes to their systems, processes and organisation to succeed in the new environment. With the latter group of buy-side clients however, our work is mainly focused around helping them consider the pragmatic options open to them. It is partnering with them to understand their needs and helping them through their compliance activities, in terms of both cleared and bilateral transactions. There is a lot of work being performed in this area right now. In addition to supporting our clients assess and respond to the impact of becoming compliant, we also help them ready for the demands of ‘post-compliance’. This includes for example; planning for the potential extra BAU resource requirements, or introducing/amending operational controls and the associated MI on new/changed BAU processes, just to name a few.

THE NEW COLLATERAL EQUATION: EVOLUTION & MARKET CHANGE JEAN-ROBERT WILKIN: Each of us around this table, whether we are a consultant, an ICSD or a global custodian, are looking at collateral. That is already an indication of the evolution of collateral in the markets and its growing importance. Take Clearstream as an example: We launched the concept of the Liquidity Hub back in 2009 with the aim of putting collateral management at the forefront of the ICSD and CSD strategy. It is not the only thing we do, of course, but it is instrumental in terms of the strategic investment that Clearstream as a market infrastructure has been making for the last five years and is making in preparation for the implementation of this regulation. Ultimately, the driver for change and efficiency must come from the provider side. For clients, collateral represents bureaucracy and cost, not a revenue opportunity. It is an operational hassle, though it does help mitigate some market risks. Therefore, from a provider perspective, if we are to make it cost effective for clients, then commoditisation or standardisation of processes must be part of the overall service solution. Commoditisation, unfortunately, is sometimes seen negatively, but given what we will face as an industry, it is inevitable. Let me explain: there are a number of realities we have to face. Collateral is and will be increasingly transformational of the markets. We will have to drag collateral management out of, if not the Dark Ages, then out of a very outdated, manual process. As the collateral business evolves and usage of collateral accelerates the modernisation of this business segment will follow. Moreover, as I mentioned earlier, the number of participants is going to increase the exchange of collateral in whatever form, cash or non-cash, dramatically. That means volumes will increase dramatically. Regarding OTC collateralisation, fantastic progress has already been made in terms of reconciliation and processes; but as I outlined earlier, still more has to be done and new partnerships must be forged to meet the challenges ahead. FRANCESCA CARNEVALE: Obviously, the volumes of collateralisation and margin call management are going to increase, some say significantly, as a result of the rules coming through. In this regard, are both standardisation and automation key? A good example is for the tri-party segregation of independent utilisation of initial margin; for instance, defining a standard legal document that will allow and help both the buy side and sell side to avoid an extended negotiation for the individual terms of each transaction. Is this likely? To ensure best practice is more automation required? BRIAN STAUNTON: The core of collateral management is identification of assets, their allocation, monitoring and reporting. What we're finding now is the addition on top of that of the aggregation and Optimisation of collateral, which —although it has been around for many years—these days it is increasingly important. The ability to optimise and have collateral in the right place, at the right time and are using

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it in the most cost efficient way are critical. Also, the quality of reporting services around collateral is now a differentiator between providers. In particular, providing bespoke reporting to clients that confirms they have properly collateralised particular exposures against derivatives, repos, loans, and so forth and are in compliance with regulations is vital. The core of the business will stay the same, volumes will certainly increase; however, it is around the provision of these additional enhanced services that providers come into their own. JOERN TOBIAS: I would see collateral management evolve in a variety of ways. The first element is the players themselves: they have to be up to scratch. It is a strategic imperative for State Street to excel in its provision of collateral services; we fully understand the growing role of collateral in tomorrow’s financial markets. The second element is regulation: we approach regulation incrementally. I think there is still a lot of ambiguity in current regulation and in order to avoid unintended consequences there will be amendments. We continually seek clarification and push for change where we see ambiguity and problems arising. In terms of our clients, we constantly review regulatory change and report on its impact on their operations. These elements link together in that there will be evolution in best practice, STP connectivity (and automation) between the various participants in the market. In the past collateral management was a back office operation. It was more about collateral processing, it was conducted manually in many instances. Going forward, I think evolution will be nuanced: it will sit between the front office and the middle office. However, collateral management services will help clients make the best economic decision when they are entering into trades. You need to be able to prepare a lot of data in order to support that as a collateral manager. In that regard, collateral transformation, collateral optimisation will be must-have services; not nice-to-have services. Additionally it’s not just only about the right systems, the right intellectual capital is required. And finally, it has to do with connectivity, automation and collateral velocity. There will be evolution. I would say, today we operate in a T+1, T+2 regime, depending on the markets. Tomorrow it must be, or it will be T+0, with the cleared business. And probably even for the buy-side at one point we will operate in an intraday environment, and that, again, will pose a lot of challenges on the infrastructure and the providers. MEYSAM RAHGOZAR: Clearly, the additional project resource requirements that help achieve regulatory compliance as well as the additional future BAU requirements around topics such as regulatory reporting and segregation, will collectively contribute to a higher cost base for all market participants involved. Easier methods of cost reduction such as near-shoring, offshoring or outsourcing have already been explored by most if not all market participants. So the main focus of the work

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Joern Tobias, head of collateral services EMEA and global product management collateral services, State Street. “In the past collateral management was a back office operation. It was more about collateral processing, it was conducted manually in many instances. Going forward, I think evolution will be nuanced: it will sit between the front office and the middle office,” says Tobias. Photograph © Berlinguer, December 2013.

we are performing with our clients is around innovative solutions that help standardise collateral management systems and processes to enable, as Jonathan mentioned, management by exception. This in turn, will lead onto smaller teams of collateral managers that can operate autonomously across multiple products/functions whether cleared or bilateral. Other areas we are discussing with our clients are around the considerations when it might be more cost effective to work in partnership with third party utility providers. Certainly, in the documentation/reconciliation space, we work with organisations that want to utilise some or all of these options. The approach taken to implementing regulatory change is itself another potential way to reduce cost. PwC’s Smart Regulatory Change Implementation Methodology helps clients achieve this through taking a thematic view of the requirements across all existing and upcoming regulations. This approach helps save on the number of regulatory change, SME, and IT resources required to successfully achieve compliance. As a consulting firm, our role is therefore to advise on industry best practices and work closely with our clients to design strategic solutions across the collateral management lifecycle that will address their immediate regulatory compliance needs, but also positions them well for the long term needs of their clients. I

20-20: AQUIS

We kick off our annual nominations for the 20 market makers to watch in 2014 with a look at Europe’s new Aquis Exchange, which aims to “revolutionise” the exchanges space. Launched in October 2012, with its first trades conducted in November 2013, it is pushing ahead with growing its infant multi-lateral trading (MTF) business, including equity trading, data provision and technology sales. Ruth Hughes Liley reports.

Alasdair Haynes, chief executive officer, Aquis Exchange. Photograph kindly supplied by Alasdair Haynes, December 2013.

NEW LOOK EXCHANGE BUSINESS N SPITE OF its pre-launch pretensions, however, growth on the platform may be more evolution than revolution as it grows from its initial 0.03% market share in the CAC40 index and 0.02% in the FTSE100 following the quiet period over Christmas. Aquis opened by offering trading in 165 instruments in the UK, French and Dutch main indices, and added German stocks at the end of January and is aiming for more than 1,200 instruments in 14 European markets, plus a number of international depository receipts. Haynes has not ruled out a dark book at some future stage. In contrast, well-established rival Turquoise already trades more than 2,800 stocks and exchange-traded funds in 18 European and emerging markets as well as US stocks and depositary receipts Aquis is already facing what CEO, Alasdair Haynes, describes as “huge” opposition from incumbent exchanges with one unnamed CEO of a European venue telling him ‘I hope you fail’. The platform’s first growth opportunity has come from the unlikely arena of the European Union, which will effectively ban broker crossing networks under MiFID II, forcing them to re-register as MTFs or go out of business.“It’s a huge opportunity,”says Haynes, who plans to sell technology to them as well as picking up trading volume. “MTF status is not easy to achieve. Setting up an MTF is completely different from running an internal crossing network.You need to provide equal access to all, better surveillance technology, and better matching tools. It’s cheaper and more efficient for banks to outsource. Our system and response times will be competitive, all they have to do is say what they want.” Haynes is expecting Aquis technology—what he calls an “exchange-in-a-box”—to be in demand. In fact, it is the firm’s IT employees who could be said to hold the key to Aquis success. When Chi-X merged with BATS, many of its IT staff were made redundant and later employed by Aquis. Out of a team of 33 at Aquis today, some 17 are former Chi-X Europe employees, many, significantly from the IT team that had developed two exchange systems. For some employees, building the technology for Aquis is the third time they have built a low-latency infrastructure from scratch. Its proprietary technology (the prototype was built in one employee’s garage) allows for ultra-low latency simultaneous trading connections and has a high transaction capacity. A proprietary protocol allows fast access to markets and reduced bandwidth, although FIX protocol is also built in.

Clients can connect to Aquis Exchange via co-location at the firm’s primary data centre at Equinix in Slough, which offers access to more than 30 markets and 80 venues, or the secondary centre at Interxion’s City of London campus. Because the software is built around message traffic on its system, it can be applied to other asset classes. The team even had one inquiry from an advertising agency wondering whether it could be applied in that sector. Its first real customer is Quote Africa Group which wants to create a network of African listed stock exchanges. Aquis is providing it with a matching engine and surveillance technology. But with Africa representing only 7% of active emerging market equity trading, the sums are small. However, while Haynes says the “real money” lies in the sale of its software, he says the trading capability of Aquis is the ‘shop window’ for its technology suite and here is where the ‘revolution’ comes in. Haynes wants to break what he sees as exchange duopoly—that although competition came to European exchanges with the Markets in Financial Instruments Directive (MiFID) in 2007, 90% of European equity trading still takes place on two exchanges, the national exchange and MTF BATS Chi-X Europe. Haynes wants Aquis to become the number three venue.“We spotted the duopoly and that is no good for markets. Last year was an ideal time to hire people as firms were cutting costs and it was a great time for change.” While Aquis is late to the party, Haynes brings with him his experience as CEO of pan-European MTF, Chi-X Europe. Within four years Chi-X Europe was profitable and within five years Haynes had built its share to up to 24% of trading across Europe. However, at Chi-X Europe, he had the support of parent company Instinet; earlier, working on the Posit crossing engine in the late 1990s, he had the backing of his employer ITG. This time he is going it alone. “Aquis has had all the ups and downs of a start-up and it’s a fairly scary thing,” he admits. “There are around 175 MTFs listed in Europe so the odds are against you. If you were fainthearted you wouldn’t do it. If all we have done in the next 12 months is gain a 2-3% market share I will think we have failed. But if Aquis succeeds, exchanges are going to have to change their model.” Haynes has spoken to buy-side representatives who he points out are traditionally suspicious of new markets because they see it as adding to fragmentation. Indeed, 50%

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of the buy side rate finding liquidity their second biggest challenge after regulatory concerns, according to TradeTech’s 2013/14 buy-side report. Steve Grob, Fidessa’s director of Group Strategy, anticipates that Aquis should be included in the Fidessa Fragmentation Index before the end of Q1 this year. The index calculates how many venues a stock has to trade on to achieve best execution and so is a measure of liquidity across all venues. He says the key to Aquis’s success will be its focus and attracting sufficient varied participants to connect to the venue. “History suggests that focusing on particular areas brings liquidity more easily than trying to attract liquidity across all areas, particularly with limited resources. Volumes on Aquis are modest at the moment, but it is an innovative idea and I think it could be disruptive. I know the team has put a lot of effort into it, but it is a challenge in today’s very complex world to get attention. It will naturally take some time,” says Grob. Attention will be on Haynes in March when he is speaking at the World Exchange Congress in Qatar on “A case study of a market disrupter”. The confidence that Aquis is ‘disruptive’ is based on the firm’s innovative subscription pricing model, inspired by a trip by Haynes to buy a mobile phone for his teenage son. Garden leave after Chi-X Europe and the prolonged negotiation period before Chi-X Europe merged with BATS allowed him time to research subscription pricing in the telecoms and other industries. So Aquis has launched with a fee structure where clients pay a set monthly tariff for the amount of messages—orders, cancellations or modifications—they generate rather than a percentage of the value of each stock they trade. There are three price bands: low for smaller-usage firms, an upper band for the largest consumers, capped at £10,000 per month and all messages which post liquidity from designated liquidity providers). Data packages are wrapped up in the monthly fee. “Our costs are directly related to revenue,” says Haynes, “so our future is predictable. This way I have a better idea of how many customers I have and what my income is going to be. Members can predict their costs in advance. It’s a very logical story. It has worked in every other industry where it has been tried. In telecoms, in leisure, media, entertainment. It is very much the way you pay for things now. And every single time it has been introduced, there has been growth in the underlying industry.” The subscription model is hard to find in other parts of the industry: some clearing companies offer fee-capped charging structures: LCH Clearnet, EuroCCP and EMCF cap fees, with volume above that cleared for free. Volumes below are priced at a tiered discount. In Chile, investors may sign halfyearly or annual agreements with the Santiago Stock Exchange to operate without fees by paying an inflationindexed tariff, but Haynes knows of no other exchange “brave enough or foolish enough” to offer subscription pricing.“International exchanges will not move to a subscription model unless we are successful because it is not in their interests to do so because we are capping the upside. With the share price of stock exchanges at or near their pre-crisis

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

peaks and as public companies, none of the exchanges are able to do that. I believe exchanges should be utilities. Aquis is not an exchange business, we’re a utility. “Our model allows you to do all your execution, and have all your data under one monthly subscription. If you could do that and include things like settlement fees, the business will explode. This could be rolled out to other asset classes too,” says Haynes.“Many people won’t trade equities today in Europe because huge data and settlement costs make it too expensive. Plus the volume in European markets is a quarter the size of the US market, so there is huge potential.”

