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ROUNDTABLE - T2S AND THE FUTURE OF EUROPEAN POST TRADE

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ISSUE 79 • NOVEMBER/DECEMBER 2014

FTSE GLOBAL MARKETS

Why conduct risk is on everyone’s agenda SEPA: the emerging landscape The long term impact of QE The pros and cons of converti tib bles Time for a utility for data transformation?

ISSUE SEVENTY NINE • NOV

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his year was always going to be a swing year, neither beast nor fowl; and so it has come to pass.There’s been much to celebrate (reliable recovery in some benchmark markets and continued promise in others). Even so, legacy issues continue to annoy like a bee sting on a summer picnic, and mar the clear promise that sits still waiting in the wings to take centre stage. Certainly, trustees and investors in the structured credit markets are still feeling the lingering effects of unresolved markets issues. The remnants of the financial crisis continue to generate lawsuits (some quite massive). Some have potent power; the potential for a detrimental impact on the regional banking sector and yet others are distorting the use of cash and derivatives. More than $250bn in litigations were filed this summer, citing damages that are ten times as large as all of the funds raised by the venture capital industry last year (around $25b). Trustees are the targets of these actions under the premise that they had a continuing duty of care that has been refreshed through time. Moreover, several hundred banks are reaching the end of their deferral periods for their Trust Preferred (TruPS) liabilities. This market represents some $4bn/$5bn of securities that could affect hundreds of banks if TruPS are not restricted successfully. What will it mean for the regional banking sector, already under fire from onerous Basel III requirements? Then there is the inevitable legacy of too low interest rates for too long a time and, in Europe and Japan at least, continued regulatory and central bank intervention, which is continuing to distort normal market functioning, especially in cash markets. Deposit rates are negative in large swathes of Europe and the new capital treatment of collateral is leading to short squeezes in the Treasury market. These efforts are now leading private investors to engage in more derivatives trading (look at the rising demand in the options market), since cash markets are dysfunctional and the high cost of credit is almost killing off the forwards market. The evolving post trade infrastructure also remains in full focus as T2S begins to roll out (look out for the extended roundtable in this edition). The stress points however, now that the ECB has assumed the role of settlement guarantor of last resort, has shifted more attention on the role of CCPs and trade repositories.There are some commentators that believe that market transparency and regional harmonisation are still some way off for the infrastructure to be useful right now. Big Data too is a headache waiting to happen. We have often said in these pages that the second decade of a century is the one that starts to colour the remaining 80 or so years and where the vestiges of the previous century start to be discarded (big time). Advances in technology make Big Data management possible, with the proviso that quantum computers end up both efficient and (relatively) inexpensive. Moreover, the effectiveness of Big Data management (especially data related to securities transactions) that is collectable (across borders), can be aggregated and turned into a meaningful tally or analysis that means that all markets are transparent and concentrated risks can be identified and ring-fenced before they can exert their devastating effects on the global financial market. We know that markets are interdependent and we have witnessed the carnage on the (for example) money markets, corporate lending and structured products of the quantitative easing policies of central banks. What we did not learn, because the collapses of Bear Stearns and Lehman Brothers skewed perceptions was where risk lay in the markets. Nowadays we continue to look at risk in very fragmented ways: there’s still no unified field theory of the financial markets. Will Big Data help in that? I doubt it, at least not anytime soon.What happens with the data we harness in the meantime? This edition touches each of these issues outlined above and in each case, the intention is to stimulate discussion and more questions rather than provide prescriptive answers. But then you wouldn’t expect answers from a journalist, would you? Francesca Carnevale, Editor

ISSN: 1742-6650 Journalistic code set by the Munich Declaration. Total average circulation per issue, July 2011 - June 2012: 20,525

COVER PHOTO: Binary code data flow. Photograph © Artida/Dreamstime.com, supplied December 2014.

FTSE GLOBAL MARKETS • NOVEMBER-DECEMBER 2014

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CONTENTS COVER STORY

THE BIG DATA CONUNDRUM ..........................................................................................................Page 4 There’s so much more to data management than meets the eye. Not least the geostrategic implications of advancements made by different countries in the race to develop hardware and software that can compute and analyse billions of bits of information. Who will lead and who will follow in tomorrow’s supercomputing world and what are the implications for institutional investors? DEPAR DEP RTMENTS

MARKET LEADER SPOTLIGHT

ASSESSING THE LONG TERM IMPACT OF QE ...............................................................Page 11 Is Keynes on the ascendant; or will there be a return to monetarism?

WHAT NOW FOR FUND ADMIN? .....................................................................................Page 14 Ian Kelly looks at the new business dynamics amid stories from around the markets.

WHY REGULATORS ARE LOOKING AT CONDUCT RISK? ...........................................Page 18 Michelle Bedwin, senior consultant at CCL explains the dynamics

IN THE MARKETS

COMPLIANCE IN BANKING MEANS MUCH MORE THAN FAIR PLAY ...................Page 20 LOC Consulting’s Rob Norton-Edwards explains why banks must now play fair

REGULATION RECALIBRATES ALTERNATIVE FUND ADMINISTRATION...................Page 22 Bill Prew, CEO INDOS Financial, looks at the cost of regulation on securities services

OPINION PAYMENTS

FIT FOR PURPOSE DERIVATIVES WORKFLOWS ............................................................Page 23 Steve Grob, director group strategy at Fidessa, on the search for operational efficiencies

THE DAWN OF THE AGE OF SEPA ..................................................................................Page 26 Deutsche Bank’s Andrew Reid assesses the opportunities in the post-SEPA landscape

THE IMPORTANCE OF MANAGEMENT ACCOUNTABILITY ..............................................Page 28 Peter Brown, senior consultant at CCL explains the regulator’s expectations

REGULATION

THE IMPACT OF MARKET REFORM IN KAZAKHSTAN ......................................................Page 52 David Simons reports on the coming oversight of asset management.

STRESS TESTS: A CATALYST FOR BUSINESS TRANSFORMATION?

......................................Page 53

Rohit Verma, Oracle Financial Services, looks at ways for banks to enhance overall performance

DERIVATIVES

THE IMPACT OF A LACK OF FORMAL STANDARDS IN REPORTING ..........................Page 29 Phil Matricardi and Adam Kott explain the need for a utility for data transformation

SPEEDING THE CONVERSION OF NON-BELIEVERS ..............................................................Page 31 Paul Latronica of Advent Capital Management outlines the pros and cons of convertibles

ASSET ALLOCATION

BOND INVESTORS FOCUS ON TOTAL RETURNS

..................................................................Page 32

How bond investors will have to deal with diverging central bank policy

TACKLING THE DECLINE IN BOND MARKET LIQUIDITY ..................................................Page 34 Why the secondary bond market needs stakeholders to contribute liquidity

DEBT REPORT

NEW TRADING VENUES HOPE TO COALESCE LIQUIDITY................................................Page 35 Lynn Strongin Dodds on the evolution of the electronic fixed income landscape

T2S: IMPLICATIONS FOR THE POST TRADE LANDSCAPE ..................................................Page 38

ROUNDTABLE

Is the ECB’s settlement platform a panacea for Europe’s post trade inefficiencies?

TRADING TECHNOLOGY IN A TIME OF MARKET CHANGE ............................................Page 54 The inter la of market chan e and technolo ical innovation in the Russian market

OFFSHORE REVIEW

GUERNSEY’S ENDURING FUND APPEAL ..................................................................................Page 49

MARKET DATA

Market Reports by FTSE Research ..........................................................................................................Page 62

How the jurisdiction is leveraging its diversified appeal for asset managers

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COVER STORY

SUPERCOMPUTING AND THE EVOLUTION OF INVESTMENT MARKETS

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

MARKETS IN FLUX, THE IMPACT OF BIG DATA AND BIG COMPUTERS Effective Big Data management requires ultra-modern computing. In the last century, superpowers competed over the size, range and number of nuclear warheads. Defence issues aside, the big power-play among the world’s economic super-giants is now around technology and, in particular computing. What will it all mean for the global financial and investment markets?

n late November the United States Energy Department announced it will spend as much as $425m on advanced supercomputer technology. It will install two International Business Machines Corporation systems (valued at $325m) at Lawrence Livermore National Laboratory and Oak Ridge National Laboratory. The project, called Coral, also includes Argonne National Laboratory. The machines, (which also include chip technology from Nvidia Corporation) will carry out calculations five to seven times faster than any of the most advanced systems now in use in the US claims the energy agency. The department will spend another $100m to develop "extreme scale" supercomputing technologies as part of a program titled FastForward 2. In this element, IBM will deploy what it calls a data-centric design to reduce the need to

shuttle massive amounts of data within the supercomputers. Nvidia, meanwhile, will contribute chips to handle numbercrunching as well as a new technology called NVLink designed to transfer data between them at unusually high speed. There’s also a socially responsible (SR) element to the project, which has reduced energy consumption included in its key performance indicators (KPIs). Supercomputers, room-sized systems that comprise thousands of microprocessor chips, perform tasks that include simulating nuclear explosions, cracking encryption codes, projecting climate trends, designing jetliners and even, locating new oil deposits. The announcement comes at a sensitive time for the United States. In early December, the quiet announcement, that despite chilling economic winds in China’s still expanding economy, it overtook that

of the United States. The US is not used to being number two at anything; let alone in economic ranking or in advancing technology. It’s a double ouch, as China has scored a first there as well. In 2013 it built the world’s leading supercomputer; and up to now the US has yet to leapfrog China’s dominance in this segment. The news from the Energy Department was released only a few days before the publication of a ranking of the 500 largest supercomputers, dubbed the Top500. The list is compiled twice a year by researchers at the Lawrence Berkeley National Laboratory, the University of Tennessee and a German company, Prometeus. Even though the United States remains the top country with the most supercomputers with a total of 231, China has the largest, fastest computer. China itself has around 61 super- systems, Japan (32 systems), the United Kingdom (30 systems), France (30

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COVER STORY

SUPERCOMPUTING AND THE EVOLUTION OF INVESTMENT MARKETS

systems) and Germany (26 systems). For the fourth consecutive round, China’s massive Tianhe-2 supercomputer, otherwise know as“Milky Way-2″, retained the top spot as the world’s fastest supercomputer. Here’s the techy bit: Tianhe-2, developed by China’s National University of Defense Technology (NUDT,) can operate at 33.86 petaflops per second (Pflop/s). In other words, it can compute 33,860 quadrillion calculations per second, at a cost of approximately $390m to build. It’s also big; comprising thousands of Intel Xeon E5-2692v2 12C 2.2GHz processors. The project was sponsored by the Chinese government’s 863 High Technology Programme – an effort to make the country’s hi-tech industries more competitive. HP has the most supercomputers on the list, with 179 and IBM has the secondmost with 153 systems. When it comes to processors, though, Intel dominates. 85.8% of the supercomputers on the list use Intel processors and 25 use Intel’s Xeon Phi coprocessors, including the Tianhe-2. The US Department of Energy hopes its computers will be up to three to five times faster than Tianhe-2; though it has some way to go. The Titan computer, installed at the Department of Education’s Oak Ridge National Laboratory, is the number two system in the top500, but ‘only’offers a performance of 17.59 Pflop/s. The US also has the third ranking computer Sequoia, which is installed at the Department of Energy’s Lawrence Livermore National Laboratory, with a performance of 17.17 Pflop/s, while Japan’s K computer ranks fourth. It is unlikely however, that China will readily cede its dominance. Already, the National Supercomputer Center in Guangzhou in south China, whereTianhe2 is installed, is reported as saying it is close to installing an upgrade to increase the system’s speed to over 100 Plops/s So there’s a lot more hanging on Energy Secretary Ernest Moniz’s statement that the department was investing in "transformational advancements in basic science, national defense, environmental and energy research." Clearly the investment is laying the groundwork to leapfrog China in a field often linked to national

security and economic competitiveness. It won’t happen overnight. Supercomputing technology has a long lead time. Installation work on the two supercomputers is not expected to begin until 2017. Beyond their sheer scale, the new machines will require new technologies to support them and to provide them with juice in the race to solve tough scientific problems more quickly. While it will take time for the benefits of super-computing to trickle down into the markets, the benefits for the global financial community are manifold. Supercomputers will help both in the super rapid and safe encryption of data, with attendant implications for theoretical issues such as ‘ownership’of assets or securities. An early pointer as to how this might evolve is highlighted by the Bitcoin market. Often called digital currency, a bitcoin is a long string of computer code protected by a personal key which provides ownership and security, which can be downloaded. The protocol governing the software controls both the rate at which bitcoins are issued (or downloadable) and the total number of bitcoins that can be produced. Most projections say that the last bitcoins will be mined around 2140 – that might be optimistic as computers become more advanced, but you get the gist: it is ultimately a limited resource, which proponent of bitcoins say only increases their values. Bitcoins are the current modern construct; a digital currency based on Block Chain technology. Block Chain technology also appears to have applications in the selling of assets such as cars, in the production of passports and more secure bank accounts. It also has implications in the assignment of irrevocable numbers attached to tradable securities: once you buy the securities the numbers are attached only to the buyer, and therefore ownership is indisputable. Once the securities or assets are sold, the numbers related to the asset change and it becomes something else entirely. Supercomputers will also help regulators make more sense of complex money movements and the numbers generated by technology such as Block Chain. At

some point in the future, the Big Data world that regulators will inevitably inhabit will be made manageable by advanced computer systems that can track and monitor asset ownership, trading patterns, the movement of money, credit trends and anomalies and also generate complex predictive models to manage Black Swan events. The world can only wait on the imagination of developers to apply quantum based computing models to the question of security around ownership of assets, trading and identity.

The race to the top Over the immediate term: say the next five years, market evolution will largely depend on the race to the top in terms of computing ability. Although the US investment in super computing is clearly on a growth trajectory, any leapfrogging of the Chinese won’t happen overnight. The US is however upping its game. On December 11th, both the Senate and Congress passed the Cybersecurity Enhancement Act, which will standardise best practice in information networks, as well as codify government approaches to research and developments. The Act however does not legislate for government funding, thereby encouraging private sector involvement. If anyone thinks that the slowdown in the Chinese economy’s rate of growth will somehow give time to the US to overtake it, think again. Slower growth in China in the race to the top is also something of a chimera. Lower growth rates are offering the Chinese government time to retool the economy. In turn, this means that technology-enabled offerings will rise in prominence, for two reasons: it offers the promise of improved workforce productivity, and it dovetails well with the government’s strategic investment in the sector, which is designed to foster sustainable development. In other words, China’s taking time out to ensure that the next phase of growth in both the economy and technology is sustainable over the longer term. It will require massive investment, and it won’t just be local. Cross-border investment from China to overseas markets is estimated to grow to around $2trn (from

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measure it understand it apply it sĂZ ƌĞŵĂŝŶƐ Ăƚ ƚŚĞ ŚĞĂƌƚ ŽĨ ƌŝƐŬ ĞƐƟ ŵĂƟŽŶ ĨŽƌ ďĂŶŬƐ ĂŶĚ ĂƐƐĞƚ ŵĂŶĂŐĞƌƐ But a single VaR number is not the whole story D ƉƉůŝĐĂƟŽŶƐ Excerpt ĚĞůŝǀĞƌƐ͗ ^ŚŽƌƚͲƚĞƌŵ ĂŶĚ ůŽŶŐͲƚĞƌŵ sĂZ hƐĞƌ ĚĞĮ ŶĞĚ ƌŝƐŬ ĂƩƌŝďƵƟ ŽŶ ŽŵƉƌĞŚĞŶƐŝǀĞ ŝŶƐƚƌƵŵĞŶƚ ĐŽǀĞƌĂŐĞ ƌŽďƵƐƚ ƐƚĂƟƐƟ ĐĂů ŵŽĚĞů ĂƐǇ ŝŶƚĞŐƌĂƟ ŽŶ ŝŶƚŽ ǇŽƵƌ ŝŶǀĞƐƚŵĞŶƚ ƉƌŽĐĞƐƐ

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ĂŶĂůǇƐŝƐ ŝŶƚŽ ĂĐƟ ŽŶ

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COVER STORY

SUPERCOMPUTING AND THE EVOLUTION OF INVESTMENT MARKETS

$500bn or so today) in value by the Rhodium Group. Taking a more localised view, the markets have not been slow to embrace the changes which technology allows. Moreover, it looks over the long term to have transformative effects. The banking industry has not been slow to prepare for change and right now, Goldman Sachs provides an interesting paradigm in terms of how some elements in the market might evolve. In late November this year Kensho, a provider of real time computing systems,

announced that Goldman Sachs led a $15m investment round in the firm and, at the same time, entered a strategic partnership to use Kensho's real-time statistical computing and analytics technology across the firm. "Our unique partnership with Kensho is an extension of our overall strategy of using and investing in new technology which allows us to deliver insights to our clients. We are excited to work with Kensho to develop user-friendly big data analytics tools which can be put into the hands of our client facing teams," explained Tony Pasquariello, co-head of

North American Equity derivatives sales in the bank’s Securities Division on the announcement of the investment. Investment bank Goldman Sachs is now the largest strategic investor in Kensho, with RanaYared, managing director in the Securities Division at the bank, joining Kensho’s board of directors. Don Duet, global co-head of Goldman Sachs' Technology Division, will join Kensho's Advisory Board. It is an important move for the bank as it seeks to move into more advanced, accessible, real time analytics. For its part Kensho is a next generation

Against a backdrop of increasing regulation and investor due diligence, investment managers face an analytical systems proliferation, exacerbated by cost, data management and operational risk issues. Meanwhile, the costs of supporting trading and distribution have gone up just as fees have gone down. As a result, more firms are considering their options such as whether to outsource their middle and back offices. Ian Hallam, CEO, 3i Infotech (Western Europe) outlines the options.

‘INTELLIGENT’ BPM: EXITING THE SINGLE APPLICATION SILO

Tools to cope with the increased process complexity not to mention outsourced services - are particularly in demand, as they help to manage the relationships not just with clients but also with trading partners and other counterparties. Reporting, valuation timing, trade accuracy and estimated NAV production is also occurring in quicker cycles, requiring systems that can work within a daily reporting model. There is an opportunity to improve the flow of this information across both the applications and the myriad of departments who manually filter and enrich the data as input to the next process. To date, investment managers have typically tackled this issue by asking the application vendor to build localised workflow into their application. Often-overlooked questions are: Does the client on-boarding workflow integrate with the dealing workflow identifying trade exposures and investments in high risk instruments or markets, during the customer profiling process?; Are there gaps that will create a potential operational risk or slow down

the overall business process?; and Is there a need for an end-to-end business process management capability that sits above the individual application workflow, providing a full front-to-back office viewpoint?” Departmental silos are a common problem for investment management firms. For example, the client onboarding department receives funds that must be invested within an agreed timeframe. Funds must be deposited and cleared, possibly in conjunction with an external banking system. Once funds are available, the dealing team must be notified. The onboarding team may then need to communicate with the client to confirm that their instructions have been carried out. These silos create inefficiencies, costing time and money.

The search for efficiencies

In investment management firms, there is a wealth of data circulating and many touch-points with that data. One common problem is that the operators touching the data are not always aware of precisely how colleagues upstream

have manipulated that data or the dependencies other departments have on their output. There is a fundamental requirement to optimise the process, identify the key tasks within it and feed information on the status of those tasks both up and downstream. In this way, investment managers can manage client expectations for services such as reporting as well as managing the ‘pinch points’ or bottlenecks in the middle and back offices that can leave some staff under utilised one week then overwhelmingly busy the next. For example, the process work done in the middle office is often compressed in terms of time available, due to delays in the back office or pressures from the front. Regulators and institutional clients are also increasingly looking at the operating and governance controls of firms. Although most firms have good controls in place, it is often difficult to visualise them as they consist of a mixture of manual and automated processes including; individual application controls, email notifications, spreadsheet logs and shared

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platform for investment professionals that can handle millions of permutations of complex financial questions, able to harness “massively parallel statistical computing … and breakthroughs in unstructured data engineering.” It is not the first time that the investment bank has taken a strategic position in a technology firm. Early in 2013 the bank helped raise a reported $25m for San Mateo based Motif Investing Inc., a Web-based start-up that lets investors buy baskets of stocks based on themes

Photograph © Skypixel/Dreamstime.com, supplied February 2014.

Microsoft Outlook calendars. As the demands of regulators (for example, the UCITS IV requirement for Key Investor Information Documents) and clients increase, a more holistic and robust platform is required to both enable deadlines to be met through improved efficiencies and for the governance and management functions to provide evidence that they have oversight across the process. The solution? ‘Intelligent’ Business Process Management.

Workflow or BPM?

In contrast, BPM allows investment management firms to take ownership of their processes. User interaction is just one mechanism though which information is captured. Data is continually flowing within and between different applications and systems. BPM automates these information flows, facilitating STP

such as home improvement and Obamacare. Foundation Capital, Ignition Partners and Norwest Venture Partners, which were existing investors in the firm, also contributed to the round. Darren Cohen, who leads Goldman’s principal strategic investments group, joined Motif’s board as an observer. The firm is among a growing crop of start-ups, such as FutureAdvisor and Wealthfront, which provide asset-allocation advice and help clients make the recommended trades. Motif is now providing through management by exception. User interaction is utilised to handle these decision points. In addition, workflow identifies that a task has not been completed, but it does not help beyond flagging up the outstanding task. It instructs the operative to perform a task and then another task, but it doesn’t actually perform the task. BPM goes a stage further and informs the user, for example, “if you don’t complete Task 1, you will be breaching regulations a, b and c. The system will therefore re-route this business process to a different operative to then achieve compliance.” In this way, BPM operates rather like a SatNav: adopting a real-time approach to finding a critical path for any problem - taking into account traffic flows, closed roads and other obstacles. Next generation BPM will deliver the instruction but then actually perform the task within the same framework (usually, workflow tools are part of a different platform or framework, not integrated with the analytics systems). Next generation BPM will also forecast bottlenecks through the analysis of existing data and patterns. Resource management systems will automatically divert users from other tasks in order to avoid a bottleneck and managers can be alerted in time to take the appropriate actions. Such analytics can act in a management information (MI) capacity,

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software to investment advisors, providing them with products to offer clients at lower than market management fees charged by mutual funds. These types of firms are beginning to offer an alternative to traditional brokerage players, which, such as E*TRADE Financial and Charles Schwab Corporation (in fact some Motif executives originated at E*TRADE); opening up competition in the sector and providing end investors with a greater choice of investment allocations. Elsewhere, Goldman Sachs made an alinforming the operative about what has happened i.e. a particular task was breached two hours ago but the BPM engine will re-route the task, given all the alternative routes available. In most wealth management firms, many tasks are performed in series by multiple applications, with the result that the monitoring of tasks becomes manually intensive and therefore prone to errors. A UI that could be overlaid across all third party platforms and expose data validation and business rules would make that BPM capability appear seamless and also provide immediate feedback as data is entered. The user would not have to submit a form and then wait for the response. Every department within a wealth management firm has its own processes and management controls – and its own software applications. All too frequently these processes are not aligned and significant amounts of staff time are wasted in the co-ordination of these tasks. Next generation business process management will integrate these processes seamlessly, providing relevant and timely information to decision makers, risk and compliance officers. The search for efficiencies and the demands of regulators will attract increasing numbers of investment managers toward ‘Intelligent BPM’ —reducing errors, speeding up processes, avoiding bottlenecks and delivering a better customer experience to the investor. n

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COVER STORY

SUPERCOMPUTING AND THE EVOLUTION OF INVESTMENT MARKETS

together more substantial investment in Perzo, a Palo-alto based instant messaging start-up. The company's product is an open-source messaging app for the workplace.This time the bank joined with BlackRock, Citadel, Citi, Credit Suisse, Deutsche Bank, Jefferies, JP Morgan, Maverick and Morgan Stanley, as investors, with all of them expected to use the firm’s programme, although it could be months before the firms have a product ready for trading desks. The move is interesting . Banks working in tandem to own technology that enables the efficient operation of messaging and communications services is an obvious next step. Mutual ownership, are focused on service provision rather than profit. As banks move away from traditional lending and into more service driven offerings, it is natural that they will invest in advanced computing and technology-based systems that ultimately will help them gain internal efficiencies and cost reduction. In that regard, they will be taking on third party suppliers such as Bloomberg andThomson Reuters, which often charge on a high fee/per-terminal basis to help banks communicate with each other electronically. The banks are clearly setting out a marker that as technology advances they can have an active stake in how it will roll out across the firm. As computing becomes more advanced and their processing capacity increases, the opportunity to exploit breaches also increases. Big data is a big challenges for security teams. As security data volume has grown, relational and time-indexed databases are struggling under analytics loads. At a recent Global Cyber Security Innovation Summit in London, security experts highlighted the reality that in the battle against cyber threats, many of the tools available to both developers and financial institutions remain immature. An important goal for big data analytics is to enable organisations to identify unknown indicators of attack, and uncover when compromised credentials are being used to bypass defences. Handling unstructured data and combing it with structured data to arrive at an accurate assessment is one of the big

Photograph © Ashdesign/Dreamstime.com, supplied February 2014.

challenges of big data security analytics. The UK’s national Computer Emergency Response Team (CERT-UK) is looking at structured language for cyber threat intelligence information called Structured Threat Information eXpression (Stix), which if successful, could be key to enabling different CERTs to share information at speed and scale. CERT-UK is reportedly working with counterparts in the US and Australia to find ways of getting information to defenders quickly in a format that is useful. However, and this seems to be the kicker for all parts of the super-computing equation, whether it be big data security analytics or market analytics, to be successful organisations first need to have a clear idea of exactly what they want to get out of the software.

