FTSE Global Markets by FTSE Global Markets

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EUROPEAN TRADING ROUNDTABLE: DEFINING THE FUTURE I S S U E 3 3 • M AY 2 0 0 9

Cash collateral is king in today’s sec lending Private equity’s slow comeback Brazilian hedge funds feel the pinch Schapiro’s new look SEC

REDRAWING

SOCGEN

STURDY’S ASIA: BNY MELLON IN THE FAR EAST

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a passion for solutions.

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F T S E G L O B A L M A R K E T S • M AY 2 0 0 9

ITH SO MUCH still in flux, we decided that this edition would focus on the nuts and bolts of the international financial markets. We kick off the edition with a detailed look at Mary Schapiro, Barack Obama’s frontline securities regulator at the US Securities and Exchange Commission (SEC). She moved to the SEC from her role as chair and chief executive officer of the Financial Industry Regulatory Authority, the securities industry’s self regulating organisation for broker-dealers and exchanges. A long time Washington hand, she has had a long and distinguished career under both Republican and Democratic administrations (having served under Ronald Reagan, George HW Bush and Bill Clinton, who appointed her chair of the Commodity Futures Trading Commission (CFTC) in 1994). She also has had corporate experience, having been a board member of Duke Energy and Kraft Foods. Her CV will stand her in good stead if she is to stay abreast of the sweeping changes blowing through the global financial markets. What is becoming abundantly clear is that over the last couple of years the US was weakened, both as a moral and financial leader. Most likely, the damage will not be long lasting; but what is required in the immediate term is a degree of anticipation, clarity of purpose, proper due diligence of the institutions covered by the SEC and a short, sharp line on any and all transgressions. For instance, the SEC has reportedly filed more than 75 separate enforcement cases involving alleged Ponzi schemes over the last two years. While one applauds the agency’s assiduousness in prosecuting known transgressions, one must wonder how so many outfits felt safe filing false statements and how easy it seems to be to establish bogus investment operations in the US that have taken in both traditional and hedge fund managers. Something is seriously amiss when architects of so many so-called Ponzi investment schemes are only unmasked when investors try to redeem their cash. The words, stable-door, horse and bolted come to mind. As the ancients would have it, it is an ill wind that blows no one any good. Even in these storm tossed recessionary days, some investors appear to be winning large, particularly those in gold. Hedge funds spearheaded a heavy sell off in gold in the last quarter of 2008 as they were forced to make quick redemptions to pay out investors. Ironically, this rush was prompted by the fact that gold was doing rather well, not badly. Many a hedge fund liquidated gold positions because gold was one of the few assets that had not made a loss in the second half of last year. Since then gold has undergone another boost in the first quarter of this year, picking up from below $900 a troy ounce to $1,000 as investors rush to buy gold exchange-traded funds (ETFs), bars and coins. Ironically, it may very well be the efforts of governments and central banks which are choosing to go down the route of quantitative easing and of lending more money to ailing institutions and industry that may very well be helping the cause of the precious commodity.“The challenge of the policy, once they have done that, will be to stabilise prices by wiping liquidity out of the system,” explains analysts, adding that if this does not happen inflation will push investors towards gold. Analysts believe that there are two possible outcomes of printing more money. If it works the global economy will stabilise and a period of high inflation will follow. Alternatively, if it does not, global economies will enter a deep recession or even depression accompanied by a period of falling prices. Either way, the outcome will be bullish for gold, argues our commodities editor Vanya Dragomanovich.

Francesca Carnevale, Editorial Director May 2009

COVER PHOTO: Séverin Cabannes, who was appointed co-chief executive officer at Société Générale in May last year.“The financial crisis will have a lot of consequences,” says Cabannes,“We have been concerned that two major business areas will be impacted: corporate and investment banking (CIB) and asset management.” Photograph by Michel Labelle, provided by Société Générale SA, April 2009.

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Contents COVER STORY COVER STORY: REDRAWING SOC GEN ................................................................Page 58 Scarred by the global financial meltdown, which cut a swathe through its credit derivatives and investment banking businesses, Société Générale SA was also buffeted in early 2008 by a high profile trading scandal. The subsequent restructuring at the 145-year old lender is, say some analysts, uniquely instructive in understanding what Europe’s banks might look like after the banking and economic crisis has passed. Paul Whitfield talks to Séverin Cabannes deputy managing director (and co-chief executive officer) of Société Générale SA.

DEPARTMENTS ....................................................................Page 6 Neil O’Hara profiles the new chairman of the US Securities Exchange Commission.

CAN SAINT MARY SAVE THE SEC?

MARKET LEADER

FINE TUNING NEW RULES............................................................................................Page 12 Jacqui Hatfield, Financial Services Regulatory partner at Reed Smiths on the new look FSA

SFM & THE RIGHT TARGET MARKET......................................................................Page 16

Simon W Holden, of law firm Faegre & Benson, looks at the LSE’s new specialist fund market.

IN THE MARKETS

IS PRIVATE EQUITY MANAGING A COMEBACK? ............................Page 20

Ian Williams reports on the changing tactics of buyout firms.

......................................Page 24 David Simons on the impact of greater regulatory control of the OTC derivatives market.

GETTING A HANDLE ON OTC DERIVATIVES

INNOVATORS FACE TO FACE REAL ESTATE

..........................................................Page 30 Francesca Carnevale talks to Chris Sturdy, chairman of BNY Mellon’s Asia-Pacific business.

BUSINESS BUILDING ASIA-STYLE

......................................................................Page 34 Profile of Karen Fawcett, group head of transaction banking at Standard Chartered.

PROFIT IN A COLD CLIMATE

............................................Page 37 Mark Faithfull on the need for refinancing of many Asian real estate investment trusts

TAKING A THE PLUNGE INTO ASIAN REITS

............................................Page 39 Rising gas receipts fund Qatar’s industrial and financial diversification programme

QATAR’S LONG TERM INVESTMENT PLAY

COUNTRY REPORT

....................................................Page 43 Despite the gloom, ITD is fighting for more inward investment. Francesca Carnevale reports.

HUNGARY STILL OPEN FOR BUSINESS

............................Page 46 John Rumsey reports on the impact of the financial crisis on the Brazilian fund industry

BRAZILIAN FUNDS SHAKEN BY ROUGH WINDS

INDEX REVIEW COMMODITY REPORT DATA PAGES

............................................................................Page 48 Simon Denham, managing director, Capital Spreads, takes the bearish long view

G20 & A DEAD CAT BOUNCE

................................................................................Page 50 Vanya Dragomanovich asks whether gold’s upsurge has run its course, or better is to come?

GOLD REGAINS ITS GLISTER

Fidessa Fragmentation Index ......................................................................................Page 83 ETF Data, supplied by Barclays Global Investors ....................................................Page 88 Securities Lending Trends by Data Explorer ............................................................Page 91 Market Reports by FTSE Research ..............................................................................Page 92 Index Calendar ..............................................................................................................Page 96

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Contents FEATURES SECURITIES LENDING ROUNDTABLE

STOCK LENDING IN EUROPE: KING COLLATERAL ................Page 54

Beneficial owners lending securities are managing risk on a day to day basis, and obviously looking at how they manage their lending practices at a time when volumes are rising once more, albeit slowly. However, right now, the quality collateral against securities out on loan, is at a premium.

THE TRADING REPORT

......................................................................Page 64 The US Treasury's funding activity indicates how intense investors' aversion to risk has become. Short term rates have plummeted even though the market has had to absorb unprecedented quantities of Treasury bills. The rate dipped briefly below zero at one point, which hasn't happened since the early 1930s. Neil O’Hara reports on the outlook for the asset class in 2009.

TRADING TECHNOLOGIES:

EUROPEAN TRADING ROUNDTABLE................................................Page 67 “Volatility has really changed trading patterns on the buy side,” thinks Steve Wood, global head of trading at Schroder Investment Management. “Risk patterns always become more and more expensive, not only from a single stock perspective, but also from a risk programme element, so we are using a lot more direct market access (DMA) and algorithmic trading. Low touch trading has therefore begun to outstrip normal high-touch trading.” Find out what other participants in the roundtable had to say about the changes blowing through the European equity trading theatre.

COST EFFICIENT TRADING ........................................................................Page 76

Scott Cowling, head of equity trading at Barclays Global Investors (BGI), says: “There are uncertainties about trading. You don’t know in advance how much you are going to trade or even if it will find the other side straight away. So by the same token you don’t know how much you could end up paying. Rates may sound small, but they all add up when you talk in big volumes.” Ruth Hughes Liley reports on ways in which traders find cost efficiencies all the way through the trading cycle

ARCA – THE NEW MTF ON THE BLOCK ........................................Page 79

Cees Vermaas, executive director, sales and relationship management, European cash markets at NYSE Euronext says, “You need to create the possibility for electronic trading firms to arbitrage between platforms. … With low fees we will add more flow from existing Euronext clients and then some firms come in using their smart order routers. And finally you reach the tipping point of 10% to 15% of market share. We cannot take too long to reach this tipping point with Arca.” Ruth Hughes Liley describes the possible futures of the new MTF on the block

FLEXTRADE & BROKER NEUTRAL ALGORITHMS ........................Page 81

Broker algorithms are not necessarily one stop solutions for the buy side. That thinking alone raison d’etre for FlexTrade’s burgeoning business strategy. The award winning firm explains its product expansion programme

TRADING ETFS: THE NEW TOOLBOX ..............................................Page 85

As a toolbox that can be used by both retail and institutional investors to gain exposure to most available equity benchmarks, exchange traded funds (ETF) continue to outpace many other products on today’s global markets. The rise in demand has sparked an increase in ETF issuance, and providers will likely continue to push the barriers of ETF structures over the coming years. Dave Simons reports from Boston

M AY 2 0 0 9 • F T S E G L O B A L M A R K E T S

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Market Leader NEW SEC CHAIR: REBUILDING CONFIDENCE

Mary Schapiro, chairman of the United States’ Securities Exchange Commission (SEC), testifies at a House Appropriations subcommittee hearing in Washington, DC, on Wednesday, March 11th 2009. Schapiro urged Congress to give the agency more money, saying $943m approved for the current year is not enough to protect investors. Photograph by Jay Mallin for Bloomberg News /Landov, supplied by PA Photos, April 2009.

WILL SAINT MARY

SAVE THE DAY? When President Barack Obama nominated Mary Schapiro as chairman of the US Securities and Exchange Commission (SEC), he tapped a career regulator with unparalleled experience. Mary Schapiro not only served a previous six-year term as an SEC Commissioner (between 1988 and 1994) but also headed the Commodity Futures Trading Commission (CFTC) for 15 months (from 1995 to 1996) as well as the Financial Industry Regulatory Authority (FINRA) and its predecessor for more than a dozen years (from 1996 to 2009). She will need every ounce of that heft to revive confidence in the Securities and Exchange Commission, an agency reeling from years of weak and ineffective leadership, say local commentators. She will need every drop of her considerable experience to revive confidence in the agency. Neil O’Hara reports. OST NOTABLY OF late, the SEC has come under fire for failing to examine Bernard Madoff’s investment advisory business despite repeated tips from Harry Markopolos [who until December last year was an unknown, somewhat bookish accountant from Whitman]. Markopolos had tried for more than a decade to alert authorities to the fact that Madoff’s

stated investment strategy could not deliver the returns he reported and highlighted red flags that scared off numerous sophisticated investors. It is early days, of course, but Schapiro made it clear at her confirmation hearing before the Senate Committee on Banking, Housing, and Urban Affairs that that kind of slippage would not happen on her watch. It was a sentiment that she reiterated in

her first speech as chairman two weeks later; that beefed up enforcement is her top priority. She said,“A strong and reinvigorated SEC will be on the beat like never before to catch wrongdoers,” and vowed the agency would pursue miscreants“until the full force of the law is the sure, certain, and sole reward for their wrongdoing.” Schapiro reinforced the heavy message by ending a “penalty pilot” experiment that enforcement staff blamed for slowing down investigations. The penalty pilot required SEC attorneys to obtain advance approval from the full commission for settlement negotiations in cases that involved civil monetary penalties assessed against public companies as punishment for securities fraud. Schapiro has also streamlined the approval process for staff seeking subpoena powers to pursue investigations. To Nick Morgan, a partner in the Los Angeles office of law firm DLA Piper, however, the changes Schapiro has implemented so far are more cosmetic than substantive. He concedes that enforcement staff will have a little more discretion in negotiating penalties, but final settlements still have to be approved by the Commission.“It is not as though the staff has been given free rein to impose whatever penalties they think are appropriate,”says Morgan. Before he joined DLA Piper in 2005, Morgan worked in the SEC’s

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Market Leader NEW SEC CHAIR: REBUILDING CONFIDENCE

bill, Schapiro has other enforcement division for priorities, too. She plans to seven years, during which make the SEC more time Arthur Levitt, Harvey responsive to investors by Pitt and William creating an investment Donaldson occupied the advisory group, a forum in chairman’s office in turn. which market participants Morgan says that although can air their concerns to each one had a slightly help Schapiro direct the different philosophy agency’s agenda. She toward enforcement, it expressed interest in made little practical giving shareholders “a difference to attorneys in greater say on who serves the trenches prosecuting on corporate boards, and cases. He expects any how company executives major changes in securities are paid.” regulation will emanate Also taking aim at the from Congress rather than James Heinzman, managing director of securities solutions at Actimize, credit ratings agencies, Schapiro’s office. a developer of risk management and surveillance software for financial Schapiro wants to tackle services companies, says current investment advisor regulations hark The view from the inherent conflict of enforcement tends to be back to the days when portfolios were long-only, unleveraged and plain interest in their business backward-looking. In vanilla. In that environment, money management didn’t need heavymodel (the ratings other words, somebody handed regulation; it was low risk and the asset-based fee structure agencies get paid by the has to do something kept the interests of investors and their advisors aligned. Photograph same entities whose wrong first. That may kindly supplied by Actimize, April 2009. securities they rate), and however understate the influence a chairman can have. Paul battles over regulatory mandates that talked of “limiting the impact of credit Maco, a partner in the Washington, erupted ten years ago when Congress ratings on capital requirements of D.C. office of law firm Vinson & Elkins, was working on the Gramm-Leach- regulated financial institutions.”She has says Schapiro needs to shore up Bliley Act, which repealed the also added her voice to the chorus confidence in the SEC among investors segregation between commercial and calling for centralised clearing of credit and in Congress, reinvigorate the staff investment banks embedded in the default swaps. In an obvious reference and define the role the SEC should play Depression-era Glass-Steagall Act. to the Madoff scandal, Schapiro plans to in regulatory oversight. “She has the “The debate over regulatory strengthen oversight of broker-dealers intelligence, energy, experience and responsibilities needs to be rekindled, and investment advisors, improve the skill to meet those challenges,” says but in today’s different environment,” quality of audits for non-public brokerMaco, who worked with Schapiro at Maco says,“Experienced credible voices dealers and promote the safe and sound the SEC in 1994, “She is very highly will be very valuable so Schapiro has custody of customer assets by both broker-dealers and investment advisors. regarded. Her credibility and indeed potentially a significant role to play.” James Heinzman, managing director her personality will probably play an If Schapiro does get a seat at the important role in how the regulatory table, it would represent a dramatic of securities solutions at Actimize, a architecture evolves.” change from the recent past. Under the developer of risk management and Maco says Schapiro’s early moves as agency’s last chairman Christopher surveillance software for financial chairman were designed to set a new Cox, the SEC played at most a bit part services companies, says current tone for enforcement, that he believes while the Federal Reserve and the investment advisor regulations hark that the way the commission handles Treasury orchestrated the bailout and back to the days when portfolios were cases in the future will be a better guide reorganisation of the United States’ long-only, unleveraged and plain to substantive changes in enforcement financial system, including the major vanilla. In that environment, money policy. How Schapiro articulates the securities houses that fall under the management didn’t need heavyhanded regulation; it was low risk and SEC’s mission to Congress will be even SEC’s regulatory purview. more important. Maco recalls the turf While stronger enforcement tops the the asset-based fee structure kept the

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Market Leader NEW SEC CHAIR: REBUILDING CONFIDENCE

interests of investors and their advisors aligned. The advent of hedge funds, which charge upward-only performance fees, introduced a conflict of interests, while the funds’ use of leverage and exotic derivatives ratcheted up the risk. “Even Madoff’s stated strategy was not exactly plain vanilla,”says Heinzman,“The regulators need to catch up.” The SEC may not have the right resources to accomplish Schapiro’s goals, however. “The agency has lawyers and economists, but it is a little short on industry practitioners,” Heinzman says, “They need subject matter experts, people with forensic accounting skills and risk management types.”He says the SEC has outmoded information technology, too—the result of inadequate funding. President Obama’s proposed budget pencilled in a 13% increase in funding for the SEC, but Congress—and Republicans in particular—may be reluctant to go along when the nation’s finances are under intense pressure from so many other quarters. Every crisis throws up opportunities to overcome the bureaucratic inertia that so often stalls reforms no matter how logical or necessary. A consolidation of financial regulatory agencies under a single body like the UK’s Financial Services Authority (FSA) may be a bridge too far, but a long-mooted merger of the SEC and the CFTC could be on the cards. In the past, efforts to merge the two foundered on opposition not only among regulators and some regulated entities but also on Capitol Hill. Reflecting the historical link between the futures markets and the farm economy, the House and Senate committees responsible for agriculture oversee the CFTC, while the financial services and banking committees keep an eye on the SEC. Although financial futures long ago surpassed physical

Nick Morgan, a partner in the Los Angeles office of law firm DLA Piper. Morgan holds that the changes Schapiro implemented are more cosmetic than substantive. He concedes that enforcement staff will have a little more discretion in negotiating penalties, but final settlements still have to be approved by the Commission. “It’s not as though the staff has been given free rein to impose whatever penalties they think are appropriate,” says Morgan. Photograph kindly supplied by DLA Piper, April 2009.

commodities as the most actively traded asset class on commodity exchanges, Congress has never altered the reporting lines. Whether legislators resolve the anachronism in response to the current crisis remains to be seen, but if a merger does take place Schapiro is uniquely qualified to oversee the integration. Schapiro’s ambitious plans smack of populist politics as well as legitimate regulatory initiatives, however. For example, the debate about central clearing for over-the-counter (OTC) derivatives is effectively over. Egged on

by regulators and politicians, the industry has thrown its weight behind the initiative and at least four clearing houses have either added credit default swaps to their product range or are just about to. The ratings agencies are another easy target. Market participants were quick to blame the agencies’ spectacular misjudgements in the ratings of structured debt on cosy relationships with issuers and underwriters whose profitability depended on the ratings assigned to the various tranches in securitised debt transactions. One more voice—albeit a powerful one—won’t hurt, but the SEC staff had already finished work on the ratings agencies before Schapiro took over: the new rules were published on February 2, less than two weeks after her appointment. Schapiro must also balance her desire for stronger enforcement against the ability of regulated entities to bear the cost. Heinzman says regulators like to levy huge fines in a few high profile cases to show they mean business, but many financial firms are so weak today that a large penalty could tip them over the edge. Yet if settlements are seen as lenient they will blunt the in terrorem effect regulators rely on to alter behaviour throughout the industry. Despite the challenges, Heinzman points out that Schapiro has led a regulatory agency under siege in the past. When she took over NASD Regulation—one of FINRA’s predecessors—in 1996, the organisation had just been fined by the SEC and ordered to upgrade its technology at considerable cost. The same questions that are flying around today about the SEC (whether it is relevant or should be replaced) were being asked about NASD Regulation at the time. “Mary Schapiro did a very good job at modernising the NASD,” Heinzman says, adding: “If anyone is capable of solving the problems the SEC has, Mary is.”

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Market Leader RECESSION & THE REGULATOR: FSA IN THE DRIVING SEAT

The FSA moved more towards PBR in a more formal way throughout 2006 and 2007 and in April 2007 it set out its approach in a formal paper. In the document, the FSA stated that it would focus on the Principles for Businesses, concentrating on outcomes and behaviours as opposed to processes, and permitting firms flexibility in meeting those principles. It also stated that it would bring out guidance (both formal and informal) to assist firms in working out what was expected from them in relation to the principles, but firms could decide whether or not they complied with it. Photograph © David Cox/Dreamstime.com, supplied April 2009.

FINE TUNING NEW RULES The impact of the recession has, unsurprisingly, led to an increase in proposals for tighter regulation on individuals and institutions in the financial sector. This has implications for the way that the Financial Services Authority (FSA), among others, controls and monitors the actions of organisations operating in this arena, writes Jacqui Hatfield, Financial Services Regulatory partner, at Reed Smith. “

O MORE LIGHT touch regime,” commented FSA chairman Lord Turner before the Treasury Select Committee recently. There will be a shift of focus away from principles based regulation (PBR) to outcomes focused regulation (OFR), the FSA announced in its 2009/10 FSA Business Plan, which runs from April 1st this year. PBR is a core element of the UK’s Department for Business, Enterprise and Regulatory Reform’s (BERR’s) Better Regulation Agenda, which was initially introduced for UK regulated firms in the Financial Services and Markets Act 2000 (FSMA) and is being rolled out across all government departments. More detailed reporting requirements

and prescription for all United Kingdom regulated entities relating to liquidity, risk management and stress testing have also been introduced. For instance, liquidity capital buffers at the UK level for non-European Economic Area (EEA) banking groups were proposed by the FSA in its January 2008 consultation process. Additionally, the Principles for Businesses are a series of high-level outcomes and behaviours that were first introduced by detailed rules and formal guidance in the FSA Handbook. They were all subject to consultation and cost benefit analysis and a breach of a rule would lead to a breach of a principle, but a firm would not be disciplined for a breach of a principle alone.

Moreover, 7 Principles for Approved Persons (people carrying out key officer roles or customer-facing functions with regulated entities) were introduced, together with a Code of Practice under FSMA, providing the FSA with the potential to discipline individuals for non-compliance through the Approved Persons regime. For example, notably in respect of PBR, the FSA has emphasised that engagement of senior management is required in order for it to work effectively. Senior management can be held accountable for the failure of a firm to comply with a principle and can be disciplined through the Approved Persons regime.

Formalising approaches The FSA moved more towards PBR in a more formal way throughout 2006 and 2007 and in April 2007 it set out its approach in a formal paper. In the document, the FSA stated that it would focus on the Principles for Businesses, concentrating on outcomes and behaviours as opposed

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Market Leader RECESSION & THE REGULATOR: FSA IN THE DRIVING SEAT

to processes, and permitting firms flexibility in meeting those principles. It also stated that it would bring out guidance (both formal and informal) to assist firms in working out what was expected from them in relation to the principles, but firms could decide whether or not they complied with it. Although the April 2007 paper stated that firms did not need to comply with guidance issued by the FSA and would not be subject to enforcement for not following it, firms have complied with the guidance as if it involved legal rules. Strictly speaking, guidance is not binding. It is not subject to consultation or cost benefit analysis and firms cannot be disciplined for failing to comply with it. However, it is considered by firms that compliance with the guidance is necessary because it forms a relative “safe harbour”in enforcement actions. Notably, all firms with retail customers have sought to comply with the Treating Customers Fairly (TCF) initiative, which was based on guidance and consisted of six outcomes under principles 6 (duty to treat customers fairly) and 7 (fair, clear and not misleading communications), despite it being a costly exercise.The FSA has also announced that it will take enforcement action for non-compliance. Importantly, the April 2007 paper clearly stated that enforcement could be brought against a firm for a breach of a principle alone. Since April 2007 there has been a proliferation of guidance issued by the FSA in the form of, for example, “Dear CEO” letters, best practice guidelines, industry guidance and informal guidance. In addition, changes to the FSA handbook in line with PBR have been made. For example the conduct of business rules and enforcement manual have been streamlined and simplified, and the money laundering

“More clarity is required on the subject, in particular because the FSA, in line with its response to the light touch regime, has warned that it will be taking more enforcement action against firms and individuals.” sourcebook has been replaced by reliance on industry guidance.

The right kind of rules PBR has nonetheless created pitfalls and dangers. For example, a common criticism of PBR is that it has facilitated regulatory creep through the back door. It is said to have done this in a number of ways: through issuing guidance, without cost benefit analysis (for example the TCF initiative); through a blurring of the line between minimum standards and best practice guidelines by the issuance of best practice guidance; and, with the benefit of hindsight, through the potential for arguments in enforcement actions and a general lack of clarity for firms regarding what is expected of them by the FSA. It has also been viewed as a “light touch regime”, which has led to the shift by the FSA from principles based regulation to outcomes focused regulation. However, the light touch regime criticism is perhaps more a failing of the FSA’s risk-based approach to supervision regarding banks. In particular, this relates to the weakness in the tripartite responsibilities of the Treasury, the Bank of England and the FSA in the supervision of banks found after the collapse of Northern Rock, rather than in relation to PBR itself. It is a

separate issue from PBR and should not be a reason for moving away from PBR/OFR. It is generally thought by authorised firms and their key stakeholders that, despite the dangers, PBR as a concept is a good one. It notably creates flexibility for firms and requires senior management engagement. It has also led in part to the attractiveness of the UK as a place of business. Obstacles to PBR have included European law, which the FSA has had to implement. The Markets in Financial Instruments Directive (MiFID), for example, was very prescriptive, particularly with respect to conflicts of interest and best execution. Moreover, while the FSA has been advocating PBR in European legislation, the objectives of Europe are to create a single market and there is a belief within the European Union that this can only be carried out effectively through prescription. Late 2007 heralded the current credit crunch and as late as October 2008, Hector Sants, the FSA chief executive at the time, was advocating the continuance of PBR. However, a number of developments have led to a change in the FSA’s public stance. Among them can be listed: • The collapse and full nationalisation of Northern Rock, as well as the mortgage business of Bradford and Bingley; • The part-nationalisation of RBS and the Lloyds Banking Group and the recent failure of Dunfermline Building Society; • Failing foreign banks with branches and subsidiaries in the UK, such as the Icelandic banks and Lehman Brothers, leaving UK depositors without access to assets until insolvency has been finalised; • More detailed prescriptive rules regarding liquidity, risk management and stress testing being introduced,

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leading to a shift in PBR and a move to more protectionist measures, with the FSA “going it alone” in the international field. Concerns currently revolve around exactly what the FSA is intending with respect to PBR. Is the shift to OFR merely a shift in focus to ensure that there is no misunderstanding about light touch supervision or will it herald changes, including more prescription? It may be a means of introducing more TCF type initiatives as guidance, without a cost benefit analysis, setting out the outcomes the FSA expects under each principle, leading to more costly compliance exercises and management information requirements. Evidently, more clarity is required on the subject, in particular because the FSA, in line with its response to the light touch regime, has warned that it will be taking more enforcement action against firms and individuals. It has also visibly increased the number of its enforcement staff. In addition, the FSA’s proposed protectionist stance regarding liquidity may lead to businesses going elsewhere, contributing, in turn, to a slow recovery from the recession. For example, the FSA requires liquidity buffers at the UK branch/subsidiary level for banking groups. Moreover, it also contains a proposal to require individuals in a parent company which has authority to influence decisions of the UK regulated entity to be an approved person of the UK regulated entity and hence potentially puts them at enforcement risk.

Reviewing liquidity Separately, the Basel Committee and the Commission of the European Union are reviewing liquidity, risk management and governance issues as a result of the current crisis and are bringing out measures to try to avoid the situation occurring again.Therefore, the FSA must ensure that it moves in line with (and

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with the co-operation of) them both to ensure that it does not lead the way in measures that will lead to business leaving the UK. Furthermore, if the FSA is really proposing to move away from PBR and to impose protectionist measures, it should take heed of examples where protectionist measures and prescription have not worked. For example, the Sarbanes-Oxley Act in the US was intended to restore public confidence in American business in the wake of the bankruptcies of Enron and WorldCom. It aimed to do this by improving the accountability of managers to shareholders. However, it had the disadvantage of having international regulatory creep and as a result led to de-listings from American stock exchanges. In addition the FSA should bear in mind that more prescriptive rules-based regulation in the US did no better at anticipating or dealing with its domestic banking collapse. Rules-based regulation can help to provide tighter control in some areas, but at the same time, we also need to be aware of both its strengths and weaknesses, based on past experience. Post-recession, it is certain that tighter regulation, particularly in the financial arena, will be the order of the day, but it could be argued that the jury is still out on exactly what form this will take.

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In the Markets AIM VERSUS SFM: THE ISSUER CHOICE

THE RIGHT TARGET MARKET Photograph © Dawn Hudson/Dreamstime.com, supplied March 2009.