Standing to benefit Those who stand to benefit first are the sell side firms still paying the largest exchange fees. For example in 2012, globally, the industry spent $25.53bn on data, up 2.34% over 2011, according to consultants Burton-Taylor. Should the subscription model take off, Haynes estimates the industry could save hundreds of millions of pounds. For example, an investment bank paying Aquis’ £10,000 monthly fee would pay £120,000 a year, a fraction of annual trading profits. The fees at Aquis will rise gradually over the next few years in three tranches to a top rate of £50,000, on the assumption enough liquidity is attracted, after which it will rise with inflation. With electronic order book turnover in EMEA down 24% in 2012, according to the latest figures from the World Federation of Exchanges, attracting liquidity will be key. Aquis opened with 11 customers including three bulge-bracket investment firms, a handful of market-makers, including high frequency firms, and some smaller brokers. Haynes says 40 more customers are in the pipeline, with a programme to connect several each month. One magnet for the larger firms is that with fees capped at the upper end, firms can trade as much as they like after that point, subject to fair usage policy. Haynes points out: “The more they do, the more the cost per trade comes down. The telecoms industry has fair-use policies and we too are able to monitor transactions to ensure people are not abusing the system.” For example, Aquis’ four order types do not include post-only order types. If firms want to post an order and then cancel it, they have to pay for the cancellation. While other MTFs have launched with investment and liquidity commitments from the sell-side (Turquoise launched with a consortium of 14 banks) Aquis initial investment has come from a group of wealthy individuals, comprising 45%, and a 30% £5m investment by the Warsaw Stock Exchange, sitting two directors on the Aquis board and eventually allowing clients of both venues to gain access to the other through connected routes. The 75% is worth $12.5m, putting the value of the company at more than $16m. The remainder is owned by Aquis employees. Some of these employees turned down other job offers, waiting to see whether Aquis Exchange would provide them with an opportunity. This year may determine whether they were right to do so. I

20-20: REFINED BUSINESS

To help offset a shortfall in commodities-based revenue streams, UK’s Barclays has continued to mine an array of alternative opportunities, among them a series of financing initiatives that has enabled Barclays to flex its structured capital and M&A-transaction muscle on behalf of a host of international producer clients. Dave Simons reports from Boston.

THE COMMODITIES PLAY S IS OFTEN the case in the global financial sweepstakes, one sector’s gain is another one’s pain. In 2013, equities returned with a vengeance, helped in no small part by a reapportioning of assets derived from various former high-flyers, commodities included. Year-end data painted a stark portrait of a sector in exodus: more than $34bn was siphoned from commodity funds during the past 12 months, according to UK analytics group Coalition, sending S&P commodities prices into negative territory for the first time since pre-crisis 2008. Like other industry stalwarts, UK-based Barclays spent much of the year honing workable new strategies as the reality of a post-supercycle commodities era began to set in. Along with a shift in investor preference, banks like Barclays have been buffeted by growing regulatory pressure to disengage from the direct trading of commodities, including the physical ownership, warehousing and delivery of energy products, metals and other essential goods. (Critics have likened such intertwining of commodities stockpiling and financing to the model espoused by bankrupt energy giant Enron.) Many banks have already moved on. At year’s end Deutsche Bank announced it would cease trading in raw materials (the firm will continue its commodities index business, however). DB’s exit follows the decision by JP Morgan earlier in the year to end its own involvement in physical commodities trading and ownership. Nor will December’s green-lighting of the long-overdue Volcker Rule make things any easier. The controversy packed component of Dodd-Frank bars banks from using certain types of securities—including commodities—for proprietary trading purposes. Among those voting in favour was former Volcker opponent Bart Chilton, the outgoing head of the Commodities Futures Trading Commission (CFTC), who ultimately concurred that a portfolio should not be built around “some amorphous set of excuses for doing a trade…as a rationale for a hedge.” It was Chilton who advised policy makers to consider the ramifications of banks’ continued physical ownership of commodities, arguing that banks should just go back to being banks—that is,“making loans to businesses and individuals.” Barclays seems to have been following such advice, though with a twist. To help offset the reduction in revenue streams while still staying within the good graces of the global governance gods, Barclays has continued to mine an array of alternative commodities-based opportunities, chief among them a series of financing initiatives that has

allowed Barclays to flex its structured capital and M&Atransaction muscle on behalf of a host of international producer clients. Barclays threw its hat into the commodities-financing ring a year ago when it struck a deal with India’s Essar Energy to maintain the company’s fuel inventories at Essar’s UK refinery in Stanlow. Earlier this year, the bank helped facilitate the acquisition of the Tesoro Hawaii LLC refinery by Houston-based energy company Par Petroleum Corp (as part of the deal, Barclays will handle on-site inventories and supply monthly crude cargoes). The bank has also invested in various gas extraction projects, including the recent UKbased fracking effort by Third Energy Holdings LTD (through Barclays’ Natural Resource Investments division, BNRI). Barclays has also been keen on refined energy opportunities in the US, in particular the facilitating of transactions related to the production and export of lowercost, liquefied natural gas, and continues to pursue inventory financing prospects in emerging areas such as Asia as well. It remains to be seen how such financing arrangements will hold up as Volcker begins to roll out over the coming year (banks have until July 2015 to comply with the new rules). In the aftermath of the London Whale episode, CFTC chairman Gary Gensler successfully lobbied regulators to include broader language extending Volcker’s reach into foreign territories with the goal of putting institutions like Barclays under its purview. The ramp-up in financing activity comes as Barclays works to plug a sizable hole in its Fixed Income, Currency and Commodities (FICC) segment (which saw a 44% year-over-year income drop during the third quarter, consistent with FICC shortfalls experienced elsewhere). At year’s end, Barclays joined a chorus of one-time commodities champions like Citi and Deutsche Bank with its own dour assessment, commenting that investors were unlikely “to warm to commodities in the near term” due to criteria such as global oversupply and a shift in Fed monetary policy. “A big puzzle for financial markets is the lack of a commodity price response to what is turning into a robust improvement in global manufacturing confidence,” added Barclays in its report. The challenges have been compounded by the ongoing lack of correleation within the sector, with certain commodities moving in response to specific supply-demand or regional factors. Barclays believes this divergence will remain in place through the coming year. I

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

20-20: ECM: GOLDMAN SACHS

Photograph © Nn555/Dreamstime.com, supplied December 2013.

THE SLOW RETURN OF THE IPO MARKET? Contrary to what most market watchers are saying, this is not a golden age of IPOs. In terms of numbers: by the time this magazine went to press some 864 transactions worth $180bn had been finalised through the year. True, flotations through the year look to have been well covered and after-market trading is more resilient than it has been for some time; but the reality is that some six years after the financial crisis exploded, the IPO market has barely touched 2003 levels. Moreover, volume and value are still way off the false dawns of 2010 and 2011 activity. A golden age: I should cocoa! However, fundamentals look better than they have done for some time and some trends look hopeful. Is it time for a return to form? David Simons reviews the outlook and suggests that investment banks, including Goldman Sachs, UBS, JP Morgan and others have at least a healthy pipeline of deals coming through in 2014. N DECEMBER, EQUITY capital markets commentators looked to be searching for an upward trend. The reality is that the sector is in the same low segment that it found itself in as the century began to take shape. Graph A: Global IPOs 2001-20013: is the tide turning? illustrates a markedly more nuanced trend than many market commentators would have us believe. Clearly following a muted period between 2001 and 2004, the global IPO market looks to be in another low cycle. Even so, volumes look to be at least stable and at least higher than the nadir of the 2008/2009 period. Even so, with $180bn worth of IPOs across 864 separate transactions, values are still well below the peak issuance volume of $338bn across 1967 transactions in 2007. Will IPO volumes start to rise significantly once more? Heading into 2014, prospects of a broad-based, highervolume rotation into equities might be over-stated, nonetheless any number of market watchers say the 2014 will be healthier than the last few years. If so, it bodes well for UBS,

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

JP Morgan and Goldman Sachs, the triumvirate often topping this year’s regional league tables. ECM teams are hoping for a sustained upswing. Questions hang: was the 2005-2007 period an anomaly? Are current levels a better reflection of a sane and boom/bustfree market? Certainly, flotations through the year look to have been well covered and after-market trading is resilient. Evidence around the world is mixed. The US provided much of the 2-013 blunderbuss behind this year’s issuance calendar. US exchanges led global IPO activity with 222 IPOs raising $59.6bn (which accounts for 26% by global deal number and 37% by global capital raised) in 2013. This is 67% higher by deal number and 28% rise by capital raised compared to 133 IPOs which raised $46.7bn in 2012. Low interest rates and the high yields on offer encouraged technology, healthcare and retail firms in particular towards listing. Health care was the leading sector in 2013 by deal

20-20: ECM: GOLDMAN SACHS

Global IPOs 2001-2013: is the tide turning?

Source: Ernst & Young, Forbes, various news reports, December 2013.

volume with 49 IPOs raising $8.8bn. Real estate provided 22 IPOs raising $6bn or so. Twitter set the benchmark in the technology sector, which in total saw 39 IPOs raised just under $7.5bn. NASDAQ beat other US exchanges saying hello to some 233 new listings, including 125 initial public offerings (a 74% increase from the 72 IPOs it saw in 2012). The exchange claims 60% of the top 100 performing IPOs overall this year, including seven of the top ten. NASDAQ also led the industry with 30 listing venue switches with $66.6bn in combined market value switching from competitor exchanges over the year. The surge in listing momentum in the US, has been fuelled by a strong market and provisions of the JOBS Act, which has brought a diverse mix of industries to market. Another story in the ECM segment is that global private equity backed IPOs raised over $57bn through the year. Notable deals in this segment includes Plains GP Holdings LP, which raised $2.9bn on the NYSE; Hilton Worldwide ($2.2bn) and Antero Resources Corporation (around $1.8bn). According to Ernst & Young, of the top 20 private equity IPOs, 11 were from the US and only nine from Europe. Also, says the global financial services firm, over the last several years, private equity firms have become an increasingly important driver for the IPO markets. In 2008, PE accounted for 10% of global IPOs, while over the last twelve months companies backed by private equity firms accounted for 31% of all proceeds.â&#x20AC;? Bank of America Merrill Lynch currently leads the ranking of underwriters of US listed IPOs with 12.2% market share, an increase of 2.1 market share points. Goldman Sachs and JP Morgan round out the top three IPO book-runners in the United States. Although the US remained the dominant market for private equity driven IPOs, the year also witnessed a gradual return to form of the European market. In the European, Middle East and Africa (EMEA) regional segment, big ticket IPOs (those worth $1bn and over) more than doubled over the past year, with $13.2bn raised through nine separate

deals, compared with four billion dollar plus deals (worth a combined $6.4bn) a year earlier. The largest IPO transaction this year to date is Royal Mailâ&#x20AC;&#x2122;s $3.2bn offering via Goldman Sachs, UBS, Barclays and Bank of America Merrill Lynch. Controversy over the deal aside (were its shares undervalued and sold to big ticket investors at the expense of the UK retail segment?) it marked something of a turning point in the affairs of the UK government and the overall outlook for the UK equity segment. Deutsche Bank led the EMEA billion dollar plus segment, with the ECM volume book-runner ranking in 2013 with an 11.9% market share, followed by Goldman Sachs and Bank of America Merrill Lynch with 11.7% and 11.3% shares, respectively. In 2012, there were a paltry six PE-backed IPOs in EMEA, which raised $2.3bn in total. This year, private equity firms pushed the boat out, raising $17.6bn across 34 separate IPOs. Approximately one-half was raised in London; however, Paris, Frankfurt, Milan and Brussels all saw IPOs from private equity backed firms, although combined these IPOs raised only slightly more than $1bn. Notably deal volume dipped slightly by 4% year-on-year, highlighting the rise of larger offerings in 2013. The financial services, consumer products, real estate and industrials sectors led by capital raised and, companies looking to list over the next 12 to 18 months will also come from a very broad cross-section of industries; in other words, deal volumes will be larger though many of the new IPOs will be from smaller firms. It is a signal of change perhaps and one that is certainly welcomed by private equity firms which have built up a large portfolio of firms on their books which have been in the portfolio for well over five years. The opening of the IPO market provides a much needed exit alternative and this yearsâ&#x20AC;&#x2122; experience has taught private equity majors to hope. As Ernst & Young figures show, year-to-date, private equitybacked IPOs on average delivered a 13.0% first-day increase from their offer price and through mid-December, were up 18.6% above their offer price on a weighted average basis. There are currently nearly 60 PE-backed companies in registration, expecting to raise more than $14.0bn in total proceeds. Some of the largest companies currently in the pipeline to bring their shares to market in 2014 include Shuanghui International Holdings (which was acquired by CDH China Holdings Management Co Ltd and New Horizon Capital), Card Factory Ltd, acquired by Charterhouse Development Capital Ltd, and Lenta Ltd, which was acquired by TPG in 2011. The year has not been without controversy: the fight for market share has not been pretty, particularly when it comes to auctioned block trades, where some institutions have been accused of bidding over the odds to win league table credit. Looking forward competition looks likely to intensify, particularly as some optimistic prophets suggest 2014 could generate a whopping 36% increase in revenues linked to IPO underwriting activity. Asia is expected to provide much of the uptick expected over the coming 12 months and bankers will welcome the