The FinTech challenge Dassault Systèmes announced the winner of the 3D FinTech Challenge 2014, an immersive program designed to empower and accelerate technology innovation in financial services, this year, specifically within the investment management industry. Prophis, formerly known as Pontchartrain Advisors, was declared winner by virtue of their service offering which helps enterprises identify relationships and derive exceptional value and insights from their“medium data”. Prophis impressed the judging panel composed of leading figures from the FinTech, Investment Management and Venture Capital industries and they beat 5 other finalists including Closir, Data-Next, and Heckyl. Prophis will be taken by Dassault Systèmes to New York to connect the firm with the Challenge’s mentors’US-based colleagues. They will also leverage legal firm Fried Frank’s Coming to America support program. Charles Pardue, managing

partner and founder of Prophis Technologies, explains that with input from Dassault Systèmes, mentors, partners and subject matter experts,“we made terrific strides in productising the powerful functionality embedded in our Proteus platform.” Finalists benefited from an immersive program of master classes and on-going commercial mentoring from leading industry figures and senior executives at Dassault Systèmes. They also received technical and legal support, and pitching guidance. Recent trends impacting the asset management industry, such as regulation, are increasing the need for data and process centralisation. In a recent publication, Global Asset Management 2014: Steering the Course to Growth, The Boston Consulting Group highlighted what it called “disruptive trends” that asset managers should consider as they design their technology architecture, either internally, or outsourced to a third party.The disrupters are well recognised, including regulatory change, the digital and data revolution, more demanding investors with a growing preference for non-traditional assets, new competitors providing non-traditional assets, and globalisation.These disrupters look unlikely to change over the near term though technology will. Risk analytics and decision support tools are already part of the suite of systems that asset managers and beneficial owners use. Increasingly, a core function of asset management technology will be designed to support heightened data management and information processing. Clearly, the landscape for investment management technology is highly competitive, with many competitors and low barriers to entry for new vendors. If technology is now being used by asset managers to help them decide their risk parameters and asset allocation strategies; service providers are dovetailing with that end decision, investing in firms that will facilitate the purchase and processing of those assets cheaper and faster and more securely. How that will ultimately change the face of investing is yet to be fully defined; but getting there should be very interesting indeed. n

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MARKET LEADER

Whether you agreed with quantitative easing or not, now that the US Federal Reserve Bank has decided to terminate its monetary easing programme after five years, one question is: did it do more harm than good? Moreover, as the Bank of Japan, the People’s Bank of China and the ECB look to be on the brink of expanding their own programmes, and Europe embarks on a distinctly Keynesian growth strategy – is the left, rather than the right in Europe now dictating tomorrow’s economic policy?

he Federal Reserve, finally called time on its $4.5trn bond-buying programme at the October Federal Open Market Committee (FOMC), the central bank’s policy setting meeting, bringing to a stop six years’ worth of monetary easing. Although the last tranche in its bond buying programme would be finalised at the end of October, the central bank says it remains committed to its strategy of keeping interest rates at a record low level (between zero and 0.25%) for the foreseeable future. Actually, the words used by the Federal Reserve chair, JanetYellen, in a subsequent press briefing were“a considerable time”. Once US employment figures began to rise, it was only a matter of time before the Federal Reserve tightened monetary policy.The monetary policy committee acknowledged a “substantial improvement in the outlook for the labour market,”and had grounds to believe that there was“sufficient underlying strength in the broader economy to support ongoing progress toward maximum employment in a context of price stability.” In the end, quantitative easing ended with more of a hint of a whimper rather than a bang. A less than fitting end perhaps for a programme that was deemed hugely radical, when it was launched back in December 2008 (designed to help support what looked to be a fast collapsing house of cards). The beginning of the end actually came in January this year, as the underlying US economy looked to be brightening and the central bank began to reduce the volume of its bond purchase from $85bn a month, down to $15bn. “Financial markets continue to project a much shallower path for US interest rates

President of the European Central Bank (ECB) Mario Draghi Photograph supplied by PressAssociationImages, September 2012.

than that indicated by the Federal Reserve,”suggests Jeff Keen, head of asset allocation and lead manager of the Waverton Global Fund and the Waverton Sterling Bond Fund at London-based boutique investment firm Waverton.“We think this is symptomatic of a general complacency towards the potential for higher rates over time. In our view, just a slightly more optimistic view of the global economy, or perhaps less focus on deflation risk, could lead to a much higher level of expectations for interest rates across the developed world. This would represent a major headwind for the fixed income asset class and therefore we recommend a highly strategic approach to this part of clients’portfolios,”he adds. US markets reacted to the Fed’s news, but nowhere near levels that suggested that they were shocked by the decision: after all, warming US economic data has been drip feeding into the news since August. No surprise perhaps, that the

FTSE GLOBAL MARKETS • NOVEMBER-DECEMBER 2014

same day of the announcement, the Dow Jones Industrial Average dipped by only 0.2%, and the S&P500 by 0.5%. The success and benefits of quantitative easing are now widely debated, particularly as the People’s Bank of China, the European Central Bank and the Bank of Japan are seemingly on a round of monetary easing. Will they, and would the US economy, be significantly worse off without it? According to John Mcleod at Citigate, yes.“The broad-based easing of financial conditions it created and, equally important, the signal it sent to households, firms and investors of full commitment to do whatever it takes to achieve the objectives of the Fed’s mandate, contributed substantially to first stabilising and later reviving the US economy,”he avers. However, for Mcleod, it is impossible to disentangle the QE-effect from other important policy measures that were taken, such as banking sector recapitalisation, stress-tests and the fiscal stimulus of 2009-2010.“QE was an important pillar of the policy mix that enabled the US to significantly outperform most other regions in recent years. None of the large economic blocks in the developed world can match the US performance. In terms of GDP growth, the improvement in labour market conditions and the stability achieved in underlying inflation (expectations) since 2009,”he insists. Even so, Mark Mobius, executive chairman, Templeton Emerging Markets Group, thinks that QE is something of a misnomer, “typical of the euphemisms common in financial circles, “ he states. “Easing” really isn’t an accurate description—in actuality, it is about expanding rather than easing. There was QE1, then QE2, and finally QE3, the last version of

MEASURING THE VALUE OF QUANTITATIVE EASING

Assessing the long term impact of QE

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MARKET LEADER

MEASURING THE VALUE OF QUANTITATIVE EASING

the Fed’s money-creation program. QE1 started in late 2008 in response to the US sub-prime financial crisis, in the form of a program to purchase government debt, mortgage-based securities and other assets primarily from banks which were suffering from the decline of the value of those assets. The original program was set at $600bn, but the expected economic recovery and ending of tight credit did not materialise as expected. Hence, QE2 was launched in 2010, and then two years later, QE3, as policy makers became more and more desperate to create the required economic stimulus.” Mobius thinks there have been winners and losers in the QE circus. “The low interest rates we see globally in many markets now disadvantage regular bank deposit savers and pensioners, while the equity holders have generally benefitted as the surviving banks have grown bigger, and perhaps are now in the “too big to fail”territory.” Mobius is also aware of the long standing Fisher equation (MV=PT), which essentially posits the inflationary effects of the creation and mobilisation of money. “The savers who have suffered with low interest rates could be hit with another problem of high inflation down the road,” says Mobius. “Although inflation has generally remained low in the markets where central banks have been engaging in easing measures, many—including me— believe that once the banks gain the confidence to begin lending aggressively again, inflation will likely rise. This, of course is a double-edged sword. Countries battling deflationary forces, including Japan and the eurozone— would welcome inflation. But the flip side is that inflation can quickly spiral out of control, and it can hit emerging market economies particularly hard, as a higher proportion of their consumers’budgets go to basics like food and fuel,”he explains. So what now? Ironically, while leading the pack, the outlook for the US is not in the major league. ING IM expects a shift in earnings growth leadership in 2015 whereby US companies will see earnings growth slow down while eurozone and Japanese companies may see it accelerate.

Explains Patrick Moonen, equity strategist at ING IM,“We expect a less US-centric equity market next year due to a slowdown in earnings growth and tighter monetary policy, while equities in the eurozone and Japan will benefit from easy monetary policy and positive exchange rate effects causing earnings growth prospects to accelerate. Generally speaking, corporates do have money to spend, but at the same time we observe growing differences between the valuations of equities in the various regions. Japan is our favourite because of its very favourable valuation-growth trade-off. US valuations are a bit expensive, although certainly not in bubble territory. More buybacks in the US would even offset lower profit growth.”

Japan’s QE The Bank of Japan’s recent move to inject more money into the system has resonated well with investors, posits Michael Woolley, client portfolio manager for Asia equity at Eastspring Investments.“Regardless of [the Bank of Japan] achieving its desired outcome, this market-oriented approach to policymaking will likely underpin market sentiment and stock prices in the near term,”he avers. Woolley thinks the Japanese stock market will benefit from a wholesale increase in liquidity, as a result of easing in central bank policy. “Japanese households hold 53% of their assets in cash (compared to 15% in the US), and a 1% shift from household financial assets into domestic equities over the next five years implies $150bn of new funds into equities,” he says. Even so, he does not rule out attendant market volatility.“This year has been a case in point; market performance and volatility has coincided with short term focused participants responding to thematic macroeconomic news flow, irrespective of company fundamentals,”he adds. However, continuing headwinds hampering growth (created by public and private sector deleveraging) are fading and broad-based improvements in labour markets are being seen, believes asset manager ING. According to Moonen,

“Together with the recent fall in oil prices, this should help global growth to re-accelerate in 2015”. Michael Hasenstab, executive vice president and chief investment officer, Global Bonds Franklin Templeton Fixed Income Group, thinks the Bank of Japan’s QE are indicative of not only how important quantitative easing is to both Japanese Prime Minister Shinzo Abe’s “Abenomics” policy and his political legitimacy, but also as a driver of Japan’s domestic economy. “QE facilitates two major dynamics: First, it funds massive government indebtedness. Basically, the Bank of Japan is now directly financing the government, which is important in Japan because the government is running massive fiscal deficits on top of a huge debt stock. At the same time, the pool of assets domestically from the private sector is shrinking because the current account has moved basically from massive surpluses to flat-like deficits at times, while at the same time the population has been aging,”he explains. However, there is a caveat in that Hasenstab maintains that Japan’s policy motivation is very different from the motivation of QE in the United States or the motivation of QE in Europe, “which are not really about explicit debt financing. Japan’s debt dynamics are more of an explicit debt financing,” he avers. “The other component of QE that we believe is critical in Japan’s case is that it facilitates pension fund reform. Pension fund reform is important because changes in the Japanese Government Investment Pension Fund’s asset allocation mix toward more domestic equities, global equities and global bonds should allow the return on the global pension fund to increase, which is important to help offset the higher inflation that retirees are likely going to face”. Pumping money into the economy and changing the asset allocation mix of a trillion-dollar pension scheme has had an impact on Japan’s domestic asset prices. Globally, it’s also very supportive, in our view, because money is fungible. Money that is printed in Japan doesn’t just stay in Japan; it flows into other markets. So

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Photograph © comradecg/dollarphotclub, supplied December 2014.

menting capacity this extra investment helps keep inflation low: the prices consumers paid for goods and services rose by only 1.2% year on year in Q3. Mcleod thinks that Europe’s monetary policy still has some way to go in in addressing the region’s economic challenges. “Whether Europe will eventually take the QE road remains to be seen. But without a more US-like flexibility in policymakers’ thinking and commitment to do“whatever it takes”to reach the desired objectives then it will take a long time for [the region] to heal,”he maintains. Certainly, the ECB has deployed many unconventional policies this year, most recently buying corporate debt, but the prospect of falling prices means there’ll be more to come. ING IM predicts that 2015 will see growing confidence among developed market corporates, which will shift their focus away from deleveraging and increasingly onto M&A activity and capex, especially in the US and Japan. “Whether Europe joins the investment agenda in 2015 will partially depend on the political willingness to raise public investment in the region’s aged infrastructure and the success of this in kick-starting publicprivate investment initiatives,” adds Moonen. In that regard, should it meet its promise, the Juncker investment initiative, announced at the close of November, should help. At its Annual Outlook Conference held in London in mid-November, ING IM highlighted that imbalances from the past and uncertainty over future growth potential continued to haunt the global economic outlook.The asset management

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firm thinks that equities and real estate will be the strongest asset classes in 2015, while interest rates might rise somewhat from current levels in the US on the back of Fed tightening. Limited upward pressure on bond yields is expected to materialise in both Germany and Japan. “Big price dislocations are opportunities for us to buy shares in cheap companies we deeply understand from a fundamental perspective. We find many companies in strong financial health and observe that companies’ restructuring efforts are continuing and in some cases have accelerated. The strength of earnings improvement remains under appreciated by the broader market. Real sustainable change in Japan will be delivered by further improvements in corporate efficiency and performance,” avers Keen at Waverton. Valentijn van Nieuwenhuijzen, head of multi asset at ING IM, says:“Going forward into 2015, global imbalances will still weigh on growth and investor sentiment but unorthodox central bank policies will keep overall liquidity conditions easy and both the US and Japanese economies are poised to grow above potential. Ongoing quantitative easing from the Bank of Japan is likely to further boost Japanese equities. Japan remains our favourite market.Although the eurozone’s travails are unlikely to be fully resolved in 2015, equities in the region will continue to offer attractive yields. Fears related to China’s slowdown and European deflation will undoubtedly weigh on investors. However, at ING IM we remain optimistic as developed markets enter into the most sustained recovery since the crisis and risk premiums appear attractive”. “We feel that fears of bubbles bursting are overdone and we only see stretched valuations in fixed income-spread products. However, low nominal growth and aging populations continue to prompt a search for yield amongst investors, while default expectations are low. Other parts of the market, such as government bonds, real estate or equities, still offer risk premiums at or above their long-term average. A renewed strengthening in global growth momentum will generally support risky assets in the early stages of 2015,” he adds. n

MEASURING THE VALUE OF QUANTITATIVE EASING

we think Japan’s QE program is very positive for global risk assets but will be unambiguously negative for the yen. The pressure is now on in Europe to ensure that deflation does not take hold and the very low level of inflation expectations gives Draghi the mandate to move more aggressively,”says Waverton’s Keen. “Following the increase in stimulus announced by the Bank of Japan last week, the pressure will be on the ECB “The macro-economic environment is a complex one but we remain biased towards risk assets,”he adds. The question is: can Europe achieve the same success with a quantitative easing programme that the US has? Mcleod at Citigate thinks the comparison with Europe is especially striking as “its GDP is still below its pre-crisis level, underlying inflation is at a record low level and inflation expectations are under downward pressure. It is over-simplistic to blame this all on the lack of QE by the ECB because the widelyapplied austerity agenda was at least as much to blame for it. Also, the poor diagnosis of the origin of the crisis played a big role – unlike their US counterparts, European policymakers did not see the core of the problem as being a balance sheet recession that resulted from excessive credit creation in the private sector”. According to Mcleod, the US was faster and better than Europe in identifying the problem and more willing to apply unconventional medicine for an unconventional disease, “such as a balance sheet recession. European policymakers, meanwhile, remain stuck in their fight against ghosts from the past, with a focus on 1980s-style medical treatment (fiscal prudence and supply side reform) that has proved ineffective so far in addressing the massive demand shortfall, the underutilisation of resources and a persistent downtrend in inflation in Europe”. In that regard, he’s right. US GDP grew faster in Q3 than first thought, by 3.9% year on year rather than 3.5%, as most analysts expected. Non-housing investment has been particularly strong, up 6.2% year on year. That suggests firms are confident enough about their prospects to commit to projects. Moreover, by aug-

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SPOTLIGHT

REDEFINING SECURITIES SERVICES

What now for fund admin? A step change in the volume of reporting means that the best administrators are now a central hub for a vast array of important information from multiple sources – information waiting to be turned into value. Moreover, the increase in complexity combined with the rising importance of technology and automation means that these days leading administrators see the value in investing heavily in higher intellectual capital. In many cases fund administrators are no longer the bean counters of old. Ian Kelly, chief executive officer of fund administrator Augentius explains the new dynamics.

he clients of fund administrators are operating in a landscape that would have been unrecognisable just five years ago. The immediate post-crisis climate triggered a deluge of new regulation that continues to roll around the globe. From FATCA to Dodd-Frank to AIFMD and beyond, the volume and complexity of data that funds are expected to capture and report to regulators and investors alike has ballooned. Regulation aside, funds are also facing a more complex landscape as ongoing globalisation opens up a variety of new markets, all with their own idiosyncrasies. And all the while, competition for capital has become ever more intense. This changing environment has also had a transformative effect on fund administrators themselves.The upshot of all this has been the rise of a new breed of fund administrator. While accurate, quality outsourced administration remains at the heart of the business model, some administrators are taking advantage of their newfound position to take on a greatly expanded role. Unlike the role of third party administrator (taking a bothersome task off a fund manager’s plate), these new roles involve actively adding value to the client’s proposition. One area where fund administrators are starting to actively add value is in the area of investor communications. Given the trove of data administrators sit on, the best administrators are perfectly placed to help a fund ensure that its investors receive the information they need. This means providing it in the relevant format, and

allowing the investor to access in-depth information about their investments on a far more regular basis, tailored to their own particular requirements. The fact that modern fund administrators now need to be absolutely on top of the precise, technical details involved in the new regulatory environment – details that are ever shifting thanks to the ebb and flow of global regulation – also puts these providers in a perfect position to offer wider compliance services. Given that regulatory reporting now forms such a crucial and large part of the wider administrative workload, administration and compliance practices have never been closer.

Advice-based service More broadly, the steady accumulation of expertise and data within the fund administration sector means that the best firms are able to take an increasingly advicebased, consultative role – helping managers to improve their businesses and tackle any challenges that may arise for funds with unusual needs. The ideal relationship between a fund and its administrator is now an active partnership. It is not an unthinkable leap to see this relationship develop into an expanded role and the wider provision of back-office consultancy. Additionally, as the role of fund administrators expands, specialist knowledge of the private equity and real estate industries becomes ever more important.The services described above will, as always with the asset class, have to be modified to suit the

idiosyncrasies of the sector. Regulation presents a good example: the AIFMD places very different demands on private equity and real estate funds than it does on other alternative asset classes. Given the distinct challenges that are now being faced, managers are increasingly looking for administrative partners that understand the particularities of their business model inside out. The industry will continue to evolve in this direction.The expertise and experience of the best fund administrators mean that they are well placed to transcend the limitations of pure administration, and instead offer funds a wide range of services. As the market environment continues to become more complex, demand for these additional services will only increase. So we are fast reaching a point where the name ‘fund administrator’ no longer paints the full picture. Fund administration is no longer a simple facilitator of backoffice processes. Today’s service provider is a new breed of specialised functions that will come to fill an indispensable niche within the private equity and real estate industry. n

West Coast US real estate funds see surge in fundraising Uptick in US West Coast investment In recent years there has been a clear upward trend in fund managers successfully attracting more capital for West Coast-focused vehicles, reports Preqin, with the aggregate capital raised by these funds increasing year on year from $0.8bn raised by 11 funds closed in 2011 to $2.7bn raised by 18 funds closed in 2013. 2014 so far has seen 11 West Coastfocused private real estate funds reach a final close, having raised an aggregate $1.6bn in capital commitments. Some $4.3bn has been raised by private equity real estate funds focusing solely on the West Coast since the start of 2013, compared to $2.6bn throughout 2011 and 2012. In recent years there has

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SPOTLIGHT

THE COMEBACK OF LEVERAGED PRODUCTS?

been a clear upward trend in fund managers successfully attracting more capital for West Coast-focused vehicles, with the aggregate capital raised by these funds increasing year on year from $0.8bn raised by 11 funds closed in 2011 to $2.7bn raised by 18 funds closed in 2013. 2014 so far has seen 11 West Coastfocused private real estate funds reach a final close, having raised an aggregate $1.6bn in capital commitments. Eighteen private real estate funds focused on the West Coast closed in 2013 raising an aggregate $2.7bn, the highest amount of capital raised by West Coastfocused real estate funds in any year in the period from 2007 to date. Some $1.6bn has been raised by West Coast-focused real estate funds closed so far during 2014, accounting for 41% of capital secured by US regionally-focused funds.This proportion has increased each year since 2007 when it represented just 2%. A significant 76% of West Coast-focused real estate funds closed from 2013 to October 2014 have met or exceed their fundraising targets, compared to 38% that closed between 2011 and 2012. At least 85% of West Coast-based managers told Preqin that competition for value added/opportunistic assets had increased, while 58% said so for core assets, demonstrating the challenging environment fund managers face at present. In the meantime, 46% of West Coastbased real estate fund managers expect to deploy more capital in the year ahead compared to the last 12 months, while 46% plan to invest the same amount of capital. As well, 22 West Coast-focused real estate funds are currently in market seeking an aggregate $3.5bn, compared to 19 funds and $3.7bn as of October last year. Almost a third (32%) of West Coastbased real estate investors have assets under management of more than $1bn. On average, West Coast-based investors are under-allocated to the real estate asset class.These investors maintain an average target allocation of 9% of total assets to real estate and an average current allocation of 8%, suggesting that they are likely to place more capital in the asset class in the coming year. n

A return for Europe’s leveraged product market? After a promising beginning, trading volumes on European exchanges dipped slightly in the third quarter of the year. Even so, Europe’s exchanges generate turnover of €26.2bin Q3 2014.

rading in investment products and leverage products on European financial markets fell slightly in the third quarter of 2014. At €26.2bn, the trading volume was down one percent in comparison with the previous quarter. However, exchange turnover was up 9% compared with the same quarter of 2013. This is one of the findings of an analysis by Derivative Partners Research AG of the latest market data collected by the European Structured Investment Products Association (EUSIPA) from its members. The members of EUSIPA include: Zertifikate Forum Austria (ZFA), Association Française des Produits Dérivés de Bourse (AFPBD), Deutscher Derivate Verband (DDV), Associazione Italiana Certificati e prodotti di Investimento (ACEPI), the Swedish Exchange Traded Investment Products Association (SETIPA), the Swiss Structured Products Association (SSPA) and the Netherlands Structured Investment Products Association (NEDSIPA). The trading volume of investment products on the European exchanges in the third quarter was €9.1bn, 35% of the total turnover. Exchange turnover was down 3% compared with the previous quarter and by 10% compared with the third quarter of 2013. Exchange turnover in leverage products in the third quarter was €17.1bn, representing 65% of the total turnover. The trading volume of warrants, knock-out warrants and factor certificates was almost unchanged in comparison with the previous quarter. However, year on year the volume jumped 21%.The current low interest rate environment has set off a search for yield, leading to a resurgence of high-yield products. Leverage also has rebounded after initial signs of creditrelated deleveraging by households and

corporates in the wake of the financial crisis. While increasing leverage can signal returning confidence in the financial system, according to IOSCO’s recent Securities Market Risk Outlook report, it could also “become a source of potential risk when interest rates increase.This is of particular concern in the case of leveraged, complex and often opaque products and constructions such as CDO squared”. At the end of September, the exchanges of EUSIPA member countries were offering 492,753 investment certificates and 702,216 leverage products. The number of products listed grew by one percent overall in comparison with the second quarter. The number of investment products listed was up 9% in comparison with September 2013, while over the same period the number of leverage products increased by 10%. Issuers released a total of 596,647 new investment products and leverage products in the third quarter of 2014 – an increase of 10% in the number of new products in comparison with the previous quarter. Investment products accounted for 23% of the new issues, with 138,459 new securities. Leverage products accounted for 77% of new issues, with 458,188 of new securities. Market volume in Austria, Germany and Switzerland at the end of September was €251.9bn, about the same as in the previous quarter, but as much as 11% higher than in the third quarter of 2013. At the end of the third quarter of 2014, the market volume of investment products was €234.4bn, a decrease of 2% in comparison with the end of June 2014, but an increase of 7% year on year. At €17.4bn, the outstanding volume of leverage products was up 35% in comparison with the previous quarter n

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IN THE MARKETS

THE LOWDOWN ON CONDUCT RISK

Photograph © Crednik/Dreamstime.com, supplied February 2014.

Why regulators are looking at conduct risk The financial crisis and subsequent change of regulatory authority has brought in a new regulatory landscape with an increased focus and scrutiny on the conduct of individuals and institutions. Following the division of the Financial Services Authority (FSA) into the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA), the regulatory approach may now be regarded as having two main areas of focus: conduct risk and prudential risk. As conduct is arguably the more ‘subjective’ of the two, managing conduct risk for firms and senior management has become a matter of keeping abreast of the FCA’s rules and guidance, ensuring best practice within the industry and regularly re-evaluating and assessing the firm’s own policies, procedures and culture. Michelle Bedwin, senior consultant, CCL explains the dynamics.

he first Risk Outlook published by the FCA in 2013, shortly before the entity took over responsibility for regulating the UK financial services industry, clearly revealed a new emphasis on identifying and mitigating conduct risk. Much of this publication was devoted to what the FCA determined to be the‘drivers of conduct risk’, which were broadly divided into three main subcategories: those that are inherent; those that are environmental; and those that are driven by structures and behaviours.The regulator’s position on these three areas was further explored within the FCA’s 2014 edition of their Risk Outlook. Only those factors which may be classified as being ‘internal’to firms are considered in this article, as opposed to the risks which arise from wider economic and market trends, or from the market structure. In order to ensure that they are managing their conduct risk, firms, particularly senior management, ought to pay close attention to the regulatory requirements, best practice in the industry and, perhaps most importantly, their own culture and conduct in order to establish what they must be doing, what they should be doing and what they are doing. Conflicts of interest is an area from which conduct risks can readily arise,

with the FCA identifying it as being “at the root of many conduct risks”. As a result, this remains an area of high priority for the regulator, particularly within the asset management and investment banking sectors of the industry. Much of the potential for conflicts of interest to have a significant and adverse impact comes from deeply embedded structural flaws within these sectors.This makes it even more important that senior management comply with the overriding obligation to identify, prevent and manage these conflicts effectively (or risk disciplinary action by the regulator where they fail to do so. Recent examples of such action include the £4,000,000 penalty imposed against Forex Capital Markets Limited and Forex Securities Limited (jointly, as “FXCM UK”), the vast majority of which was imposed due to failings in respect of Principle 6,‘Customers' Interests’.