The choice for funds to float on the Alternative Investment Market (AIM) or the Specialist Fund Market (SFM) is a subjective and highly individual one. There is no significant difference in the timing and cost between the two options, which can usually be the driving factors for management teams when choosing the market on which to list. For funds wanting to adopt a flexible structure whilst appealing to the widest investor base, AIM will be the ideal route. However, more sophisticated or specialised funds wanting to retain the flexibility in approach offered by AIM, while attracting a more savvy investor, may find the SFM a more suitable venue. Simon W Holden, an associate in the London office of international law firm Faegre & Benson LLP, who specialises in corporate law, assesses the options. RESCIENT SOULS AT the London Stock Exchange (LSE) who, in the mid-1990s, foresaw the need for a stock market for younger growing companies, are probably hunkering down about now. The UK’s stock exchanges, particularly AIM, the LSE junior market, have experienced a steep decline in market capitalisation. It was always going to be the case that those smaller, some would say riskier, quoted companies would bear the brunt of any economic malaise. AIM is comprised of such companies, having played host to companies focused on ventures ranging from exploration in far flung places to online gaming companies. Having been set up in June 1995, AIM grew from 10 quoted companies (all of which were based in the UK) to 1,694 companies by the end of 2007 (347 of which had an international

focus, either being domiciled overseas or having a business concentrated outside the UK). A more startling figure is the combined market value of the companies quoted on AIM. By the end of 2007, this figure stood at £97.5bn. Fast forward to the end of February this year, and that figure has been slashed to £37.9bn. What of the LSE in these tough times? Perhaps it can rest on its laurels and hope that the market recovers sooner rather than later, and companies and investors are attracted back to AIM in the droves they were over the past few years. Not so. The LSE has a real job on its hands, now having to extol the virtues of three markets rather than two.

Complements main board On November 1st 2007, the LSE set up the Specialist Fund Market (SFM),

to complement the main board and AIM. The idea behind SFM is to attract specialist investment funds that will target institutional and professional investors. Over the past few years, AIM has attracted a number of funds, with investments ranging from commercial property interests in Bulgaria and Ukraine to “fund of funds” focused on India. Unlike AIM, the LSE has stated that the SFM is not suitable for retail investors. From a regulatory and trading perspective, the SFM sits between the main market and AIM. It has been designed to accommodate a broad array of funds including hedge funds, private equity funds, emerging country and specialist property funds. One could argue that these are funds in the true sense of the word, whereas those vehicles describing themselves as such on AIM are nothing more than companies established with an investment strategy. Funds listed on AIM do not have the same complex structure typically associated with a private equity or hedge fund. Their constitutions are typically less rigid and they are structured to take advantage of the flexible regime offered by the AIM Rules, which are much less demanding than those of the SFM. Unlike AIM but like the main market, the SFM is an EU regulated market as defined in the Markets in the Financial Instruments

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In the Markets AIM VERSUS SFM: THE ISSUER CHOICE

Directive (MiFID). However, unlike the main market, funds do not have to comply with the Financial Services Authority’s (FSA) listing rules, which pre-suppose general retail investor participation and are not applicable for funds wishing to appeal to a more sophisticated, predominantly institutional, investor base. Importantly, EU regulated market status is the baseline requirement for access to European institutional investment mandates without being subject to threshold limits. Securities quoted on the SFM are eligible for inclusion in insurance funds, occupational pension funds and other mutual funds such as Undertakings for Collective Investments in Transferable Securities (UCITs), something AIM cannot lay claim to. Given the more restricted scope of AIM investors, and ultimately the lower investment thresholds of retail investors, there is a strong argument that the SFM provides funds with a stronger liquidity platform than AIM. The SFM is also capable of accepting more complex structures, governance models and security types. Limited partnerships, non-voting shares, and funds with concentrated investment policies and bespoke governance arrangements can be accommodated, attributes not applicable to AIM companies. In terms of the admission process, the SFM process is a lot more intensive than that of AIM. The LSE has been lauded in the past for its AIM admission process, which is geared towards smaller growing companies that neither have the maturity of operations nor, usually, the resources, to undertake such a process. Having delegated the AIM admission process to nominated advisers (Nomad), the LSE can maintain a suitable regulatory environment for smaller companies whilst ensuring the overall integrity of its markets.

Admission to trading on the SFM is a two stage process requiring production of a prospectus approved by the relevant European Economic Area (EEA) Competent Authority. In the UK, this is the FSA. Rules for approval and publication of prospectuses are contained in the prospectus rules. Following approval of a prospectus, an application is made to the LSE. Admission depends on compliance with the LSE’s admission and disclosure standards. The timescale for the production and approval of a prospectus (SFM) and an admission document (AIM) can vary. Since a prospectus needs to be approved by the FSA, some people think this will take longer than the process for a Nomad to approve an admission document. However, this is not strictly true as, typically, funds are incorporated with no pre-existing investments. Given that little due diligence is required as part of the admission process for a fund with no pre-existing investments, the timescale for producing a prospectus versus an admission document will likely be very similar. Typically, the process would take between three and four months. Operating companies require a lot more due diligence to be undertaken on them, especially in historical financial information, and therefore the admission process will inevitably be longer. The same would be true for funds with a prior operating history and existing investments. In this instance, the AIM admission process may be a quicker route to market than that for the SFM because of the Nomad versus FSA approval process.

Track records On May 29th 2008, hedge fund DaVinci CIS Private Sector Growth Fund became the first company to list on the SFM. The fund raised approximately $110m to invest in unlisted equity and

equity-related securities of companies located in Russia and other member countries of the Commonwealth of Independent States (CIS). Unfortunately, the fund’s existence as a quoted company was short-lived and it de-listed from the SFM in January 2009. Guernsey domiciled investment company MarwynValue Investors (MVI) de-listed from AIM in favour of the SFM on December 8th last year, in the hope of narrowing its discount to net asset value. At the time, MVI said it hoped to raise its profile and access a broader base of potential investors, as well as increasing transparency for investors. Another company to follow the route of delisting from AIM in favour of the SFM is IRF European Finance Investments (IRF), which was admitted to trading on January 19th. Its directors stated that the SFM, as a regulated exchange, should provide access to a broader base of investors. Despite the ongoing deterioration and volatility of market conditions, demographics dictate that the alternative funds industry will continue to be in demand, presumably increasing in the long term. With people living longer, traditional institutional investors increasingly have to make their assets work harder for longer. Investor demand for a range of alternative funds offering the discipline and secondary market potential that the public capital markets bring will also increase. London, with its choice of capital markets designed to suit the needs of companies and investors alike, will continue to play a central role in meeting that demand. Right now, only four securities are traded on the SFM, two for each of MVI and IRF. It is therefore too early to tell whether the SFM will be a success. However, given the LSE’s track record in developing an alternative market and turning it into a world beater, the signs for the SFM are promising.

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In the Markets PRIVATE EQUITY: WILL IT HELP TURN THE TIDE?

Photograph © Rolffimages/Dreamstime.com, supplied April 2009.

MANAGING A COMEBACK The aftershocks of the financial crisis are still coming, and most investors still seem to be in post-crisis trauma. However, while the banking industry is clearly in an almost paraplegic state, there is a lot of money out there, and private equity (PE) groups in particular have weathered the shocks fairly well, even if they too have to adjust their strategies and tactics in the light of the credit crunch. Ian Williams reports.

ESEARCH FIRM PREQIN’S 2008 Private Equity report estimates that taking into account“dry powder”– committed but as yet undelivered investment from limited partners (LPs)—there is upwards of $2.5trn in the private equity (PE) funds. If they see opportunities, they can take them, without the constraints of those dealing in the listed markets or the battered banks and institutions. Preqin’s Tim Friedman contrasts the general mood of doom and gloom. “I think people in private equity are quite upbeat. The flows dropped down in the third and fourth quarters but private equity still raised $100bn a quarter.”The sources are, he says, “primarily institutions and some hedge funds. Our analysis shows that PE has done very well, even in the current market, so when they have capital they are maintaining, and in some cases even increasing, their allocations.” Some surprising sources have noticed

the trends [the United Nations pension fund, for example, doubtless ruefully contemplating the hole in its equity portfolio, is now venturing into private equity for the first time] and funds are increasing their allocations. Friedman, still upbeat, predicts “Although there was some step back from 2007, because there weren’t as many people as a year ago with liquid capital to put into private equity, when they do have capital they’ll be eager to get back in … tentatively we think that it will improve towards the end of the year when investors can make new investments.” For many institutional investors the denominator effect is a problem, since they are still not sure how their portfolios have weathered the crisis. With a ceiling of between 5% and 10% of their portfolio for “alternative” investments, declining listed equity values reduce absolute availability of funds, despite moves to increase the allocation by many funds. That does mean that PE fund managers cannot afford to relax,”he says.“At an individual level, it’s a problem for them, with so many funds on the road, and with less capital to go around, so if you are a fund manager you have to work harder against more competition. Even so, there are great opportunities for PE funds.”

Despite the reservoirs of capital, Friedman thinks that financing deals is going to be more of a challenge, since the usual leverage from banks has dried up.“It is going to be extremely difficult to raise money that way in 2009,” Friedman predicts. “There has been a drop-off in deal activity, but PE managers are quite innovative. Since there is now limited leverage, they have to use more of their own capital in these deals, and so we may see a situation where they negotiate taking on companies already in debt and maintain a three to one debt equity ratio to prove that they would be a better custodian for that debt.”It could well be an offer that creditors cannot refuse. Moreover, there are sectors, such as emerging markets and venture capital, where debt leverage has traditionally been far less important. While the PE world may appear to be countercyclical, its venture capital subset, representing a quarter or so of funds, is where those who want to peer into a crystal ball might get the clearest pictures, not least because of its relative independence from the frozen credit markets. John Taylor, the National Venture Capital Association’s (NVCA’s)vice president for research, points out that “It is the leading

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In the Markets PRIVATE EQUITY: WILL IT HELP TURN THE TIDE?

indicator because it’s building companies up, from two guys and dog in a garage, up through the initial public offering (IPO) and acquisition.” NVCA’s latest figures show that 43 venture capital funds raised $3.4bn in the fourth quarter of 2008, which is a significant decline from the third quarter ($8.4bn) and the fourth quarter of 2007 ($11.7bn). Overall, this represents a 21.4% decrease in volume from 2007 but obviously a much more significant drop in that cataclysmic fourth quarter. Taylor identifies the same problem as Friedman. “The public side of the big pension/endowment funds has fallen so far, so proportionately the amount they put in alternatives is currently overallocated. Even if a manager came along with the most wonderful VC proposal it would be difficult for them to raise money right now.” Even so, Taylor points to more than 1,000 first time fundings in 2008— pretty much in line with recent years. Each of those is “a new multi-year commitment of capital and time.” However, he cautions that “a VC fund manager probably has a completely difference Rolodex and set of skills from a PE manager, and probably a very different need for capital; from a timing standpoint, these are companies at the beginning of the business cycle, which private equity, IPOs and other financing options will take up, anything from five to ten years around the cycle.” Despite that long forward perspective, the credit crisis is not without its effect. Taylor reports. “VCs are sending out strong signals to all of their companies to conserve cash, make it a two-year rather than a one-year thing.”While the broader buyout side of private equity has more flexibility in timing, VC is predicated on a regular cycle of nurturing enterprises for sale— and the prospects for that are not good now. “So, if the exit markets remain shut, the number of new fundings will

be suppressed because VCs cannot wrap up existing projects—those late stage portfolio companies which in other eras would have moved on. It becomes a bandwidth issue. How soon can they turn their attention to the next crop of companies? Everyone knows that some of the best deals are funded during down times,”he says. Taylor is still baffled at investor reticence in corporate America.“There is an awful lot of money on the sidelines even though many companies have large cash reserves and could use it to acquire VC backed companies in the near term, not least because prices are good. When you look at how many of these companies are trading, with their cash flow and their cash on hand, they are very attractive,”he says. It is not only the well springs of liquidity that the crisis has affected; it is also the directions in which they flow—or rather are poured. As Friedman says, “There has been a shift towards niche funds, such as distressed private equity funds, going up as a proportion of the market.” While PE is poised for some very effective bottom feeding itself, it also has its own bottom feeders within it. There is growing interest in the secondary market, where canny buyers are getting bargains from distressed LPs with other calls on capital who are selling their interests in PE funds at large discounts to their net asset value

(NAV). There have been some questions about NAVs, since managers getting a percentage on funds managed have an incentive to maintain notional value, and marking to market is not so easy since many of the deals are not on the market. Preqin considers, however, that most funds have practiced conservative valuation. In any case, the discounts are so considerable that there a lot of opportunities. John Taylor comments on defaults, “Interestingly it has not happened so much yet in VC because there are very heavy penalties. They could lose all their interest, and the money they have put in.” Indeed, they are not so much locked in as entombed for the duration. Emerging markets have retained a comparative attraction for PE (see chart) partly because their relative lack of exposure to the allegedly “sophisticated”financial instruments of the US and Europe have left them in better shape, even as the retreat of liquidity to the developed world’s financial centres creates opportunities. With the element of compulsion about capital commitment and private equity’s longer-term perspective and recent exponential growth, it is possible that private equity and its various subsectors will play a catalytic role in any economic turnaround. The sector could be the bellwether that leads the battered global economy into the light.

Private Equity Funds Focusing on Emerging Markets: 2003-2008 Year

Number of Funds

Aggregate Capital $bn

2004 2005 2006 2007 2008

73 148 240 248 175

7.6 39.6 75.1 97.3 90.1

Private Equity Funds on the Road Focusing on Emerging Markets Number of Funds

Aggregate Capital $bn

444

187.3

Source: Prequin, January 21st, 2009

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In the Markets OTC DERIVATIVES: A MORE CONSISTENT TRADE CYCLE

GETTING A HANDLE ON DERIVATIVES

Photograph © Michael Monahan/ Dreamstime.com, supplied April 2009.

Despite the recent reduction in trading volume and the likelihood of tighter regulatory controls, overthe-counter (OTC) derivatives will probably remain an important part of the investment landscape. Greater demand, however, will require more consistent trade-cycle data, tougher pricing standards and increased risk management—not to mention sufficient investment capital to support these needs. David Simons reports from Boston. PEAKING IN WASHINGTON in late March, US Treasury Secretary Timothy Geithner issued a multi-step proposal to standardise and clear through a centralised agency all over-thecounter (OTC) derivatives contracts, including the use of more stringent guidelines covering trade confirmation, collateral and margin practices, and documentation. Geithner vowed to“bring unparalleled transparency to the over-the-counter derivatives markets by requiring counterparties and trade repositories to make aggregate data on trading volumes and positions available to the public, and make individual counterparty trade and position data available on a confidential basis to federal regulators.”

Also in March, the Securities and Exchange Commission (SEC) granted conditional exemptions allowing both the Chicago Mercantile Exchange (CME) and ICE US Trust LLC to operate as a central counterparty clearing house (CCP) for credit default swaps. LCH.Clearnet, which won approval from the SEC in December, has already

enlisted the support of HSBC and JPMorgan as shareholders in its OTCDerivNet platform, which oversees the company’s SwapClear worldwide clearing service. Though hopes are high that the central-counterparty approach will help mitigate the threat of systemic risk, the sheer number of global

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Spotlight on Small-Cap: A Q&A Session with Vanguard’s Head of Financial Advisor Services, Martha Papariello What is the name of Vanguard’s new Small-Cap ETF? This new exchange traded fund is called the Vanguard FTSE All-World ex-US Small-Cap ETF. It began trading on the NYSE ARCA exchange under the ticker symbol VSS on April 6, 2009. What kinds of stocks are included in this new ETF? The fund seeks to track the investment performance of the FTSE Global Small Cap ex US Index, a benchmark of approximately 3,100 stocks of companies located in 47 countries outside the United States. A look at the index’s current top ten constituents shows a concentration of companies domiciled in Canada and the United Kingdom, across a variety of sectors including mining, software & computer services, nonlife insurance, construction & materials, food & drug retailers, and pharmaceuticals & biotechnology. FTSE Global Small-Cap ex US Index: Top 10 Constituents Rank Constituent Name

Country

ICB Sector

Yamana Gold

Canada

Mining

6098.496

0.61

Fairfax Financial Holdings

Canada

Nonlife Insurance

4112.835

0.41

Autonomy Corporation

United Kingdom

Software & Computer Services

4081.449

0.41%

SNC-Lavalin Group

Canada

Construction & materials

3780.968

0.38%

Scor S.A.

France

Nonlife Insurance

3722.669

0.38%

Metro Inc A

Canada

Food and Drug Retailers

3448.391

0.35%

Randgold Resources

United Kingdom

Mining

3192.971

0.32%

Indra Sistemas

Spain

Software & Computer Services

3153.174

0.32%

Qiagen Nv

Germany

Pharmaceuticals & Biotechnology

3092.854

0.31%

United Kingdom

Mobile

2996.985

0.30%

10. Inmarsat

Market Cap (USD)

Index Weight (%)

Source: FTSE Group, as at 18 March, 2009. FTSE does not accept any liability for any errors or omissions in the FTSE indices or underlying data. No further distribution of FTSE Data is permitted without FTSE's express written consent

Why did you launch an international small-cap ETF at a time when these stocks are out of favour? Vanguard research shows that there are long-term diversification benefits associated with international investing, as demonstrated by a historically low correlation between U.S. and international small-cap securities. Certainly, equities today are more closely correlated globally – stocks are generally lower across all segments. However, when the financial crisis eventually passes, we believe differences in performance between the United States and other countries will emerge. We always encourage investors to make decisions based on long-term asset allocation needs, not based on what is in or out of favour at the moment. Vanguard ETF Shares can be bought and sold only through a broker (who will charge a commission) and cannot be redeemed with the issuing fund. The market price of Vanguard ETF Shares may be more or less than net asset value. All ETF products are subject to stock market risk, which may result in the loss of principal. International ETFs involve additional risks, including currency fluctuations and the potential for adverse developments in specific countries or regions. ETFs that invest in emerging markets are generally more risky than those that invest in developed countries. Prices of small-cap ETFs often fluctuate more than those of large-cap ETFs. Visit www.vanguard.com or contact your broker to obtain a Vanguard ETF prospectus, which contains investment objectives, risks, charges, expenses, and other information; read and consider carefully before investing. Vanguard Marketing Corporation, Distributor.

THE FTSE I WANT THE WORLD INDEX FTSE. It’s how the world says index. Global markets grow more complex and interconnected every day. To stay abreast, you need a comprehensive index that can slice and dice markets the way you do. The FTSE Global Equity Index Series was the first benchmark to cover the world seamlessly with a single consistent and transparent methodology. Wherever you invest, FTSE gives you the clearest view of how you are doing. www.ftse.com/invest_world © FTSE International Limited (‘FTSE’) 2009. All rights reserved. FTSE ® is a trade mark owned by the London Stock Exchange Plc and The Financial Times Limited and are used by FTSE under licence.

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In the Markets OTC DERIVATIVES: A MORE CONSISTENT TRADE CYCLE

Geoff Harries, vice president, product strategy for Fiserv, the Brookfield, Wisconsin-based technology solutions provider. Companies such as Fiserv, then, see themselves as part of the universal goal of streamlining the operations of financialservices firms in order to reduce the level of global fragmentation. “There really is a significant amount of operational improvement that can be done on behalf of these institutions who want to trade these financial structures within their portfolios. That is really where our focus has been of late—helping clients to create better procedures, better processes, as well as streamline their post-trade management requirements.” Photograph kindly supplied by Fiserv, April 2009.

counterparties and their affiliated regulatory agencies raises questions about fragmentation, says Geoff Harries, vice president, product strategy for Fiserv, the Brookfield, Wisconsin-based technology solutions provider. Companies such as Fiserv see themselves as part of the universal goal of streamlining the operations of financial services firms in order to reduce the level of operational risk posed by OTC derivatives. “There really is a significant amount of operational improvement that can be

done on behalf of these institutions who want to trade these financial structures within their portfolios. That is really where our focus has been of late—helping clients to create better procedures, better processes, as well as streamline their post-trade management requirements.”, says Harries. Unlike the relatively brief cashsecurity trade cycle, certain OTC contracts may last for years, which, says Harries, represents a major adjustment for any investment firm moving into the world of derivatives. “The OTC world is fundamentally different—there can be payment streams that occur off the back of a contact that need to be managed for a very long time.”This requires a very different approach with respect to all the processes that occur following the execution of the trade, he says. The continued reliance on legacy systems initially designed to support fixed income and equity products is hardly a sustainable long-term solution, particularly as volumes continue to grow and the market becomes increasingly complex. A recent State Street report entitled Derivatives Servicing: Managing the Complexity warns that the surge in volume of OTC derivative trades threatens to overwhelm outdated processing systems. Recognising the severity of the situation, the Operations Management Group (OMG), a consortium of sell side and buy side firms representing the investment management and hedge fund sectors, has been working to address issues that have been raised by regulators. “Significant commitments have been made to improve the infrastructure and the processes around servicing derivatives,” says Neil Wright, senior vice president and

product manager for derivatives servicing at State Street Corporation. Efforts such as State Street’s derivatives servicing platform, the OTC Hub, with linkages connecting State Street to industry utilities such as the Depository Trust and Clearing Corporation (DTCC), are the kind of pro-active steps that will help the industry move forward, says Wright. “The hub provides an end-to-end soultion for servicing OTC derivatives and covers the full life-cycle from post execution to maturity. It is designed as an across-the-board solution, and as such it is our goal to eventually convert all of our clients onto the `

“Significant commitments have been made to improve the infrastructure and the processes around servicing derivatives,” says Neil Wright, senior vice president and product manager for derivatives servicing at State Street. platform,” says Wright. “At the same time, we are also keeping abreast of the evolving central counterparty developments around CME, ICE and other companies. While the dealer community will ultimately drive the solutions, we need to be well positioned in order to support our clients’ participation in these industry events and offerings.” Now more than ever it is crucial that the industry address manual or redundant processes that continue to hamper the OTC trade cycle, says Harries.“There are members of DTCC’s Deriv/SERV platform, for example, who are still communicating via spreadsheet upload, which is not a real-time

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message exchange and is therefore vulnerable to errors and lack of audit. The point is, everybody really needs to take a step up—those who process manually need to move to the next level of automation, while those who process via spreadsheet need to step up in terms of real-time messaging. That is really the evolution that is required in order to be able to achieve the objectives that have been outlined by the President’s Working Group on Financial Markets and the ISDA Operations Management Group.” Capital outlays in the midst of a market downturn may seem counterintuitive, however, Harries underscores the importance of implementing streamlined OTC services, particularly for companies forced to operate with a reduced workforce. “Organisations must now handle the same amount of volume with fewer people on hand, and in that regard, automation isn’t really a luxury, but rather a necessity. In essence, the payback from investing in the technology makes a much stronger business case now than it

“The OTC world is fundamentally different— there can be payment streams that occur off the back of a contact that need to be managed for a very long time.” This requires a very different approach with respect to all the processes that occur following the execution of the trade, says Geoff Harries, vice president, product strategy for Fiserv.

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did even six months ago.” Despite some reduction in derivatives trading volume and the likelihood of tighter regulatory controls around the processing and oversight of these instruments, Pascal Scatozza, product manager, Global Fund Services, BNP Paribas Securities Services, believes that OTC derivatives will remain an important tool for the industry. “The original aim of derivatives is to hedge risks, and this will continue to be the case going forward.” In keeping with the general trend towards simpler and easier-toinvestment strategies, support Scatozza sees vanilla products dominating the global OTC derivatives market over the near term. Additionally, service providers need to support the full value chain for OTC processing and risk management, says Scatozza, encompassing trade affirmation and confirmation, cash flow calculation and settlement, investment compliance, independent pricing and collateral management. The use of OTC derivatives for hedging or speculative purposes will continue for those in and outside of the financial industries, says Judson Baker, product manager for derivatives processing in North America at Northern Trust. “And as more listed products are developed that mimic the economic exposures of the popular OTC derivatives, we should also see a move in that direction.”To that end, Northern Trust is continuing its investment in services needed to support clients’ use of OTC derivatives. “We have developed capabilities to accept OTC transactions via FpML, the industry standard format for OTC trade communication, and the regulatory demands on OTC valuations support our approach to providing independent valuations by leading specialist firms.”

Pascal Scatozza, product manager, Global Fund Services, BNP Paribas Securities Services, believes that OTC derivatives will remain an important tool for the industry. “The original aim of derivatives is to hedge risks, and this will continue to be the case going forward.” Photograph kindly supplied by BNP Paribas, April 2009.

Regulatory measures Though the threat of systemic risk has helped quicken the pace of derivatives regulation, Jon Anderson, global head of OTC derivatives for administration specialist GlobeOp, is pleased with the performance of derivatives since last September’s meltdown.“I think it is worth noting that of the 15 significant credit events that have occurred over the last few months, not one of them has led to a systemic problem, they have all cleared smoothly. Yes, there have been investments that have been severely mismanaged, and we’ve certainly seen that in products as traditional as mortgages. So I think the problems in the markets have really been more about leverage, and less so the instruments that have been used to lever.” Anderson believes that the opportunity currently exists to take the middle path between over-regulation

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In the Markets OTC DERIVATIVES: A MORE CONSISTENT TRADE CYCLE

and insufficient regulation, and applauds efforts by US Treasury Secretary Tim Geithner to refine the OTC derivatives market. “The most efficient means of trading isn’t always the most transparent,” says Anderson. “As Geithner correctly pointed out, the main objective is to find a quicker path towards standardisation for when new types of instruments appear on the market—rather than inhibit the ability to innovate.” This is crucial, says Anderson, since efforts to boost regulation have often come at the expense of efficiency. As an example, Anderson points to the Trade Reporting And Compliance Engine (TRACE), a program initiated seven years ago by the National Association of Securities Dealers (NASD) requiring brokers to report all over-the-counter

Neil Wright, senior vice president and product manager for derivatives servicing, State Street. Efforts such as State Street’s derivatives servicing platform, the OTC Hub, with linkages connecting State Street to industry utilities such as the Depositary Trust and Clearing Corporation (DTCC), are the kind of pro-active steps that will help the industry move forward, says Wright. Photograph kindly supplied by State Street, April 2009.

transactions pertaining to specific fixed-income securities. “Those trades are now reported on such a timely basis that it actually serves to reduce liquidity in some of the less-tradable instruments such as the emergingmarkets,” says Anderson. “As soon as you executed the trade, your competitors would know your positions. So I think it is very important to avoid going down that kind of a path with regard to trading.” Blaming the OTC market for the ills of the entire financial world is misguided, says Jonas Lundberg, global head of structured derivatives for Stockholmbased SEB Merchant Banking.“It is very much a credit problem, in many ways, therefore I’m just not sure that all of the discussions that are geared towards ‘fixing’ OTCs are that valid. One could argue that the auction processes around credit-default swaps have not gone very well. However, the question to ask is, how would you settle these things if they were cleared through an exchange? Because there would still need to be some kind of auction process, in which case you might still have some of the same issues that we’ve already seen. So I’m not certain the outcome would be very different.” While mainstream indices such as iBOXX.CDX would no doubt benefit from the enhanced liquidity of clearing through an exchange, Lundberg sees the potential for trouble when handling tailor-made OTC products through a central clearing house. “If you have an exchange calculating the value of every derivative that you can come up with, that means that everything will have to be vetted, which is certainly not favourable from a competitive point of view.” More comprehensive regulation will probably have a beneficial effect on the OTC derivatives market, says Scatozza, “as this will secure trading

Jon Anderson, global head of OTC derivatives for administration specialist GlobeOp, is pleased with the performance of derivatives since last September’s meltdown. “I think it is worth noting that of the 15 significant credit events that have occurred over the last few months, not one of them has led to a systemic problem, they have all cleared smoothly. Yes, there have been investments that have been severely mismanaged, and we’ve certainly seen that in products as traditional as mortgages.” Photograph kindly supplied by GlobeOp, April 2009.

and will encourage the industry to use these instruments in a more stable environment. The new regulatory framework should be precise and unequivocal in order to facilitate the understanding of the exposures and the controls to be applied to these instruments.” In other words, it is important to remember that instruments don’t behave badly—it is the people who use them, says Anderson. “It is the same as investors who were overextended on repos a decade ago, or on mortgages last year…derivatives are an extremely powerful instrument, and as beneficial as they are when handled properly, they can be extremely dangerous when used the wrong way.”

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Innovators CHRIS STURDY: CHAIRMAN, BNY MELLON, ASIA-PACIFIC

Without doubt the chairmanship of the bank’s Asia-Pacific business comes at an opportune time for BNY Mellon, particularly as its rivals’ overseas ambitions are impaired by balance sheet constraints. Photograph © Mikael Damkier/Dreamstime.com, supplied April 2009.

