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THE IMPACT OF THE US DOLLAR ON EM DEBT

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OUTLOOK

I EDITORIAL Francesca Carnevale, Editor T: +44 207680 5152; E: francesca@berlinguer.com David Simons, US Editor, E: DavidtSimons@gmail.com CORRESPONDENTS Lynn Strongin Dodds (Editor at Large); Ruth Hughes Liley (Trading Editor); Vanja Dragomanovich (Commodities); Neil O’Hara (US Securities Services); Mark Faithfull (Real Estate). PRODUCTION Andrew Lawson, Head of Production T: +44 207 680 5161; E: andrew.lawson@berlinguer.com Lee Dove, Production Manager T: 01206 795546; E: studio@alphaprint.co.uk OPERATIONS Christopher Maityard, Publishing Director T: +44 207 680 5162; E: chris.maityard@berlinguer.com CLIENT SOLUTIONS Marshall Leddy, North America Sales Director T: +1 612 234 7436, E: marshall@leddyassociates.com OVERSEAS REPRESENTATION Can Sonmez (Istanbul, Turkey) FTSE EDITORIAL BOARD Mark Makepeace (CEO); Donald Keith; Chris Woods; Jonathan Cooper; Jessie Pak; Jonathan Horton PUBLISHED BY Berlinguer Ltd, 1st Floor, Rennie House, 57-60 Aldgate High Street, London EC3N 1AL Switchboard: +44 [0]20 7680 5151 www.berlinguer.com PRINTED BY Headley Brothers Ltd, The Invicta Press, Queens Road, Ashford, Kent TN24 8HH DISTRIBUTION Postal Logistics International, Units 39-43 Waterside Trading Estates, Trumpers Way, London W7 2QD TO SECURE YOUR OWN SUBSCRIPTION Please enrol on www.ftseglobalmarkets.com Single subscription: £87.00 which includes online access, print subscription and weekly e-alert FTSE Global Markets is published 6 times a year. No part of this publication may be reproduced or used in any form of advertising without the express permission of Berlinguer Ltd. [Copyright Berlinguer Ltd 2014. All rights reserved). FTSE™ is a trademark of the London Stock Exchange plc and the Financial Times Limited and is used by Berlinguer Ltd under licence. FTSE International Limited would like to stress that the contents, opinions and sentiments expressed in the articles and features contained in FTSE Global Markets do not represent FTSE International Limited’s ideas and opinions. The articles are commissioned independently from FTSE International Limited and represent only the ideas and opinions of the contributing writers and editors. All information in this magazine is provided for information purposes only. Every effort is made to ensure that any and all information given in this publication is accurate, but no responsibility or liability can be accepted by FTSE International Limited and Berlinguer Ltd, for any errors, or omissions or for any loss arising from the use of this publication. All copyright and database rights in the FTSE Indices belong to FTSE International Limited or Berlinguer Ltd or its licensors. Reproduction of the data comprising the FTSE indices is not permitted. You agree to comply with any restrictions or conditions imposed upon the use, access, or storage of the data as may be notified to you by FTSE International Limited, or Berlinguer Ltd and you may be required to enter into a separate agreement with FTSE International Limited and Berlinguer Ltd.

F THERE IS one overarching theme in this edition it is about moves by regulators and associations to adopt global, harmonised standards of reporting across the spectrum of financial services. Among the latest initiatives on the table, in June, the European Council presidency and the European Parliament reached an agreement on a regulation to improve the transparency of securities lending and repurchase transactions. The regulation has the goal of enhancing financial stability by ensuring that information on securities financing transactions is efficiently reported to trade repositories and investors in collective investment undertakings. Improved transparency will prevent banks and other financial intermediaries from attempting to circumvent regulation by shifting parts of their activities to the less-regulated shadow banking sector. The draft regulation introduces measures to improve transparency in three areas: the monitoring of the build-up of systemic risks in the financial system related to securities financing transactions; the disclosure of information on such transactions to investors whose assets are employed in the transactions; and rehypothecation activities, where market participants re-use collateral pledged by their clients. Elsewhere and highlighted in this issue is the call by the International Swaps and Derivatives Association (ISDA) to inculcate a global set of principles covering the reporting of derivatives trades. Market associations and post trade market institutions (read the US Depositary Trust and Clearing Corporation, or DTCC) have rushed to establish benchmark rules and initiatives in order to set and dominate the process. ISDA principles specifically call for derivatives reporting requirements to be harmonised across borders, and for the further development and adoption of global data standards, among other things. The principles were developed to address challenges that have emerged in the cross-border implementation of derivatives reporting rules. Significant progress has been made in meeting a G-20 requirement for all derivatives to be reported to trade repositories to increase regulatory transparency. However, a lack of standardisation and consistency in reporting requirements within and across jurisdictions has led to concerns about the quality of the data being reported. Differences in reporting requirements also increase the cost and complexity for firms that have reporting obligations in multiple jurisdictions. Policy makers too must embrace this complexity and harness initiatives such as legal entity identifiers (LEIs), unique trade identifiers (UTIs), unique product identifiers (UPIs) and existing messaging standards (for example, FpML, ISO, FIX) – to drive improved quality and consistency in meeting reporting requirements. Another theme to follow in the issue is the growing belief that markets and asset allocation in the second half of the year will increasingly be influenced by the understanding that US interest rates will, at some point, begin to rise. The only question is: how soon? Although any rate rises will likely be modest in scope and gradual in their implementation, investors in sovereign debt in both or either advanced or emerging markets have much to consider in their approaches to the purchases of sovereign bonds. The Federal Reserve has much to consider in making its first move to raise rates: an international as well as domestic agenda and on that basis, we think the central bank will move very slowly indeed, and most likely wait until next year. Francesca Carnevale, Editor

ISSN: 1742-6650 Journalistic code set by the Munich Declaration.

COVER PHOTO: Photograph of Daron Pearce, Head of Global Finnancial Institutions EMEA at BNY Mellon Asset Servicing Photograph kindly supplied by BNY Mellon June 2015.

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CONTENTS COVER STORY

TRANSFORMATIONAL INVESTMENT SERVICES

...............................................Page 4 Technology and big data is changing the terms of service for global custodians. Not everyone can compete in this space and BNY Mellon as the world’s largest custodian can clearly play with the big boys. Does it mean that the rest of the world is left with crumbs? BNY Mellon’s head of Head of Global Financial Institutions EMEA Daron Pearce, explains the business’ new dynamics and what it means for clients.

DEPARTMENTS

MARKET LEADER

SPANNING THE REAL ASSET INVESTMENT GAP .....................................Page 8 THE GROWTH OF PRIVATE FINANCE IN EM INFRASTRUCTURE.....Page 12

VANTAGE POINT

PREPARING FOR THE NEW MARKET LEADERS .......................................Page 14

SPOTLIGHT

CREDITOR ENGAGEMENT CLAUSES AND OTHER STORIES ...........Page 16

BELVEDERE

IS US DOMINANCE A GOOD THING? .............................................................Page 20 UK DB LIABILITIES OUTSTRIP UK GDP ...........................................................Page 22 HAS ESMA GONE TOO FAR ON ASSET SEGREGATION .....................Page 26

IN THE MARKET

BEYOND THE GOLD STANDARD .......................................................................Page 29 SHIFTING SANDS AND TRADE EXECUTION ...............................................Page 30 MOZAMBIQUE MOVES TO BUILD LNG FRANCHISE ...........................Page 31 GLOBAL DATA HARMONISATION: NEW DRIVER

COUNTRY/REGIONAL REPORTS

GCC BANKS KEEP DCM TICKING OVER ................................................................Page 34

COMMODITIES

MANAGING THE INTERPLAY BETWEEN OIL STOCKS AND PRICES ..Page 42

PAYMENTS

REAL TIME PAYMENTS: ABOUT TIME TOO!

..................................................Page 45

KEEPING TRANSACTION REPORTING UP TO SCRATCH ........................Page 50

DEBT REPORTS

THE PICK UP IN PRIVATE FINANCE IN CLIMATE CHANGE ................Page 47

THE LAST WORD MARKET DATA

TURKEY’S ELECTION RESULTS RAISE THE POLITICAL STAKES ......Page 36

TRANSACTION REPORTING

INVESTMENT SERVICES ..

......................................Page 35

CAN FIRMS AFFORD TO COMPLY WITH TRADE REPORTING ..........Page 51 A FIX FOR FIXED INCOME?................................................................................................Page 57 WHAT’S HAPPENED TO PRIME BROKERAGE?

............................................Page 54

WHY IS THERE INVESTOR CONCENTRATION IN HEDGE FUNDS? ..Page 56 THE IMPACT OF US DOLLAR RATES ON EM DEBT

..................................Page 60

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

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COVER STORY NEW APPROACHES TO CLIENT SERVICES Photograph of Daron Pearce, Head of Global Finnancial Institutions EMEA at BNY Mellon Asset Servicing Photograph kindly supplied by BNY Mellon June 2015.

New age investment services: Transforming the client’s business spectrum There’s a new paradigm in investor services. FTSE Global Markets spoke to Daron Pearce, Head of Global Financial Institutions EMEA at BNY Mellon Asset Servicing about the evolution of the investment services business set and what it means, long term, for the bank’s clients. Backed by advances in technology the bank now mines a rich seam in ground-breaking client services based on indepth analytics that help its clients better understand the world in which they operate and help them develop new ways to leverage their expertise to service their own customers.

ECHNOLOGY AS A business facilitator is now front and centre of the investment services story. In part it involves bolstering the analytics

available to clients; and in part it involves both efficiencies in process and standardisation – and therefore predictability and transparency – in transactions and oper-

ations. However, it also changes the way that financial services providers now interact with their clients and helps investment services providers redefine their overall service offering. It is a mantra that has resonance, says Pearce: “Bearing in mind that our focus is on serving our clients, being a technology leader in our space, being the best quality service provider, and being most aligned with our clients’ objectives among our peers. Technology leadership is a very important consideration for us and we are going through a process now of structuring ourselves for long term success.” How each player in the investment services space responds to the march of progress could fill an encyclopaedia; but ultimately it depends on the firm’s strategy as well as legacy business and technology considerations. Regardless, the demands of the new world economic order is propelling market players to new alliances and acquisitions to absorb innovations and adapt to change ever more swiftly. Explains Pearce: “If you look at our story, BNY Mellon is the product of more M&A activity than I can even remember. My first exposure to BNY Mellon was when they acquired the global custody business and the master custody business from JP Morgan in 1996. Since then, there have been some 100 pieces of M&A activity of varying size, so over the years we became a complicated, in some parts disparate, organisation, albeit one with a very sophisticated and client focused capability.” Rationalising that complexity is now very much the company’s goal.“While we have not completed the task of turning that into a slick, single homogenised capability, doing so is our primary focus at the moment: through a process of continuous business improvement, we are embedding strong discipline into the business: doing it once, doing it right – and doing it for scale.” Once those new foundation stones are firmly in place, the company will be positioned to push even harder on where it can really add value to the customer. As Pearce explains: “For a productive conversation, you need to be bringing fresh insights,

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value, and access to new markets, alongside new technology that clients can use to better support their own end-client. . It turns on one simple question: what more can we do together?” When added value is the game, a hightouch service model must be a given. BNY Mellon has a very sophisticated coverage model, says Pearce:“If you look at our top 100 clients, our Executive Committee members are each dedicated to working with one or two of the very largest clients with a view to ensuring that the conversation really is around value, that untapped opportunities for those clients are being fully explored, and that we are raising the bar in respect of our competitors around the more standardised services that we offer our clients”. While he acknowledges that standardisation is an important business pillar, Pearce is firm that it does not merely mean reducing services down to a common denominator: “Far from it. It actually allows firms to build flexibility into the service engines. Once you create that common architecture, it frees up capital to invest in the next big thing: innovation, digitisation, new markets, new asset classes and new ways of doing business. All of that can be properly leveraged once your infrastructure is built for purpose and scale,” he explains.

Growth and big data It is a given in these post-post recessionary times that shifts in the investment landscape are dramatic and invariably have an international, if not global dimension. The investment world is perforce more complex and fluid; it is increasingly fragmented to suit a multiasset, multi-national universe. In that sense, you can see the logic of asset managers wanting consistency, predictability (where possible) and the right kind of analytics that give them comfort in making decisions. Today, conversations with clients are highly charged around issues such as business efficiency, growth, investment performance and distribution, says Pearce. Growth is a constant theme and now there is a big data story attached to that, he adds:

F T S E G L O B A L M A R K E T S • M AY / J U N E 2 0 1 5

What particularly engages Pearce is tomorrow’s world and technological innovation, whether that be the impact of ultra-low latency data transfer and data manipulation or the impact of block chain technology.

“Managers are waking up to the fact that if they use the data that is inherent within their investment portfolios or in client portfolios in the right way, they will generate fresh insights that they don’t get today. That presents us with the opportunity to be unique in how we help those managers. Whether it is an investment book of record, or a distribution book of record, or an accounting book or whether it is the custody view, there are many different ways of viewing the portfolios and mining that data to bring fresh insights.” Institutions can leverage big data to store large volumes of historical market data to feed trading, predictive models and forecasts, and perform analytics on complex securities, using reference data, market and transaction analysis from multiple sources. Essentially BNY Mellon can now provide previously untapped information to a manager to give insights around who is buying their product and the type of investor that they are capturing. It is “transformative,” says Pearce: “It is invaluable to the client in terms of where they target their firepower in terms of determining which demographics they do reach and where they are not hitting their marks. But you have to have the right platform and capability, structure and technology to do the right kind of mining.” As the market has turned from a post recessionary period into a time of increased market regulation and scrutiny, doing business has become a more acutely balanced trade-off between risk and reward, says Pearce, and BNY Mellon has already come to terms with the hard decisions it needs to make.

The byword now is focus, with the company leveraging existing strengths while scaling back or even exiting (as was the case with transition management) those activities where the potential for profitable growth is limited. Pearce is pragmatic about the lessons taught by the financial crash: “I am proud of the way we responded to the challenge. As a GSIFI, we came under massive scrutiny at a testing time when we suffered a reduction in our earnings. The company reacted well and utilised its capital strength and power base to buy businesses that have added to the institution’s service depth.” Among the key acquisitions the bank made were PNC’s investor services business, Insight Investment Management – “the fastest growing LDI manager on the planet,” says Pearce – “and hedge fund administration and analytics specialist HedgeMark. “All in all, I’d venture we managed the crisis incredibly well and came out of it stronger than anyone,”he says. Aligning with winners There’s a logical strategic imperative behind the tactics. “We want to be top three in everything we do, and where we are not, we have a plan to get there – and if we can’t see a plan to take us there, then there is a strong likelihood that we will exit. We have to do that not because of vanity, but because we won’t get the return on capital we need in the current regulatory environment to make it worthwhile,” expands Pearce. Technology is fundamental to supporting and driving BNY Mellon’s growth plans; there is a renewed commitment to investing and focus in the right spaces. Pearce believes that the connectivity in the business and model insights, “gives us the edge in thinking about how we leverage the data insights that the model gives us – and we are winning the race in bringing that to market. We help our clients solve their problems, rather than focusing on selling them a particular service or product.” As Pearce describes it, there is “something of an arms race” in effect. “If you are not in a position to help your clients

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COVERY STORY NEW APPROACHES TO CLIENT SERVICES

meet their regulatory burden, or to meet the regulatory burdens that are now placed on you as a service provider and to keep investing in infrastructure, then maybe you are not fit for the long term in this business. For example, UCITS V is coming up – can you be first to market with a compliant solution? If you can’t deliver quickly and effectively, you need to seriously question your commitment to the business. That is just simple economics.” This pragmatism has helped the bank define with precision which market segments it aligns with; the reality is that today it is focusing on the largest asset gatherers and institutional investors.“We have the largest asset pool as a custodian in the world, $28.5trn,” acknowledges Pearce,“The reality is that the very biggest asset gatherers are getting bigger and the smallest are doing well, but there is a squeezed middle. The large asset gatherers can easily do multi-product and multi-region, while and at the other end of the spectrum the boutiques are specialised and focused. However the firms in the middle do not have the scale that is required and are susceptible to having the larger players pick off anything that provides long term benefit.” In today’s world then you have to have big revenue streams to deliver new product development and innovation. The question then for BNY Mellon is how it responds to the rest of the market. “. Aligning with the long term winners is obviously a good strategy and we have pivoted our client services coverage model accordingly, though that’s not to say we won’t service the smaller outfits, as long as it is profitable business,” is Pearce’s succinct analysis of the bank’s sales focus. Pearce recognises that his business cannot stand still. Competition and heightened regulatory requirements continue to change the mix of providers with utilities, such as Clearstream, the DTCC and Euroclear, which have the financial heft, global strategic relationships and access to collateral assets, now beginning to make a play in the traditional custodian space, assisted by regulations such as Target2Securities (T2S) in Europe. “There will be more competition

between investment services companies and utilities. It is a feature that Pearce says he does not find frightening, for two reasons. “One, we are already part of the Euroclear/DTCC infrastructure, in fact probably one of their biggest clients, and over time they are moving into a space where they are more a competitor of ours. Now I would back us every time, given our depth of capability, people and investment spend. But competition is good, it is a natural feature of our new world and it should encourage us to constantly review what we are doing and why,” he avers. Secondly, he highlights the fact that BNY Mellon is a self-sustaining universe of sorts. “We have our own diversified business lines and a huge investment business (we are the world’s fifth largest asset management firm) encompassing 12 different boutiques. It seems unlikely that we cannot delve into our group and pick out expertise that can provide solutions for our clients. And should a client want a certain investment profile that includes a country capability or asset class that falls outside our remit, we would be happy to partner with someone who has that specific capability. We might have 90% of a solution; another firm might have 10% - ultimately, whether you are a service provider, asset manager or broker-dealer, the key is to focus on being the best at what you are good at and tap into others to be really strong in the things you’re not. That is the way forward.”

The future What particularly engages Pearce is tomorrow’s world and technological innovation, whether that be the impact of ultra-low latency data transfer and data manipulation or the impact of block chain technology.“That is something I am really excited about,” he says. “I think it will be one of the biggest game-changers since the advent of the personal computer. We are a holder of assets for other people, so if the block chain makes that unnecessary, then that means our business will be forced to change. It is not bitcoin itself that is the issue– it is the concept of not having to maintain a separate record that

“While we have not completed the task of turning that into a slick, single homogenised capability, doing so is our primary focus at the moment: through a process of continuous business improvement, we are embedding strong discipline into the business: doing it once, doing it right – and doing it for scale,” says Pearce

may make the need for certain types of records redundant. We have woken up to its potential and we are beginning to harness some ideas around it, though clearly it is in its infancy right now.” Another spur is what the future of ‘robo-advisors’ might mean for the investment services business over the long term. “The provision of electronically tailored advice on pre-determined information fed into a website, is already being harnessed by the wealth industry,” adds Pearce.“We are certainly looking at what additional automation might mean for our wider business. It is a case of watch this space.” Looking to the future, Pearce returns to the theme of building“veracity around repeatability” in the business, and the dynamic that transforms a one-off solution for one large client into a solution for the market at large. This model is central to the company’s strategy and is borne out by the arrangements BNY Mellon has forged with Deutsche Asset & Wealth Management and most recently with T. Rowe Price. “We're aligning with world-class anchor clients to make big strategic platform investments in what we perceive to be markets with strong growth dynamics,” he says. “Those strategic platforms will create shared economies of scale which benefit our clients and our shareholders in the long term, and we are confident that these long-term returns and growth opportunities they represent an important investments in the future of our business.” n

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

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ĂŶĂůǇƐŝƐ ŝŶƚŽ ĂĐƟ ŽŶ

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MARKET LEADER THE GROWING APPEAL OF REAL ASSETS

Photograph © Boris Djuranovic/Dreamstime.com, supplied April 2015.

SPANNING THE REAL ASSET INVESTMENT GAP Frustrated by low interest rates, investors are looking to secure long-term returns by investing in real assets, primarily infrastructure projects but also real estate development and management, and certain commodities. With governments and municipalities struggling to reduce debt levels, public-private partnerships (PPPs) offer private investors access to opportunities while politicians can attain the funding they need to support growth. Investing in real assets can expose investors to well-grounded returns but also unquantifiable risks from political corruption to environmental issues. Dan Barnes looks at the opportunities and pitfalls.

NVESTMENT MANAGEMENT FIRMS see a growing appetite for real assets among end investors. In October 2014 a global study of 201 executives from institutional investors commissioned by BlackRock found that 96% of investors had real estate assets with over 50% planning to expand on that over the next 18 months and 66% had infrastructure investments with nearly 60% expanding over the next 18 months. More recently, in a 2015 survey of 169 of its largest institutional clients representing US$8 trillion in assets under management (AUM), BlackRock found that six in 10 anticipate increasing allocations to real assets and 50% plan to add to real estate and private equity 47%, while 26% anticipate decreasing allocations to cash and 39% plan to decrease investment in fixed income. Institutions including life insurers, sovereign wealth funds and pension funds that are seeking long life liability

and are able to handle the illiquidity inherently associated with infrastructure projects are well suited to this heterogeneous asset class, but also family offices and general insurers with shorter term horizons can be open to allocations of between 3% to 10%. Bernie McNamara, executive director for Global Real Assets at JP Morgan Asset Management sets the scene.“The unifying themes are a search for income, whether a pension plan or an insurance company. Given where rates are and will continue to be for some time, the ability to generate return from what we would consider to be core or core plus type of real assets is a persistent area of interest for investors,” he says. According to Bill Hughes, head of real assets at Legal & General Investment Management, “Two factors driving increased private investment in real assets have been the level of government indebtedness and the retrenchment of the banks.

Investors have become more motivated to consider the style of investment returns. In real assets you have a relatively attractive level of income and predictable growth based on tangible assets delivering return with low correlation and relatively intensive management. In anticipation of low levels of liquidity, real assets make sense for long-term investors within a wider investment portfolio.” The nature of real assets – being fixed, requiring active asset management and investment in real estate and infrastructure – requires an entirely different set of skills and resources than other investments. According to Tim Stringer, senior consultant at asset consultancy Frontier Advisors, “The beauty of that is you can actually change the outcome through having superior skill and experience.” The challenge for investors can be the considerable management and expertise needed to deal with projects; the assessment of risk is far more complex than for

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standardised products such as securities and they are highly illiquid, requiring investors to take a very long-term view. Martin Bellamy, chief executive at Merchant Bank and operational risk specialist Salamanca Group, says,“Assessing the risk in some of these markets is very difficult; if you are going to go into developing markets you have got to be prepared to be in there for the long term and you have got to have what we term ‘patient capital’.” While a power plant might appear to be a solid piece of infrastructure and a physical asset, Barry observes that it can actually be anywhere on the risk/return spectrum depending on where in its lifecycle an investor acquires it and its contractual and other specific characteristics.“If I bought that asset operating for three or four years with GE equipment at a 15-year contract for the power and matching gas contract that’s a classic infrastructure asset; if I bought that same asset just shy of construction so there is still some development risk and maybe I am going merchant on the gas and on the power, I am taking significant risk exposure on that,” explains Jim Barry, global head of BlackRock Infrastructure Investment Group. The risk matrix in investing in infrastructure projects or real assets is complex and nuanced. Salamanca Group explains that it invests with its clients in a range of real assets including mining, heavy industry, manufacturing and real estate. One of the other ways it thinks about the risks is to follow the terminology that the energy industry use by calling them Above Ground risks. This generally refers to non-technical risks that may adversely impact an asset/investment/project and they generally take the form of environmental issues, regulatory climate, political risk, corporate risk, counter-party risk, security, corporate governance, efficiency of the legal system, pro-business policies and bribery and corruption. After a list like that, it should come as no surprise then that investors newly into the space typically look at the low-risk end of the spectrum, with projects that involve either build-operate-transfer

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(BOT) structures in which the private partner has a fixed period of ownership, or build-own-operate-transfer (BOOT) where the private entity has full ownership of the asset for a fixed period of time before the asset is ultimately transferred back to the project sponsor. If it is a build-own-operation (BOO), then the asset stays with private partner.