Culture and incentives The FCA views corporate culture and company incentive schemes as having the potential to directly influence and affect one another. When the culture of a firm and its incentive structure are aligned and designed to deliver outcomes which put the interests of the

consumer first, then the two factors can reinforce one another and help to contribute to market integrity. Where the focus of these drivers is poor, however, or when there is misalignment between the two, there is a potential for conduct risk to arise. With growing regulation around this area (for example, the remuneration codes introduced under the Alternative Investment Fund Managers Directive), firms and senior management will be increasingly required to examine their practices to ensure that they meet the FCA’s expectations.

Next Steps As the regulator is placing increasing focus on individual culpability for failings at firms and the increased emphasis on conduct, particularly in wholesale markets, firms and senior management ought to be reviewing their internal policies and procedures to ensure that the outlook of the business is aligned so as to minimise conduct risk. Performing effective compliance monitoring and undertaking conduct risk focused reviews can help to ensure that areas of risk are identified and appropriate steps are taken before costly failures arise. n

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IN THE MARKETS

COMPLIANCE & FAIR PLAY: THE BANKING CHALLENGE

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Why compliance means more than fair play for banking FIFA’s Financial Fair Play (FFP) regulations have come under the spotlight recently with several clubs falling foul of the rules. LOC Consulting’s Rob Norton-Edwards draws comparisons between changes in the sporting sector with regulation in the financial services industry and examines how banks must also now play fair.

t is hard not to agree with David Dein, former chairman of Arsenal football club, when he says: “There’s no point putting red traffic lights on the street unless people respect them and stop. If there are rules, they have got to be respected.”Dein was commenting on FIFA’s Financial Fair Play (FFP) regulations, introduced several years ago but which are only now being enforced with a stringency that’s making Europe’s elite soccer clubs take notice (just ask Manchester City, fined £50 million last season, or Paris St Germain (PSG) hit with a €60m fine for imprudent spending). Football aside, Dein could as easily have been talking about the current era of compliance in the financial markets. A new set of controls was agreed at the 2009 G-20 summit in the aftermath of the financial crisis. Designed to bring more transparency, stability and consistency to the financial markets, major regulations coming out of this were Dodd-Frank in the US and EMIR in Europe. Of course, the process of regulatory change was afoot long before the crisis took hold, examples being BASEL II, BASEL III, and Solvency II. There was also Sarbanes-Oxley to govern financial reporting, and MiFID (with MiFID II due to become effective in 2016/17). Even so, while the financial crisis

forced a step-change in the attitudes of governments and regulatory bodies towards compliance, as with FIFA’s FFP, it is taking time for the ramifications of the new highly-regulated landscape to sink in. In 2012, Barclays was fined £290m after some of its derivatives traders had attempted to rig the Libor rate. This year, Lloyds was fined £218m for serious misconduct, and RBS reported that its PPI bill had jumped by £150m to £3.2bn. This less than august set of figures does not come near the almost billion dollars’ worth of fines regulators both sides of the Atlantic imposed (in tandem) on a group of banks they investigated for alleged manipulation of the foreign exchange trading market over a period of years. It’s clear that an understanding of how to work within the rules is necessary. Until now, the Financial Conduct Authority (FCA) has shown a proactive and hard-line approach to regulatory enforcement in the UK. It issued financial penalties amounting to a record breaking £409m in 2013, according to research by Wolters Kluwer Financial Services, although that figure looks to be dwarfed by the total fines it will have imposed by the end of this year. Like the soccer clubs competing for the best players, financial institutions must un-

derstand exactly what the rules are, and how to apply them to ensure compliance. One major challenge is that compliance departments in organisations trading cross-borders not only have to know the rules affecting their own markets, but also the rules in every other country they are trading with. New regulations affect how banks operate, how they interact with investors, clients and individual parties and how products are created and put to market. They can also affect how investors, clients and individual parties communicate with each other. Moreover the rules often require fundamental changes to business and operating processes and systems that have just been changed for the last rule.

Forward planning Capacity issues start to bite when a succession of new rules is introduced. How can a firm have the necessary expertise and bandwidth to deal with understanding the regulation and managing the implementation programme, whilst continuing the day job? What’s more, the rules themselves aren’t always clearly specified. Often, they are written in legalese or jargon, and contain ambiguities. Compliance teams are forced to make an interpretation, usually in the way that is most favourable to their business (the risk being that the organisation then builds a solution addressing this interpretation, rather than what was intended when the rule was documented). Forward planning is becoming essential. We have seen how the interpretation of rules has worked out in soccer. Under FFP, not all spending is subject to the rules. Spending on infrastructure is exempt, for example, as is the cost of youth development facilities and in some cases historical player contracts. Furthermore, the introduction of third-party agents means any sell on cost for a player can be unclear. PSG tried to get round FFP rules by agreeing a £167m sponsorship deal with Qatar Airways, which would have balanced the books. It didn’t work, with FIFA ruling the agreement“unfair value”. Likewise, Manchester City thought its

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£350m agreement with Etihad would shield it from financial sanctions. Even then, FIFA ruled that although the deal was essentially sound, some of the club’s secondary agreements weren’t of a fair market value. The clarity and capacity challenge not only manifests in having to understand what the rules mean, but what the team responsible for turning reams of regulation into a set of delivery requirements can achieve. Given that building a solution to ensure compliance can take several months, they are often forced to jump the gun and start building ahead of final technical standards being published. A significant challenge is that it is often the case that a statement about a rule is issued, but the technical details of what has to be done are not documented before organisations start to build a solution. There are many instances where draft rules are published for public review and debate close to the intended implementation date. They are often evaluated by several different industry bodies with banks, insurance companies and asset managers amongst their number (each with different agendas), who evaluate different aspects of the rule depending on their specific market focus. Also, the approach desired by larger institutions can often directly affect the final published rule. Not only is there the potential for various interpretations, but also it is almost certain that the final technical standards will be revised in several areas. Solutions being built to accommodate regulatory change may or may not be heading in the right direction. Either way, there is a good chance that they are not going to make the grade after final technical standards are published. Organisations then have to back track, undo and rejig their responses.

Joining the dots The scale and complexity of regulatory change is overwhelming. Global banks, even if they are centred on just one or two locations, might have 80 offices around the world, so compliance calls for a global approach. This blurring of the lines of jurisdiction contributed to the global financial

crisis (it wasn’t just sub-prime mortgages). With so much information moving around, in so many places and involving so many people, nobody really knew what was where, what rules applied, or what underpinned those trades or products, and nobody could explain or unwind how the trades went through. As a result, banks have increased their focus on compliance and are making great efforts to tackle the challenges. This is evidenced in part by the fact that the chief compliance officer today is quite likely to be a board member. A high level of investment in compliance can backfire.The danger is that large compliance departments become divided into sub-teams and end up working in siloes, each with its own specific remit. These teams might not necessarily be talking to each other directly to understand cross-implications, because the organisation is too big. Joining the dots internally between compliance teams becomes an issue in the same way that organisations must join the dots for compliance across different jurisdictions. The protection teams that oversee the compliance department in banks have also grown too large and unwieldy to be as agile as they should. Compliance is only one aspect of three in the protection team equation. The second element is the legal team, who look at the rule and solution as interpreted by the compliance team to ensure its basis is legally sound. The third component is the public policy team, setting and enforcing house position in terms of messaging, and how the bank interacts with regulators, competitors, markets and clients globally. Put simply, all three elements of a bank’s protection team have to be in lock step. There are three key steps to achieving this. It includes understanding what the rule means. This means entrusting the task to someone with an end-to-end understanding of the rule and who can see the context of how it applies to the organisation. The second admonition is to address a rule at the process level. Processes cut across departments, so assess where the process is compliant and where the process is

FTSE GLOBAL MARKETS • NOVEMBER-DECEMBER 2014

deficient and what needs to be amended or indeed removed to make it compliant. Third, change should be implemented in a structured way. Firms should formalise the steps it needs to take in order to change the process, and identify the systems and the people in the organisation that operate that process to ensure change is delivered across siloes Finally, it is critical to get the right people on board to run compliance programmes as a formal project. It is already apparent that non-compliance can result in severe penalties and, as new regulations take hold, these look set to increase. Implications for the business include monetary sanctions and fines, bad press, and loss of trading and banking licences – not to mention certain executives being placed under personal sanctions, such as fines, removal from office and prison terms or indictments.

Upping the game The FFP rules in football have been a boon to those who prepared for them and adapted accordingly and an abrupt wakeup call for the clubs who ignored them. Last year, PSG had a net spend of almost £100m on players, this year it has had to be more ‘prudent’ (although this did not prevent the reported £50m outlay to acquire Chelsea’s David Luiz). Similarly Manchester City agreed to limit its spending to £49m (a 33% cut year on year) as a result of the fine and a deal with FIFA. The two clubs are among 76 under investigation for breach of the fair play rules. Meanwhile, Chelsea cut their spending in 2012 after years of heavy losses, leaving them free from sanctions and able to deal in the transfer market this year. Although the world of finance is perhaps a more complex and nuanced environment than that of football, it is clear that in many respects compliance presents the same challenges: understand the rules; know how they impact you; and how you can prepare to move forward with the new framework in place such that a firm’s business can focus on its clients and markets, rather than just trying to stay one step ahead of the regulators. n

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IN THE MARKETS

HEDGE FUND REGULATION: OPPORTUNITIES IN ADVERSITY

Regulation recalibrates the tempo of fund administration The hedge fund industry is facing a challenging time amid growing and costly regulatory oversight. There is an ever-growing menu of regulations. Bill Prew, chief executive officer INDOS Financial Limited, an independent AIFMD depositary business, looks at the inevitable effect on securities services.

asel III will have an enormous impact insofar as it imposes capital and liquidity requirements on banks, which in turn will result in prime brokerage arms being less willing to provide financing to hedge funds. This is going to lead to hedge funds paying higher costs to obtain their desired level of financing in what will hurt returns even further. As a result of all of these rules, some prime brokers and fund administrators have been curtailing the number of client relationships they have to refocus their efforts on larger, more profitable clients. These actions have put some smaller to mid-sized hedge fund managers in a bind while simultaneously presenting a significant opportunity for tier two banks, independent fund administrators and niche service providers to assist these firms in growing their businesses in this low return, high cost environment. The inevitable question then is: what exactly does this mean for smaller, sub $500m managers, and which providers will help them grow their businesses in an increasingly competitive marketplace? The impact that regulation is having on service providers is perhaps clearest in the prime brokerage market. Since the failure of Lehman Brothers in 2008, hedge fund managers have sought to diversify their risk across multiple counterparties and many prime brokers have taken the opportunity to win market share from a relatively static market of managers and funds. The Basel III capital requirements adversely affect prime brokerage financing, and this will ultimately result in the prime brokers reducing their client base to renew their focus on a select few profitable hedge

funds. This could spell an opportunity for tier two banks to either grow their prime brokerage businesses or launch prime brokerage businesses to cater to the needs of smaller hedge funds facing an uncertain future with the tier one providers. Like prime brokers, there has been competition between fund administrators to gain market share. Some firms have grown organically while others have grown scale through the spate of mergers and acquisitions since 2006. A combination of factors is now likely to be causing some of the larger administrators to scale back the number and type of clients they are willing to support. These include: The impact of building market share through competitive pricing. Due to intense competition between fund administrators and pressure from managers seeking to reduce costs, fund administration fees have reduced over recent years. Many funds have not seen assets grow and therefore some relationships are un-profitable. Administrators either need to re-price their businesses or exit less profitable relationships. Continuing investment in technology and new services. Administrators face a continual need to invest in technology. This investment comes at a significant cost, particularly for larger, less nimble providers and puts increased pressure on client profitability. More profitable business lines being challenged. Much of the industry consolidation, in AUM terms, has been driven by larger players looking to grow scale and generate cost savings, or generate revenue from cross-selling higher margin services such as custody, securities lending, foreign exchange and

collateral management. Regulatory changes, as well as once accepted business practices now being challenged, are also impacting a number of these higher margin service lines. This has a detrimental effect on the overall level of revenue and profitability of some clients. Fines and regulatory sanctions imposed on a number of service providers for control failures and operational shortcomings have increased significantly since the financial crisis. As a result, service providers are becoming more risk averse. Some firms may feel that larger managers, subject themselves to greater regulatory scrutiny (for example full SEC registration), may present a lower level of inherent risk than some of their smaller peers. The traditional hedge fund market is mature and there are limited opportunities for administrators to grow organically. Several larger administrators are now re-allocating resources to capitalise on growth areas, such as the burgeoning liquid alternatives industry in the United States. Others are repositioning their businesses to focus on fund managersâ&#x20AC;&#x2122; growing demand for middle and back office outsourcing, or increasingly looking to provide administration services to private equity. So where does this leave small-tomedium sized managers? Many in the industry predicted that regulation would result in a consolidation of business with the largest providers and that it would become far harder for smaller players to compete. In reality, we are seeing the opposite â&#x20AC;&#x201C; larger players are pulling back from the smaller end of the market, meaning small-to-mid sized managers may have little choice but to look to boutique service providers that cater to their financing and administration requirements. This plays into the hands of, and will strengthen, the tier two banks, independent administrators and other niche service providers that will be all too willing to step in and fill the void. The challenge for these firms is to provide a robust, flexible and cost effective service without compromising on service. n

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OPINION

The introduction of the T+2 settlement cycle has marked another milestone in the effort to reduce systemic risk for firms trading European securities. What about other asset classes, such as derivatives though? The inconvenient truth is that the world of derivatives, which some view as a much riskier investment choice, lags a long way behind equities in terms of operational efficiency. Steve Grob, director of Group Strategy at Fidessa, looks at the reasons why and suggests how derivatives market practitioners can not only learn from their equity counterparts, but leapfrog ahead of them.

erivatives are big business. World markets overshadow equities by as much as ten-fold and they’re used by a dazzling array of organisations to do business; from airlines hedging against fuel price rises to oil companies insuring themselves against adverse weather events. Yet despite the colossal size and intrinsic importance of the market, the behind-the-scenes processing of traded derivatives has languished in a technological backwater. The process for creating, filling, confirming and clearing a derivatives order is different from equities - and that’s why the two markets are still worlds apart, despite great leaps forward in the available technology. Getting the process wrong in equities results in buyers not receiving their share certificates and sellers not getting their money - a very obvious mistake. So equity markets have built systems to automate this process, making it transparent and relatively low risk. Europe is actually going even further with the recent adoption of T+2 which effectively cuts by a third the time taken to clear and settle trades. It's also getting cheaper, as open industry standards such as FIX come to dominate equities middle office just as they have in front office trading. Unfortunately, this technology doesn’t translate easily to derivatives as the posttrade process follows a different route. Rather than just settle cash and the right number of shares in a few days, the derivatives world needs to maintain

Photograph © 67668061/dollarphotoclub, supplied December 2014.

positions over the lifespan of the contract. This may be months or years and is required so that margin calls can be made to the respective parties by the relevant central clearing house. Despite these complexities, continuing to do nothing is no longer an option. The twin thorns in the side of today’s financial markets—cost and risk—come to bear heavily on the outdated processes under which derivatives middle offices labour. Manual processes are fraught with human error; they are slow and tied to bulky physical sites full of people operating within their own time zones. In a globally connected world full of concerned regulators and paper-thin margins, this just isn’t good enough any more. Solving this issue for derivatives is

FTSE GLOBAL MARKETS • NOVEMBER-DECEMBER 2014

probably one of the biggest things the industry as a whole can do to reduce systemic risk.The global derivatives market is huge and growing and forms an absolutely vital foundation for businesses of all kinds. And yet, as we saw in the aftermath of Lehman's collapse, not knowing exactly who is holding which cards at the table can get pretty messy especially if there is any kind of meltdown. The technology needed to solve these problems is there, but it’s not an out-ofthe-box deal—yet. Deploying middle office terminals to buy-side clients is a half-way point. But then buy-sides can’t see what’s going on within the context of their own OMSs, and now they have two systems to keep track of and those systems don’t talk to each other at all. That’s been the issue through time with proprietary solutions. They don’t communicate well with existing systems and require a whole lot of external expertise to maintain. Running and maintaining multiple systems is a headache that both the buy-side and the sell-side are grappling with all the time and any moves need to be away from that and towards a properly integrated approach. Alternatively, some firms have created centralised middle office 'warehouses' to handle all the workflow in one place. Whilst this makes economic sense it doesn’t improve the risk profile at all, and injects extra risk and inconvenience as the tyranny of time zones comes into play. So how can the derivatives industry learn from its cash equity counterparts? For a start, the use of existing open-source protocols will drive the development of acceptably fast and accurate processing of derivatives workflows. FIX is a great candidate because the language starts at the order level, so the protocol naturally follows the workflow and has a spot for all the pieces of information that will ultimately be needed to clear the trade. It sweeps away the hassle and risk of adding information all the way along the workflow. This persistence of information is now a very achievable goal - and once this is in place, the rest is pretty easy. Of course FIX was born in cash equities

MIDDLE OFFICE TAKES CENTRE STAGE

Fit for purpose derivatives workflows

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OPINION

MIDDLE OFFICE TAKES CENTRE STAGE

and while newer versions support all the complexities necessary to trade, process and clear derivatives of all kinds, most big buy-sides are running on earlier versions. In order to get around this, a number of technology vendors have added their updates to make it fit-forpurpose for derivatives for the vast majority of firms. Enabling FIX does two important things for the buy-side. First, that persistence of information drastically lowers risk. Second, it puts power back in their hands, enabling the desks themselves to manage alloca-

tions. The role of the buy-side trader is changing to incorporate the full order lifecycle, and with a proper, fully automated system, writing out paper tickets and managing the errors that inevitably follow will become a thing of the past. The front office will have a complete view - and in real time - about the status of all trades, creating a far more intelligent desk to empower the organisation. This works for the sell-side too, as it can improve its error rate, reduce duplicated allocation methodologies and lower its own risk, all at the same time.

So by streamlining the workflow, both the buy- and the sell-side achieve a safer, cheaper and altogether more efficient middle office outcome. It seems like the direction of travel is set, then. No longer can derivatives trade allocations languish in the 1980s. However, like a lot of firms that embrace new technology later on, many Futures Commission Merchants (FCMs) may very well leapfrog the progress made by their equity market counterparts and, with the path now clear, get there with less friction. n

INCREASED REGULATION AND IMMATURE PROCESSES STYMIE CLIENT/LEGAL ENTITY DATA MANAGEMENT Increased regulatory requirements and related penalties, along with immature and fragmented data management processes are ranked as top concerns for financial firms in the management of client and legal entity data, according to a study based on 23 respondents from 16 firms in the US and Europe published by Aïte Group and commissioned by The Depository Trust & Clearing Corporation (DTCC) the US post-trade market infrastructure. Some 80% of 23 respondents polled in the study believe global over-thecounter (OTC) derivatives regulation and the Foreign Account Tax Compliance Act (FATCA) pose the greatest operational challenges for entity data management processes due to the numerous checks and classifications that need to be applied to legal entity data. With data management processes fragmented and immature, and over-reliance on manual onboarding processes, most firms anticipate investment in data management to be one of the highest technology investments they will have to make in the coming years. Over two thirds (69%) of firms say data quality and the need for defined governance processes for entity data management were of greatest importance when meeting investor transparency and regulatory reporting obligations. Some 56%

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

of respondents said they plan to establish a single client Masterfile as a means of staying ahead of the next wave of regulations. Additionally, over 88 percent of respondents are considering a utility model to simplify and standardise the client onboarding and lifecycle management process. Virginie O’Shea, author of the study, says, “It is worrying that 70% of firms are still using legacy manual processes to onboard clients, exposing themselves to increased costs and operational risk. The tide is however changing with regulatory requirements and fear of penalties among the key drivers. There is an increasing focus on streamlining processes that can support legal entity data in a holistic way, from client onboarding all the way through to settlement processing.” Some 82% of firms cite regulation as the driving force behind investment in, and improvement of, legal entity data

management, while 62% indicated risk management obligations as second on the list of drivers for investment. More than half the respondents worry about their entity data management processes when planning for the Markets in Financial Markets Infrastructure Directive (MiFID) II and the Market Abuse Directive (MAD) II—which will require firms to store and report the legal entity data underlying their trades. Almost 63% of respondents do not see efficient onboarding processes as a competitive differentiator, although they acknowledge the inability to quickly create a new account can result in a loss of the opportunity to a competitor. Instead, they are more concerned with compliance and mitigating risk. Contrary to this, investing in onboarding processes can mitigate the need to reconcile data further downstream and reduce operational risk. “Siloed and legacy data management systems have created challenges around data quality and governance which could prevent firms from meeting regulatory requirements and lead to penalties, loss of business and reputational damage. Increasing costs related to poor data management continue to be a significant and growing concern for these firms,”concludes Ron Jordan, DTCC’s chief data officer. n

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PAYMENTS

ASSESSING THE BENEFIT OF SEPA

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

The dawning of the age of SEPA: the benefits are just beginning The Single Euro Payments Area (SEPA) standardising and harmonising the European payments landscape – has been some time in both creation and implementation. But with the migration phase now complete – following the August 1st end to the extended period of grace – the 34 participating countries (all EU member states, including those without the euro, the European Free Trade Association nations, and Monaco and San Marino) have now entered a new payments era. Andrew Reid, managing director and co-head of corporate cash management, EMEA, Deutsche Bank, discusses the post-SEPA landscape and the opportunities it presents.

EPA brings direct benefits, including the standardisation of formats and regulations across the zone and greater levels of automation and efficiency. In addition, SEPA is enabling corporates to move beyond legacy payment schemes, which not only differed between countries but were often firmly established – a somewhat restricting environment for innovation or adaptation. While compliance with the SEPA standards – with regards to SEPA Credit Transfer (SCT), Direct Debit (SDD), and XML formats – has undoubtedly proven a costly challenge for corporates, far from writing this off as an expensive necessity treasurers should view such changes as a launch pad from which to reap further cost savings, efficiencies and added value. Both through the overturning of these mature and disparate operational environments and through the necessary modifications that SEPA has wrought on treasuries, greater oversight, streamlining and sophistication can be achieved via

some re-modelling and upgrading based on SEPA characteristics. Indeed, the most effective reforms introduced by SEPA can be summarised as ‘upgrading’ and ‘standardising’. From these two simple principles, several further enhancements can be made by treasurers ready to exploit the necessary efforts of compliance – including rationalisation, centralisation, streamlining of workflows and the extension of best practices. Such operational improvements will open the door to greater efficiency and transparency, in turn leading to improved liquidity and risk mitigation.

Reassess and reengineer The process of implementing SEPA formats and standards – and the greater clarity afforded now, post-implementation – has made this the ideal time for corporates to undergo a thorough review of treasury and banking software throughout their group.Treasurers should explore which systems and processes can

be productively upgraded, and outline a timeline for such works going forward. Infrastructural changes can bring more added value than ever within the clean lines of the post-SEPA landscape, and banking and account relationships in particular should be subjected to scrutiny. Treasurers are now ideally positioned to revise the number of bank accounts utilised and treasury departments run across the SEPA zone – seeking out areas for rationalisation to improve efficiency. The number of bank accounts a corporate uses can now be reduced, even, theoretically, to a single central account, although this may not be possible in certain jurisdictions – where a local account remains legally necessary for salary or tax payments (as in Ireland and Portugal) for example. A local account number may also be needed for tax refunds, BBAN/sore-code functionality, irrevocable direct debits or access to AOS. By pursuing centralisation and rationalisation of treasury functions through-

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out SEPA-zone subsidiaries, corporates can remedy any fragmentation or duplication within their operating structures. A single central treasury can reduce staffing and administrative costs, and provide a far more accurate and up-todate overview of a corporate’s positions at any given time. It also improves risk control, opportunities for both funding and investment and, by streamlining workflows, improves working capital. Such centralisation lends itself to, and is potentially dependent on, higher levels of automation – also supported by SEPA and any technological upgrades undertaken in its wake.

Sophisticated solutions Such rationalising or centralising objectives can be achieved with the aid of several more advanced offerings, such as virtual accounts, sweeping or notional pooling. Similarly, the SEPA initiative has paved the way for other bank offerings to be upgraded by having, at its heart, the principle of promoting and disseminating best-practice across the region. The momentum around this adoption of the highest standards should continue to gain traction. Specifically, Additional Optional Services (AOS) that currently exist only within one country or jurisdiction may in time be rolled out across all SEPA markets. For example, France’s CAI (Customer Account Information) and Italy’s SEDA (SEPA-compliant Electronic Database Alignment), amongst others, could become pan-European offerings. Standardisation also makes more sophisticated solutions such as Shared Service Centres (SSC) and Payment Factories (including those that utilise Payment- or Collections-On-Behalf-Of structures) more accessible. The infrastructural changes that occurred in transitioning to SEPA resulted in a notable enhancement of granularity for transaction-related data, which in turn supports the implementation of these more advanced models. In addition, financing solutions – both on the confirmed payables and, potentially, on the direct debit side – can now be more easily integrated into transac-

tions, executed alongside the payment with no alteration to the format necessary. Furthermore, the growing demand for financial supply chain financing programmes will be appeased by the relatively seamless implementation now possible under SEPA. SEPA enhancements can be further leveraged to reduce risk and improve efficiency and control, even beyond the SEPA zone, across a multinational corporation as a whole. Improved automation can not only reduce the pressure placed on often under-staffed treasury departments, but also reduces the risk of human error. Risk mitigation in all directions continues to be a key concern, and in this sense the standardised XML format imposed by SEPA can, indirectly, be beneficial. In today’s fast-changing environment, corporate treasurers are keen to increase their flexibility by relieving their dependency on any one relationship. It is this concern that largely accounts for the popularity of SWIFT as a bank-agnostic offering that allows information to be sent and received securely and reliably. SEPA’s XML makes the use of bankagnostic solutions – and seamless integration of them with the rest of the corporate body through systems such as the Enterprise Resource Planning (ERP) system – far easier. And the ability to move between banks is made easier by the standardisation of formats – which will promote competition and ensure banks focus on their levels of service as much as their products and pricing. Offering reduced dependency in other ways, SEPA is a catalyst for the development of both non-proprietary models and in-house banks. The standardised XML format also means that bundles of payments (including, for example, SEPA payments, confirmed payments and noneuro payments directed outside of the SEPA zone) can be sent in one payment ‘package’; improving efficiency and accelerating workflows by streamlining treasury functions. Perhaps most significantly of all, if a corporate adopts the XML format across their group, then the benefits of stan-

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dardisation – and resultantly of centralisation – can be rolled out globally. By extending SEPA formats and standards wider, across the full reach of multinational operations and subsidiaries, corporates can exploit the benefits of a standardised operating model (more efficient and granular communication, improved working capital and supply chain management, full automation and stronger risk control) beyond the SEPA zone.