Business Building Asia Style Although something of a well worn and sometimes bumpy trail, Asia’s growth story still boasts substantial mileage. In fact, Asia appears to be holding up rather better against the recessionary winds battering its current growth trajectory than most market watchers expected. Even so, the adage that purports a decoupling of the Asian economic matrix from the West is definitely yesterday’s child, says Chris Sturdy, chairman of The Bank of New York Mellon’s Asia-Pacific business, evinced in tightening liquidity and invariable difficulties in getting big ticket debt and/or equity transactions finalised. Some eight months into his role, Sturdy has a big job ahead as the bank moves to integrate new acquisitions that expand its remit in the corporate trust segment and builds out a multi-stranded growth strategy across the continent. Francesca Carnevale talked to Sturdy about the challenges inherent in new business building in the region. HRIS STURDY, CHAIRMAN of The Bank of New York Mellon, Asia-Pacific, epitomises the economically conservative, committed internationalist intellectual tradition that has driven the globalisation of the financial markets for the last thirty years. A veteran of the bank, Sturdy rose through the ranks literally on the sell side of the business. He drove a strong client focus through his management of the bank’s global sales in company with quasilegendary banker Joe Velli, who literally reinvented the Bank of New

York brand from a state focused retail and commercial bank into a global asset servicing giant. Sturdy took on the Asia-Pacific chairmanship in May last year in a move intended to signal the bank’s increased focus on the region. It is a significant move, in that China has become a crucial market for the bank, serving as one of its five major markets in the Asia Pacific region. Even so, the move also reflects a corporate preference at the Bank of New York Mellon for experience over image and strong client relationships

over political connections. Sturdy’s particular qualifications for the job, roll back years. Originally working at Irving Trust, Sturdy was working in London in the 1988/89 period when “internationalism” was at the start of its drive to maturity. In the event, he was well positioned to take a prominent role in a new organisation when the merger between Irving and The Bank of New York took place. Transitioning into depositary receipts at the height of the European privatisation boom, when French and Italian corporations

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rushed to American Depositary Receipts (ADR), Sturdy stepped up rapidly to head up global sales and took over the operations in Asia. “It was not a bad way to get a role like this. I had always dealt with non-US companies in more than 60 countries,”he notes. Building on his experience in Europe, Sturdy and the bank took full advantage of the initial public offering (IPO) boom in China and Southeast Asia at the turn of this century, building his and the bank’s franchise in the region. By the time Sturdy took over the helm of the Asia-Pacific business, the bank had a tad under 3,800 staff, working out of 16 offices in 12 countries, servicing over 1,000 clients that include the region’s top 100 banks and at least one third of the region’s central banks. “My brief now is not product specific. Rather, it is a region wide focus that encompasses all products and services, including asset management, asset servicing and the bank’s trustee business, which has grown substantially,”explains Sturdy. Sturdy’s appointment was a catalyst for a number of senior management changes through the region to support the bank’s expansion programme in its five designated key markets, namely China, Japan, South Korea, India and Australia. In January last year, Jai Arya became head of client management for Asia, while a few months later Lee B Stephens, another long time staffer at the bank, was appointed chief administrative officer for the bank’s Asia-Pacific business, reporting directly to Sturdy. Stephens is driving the bank’s buildout of the regional infrastructure to support the company’s governance and growth initiatives across the greater region. Additionally, Makoto Saji was appointed as managing director and president of the bank’s

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Japanese securities company, The Bank of New York Securities Company Japan Ltd, reporting to Arya. Meanwhile, John Hills was appointed as head of treasury services for South Asia. Reporting to Richard Brown, the bank’s Hong Kongbased head of treasury services for Asia, Hills leads the bank’s treasury services teams for Singapore, Vietnam, the Philippines, Indonesia, Chris Sturdy, chairman of The Bank of New York Mellon, AsiaMalaysia, Thailand Pacific. Sturdy took on the Asia-Pacific chairmanship in May and Australia. last year in a move intended to signal the bank’s increased Without doubt the focus on the region. It is a significant move, in that China has chairmanship of the become a crucial market for the bank, serving as one of its five bank’s Asia-Pacific major markets in the Asia Pacific region. Photograph kindly business comes at an supplied by The Bank of New York Mellon, March 2009. opportune time for BNY Mellon, particularly as its rivals’ typical of the bank’s multi-faceted overseas ambitions are impaired by strategy and also Sturdy’s dynamism balance sheet constraints. Speed to in pushing through a business action and surety of purpose are key strategy that is a mix of organic in an environment where cash is growth and strategic alliances and king. Sturdy has not been slow to acquisitions across the board. expand the bank’s footprint in its key Moreover, the bank has been developing business relationships at markets, particularly in China. By early February this year, the all levels and across business bank was ready to announce its sectors―a reflection of the massive plans to establish a joint venture (JV) growth in Asian trade flows, both fund management company with within and outside the continent. It is Western Securities of China. The JV, a subject of particular interest to which is expected to gain an those international banks looking to operating licence by June this year, maximise the potential of their will bring Western Securities’ local transaction banking businesses and experience in asset management and in this instance: “The bank has marketing together with BNY cooperated with major Chinese Mellon’s global asset servicing and financial institutions in US dollar asset management expertise. clearing and trade financing Moreover, following the recent businesses,”explains Sturdy. Asia is a long term play, concedes establishment of its Shanghai branch, BNY Mellon is now Sturdy, from both sides. “I think, for preparing for another branch instance, that the Chinese saw and opening in Beijing. The move is continue to see opportunity and a

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Innovators CHRIS STURDY: CHAIRMAN, BNY MELLON, ASIA-PACIFIC

Following the recent establishment of its Shanghai branch, BNY Mellon is now preparing for another branch opening in Beijing. The move is typical of the bank’s multi-faceted strategy and also Sturdy’s dynamism in pushing through a business strategy that is a mix of organic growth and strategic alliances and acquisitions across a broad brush of business. Photograph © Yang Yu/Dreamstime.com, supplied April 2009.

necessity to look and work crossborder. They may have moments when the authorities might regret starting when they did, however, now they are committed to the trend, I think they are in it for the very long haul. In that respect, we have worked hand in hand with Chinese clients and the Chinese authorities to help them along this path. Similarly, the bank has moved to consolidate its business expansion programme in Japan, where it has had a presence for more than 40 years. In March this year the bank completed its acquisition of JPMorgan Trust Bank Limited in Japan from JPMorgan Chase & Co. The transaction is a result of the

company’s acquisition of JPMorgan Chase’s global corporate trust business in 2006. Terms of the deal have never been disclosed. With the closing of the transaction BNY Mellon will build on the securitisation asset trustee, cash management and fiscal services business offered by the trust bank and augment the sales of its own corporate trust services. Corporate trust providers are appointed by corporations, municipal governments and other entities issuing debt to perform a variety of duties, including servicing and maintaining the debt issue, processing principal and interest payments for investors, representing investors in defaults,

and providing value-added services for complex debt structures.“With the completion of this acquisition, we have significantly improved our corporate trust capabilities in Japan and expanded the wide range of issuer and securities services available to our growing client base,” says Sturdy. Explaining the significance of the acquisition to the bank’s overall strategy, Sturdy explains that, “corporate trust is core to our business model: melding our global reach with in-country reach. Before this acquisition we were limited to our cross-border platform. This raises the game. In Japan once we close the integration of the two businesses, it will allow us to expand our yen trustee work. It is a model that we are applying in other countries as well.” Confidence in the bank’s ability to leverage the opportunities extant is raised by the fact that “Asia has developed a vibrant regulatory, trade and economic system that can to a degree subsist in itself. Some of South Korea’s funds will be regional, rather than national, or global in reach,” thinks Sturdy. “Moreover, you have the internationalisation of the Islamic finance sectors in Malaysia and Indonesia. Add to that a growing population of consumers and you have a real economy that will still grow by between 3% and 6% this year. This must help Asia weather at least some of the storms battering the global markets this year, and possibly next,”he posits. Although mindful that the region remains tomorrow’s child and is replete with opportunity, Sturdy’s viewpoint remains conservative. A stalwart of globalisation, he considers the complex financial links between nations with some trepidation. “I have never subscribed to the view that there were decoupled parts of

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the world. Everything is absolutely connected. Assets are held globally, though frankly what has surprised me is the depth of that connection, whether that is Japanese or Chinese or Korean exposure to US treasuries. However, I do not think that we have yet felt the pain in Asia to the extent that it is being felt elsewhere. Here, the problem is evinced through the difficulty of raising funding, or the loss of jobs right now, but contagion is real and the full effects of the interlocking of markets around the world has yet to be felt.” “Everything is absolutely connected now and that brings its own problems,” notes Sturdy. “I have observed that if one takes the contagion that began in the US mortgage market, one should not be surprised that it should and will continue to touch Asia. Assets are held globally,”he adds. Additionally, Sturdy is wary of the impact of the global credit crisis on individual country risk. “Russia, for example, used to be all the rage and regarded as a relatively safe haven. That is quite different now: in that vein, I am concerned that some nascent economies, such as Vietnam, could be crowded out by risk aversion. Everyone is fleeing risk and that trend does concern me.”Equally, “There has been a seizing up of the credits markets in the region. Interbank lending has come back to reasonable levels only recently in the region; though we have to be vigilant on the lines we extend and we drill down deeply at the institutional level as these days one can ill afford to make mistakes,”he cautions. Sturdy remains pessimistic that the world will shake off its financial worries in 2009, with all that entails for the bank’s future business growth. Nonetheless, he believes that BNY Mellon is particularly well

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cushioned to optimise opportunities, even though “headwinds will be around for at least the next 12 to 18 months.” Sturdy says that the bank has geared up with this reality in mind. “We are well capitalised, our rating was upgraded by Standard and Poor’s in 2008 and as a result of that we have become more liquid.” Nonetheless, while many people’s loss has been BNY Mellon’s gain,“ it has given us no pleasure to go through these kinds of problems.” With his sales hat on, the bank is now focused on revenue generation, avers Sturdy.“While we were pleased to have reported profits in all four quarters of 2008, we fully recognise that 2009 will be a lot tougher. By the end of this year, we will have finalised the integration of Bank of New York and Mellon. Make no mistake, it has not been easy manoeuvring two enormous institutions, but we have done it and are well placed to leverage the key strengths that both sides have brought to the whole. We are also proud of the role the bank has played in the Troubled Assests Relief Program (TARP) initiative. Altogether, we are getting through this challenging period in a very positive way,”he states. Looking ahead, Sturdy’s forward strategy is in part determined by the institutional investment trends. “One of the things we have studied closely is the directional flows of capital in a historical context, that is the flow of funds through the 1980s and 1990s and the more recent flows which have encompassed the Asia-Pacific region, as a template for future investment.” The rise of financial centres in Kuala Lumpur, Hong Kong, Seoul, Taipei bode well for the continent as a whole, though some markets are better placed than others in his thinking:“In the aftermath of the crisis you may well see the resurgence of Japan and

Australia, for instance,” moots Sturdy. He maintains however, that in spite of the immediate limitations on the markets, fundamentally the region is well placed for the upturn.“The kicker for the region was the currency crisis in the late 1990s and almost all the Asian economies learned and applied important lessons, determined not to repeat the experience. If this crisis had happened ten years ago, it would have been a disaster for the region; and that is definitely not the case this time around.”

In March this year the bank completed its acquisition of JPMorgan Trust Bank Limited in Japan from JPMorgan Chase & Co. The transaction is a result of the company’s acquisition of JPMorgan Chase’s global corporate trust business back in 2006. Terms of the deal have never been disclosed.

Tellingly, the region’s main stock exchanges are areas of particular interest for the bank. In line with a small but growing group of internationalists, the bank is looking at the way that stock exchanges will provide a locus for asset aggregation going forward.“It will be interesting to see how much of a hiatus this financial crisis will create and what its impact will be on this trend of gathering capital. We may go slow for some time, and right now in some markets, the trend is pretty moribund, however it will pick up and we will be ready to service it.”

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Face to Face KAREN FAWCETT: STANDARD CHARTERED

Profit in a Cold Climate As financial institutions continue to come to grips with the global credit crunch, Standard Chartered Bank finds itself well positioned to support the growth of companies in Asia, maintains Karen Fawcett, group head of transaction banking at Standard Chartered Wholesale Bank. Standard Chartered’s Wholesale Banking business recently announced its year end 2008 results with broad-based top line growth of 43% across all geographies and products; of this, wholesale banking client revenues represented almost 80% of the group’s total revenues. Transaction banking, which encompasses cash management, trade services, securities services and electronic channels, contributes nearly half of the bank’s wholesale banking client business and last year reported an income increase of 31%. The squeeze in credit has made effective liquidity management critical for companies, maintains Fawcett. Francesca Carnevale talked to Fawcett about changes in the fundamental character of business in emerging markets in 2009 and how the bank intended to leverage the new dynamics.

Karen Fawcett, group head of transaction banking at Standard Chartered Wholesale Bank Photograph kindly supplied by Standard Chartered, April 2009.

capability. Especially in Asia, where we expect markets to grow faster than in the west, we see tremendous opportunities to offer clients, distribution, equity research, enhanced advisory capabilities and institutional equity brokerage.” The build out is one skein in a multi-stranded growth strategy at Standard Chartered right now, buoyed by its relatively advantageous position as a safe haven capital aggregator in a post financial crisis world.“We are in a strong position largely because of the policies we have followed historically and because of our position geographically,” notes Fawcett. “Because of our geographic and strategic focus on emerging markets, we had no direct exposure to the sub-

prime crisis. As a consequence, unlike many of our competitors we have seen strong growth across all our business lines, particularly in Asia,” she adds. Fawcett stresses that she concentrates on the practical to deliver overarching strategy.” By its very nature, transaction banking is about providing a very consistent set of products, many of which have changed little over the years. The challenge today is improving how we deliver them,” she maintains. For example,“Over the last few years, the focus was on the supply chain in China and traditional global trade to and from China. Now, the liquidity focus is on the Middle East and Africa and trade flows within and between the Middle East and Africa. Again, we

N EARLY FEBRUARY, Standard Chartered Bank (Hong Kong) Limited, the subsidiary of Standard Chartered Plc, acquired Cazenove Asia Limited, the Asian equity capital markets, corporate finance and institutional brokerage business, from JPMorgan Cazenove. A member of the Hong Kong Stock Exchange, Cazenove Asia has offices in Hong Kong, Singapore, Beijing and Shanghai, and sales teams in London and New York. The acquisition provides Standard Chartered with a strong equity markets platform to offer clients a wider range of transactions in key markets. Mike Rees, global chief executive officer of Standard Chartered Wholesale Banking, noted at the time that the acquisition is“a further build-out of our equity capital markets

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are well positioned as we operate in the emerging markets that are driving this global growth.” Fawcett acknowledges that a lot of pedal work has been going on behind the scenes.“Asia has had a lot of blips over recent years,” notes Fawcett, “SARS, political and economic challenges, by no means has it been a smooth upswing. After the currency crisis, Asia took a good eight to 10 years to get going again,”says Fawcett, who joined the bank from Booz Allen Hamilton in 2001, to run strategy for the wholesale banking business, before taking on the leadership of transaction banking in 2005. She is also a nonexecutive director for the Standard Chartered Bank Malaysia Bhd board and has governance oversight within wholesale banking for the bank’s North East Asia business. It is a comprehensive remit that included, “pulling a business back together again, after the Asian crisis, investing dollars in technology encompassing our fully integrated electronic working capital platform, Straight2Bank, our global trade finance, cash management and securities services platform.”

Management building Fawcett has also brought an ongoing focus on building an already strong leadership base to drive the business forward. Neil Daswani, initially recruited by Fawcett to head the Securities Services business, is a case in point, being recently promoted to the role of regional head, transaction banking, for North Asia. Again, in line with Daswani’s appointment, Fawcett promoted Giles Elliott, whom she had originally brought on board from HSBC, to the role of global product head, securities services which includes custody, fund services and the bank’s broker clearing businesses. Neal Livingston, previously Fawcett’s chief operating officer for transaction

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banking, is now global head, client access, with responsibility for“channel management, solution delivery and network management”. Building out across the region, Jiten Arora, the global head for client access, was chosen to lead transaction banking’s regional team in South Asia, incorporating the two previous South Asia and South East Asia regions. Fawcett’s goal in making these changes, was to put in place“a strong leadership team to continue growing a strong business across Asia, Africa and the Middle East, upgrading the bank’s services, building confidence in our product range and getting ready to take on growth,”she says. Business drivers at the bank have not always been about transactionbased elements. The bank has enjoyed rapid advancement over recent years, substantially through organic growth. Its acquisitions of local banks in Pakistan [Grindlays followed by Union Bank], Taiwan [Hsinchu] and South Korea [Korea First], are indicative of its current business loci. In addition to its recent acquisition of Cazenove, the bank completed the acquisition of American Express Bank Ltd (AEB) in February 2008. “AEB enhances our financial institutions business and fast tracks our private banking business which we launched in 2007. The acquisition will help us to deliver economies of scale, a more complete product set, a stronger operating platform, a wider distribution reach and add new customers in the wholesale and consumer banking businesses,” explains Fawcett. It also added a neat $14bn in customer and bank deposits.

Securities and custody services Standard Chartered has also started offering securities and custodian services via offices at the Dubai International Financial Centre (DIFC)

for corporates and fund managers. “This is a key element of our growth strategy,”notes Fawcett.“In this aspect we are working with global customers as a sub-custodian in markets where they do not have representation. With the development of capital finance and DIFC and the Dubai International Financial Exchange (DIFX), we see many opportunities to grow our cross border business,”she adds. Either by good fortune or good judgement, and Fawcett would argue more of the latter, Standard Chartered’s business has evolved to take advantage of the zeitgeist that haunts the West and advances the emerging markets in general and Asia in particular as tomorrow’s economic motors. While the bank boasts its headquarters in London and branches in New York, 90% of its operating income and profits come from Asia, Africa and the Middle East. Globally, “we are the leading trade bank. We are in the top three or four for cash management as well as in the sub custody space. Moreover, emerging economies contribute almost 100% of the transaction banking business. For us, what is important is where the business has been booked and where it has originated from. In that regard, Asia contributes between 60% and 70% of the transaction banking business and within this, India contributes a significant element,”highlights Fawcett. The significance of that footprint is writ large. Asia now accounts for 25% of global trade flows, and consultancy McKinsey and Company estimates that the overall trade finance and cash management revenue pool for the region will exceed $100bn by 2012. This is not just true of China and India, but also countries such as Taiwan, South Korea, Thailand and Singapore. Fawcett takes an even wider regional view: “To understand how critical the Middle East and

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Face to Face KAREN FAWCETT: STANDARD CHARTERED

Africa are to Standard Chartered, you need to consider that in terms of regions they are two thirds of our vision. It is more than just the consolidation of the spokes, for example by a retailer sourcing goods from Pakistan or India. We are focusing on adapting to client needs, along that spectrum. We can add value on both sides,”avers Fawcett. Inevitably then, Standard Chartered is supplementing its traditional trade sales by offering a full complement of working capital solutions and services. The driver is the trade flows,“but the products needed are always mixed, including, of course the other aspects of working capital, for example cash management, which is key right now.” “We operate on a matrix structure, whereby client segments and sets of banking services cross over each other. Every client has a relationship manager who can work across the entire network for that client,” explains Fawcett. She affirms that the bank does not intend to cross a chasm with tiny steps.“We don’t want lots of markets with a small amount of middle-market business, we want to have enough critical mass to offer risk management and relationship managers on the ground and get close to the clients through mechanisms that provide tailor made solutions. “In that respect, “We have staff on the ground thereby building up local credit expertise and knowledge of the local community,”she adds.

Cost pressures Fawcett says Asian companies are coming under increasing cost pressures, both as a result of their growth, and because of the dearth of liquidity in the market. “They look to their banks to provide a cost-effective and operationally efficient way of doing things. We expect more of them to be demanding consistent products

and services across multiple countries,” she says. The increased sophistication of corporate Asia means companies increasingly demand not only traditional trade finance from their banks, but also cutting-edge cash management services. It is not, however, bigger Asian conglomerates that represent the biggest opportunity, she holds. Mid-sized enterprises (SMEs) are a growing segment. “In the past few years we have had a concerted strategy to build up a local corporate and SME business,” says Fawcett. “In wholesale banking, we look after clients with $25m sales turnover and more—this represents a vast number of clients in our core markets. They have traditionally been served very well by local banks, but as they expand and begin to go crossborder in greater numbers they are looking for a bank like Standard Chartered to support them.” It is a singular strategy by Standard Chartered, as traditionally global banks have largely ignored this section of Asian companies, despite them offering enormous potential for growth. In China alone, SMEs make up 60% of overall corporate revenue. “Larger companies will continue to be a key part of our client base, requiring increasingly sophisticated solutions, but the SME sector represents a relatively untapped opportunity,” holds Fawcett. Tapping into this potential, however, is easier said than done. Small companies tend to be geographically dispersed, which makes servicing them expensive. They also tend to be loyal to their traditional banks, making it harder to lure them away.“Any bank looking to capitalise on the market will need a strong balance sheet and the necessary experience on the ground to succeed,”she agrees.

Clients willing to pay more Fawcett acknowledges that an upswing in the immediate term will be a challenge to secure.“Liquidity lines continue to be under pressure. Nonetheless, she maintains that: “Globally, clients are showing the willingness to pay more for trade facilities. Margins are, however, getting squeezed and there is no immediate relief to this shortage. Rates will continue to rise and the situation with respect to liquidity may be seen for many months.” So far, so good for the bank. In its 2008 financial year, the Group focused on building balance sheet strength and on maintaining high levels of liquidity. “We also continued to invest in the business and to grow while remaining focused on our strategy,” highlights Fawcett. Operating profit rose 13% to $4.57bn with income rising 26% to $13.97bn for the group. The bank’s custody balances grew by a healthy 24% to $64bn in 2008, and “we continued to be a net lender to the interbank markets,”adds Fawcett. “The events of last year were extraordinary,” says Fawcett, “testing all market participants. The uncertainty and the contraction of economies will continue this year and the situation may even worsen before it improves. It is not clear how much banks will be forced to concentrate on their home markets: it is about balancing optimal business decision making with political necessities.” Fawcett maintains a positive outlook. “Our clients will still require network extensions and that is where we come in, connecting key markets in Asia, the Middle East and Africa. We think the best way to continue to deliver growth is to continue with our emerging markets strategy, while remaining disciplined in being client focused, offering end to end solutions, maintaining cost controls and encouraging risk management through the entire service offering.”

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Real Estate ASIA: CHINA DIPS ITS TOES INTO REITs

China takes the plunge despite Asian REIT troubles In February one of Asia’s leading property bodies made a call for the region’s governments to help refinance Asian real estate investment trusts (REITs) and the property sector as the market continues to rock from the global downturn. Yet just at the moment when the region’s established property sectors are struggling most to overcome plummeting capital values and the liquidity crisis, heavyweight market China looks set to introduce domestic REITs, writes Mark Faithfull. Is this a desperate move or inspired timing? T MAY BE the year of the ox but the property markets in big hitting countries such as Singapore, Malaysia and Hong Kong are far from bullish. The once promising property markets in Vietnam, Thailand, the Philippines, Indonesia and Cambodia are not immune either, suffering as they do from a lack of transparency that in a risk-averse climate offers too many“known unknowns”. The growing trials and travails of markets which believed initially that their growing inter-dependence would shield them (at least partially) from the liquidity crisis, led the Singapore-based Asian Public Real Estate Association (APREA) to plead in February for government help for listed firms, particularly REITs. It asked the government to refinance an estimated $12bn in debt.“Government assistance is needed to get liquidity moving and reduce the risk of plummeting real estate values and pressure on the capital positions of lenders,”says APREA chief executive Peter Mitchell. “Its help is needed to restart the credit markets for commercial real estate debt.”

Development of China REITs also promises foreign property investors the opportunity to exit the market more easily in the long run and take profits. Firms such as Morgan Stanley and Macquarie Bank have been accumulating Chinese real estate assets.“The Chinese government has recognised the risks and stated the financial reform will be done in a moderate and even conservative way,”says Kurt Jia, China investment director of agent Jones Lang LaSalle. Photograph © Gordon Logue/Dreamstime.com, supplied April 2009.

“They are looking at ways to bring capital back to the real estate market because it has softened substantially,” says Peter Mitchell, Chief Executive of the Asian Public Real Estate Association.

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“The shine has come off the local REIT industry, with almost all trading well below net asset value (NAV),” adds Steven Laposa, director of global real estate research at PricewaterhouseCoopers, of the Asian region. “REIT prices are now so low they offer attractive yields and the large number of real estate investors operating in Asia provides plenty of opportunity to exit deals, meaning the role previously played by REITs is not as pressing as before.” APREA describes REITs as a “handle with care” product and ratings agencies are talking about downgrading Singapore REITs because of refinancing concerns.“It is not the REITs themselves having problems. They are just being impacted by the freezing of credit,” counters Mitchell. “Of the estimated $12bn of refinancing needed this year, one-third is attributed to REITs. It is important to help REITs through the turmoil as they are what will attract investors as Singapore moves out of this downturn,”he said.“Investors are going to be risk averse and will look

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Real Estate ASIA: CHINA DIPS ITS TOES INTO REITs

for things that are liquid, transparent and lowly geared, equity-oriented investments. That’s what REITs are.” Certainly China seems to concur and it plans to launch its own domestic REITs this year. The timing mirrors many of the past market launches of REITs, which have typically coincided with property downturns, albeit not on the present scale. Europe in January 2007 was highly unusual in hosting the launch of REITs in three of its most important markets—the UK, Germany and Italy—during a boom and those REITs have since paid the price for overinflated expectations. Launching a domestic REITs market is part of a financial reform package unveiled by the Chinese government in December to bolster its slowing economy—prime office rents in Shanghai, China’s commercial hub, started to fall in the third quarter of 2008, while average vacancy rates jumped 7.5 percentage points to 16.8%. Slower business activity will hit rents further this year. Development of China REITs also promises foreign property investors the opportunity to exit the market more easily in the long run and take profits. Firms such as Morgan Stanley and Macquarie Bank have been accumulating Chinese real estate assets. “The Chinese government has recognised the risks and stated the financial reform will be done in a moderate and even conservative way,” says Kurt Jia, China investment director of agent Jones Lang LaSalle. “China REITs give property owners an alternative approach to divest. [For Beijing] it is another way to increase liquidity besides decreasing interest rates and reserve ratios.” REITs would also give China pension funds and insurers, currently barred from property investment, a

Launching a domestic REITs market is part of a financial reform package unveiled by the Chinese government in December to bolster its slowing economy—prime office rents in Shanghai, China’s commercial hub, started to fall in the third quarter of 2008, while average vacancy rates jumped 7.5 percentage points to 16.8%. Slower business activity will hit rents further this year. Photograph of Shanghai business towers © Bertrand Benoit/Dreamstime.com, supplied April 2009.

new investment vehicle. “For institutional investors, this is a rather easy way to participate in the real estate investment market, and to build a more diversified portfolio,” says Jia. However, China first needs a comprehensive securitisation law, which is critical if investors are to accurately assess the risks of REIT products. Another major issue is tax treatment of asset holdings, transactions and profit distribution. Mitchell believes the Chinese government has approached the issues the right way by stating that China REITs must own quality, incomegenerating assets.“They are looking at ways to bring capital back to the real estate market because it has softened substantially,” he says. Indeed, investors have been left with few viable investment options in the region. For Hong Kong, the REITs sector is set to underperform, according to a recent assessment by Credit Suisse. “We would not be surprised to see retail rents of mass and prime shopping

malls fall by 20% and 15%, respectively, in 2009, although most major landlords are not feeling major downward pressure on rents yet,” the report says. “We look at what is the availability of funds. We like Singapore but there’s no Singapore-specific fund that can promise returns at the moment. For now, Australia, China and Japan would be our key focus and to a lesser extent, India and South Korea.” Property funds are sitting on an estimated $10bn of unspent, Asiadedicated capital. To that can be added giant global funds raised by the likes of Morgan Stanley and Blackstone, whose Shanghai foray followed the closure in April of a $10.9bn real estate fund. While smaller developers are now facing distressed asset sales, most of Asia’s property owners are sufficiently capitalised to hold on to their main assets. If those funds become convinced that the bottom is nearing, Asian real estate may still seem preferable to the turmoil enveloping Europe and the United States.