Brownfield assets Jim Barry, global head of BlackRock Infrastructure Investment Group says,“Most institutions that get into this asset class aren’t looking for private equity, they are looking for brown field operating assets to invest in, what they call classic core infrastructure, which would potentially have lower returns against higher risk products but are still attractive on a risk assessment basis. That’s the natural starting point, for example the classic UK PPP.” As investors feel they are maturing they may take on additional risk to increase returns, such as an element of construction risk or more operating or revenue risk. The next level of investment, termed ‘core plus’ typically covers developed markets and might include low sovereign risk, green field operating assets, more merchant exposure on the revenues. From there a firm might increase its exposures by acquiring a company that has assets instead of individual assets with more operating leverage to generate higher returns. “More sophisticated investors look for higher return and yield by going into that space,” says Barry. “The next level is opportunistic but I think that by the time you get to that level you need to be careful you don’t drift into private equity levels of risk. You may have infrastructure underlying it but the level of risk exposure moves you into the private equity space.” In some national markets the maturity of the public-private partnership (PPP) model has been successful in supporting investors and governmental bodies jointly to develop infrastructure. The UK found the need for an innovative financing model after London and Continental Railways (LCR) was awarded the contract for construction of the channel tunnel rail

link and control of the European passenger services rail company Eurostar UK, which operates services from London Waterloo to Paris and Brussels and latterly the HS1 line to St Pancras station. John Prescott, the British deputy prime minister recorded in his autobiography that LCR came to see him in May 1997 to ask for £1.5bn from the UK government in two months to avoid a default. He wrote that, “The only way to move forward was to take the Rail Link back somehow into public ownership, and therefore be in control. It was too late to put it out to tender and find a new company who might complete it … So I kept the existing company but got new people to run it and new engineers.” In order to deal with the firm’s £2bn of debt which the government had to take on, Prescott wrote, “The Treasury agreed on a system of bond financing ... to get the project up and running again.” On June 3rd 1998 he announced that the UK government had signed a public private partnership (PPP) with LCR and Railtrack under which the public took a stakeholder share in LCR, yielding a 35% share of the company's pre-tax surplus after 2020, and a 5% stake in the Eurostar management company. Situations where public sector money has carried the risk is not a comfortable one says Hughes. “A better regime is where the government acts as a catalyst, with gap funding and providing some certainty of outcome. Capital investing alongside the government puts less capital at risk,” he avers. However political attitudes to PPP differ enormously between countries. In Germany the Kreditanstalt für Wiederaufbau (KfW) uses government guaranteed bonds as funding to provide loans for development at better rates than commercial banks, for investment in tangible assets. However political resistance to the PPP model means that KfW finds overseas markets more accessible than the local market. By contrast Turkey has seen considerable investment in infrastructure due to a broad consensus across the political spectrum. It has been the recipient of €5bn in investment from the European

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MARKET LEADER THE GROWING APPEAL OF REAL ASSETS

Bank for Reconstruction and Development (EBRD) over the last six years, with a further €1.75bn target for 2015. That makes it the recipient of the largest single investment the bank has made in any national market, and the EBRD has also mobilised other sources to deliver a further €12bn. Jean-Patrick Marquet, the director for Turkey at the European Bank for Reconstruction and Development (EBRD) says “You have to factor political risk in, like in any other country and of course the risk is not nil in Turkey, but at the same time there has been a lot of stability over the years and there is no obvious factor that would unsettle that stability. There is a pretty broad consensus in the governing party and beyond the governing party in favour of infrastructure investment, in favour of PPP.” Despite this enthusiasm, globally the market is not flooded with opportunities says Thomas Alberghina, head of syndications at KfW IPEX Bank, the overseas development bank arm of the group. “In active PPP markets like Australia no more than 10% of public infrastructure has been procured by a PPP,” he says. “In Germany according to a most recent statistic, 1.3 % have been procured via PPP. So if we talk about PPP and the involvement of private money we are always talking about a very small piece of the overall market.” Alberghina notes that although interest in such assets has dramatically increased, “The number of deals concluded on a worldwide basis has substantially pulled down. Australia is the most vivid market, and it should be noted that most recently a number of projects have been withdrawn by the public so that even this market is deteriorating quickly. The second largest market is Canada but the situation in Germany is utterly disappointing because PPP as a procurement type is not well accepted by either the politicians or their constituency.” A study of North American and European investors by Frontier Advisors in June 2014 found that fund managers in both regions were finding infrastructure deals tougher to close with significant

amounts of up-front work required. Completion was more likely where the approach was made by a buyer and as a result investors spent greater amounts of time formulating the deal and the management team prior to making an approach. Core real asset markets were considered highly competitive and very expensive with the infrastructure sector expected to see pricing increase as, “the unofficial 9%-10% required return threshold that many investors benchmark against (either directly or loosely) has been breached” while prime assets in property markets were noted to be transacting at very tight yields. The study cited the sale of Lend Lease’s 30% stake in the Bluewater shopping centre in the UK on a 3.85% yield.

Real estate on fire Bellamy says, “The real estate market in London is on fire. It is also an unbelievably sophisticated market, one of the top three in the world. Nevertheless as long as the investor feels it is getting assets in the right place with the right type of covenants for the right period of time they still see it as a viable investment, even with entry yields of between 300 basis points to 400 basis points.” However where investors are frustrated in finding opportunities in developed markets, they may look farther afield to developing markets where returns are higher and completion is less. McNamara says,“If you look across Asia over the next five years or so there is an estimated $750bn to $1trn worth of new infrastructure investment needed per year. And governments themselves will not be able to fund that bill. So a country like India, particularly on the heels of the election last year with Prime Minister Modi and national mandate essentially to focus on infrastructure expansion and improvement, is welcoming private capital and working very much in partnership with private capital for example on the development of the national highway systems.” As the real asset class has got more attractive, more capital has flowed in and returns are compressed. There is a danger

that as investors are unable to get returns they want, they extend themselves too far. The developing markets have more attractive returns than in developed markets because the risks involved cannot be priced says Martin Devenish, group head of strategy at Salamanca Group. “One of the reasons investors want a 25 per cent ROI in Africa is because they figure they need that extra 15% over a 10% ROI in Europe as a buffer when stuff goes wrong,” he says. “If you could price and mitigate some of these risks you can offset them. When you think about investing in emerging markets there are different types of risks you need to think about and if there is nothing that you could buy off the shelf that mitigates it for you, you have got to get yourself very well informed so you are making educated judgement calls.” Mitigation might require putting physical protection in place or ensuring that information lines are opened with diplomatic channels so that any political or social developments that are a cause for concern can be flagged up early. Investors from developed markets must not carry assumptions doing business from their home markets to developing markets warns Bellamy. “The UK is attractive to invest in because investors trust the integrity of the system, they trust in the rule of law,”he says. Marquet notes that in Turkey long-term relationships are important to support successful investment but a broader perspective is also needed. “Even more important is to know where to go and where not to go. It’s not something you can do overnight. It takes a lot of experience, a lot of understanding and therefore you really need to be a longterm player to have this kind of insight. It is essential to be on the ground.” Barry says that investors and investment managers are beginning to bleed up the risk curve. “That’s okay if that’s what you are looking for in terms of risk exposure, but it’s not okay if you are retaining the same risk that’s in core/core plus. That clarity of thinking is absolutely critical,” he says. n

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24th ANNUAL

SECURITIES FINANCE AND COLLATERAL MANAGEMENT CONFERENCE 23 - 25 June 2015 Epic Sana, Lisbon Portugal

ISLA is delighted to announce its two keynote speakers for this year’s 24th Annual ^ĞĐƵƌŝƟ ĞƐ &ŝŶĂŶĐĞ ĂŶĚ ŽůůĂƚĞƌĂů DĂŶĂŐĞŵĞŶƚ ŽŶĨĞƌĞŶĐĞ. The opening keynote speech will be given by ƌŝƐƟ ŶĂ ĂƐĂůŝŶŚŽ, Chairman & CEO at the Portuguese Treasury and Debt Management Agency and the conference will conclude with a speech by ^ŝƌ ůŝǀĞ tŽŽĚǁĂƌĚ K , Former England Rugby Coach and Winner of the 2003 World Cup.

SPECIAL KEYNOTE ADDRESSES Cristina Casalinho

Sir Clive Woodward OBE

Chairman & CEO

Former England Rugby Coach and Winner of the 2003 World Cup

Portuguese Treasury and Debt Management Agency

FOR ALL CONFERENCE INFORMATION

FULL AGENDA LIVE

Email: isla@eventrock.co.uk Tel: +44 (0) 208 288 7738 Web: www.isla.co.uk/isla2015

Moderators and speakers have now been announced! For all the latest agenda developments join our linkedin group.

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MARKET LEADER THE GROWING APPEAL OF REAL ASSETS

World Bank says emerging markets infrastructure finds $107bn of private finance

Total infrastructure investments in 139 emerging economies – for projects with private participation in the energy, transport and water sectors – rose to $107.5bn last year, driven largely by increasing activity in Brazil, according to the World Bank.

“Our update reveals that the top five countries with the highest investment commitments in 2014 are Brazil, Turkey, Peru, Colombia and India,” says Clive Harris, practice manager, Public-Private Partnerships, World Bank Group. “These five countries together attracted $78bn, representing 73% of the investment commitments in the developing world in 2014.” An uptick in infrastructure spend in Latin America and the Caribbean (LAC) region, meant that the region managed to capture $69.1bn of private finance— much of which is attributable to investment commitments in Brazil, Colombia and Peru, which together accounted for 55% of the global total. Brazil is a long term story, as the country managed to capture up to 24% of global investment in 2013 and 42% in 2012. Meanwhile, Peru completed eleven deals, totalling $8.1bn last year, of which eight were in energy, and the others in infrastructure, including a $5.3bn investment in Lima’s Metro Line 2 project. Even given this hive of activity around infrastructure investment in emerging and frontier markets, the total value of investments over the year is still well below the average for the 2009-2013 period, which managed to attract an average $117bn of private investment each year. Private investment in infrastructure in China and India suffered the largest drop. In China, only $2.5bn was invested (the lowest level since 2010. Investment commitments in India also waned in 2014, dropping to $6.2bn. Sub-Saharan Africa saw an especially steep fall from $9.3bn in 2013 to $2.6bn last year, because of a drop in activity in the energy sector. However, 2014’s figure was closer to levels seen before 2012, and the emergence of activities in countries such as Ghana, Kenya, and

Senegal is particularly encouraging. Regionally, LAC led the other regions, followed by Europe and Central Asia (ECA); East Asia and Pacific (EAP); South Asia (SAR); and the Middle East and North Africa (MNA). Sub-Saharan Africa (AFR) experienced the lowest amount of investment. The Middle East and North Africa (MNA) region, which had a much smaller total of commitments of $3.3bn, also saw increases compared to the previous year.

Transport trumps energy Although the energy sector had the largest number of new projects, the sector with the greatest total of investment commitments was the transport sector, receiving $55.3bn, accounting for just over half of global private sector investment commitments. However, consistent with a trend noted in previous years, roads attracted the most investment commitments with $28.5bin in 33 projects, about the same number as in 2013. Four out of the top five road projects were in Brazil, with the fifth-largest project in Turkey. Airports captured the second-highest investment commitments total with $13.2bn devoted to five projects. According to a recent conference held by the EBRD in Tbilisi, the private sector will have to play a significant role in financing the infrastructure that is needed to lead the global economy back to a path of sustained growth. EBRD President Sir Suma Chakrabarti told the conference that infrastructure requirements were huge and likely to rise to around $500bn a year just in the 36 countries where the EBRD works. Cavit Da da Undersecretary of the Turkish Treasury, who co-hosted the conference with the EBRD and the Reinventing Bretton Woods Committee, said: “Lifting infrastructure investments is a multipart

task which involves collective and coherent action by all stakeholders.”. Turkey currently holds the presidency of the G20 countries and has placed a very high priority during its term in helping to close the global infrastructure gap. Undersecretary Dagdas, who is also the governor of the EBRD for Turkey, said the infrastructure gap had widened as investment levels dropped in reaction to the global crisis. Turkey, he says, is focusing on mobilising long-term private finance sources and also emphasising the importance of diversifying the sources of finance to fund infrastructure development. Important to this agenda is green infrastructure that protects the global environmental heritage. According to Aaron Bielenberg of McKinsey & Company, the additional cost of greening infrastructure globally will amount to $4trn trillion between 20152030, but will generate an operating saving of as much $ 5trn; the challenge in doing so involves solving problems around affordability, efficiency and the cost of financing and risk mitigation for lenders. Clearly then, as EBRD Vice President Philippe Le Houérou noted in the conference’s closing address, in in public infrastructure by the private sector can work well, but needs to be backed by strong institutions and policies. In particular, it is crucial to find a fair and viable burden of risk distribution between the private and public sectors. For the private sector it was particularly important that the rules surrounding infrastructure investment were transparent and predictable.“Public authorities need to build resilient project development and implementation capacity and mitigate to the extent possible the policy risks that can so easily deter private investment in infrastructure,” said Le Houérou. n

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VANTAGE POINT LOOKING FOR BETTER RETURNS, ONE STOCK AT A TIME

Kathleen Hughes managing director and head of Global Liquidity Sales and European Institutional Sales at Goldman Sachs Asset Management. Photograph kindly supplied by Smithfield Group, March 2015.

Preparing for the new market leaders Macroeconomic themes, including diverging monetary policies, the strong US dollar, low oil prices and structural reforms, affect every company’s earnings and stock price in a unique way. For this reason Goldman Sachs Asset Management differentiates between equities and economies and buys stocks, not stock markets, although some trends affect entire national markets. Kathleen Hughes, managing director of the firm’s Investment Management Division, explains why she is preparing for the emergence of new equity market leaders.

n the US, the strong dollar is likely to be good for consumption, which accounts for a critical 70% of gross domestic product (GDP). However, corporate earnings are increasingly likely to reflect the negative effects of a strong currency. While the immediate effect of currency translation may be a near-term hit to earnings, we are more concerned about competitive disadvantage, which can have longer-term consequences. We are therefore less bullish on US equities relative to other regions, even as we remain en-

thusiastic about the US economy. We are now increasingly bullish on European equities. Europe’s economy is expected to grow 1.1% this year, an improvement from roughly 0.8% in 2014 and contraction in 2013. This modest growth could have an outsized impact on corporate earnings growth, given the potential for operating leverage with increasing revenues. We believe the European Central Bank’s (ECB’s) easy monetary policies should encourage growth, inflation and a weak euro, all of

which Europe needs to recover. Quantitative Easing (QE) is exceeding high consensus expectations and has been particularly helpful for the peripheral countries. So far, the ECB’s policies to repair the banking system appear to have been effective. Europe’s banks are adequately capitalised and their willingness to lend and companies’ desire to borrow is important for growth. Although Europe’s economic recovery is still fragile, corporate earnings are on the upswing and we think equities could be too. Even so, the European story is not without risks and in particular noise created around elections is likely to maintain volatility. Japan’s economy appears to be stabilising and could improve further with continued monetary easing, the weak yen and low oil prices. However, we are even more excited about the prospects for Japanese equities, which have drivers beyond macroeconomic improvement. Boosting growth and inflation are among the key initiatives of Abenomics, and both the government and Bank of Japan have provided substantial economic stimulus. As a result, the yen has depreciated against the dollar and other regional currencies such as the Korean won and Chinese renminbi, and is helping Japan’s many export-orientated companies become more competitive. While inflation looks like it will fall short of the central bank’s 2% target, largely due to low oil prices, real wages are starting to rise and we believe continued increases could drive more consumption. The real boost to equities however may come from corporate profitability, which has significantly improved. This has several drivers: the weak yen is making Japanese exports more competitive; while at the same time, sales in foreign currencies translate to higher revenues in yen for many companies.

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Japanese corporations have also been cutting their cost structures for years. In China, expectations for growth are coming down. We do not believe that the economy is on the verge of a crisis. However, several recent events are making us more cautious and we think it is too early to get bullish on equities as long as the financial system remains under pressure. Bottom-up signals such as power consumption, diesel consumption and the property market suggest lower growth than the official numbers. Our conversations with banks suggest that the government’s efforts to stimulate lending may not be working, as they seem willing to lend only to state-owned enterprises (SOEs). Lastly, the property market is still oversupplied and falling prices are dampening the urgency to buy.

Given our concerns about the economy, we are cautious on the Chinese equity market and selective in our positioning but we do see considerable opportunities. We have limited exposure to banks, SOEs in general and to the industrial economy. However, we are well-exposed to consumerorientated stocks in the Staples, Healthcare, IT and Discretionary sectors. We also like stocks outside of China that benefit from Chinese consumption in countries including Korea, Taiwan and Thailand. A year ago, just the idea of a new reforming government able to jumpstart India’s economy sent the equity market soaring. The government still appears committed to reforms and we believe the new budget presented at the end of February is the most progressive since 1991. India is placing a big focus on reforms

to improve the ease of doing business, which is a structural necessity for accelerating the economy and corporate capital spending. India is a huge beneficiary of lower oil prices, which are also helping tame the country’s high inflation rate. In this improving economic environment, we believe businesses exposed to the domestic economy have stronger prospects. Some current macroeconomic conditions have been a long time in the making, such as the widely anticipated interest rate hike by the Fed and Europe’s economic recovery. Other events, such as the sharp drop in oil prices, caught most investors by surprise. Expected or not, the effects differ between companies and regions. We will therefore continue looking for the new market leaders in every country and sector, one stock at a time. n

Why OTC is back in vogue In the world of fashion they say trends from years ago always come back. Well, the same is true in the not quite so glamorous market of over the counter (OTC) derivatives. Seven years after the crisis, the same contracts once more vilified than a Supermodel’s waist size are once again the talk of the street – that’s Wall Street not the high street. A recent study by the Bank of International Settlements (BIS) shows that market value for OTC derivatives increased from $17trn to $21trn between June and December last year - their highest level in three years. What’s driving this renewed interest and who will reap the rewards? Edward Lopez, vice president, EMEA at OpenLink posits some answers.

ROM DODD-FRANK to MiFID I/II, the main concern for fund managers whether large, mid-sized or small, has been finding ways to comply. This has led to a boom in compliance officers on six figure salaries and widespread adoption of technology and infrastructure tools. All because every aspect of a fund’s performance is now under the microscope. As a consequence of having to conform to the same rules, firms across the spectrum have been adopting similar risk averse trading strategies. Therefore, it has become far harder for firms to differentiate themselves. But with regulatory houses now in order and confidence rising, many are now turning back towards what they do best – increasing margin and profit. Hence the re-emergence of OTC. And in an attempt to steal a march on the competition, the latest buzz is around Contingent Convertible Bonds, more

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commonly known as CoCos. Unlike CDOs and CDSs, which are now so 2008, CoCos are recognised for preventing systemic risk. For tier ones with large resources, refocusing trading strategies to incorporate these new products is hardly a tall order. And at the other end, while they may not have the resources, the boutique players have the flexibility to adjust their trading models. However, it’s somewhat of a different situation for funds operating at the top end of the middle tier. They simply don’t have the manpower or the capital of a tier one, and they aren’t as nimble as a smaller player. The upshot is that these midsized firms need to review operations with a view to cutting costs. Only then will they be able to deliver the scale needed to support new OTC strategies – otherwise they risk falling behind. This is no easy task, which

is why firms are looking for systems that can remove the headache of managing complexity. Whether that’s operating multiple asset classes to consolidate, control and manage risk, or satisfying the reporting demands of regulators. Having infrastructure in place to handle all this frees fund managers up to focus on devising the best possible trading strategies in order to compete. Despite the recent rise, it’s hard to say whether we are at the start of a longer term move back to OTC. Capital adequacy, clearing, collateral and margin pressures means derivatives are unlikely to deliver pre-2008 levels of profitability. But as long as there’s some profit to be made one thing’s for certain; successful fund managers will be the ones with the right systems to handle any returning volumes – regardless of the latest OTC instrument in vogue. n

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SPOTLIGHT CREDITOR ENGAGEMENT CLAUSES FOR SOVEREIGN DEBT ISSUES

Photograph ©Keo/Dollarphoto.com, supplied June 2015.

ICMA publishes creditor engagement clauses for sovereign debt issues

The International Capital Market Association (ICMA) has published collective action, pari passu and creditor engagement clauses for sovereign debt securities issued under New York governing law. The use of these new terms in government bonds is intended to facilitate future sovereign debt restructurings.

HE INTERNATIONAL CAPITAL Market Association (ICMA) has published standard terms for new, aggregated collective action clauses (CACs). Concurrently, ICMA released new model wording for the pari passu clause typically included in international sovereign bond contracts. Collective action clauses allow a supermajority of bondholders to agree to changes in bond payment terms, for example to extend maturities or reduce principal, that are legally binding on all holders of the bond, including those who vote against the restructuring. ICMA’s model collective action clauses provide a practical solution to the problem of blocking minorities through an aggregation mechanism, which allows voting across multiple bond issues. The new CACs will make it much harder for holdout creditors to disrupt future bond restructurings or to be paid in full after the other bondholders receive haircuts. Under the new contractual form, a supermajority of bondholders can vote to force non-participating creditors into a restructuring, subject to strong protections against the abuse of minority creditors by the majority. At the same time, the new pari passu clause is designed to prevent the kind of rulings that lead to a disruption in payments to investors, as was the recent case with Argentina. Neutralising holdout creditors in this fashion is of immense economic importance. It should facilitate more predictable

outcomes for debtors and creditors, and fairer outcomes among creditors in situations that require debt restructuring. These announcements and the commencement of issuance of bonds with these clauses are an important turning point in the evolution of sovereign bond markets. According to Leland Goss, ICMA’s General Counsel, “Following publication of ICMA’s sovereign debt contract reforms and their endorsement by the IMF and G20 last year, further work has been undertaken to develop model terms that operate the same way in substance, but that are more suited in their written format and style, to the terms and conditions customarily found in sovereign bond contracts governed by New York law. … We are also publishing a slightly updated version of the corresponding set of clauses intended for use under bond contracts governed by English law, which are substantially the same as the clauses that ICMA published last year. Following further consultation with issuers, investors and other market participants, the “Uniformly Applicable” condition has been refined in both the English and New York governing law collective action clauses published today, so as to provide greater clarity as to the application of this term in the context of Cross-Series Modifications with Single Aggregated Voting, and minor amendments have also been made to the Noteholders’ Committee provisions.” The interpretation given to the pari passu clause in the Argentina litigation

has caused considerable uncertainty for future sovereign debt restructurings. In the case of Argentina, the country recently fell into default on $30bn of debt issued to participants in its 2005 and 2010 debt restructurings as a result of a lawsuit by a group of holdout investors. The investors obtained a favourable ruling based on the interpretation of the pari passu clause embedded in a large number of sovereign bonds, as well as an injunction against paying on the restructured bonds without pro rata payment of the subject bonds; these were terms that Argentina was unwilling to meet. While the holdout problem has been understood for a long time, the case of Argentina (and more latterly Greece, albeit for different reasons) refocused investors on the issue and ICMA and the US Treasury stepped in to help clarify the issues and reduce the ability of investors to hold back restructuring of sovereigns in financial difficulties. In other words, ICMA’s model pari passu provision reduces the risk of the pari passu clause being a basis for obstructing future sovereign debt restructurings. The revised standard CACs and new pari passu clause will be included in the ICMA Primary Market Handbook in respect of syndicated issues of sovereign debt securities lead managed by one or more ICMA members with cross-border distribution (that are not otherwise subject to the mandatory euro area model collective action clause introduced in January. n

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Photograph © Jumpeestudio/Dollarphotoclub.com, supplied June 2015.

Banks push back on FCPA reach: is it worth fighting over? A group of major financial institutions are accusing the US government of overreaching in its enforcement of the Foreign Corrupt Practices Act (FCPA). In with the mix are accusations that the banks hired family members of Chinese government officials in order to curry favour in getting deals. The question then becomes: is the hiring of a child of a government official or executive in a state-owned enterprise "giving that official something of value”?