DECEMBER 2013/JANUARY 2014 â&#x20AC;˘ FTSE GLOBAL MARKETS

change in pace, given that equity capital markets in the Asia-Pacific ex-Japan region shrank for a third consecutive year in 2013, hurt by a downturn in India and slower activity in mainland China. New issuance levels in 2013 were muted, especially compared with 2012 totals (347 IPOs, compared with 414 in 2012). Proceeds were also down ($44.4bn raised, compared to $56.2bn in the region in 2012), with the downturn due to the suspension of IPO activity in China through the year. Even so, Hong Kong, Japan and South East Asia saw an increase in the number of deals and capital raised, a trend that is set to continue into 2014, as robust economic activity in the individual ASEAN economies and the economic integration benefits from the creation of the ASEAN Economic Community (AEC) creates market momentum. Moreover, the resumption of IPOs in Shanghai and Shenzhen in January will help deliver a volume uptick in the region. Some of the top deals expected include a $5.7bn IPO for the electricity business of Li Ka-shing’s Power Assets Holdings Ltd, a $6bn deal from Chinese meat processor Shuanghui International Holdings and listings from health and beauty products retailer AS Watson & Co Ltd. The resumption of IPOs in Shanghai and Shenzhen next month should provide a much needed boost to deal volumes in the region, after zero activity for more than one year in China. The bun fight for leadership of the global equity capital markets has always been a three horse race; between UBS, Goldman Sachs and JP Morgan. Goldman Sachs looked to be gaining the edge this year, and by the end of the third quarter (at least in Asia) it had topped UBS in terms of the value of IPOs brought to market, if not volume. UBS in Asia is a tough act to top, having led in the league tables for nine of the last straight years. UBS is reported to have raked in around $221m in fees, buoyed by its strong presence in Southeast Asia, compared with Goldman Sachs which is expected to earn some $175m or so in fees in the region, according to Thomson Reuters’ preliminary figures, issued in mid-December. Advisory firm Ernst and Young forecasts some $23.2bn worth of IPOs in Hong Kong through the year ahead, with some $32.9bn of new listings in China, the two main markets in the Asia-Pacific region. Elsewhere, pickings should be rich too. In the United States, Chrysler is expected to return to the public market sometime in the first quarter. The thirdlargest US automaker, which went bankrupt in 2009, could have a market value of about $30bn, say commentators. Investors are also looking towards Silicon Valley for IPOs: mobile payments provider Square, as well as file storage companies DropBox and Box, plus photo-sharing website Pinterest is another tech company that some think may look to go public. Virgin America is also said to be mulling a market debut. In all the brouhaha, the one house that has been consistently appearing in all regional league tables though this pivotal year is Goldman Sachs. In a pointer that 2014 might deliver much more than 2013, trading firm Virtu Financial,

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

From left, Warren Buffett, Goldman Sachs CEO Lloyd Blankfein and Michigan governor Rick Snyder hold a news conference at Ford Field in Detroit on Tuesday, November 26th 2013, to announce the “10,000 Small Businesses Initiative.” The initiative aims to help create jobs and boost economic growth through the loans as well as business support and education provided by local colleges and universities. Photograph by John T Greilick, for Detroit News. Photograph supplied by PressAssociationImages, December 2013.

was reportedly preparing for an IPO and was said to have hired Goldman Sachs to bring it to market. Virtu is a market maker in equities, fixed income, currencies and commodities markets, and is said to be about to submit a confidential IPO filing under the Jumpstart Our Business Start-ups Act within the next couple of months, said one of the sources. Virtu has around 150 employees and offices in Europe and Asia, as well as the US. If the reports are accurate, the deal will be a template issue, bringing together some of the main themes of recent months. [Virtu is backed by private equity firm Silver Lake, and in 2012 bid for market-making firm Knight Capital Group, planning to take the company private. In the end the bid was unsuccessful, and Virtu lost out to Getco Holding Co. Getco went public upon merging with Knight and is now called KCG Holdings]. According to Douglas Sipkin, senior analyst covering brokerage and asset management for equity research firm Susquehanna Financial Group, suggested that Goldman’s equity business“is likely seeing its best quarter since prior to the credit crisis.” Heading into 2014, indications of a broadbased, higher-volume rotation into equities bodes well for Goldman Sachs. Coalition sees equity trading revenues at the top investment banks closing out the current year an estimated 22% higher than in 2012, the segment’s best showing in three years, and expects an additional 36% increase in revenues linked to IPO underwriting activity. Goldman’s final quarter of 2013 should give market watchers a good indication as to the near-term direction of the firm. According to Sipkin, Goldman “is beginning to execute on its best banking pipeline in five years, driven by a torrid pace of equity issuance.” I

20-20: ETFS: VANGUARD

After years of steady inflows, the first half of 2013 was a difficult time for exchange traded funds (ETF). Investors withdrew en masse on the back of market volatility and concerns over the Federal Reserve pulling the plug on its $85bn monthly bond programmes. Vanguard managed to weather the storm better than its rivals, capturing the number one spot on the global league tables during the most turbulent period. Lynn Strongin Dodds reports.

VANGUARD TAKES POLE ON ETFs

Photograph © Gino Crespoli/Dreamstime.com, supplied December 2013.

S BASED ASSET gatherer Vanguard, which has a stable of 67 ETFs, upset the traditional apple-cart and usurped BlackRock’s iShares in June 2013 to take pole position when the investment segment witnessed its first net investor outflows. According to ETFGI, an independent consultancy firm that monitors industry trends some $3.89bn worth of funds exited over a two year period. Vanguard was the only one of the top five ETF managers to receive net inflows of $39m that month while BlackRock saw net withdrawals of $7.9bn. ETFGI figures show that the fortunes of the industry recovered in the second half due to a combination of $17bn in global net inflows and positive market performance. Assets reached a new record high of $2.4trn at the end of November with BlackRock regaining its lead on the international tables garnering $57.3bn. Vanguard though was not too far behind with $55.7bn and the two together were far ahead of the rest of the pack. The moral of the story was two-fold: iShares’ much vaunted leadership of the segment looked vulnerable for the first time in epochs. The second was the Vanguard had established its credentials as the king in waiting. WisdomTree was in third place with S$13.6bn followed by PowerShares at $13.3bn and State Street’s SPDR with $11.5bn.

“In many ways the growth of the ETF industry has been remarkable,” says Joel Dickson, principal and senior investment strategist in Vanguard Investment Strategy Group. “The industry has grown to over $2trn over the past 12 to 13 years even though global equity markets were fairly flat until 2009. I think one reason is because investors can either tactically or strategically use ETFs to create a portfolio. The strategies are not new but ETFs provide a different distribution mechanism for index products. The other benefit is that they can be used for many different purposes and are much less complicated than, for example, futures or swaps.” Vanguard, which was founded by indexing pioneer John Bogle in 1975, is steeped in passive investing experience but it did come late to the ETF party. It launched Vipers in 2001—now branded as Vanguard ETFs—at a time when SPDRs and iShares dominated the landscape. The company had just started to make its mark though when the credit crisis hit, bringing all the providers down with it. However, the ensuing market stabilisation combined with Vanguard’s hard line approach to fees, straightforward products and emphasis on education enabled the firm to make up for lost time and win a place in investors’ portfolios. “Our approach is very consistent with traditional passive fund management,”says Dickson.“We started with retail and targeted the financial adviser community in the US. We believe in low cost, broadly diversified products that can be used as building blocks. We do not get into narrowly defined or niche areas but focus on broad or sub asset classes. I think we are in the latter innings of our product development in the US but we are looking to continue to develop local products in several other global markets.” For example, in the first six months of the year, Vanguard added four new funds to the five it listed on the London Stock Exchange (LSE) in 2012, while it debut on the continent with seven ETFs on the SIX Swiss Exchange and on the NYSE Euronext exchanges in Amsterdam and Paris. Assets under management have just passed the $3bn mark, making it the third fastest growing provider in the region behind its longer established rivals iShares and State Street Global Advisors. While the firm’s broadly based products may not be that dissimilar to its rivals, its fee structure does set them apart. It fired a warning shot in December when it announced a cut in fees across its entire European range, including its fast growing emerging market products. The total expense ratio for the Vanguard FTSE emerging markets ETF has been reduced from 45 basis points (bps) to 29 bps. Research from ETFGI shows that charges for Vanguard’s ETFs were already substantially cheaper than the average across the region, even before the latest price cut. Vanguard’s asset-weighted total expense ratio averaged 12 bps at the end of October, compared with an average of 37 bps across other European ETF providers, according to the consultancy. The lower fee structure was honed in the US where industry estimates show that Vanguard’s average ETF sits on an expense ratio of 0.14%, compared with 0.39% for iShares and 0.35% for SPDRs. This does not come at the price of fewer holdings in their funds. Its typical ETF comprises 1,171

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

20-20: UGANDAN CENTRAL BANK

securities versus 312 for iShares and 308 for State Street. Its competitive price streak can be attributed to the way the company is organised. ETFs are a separate share class of Vanguard’s mutual funds, a structure on which the firm has a patent valid through 2019. The philosophy is that enormous economies of scale can be created by pooling them together—total assets under management are $2.2trn—and this can be passed down to the end user. Moreover, Vanguard’s mutual ownership structure means its fund investors are its shareholders. Unlike publicly traded BlackRock and State Street, it doesn’t face any potential conflicts in balancing the interests of its fund investors with those of its stockholders. “The concept of a price war in Europe is not our approach and not how we think about doing business,” says Dickson. “Our low-cost pricing is an across-the-board strategy and not selectively targeted to a narrow product range like many others.” Cost was also the main driver behind its surprise decision last year to switch index providers from the MSCI for 22 of its ETFs. In the US, it moved 16 funds with $367 bn in assets under management to benchmarks developed by the University of Chicago’s Centre for Research in Security Prices (CRSP) while in Europe six ETFs worth $170 bn in AUM were realigned to follow indexes maintained by Londonbased FTSE Group. “The index license is one of the largest parts of the cost of managing ETFs,” says Dickson. “Our concern is that the economies of scale are not being returned to investors but instead to the index provider. We look at the whole package and chose FTSE because it is a world class provider with billions of dollars traded against its products.” Vanguard assesses five characteristics of a provider’s construction methodology—objectivity, adjustment for float, approach to market capitalisation, categorisation of value versus growth and rebalancing. There are key differences between the two. For example, MSCI covers approximately 85% of the free float-adjusted market capitalisation in each country while FTSE holds 98% of the overall investable market capitalisation. In addition, FTSE’s developed market indexes include more small and mid-cap stocks than MSCI and the number of emerging market countries followed by FTSE is greater than MSCI. Probably the most important change is South Korea. MSCI classifies the country as an emerging market while FTSE categorises it as a developed market. This is significant because South Korea is home to the third largest stock market in the Pacific Rim following Japan and Australia. The gamble to move to MSCI did not immediately pay off though. In fact the company took a temporary hit and last November saw its emerging markets ETF post an $887m outflow, compared with inflows of $2.3bn for its rival, the iShares MSCI Emerging Markets ETF, according to data from Morningstar. The firm’s net sales lagged behind iShares’ main emerging markets product to the end of 2012 into 2013 but the numbers have been skewed this year because of the poor performance of the asset class. However, Vanguard FTSE Europe has grown by $7bn this year to become the largest ETF in the region with $12.6bn of AUM. I

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

It’s not easy to be a central banker, let alone the head of a central bank in a frontier market and Africa’s third largest economy that has borne economic turbulence (with 2.8% growth in 2012, compared with 5.6% last year). Through 2013, Governor Emmanuel, of the Bank of Uganda has garnered respect through his efforts in fostering price stability and improving Uganda’s competitiveness for direct and indirect foreign investment.