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Country Report

Qatar’s hydrocarbon industry has been the backdrop for a massive investment spree that will take the country into the next decade with a much diversified industrial profile. While the country’s overall revenue base has been relatively stable, as it is governed more by long term off-take agreements than fluctuating energy prices, the country nonetheless has been impacted by the downturn in investor sentiment, which has seen the local stock market fall by almost 65% in recent times. The Qatari government remains committed to its ambitious diversification programme and the establishment of a thriving financial centre: how can it fail? Francesca Carnevale reports. VEN IN THE throes of outrageous fortune, Qatar is suffering its own slings and arrows. “Qatar remains linked to the global economy,” notes Sandeep Nanda, Executive Vice President, Investments and Treasury, of Qatar

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Insurance Company, the property and casualty cover insurer based in Doha, and investment adviser to Epicure Qatar Equity Opportunities (EQEO), a UK AIM-listed vehicle specialised in investing in the Doha Securities Market. “Urea, steel are coming off

QATAR: FINDING ITS PLACE IN THE GCC MIX

Photograph © Orham Cam/ Dreamstime.com, supplied April 2009.

their highs and local banks are not always able to raise either funds or general sentiment in this environment,” he adds. In particular, notes Nanda, the global downturn has had an impact. “Qatar remains dependent on international corporate capability for research and development. Even if the Qataris are expanding their petrochemical base, for instance, the country remains dependent on major producers providing both equity and technology,”he explains. In light of variable demand for petrochemical products and oversupply in some markets, particularly in China, some joint venture partners working in Qatar’s

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Country Report QATAR: FINDING ITS PLACE IN THE GCC MIX

petrochemical sector have withdrawn. In February, for instance, Honam Petrochemicals and Qatar Petroleum agreed to defer a decision on whether to progress on a 30:70 joint-venture cracker complex at Messaied, near Doha, originally scheduled for startup in 2010. The plan was to build a 900,000 tonne/year cracker and plants for polypropylene (PP), styrene, polystyrene (PS) and mixed xylene. The move had been something of a bold step for Honam, which originally agreed to the joint venture back in 2005, as the firm is regarded as one of South Korea’s most conservative petrochemical companies. It was also the first time that a South Korean company had ventured overseas for a cracker project. Honam and Qatar Petroleum were in the middle of the bidding process for the cracker when they decided to put the project on hold. However, despite commitment from both sides, the $2.6bn project was slow to take off and the start-up date kept getting pushed back, first to 2011 and then to 2012. The firm is not

commenting, though Nanda notes that the project “requires project financing and that ultimately depends on the global financial environment.” Qatar has nonetheless benefited from a rising trend whereby gas income began to exceed oil revenues in the third quarter of 2008. “Japan, India, South Korea, for instance, have invested heavily in infrastructure to accept and process LNG from Qatar and are unlikely to renege on long term off-take agreements at predetermined prices,” and says Nanda: “this year will be a gas story rather than crude oil. Moreover, oil producers have been affected by two developments: a fall off in price and the decision by OPEC to reduce production volume. In the case of LNG there are no such problems. Even then, Qatar’s budget is based on a price floor of $40 per barrel and the average price through 2008 was $100 per barrel. What’s working on the economy now is a sentiment issue and that is significant,”he adds. Qatar is a strange brew of extremes.

Qatar’s international competitiveness ranking

Good 7 Public Institution index

6.5

Singapore 6

Luxembourg Hong Kong

QATAR 5.5

United Arab Emirates

Ireland

Bahrain

United States United Kingdom Saudi Arabia

4.5

Bad

4.5

5.5

Global Competitiveness Index

Source: The Global Competitiveness Report 2008-2009 (index out of 7)

6.5

Good

Just how much was amply illustrated by official figures released earlier this year that showed Qatar’s nominal economy shrinking by more than 23% in the fourth quarter of 2008 but ending the year higher by a massive 44%, mainly due to rising gas exports. The reason for such a vacillating yet strong performance at a time when other economies are jolted by the global crisis is that Qatar has been set for some years to almost double its production of liquefied natural gas (LNG) to more than 60m tonnes this year. Output is expected to peak at 77m tonnes by end-2011, according to a recent report by Saudi American Bank (SAMBA), thereby maintaining its position as the world’s largest LNG exporter. Not content to rest on its LNG laurels, “The government has really managed an excellent programme, in terms of giving stability to the economy and working towards real and significant diversification away from hydro-carbons in the near term,” notes EQEO’s Nanda. In the immediate term Nanda thinks that in Qatar at least, “the market may have found some kind of bottom in February through March. From that point of view we are looking at reasonable value in the market; certainly there are no companies on the exchange that are looking to be in distress. Volatility in the market is therefore more related to international investors moving in and out of the market; that is about immediate market sentiment. The Qataris however are moving to a different beat; and the strength they have is the ability to look at business from a long term perspective, with the money to finance the interim stages.” It is a view echoed in part by Francis Beddington, head of research at Insparo Asset Management, the London based absolute return manager, whose $140m

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*Refer ences the 2008 Forbes Tax Misery & Refor m Index

FIRST CLASS BUSINESS ECONOMY It’s no wonder that banks from all over the world are heading to Qatar. With its world class regulation and secure and transparent rule of law, the QFC has helped Qatar to become the region’s most dynamic economy. Benefit from the lowest tax in the world,* 100% ownership, repatriation of all profits, and an onshore trading environment. See the heights your business can reach. www.qfc.com.qa

BUSINESS ENERGY

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Country Report QATAR: FINDING ITS PLACE IN THE GCC MIX

Africa and Middle East fund specialises in investment in the Middle East: “Qatar’s equity market has suffered somewhat from the fact that it is less open than many others in the GCC. Foreign investors cannot buy into initial public offerings for example.”According to Scott Callander of AXA Investment Managers (AXA IM), which is licensed by the Qatar Financial Centre (QFC), Qatar is still a blank canvas in some respects.“Increasingly local investors are looking for customised investment solutions at home and abroad. There is certainly growing sophistication in the market, but the limitations in the local stockmarket are obvious. There remains a high degree of gearing, which naturally creates some stresses in the market. In Qatar, investors invest for income and so a correction impacts much more strongly on the local economy.” Nonetheless, for investors such as Beddington, with GDP growth just under 10% this year,“the attractions of the market are obvious: it is the richest country on the planet. Gas to liquid is very interesting, the banking sector looks interesting and so does infrastructure.” Beddington remains pragmatic however,“the population is small, it’s something of a problem, as it relates to local market depth; also it is not the easiest market to enter: and it is more of a fixed income than equity play.” Duncan Buchanan at insurance broker Marsh McClellan (another QFC licensed company) says this applies across the board. “Key questions for anyone with aspirations to work in Qatar are: how do you access the growth? How do you access growth outside of energy? What financial systems are in operation? Outside of the obvious energy business, it is a growth story, but one that is tightly managed.” That is a pertinent question in a market which is pursuing a

multistranded diversification programme that encompasses petrochemical product, the establishment of extensive educational and research facilities, real estate and tourism as well as financial services. In regard to the latter, insurance is a key plank of Qatar’s policy of encouraging market specialisation. Not only is the country encouraging brokers and insurance companies to widen their presence and service offering in the market, but it is actively providing local infrastructure upon which the insurance industry can build substantive volume and write new cover. In the summer of 2008 the Qatar Financial Centre (QFC) Authority began to establish the Qatar Insurance Services (QIS), a technology-based insurance trade fulfilment platform that will provide a secure, structured electronic service and will facilitate transaction workflow, the production of documentation and effective management information to local regional and global insurance firms. “The establishment of QIS will advance the sophistication of Qatar’s insurance industry,” says Stuart Pearce, chief executive officer and director general of the QFC Authority, “and will help to attract further insurance expertise to Qatar.” Pearce explains that the platform brings together international insurers/reinsurers and brokers to conduct insurance trading activities through the system. “In so doing it will fortify Qatar’s intention to become the region’s leading insurance centre,” he says, “and provide access for the global insurance and reinsurance industry to a fast growing portfolio of both GCC and near Asian risk for structuring and placement. Right now the business remains very paper based and this will help redraw the

infrastructure support for the industry in Qatar.” However, Pearce acknowledges that in the near term, much of the financial services build-out in the state is still linked to the energy sector. “It is no surprise, given that it is still a gas and oil economy. That is changing though and we have an increasing number of category one firms doing business with high net worth individuals for instance. Moreover, other banks in the region are looking at the advantages of locating in Qatar to service international companies and to this end we are soon expecting the opening of full branch of an Abu Dhabi bank in the near future. In terms of diversification we are looking at the medium term and over the next five to six years, we will witness substantive changes. The government itself is planning on reducing the share of energy revenues in the country’s total GDP down to 20% by 2018; and it is doable.”

“Qatar remains dependent on international corporate capability for research and development. Even if the Qataris are expanding their petrochemical base, for instance, the country remains dependent on major producers providing both equity and technology,” says Sandeep Nanda, Executive Vice President, Investments and Treasury, of Qatar Insurance Company and investment adviser of Epicure Qatar Equity Opportunities.

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Country Report ITD HUNGARY: INVESTMENT PROMOTION AGENCY LEVERAGES THE NATION

OPEN FOR BUSINESS IN A TESTING MARKET Against the odds, Hungary’s inward investment and trade promotion agency ITD Hungary, is working overtime to ensure that the one time star of the eastern European economies regains its crown once more. Much of that strategy is predicated on Hungary acting as a centre for high technology research and development. “It means the country will compete with Western Europe as a whole in this regard. However, that is our path and it is a strategy Europe has to face head on,” says Gyorgy Retfalvi, chief executive officer of ITD Hungary. UNGARY’S INVESTMENT PROMOTION and trade development agency ITD Hungary has a gargantuan task in 2009, to maintain and expand foreign direct investment in Hungary in a testing market, while helping local firms build up their international exports. It is a challenging task at any time; it is made much harder by the economic crunch sweeping all markets before it. Hungary, as an export dependent economy, has proved particularly vulnerable. In March this year credit ratings agency Fitch Ratings revised the outlook on Hungary’s long-term foreign and local currency ratings to negative from stable over the country’s worsening economic outlook. Fitch rates Hungary at BBB for foreign currency debt instruments and at BBB+

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for local currency instruments. “The negative outlook reflects the continued deterioration in Hungarian and European economic prospects, which combined with on-going pressure on Hungary’s balance of payments and currency, increase the risk that Hungary’s external and public debt profile will worsen by more than anticipated when its sovereign ratings were downgraded last November,” according to Fitch sovereign team director David Heslam in an official statement supporting the decision. It is a cruel twist for a country which until recently has enjoyed substantive industry development, through the growth of a manufacturing sector that encompasses IT, automotives, and pharmaceuticals. Of late, however the country has come into direct

competition with cheaper emerging market producers and the growth potential of these sectors has come under strain. In order to help revitalise these sectors, key companies need to be provided with operating incentives to integrate more deeply into Hungarian industry, such as providing construction and logistics sites at preferential rates, customised vocational training and promoting joint research and development centres. Moreover, the networks of domestic suppliers in the country need to be made more competitive through the promotion of local small and medium sized industries. Enter then the ITD Hungary, tasked in large part with helping companies find solutions to these problems. A substantive portion of its work is

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Country Report ITD HUNGARY: INVESTMENT PROMOTION AGENCY LEVERAGES THE NATION

targeted at building the country’s SME segment whose competitiveness stands at the average EU level. “We have a certain competitive advantage in Hungary vis-à-vis their foreign competitors,”notes Retfalvi who holds that particular opportunities can still be identified primarily in the meat, vegetables and food processing industries, beverage manufacturing, machinery and equipment manufacturing, and the manufacturing of certain chemical products (pharmaceutical products). “These are the areas where economies of scale can be exploited to achieve competitiveness,”he holds.“In the area of trade promotion meanwhile, ITD Hungary focuses on the improvement of the international competitiveness of the Hungarian small and medium sized enterprise sector, with the hope of diversifying the country’s export markets,”he explains. The bulwark of ITD Hungary’s work however is in investment promotion. Any immediate term requirement for structural adjustment facilities and new G20 money aside, the need for Hungary to attract new foreign direct investment in key economic sectors is a must. According to Retfalvi, the promotion of foreign direct investments into Hungary remains focused on the technology-intensive sector, and in particular on those investments producing higher added value using Hungarian research and development capacities, establishing regional trade, finance, service and research and development centres. A customised one-stop shop service is provided by the dedicated teams of ITD Hungary in over 53 trade offices in 45 countries, 10 representative offices in neighbouring countries and 15 regional offices in Hungary, managed from ITD Hungary’s Budapest headquarter. Through its “global network, the agency can offer investors and trading

partners a total service package - free of charge and with full confidentiality,” says Retfalvi. “ ITD Hungary now participates in some 30% to 40% of all new investment projects realised in Hungary,”he adds. Contrary to expectations, in 2008, FDI inflow to Hungary did not decrease compared to 2007, and reached €4.4bn (Hungarian National Bank, 2009). In line with global trends, however, in 2009 and 2010 FDI inflow is expected to fall to €1.5-2.5bn in Hungary (EIU, 2008; wiiw, 2009). However, experts forecast a recovery in 2011. Despite the high inflow, the value of the Foreign Direct Investment FDI stock decreased in 2008. In 2008 the Hungarian National Bank introduced a new methodology in FDI data collection. The new methodology is based on a survey of close to 3000 large multinational companies and the financial reporting of the smaller foreign companies. Due to the new methodology, the data of 2007 and 2008 can not be compared. (The stock of FDI in 2008 decreased partly because the“other capital”part of the FDI stock decreased. The “other capital” records intra-company loans within a company group. This item was accounted for under different statistics until 2008 and were transferred under the foreign direct investment statistics this year.) “Equity and reinvested earnings” decreased only in euro terms, but not in HUF terms, due to the negative changes in the exchange rate. In forint terms, “equity and reinvested earnings”increased. Unsurprisingly, the geographic profile of Hungary’s inward investment reflects both history and new market preferences. Germany accounts for some 30% of inward investment, some 15% of the total comes from the US and more or less the same amount is generated in Austria. The UK and France account for around 10% each of

the total with Italy and Japan taking up the rear end of the league table. The make up of the table should not be a surprise, acknowledges Retfalvi as Hungary’s exports make up 70% of GDP of which the largest export segment is automotives. For now the work of the ITD Hungary is in flux, with “changing priorities under pressure of the current crisis,” explains Retfalvi. However, he maintains that in the medium term, if Hungary and ITD Hungary focus its message that the country can provide cost effective manufacturing facilities, then the country can regain its crown as a prime location for new inward investment. Short term difficulties aside, Retfalvi believes the country is a natural magnet for new investment going forward. “The macro-economic situation will focus everyone on cost issues. Moreover, increased regulation of the global financial markets will have an impact on globalisation and the flow of goods and services.” Retfalvi thinks that this will benefit Hungary as investors look closer to home for new opportunities. He points out that countries in Hungary’s immediate hinterland, such as Turkey, are already beginning to enter the market, “particularly in real estate,”he notes. Nonetheless, he is pragmatic.“In this regard, we also have to note that we face competition from rising markets such as the Ukraine and Georgia, which are cheaper. However, Hungarian production remains half the price of Germany and the country offers a highly educated and technologically literate population that is able to leverage growing opportunities in high-value manufacturing, technology and pharmaceuticals, for instance. Added to this is the fact that Hungarian salaries are still at 65% of the EU average, I think it is clear that we remain a competitive investment prospect,”stresses Retfalvi.

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The rules of the game have changed.

Bold moves are needed. Think ahead and invest in Hungary!

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Alternatives HEDGE FUNDS: HARSH TIMES FOR BRAZILIAN FUND MANAGERS

ROUGH WINDS SHAKE BUDDING FUNDS Brazil’s asset managers are reeling after a brutal 2008. The onshore industry lost a total of R$58.6bn in assets last year, equivalent to more than 5% of total assets and the worst performance since 2002. That trend accelerated through the year with R$31.8bn pouring out in the last quarter. More worryingly, investors are yanking mandates from all the most lucrative segments of the market, particularly the giant multiasset and hedge fund industry, and retreating to the least remunerative area for asset managers, fixed income. That hurts an industry that is still nascent and where new and existing managers were rapidly expanding the available product range, particularly in more exotic strategies including long-short, arbitrage and private equity. The industry will need some radical thinking to get back on its feet, reports John Rumsey. RAZILIAN HEDGE FUNDS, one of the particular bright spots of the industry in the boom years, have fared much worse than the industry as a whole. Funds got mangled by poor performance and over the last 12 months 48% of total assets leaked out of the onshore area alone. Assets under management across the hedge fund industry came down to R$26.3bn in mid-February from R$50.4bn at the beginning of 2008 within the 160 onshore hedge funds measured by manager and consultant M Square of São Paulo. In large part, their dismal performance and the large gap between asset losses in the hedge fund and wider industry, marks a substantial re-allocation by investors. Scared by weak equity market performance and the inability of hedge fund managers to generate

absolute returns, they have changed their way of thinking about mandates. Rather than hand an entire portfolio to a multi asset class fund, thereby giving up asset allocation autonomy, they have used consultants to draw up a tactical asset allocation plan and then found individual traditional asset managers to implement it. That has seen a substantial reallocation to fixed income, which now typically represents 90% or more of portfolios. Investors have pulled back in equity to just an allocation of between 5% to 10%, mostly to longonly equity managers, says Arthur Mizne, partner at M Square. The change in allocations is reflected in the overall numbers for hedge funds. They accounted for a healthy 30% to 32% of the asset management industry at the start of last year, but currently represent only just over 20%, says

The change in allocations is reflected in the overall numbers for hedge funds.They accounted for a healthy 30% to 32% of the asset management industry at the start of last year, but currently represent only just over 20%, says Otavio de Maghalães Coutinho Vieira, executive director at private bank Safdié in São Paulo. Photograph © Javarman/Dreamstime.com, supplied April 2009.

Otavio de Maghalães Coutinho Vieira, executive director at private bank Safdié in São Paulo. “This is a market that has gone back to the basics of cash and fixed income,”he says.

What went wrong? The Brazilian asset management industry is clearly not alone worldwide in facing substantial withdrawals and the reasons are often similar to elsewhere. Poor equity market performance and two large scandals related to hedge funds in the United States have exposed both a lack of transparency and understanding of risk in the industry. In Brazil, the situation is different in two fundamental aspects. First, the country continues to have an exorbitantly high risk-free rate of return thanks to a hawkish monetary policy designed to keep inflation down and maintain strength in the local currency. The Selic benchmark overnight interest rate was an appetising 12.75% at the start of March with inflation at around 6%. Banks have been offering certificates of deposit at 104% to 107% of the Selic rate, make it even tougher for asset managers to compete, says Pedro Bastos, chief executive at HSBC Asset Management in São Paulo. Government-issued securities are issued free of fees too, notes Mizne. Two, short lock-up periods enable investors to bolt at will. Brazilian funds typically offer a maximum 30 day lock-up and attempts by managers to increase that just as the market turned down were

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unsuccessful. If the onshore market has been cruel to fund managers, the offshore market has been brutal. Partly that’s a function of performance as the Brazilian currency has slid against the US dollar, making performance for overseas investors especially weak. Many managers did not hedge currency exposure even after the collapse of Lehman Brothers, notes Mizne. Although the offshore industry is less transparent than its onshore cousin, M Square estimates that offshore has lost more assets and says that some funds have seen as much as 80% of their assets walk through the door. Foreign investors split into two classes. The growing contingent of global fund of funds groups have proven to have little staying power and are at the whim of their own investor base. They have met redemptions by selling those funds with the shortest lock-ups in what has been dubbed “the ATM effect,” says Enio Shinohara, fund of funds manager at São Paulo-based hedge fund manager Claritas. Only Brazilian funds that had successfully marketed offshore to endowment and family offices saw more stickiness, says Mizne.“These are the funds that carry out a long process of due diligence and have long-term plans,”he says. Finally, the Madoff and the more recent Stanford International Bank scandals have made investors question the safety of the entire industry. Ironically, Brazil’s regulations covering the industry, including hedge funds, are some of the most transparent in the world. Managers must publish portfolios with a short time lag and standards for third party administration and custody and a truly open platform preclude any similar scandals in the country, says Zeca Oliveira, CEO at BNY Mellon in Rio de Janeiro.

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Even so, many Brazilians had bought into Madoff from private banks with feeder funds that went offshore. They read the scandal as a sign to head for the exits in all their hedge fund investments, says Mizne. This has reinforced the trend by investors to stick with easily understood financial instruments.

“This is a market that has gone back to the basics of cash and fixed income,” says Otavio de Maghalães Coutinho Vieira, executive director at private bank Safdié in São Paulo.

What next? The question for hedge fund managers now is how to react to the very altered scenario. Many within the industry see a certain passivity with managers waiting for a market uptick to bail them out. Brazilian managers tend to see crises as short-term and have not yet realised the secular nature of the market changes taking place, thinks Shinohara. That has been the experience in Brazil before. In 1994, the launch of the Real currency plan and in 2002, ahead of presidential elections, Brazilian equity markets showed a V-like performance: they dropped rapidly and then recovered swiftly. Many managers expect to be able to ride out the next few months thanks to payouts accumulated in the boom years, says Shinohara. Not all managers have taken a head-in-the-sand approach. Some are re-thinking their business plans and adapting to the new hair shirt environment. These managers are launching the very funds that have proven more resistant: low volatility and fixed-income strategies, says Vieira. Other managers have been proactively cutting headcount. Hedge fund Mauá Investimentos, which was affected early on by poor equity performance and has since reined in losses by adopting a more conservative stance, slashed staff numbers by half, for example, says Mizne. Other, smaller managers, who have been eating up cash and were relying on juicy performance fees to pay the bills,

will no doubt follow that example. This may be a perfect time for global institutions that don’t have a footprint in the country to acquire a Brazilian manager, says Oliveira. That was certainly a trend in the boom years and BNY Mellon acquired ARX late in 2007 with other deals following, including Prudential Financial’s purchase of a roughly 40% stake in GAP Asset Management. The big question is what strategy is likely to pay out this year. Some, like Oliveira, are adopting a value-style approach, seeing the markets as heavily discounted. He is looking at valuations to find value and a generous dividend yield. Mizne agrees that this is becoming a more interesting approach. He cautions that until recently there has been little visibility on company earnings, but as that opacity eases, investors will want to consider companies with low debt, who are market leaders and need to make little capital outlay this year. “You can buy companies that have enough cash to get through, enjoy good margins, and are competitive enough to stay in the game, at between five and seven times earnings,”he says. Shinohara, however, does not share that optimism. He does not think there will be a great rebound in the Bovespa stock exchange index and believes it is much better to focus on nimble arbitrage trades and macro issues that will be the driver for the Brazilian economy.

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Index Review INDEX REVIEW: IS AN END TO THE RECESSION IN SIGHT?

G20 AND A DEAD CAT BOUNCE Investors are worrying whether the recent rally is a sign that the bottom has already been hit and this is causing even professionals to leap into the markets without all the signals going green. Others are fearful that we are being built up for a sucker punch with current strength based on fear of missing out rather than fundamentals showing a definite turn. Simon Denham, managing director of spread betting firm Capital Spreads, wrote his last acerbic missive in late January when the FTSE was trading at 4,100 and on the way down. At the beginning of April the price is the same but the sentiment (for now, at least) is rather more positive and “we are in for the ride”, he writes. The words “dead cat bounce” spring to mind. URRENT NEWS IS focused the impact of the G20 meeting at the Excel Centre in London. Forgive me for being cynical but the last people to whom I would turn to solve any sort of problem is a bunch of politicians. Seasoned analysts of this type of jamboree will tell you that it is the pre-meeting statements that generally give one an idea of the likely chances of success of such assemblies over the long term. The dollops of wisdom we were subjected to do not bode well. Gordon Brown, fresh from his massive world tour, talked about moral compasses and fairness; Angela Merkel and Nicolas Sarkozy whined that if everyone did not agree with them they would pick up their ball and leave. Obama (having checked his bank account) stated that he was up to his limit on his credit card and, please, could someone else pick up the tab this time. China’s Wen Jiabao tried to ensure that all the aces were held, very tightly, in his own hand (not difficult when you own the company that prints the pack); and finally Japan’s Taro Aso, whose overdraft is now over two times the size of his annual income was busy telling everyone that

“living on tick”is no problem at all. Then again, at the end of the G20 everyone talked about history, compromise and achievement. What we got was $500bn extra money for the IMF, $250bn to boost world trade, a $250bn IMF overdraft facility for countries in “dire”trouble (is there any other kind?) and $100bn for banks to lend to the poorest countries. However, on solving the problems of the rich countries, very little was agreed upon that might help the man in the street.The only areas that seem to meet any standards of agreement are those covering hedge funds and tax havens. Mmmm! In the Alice in Wonderland fantasy we seem to be living in today, hedge funds are accused of being totally beyond the pale. Making a profit in this environment appears tantamount to criminal activity and the heinous crime of being right is one that government agencies obviously cannott tolerate. Tax havens are similarly on the list for excommunication even though (in reality) the vast majority of offshore business is corporate and designed to ensure that profits are made in the most tax efficient locales (generally a G20 nation).The taxman might well discover

Simon Denham, managing director of spread betting firm, Capital Spreads, October 2008.

that the reason for all those brass wall plates in the Cayman Islands helps lift profitability in the quoted country. For the UK this means 28% more revenue for the exchequer. In its efforts to use a sledgehammer to crack the nut of private tax evasion it may well smash the golden egg of tax avoidance. My last commentary focused on fears that massive increases in government issuance will create a barrier to growth. Since then the sums seem to have gone under a sort of imaginary “think of a number and double it” scenario. With money presses running red hot the authorities are treading a very thin rope over a very deep chasm. The yield curves for UK, Euroland and the US debt are showing a near 300 basis points spread between three month and 10 year expiries (and considerably more for corporate issuance). A very real worry is that the policies of the US and the UK could lead to an explosion of inflationary pressures. Readers may well remember the problems of Northern Rock which ran a shortterm funding book versus long-term exposure (and this when the yield curve was actually flat). Its policy ran into difficulties not because of a sudden surge in short-term interest rates but because of the liquidity crisis. If state borrowing leads to a resurgence of inflation then the problems that we have seen over the last year will pale into insignificance compared to what might come. As ever, Ladies and Gentlemen, place your bets!

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ISLA & RMA Present

18th

2009

Annual

Conference on

23 26 june

international securities lending $GL=D JLK ^ 9J;=DGF9 /H9AF The joint U.S./European Securities Lending Conference sponsored by the two recognized industry associations. Issues that influence lending markets in Europe and around the world: t Change in Regulatory Requirements Aﬀecting Securities Lending. t Beneﬁcial Owners: Are You Lending Securities Now? t Industry Leaders: Surviving the Crisis and What’s Next for the Market? t Central Counterparty and Recommendations of ISLA Working Group.

Keynote Address: Risk Management Lessons from the Financial Crisis Juan Andres Yanes, Chief Risk Oﬃcer, Grupo Santander, Madrid

This is the conference that identifies best market practices and sets global standards in international securities lending.

Come and join your colleagues for these important updates and discussions! For more information and to register visit RMA’s Web site: www.rmahq.org/RMA/SecuritiesLending/ or contact Kim Gordon (215) 446-4021, E-mail: kgordon@rmahq.org Conference Chair: David Hopton, Managing Director, Santander Global Banking & Markets, London

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Commodity Report GOLD: HOW FAR CAN ITS VALUE RISE?

GOLD REGAINS ITS GLISTER The G20 summit is over, stock markets are trading higher and gold is down. It may look as though the yellow metal has run its course after its rally in the first quarter of the year. Given how much value has been destroyed in the equities and the bond markets over the last 18 months, however, large investors like pension funds are starting to shift more towards long-term safe investments and gold is at the top of that list, reports Vanya Dragomanovich. EDGE FUNDS SPEARHEADED a heavy selloff in gold in the last quarter of 2008 as they were forced to make quick redemptions to pay out investors. Ironically, this rush was prompted by the fact that gold was doing well, not badly, and hedge funds liquidated gold positions because gold was one

of the few assets that had not made a loss. Since then gold underwent another boost in the first quarter of this year, picking up from below $900 a troy ounce to $1,000 as investors bought gold exchange-traded funds (ETFs), bars and coins. According to research by Bank of America (BoA)/Merrill Lynch, small cap

value mutual funds now hold more than 2% of their assets in the world’s largest gold ETF, the Standard & Poor’s depositary receipt gold fund, up from virtually zero during 2008. Arguments for buying gold are all about fears of inflation and loss of value signalling that traditional long-only equity managers [who are supposed to pick stocks based

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on company fundamentals] are increasingly making macroeconomic asset class investment decisions. BoA/Merrill Lynch also notes that large speculators now have about $16bn long exposure to gold with hedge funds holding a substantial part of that. This is more than during the somewhat panicked period right after the collapse of Bear Stearns. Asset management firms have been burned by a multitude of woes: falling returns in equities and bonds; heavy redemptions and a deepening recession. The brakes are well and firmly put on new product innovation and fund managers are struggling win back clients. Towards the end of last year there were barely any new funds coming onto the market, but among those that did were two gold funds: the Julius Baer pure physical gold fund and the Zürcher Kantonalbank’s gold exchange-traded fund (ETF). The Julius Baer fund invests exclusively in physical gold, in standard 400-ounce bars stored in high-security vaults in Switzerland. At the time of the launch Stephen Müller from the physical gold team of Julius Baer said that the bank’s clients wanted to invest into a safe haven that has no counterparty or balance sheet risk. The fund eschews other gold exposure such as derivatives or metal accounts.