HE FCPA WAS passed back in 1977 and is known for two provisions: one that addresses accounting transparency requirements under the Securities Exchange Act (1934) and another that covers bribery of foreign officials that is designed to deter companies from influencing anyone or the outcome of transactions through payments or rewards. Obvious areas of potential abuse include gifts, meals, entertainment and travel expenditures. Other less obvious areas include hiring the children or relatives of clients, either on a full time or temporary basis. Some firms would say this an example of ‘community spirit’; others might take a more cynical view. The heart of this particular matter appears to be the intent behind the act. The FCPA specifically prohibits giving or promising to give a foreign official “anything of value” to obtain or retain business. In this instance,“The banks are complaining about something very specific: the Department of Justice’s (DOJ’s) approach to the banks’ hiring of

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the children of Chinese officials and businessmen. The banks are not attacking the entire Foreign Corrupt Practices Act,” explains Richard L Cassin, publisher and editor of the FCPA Blog, a highly regarded website providing news and commentary concerning white-collar crime, enforcement, and compliance. There hasn’t been a case before that determined authoritatively that the hiring of the child of an official or SOE executive is giving something of value,”adds Cassin. “The banks, of course, regularly hire children of powerful people, not only in Asia but around the world. That’s how banks in part grow their business and perpetuate themselves. But now the DOJ and SEC are looking at that practice, particularly in the China context, and asking if the practice violates the FCPA. There was some indication in earlier DOJ opinions that the mere hiring of a family member of an official doesn’t necessarily equate to giving something of value to the official. Now the DOJ and SEC are apparently taking another look at the issue, and that scrutiny is putting pressure on the banks,” he adds. Acknowledging that this particular type of bribery, involving hiring of wellconnected individuals to win favourable treatment on government contracts, can be very difficult to root out and enforce. Lisa Osofsky, European Regional Chair at corporate compliance and risk management firm Exiger, where she focuses on financial crime and anti-bribery compliance as well as investigative operations thinks that banks will need to redouble their diligence efforts on this front to avoid any doubt that they are contravening FCPA requirements. “What you worry about as a prosecutor is whether there is an explicit or implicit favour system,” says Osofsky, who is also the former Deputy General Counsel of the FBI. “When you are dealing in China often there are arms of private enterprises that are state supported. A prosecutor will ask: is this a situation where the firm is hoping to get a payback?” she explains. Another important consideration in this whole matter looks to be whether the banks have a reasonable chance in suc-

ceeding with their claim. As Osofsky explains, most firms settle out of court. “It is highly unusual, unless you are an individual charged with FCPA violations, for firms to contest charges in this way as it can be very costly indeed to fight a protracted court battle,” says Osofsky. She also notes that the propensity for firms to pay up rather than contest DOJ charges has been something of a money spinner for the government. “We know that FCPA enforcement has been on an upward trajectory for years. The fines are huge. At the end of 2014 a record $1.25bn was collected in fines. Two of the cases accounted for the billion. The moral of the story is that the government is ratcheting up the amount of money it is collecting from law enforcement,”she states. So far this year the US market regulator, the Securities and Exchange Commission (SEC) has charged a number of firms with violations of the Act, including in early April, Oregon-based FLIR Systems which allegedly financed a "world tour" of personal travel for Middle East government officials who played key roles in decisions to purchase FLIR products. FLIR, which reportedly earned more than $7m in profits from those sales, agreed to pay $9.5m to settle the charges. The SEC has also charged Goodyear with violating the FCPA, explaining that its subsidiaries allegedly paid bribes to land tire sales in Kenya and Angola. The company agreed to pay $16m to settle the charges. Additionally the SEC charged a former officer at a Tampa, Florida-based engineering firm with violating the FCPA by offering and authorising bribes and employment to foreign officials to secure Qatari government contracts. The charges were settled out of court and the company entered into a deferred prosecution agreement and fines worth $3.4m. Enforcement of the FCPA continues to be a high priority area for the SEC. In 2010, the SEC's Enforcement Division created a specialised unit to further enhance its enforcement of the Act. Osofsky says that the FBI has recently tripled the number of agents investigating FCPA violations. The FCPA Blog lists at least one hundred firms that are currently

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REGIONAL REVIEW RISK MANAGEMENT IN BANKING

under investigation. The tussle raised by the banks challenging the remit of the Act looks to run for some time. On the one hand, the US authorities look to have the bit between their proverbial teeth when it comes to the FCPA right now and in this latest suit, the banks are clearly testing the boundaries of the Act. An interesting question now might be: how far will the US authorities look to take the application of FCPA? How international will its reach end up being? According to Osofsky, the reach of the Act is growing.“You have an enforcement regime that has a different view of its extraterritoriality than say other countries. The US government wants to stamp out corruption wherever it finds it, even if that means pursuing actions that may touch other parts of the world, as long as there is US jurisdiction in some part of the suit,” she avers. n

Risk management in banking: easier said than done Risk management is the heart of all banking institutions. Few wonder why regulators have been so outspoken on managing risk, or question why there have been multiple regulations around the subject; CRD4, Basel3, Liquidity Reporting and recently, BCBS 239/RDA (Risk Data Aggregation). In this opinion piece Senthil Radhakrishnan, vice president and head of Capital Market Solutions Group – Virtusa outlines the main risk groups and how to measure them effectively.

N ONE HAND, the government wants banks to take risks in lending money, which is a key element of entrepreneurship, jobs and the well-being of society; extreme conservatism could make banks unviable and customers could end-up paying fees on their deposits.

Photograph ©verticalarray/Dollarphoto.com, supplied June 2015.

Yet, on the other hand the government is worried that banks may take excessive risk, which could make them fail. And when a bank fails, the fallout from depositors losing money or a damaging government bailout is significant. To aid in risk management, regulators have sought to devise tools and measurement techniques to assess the risks that banks are taking. The hope is that if there are adequate funds maintained matching the potential risk value, there will be less of a chance that a bank will fail. Risks are measured broadly in four categories. There is market risk, which involves the risk of sudden shifts in markets, factors such as sudden changes in the central bank rate, foreign exchange rate and stock price index; there is credit risk, essentially the risk banks take when they lend to their clients; operations risk, which involves the risk bank processes failing and their impact on the bank itself and finally, liquidity risk, which encompasses the very credibility of the bank itself (in the eyes of depositors and other creditors) in poor market conditions. Measuring risk is a nebulous topic and it is unlikely that one will get the exact same definition from two experts. One of the key reasons for this is that the variables for risk calculation; such as client defaults, market factors including interest rates and FX rates, and the impact of process failure, etc., are random and extremely difficult to predict. Ultimately, risk management is an art as much as a science. Risk management methodologies have been around for more than twenty years; over this period they have evolved and been refined. After the financial crisis in 2008, risk management gaps were observed and new measures, such as liquidity were added. At the same time, existing risk

managing measures were tweaked. During the 2008 crisis, even sound banks faced the risk of shutdown as they weren’t strong enough to navigate adverse market conditions, which set in motion new measures on liquidity ratios. The key lesson learned, is that learning and adapting is key to effective risk management. Banks have also struggled to get risk reports in order; with collating information from different systems, which could be in different countries and regions, presenting a huge challenge. Other issues included normalising data from various sources into a common format, getting new data points from source systems, running risk calculations and simulations, etc. This added massive cost to the risk reporting exercise, with the resulting data often still questionable. Incomplete or ‘bad’ risk data could mean that banks have less reserve money to protect themselves or have excess money, which could make them inefficient. Recently, it was felt that since the risk reports were unreliable, banks need to have a program to ensure their data management (used in risk reporting) is in order. This led to the introduction of regulation BCBS239(RDA), which prescribes/guides banks in data governance and applying best practices in data management. Ensuring peace of mind Risk management is a tricky subject for banks, regulators, creditors and depositors alike. Poor or inadequate risk management and the resulting shortage of reserve funds can abruptly make a bank fail. This has the potential to bring immense losses to its shareholders and depositors, while conservative risk management and excess reserves, leading to lower profitability, can kill the bank slowly over the long term. Banks must therefore ensure that they have robust systems and processes in place that ensure risk management is fully and adequately provided for. This not only eases the burden on themselves, but also gives depositors and shareholders the peace of mind and confidence to continue being part of a bank’s ecosystem. n

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Photograph ©boomingpie/Dollarphoto.com, supplied June 2015.

When the price is right Any analysis argues Christopher Cruden, CEO, Insch Capital Management, Lugano, Switzerland, which distances the FX trader from price discovery, for example of volumes or the open interest in futures markets, is a distraction rather than a help. There are no dividends in these markets, no yields, takeovers, mergers or redemptions, he notes. Though currency forecasting is an important sub-set of the job of an economist, Cruden says few if any good investment managers are brave enough to apply such predictions to the business of intraday FX trading and fewer still survive for any length of time if they try it. What is an FX trader to do?

N JANUARY 17TH this year, two days after the Swiss National Bank had shocked the global foreign exchange markets by abandoning its self-imposed cap on the Swiss franc’s rate versus the euro, the long-established Florida-based hedge fund manager Everest Capital announced that, as a result of losses sustained in the currency turmoil, it was to close its $830m flagship Global Fund. A little more than a month later,

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according to a Reuters report, Everest’s head, Marco Dimitrijevic, sent a letter to investors announcing the further closure of six of the firm’s seven remaining funds which had started the year with combined assets of over $2bn. Everest was by no means the only casualty of the SNB’s decision. Many investment firms were positioned on the wrong side of the trade; a bad place to be on a day which saw the value of one Swiss franc rise some 20% against the euro (with an intraday spike of more than double that) and near catastrophic if positions were highly geared or leveraged as is frequently the case in the FX business. As one of Britain’s senior hedge fund managers once commented, “You’ll always make money if you use leverage ... provided you don’t go broke first”. Shocks of this magnitude are fortunately uncommon in global FX but they are not unknown: financier George Soros’s $1bn move on 16th September 1992 to smash the pound out of ‘Exchange Rate Mechanism’ is a case in point. For the most part, however, the markets trend rather than spike, are highly liquid (with an estimated daily turnover of some $4trn per day) and present a large number of attractive trading opportunities. In short, the FX market is huge, fast and excepting third-tier or state controlled currencies, very efficient. It’s therefore no surprise that many (alternative) investment managers of all sizes are tempted to try their hands at trading currencies but what is or seems strange is how few of these make genuine and regular profits from their involvement and how many end up as also-rans and pull out after only a few years. The answer to this apparent conundrum is quite simply the price. That is, the exchange rate between any two currencies at a moment in time. Because the market is highly liquid, it’s fair, indeed necessary for success, to see the price as the sum of the world’s knowledge at that particular microsecond. Any other analysis which distances one from the price, for example of volumes or the open interest in futures markets, is

I would argue a distraction rather than a help. There are no dividends in these markets, no yields, takeovers, mergers or redemptions. And while currency forecasting is an important sub-set of the job of an economist, few if any good investment managers are brave enough to apply such predictions to the business of intraday FX trading and fewer still survive for any length of time if they try it. Instead, the great currency managers employ formally constructed, durable and usually simple algorithms. There’s a lot of excitement, even among savvy institutional investors, about socalled ‘algo-trading’ but, in reality, all that is happening here is that a computer is generating trading signals by systematically applying a concise set of rules which have been honed and tested over the long-term, employing advanced statistical analysis before being applied to the markets for real. The trick is constancy. Any attempt to second-guess the algorithms, once proved, is inevitably doomed. The set of rules should only be modified when the evolution of the markets demands a change not when temporary circumstances suggest it might be a good idea. Regular tinkering intended to improve algorithms automatically destroys a systematic approach and if an investment strategy is not applied systematically it is, by definition, random. An example from the equity markets is illustrative here. If one investigates the methodology for the S&P Indices (easily available on the internet), it’s clear there are about 17 criteria but only about seven formal rules that define an index’s construction yet, at the same time, the flagship S&P 100 index outperforms as many as 80% of the investment managers who use it as a performance benchmark. If regular ‘improvements’ to trading algorithms do boost returns, the manager is, again by definition, lucky. Experience shows that such luck will not hold given this, the most important of all trading rules: “The markets do not exist for personal enrichment but to teach humility which they do with crushing regularity”. n

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BELVEDERE COLUMN VOLATILITY IN FIXED INCOME: WHAT’S THE OUTCOME?

Why we are probably into “injury time” on the great bond bull market

Every now and then, markets deliver a wakeup call to question consensus and shake out lazy positioning—in our view, a shake out from extreme levels explains a good deal of the severity of moves in fixed income. At the margin, concerns over growth have challenged the consensus around the timing of the first US rate increase at the same time as two-way risk on inflation has been reintroduced to the bond market. John Bilton, Global Head of Multi-Asset Strategy, JP Morgan Asset Management looks at the implications.

UNDAMENTALLY LITTLE APPEARS to have changed in the past month. We don’t think that the US is heading into recession, given there is little evidence of the kind of economic imbalance that often precedes a contraction. It is also doubtful that we are heading towards stagflation, given producer price indices (PPIs) this week surprised to the downside and wage inflation remains contained. Furthermore, we don’t think the US Federal Reserve (the Fed) or the European Central Bank (ECB) are about to shift their reaction function, or make a policy mistake. Fed chair Janet Yellen remains “data dependent” and ECB president Mario Draghi has reiterated that policy stimulus continues. Nevertheless, markets are (rightly) weighing the risks to these views—so our outlook needs to consider what the last few weeks have told us about growth, inflation and policy. On growth, the US slowdown in the first quarter succeeded in being well telegraphed and surprising at the same time. That forecasters have notorious difficulty seasonally adjusting for the (now traditional) first-quarter slump is well understood. What appears to have shaken market confidence is the scale of the weakness, limited evidence so far of a sharp rebound, and the inability to pin the soft patch to a specific factor. Weak oil and a strong US dollar shoulder a lot of the blame for the first-quarter weakness. US earnings revisions were cut to non-recession lows because of these factors. Yet, lower gasoline prices are

usually viewed as a boost to real disposable incomes—so why the weak consumer? There are few satisfactory explanations, but we believe it is simple dumb luck that three otherwise minor factors coincided. First, gas prices are a bigger slice of the weekly budget for lower income households. These consumers saw little of the benefit from quantitative easing as many are not asset owners. Hence the windfall boost to real disposable incomes from lower gas prices was an opportunity to improve household balance sheets and was saved rather than spent. Second, April is tax bill time and there is anecdotal evidence that new healthcare rules (Obamacare) may have prompted some modest overprovisioning, especially among the self-employed. Finally, the strong dollar reduced import prices so even if volumes were stable, aggregate spending could have ticked down in dollar terms. If, arbitrarily, we assume each of these three factors has slowed retail sales growth by a tenth or two tenths of a percentage point, we can quickly explain the weakness. But crucially, the lack of a single cause creates a possibly misplaced sense of “broad based weakness”. We expect US growth to accelerate over the remainder of 2015. Initial jobless claims at the lowest level since 2000, robust payroll data, and better housing data are encouraging. So too is the generally sound state of consumer balance sheets. Moderation in dollar strength and the bounce in oil should also

help corporate confidence and earnings expectations. Nevertheless, the next couple of months’ data will be closely scrutinised for signs that the worst of the slowdown has passed. On inflation, the deflation fears in Europe are fading and the global disinflationary impulse associated with the slump in oil prices has run its course. Nevertheless, excess capacity, labour market slack and wide output gaps in many regions persist—the deflation scare may be over, but it is premature to be priced for a v-shaped recovery in inflation data, in our view. PPI data from last week back this up. So, while the re-pricing of two-way risk into inflation and into bonds is reasonable, to extrapolate to either an inflationary or stagflationary end-game is unrealistic. The stabilisation in the oil price is welcome, but here too we think extrapolation of recent price action is naïve. US rig counts dropped sharply in response to falling crude prices, in turn slashing the rate of forecast supply growth. But with West Texas Intermediate (WTI) back towards $60/bbl the impetus to cut rig count is lower. We are also edging towards the breakeven price for many shale producers, which suggests that at current levels the market will not clear. This is a problem given the level of inventories and supply and we see some risk that energy prices drift lower after the summer. On-land US storage facilities are approaching 90% capacity in some cases, leaving oil markets sensitive to even modest upside

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in supply, or supply growth forecasts. However, even if oil fell back to the upper-$40 range, this would be a much less dramatic re-pricing than took place in the second half of 2014. As a result, the effect of a subsequent drop in oil prices from here is more likely to manifest itself as slower inflation rather than outright disinflation. Finally, on policy, we still see September as the likely Fed “lift off” date. The proba-

bility of a delay to December has ticked up, but we still believe that policymakers prefer “earlier and slower” to “later and faster” for a hiking trajectory. Crucially, we do not see any change to the Fed’s reaction function following the sell-off in bonds—it may even give them confidence that markets will price the cost of borrowing higher along the curve when they do finally raise rates. With European net bond supply turning

negative again over June, July and August, and inflation data remaining contained there is scope for global bond yields to drift lower once again this summer. But with two-way inflation risk now back into the long-end, bond bears are likely to be much more emboldened should yields drift too far. On balance, we are probably into“injury time” on the great bond bull market, but pricing for a surge in inflation, or fearing stagflation, is premature.” n

Shuffling the emerging corporate bond issuance pack In the emerging markets bond segment it looks as if there is too little money looking for too few opportunities right now. The absence of Russian and Brazilian borrowers means that emerging markets institutional investors are jostling for space in the retail focused Asian markets. What needs to give? Western sanctions against Russia, recurring corruptions scandals in Brazil, and uneven commodities prices are encouraging emerging markets bond buyers into Asia. Asian corporations now account for almost 60% of issuance this year, says BNP Paribas. However, says the bank, Asia's swelling pension and mutual fund industries, and an active retail market means a rather large home team demand base has been established, keeping out non-Asian investors. Allocations in some recent cases were filled almost entirely within Asia. In April, for instance, China Construction Bank (CCB) came to market with a $2bn Tier 2 bond. Arranged by Citigroup, HSBC and Standard Chartered as joint global co-ordinators and bookrunners (together with ANZ, Credit Suisse and JP Morgan), the transaction marked the first offshore bank capital bond to be sold by a Chinese financial institution so far this year. In the event, it attracted $7bn worth of bids for allocations and ultimately almost 90% of the deal was sold down to Asian buyers. No surprise then that Asia’s weighting in the CEMBI Broad and Diversified indexes, the benchmark for most investors in emerging company debt has been increased. Increasing participation

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by Asian buyers in local bond issuance is once more encouraging western asset gatherers to either open up new operations in Asia to be closer to the action, or add on local staff. In spite of lower growth rates in Asia, the looser monetary policy of the region’s main central banks has meant that in many instances local banks are increasingly flush with funds. China's recent cut in banks' reserve requirements alone has been reported as unleashing RMB1trn ($160bn) into the economy and markets. Moreover, Asia’s savings pool (aka mutual fund assets) look to be growing at 10% or more a year, according to PwC. Over the next couple of years, there may be opportunities closer to home. For their part Russian corporations for the moment have been able to meet their funding requirements in the domestic capital market during the country's current period of weak economic activity, but they will need to turn to international markets to support the expanded investment required for a sustained recovery, says Moody's. The top 20 Moody's-rated Russian nonfinancial companies with the biggest debt maturities have to repay or refinance about $40bn of debt this year-- of which $30bn is in foreign currency. They also face sub-

stantial repayments in 2016-17, totalling some $60bn, of which $40bn is in foreign currency. "Once Russia's economy starts to recover, the levels of funding needed to sustain growth could outstrip the domestic capital market's capacity, particularly taking into account Russia's desire and need to continue diversifying and expanding its economy beyond its current reliance on the hydrocarbon and commodity sectors," says David Staples, Moody's managing director - corporate finance," Russia's largest corporations need to repay or refinance over $100bn of debt by 2017,while the domestic market continues to contract as the economy faces recession this year." Although China has become an increasingly important partner, particularly in the oil and gas sector, Russian issuers not subject to sanctions will continue relying on Western banks as the key source of financing while access to Chinese capital markets proves to be more challenging. Moody’s says it is premature to suggest China is replacing other international markets as the key source of refinancing. Nevertheless, energy deals presenting Russian companies with new growth opportunities in China are indeed frequently accompanied by Chinese funding for particular projects. n

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IN THE MARKETS DB BENEFITS OUTSTRIP UK GDP

Photograph ©boomingpie/Dollarphoto.com, supplied June 2015.

UK DB liabilities outstrip UK GDP

One bit of good news for the UK, the other less good. This year, at current sterling/dollar exchange rates, projected GDP is almost back to 2007 levels (£1.8trn/$2.808trn). The less good? UK direct benefit schemes’ liabilities now outstrip UK GDP.

IGURES RELEASED TODAY from Hymans Robertson, the independent pensions, benefits and risk consultancy, show that despite companies attempting to shore up their pension schemes, paying £44 billion in contributions in the last three years, the financial cost of settling liabilities have reached a staggering level of over £2 trillion. UK private sector Defined Benefit (DB) schemes collectively now have liabilities in excess of the UK’s GDP of £1.8trn. The exposure of has been driven by ultra-low long term interest rates, stimulated by the likes of the EUR£1.1tn EU quantitative easing programme. This has pushed up liabilities much faster than modest rates of economic growth. “However, pension scheme asset bases are also at their highest levels, following a period of strong performance across most asset classes. Over the last 5 years assets have grown by over 40% from around £900bn five years ago to around £1.3tn today, says Calum Cooper, partner at Hymans Robertson. According to the pensions advisor, time is running out for assets to deliver the returns needed to meet the mountain of pension payments that lie ahead. The advisor says that the investment time horizons are shortening for mature DB schemes - they are increasingly paying out far more in benefits than they receive in

contributions. “This dynamic will only be heightened with the lure of freedom and choice leading to increased transfers out of DB schemes – we expect flows of £10bn from DB-DC per annum As a result, there’s a pressing need for DB schemes to focus on income generating assets rather than simply chasing capital growth. This will help raise schemes’resilience to poor capital returns - avoiding the any fire sale of assets at depressed prices to pay pensions,” says the firm in a statement. Additionally, it says that with prices high across most asset classes, and insurers keen to replace old world DC annuities with DB assets, now is also the ideal time to explore protection opportunities, which can enhance income whilst reducing and/or transferring risk “In the current environment, this leads to two pressing actions for both trustees and corporate sponsors of pension schemes. First, review your investment strategy with an eye to income requirements – from your assets, to pay pensions. As schemes mature, getting closer to the day when all promises are paid to scheme members, they increasingly pay out more in benefits than they receive in contributions. So without this focus, there is a very real risk of a downward spiral: cannibalising your capital,” explains Cooper. “Investment time horizons are clearly

shortening, heightening the risk of investing in long-term growth assets. It’s important to make sure that cash is easily available when it’s needed - without a fire sale - to pay the pensions promised. It’s therefore vital that schemes move beyond a simple focus on growth (e.g. equities, diversified growth funds) and protection (e.g. LDI, buy-ins, longevity swaps) and begin to focus on the role of income generating assets (e.g. investment grade credit, debt) – in other words to shake of the one dimensional balance sheet focus and do some good old fashioned cash flow planning,” he adds. This approach, he says, has the added benefit of minimising the risk that schemes will have to sell assets at depressed prices. This risk is all the greater due to record highs in asset levels due to bull runs across most markets.“The second action is to look for opportunities to reduce risk, by looking at the protection strategies in place; and in some cases de-risk. For many DB pension schemes the ultimate end game is to undertake a full buy-out. While this ultimate transaction will be years off for many, a buy-in, which is a bulk annuity purchased by trustees as a well-honed protection asset, is an excellent and popular first step,”states Cooper. According to Cooper,“Fortunately there is a clear opportunity right now for

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schemes, especially small and medium sized ones, to complete bulk annuity deals at highly competitive prices. This is because the life assurance sector has been hit hard by George Osborne’s ‘freedom and choice’ in pensions, which has caused sales of individual annuities to collapse. Insurers are looking to offset this lost income by entering the corporate pensions market. The conditions are good, but pension schemes will need to move quickly to take advantage of this short window of opportunity.” Mercer’s Pensions Risk Survey data shows that the accounting deficit of defined benefit pension schemes for the UK’s largest 350 listed companies largely remained unchanged at end-May (£93bn) versus that at end-April (£95bn) and still higher than at the year-end (£75bn). At the end of May, asset values were

£641bn (representing an increase of £3bn compared to the corresponding figure of £638bn as at April 30th), and liability values were £734bn (representing an increase of £1bn compared to the corresponding figure of £733bn at the end of April). “The small improvement in deficits during April was largely driven by an increase in corporate bond yields although even this was substantially offset by an increase in market implied inflation. The result of the General Election also appears to have had little overall impact on the funding position by the end of the month. The apparent stability in deficits over the last three month-ends might provide some comfort compared to some of the bigger fluctuations seen in earlier months but it is very cold comfort when this stability is around such historically high levels,” explains Ali Tayyebi, senior

partner in Mercer’s Retirement business. Le Roy van Zyl from Mercer’s Financial Strategy Group says, “Even though the deficit remained largely unchanged from month-end to month-end, the material volatility during the month is very significant. Looking back over the past year, we see that deficits have been as high as £100bn, and as low as £70bn. Scheme sponsors and trustees with a prepared and robust process to take advantage of the opportunities and threats that arise will therefore be much better able to deal with the pension issues. In this, it is important to recognise that a number of risk and cost management steps can be taken while one waits for investment markets to become more favourable. Key steps here include longevity hedging and providing scheme members with greater choice with regard to their benefits.” n

How monetary policy impacts on pensions Quantitative easing (QE) might create favourable conditions for insurers and pension funds in the long run by stimulating economic growth, but in the short term is puts pressure on insurance and pensions by further lowering the risk-free rate. The profitability of insurance and pensions products remain under pressure. What’s to be done?