THE INFLATION BUSTER AINTAINING LOW INFLATION is a cornerstone of Tumusiime Mutebile’s tenure and his work over the last 12 months has resulted in bringing down inflation from 6.9% midyear to 5.6% by year end, no mean feat in a still largely informal economy. The central bank has worked hard, in tandem with the government to stabilise the economy, bringing inflation down from a gut-busting 18.7% in 2011 and 14.6% through 2012, after a year of turbulence. Tightened fiscal and monetary policy have helped bring fiscal balances under control. Even so, stabilisation at this level has not come without cost. In Uganda’s case it has involved a slowdown in gross domestic product (GDP) growth to 3.2% by the end of June 2012, though the World Bank expects growth to step up to 4.9% in 2013 and 5.5% in 2014. Key challenges remain: not least endemic corruption, which has variously impacted on the rate and volume of aid coming into the country. Uganda though has regularly defied expectations and achieved growth rates in excess of 6.5% between 1992 and 2001 which has brought substantial change to the overall economy. With a rich and diversified base, natural resources weigh heavily on the Ugandan economy, although their contribution to growth and structural transformation has been declining. However, the recent discovery of commercially viable oil reserves in the Albertine Graben region, in western Uganda, has the potential to provide a unique opportunity for the country to carry out an economic structural transformation. No surprise that the Ugandan shilling has been inching up through the second half of 2013; though concerns over Uganda’s sovereign credit rating could undo the gains in the first half of this year. I

20-20: JOSH GALPER FINADIUM

There have been many pretenders to the crown of providing long-standing, valuable and definitive analysis of the securities and investment industry. Some firms have concentrated on hard data; others on service provision in niche segments, Finadium has consistently found its voice, bringing together both data and incisive commentary. The firm rings with adjectives such as accuracy, reliability and consistency. Are there any better words in the consultancy field? Andrew Neil reports.

THE NEW MARKET PROPHET D

they have started to come on EVELOPING MEANboard as paying subscribers,”acINGFUL ANSWERS to knowledges Galper. the financial industry’s Finadium’s work has won current crop of problems is the plaudits throughout the year, crux of a research firm’s business particularly within the securities proposition; its unique selling lending space. The firm released point. Research and consulting a cost/benefit analysis roadmap firm Finadium is now beginning for securities lending CCPs in to enjoy its time in the spotlight. September which was met with Its founder and managing industry-wide praise. The principal, Josh Galper acknowlanalysis looked at how global edges that the time is ripe for trends are moving in favour of research firms that add meaningCCPs, including Basel III direcful analysis to their craft. In that Photo supplied by Shutterstock.com, January 2014. tions that CCP transactions regard, market change is often a good thing for consultants. Given shifting dynamics across should have a better cost of capital outcome than bilateral the financial industry, a service providing a sounder footing transactions. Other reports from the last twelve months include a and nuanced understanding of change is increasingly valued and Finadium has grasped the opportunities survey on bilateral and tri-party repo; a study for large OTC derivatives end-users on clearing and collateral and a report presented by change. Across the business segments of securities lending, repo, for hedge funds on prime brokerage services and technology. custody, prime brokerage, collateral and liquidity manage- On the consulting side, the business continues to help clients ment, unease and uncertainty remain a watchword. Massa- take action through vendor selection and monitoring, chusetts-based Finadium has put itself full forward in this organic growth and strategic partnerships. The firm conducts latest era of market prophecy and prediction; and has begun studies, client assessments, quarterly risk management and to reap the rewards. “We’ve seen a growing interest in our benchmarking on securities lending, collateral management, research reports this year from a broader scope of clients,” cash management and custody programs. Recent clients explains Galper.“Across the securities finance industry we’ve have included mutual funds, pension plans, brokerages, signed up a wide range of sell-side clients as subscribers to custodians and exchanges. For Galper it all comes back to adding value to clients. our reports along with hedge funds, asset managers, “We want our clients to succeed and understand that their exchanges and tech firms.” Of course, it takes a long time to burst onto a stage. revenues are increased by focusing on strategic opportuniOvernight success is about years of hard work as well as ties in the market. We enjoy the work; these are compelling timing. The firm has built up its research unit in increments and interesting areas for us. We feel it’s worth doing and it since launching in 2005. Independent reports now cover appears to be of value.” There’s a straightforwardness and soundness to asset servicing, repo, securities lending, and collateral management and are issued at a clip (some 12-14 times a year). Finadium’s output, in part a result of extensive market relaAnalysis, as Galper explains, should at the very least try to tionships, in part from the testing and refining processes in describe new market curves: “Certain topics might not be place. “There’s a whiteboard full of potential ideas for next important to businesses now, but are likely to be in the near year,” adds Galper. “For our clients, we see 2014 as being a future. For that reason, as a consultancy and provider of year to make a plan.” In any case it’s likely to be Finadium research, we strive to be ahead of the market and present that sets the course for its clients. However, Galper explains the firm doesn’t look at this how upcoming changes will affect our clients.” A mark of the firm’s growing stature is that regulators take from a revenue perspective. “We want to add value to our it increasingly seriously.“[They have been] calling for the past clients and deepen the pool of knowledge in the industry as six years and showing an interest in our work. More recently a whole,” he adds. I

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

20-20: SOCIETE GENERALE – EMEA CUSTODY

Regulatory and market-led change continues to have a vast impact on the securities services chain. In the custody space, those still strong enough to be in the game have to handle complex and constantly evolving securities regulation, both at a local and regional level. Compliance pressures, combined with challenging economic conditions, lower fees and rises in service expectations, have pushed securities services providers into a corner and forced them to re-evaluate their existing approach. SGSS has expanded in Africa. Andrew Neil reports on the implications.

GOING SOUTH: SGSS SCOURS FOR NEW BUSINESS IN AFRICA N RESPONSE, NEARLY all have placed a heightened emphasis on regulation and risk, many have moved to streamline processes and increase efficiencies for clients while others have broadened their range of services and looked at new opportunities. Société Générale Securities Services (SGSS) has shown steady market momentum in the past twelve months, reinvesting in technologies and products, making sense of regulation, and picking up significant mandates along the way. The bank has also redefined its remit and committed to a real EMEA presence; a bold move as economic conditions remain difficult, and new business developments projects don’t necessarily always intrinsically provide revenue opportunities up from. Even so, it ended 2013 at a clip, picking up significant mandates and expanding into new markets across Europe, and Africa. By September the company had established brand new custody operations in Bulgaria, Tunisia and Ghana. It hasn’t all been about winning mandates. On the regulatory side, the firm has enhanced its product offering in response to Basel lll. With capital constraints placing a greater focus on collateral and liquidity, SGSS’s liquidity division has broadened the range of customised securities and cash liquidity solutions on offer to clients, including securities lending and borrowing, repurchase agreements, cash reinvestment and management of intra-day liquidity. It has also positioned itself to capitalise on its experience as a pan-European stakeholder in securities services in the area of a depository bank as well as in that of distribution of funds. “The industry has entered into a challenging era,”says Andy Duffin, head of sales for emerging markets at SGSS. “For some years now SGSS and our industry peers have been contributing to the regulatory and technical framework that apply to our businesses, we now have to adopt it. When it comes to SGSS, our ability to adapt continuously, whether by deepening the range of services available to clients, or by expanding into new markets, are our defining hallmarks.” Thought leadership has also been a popular theme over the last year. In SGSS’s particular case it focused on the implications of the Alternative Investment Fund Managers Directive (AIFMD). The firm released a detailed white paper

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

in July, gathering essential information on the directive, its application scope and the impact it will have. On the technical side, SGSS has pressed ahead with its plans for T2S, the ECB’s new European securities settlement engine. SGSS established a team to co-ordinate its T2S preparations and this has now expanded to around 30 staff with the number likely to double as the project moves into its execution phase from 2013 onwards. Although aspects on all levels are evolving, Duffin says the firm’s forward-thinking view and willingness to adapt has been key to winning new business globally.“What has been most satisfying about some of the mandates we’ve picked up this year is that they have come from diverse client segments across the entire SGSS footprint.” There have been several mandates of note including SGSS’ transfer of global back-office activities for Kepler Cheuvreux, a custody mandate from Fondul Proprietatea a Romanian government fund, while Peregrine Equities, member of the Johannesburg Stock Exchange, also picked SGSS to provide custody services in South Africa. Over a period of barely three weeks between June and July 2013, SGSS issued several announcements proclaiming its growth on the African continent. The firm set up shop in Ghana and Tunisia, and now provides services to equities and bonds, together with foreign exchange and cash management services to local and foreign investors in both countries. Plans now turn to establishing a sub-custody and clearing offering in Côte d’Ivoire. “Today, a wider range of well-qualified sub-custodians is servicing the more active markets on the African continent– and buyers are looking to appoint sub-custodians on a market-by-market basis,” says Duffin. “This provides good opportunities for SGSS to extend its market share in a range of markets across the continent as clients review their existing service provision.” Looking ahead, Duffin is optimistic and believes the work put in this year will bear fruit. “We are well positioned to adapt to and adopt change, our many years of global experience, combined with our detail knowledge of local market practices and our strong relationships with the key actors involved, means we go into 2014 in a confident mood.” I

20-20: L&G – INVESTMENT FIRM

Photograph © Skypixel/Dreamstime.com, supplied December 2013.

Legal & General Investment Management (LGIM) hasn’t always had the high-profile press coverage that some of its investment peers have enjoyed in recent years. The firm has undergone a quieter evolution. Still, it is clear that strategy has moved on from a postfinancial crisis focus on cash, to one based on cash plus growth. In the past twelve months LGIM has undergone something of a step change, competing for business and customer service provision alongside larger global firms. Andrew Neil reports.

LGIM’S STEP CHANGE CONSISTENT FIRST RANKED house when it comes to fixed income, passive index investing and multi-asset vehicles, almost 90% of LGIM’s £433bn of assets under management are currently sourced from the UK, where it owns 4% of the stock market. Away from its UK heartland, the LGIM manages £52bn on behalf of 60 pension funds in the US and more than 100 institutions in Europe and the Gulf. Thanks to a number of recent initiatives to internationalise its business, inflows from international clients are on the rise. In the third quarter of 2013, international assets into the business totalled £6.4bn, double compared with the same period in 2012. “Our client reach, reputation and expertise have enabled us to begin building a truly global investment solutions business,”says Hugh Cutler, LGIM’s head of distribution for the UK and overseas. “Over the past year we have experienced tremendous growth. Already we are seeing robust flows from international clients which reflects the success we are having implementing our strategy to develop the business in selected markets globally.” In July, LGIM revealed it had opened its first desk in Asia, headquartered in Hong Kong as part of a push to provide index and fixed income solutions to institutional clients across the region. The move was in response to both market conditions and client demand, as Cutler explains: “It’s clear the centre of gravity of the financial world is moving eastwards. “As Asian sovereign wealth and national funds continue to seek diversification and place larger allocations overseas, they are increasingly turning to specialist managers with the track record and scale of firms such as LGIM to provide investment solutions.” Elsewhere, the creation of the firm’s first Luxembourg SICAV in November marked LGIM’s first big push into European wholesale market. The firm received approval to launch a SICAV fund platform and three underlying funds in Luxembourg, with five more in the pipeline. Work is underway to register the funds initially in 12 further European countries, allowing investors in key markets in Europe to also access these strategies. The firm also moved through the year to provide transition management services.