Beyond SEPA foundations Once a comprehensive review of a corporate’s post SEPA set-up has been conducted, and possible areas for building on the enhancements of SEPA and extending its benefits have been identified, treasurers’ next task is to set about implementing such changes with a minimum of disruption. For corporates introducing Payments-on-Behalf-Of (POBO) or Collections-On-Behalf-Of (COBO) structures, it should be noted that it is not necessary to integrate both at once. Indeed, many treasurers choose to implement POBO first, as part of a rationalisation strategy, with COBO to be deployed at a later date. Even so, before implementation, corporates must first arm themselves with knowledge of the legal, regulatory and tax requirements for their jurisdiction surrounding Shared Service Centres, Payments Factories, virtual accounts, and so on. Such insight should be sought from a strong banking partner, alongside advice and guidance on smooth implementation. The role of treasurer has been radically altered and expanded over recent years – due in part to initiatives such as SEPA and it is now a value-creator (rather than cost-centre) integral to profit and functionality. Treasurers that grasp the opportunity at hand and look innovatively and creatively at building on these new but fertile foundations – moving deeper and wider beyond the‘must dos’of SEPA to the‘could dos’– will distinguish themselves from the crowd, and ensure their corporates are best-placed in the marketplace as we enter what is undoubtedly a new and exciting age in the field of payments. n

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REGULATION

SENIOR MANAGEMENT MUST RECOGNISE FINANCIAL CRIME

Fighting crime through management accountability A major theme of the latest consultation paper into anti money laundering (AML) is bringing more precise understanding of what must be done to satisfy the FCA and the responsibilities of senior management, writes Peter Brown, senior consultant at compliance consultancy CCL.

he importance of financial crime hasn’t slipped since the high profile cases against the likes of HSBC (and its £1.1bn money laundering penalty in 2012). In terms of malpractice, there are bigger fish to fry at the moment, such as LIBOR and FX rate fixing or payment protection insurance. They are rightly getting a bigger profile because it is easier for the public to understand whom the victim is and what they have ‘lost’. With money laundering, it is much more difficult to quantify the effect of the crime on the consumer. For the over 20 years, the Joint Money Laundering Steering Group (JMLSG) has been providing financial firms with practical insights into AML best practice, regulation and statutes.The body consists of representatives from the leading UK trade associations in the financial services industry. The latest set of revisions was announced in August, for consultation across the market as a whole. The key issue in this particular consultation appears to be generating a greater understanding of the assessment of money laundering risk. This has long been a concern for those involved in

AML prevention in many firms, mainly because senior management in those firms do not understand what is required to tackle AML thoroughly and properly. To be ‘fit and proper’ as management, the UK’S Financial Conduct Authority (FCA) has made it clear that business leaders need to be proactive in assessing the risk of financial crime for themselves, rather than reacting when the AML team informs them. Often this problem boils down to a lack of AML training among the senior management team. It is not unusual for senior management in firms that have been operating under these statutory obligations for twenty years to have completely failed to undertake any such training. The tendency is for the senior management to assume that if it has delegated the task, then it no longer bears the responsibility. Some of this failure to tackle the issue at a senior level is simply down to an assumption that an investigation will never happen to them.This not such an illogical position to take when one remembers that the regulator is responsible for over 30,000 firms, and the fact that AML is not necessarily a theme that the FCA will

enforce every year. The FCA will undertake sample searches that are representative of high / low risk and large / small firms. If the size of the sample is about 15 (as it often is), then the statistical probability of a search hitting your firm is very low. The FCA is trying to tighten the wording in a number of important instances, ‘for the removal of doubt’. Whenever we see wording of that ilk, we know that it is only a matter of time before the regulator will be following up to see that firms have adopted all of the revisions when they have been finalised (which will probably be towards the end of the year). We anticipate that it will be the bigger firms that will generate the most ‘noise’ around this consultation. FCA guidance will inevitably be written to suit the large firms best, because in quantitative terms they will make more use of it. If the FCA investigates 15 firms and finds the same weaknesses, either it will admonish the market as a whole, or it will be making sure that it hasn’t misunderstood the approved industry guidance. Either way, senior management need to be ready. n

BASEL COMMITTEE AND IOSCO ISSUE SECURITISATION CONSULTATION The Basel Committee on Banking Supervision (BCBS) and the International Organisation of Securities Commissions (IOSCO) has issued a consultative document on criteria for identifying transparent and comparable securitisations. The idea is to identify – and to assist the financial industry’s development of straightforward, transparent and comparable securitisations structures, as well as helping parties involved in a securitisation transaction to evaluate the risks of a particular securitisation as part of their due diligence on securitisations. Criteria promoting simplicity refer to

the homogeneity of underlying assets with simple characteristics, and a transaction structure that is not overly complex. Criteria on transparency provide investors with sufficient information on the underlying assets, the structure of the transaction and the parties involved in the transaction, thereby promoting a more thorough understanding of the risks involved, says IOSCO.“The manner in which the information is available should not hinder transparency, but instead it should support investors in their assessment”says an official statement from the agency announcing the

consultation. Criteria promoting comparability, adds IOSCO, could assist investors in their understanding of investments and enable more straightforward comparison between securitisation products within an asset class. The proposed criteria have been mapped to key types of risk in the securitisation process, including generic criteria relating to the underlying asset pool (asset risk); transparency around the securitisation structure (structural risk); and governance of key parties to the securitisation process (fiduciary and servicer risk).

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DERIVATIVES

THE HIGH PRICE OF NON-STANDARD COMMUNICATION

Combatting the lack of a formal standard in derivatives reporting Now that some of the dust has settled following the implementation of several regulatory initiatives, such as Dodd-Frank, MiFID II/MiFIR, and European Market Infrastructure Regulation (EMIR), many financial institutions are grappling with how to deal with the impact these initiatives have had on their derivatives business. In this article, Phil Matricardi, who manages the Clearing Connectivity Standard for the communication of cleared OTC derivatives data on behalf of ISDA and Adam Kott, a senior associate business consultant based in New York, discuss why firms are adopting the new ISDA Clearing Connectivity Standard (CCS), introduced two years ago, for derivatives reporting and communication and why an industry utility for data transformation is a necessary next step.

ew regulatory requirements, combined with the increasing volume of cleared derivative trades, number of new players, and expansion of new offerings from existing players have added more complexity and expense to managing derivatives. As a result, firms—those interested in remaining competitive and protecting revenues— have begun to critically evaluate their operating models, processes and technology and look for ways to be more efficient and cut unnecessary costs. One area ripe for improvement is derivatives reporting and communication. Particularly as the industry comes to terms with mandatory clearing, the lack of a formal standard for formatting and transmitting margin and position data is a significant hurdle to achieving efficient and cost-effective connectivity between market participants. Currently, data between asset managers, clearing brokers, custodians and service providers is transmitted in a variety of formats. Custodians, for example, routinely receive a wide range of account-related information, such as fees, trade positions, netted positions, terminated trades and collateral from clearing brokers. Due to a lack of formal standards for formatting this type of data, most clearing brokers supply information to their customers in different electronic formats; these formats have been developed over time to suit their own operational needs and based on their own proprietary software or heavily modified commercial software.

Up until new regulations went into effect and firms began to look for ways to decrease costs, use of proprietary data formats was considered a competitive advantage. Clearing brokers are often required to comply with their clients’proprietary file formats. If a client wants to work with a new clearing broker, that broker may have to build a new set of reports—a process that can be expensive and time consuming to the broker. In fact, brokers have related that their clients negotiate format with them in the same way that they negotiate fees, and that compliance with custom formats is a constant and expensive burden. Pushing back on clients by insisting that they use the International Swaps and Derivatives Association (ISDA) standard set of CCS reports is a key reason why clearing brokers support the initiative. On the other side, such propriety data formats cause custodians to spend considerable time and effort manipulating the data into a consistent format that their systems and operations teams can consume. As the volume of cleared derivatives trading multiplies and custodians are forced to spend more resources reformatting non-standardized data, costs are increasing along with instances of manual errors and, subsequently, operational risk. In fact, according to the ISDA 2011 operations benchmarking survey, roughly 10% of trade records contain errors across interest rate, credit, equity, currency and commodity derivatives. The survey also attributes 50% of trade capture errors to

FTSE GLOBAL MARKETS • NOVEMBER-DECEMBER 2014

the front office. These errors range from counterparty name to legal agreement date, and plague all the commonly traded derivatives. Such errors can only be caught and corrected by reconciling positions and trading activity across counterparties, which is a very expensive process if each position at each broker has to be translated manually to match the client’s preferred format. The reality is that the use of proprietary data formats is a costly and inefficient business practice, and clearly an area of competitive disadvantage. In 2012, the ISDA Clearing Connectivity Standard (CCS), a standardized connectivity format, was introduced to the clearing broker community for transmitting cleared over-the-counter (OTC) derivative-related information. Specifically, CCS standardizes all of the message elements that should be universally present in margin statements, such as fields, headers and descriptions. The standard currently covers cleared IRS, CDS, and NDF trade, position, margin and collateral data for LCH, CME and ICE products. The CCS format can also be applied to varying timing and/or frequencies for complete or partial feeds based on the needs of the various parties.The format is currently specified as a series of CSV files, and made available as a free, downloadable Excel document from the ISDA website. When the ISDA CCS Steering Committee deems it appropriate, the CCS format will transition from CSV to FpML. Today, CCS is recognised as the industry

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DERIVATIVES

THE HIGH PRICE OF NON-STANDARD COMMUNICATION

standard by ISDA and many of the largest OTC derivatives clearing brokers including Bank of America Merrill Lynch, Barclays, J.P. Morgan, and UBS. In addition to CCS being a significant step towards achieving efficient and cost-effective connectivity between market participants, members of the Futures Commission Merchant (FCM) community are embracing its use to, among other things, reduce errors and risk. By moving to a standard format, firms greatly reduce the need to spend time interpreting and reconciling data from different formats, or having to manually enter data from reports into their own systems, putting the data at risk for human error. It is also being utilised to improve communication. Currently, when counterparties, or clearing brokers, service providers and custodian banks call to report or resolve an issue, they spend a considerable amount of time describing the content and defining the data. This process of break identification is streamlined by adhering to CCS. Derivatives customers, notably large asset managers, have already begun approaching their clearing brokers to request compliance with CCS. Moreover, as margin reconciliation becomes standardized and automated, operations staff can be reallocated to more capital-efficient processes. Equally, the automation of margin standardization and reconciliation may allow clearing brokers, custodians and service providers to pass savings on to their clients, who in turn can use this newly freed capital to engage in more swap transactions. End users who wish to receive CCS reports can do so quickly and efficiently, eliminating the need to negotiate numerous custom reports required by their clearing brokers, custodians and service providers. By using a standard format, custodians and service providers can see a complete view of their clients’ swap data across all clearing brokers, including margin balances and requirements, collateral holdings, and upcoming cash flows. Likewise, end users can easily view their information across clearing brokers, custodians and service providers.

Photograph © Oliver Le Moal/Dreamstime.com, supplied April 2014.

Furthermore, as more firms adopt CCS, its use will strengthen an industry mandate, creating added pressure for those firms that delay complying with the standard. It is highly likely that, in the future, clearing brokers who do not adopt CCS may have increased costs passed on to their clients from custodians who are no longer willing to absorb the high cost of translating non-standardized data. Today, some 26 firms have joined the ISDA CCS Steering Committee to continue defining the standard, and 17 firms are testing or producing one or more standardized CCS reports. Committee members are already asking to expand CCS’s scope beyond cleared OTC into listed futures and options to facilitate cross-product margining and netting. CCS currently allows for this at the account level, and discussions are underway to make enhancements to existing reports to include more granular futures and options information. Additionally, members have asked for the creation of a parallel set of standardized reports focused exclusively on futures and options products. With industry-wide adoption of the new standard a future reality, the creation of a market utility that automates the translation and normalisation of cleared product data is a clear next step for the industry. Such a utility would remove the burden of having to modify existing systems and reports for firms that do not have (or do not wish to spend) the resources to do so. Additionally, despite regulatory needs and the industry’s cry for standardization, some firms may continue to use their proprietary formats. An industry utility would relieve custodians and service providers of the time-consuming and costly task of translating these reports. Non-standard data would be passed through the utility, which would translate and transform it into a CCS report and deliver it to the report recipient. Such a utility would also

support data transparency requirements and enable straight-through processing. The derivatives market has already undergone major changes in the last few years—and more changes are likely to come if they can help firms dramatically reduce costs or increase profits. Identifying areas where efficiencies can be gained and expenses can be cut is now a necessity for market participants that wish to remain competitive and protect revenues. The industry has begun to address the issues of non-standardized data formats for derivatives reporting and communication with the development of the CCS. With the market-wide need to remove the cost and burden of complying with non-standardized reports and bring speed and efficiency to derivatives reporting and communication, the creation of an industry utility only seems like a matter of time. Markit and Thunderhead.com partner to launch electronic derivatives agreement service: Markit will integrate Thunderhead.com’s ONE for Capital Markets, software as a service that automates the production, editing and execution of MCAs and other capital markets documentation, with Counterparty Manager, Markit’s document management platform used by approximately 80 banks, 900 buy side firms and 6,000 corporations for trading account onboarding, reference data management, regulatory compliance and other reporting. A recent pilot programme with eleven global derivative trading firms from the buy side and sell side showed that negotiating and executing MCAs took 30% less time electronically than in paper form, says the firm. Lansing Gatrell, managing director and head of Counterparty Manager at Markit, says:“Automating how MCAs are created, negotiated and managed is just the first step for us and we aim to expand our partnership with Thunderhead.com to automate other trade and relationship documents ranging from credit support annexes to investment management agreements. This partnership exemplifies how Markit collaborates with third party providers to offer centralised, highly scalable services that help the industry reduce costs and become more operationally efficient.”n

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ASSET ALLOCATION

Why are convertible bonds a fundamentally attractive asset class? The low issuance level of convertibles (relative to more traditional bonds) has until recently kept them in the purview of professional money managers. Frankly, convertibles have tended to be overlooked yet they share many of same characteristics of fixed income securities (a maturity date, principal repayment at maturity, fixed coupons and a credit rating). They also include an option to convert into the common stock of the underlying company. The bond-like characteristics of convertibles provide downside price support, while the embedded equity option provides upside potential. Convertibles looked to be priced reasonably right now, though this is not an allocation without risk. However the very nature of a convertible bond, with its asymmetric payoff profile, makes it interesting. Paul Latronica, portfolio manager, Advent Capital Management in New York, outlines some of the pros and cons.

ix years after the most severe economic crisis since the Great Depression, the global markets finally appear to be entering what seems to be a sustainable recovery. Central banks are conveying cautious optimism, bringing confidence back to the markets and expectations that interest rates will rise. Treasuries are up 1.5% from two years ago and are still climbing. If investors haven’t already done so, now is the time to re-evaluate how to best position their portfolios for the changing economic environment. In many cases investors are still playing catch-up from their 2008-2009 losses, and are avoiding core fixed income allocations, opting instead for investments that can provide relative safety of principal with some upside. For these investors, convertible bonds might be a worthwhile consideration. Somewhat under the radar in the United

States,“converts,”as they often called, are earning more attention from both institutional investors and their savvy high networth counterparts who recognise how convertible bonds have performed in previous rising interest rate environments. For those less familiar with convertible bonds, here’s a brief primer. Just like regular bonds, convertible bonds are issued by corporations looking to raise capital by selling a portion of their debt to investors.The difference between converts and other bonds, however, is that these instruments can be converted to shares of the issuing company’s stock at the bondholder’s discretion. Convertible bonds typically offer higher yields than common stock, but they have lower yields than straight corporate bonds. If a particular company’s stock is on the rise, convertible bondholders capture part of the move given the security’s equity optionality.

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IS IT WORTH LOOKING AT CONVERTIBLE BONDS?

SPEEDING THE CONVERSION OF NON-BELIEVERS

Perhaps the most compelling argument for considering an allocation to convertible bonds is their performance. Since 1973, convertible bonds have actually outperformed equities, returning 5,744% in relation to the benchmark S&P 500’s 5,601%. By further comparison, investment grade bonds and high yield bonds returned 2,377% and 2,127%, respectively, over the same time horizon against the same benchmark. Defensively speaking, some insulation from volatility is built into the structure of convertible bonds. In fact, since 2009, the average convertible bonds experienced 26% less volatility than the S&P 500 while achieving similar returns. Convertibles are also ideal for rising rates because they have shown a reduced sensitivity to interest rate changes (lower duration risk) and also benefited from declining default risks (narrower credit spreads). The one issue investors should bear in mind is if the issuing company’s stock does poorly, the investor will only be able to gain on the yield from the bond. Luckily, convertibles bonds have limited downside, more so than equities, since they’re locked into a maturity date when investors will receive their principal. The only risk associated with this is if the issuer goes bankrupt or defaults. Even then, convertible bond holders sit ahead of equity investors with regards to recourse but are often subordinate to other debt within the capital structure. As with any investment, there will always be some amount of risk, but US investors need to consider how convertible bonds can fill a role in their portfolio that no other investment product can. Investing counterparts in Europe have figured out the opportunities that exist in convertibles. By allowing investors to ride positive equity performance while being protected against any unanticipated corrections, there’s no missing out on any upside with convertible bonds. Rising interest rates are on the horizon, giving investors ample reason to consider converts as a way to mitigate volatility and potentially reap higher returns in the new financial environment. n

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ASSET ALLOCATION

FIXED INCOME INVESTMENT PLAYS IN AN ULTRA LOW YIELD ENVIRONMENT

Photograph © 68417262/dollarphotoclub.com, supplied December 2014.

BOND INVESTORS FOCUS ON TOTAL RETURNS WITH AN UNCONSTRAINED APPROACH Government bond yields remain near all-time lows, the Bank of Japan is monetising the country’s massive deficit, the European Central Bank is buying bank debt and China, the world’s growth engine for much of the last decade, has just cut interest rates.The most important theme for bond investors right now looks to be grappling with the implications of diverging central bank policy. Investors remain faced with the challenge of seeking returns within an ultra-low yield environment, without exposing themselves to undue levels of risk. In this environment, which investment strategies have the requisite flexibility to seek out the best total return opportunities from the $100trn global bond market?

ver the past five years, fixed income has provided investors with significant positive returns. Government bond values have risen as market yields as a whole have fallen. According to Jim Celinksi, head of fixed

income at Threadneedle Investments, “Returns on corporate credits have been even higher as the difference in market yield between corporate bonds and government bonds has fallen to historically low levels. Looking ahead however,

prospective returns are likely to be limited by the extremely low level of yields now offered, particularly by government bonds.” It is important to be selective according to other asset managers. Ben Bennett, credit strategist, Legal & General Investment Management posits the view that the US dollar high yield market is worst hit given the relative size of the energy sector (15% versus 11% for investment grade) and the fact that highly levered companies are more sensitive to declining revenue. “There have already been some big price moves within the high yield universe and if oil prices continue to slide, I’d expect a few companies to get into trouble next year and even look to restructure their debt. This possibility is also not great news for the broader high yield bond market as the prospect of defaults may undermine investor confidence and lead to a repeat of the fund outflows that plagued the asset class during the summer,”he warns. For its part, JP Morgan Asset Management likes long-end, US high quality investment grade corporate bonds. In the first half of this year, spreads globally tracked each other, driven by strong investor demand for fixed income, “but more recently we’ve seen some divergence. European credit spreads continue to tighten as the ECB has taken cash rates negative in Europe” says JP Morgan Asset Management chief investment officer for fixed income, Nick Gartside. Gartside thinks the ECB will take further action on monetary easing, in addition to their purchases of covered bonds and asset backed securities, “causing European spreads to continue their drift lower. Meanwhile we’ve seen a lot of credit supply coming to the market in the United States and that is causing US spreads to widen out. We’re likely to see supply dwindle as we come into the end of the year, and that in general should be good for spread products. Hence we’re looking at opportunities in credit such as industrial names offering yields of 4% or more.” However, Cielinski believes that there are opportunities to generate meaningful

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returns in bond markets.“With the right approach and strategy, it is possible to deliver sustainable risk-adjusted returns even in changing market conditions. In our absolute return strategy, we aim to produce a total return of 4.5% above one-month dollar cash, before fees, over rolling 12-month periods,” he avers. “Credit spreads have also declined significantly.Yields are approaching zero in many markets and investors clearly cannot rely on benchmarked ‘long-only’ fixed income strategies to deliver meaningful returns,” he adds. Gartside agrees. “Our preference as investors remains credit, where we have the majority of our positions, the largest of which is US high yield debt. We’ve rotated between European and US high yield debt quite a bit as we’ve seen relative value opportunities,” he says, warning though that, “Overall we’re watching our duration closely, keeping a low sensitivity to interest rate rises”. For Cielinski, it is important to be able to generate alpha independent of beta in order to boost returns. Portfolio diversification is also critical. “One of the biggest mistakes that investors can make in fixed income is to rely on one or two large, directional macro calls, as these are notoriously difficult to get right. The cost of getting it wrong can be further amplified by liquidity problems,”he says. Gartside thinks it is a numbers game, particularly in Europe.“The ECB’s actions have been very impressive, taking the cash rates to negative twice now. When we think about European rates, there are two important numbers for investors to recall: 20 and 50. Roughly 20% of all European government debt issuance is currently trading with a negative yield. And almost 50% of that market is trading with a yield of less than 50 basis points. In effect, the ECB is desperately trying to get investors into riskier assets,” Gartside explains.“Given these incredibly low levels, there is significant room for further yield compression in European high yield debt. Europe is slowly improving and with the central bank remaining committed to supporting the economic recovery, European

high yield doesn’t look overstretched relative to fundamentals

Emerging markets In emerging markets, one of the big issues is volatility. “In the second quarter of 2013, emerging market debt suffered significant falls in value and more recently there has been more volatility within the high yield market,” says Cielinski. That can also work in favour of the emerging market bond investor. Divergence across emerging markets is creating security selection opportunities, holds Gartside, who cites Turkey as a workable example. “Whilst many investors associate emerging markets with sensitivity to falling commodity prices, as an oil importer Turkey actually benefits from falling oil prices, which help to improve its current account deficit and reduce inflation. We’ve done well being overweight Turkish local currency sovereign bonds,”Gartside says. However, Legal & General’s Bennett cautions, “Behind this is a very difficult political story and very confused monetary policy. Without implementing reforms, Turkey is vulnerable should financing conditions deteriorate once more. India, on the other hand, appears to be implementing structural reforms following the election success of Narendra Modi, and we are happy to take investment opportunities even if the oil price decline starts to reverse”. Emerging market debt has also been affected by declining commodity prices, notes Bennett.“The market reaction feels as simple as commodity exporters weakening and importers strengthening. So many Latin American countries, such as Brazil, Colombia and Venezuela, are under pressure, and markets have been particularly harsh on Russia, which was already suffering due to international sanctions related to the Ukraine crisis,” he says. Looking further ahead, JP Morgan Asset Management’s long term capital market assumptions (over the next ten to 15 years) highlights the fact many institutional investors still expect returns

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in the region of 8%.“However, given the extended period of low growth and low inflation that we’re in, these investors need to readjust their asset allocation to recognise this,” says Gartside. “One option for this, may be to move higher up the risk curve e.g. through an increased exposure to emerging markets, whilst maintaining a diversified portfolio through an unconstrained investment strategy to lower their risk profile. Alternatively a more flexible approach to the credit part of fixed income portfolios could offer greater risk adjusted returns to compliment more traditional bond holdings,” he states. The Threadneedle (Lux) Global Opportunities Bond Fund, managed by Cielinski since its launch three years ago, also offers “an unconstrained, high conviction, flexible investment approach employing a wide variety of strategies with the aim of producing a positive return in all market environments,” he says. In other words, the fund can position to take advantage of rising bond yields, falling bond yields, or a convergence/divergence in one country relative to another. Martin Harvey, deputy manager of the fund explains: “The flexibility afforded by derivative instruments allows us to take advantage of rising yields or rising credit spreads as and when it is appropriate, a feature that becomes invaluable as yields and spreads decline to low levels. For example, we currently hold a long position in high yield bonds, hedged by a short position in investment grade bonds.” “Currency is another important source of added value within our macro views, whereby we employ a relative value overlay of positions across a range of currencies in developed and emerging markets. For example, we are currently long the US dollar versus a range of other currencies”adds Harvey. Following the turbulence of mid-2013, Harvey says the fund increased exposure to US dollar-denominated EM debt, but has recently reallocated towards local debt of high-quality markets such as Mexico and Colombia. n