N ITS MAY Financial Stability Report, the European Insurance and Occupational Pensions Authority (EIOPA) says the weak macroeconomic environment, protracted low interest rates and increased credit risks continue to affect the (re)insurance and occupational pension sectors in the European Union. “Today’s macroeconomic reality is creating severe challenges for certain insurance and pension fund business models. In this environment it is fundamental that supervisors monitor the situation very closely and challenge the industry on the sustainability of their business models. Furthermore, action is needed from the industry to deal with the vulnerabilities of the “in-force” business and to restructure their mix of products,” says Gabriel Bernardino, EIPA chairman. While QE policy might create favourable conditions for insurers and pension funds in the long run, with the important caveat that economic growth

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improves, the reality is says EIOPA is that QE has resulted in a lower risk-free rate thereby putting additional pressure on insurers’ and pension funds’ business models. The risk-free rate, or as it is sometimes known, the risk-free interest rate, is the yield on high quality government bonds. For most investors the US Treasury yield is the risk-free benchmark to discount their liabilities to present value, so they can compare them with assets and get a funding ratio. They also use it for their own internal purposes. They use a different rate to discount liabilities for the purposes of the deficit companies have to report on their balance sheets. QE programme might also significantly reduce market volume for some asset classes, says EIOPA. “In this case, the herding behaviour of investors related, for example, to a deteriorating geopolitical situation, could trigger a risk reversal or ‘double-hit’. This refers to the situation

when the value of liabilities increases due to the lowering of the risk-free rate, while the value of assets decreases due to the raising level of risk premiums, which invariably has a negative effect on insurers’ and pensions’ business. In the insurance sector, returns and profitability of products remain under strong pressure with a potential negative impact on solvency. In the reinsurance sector, risks arising from the low yield environment may urge the reinsurance industry to further consolidate. Reinsurance premiums have been pressurised as companies face continuing competition from non-traditional sources of capital avers EIOPA. “The transitional measures included in Solvency II should be used to ensure a smooth transition to the new regime, avoiding disruptions in the market, while ensuring that firms will take the necessary steps to restructure their businesses,” avers Bernardino. n

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IN THE MARKETS CHINA REGULATOR PROMISES CURBS ON MARGIN FINANCE

Photograph ©Sergey Nivens/Dollarphoto.com, supplied June 2015.

China’s regulator moves to take the speculative heat out of the stock market

China’s securities markets are at a pivotal stage in their evolution and the impact of market opening and increasing market liberalisation and complexity is beginning to weigh on the China Securities Regulatory Commission, the country’s securities regulator. China’s stock remains one of the best performing; even so, the regulator issued a clarion call at the opening of June over tightened rules on margin lending and its possible impact on the country’s stock markets.

HINA’S BROKERAGES HAVE been steadily tightening margin financing this year, with the potential to begin curbing China’s long duration, retail driven Bull Run. At the end of the first week of June, the China A50 index had fallen by 6.5%, the largest drop since mid-January. The reason? Margin curbs. It appears brokerages were front-running new tightening measures on margin financing by China’s financial market regulator. The regulator announced it had banned umbrella trusts that provided cash for margin trading, the practice of borrowing against the value of common shares held at a brokerage, and placed limits on margin trading for highly risky small stocks that trade over the counter (OTC), rather than on exchanges. The volume of outstanding margin loans has exploded this year. An estimated RMB2trn (around $322bn) was outstanding by the end of May, five times the level estimated at the end of May last year. In other words, the Chinese equity market has become way over-leveraged. Both brokerages and the regulator are keen to limit risk should the market suffer a major correction. Despite current volatility, overall, the index remains up 20% since January, while the CSI300 continues its upward trajectory (rising a steady 1.7% over May

and up 9.1% since the start of the year). Everyone is now asking what will be the impact of tighter margin rules? For one, it should result in a better quality market, even though curbing the enthusiasm of Chinese retail investors looks increasingly difficult to achieve. There are also other pressures. So far MSCI has held off adding China A shares into its emerging market benchmark index; once it does so, it will bring another avalanche of cash into the market. Even so, the regulator is mindful that speculative retail investors remain the backbone of the stock market, particularly the Shanghai market; some of these investors, given the borrowings involved in their stock purchases, could be ruined if there was a serious market correction. Margin financing is still in its infancy in China, which only became a standard programme in October 2011. Essentially it involves an investor borrowing money from a broker, with the loan being secured against the assets purchased. The borrower also has to put down a deposit, or margin, which is initially equal to the cash he is putting into the transaction. If losses go above this amount, the investor has to deliver more cash (or other assets) to the broker as security or the position is closed. Trading on margin magnifies gains and losses and regulators often limit

the amount investors can borrow. Margin financing took off in 2013 when the CSRC lowered the account-opening requirement to six months and said it was cancelling “window guidance” on the minimum value of account holdings. Brokers interpreted this change to mean they were now permitted to set their own requirements. Actual limits ranged from Rmb2m to zero. On June 4th the CSRC brought back a minimum RMB500,000 threshold, which it had initially introduced back in 2011 and then cancelled two years later. The initial margin requirement is 50% of the margin portfolio in the form of cash or securities. The market will now have to wait and see what the regulator’s final decision and rulemaking on both short selling and margin finance will involve. The regulator did not signal a fixed timeline; simply that it would make an announcement when the ‘time is ripe’, Zhang Xiaojun, a spokesman for the Commission said at a weekly news conference. Zhang also said that the regulator was considering new rules for crowd funding. Beijing has traditionally frowned upon informal forms of finance such as crowd funding, but is searching for new ways to boost investment as broad money supply in China, known as M2, has been growing very slowly in recent months. n

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IN THE MARKETS ASSET SEGREGATION: SAFETY FIRST?

Has ESMA gone too far with its proposed guidelines on asset segregation?

There is mounting concern that enforced segregation of AIF assets [and most likely UCITS, depending on regulatory harmonisation with AIFMD] across all levels of the custody chain as proposed under a recent ESMA consultation paper, will significantly impact the ability of these funds to utilise tri-party collateral management services and participate effectively in securities lending,” holds Ross Whitehill, managing director, at BNY Mellon Markets Group. “The impact on funding and liquidity in the market will, we believe, be very significant affecting growth and investment in Europe. Is he right?

IRECTIVE 2011/61/EU, better known as the Alternative Investment Fund Managers’ Directive (AIFMD) is designed to provide a comprehensive framework for the regulation of alternative fund management and ensure that alternative investment funds (AIFs) can be managed and sold on a cross border basis. Since the adoption of AIFMD, European markets regulator ESMA, has produced a range of material related to the directive. In December 2014, the regulator issued a consultation on its guidelines on asset segregation under AIFMD. BNY Mellon’s Whitehill says that ESMA's proposed AIF asset segregation rules endangers the effective participation in tri-party collateral management and securities lending by AIFs and possibly UCITs funds as well. ESMA requires alternative asset fund managers to ensure that each alternative investment fund they manage utilises a single depositary. This depositary should hold all the firm’s financial instruments in a segregated account and clearly identify the financial instruments as belonging to the AIF/AIFM. These safekeeping functions can also be delegated to a third party, provided that certain specific conditions are met. For example, the depositary has to ensure the third party actually segregates the assets of the depositary’s clients from its own assets and from the assets of the depositary. The key is that all assets, at all times are clearly identified as belonging specifically to the relevant entity. ESMA says that this segregation obligation is a vital safety value should a force majeure event

Photograph © agsandrew/Dollarphotoclub.com, supplied June 2015.

occur and that similar rules already exist in MiFID. ESMA also says that the practical application of these rules ultimately depends on the interpretation of Article 21 911) 9d (iii) of the AIFMD and related implementation measures. In other words, the guidelines, in essence are nothing new. It also argues in the consultation on the guidelines that certainty is best, to ensure harmonisation of segregation rules across Europe. ESMA holds that if it did not issue guidelines applicable across Europe, individual national requirements might actually turn out to be stricter. The consultation outlined five options, but ESMA noted that it had discarded options 3, 4 and 5. The regulator held they were ‘sub-optimal’ and would have

provided a lower level of investor protection. Moreover, noted the regulator, the options were not compatible with AIFMD. In particular, in the case of Option 5, the marginal benefit of the additional level of segregation did not exceed the marginal cost of this level of segregation. The options, included and discarded by ESMA are: Option 1: AIF and non-AIF assets should not be mixed in the same account and there should be separate accounts for AIF assets of each depositary when a delegate is holding assets for multiple depositary clients. Option 2: The separation of AIF and non-AIF assets should be required, but it would be possible to combine AIF assets of multiple depositaries into a single account at sub-custodian level. Option 3: AIF and non-AIF assets could be co-mingled in the account on which the AIF’s assets are to be kept at the level of the delegate. However, the delegate could not co-mingle in this account, assets coming from other depositaries. Option 4: AIF and non-AIF assets could be co-mingled in the account on which the AIF’s assets are to be kept at the level of the delegate. The delegate could co-mingle in this account assets coming from different depositaries. Option 5: Assets should be segregated on an AIF by AIF basis at the level of the delegate. ESMA asked for feedback on all the options; but clearly 1 and 2 are outlined in much more detail. Irrespective of what will eventually come down the line when ESMA

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IN THE MARKETS come down the line when ESMA publishes its final decision, Whitehill says that segregation of AIF assets will significantly impact the ability of AIFs to use tri-party collateral management services and participate effectively in securities lending. "The impact on funding and liquidity in the market will, we believe, be very significant affecting growth and investment in Europe," he explains. Taking [the proposed AIFM directive asset segregation rules] to mean that accounts should be segregated down to the sub-custodian level to enhance investor protection, could result in a policy that exacerbates rather than mitigates counterparty, operational and systemic risk,” he adds. How? Segregation of accounts, Whitehill argues, increases investor risk along the post-trade chain and systemic risk. "This is due to the substantial increase in accounts, a corresponding increase in movements of securities, and in particular the inability of AIFs to function in a tri-party environment. There will also be increased settlement and operations risk because market deliveries will be necessary, rather than intraday book entry books and records management," he avers.

ESMA guidelines on the other hand say the rules are designed to ensure investor protection as assets held in a depository or designated to safekeeping by a third party, are not exposed to events such as bankruptcy. In particular, Whitehill says, the requirement could have a direct, negative impact on pension funds, insurance companies and other non-AIF counterparties, if the regulation were to lead to a situation with no third-party collateral managers able to support the related transactions such as repo and securities lending. "Collateral management is a highly specialist function and (given the demand for, and likely scarcity of eligible collateral) it is highly unlikely that funds will be in a position to effectively support their collateral management requirements themselves," he says. "The removal of tri-party collateral management will place an inordinate burden on the funds themselves and their counterparties, forcing them into bi-lateral collateral management." Essentially Whitehill is arguing that the segregation into bi-lateral arrangements, rather than tri-lateral arrangements is no guarantee of failsafe protection and two, inhibits the natural flow of transactional relationships in key segments of the

market, such as securities lending, repo and even some collateral management activity. These are the important arteries for the smooth running of the financial and investment markets. If as ESMA is seeking from its guidelines on segregated assets, it essentially blocks up these important arteries. “Funds will continually need to borrow either cash or government securities to provide collateral for trades, if you are constrained by segregated accounts, how can you do that?”asks Whitehill. ESMA, says Whitehill, may have been surprised by the antipathy towards Options 1 and 2. Clearly, the question then arises as to whether ESMA has gone too far down the line in the implementation and delineation of segregated assets. If Whitehill is correct, the market is arguing for looser binding and more breathing space. The results of the consultation will therefore be important. The threat, as always in the skittish world of asset management is that in an increasingly interconnected world, it is easier to push assets and investment accounts offshore into markets that are competing with Europe for prominence. It is vital therefore, that ESMA thinks carefully on the crafting of the final terms of its guidelines. n

EU deal agreed on transparency rules for lending and re-use of securities Basic principles covering the disclosure on the use of securities financing transactions (SFTs) by investment funds to the public and to the potential investors have been agreed under an informal deal struck by Economic and Monetary Affairs Committee MEPs and the Latvian Presidency of the Council.

RAFT REGULATION WILL be outlined that seeks to cover all forms of lending, borrowing and re-use of securities in the EU. While the effect on current market practices will be marginal, the heightened disclosure requirements attached to these trades means that the market in Europe will become more transparent, provide regular information to both regulators and the public, and will contribute to financial stability. The political agreement will now be subject to technical finalisation before a draft can be endorsed by the Council and the ECON Committee. As soon as the official legal text is ready, Parliament

will put it to a plenary vote in October. The final text will also need to be endorsed by EU member states. The complex and opaque nature of SFTs makes it difficult to identify counterparties and for supervisors to monitor risk concentration, says the EU. The agreed draft rules require that information on SFTs carried out by all counterparties (with enlisted exceptions) is reported to trade repositories that centrally collect and maintain the transactions' records. Transparency would allow regulators and supervisors to obtain a proper overview of the risks linked to securities financing transactions and of the links

between the regulated and the shadow banking sectors. As well, MEPs extended conditions that must be fulfilled when financial instruments received as collateral are being re-used. The providing party should be informed about risks and consequences involved in granting a right to use collateral and transferring a title to it in the event of default. The Parliament also underlined the need to develop clear entity and transaction identifiers to mark each reported transaction.Details should be reported to a trade repository no later than the first working day following the conclusion, modification or termination of the transaction. n

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Beyond the gold standard Funds that can differentiate themselves across areas such as investor reporting hold the trump card in a challenging fundraising environment. For many firms however, the time and resource required to achieve true operational excellence can be daunting. Ian Kelly, CEO of Augentius, explores the options.

S THE GLOBAL economy turns back to growth, private equity and real estate investors are filling their coffers. Record distributions have left LPs flush with cash – cash that they're looking to reinvest into alternative assets. A recent global EY report on the industry showed strong investor demand for the asset class, with 46 per cent of investors looking to increase allocations, 46 per cent intending to maintain current allocations, and only 4% planning a decrease. With more funds than ever raising money—2,252 globally, according to recent Carlyle data—these days GPs must differentiate themselves to gain an edge. While financial performance will always be front and center, funds are beginning to see LPs place a premium on operational excellence too. The EY report showed that after performance, 49 per cent of investors stated “operational excellence” as the factor that most concerned them. After high-profile scandals like Madoff, transparency and clarity have become key concerns. The quality of reporting is critical. Investors want to be closer to their investments than ever before. According to that same EY report, 66% of investors feel that the transparency of reporting could improve. Using a third party to assist with reporting not only reduces the operational burden on GPs, but also gives investors piece of mind. A more pressing concern for fund managers perhaps is the frequency with which investors—and regulators—are demanding reports and the detail that they’re demanding in them. Another industry survey, which polled more than two hundred GPs and LPs across more than twenty countries, reports some GPs receiving more than

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Ian Kelly, chief executive officer of Augentius. Photograph kindly supplied by Aspectus PR, June 2015.

9,000 LP inquiries in a single calendar year. Additionally, it notes the disparity between what LPs want and what they’re actually getting: 90% of GPs surveyed said that they provide their investors with all the information they need, a reality that less than half of LPs agreed with. This disconnect is down to the nature of private equity and real estate investors and the size of the allocations they commit to funds. In public equities and hedge funds, with their multitudes of investors holding very liquid positions, standardized reports are generally accepted. But of course LPs investing in private equity or real estate demand more. The typical fund will have tens, rather than hundreds, of investors who all expect the level of attention and care that their sizeable commitments dictate. Improving the timeliness of reporting solves this challenge to some extent. But more difficult is serving the growing number of LPs that want to dig into fundamental financials at the investee level. For the large GPs with sophisticated back

office functions, this poses an operational challenge, as more resources will have to be channeled to reporting processes and data collection. Investment in new systems and internal change are likely to be necessary, generating the potential for considerable costs. For mid-size firms, however, these requests can prove almost insurmountable across a diverse base of LPs, as may be the cost of installing and operating enhanced technology. Standardisation in the data collection stage of reporting certainly has a role to play here. Reliance on manual processes is no longer sufficient. Technology that can source and collate data quickly and easily is of paramount importance for funds that need to process LP requests effectively. Even so, standardisation alone is not enough. The age of the pdf is dead. Investors increasingly require tailored reports, in a format that can be automatically downloaded to their own systems. This will become the norm as LPs start to dig deeper into company-level data across their private equity portfolios. In fact, standardization is only one step in the process to developing more customised solutions. LPs are starting to see the value they can derive from their fund reports by asking for specific data points. As this trend continues, and as LPs develop individual preferences as to how their fund data is broken down, GPs will be faced with a huge range of different requests, all of which require time and attention. That care and attention, of course, distracts GPs from their core business of deriving value from their investments. Without a function—either outsourced or in-house—that has the time and resources to tailor reporting to individual investors, GPs will lose a key element of differentiation against their competition. Private equity and real estate will always be a bottom line business, and LPs will always clamor to get into the highestperforming funds. But GPs that can supplement performance with sound operational processes and a tailored reporting function that adds value to LPs’ investment process, will position themselves well in the competition for capital. n

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IN THE MARKETS IS THE SECURITIES TRADING MARKET NOW TOO COMPLEX?

Shifting sands – the harsh realities of executing in today's markets

The electronic execution landscape has undergone a steady transformation. The underlying infrastructure provides essential functionality, but few brokers see it as a means of gaining competitive advantage. Will Winzor-Saile, electronic execution product specialist at Fidessa looks at the inflection points.

HE COSTS ASSOCIATED with execution have ballooned during a period when brokers’ margins are already under tremendous pressure. The execution landscape has become far more complex too. Electronic trading has spread into new regions and new asset classes, each with their own regulatory dimensions. The increasing need to be everywhere and support everything, but do this in a controlled and consistent manner, will define the battle for supremacy between global and super-regional brokers. The last decade has seen a staggering proliferation of new venues around the world, all of which come replete with their own subtleties and idiosyncrasies. Additionally, each venue typically makes one or two mandatory upgrades a year. That alone means brokers are running pretty hard just to stand still. A new regulatory consensus with a focus on transparency is compounding the issue. The regulators' belief that lit markets are good and OTC bad means trading is being pushed onto the former. This will put further pressure on margins and accelerate the spread of electronic trading to new asset classes. In the US the plans to move OTC derivatives trading onto exchanges has resulted in the creation of more than 20 SEFs (Swap Execution Facilities) since 2013. At this stage brokers have no way of knowing for sure which will make the cut, so they need the flexibility to switch in and out of new markets with speed and ease, and the ability to test the waters with minimal risk. With a number of European reforms underway, such as MiFID II, execution quality has been placed firmly in the spotlight. Brokers will need to make major changes to their execution infrastructure in order to support new monitoring, control and transparency requirements. Because this shift has been gradual,

many brokers’ electronic execution capabilities evolved in a patchwork manner. Market access infrastructure has been bolted together piecemeal as firms have expanded their capabilities. The upshot is a multitude of systems underpinned by different technologies, duplicating routes to market in some areas, and failing to provide any route in others. This approach simply no longer suits the vastly different trading environment that brokers now find themselves in – it’s time for a new approach.

Time for a rethink? So what should lie at the heart of this new approach? Brokers need to provide their buy-side clients with globally consistent trading behaviour. At the same time they need to be able to deliver their USPs through this client experience. Performance, reliability and cost are all part of the mix too. In today’s marketplace, the pursuit of consistency is key. This means creating a single, unified execution layer across the business that insulates the trading function from everything underneath it. No matter the geography or jurisdiction, clients should enjoy a uniform trading experience. This requires a system that understands the regional nuances as well as the specifics of the market. For example, it needs the ability to create synthetic order types on exchanges where an order type is not supported. Achieving consistency on a global scale with reliable performance is harder still. Historically, firms have tended to view performance in one dimension – like a 100m sprint – chasing faster speeds, sometimes at the expense of other factors. But as execution has become commoditised, other factors have come to the fore. Firms are realising that execution is in fact a multi-discipline event, more akin to a decathlon.Yes, speed is important: you’re

not going to win unless you can run fast, but a successful decathlete needs to be much more rounded, able to outperform in a number of different disciplines. Brokers are starting to treat execution performance in a similarly multi-dimensional way. The ability to be on time every time is far more important than the ability to be fastest on the field under time-trial conditions. If some orders take tens of microseconds and others take thousands, then it is impossible to define a reliable execution strategy. Latency needs to be consistent, regardless of throughput. Latency measures must also take into account the entire process. For instance an order can't go to the market without undergoing risk checks. A market gateway that takes a couple of microseconds is of little use if the risk checks in front of it amount to several milliseconds. Reliability is part of the puzzle. Brokers need to be able to rely on their infrastructure day-in, day-out. A patchwork of electronic trading infrastructures seriously increases this type of risk. Cost is another dimension to consistency. It becomes very hard to control cost when it's spread across multiple vendors. Whether or not these silos remain at the organisational level, there's huge scope for reducing fixed costs by collapsing them at the technology level. Moreover, control is crucial. Historically, many brokers have wished to deploy their own competitive differentiation around their electronic execution desks. Unfortunately the proprietary nature of these services has led firms into either having to build out their own execution layers or build multiple connection points into third-party systems. This calls for the ability to plug these services into a single control surface so that their competitive differential is maintained without the exorbitant cost of managing the market access complexity. n

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Photograph © 1xpertDollarphotoclub.com, supplied June 2015.

Mozambique moves to build LNG franchise Mozambique liquefied natural gas, (LNG) stands to transform the country. Mozambique is looking to gas exports to raise the government's revenues and reduce a heavy dependency on donor aid which it has relied on since independence from Portugal in 1975. Developing the country’s reserves and scaling up a currently planned LNG facility to its potentially multi-train capacity, could establish Mozambique as one of the largest exporters of LNG, a commodity of increasing global prominence, says Simon Ashby-Rudd, global head, Oil & Gas at Standard Bank. What’s the outlook for the sector?