Investor interest Marcus Grubb, managing director for investment research and marketing at the World Gold Council, a mining companies-funded organisation, says there are indications that big players such as pension, endowment and insurance funds which have so far avoided precious metals, are seriously looking into investing into gold. If that materialises, gold prices could see a serious spike. “Pension funds are putting serious resources into a preliminary stage of

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investing into gold,” says Grubb, and adds that the processes pension funds have to go through to decide on a new asset are considerable so it takes months before changes are put into place. Part of the reason for this change of view is that up until recently advisors to pension funds on their allocations have advocated avoiding gold, but that proved the wrong move. Pension funds are now beginning to disregard this advice and are looking into allocating small proportions of their funds to gold, typically gold ETFs. According to the World Gold Council, new demand for gold ETFs last year was 321 tonnes. This was up 45% in dollar terms and 27% in tonnage terms on the year. Frank Holmes, chief executive and chief investment officer at US Global Investors says pension funds are getting ready to buy gold as “gold is being communicated as a form of insurance.” The financial crisis has deepened fears about where to keep money. Policy makers are fighting global recession, the threat of deflation and a decline in household net worth of around $13trn in the US alone. In major economies interest rates are very close to zero and the tarpaulins are off money-printing presses, which means inflation is only a step away. “Gold is like a canary in a coal mine when it comes to inflation,” says Peter Lucas, Investment Strategist at RBC Wealth Management, adding that gold has always performed well at times of inflation. The spectacular rise in gold prices during the inflationary 1970s cemented conventional wisdom about the strong link between rising inflation and gold.

The impact of quantitative easing Lucas says that central banks will be increasingly forced to go down the route of quantitative easing and of

lending more money. “The challenge of the policy, once they have done that, will be to stabilise prices by wiping liquidity out of the system,”he says and adds that if that does not happen inflation will push investors towards gold. On top of potential inflation the amount of money households in Western countries have available to spend continues to decline as businesses continue to cut jobs and salaries. The total number of job losses in the US has now gone beyond 5m and the unemployment rate has reached the highest level in 25 years. Although there has been some mildly encouraging news about housing, car sales and manufacturing, the jobless number will continue to put a halt on any potential recovery. In Europe job losses also gathered pace to an alltime high in the first quarter. Aid packages proposed by the Obama administration will go some way to alleviating pressures in the US economy but some of them have already been watered down, according to US Global Investors’ Holmes. The White House pledged to pump $1trn into the economy, of which a significant proportion into infrastructure. However, the infrastructure spend will be far less than initially expected.“Typically $1bn in infrastructure creates 35,000 jobs and $6bn in revenue. This will now not happen. This creates concern that the deficit will stay,”says Holmes. “There is an expectation that the governments will have to print money. If that happens gold could rise to $3,000,” he adds. Analysts believe that there are two possible outcomes of the global money printing. If it works the global economy will stabilise and a period of high inflation will follow. Alternatively, if it does not, global economies will enter a deep recession or even depression accompanied by a period of falling prices. Both scenarios

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Regional Review GOLD: HOW FAR CAN ITS VALUE RISE?

will be bullish for gold, the second one even more so than the first.

Dollar outlook uncertain The outlook for the dollar remains uncertain, with market watchers divided between the positives—rising interest rates and solid growth—and the negatives of US current account and budget deficits. However some analysts argue that the effect of currencies on gold will become academic given that most of them are expected to weaken. The Swiss National Bank is expected to intervene to push the Swiss franc lower. After Britain, the European Central Bank might be the next to adopt some form of quantitative easing, which will take its toll on the euro. The yen is already trading at year low levels against the dollar and is expected to weaken even further. This would explain two things: firstly, why the traditional relationship between gold and the dollar has broken down (a weaker dollar typically equals stronger gold but lately gold has moved up in line with the rising dollar) and secondly why there has been so much demand for bars and coins. Minting of official gold coins rose 40% in 2008, according to the annual Gold Survey published by research firm GFMS. The bulk of such buying has happened in Switzerland, Germany and parts of France where high net worth individuals were acquiring physical gold. Other hotspots for bar and coin demand are Russia, the US and Australia, where the local mints are having difficulty keeping up with demand. The combination of gold and the dollar appreciating at the same time has made gold more attractive to nonUS dollar investors. The World Gold Council says that private investors bought 769 tonnes of gold in the form of coins and bars in 2008, an increase of 133% in value terms on the year.

The dollar’s position as the world’s leading currency is being challenged by the Chinese with proposals to swap it for a currency linked to the IMF’s artificial unit the special drawing right (SDR). The Russians are warming to the idea and Arkady Dvorkevich, the Kremlin’s chief economic advisor, recently said he supported the idea to include gold bullion in the basketweighting of a new world currency. Any shift into SDRs would be pretty traumatic for the greenback as 65% of global reserves are held in the dollar, but only 44% of the SDR is made up of the US currency. “The rationale for buying gold expressed by many of our clients is about the debasement of lots of major currencies, not about the relative merits of one currency over another. But this could change: in an environment where the reserve currency of the world could become shunned, gold could do extraordinarily well,”says UBS analyst John Reade.

Gold as currency One fund took the idea of gold as currency very literally. Bermuda-based money manager Osmium Capital Management launched a fund offering its shares priced in ounces of gold rather than dollars or euros. The fund will invest in stocks but isolate investors from fluctuating exchange rates of major currencies by having gold-denominated shares. Gold already behaves like a currency—it can be traded globally at the same price and has adequate stocks to back it up—yet it cannot be printed but must be minted at a cost. That is why it is a real asset that holds its value in inflationary conditions. Despite all of the positives for gold there are several caveats—but these are more likely to manifest themselves as a cap for a rally rather than significantly lower prices. The amount of current fund exposure in gold has in the past

Minting of official gold coins rose 40% in 2008, according to the annual Gold Survey published by research firm GFMS signalled a crowded trade which preceded short-term sell-offs. Another significant factor that will dampen a gold rise is the performance of stocks. If stocks continue to rally the case for gold will gradually weaken. Also, high gold prices have slowed down jewellery demand and have brought large amounts of scrap metal on the market. India, which is historically the biggest gold market in the world, has not imported gold for two months in a row because of high prices in rupees. Also, the G20’s plan to double the financial help to struggling emerging economies will lead to the IMF selling 403 tonnes of the metal back into the market. Some of it will be absorbed by central banks around the world which have recently boosted their gold holdings, such as Russia and Ecuador. However, the negative global outlook and the changing fund view on gold will remain the overriding factor. “For the time being gold is still no more than a small percentage weighting in many private wealth accounts and macro fund portfolios. There is still much more money that could be chasing gold. For the moment though there appears to be a lot of talking but not much trigger pulling,” says a research note by Investec Asset Managers. UBS’s John Reade forecasts that gold prices will average $1,000 an ounce but come down to $900 in 2010. Peter Lucas says he can see gold rising to $1,200 or higher, while Global Investors’ Frank Holmes is even more bullish, saying a possible peak in the gold price could be as high as $3,000 an ounce.

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The State of Global Real Estate A Q&A session with Ronnee Ades, Business Unit Head, Alternatives FTSE Group, Michael Grupe, Executive Vice President, Research National Association of Real Estate Investment Trusts (NAREIT), Fraser Hughes, Research Director European Public Real Estate Association (EPRA) Q: As we enter Q2 2009, what is the state of the global REIT and listed property market? Michael Grupe: Illiquid credit markets and the ongoing global economic slowdown continued to weigh on the performance of global REITs and listed real estate securities through most of the first quarter of 2009. The FTSE EPRA/NAREIT Global Real Estate Index was down more than 17 percent yearto-date as of March 31, 2009. Near the end of the quarter, however, there were some positive signs suggesting capital markets could be turning a bit more accommodative. Ronnee Ades: Over the course of 2008, some REIT stocks sank as much as 60% in conjunction with broader equities markets. The downturn continued into the first quarter of 2009. It is global in scope and consistent with broad global equities. In addition to market conditions affecting listed real estate stock prices, a number of underlying economic issues are affecting real estate markets – both public and private. Increased unemployment and decreased occupancy rates, for example, are playing a part in the revaluation of commercial property values. Interest rates, credit cost and availability also have played a role in the downturn. Q: Do you foresee listed real estate making a recovery this year? Michael Grupe: We don’t know where the market will be at the end of the year. However, many analysts believe the sharp decline in stock prices for REITs and listed property companies have created a value opportunity for investors. According to Green Street Advisors, US REITs are trading at appreciable discounts to their net asset values (NAVs), making them inexpensive relative to direct property investments. When discounts to NAV are significant, historical data also show that REITs appreciably outperform other equities. Fraser Hughes: It is a similar story in Europe, UK REITs/property stocks currently trade at around 65% and Continental European stocks approximately 55% discount to published NAV according to EPRA. Through REITs and listed property companies, investments in commercial real estate can be made at valuations that are far more attractive than just two years ago. Ronnee Ades: Listed real estate P/E ratios are low at present, but it’s important to remember that before the market downturn real estate prices were at historic highs, pre-indicating a real estate bubble. What we are seeing right now is possibly a normalization of values in commercial real estate, which isn’t entirely a negative thing. Q: Are there currently any misconceptions about listed global real estate? Michael Grupe: Investors long considered real estate to be the ultimate immovable, illiquid asset. REITs and listed property companies now make real estate investing easy and efficient, thanks to market liquidity. The securities of companies that own portfolios of properties or engage in real estate financing are bought and sold daily on major world stock exchanges. As a result of their liquidity, REITs and listed property companies have become the most efficient way for investors and investment managers across the globe to gain exposure to commercial real estate; an effective way for professional investment managers to manage their investment exposure to real estate; and a meaningful way to reduce the risk of illiquidity. Fraser Hughes: The lot size of listed real estate means that investors can build a global exposure in a relatively simple and cost effective way. Ronnee Ades: Compared to private, commingled funds, listed real estate offers higher governance standards and transparency. Because they are securitized and publicly traded, REITs are totally transparent and offer full disclosure in the form of financial statements. Q: Are indexes efficient tools for measuring global real estate markets? Ronnee Ades: Absolutely. However, it is important to examine ground rules and index construction when choosing a real estate benchmark. For example, the FTSE EPRA/NAREIT Global Real Estate indexes require that companies derive at least 75 percent of their total EBITDA from relevant real estate activities. Other benchmarks may include more companies by sacrificing the indexes’ purity. In order to use an index to benchmark asset-class behavior, inclusion standards must be disciplined and appropriate. Diversity is also an important factor. Real estate benchmark such as the FTSE EPRA/NAREIT Global Real Estate Index Series can be broken down across property types, market classification, and geography. This option offers investors a comprehensive toolset for measuring markets either broadly or with a greater degree of granularity, depending on their goals.

THE FTSE HOW DO I GET INTO REAL ESTATE INDEX FTSE. It’s how the world says index. Real estate has outperformed both equities and bonds over the last 10 years. But getting into real estate hasn’t always been easy. That’s changed. Whether you are looking at REITS or want direct exposure to commercial property, FTSE has the world’s leading range of Real Estate Indices, helping you measure the performance of global real estate markets and invest more easily. www.ftse.com/invest_real_estate © FTSE International Limited (‘FTSE’) 2009. All rights reserved. FTSE ® is a trade mark owned by the London Stock Exchange Plc and The Financial Times Limited and are used by FTSE under licence.

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Frederic Oudea, chief executive officer of Societe Generale, left, speaks at a news conference with Séverin Cabannes, the bank’s delegated general director, in Paris, France, on Wednesday, February 18th 2009. Photographer: Antoine Antoniol for Bloomberg News /Landov, supplied by PA Photos, April 2009.

T IS A cold March morning at La Defense, the purposebuilt business district on the western outskirts of Paris. People pour out of the underground train station, dispersing into smaller tributaries that feed into the tower blocks that line the main pedestrian causeway.Yet, there is one stream, composed almost exclusively of workers in dark suits, that doesn’t thin. It winds out the back of La Defense, along the left hand side of La Grand Arche, and into the three immense towers that are the headquarters of France’s third largest bank Société Générale SA. These towers, the most recent of which was completed only last year, have earned their place in banking folklore. It was here, in January of 2008, that a lone trader, Jerome Kerviel, amassed an unauthorised €50bn position in European equity index futures, resulting in a trading loss of €6.5bn—a record for any individual rogue trader. The towers can also lay claim to a far more important place in recent financial history. It is in these glass-fronted colossuses that anyone trying to trace the roots of the current financial crisis that has engulfed the world in the past year will find at least part of the answer to the question:“how did we end up in this mess?” Société Générale was one of the pioneers of the ultimately ruinous banking model that teamed

the plodding world of retail banking with the ultra complex, and ultimately ruinously risky, world of financial derivatives. From a two-man operation in 1982 the bank built a derivatives operation that by the mid-1990s was the envy of its peers. It became the centre of much of Société Générale’s profits propelling the lender’s corporate and investment bank’s net income from €697m in 1999 to a peak of €2.34bn in 2006. Analysts at Fitch Ratings estimated that about €1.7bn of those profits were generated by Société Générale’s equity derivative team. “They were considered the best derivatives house not just in France but in the world,” says a Paris-based fund manager who has had dealings with Société Générale’s derivatives team.“Even as the crisis unfolded in 2007 they were holding their own, until Kerviel’s trades were uncovered.” Competitors naturally took note.They not only attempted to mimic the French bank’s success in its core equity derivative business but sought new, riskier, markets— including now much maligned credit derivatives, such as credit default swaps (CDS), that have weighed so heavily on the balance sheets of western banks in recent months. However, it is not just in derivatives that the bank took a pioneering position. It also positioned itself in the

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A TEMPLATE FOR CHANGE Société Générale SA has suffered with the best of them of late. Scarred like many contemporaries by the global financial meltdown, which cut a swathe through its credit derivatives and investment banking businesses, it was also buffeted in early 2008 by a high profile trading scandal. The current restructuring at the 145-year old lender is, say some analysts, uniquely instructive in understanding what Europe’s banks might look like after the banking and economic crisis has passed. The reforms that Société Générale is undertaking cut to the heart of its operations. It is scaling back assets dedicated to investment banking, offloading and closing operations in peripheral markets and scaling back its ambitions in key growth markets. Paul Whitfield talks to Séverin Cabannes, deputy managing director (and co-chief executive officer) of Societe Generale SA, about the bank’s renewal strategy.

vanguard of expansion into higher risk, and higher growth, Eastern and Central European banking markets; regions that have since emerged as ground zero in Europe’s ongoing financial crisis. Those twin positions made Société Générale the model of modern banking in the heady pre-financial crisis days. It also meant that, as the crisis unfolded, it was perceived to be among the riskiest of the French banks, leading to a spectacular collapse in the bank’s value since early 2007. Shares in the lender have lost about 80% of their value since hitting a high of €148 in early April, 2007. Its pioneering role also potentially makes the current restructuring at the 145-year old lender uniquely instructive in understanding what Europe’s banks might look like after the banking and economic crisis has passed. The reforms that Société Générale is undertaking cut to the heart of its operations. It is scaling back the assets dedicated to investment banking, offloading and closing operations in peripheral markets and reviewing its ambitions in key retail banking markets. “The financial crisis will have a lot of consequences,”says Séverin Cabannes, who was appointed co-chief executive officer at Société Générale in May last year. “We have two major business areas structurally impacted: corporate and investment banking (CIB) and asset management.” Under the guidance of Frédéric Oudea, who took up the

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role of chief executive officer in April after Daniel Bouton [who remains chairman of the bank] gave up the role in the wake of the Kerviel affair, Société Générale is reducing the balance sheet dedicated to CIB, and scaling back its highly complexed derivatives operations. The capital allocation at a group level to the corporate and investment bank will be reduced from about 30% to 25%. That is already a significant reduction, but it is still greater when it is considered that new capital accounting methods, being adopted under the Basel II regime, would have meant that the capital allocated to the unit would have increased if no changes had been made. The reduced investment is a response to two assumptions. That CIB will be less profitable in the future and that customer appetite for many of the complex financial instruments promoted by SGCIB will be weaker. “During the period of very fast growth that is now past it is fair to say that the business was easier,”says Cabannes. “Those days are gone. The appetite for highly complex structured products from clients has declined and our own appetite has also declined.” Société Générale in 2008 said it would refocus its operations on its core competencies. In practice that will mean continuing to support customer driven activities in the areas of equity and credit derivatives, euro capital markets and structured finance. Other activities, including some

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Former Société Générale trader Jerome Kerviel, at the centre of the picture, flanked by his lawyers Francis Tissot, left, and Caroline Wassermann, arrives to appear before investigating judges, in Paris, on Wednesday, September 3rd 2008. Société Générale accused Kerviel, 31, of betting tens of billions of euros of the bank’s money without permission, which led to almost €5bn (more than $7bn) in losses once the bank unwound his positions in January 2008. Photograph by Jacques Brinon, for Associated Press, supplied by PA Photos, April 2009.

activities in US dollar capital markets, operations and some smaller Asian markets, have been earmarked for downgrading or closure. The bank has plans to close offices in some of its smaller markets. Even within markets in which it intends to remain, operations are being scaled back. The bank is paring out much of the activity that it used to conduct on its own account. “We are refocusing on our customer-driven activities and reducing prop trading [trading conducted on the bank’s own behalf], to the level needed to support our customerdriven activities,” says Cabannes. It is perhaps no coincidence then that the arbitrage, or high frequency trading operations will be one of the biggest casualties. It was here that Kerviel carried out his ultimately calamitous trades in European indices derivatives. Yet, having opened the Pandora’s box of derivatives, Société Générale, unlike some of its US and European peers, has not been engulfed by it. That is testament to its derivatives talent, its decision to eschew some of the worst excesses of the derivatives market, and no short measure of luck. An example of that good fortune emerged in March when it became known that failed US insurer AIG, at the start of 2008, transferred $11.9bn of a $173bn state-bailout package to Société Générale in repayment for contracts linked to CDS. The US government decided to save AIG because its failure would likely have predicated a far wider financial services collapse; and it is now clear that Société Générale would have been one of the banks to fall. However, the bank has not escaped the credit and asset market collapse entirely unscathed. A year after recording its record 2006 profit CIB’s contribution to Société Générale’s bottom line had plummeted to a record negative €2.22bn. That figure ballooned still further to about €7.13bn, once it was revised in 2008 to include Kerviel’s net trading loss of €4.91bn (closing out Kerviel’s unlawful position resulted in a loss of €6.5bn, a figure reduced only because he had made €1.4bn in profits from earlier and similarly unlawful investments). Société Générale is not expecting the halcyon days of investment banking to return any time soon. Cabannes

said he expected long term return on equity from CIB will settle at between 17% and 20% in the coming years, a figure he describes as“much lower than previous.”Yet if CIB is merely being stripped down by the new regime, other areas of the bank are being effectively cast off. In January, Société Générale announced plans to contribute the European, Asian and 20% of its US asset management business, Société Générale Asset Management (SGAM) to a joint venture with local rival Credit Agricole Asset Management, known as CAAM. The move effectively sees Société Générale move out of the retail asset management business, by giving up control of its operation. It will own just 30% of the combined entity.“Our view was that growth in asset management would be structurally lower than it was in the past,” explains Cabannes.“We believed that we had to create economies of scale in the production of these [fund] products and the combination with CAAM will allow that.” The move seems a sensible one for Société Générale , which had laboured, and largely failed, to reduce costs at a unit that struggled to turn a profit. At the time that the deal with Crédit Agricole was announced SGAM’s cost to income ratio stood at 62%, some 13% higher than CAAM’s equivalent ratio, and had just announced a loss of €7m for the third quarter of 2008. Société Générale will continue to sell asset management products in its branches and they will continue to be branded with the bank’s label, leaving it with the lucrative end of the advice market, while cutting costs and the risk of losses on the back end. The groups estimate the combination will save about €120m a year. The sale was notable for one other aspect. It was overseen by Jean-Pierre Mustier, who was appointed head of SGAM in September. Mustier is the one time shining star of Société Générale’s CIB, a section he had headed from 2003 until the Kerviel affair, when he paid the price for the lack of oversight in his unit by being shuffled into a new position as head of SGAM. The appointment seemed strange at the time but made more sense in the context of putting a proven deal-maker in charge of offloading the unit. “Société Générale’s response to the crisis has been to baton down the hatches and cut as much fat as possible,” says a London-based European banking analyst. “It might not be

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the most adventurous response, but Société Générale investors have had their fill of adventure in recent months and anything that reduces costs is likely to be popular.” The approach is in stark contrast to the immediate response of Société Générale’s most keen rival BNP Paribas SA. France’s biggest bank has taken advantage of the banking crisis to grow, notably striking a €4bn-or-so cash and shares deal for Fortis’s Belgian retail banking assets, and one quarter of Fortis insurance business. That deal will make BNP Paribas’s the euro zone’s biggest retail lender. Société Générale, which long considered itself BNP Paribas equal, but has more recently slipped to number three in France, behind Credit Agricole, in terms of capitalisation. In the short term at least Société Générale can only dream of such dominance. There are other frustrations in play. Société Générale’s retail banking expansion plans, much of which was premised on signing up new borrowers and savers in Romania, the Czech Republic and Russia, has been knocked sideways by the financial crisis. Central and eastern Europe, which accounts for 74% of the bank’s non-French retail earnings, has emerged as the epicentre of Europe’s economic woes. The region has been buffeted by the global problems of scarce credit, falling exports and rising unemployment, all exacerbated by sharp exchange rate falls that have left business borrowers, who often took loans in euros, in a desperate position. In February, Société Générale booked a €300m goodwill impairment of its Russian operation. Cabannes admits that expansion plans, and cash flow growth, from the market have been set back, but insists that“in the long-term the prospects have not changed.”Analysts are more concerned about the short-term prospects. “While the bank still generates a net profit of close to €400m, this is however border-line and

could turn into a loss under either an acceleration of the deterioration of the economic environment in Russia/[Central and Eastern Europe] or high markdowns on monoline exposures,” say Keefe, Bruyette & Woods Ltd analysts in a note published at the end of March. Given the problems in its existing businesses, and its focus on cost cutting, it is no surprise to learn that acquisition is not part of Société Générale’s short-term plans.“When volatility subsides and we have more visibility on the macro-economic front we would consider acquisitions, but M&A is not in our plans for at least the first half of this year,”said Cabannes. Part of the reason for that remains the Kerviel affair. Société Générale was forced in February to go to shareholders for €5.5bn to plug the hole left by the trader’s activities. Having tapped investors once the bank would be understandably reluctant to return to ask for new funds for a war chest too. Without new funds the bank has little room to do anything but slim its cost base. Its tier 1 capital ratio, a key measure of a bank’s health, stood at 8.8% and its core ratio was 6.7% at the start of 2009. That was comfortably above the minimum set by the French government, and the tier 1 ratio rises to 9.3% taking into account funds made available to lenders by the French government. The value of that cushion was made clear at the end of March, when Société Générale’s chief financial officer Didier Valet told a London banking conference that the bank expected to write down assets in the coming months. Valet insisted the losses would be manageable and pointed out that despite the bad news to come other areas of the bank, notably CIB, appeared to have turned a corner. If that is the case then Société Générale may once again be treading the pioneer’s trail, this time in leading a tentative banking recovery.

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A CAUTIOUS COMEBACK FOR SECURITIES LENDING

KING COLLATERAL Those involved in securities lending schemes ran for cover after the collapse of Lehman Brothers. Now, as programmes gradually resume, the rules of the game have changed. What will the new conservatism mean for the securities lending industry? Lynn Strongin Dodds reports.

HE EUROPEAN SECURITIES lending industry enjoyed a bountiful four to five years until the subprime and subsequent financial crisis took its toll. Demand and supply contracted but there was a collective sigh of relief this past March when the London Pension Fund Authority (LPFA) and others decided to resume lending stock. The rules of the game, of course, have changed and going forward, programmes are expected to be more conservative and tailored with non cash collateral expected to be king.

Wayne Burlingham, global head of securities lending at HSBC Securities Services (HSBC), says,“Demand is down significantly from last year and I would say that some lenders have suspended their programmes rather than completely pulling out. Programmes that take cash collateral tend to be the ones that can be in the biggest trouble, whereas programmes like ours—that take securities as collateral—potentially see clients return much quicker. I think there is now a better understanding of the risks in securities lending and LPFA’s recent announcement that it is re-entering the market should send out a strong signal to the rest of its peers in the industry.” According to Ed Oliver, senior business consultant at Spitalfields Advisors, stock available for lending has contracted by about 10% to 15%.“After the Lehman default there was an immediate impact on supply and demand. Some beneficial owners are coming back but I also believe that others will feel that the revenue generated is not worth

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the risk they may have to take.“ State Street’s experience seems to be representative of many. Chris Taylor, head of securities finance for Europe, the Middle East and Africa at the US based firm, notes that “less than 20% of our European clients terminated, suspended or made substantial amendments to their stock lending arrangements at the end of last year and that a reasonable percentage of those have returned in the first quarter of 2009 with the remainder sitting it out and reviewing their options. For those that are returning, the typical response has been to amend guidelines which include a shorter list of counterparties and permissible collateral.” It is no surprise that beneficial owners including pension funds, insurance companies and endowments are adopting a tentative and cautious approach. The Lehman collapse and the ensuing concerns over counterparty risk last September prompted the LPFA along with Vanguard, the US fund manager and the Strathclyde pension fund, the UK’s largest local authority scheme, to temporarily shut down their entire securities lending programmes. Other funds such as the California State Teachers’ Retirement System (CalSTRS) and the California Public Employees’ Retirement System (CalPERS), Paul Wilson, global head of client management & sales, securities lending, at New York State’s Common Retirement Fund JPMorgan Worldwide Securities Services, notes “While most regulators made it clear and Dutch fund APG took a different route that the restrictions targeted short sellers and not securities lenders, some lenders felt and limited the suspension to some of their there were perceived reputational issues. This has made the industry realise that it financial stocks. needs to do a better job of addressing lenders’ concerns and educating them about the Defections continued in the wake of the ban benefits that securities lending brings to the markets in terms of the liquidity, depth on short selling as well as the losses and improved price discovery. Earlier this year, Chris Hitchen, chairman of the uncovered in cash re-investment National Association of Pension Funds, called on pension funds to resurrect their programmes. The de-leveraging of the hedge stock lending programmes, saying the activity was crucial for efficient markets. The fund community, which loomed large in industry needs to make that message clear.” Photograph kindly supplied by securities lending circles, also made its mark. JPMorgan, April 2009. Not so long ago, the biggest borrowers of securities were prime brokers, mainly acting on behalf of the risk/reward trade-off had changed and the activity these institutions. With Lehman and Bear Stearns out of might no longer be worthwhile in some instances. the picture, the number of these players has shrunk while One of the biggest causes of concern was the cash rea recent report from US broker Sanford C Bernstein investment programmes that had gained momentum forecasts that about a quarter of hedge funds will close during the boom years. Typically, these were pooled their doors in the next 12 months. Assets under vehicles comprising multiple borrowers that invested in a management (AUM) are expected to drop by around 18.2% range of short- and medium-term fixed income securities, to less than $1trn this year, and a recovery is not seen until including mortgage-backed assets and commercial paper. 2013. At their height in the middle of 2008, AUM stood at While cash was always popular in the US, it had gathered $2.2trn. a following among European institutions. The problem was The final blow last year, perhaps, was edicts from that many beneficial owners did not pay attention to the industry groups and firms such as Watson Wyatt which assets the cash was being reinvested in but instead focused advised its clients, who include several large pension funds on the double digit returns being garnered. The first cracks and sovereign wealth funds, to rein in their securities in this strategy appeared during the sub-prime crisis in lending activity if they had any doubts about lending 2007 when it was discovered that some collateral pools guidelines and arrangements. The global consultant said were exposed to illiquid stocks such as asset backed

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securities. Some lenders were forced to liquidate their reinvestment assets and crystallise those losses while others opted to sit on unrealised losses. All players, including the most sophisticated, have been impacted. For example, CalPERS, which had reaped almost $1.2bn from stock lending in the eight years to 2008, surprised the market with its unrealised loss of $509m in the first quarter of last year. Jean Robert Wilkin, executive director and head of GSF product management at Clearstream, says, “There was a high level of competition among securities lending providers to give clients what they wanted, which was enhanced returns. Non cash collateral was seen as being old fashioned and not as attractive but it has now become trendy again. Today, clients are more interested in optimising rather than maximising returns, which involves taking an integrated approach to both risk and return.” Keith Haberlin, head of securities lending business development for Europe & the Middle East at Brown Brothers Harriman (BBH) adds, “The goal of securities lending should be to generate incremental returns from the investment portfolio. We believe in focusing on the intrinsic value of the assets in the portfolio, rather than on the aggressive re-investment of cash collateral. Although counterparty risk has become a significant concern for the industry, the industry handling of the default of Lehman Brothers well as the unwinding of client loan positions was generally an orderly process. The bigger and more surprising issue has been that the cash collateral vehicles of many programmes were investing in assets such as unsecured Lehman paper, and many beneficial owners did not understand the potential risks of some of the higher yielding strategies.” While the cash re-investment certainly cast a pall over the industry, the short selling ban was equally damaging. The legislation imposed by regulators worldwide to stop the run on certain securities such as financial services stocks unleashed a torrent against the securities lending industry and its practices. Industry participants bristled at the criticism claiming there was a misperception of their

Jean Robert Wilkin, executive director and head of GSF product management at Clearstream, says, “There was a high level of competition among securities lending providers to give clients what they wanted, which was enhanced returns. Non cash collateral was seen as being old fashioned and not as attractive but it has now become trendy again. Today, clients are more interested in optimising rather than maximising returns, which involves taking an integrated approach to both risk and return.”