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ASSET ALLOCATION

FIXED INCOME INVESTMENT PLAYS IN AN ULTRA LOW YIELD ENVIRONMENT

TACKLING THE DECLINE IN BOND MARKET LIQUIDITY A new study from the International Capital Market Association (ICMA) identifies the main causes of the potential crisis facing liquidity in the corporate secondary bond markets in Europe and calls for coordinated action from all market stakeholders.

ccording to a new survey from ICMA market commentators and participants are expressing increasing concerns that the secondary markets for European bonds have become critically impaired and are no longer able to function effectively. It is a high and emotive charge, widely attributed to the unintended consequences of banking regulation and extraordinary monetary policy. The survey also highlights broader concerns about increased market volatility, frozen capital markets, risks to economic growth and the potential for another financial crisis. The findings of the study are manifold, and include an acknowledgement that while market liquidity has“clearly eroded post-crisis, mainly as a result of stricter capital requirements for market-makers and unusually benign market conditions, the story is more nuanced than simply the end of liquidity. There are arguments to suggest that the levels of market depth and liquidity experienced between 2002 and 2007 were largely the result of banks mispricing balance sheet and risk, and overtrading in cash bonds being driven by the Credit Default Swap (CDS) and structured product markets,” states the study. Actually, it asks some important questions about the nature of market liquidity, acknowledging that the term is widely used, sometimes too loosely. Actually, as a concept, if not a metric, it is at the core of every interview for this study, not least from the perspective of its reported demise. “It is therefore important to remember that liquidity means different things to different participants,” says ICMA. The study acknowledges varied attempts to quantify secondary bond market liquidity. Usually, says the association, these are

related to variables such as the average bid-ask spread, trading volumes, ticket sizes, or market-maker inventories. However,“ultimately it falls down to the ability of perhaps the most salient definition of liquidity from one interviewee who explained that in a functioning and efficient market, it should be possible to obtain a price (bid or offer) for any instrument, in reasonable size, at any time. One might not like the price, but there is still a level at which something can trade. When markets become illiquid, this no longer holds true. Effectively, liquidity is a state, not a measure,”states the report. Clearly, market liquidity is cyclical and is directly influenced by both macroeconomic and policy impacts.“When considering bonds, individual securities have their own liquidity life cycles, relative to the recentness [sic] of issue, their on or off-the-run status, their relative value, credit events, and other factors that could influence secondary market demand and supply at a given time. In other words, not only is liquidity dynamic, but it is unique. If there is one overarching and consistent theme from every discussion, it is decline in secondary market liquidity,”says ICMA. It is market specific, but the RBS Liquido-Meter, which attempts to quantify US bond market liquidity, suggests that liquidity in the US credit markets alone has declined by 70% since the crisis, and continues to worsen. Anecdotal evidence suggests that this is equally applicable to the European corporate bond markets. Accordingly, as a result of more active capital allocation within the banks, there is a shift to holding smaller quantities of bonds in inventory, while they try to increase turnover through smarter, more active trading on an agency basis. In that light, the electronification of the credit

market is making an impact in Europe, and most, says ICMA “if not all, of our contacts expect this trend to continue”. However, while the general view is that technology has an important role to play this is still not a substitute for liquidity. That old Shibboleth regulation is a perennial issue in any market study these days and ICMA’s is no exception. There is no argument that regulation has weighed heavily on banks’ ability to support secondary market trading books; it has had a similar deleterious effect elsewhere. Basel III capital requirements, leverage ratios, EMIR and the additional cost of hedging,Volcker and other trading restrictions, all add to the cost of holding a position. Naturally, the interdependence of markets means that a diminuition in liquidity in one market segment has knock-on effects elsewhere. The ICMA study supports this by pointing out that diminishing liquidity in the repo market is regularly cited as a cause for concern by a number of dealers, who suggest that clients are becoming less willing to lend securities, because of either low interest rates or regulatory pressures. The low interest rate, low volatility environment also squeezes spreads and limits the scope to make profits. Accordingly, there is little incentive for banks to assign capital or risk to support secondary market trading. Similarly, at lower absolute yields, the bid-ask spread required by market-makers becomes a relatively larger cost to investors, and a further disincentive to trade in the secondary market. “Thus in better, more volatile times, we may see this trend reversing as credit trading once again becomes more lucrative,” suggests ICMA.The fixed-income market has seen a number of new entrants and new platforms from established names in recent years to help solve its liquidity problems. Among the crop of recent initiatives, agency broker ITG says it will launch a dark pool for bonds, while the buzz in London is around so-called Project Neptune, an initiative led by Etrading Software, a UK based consultancy, which hopes to establish a central hub for firms to connect to OTC fixed income trading venues. n

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DEBT REPORT

BOND TRADING: AN EMERGING TRADING INFRASTRUCTURE

Photograph © Herzlinde Vancura/Dreamstime.com, supplied December 2014.

WAITING IN THE WINGS: New venues hope to coalesce liquidity At first glance, it would seem that the electronic trading fixed income landscape is undergoing consolidation with Liquidnet buying Vega-Chi and MTS, the London Stock Exchange Group (LSEG), purchasing Bonds.com. A closer look reveals that in fact there is a proliferation of new ventures hoping to make their mark, particularly in the corporate bond space. Incumbents are not only acquiring smaller players but forging partnerships to cement their positions before the potential deluge. Lynn Strongin Dodds reports.

hile there is no concrete tally, anecdotal evidence suggests that there are around 30 new initiatives that have already launched or are waiting in the wings. It ranges from fledgling fixed income platform Bondcube which boasts German exchange operator Deutsche Börse as a minority owner to 15 broker dealers including Goldman Sachs and JPMorgan joining forces with Tradeweb, a trading hub owned by Thomson Reuters, to create a new trading platform for US corporate bonds for the buy side. It is currently in the beta phase but the aim is to keep a tight grip on trading US

companies’debt as well as boost liquidity in the $10tn market. The newest entrant has been dubbed Neptune and is thought to include BNP Paribas, Credit Suisse Group, Goldman Sachs, HSBC, JP Morgan, Société Générale plus six other banks working to develop a one-stop destination for finding buyers and sellers of US and European corporate bonds. It is very early days with the lenders reportedly working with London-based technology consultancy Etrading Software to create a standardised language and a messaging system. While the projects may differ, the

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drivers are the same – to stem the liquidity that has been draining out of the system. This has left large institutional investors struggling to transact without greatly impacting the price of the securities. As Fred Ponzo, managing partner at consultancy Greyspark Partners, point out,“The problems come from the reduction of the banks' inventories driven by Basel III, MIFIR (Markets in Financial Instruments Regulation) and Dodd Frank regulations. The brokerdealers used to use their balance sheets to act as a warehouse to manage the time mismatch. Additionally, by acting as the counterparties, information leakage was

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DEBT REPORT

BOND TRADING: AN EMERGING TRADING INFRASTRUCTURE

kept to a minimum. Since this facility has been withdrawn, the industry is looking for alternative ways to ensure sufficient liquidity.” The challenges were elevated to a new level when BlackRock, which has $1.3 trn of its $4 trn of assets under management in fixed income, issued a report in late September describing the corporate bond market as ‘broken.’The culprit was the current environment of rock bottom interest rates and low volatility which masked the structural fault lines. The world’s largest fund manager argued that the problems were not on the agenda because bond prices have generally been moving in a beneficial direction for both investors and borrowers. However, last year’s so called taper tantrum by the Federal Reserve and the threat of rising interest rates exposed the cracks that would appear once conditions returned to a more normal setting. These issues are not new and several of our clients have been assessing electronic trading and raising the urgency about the lack of liquidity in the market,” explains Constantinos Antoniades, head of fixed income at Liquidnet and former chief executive at Vega-Chi. BlackRock put forth several recommendations including increased electronic trading and product standardisation. One of the oft-cited characteristics of the bond market is that companies can have hundreds of bonds instruments outstanding. For example, JP Morgan has only one common equity but 1,695 bonds while the same is true for Bank of America which has 1,295 different types of bonds, according to the report. The result is that institutions who want to sell one of those bonds needs to find a buyer looking for the exact same security. Given the configuration, it is easy to understand why the market has been driven by principle-led market making with electronic trading platforms having limited traction.“Over the past four years we have seen a multiplication of tentative response to the new market structure including exchanges and banksponsored central limit order books (CLOBs) and buy side to buy side

venues,”says Ponzo.“We are now at the point where some of the working solutions are becoming apparent, even if they have not yet achieved the required critical mass.” Attaining the necessary scale is not an easy task, according to Michael Chuang, founder and CEO of iTB Holdings, a US based fixed income trading technology provider. “In financial technology business generally, there are enormous barriers to entry and therefore buy-in between market participants is key to driving success. It is not like consumer technology where you can just have a good App and that App will get you broad distribution. You need to have liquidity and I agree with BlackRock’s assessment that liquidity will come from a combination of expanding e-trading protocols as well as overall market participation. If you look at every asset class that has been traded electronically, the most successful ones are those that have the broadest participation and therefore have developed superior liquidity.”

Volume growth This explains why government bonds have been natural candidates. A new report by consultancy Greenwich Associates, Platform Providers Battle for Share as E-Trading Grows for Rates Products, shows that the share of overall US Treasury trading volume executed electronically by clients jumped to 44% in 2013 and 48% in 2014, after bottoming out at 31% following the global financial crisis. The research, which canvassed 1,067 institutions active in fixed income, predicts that the number could soon climb to 50% given that four out of five institutional investors have embraced this form of trading for some portion of their Treasuries. At the moment, Bloomberg and Tradeweb dominate dealer-to-client electronic trading for Treasuries and short debt with the former pulling slightly ahead in terms of market penetration. “Looking ahead, with dealers re-evaluating how much liquidity they provide to clients, and investors putting ever more focus on best execution, a

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

continued examination of trading venues and protocols is inevitable, and we expect dealer-to-dealer platforms to slowly enter the client-execution space as well,” says Kevin McPartland, head of research for market structure and technology at Greenwich Associates. This will not only be in the plain vanilla government bond arena but also the thornier, more illiquid instruments. Greenwich estimates 16% of investmentgrade corporate bond trading volume is currently executed electronically, with four out of five firms choosing this route for some chunk of their trading. This figure could hit 20% in volume by 2016 as buy side investors spread their liquidity nets wider. Lots between $100,000 and $5m are expected to be the most popular as firms still like to talk to their dealers for the block trades - those over $5m. This is not only to garner the market colour and liquidity, but also to strengthen a relationship to ensure access to sought-after new issue allocations. MarketAxess continues to be at the forefront in North America, executing 86% of dealer-to-client investment-grade corporate bond electronic trades.The firm is not resting on its laurels though. “To address some of the liquidity issues, we have increased the number of market makers to 90 from 35 but it is not just about broadening the pool,” says Jim Rucker, global head of operations at Mar-

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ketAxess.“We are also focused on introducing new trading protocols and creating better connectivity between all the market participants through our traditional RFQ (request for quote) model and our all-to-all trading solutions, Open Trading. A central order limit book has not yet proven to work for less liquid markets like corporate bonds.” Rucker adds, “We have and will continue to take an evolutionary rather than a revolutionary approach to market structure. Overall, I think the industry is going through considerable market change, some driven by regulation and others by liquidity issues but it is not a big bang event. There will be new protocols sitting next to traditional methods and if you fast forward to five years’ time, we will see the markets looking reasonably different to how they are today.” Enrico Bruni, managing director and head of Europe and Asia businesses at Tradeweb, agrees that connecting the buy side with liquidity is one of the biggest challenges. “If you look at the corporate bond market, the greatest challenges lie with the illiquid large orders. RFQ is the most popular mechanism for the liquid part but it does not fully address the rest. The shrinkage in the use of balance sheets combined with record corporate bond issuance has reduced liquidity, and there needs to be a better way of connecting

the pockets of liquidity that are available with the ability to execute.There is a lot of work being done in this area.” Some like Tradeweb are forming alliances with investment banks while others are acquiring the expertise.“Part of our strategy has always been to expand our product range and geography,” says Fabrizio Testa, chief executive officer of MTS, which bought Bonds.com, an exchange-like trading platform for US corporate bonds and emerging markets debt earlier this year. “Bonds.com brought us a large existing network of clients, including sell side and buy side firms, which ensured we were quicker to market.” Bond.com has about 600 investor and dealer participants on its New York platform, and is known for offering a range of trading methods to investors, including live streaming prices in an exchange-like format. It is not MTS’first foray into the US... Last year, the group was approved as a broker-dealer to allow US institutions to trade electronically with European dealers via its BondVision platform.

Conditional visibility order Liquidnet, a stalwart in the equity electronic world with 750 members holding $13trn in equities under management, embarked on a similar strategy in the hope of replicating its success in the fixed income arena. The firm uses what is often referred to as a "blotter scraping" model which connects to order management systems and continuously searches them to find counterparties for trades. Once found, buyers and sellers can anonymously decide a price. Vega-Chi, which launched the first electronic CLOB for US and European high yield bonds in 2012 and a multilateral trading facility for European convertible bonds four years ago, has a similar facility which Antoniades dubs the “conditional visibility order.” Antoniades explains that, “Vega-Chi currently has two order books - a CLOB with minimum order size of $0.5m and a block trading facility with minimum order size of $5m. In the block trading

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facility an order only becomes visible to other $5m plus orders that are close enough with the trader specifying how close is close enough. Next year we are introducing trading in European high yield and investment grade bonds in Europe and investment grade bonds in the US.” Despite the hive of activity, market participants expect that further consolidation is on the cards. There are several new solutions trying to address the issues and this is good for the industry as it fosters innovation,” says Bruni. “Ultimately I see the market ending up with just a few main players.” Stu Taylor, chief executive officer of Algomi, a company that sells fixedincome market data software, believes that platforms focusing on the more liquid part of the market will enjoy the most success. “I think those that don’t will struggle which is why all of the 30 initiatives being talked about will not come to fruition. This is because it is difficult to get buyers and sellers in the market at the same time and I do not see a protocol being developed to solve that. There is a huge amount of dormant liquidity with some instruments only trading once or twice a year. This does not lend itself to quick decisions being made.” Euronext launches a range of Single Stock Dividend Futures: The futures are based on the most liquid stocks listed on its Amsterdam, Brussels, Lisbon and Paris markets. The new dividend futures contracts will be available for trading in Q1 2015, starting with CAC 40® Index components. Euronext’s Single Stock Dividend Futures will offer investors additional dividend trading potential and will enable them to benefit from efficient pricing.The new products complement Euronext’s already existing dividend index offering made of the CAC 40® and AEX® Dividend Index Futures. Dividends are a key component for equity and equity derivatives holders and dividend futures are mostly used as a hedging tool. However, dividends are also becoming an asset class of their own offering strong diversification opportunities to investors. n

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THE TARRGET-2 SECURITIES ROUNDTABBLE:

IMPLICATIIONS FOR THE POST TRADE ARENA

Introducing the expert panel (from left to right) Justin Chapman, global head, industry management, Northern Trust; Alex Dockx, T2S programme director, JP Morgan; Guido Wille, head of market development at Clearstream; Paul Bodart, member of the T2S board, ECB; Mike Clarke, global product management, investor services, Deutsche Bank; and Mark Profeti; securities post trade strategy – lead strategist for T2S, Barclays. The EU’s post trade landscape has remained siloed despite initiatives supposed to lead to a single financial market. Cross-border transactions in Europe, relative to say the US, remain expensive and involves a range of intermediaries, adding unnecessary cost; galling perhaps as financial institutions remain constrained. As the euro, algorithmic trading, cross-border M&A and market initiatives such as UCITS continue to encourage trading across national boundaries in Europe, inefficiencies in the post trade infrastructure have been glaring. Aligned with efforts to remove the so called Giovanni barriers to seamless cross-border trading, the EU has tried to encourage harmonisation systematically.Alongside CSD-Regulation,Target-2 Securities (T2S) is designed to essentially create a pan-European‘domestic’market for securities settlement, bringing down cross-border settlement costs over the medium term more in line with domestic charges. The T2S project intends to build a pan-European domestic settlement marketplace. The platform is owned and developed by the Eurosystem monetary authority and will be operated by the European Central Bank (ECB), as T2S is designed to settle exclusively in central bank money (CeBM) over non-central banks (NCBs) to achieve market efficiency and safe settlement. It will

also be capable of settling securities transactions from non-euro markets, subject to the participation of the respective central banks. Essentially, T2S is a platform that receives settlement instructions, matches them and reaching settlement, creates irrevocable booking entries. T2S is a technical platform to which national CSDs can outsource their settlement process; however the CSDs will retain ownership of custodial services. The impact of T2S is huge. It will affect all market participants substantially and will force many of them to change their fundamental business models. Central Securities Depositaries (CSD), for example, which are traditional pillars of the post trade infrastructure, will have to contend with lost revenue from settlement services and will encourage CSDs to diversify their business models to compensate. There is also the likelihood in the long term that not all of Europe’s CSDs will survive the introduction of T2S. Custodians too will not be immune from change; in particular sub-custodian providers will see a decline in the revenue they generate from providing services to global custodians. That’s the background to this discussion, which brings together experts from the custodian and CSD worlds to debate and explain what the changes will mean for them and their clients in practice.

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ROUNDTABLE

SETTING THE SCENE

GUIDO WILLE, HEAD OF MARKET DEVELOPMENT AT CLEARSTREAM: T2S introduces two things: competition for us and our peers where in the past there was none or very little. We like that; and more importantly, it introduces an option beyond the mandatory change for market participants to alter the way they access domestic markets. We’ve worked hard in our investor CSD product to create an offering to clients that provides access direct into domestic markets. After we join T2S in 2016, our investor CSD product will allow market participants to access settlement in the T2S zone with less intermediation accessing central bank infrastructure for payments and a single EUR cash liquidity pool and a direct infrastructure (CSD) account with us for a single central securities pool across T2S and integrated, via collateral management, with our Luxembourg ICSD. MARK PROFETI, SECURITIES POST TRADE STRATEGY – LEAD STRATEGIST FOR T2S, BARCLAYS: T2S gives firms the opportunity to reconsider their post-trade infrastructure model and how they access markets across the Euro zone. Some of the key strategic drivers include operational and cost efficiency and effectiveness. More importantly perhaps, it brings opportunities to realise collateral and cash liquidity benefits. MIKE CLARKE, GLOBAL PRODUCT MANAGEMENT, INVESTOR SERVICES, DEUTSCHE BANK: We look at T2S in a wider context: specifically how T2S affects the market alongside regulation. We work with clients and the market to understand how we need to bring together the different components in our product set as an agent bank and bring them to bear on the very different demands that each of our clients has, within the T2S framework. We then work towards bringing the right components of our product set together to make sure we deliver the right solution to our client that supports infrastructure they have. PAUL BODART, MEMBER OF THE T2S BOARD, ECB: The Eurosystem has established the T2S Board, a specific body that monitors the progress of T2S and ensures the platform is developed and launched in June 2015. Within the T2S Board, I help ensure that the deadlines of the four phases of the T2S development plan meets are met. I also bring an in-depth knowledge and understanding of how the industry operates to board discussions. I try to bring a business perspective that I believe ensures that any decisions made will benefit the market as a whole. Now, there is a lot of discussion around next steps: what additional developments are required in Europe around the T2S program. ALEX DOCKX, T2S PROGRAMME DIRECTOR, JP MORGAN: We actively work with the ECB, CSDs and agent banks to make sure we are ready for T2S Wave 1 which is going live mid-2015. In addition, we are executing upon a firm wide JP Morgan strategy on how to best access T2S directly in key markets and derive the maximum benefits from it. T2S is not only a major and much welcomed infrastructure project designed to harmonise settlement in post-trade processing in Europe, but also it is opening the door to efficiency,

cost improvements, risk reduction, and also more competition. JUSTIN CHAPMAN, GLOBAL HEAD, INDUSTRY MANAGEMENT, NORTHERN TRUST: At Northern we see T2S and a number of the regulations as an opportunity for innovation. Our market in Europe on the custody side is service and asset owners together with investment managers and we think that the infrastructure change in the regulations allows us to take a fresh look at how this should operate within this European landscape. As we have less issues with legacy structure as maybe some institutions, it has given us a really good opportunity to develop new solutions with partners in the industry. Our job is to always put clients' asset safety at the forefront of everything we do. We are also trying to manage the cost of ownership through the asset chain, all the way from funds through to the end custodial chain, which is an important element, and provide additional liquidity in both securities and cash for our clients within this infrastructure. We've been running our T2S programme for nearly three years, as most people around the table have , and we are getting to the stage now where we really know where we are going, what we are doing and we are presenting those options to the clients and giving them optionality of leverage in this infrastructure. HARNESSING THE INTERPLAY OF REGULATION

ALEX DOCKX: Clearly,T2S interplays with other rules. CSD Regulation (CSDR) came into force in September, which regulates what CSDs are, how they're structured, what they can and cannot do. It was crucial that CSD Regulation was put in place because the CSDs will outsource their settlement activity to T2S. GUIDO WILLE: More precisely Alex, what would you consider detrimental and what beneficial in terms of settlement discipline? ALEX DOCKX: We are an advocate of improvements in settlement efficiency. The closer we can get to a settlement rate of 100% on a given day, the better it is. If that can happen through greater incentives (both on the positive and on the negative side) and if calibrated well, it could work. We've seen the example in the United States where the introduction of a fail compensation regime by the industry had a very positive effect on settlement efficiency but the balance is very fine. T2S will bring a number of benefits, in terms of making crossborder settlement more efficient. Even so, we need to be very careful in seeing how a penalty and buy-in regime is calibrated so that there is essentially still an economic incentive for a participant to do a trade. If the cost of failing or buy-ins starts to exceed any commercial benefit participants make out of trading, the results will be less trading and thus less settlements, and less liquidity at higher rates. This is mostly the case for bond markets, where spreads are very thin and market makers provide much needed liquidity. GUIDO WILLE: I’d like to spend a few moments on where we still need more harmonisation, which we don't have in CSDR. Some of it has not been dealt with either at the level of the T2S project. There is still a lot of market fragmentation and there remain a number of barriers to entry.They typically

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Alex Dockx, T2S programme director, JP Morgan Photograph © Berlinguer Ltd 2014.

exist in disguise as technical requirements, legal requirements in a number of markets that make it rather difficult for investor CSDs to offer a full scale product. Let me provide an example: if I can't participate as a market participant in a primary market in a given country because that given country rules that to participate in the primary market options I have to have an account in the local CSD. That regulation exists in a number of countries. There are other questions around CCP trades, where margin collateral has to be put at CCPs and there are different rules at different CCPs. A lot of these are being addressed at the moment, and a number of CCPs have made announcements and will use T2S. We welcome that; though there's still some way to go. FRANCESCA CARNEVALE: Mark, do you see this interplay between the regulations as fundamentally changing market structures for the better? MARK PROFETI: Absolutely. We've touched upon the settlement efficiency and the harmonisation and standardisation of the settlement process on a pan-European level. However, there are other aspects of CSDR that are quite fundamental and important, such as allowing the passporting of CSD functions across borders, where a CSD is able to set up operations in other jurisdictions. Probably one of the less understood or less highlighted reforms of the CSD Regulation is that it allows issuers to choose any CSD it likes to issue its securities. In the shortterm I don't expect it to have a dramatic effect , but over the long-term as we start to see how the CSD landscape evolves, it will help to drive some of the commercial and service decisions that certain CSDs need to make about future offerings. As CSD Regulation divorces banking ancillary services from the core CSD services it will encourage CSDs to look closely at their core service offering including issuance services.You're going to find CSDs either operating in all three areas (custody, issuance and banking ancillary services) or a combination, which is more likely in most cases. It will be interesting to see how the landscape evolves over the next two or three years.