OME OF THE world's biggest offshore natural gas fields lie off Mozambique, which despite extensive coal and gas discoveries remains one of Africa’s least developed markets. Lacking capital to develop multi-billion dollar LNG export terminals, Mozambique has to attract foreign investment for financing. The government hopes to bring in a substantial $30bn in FDI most of which will focus on the natural gas sector to build capacity to produce 20m tonnes per year of liquefied natural gas (LNG), with first exports due to start in 2018/2019. In support of the search for FDI the government is planning to introduce new energy and mining laws that will set out a clear regulatory and taxation infrastructure; though these were expected to have been finalised last December and the government concedes that various laws are still in the formulation stage. To date it remains a market for intrepid and experienced players and it will be some time before the country’s LNG output comes on stream in a meaningful quantity. Italy's Eni and US developer Anadarko Petroleum Corporation are among a discrete list of potential investors who are looking to launch LNG exports from Mozambique beginning in 2018/2019. Even so, a tough physical environment,

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challenges around getting the gas to the country’s ports and delays in reaching firm development agreements with the government in the run up to the publication of formal legislation means, say experts, that Mozambique won’t find it easy to secure all the financing it needs to expand its promising energy sector as rival LNG exporters offer a much less risky development environment. At the beginning of this year the IMF forecast the southern African nation's economy to expand by 7.5% in 2014 from 7% the previous year, but noted that delays in implementing reforms to tax administration and public financial management could hurt medium-term growth. Additionally, Mozambique's credit rating remains substantially below investment grade, Standard & Poor’s, Fitch Ratings, and Moody's class Mozambique's credit rating as highly speculative. The reality is that the Mozambique economy presents little structural transformation, relying mostly on megaprojects in the aluminium, extractive industries and the energy sectors. The capital intensive nature of capital goods projects in the country means that even when they do come on stream they do not generate enough jobs to provide sufficient opportunities for the fast

growing young population. There are also structural imbalances in the economy which urgently need tackling. Fiscal revenues, for instance, cover little more than 65% of the annual budget, while mega-projects benefit from generous fiscal incentives. Weak human capital and the country’s deficient infrastructure seriously cripple economic and social development. Increasing public spending on infrastructure and salary increases contributed to the widening fiscal deficit, while the narrow tax base limits revenue collection growth. At the same time, external aid continues to contract. The rise in external debt levels to fund the country’s public investment programme, particularly from non-concessional borrowing, increases the demand that public investments generate positive economic returns. There are also political considerations in play. Mozambique will hold national elections in October to elect a successor to President Armando Guebuza, who has served two terms and cannot stand again. There is still a small scale civil revolt that flares up from time to time. The opposition Renamo party in February ended its boycott of parliament, which was to protest against the results of the October 2014 general elections. The risk of political

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IN THE MARKETS MOZAMBIQUE – AFTER LNG – WHAT NEXT?

volatility nonetheless persist; many of Renamo's grievances about political power remain unsolved, while several aspects of the Frelimo-Renamo peace deal of September are unclear. Armed partisans of the Renamo opposition movement who remain opposed to the president’s Frelimo party cause international investors some concern over the country’s long term stability. US oil major Anadarko Petroleum is building the first two of up to 10 plants in Mozambique to liquefy gas for export. Its gas finds in Area 1 of the country's Rovuma Basin will feed the initial 10m tonne per annum (mtpa), $23bn export project.Standard Bank estimates that developing LNG in Palma will facilitate a real GDP increase of 800% by 2035 with the Mozambique government receiving in excess of $200bn in receipts over the life of a 6-train facility. The opportunity scale for stakeholders across all sectors is therefore enormous. “There is [also] significant scope to provide gas to the local market to foster gas-based industrial development,” says Ashby-Rudd. “This option has attracted interest from a number of players across power, fertiliser/petrochemicals and gasto-liquids (GTL). As Mozambique develops into a global energy player, so too can it potentially become a regional energy hub providing petroleum products, chemicals and power to neighbouring countries. Regional LNG import options are developing at a rapid pace and Mozambique will also be well-positioned to serve these.” South Africa recently announced the procurement of approximately 3 000 MW of gas-fired power. South African has no material gas-producing assets capable of supporting such plants and could soon require LNG imports. “A 2015 Final Investment Decision (FID) of Mozambique LNG would be a game-changing development for Mozambique and be key to unlocking future investment in the country and begin the geopolitical repositioning of Mozambique,” he says. However, there is some uncertainty surrounding the timeframe for Anadarko’s 10 mtpa LNG project in northern Mozambique which continues

to loom large. Gas developer Anadarko is more positive saying that it may make FID on its 10 mtpa Mozambique LNG project this year and produce its first LNG in 2019, John Peffer, the company’s Mozambique country manager, told delegates at the Deepwater East & Southern Africa Congress in Maputo in mid-April. Some industry watchers suggest late 2016 or even 2017 is more likely. Even so, according to Peffer, “It is doable, but that timing is elastic and it depends on how quickly we can get these final approvals,” he told delegates.

Bidding for contracts Anadarko is now in the final stages of selecting a contractor for the onshore portion of the project. "We’re down to two joint ventures and we’re evaluating and working towards making a selection in the near term," said Peffer. The US independent has three consortiums bidding for the offshore contract and is waiting for final FEED submissions. The company is working with the government to finalise a number of agreements, including the final plan of development for the Golfinho gas field and the resettlement action plan for the Afungi project site. The company also still needs to convert the heads of agreement it has signed with Asian buyers for 8mt of LNG offtake from the project into binding sales and purchase agreements, and secure debt financing for the project – which is expected to cost in excess of $20bn. However, the prospect of sustained low oil prices, nuclear power plant restarts in Japan, cheap shale gas exports from the United States and cheap pipeline gas imports to China from Russia suggests Asian buyers can take time before signing firm offtake commitments. Press reports in the autumn of last year suggested that Mozambique was quietly finalising 20 year offtake agreements with a variety of Asian buyers; though these have not been officially confirmed. Preliminary deals have been reported to have been reached to sell its LNG to China National Offshore Oil Corp, Japan, Indonesia's state-run Pertamina, the United Arab Emirates, Thailand's PTT and companies in India.

According to Ashby-Rudd, “While moving gas from the Rovuma Basin to southern Mozambique is subject to its own economics and wider strategic consideration, there remains potential for gas-based development around Maputo through, for example compressed natural gas, (CNG), in the short-term or a dedicated pipeline in the longer term. Such developments could facilitate industrial development around Maputo, as well as meet South Africa’s energy shortfall and generate additional revenue streams. These would of course be subject to other power/petrochemical/GTL developments further north and continued progress on the rolling out of further LNG trains over the next decade”. He also notes that gas-based industrialisation leveraging multiple LNG train developments has underpinned the economic growth of Qatar, Oman, and Trinidad and Tobago. “While there is large potential for this to be replicated in Mozambique, outstanding items still remain in realising such an opportunity,”he says. This includes finalising the development of the LNG facility near Palma and extending this to further trains which underpin the scalability of domestic gas volumes; concluding domestic gas sales agreements (including volumes and pricing structures) and fiscal terms surrounding the resultant projects, noting that multiple field developments are needed; finalising the gas allocation mechanism to individual projects; and addressing project-specific requirements and permitting (e.g. IPP bidround procedures; GTL facilities are underpinned by different dynamics relative to petrochemicals and each will require special considerations). In terms of the domestic market, gas supply will come from the Prosperidade and Mamba fields which are expected to be developed for trains three onwards, says Ashby-Rudd.“Therefore, completing the first trains and the associated infrastructure upon which more trains will be developed should be a priority and is seen as a first step for truly unlocking the potential domestic gas holds for Mozambique, in line with the Gas Master Plan,” he states. n

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GCC BANKING BAHRAIN’S HIGHER PROFILE IN THE GCC DEBT CAPITAL MARKETS

Bank issuance keeps GCC capital markets ticking over

Despite dampening optimism in the GCC and a lower appetite for equity issues overall, there’s no denying that sustained lower oil prices continues to exert a downward push on the region’s capital markets. Following a relatively quiet first two months of the year, March saw the only IPO during the first quarter, Orascom Constructions Limited listed on Nasdaq Dubai through a dual listing with the Egyptian Exchange (EGX), making it the first company to be listed on both exchanges. The second quarter has fared little better, despite the opening of the Saudi market to foreign investors and efforts by local exchanges to attract foreign issuers.

AE REGULATORS HAVE been more open to international collaboration recently in an effort to improve market liquidity. Nasdaq Dubai’s collaborative joint listing agreement with EGX is one, and the new UAE Commercial Companies Law which is expected to, amongst other benefits, reduce minimum float requirements, support existing shareholders sell down and allow a book building approach which is expected to further encourage listings. The GCC debt capital markets has exhibited most resilience, despite a slow start in January as bond yield remained low. Longer term it still remains to be seen what exactly a sustained period of low oil prices will have on the region’s bond and sukuk markets. The banking sector has been dominant as issuers of debt. UAE financial institutions were key players in the first quarter of the year, while the Central Bank of Bahrain has been a constant issuer through the year. Emirates NBD, has had a busy first half, with bonds worth AUD 450m ($351m) and a euro-denominated issue worth €500m. First Gulf Bank and National Bank of Abu Dhabi both issued bonds worth $750m early in the year. Bahrain has been a constant feature in the markets. The sovereign, via the central bank, has come to market with a series of T-bills, totalling in bulk, over $2bn. In April 2015, Ahli United Bank successfully completed a $400m issue of Additional

Tier 1 Perpetual Basel III Compliant Capital Securities. “The issue was an important step forward in terms of the evolution and diversification of the Group's capital structure and will provide tangible support to organic and inorganic business plans,” says Hamad AlHumaidhi, AUB chairman. In the sukuk market, the most notable issue so far this year was Emirates Airlines $913m sukuk issued by Khadrawy Limited guaranteed by the UK government. The offering received strong interest from investors and marked the first sukuk issuance supported by the UK government. In terms of sovereign issuance, again the Bahraini central bank has been a dominant player this year, issuing three sukuk, each worth $94.8m and three short term leasing sukuk each worth $52.7m. In May, DIB priced a $750m five year sukuk at the profit rate of 2.921%. The deal was finalised at a spread of 125bps over midswaps, which remains at the tight end of the revised guidance of 125135bps and well inside the initial price of 140bps. The deal was arranged by First Gulf Bank, HSBC, Maybank, National Bank of Abu Dhabi, Standard Chartered and DIB itself. Overall, the trend is lower than last year. In April, for instance, issuance was virtually rock bottom, falling in both value and number, mainly driven by a sharp decline in sovereign issuances (down 65% year on year), corporate issues (down 51%) and quasi sovereign issuances (down 33%).

Corporates comprised 53% of the total issuance value for YTD April 2015, followed by sovereign at 28% and quasisovereign issuances at 18%. Again, Bahrain was the largest issuer of sukuk by number of issuances (10) in GCC for YTD April 2015, followed by UAE (5) and Saudi Arabia (1) RAM Rating Services expects new global sukuk issuance to remain fairly resilient this year at around $100bn to $120bn when compared with 2014’s $116.23n. According to Steven Drake, head of PwC’s Capital Markets and Accounting Advisory Services team in the Middle East region: “Debt activity in the first quarter of 2015 in the region proved relatively stable, compared to the impact lower oil prices had on IPOs in Q1 2015. We saw bond and sukuk issuances have strong demand from investors, with deals being oversubscribed and priced on tighter levels, reaffirming the high levels of liquidity in the region. There remains a certain level of uncertainty looking into the debt market performance for the remainder of 2015; however, with the significant infrastructure developments and projects in the region such as the 2022 World Cup in Qatar, the Expo 2020 in Dubai and the transportation projects in the UAE and Saudi Arabia, we should expect to continue to see bond and sukuk issuances to finance such projects, with a focus on Islamic financing as Dubai and the broader UAE attract Shari’a compliant transactions.” n

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Global data harmonisation of derivatives reporting gains ground The US Depositary Trust and Clearing Corporation (DTCC) in mid-June issued its recommendations that the industry focus on harmonising roughly 30 credit derivatives fields across trade repositories; fields deemed critical to financial stability and systemic risk analysis. The pillar of the US post trade industry has submitted its proposals on global data harmonisation to the Committee on Payments and Market Infrastructures (CPMI) at IOSCO. The move is the latest in a series of initiatives with the goal of updating, improving and harmonising the reporting of derivatives trades across the globe.

HE CALL FOR regulators to look at data accuracy and integrity comes at a welcome time. It coincides with one of the founding principles of BCBS239, which asks banks to measure and monitor accuracy of data. But while looking for accurate data is all well and good, alone it isn’t sufficient. The quality of data must be actively managed. This requires efficient workflows for data errors, as well as a framework for continuous improvement to ensure that the quality of information remains at acceptable levels,” say Dev Bhudia, vice president of Product Management at GoldenSource. The DTCC’s paper is clearly in alignment with recent ISDA’s initiatives which have also focused on the upgrading of data quality. Legitimising its part in the debate, the DTCC already operates the Global Trade Repository (GTR), a derivatives trade reporting service for brokers, buy-side firms and corporates in nine jurisdictions across 33 countries. As a trade repository, GTR plays a critical role in bringing new levels of transparency to the OTC derivatives marketplace says the DTCC. However, in the absence of harmonised global data standards across jurisdictions and repository providers, data gathered to date has not been able to be leveraged to its full extent due to inconsistencies and quality. Following a recent DTCC whitepaper, G20’s Global Derivatives Transparency Mandate, where the firm addressed G20 goals on trade repositories and its perspectives on achieving a harmonised global data set to meet these objectives, DTCC began efforts to review GTR’s reported fields across the nine jurisdictions the service currently supports. According to Larry Thompson, vice chairman of DTCC, General Counsel of

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DTCC and chairman of the Board of DTCC Deriv/SERV LLC. “In order to be able to fully capitalise on all of the benefits of this data, greater data standardisation across repositories is required. We welcome feedback from the CPMI IOSCO Harmonisation working group and look forward to continuing to work with regulators and the industry on this important initiative.” The DTCC has hitched its star to a growing bandwagon. Eleven associations earlier in signed a letter acknowledging their support of improved and harmonised reporting standards, promoted by the International Swaps and Derivatives Association ( ISDA), including the Australian Financial Market Association (AFMA), the Alternative Investment Management Association (AIMA), the British Bankers’ Association (BBA), the German Investment Funds Association (BVI), the European Fund and Asset Management Association (EFAMA), the Futures Industry Association (FIA Global), the Global Foreign Exchange Division (GFXD) of the Global Financial Markets Association (GFMA), ISDA, the Managed Funds Association (MFA), the Securities Industry and Financial Markets Association (SIFMA) and its Asset Management Group (SIFMA AMG), and The Investment Association. Part of the drive behind the ISDA principles is the widespread view that although rules such as Dodd-Frank and EMIR have increased the amount of data being reported on OTC derivatives transactions, there are serious limitations in the current system which may make it difficult to make sense of the data collected or even benefit from it at all. ISDA has proposed that regulatory reporting requirements for derivatives

transactions should be harmonised within and across borders. Toward this end, regulators around the world should identify and agree on the trade data they need to fulfil their supervisory responsibilities, and then issue consistent reporting requirements across jurisdictions. It also says that policy-makers should embrace and adopt the use of open standards – such as legal entity identifiers (LEIs), unique trade identifiers (UTIs), unique product identifiers (UPIs) and existing messaging standards (for example, FpML, ISO, FIX) – to drive improved quality and consistency in meeting reporting requirements. Unique global identifiers for legal entities conducting a trade (LEIs), for product types (UPIs) and for trades (UTIs/unique swap identifiers) have been developed. They should be expanded as necessary and their use should be adopted across reporting regimes. The governance of such standards should be transparent and allow for input and review by market participants, infrastructure providers and regulators. Access to the standards, licensing and cost factors should be carefully considered. “Calls for reporting harmonisation across borders is all well and good, but it may take some time to come to fruition, due to the inherent complexity of derivatives,” says Edward Lopez, EMEA vice president of OpenLink says. “The good news is that we are starting to see more firms adopt technology that removes the headache of managing this complexity. These solutions should go a long way to satisfying the reporting demands of regulators, at a minimum providing greater flexibility, regardless of the complex nature of the derivative product in question.” n

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TURKEY HOW WILL THE ECONOMY FARE UNDER A POSSIBLE COALITION GOVERNMENT?

Supporters of the pro-Kurdish Peoples' Democracy Party holds a banner with an image of the party leader Selahattin Demirtas as they celebrate the party's advancement in the parliamentary elections in Ankara, Turkey late Tuesday, June 9th 2015. Opposition parties are likely to demand limits on President Recep Tayyip Erdogan's role in Turkey's next government, complicating coalition talks as the ruling party sought ways on Tuesday to remain in power. Photograph by Tumay Berkin, for Associated Press. Photograph provided by pressassociationimages.com, June 2015.

Turkey’s election result raises the political stakes

Although the Justice and Development (AK) Party won parliamentary elections in early June, with over 40% of the vote, the result marked a sea-change in the country’s political dynamic. The AKP has lost momentum in its drive to dominate the country’s political agenda over the long term and President Recep Tayyip Erdogan’s omnificence over government actions and policy has been dealt a punishing blow. What will a near term, more fluid political landscape mean for the country’s ambitious economic programme?

HIS IS POTENTIALLY a new political era in Turkey. The AKP still won this election, with over 40% of the vote a share of the vote that parties in any democracy would crave. It also maintains a substantial power base, mainly of the more religious, conservative Turks, who feel liberated by the party and the president. AKP had hoped to win at least 367 seats, giving it a two-thirds majority, which would mean (under the aegis of the country’s constitution) that it could pass legislative amendments without public consultation. On past form, this seemed achievable.

Between 2002 and 2006, during its first term in office, AKP managed to deliver growth which averaged 7.2% per year. AKP dined on the story for another three elections, which provided it with substantial majorities in 2007 and then 2011, when it obtained a comfortable majority of 327 out of 550 seat. This time round AKP managed 258 seats, some 18 seats short of a majority. Tellingly, President Erdogan actively electioneered on behalf of AKP and in that regard, the result must have been a bitter disappointment to the president who has

seen his hopes to establish a permanent and more powerful presidency potentially dashed on the rocks of democracy. Turkey’s voters, or at least those voters in the extreme east and far west of the country, seem to have opted for a more nuanced political landscape. The real winners in this election were the opposition parties. Opposition Republican People's Party's leader, Kemal Kilicdaroglu, has successfully repositioned the party on the centre-left after years of tacking to the centre, taking almost 25% of the vote and 132 seats. The far-right

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National Movement Party (MHP) remains the country’s third-largest party (80 seats with 16.29% of the vote) and its veteran leader Devlet Bahceli has softened its hard line against minority rights; but the party's appeal was to opponents of the government's rapprochement with the Kurdish community. Meanwhile, the pro-Kurdish HDP under a combined leadership team of Selahattin Demirtas and Figen Yuksekdag, won 13% of the vote, giving it 80 members of parliament. HDP successfully seized on recent disputes over women's rights and civil liberties to galvanise younger, urban voters. HDP has also broadened its appeal beyond the Kurdish minority, drawing in leftists buoyed by its acceptance of gay rights and green issues and, of course, opposition to Erdogan. In the election aftermath, Turkish Prime Minister Ahmet Davutoğlu took the high ground and resigned in a procedural move in the run up to the establishment of a new coalition government. The president reportedly accepted Davutoglu's gesture on the basis that he stay in the post until a new government was formed; possibly with MHP. AKP now has 45 days to form a new coalition government. Three trends likely undid AKP’s inexorable rise: the president’s increasingly strident politics and anti-democratic ambitions, which has not played well with younger voters and voters in the country’s more prosperous western provinces; the country’s sagging economic performance; and AKP’s failure to resolve tensions in eastern Turkey.

Short term impact There are now three possibilities: a relatively happy coalition with either MHP or HDP, either of which will likely require some kind of brake on the president’s political ambitions; the AKP might opt for minority government status and fight each policy on its merits, or no one can agree and early elections will be on the cards. It might also be that the AKP is tempted to turn to the centre and adopt more Western focused policies in order to regain the ground lost in this election. Certainly, in the Turkish press, the AKP's

much vaunted policy of "zero problems with neighbours" has been regularly mocked by commentators for becoming "zero neighbours without problems". It seems long standing relations with Israel, Egypt, Iran and the United States have all soured as the president has pursued inflexible pro-Islamist policies. Certainly, HDP will push for a softer line towards Syria's Kurds too. According to Moody’s, which has rated the country Baa3, with a negative outlook) the election result is likely to raise political uncertainty and delay the implementation of some headline economic policies that would help to protect it from external pressures. "The result is credit negative for Turkey," says Alpona Banerji, vice president, senior analyst and author of the comment. "Political uncertainty will likely impact investor confidence which is critical for an economy [such as] Turkey, which depends on external capital to funds its external imbalances." Standard & Poor's Ratings Services also projected that the outcome of Turkey's general elections has no immediate impact on its sovereign credit ratings on Turkey (unsolicited foreign currency) BB+/Negative/B; (unsolicited local currency) BBB-/Negative/A-3. "Both an AKP minority government and an AKP-led coalition government are expected to result in fragile governments with limited longevity," Banerji adds. "Under those two scenarios [sic], there is a high likelihood of early elections before 2019." If that is the case, the country will limp along in economic limbo for another three, even four years. It’s ironic for the AKP that it might be shackled by coalition, as its initial rise to power was predicated on its ability to transcend a decade of inept coalition governments that achieved little in the way of either economic or social reform. As AKP delivered on its economic programme, it appeared invincible. That level of political strength in the country looks unlikely to be achieved in the short term. That’s not the only fruit of political uncertainty. The credit ratings agency says that with a growing external debt and a currency that has weakened sharply

against the US dollar, Turkey is vulnerable to tighter external financing. Its corporate and banking sectors are also exposed to an increase in the cost of capital when the US Federal Reserve begins to raise interest rates. However, Turkey’s government's own debt and borrowing requirements are relatively low and compare well with other large emerging market countries rated Baa3. Growth weakened in early 2015, after a short-lived upturn in late 2014. Uncertainties associated with the latest legislative elections and ongoing geopolitical tensions in the region are holding back investment and consumption spending, ventures the OECD in its latest report on the country. GDP growth is projected to pick up gradually over 2015 and 2016, after the“wait and see”attitudes of businesses and households dissipate, but to remain below potential. The OECD notes in its June paper, “Against the backdrop of large foreign financing needs and volatile capital flows, inflation – which remains far above target – will need to be brought down. To further rebalance demand from domestic to external sources, freeing up the productivity potential of the business sector and achieving durable competitiveness gains is crucial. The implementation of key product and labour market reforms would spur growth.” Actually industry is a bright spot. In April, notes Mehmet Besimoglu, head of research at Oyakbank, industrial production (IP) increased 3.7% year, “slightly above expectations of 3%. According to Turkstat, IP also increased 3.8% year on year in calendar adjusted (CA) terms. In seasonal & calendar adjusted (SCA) terms, IP stayed constant month on month,” he notes. Besimoglu says the only decline is in "intermediary goods" with -3.5% in across the first four months of this year, over which time there is a recovery in both durables and non-durables. Meantime, he adds, "investment goods is relatively stronger with 12% year on year rise”. IP had decelerated to 2.6% in 4Q14, after averaging 4.1% in 3Q14. Thus, the average rise in IP stayed at 3.6% last year. “Due to the weak performance in

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agriculture, GDP growth lagged IP figures in 2014, staying at 2.9%. Figures for the first two months of this year did not give a strong signal for the general outlook, either. Nevertheless, IP in both March and April resembled a recovery to around 4%, with IP growth between January and the end of April recovered towards 2%. Our 2015 GDP growth expectation [therefore] stands at 3%.” Nonetheless, commentators regularly list a series of problems that includes rising inflation, slowing growth, foreign exchange pressure, rising fiscal expenditures, increased unemployment, overall debt, and loss of export competitiveness. It is said that we are all the architects of our own personal tragedies; and this is no less the case for AKP. Turkey’s slowdown is mainly caused by longerterm structural factors, which AKP failed to tackle, preferring instead (or being pressured by the president to do so) to focus on unsustainable, and sometimes destructive, short-term measures, such as pressuring the central bank to maintain a loose monetary policy, jeopardising its independence and legitimacy in the process. Meanwhile, the structural reforms have been ignored. Most of all, Turkey has been unable since even the heady and transformative days of Turgut Ozal to reduce its reliance on foreign invostment, especially foreign indirect investment. This has made it repeatedly vulnerable to hot money flows and (over the long term unsustainable) an almost continuous current account deficit (currently racked at 6% of GDP). [Compare this with Europe, which has utilised the opportunity of a weak euro to sell more goods, stimulate more outward investment and, in aggregate, report a current account surplus). It’s not all bad news, just too much sluggish news. Private investment peaked in 2011 after a swift recovery following the global crisis, but has since been sluggish. In contrast, government investment, mainly in infrastructure, continued to increase until the end of 2013 and provided support during a time of volatile economic activity. Exchange rate uncertainty, corporate leverage and foreign

exchange exposures, and regional geopolitical tensions will influence the pace of recovery of investment.