At the time of the launch, Mike Craston, managing director of LGIM’s global institutional business, explained that LGIM would target specific European markets with a two-pronged approach aimed at wholesale and institutional markets.“Initially we will be focusing on European investors seeking exposure to our flagship active fixed income capabilities,” he said. “There has been significant interest from global financial institutions in the UK, Germany and Switzerland and pension funds in the Nordics region wanting to gain access to our active credit and absolute return type strategies, which are already successfully marketed to institutional clients in the UK. “These are very mature, diverse and well-developed markets. Our expansion plans will be focused, targeting global and regional banks, where we are looking to add our products to their platforms, and additionally the institutional market.” As well as expanding its global footprint, LGIM remains committed to the UK market. The evolving landscape for defined benefit (DB) pension schemes continues to be a core focus. “It’s a market which has been influenced by financial market performance, regulation, changes to accounting standards and increasing longevity,” explains Cutler. “As a result many schemes continue to de-risk and fundamentally rethink their investment strategies. “The greatest challenge facing DB pension schemes is how to ensure they can pay members their pensions by generating sufficient returns from its investments to meet its liabilities well into the future. This means offering a full-derisking toolkit. So far we have experienced high demand for our liability hedging solutions along with our diversified growth strategies.” A second substantial area of growth in the UK is the ever increasing flows of client assets into defined contribution (DC) schemes following auto enrolment. In this space, Culter says that there has been plenty of demand for equities and long term orientated products, along with multi-asset strategies. In the meantime, Cutler remains optimistic about LGIM’s UK and international business lines.“We’re well positioned to provide product innovation and transparency, both of which investors increasingly demand.” I

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

20-20: MORGAN STANLEY – IPOs

Despite the controversy surrounding last year’s Facebook initial public offering, Morgan Stanley is leading the pack in global technology IPOs this year with a 14.3% market share, according to Dealogic. The Wall Street firm was lead-left bookrunner on eight of the 10 biggest IPOs since the social networking deal, while long term rival Goldman Sachs, which has a 12.8% slice, led the other two. Lynn Strongin Dodds.

LEADING THE NEW ISSUANCE PACK N DECEMBER 2012, Morgan Stanley, which has a long history of working on tech deals such as Google and Linkedln, was given a $5m fine from the Massachusetts Secretary of the Commonwealth, William Galvin, who accused the bank of trying to “improperly influence” research analysts ahead of the stock offering. The firm neither admitted nor denied guilt. There was a view at the time that this could have put a damper on its equity capital markets business but the reverse has been true. In fact, the bank has participated in many banner deals this year including the headline grabbing $2.1bn IPO of Twitter, the microblogging company, in November. The deal evoked the days of the dot.com euphoria in the early part of the century as shares traded at about 22 times forecast 2014 sale. This is nearly double the multiple at social media rivals Facebook and LinkedIn, even though Twitter is far from turning a profit and posted a loss of almost $70 m for its most recent quarter. According to Martin Thorneycroft, head of equity syndicate in EMEA at Morgan Stanley, one of the reasons for the bank’s success is the strength of its franchise. “The important thing is the intersection of investment banking with a leading institutional distribution network and the largest retail distribution network.” Morgan Stanley has also won plaudits for its ability to take risk for longer periods of time and provide transaction certainty. In addition, the bank is able to leverage the skills across the organisation ranging from research to execution, advisory services and distribution to either structure an IPO, place new shares for companies who want to raise money or sell shares of an existing shareholder. It has honed relationships over the years with corporate clients as well as institutional investors in order to create a dialogue and develop solutions that fit their particular needs. The bank’s experience also helps it determine when the best time is to launch a deal which has been particularly difficult over the last few years due to volatility and uncertainty. “Each market has seen a different inflexion point,” says Thorneycroft, “For example, the US has been the strongest for some time but the European recovery started later, with DirectLine opening the IPO market last year and an increasing volume of deals from the second quarter of 2013. At the same time, emerging markets have been more challenging.”

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

Overall though, equity capital markets have improved this year with volumes reaching $539.7bn in the first nine months of 2013, up 12% on the $483.5bn raised in the same 2012 period, according to a recent Dealogic report. IPO volume stood at $94.7bn through 553 deals for the period which represented a 7% hike but 9% decline in activity over last year’s $88.2bn and 607 deals. These figures though did not though include the Twitter deal. Follow-on transactions reached $382.2bn, the highest level for a comparable period since 2009 ($463.5bn) while equity-linked deals saw a 48% hike to $62.8bn via 289 deals. As for regions, the Europe Middle East and Africa had the sharpest rebound, enjoying a 44% spike in activity during the first nine months—the biggest year-on-year increase. Asia Pacific ECM volume was up 5% on the back of healthy deal flow from Hong Kong while the Americas saw a 3% increase in activity for that period. Although Thorneycroft notes that Twitter was one of the highlights of the year, Morgan Stanley has also been involved in other notable deals such as Polish Bank Zachodni WBK’s €1.17bn IPO where it acted as joint global coordinator as well as the €2.3 bn Daimler’s disposal of its remaining 7.5% interest in the European Aeronautic, Defence and Space Co. (EADS) where the bank acted as one of only two joint global co-ordinators and joint bookrunners. Also on the list are the $1.5bn IPO of ING Insurance in the US and the more complicated transactions such the Swedish government’s 21.6 bn kronor ($3.4 bn) spinning off of its remaining stake in Nordea Bank and the $2.2bn IPO of animal-medicine manufacturer Zoetis from Pfizer, the world's largest drug maker by sales, who owned 80% of the company. The transaction which involved shareholders exchanging $100 worth of company stock for $107.52 worth of Zoetis stock represented the largest carve-out to list on a US exchange since the $2.9bn flotation of UK hedge-fund manager Man Group from MF Global six years ago, according to Dealogic. “Zoetis was a complex deal because of the size and structure that unlocked significant value for the shareholder,” says Thorneycroft, “It not only involved our equity capital markets team but also our corporate finance team because the deal created a standalone company. It is an example of how we can use all the different elements of the bank.” I

20-20: DIANA CHAN – EUROCCP

The main benefits of the merger, according to Chan, are end users will only need a single set of membership and connectivity fees plus a larger, more efficient customer service, risk management and IT function. Photograph kindly supplied by EuroCCP, December 2014.

EuroCCP, interoperably yours Long before it was fashionable, Diana Chan, chief executive of EuroCCP, a subsidiary of US based Depository Trust & Clearing Corp (DTCC), championed interoperability. She is now one step closer to her goal of a more efficient post trade regime with the merger of the ABN AMRO majority owned EMCF. Together they will be a major force as the largest pan-European clearinghouse but there is more work to be done to persuade the national exchanges to let down their fortresses. Lynn Strongin Dodds. UROCCP AND EMCF, both formed in 2007, were trail blazers, shaking up the sleepy clearing world at the same time that alternative trading systems were challenging the dominance of incumbent European exchanges in share trading. LCH.Clearnet, which is majority owned by the London Stock Exchange Group as well as Swiss central counterparty SIX x-clear, joined the interoperability club but to date it is still only multilateral trading facilities (MTFs) such as BATS Chi-X, London Stock Exchange owned Turquoise and, more recently, newcomer Aquis that offer a real choice of central counterparties (CCPs) to their users. By contrast, many domestic incumbent bourses offer only siloed post-trade operations and access to only one CCP. For example, Deutsche Börse, operator of the Frankfurt Stock Exchange, Germany’s largest bourse, routes equity trades through its Eurex Clearing while the LSE directs it volumes via LCH.Clearnet. “The landscape has changed significantly over the past five years and interoperability has been an

important step,”says Chan who will retain the same position for the new company which is to be called EuroCCP N.V. “Both EMCF and EuroCCP were game changers, offering competition in cash equities clearing. Today, 60% of all equity trades are cleared through at least one of the four, soon to be three interoperating CCPs. We would like to see all platforms cleared by any one of the interoperating CCPs to give trade feed access to all of them. In addition, we would like to see more platforms sign up to interoperability and offer firms a choice of CCPs. Some national exchanges still route all trades through one CCP that does not interoperate.” At the moment there is no incentive for them to alter their behaviour and relinquish the profitable revenue streams emanating from clearing. The European Commission may be pushing for interoperability but it is not mandated under The European Securities and Markets Authority (Esma) guidelines on the European Market Infrastructure Regulation (EMIR). According to Chan the aim of the guidelines is to ensure interoperability among CCPs is safe and secure which

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

20-20: SECTION NAME

should give comfort to exchanges that are genuinely concerned about the practice introducing new risks. She believes though that the newly enlarged CCP, which, following completion of the transaction in early December, is expected to make its debut in 2014, will lead the way in encouraging greater competition between all cash equity clearing houses while driving down expenses. The deal has recently been given the green light by the Office of Fair Trading and is currently waiting for the Netherlands Authority for the Financial Markets (AFM) to follow suit. Once finalised, the group will clear cash equity trades for Europe’s largest MTFs including BATS Chi-X Europe, Sigma X MTF, Turquoise, UBS MTF, Burgundy and Equiduct, in addition to NASDAQ OMX Nordic venues. The main benefits of the merger, according to Chan are end users will only need a single set of membership and connectivity fees plus a larger, more efficient customer service, risk management and IT function.“We have already seen the cost of clearing come down by 80% to 90% since 2008 because of competition being introduced. Together we will be able to continue offering a competitive clearing fee. There will be very significant savings on the settlement side—at least 50% where firms will not have to settle a security twice because they will be settling with only one CCP instead of two.” In addition, there will be lower collateral obligations due to portfolio margining, single guarantee and interoperability funds.“Clients will only require one single pool of collateral,”she says.“Before, for example, if a client was buying 100 shares of a stock on a national exchange and selling 80 shares of the stock on an MTF, they would have to post collateral with different CCPs. By using one CCP, they can net their positions and only have to post collateral on 20 shares.” This comes at a crucial time when high quality collateral will be in greater demand due to regulations such as EMIR, which mandates clearing houses to hold greater collateral to mitigate counterparty risk as well as Basel III, which requires banks to hold more collateral as a buffer on their balance sheets. This is expected to lead to a shortage although estimates vary widely from a mere $500bn to a substantial $8trn. Many believe $2trn is a more realistic figure but all agree that covering positions will become more expensive. Although joining forces will improve the fortunes of its clients, both houses also hope to see a boost to their collective bottom line. These two groups have been down the merger road before in 2010 but increasing competition, slumping equity volumes and paper thin margins has provided the impetus needed to seal a deal this time. EuroCCP’s which operates an ‘at cost’ model has grabbed a roughly 40% market share although it has not been profitable, reporting a pre-tax loss off €12.4m last year (the fifth consecutive year of losses) while EMCF suffered its first loss of €1.8m in 2012 compared to the healthy €5.41m in 2011. Running a clearinghouse is an expensive proposition, according to Chan.“Much of the cost is fixed and the equity market is not growing at a rapid pace. The result is that you need greater economies of scale and I think combining two

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

houses makes perfect sense. I also think that we will see more mergers because of the regulatory and trading environment.” In the meantime Chan, along with Jan Booij, EMCF’s chief executive, and chief operating officer of the new company, are laying the groundwork for their own union. EuroCCP will continue to be based in London, but the Dutch entity will be the headquarters because it already had cash accounts—four central banks in the Netherlands, Sweden, Denmark and Switzerland, and direct securities accounts in six central securities depositories. The result is a team of 40 split between the two locations with EuroCCP handling the customer-service side of the business while EMCF will oversee risk management, technology and the operations infrastructure of the group. Currently, EuroCCP's technology is bundled in with DTCC which means all the data is stored in the US.“We believe that having standalone technology enables us to have more flexibility and also one component of being a European company is to have the technology in the region,”according to Chan.“In addition, if there is a glitch the technology team is in the same location as the operations.”

The main benefits of the merger, according to Chan are end users will only need a single set of membership and connectivity fees plus a larger, more efficient customer service, risk management and IT function.

The ownership structure will also undergo a change with shareholders receiving an equal split of 25% each in order to ensure that the risk, governance and control are spread evenly. This entails Nasdaq OMX increasing its overall position from 22% to 25% of EMCF while ABN AMRO will retain its stake. In meantime, DTCC will surrender a significant stake to make room for BATS Chi-X, which has long been a frontrunner for interoperability to become a new shareholder. It represents its first stake in a clearing house and at the time of the deal announcement, Mark Hemsley, chief executive of Bats Chi-X Europe, said: “We support the open-access or horizontal model and we want to ensure that it continues.” Merging the two groups though is not just about getting the technical nitty gritty details in order. It is also handling the human side which is not always easy in any integration. As with many mergers, there was duplication of functions and there were some job losses although Chan did not disclose numbers. “There are some cultural differences between the UK and the Netherlands because we have different ways of doing things and expressing ourselves. The most important thing is to set the right tone at the beginning, to respect the different approaches but to take the best from both groups.” I

20-20: NBK/IBRAHIM DABDOUB

In the sometimes arcane world of banking in the Middle East, NBK has been a standout promoter of change and responsiveness in a changing and sometimes risky market. Its outgoing chief executive Ibrahim Dabdoub has run NBK since 1983, having joined the bank in the green and salad days of Middle East banking in 1961. Can NBK continue to innovate without him? Francesca Carnevale reports.