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FRANCESCA CARNEVALE: Europe looks to have a cocktail of rules, directives and regulation, all leading to the same place. Do we need it in fragmented elements? Could we not just do with a unified field of legislation? PAUL BODART: There are layers and they complement each other. T2S is just a platform. What is important is to have a harmonised usage of the T2S platform to the extent that that is possible. If you bring all transactions for 24 CSDs on one platform and then some CSDs settle onT+3 and others on T+2, it will be create frictions and the users of the platform will not get all its benefits. Nokia shares are a good example. They are listed on eight or nine exchanges, some shares trade on some markets on T+2 and others on T+3. Therefore you will have fails by design because a player who tries to arbitrage between two markets might be supposed to deliver before he receives the securities. If you have penalties for fails in some markets and not in others, you will have a problem of competition if everything is on one platform. If you have buy-in rules for some transactions in some markets and other not, you will have problems. Alex is right; if we do not calibrate it well, we may have a problem. The issue is making sure that the right people do the right thing. So, for example, requiring CSDs to charge penalties or to manage a buy-in is the wrong approach.These days buy-ins are not processed by CSDs, they are processed by actors based on certain market rules. In those markets where there is a rule, as in the eurobonds market, they work extremely well. You can trigger buy-in but it's not the CSDs that should have to do it. MIKE CLARKE: That’s incredibly important in terms of the chain because who is the CSD raising the buy-in against? Does that mean that, instead of the original parties creating the need for the buy-in, we are moving up the chain so that the agent has to initiate the buy-in against the global custodian? Then it moves up to the global custodian to create a claim, and then to the end party? I don’t think it is clear at all. PAUL BODART: CCPs trigger buy-in but CCPS have different rules and the buy-in rules for CCPs work extremely well. I am a little bit nervous about the Level II measures. I hope that in the end ESMA will listen to the industry, as there will be consultations, and what will come out will be a set of rules that will be reasonable and manageable because otherwise, as Alex said, you may have more pain than what you intended. GUIDO WILLE: One of our concerns is obviously that we will be the ones to deal with an administrative beast that won’t be welcome in the industry. To Alex's earlier point in terms of how it could turn out, we hope the regulator will find a solution that works in practice and that also does not impose fine levels that undermine how markets work. In any case, we don't think we are the right organisations to run with this. We already have a lot of change to deal with in the context of T2S. This is change we welcome and we can handle it but, frankly, it’s demanding. So, we don't need new activities which could be quite bureaucratic, as Mike has just outlined, and which also would be very difficult for us to handle in practise. FRANCESCA CARNEVALE: Guido and Alex are clearly

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highlighting significant infrastructure change. How might that seep through to traditional market services? How will an investor CSD, for example, live in the same market as a custodian provider? Paul? PAUL BODART: What is an investor CSD? It's a CSD that says I'm going to start offering to my clients the possibility to keep assets from other markets in my CSD and by doing that they are stepping on the shoes of global custodians. On the other hand, we've seen Bank of New York Mellon saying it believes that it should also become a CSD for a different reason, including such things as collateral management, issuer services; all domains where Bank of New York Mellon believes that by being a CSD they will be able to service the client better. So, I'm convinced that the line which was relatively clear up to now between CSDs on one side and custodians on the other is going to blur. The second thing that you will see is that I am not sure that a sub-custodian active in only one market will be able to survive. The sub-custodians that will probably survive are the ones that I call regional sub-custodians and are present in many markets. A regional sub-custodian is not very different from a regional global custodian. So, again, you see the line between sub-custodians and global custodians blurring. So, for BNP, Deutsche Bank and HSBC, these guys are present in many open markets and to a certain extent they are not very different from global custodians. Inevitably, over the long term, the number of intermediaries in the chain between investor and the CSD will be diminished. I can see the day coming soon when the big asset managers will open accounts directly with the CSDs. I can also see global custodians keeping their sub-custodian, but also going directly to the CSD or going to an investor CSD which will offer similar services. I believe it to be, potentially, a massive transformation. FRANCESCA CARNEVALE: Justin, are custodian providers prepared for this upheaval? Do you see it as an opportunity or a threat? JUSTIN CHAPMAN: I've not really seen it as a problem. My technical guys on delivery may have other comments to make in terms of practical implementation solutions but if you look at it from a macro strategic perspective, it is clearly an opportunity. I've mentioned we began our transformative programme over three years ago; at that time we were using 17 agent banks within the European area. We are using less now and come 2016 we will be using significantly less. Also the opportunity to leverage investor CSD structures is a big advantage for our clients and us. Youâ&#x20AC;&#x2122;ve mentioned Francesca the overlay of so many regulations, in that mix who have to take into account initiatives such as AIFMD and UCITS V, CRD IV and Basel III. All these initiatives will ultimately drive liquidity into central pools. Now, there is conflict there with shareholder directives which are trying to segregate those assets versus keeping them in a pool, which gives us plenty of opportunity to work with clients to handle these conflicts and which we do not think the CSDs will want to compete in this space. Equally, we do not believe there will be a huge number of CSDs that can offer pan-European services; though some will offer a European capability, but not on the issuance side

Guido Wille, head of market development at Clearstream Photograph ÂŠ Berlinguer Ltd 2014.

but on the investor side. Equally, there will only be a small number of agents that can offer full services on a regional basis in an agent bank; and I am not convinced that the regional sub-custodians have the same product set to compete with global custodians on a global basis. So, a large asset owner on a global mandate would definitely look at a global custodian, not a regional European custodian, although a very European-focussed asset owner may have an option to go into that route. Taking these considerations, among others, into account, I am convinced we have the ability to leverage this new infrastructure with less threat and less issues than maybe some of the more domestically-focused organisations that currently sit in the market. That is why I think it is a huge opportunity for us. FRANCESCA CARNEVALE: Inevitably, all this regulation and all this change, raises barriers to entry and encourages a dash to quality. Will the core securities services business become only the preserve of a few large players and how does that help clients in the long run? ALEX DOCKX: T2S and other initiatives will fundamentally impact the role of providers in post-trade. As these changes have taken time to gather momentum, some people have been lulled perhaps into a false sense of confidence, thinking that not much is happening. That is not correct. Although slow in the beginning, the pace of change is now very fast. Market infrastructures are changing, rules are changing, and providers are expanding their offerings (going into more markets and/or by going up the service value chain). No one can say these days that they are not going to do anything about these changes. It is simply not an option and it would not be a good service to our clients to take a wait and see approach. Will the big players benefit? Certainly, scale is an important element these days. One of the key drivers behind T2S is to lower the cost of transaction processing in Europe. There's always a fixed cost of running a business; so the more volume you process, the lower your unit cost. Winners and losers are hard to predict at present because

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Justin Chapman, global head, industry management, Northern Trust Photograph © Berlinguer Ltd 2014.

there are various drivers which sometimes push in different directions, the desire for cost and processing efficiency will drive business into the hands of fewer large-scale players who excel at what they do. On the other hand, if you only do your business with one or very few providers, it increases dependency and concentration risk. The upshot is that there is no one size fits all solution, and different institutions (depending on their drivers) will have different solutions. That applies also to large firms such as JP Morgan, where various lines of business have different objectives [and benefits] they expect from T2S. On the fixed income side the focus is on liquidity and collateral; on the equity side it's about the costs of processing a settlement; and on the custody side the focus is on client benefits and risk. We managed to bring all these drivers into a single T2S strategy for JP Morgan, however I don't think we'll see one single model emerging as a result of T2S. There will be a variety of models, depending on what clients want. JUSTIN CHAPMAN: Alex is right: you'll start to see, even in institutions that have wider business models, they are looking at slightly different opportunities for clients as they execute in this environment. If you have a slightly narrower business set, you might have less things to think about in the overall scheme of things when implementing your overall strategy but actually there is also the response of the client to make sure that you can offer them availability of optionality. Large pension funds and institutions really would like as much safety as possible and you'll start to see more partnering and more shift and actually people will be picking more componentised services with multiple providers, back to Alex's point, rather than concentrating maybe on an end-to-end chain with a single provider through that value. MIKE CLARKE: There is a blurring of lines, but to me the key thing is that there's no one size fits all solution. If you look at what a domestic custodian provides, a domestic custodian is providing you with on the ground local experience in a market that's close to the regulator. Again, it's a clear dif-

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ferentiator from potentially how an investor CSD set up, or how a global custodian is set up. So, although you may have a multiple direct option via an investor CSD or an agent bank, it's very different to a global custodian. We also think that as a provider, wherever you sit in the settlement chain, you have to recognise the various needs of the different sectors you are dealing with and even the business units within an organisation. The different divisions of an organisation that you're talking to need to understand the problems that they are facing so that you can choose the components that bring real value from the right provider(s) for example,“is local market expertise key for me?” Regional access may be a key priority as you don't need certain services in terms of settlement that were needed before T2S, where the process was less harmonised. You may also still need cash and liquidity opportunities through an agent bank and picking and choosing the right components for the right solution will become more prevalent and there will be a blurring of the lines between providers. It really comes down to the unique selling propositions of each of the types of organisation in this room and how we work together. In some areas we will compete and in some areas we will partner and that’s how the market will evolve. The providers that will continue to thrive and be successful going forward are the ones that have recognised that via componentisation [sic], you can tailor a service by picking standard components that are either from one provider or multiple providers. JUSTIN CHAPMAN: What’s been interesting here, as we look at the development of products and solutions through the value chain, is actually how the market will charge for these services and products going forward. When you're having these conversations, you have to look at where the value is, and as you unbundle activities, how to get the true value of those activities that may have been hidden away within other costs within the value chain. That's becoming more and more important and will begin to feed into regulation at some stage. If you look at other trends such as pension fund reform, they're starting to look at true value through the value chain, which is ultimately reported back to funds. Actually, this has been one of the more interesting areas to look at, particularly when we are working with our partners, to try and work out what's commercially viable for the institution. It is vital so everyone feels they get right value to be able to operate at a consistent high quality level of service within the operating model. PAUL BODART: A good example is traditionally when you appoint a sub-custodian. You agree with him on the price for the transaction and then you agree on safekeeping fees and perhaps ancillary fees. As you've heard, you may have your own account at the CSD serviced by the sub-custodian and so the dynamic and the pricing dynamic has changed. Now you see the big actors like Clearstream and all of those starting to say, well, what will I offer at what price and, as Justin said, he's also in negotiation with BNP, Deutsche Bank and all of them and asking them too: well, what can you offer? What model do you offer and at what price? He does that because he has

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to make an offer to his client based on what he is going to pay. All these things are becoming clearer as T2S approaches However, there is a secondary concern. It's not easy to move from one custodian to another or to change custodians. It takes time; particularly if a firm has been using the same custodian for a long time. So, for an asset manager to make a decision to say, okay, for me it may be better to have my own corner to CSD, it's safer and so on, it makes sense for them to also say they would still want the support of a custodian. REGULATION AS A DRIVER OF SAFETY? OR A CREATOR OF PROBLEMS?

PAUL BODART: Mark said something very important. The more the market is complicated, the more you need a local player to help. Okay? So, you may have complex tax rules, complex actions. So, if all that is being simplified, harmonised and so on, the less you will need a local player. MIKE CLARKE: Regulators have acknowledged that the biggest gap in the market was mitigating systemic risk. EMIR was introduced to address that specific issue in the CCP clearing space and also to introduce transparency around the OTC derivatives markets. CSD Regulation underpins T2S. It wasn't designed specifically to address or to encourage more liquidity into the marketplace, or to help the markets increase their performance, it was about what risks exist in the marketplace today, what could potentially bring the marketplace down in its entirety and how do we address those gaps? ALEX DOCKX: We are approaching the limits of our capacity to absorb change very quickly. That came out not just on post-trade but everywhere in the industry we've seen a barrage of regulations. Actually, the market has coped pretty well up to now and the roll out of much of the regulation has not flagged unsurmountable problems. But this avalanche of rules and directives is becoming harder to assimilate. GUIDO WILLE: It seems like an unstoppable tsunami. ALEX DOCKX: Post-trade is a very system-based, highvolume environment. Most changes in this space –whether it’s the result of infrastructure changes such as T2S, or of regulations have major system and processing impacts. Even for big infrastructures and big banks this is a challenge. It also requires a lot of investment.Therefore, if at the same time the objective is to better structure markets and to reduce cost, the short-term impact on costs may not always be positive. We are a large firm, with a supportive infrastructure. Smaller players do not always have the bandwidth to do all of these things, and that risk needs to be considered as well. MARK PROFETI: The bandwidth issue is a very important consideration.While so much change is going on, to determine the right operating model for the future is quite difficult. We’re all looking at the regulatory agenda and the underlying themes and the impact that it has on firms’ post-trade operating models. T2S is a huge enabler as it provides a significant opportunity for firms to simplify their post-trade infrastructure model. However, the post-trade service providers are taking the brunt of the changes as they are having to look after the now, as well as manage their clients future service needs and

implement the market infrastructure changes. As Paul said earlier, change is happening now within the providers, and the change scope for securities service providers is growing. Ultimately, it’s great for their clients, who will have much more service choice going forward; it’s also good long term thatT2S will deliver clear benefits for the market. Nevertheless, delivering the scope and scale of change is challenging. MIKE CLARKE: It is understanding what your desired end state looks like and then defining the journey to achieve that end state. A trap that a lot of organisations fall into is trying to do everything all at once and get there by the quickest possible route and therefore the consequences and the risks attached to that approach are often overlooked, particularly by decisionmakers. People who realise that it's a longer journey and that the overall benefits are much more sustainable if you approach it in a much more prudent way. That is where we want to be, at what point do we want to be there, how do we get there and how do we start to realise some of those benefits on an interim basis during the course of that journey. JUSTIN CHAPMAN: There was an interesting discussion a number of years ago with my management group around how the European landscape would evolve and the impact of complex regulation. It is clear, that for many of our clients, we still have to provide a road map that gets us from here to there. We are still in the initial stages of the roll out of regulation, and that roadmap is not always immediately apparent. It involves building new structures, new products, new relationships; but we do see the light at the end of the tunnel. We make the decision about whether we become a CSD, or whether we invest in a CSD, or whether we carry on with a standard agent network, in that journey. We review and revisit the ideas, some fall off the route, and others don’t. This approach works really well rather than dealing with the silobased approach which historically this industry has dealt with and, frankly, we are much more aware of the interaction of these elements in the market right now. With that in mind, testing our outlook, systems and approaches at every turn is really important now. THE ROLL OUT OF T2S: WHERE ARE WE, WHAT’S DOWN THE ROAD?

PAUL BODART: CSDs confirmed that they would start user testing in October. The results of the testing we undertook in late summer are better than what we expected. By that I mean the number of defects that we have found is (from benchmarks that we have received) slightly lower than what you could expect from a project of that size and complexity. The effect is not small but there are no critical defects, not a lot of high defects. Now the key point is at which speed the four central banks that are developing will be able to correct these defects and what is important for us is really to see how the CSD will adjust. Bilateral testing will go on until the end of the year. Each CSD tests the system bilaterally with us.Then in January we will start a new phase of testing, we will start multilateral testing, where all the CSDs together to test the system. Then

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Mark Profeti; securities post trade strategy – lead strategist for T2S, Barclays Photograph © Berlinguer Ltd 2014. in March next year we start community testing. At that point we involve local banks and all the people that are clients of the CSDs will be able to start testing the system. So, that's really where we are. Has it been difficult? Yes, it has been difficult. The important point here is the discipline that we have imposed on ourselves. We have received multiple requests for change and when you launch a project of that size and complexity, if you make too many changes in the middle of the road, you will have the delay. It was important that we were very disciplined; to ask ourselves whether we really needed to make this change or that change, or whether there is something else that can be done to avoid change. Stability in the design of what you want to do is critical and that discipline is paying off. We are delivering and we are going to reach a synchronisation point at the pace that we were expecting. So far none of the synchronisation points has been missed. I'm not saying that the last months will not be hectic. I expect to get some interesting feedback from in particular the large CSDs which have an army of people ready to test. So, they will come with 7,000 test cases and they will try to kill the platform and that's what we need. We need to make sure that this platform works smoothly. FRANCESCA CARNEVALE: Alex, you're smiling and it is a wicked smile. ALEX DOCKX: This is a large run-up into T2S but we are now near to the delivery stage. For a project this size and this complexity, it's gone fairly well. There has been a good balance between the need to make the system user-friendly against the need to deliver on time. Even so, regarding change requests, the number we ended up with is in the hundreds. This good balance has been achieved in no small part because of the good governance structure put in place for T2S. Clearly everyone wants their own tweaks, but overall the somewhat surprising conclusion is although different parties have different drivers, there has so far always been a way to obtain a majority view, if not a consensus, which I think is very hopeful. That being said, the system testing needs to be ex-

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haustive. As from June next year much of Europe will start to move to a new, single platform, and that is a major challenge. We all have to ensure the seamless processing of our transactions from July 2015 onwards, which is and should be at the forefront of everyone’s thinking. FRANCESCA CARNEVALE: Mike, where are the pressure points? MIKE CLARKE: For us, key pressures at the moment are where we don't know key information. There's a lot of things that are unknown still in terms of where we are. We are in a situation where we don't know what the price is going to be in some of the markets that are there in Wave 1; and that's an incredible challenge when we are trying to understand how we can pass benefits on to clients. When it comes down to harmonisation and certain processes in the corporate actions process, we still face challenges where not everything is fully defined in terms of how the market will operate. We have had to make assumptions and move forward make sure that come Day 1 of Wave 1 we are there and we continue to process our client’s business. GUIDO WILLE: The place where we see most issues is uncertainty around the ability to implement what I called before this optional change enabled by T2S. The option is, for me to offer a service to market participants that is different in structure and in terms of access from today, and that's because for that we need information from other markets and Mike has just mentioned one important example, if I don't know the price of an issuer CSD that I'll have to use as a service, I've got a slight issue. He’s right to point out the uncertainty. We are confident of working through the testing. We have invested a lot of money over the years in the T2S, now we want to see the product and we continue to try to break it in the interests of everybody, as are other CSDs, because we want to be sure that it's going to work. Overall, and particularly in some markets such as Germany, I believe the readiness for T2S is very good. PAUL BODART: It continues to be an interesting process. We have a concern in the Board with the smaller CSDs, their bandwidth, they have no presence in all our meetings and they continue to rely a lot on the four big CSDs. Most of the CSDs are trying to minimise the impact of T2S on their clients. It's logical and it's feasible.Technically you don't need to make a lot of change if you continue to send your messages to Clearstream as you do today but the way you behave on the platform will change. Matching will be binding on T2S, which is the not the norm in most of the markets in Europe today. You will be able to do partial settlements, which is not the norm in most markets in Europe. If you want to cancel a matched trade, you need the agreement of your counterparty. So, the way you operate on the platform is going to change and, again, how much are the smaller players understanding that this is going to change? So, that's something where we do not have a lot of information. It's in the hands of the CSDs. We try to get some information but if the tail, so the 10% of transactions that come from the smaller players do not operate properly, we may have problem after launch. So comprehensive testing and kicking off the tires is imperative.

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JUSTIN CHAPMAN: That is a very good point. Actually, we have a slightly different investment in technical. We work with partners in this industry because of the type of institution we are but we are not so concerned about the technical delivery of code as much as maybe some institutions. We think they're in a good place. We have operational reengineering activities that have been running parallel with the technical build but also with the partner in discussions and also the analysis of the adaptation and readiness of our partners is probably the biggest element of this. FRANCESCA CARNEVALE: Is that a disproportionate responsibility, though? JUSTIN CHAPMAN: We are a custodian and out clients expect us to look after their assets. So, my technical teams are doing the coding changes. We have operational engineers doing the operational reengineering. My prime role on the strategic side is to make sure that I'm really confident in the people I invest our money in on behalf of our clients to offer services. Programmes are really fit for purpose. They have thought of all of these things. Although I might not be giving them everything, but infrastructure and downstream will deliver. My teams are in their shops looking at their project plans, looking at their deliverables, understanding that they're going to give my client and what my client needs by using them as institutions and that's not an unreasonable request. FRANCESCA CARNEVALE: Guido, the custodians look after their clients and some of those will be the smaller clients. Will you as a larger CSD have to look after the smaller CSDs? GUIDO WILLE: We are always open to partnerships that benefit our clients. If the CSDs seek our support, we are open. We have more bandwidth, and so do some others, to deal with these things but it's not the case that we will actively seek to enter other people's markets or other people's business. What we do, however, is work with other CSDs in Europe, and beyond, where some of these organisations have decided that they don't have certain services and they would like to draw on capability we have. For example, we operate a derivatives trade registration business together with Iberclear, which is publicly known. In addition, Iberclear has decided that they would like to offer collateral management, or specifically tri-party collateral management, services to their clients and determined that there may be a better option than selfbuild (which is probably a smart choice, given the complexity of the collateral management business) so they use our product on a white labelled basis. The wider question is, the longer run, how the market will restructure itself; but that's clearly not something I can comment on today. PAUL BODART: The speed at which the CSD market will consolidate is not what we expected when we launched T2S. So, it will come but it will come much later. We are starting to see some interesting developments. For example, the three Baltic CSDs have decided to scratch their existing platforms and build one platform for the three and logically you would think that the next step is to merge. That in Europe a group has been in one platform for Belgium and France and they may evolve to a CSD because CSDs are now allowed to do that. But there the question again is will the Slovenian CSD

or the Slovakian CSD survive? They are small. We need to remember that the net present value of a CSD today is negative. So, the fee revenue is going down and T2S will accelerate that and they are facing a massive investment to connect to T2S. Clearstream may be tasked to acquire some of them, but you do not buy something whose net present value is negative.There is a dynamic here. If, for instance, I'm the owner of a Slovakian CSD, I'm expecting to get some money from it but what I want to sell has no value. So, you will see a consolidation in Eastern Europe. THE END GAME: WHAT ARE THE BENEFITS OF T2S?

PAUL BODART: Having the same securities law across Europe will make things easier. Just think about collateral management in a cross-border context. It's quite something and because the rules are different, bankruptcy rules, commercial, we know that it is not easy. So,T2S will not solve that. The benefit is that to move securities from one place to the other going forward, everything will be on the same platform. One of the big advantages ofT2S is the framework of collateral management. There's a growing demand for efficient collateral management, substitution, optimisation, transformation. The best way to move securities from one account to the other is to do a debit and a credit between two accounts on the same platform. This is what Clearstream, what Euroclear, what JP Morgan, and what Bank of New York Mellon are doing quite well with its collateral management product. With T2S you will have all the accounts of 24 CSDs on one platform; all the securities accounts, all the cash accounts on the same platform. Therefore, moving assets from one account to the other will be much simpler. It is a massive benefit. MARK PROFETI: One of the principal benefits is a single point of access to settle transactions across all markets. This enables firms that operate on a pan-European basis to reduce the risk and complexity of their operating footprint. Today, firms who donâ&#x20AC;&#x2122;t directly participate in a local CSD need a local agent bank to access the local market infrastructure.That dependency potentially goes away allowing firms to reduce and consolidate their agent bank network but continue to access the same amount of markets. Consequently, firms are able to operate a leaner operational and IT infrastructure, thereby reducing the complexity, the risk and associated costs ALEX DOCKX: Actually, some of the biggest benefits of T2S are in the area of liquidity and cash management. Now we have different collateral and liquidity pools in different markets.T2S will allow to aggregate and net cash and securities balances much more, and settle in central bank money, albeit not completely because the ICSDs are separate. That comes at the same time when there is an enormous demand for collateral. It is not just a luxury, it is a necessity to become much more efficient, especially institutions that have large crossborder activity flows. The benefits of having one central bank account where you can net your balances and one collateral account is major, and may well outweigh most other efficiency and cost benefits of T2S on the securities processing side, depending on the institution.

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Paul Bodart, member of the T2S board, ECB Photograph © Berlinguer Ltd 2014.

GUIDO WILLE: T2S enables market participants to choose to settle in central bank money, which is a completely different risk profile if compared to commercial intermediaries. It also has other benefits in terms of capital costs for banks, either because of the risk profile, or should I say, the absence of a risk profile of the central bank. Clearly, the liquidity pooling opportunities in T2S are probably the most relevant contribution it will make in the mid-term because they will create massive savings for banks. Let me expand: on the cash side of things cash pooling and netting will offer significant savings for banks. Moreover, the ability to consolidate multiple accounts into one is a clear plus. A schoolchild can calculate the efficiencies that result from the reduced need for credit and collateral that are currently consumed by the sheer volume of intraday exposures to current providers. Then there is the consideration around securities. Securities today behave in very different ways; some asset classes are very efficient. Equities tend to settle very well, because essentially they're consolidated into the CSDs. Other asset classes behave less nicely. If you look at the fixed income markets that are more or less domestically organised; one of the biggest headaches and one of the most significant costs bases in back offices today is the rate of fails in cross-border transactions. That's not because anyone does anything wrong; it's just a fact of life that a cross-border transaction is less efficient than an internal transaction. I estimate 99 point something percentage efficiency for within Clearstream Luxembourg and across the bridge to Euroclear Bank and it's going to be something like 95% cross-border.The contribution of T2S here is that it enables the pooling of liquidity that is currently not pooled and moved across domestic markets and ICSDs. The last element is the collateral management side of things. We think this element is quite dramatic. T2S allows organisations such as Clearstream to offer collateral management on accounts inT2S; currently the opportunity in domestic markets is very limited. This is because of the four global col-

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lateral managers in Europe only the ICSDs offer both collateral management and settlement and therefore enable automatic sourcing of collateral and substitutions from the client’s trading account. In the domestic markets financing of collateral involves clients moving collateral from their settlement agent to their financing agent. With T2S we will see our ICSD collateral management product be made available on settlement accounts in our T2S investor CSD. MIKE CLARKE: I agree with a lot of the points made, in terms of liquidity, netting and collateral mobility but particularly with cash and the balance between commercial bank and central bank money. People need to go into the decision, and understand what is important to them.They also need to define their business model when making the choice between commercial bank and central bank money. To manage central bank money is not a simple thing. ALM departments are very large. They need to make decisions about when they're putting collateral up to create the liquidity. Is it on a onemonth, three-month, and six-month tenure? What is the size of that? Do I go in one batch, do I go in rolling batches? Moreover, the management of that liquidity is quite complex and requires an understanding that in times of crisis it may be 20 basis points today, it may be 70 basis points tomorrow and that is a risk process that today people don't necessarily appreciate if they're using a commercial bank where they're working off the back of an unsecured uncommitted credit line. There are other ways of getting the pooling effect of T2S without necessarily moving straight to the central bank answer. You can still get netting and pooling effects by consolidation through an agent bank into a single cash account. It gives you some of those same benefits. However, as I said, you also have to look at your business model. If someone today is using an integrated brokerage product outside of their home market, those models are efficient because the custody is held in the same omnibus account where the main execution settlement is taking place, which minimises cost.You’re also using the liquidity of your provider to help facilitate settlement. If you're using this model for some markets in Europe, the only way to attach your own central bank money is to segregate your assets into a separate securities account away from that main omnibus account. All of a sudden then you're introducing additional costs into your per transaction execution cost because you've now got a physical movement into your segregated custody account before you can then make an onward delivery. We are clear with our clients: both we and they need to their individual business model, the aspects of the services they use and what that means for their business.This will lead us to the point where both central bank money makes sense and where commercial bank money still makes sense. JUSTIN CHAPMAN: From a Northern perspective, central bank money is a logical step for us. Moreover, we are not running prop books. It's a very different animal to a broker dealer. To have that level of intraday flow and cash, working with a central bank is a logical solution. We run billions through settlement processes a day but we don't have any proposition. So, cash netting across multiple markets into a central bank is a big opportunity. Clearly, there is an argument

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ROUNDTABLE

around support for central banks and stress situations versus commercial. From a risk profile perspective and a credit risk perspective, it is a strong argument. Also our large asset owners, governmental funds, large multinationals, superannuation like us to be in that space. Touching on the collateral point, if you look at pension funds moving to collateral because of the requirements of clearing, T2S will provide an opportunity to hold away from the execution mode those assets within a custodial environment between now and 2018. There is a big opportunity for custodians to offer active platform management. That’s a very new dynamic we are going to start to see emerging.You'll certainly see some relationships and partnerships where assets just don't have to get delivered to a general clearing member (GCM) or a broker in future; they can stay within the safety of the people that are not maybe perceived to be a riskier element for a significant pension fund in the future. In that regard, we see big opportunities on this side of things. PAUL BODART: Recent market research says that EMIR is going to multiply by 50 the number of people that will require collateral management support and Justin has described all the pension funds that have some derivative, some swaps and so on, will have by 2018/2019 to clear this input. So, the number of people that will be involved in some way or another with collateral management services or requirements is going to multiply. I completely agree with Justin, the large custodians will have an opportunity to service them. MIKE CLARKE: I do see the number of organisations in this space growing. I just think the key question still remains the interoperability between these collateral services versus being able to have your collateral with a provider and still be able to have access to distribution via the right channel. GUIDO WILLE: There are going to be many more organisations that need collateral management. These institutions, many of them from the buy side, will be dealing in smaller lots of collateral, because they are not of the same size as the large investment banks and secondly, they do not have the same level of sophistication that the large investment banks have. Therefore they will not have the same extent and depth or level of exposures and may need more help than the banks needed in the past. However, we are not JP Morgan, or Northern Trust. We are not global custodians. We do not service buy side clients for custody and settlement services. So, there is a very interesting question to ask and it goes back to a question you asked earlier Francesca, about the impact of T2S on the custodian community. How is collateral management going to play out for the global custody community that doesn't offer their own collateral management product? Clearstream has agreement in place to enable the main European domestic agent banks to provide collateral management via our Liquidity Hub Connect service. In the new context, there may be room for similar cooperation and organisations in the global custody space who need to offer collateral management to their buy side clients. JUSTIN CHAPMAN: This is where it brings in the T2S, the account structures, and the overall new structure in the new

world will enable this and that's Guido's point. Inevitably, there will be partnerships, and actually multiple partnerships will and must form. We are already seeing those components coming together in the market. ALEX DOCKX: One of the more interesting questions is to what extent the system changes will actually drive liquidity shifts between T2S and other CSD platforms? That’s crucial because cross-border settlement is credit-intensive. Apart from everything else which is changing, that, actually, is really interesting and I'm sure Paul would welcome more flows on the T2S platform. T2S AND THE OUTSIDE WORLD: HOW MIGHT THE NON-EURO MARKET HARNESS ITS VALUE?