Crushing politics Sad, but true, both foreign investors and many domestic financial institutions have also been cowed by the increasingly strident polemic from both the president and his government. Since the government crackdown on mass protests in 2013, the country’s democratic trajectory has taken a marked turn for the worse. Significant deterioration in crucial indicators such as rule of law, freedom of speech, judicial independence, media freedom, and checks and balances has further shaken the confidence of investors. Turkey’s rankings in corruption prevention and perception indices have slumped. Freedom House downgraded Turkey from “Partly Free” to “Not Free” in its 2014 report on press freedom around the world. The rising political risk indicated by these developments does not bode well for Turkey’s economic and investment prospects. Several open conflicts over economic policy have added to the jitters. In the recent Bank Asya incident, Turkey’s banking watchdog cited alleged irregularities as the justification for its seizure of shares from an Islamic lender — though most informed observes saw the move as a politically motivated outgrowth of the continuing rift between Erdogan and his bitter rival, the Gulen religious movement. The president also clashed publicly with Central Bank governor Erdem Basci on monetary policy decisions, pressuring him to cut interest rates. These conflicts have raised significant questions about the quality of Turkey’s economic policymaking at a time when the country desperately needs foreign investment to keep flowing. In this uncertain climate and with a growing fear of a backlash from the president should any overt or veiled criticism of presidential policy occur, no banker will go on the record to say anything; believing it safer to keep one’s head and opinions under the parapet. Among required action to normalise the democratisation of dissent, improved

legislative support for working women, the freeing of key pillars of the Turkish economy from presidential interference (including the stock exchange, the central bank and the financial market regulator) there are other more systemic risks that require tackling. Not least is the country’s savings rate, one of the lowest among emerging market economies (14% of GDP), to help reduce the country’s chronic reliance on foreign capital inflows. Finally, the rule of law should be improved, and basic freedoms protected that protect people and institutions from the arbitrary nature of decision-making and the formulation of policy.“We believe that the implementation of the last government's stated objectives, including structural reforms outlined in its development plan, will depend on key cabinet appointments and whether the AKP will choose to form a coalition or rule as a minority government … We believe this could help Turkey shift away from its current economic growth model, which remains highly dependent on net debt financing from abroad. We continue to see weak GDP performance in Turkey compared with previous historical norms as credit conditions have tightened, and business confidence remains muted,” notes Standard & Poor’s. Jan Dehn, head of research at Ashmore notes, “This election outcome may be good news for democracy in Turkey, but it will be received with scepticism by febrile investors. Borsa Istanbul, Turkey’s main stock exchange, opened down 8.2% on June 8th, while USD/TRY rose to 2.77 (from 2.66). In response, the central bank on Monday took steps to increase access to USD liquidity by cutting USD interbank deposit rates to 3.5% from 4.0% and EUR interbank deposit rates to 1.5% from 2.0%. Official final results will take a few days, but the political landscape could remain unclear for some time. Prime Minister Davutoğlu, or another person chosen by President Erdogan, will then be asked to form a new government, which must be put before a confidence vote in parliament within 45 days. Between now and then, let the political horse-trading begin!” n

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COMMODITIES/ENERGY MANAGING SUPPLY AND DEMAND IN THE OIL MARKET

Managing the interplay between oil stocks and oil prices The recent OPCE conference in Vienna in early June noticed what it described as ‘stabilisation’ in the recovery of the global economy, albeit with growth at moderate levels. In the current year, GDP growth is projected at 3.3%, with this expected to be at a slightly higher level of 3.5% for 2016. It was a generally optimistic note than the conferences in 2014, which had resulted in a free fall in oil prices as OPEC producers opted for aggressive output strategies in the pursuit of market share. Even though oil prices have look over the near term to have found some stability, the watchword for the market in 2015 is inventories, which remain at historically high levels.

ECORDING ITS CONTINUED concern over market volatility and the challenges faced by the global oil industry as a whole, the OPEC members highlighted that the sharp decline in oil prices witnessed at the end of last year and the start of this year – caused by oversupply and speculation – had now abated, with prices moving slightly higher in recent months. In the first week of June, oil prices looked to continue the recent rally, particularly as US government data confirmed a big weekly drawdown in domestic crude stockpiles. The US Energy Information Administration (EIA) reported crude oil inventories falling by 6.8m barrels over the week, four times more than the 1.7m barrels forecast by analysts. However, industry group the American Petroleum Institute had raised market expectations estimating a drawdown of as much as 6.7m barrels; but even it was taken aback by the final amount. Even so, it remains difficult, given seasonal demand shifts and underlying structural issues how the interplay between oil in storage volumes and price will play out over the summer. According to Arthur Berman, expert commentator on the energy web service Oilprice.com, “storage withdrawals and falling rig count have been the main sources of hope that US tight oil production will fall and that oil prices will rebound. That hope is fading as it is now clear that recent withdrawals from US crude oil storage are because of price, not falling supply, and that the drop in rig

Photograph © bluebay2014 Dollarphotoclub.com, supplied June 2015.

count has stalled”. Even so, he notes:“The recent inventory build correlates almost perfectly with the fall in oil prices and the withdrawals from storage over that last three weeks correlate with the 35% increase in oil prices since late March.” US light crude closed up $1.29 (up 2.14%) to touch $61.43 a barrel ($61.43/b), the highest point since December 9th 2014. Brent crude meanwhile rose to $65.60 a barrel – though reported profit taking by players that had bet on the drawdown on stockpiles pulled the market back from going higher. As Berman notes, falling rig numbers have also a role to play. Rig counts not only tell the market how many rigs are drilling for oil and gas; it helps understand how long term supply might evolve and naturally points to a fall-off in upstream activity. Invariably over the longer term any drop in rig numbers will also adversely affect oilfield service companies. According to oilfield service company Baker Hughes (BHI), there were 868 active oil and gas rigs in the United States (both onshore and offshore) in early June, some seven less active rigs than in the last week of May. The drop continues an

average four week US rig count drop of seven. However, this denotes a marked slowing on figures recorded earlier in the year. For example, the rig count drop averaged 24 over April and 34 in through much of March. Rig numbers have been falling for an uninterrupted 26 weeks. For the highpoint in rig numbers you have to go back to September 2008 when the tally was 2,031, which itself had touched a high not seen for 20 years (July 1987 to be exact). In September 2014, the signs were hopeful for a return to those record levels, as the rig count touched 1,931; but since that highpoint, rig numbers have fallen off by a rather drastic 55%. While some analysts expect prices to fall back over the near team, The ShortTerm Energy Outlook (STEO) released on June 9th by the IEA would suggest some stability in an around the $60-$65 level for some time. It forecasts the average price for North Sea Brent crude oil in 2016 at $67 per barrel $3/b lower than projected in the May STEO. The 2015 Brent forecast remained unchanged at $61/b. Expectations of looser global balances in the latter portion of the forecast period drove the adjustment to the price outlook. WTI prices are expected to average $5/b below Brent in both 2015 and 2016. Adjustments to the supply-side outlook look to be the major driver of looser global balances. Global oil supplies fell by 155 000 barrels per day (155 kb/d) in May to 96m barrels per day (mb/d) on lower non-OPEC output, but remained

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at a steep 3 mb/d above the level of May 2014, the IEA Oil Market Report (OMR) for June noted. In the June report, the IEA forecast global inventory builds average 1.9m barrels per day (b/d) in 2015 and 0.8m b/d in 2016, a significant change from the previous forecast builds of 1.3m b/d in 2015 and 0.2m b/d in 2016. EIA now forecasts greater oil supply than it did last month. Coupled with little to no change to the demand growth forecast compared with last month’s projections, the greater supply likely will lead to larger inventories. Annual growth has slowed marginally from March and April and has remained roughly split between non-OPEC and OPEC countries. The OPEC Conference noted that world oil demand is forecast to increase in the second half of 2015 and in 2016, with growth driven by nonOECD countries. On the supply side, non-OPEC growth in 2015 is expected to be just below 700,000 barrels per day, which is still only around one-third of the growth witnessed in 2014. However, the IEA’s June report raised the forecast of non-OPEC supply growth for 2015 by 195 kb/d to 1 mb/d. Production growth outside of OPEC continues to largely reflect US and Canadian output. Projected US crude oil production in the June STEO averages 9.4m b/d in 2015 and 9.3m b/d in 2016, an increase of 0.2m b/d

in 2015 and 0.1m b/d in 2016 from May’s STEO, primarily because of upward revisions to estimated production data in Q4 last year and Q1 this year. Canadian production is also expected to be higher than previously estimated despite recent outages because of wildfires in Alberta. OPEC supply edged up 50 kb/d in May to 31.33 mb/d, the highest rate since August 2012. Saudi Arabia, Iraq and the United Arab Emirates pumped at record monthly rates to keep output more than 1 mb/d above OPEC’s official supply

target for a third month running. Oil ministers agreed to maintain that target at their 5 June meeting. In the June STEO, OPEC crude oil production is expected to rise by 0.6m b/d in 2015 and fall by 0.2m b/d in 2016. At the June 5 OPEC meeting, the group did not change its 30m b/d crude oil production target. EIA forecasts OPEC crude oil production will continue to exceed that target over the forecast period, contributing to the expected continued global inventory builds. n

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OPINION TRANSACTION REPORTING FAILURES – WHY DOES IT KEEP HAPPENING?

Keeping transaction reporting up to scratch: you know it makes sense!

In late April another top firm was hit with a multi-million dollar fine. This time Bank of America Merrill Lynch was the recipient – for failing to report its transactions correctly. This follows a recent raft of other sophisticated Tier-1 institutions being subjected to heavy fines, as regulators continue to focus on what is actually being reported. One thing is for sure: Bank of America Merrill Lynch will certainly not be the last firm to suffer the same fate. In fact I suspect it’s the tip of the iceberg! So why does this keep happening? Bill Blythe, Global Business Development Director, Gresham Computing goes in search of answers.

HE INTRODUCTION OF the Markets in Financial Instruments Directive (MiFID) in 2007 was challenging for many institutions, having to report approximately 28 fields for ISIN, for Alternative Instrument Identifier (Aii) and some OTC instruments. That however only applied to financial services firms. With the newer regulations coming on stream, such as the European Market Infrastructure Regulation (EMIR) any firm – including corporations – need to report on as many as 90 separate fields for any derivatives transaction. It appears much ado about a single transaction. Even so, transaction reporting serves a vital purpose. For regulators, these transaction reports are fundamentally important in identifying market abuse and, therefore, applying market surveillance so that the entire market works well. That seems simple enough. By law, firms must send a set of fields, including the descriptive information of the trade for certain asset classes, to a reporting mechanism or trade repository. Few will have forgotten that the global financial crisis was the worst since the Great Depression. The after-effects are still being felt today, and form much of the current political and social rhetoric. The over-arching reason for this newly imposed tighter regulation is to lower risk in various points of the financial system, so that it doesn’t happen again. Special focus has been paid to derivatives, both ETD and OTC, because they played such a significant role in the recent crash. There is no doubt that this shift has thrust a greater emphasis on compliance

among firms. Meanwhile, the cost of capital and doing business has increased which, in turn, leads to decreased returns on equity and subsequent cost cutting. What follows is often a reduction in investment appetite and, by extension, less risk mitigation. This is a vicious and unsustainable cycle. In various discussions with senior investment bankers, it has become clear they are looking intently at the cost of doing business and whether their firms can actually continue to be an effective and profitable business in all the areas in which they operate. The complexities involved in ensuring that adherence to the regulatory framework are immense. The sheer breadth of regulation and regulators is breathtaking: encompassing ESMA and the US CFTC to MiFIR and AIFMD. When you also factor in the rules required for the various asset classes and associated trading jurisdictions, it’s clear that firms are facing an uphill battle.

Data integrity now key The problem also lies with poor internal data quality. As we all know, data within most firms is unstructured and badly managed – to put it mildly. Even simple Standard Settlement Instructions (a problem from decades ago) are often difficult to manage. Trades with counterparties in different jurisdictions often involve two or more incompatible data stores and trade processing systems. Throw the newer fields into the mix, such as the UTI, USI and LEI – which the front office must be able to handle – and trade reporting becomes a nightmare with data

quality issues. Various trade repositories also require different formats, making the challenge even greater. Siloed systems and complex frameworks across multiple geographical regions just compound the problem – but starting again with new systems is just not viable. Technology is not the silver bullet here. Yet, firms can at least begin to remedy these issues by putting in place a control framework that stops these transaction reporting fines being issued. In my opinion, it’s about adopting a flexible and adaptable framework for providing integrity in the context of risk reporting. The need to validate and prove accuracy, compliance and completeness has never been greater. Operationally strong levels of governance are required, along with robust architectures that can be flexible to meet the everchanging regulatory landscape. Can you prove that what you actually report is valid? Does this data match up with the front-office system, with the books and records system, and with the exchange data? Can this data be validated in real-time across multiple data sources? Unfortunately for many, current inhouse systems and old legacy reconciliation tools simply aren’t up to the task in today’s new world of regulatory control. However, with front-to-back integration, firms can equip themselves with a holistic view across the trading environment. Being prepared to adopt a different mindset is key: firms must be open to the notion of putting in place a comprehensive and sophisticated rules engines to ensure full compliance and avoid falling foul of the regulator. n

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Real-time payments: about time too Heightened customer expectations, evolving business needs and rapid advancements in technology have changed the game for payments, with Faster Payments – 24/7 real-time transactions – now taking centre stage. Jan Gonnissen, SVP Payments, iGTB, explores the developments taking place around the world and what faster payments entail behind the scenes.

T’S A BRAVE new world for commerce. While corporations and the banks that serve them have always had to adapt to changing market dynamics, never has the pace of change been so fast. The rapid development of emerging markets, the associated geographic shifts in round-the-clock commercial and payment flows, and postcrisis economic and socio-political upheavals have changed payment needs and preferences around currencies, formats and the manner in which transactions are conducted. By the far the most significant change, however, comes from recent developments in technology – both in new innovations transforming banking capabilities and in the heightened expectations of customers. Accustomed to the ease and immediacy of technology in their every-day lives, today’s corporate clients demand ever-greater levels of speed, mobility and flexibility. Enter the era of real-time payments; the culmination of all these factors and a revolutionary step forward for payment providers and their customers. Whether known as“real-time”or“faster”payments, there is a clear demarcation between these instant, digitally-enabled payments of the future and the slower, traditional payment formats of old. Historically, lowvalue payments were settled in batches through domestic clearing or netting systems, in one of several cycles conducted each day. As recently as a couple of decades ago, you would have needed to leave up to five working days for a payment to be processed and settled, as bank processing at the time entailed the physical delivery of magnetic tapes to a national clearing facility. At least it was better than the traditional disclaimer when ordering goods mail order: Allow 28 days for delivery.

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How times have changed. Teenagers – tomorrow’s business leaders – don’t have the tolerance for long cycle times. Today, in line with the right here/right now expectations of the internet generation, payments can be conducted in real-time with near-instant processing and settlement. These faster payments are undoubtedly the most significant development in the payments and transaction banking space in recent years; it’s no wonder they’ve become so universally popular.

The roll-out of real-time Now real-time payments infrastructures and schemes are being rolled out across the globe. The UK has the Faster Payments Service (FPS), Singapore boasts a new G3 Immediate Payments system, and Australia will be launching its New Payments Platform (NPP) sometime next year. Moreover, the European Central Bank (ECB) has identified Faster Payments (with immediate availability of funds) as the next step in its overarching aim to aid regional harmonisation and cross-border collaboration, in line with the implementation of SEPA. EBA Clearing has also added to this momentum by creating a specialist team tasked with building the foundations for a pan-European instant payment processing service, with the aspiration of launching a fully-operational service by 2018. In the US, the Federal Reserve Bank,

the central bank, has echoed such efforts in a strategy document proposing the transformation of the country’s antiquated payment systems, pushing for this project to be fast-tracked. In the shortrun this is likely to manifest as extended operating times for the National Settlement Service as well as additional clearing cycles, but should in the long-term lead to a more comprehensive overhaul of current payment systems. So what does the catch-all term of realtime payments actually mean? Despite the variation in faster payment schemes across the globe (with differences around maximum value thresholds, for example), it is generally understood that the term applies to 24/7, 365-days-a-year payment mechanisms that enable interbank funds transfers to be conducted with availability of funds in the beneficiary’s account effectively (if not quite literally) in a realtime manner. For both personal and business customers, such payments should be available anytime, anywhere – be it in a branch, via internet banking, or on mobile devices such as a smart-phone or tablet. A broad number of payments can be conducted on these new real-time payment mechanisms, including: single immediate payments; bulk payments, undertaken mostly by corporations; forward-dated payments; standing orders; and direct corporate access – usually via a secure ITsolution for sending bulk files for sameday processing. While different schemes vary in their requirements, funds are usually expected to become available in the receiving customer account in the time it takes to send an email (or, at most, within a maximum two-hour period). Confirmation responses (from the receiving to the sending bank, either confirming or

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PAYMENTS THE MECHANISM OF REAL TIME PAYMENTS

rejecting the payment) should be received in no more than 15 seconds. In addition, any payment rejections need to be accompanied by a reason as well as an expected timeframe for funds reaching the account. For end-customers – the tech-savvy drivers of this payments transformation – the benefits are myriad. Faster Payments offer not only improved efficiency and speed, but greater security and reliability thanks to the provision of status confirmations (e.g. paid or rejected), improved payment information, and the increased traceability of and transparency over cash-flows.

Behind the scenes What does this development entail for banks? Actually, adapting to the new payments regime is easier said than done. Even once country- or regional-level central market infrastructures have been updated, participating banks will still need to upgrade their own payments-execution platforms if they are to unlock (and pass on) the full range of benefits Faster Payments have to offer. Such upgrades are all the more pressing when advances in technology – the very enabler of real-time payments – have also allowed non-bank competitors to enter the scene. Free of hindrances such as stringent regulatory requirements and cumbersome legacy systems, these new types of payment service providers (PSPs) are both nimble and flexible, putting pressure on banks to improve their ability to meet customers’ fast-changing“wants and needs”. First and foremost, banks looking to move with the times will need to adopt a new mind-set. Their traditionally siloed vision is no longer adequate for navigating market disruptions and opportunities, and the banking sector – never known for its speed – needs to become more proactive and much faster in anticipating and addressing changing needs. The success of faster payments also relies on the ability of banks to adopt “best practice” payments integration. One solution, preferred by best-in-class banks, is the creation of an International Payments Hub; as the name suggests, a centralised platform for covering both domestic and

international payments, to simplify payment operations and make disparate country-level systems redundant. Such hubs allow for the incorporation of the necessary functionality for Faster Payments alongside existing ACH or RTGS payment streams, with any specific format requirements addressed (via a flexible configuration layer) without the need for hard-coding into the payments application itself. While some processes (such as query responses) may require re-visiting in order to comply with new maximum response times, the all-important considerations of AML and other compliance checks can be addressed by the existing orchestration layer. Banks will also need to implement realtime funds control and verification of available credit facilities. Indeed, corporations should expect their banks to almost instantaneously obtain and communicate real-time cash positions and overall credit utilisation. For banks building a roadmap to future success – addressing not just these realtime expectations but also the threat of increased competition and the onslaught of regulation – their capabilities and understanding should ultimately boil down to what is referred to as the Digital Inside and Digital Outside. The Digital Outside encompasses all client-facing operations and both defines and is influenced by the customer experience. For banks, a successful Digital Outside is one that helps achieve higher profits and greater levels of transparency, alongside lower exceptions and shorter transaction time windows. International payment hubs can add significant value to this Digital Outside by consolidating all payments and payment types into a single processing location and operations function – moving towards an “enterprise payments approach”to improve the customer experience and inject greater visibility over payment flows; a factor all the more important in today’s riskconscious environment. Furthermore, such hubs not only enable banks to meet the more sophisticated needs and demanding expectations

of customers, but can also result in straight-through processing (STP) rate improvements of 15%-20%. In addition, the enhanced digital insight allows for greater clarity from a product-technical and costing perspective, which in turn reduces the time-to-market for new or customised solutions, leading to greater customer satisfaction (at a time of increased competition). International payments hubs can also benefit banks on the Digital Inside; the internal-facing aspect of banking operations, and where banks will look to increase quality and productivity while reducing costs and process times. Alongside the cost benefits of improved STP rates, banks deploying a future-ready International Payments Hub can expect to improve operational efficiency and reduce costs through the simplification and centralisation of operational functions. Furthermore, governance and control functions become more robust, and economies of scale reduce marginal cost-of-processing; a critical measure of importance in the payments space. Ultimately, if banks take advantage of this new era of payments to take stock of their operations (both “inside” and “outside”) and leverage current market infrastructure changes as a launch-pad for their own structural improvements, then they have as much to gain as their end-customers in this transformation of the payments market. Although some country and regional real-time payment schemes are still in the development stage, the general trend of the market is unmistakably clear. End-customers want payments right here, right now – and it’s only by understanding and adopting bestpractice capabilities that banks will be able to stay ahead of the game, and make real-time banking a long-term and sustainable success for both themselves and their corporate clients. Then flown-from-the-nest teenagers the world over will have the luxury of demanding, when out shopping, yet another “loan” from their parents right now – and checking their account and spending it in the next few minutes! That’s the future! n

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Photograph ÂŠ Seamartini GraphicsDollarphotoclub.com, supplied June 2015.

Green bonds see pick up in private sector investment The Catholic Pope is putting his two-penneth in on climate change; and once more climate change is now centre stage, but this second act has a clear financial complexion, and that makes all the difference. Multi-laterals, asset managers and banks now realise that climate change will not only affect investment returns; it will also provide a new avenue for fund-raising for sustainable projects that will have a beneficial impact on the earth. Whoâ&#x20AC;&#x2122;s investing in what?

REEN BONDS ARE changing investor expectations and making sustainable investment just that bit easier. Investors can no longer bypass implications posed by the changing climate on their portfolios, says a recent report by Mercer, sponsored by the private sector financing arm of the World Bank, the IFC, the Federal Ministry for Economic Cooperation and Development, Germany and the UK Department for International Development (DFID). The report, Investing in a time of climate change, looks at the impact of climate change on investment returns to

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demonstrate why climate-related risk factors should be standard considerations for investors, as the majority of investors are not incorporating climate considerations into their portfolio decisions. The study warns investors not to expect that the future will mirror the past, particularly at a time when economic growth is heavily reliant on an energy sector powered by fossil fuels. It shows that the impact on returns from climate change are inevitable, irrespective of which climate outcome evolves (either a two or four degree rise in temperature) unfolds. Environmental degradation, poverty and

the effects of climate change all threaten the well-being and stability of countries, communities, resources and businesses. Investors, suggests Mercers, should begin to understand the threats these forces create for long-term financial value. The research also points to opportunities for investors in an economy that would transition to a two degree low carbon outcome, highlighting actually that this outcome most likely will not jeopardise financial returns for long-term diversified investors. Unfortunately, that is not the case should temperatures rise beyond this benchmark.