business models. According to Oliver from Spitalfields, only a third of stock lending is employed for short selling. The remainder is used for a variety of reasons such as settlement, dividend reinvestment, providing liquidity, various trading strategies and the collateral needs of brokers. Paul Wilson, global head of client management & sales, securities lending, at JPMorgan Worldwide Securities Services, notes “While most regulators made it clear that the restrictions targeted short sellers and not securities lenders, some lenders felt there were perceived reputational issues. This has made the industry realise that it needs to do a better job of addressing lenders’ concerns and educating them about the benefits that securities lending brings to the markets in terms of the liquidity, depth and improved price discovery. Earlier this year, Chris Hitchen, chairman of the National Association of Pension Funds, called on pension funds to resurrect their stock lending programmes, saying the activity was crucial for efficient markets. The industry needs to make that message clear.” Graeme Perry, who is head of agency lending at BNP Paribas Securities Services, agrees, adding,“Everyone in the securities lending chain–custodians, prime brokers, asset managers etc—has suffered and beneficial owners are being much more inquisitive about what securities lending entails. The industry as a whole is making a much greater

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effort at communicating with clients about what the mechanics of securities lending involve. The industry was able to withstand previous market shocks such as the collapse of Barings and the Asian and Russian financial crises but the recent events did highlight that maybe there was a lack of understanding about where the risks of lending securities lie and what each party in the transaction was responsible for. Looking ahead, there is a new-found conservatism permeating the air, with clients now assessing collateral types and amounts, re-investment guidelines, counterparty restrictions and any collateral indemnification provisions provided by the lending agent, according to Blair McPherson, global head of technical sales at RBC Dexia Investor Services. “Many beneficial owners are conducting risk return reviews and are tightening their parameters. There is also an acceptance that returns will not be as dramatic as in the past but any return in this current environment with asset values falling will be seen as attractive.” According to Brooke Gilman, managing director of client relationship management at ESecLending, an electronic auction-based securities lending manager, “Beneficial owners are placing an increased emphasis on risk management across both lending and cash collateral reinvestment portions of their programmes. Clients are seeking more information from their lending agents so that they can better understand and evaluate the risk, returns and exposures in their programmes. They want to see where returns are being generated from and understand why risks they are taking to achieve these returns.” As for collateral, in the past, corporate bonds and small cap equities were commonplace but in today’s world, government bonds and large cap stocks are now the preferred route. Rob Coxon, head of international securities lending at BNY Mellon Asset Servicing, says, "I do not see cash re-investment disappearing as it is integral to the US securities lending market. However, what is gone is using products such as asset backed securities and SIVs (structured investment vehicles). We have always encouraged our clients to diversify their collateral in cash and non cash instruments. Today, liquidity is key, which is why we prefer using sovereign debt and large cap equities in the main indices. We do, though, have concentration limits, because we do not want to wind up only holding a stock such as the Royal Bank of Scotland." Wilson agrees, adding, “The reliance on aggressive management of cash to generate returns has diminished. Going forward I think we will see more customisation versus the co-mingled pooled accounts that had become popular. We have always managed cash collateral in separate accounts because we never thought there was a one size fits all solution. Clients, especially today, want a programme that responds to their specific needs and one that provides daily transparency.” As for which provider will win out in this new landscape, it is not surprising that each group whether it be a

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custodian, lending agent or firm such as ESecLending believes it has the added value. Gillman believes that unbundling will continue because it allows for greater control and transparency in a lending programme. “Beneficial owners are taking a more active role in the management of their programmes and are not only looking for diversification of borrowing counterparts but also of agent providers.” Oliver of Spitalfields adds, “There will be opportunities for those conservative players who can offer risk mitigation, transparency and can manage the programme in reference to a client’s particular requirements. The level of indemnification cover has also become important. What I expect to see is providers offering a shopping list of indemnifications with different prices depending on what type of activity it is.” Market participants also agree that the emphasis on greater transparency will mean a bigger push for centralised clearing for securities lending. Earlier this year, LCH.Clearnet joined forces with SecFinex, a stock-loan platform majority-owned by NYSE Euronext, to launch the first central counterparty services for stock borrowing and lending across the Euronext markets, including France, Belgium, the Netherlands and Portugal. Burlingham of HSBC notes,“Due to the Lehman's collapse, counterparty risk has come to the fore. The argument for launching such a platform is to aim to reduce risk and as a result costs. I expect borrowers will look positively at this development.” Jean Robert Wilkin of Clearstream adds, “There are a number of central counterparty initiatives arising for securities lending in the US and Europe which will bring a greater level of transparency and standardisation. This should help restore confidence back into the securities lending marketplace. I do not expect to see it cover the whole market as you still need specialised transactions but even if it is 30% of activity as for the repo market, it will already be a big achievement.”

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TECH TOOLS FOR A DOWN MARKET Times may be tough, but with transaction costs threatening profits and demands for transparency on the rise, fund managers can ill afford to do without top-notch trading and portfolio-management systems in place. David Simons reports from Boston. LTERNATIVE INVESTMENTS SUCH as 130/30s and precious-metal commodities have only increased demands placed on trade execution, as has the ongoing dispersion of liquidity prompted by the rise in alternative trading platforms. Add to that the universal tumbling of the world’s major markets, and one would expect to see managers queuing up at the door of their local IT solutions provider in order to help them stay above the fray. However, in a world of tightening belts and shrinking revenues, IT spending may seem more like a luxury than a necessity. This raises the question: How can technology help trading teams meet their demands without breaking the bank? Though times may be tough, fund managers can

ill afford to do without top-notch trading and portfoliomanagement systems in place. Unchecked transaction costs can easily whittle away returns, notes Boston-based research firm TABB Group in its new report entitled Portfolio Decisions and Trading, Aligning Execution to Investment Needs. According to TABB analyst and report author Matt Simon, funds subject themselves to a number of risks if buy and sell orders fail to stay“in line”with the desired portfolio characteristics.“Best execution needs to be looked at from the portfolio perspective to preserve projected portfolio returns,” says Simon. In order to do so, it is imperative that investment decisions are implemented in the most efficient manner possible. Investment firms have a number of weapons at their disposal, notes Simon, running the gamut from pretrade analytics to alternative trading systems, designed to help successfully integrate daily portfolio management and trading processes. In a market where wild intraday swings have become a way of life, such mechanisms could turn out to be the wisest investment a manager can make. Additionally, all signs point to an increasingly

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transparent and restrictive market environment, requiring better planning and more sophisticated use of technology. Such demands also strengthen the case for leading edge technological solutions, enabling managers to boost their level of preparedness while improving operational efficiency. As the ranks of alternative trading venues grow, so will the need for sophisticated mechanisms that can minimise costly execution errors, thereby streamlining the execution process. The continued growth of smart routing technology, for example, allows clients to be reasonably assured of finding best price in the most efficient manner.

IT to the rescue! In reality, technologies such as smart-order routing and cost savings go hand-in-hand, observes Raj Mahajan, president of SunGard Trading. Given the current state of the markets, Mahajan contends there has never been a better time to improve one’s execution costs. “You need something that seeks out liquidity—you are a brokerdealer perhaps, and you need to buy 1000 shares of IBM. What is the best way you can make the transaction for the cheapest possible cost? If you have the technology that can scour 40-plus pools of liquidity including dark pools, electronic crossing networks and exchanges, each one charging a different fee, and locate the best possible price available, you are ultimately going to be able to lower your take fee, and with the same execution quality.” The ability to tie together multiple service offerings under a single application is another way vendors can distinguish themselves in an increasingly frugal market. “When buying or selling stock, on average you are going to encounter upwards of seven different counterparties representing perhaps a dozen different nodes, all of them making money on that trade. However, if one of those individuals can provide not just one but perhaps six of those services without increasing your costs, once again you’re saving money,”he notes. For instance, a provider might be able to discount an order-management system as an incentive for selling the client smart-routing technology in the same bundle. “The whole idea is to take all these different services that the client would normally have to pay for individually—from algos and smart-routing to compliance and more—and charge them a fraction of the amount, which is the ultimate goal in terms of lowering one’s overall execution costs,” says Mahajan.

“The whole idea is to amortise costs across a huge network,” says Mahajan. “If you’re going to be an order-management system provider to the sell-side and you don’t have at least 80 customers, you’re not going to earn a profit—it’s that simple.”

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Toby Corballis, chief executive officer of Rapid Addition. Photograph kindly supplied by Rapid Addition

However, it takes a fair amount of scale to make such one-stop shopping possible, says Mahajan. “You need a broker-dealer with air-tight compliance, risk-management and balance-sheet capital. If you don’t have a $100m balance sheet just to be in the game, you can forget about it. If you’re a large investment bank are you really going to trust your business to a broker-dealer who may not be 100% capable of confirming the trade? Of course not.” Offering industrial-strength connectivity and being able to meet increasingly stringent latency standards are additional prerequisites for vendors looking to differentiate themselves within a crowded field of competitors. Like any resourceintensive enterprise, maintaining a vast customer base is crucial. “The whole idea is to amortise costs across a huge network,” says Mahajan. “If you are going to be an ordermanagement system provider to the sell-side and you do not have at least 80 customers, you are not going to earn a profit. It is that simple. If you do not have the broker-dealer wherewithal, or the domain expertise, or a development organisation large enough to support latency requirements, it is not going to work.You need to go big, or go home.” Above all, you have to maintain your neutrality.“If you are a big broker-dealer and you have a proprietary order book, your interests may not be perfectly aligned with those of your customers, because in each trade there’s somewhat of a zerosum game,”says Mahajan.“The more profit you make on the trade, the less profit the customer makes. So you need to be able to prove that you’re really acting as the agent,”he adds.

Free no more The good old days of having the sell side foot the bill for the buy side’s technology are all but gone, says Toby Corballis, chief executive officer of Rapid Addition, a provider of FIXprotocol based products and services to the financial-

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services industry. “The buy side now has to pay for everything themselves. Not only will that take some getting used to, but the proliferation that once existed among buy-side venues has changed. It’s one thing to accept using three or four different applications if you are getting them for free. Once you have to start paying for it, however, you are going to have much less tolerance.” All of which plays to the strengths of providers who are able to consolidate a number of service applications under a single umbrella, says Corballis.“Given that the buy side is not accustomed to paying for these services, it will put the onus on vendors to become more agile and, most of all, far more cost-conscious.You have got to have a high degree of adaptability. If you don’t, that is undoubtedly going to impact on your ability to survive in this market.” Vendors equipped with FIX, for instance, have the ability to handle the full spectrum of messaging that occurs between venues, says Corballis, as opposed to relying on more than one application programming interface (API).“I think it is going to be difficult for some of the more established venues which do not have that kind of agility in their code base, simply because they may not have the appetite for making significant changes to their products.” While there will always be a contingent of companies that prefer to keep their IT to themselves, the need to trim costs has compelled even larger organisations to go out and seek an outsourced solution. Ensuring fast and efficient

implementation, then, often seals the deal.“Monetary cost is one thing, but given today’s pronounced market volatility, people are loath to go through a long drawn-out integration cycle—they just want to hand over a file and have the vendor take care of it for them in order to minimise the potential interruption.” Using a hosted FIX application, for example, firms can sidestep the cost and time constraints associated with licensing and implementing a full-on FIX engine, says Corballis.“Yet at the same time they have the knowledge that they are making the necessary advancements into electronic trading.” With companies continually scaling back, there are far fewer personnel overseeing a firm’s critical daily tasks.“The last thing you want to be doing at this time is taking whatever people you’ve got left and having them oversee IT duties,” says Corballis. “Particularly for small- to medium-sized firm, it just makes a lot more sense to simply outsource the whole lot. So I think this will really drive this business over the near term.” Those who are scared by the market and aren’t willing or able to make the necessary changes because they can’t afford to guess wrong are merely setting themselves up for a fall, says Corballis. “However, if you decide to be innovative and provide different types of solutions and are able to respond quickly to clients’ needs and do it in ways that drive client costs down, then I think you will ultimately survive and prosper.”

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T H E 2 0 0 9 E U R O P E A N T R A D I N G R O U N D TA B L E :

HARNESSING CHANGE & VOLATILITY

Attendees

JAMES DAY – Director, Equity Trading, Barclays Capital

CARL JAMES – Global Head of Dealing, Fortis Investments

TARUN KUMAR – Senior Dealer, Northern Trust Global Investments

BRIAN MARTIN – Head of European Equity Trading, Fidelity Investments BOB MCDOWALL – Research Director Europe,Tower Group

Supported by:

TIM WILDENBERG – Head of Execution Europe, UBS

STEVE WOOD – Global Head of Trading, Schroder Investment Management FRANCESCA CARNEVALE – Editor, FTSE Global Markets (Moderator)

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ALONG CAME THE CRISIS... JAMES DAY, DIRECTOR, EQUITY TRADING, BARCLAYS CAPITAL

A huge change took place last year for us with the acquisition of the Lehman Brothers US business. Not only that, a real challenge was seeing the degree of market volatility out there. You had stocks moving in an excess of 80% in any one day; this is a level of unprecedented volatility over the near period. It has brought into focus the need to ensure that we provide customers with good execution in a challenging market environment. STEVE WOOD, GLOBAL HEAD OF SCHRODER INVESTMENT MANAGEMENT

TRADING,

Volatility has really changed trading patterns on the buy side. Risk patterns always become more and more expensive, not only from a single stock perspective, but also from a risk programme element, so we are using a lot more direct market access (DMA) and algorithmic trading. Low touch trading has therefore begun to outstrip our normal high-touch trading. Crossing networks have gained traction in Europe as well as in the United States, though not quite so much in Asia. The low-touch element has also raised certain challenges, because in this environment you are not outsourcing your trading in any form or manner. You are controlling the quality of execution yourself, not only from a low touch perspective, but from a high-touch perspective too. Moreover, we can monitor the quality of execution from brokers and dictate where we want the business placed as well. Going forward, we will be better able to evaluate smart order routers and become more robust in scrutinising where these smart order routers do touch: not only the market layer and the multilateral trading facilities (MTF) exchange layer, but also the dark pool layer as well, which is becoming more and more important. Dark pools are giving us different headway into highly liquid as well as illiquid stocks and get big blocks of business done without moving the market, without information slippage. There is some regulatory intrigue going around with a couple of the crossing networks, not internalised ports within the brokerage community but the actual standalone crossing networks. The European regulator is coming under pressure from exchanges, an interesting development considering the Markets in Financial Instruments Directive (MiFID) was supposed to give open competition to all exchanges and MTFs. There is

also a lot of divergence in the market; with our clients looking for clarification around our trading execution policy and how robust our internal systems and processes are in terms of risk management, the expertise of traders and technology. This will be a key differentiator on requests for proposal (RFPs) going forward. Much of this divergence is steered by MiFID, which in my humble opinion did not go far enough.

CARL JAMES, GLOBAL HEAD OF DEALING, FORTIS INVESTMENTS

In the last year we had the integration between Fortis Investments and ABN Amro Asset Management (AAAM) which took up almost all of our time. We pretty much finished at the end of August and now we are preparing to be taken over by BNP Paribas. Within the wider business, we have witnessed a real push regarding counterparty risk and operational risk. Steve is right about technology: over 95% of our orders are now traded electronically and I cannot remember the last time we utilised capital commitment. We also do far more algorithm-based and direct market access (DMA) trading and we want to utilise these elements more and more. Today is also about people, ensuring staff has the right skillsets to work and develop in new market conditions. Go back 10 years and the buy side was very, very different. Today there is much more a sell side approach to the market. I certainly see it within Fortis. We have a model of centralised dealing coupled with a model where dealers are embedded in the investment teams, so they are actually part of the investment process. Moreover, we have started to go down the route of tactical trading so that our dealers are able to take positions on with the full knowledge of our portfolio managers (PMs), and a very closely scrutinised structure around compliance and legal risk. That is the people part, and they couldn’t do that if they didn’t have the technology. Finally, the industry is in a dreadful state. I have seen some numbers on some of the asset managers and the numbers of the brokers, and realise this industry needs real hard work to get it back in shape. TARUN KUMAR, SENIOR DEALER, NORTHERN TRUST GLOBAL INVESTMENTS

We have had a very interesting 2008, and 2009 seems to be equally so. One thing that we have noticed from the start of the year has been the lack of volume in the market generally and volumes have been down in the order of 50% or so; this led to the obvious increase in volatility and widening of spreads. There is little conviction in the markets as people

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wonder what sensible levels actually are. Some fund managers seem to be happy to sit on cash as opposed to actually getting their money in the markets. Post-MiFID, we began to get a lot more of the sell side signed up on commission sharing agreements (CSAs) and that is working out reasonably well. At the beginning of last year we split execution and research and it seems to be working okay so far. That allows us full flexibility as to where we trade, allows us to use more algorithms and DMA as we choose and then ask the CSA provider to write a cheque out to the broker for any research which they give us. Getting brokers to sign up to the CSAs was time-consuming and there were legal teams on both sides working furiously, trying to agree on common terms and conditions of the arrangements. BOB MCDOWALL, RESEARCH DIRECTOR EUROPE, TOWER GROUP

The exchange venues have actually stood up pretty well to volatility and other issues. It is a tribute to their tenacity.Yes, there have been problems, but compared with other parts of the financial services industry, the exchanges have stood up remarkably well. Looking forward, we are still waiting for the dust to settle, we are still nervous that other ‘events’ might happen and therefore quality institutions are behaving tactically. I do not see any institution with a threeor five-year strategic route map showing how their institution will be nursed back to health and develop in that time. Obviously that is particularly difficult for those institutions that have taken the government’s shilling, so that is an issue. The other thing is the way Europe is addressing systemic risk and recapitalisation of the banking system: it is actually sowing some of the seeds of protectionism even in the Eurozone. Countries are addressing things in their own way at their own time for the benefit of the national banking system and the national economy. Some might say: “Why shouldn’t they?”So there are some seeds of protectionism. Moreover, the European Commission has, in my view, proved itself to be frankly not structurally equipped to address the economic and systemic issues that have come up, particularly in its bureaucratic organisational structure. We are facing some significant regulatory conundrums going forward and tensions between what I call anti-Anglo-Saxon capitalism, if you like, as represented by the US and the UK, and the more sort of corporatist approach of mainland Europe. I wonder what that mix might throw up over the short term. TIM WILDENBERG, HEAD OF EXECUTION EUROPE, UBS

The bizarre thing is that September 2008 seems like five years ago, doesn’t it? It doesn’t feel like only five months have passed, and that reflects the depths of the difficulties we have all faced. Volatility and all the other trends mentioned aside, if I look back, a hidden piece that is much less obvious is that asset values have come down significantly, with an attendant impact on the income of both the broking and fund management segments. Moreover, mergers and acquisitions among key institutions in this recent period are changing the face of the market. If I look at our top ten hedge fund clients, for instance, and

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TARUN KUMAR- Senior Dealer, Northern Trust Global Investments

compare it to the list we had a year ago, it is now a completely different set of names. So, it is an interesting backdrop. Then there is the overlay of MiFID, which would have been difficult enough if it had been introduced in more benign times, and so we have a proliferation of trading venues, such as Chi-X, Turquoise and NyFIX Euromillenium. There is also a technology trend, which requires market participants to put their hands in their pockets to keep pace. The demise of Lehman Brothers sort of opened up the high-volume DMA business in Europe, which until recently had been a business that was clearly ring-fenced. A lot of second-tier brokers have been knocking on the door saying they need smart order routing, which is too expensive for them to buy from a vendor (and they are not quite sure of its efficacy). Certainly, for us, opportunities have emerged from these trends. However, the outcome of the technology race and some of the investments in the clearing side are yet to be determined.

THE FALL OF LEHMAN BROTHERS PUT EVERYTHING AND EVERYONE TO THE TEST... TARUN KUMAR: Counterparty creditworthiness became a

more important issue for us and one where we were looking more carefully at who we were trading with.

BRIAN MARTIN – HEAD OF EUROPEAN EQUITY TRADING, FIDELITY INVESTMENTS

The counterparty risk element of our business has been brought into focus in a way we never saw before and not only at the broking level, but also looking through to the Lehman Brothers systems and clearing systems. It is now about questions that traders did not need to ask before this crisis kicked off. Now, with the new trading venues in play you are asking questions such as:“How do they clear? Who is backing that clearing system or that third party vendor?” There has been a lot of change on both the buy side and the sell side, particularly over the last two months. Brokers can no longer assume that everything will work smoothly. The demise of Lehman Brothers clearly underscored that

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TIM WILDENBERG - Head of Execution Europe, UBS

STEVE WOOD - Global Head of Trading, Schroder Investment Management

point. It became very clear, very quickly that the regulator and the systems and processes were not set up to handle a crisis of that magnitude. We have not had a major institution go into administration in the way that Lehman Brothers did. Buy side firms with outstanding positions with Lehmans were looking to their sub-custodians five, six or seven days later, to try to work out where and if their trades had settled. CREST pulled the plug because it could not deal with the firm’s administration and it was a really trying time for the buy side to understand where exactly it stood. Moreover, there were no useful regulatory guidelines to help and so the buy side was forced to look for market led solutions, which put them in a bad, bad place. Additionally, the buy side now has many more electronic systems to utilise than ever before, and while it gives the buy side more opportunity to interact with the marketplace, it still lacks a deep understanding of how those markets really work and how you impact on those markets and the operation of true liquidity and dark liquidity. I think it adds up to a significant challenge for the industry this year.

STEVE WOOD: Really though, how much is down to regulatory oversight? Should there be more regulatory oversight in that sort of environment, or should it apply all the time? The US has gone down its usual path. First it was Sarbanes-Oxley; now they have (US senators) Kaufman and Isakson wanting to bring the uptick rule back. The Americans go from one extreme to the other. How much do we want to see regulatory interference in the process? Do we even need regulatory interference in the process? JAMES DAY: Much of the confusion with the Lehman Brothers issue arises because a lot of trades were done through a non-central clearing counterparty; a lot of trades were being done on exchange, done by exchange rules, and a lot of OTC transactions were also in play. There were no clear directives from administrators or regulators as to how you deal with that array of trades in that particular situation. Some of the market trades in the countries that do not use a central clearing counterparty were still settling a week afterwards. There was no facility to cancel trades in the UK because CREST had suspended Lehman. There was a lot of confusion out there and no clear directive on how to handle the outstanding trades. TIM WILDENBERG: We have had conversations with various people around issues such as redefining what we mean when we talk about agent and principal and other core concepts that the industry just takes for granted, or at least accepts on principle. The industry has grown to accept, for instance, that in a principal deal there could be risk, though what that really means is that you should be asking who your counterparty is and drilling down and getting to the nitty-gritty about the way a clearing house works. These are issues that have not been discussed for 10 years or so, and we are back to focusing on such basics right now. BRIAN MARTIN: The point being that the emphasis was all around efficiency and cost at the detriment to the ways these trades were being cleared. There were also other questions: How robust is the clearing agent? Who owns the clearing agent? Are there any hammer prices? Are there any default provisions on that clearing system? All these points were overlooked. It seems to be all about competition and ways in which you can do it quickest and fastest, but maybe not who can do it the best.

THE SHAPE OF THINGS TO COME ... CARL JAMES: Look at what has happed so far. We have had Credit Suisse Asset Management London business going to Aberdeen. We have had Société Générale and Crédit Agricole joining together, and Henderson buying Newstar.Then again, if you look at assets under management, they have dropped off a cliff, particularly in the hedge fund segment. Hedge funds had $2trn under management, and that has probably been halved. In the long only space, with the reduction in asset values, an adverse impact on cost/income ratios has and will have a huge impact on asset management. Additionally, average volumes in the UK trading market used to be something of the magnitude of £12bn to £15bn and now it is

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£3bn to £5bn. That is a They are buying their huge drop. Moreover, the technology and/or market number of brokers will access from me or James or drop as well. Therefore, in people like us. Therefore both the asset what you are seeing is that management world and in the execution space is the broking world there becoming divided. One side will be consolidation, is providing a market access rationalisation, whatever style service that involves you want to call it. algorithms and DMA and so Additionally, I think we on. This side is offering much will see a simplification of more of a utility service that is products. I do not believe if about technology spend, you go and see a client, a critical mass, clearing client is going to be saying: relationships, and the ability “Please sell me a to invest. Certainly, at UBS, structured or a leveraged we believe we are good at product. I really want to various channels of buy one of those right execution, for instance, but now.” I’m pretty certain now we see others that are saying, “Actually I do not they’ll say: “If you can think I ever want to play in explain it in two minutes, I the DMA space.” Or, “the might buy it.” Now that economics of playing that obviously has a knock-on game or building an effect on the sell side as to CARL JAMES- Global Head of Dealing, Fortis Investments algorithm just do not make what they need to service. sense to me.”At the same time, I see guys with some fantastic BOB MCDOWALL: The investment bank/brokerage side of the banking business is going to be very interesting over the relationships who can find liquidity and therefore set up that next two years.There is a sort of question mark as to whether kind of specialised shop. What this means in turn is that there that part of the business is broken to a large extent as far as will be further fragmentation. a service level to the buy side is concerned. Undoubtedly TARUN KUMAR: The sell side future is looking uncertain. there will be consolidation, there will be fewer brokers, but it I think we will be looking at a consolidation of the large is going to be very interesting to see what the dynamic will global brokers and the emergence of lots of smaller be in redefining the broker segment. Most likely we will execution-only venues and pure research houses. To some witness a very polarised environment, where the top five extent we have seen evidence of this already. For the buy dominate and a load of little boutique brokers are in play side I think the trader on that side has been empowered a that will focus on execution only and will only hunt out lot more recently and now has all the tools at his/her liquidity. This development is being driven not only by disposal to trade as effectively as any sell side trader, if not more so. The emergence of several more exchange venues market events but also by commission sharing agreements. JAMES DAY: I agree with you. It is changing markedly: the is not helping the traders at present and a buy side dealer buy side is becoming much more aware of different trading will want a simple smart order router to “hit” all the venues and how assets are being traded and require much necessary venues and report back. I fail to understand how more from the sell side. It is those people and houses in all honesty these different exchange venues can co-exist which can adjust to that change, provide access to the for any meaningful length of time, but we shall see. liquidity that is out there and provide technical solutions STEVE WOOD: The marked difference now is the quality of and support for the buy side that will win out. It is about trader that the buy side has is probably as good, if not helping the buy side become more comfortable and better, than the sell side. Also, we have a much better list of helping them navigate through the market fragmentation. venues to go to than the sell side trader does. So we view brokers now on a high-touch basis, as just another venue TIM WILDENBERG: There’s no question there’s going to be change on both sides. What is really interesting is that people we go to and we evaluate brokers in the same way as we are becoming very, very choosy about the services they buy evaluate all the other venues, and on that basis decide and are more focused on the value they get for that purchase. which one we are going to touch to get the optimal In that regard we will invariably see more specialisation. transaction cost for our client on any particular trade. In Some of those smaller firms will be research boutiques rather that sense, sell side brokers now have much more than execution boutiques—though at the moment we competition: not only from other brokers, but also from definitely see a trend in execution boutiques. Even so, many other venues. That trend is going to become more of those execution boutiques are very sales trader driven. important going forward.