PAUL BODART: Should T2S be used by more CSDs? I hope it will happen and we have good reason to believe that, for example, the Scandinavian markets, Sweden and Norway, are just waiting for T2S to be launched and if T2S is a success they will join the platform. With time I am convinced that more markets will join both with their Euro-denominated transactions and hopefully also with their local currency transactions. We should not forget thatT2S is an open, multicurrency system and remain so. Whether or not other regions of the world can benefits and be inspired by the T2S vision remains to be seen. MIKE CLARKE: From an Asian perspective, particularly in ASEAN, we've seen seven markets come together and say they need to make the inward investment into those markets much more attractive. One way to do that is to join together and make settlement easier and more efficient between them and, as a knock on effect, increase liquidity in the region. In that regard, I think the idea of T2S is eminently exportable and in some cases might look to the ECB to provide a template of the platform: who knows. I would not be surprised at seeing more groupings leveraging the idea of T2S as it is a good one. How they might implement it to meet local conditions is altogether another consideration. GUIDO WILLE: I agree with everyone, but I also believe there is a third dimension. As Paul notes, whoever invests in an asset that is in T2S is by definition in T2S. The only question is, will they use intermediation or not? PAUL BODART: You will see asset managers like BlackRock saying: OK, I want you to continue to be my custodian but I want my account on the CSD. GUIDO WILLE: I agree. JUSTIN CHAPMAN: Absolutely. It's a product offering that a custodian may or may not be willing to offer, from an omnibus to full clients at a central repository as an accounts operator. There are multitudes of different things in between and people, from a safety perspective or a liquidity perspective, may want (and if they had the size to) want to be there directly. Moreover, a BlackRock is very different from a governmental fund. PAUL BODART: But they still need your service, right? JUSTIN CHAPMAN: Of course. The part afterwards is re eurobonds in T2S and that needs to be clearer, the question seems to be missing? GUIDO WILLE: If you talk about liquidity shifts in T2S, the

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Mike Clarke, global product management, investor services, Deutsche Bank Photograph © Berlinguer Ltd 2014. asset classes that are most widely expected to concentrate more on T2S are domestic bonds from T2S-in countries that currently settle a lot in the ICSDs. Eurobonds are a more complex story. In the very broadest term, there are two categories of eurobonds to be considered.There are euro-denominated assets where the question hangs around whether they will migrate wholesale on to T2S. These are the eurobonds denominated in euro as a currency. The question whether they will or will not migrate is moot, but what is clear is that one of the strongest incentives that T2S creates—the cash pooling side—will be available for these assets. That's a financial incentive that is very, very strong for many organisations to take into account whether they will move these assets onto T2S. There are some obstacles and constraints in these assets moving to T2S because they behave in a very different way to domestic assets and also they are married to the rest of the Eurobond universe, which is obviously not all denominated in euro. Even so, you will still be able to settle them on T2S. For non-euro assets, while one can reasonably question the idea that large organisations will move non-euro assets to the platform, simply because of the complexities involved and the absence of (and it is a key benefit) cash pooling, we do see interest in the area of non-euro-denominated euro bonds, such as Japanese bonds, or US bonds, from our smaller clients. There are a host of smaller organisations in markets such as Germany, that are mainly active in fixed income and they just use us as a single interface. These types of organisations are interested in looking into further consolidation and utilising us as an investor CSD for T2S, as they have 95% of their assets in T2S anyway. They might also have 5% of investments in dollar and sterling and though they are aware of the complexities involved, they are convinced that the benefits of pooling and consolidating interfaces into one platform outweigh the operational issues of moving these assets into a new space. So, it is a very interesting question; particularly on

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the euro-denominated side. What will happen over the long term? We will have to see once T2S is fully rolled out. MARK PROFETI: One of the prime strategic drivers going forward is going to be the mobility of collateral. Mobility within the eurozone region via T2S is going to be important for both participants and market post-trade infrastructures. Particularly, with multi-location strategies being adopted by a number of European based CCP’s looking to operate in other regions such as Asia ,it will be interesting to see if and how they leverage T2S to facilitate the movement of margin collateral for their clients in these regions. Also,T2S is potentially a settlement gateway to Europe for non-European based entities. Therefore, I see an opportunity for the T2S user community to be extended to include other non-European market infrastructures and financial institutions ALEX DOCKX: I like to compare T2S a little bit to the introduction of 3G and 4G broadband It's a community service being offered to all providers who are going to leverage the service. I don't think anybody could have predicted ten years ago that the introduction of 3G and 4G would lead to the explosion of apps and Internet services. Similarly, with T2S, new opportunities are being created. The hope and the expectation is that T2S will, albeit on an institutional level, lead to a similar metamorphosis of the industry, in that respect there will be winners and losers but hopefully the market as such will become bigger and more efficient. PAUL BODART: One possible development is in the fund business. Clearstream with LuxCSD and VP with VP Lux are clearly thinking to utilise T2S as a platform where you can settle issuance but, more importantly, perhaps transforming a portion of the offshore fund business in a secondary market. Today the European market for funds is mostly primary, so you continuously issue and cancel shares and the settlement piece is on the CSD platform. Could we move to a solution as we have in Germany and France where the shares are issued once and then they are just traded on the platforms and then settled on the CSD? Yes, probably. I believe that the fund business should not be underestimated. JUSTIN CHAPMAN: This is a catalyst for innovation and opportunity. All the answers aren't clear but it's enabled us to review opportunities to deliver client solutions for investors, for asset managers, for funds. I’ve had quite an active dialogue with institutions over the last 18 months, and asset owners are interested in market change and the opportunities that presents. They're not just seeing this as an infrastructure development and what the education industry is doing with the client base, particularly the active ones that have the innovation, has been really positive. Some of those products will fly and some of them may; what it will do is change things around a bit, shake things up a bit. That’s all to the good. MIKE CLARKE: Innovation is key and as service providers around this table, all of us appreciate that staying the same is not an option. With this element of change, it's about finding where your value is as an organisation, focusing on the value that you bring to your clients and making sure that you've evolved to be that provider of services. To stay as you are today is a way to make sure you're not here in the future. n

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OFFSHORE REVIEW

GUERNSEY UPS THE ANTI FOR NEW FUNDS The Channel Islands don’t really like to see themselves as offshore jurisdictions. Yet, either by accident or design, the reality is that the islands compete for company incorporations, listings and new fund launches with other non-traditional markets. Looking at the Crown Dependencies, Jersey saw a 6% increase over the previous half-year, while Guernsey saw something of a dip in the number of new company incorporations. The report noted, however, that Guernsey’s story remains encouraging as the total of 833 new incorporations is historically high.

he total number of new company registrations increased 4% over the previous six months, across offshore jurisdictions in the first half of 2014, according to Appleby, a provider of offshore legal, fiduciary and administration services. In the first half of the year, there were 46,455 new offshore company incorporations, according to the firm’s latest On the Register report. In terms of incorporations, the Crown Dependencies lost out to the Cayman Islands as the standout jurisdiction, the report found, powering through the 5,000-level for the first time in a sixmonth period since 2008, up 17% increase over the previous six months. Nonetheless, the British Virgin Islands (BVI) continues to dominate offshore new company registration activity by volume, reporting 25,533 new companies – a 6% increase on the previous half-year – and easily maintaining its two-fold lead ahead of its nearest comparator. Where the Channel Islands do outperform is in the funds sector. Guernsey’s financial services regulator approved 42 new investment funds for the second quarter in succession, resulting in a total of 140 additions during the 12 months to the end of September. Figures from the Guernsey Financial Services Commission (GFSC) show that 30 new funds were approved during the fourth quarter of 2013, 26 in the first quarter of 2014 and 42 during both the second and third quarters of this year. Overall, the net asset value of all funds under management and administration in Guernsey fell by £0.4 billion (1.1%) during the third quarter to £260.9bn at the end of September. Dominic Wheatley, who took on the mantle of chief executive of promotional agency Guernsey Finance in October this year, explains that “It is encouraging to see that Guernsey continues to attract new funds and that both the open-ended and closed-ended funds sectors grew in value during the last quarter. The figures demonstrate the solidity and stability of our funds industry and the continuing attractiveness of Guernsey as a funds centre.” Among the leading asset management firms to migrate the domicile of specific funds to Guernsey are Investec Asset Management, which has migrated and re-domiciled a

$1.2bn fund from Ireland to Guernsey, due in part, says Wheatley,“to our dual regulatory regime in respect of the Alternative Investment Fund Managers Directive (AIFMD]. This is a huge vote of confidence in our funds industry. We have also heard that a number of funds are being moved here from the Cayman Islands because of the effectiveness of our national private placement regime for distribution into the European Union.” Vic Holmes, Chairman of the Guernsey Investment Fund Association (GIFA), said he was encouraged by the current health of the Island’s funds industry. “National private placement regimes are generally working well in most European countries and proving popular for fund managers based outside the EU. Since the introduction of AIFMD, promoters have recognised the advantage of Guernsey’s ability to distribute funds into both European and non-European jurisdictions to best meet their specific circumstances.” Excluding the United Kingdom, Guernsey also looks to be a preferred jurisdiction for the listing of vehicles on the London Stock Exchange (LSE), with figures to the end of November showing 119 Guernsey-incorporated entities listed on its various markets. “Overall, Guernsey’s funds sector is in a stable position. We’ve seen growth in the number of new funds and a positive response to our regime under AIFMD. As an association we will shortly be submitting our response to ESMA’s consultation paper on whether or not AIFMD passports should be extended to third countries and will do our utmost to ensure that Guernsey is part of the first wave of approved jurisdictions when the third party passports come into effect,”adds Holmes. In response to AIFMD, Guernsey introduced a dual regulatory regime whereby it is possible to continue to distribute Guernsey funds into both EU and non-EU countries. The existing regime also remains in place for those investors and managers not requiring an AIFMD fund, including those using EU NPP regimes and those marketing to non-EU investors. There is, as well, as an opt-in regime which is fully AIFMD-compliant for those funds that require it. The most recent figures from the GFSC show more than

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34 Guernsey Alternative Investment Fund Managers (AIFMs) have utilised the jurisdiction’s National Private Placement (NPP) regime to market Alternative Investment Funds (AIFs) into one or more European states.These cover 15 of the 27 jurisdictions with whom Guernsey signed bilateral cooperation agreements back in July 2013. The UK in particular remains a key market for Guernsey managers with 56 AIFs marketed there. The 42 new investment funds approved by the GFSC between the start of July and the end of September comprised three open-ended funds, eight closed-ended funds and 31 non-Guernsey open-ended schemes.Taking into account licences relinquished, this represents net growth of 17 funds during the quarter and takes the total number of funds currently approved for domiciling or servicing in Guernsey to 1,125. Guernsey open-ended funds increased in value by £1bn (2.5%) to £41.7bn, while Guernsey closed-ended funds also increased by £0.1bn (0.1%) to £135.8bn. Non-Guernsey schemes – open-ended funds that are not domiciled in Guernsey but where some aspect of management, administration or custody is carried out in the Island – decreased in value by £1.5bn (1.8%) during the third quarter to reach £83.4bn at the end of September. “It was pleasing to see that during the last quarter we added 22 non-Guernsey schemes,” adds Wheatley. “This reflects the significant substance which already exists in Guernsey, especially in

comparison to some other jurisdictions, something that is likely to be an increasingly important differentiator moving forward,” he says. In 2015 the island will be holding a technical showcase of Guernsey's funds offering in London at the end of January, explaining how the Island is positioning itself in Europe’s emerging regulatory landscape. "Guernsey is not alone in having to deal with the increased amount of onerous regulation we are seeing, but the island's industry and how it is positioning itself amid the latest regulatory pressures will be at the heart of our discussions in London,” explains Fiona Le Poidevin, previously chief executive of Guernsey Finance and now head of the Channel Islands Stock Exchange.“We believe Guernsey's position 'offshore' and outside of the EU, coupled with our regulatory regime, infrastructure and expertise means the domicile offers tailored optionality for the international fund community,” she adds. According to Le Poidevin, "The post-crisis environment, including AIFMD, has brought about greater scrutiny of structuring arrangements and in particular, issues of substance. Unlike some competitor jurisdictions, Guernsey has the advantage of significant substance already being present within many existing structures, while corporate governance is enhanced by having a considerable pool of experienced non-executive directors with a deep knowledge of investment funds”. n

If you want a more enterprising approach to fund business, there’s one place you should look...

here. Find out more at guernseyfinance.com

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STRESS TESTING

Market reform, prudence and the Kazakh central bank The Kazakhstan banking regulator, the National Bank of the Republic of Kazakhstan (NBK) recently adopted important amendments to its rules on prudential limits, strengthening the requirements for banks’ net equity and charter capital. NBK also adopted a new version of the Rules on the restriction of price manipulation in the securities market. These rules provide further detail on the process for recognising transactions as manipulative on the organised and over-thecounter (OTC) markets. Aset Shyngyssov, managing partner and Marat Mukhamediyev, associate of the Almaty Business and Finance Practice of Global Law Firm, Morgan Lewis reports on the implications.

n May 6th, the National Bank of Kazakhstan (NBK) amended the prudential limits rules for all commercial banks, including Islamic banks.The amendments outline the minimum charter capital amount for a newly founded bank, as well as the net equity amount for an existing bank performing main banking operations.These capital requirements will gradually increase from KZT30bn (approx. $165m) to KZT100bn (around $549m) between January 1st 2016 and January 1st 2019 As of the start of 2016, the minimum amount of net equity capital for a bank that performs only limited banking operations will be KZT10 billion (55m). This measure was introduced due to the high level of nonperforming loans (NPLs) at the beginning of 2014 (about 31% across all commercial banks) and was aimed at supporting the banks’ competitiveness. Prudential rules define an NPL as a loan with more than 90 calendar days overdue debt (principal amount and/or interest), excluding reserves. The central bank intends to force a reduction of this level of credit risk to support banks’ competitiveness. For this propose, NBK has inter alia established a practice of making agreements with banks regarding specific measures to improve their loan portfolios. In addition, the central bank has introduced a new coefficient k11 (the maximum limit of NPLs in a bank’s loan portfolio), which takes effect from the beginning of 2016. Coefficient k11 should not exceed 0.10 and is calculated as a ratio of NPLs to a bank’s total loan portfolio. Currently, there are thirty eight commercial banks registered and functioning in Kazakhstan. When new requirements to equity capital apply, the number of banks is likely to decrease as there is no guarantee that all these banks will be able to meet more severe prudential limits. On 23 April, the NBK adopted new rules on the classification of transactions in organised or OTC securities markets that are aimed at manipulating the markets (the Manipulation Amendments). The Manipulation Amendments came into force and apply as of 15 July. Kazakhstan Securities Law defines manipulation on a securities market as actions of securities market participants aimed at establishing and/or supporting higher or lower

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prices for securities compared to fair market price, giving the appearance of trading with securities, and/or entering into transactions using insider information. A list of transactions that are subject to monitoring and control for the purposes of manipulation is established by the Securities Market Law and the Manipulation Amendments. The list includes, among other things, transactions entered on stock exchanges for pre-agreed prices that materially differ from prices at the securities market prior to the transaction. A material difference in the price of stock exchange transactions to be evaluated (i) for share transactions, a 30% transaction price deviation test, based on the average prices on the stock exchange, and (ii) for bond transactions, a 3% or more of yield to redemption deviation test, based on average market profitability.

Manipulation amendments The Manipulation Amendments provide for separate procedures for recognising transactions as manipulative on the organised and OTC markets. Transactions entered into on the organised market require an opinion of the Kazakhstan Stock Exchange’s (KASE) expert committee, previously, this was done by KASE board of directors. For OTC transactions, KASE expert committee opinion is optional. Note that such opinion does not have a binding effect for the NBK, which is the final authority to decide whether a transaction is manipulative or not. The list of transactions that are subject to monitoring (for instance transactions where the seller and the purchaser are the same person acting on their own or via professional broker, sham transactions, etc) was expanded. Currently, transactions that meet the material difference thresholds discussed above are also subject to monitoring and control. The list of exempt transactions was also expanded. For instance sale and purchase transactions were added to the list when they are closed on the stock exchange via the“open trade”method within five business days and do not change the securities volume held by the parties to the transaction by 10% or more, provided that the securities were included into the so-called “representative list of KASE”. n

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STRESS TEST

From regulatory burden to catalyst for business transformation Six years after the onset of the 2008 financial downturn, financial institutions are reconciled with the fact that more rigorous and frequent stress testing is here to stay. While banks must garner their resources to ensure compliance with increasingly demanding stress testing standards, they should also find ways to put this investment to work to enhance the overall performance and profitability of their organisations writes Rohit Verma, senior director, Oracle Financial Services Analytical Applications.

n many cases, financial institutions remain focused on simply fulfilling the regulatory requirements of stress testing, and overlook an important opportunity to use the information gathered through these labor-intensive efforts to peer into their operational DNA and drive their institutions forward. Finding new ways to use this information as a proactive and dynamic management tool will help leadership gain new perspectives, improve decision making, and provide financial institutions with long-term value. No longer just a check-the-box exercise to fulfill regulatory obligations, stress tests represent a complete dissection of a financial institution’s multiple risk types – including credit, market, operational, and liquidity risk as well as the impact of such risks on an institution’s balance sheet and income statement. Regulators are not the only ones who can benefit from this valuable data. Rather than looking at the narrow impact of stress testing, Comprehensive Capital Analysis and Review (CCAR), DoddFrank Act Stress Test (DFAST), and Basel III requirements, the information retrieved provides an enormous opportunity for senior leadership and boards of directors if the information unearthed through these deep dives into bank data is used to and refine management strategies moving forward. For example, stress test data can reveal undetected hypersensitivities of a loan portfolio to macro-economic factors. A bank can also use stress-test-related tools, such as data marts and ad hoc reports, to identify how well its risk profile aligns with management’s intended profile and analyst projections. With data scattered across so many different applications, an enterprise-wide analysis of risk is a rare opportunity to objectively assess all risk positions acknowledges consulting firm Aïte Group, in its publication The Global Stress-Test Automation Market: Stress, Uncertainty, and Moral Hazard, September 2013. Realising this important change will first require a significant cultural shift. Fundamentally, it means ensuring that information gleaned from stress tests continues to flow unimpeded from the bottom all the way up the chain to the board of directors level, and that leadership mandates the use of data at all levels to drive strategic and operational decisions. Stress test outcomes, however, have been put to limited use at the highest levels of financial institutions, as the reports and data, historically, were treated as an “information only” item at board meetings.

While leadership has and must be inherently involved with the results and regulatory impact of stress test results, it has historically been difficult to operationalize that information to safeguard the bank’s business model, and as such, the responsibility to interpret and report the data has been left to others. Simply put, banks must be able to present information and analysis gleaned from stress tests in a way that is understandable and actionable. However, the volume and technical nature of the data makes this difficult, thus it is critical that banks get a transparent view of stress tests across the enterprise. Advancing stress test data to the boardroom requires more than changes in culture and process. There is an IT component to solving this problem and ensuring that data is delivered quickly and in a standardised format. For many, extracting the most utility out of stress test data will require creating a fully automated and integrated environment that improves data extraction and aggregation enterprise-wide and ensures the consistency of balance sheet data, risk data, market data, and qualitative data. Forward-thinking financial institutions understand that this transformation to an enterprise-wide platform is as much about increasing visibility and improving decision making for senior leaders and directors as it is about fulfilling stress testing, CCAR, DFAST, and Basel III compliance obligations. Having the ability to produce critical data on demand and in nanoseconds holds great value for directors and senior leaders. Although this level of speed is not required for a bank’s stress testing program, this real-time view offers greater insight into the immediate and longer term impact of any particular stress scenario and allows for a faster defensive response during periods of heightened market volatility. Advancing stress test data from the conference room to the boardroom gives leadership the best information available to make critical business decisions. This change will drive long-term value. Financial institutions must understand the role that stress test outcomes have in improving internal decision making, long-term planning, and risk assessment. If firms can transform their ability to compile stress test data into a useful framework that allows leadership to strengthen their analytical capabilities, their organization and shareholders will see dramatic benefits. n

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ROUNDTABLE

TRADING TECHNOLOGY IN A TIME OF MARKET CHANGE: THE RUSSIAN PARADIGM Photograph © 58931447/dollar photo club, supplied December 2014.

EXPERT PANELLISTS Irina Glazkova, DMA sales director, Asia, Russia and CIS, Otkritie Securities Vladimir Kurlyandchik, business development director, ARQA Technologies Tom O’Brien, head of international sales, Moscow Exchange Francesca Carnevale, Editor, FTSE Global Markets

SETTING THE SCENE Until the end of the first quarter of this year Russia’s revitalised Moscow Exchange (backed by a burgeoning post trade infrastructure provided by the National Securities Depositary) was gaining significant traction among global investment banks and hedge funds. All eyes were on DMA. Current woes resulting from the land-grab crisis in the Ukraine, have deflected both opinion and attention from the very real market reforms underway in the Russian market. Nonetheless, there is a steady stream of business (although at levels much lower than they were at the end of 2013) which necessitates discussion of the salient market trends. Direct market access clearly offers advantages, such as a reduction in latency and immediate access to an exchange’s block trading function or simply to trade options. It also negates the need to maintain dedicated hardware and software. A DMA service can unlock trading features that

FTSE GLOBAL MARKETS • NOVEMBER-DECEMBER 2014

may not previously have been available to many international investors in particular markets such as Russia. The Moscow Exchange was created in 2011 from the merger of the RTS and Micex exchanges, which previously operated separately, settled in different currencies (ruble and dollar) and specialised in different asset classes. The combined exchange is a central plank in the Russian government’s drive to turn Moscow into a major global financial centre and claim back some of its lost IPO business from London, which has emerged as a rival Russian IPO centre. Those plans are perforce on the back foot right now, though the exchange and the NSD have been polling and networking hard both in the CIS states and Asia, where there is expected to be a substantial uptick in business going forward. Deutsche Bank’s client briefings anticipate a flurry of initiatives around tax and settlement to follow in the next few weeks. The year has not been a total write off for the Russians in terms of dealing with the West. A recent seminar

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held by the Moscow Exchange in London attracted over 450 attendees. Moreover, over the last 18 months, connectivity providers have raced to roll out low-latency connections to the Russian market. In September, TMX Atrium released a set of options for trading Russia through its connection to Frankfurt’s Equinix FR2 IBX data centre and the Moscow Exchange. Meanwhile, BSO Network Solutions has its own link from London to Moscow, which it upgraded in March to achieve a roundtrip latency of 39.15 milliseconds. Through the first half of 2014, Russian brokerages in London steadily decreased the ultralow latency data lines between London and Moscow and now must be the fastest trading connection yet built between the two cities, well below 39 milliseconds. Elsewhere, Horizon’s software focuses on providing DMA to the Russian market. Its DMA gateway provides support for order routing as well as pre-trade risk management, which has become an important feature of the Russian market ever since Moscow moved from its original T+0 settlement cycle to T+2 settlement in the second half of last year. It also provides an ‘exchange-native’ data feed, which Horizon says is important because otherwise the data would be more complex to obtain and may suffer from higher latency. One of most important developments over the past year, irrespective of, but clearly linked to, sanctions has been the expansion of the client universe of the Moscow trading infrastructure. Sanctions have encouraged the Russians to look eastwards and south for new strategic partnerships, new business and trading flow. In the following roundtable, we look at the nuts and bolts of trading with the Russian market infrastructure and the changes and efficiencies now placed in chain.