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DEBT REPORT PRIVATE FINANCE AND GREEN BONDS

As in all investment market activity, climate change will give rise to investment winners and losers, with the energy sector becoming the most affected. Mercer posits the view that the coal industry will be the biggest loser while the renewable sector will win. Depending on whichever climate outcome plays out, the average annual returns from the coal sub-sector could fall by as much as 26% to 138% over the next ten years. Conversely, the average annual returns in the renewables sub-sector could increase by between 4% and 97% over the next 10 years. Though even Mercer concedes this is a very wide spread. The report assesses investment exposure to climate risk, estimates the impact on investment returns through to 2050 and offers insights on how investors can improve the resilience of investment portfolio in a time of climate change. Irrespective, financial institutions are clearly taking the implications of climate change to heart and looking to secure at least part of their overall business activity within the parameters of long term good governance and sustainability criteria; albeit that the green industry and green capital markets are still in their infancy. Investment in alternatives is a quick and easy solution for asset managers anxious to build their climate supporting credentials. Aviva Investors, and the Pensions Infrastructure Platform (PiP) announced first close on a new solar photovoltaics (PV) Fund in early June. The fund, managed by Aviva Investors, closed with £131m of commitments from four UK pension schemes. The fund was launched with the aim of delivering predictable, long-term, inflation-linked cash flows through investing in small-scale solar PV installations in the UK. Expecting growing demand for green investment, the fund will now look to raise additional commitments and will have a hard cap of £250m. Returns of the fund are expected to be in line with the key feature of the PiP, at RPI+2-5%. Matthew Graham, Business Development Director, at Aviva Investors, explains the fund has attracted strong investor

interest. “Aviva Investors’ proposition in infrastructure has been designed to respond to our clients’ need for outcomeoriented solutions, offering long-term secure inflation-linked income that can provide attractive risk-adjusted returns”. Since the start of the market in 2007, the majority of green bonds have been issued by development banks such as the EIB and the World Bank, which has issued some $7bn worth of green bonds in as many as 18 currencies, and its private sector funding arm, the IFC. Funds from the issuance of green bonds have been utilised for climateand environment-friendly projects such as expanding rural solar power in Peru and large-scale renewable energy in Mexico; increasing irrigation efficiency in Tunisia; and expanding clean urban transport in Colombia, among other sustainable infrastructure projects. Green bonds can provide the verification and impact measurement that investors need in deciding allocations to sustainable green infrastructure strategies. Moreover, they often, as in the example of World Bank and IFC green bonds, they also bring AAA/Aaa ratings. The private sector is also building credentials in the green bond segment, which totalled some $35bn in issuance last year. ABN AMRO is the first commercial bank in the Netherlands to enter the market, with a debut €500m bond at the beginning of June. The bond has a maturity of five years and was issued at midswaps plus 45 basis points. [Mid-swap is the average of bid and ask swap rates used as a benchmark for calculating total interest rate cost of issuing a variable rate bond. Bid is the fixed rate that is received in exchange for a floating rate (usually LIBOR), while ask is the fixed rate which is paid for that floating rate. The bond issuer pays midswap fixed rate to the market maker and LIBOR plus a given premium to investors and receives LIBOR]. ABN AMRO structured the green bond itself and sold it down to investors, the majority of which are European institutional parties that the bank says favour sustainable investments. “These sustainable investors further diversify our existing investor base. Given the success of the first bond, we are definitely keen to return to

the green bond market on a regular basis,” says Daniëlle Boerendans of ABN AMRO Funding & Capital Issuance: “During our talks with investors we noted that they were very interested in our first green bond. This was reflected in the order book, which was well oversubscribed.” Joop Hessels, at ABN AMRO Green Bond Origination explains: “We have followed the advice of the green bond principles and responded to the needs of NGOs and investors. The result is a transparent and innovative bond. Investors can invest in highly sustainable property while benefiting from the rating and moderate risk profile of ABN AMRO, the issuer of the bond. ABN AMRO will use the knowledge it has acquired in this process to advise other organisations on issuing green bonds”. Developed areas in the Netherlands account for more than 25% of the country’s carbon emissions. Richard Kooloos of ABN AMRO Sustainable Banking adds that ABN AMRO is one of the organisations that has endorsed the National Energy Agreement.“The bank’s balance sheet consists largely of mortgages and property loans, so we can make a real contribution to the goal of making developed areas in the Netherlands energy-neutral,” says Kooloos.“We will do so on the one hand by financing sustainable assets; on the other, by using this green bond to bridge the gap with the capital market. We will not meet the 2020 targets set in the Energy Agreement with bank financing alone. Financing from the capital market is essential.” Morgan Stanley also issued an inaugural $500m green bond in June to fund clean energy and energy efficiency projects. Funds connected with the offering will be used on projects including the construction of four Texas wind farms and the installation of energy-efficient lighting to Morgan Stanley’s New York headquarters. “Sustainable Investing is about trying to maximize capital to build a more sustainable future,” says Audrey Choi, CEO of Morgan Stanley’s Institute for Sustainable Investing, says.“We believe that the green bond market embodies that

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cause by ensuring an appropriate rate of return and funding projects that fulfil a sustainable and green outcome." Choi says the issuance of the 2.20% senior notes, due in 2018, is part of the company’s larger strategy of offering market-based solutions to environmental issues. Knowing where the money is flowing is critical for reaching areas of opportunity and need, on the basis that what gets measured gets managed. Two initiatives have been put in place this year which have encouraged the harmonisation of principles among relevant institutions and put in place the means to track the progress and volume of finance in support of climate mitigation. The multi-lateral development banks (MDBs) have their International Development Finance Club, and have started a similar process for adaptation finance. In the private sector, four banks got together in 2014 to create the Green Bond Principles and in early April this year issued a governance framework that will allow for diverse stakeholder input into the Principles, provide effective oversight, and support further development of the green bond segment. The governance framework sets out the membership eligibility, which requires organisations to have issued, underwritten, or invested in green bonds, and admits others in the

field of green finance as observers. It also establishes an executive committee, which includes underwriters, issuers, and investors with global geographic representation. The International Capital Market Association (ICMA) serves as the Secretariat, assuming administrative duties, and providing guidance for the governance of the Principles and other issues. Its duties, explains ICMA, include facilitating information exchange with issuers, investors, underwriters, and other stakeholders, as well as gathering input for the annual update of the Green Bond Principles. To date, 25 banks have announced their support of the Principles in addition to the four founding banks that served as a drafting committee for the Principles (Bank of America Merrill Lynch, Citi, Crédit Agricole CIB, and JPMorgan Chase & Co) and nine initial supporters, including BNP Paribas, Daiwa Capital Markets America Inc, Deutsche Bank, Goldman Sachs, HSBC, Mizuho Securities, Morgan Stanley, Rabobank, and SEB. The world’s six large MBDs delivered over $28bn in financing last year to help developing countries and emerging economies mitigate and adapt to the challenges of climate change. The latest figures bring total collective commitments of the past four years to more than $100bn. In 2014, the six banks together provided

over $23bn dedicated to mitigation efforts and $5bn for adaptation work, according to the fourth joint report on MDB Climate Finance. Josué Tanaka, EBRD managing director, Operational Strategy and Planning, Energy Efficiency and Climate Change, and Portfolio Management, says the record level of climate finance has been achieved with a high share of activity in the private sector and in energy efficiency, and says these are “two crucial areas to scale up climate finance and meaningful carbon emissions reductions over the short to medium term. As COP21 approaches, this focus on scaling up finance while delivering concrete results across a large number of countries becomes ever more relevant.” Of the total commitments in 2014, 91%came from MDBs’own resources, while the remaining 9%, came from external resources including bilateral or multilateral donors, the Global Environment Facility, and the Climate Investment Funds. It is increasingly clear that the finance required for a successful, orderly transformation to a low-carbon and resilient global economy is counted in the trillions and not billions. “The immediate challenge of climate finance, while we build the policy framework that will drive investment of the trillions, is to meet the promise made by developed countries to mobilise $100bn a year by 2020,”adds Tanaka. n

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TRADE REPORTING TRANSACTION REPORTING FAILURES – WHY DOES IT KEEP HAPPENING?

Keeping transaction reporting up to scratch: you know it makes sense! In late April another top firm was hit with a multi-million dollar fine. This time Bank of America Merrill Lynch was the recipient – for failing to report its transactions correctly. This follows a recent raft of other sophisticated Tier-1 institutions being subjected to heavy fines, as regulators continue to focus on what is actually being reported. One thing is for sure: Bank of America Merrill Lynch will certainly not be the last firm to suffer the same fate. In fact I suspect it’s the tip of the iceberg! So why does this keep this happening? Bill Blythe, Global Business Development Director, Gresham Computing goes in search of answers.

among firms. Meanwhile, the cost of capital and doing business has increased which, in turn, leads to decreased returns on equity and subsequent cost cutting. What follows is often a reduction in investment appetite and, by extension, less risk mitigation. This is a vicious and unsustainable cycle. In various l discussions with senior investment bankers, it has become clear they are looking intently at the cost of doing business and whether their firms can actually continue to be an effective and profitable business in all the areas in which they operate. The complexities involved in ensuring that adherence to the regulatory framework are immense. The sheer breadth of regulation and regulators is breathtaking: encompassing ESMA and the US CFTC to MiFIR and AIFMD. When you also factor in the rules required for the various asset classes and associated trading jurisdictions, it’s clear that firms are facing an uphill battle.

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Can firms afford to comply with trade reporting requirements? Now that most G20 member states have mandated trade reporting of derivatives, market participants have an opportunity to evaluate the agility and sustainability of their current approach. In this article, Randall Orbon, Arun Karur and Cian Ó Braonáin of Sapient Global Markets discuss the state of trade reporting and show how growing costs, complexity and regulatory scrutiny are fuelling a compelling business case for third-party managed solutions.

O ADDRESS THE trade reporting requirements outlined in DoddFrank and EMIR, many organisations made significant investments in internal systems. Now additional regulations and further enhancements— including MiFID II/MiFIR and requirements in other regions—are poised to effect more change. In addition, it is likely that regulators will begin to scrutinise data and organizations will need ways to create assurance and paths to remediation for trades that are self-reported or reported on their behalf. With many of the systems currently implemented there is no clear path to efficient tracking, reconciliation and remediation of trade data. The time is right for firms to reevaluate the ongoing business as-usual outlay for trade reporting and determine whether or not the cost for compliance will be sustainable into the future. More specifically, firms may benefit from exploring how to cost-effectively maintain their reporting systems improve their ability to remain 100% compliant, ensure their systems are enhancing overall reporting capabilities; afford the expansion or adaptation of their systems to meet emerging requirements and, at the same time, track what has been reported and provide assurance and remediation capabilities Driven by requirements, existing systems and available budgets, market participants have tackled regulatory compliance in a variety of ways. With an average spend of almost $25m to achieve compliance for both DoddFrank and EMIR, many investment banks have implemented basic compliance, often with more than one reporting system

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servicing different silos of the bank. Most have quickly discovered it was too difficult and time consuming to build a single, enterprise-wide solution to comply with regulations. Despite sizable investments, many banks are still grappling with data management challenges and inefficient trade reporting processes and governance. Tight timelines have resulted in many shortcuts and reduced features, particularly related to data mapping, data ingestion and operational management information reports. In addressing these challenges, banks face tight budgets and a persistent belief that once compliance dates are achieved, additional funds will be unnecessary. In reality, many investment banks will spend almost as much to meet forthcoming regulations as they did to get to where they are now. In all likelihood, they will realize little to no savings due to the lack of extensibility and flexibility in their current reporting solutions. For most, the bigger concern is that delegated reporting is becoming a risky proposition, with hard-won clients facing difficult questions from regulators. Initially rolled out as a free service to clients to retain business, trade reporting is quickly becoming a high-risk offering; reporting confidently for clients will require a sizable investment.

The buy side Until EMIR took effect in August last year, buy-side firms felt confident that their executing broker or clearing member was fulfilling their basic transparency requirements. Unlike Dodd-Frank’s single-sided reporting obligation, which placed re-

sponsibility for reporting to a trade repository on the executing broker or clearing member, EMIR requires that both the buy-side firm and the sell-side broker or clearing member report their transactions. Although firms have the option of continuing to delegate their reporting obligation, they cannot delegate liability for the collateral and valuation information provided to the broker. Thus, even with a third party handling reporting, buy side firms must be able to demonstrate to regulators that they are validating the delegated reporting against their own records. Also, they must provide assurance to regulators and their own management teams that reporting data is accurate, timely and complete. Doing so can be challenging for buy side firms if they lack a detailed understanding of regulations. Many buy side firms have turned to service providers for solutions to reporting commitments. While service providers are frequently the only data source for reporting buy side trading activity, many have been reluctant to assume the added responsibility of ensuring regulatory compliance for their customers. Reconciliation and control challenges, as well as the risk of duplication and fragmentation, are among the potential downsides to providers. Reporting flow is further complicated by the buy side’s use of delegated reporting by their banking counterparties—who select data repository locations convenient to them, not to buy-side firms. This fragmented approach complicates reconciliation and puts pressure on service providers to maintain connectivity to all relevant trade repositories.

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TRADE REPORTING TRANSACTION REPORTING

Given firms’ small appetite to pay for reporting services, third-party service providers are realizing that the risks may outweigh the profit potential. Now that several major deadlines have passed, market participants can expect active regulatory scrutiny. What regulators find will likely be fraught with issues, and the cost of non-compliance can be steep. Deutsche Bank recently was fined £4.7m for failing to properly report transactions. Previously, Barclays was fined £2.45m for failing to provide accurate transaction reports under MiFID I to the Financial Conduct Authority (FCA) and for serious weaknesses in its transaction reporting systems and controls. Regulatory audits aside, organisations face other potential threats—including confidential data breaches, technology failures or client transaction errors. Such threats have significant reputational, regulatory or legal ramifications, and very likely expose the organization to financial loss. A number of triggers may prompt market participants to re-evaluate their current trade reporting infrastructure. Depending on entity classification, reporting requirements for the same trade can differ across jurisdictions. Institutions delegating their trade

reporting or offering reporting services need to be ready for potential conflicts if they are operating within the EU or within countries where local law differs from ESMA or Dodd-Frank. To ensure full compliance, institutions need sophisticated rules engines, systems and data management—features which most current in-house systems lack. Moreover, siloed infrastructures persist throughout the financial services industry, presenting tremendous challenges for cross-border trade reporting. Trades with counterparties in different jurisdictions often involve two or more incompatible data stores and trade processing systems. Such structural issues create poor data quality and significantly hinder a reporting party’s ability to achieve 100 percent match rates. Compounding the data quality issues is the introduction of several new fields that trade capture systems need to accommodate—including LEI (Legal Entity Identifier), Product Taxonomy (UPI) and UTI / USI (Universal Trade / Swap Identifier). Many organisations are managing their governance, risk and compliance initiatives with dozens of disparate, often disjointed systems. The approach fuels duplicative and contradictory processes and documentation. With such complexity, it becomes easy

for suppression logic to become stale. That, in turns, results in over- or under-reporting, which puts organizations at risk of censure and fines. Add the expense of maintaining multiple point software solutions, and the cost of compliance can quickly spiral out of control. Additionally, the inconsistent interpretation of reporting requirements has led to varied reporting formats and standards within the industry. With multiple intertrade repositories accepting these different standards and formats, the result has been poor trade pairing and low matching rates.

New approaches Why are so many companies reexamining their original decision to build in-house solutions? There are multiple answers. First, companies underestimate the total cost of ownership. Companies often estimate only the cost of an initial build or implementation and don’t typically account for the cost of understanding regulatory requirements and creating traceability to the reporting functionality upfront but also on an ongoing basis as regulations change or new ones are rolled out. There is also the likelihood that tech-

Trade reporting: assessing available options in third party managed services When financial regulations were coming into effect in 2012, there were no managed solutions available to help market participants handle trade reporting. Today, robust, third-party managed services are available, offering organizations a number of benefits:

Lower Total Cost of Ownership (TCO): A managed solution helps organizations minimize capital outlay and staffing requirements. With operating costs syndicated across multiple subscribers, ongoing cost of ownership is also significantly reduced. Improved Reconciliation: Trade reporting service providers maintain a reconciliation engine that takes reports from trade repositories, TriOptima and other sources, and then reconciles them to a client’s internal database. This approach addresses regulatory rules for portfolio reconciliation, discrepancy identification and dispute resolution, as

well as reporting. Reduced Compliance Risk: In addition to offering out-of-the-box support for reporting to all global trade repositories for all asset classes and message types, best-in-class trade reporting solutions include regular, timely updates reflecting reporting rule changes. Additionally, such providers maintain close relationships with regulators to stay informed about new requirements. Improved Data Usability: Access to a comprehensive solution that aggregates data from multiple sources creates an opportunity to expand data analytics and utilize the trade reporting solution

as a decision support system. Rapid Deployment: With pre-configured reporting rules and message types, trade reporting service providers seamlessly integrate with any source system. Designed to work in conjunction with other reconciliation applications, they also enable easy integration with all trade repositories, counterparties and vendors. Better Reliability and Security: Despite continued concerns about the reliability and security of managed solutions, remotely hosted services can offer a higher and more reliable standard for data protection than onsite software. n

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nology builds and implementations do not go as planned creating either additional technology costs or compromised solutions that often create additional operational overhead on an ongoing basis. The cost of supporting and adapting the technology platform as regulations change is also an important consideration. This involves infrastructure and connectivity cost to support their platforms and negotiate the onboarding and ongoing relationship management with trade repositories such as the DTCC, CME, ICE, REGIS or UnaVista. Then there is also the emerging cost of reconciliation and assurance as firms will need to have teams and technology that

can work across trade repositories to reconcile what has been submitted, remediate errors and provide assurance to key stakeholders or clients. Many firms only account for the cost of submitting trades. In the past, building in-house systems was the accepted practice, especially for large banks and custodians. However, this is no longer true. Banks are now looking for alternatives to building their own systems for all of their needs, not just trade reporting. Today’s growing availability of managed services and cloud computing has driven many industries to shift away from developing software and maintaining hardware— functions deemed too expensive and

complex to keep in house. For example, long ago most major airlines have done away with their proprietary ticketing systems in favour of outsourcing through systems such as Sabre or Amadeus. Ultimately it all comes down to cost and here the larger by side players have the advantage in having an ability to fund tailor made in-house systems, or at least buy in off the shelf solutions that are the closest fit to their requirements and which are compatible with legacy systems. In Europe, the trend is to build in house and outsource at the same time, as a cross check; but in these increasingly cost conscious times that is beginning to look like a luxuy.n

Weighing up the options: In-house build or outsourced service? As with any business decision, financial analysis is a critical input to deciding whether to upgrade/build a trade reporting solution or outsource to a third-party provider. In building or upgrading a solution, firms typically incur costs involved in interpreting regulations and defining business requirements, design/engineering and project implementation, physical infrastructures, operations and support staff and trade repository fees. Finally, there is the consideration of opportunity costs—the consumption of resources that could support other business initiatives—should be factored into the total cost of ownership. The following two scenarios demonstrate the total cost of ownership of building an inhouse reporting system versus using a managed solution. Costs and calculations reflect Sapient’s firsthand experience working with banks and buy-side firms worldwide.

Scenario 1: managed trade reporting solution for tier 2 banks Large banks with 500,000 trades per month can expect to spend close to $30m to build an initial reporting approach plus another $18m per year to maintain it, including operations, testing, technical, remediation and business analysis resource costs (based on modelling scenarios using $150,000 average annual resource salary and 3 reporting systems). Additional system build-out costs for Tier 2 banks to address EMIR and other G20 rules are estimated at $45m. In comparison, a fully managed solution—in which infrastructure, software and operational processes are managed by a third party—removes the costly upfront build and many of the ongoing internal resource expenses. With an estimated yearly managed services

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fee of $3.5m, a Tier 2 bank’s total business-as-usual expenses are reduced from $18m to $8m per year—a saving of $70m over seven years.

Scenario 2: managed trade reporting solution for buy-side firm Buy-side firms are likely only partially down the path of implementing robust trading capabilities. For Dodd-Frank, they relied on their counterparties to report. For EMIR they are still figuring whether to delegate or self-report. Most have not yet begun to consider what capability they will need in order to assure management and investors that they are compliant. Depending on volumes, a fully managed solution, which removes costly upfront build and many ongoing internal resource expenses, would cost in the range of $50,000-$2,000,000 per year. Variability of cost to volumes is a signif-

icant benefit of managed services as opposed to the fixed one-time and ongoing costs of an owned solution. After making considerable investments, firms now face another wave of trade reporting regulations. As a result, market participants are re-examining their current strategies and, in many cases, are questioning whether or not it makes financial sense to continue to adjust internal infrastructures—particularly with the availability of new alternatives, such as outsourced trade reporting services. For some firms, cost savings will be a key driver. Others will be seeking ways to mitigate risk as regulatory scrutiny intensifies. Either way, outsourcing offers what in-house systems cannot: a more adaptable, cost effective approach to meeting today’s trade reporting requirements and those that are bound to emerge in the future. n

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INVESTMENT SERVICES THE EVOLUTION OF PRIME SERVICS

Find me a prime

Will the current climate continue to favor the various small-time prime models that have emerged in the wake of the recent PB purge? Are these specialty firms capable of handling the ever-expanding field of small funds in need of a home? Dave Simons reports.

T WASN'T ALL that long ago that hedge funds decided that having a single prime broker (or perhaps two at the most) was too risky in the postcrisis climate, and thus began accumulating upwards of five different providers in an effort to keep their eggs in a handful of baskets. But that model was short lived, ultimately devolving under the weight of regulatory and reporting changes that made juggling multiple primes too complex for all but the largest funds; by 2011, the prime number was once again back to pre-Lehman levels. As it stands, going forward some funds will be lucky to have any prime involvement at all. Tougher capital standards, lower liquidity and eroding margins have kept up the pressure on major prime-brokerage players, compelling many to cut loose lessprofitable, higher-risk fund clients. The steep currency losses incurred following the Swiss National Bank's decision to remove its three-year-old Swiss franc-euro cap last January only accelerated the rate of rationalization, as Citi, Deutsche Bank and other PB big-wigs subsequently raised minimum thresholds (as high as $50m, in some instances) in an effort to weed out smaller, riskier participants such as FX and fixed income arbitrage, among others, leaving even more fund clients without a home. "Many PBs have re-evaluated their client base against the risks they are willing to take in light of the SNB debacle," notes Peter Plester, head of FX prime broker services at Copenhagenbased Saxo Bank. In addition to cutting loose clients that do not meet the new risk standards, with competition down in some instances brokers have raised prime-services fees. "This will affect the viability of some clients’ trading models, and may also cause a short-term drop in volumes," says Plester.

Doug Nelson, Convergex executive managing director and head of global clearing and prime services, notes that some primes have fared unusually well of late. Earlier this year New York-based Convergex Prime Services notched its best-ever quarter of growth, adding more newclient AUM than at any point in its history. Nelson chalks it up to the firm's multi-custodian model resonating strongly "with funds that are being ignored or underserved in the big shuffle currently underway in the prime brokerage business.” Photograph kindly supplied by Convergex, June 2015.

The latest prime pullback has also expanded an already wide berth occupied by opportunistic second-tier, prime-ofprime (PoP), integrated prime and other niche models, whose target clients are the same small- to medium-sized funds deemed undesirable by the major brokerages (some with AUM as low as $5m). Some have fared unusually well of late: earlier this year New York-based Convergex Prime Services notched its best-ever quarter of growth, adding more new-client AUM than at any point in its history. Doug Nelson, Convergex executive managing director and head of global clearing and prime services, chalks it up to the firm's multi-custodian model resonating strongly "with funds that are being ignored or underserved in the big shuffle currently underway in the prime brokerage business.” Of course, it's hardly the first time that

small-time prime providers have risen to the fore. As the financial world began to teeter back in 2007, scores of disenfranchised senior executives cast off from the likes of Morgan Stanley and Merrill Lynch sought to use their hedge-fund connections in order to reinvent themselves as "prime light" start-ups. While the catalyst may be different, getting a toehold in the prime space is no less difficult today, remarks Jim Toes, president and chief executive officer of the Security Traders Association, the New York-based organization representing the interests of North American securitiesindustry professionals, despite the increased demand. "At the end of the day hedge funds require access to capital in order to survive, and as such mini-primes are often still reliant on larger banks to meet their needs," says Toes. "Going forward, banks are going to be carefully assessing the situation due to the added counterparty risk. Additionally, any hedge funds that aren't registered will find it exceedingly difficult to obtain any kind of meaningful assets." Well before the SNB fiasco, key providers were already questioning the wisdom of continuing to maintain a prime presence. “Pricing eventually has to go in the other direction,”surmised Stu Hendel, the ex-global head of Bank of America Merrill Lynch's prime-brokerage unit, during a 2012 Global Markets interview.“If it doesn’t, sell-side firms may need to re-examine the returns being generated by the prime-brokerage business. And in an environment where resources are scarce, all balance-sheet businesses may be vulnerable—not just prime brokerage.” As it turns out, Hendel, who left his BofAML post in 2014 after a valiant threeyear campaign, was spot on. Assailed by a host of new rules including stiffer US leverage-ratio and Basel III capitaladequacy requirements, larger primeservices divisions in particular have struggled to maintain profitability as the emphasis on balance-sheet integrity increased. Last year's $56bn excessinventory housecleaning by Goldman Sachs was emblematic of an industry still

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in the throes of a service identity crisis. As one executive recently put it, today a new entrant not only has to consider the impact of prime broking on their balance sheet, but also "whether or not they have the risk appetite to support the business." Even so, many see a continued place in the world for not-quite-so-big prime providers, whose (lack of) size has allowed them to avoid the regulatory constraints affecting their top-tier peers, and whose menu of services often include such bigtime prime features as capital introduction, securities lending, financing and consultative services, while also supporting synthetic and cash prime strategies. Niche players, unburdened by legacy technology infrastructure, as well as those with novel business models such as prime of primes, are aspiring to take a larger share of the market, observesVal Srinivas, banking & securities research leader for Deloitte Services LP. "The world of prime brokerage is in a state of flux yet again," says Srinivas. "Big banks are retrenching, just as some of the smaller prime brokers look to expand their foothold. By these measures, it appears that prime brokerage is bracing for further changes in the near future."