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BRIAN MARTIN: Let’s not

crossing network, is that forget, the buy side use sell the technology behind it is side firms for their giving you the ability to technology and access to find liquidity without risk the venues. We are not of being compromised by developing our own showing that liquidity, and technology; we are not that that has got to be a good smart yet, though the thing. A dark pool is situation is quickly allowing you to say:“Look, evolving. Even so, new I can anonymously post a venues are popping up, as bid or post an offer, and if Tim mentioned, every somebody else wants to week and you have to try do the thing the other way, to understand what the something’s going to implications are for your happen, and nobody flow into those markets. knows I’m the buyer, and That is very tricky, very, therefore if I do not do very difficult. What’s a anything there’s no cost to good venue? What’s a bad me and my hand isn’t venue? Meantime the spoilt.”That is a good thing regulator is telling us we for the market. MiFID has JAMES DAY - Director, Equity Trading, Barclays Capital opened up competition should be trading in different venues and locations. Is that a good thing? Maybe and it is uncomfortable for lots of people, and not yes, maybe not. So then you look at platforms such as Chi- everybody is quite ready for it. If you have competition, X and a third of the flow in Chi-X is provided by buy side clearing costs come down, exchange costs come down and liquidity providers, such as Optima. Are they liquidity that is a good thing. In a year or so, actually we will be in a providers, or is the description an oxymoron because they better place, and we’ll feel much more comfortable about it. go home flat every day? You have a provider that has We are just in that process of change, coupled with the something between 10% and 15% of market share every overlay of world markets, volatility, volume depression, and day, depending on the numbers that you read, and a third turnover down, makes it all feel a bit uncomfortable. of that flow in a venue is someone that goes home flat STEVE WOOD: Can I just pose one question of Bob? every day, because they are real smart and they can trade at Regulators appear to be changing the goalposts as far as five or sub five milliseconds. I’m not entirely convinced that crossing networks are concerned. There is even intimation that is good liquidity for me. It’s good liquidity for them, that crossing networks might have to set up as MTFs. but I’m just not sure it’s good liquidity for the buy side. What’s your perception of that? There is an additional point I want to make. The UK put our BOB MCDOWALL: My perception is that regulators panic, flag in the ground: we were the first to implement MiFID. and others are getting much more nationalistic, If you look at Spain and Italy, for instance, they still haven’t protectionist, and effectively some of these will be implemented MiFID, and we are 18 months down the line replicated ultimately in other jurisdictions which actually on this initiative. Some 18 months on MiFID has not been isn’t going to be very helpful, because it will create more enacted across Europe, yet buy side firms in the UK are fragmentation. I just feel that the seeds are there for that being looked at rigorously, in terms of how we’ve unfortunately. proceeded and what we are doing. TIM WILDENBERG: It feels to me that the Financial Services Authority (FSA) have been overwhelmed by the STEVE WOOD: I’ll just make one observation on the crossing networks. I agree, the hit rate there is very low. amount of interest, and the requests on them for One thing that differentiates it though is that we have quite information and views. My sense is that, not only the buy a substantial hit rate on the small, mid cap segment. There side, but also brokers definitely felt that MiFID was going is only limited traction on big cap, small/medium cap is to be a good thing and would level the playing field once where people perceive the crossing network has an axe to more. If you look at what’s happened, to some extent it’s grind. This type of venue is an active place; you can place created a technology burden that you’ve got to be big liquidity without information slippage. Do you need it in enough to play in the game. It’s raised the stakes definitely. the big cap arena? Probably not, to be perfectly honest.You Moreover, the FSA has been talking to everybody to understand how everyone’s dark pools work, but it just can do that through an exchange, or through an MTF. TIM WILDENBERG: What’s interesting with those— seems that they still cannot decide whether we can trade in because actually my sentiment is that you’re right—this the middle of the spread rather than just somewhere in the whole dark pool thing has gotten itself a bad name. touch.You wonder where the confusion arises; perhaps it is Certainly, the way we run our dark pool, or our internal because they are drowning in work.

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DARK POOLS OR DARK PUDDLES? BRIAN MARTIN: There are dark pools and they are good and there are dark puddles, and they are bad.They’re bad because they are of no consequence to the buy side. If I have a million shares to buy, and I trade 1,000 in a dark puddle, so what? It’s inconsequential. I’d much rather not trade that stock, and not give any information away about that trade, and go and meet in a bigger venue, where maybe it’s better regulated, and maybe there’s good anti-gaming logic. So, theoretically, could you pass through the sort of organic liquidity within a broking firm, and pass through the links that they may have to try and capture that flow before it goes to the market? Before going to the primary exchange or to a Chi-X, if you can end up in a well represented liquidity pool that has good anti-gaming logic and is being well regulated, pre and post trade, that would be a better result for the buy side. It would be more expensive for the broking firms, but it would be a better result for the buy side. If you look at the States, where you have 50 venues in the US, I made my numbers up, so correct me if I’m wrong, but about 50 venues, and 80% of volume is done on six or seven venues, five, six, seven venues. TARUN KUMAR: At the moment probably dark puddles! I think on average the total value of trades being crossed up is about 3%; this is a very low figure. I am happy to leave part of my order in a dark puddle for a bit to see if I do find something there. If I am not getting any joy there I will have to get something working in the market. Lots of puddles don’t always make a pool! CARL JAMES: A dark pool nowadays is quite an intrinsic part of the actual algorithmic suites a broker offers because when you’re looking at algorithms, you have to take into account the perceived crossing rate with that algorithm, and that could actually encourage you to use one person’s algorithm rather than another. So, it is becoming a part of, not just stand-alone, but cross trading. TARUN KUMAR: Dark pools in theory are a great idea but there will still be some information leakage as if I cross up some flow there I know there is the other side to my order. Now they may have completed their order or they may have more to do and are waiting for better levels but I still know someone is out there. A way to increase dark pool participation is to get your chosen algorithm to participate in all available pools, though this is an option we don’t always choose to use. Another way is for the owners of the dark pools to consolidate their liquidity and remain competitively priced. TIM WILDENBERG: Unfortunately the whole dark pool thing’s got itself a bad name. At one time, if I had an order that I was working from Brian and an order in the same stock in the other direction from Steve, if I wasn’t able to get them both good prices, everyone would look at me like I was a bad broker and I wasn’t doing a proper job. Our dark pool (which we call PIN) is actually just an evolution of our natural crossing service. It means that if I’m buying some stock for Steve and I’m selling stock from Brian, my machinery should be intelligent enough to get a good price for both of them by trading in the middle.

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BRIAN MARTIN - Head of European Equity Trading, Fidelity Investments CARL JAMES: Let’s be clear, ‘dark pools’ are nothing more

than brokers crossing stock between a buyer and a seller, which is what brokers should be doing. It is a very simple thing. It does slightly irk me. These dark pools are sold as if they are new and will bring something different.They do not. Technology has allowed the brokers to do it more efficiently. STEVE WOOD: I do not know what we should make of Baikal. They are not supposed to be a broker, but they are setting up a brokerage. That is a very grey area. TIM WILDENBERG: Baikal, NASDAQ OMX etc engage in onward routing. What they are trying to say is“Look, we think we’ve got a pretty cool platform and we understand that you do not want to waste your time by giving me an order and not having a trade, so as a service to encourage you to put flow here we will order it for you such that if you put something in my pool and I haven’t got anything for you, do not worry I’ll make sure you go somewhere you can get it.” So effectively the cost of you giving me the order in the first place is ‘derisked.’It is subtly different. We personally will not use another venue’s router, so we will never give an order to Baikal and ask them to onward it.That is our view. Our view is we must never onward route, however our view is you are paying us, so you’re expecting us to find liquidity. We have a process by which we review new venues as and when they come on, and we have a kind of stepped and staged approach by which we tiptoe in and look at the data, and go through it in real detail. We have a process by which we do that the right way. So exactly as Brian says, you are giving us an order, and there’s a number of things you rightly expect from us.You tell us to buy, let’s call it Vodafone, you expect us to get you some Vodafone and you also expect us to match up any sellers we have in the other direction; but also, you wouldn’t want to discover that we’ve been selling them or buying them at say 10, when nine had been offered.You’d want us to buy them at nine. CARL JAMES: Okay this is the point. The buy side delegate responsibility of getting orders done. However, the buy side do not abdicate responsibility. So in my view the buy side should be giving you, the sales side very, very clear instructions as to how that order is executed. If the buy side person gives you an order and gives woolly instructions like“do your best,”they will get the execution they deserve. The buy side absolutely own the responsibility for getting the best execution for their client.

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THE 2009 EUROPEAN TRADING ROUNDTABLE

TIM WILDENBERG: We have clients who ask us to exclude

certain venues, so some people have strong views about certain venues. CARL JAMES: Yes and that is good because they should be, they are managing how they want that order to be. That is their strategy. I do see brokers at the moment purely as estate agents. There is very limited principal pricing being offered, therefore the brokers are reliant on their clients’ order flow. Think of an estate agent’s window, advertising all the liquidity they have in houses. As a client, you will be attracted to this liquidity if it matches against yours. The brokers need to maximise this liquidity, so they have started marketing“dark pools”. It is all about marketing or advertising. More people buy more of your stuff for more money. That is what it boils down to. There are some firms out there that do their marketing better than others and that is one of the reasons why it becomes popular. Obviously the more liquidity it attracts the better rates of crossing it has, which attracts more liquidity… BOB MCDOWALL: I was at an event where an MP came up to me and said, “Bob what are these dark pools? Doesn’t everyone get access to them?”It is extremely important that these issues are better articulated from the industry point of view otherwise as I say when government meets industry there are going to be more problems. JAMES DAY: Your point about how you do not like the whole new marketing spiel about dark pools is interesting. A couple of thoughts: what is a dark wave? Non-displayed liquidity, that is all we are talking about here. So whether that non-displayed liquidity is within the broking firm in their flow, their natural flow, their organic flow or whether that is liquidity that the buy side shops are sending down to the market into Liquidnet or other. That is more block non-displayed liquidity. STEVE WOOD: However, the argument is that one of the first electronic dark pools was Euronext with its Iceberg orders. That is a dark pool. Exchanges then were the people that literally near enough invented the electronic version of a dark pool. CARL JAMES: It’s interesting that Brian and Tim, they are making different points, because Tim was saying that they would happily trade a small amount in a dark pool and what Brian was saying is that he wouldn’t want that signal if it was just a small lot in there.

HOW LONG MIGHT THIS MARKET IMPASSE LAST? BRIAN MARTIN: There is a lot of uncertainty out there still.

An interesting point that Carl made about how asset managers will look to go back to more familiar type of products and stay away from slightly more exotic types of instruments, is very true. Asset managers are not really going to be spending a lot of money in the future certainly. So IT will probably take a bit of a hit on that I would have thought. What will happen with the banks is going to be interesting. A split between more execution venues than

research venues, is probably the way but I do not think it will be that simple. I can’t quite see how it will work. There will be less brokers going forward—most people probably agree on that—certainly less global brokers going forward; a number of about five to six is probably about right. BOB MCDOWALL: Yes, we will see the emergence of Glass-Steagall again. We’ll have what I call public capitalism and private capitalism. Public capitalism, I’m afraid, is big amorphous utility financial institutions with clearly a spot of government involvement, not too much innovation competition. With that private capitalism can still thrive as long as it doesn’t … spill over in terms of creating systemic risk. That is one observation. The second is more of an anecdote. I came into this business in 1975 which was in this country about the worst time ever before the current time and the FTSE was down to about 140 and the fund managers had been virtually piling up cash for about a year before that. There was suddenly a tipping point, and literally the index had doubled in a period of three or four months. I sense we’ll have a tipping point in the second half of this year because what can you do with cash or gold but put it under the bed. There comes a tipping point in this environment where stocks will start to look attractive again and we’ll see a splurge. My personal view is that this will come in the third quarter of this year. TARUN KUMAR: A very difficult question and I don’t think anyone can say for certain when and how it will end. I am not terribly optimistic going forward and think there will be more casualties in 2009. I think the industry will go through many more changes with less people being employed overall. I think the buy side is way over serviced by the sell side as it stands and do not see how so many brokers can co-exist chasing the same business. From a market perspective I think any small short term gains won’t really help build confidence back. I think market will end flat to small up, which given where we have come from does not really mean a lot. CARL JAMES: I am slightly more bearish than most people round this table: I can’t see any recovery this year. We are going to look back in three to five years time and will not believe how many houses were around. If you look pre Big Bang, and you looked at the houses that were operating then particularly on the sales side the numbers and names are very different to today. In those days James Capel for instance was the number one research house, with a strong agency trading business. I think things will change a lot. The big global houses will keep chugging along. There will be a lot of small agency houses springing up, and the midtier houses will have a harder time. I also think the electronic trading space will get bigger and bigger. JAMES DAY: My feeling is there is a wall of cash out there waiting to be invested. There is a statistic published that there is more money invested in US money market funds than there is in stock-market mutual funds. When that money finally comes in to play it will be a much bigger bounce than you would expect, the index will jump quite significantly. Volumes will start to come back as people get

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comfortable that we’ve Additionally there is going reached the bottom. The to be a question mark beneficiaries for it, it’s the whether risk capital is ever larger investment banks going to emerge again, let who have got their alone this year or next year. management structure in Since the brokers have place, they’ve got their obviously negated quite a focus and really now it’s substantial amount of their time to put their house in loss ratios and probably order. They will really deriving as much benefit from the upturn. commission, it will be Second tier brokers, the interesting to see how that other investment banks pans out. Electronic trading that haven’t really got their will become more act together, will probably pronounced in these struggle when the upturn volatile markets. Dark pools takes place. Hedge funds will probably become more were forced to liquidate advanced because trying to assets as investors grab liquidity is becoming withdrew money from the more and more difficult and the hunt for alpha is sector. In the fund-to-fund BOB MCDOWALL– Research Director Europe, Tower Group becoming a focus from the space there is, again, a load of money to be invested, there’s a number of start-up fund managers down to the trading desk level. The funds sitting in the wings. Why would you start up a hedge interplays between the FSA and Committee of European fund right now? You’ll see the hedge funds come back in, Securities Regulators (CESR) will become very interesting certainly not to the same extent that they were but you will over the next year. CESR is finding its voice and setting out its credentials in the marketplace. Then there is the still see them in there as an influence within the markets. BRIAN MARTIN: One would like to think that stocks are upcoming review of MiFID one year on: we shall have to cheap and that economies are going to recover, but I have wait for the conclusions of the review. Additionally, you are no view on that. A bear market focuses people’s mind on going to see more specialist firms come on line, more midtheir core businesses: what they do well, what’s peripheral tier firms go out of business and from that perspective to making money over the long term, what will add value maybe a consolidation of the brokerage list, but it is going to to shareholders and so on. Meanwhile, technology be a very different landscape by the end of this year and next continues to roll on and as markets fragment the mix year. The same goes for the MTF exchange marketplace. We becomes interesting. Firms will need to get up to speed and have already seen this process in the US through the 1990s to feel very confident that they are trading in the right with electronic communications networks (ECNs) so we venues, using the right broker supply technology. should not be surprised at the outcome. Moreover, with revenues down and trading volumes down TIM WILDENBERG: The slight concern here is that 70% in January 2009 over 2008, there is the possibility for a everyone thinks the market is going up, which tells me conflict of interest throughout the year—as the revenue normally that it isn’t. I generally am pessimistic and bearish from and to the sell-side contracts. The impact of that could so my sense is actually it is going to become really difficult. be interesting. Then there is the educational process that Consolidation in the broker segment is definitely going to needs to occur in markets, in the FSA and why they all gave happen (and it certainly would help me to have some more unconditional support to MiFID and the consequences of competitors disappear). The exchange space is that stance; the FSA for instance remains behind the curve interesting—we’ll see some new arrivals, however, net-net, and maybe the industry should help the FSA get to where there will be some consolidation by this time next year. it needs to be. Maybe Barclays Capital and UBS and others One development is rather interesting: although hedge should invite the FSA into their organisations to learn more funds per se lost money, what became very clear is that from the experts, assuming that those experts will be small, light, very low cost structures are effective ways to manage money and I predict we’ll see more of that. Just in around in the near future. That is a topic in itself. my own little space, to some extent, we are going to have STEVE WOOD: I’ll go down the same road as Brian. I believe markets will be higher at the end of the year—how much is to work harder and harder. Moreover, we have to put more debatable. Volatility is going to play a large part in how we intelligence into technology. Unfortunately you cannot actually undertake our trading this year, as it has done simply build it and walk away; you have to continue during the last year. That in turn will determine where our upgrading and refining the offering. Finally, of course, liquidity base is going to go and we are going to trade. We competition just keeps on coming and things do not seem will carefully look at where we trade and how we trade. to be getting easier, it just all seems to be getting harder.

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COST EFFICIENT TRADING?

POWER to the TRADE? The cost of trading breaks down into implicit costs (including market impact, risk and spreads) and explicit costs (covering commission, execution costs, clearing and settlement). While explicit costs can be predicted and allowed for, implicit costs are variable and unpredictable. Nonetheless, trading still carries a cost and brokers, the buy side and fund managers are all looking for the perfect balance between the best trade and the cheapest way to conduct that trade. However, identifying exactly how much each trade costs is not easy and cost, risk and service are all intertwined in this post-Lehman Brothers/MiFID, credit crunched world. As one broker puts it: “The cheapest way to trade is not to trade at all and if the only focus was cost, you would never trade at all.” Ruth Hughes Liley reports. HE HUGE QUANTITY of data and “the intricate puzzle of maintaining an accurate trail of executions and keeping variable execution costs low” are tasks for teams of people, according to TABB Group analyst, Matt Simon. He also authored the recently published TABB Group report Execution Cost Management: Improving margins, strengthening relationships, in which he notes: “The ever increasing number of execution venues – not to mention the proliferation of opaque or confusing pricing models – makes it all the more difficult for brokers to keep tabs on sourcing liquidity at the lowest cost.” Charging structures vary from the simple to the complex. Multilateral Trading Facilities (MTFs) generally have simple pricing models. For example, Nasdaq OMX Europe has a flat rate price promotional rebate of 0.25 basis points (bps) for adding liquidity on the market and a fee of 0.25bps for removing liquidity, although the deal ends on May 1st this year when a new fee structure comes into effect. Brokers are using cost plus models more frequently as well, where they charge a small premium to clients over how much

it costs them to transact the trade. There are discounts for large volume orders and venues are even wooing custom by offering free data and even cut price introductory offers. Many are finding it hard to keep track of changing pricing models. Scott Cowling, head of equity trading at Barclays Global Investors (BGI), says: “There are uncertainties about trading. You don’t know in advance how much you are going to trade or even if it will find the other side straight away. So by the same token you don’t know how much you could end up paying. Rates may sound small, but they all add up when you talk in big volumes.”

Andrew Bowley, head of electronic trading services, product management, Nomura, says Europe is seeing a move to smaller tick sizes: “There is an initiative to try to get industry-wide agreement on tick sizes and all four of the major MTFs have agreed to standardise tick sizes. This is about efficiency of the market and trying to avoid a tick size war as happened in the US where they had to introduce tick size regulation.” Photograph © Spectral-design/Dreamstime.com, supplied April 2009.

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Execution cost management systems are beginning to come on to the market and Matt Simon says: “Variable execution costs can be tracked, calculated and reported on more precisely as execution cost management (ECM) technology is implemented by firms of all sizes. Many brokers already feel they have a strong grasp on their execution choices and are continually monitoring venues for the best prices and best executions. Still, there is more than ECM technology can do to help them make the best trading decision as the structure of the marketplace evolves and expands. The future of managing equity variable execution costs is combining the data with transaction cost analysis (TCA) and improving trade decisions by reducing bills.” TCA has traditionally helped untangle the web of implicit costs with hindsight, but according to Paul Squires, head of trading at AXA IM, Europe’s Markets in Financial Instruments Directive (MiFID) has muddied the TCA waters. “There has been a deterioration in the quality of data that feeds TCA which depends on a nice clean platform. However, it is better than not having it at all. We know it is not 100% reliable and we know that some volumes will be double-counted for example, but you look for trends rather than a set of isolated statistics and this type of analysis can save costs.” The unbundling of research and execution in 2006 has brought benefits, according to some on the buy side, particularly through the use of commission sharing agreements. Squires says AXA IM, which has 13 commission sharing agreements (CSAs) in place, has more flexibility to pay for independent research than in the past, when they were held to a broker who might give good advice but had a bad trading desk.“We monitor how much business is done so we can see where the commission has been paid on execution in comparison with the advisory targets. If we hit our target in October, we still have November and December to generate excess commissions which we can then use to pay for independent research.” However, Clive Williams, head of the London equity trading team at T Rowe Price, thinks overall unbundling has cost more. “We are committed to small and mid cap stocks and this type of research has been divested by the bulge bracket firms as share prices have come down and make it less worthwhile investing. [However,] we are still having to pay for research, now with one of the new specialist houses. Net-net it probably costs us more.” One area where costs have undoubtedly risen is the implicit costs of market impact and risk. With the Chicago Board Options Exchange (CBOE) volatility index rocketing to 80 in December 2008 and falling back to 40 in February 2009—still double its highest pre-crunch levels, risk prices have risen for brokers.“Wider spreads are an indication of greater risk and hence a greater cost of covering that risk,” explains Richard Semark, managing director, client execution, at UBS.“Volatility has led to a rise in clearing and settlement costs because you have to post more collateral as margins have increased. Clients are trading with strict limits,VWAP or time-based algorithms over the whole day.

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Wider spreads benefit passive traders, but there is an opportunity cost from the waiting. I have definitely seen more reluctance to trade in blocks because of the uncertainty of how good the price will look at the end of the day,”he adds. Tick sizes play their own part in execution costs. Tick sizes are the increment set by an exchange by which prices rise or fall and therefore the smallest gap between bid and offer. In markets where tick size schedules, and therefore spreads, have large bands, typically in emerging markets, execution costs can balloon in a down market leading to a reluctance to trade and to a reduction in market trading activity, says a recent report by Credit Suisse, as well as to gap risk and price reversals after the open. Andrew Bowley, head of electronic trading services, product management, Nomura, says Europe is seeing a move to smaller tick sizes:“There is an initiative to try to get industry-wide agreement on tick sizes and all four of the major MTFs have agreed to standardise tick sizes. This is about efficiency of the market and trying to avoid a tick size war as happened in the US where they had to introduce tick size regulation. We are very keen to trade competitively across multiple venues and we don’t want to see one venue at a disadvantage based on tick size alone. It is not the basis for good competition.” One area in which the buyside has been cutting costs is in its increased used of direct market access (DMA) and algorithmic trading.This type of low-touch trading carries the lowest type of commission at typically 3bps to 5bps for cash equities. Today it is estimated that more than a quarter of buy side traders have turned to algorithms for more than 40% of trading. T Rowe Price, for example, is doing between 35% and 50% of business through DMA today compared with around 15% in 2004. Williams says: “Clients are benefiting from cost savings. Instead of paying 15bps or 20bps per trade they are only paying a fraction. Sure, we have had to put in order management systems and execution management systems, but smart order routing and our DMA connections are supplied by brokers because they have to make sure that best execution is adhered to, so it’s not costing the buyside much now in the way of technology.” Trading with algorithms is about efficient management of liquidity, according to Nomura’s Bowley. The bank inherited much of Lehman Brothers electronic trading capacity when it bought Lehman’s London based equities business and Bowley says it is a lynchpin of their offering. “Algorithms are part of a suite of trading tools. The part which is growing is smart order routing technology and

“Wider spreads are an indication of greater risk and hence a greater cost of covering that risk,” explains Richard Semark, managing director, client execution, at UBS.

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this is a function of fragmentation and the post-MiFID landscape. Risk traders make risk decisions, sales traders advise and algorithms provide an aid to execution efficiency and can save money.” Looked at from the buy side, some feel that brokers were aggressively pushing technology last year. Squires at AXA IM, says: “Technology does not lend itself to discreet conversations.You can post an interest in a large trade in a dark pool but success in execution is sometimes based on a relationship and a good conversation. This type of hightouch trading ‘costs more’, but people get fixated on commission rates. If you are improving execution performance by more than the increased commission you are paying, then it has to be worth it. We are often building positions for our fund managers for several months or even several years, so liquidity becomes more important than spreads. MiFID caused a fragmentation of liquidity, but more important was the collapse of traditional investment banking which caused a paradigm shift, one consequence of which was a deterioration in liquidity. “Traditionally it was larger brokers who could provide instant liquidity – they would provide a risk price. It was expensive and only a few investment banks were able to offer it. But post-Lehman’s they can’t take such big risk positions. They still use ‘facilitation’ but it’s nowhere near the levels of before. Fund managers too don’t want to take on such big positions, and with volumes so low, it means there is potentially more market impact than previously because your trade is a bigger share of the whole and so that’s a big potential cost area.” Bowley believes that market impact can be much reduced when brokers use internal crossing.“Crossing has huge benefits.You can save half the spread by trading at the midpoint for an order that would otherwise have crossed the spread and in a large trade that is critical for best execution. It gives an enormous reduction in fees: trading fees to exchanges, clearing fees to central counterparties and settlement fees to agents. Finally, it aids liquidity management for the sellside because you can cover positions internally in providing a risk facilitation capability linked to your dark pool.” Twelve months ago clearing and settlement costs had come down making it cheaper to trade. Now, however, with orders split up and worked over several venues each with different clearing houses, this could mean several sets of clearing and settlement fees. Compared with the United States, European settlement fees are huge. The Depository Trust & Clearing Corporation (DTCC), the principal clearing house in the US, claims:“Europe’s average clearing fees are more than 11,000% higher than in the US—$0.34 per side, compared to just $.003 per side here. European trading firms are paying millions of dollars more every year to clear trades under a fragmented system.” Semark at UBS notes that: “We have started to see interoperability between clearing houses, but there is a long way to go until we have a situation like the US. It is important because each venue that you trade at needs to be confident

Scott Cowling, head of equity trading at Barclays Global Investors (BGI), says: “There are uncertainties about trading.You don’t know in advance how much you are going to trade or even if it will find the other side straight away. So by the same token you don’t know how much you could end up paying. Rates may sound small, but they all add up when you talk in big volumes.” Photograph from the Berlinguer archives, supplied April 2009.

that both sides of the trade are good, so interoperability or connectivity is vital. Higher margins have to be posted and there is no consistency between clearing houses as to what you can post as collateral. Without interoperability the efficiency of netting off positions disappears. Taking offset positions on different platforms does not give any netting efficiency if they use different clearers.” TABB Group analyst Miranda Mizen suggests that central counterparties need to consolidate into three clearing houses in Europe to bring enough breadth and depth of services and economies to their members. “However, large-scale interoperability in Europe is not the answer. Without consolidation, new clearing houses add to complexity and brokers’ margin fragmentation.” Overall under MiFID, whether fees and costs of trading have risen or fallen is still open to debate. As one set of costs fall (exchange fees, for example) another set of fees goes up such as clearing fragmented trades. BGI’s Cowling believes that trading decisions are based more generally:“If you want a broadband package, your first decision is whether you want it to cover the phone or your television or your computer or all. Only when you have made that decision will you decide on the nitty gritty—what speed, how long a contract and so on. MiFID hasn’t reduced costs and has probably raised them. There is a greater focus on compliance, on legal accuracies and trading costs. There have been huge set up costs, but are clients better off? Not really. There has been a lot of work just to stand still.”

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Photograph © Orland Florin Rosu/Dreamstime.com, supplied April 2009.

NYSE Arca Europe is the latest multilateral trading facility (MTF) to burst on to the European trading scene and it wants to be leader of the pack – or at least in the top three - within 18 months. If past history is anything to go by, then the organisation’s ambitions are not unrealistic. It has been only two years since its parent company, “ NYSE Euronext, was formed after a merger between the New York Stock Exchange Group and Euronext. It now claims to represent nearly 40% of the world’s cash equities trading volume; the most liquidity, it says, of any global exchange group. This latest addition to the European scene plans to offer high frequency, high speed, low-cost trading in the most liquid blue chip stocks not currently offered through Euronext. How might it fare? Ruth Hughes Liley reports.