CONNECTIVITY & COLOCATION: THE TRENDS

VLADIMIR KURLYANDCHIK, BUSINESS DEVELOPMENT DIRECTOR, ARQA TECHNOLOGIES: There are now many ways to gain connectivity. The primary data centre of Moscow Exchange is located in an international data centre in the south of Moscow. All major Russian local telecoms providers can now avail themselves of network access to trading engines of Moscow Exchange. Big international players like BT Radianz also offer connectivity to the exchange. Co-location is a separate area in the M1 data centre. A client can rent a rack or several units on Moscow Exchange and the typical connectivity for colocation is 10GB. There are several options to achieve colocation from outside.You can rent an internet link, as part of the colocation services that Moscow Exchange provides or utilise dedicated lines from one of other data centres. An optimal solution to harness this infrastructure is to arrange a rack and then to connect on to Moscow Exchange colocation or other data centres. Most Russian prime brokers provide services based on links between the M1 data centre and London data centres. Moreover, both telecom and

Irina Glazkova, DMA sales director, Asia, Russia and CIS, Otkritie Securities Photograph © Berlinguer 2014.

service companies can organise links easily. Specifically for the London based community LD4 is also an option for connectivity to the Moscow Exchange. TOM O’BRIEN, HEAD OF INTERNATIONAL SALES, MOSCOW EXCHANGE: We moved into M1 more than a year ago now. It’s not an ideal data centre, mainly due to its size, but it’s actually pretty good in some parts. From a power supply point of view its actually very well set-up. It is not a long term solution, though I believe when we moved in we committed to it for a period of time. Separately, London and the LD4 link has, I can say, been really successful. We have a host of customers in LD4. They are not going to be the true low latency customers, mainly because our latency from London to Moscow is never going to be the fastest. Actually though, and especially these days, that’s not really the game we are in. As a pillar of the market infrastructure our focus is always on making connectivity to Moscow easier, from whichever part of the world you are based. We’re not particularly looking to make it faster. Clearly now we are looking to open up data centres or points of presence (POP) in other locations. LD4 will carry on being the primary data centre overseas but I think of LD4 as an FX data centre in the way that it is actually set up. That really works from the FX side. Interxion is closer to LSE, so if we’re going to have people doing some sort of arbitrage between the two, that’s somewhere we should be. Again we are not going to be the fastest and we aren’t going to pick all those customers up but there will definitely be customers in there who are in Interxion which aren’t in LD4. The same applies for Frankfurt, where we’re seeing derivatives contracts traded in Frankfurt which are interesting to us back in Moscow. Some people are sitting in Frankfurt doing index arbitrage type trading from Frankfurt back to Moscow. Then you also have the Scandinavian countries, where most of the trading goes through Stockholm. Should we break it up in some way and offer some sort of POP in one of three Stockholm based data centres that are available? I think the answer is yes. Overall,

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Vladimir Kurlyandchik, business development director, ARQA Technologies Photograph © Berlinguer 2014.

I would posit that low latency from an exchange perspective is too costly, it moves too fast. Our focus now is to extend our reach, either through connectivity, POP, and or relationships with other exchanges and parties. FRANCESCA CARNEVALE, EDITOR, FTSE GLOBAL MARKETS: The data centre market in Moscow is different from that in the UK or the US, in the sense that it’s still quite a new market. What are its main features? IRINA GLAZKOVA, DMA SALES DIRECTOR, ASIA, RUSSIA AND CIS, OTKRITIE SECURITIES: Whatever our clients would like to have in terms of proximity, connectivity and colocation, we will always strive to offer them. Just a couple of years ago there was a trend where each client began to believe they were extremely big HFT players. This notion was created by M1 providing them with an opportunity to be installed in a colocation centre rather than in proximity hosting. It was a big buzz and everybody immediately wanted to be collocated rather than proximity hosted. These days, naturally, it is very different. Smaller, even mid-tier clients realise they are not GETCO’s or Kite Groups and trading is more considered. The bigger players, real HFTs, with quite a big market share on MOEX now require not so much colocation as a much broader service set that also includes other markets. Colocation is something of a game changer because if you are collocated somewhere you lose something of a competitive edge, irrespective of whether you are trading in Russia or not. For example if you want to trade US markets CME against LSE, once you are collocated somewhere there is nothing close to quick post-trade, pre-trade risk management that a broker can offer. With all these other players the bigger players started to be less focused on being collocated.This continues to happen across the board.

TREND SHIFTS: LOOKING EAST AS SERVICES DEEPEN & SANCTIONS BITE

FRANCESCA CARNEVALE, EDITOR, FTSE GLOBAL

FTSE GLOBAL MARKETS • NOVEMBER-DECEMBER 2014

MARKETS: I guess there are broadly two types of requirements.You have people who are really keen on speed directly into a local market, they will go for the colocation facility and not for anything else. What we hear about is that many of our clients who already trade other markets are keen to use other points of presence. In that sense, Stockholm is interesting because it’s sort of halfway between Moscow and London. So you get that GDR arbitrage opportunity. With Frankfurt, we are beginning to see, some of our clients beginning to treat it as a kind of hub. Part of that is because Deutsche Börse trades so many markets in central and Eastern Europe. As Irina says, people who care about the speed don’t necessarily want to go to Russia. On that last point, clearly some investors remain afraid, or nervous, about actually putting their software in Russia. Do you accept that? Equally, speaking to the Russians, they are increasingly looking eastwards. What are the implications of that? IRINA GLAZKOVA: Actually, some of our Asian clients clearly articulate the concerns over their trading equipment being too far away and say‘we are not there, we don’t know what is happening there.’ TOM O’BRIEN: It is true, we have recently signed a range of memoranda of understandings (MoUs) with Asian exchanges and clearly we’re investigating whether we can do something with them. We’ve looked at how we penetrate into the US and what we do on that side. US is a no go for equities.That’s mainly our business side, CFTC approval for index and contracts. The asset class that actually interests us is currency. What do we do on the FX side? China Japan, Korea, Singapore. It’s just a case of finding out what to do in those spaces. Moscow is actually not in a bad place to offer some sort of currency exchange. Our biggest contract on the futures side, apart from the index is USD/Ruble, though in the short term we have had to face some issues with the decline in the value of the currency post sanctions. Even so, that contract is as big as all the equity market combined, the cash market on just cash and swap is 25 times greater than the equity market. We tend to be overly focused all the time, especially in the UK, around equities but it’s a small part of what we are doing. My interest is really shifting away from equities and looking at what we do around currency. I’m considering what the rouble going through CLS would mean for us and looking at how you do offer settlement and clearing for currencies such as the Renminbi, which is becoming increasingly important. Now we’ve got very good technology, which is pushing us much more to the East really. Our relationships from Russia are with China, and again with Japan. Huge amount of flows on the currency side. Most of that actually comes back through London. But why? A lot of it is pushed into London for a variety of reasons, but one is really around settlement. Technology is just an enable you have to be understanding of what you want to do from a business point of view. Regulation is also a big driver globally. What we do with MiFID II, EMIR, Basel III and so on. What do we do with clearing, settlement, reporting? That really drives our rela-

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tionship with other exchanges. Is Moscow ideally situated now with the change to move to the east? Don’t know how quickly the shift away from the US, a shift away from the UK, into China, Japan, South Korea, and Singapore will be, but clearly sanctions have accelerated that process. Frankly, Moscow sits in a very good geographical space for that shift. London has had a thousand years of history of working with financial markets. Russia, effectively, with the reengagement has only really had three years! It’s not a long time! We just have to look at what we want to do. Our main focus from a Moscow Exchange perspective is how we repatriate trading around rouble denominated assets. That’s FX, futures, equities, repo, corporate bonds, and government debt. Rather than looking at us being global, I think that actually, from a Russia/Moscow exchange point of view, it’s about making sure we are the venue that people recognised for ruble trading. VLADIMIR KURLYANDCHIK: How do you propose to build a financial ecosystem with Asia? IRINA GLAZKOVA: It is a universal issue. Earlier this year I spoke with the Singapore Exchange and this element was key for them too. They really want to have connectivity to as many data centres as possible. They are even thinking about investing in themselves as an exchange into channels and to keep up the fastest channels, upgrading systems and being in the centre of the trading activity. They actually see themselves as London is nowadays because this is somehow, in terms of territory and history, London is the centre point for going West (to the US) and to going East. Singapore now considers itself more as a regional centre and have made a lot of significant steps as a technical centre point for connectivity from the ASEAN area. It is also very well connected with Korea, with Japan, and with Australia. Whoever is collocated in their data centres enjoys one of the lowest latency in the region. So they are constantly thinking of ways to upgrade their technology. VLADIMIR KURLYANDCHIK: We now have live microwave links in London and Frankfurt and New York and Chicago. Longer term, what sort of demand would you expect to see from microwave links between for example Moscow/Stockholm, Frankfurt? Is that what clients are currently asking for, or do you see it farther down the line? TOM O’BRIEN: Frankly, that’s a question about liquidity and you need enough liquidity to make it worthwhile and big markets to make it work. Chicago and New York came first, next it was Frankfurt and London. Is there enough business in Moscow and arbitrage deals going back to London? I’m not so sure. I think the obvious route is to build the network into Frankfurt better and then use the microwave back from Frankfurt to London. So you have 4.1 on Microwave London into FR2, you’re currently probably 36 – 37 and a half from Moscow into FR2. So you’re above where you would be in London. All of these things keep moving every single week. That’s really the problem that Singapore actually finds. Being in the telecoms game is a very hard game. All the evergreen stuff that you have to do to guarantee that stuff means you move away from being

an exchange to being a telecoms provider. I don’t really want Moscow Exchange to get too much involved in that. I think it can be a distraction for an exchange. VLADIMIR KURLYANDCHIK: Next point, what protocols can be used to access the trading engines of Moscow Exchange? Moscow Exchange has two major trading platforms, one is ASTS for stock and currency markets, and SPECTRA for derivatives. Each platform has its own native API, both these APIs provide full functionality in a trading sense and in the sense of receiving market data, special data like market making obligations and so on. At the same time both of the platforms support FIX or order routing for market data dissemination. At the moment there is talk on currency markets using the same unified FIX and the same product will be in production for derivatives by the end of this year. All markets use separate entry points for FIX order routing and separate channels for fast market data dissemination. One important remark is that FIX now provides access only to trading functionality not for clearing, or other specialities. I think we will cover latency a little bit later and my last remark about protocols is that most brokers provide fix connectivity to their clients using different vendor solutions. Usually a client can get the same FIX protocol version for any markets of Moscow Exchange from their broker. Irina, is their client demand for native or FIX connectivity? Which connection do they prefer for market data? IRINA GLAZKOVA: If FIX connectivity could provide this same low latency as native protocols our clients would be happy to stay with FIX. In the majority of cases they don’t want to really have the headache of having too many protocols to operate. The point is some of them, and here we talking about the most experienced clients, and the really qualified ones (with a good HFT history), for them Russia is just one more market to add to their trading strategy. For many of them operating via native protocol is having another competitive edge. As long as it’s there, native protocols will be really in demand. We have clients who go through the hassle of being certified in Moscow Exchange, being certified in LSE. Interestingly quite experienced clients, very experienced in Moscow, tell me how difficult it is to be certified in LSE with their native protocols, sometimes it takes a few months for them to go through the certification process, sometimes its vice versa, suddenly they get a very fast result and they are all very positive. Generally though, if it could be unified, it would be convenient for clients as long as this unification doesn’t kill the competitive edge. If the competitive edge is there, they will go through all the hassles of native protocols. It’s up to client readiness. If they want to be certified everywhere, have native protocols for market data, we are there, it is okay. If the FIX protocol is enough, that’s okay too. TOM O’BRIEN: I think everyone knows that on equities that FIX is faster when it comes to equities. It’s just the design. Most of the reason why FIX is always slower tends to be an add-on to a native protocol that sits under it, so there’s a translation there. That’s not how the equity platform was built. So effectively, both fix and what you term the

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TOM O’BRIEN: If you go to the fastest you’re probably looking at Toronto’s system in a few micros, we’re up around 330. It’s not comparable. LSE is around 120. On our side we do all the risk checks. So it’s not all about speed, some of it is about functionality and how it all actually works. People don’t care that much about it. VLADIMIR KURLYANDCHIK: Another important thing about latency and what people care about is deviation, deviation of latency. From this point of view, FIX for example, is looking like 90% of transactions are under 400micros. It’s a really good result from my point of view and 99% are under 600 micros, so this 10% which is what people care about on Moscow Exchange. Generally, this jitter is not so bad and the numbers appear quite good. Tom O’Brien, head of international sales, Moscow Exchange Photograph © Berlinguer 2014.

native, go through a translation exercise back into the platform. It’s not that fix is always going to be slower. FRANCESCA CARNEVALE: Which does raise the question: is there a plan? I ask because basically ATS is just another protocol. Is your plan to open up a real native protocol? IRINA GLAZKOVA: It’s not only Moscow where it is changing. At the LSE I think that just five or six years ago, FIX was not considered the native protocol, but now they are moving closer to FIX. VLADIMIR KURLYANDCHIK: For market data dissemination players can use FAST channels. The time between receiving confirmation on order and receiving order in market data flow is the following. For equity FIX the average time is 90 micros. FIX is the fastest way for order routing for equity and FX markets.The average latency is 340 micros. For derivatives, the situation is the opposite. As regards SPECTRA, the native protocol is faster, the number is around 600 micros, for transaction latency on colocation. For FIX there are no exact numbers because, as I mentioned a little bit earlier, Moscow Exchange is now in the process of implementing the same FIX version for derivatives they use for fixed and equity market. The expectation is that the protocol will be slower than 100 micros for native for derivatives. FRANCESCA CARNEVALE: Those clients that really care are the same sort of people who say:‘I won’t do proximity I must have colocation, even if it costs more. They will want the native connection surely? TOM O’BRIEN: I think you shouldn’t call it native. I think they’ll always go for the faster one if it doesn’t matter if it’s native. I think the issue that the exchanges have got into is all around choice. Everyone puts FIX in because it’s just an easier protocol to actually build. I think you’ll probably go through a process over the next few years where this will change. It’s not about fix or native it’s about building a connection to the faster one. FRANCESCA CARNEVALE: How does this compare with other exchanges?

FTSE GLOBAL MARKETS • NOVEMBER-DECEMBER 2014

RISK MANAGEMENT: NEW CONSIDERATIONS

VLADIMIR KURLYANDCHIK: When it comes to Russian financial markets, we have different levels of risk management implementation. As Tom already mentioned, at an exchange level, all markets support the opening of separate accounts for end clients, the typical situation is that the broker has an account and CCP for collateral and settlement for all his clients. Equally, though a broker can offer separate accounts for particular clients. In this case, the broker maintains a collateral pool for this account and conducts separate settlement for this account. The exchange has two different risk management systems on board.These risk management systems are encapsulated into trading platforms. One risk management system is SPECTRA proprietary methodology. Another one is used for stock and currency markets and based on haircuts for different instruments. At the moment all three major markets of the Moscow Exchange have separate collateral pools, and one of the main projects for the exchange is to provide a service to optimise collateral. The second level of risk management is at the broker level, usually the broker’s motivation in this process is to provide for the end client a possibility to increase their positions in different markets without increasing market risk. Typically a client can receive collateral management as two opposite flags on Moscow Exchange and LSE in the same instrument. Also, all major prime brokers provide portfolio margining for complex portfolios with stocks, GDRs, futures and options. Usually in this service the client has the possibility to trade using USD on stock market, and use USD for collateral and settlement currency. So all three major markets, equities, derivatives and FX are mixed in brokers’ risk managers systems. Of course, what people in London usually think of as risk management is fat fingers checks, frequency, like the number of allowed securities and so on and so forth. This is also in place in brokerage platforms. TOM O’BRIEN: We’ve gone through a T+0 model which was all pre funded to T+2 model, partial refunded, but you’re always going to err on the side of safety. I think it’s just how

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that actually moves forward. I can see that changing over time. I think our real focus as a group has really moved a bit away from the trading side, into clearing and settlement and about tidying up, reducing costs of settlement, reducing costs of clearing. There are things actually going on around real time gross settlement, moving the accounts, how we actually structure the accounts with the NSD with the corresponding banks that will make all of this movement much simpler. You go back, and coming to this forum I thought it has been a couple of years of ongoing work from Moscow about changing. In reality it is actually less than that, when I look at the completion of the NSD, the merger to the exchange, the coming together of the central counterparty, the change that’s actually going on around settlement. It’s all happened in less than a year. You just have to work through all the changes really. I can see the issues mentioned probably disappearing over the next couple of years. I do come back to the fact that actually a pre funded model is actually a very good model, and I see that it’s something Russia should be proud of. I can see other exchanges globally coming to adopt that model. We’ve had some good conversations with our clients.They know the GDRs, but don’t know the real stocks that well. And actually when you explain how the funding model works, added costs etc, but when we say‘here’s why’ they say they feel fairly safe, the exchanges are going to look after them. IRINA GLAZKOVA: I’d like to interject with a couple of remarks around risk management. Tom didn’t go into too much into detail about the project with Eurex, our experience was that we have quite number of clients who are really big market makers in Russian trading venues, and they were, really avidly waiting for something to launch, something Russia-related to be launched on Eurex, but the problem was, after they started checking the conditions, the problem was that the risk management does not properly exist on the Eurex side, as they used to on the risk management on the Moscow Exchange.They understood that there is always an additional layer of risk management checks which will be minimum by the clearing member which does now exist as a recognised institution in the Moscow exchange, and there is inevitably the expectation that ‘we will always be slower than somebody, than a clearing member itself for example, if they would like to take over the market making functions, we will lose anyway.’ The other thing is that we were talking pre-trade risk management and having collateral prefunded before the trading, I fully understand all exchanges who are thinking about changing their business model into a former Moscow Exchange model. I even understand why brokers would love to keep the same model, the bad news is that however, the clients who were trading US markets, at least via us, LSE, and I used to T+3, expected that this will be T+2 will be like fully T+3, even in terms of settlement, so you are definitely not going to pre deposit anything even less liquid stocks which are still the requirement of the Moscow exchange side.

VLADIMIR KURLYANDCHIK: There are very different variants on different exchanges as to what kind of orders usually exchange trading engine supports. In the Moscow Exchange the situation is quite clear, SPECTRA only supports limit orders and it is very important to know because there are no ways to send a market order directly to a trading engine, but most platforms can emulate market orders for end clients by sending limit with low or high possible price on the derivatives market. The good news is that FIX drop copy service is on the way for the ASTS platform, and for SPECTRA it will be completed by the end of this year. Market participants also may use the native API connection to receive all drop copy from exchange trading platforms. There has also been significant success in resolving related legal questions and the working mechanisms for different platforms on the exchange. Another important element is that there is no kill switch functionality on Moscow Exchange and there are not any plans about introduction of this functionality this year. I think that pressure from market participants about this particular functionality will grow and next year will be the year of implementing this feature. FRANCESCA CARNEVALE: As an outsider looking in, the level of change, reform and upgrades implemented in the Russian market have been impressive. I think the exchange has done what most other exchanges have done over a ten to fifteen year period in about two years. There’s still lots to do and there is no escaping the political questions that surround trading and which have undermined some investor sentiment. That is not our lot to debate, however. Over the long term do you still believe we will see Russia as a major market? IRINA GLAZKOVA: We will be trying to complement anything that Moscow Exchange is doing and other exchanges are doing. We cannot only be focused on Moscow Exchange, we do anything that is Russia related worldwide, plus global instruments as well, but our top focus that we see from all our groups of clients from all types is efficiency of their collateral, use of their collateral, whatever can be netted, should be netted. Whatever should be matched, must be matched. All these things that Moscow Exchange will undertake in the Russian market there is still a lot to do on Russian instruments worldwide. Irrespective of the political situation, we believe this will be the bigger demand within a year and a half for our big international clients, much more important than the low latency alone. Although low latency players are still our biggest source of revenue, this focus is shifting, even for HFTs. VLADIMIR KURLYANDCHIK: My last remark will be about another unique feature of Moscow Exchange - each September over the last eight years, Moscow Exchange, has organised a stress test in a production environment, for all market participants, it’s a very good chance to check all market infrastructure, (trading platforms, brokerage platforms and so on and so forth). I believe the last one was quite successful and so that means that the exchange can

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GM Data pages 79_. 18/12/2014 09:42 Page 62

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% 1.1 2.4

12.0 17.0 14.1

0.8 -0.9

0.6 3.3

2.5

7.4 8.1

-1.8 1.8

COMMODITIES Brent Crude Oil Gold Copper Credit Suisse Commodity Index

-21.2

-10.6

-11.3 -6.6 -8.6

-2.9 0.6 -4.0

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)

4.3 5.5 9.0 10.9

1.4 1.6 0.7 0.6 -0.2

16.6

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

5.7 8.3

0.8 0.4

FX - TRADE WEIGHTED USD GBP EUR JPY

1.3

9.4 6.0

-0.6 -3.5

0.3 -1.7

-15

-10

-5

-9.6

-30

-20

-10

EQUITY MARKET TOTAL RETURNS (LOCAL CURRENCY BASIS) Regions 12M local ccy (TR)

Regions 1M local ccy (TR) Asia Pacific ex Japan BRIC USA Emerging FTSE All-World Developed Japan UK Europe ex UK -1.8

2.5 2.5 2.4 1.8 1.1 1.1 0.8 -0.9

-2

-1

17.0

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

14.1 12.4 12.0 8.1 7.4 4.8 3.3 0.6

-6

-4

-2

5.3 4.7 2.4 1.1 1.1 1.1 0.8 0.4

Denmark Israel USA Finland Sweden Belgium/Lux Japan Canada Developed Spain Switzerland Hong Italy Australia Norway Netherlands Germany Singapore France UK Korea -5.7

0.5 0.2 0.2 -0.1 -0.5 -2.7

Emerging 12M local ccy (TR)

2.5 1.8

-2

34.5 31.5

India Indonesia South Africa Taiwan Mexico Thailand Emerging China Malaysia Brazil Russia -24.1

4.1 4.1 3.9

-4

17.0 14.5 14.2 14.2 14.1 13.4 12.4 10.7 10.4 8.0 6.9 6.8 6.6 5.7 3.4 3.2 2.4 0.6

-10

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

Developed 12M local ccy (TR)

Developed 1M local ccy (TR) Hong Kong Australia USA Israel Developed Sweden Japan Finland Switzerland 0.0 Singapore -0.2 UK -0.9 Germany -1.1 Belgium/Lux -1.2 Denmark -1.3 Netherlands -1.4 Canada -1.7 Korea -2.6 Spain -3.3 France -3.5 Norway -4.2 Italy -5.0

-30

33.8 19.1 18.0 15.4 10.6 9.6 8.1 6.1 2.1 -1.1

-20

-10

Source: FTSE Monthly Markets Brief. Data as at the end of October 2014.

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

GM Data pages 79_. 18/12/2014 09:42 Page 63

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

US Emerging

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

Oil & Gas Health Care Financials 120

Asia Pacific ex-Japan

150

Consumer Goods Industrials Telecommunications Utilities

140 110

130 120

100

110 90

100 90

80 70 Oct 2012

70 Oct 2012

Feb 2013

Jun 2013

Oct 2013

Feb 2014

Jun 2014

Oct 2014

Feb 2013

Jun 2013

Oct 2013

Feb 2014

Jun 2014

Oct 2014

BOND MARKET RETURNS 1M%

12M%

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

1.4

UK (7-10 y)

4.3

1.6

Ger (7-10 y)

5.5

0.7

Japan (7-10 y)

9.0 2.4

0.6 0.6

France (7-10 y) Italy (7-10 y)

10.9

-0.2

16.6

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

1.1

Euro (7-10 y)

6.5

0.7

UK BBB

12.5

0.8

Euro BBB

5.7 8.3

0.4

UK Non Financial

0.9

Euro Non Financial

6.3 7.7

0.5

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

3.8

1.1

-1

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

7.00

6.00

6.00 5.00

5.00 4.00

4.00

3.00

2.00 2.00

1.00 0.00 Oct 2011

Apr 2012

Oct 2012

Apr 2013

Oct 2013

Apr 2014

Oct 2014

1.00 Oct 2009

Oct 2010

Oct 2011

Oct 2012

Oct 2013

Oct 2014

Source: FTSE Monthly Markets Brief. Data as at the end of October 2014.

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2014

GM Data pages 79_. 18/12/2014 09:42 Page 64

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

110

FTSE US

120 115

105 110 105 100 100 95 Oct 2013

95 Jan 2014

Apr 2014

Jul 2014

Oct 2014

Oct 2013

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

Jan 2014

Apr 2014

Jul 2014

Oct 2014

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

FTSE UK

FTSE US Bond

180

FTSE US

220

160

180

140 140 120 100

100

80 Oct 2009

Oct 2010

Oct 2011

Oct 2012

Oct 2013

1M% FTSE UK Index

Oct 2014

8.0

-4

-2

116.6

3.3

1.5

24.2

2.2

Oct 2014

56.3

3.0

1.0

Oct 2013

5Y%

4.8

1.4

FTSE USA Bond

Oct 2012

-1.7

2.4

FTSE UK Bond

Oct 2011

6M%

-1.7

FTSE USA Index

-1

Oct 2010

3M%

-0.9

-2

Oct 2009

-5

22.6

100

Source: FTSE Monthly Markets Brief. Data as at the end of October 2014.

NOVEMBER/DECEMBER 2014 • FTSE GLOBAL MARKETS

150

COVER_78-9.1.qxp_. 17/12/2014 17:02 Page FC1

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