Not completely safe As evidenced by last winter's SNB event, the interconnectedness of today's electronic markets ensures that when things go bad, they usually do so in a hurry. "Because money is flowing so freely on a global basis, it's very hard to ring fence it in," says Toes. "Had this happened even five years ago, it probably would have had only marginal impact on US retail investors, if at all." The damage inflicted by SNB brings to mind other one-off jolts, including the 30-minute meltdown at former marketmaking outfit Knight Capital in 2012, which subsequently compelled many in the broker-dealer community to take a closer look at the efficacy of kill switches, pre-trade risk checks and other automated safeguards. "Post-Knight, the main catalyst within the industry was fear-that is, brokers watching this ultimately fatal blow being inflicted upon one of their peers and not

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wanting to suffer the same fate," says Toes. "Since that time I think there has been a lot of improvement in terms of having the proper shut-off mechanisms in place. Still, as SNB showed, no one is ever completely safe. In a recent blog, Javier Paz, senior

Peter Plester, head of FX prime broker services at Copenhagen-based Saxo Bank. "Many PBs have re-evaluated their client base against the risks they are willing to take in light of the SNB debacle," says Plester. In addition to cutting loose clients that do not meet the new risk standards, with competition down in some instances brokers have raised prime-services fees. "This will affect the viability of some clients’ trading models, and may also cause a short-term drop in volumes," says Plester. Photograph kindly supplied by Saxo Bank, June 2015.

analyst with Aïte Group's Wealth Management practice, said that the SNB's "sudden and uncoordinated decision" to pull the rug out from under the Swiss franc would have lasting repercussions— not only affecting the likes of currency brokerages, but also reshaping prime-ofprime relationships as well. As their balance sheets are used to shield the large broking firms that extend them credit, PoP firms can be left holding the bag should a small retail broker client fail to cover a deficiency (similar to those that followed the SNB event). With credit flows likely to be reduced in light of the debacle, retail FX activity, as well as the number of retail FX firms, could contract over the near term, suggests Paz. Does the SNB incident make certain "prime light" offerings such as margintrading platforms less feasible? Probably, says Toes, not so much because of additional regulatory constraints, but rather traditional prime brokers spooked by the pos-

sibility of further spontaneous eruptions. "Brokers are looking at the SNB situation and realising they need to continue tightening their parameters because of the ongoing risk to the firm," says Toes. "Because it was a one-off type of event I think it will only be remembered by those investors who suffered direct losses—however the impact on the prime business itself will be longer lasting. The question remains: will the smalltime prime participants that have emerged in the wake of the latest PB purge continue to thrive? And are these niche firms capable of handling the ever-expanding field of disenfranchised small funds? While PoPs may be able to obtain credit courtesy of a prime broking relationship, they may not always have the infrastructure needed to support a complete service offering, notes Plester of Saxo Bank. Thus, features such as account management, post-trade allocations, global coverage and support and availability of directmarket-access liquidity can help PoPs stand out in a crowd of opportunistic newcomers, says Plester. Additionally, the use of pre-trade credit risk control applications provides an extra layer of protection for both broker and client by helping to prevent over-allocations of credit for PBs that utilize such functions. "This gives the PB more freedom to allocate credit on platforms whilst being able to control the client’s net open position on a pre-trade basis," says Plester, "and also makes it simpler for the client to connect to multiple providers, venues and platforms." With more PBs exiting the business or reducing risk thresholds, pretrade risk control technology is likely to continue to gain traction, becoming more of a standard requirement by both PBs and their clients, adds Plester. Ultimately, says STA's Toes, a majority of those offering these types of 'light' arrangements still require a relationship with a larger entity that can provide them with crucial financing and clearing capabilities. "It's not like you can go out there and be completely independent," concurs Toes. "It's that need to be bankrolled that will always make running a boutique-style prime business so challenging." n

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INVESTMENT SERVICES MIXED APPROACHES TO HEDGE FUND INVESTING

Increasing investor concentration in hedge funds?

According to the latest survey from data provider Preqin, some 51 investors have increased their allocation to the hedge funds to over the $1bn benchmark, while 27 investors have seen their allocation fall below that level. There are now a total of 227 investors around the globe that have $1bn or more in assets invested in hedge funds, and collectively these investors have $735bn invested in the asset class, representing almost a quarter of the total capital invested in the industry (up 13%) on a year ago. Most of these were in America. What’s going on?

NY DESCRIPTION OF the hedge fund industry over the past year or so has been marked by the mediocre performance of the industry. Not surprisingly, some high-profile pension funds have publically announced their intention to scale back their hedge fund allocations. Scalability was, apparently, behind the decision by US pensions behemoth the California Public Employees’ Retirement System (CalPERS) in the autumn of last year to unwind its $4bn absolute return strategies investment programme above issues of cost and complexity, according to Ted Eliopoulos, the pension fund’s chief investment officer at the time. “Nevertheless, assets under management across the industry increased during this period and inflows from institutional investors continue to pour in,”says the Preqin report. Hedge fund industry assets have seen notable growth and inflows from investors have continued to pour in, driven by a number of large investors allocating at least $1bn to hedge funds, says the data provider. Elsewhere, high profile asset management firms continue to remain committed to the sector. In late May Hermes Investment Management, the £30.1bn manager said it had added to its suite of global fixed income offerings with the launch of the Hermes Absolute Return Credit Fund. The UCITS fund, which launched on May 29th, hopes to target a positive investment return (absolute return) over a rolling 12 month period irrespective of market conditions. Fraser Lundie, co-head of Hermes Credit and Raphael Muller, Senior Portfolio Manager will manage the fund. Says Lundie, “The [fund] is a market neutral solution and follows our … philosophy that investors must look beyond issuers and focus on a multi strategy

approach which incorporates both long and short investments across multiple security types including loans, bonds and CDS. In the past decade we have seen the globalisation of credit markets in the US, Europe and Emerging Markets and in order to fully maximize these opportunities on offer, investors must invest with a truly global mandate, which is core to our offerings.” Also in late May, BNY Mellon Investment Management said it had launched a UCITS Dynamic Total Return Fund, giving European investors access to the Dynamic Total Return strategy which was previously limited to US investors.“We are seeing significant and growing client demand for multi-asset investment solutions. The Dynamic Total Return Fund provides our clients with access to an equity-like target return product alongside our existing suite of absolute return and total return products. It fits perfectly into our range as we continue to build out our offering in this space,” says Matt Oomen, head of European distribution at BNY Mellon Investment Management EMEA The US vehicle recently passed through the $1bn mark and has been the number one fund in the Morningstar Multi-alternative universe over five years. The Dublin-domiciled UCITS fund is targeted at investors seeking to achieve managed growth with a lower drawdown. The portfolio primarily uses futures to gain exposure to global equity and bond markets. It also invests in more specialist asset classes such as currencies, commodities and inflation-protected securities. The Fund will be managed by the multi-asset team at Mellon Capital Management, led by Vassilis Dagioglu, who also is lead manager on the US vehicle. While 51 investors allocated $1bn or

more, some 27 dropped out of the $1bn allocation segment. Preqin says the rise in the number of $1bn Club members over the past few years shows that the appetite for major investment in hedge funds remains strong, and appetite shows no signs of abating.” There are now a total of 227 investors around the globe that have $1bn or more in assets invested in hedge funds, and collectively these investors have $735bn invested in the asset class. This represents 24% of the total capital invested in the industry, and is up 13% on the amount of hedge fund assets the Club had in their portfolios as of May 2014. The numbers tell the story. Private sector pension funds make up the largest proportion of new entrants over the past year, accounting for 29% of new members. Over three-quarters (77%) of new entrants are based in North America. Public pension funds account for the largest proportion of capital invested in hedge funds, despite a handful of high-profile exits from the asset class by these investors over the past year. Sovereign wealth funds follow this with 16% of the total capital invested by the Club. Some 45% of investors putting their money into hedge funds solely target direct investments in the segment, compared to 33% of all other investors. According to Preqin they are also unlikely to solely allocate to funds of hedge funds, with only 8% of members investing via this route. The average number of hedge funds that investors have in their portfolio is 30. This compares to only 8 hedge funds for all other investors. Macro funds are the preferred strategy for the $1bn Club investors, with 48% of members targeting this strategy over the next 12 months. This is followed by long/short equity being sought by 39% of investors. n

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A fix for fixed income?

With the corporate bond market still dealing with a pronounced demand-supply imbalance, newer protocols capable of connecting multiple sources of liquidity continue to grow in popularity—among them open or all-to-all trading solutions, designed to provide investors, dealers and other market participants with greater efficiency around fixed-income trades. Dave Simons reports from Boston.

HOUGH ABSOLUTE VOLUMES within the still-buoyant corporate bond market remain in record territory, capital restrictions on large dealers have transformed what was once an ocean of secondary market liquidity into a mere wading pool (with levels currently 20% to 30% lower than in precrisis 2007 when taking into account the increased asset class size). In the US, dealer inventories have fallen from $8bn in 2007 to less than $3bn as of last year, according to Greenwich Associates data, causing average daily turnover to tumble 48% through the period. At the same time, institutional investors have continued to gorge themselves on corporate bonds, “buying and holding anything that yields above the close-to-

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zero rate imposed by the central banks," remarks Urs Widmer, chief operating officer for Zurich-based SIX Swiss Exchange, Switzerland's primary trading venue. Though electronic trading accounted for 35% of total volume in European major fixed-income products last year, most of the activity occurred on dealerto-client (D2C) platforms, according to Greenwich Associates, putting added pressure on banks' balance sheets and negatively impacting D2C in the process. However, emerging platforms are attempting to rectify the problem, using market structures that support client-toclient trading platforms. With the corporate bond market still facing headwinds, these newer protocols capable of connecting multiple sources of

liquidity continue to grow in popularity. According to TABB research, more than three in four buy side traders support alternative trading systems that can help increase transparency while lending support to the liquidity-challenged corporate bond environment. As participants increasingly view electronic trading as the most viable way forward, demand for open or all-to-all trading solutions—which facilitate orders between dealers, investors and other market participants, as well as investorto-investor—has continued to trend upward. Given the enormous dispersion of bond types (the market for US high grade alone includes some 50,000 different products), maturities and lot sizes, providers must be equipped with

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DEBT REPORT DEBT TRADING: LOOKING FOR GREATER EFFICIENCIES

systems that are glitch-free and able to bring real order-flow efficiency to the fixed income space. A keen understanding of how the various segments of the market operate, as well as having the expertise to build focused, dedicated types of solutions, are plusses.

Rapid implementation

"One of the things our clients find attractive about our open trading protocols is that they are integrated with the same trading system that clients have been using for the past 15 years, which is tremendously important," says Richard Schiffman, open trading product manager for MarketAxess, the New York-based electronic trading platform operator that has sought to fill the liquidity gap by providing institutional participants with streamlined access to a wealth of fixedincome products. “This workflow means that traders aren't required to bring up a different part of the trading system in order to take advantage of the new liquidity. This also allows them to interact with any market participant, as opposed to just with counterparts on the street with which they have direct trading relationships. As a result, clients are able to find liquidity wherever it resides—which, in most instances is still with the dealers they've been doing business with all along." As noted by Greenwich, the US continues to trail Europe in fixed-income electronic execution (stateside e-trading of investment-grade corporate bonds remained mired at 12 percent last year, compared to 50 percent of volume in Europe). Schiffman acknowledges that for some traditional managers, open trading can take some getting used to. "Investment managers are being called upon to act as 'price makers,' enabling them to respond to other parties' inquiries, which is truly unique for this space," says Schiffman. "At the same time, it does represent a real behavioural change for buy side firms-some, such as our partners at BlackRock, have gotten quite ahead of the curve, while others have been content to just kick the tires for the time being." Nonetheless, at this point some 350

Constantinos Antoniades, Liquidnet’s global head of fixed income and creator of the Vega-Chi product. Liquidnet's new capabilities will serve as a "successful recipe" for corporate bond electronic trading, says Antoniades. "It's materially different from some of the more outdated, lower-impact protocols that have been available on the market recently”. Photograph kindly supplied by Liquidnet, May 2015.

participants serve as MarketAxess price makers, reports Schiffman, who sees even further growth on the horizon. "It is not something that all firms can immediately adapt to—sometimes there are tradingdesk or best-execution policy adjustments that need to be made in order for companies to get acclimated. Still, with each quarter the number of participants continues to go up, as more firms gain insight into how the system works and how they can ultimately benefit." Rather than trying to disintermediate dealers who are still essential for price discovery and formation as well as for protecting investors from information leakage, Widmer of SIX Swiss Exchange believes that a better approach is to improve and facilitate the netting of risk between dealers. "For each million traded on SIX, the two counterparties can then redeploy two million to provide liquidity to their respective clients,” says Widmer. SIX Swiss Exchange's dealer-to-dealer New Corporate Bond Facility enables participants to find counterparties in order to trade large tickets efficiently without negative market impact. "It improves the liquidity by offering an innovative logic to match Indications of Interests, for example, by taking trading history into

account," says Widmer. "Further, the NCBF offers participants the opportunity to trade additional volume at the negotiated price in work-ups." One of the main factors impeding a broader-based acceptance of corporatebond e-trading, especially in the US, is the absence of electronic markets for single-name credit default swaps, concurs Widmer. "We believe that the situation will rapidly change as soon as the exemption on central clearing of singlename CDS lapses," he says. At the same time, Widmer sees the implementation of swap execution facility (SEF) rules in the US likely having a profound effect on the structure of markets for exchange-traded products. "Long term, it is reasonable to expect that the SEF landscape will consolidate around one or two facilities per instrument type or asset class," says Widmer. "However, the current heavily regulated and stage-managed environment for SEF creation and market utilization in the US is expected to continue for some time.” Last year, global institutional trading network Liquidnet threw its own hat into the ring with the acquisition of bond trading platform Vega-Chi, forming the basis for Liquidnet’s fixed income platform, an all-to-all anonymous institutional electronic crossing network for peer-to-peer trading of high yield and investment grade bonds in US and Europe. Liquidnet's new capabilities will serve as a "successful recipe" for corporate bond electronic trading, says Constantinos Antoniades, the firm's global head of fixed income and creator of the Vega-Chi product. "It's materially different from some of the more outdated, lower-impact protocols that have been available on the market recently," says Antoniades. According to Antoniades, the rate of fixed-income electronic uptake is such that even last year's numbers are fast becoming outdated. "What is coming up is a new breed of trading platforms like Liquidnet’s which will have even further impact," says Antoniades. While buy-side holdings have been bigger than ever, dealers' ability to trade has been hampered by these new regu-

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latory requirements, resulting in a pronounced demand-supply imbalance, says Antoniades. And the ramifications for investors? At present the combined market for high-yield and investmentgrade corporate debt stands at around $7.5trn, compared to some $18bn in dealer holdings. As such, redemptions totalling a mere one-percent would account for four times dealers' aggregate inventory. Given this scenario, one can easily see the need for market-driven alternative solutions. "Under normal circumstances, intermediaries have offered the most efficient trade methods possible," says Antoniades. "However, the current situation calls for a partner that can effectively unblock the pipes by allowing buy side and seller participants who hold the liquidity to interact directly with one another. By using this approach, we could begin to get liquidity levels back to where they should be."

Pullback Imminent? As the markets are likely to experience a macro or technical dislocation sooner or later, providers must be equipped to deal with the potentially significant redemption challenges. "While there isn't much that can be done about the demand-supply issue, trading platforms can at least help ensure a successful transfer of risk and liquidity from natural sellers to natural buyers," says Antoniades. Which, he adds, is one of the crucial functions of an automated all-to-all system. "In a marketplace of some 50,000 different CUSIPs and several hundred clients, it is exceedingly difficult to get things done over the phone, especially outside the most liquid segment of the market," says Antoniades. By comparison, Liquidnet's dark pool automatically interacts with clients' order-management systems, helping clients to find the best possible match for their trade with minimum effort and in an environment that protects their information, says Antoniades. Jim Toes, president and chief executive officer of the Security Traders Association, the New York-based organization representing the interests of North American

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Richard Schiffman, open trading product manager for MarketAxess. "One of the things our clients find attractive about our open trading protocols is that they are integrated with the same trading system that clients have been using for the past 15 years, which is tremendously important," says Schiffman, the New York-based electronic trading platform operator that has sought to fill the liquidity gap by providing institutional participants with streamlined access to a wealth of fixed-income products. Photograph kindly supplied by MarketAxess, May 2015.

securities-industry professionals, says there are a number of factors to blame for the ongoing dearth in secondary market liquidity. "There is far greater transparency into the fixed-income markets today, and even more on the way," says Toes. Nor is this extra transparency free, adds Toes. "There is an explicit cost for providing the additional transparency, as well as an implicit cost due to a change in behaviour by the traditional participants.” Furthermore, these added costs can vary depending on the type of issue and the nature of the market. "For instance, generally speaking if you're trading equity shares of General Electric, the more transparency, the better," says Toes. "But it's a different story if you're holding GE corporate bonds-the lack of uniformity means that providing the extra clarity will be much more involved.” Indeed, unlike equity market fragmentation, which is mainly defined by the number of venues on which a stock trades, in fixed income fragmentation is the result of the number of reportable CUSIPs in the market at any given time.

"Which of course makes fixed income very different and infinitely more complex, especially when you consider all of the variations of corporate bonds per company," says Toes. Though it may feel like a permanent shift, Toes believes that the large dealer community will ultimately have a significant role in the liquidity game. "Any major electronic trading platform has to be able to offer the kind of large-scale principle transactions that traditionally have been the domain of the large banks—it can't survive purely on customer-to-customer relationships alone," asserts Toes. "While there is the notion that an electronic trading platform can match investors willing to buy with those willing to sell, I don't think that system is sustainable if it disallows investors to interact directly with the larger dealers.” In reality, the “problems” plaguing the corporate bond market today are not as pronounced as the narrative would have us believe says Anthony J Parrotta Jr, an analyst at TABB Group. “Large asset managers report they are acclimating to illiquidity by altering their trading and investment strategies. Inflows find their way into new issues, and dealers are providing bids (or can source bids from other investors) when selling is required. The fear is in the unknown – what happens when rates rise and the demand to invest in bonds starts to fade? Will there be an orderly exit, or a rush to the exit? Large investors are quick to acknowledge the market is more vulnerable to extreme volatility and price dislocation,” he says in recent blog. The proliferation of platforms is a healthy and constructive development for the market thinks Parrotta,. Competition, even if only in the ideas being put forth, ultimately spurs innovation. “The key to any of these platforms succeeding lies in whether they can identify a problem and remediate it. Given the issue facing everyone may be rooted in market structure, these firms have their work cut out for them. History has shown runways get short quickly in this world. Solve a problem, or die trying,” he avers. n

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THE LAST WORD CALLING THE END OF A 30 YEAR BULL MARKET IN GOVT BONDS?

The emerging world according to US rate rises

High valuations and the prospect of a gradual rise in US interest rates look to be the main concern of investors right now. Given the oversubscription of even measly priced UK gilts and other sovereign bonds, it is clear that sovereign debt will remain the asset class of choice for pension funds. Given that understanding and failing a grand rotation back into equities, the issue is then whether rate rises reinforce the drift into developed market sovereign bonds at the expense of emerging markets. Relative to equities flows government bonds remain at historic highs. Just how soon the US Federal Reserve will begin to raise rates now the question du jour. We look at some of the fallout once it happens

S RETAIL SALES, excluding volatile gasoline, which has fallen by almost 19% this year, rose 5% year to date hinting at a more optimistic household outlook. Non-farm US payrolls have risen by almost 3m over the year (all private sector), pushing unemployment down to 5.5% and core CPI inflation is at an annualised rate of 2.6% all near stated triggers for the unwinding of near to zero interest rates this year. US rate rises could cut capital flows to developing markets by 1.8 percentage points of GDP says the World Bank. That’s a stark assessment based on the perception of a flight to the dollar once rates rise. However, it is also a recognition that emerging markets as an investible segment is much more nuanced these days than it was even two years ago. Risk is certainly in the equation. Clearly once dollar interest rates rise borrowing will become more expensive for emerging and developing economies. This process, however, is unlikely to be sudden; as any rate rises by the Fed are likely to unfold relatively smoothly since the US economic recovery is continuing and interest rates remain low in other major global economies. Nonetheless, the World Bank posits the view that there are considerable risks around this expectation. Just as the initial announcement of US policy normalisation caused turmoil in financial markets in 2013 (now referred to as the "taper tantrum") the US Federal Reserve's first interest rate increase, or lift off, since the global financial crisis could ignite market volatility and reduce capital flows to emerging markets. The World Bank now projects developing countries to grow by

4.4% this year, with a likely rise to 5.2% in 2016, and 5.4% in 2017. That is still in excess of projected growth rates in developed markets and may mitigate some of the natural tendency of investment firms and pension funds in advanced countries to keep their money in home markets. “The next five to ten years are going to be a very difficult time for investors but we still believe there are some very interesting opportunities,” says Pictet Asset Management chief strategist Luca Paolini, ”USD-denominated emerging market government and corporate debt are trading at levels below their fair value. True, Venezuela and Ukraine may have tarnished the image of EM debt, but they are not representative of the asset class as a whole. EM local currency sovereign bonds should also perform better than their developed market counterparts. The potential for yields to rise remains limited as we expect a number of central banks to loosen monetary policy over the next

five years as inflation eases.” Nonetheless, a complex picture is emerging. “A deterioration of secondary market liquidity and increased corporate indebtedness across emerging markets could exacerbate the fallout from a potential EM stress event,” holds Hung Tran, executive managing director at the IIF. “In an environment of rising global interest rates, Fed tightening, EM currency depreciation, and slowing economic growth and capital flows, USD-denominated debt may become more difficult for many EM non-financial corporate companies to service and refinance their debt.” Earlier this year the IIF issued its own warning that capital flows to emerging markets are projected to slow to $981bn this year their lowest level since 2009. Explains Charles Collyns, chief economist at the IIF. “We do project a moderate pickup of flows later in 2015 and 2016, but this depends on some strengthening of growth and no surprises from the Fed. Continued economic weakness or a bumpy Fed ride could lead to further stagnation of EM capital inflows. However, emerging markets look not to be giving up so easy. ”Emerging market GDP growth likely accelerated in 2015Q2 after having fallen to a six-year low in Q1 according to the latest update of the IIF's EM Coincident Indicator. The EMCI shows an increase to 2.2% in May, up from 1.6% in April.“We’ve begun to see a more positive trend in emerging market growth since the steep decline observed since last autumn,” says Kristina Morkunaite, lead author of the report. “This underpins hope that EM growth will pick up in Q2, having reached a six-year low in the first quarter of 2015.” n

M AY / J U N E 2 0 1 5 • F T S E G L O B A L M A R K E T S

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