GOODBYE TO THE TOMORROW MAN LMOST EVERY YEAR NBK has marked the year end with a paean to a global leader; giving them a forum to outline their world view. Looking back, its rota of high priced speakers have included the usual roustabout celebrity politicos such as Bill Clinton, Tony Blair and Condoleezza Rice. However, it has also included some left of field candidates, such as Lee Kwan Yew; an illustration perhaps of the cosmopolitan make-up of the bank’s leadership and thinking; an embellished yet nuanced tapestry that has marked the NBK brand over the last thirty years. NBK in effect has brought a broad brush of political and financial debate into the Kuwaiti market which has helped cement its role as a brand/thought leader. Much or all of that liberality is down to Dabdoub. True, Ibrahim Dabdoub has not set out NBK’s stall alone. At various times there has been a clearly delineated golden circle of management, that has invariably included Shaikha Al-Bahar, Adel Abdul Wahab Al-Majed, Isam Al-Sager, Randa Azzar, Salah Al Fulaij and (before his departure) George Nasra, who famously took the brand into investment banking (via NBK Capital) and later Qatar via International Bank of Qatar (IBQ). The executive group today continues almost the same with Dabdoub, group CEO, and Al-Bahar now CEO of the bank’s Kuwaiti operations. Mazin AlHahedh is group general manager (GM) for the bank’s consumer business, while Isam Al-Sager is now deputy group CEO and Salah Al Fulaij is in charge of the group’s investment banking operations via NBK Capital. NBK has and continues to enjoy the largest domestic network in Kuwait and one of the largest international networks among Arab banks. Under Dabdoub it clearly broke out of a confined national and GGC based banking model which has taken it into Africa and Asia as well as more traditional markets in Europe. Notably the bank was among the first movers in market such as Vietnam and Turkey. The Middle East continues to enjoy something of a renaissance following the dark days of 2007 when firms and banks in the region were caught by the firestorm that was the financial crisis. By that time however NBK had laid out much of its international stall: having bought a 20% strategic stake in IBQ (formerly Grindlays Qatar Bank) as far back as 2004, opened additional branches in Amman (Jordan) and Beirut (Lebanon). The following year it opened a rep office in China and bought Credit Bank of Iraq, and then in 2006 began operations in Saudi Arabia. Operations in Turkey, Egypt and the UAE soon followed. Despite the vicissitudes of the Arab Spring, the bank has maintained its MENA-wide business network.

The bank is a strange brew of compassion and competitiveness, brittleness and brilliance, liberality and ruthlessness. It has forged its current reputation on the premise that it is the safest bank in the Middle East: at times it has been the most innovative and yet has tempered that with intense caution. As a journalist, you are often in the position of having to know the answer to the questions that you pose, either in order to test their veracity or to prove a viewpoint. In that regard, Dabdoub is a journalist extraordinaire: he rarely makes a move that doesn’t result in an assured outcome. In part, that predictive ability has been honed under the confident banner of client knowledge. Under Dabdoub, the bank has been consistent in its commitment to providing outstanding customer care and focus and following key clients into new markets. At various times over the last ten years, Dabdoub has conceded that “our expansion has not been world-wide. Because we have a high level of customer focus, we are in some markets not on a competitive basis, to win market share, but on a supporting basis to help our customers.” As Shaikha Khaled Al-Bahar underscored in an interview back in 2007:“Our business is defined by our clients. Our relationship with some of the strongest international players in the region, which make up the bulk of our corporate banking clients, continue to want us to provide creative and complex solutions in different markets.” Knowing that the business is there and sustainable makes the decision to expand into a new market logical rather than a risk. The bank remains however a capital markets powerhouse. In December 2013 in consortium with a group of international banks arranged the $1.43bn financing for the local Az-Zour North project, a power and desalination project that is the first public, private partnership (PPP) in the country. The consortium includes the Japan Bank for International Cooperation (JBIC), Nippon Export and Investment Insurance (NEXI)—both government agencies—Bank of Tokyo-Mitsubishi UFJ, Sumitomo Mitsui Banking Corporation and Standard Chartered Bank. The deal is also interesting for its shareholding. In the UK, the so-called public element of a PPP transaction is usually a quasi-statial entity, or municipal authority; in this instance, the ultimate shareholders of the special purpose project company that will be in charge of the management and maintenance of the power plant, Shamal Az-Zour Al-Oula, will be public institutions (10%), Azour North One KSCC (which will have 40%) and the rest will be sold in an IPO to Kuwaiti retail investors.

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

20-20: FIRST STATE INVESTMENTS

The Project Company will build a combined cycle natural gas-fired power plant with the capacity of approximately 1,500 MW and a seawater desalination plant with the capacity of approximately 105m imperial gallons per day at Az-Zour North. It will sell the power and freshwater generated to the Ministry of Electricity and Water for 40 years on a build, own, operate, transfer (BOOT) basis.

End of an era Mohammad Abdul Rahman Al-Bahar, NBK’s group chairman announced in mid-December that Dabdoub decided to retire, and will step down from his post as group CEO following the bank’s next general assembly meeting. In a downbeat eulogy, Al-Bahar explained that over the years Dabdoub built a franchise with assets now exceeding $60bn, and over the period moving profits from KD20m back in 1983 to KD305m in 2012. The bank chair emphasises Dabdoub’s role in leading the bank through the Kuwaiti stock market crash of 1982 and the Iraqi invasion in 1990, keeping the bank afloat all the while. However, Dabdoub did more than that. He helped carve out a confident niche for Arab banks in international markets; highlighting the advantages that good corporate governance and a high aversion to risk can bring to a banking brand. NBK has been a standout, consistent and reliable brand in a market noted for high returns and sometimes as high losses. ‘Safety first’ has been a Dabdoub watchword through the years even as the bank opened up new business in frontier markets and financed big ticket deals in the African telecommunications segment; successful ventures all. The ability to manage a clever and talented team and keep everyone moving in the right direction is also important and Dabdoub, ever the consummate politician has enjoyed those skills in spades. Sometimes he has moved too slowly for some of his team; others he has given a wide berth, allowing them to carve their own business niche. Nevertheless, overall, given the stability of the executive team and its consistent success, even the most distant observer must reckon on efficacy of his methods and his management skills have set a benchmark. Thought leadership and customer focus were not an obvious mix in GCC financial institutions before Dabdoub. They are much more prevalent now; and that will be the challenge for the incoming CEO that will replace him. Dabdoub walked a sometimes lonely, new, but unchallenged business path. His successor will find many more bright, confident banks wanting rights of way along the same paths. What NBK has though is brand value and first mover advantage. Executives such as Shaikha Al-Bahar are in the Dabdoub mould of bold stroke businessmen backed by a sure knowledge that all risks and bases have been covered. NBK’s executives are schooled in fine detail. Even so, Dabdoub will be a hard act to follow; but then that’s half the fun of being a new CEO, carving one’s own, original yet still commercial path. I

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

First State Investments’ Global Emerging Markets (GEM) funds have proved their worth by investing in so-called ‘quality’ defensive stocks, which tend to be firms with high recurring cash flows and strong management. Can the run continue? As quality stocks have reached high valuations it will be tough for First State to outperform in 2014. With this knowledge in mind First State has already said it’s “well prepared for a difficult environment,” in any case, the funds remain favourites among investors for their ability to outperform in the long run.

Defensive approaches to EM investing LOBAL EMERGING MARKETS (GEMs) have underperformed developed markets for the past three years due to a combination of weakerthan-expected economic growth and earnings, a strong dollar and more recently, concerns over the potential ramifications of policy stimulus tapering in the US. These factors have led some commentators to suggest that many emerging markets funds may be set for a period of underperformance. The two biggest franchises in this space are the Aberdeen Emerging Markets fund, with £3.7bn in assets, and First State Global Emerging Markets Leaders, with £3.4bn. Of course size is not everything, and the smaller First State Global Emerging Markets (£718m) stood at the top of the best performers’ list mid-way through this year. Both First State funds are led by Jonathan Asante, the firm’s head of global emerging market equities. Asante spends his time rotating between Singapore, Hong Kong and Edinburgh. Often cited as a cautious investor, he has developed a knack for picking well-run and transparent GEM companies and has a proven track record when it comes to outperforming his peers and indices. The flagship GEM Leaders fund is the third best performer in the IMA Global Emerging Markets sector over the past 10 years and has also comfortably beaten its benchmark. In the five years up to the end of April it generated a total return of 85%, placing it fourth out of 57 funds in its sector. It’s been a remarkable rise to the top which began in 2004 when Asante switched to First State as a senior analyst to learn from the firm’s legendary emerging markets manager Angus Tulloch. Asante talks less about his performance and more about the team-based approach of an impressive group of managers; he now manages a 30-strong global emerging markets investment management team and is responsible for close to €18bn in investor assets. I

20-20: TIM HOWELL

From this year’s raft of initiatives, and last year’s performance, Euroclear increasingly looks to be relishing the challenge of market change and through the year generally set the pace among post trade providers; 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). What next?

EUROCLEAR: REDRAWING THE POST TRADE LANDSCAPE RAFT OF INCOMING regulation is redrawing the investor services map in Europe. The post trade landscape was perhaps overdue for change, as new investor trading patterns evolve; as 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. Regulation and the natural dynamics of market change have brought the post trade space into full focus. All the leading international post trade provider such as Euroclear, Clearstream and the DTCC, have been well aware that to meet the challenges and demands of the new financial order they must redefine themselves as service centres for investors. At various times it has involved upgrading settlement, custodial, depositary, processing, technology and data services; and at other times managing collateral (or liquidity) pools, or combinations of the above. Equally it has required a new global outlook in which the formulation of new strategic alliances is a key requisite. Euroclear’s strategy has looked to expand business in five areas: fund services; improvements in post trade processing; strategic linkages and building out services that support capital markets transactions in multiple jurisdictions. 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 post-trade services for Russian OFZs—one of the most actively traded classes of 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. At the time, the move was groundbreaking; but more was to follow. A game changer came in May with the agreement between Euroclear and the United States’ Depositary 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 partici-

Tim Howell, chief executive, Euroclear. Photograph supplied by Euroclear, August 2013.

pants. As demand for collateral increases, both DTCC and Euroclear are each developing our own means to ease collateral sourcing and mobilisation for clients. 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. In January last year, the Euroclear Bank and Citi launched a service, via the Collateral Highway, that allows mutual client assets held at Citi to be used as col-

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

lateral through the tri-party 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 tri-party 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 service agreement with the DTCC on the other hand, offers 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. Services to 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 sometimes causes inefficiencies when ETFs are traded across borders. By using a single European settlement location, the new international ETF structure will 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 importantly, 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

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

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 getting all these things aligned and in the instances of Russia and the United States the impact has been more dramatic than we expected. We have witnessed an absolute reduction in yields and it has meant that we have many more people 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 at high fixed costs and relatively low marginal cost, which gives us breathing room to expand 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

Not to under-estimate the work, Howell acknowledges a significant lead in time for these initiatives to mature. “We spent two years getting all these things aligned and in the instances of Russia and the United States the impact has been more dramatic than we expected. a return on equity of 10%, which is a level that our shareholders think is appropriate for an organisation of this type and which provides a return to shareholders and gives us room to reinvest. However, it is a level of profit that is lower than our peer group. Nonetheless, we have a strong balance sheet and we live with a Tier 1 ratio of 50% (check. Moreover, we are immensely risk averse,” he explains. Howell concedes 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 doing things 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 any change,” he says. I

20-20: INFORMATION MOSAIC

Financial firms face an unprecedented extension of their risk management operations—not only are they responsible for what they do themselves, but they now have to carefully consider their suppliers and software vendors. In the post-trade arena, there continues to be a growing demand for fresh, insightful and intelligent software applications, particularly in corporate actions and custody. This year’s technology provider Information Mosaic has led the charge in the post trade space. Andrew Neil reports.

SERVICING THE POST TRADE SPACE INCE LAUNCHING IN 1997 Information Mosaic has morphed from being a technology provider to investment banks into a fully-fledged post-trade software vendor, with an expansive suite of custody, corporate actions and analytics products. Although the firm has a back-office business, its importance has moved to front and centre. Current clients include several of the world’s largest investment managers and the firm claims to handle more than half of the world’s corporate actions by volume. For its founder and one-time chief executive John Byrne, it hasn’t just been about winning mandates. There are deeper trends afoot. “Post-trade remains a segment of the market ripe for improvement,” explains Byrne, who now has a vice chair role at the firm. “Of course automation and transparency have improved over the years, but the whole industry is being reshaped and roles are being redefined. Banks are under tremendous pressure to transform and face huge capital constraints. They require better returns on capital; clients are seeking greater transparency and quality; and regulators are mandating improved risk mitigation.” This year the firm has been ahead of the curve in upgrading and creating new products in response to changing market dynamics. In particular, the vendor has picked up on an appetite for analytics. In May, IMValue was launched to widespread industry support. The new platform is a set of industry endorsed key performance indicators (KPIs) and tools that allow financial institutions to capture, predict and intervene on potentially risky situations in their post-trade environment before they happen. On the settlement side the business responded to the European Central Bank’s TARGET2-Securities (T2S) initiative by upgrading its corporate actions automation solution IMActions at the start of the year. The corporate actions enhancements were implemented in a bid provide banks and depositories with clear and achievable migration path to the new settlement system. The IMActions platform also acquired Thomson Reuters’ corporate actions data which spans 94,000 companies in more than 93 countries. Regulation has also provided new business opportunities; particularly Dodd-Frank and EMIR, which have involved the tightening of rules on derivatives clearing and trade reporting. Rule changes have resulted in closer client en-

gagement for the firm as the need to streamline derivatives processing and developing new workflow systems become increasingly important. Since Byrne stepped down from his role of chief executive in August, much of the responsibility has fallen to interim chief executive and chairman Ulrich F. Kunz. Still, there appears to have been no let-up in the pace of new business development. Although the hunt for a permanent chief executive continues, the firm has pressed ahead with a forward thinking view and continued its focuses on multiple time zones and markets. The firm now lists offices around the world in Dublin, London, Melbourne, New Delhi, Singapore, Kuala Lumpur and New York. “I see the same amount of opportunity now as I did when we first started the business,”Byrne continues. “Information Mosaic was launched with the aim of creating a single global enterprise platform for post-trade securities and corporate actions processing and in my opinion, it’s succeeded. Now there are new drivers, backed by regulation, which will shape the business going forward. “Utilities in the securities market place will become increasingly important because of capital constraints for banks. Capital may need to be shared or leveraged. Additionally, still within the capital markets space, firms are not just interested in efficiency and straight through processing (STP), instead they have a thirst for risk prevention through analysis, and if things go wrong, regulators and firms want to know how errors occurred.” Byrne’s entrepreneurial approach has clearly been influential in shaping the business but the firm has already embarked on a new era with opportunities in abundance. “Processing corporate actions isn’t getting simpler and the consequences of getting something wrong are enormous,” says Byrne, who plans to start a new business focused on enhanced data workflows.“New applications have been borne others updated. What I do best is spot opportunities.” For now, the business will continue to craft and implement solutions around post-trade processing and post-trade analytics. Next year is sure to bring new products and upgrades that meet the needs of an increasingly regulated yet dynamic marketplace. I

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

20-20: NASDAQ

The last year has been something of a curate’s egg for NASDAQ; even so the exchange has made important strides: not least moving to regain its crown as a leading venue for IPOs. Additionally, the exchange has successfully exported its technology credentials, with a series of high profile agreements to provide its technology platform to leading emerging markets exchanges. Where can it go from here? Andrew Neil reports.

EXPORTING TECHNOLOGY NITIAL PUBLIC OFFERINGS bounced back in 2013 from a relatively poor showing in 2012. NASDAQ OMX took full advantage. The US-exchange benefitted from a hot IPO market in 2013 and welcomed 233 new listings to the NASDAQ Stock Market, including 125 initial public offerings; more IPOs than any other US exchange. The figures represent a 74% rise from the 72 IPOs that took place in 2012 and take the combined proceeds raised via NASDAQ-listed IPOs in 2013 to more than $15bn. NASDAQ also led the industry with 30 listing venue switches with $66.6bn in combined market value switching from its competitors’ exchanges to NASDAQ in 2013. Especially noteworthy in 2013 has been sustained momentum from the technology, biotechnology and financial sectors. Some of the largest and best-performing technology IPOs in 2013 took place on NASDAQ, including GoGo Inc, West Corporation, FireEye and Rocket Fuel. The exchange also continued to attract healthcare and financial IPOs, listing six in each sector during the first quarter alone. NASDAQ also attracted two of the three largest private equity-sponsored IPOs last quarter, Norwegian Cruise Line and West Corp, which together raised more than $872m in combined proceeds. The IPO rocket did not entirely fly NASDAQ’s way. Rival firm NYSE won the mandate to take Twitter public; with the giant IPO going through without the technical glitches that marred Facebook’s debut. Moreover, NYSE made some important inroads into the tech IPO space that historically was NASDAQ’s natural hunting ground, with NASDAQ retaining its IPO lead because of a spate of biotech IPOs. Even so, NASDAQ did not look back in angst. After all, “2013 has been a fantastic year for listing activity on NASDAQ as we welcomed more new listings than any other US exchange,” says Bruce Aust, executive vice president, NASDAQ OMX.“The value of a NASDAQ listing has never been stronger, boosted by our market-leading corporate solutions offerings and unrivalled visibility assets, including the NASDAQ MarketSite in Times Square. “The surge in listing momentum, fuelled by a strong market and provisions of the JOBS Act, has brought a diverse mix of industries to our market,” continues Aust, who also maintains that the exchange’s future pipeline remains robust.

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

Like other exchanges, the challenge for NASDAQ over the last decade has been the need to diversify away from cash equities; and by and large it has succeeded. Today, cash equities trading accounts for approximately 9% of NASDAQ’s net revenue, says CNN Money, while derivatives, fixed income, and access and broker services account for 14%, 4% and 13% respectively. Together, these segments comprise NASDAQ’s Market Services division, which is responsible for 40% of its overall revenue. The other 60% comes from Technology Solutions (26% of revenue) and information services (23% of total net revenues), both of which provide recurring revenue from long-term client relationships.

Technology services The bigger story for the exchange over the near term has been the emergence of its technology services. Its achievements have rested on the firm’s willingness to spend big on investment and diversification, as well as a bold international sales strategy, which has focused largely on high growth, liquid securities markets. Already a highly diversified exchange player, NASDAQ has spent over $1bn in the last year to acquire fixed income platform eSpeed and Thomson Reuters’s corporate solutions business. Such bold strokes have not been without cost. NASDAQ took on debt, which by the second quarter of last year had increased by $807m; though the firm states that it has kept to its repayment schedule and is on track to return to a gross debt to EBITDA level of multiple of 2.5. Late last year the exchange announced that it had gone live with Bursa Trade Securities 2 (BTS2), Bursa Malaysia’s new trading engine, powered by NASDAQ OMX’s X-stream INET. The project was delivered ahead of schedule (well in advance of its Q1 2014 deadline). The deal follows an announcement in the same month that the exchange would take a 5% stake in Borsa Istanbul as part of a deal that also includes technology-sharing and advisory services, the exchanges. NASDAQ will have the option to increase its stake in the Turkish entity by 2% and will receive a series of cash payments. Borsa Istanbul will share in NASDAQ’s market technology while receiving guidance on strengthening its brand and building a capital markets hub for Eurasia. I

20-20: EDDIE ASTANIN/NSD

It’s been a hectic year of change and reform in Russia as its National Settlement Depositary (NSD) has worked to eliminate the glitches (settlement delays, shareholder rights, counterparty risk and variable governance) that used to dog the Russian trading market.

NSD: PILLAR OF THE ESTABLISHMENT INCE ITS FORMAL launch in February 2013, Russia’s NSD has rapidly cemented its role as a key pillar of the country’s capital markets reform programme. Any number of advances have been achieved over the year, including legal recognition of the CSD itself, improvements in the settlement process (now T+2), and links with international securities post trade services providers Euroclear and Clearstream and at the same time, providing their clients with improved market access to Russian government bonds, which has resulted in a virtual tripling of volume. Euroclear and Clearstream’s connectivity with the NSD allow foreign investors to either settle their trades in Russian government bonds directly on the books of either depository or to rely on local custodian banks to settle their trades on the books of the NSD. Pending changes to Russian regulations, Russian equities are expected to be added to the mix in July 2014. The T+2 settlement cycle, created for over two hundred of Russia’s most liquid equities as well as for Russian government bonds, eliminates the need for foreign investors to pre-fund the entire cash value of their transaction before settlement as was the case with the previous T+0 timetable. The move was not entirely welcomed by the Russian broking community, which also made a turn on the need for investors to pre-pay for the day’s trades. Even so pre-funding of a percentage of the value of the account is still the case for some Russian securities even under the T+2 schedule. The Russians have even worked to encourage American institutional investment in the country through achieving recognition among US regulators through compliance with Rule17f7 of the US Investment Companies Act (1940). The NSD also has ambitions to become a regional liquidity hub and has established bilateral links with CSDs in the former Soviet republics, among them Kazakhstan, Ukraine and Belarus, providing investors in the CIS states easier access to each other’s markets. Improved corporate governance is now the latest watchword among NSD staff and through 2014 the post trade services provider will be rolling out a series of initiatives that will standardise information, particularly around corporate actions. I

20-20: STRATE

Few chief executives of central securities depositaries have done more than Monica Singer, CEO of South Africa’s Central Securities Depository (CSD), to promote international settlement standards and principles for financial market infrastructure in the nascent African securities trading segment. A vocal proponent of best practice over rules based principles, Singer has stressed that the principles-based route is the only one that works, believing that international pressure groups, such as CPSSIOSCO cannot, realistically, prescribe things (as would be the case with ‘rules-based’ legislation). It is rather ‘best practice’ considerations that help a local market identify areas to focus on in order to provide a robust financial market infrastructure.

STRATE SETS THE PACE IN AFRICAN FMI CCORDING TO SINGER, the principles issued by CPSS-IOSCO have put all financial market infrastructures on par with one another—from central counterparties to CSDs to continuous linked settlement (CLS)—giving them equal weight and encouraging them to comply with the same set of principles for the benefit of the global financial market. It is a huge advantage for the market that the playing field is levelled. The principals for financial market infrastructure (PFMI) were issued by CPSS-IOSCO in April 2012. In South Africa, there is already legislation in place to support the PFMIs called the Financial Markets Act, which became operational at the beginning of June 2013.“Strate complied with international best practice before the principles were drafted by CPSSIOSCO and when these principles were published, they affirmed that we were on the right track. For example, we had a participant failure manual that was translated into other languages for other Financial Market Infrastructures. In addition, Strate strongly believes that we all have a responsibility to work with and educate the local market and our international counterparts as we are all interdependent and have an impact on one another,”says Singer. Singer has taken a leading role in the region in encouraging the upgrading of national market infrastructure and adheres to the international adoption of standards and principles based structures that supports the creation of a level playing field that allows investors to move between countries and market unimpeded and in safety. Singer explains that if the financial market infrastructure is highly rated in its PFMI assessment, it provides a strong platform to support efforts to attract funds and investment into the country. I

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

20-20: SIX

Christian Katz is the chief executive officer of SIX Swiss Exchange. In November last year, he was named as the new president of exchange lobby the Federation of European Securities Exchanges (FESE). Andrew Neil spoke to Katz about his objectives for the Swiss bourse, challenges for the European Capital Markets and what he hopes to achieve in his new role with FESE.

SIX FACES UP TO MARKET CHANGE NDREW NEIL (AN): Can you talk a little about your strategic objectives? CHRISTIAN KATZ (KZ): SIX is run along three strategic thrusts—increase client focus, drive business growth and increase productivity. We achieved a new record in operating efficiency in 2013, measured by the operating margin. We’ll keep pushing our limits in search of new operational efficiency. But our objectives for this year and the next will be growth and even better client centricity. Key initiatives in this regard are the further development of our young trading segments such as mutual funds trading and new index launches to capture nascent investment themes. AN: The European financial markets are mired in evolving regulation. What are the main challenges for the SIX in this new regulatory environment and how well prepared is the exchange to meet them? KZ: We are well prepared to meet this universal challenge. We are an integrated infrastructure provider which has been exposed to intense competition along the whole value chain. We have been among the pioneers in trading system stability, circuit breakers, clearing interoperability, fragmented blue chip trading, multi-currency ETF listing and trading, innovative listed structure products to name just a few. This makes us an ideal partner for regulators and politicians to develop solutions for the future. AN: What is the new issue pipeline looking like for 2014? What is SIX doing to win new business? KZ: There is a healthy pipeline for IPOs in broader Europe as well as in our home market. Some of these companies are focusing on the post full year earnings seasons for capital raising through IPOs. Our teams are actively out there speaking to potential issuers of securities in need of capital as well as to our established listing partners such as banks and law firms. The key is not to just get narrowed down to potential equity issuers. Our market is so deeply liquid with investors wanting to allocate smart capital that we are also very actively promoting bond, ETF, ETP and structured products issues on SIX. AN: You have recently been elected president of the Federation of European Securities Exchanges (FESE). Can you talk through FESE’s objectives? What you hope to achieve as its President? KZ: European capital markets face big challenges. Many of these stem from the new economic realities and from regulatory change. FESE helps tackle these issues by actively

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

Christian Katz, chief executive officer of SIX Swiss Exchange. Photograph kindly supplied by SIX Swiss Exchange, December 2013.

shaping the debate with regulators, politicians and representatives of the financial sector. We will focus on creating a market structure of the future oriented towards efficiency, safety, and competitiveness driven by innovation. We will do this in collaboration with the investor buy-side and the banking sell-side representatives of the market. Wherever we see that the financing of the European economy needs new solutions from exchanges as the hosts of regulated markets, we will work towards finding new ways to make this happen. AN: What do you consider to be the hallmarks of an effective exchange in a changing European landscape? What are SIX’s strengths in this regard? KZ: A securities exchange like ours fulfils four fundamental functions in an economy—capital raising through listing, transfer of risk through trading, market information through data and indices and regulation for safeguarding the integrity of the market. We are a key player on all these measures in Europe and technologically a world leader. While we have been internationalised on the market information side among others through our build-out of STOXX, we have more potential to internationalize capital raising and the trading role of our market. We come from a strong position of having around 40’000 securities listed and 16% of our equity issuers being non-Swiss, but there is a high potential to offer our services to even more clients. I

20-20: EUROBONDS: DEUTSCHE BANK Photograph © Maciej Frolow/Dreamstime.com, supplied December 2013.

THE LAMBENT APPEAL OF EUROBONDS Håkan Wohlin, global head of debt origination at Deutsche Bank states: “We have not seen this much activity from emerging markets ever. I think this trend will continue with sovereign, companies and banks wanting to raise capital to support growth and expand their investor base. We will not only see more big names from China and Asia in general but increasingly companies and governments from the frontier markets coming to Europe and US.” EUTSCHE BANK CUT its teeth 50 years ago on the world’s first ever Eurobond—the $15m issue from Italian motorway operator Autostrade and it has been at the forefront of the industry ever since. It has not only won a place with European companies seeking to tap their domestic market but also the growing army of issuers who are looking towards Europe to take advantage of favourable market conditions. In fact, the quantity of bonds denominated in euros issued by non-European companies has reached the highest level since the financial crisis. They have typically accounted for 5% to 15% of the total in recent years but the figure is expected climb to 20% by the end of 2013. As of October, 15th these corporates issued €35.9bn, a 47% hike from the same period in 2012 surpassing the previous record of €34.1bn set for the corresponding period in 2007, according to data provider Dealogic. The US has been the most active in the Eurobond space with issuance jumping 72% to $18.8m (€13.6bn) although this is still below the €28bn reached six years ago. Asia-Pacific companies have also been engaged, accounting for 37% of the total, up from 33% for the same period in 2012. Dealogic figures showed that the overall euro-denominated bond volumes have risen by 11% to €217.9bn, from the €196.5bn

issued in the same period last year, and the highest since the comparable period of 2009 which was €270.8bn. One reason for the growing popularity among nonEuropean borrowers this year is attractive pricing. The expectations that the US Federal Reserve was poised to start reducing its asset purchases triggered a sell-off in global fixed income over the summer, pushing up yields on dollar debt. By contrast, better economic news kept yields down on German government bonds which set the benchmark for euro issuance. The increased activity of course was good news for firms such as Deutsche Bank, which consistently places among the top five in the Eurobond league table. It has had a busy year working on several notable deals including the Russian government’s $7bn financing as well as the CNOOC, China’s largest offshore oil and gas producer’s $2bn deal. It was split into a $1.3bn 10 year tranche with a coupon of 4.5% and a €500m, seven year tranche with a 2.75% coupon. The success of this Chinese deal and the record corporate supply from China also indicated that fears over a dramatic slowdown in the second largest economy have been replaced with optimism based on recently announced reforms and European and US investors keen to invest in their credits.

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

20-20: GORAN FORS, SEB

Deutsche Bank was also active in a spate of deals emanating from Africa, including Nigeria’s $500m, 5year bond at a yield of 5.375% and a $500m 10-year bond on 6.625% rate issued in the summer as well as the more recent Gabon’s issuance of a $1.5bn, 10-year Eurobond and a partial buyback of its existing 2017 issue. In Europe, the German bank was one of the managers of Italian company Hera’s (Holding Energy Resources Environment) €700m, 15 year bond which Håkan believes“reopened the peripheral corporate bond market. It was one of a record number of corporate deals that occurred during the year. We have also worked on more complicated deals such as KPN €2bn hybrid bond which included a €3bn rights offering. The capital instruments receive 50% equity recognition and thus reduced the need to raise more dilutive equity. We were also involved in American Movil’s €2.1bn hybrid deal, which was a ground breaking deal in Europe as first Latin American hybrid in Europe and I think we will see more of these types of deals next year. One of the reasons is because of the focus on balance sheet management, leveraged share repurchase deals which I think will continue to be a theme. These deals are attractive because they are nondilutive while having equity characteristics.” Another challenging transaction was Slovenia’s $3.5bn dual-tranche US dollar-denominated Eurobond. The deal had to be delayed due to an unexpected ratings downgrade of the country by Moody’s Investors Services from Baa2 to Ba1 while maintaining a negative outlook. “Investor demand was strong and we were able to help secure the sovereign's access to the markets at a very attractive price,” says Wohlin. “I think that speaks to our broad distribution network. We have a strong institutional footprint which has held us in good stead and has helped us lead the way for sovereigns, financials as well as corporates.” Wohlin also attributes the bank’s success to the long term and continual investments it made into developing strong local sales and trading teams.“This has allowed us greater penetration into jurisdictions where we now have a significant footprint. Overall, if you look at map of where Deutsche Bank has an institutional presence, we are in more locations than our competitors. “We have seen more than 100 countries tapping the international debt capital markets in past couple of years and Deutsche Bank has been involved in at least two-thirds of these. In addition, we have the strong foreign exchange business which supports our currency agnostic approach to clients, which means we can cater to clients in whatever currency they wish to raise money in,” he says. The bank’s strength in the secondary markets has been important.“Sophisticated investors not only look at a bank’s track record in the primary but also importantly the bank’s ability to support an issue in the secondary markets. This has been particularly true over the last few years because of increased market volatility, bigger size and longer maturities,” he adds. I

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

The Nordic economies combined will grow by 1% this year, rising to 1.9% in 2014 and 2.1% in 2015 expect a consensus of local economists. The projections mark a turning point although for some time the Nordic zone has enjoyed stronger economic performance than the wider eurozone region. Good news then for Goran Fors, head of custody at SEB since 2005, as SEB negotiates a sweeping changes across the securities services set. Can Fors lead SEB into further growth; or will regulation such as T2S sound the death knell for Europe’s specialist custodian providers?

SEB navigates the European custody maelstrom T’S A TESTING time ahead for specialist custodian providers, particularly regional players. Regulation such as T2S threatens their already testing business model. For firms such as SEB, the question is whether to continue as before or transform into a more diversified business set? If anyone is placed to find answers to difficult strategic questions it is Goran Fors, SEB’s head of custody. Fors remains a committed reformer: a role honed as a board member at SWIFT, at Euroclear’s cross-market advisory committee, at Omgeo Bank steering group and on several committees of SEB. Certainly, to have survived already in the complex regional blend that is the Nordic zone says something for the tenacity and ingenuity of the firm. While the Nordic zone has a common description, in fact its constituent markets remain firmly individual. One advantage of market reform is that both custodian providers and client are now firmly focused on risk, collateral, liquidity and market transparency. What this means for specialist custodian providers such as SEB which have already been affected by a squeeze on fees and commissions and growing encroachment on their market from the large custodian firms such as Northern Trust and JP Morgan. The Nordic custodian market, which over recent years has been described by Danske Bank, Handelsbanken, Nordea and SEB. Important questions still abound over the expected round of consolidation in the sub-custodian space, driven by cost considerations and regulation. Diversification and delineation strategies will become key selling points in any future business equation and areas such as corporate actions, taxation and compliance will be key pillars or functions going forward. Over the longer term, further challenges will arise as the impact of European wide legal harmonisation takes root and differential market challenges are minimized. Firms such as SEB are predicated as much on difference and regional specialisation as they are in terms of product offering. If one of those elements is taken away, it puts a lot of pressure on other parts of the business. How SEB and Fors will respond is a story for another day. I

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%

1.8 2.7 3.4 1.6 -0.4

26.1 32.8

0.6

-0.6

COMMODITIES Brent Crude Oil Gold Copper Credit Suisse Commodity Index

0.4

-3.8

4.6

-6.7 -1.7 -5.7 -5.0 -2.1

-1.7 -1.7 -1.8 -1.4

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

0.9

-28.0 1.8

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)

0.1 8.8

0.0

-0.8 -0.3

FX - TRADE WEIGHTED USD GBP EUR JPY

2.5 3.6 0.4 0.4 1.1

-3.1

-5

54.8

18.8 11.7 24.3 3.9

6.4 1.7 6.8

-18.9

-50

100

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

Regions 12M local ccy (TR)

3.4

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

0.6 -0.4 -0.6 -1.9

-3

-2

-1

54.8

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

2.7 2.0 1.8 1.6

32.8 29.0 26.1 24.3 18.8 11.7 3.9 1.9

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

-1.4 -2.0

-3

-2

0.8 0.7 0.7 0.5 0.5 0.1

-0.2 -0.4 -0.5 -0.6

-1

2.7 2.6 2.5 2.0 2.0 1.9 1.6 1.5

3.4

-6

-4

-0.6

54.8

43.5

Emerging 12M local ccy (TR)

2.4 2.4 2.1 1.7 1.3 1.1

32.8 29.0 26.5 26.2 25.2 24.0 23.7 23.2 22.9 22.0 21.3 20.7 18.8 17.6 13.3 9.5 6.0 4.8 1.5

South Africa Taiwan Malaysia India Emerging China Russia Mexico Indonesia Brazil Thailand

3.9

-2

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

Emerging 1M local ccy (TR) South Africa India Taiwan Malaysia Russia Indonesia Mexico Emerging Brazil -3.6 China -3.6 Thailand -5.0

17.5 13.2 12.2 7.5 3.9 3.7 0.1 -0.3 -1.2 -3.7 -5.4

-10

-5

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

DECEMBER 2013/JANUARY 2014 â&#x20AC;˘ FTSE GLOBAL MARKETS

PERSPECTIVES ON PERFORMANCE Regional Performance Relative to FTSE All-World

Global Sectors Relative to FTSE All-World

140

Oil & Gas Health Care Financials 120

130

110

Japan Europe ex UK

US Emerging

Asia Pacific ex-Japan

120

Basic Materials Consumer Services Technology

Consumer Goods Industrials Telecommunications Utilities

100

110 90 100 80

70 Dec 2011

80 Dec 2011

Apr 2012

Aug 2012

Dec 2012

Apr 2013

Aug 2013

Dec 2013

Apr 2012

Aug 2012

Dec 2013

Apr 2013

Aug 2013

Dec 2013

BOND MARKET RETURNS 1M%

12M%

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

-1.7

UK (7-10 y)

-1.7

Ger (7-10 y)

-5.7 -5.0 -2.1

-1.8

Japan (7-10 y)

1.4

-0.9

France (7-10 y)

-1.4

0.1

Italy (7-10 y)

8.8

0.0

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

1.4

-1.3

Euro (7-10 y)

2.0

-0.6

UK BBB

2.5

-0.8

Euro BBB

3.6

-0.3

UK Non Financial

-0.9

Euro Non Financial

0.1 1.5

-0.5

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

-2.9

-1.7

-3

-2

-1

-8

-6

-4

-2

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 Dec 2010

Jun 2011

Dec 2011

Jun 2012

Dec 2012

Jun 2013

Dec 2013

2.00 Dec 2008

Dec 2009

Dec 2010

Dec 2011

Dec 2012

Dec 2013

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

FTSE GLOBAL MARKETS • DECEMBER 2013/JANUARY 2014

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

125

135

120

130

FTSE US

125

115

120

110

115

105

110 105

100

100 95

90 Dec 2012

Mar 2013

Jun 2013

Sep 2013

90 Dec 2012

Dec 2013

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

Mar 2013

Jun 2013

Sep 2013

Dec 2013

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

FTSE UK

FTSE US Bond

200

FTSE US

240 220

180

200 180

160

140

140 120

120

100

80 60

80 Dec 2008

Dec 2009

Dec 2010

Dec 2011

Dec 2012

1M%

Dec 2013

FTSE USA Index

-2

-5

84.4

130.1

20.9

-1.6

-0.3

-0.9

-1

Dec 2013

16.7

-1.5

-1.4

Dec 2012

5Y%

10.4

-1.6

Dec 2011

10.3

2.7

-3

Dec 2010

6M%

5.0

1.6

FTSE USA Bond

Dec 2009

3M%

FTSE UK Index

FTSE UK Bond

Dec 2008

-10

14.8

100

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

DECEMBER 2013/JANUARY 2014 • FTSE GLOBAL MARKETS

150