F T S E G L O B A L M A R K E T S • M AY 2 0 0 9

IGH SPEED AND low cost is the only way to start a market,” holds Cees Vermaas, executive director, sales and relationship management, European cash markets at NYSE Euronext. “You need to create the possibility for electronic trading firms to arbitrage between platforms. This is the way to start. With low fees we will add more flow from existing Euronext clients and then some firms come in using their smart order routers. And finally you reach the tipping point of 10% to15% of market share. We cannot take too long to reach this tipping point.” Phase one of NYSE Arca Europe’s launch on March 9th this year offered 377 stocks on a central limit order book from nine countries: Austria, Denmark, Finland, Germany, Italy, Norway, Spain, Sweden and Switzerland. In early April it added 159 UK blue chip stocks from FTSE and followed up with stocks from Ireland. In total it will offer more than 600 stocks from the Committee of

PROFILE: ARCA – THE NEW MTF ON THE BLOCK

ARCA SETS OUT ITS STALL

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European Securities Regulators’ (CESR) most liquid list. Clearing and settlement will be managed by EuroCCP, the European arm of the US Depository Trust and Clearing Corporation (DTCC). NYSE Arca Europe was originally scheduled to launch back in 2008. According to Vermaas market volatility did not play a part in the later launch date. Rather it was because NYSE Arca Europe wanted to be ready with its new Universal Trading Platform (UTP). Once UTP was rolled out through Europe on the 16th February the scene was set for Arca, which launched three weeks later on 9 March. Vermaas explains: “No-one can foresee how the market is going to look in a couple of months’ time. On the one hand it is not a good time to launch, on the other hand it is a very good time. This volatile situation might go on for a while, but it is better to start now with a willingness to have risk exposure so we are completely ready when a lot of clients and stocks start trading.” Top of Vermaas’priority list has been to draw liquidity to NYSE Arca Europe through its low cost flat rate fee structure of 0.15 basis points (bps) for both making and taking liquidity. Two weeks after NYSE Arca Europe’s launch, a new transaction fee structure affecting the whole of NYSE Euronext was announced. Arca’s flat rate fee is accompanied by a rebate for trading on the linked regulated markets of Euronext (Amsterdam, Brussels, Paris and Lisbon). A specific liquidity sponsor scheme to boost volume on NYSE Arca Europe launched in mid-April and it aims to focus on highly liquid blue-chip stocks with up to seven liquidity sponsors.“We have a mixture of banks and high frequency traders for the flow and market makers for the attractiveness of price,” says Vermaas. “The discounted price for generating volume on NYSE Arca Europe is a huge incentive. And we have had an enthusiastic responses from our clients.” Bridging the gap between NYSE Arca Europe, Euronext and the new non-displayed block trading facility, SmartPool, will be further facilitated by the new trading platform. Once the US is on the UTP from Q3 2009, clients will have a one-stop-shop to access all NYSE Euronext’s cash and derivatives markets, NYSE Arca Europe and Smartpool. And it is fast, claiming to offer the highest speed trading in Europe, at 150 microseconds (a microsecond is one millionth of a second). On that basis: “We believe Arca is on the fastest platform in Europe, which attracts the high-speed traders. There is no new line, no new equipment. The only thing clients have to do is to allocate space on their servers. Once they are a member of Euronext, they can extend their membership to Arca. This integration is unique,” explains Vermaas. “The general strategy is to have coverage of Euronext globally with choices between Smartpool our dark pool, Euronext’s liquid regulated markets and the high frequency, high speed, low cost Arca. These might converge.” NYSE Arca Europe is the extension of NYSE Arca in

“No-one can foresee how the market is going to look in a couple of months’ time... This volatile situation might go on for a while, but it is better to start now with a willingness to have risk exposure so we are completely ready when a lot of clients and stocks start trading,” says Cees Vermaas, executive director, sales and relationship management, European cash markets at NYSE Euronext.

the US, an electronic trading platform with displayed and dark liquidity, trading more than 500 million shares of non-displayed liquidity every day. The European model was built through consultation with colleagues and clients in the US at every stage, where volumes are six times higher. “We learned we had to position ourselves in comparison with Nasdaq OMX and BATS, but NYSE Arca Europe’s competitive strengths are obvious as it leverages the trading expertise of a global leading exchange,” says Vermaas. “We have also built the model looking at the US where volumes are six times higher because of more usage of electronic trading and more competition among more than 40 venues. But electronic trading is developing so fast. In Europe a couple of years ago the average transaction was €20,000. Today it is €8,000, so there is a huge increase in transactions of smaller sizes. We have seen more principal trading than agency trading and principal trading is more price sensitive with low prices and smaller margins. Pricing is under pressure and so we need to encourage more activity. We are not completely in line yet, but are not totally dependent on volumes either. Global business may be on the board’s agenda list, says Vermaas.“If you are going to attract global business, you have to be big. We have a big stake in Qatar and a memorandum of understanding in Shanghai. The US and Asia are already trading in Arca, but to do so, they have to have a base here in Europe. Firms from the US are coming into London and Dublin in particular because it is English speaking, and we see this trend continuing in spite of current conditions. In the US, once the UTP is rolled out we might talk about connections between US and Europe, but there are many regulatory issues to overcome before that.” “A lot of clients are in survival mode just to exist in three years’ time,” thinks Vermaas. “For ourselves, if markets are recovering, with our US experience and our brand, we are confident that our strategy is going to work and this is reflected by what our clients are telling us. My estimate is that the MTFs will probably be doing 40% to 50% of trade in Europe in three years’ time and we would like to be leading in this market.”

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Algorithmic trading solutions are often the proprietary preserve of international investment banks with the financial clout and established trading technology required by clients. How then does a small company based in Great Neck, New York regularly win prizes for its multi-asset algorithmic trading offerings? Francesca Carnevale talks to FlexTrade’s chief executive officer, Vijay Kedia, about the firm’s business development strategy.

PROFILE: FLEXTRADE

Why being broker neutral works best IJAY KEDIA, CHIEF executive officer of technology company FlexTrade, is proud of his firm’s achievements. “We have always taken great pride in working hard to provide leading edge trading solutions to our clients—whether it is for speed, innovation, access to the widest range of liquidity providers, the largest suite of pre-packaged algorithms, straight through processing or complex event processing,” he says. Kedia can point to the fact that the firm was honoured in three consecutive years by readers and judges of industry specialist FXWeek’s e-FX Awards for being the provider of the “best algorithmic trading solution for foreign exchange in terms of technology and the range of services provided to clients,” according to the official blurb. FlexTrade won its accolades for FlexFX, which is marketed as a neutral solution with multiple connectivity options and flexible foreign exchange trading capabilities. The system, explains Kedia, helps minimise market impact, transaction costs and risk exposure: “Offering tools to implement intelligent trading strategies, including user-defined analytics for real-time quantitative trading and order management. At the same time, it supports individual trading strategies with customisable analytics, integrated quantitative capabilities, smart routing connectivity and low latency data.” Founded in 1996, FlexTrade Systems now provides broker-neutral algorithmic trading platforms and execution systems for equities, foreign exchange and listed derivatives. Its flagship algorithmic platform is the award winning FlexTRADER, which Kedia says is known for its “high performance and multi-asset capability.” It is also regarded by the industry, he says, as “the most innovative execution management system of the last 12 months”. FlexTRADER EMS is the company’s current claim to fame. The firm works out of offices in North America, Europe and Asia and now boasts a worldwide client base spanning more

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PROFILE: FLEXTRADE

than 120 buy- and sell-side firms, including investment banks, asset managers and institutional brokers. Kedia is adamant that discrete firms such as FlexTrade are best placed, as independent providers of services to harness the changes running through the global trading market. “People ask: ‘How does the market cope with ever changing technology?’ We turn that on its head,” says Kedia. “Technology allows the market to deal with fragmentation and while trading houses, exchanges and the buy side are all working with technology to ensure they are not disadvantaged by higher latency or market fragmentation. We hold that the crucial role that FlexTrade plays in this regard is levelling the playing field.” In fact, increasing market fragmentation helps FlexTrade, holds Kedia, “more so because of the greater role that technology plays in a fragmented environment. In addition, the buy side in using technology such as ours can maintain confidentiality throughout the entire trading portfolio. That is where the advantage of being neutral lies in the overall equation. The trader can utilise different algorithms to suit various trading situations and still enjoy anonymity.” Through its platform, holds Kedia, the buyside now has exactly the same technology as the sell side and “as an important source of liquidity, where there is appropriate technology, we can link orders seamlessly, even in markets with a high level of fragmentation.” It is a significant leveller, as traditionally the sell side trader has survived on intermediating orders. However, the global trading markets are undergoing significant change and among the most salient is the rise of the buy side in the overall trading universe as it seeks to maximise trading efficiency.“It is a fluid relationship and where we come in is in balancing that relationship.” In part, this is because of the “increased flexibility” that Kedia says is embedded in its offering. “The buy side can utilise our system to write its own algorithms. It can also decide to utilise a number of algorithmic trading programmes to suit particular situations. That flexibility is simply not embedded in the sell side offering. In some instances, it is a one size fits all offering, though that is not always the case and some brokers have specialist algorithms that are suited to particular trading styles.” However, the key selling point for the FlexTrade offering is that the client has active and complete control over the trading process with seamless access to all sources of liquidity as well as sell-side capabilities.

The sell side advantage Even so, Kedia is aware of the embedded advantage enjoyed by the sell side. “Certainly, dark pools have to a degree given the sell side control again of that buyside order. Remember that the sell side is good at seeking advantage and proves its expertise in the growing array of services it offers; because of this proactive approach, it stays one step ahead of its buy side clients.” Kedia gives a nod that when FlexTrade was initially built, “it was with the buy side in mind. That is why we chose a broker neutral stance—one that could access all brokers. In other words, we are the other side of fragmentation.”

Initially, the business was built out in the United States, and embroidered by a few“early adopters”in the European trading theatre. “Interestingly, and to our huge surprise,” smiles Kedia, “despite that buy side focus we ended up selling large amounts to the sell side.” Looking ahead, Kedia says the challenge, as more markets take on an electronic character and there is an increasing depth of market data to deal with, is“to stay ahead in terms of new ideas, services and technology and adapt product to regional needs. In the US, for instance, we are looking at the provision of consolidated feeds via a single pipe, while Europe is only now catching up in this regard.”

Opportunity knocks However, Kedia is brightened by the opportunity before him.“Europe certainly has lofty goals in the search for best execution and ultimately that means laying down a new layer of technological groundwork.” While the future is bright for FlexTrade, it is also multi-focused.“Actually we also do asset classes other than equities quite well and we are looking to raise functionality across a number of segments.” This multi-stranded approach is paying off in “buckets,” holds Kedia, “simply because of the need to provide services in depth. It also gives the buy side alternative sources of liquidity to boot. Additionally in this post crisis environment, with increased focus on regulation and risk management, new iterations are designed to allow the buy side and the sell side to improve their risk management systems, particularly in terms of hedging exposure across the entire multi-asset portfolio of securities.” The globalisation of the FlexTrade offering is the next logical step. “Most of our customers are already well established in the Asian trading markets—either hedge funds or trading desks embedded in traditional fund aggregators. As more desks trade internationally, it is encouraging us to expand both our sales reach and hone our products accordingly.” The future, thinks Kedia, will see greater demands from the buy side. “Technology has freed the buy side and independent providers such as ourselves have added to that freedom of movement. The buy side is no longer tied strongly to the sell side and that benefits both,” he maintains. “The sell side remains committed to innovate and think in terms of overall service packages, and the buy side enjoys increasing market efficiencies.” In part that trend will accelerate, he thinks, as expertise from the sell side increasingly migrates to the buy side as broker/dealing operations at the large investment banks shrink in the current economic climate. “Our work is cut out in supporting that movement, offering the increasingly sophisticated buy side trading desk ultimate flexibility and ease in deciding where and when to trade, and allowing efficient price discovery in the market. Moreover, we couple that with functionality that lets the customer analyse his trading activity and introduce proper risk management controls that apply across the portfolio. In that respect, we are working towards providing tomorrow’s needs now.”

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The Fidessa Fragmentation Index (FFI) was designed to provide the trading community with an accurate, unbiased measurement of the state of liquidity fragmentation across the order driven markets in Europe. Liquidity is fragmenting rapidly as new MTFs have unveiled a range of low cost alternative trading platforms. It is essential for both the buy and the sell side to understand how different stocks are fragmenting across the new venues. To make it easy to measure and compare fragmentation across Europe, the Fragmentation Index provides a single number to show how a stock or index is fragmenting. It is calculated using proven mathematical principles and shows the average number of venues that should be visited to achieve best execution when completing an order. An FFI value of 1 therefore means that the stock is still traded at a primary exchange. An FFI value of 2 or more shows that the stock has been fragmented significantly and can no longer be regarded as having a primary exchange. The FFI is calculated daily across all the constituents of the major European indices, which illustrates how many stocks are fragmenting and the rate at which they are doing so.

Venue turnover in major stocks: August 2008 through March 2009 (Europe only). (â&#x201A;Ź) August

September

BTE/BATs

October

November

December

January

February

March

12,912,601

1,692,679,055

3,117,405,897

4,790,110,404

5,600,695,181

8,284,331,344

CIX/Chi-X

65,485,105,599

100,401,073,369

106,153,062,152

55,474,806,309

37,565,687,908

46,712,279,892

44,287,264,624

57,055,170,476

CPH/Copenhagen

6,715,541,919

9,088,419,945

9,799,125,787

5,627,172,892

3,169,443,325

4,658,766,694

4,781,868,780

4,172,100,968

ENA/Amsterdam

40,078,363,113

62,969,948,029

58,477,575,182

29,515,979,897

23,377,293,076

28,998,109,764

28,228,747,464

33,374,484,823

ENB/Brussels

7,769,551,527

12,362,582,317

10,689,261,202

5,618,466,860

5,525,054,653

6,557,604,579

6,677,562,065

7,285,738,551

ENL/Lisbon

3,265,459,550

4,358,621,402

4,105,636,725

2,613,601,564

1,781,804,343

1,942,925,835

1,699,902,475

2,192,516,989

ENX/Paris

89,561,950,040

143,845,030,869

158,687,540,849

83,259,044,929

65,223,182,965

68,569,494,159

62,176,825,878

71,521,595,572

GER/Xetra

96,074,671,382

171,318,595,178

206,777,148,040

86,619,580,417

67,500,746,934

65,531,679,523

58,938,123,381

72,362,496,131

HEL/Helsinki

11,476,253,210

18,654,125,589

19,248,238,567

10,391,280,842

6,544,928,692

8,018,556,502

7,630,785,531

8,002,261,708

LSE/London

154,886,443,195

240,104,147,083

218,235,697,409

128,535,134,938

88,925,334,643

98,676,987,434

90,529,113,476

113,505,101,306

MAD/Madrid

44,029,717,439

79,041,830,393

86,557,745,208

47,772,645,094

38,385,030,437

43,520,648,521

37,123,194,201

45,141,078,254

MIL/Milan

47,007,014,009

103,999,753,619

69,520,744,329

40,577,825,970

27,355,375,071

33,878,620,775

33,642,167,059

40,867,417,146

17,962

45,339,983

138,799,631

290,807,724

603,441,883

487,436,557

489,152,477

NEU/Nasdaq-OMX STO/Stockholm

22,502,159,413

35,401,145,511

34,318,445,867

20,077,565,709

15,283,216,874

18,432,301,605

20,449,832,829

21,258,141,925

TRQ/Turquoise

311,082,282

17,716,364,835

27,088,688,572

19,577,155,245

15,473,634,349

26,311,426,009

29,084,346,493

23,016,525,997

VTX/SWX

48,685,822,760

79,997,213,817

86,469,471,856

45,647,116,803

35,217,759,178

39,198,800,982

41,645,468,998

42,750,059,854

Monthly Total

637,849,135,438

1,079,258,869,918

1,096,186,634,329 583,138,856,156

434,736,706,069

496,401,754,564

472,983,334,994

551,278,173,520

EUROPEAN TRADING STATISTICS

THE FIDESSA FRAGMENTATION INDEX (FFI)

Market share by venue in electronic order book trades in major stocks: August 2008 through March 2009 (as a percentage) (Europe only) August

September

October

November

December

January

February

March

BTE/BATs

0.00%

0.29%

0.72%

0.96%

1.18%

1.50%

CIX/Chi-X

10.27%

9.30%

9.68%

9.51%

8.64%

9.41%

9.36%

10.35%

CPH/Copenhagen

1.05%

0.84%

0.89%

0.96%

0.73%

0.94%

1.01%

0.76%

ENA/Amsterdam

6.28%

5.83%

5.33%

5.06%

5.38%

5.84%

5.97%

6.05%

ENB/Brussels

1.22%

1.15%

0.98%

0.96%

1.27%

1.32%

1.41%

1.32%

ENL/Lisbon

0.51%

0.40%

0.37%

0.45%

0.41%

0.39%

0.36%

0.40%

ENX/Paris

14.04%

13.33%

14.48%

14.28%

15.00%

13.81%

13.5%

12.97%

GER/Xetra

15.06%

15.87%

18.86%

14.85%

15.53%

13.20%

12.46%

13.13%

HEL/Helsinki

1.80%

1.73%

1.76%

1.78%

1.51%

1.62%

1.61%

1.45%

LSE/London

24.28%

22.25%

19.91%

22.04%

20.45%

19.88%

19.14%

20.59%

MAD/Madrid

6.90%

7.32%

7.90%

8.19%

8.83%

8.77%

7.85%

8.19%

MIL/Milan

7.37%

9.64%

6.34%

6.96%

6.29%

6.82%

7.11%

7.41%

NEU/Nasdaq-OMX

0.00%

0.02%

0.07%

0.12%

0.10%

0.09%

STO/Stockholm

3.53%

3.28%

3.13%

3.44%

3.52%

3.71%

4.32%

3.86%

TRQ/Turquoise

0.05%

1.64%

2.47%

3.36%

3.56%

5.30%

6.15%

4.18%

VTX/SWX

7.63%

7.41%

7.89%

7.83%

8.10%

7.90%

8.80%

7.75%

Monthly Total

100.00%

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EUROPEAN TRADING STATISTICS

TRADING DATA FOR THE WEEK ENDING 27TH MARCH (EUROPE ONLY) Venue turnover for the week ending 27th March Venue

Trades

European top 20 fragmented stocks

Turnover € 000’s

Share %

-1

London

3,382,357

25,004,444

21.80%

-4

Xetra

830,402

15,541,461

13.55%

-8

Paris

1,416,383

13,279,286

11.58%

-17

Chi-X

2,339,660

12,973,666

11.31%

-10

-34

Madrid

510,771

9,829,048

8.57%

-36

Milan

984,998

9,549,707

8.33%

-13

SWX

532,588

8,048,581

7.02%

-47

Amsterdam

733,516

6,194,190

5.40%

-65

Stockholm

340,902

4,725,354

4.12%

-16

Turquoise

451,731

2,883,790

2.51%

-22

-45

BATS

454,274

2,294,096

2.00%

-11

Helsinki

137,294

1,502,648

1.31%

-5

Brussels

221,855

1,262,972

1.10%

-74

-3

-9

-32

Wks

Stock

Description

BP..L

BP $0.25

2.12

RDSA.L

RDS 'A' 'A' ORD EUR0.07

2.11

RDSB.L

RDS 'B' 'B' ORD EUR0.07

2.04

REL.L

REED ELSEVIER ORD 14 51/116P

1.98

BA..L

BAE SYS. ORD 2.5P

1.9

BG..L

BG GRP. ORD 10P

1.89

RR..L

ROLLS-ROYCE ORD 20P

1.86

RBS.L

ROYAL BANK SCOT ORD 25P

1.86

NG..L

NATIONAL GRID ORD 11 17/43P

1.85

GSK.L

GLAXOSMITHKLINE ORD 25P

1.84

PHIA.AM

PHILIPS KON

1.82

SDRC.L

SCHRODERS NV NON-VTG SHS ?1

1.82

BATS.L

BR.AMER.TOB. ORD 25P

1.82

DGE.L

DIAGEO ORD 28 101/108P

1.81

CNA.L

CENTRICA ORD 6 14/81P

1.8

MRW.L

MORRISON (WM) ORD 10P

1.8

RDSA.AM

ROYAL DUTCH SHELLA

1.8

IMT.L

IMP.TOBACCO GRP ORD 10P

1.8

TRIL.L

THOMSON REUTERS ORD 25P

1.79

SSE.L

SCOT.&STH.ENRGY ORD 50P

1.77

-19

FFI

TW=This week; LW=Last week; Wks = Number of weeks in the top 20 over the last year.

Index market share by venue for the week ending 27th March Primary

Alternative Venues

Index

Venue

Chi-X

Turquoise

Nasdaq OMX

BATS

AEX

Amsterdam

74.84%

15.75%

3.03%

0.08%

2.19%

Copen.

Amst.

BEL 20

Brussels

58.20%

7.37%

2.23%

0.11%

1.61%

CAC 40

Paris

73.14%

13.85%

3.39%

0.06%

2.43%

6.30%

DAX

Xetra

81.05%

12.51%

2.33%

0.04%

3.00%

†

FTSE 100

London

75.22%

17.45%

3.88%

0.25%

3.21%

FTSE 250

London

87.21%

10.28%

0.46%

0.17%

1.88%

IBEX 35

Madrid

99.86%

0.08%

†

MIB 30

Milan

93.80%

4.59%

0.83%

0.02%

0.69%

NORDIC 40

Stockholm

60.84%

5.70%

1.29%

0.09%

0.23%

Paris

Xetra

3.54%

0.17%

30.15%

0.03% 0.10%

0.01%

†

0.03%

† 12.09%

Helsinki

†

0.05% 0.40%

19.35%

† market share < 0.01%

COMMENTARY When we first compiled these figures in January for FTSE Global Markets, there had been a steady rise in fragmentation of the major indices over the previous months. In contrast, February and March saw the rate of fragmentation flatten. At first glance, this might seem to indicate that liquidity was starting to reach a steady state or was even flowing back to the primary venues. Further analysis shows that this is not the case. Like many venues, Turquoise was launched with a liquidity incentive scheme that was aimed at providing a ‘kick start’ to trading on its platform. In this case, its investors were obliged to support the platform as market makers until the end of March this year. What we have seen then is the gradual pull back of this support as these obligations have withered. So where has this liquidity gone? Again, analysis of the figures shows that it has moved on to neither other MTFs nor back to the primaries—it has just been removed from the system altogether. Over the past week fragmentation has picked up again reflecting the new incentive schemes that MTFs, including Turquoise, have put in place. The trading community’s appetite for the lower costs offered by MTFs seems as voracious as ever—the problem is that with so many different venues to choose from, it is increasingly difficult to spot the winner.

All data © Fidessa Group plc. All opinions and data here are entirely the responsibility of Fidessa Group plc. If you require more information on the data provided here or about FFI, please contact: fragmentation@fidessa.com.

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ETFs

As a toolbox that can be used by both retail and institutional investors to gain exposure to most available equity benchmarks and many other fixed income and commodity indexes, exchange traded funds (ETF) continue to outpace many other products on today’s global markets. The rise in demand has sparked an increase in ETF issuance, and providers will likely continue to push the barriers of ETF structures over the coming years. David Simons reports from Boston.

T HAS BEEN exceedingly difficult to find winners in this downtrodden global marketplace, but one product that has managed to rise above the fray is the exchange traded fund (ETF). Attracted by their high liquidity and below-average expense ratios, over the past year investors have transferred some $112bn from mutual funds into ETF products globally. The ability to execute trades quickly and easily, including on margin, is a major benefit, and ETFs also allow investors to create a diverse portfolio using index-oriented, market-centric, commodities-based, or any

number of other strategies. Certain fixed income ETFs pay dividends as well, giving investors a regular rate of return and additional tax efficiency. ETFs historically find favour particularly during volatile markets, because traders are able to secure positions within entire sectors, rather than pick individual stocks and be vulnerable to the volatility of each security. The current wave of market volatility has been particularly good for business, compelling investors to get back to basics by seeking out the simplest products based on familiar benchmarks and trade with multiple counterparties. “While some ETFs can be thought of as ‘complex instruments,’ it is still pretty easy to understand what they are all about,” says John Fletcher, technical analyst of derivatives, ETFs & equities with London-based Charles Stanley & Co Ltd. “For example, the iShares FTSE-100 is just that—a fund that closely tracks the FTSE 100 index. One need not be a rocket scientist to get involved!” In a market clamouring for increased transparency, ETFs get high marks. Most ETFs publish daily net asset values (NAVs), and also allow investors easy access to the

ETFS GARNER INTEREST AMID MARKET VOLATILITY

EAGER FOR

Photograph © Svet13 / Dreamstime.com, supplied April 2009.

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Fuhr, head of ETF research, product’s current list of Barclays Global Investors. holdings. “There is nothing “People are concerned about more unnerving, especially in counterparty exposure, the today's markets, than not structure of products they are knowing what you are really using as well as the trading in,”says Fletcher. instruments used in the The liquidity and taxproducts they are investing efficiency of ETFs have, if in,” says Fuhr. “But more anything, become even more importantly, there is an apparent to institutional overwhelming concern over investors during these trying liquidity—the ability to be times, says Kurt Zyla, managing able to get in and out at any director and head of Index and time during a trading day. ETF Strategies, Mellon Capital Last year there were 18 Management. “On any given day, investors using ETFs can see trading days when the S&P exactly what is inside the moved by more than 5%— John Fletcher, technical analyst of derivatives, ETFs & something that had happened equities with London-based Charles Stanley & Co Ltd.“For portfolio, and then make their only a total of 17 times during decisions accordingly,”says Zyla. example, the iShares FTSE-100 is just that—a fund that the previous 53 years.” “That really helps explain their closely tracks the FTSE 100 index. One need not be a rocket In Europe, the adoption of increased popularity, even in a scientist to get involved!” Photograph kindly supplied by Undertakings for Collective difficult marketplace.” Charles Stanley & Co Ltd, April 2009. Investment in Transferable Claus Hein, executive director of Lyxor Asset Management, agrees. “In the current Securities (UCITS) III guidelines, permitting investment in a environment transparency is key, and ETFs are index tracking much wider range of underlying asset classes, has greatly funds with limited counterparty risk compared to derivatives." accelerated the move into ETFs.“UCITS funds, which were The ability to diversify across multiple market segments previously only allowed to invest 5% of its assets in ETFs, and asset classes is a singular benefit of ETF investing, says may now invest up to 20% in a single ETF,”says Fuhr.“So in Hein. Lyxor has seen significant demand for ETFs tracking that regard, the ways in which people are using ETFs have blue chip, broad-based equity indices such as the FTSE 100, certainly evolved.” Because they thrive on liquidity, ETFs have had a more MSCI USA and MSCI Europe. Fixed income and money market products have also risen in popularity in recent difficult time expanding into emerging territories where local laws prohibit foreign ownership of assets. At present months, says Hein. "ETFs should track indices that accurately reflect a there is no ETF representation on the London Stock specific market and provide a level of diversification which Exchange’s Alternative Investment Market (AIM) because, meets fund investment guidelines. In addition, we work says Fletcher, there is no guarantee from day to day what with a number of ETF authorised participants that must be the liquidity will be.“For instance, China has limitations on able to trade the index basket for fund creations and foreign ownership of shares and thus this creates a barrier to effectively offering a fund to follow the Shanghai index.” redemptions so index basket liquidity is very important." Under the right circumstances, however, the inherent structure of ETFs can be highly useful on the global ETF strategies The core/satellite model remains a popular ETF strategy, marketplace. Says Zyla,“Obviously it makes a great strategy says Fletcher. Investors purchase an underlying ETF to from which to go long in the market, but since they are follow a major index, giving the fund manager the beta exchange-traded tools, ETFs can also be used as a hedging element of the portfolio. “One would then buy satellites tool in order to short against a particular benchmark, which around this core holding either using ETFs or shares, again points to the diversity of this kind of product.” And commodities or a mixture of all, to try to achieve alpha. because they are efficiently packaged products, ETFs spare Some of the more ‘intelligent’ ETFs from (investment investors the time and energy otherwise required to go advisory firm) Powershares could be ideal for this strategy, shopping overseas, says Zyla. While passive ETFs offer the lowest costs, active ETF as they do not use a cap-weighted method of choosing the companies that make up their funds, but use fundamental products, which have been constructed with a more criteria to choose instead. This can often give investors fundamentals-based approach, have been gaining traction particularly within the registered investment advisor space, outperformance over and above plain-vanilla ETF funds.” Heightened concerns over the opacity of investment says Zyla. “Given the level of turmoil that we’ve seen, products that followed the collapse of Lehman Brothers people are going to be on the lookout for new ways of last September and the Madoff scandal months later have addressing the marketplace and that’s what these made investors take a second look at ETFs, concurs Debbie fundamental benchmarks are all about.”

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ETFs for MTFs Multilateral trading facility (MTF) Chi-X Europe began offering ETFs as a product back in mid-2008 with the introduction of BGI’s iShares line of indexed products, and business has been particularly brisk of late, says Hirander Misra, Chi-X Europe’s chief operating officer. From January to February alone, Chi-X saw its market share for the iShares AEX, an ETF product that offers exposure to the top 25 blue-chip companies in the Netherlands, rise from 1.8% to 11.8%. “That is really a fundamental difference,” says Misra.“Though the market isn’t as mature as it is in the US, we’ve seen an increasingly strong appetite for ETFs among investors throughout Europe. The recent figures show that the tide is getting much stronger.” Sparked by the European Union’s Markets in Financial Instruments Directive (MiFID), Misra sees a much more favourable regulatory climate in the EU over the near term, which will bode well for ETF adoption. Choosing the right kind of provider is a crucial part of the process, says Misra, in terms of getting real traction and volume. “Which is why when we look to trade ETFs, we want to use the most liquid instruments possible, because that is where the largest opportunity for us as a trading venue exists.” Experience is a definite factor when working the ETF market, adds Fletcher, who looks for managers/sponsors with a solid history of ETF issuance.“I would also want to have met the managers on either a one-on-one basis or at one of their many presentations. Again, in today's markets, one needs to be confident that the ETF issuer will be around next week!” Rising demand has led to an increase in ETF issuance, and providers will likely continue to push the barriers of ETF structures over the coming years, opening up previously difficult to access asset classes. Deutsche Bank’s DB x-trackers, which include a recently launched ETF that invests in an underlying basket of hedge funds, is one example of this kind of innovation.“The DB inverse ETFs have offered a new way of shorting the markets without using derivatives or needing margin accounts,” says Fletcher. “They have the added benefit of limiting the amount the investor can lose to the amount they have invested. If one were to use futures or write options, then the losses are unlimited. They also do not have an expiry date, so one will not see capital destruction through time value eroding the investment.” Meanwhile exchange-traded commodities (ETCs) primarily those focusing on precious metals, have been gaining favour as investors continue to seek a safe haven from the global economic slowdown. HSBC Bank, the world's leading custodian for ETCs, has been widening its services in this area, and over the next several months ChiX is looking to increase its exposure to gold and silver ETCs. Despite the upward trend, exchange-traded funds still have some catching up to do. Expanding ETFs as a retail product, in particular, continues to be a challenge, one that requires an ongoing educational effort in order to increase

F T S E G L O B A L M A R K E T S • M AY 2 0 0 9

Debbie Fuhr, head of ETF research, Barclays Global Investors.“People are worried about the kinds of holdings that money-market funds have had, and of course Madoff has underscored issuer-counterparty risk,” says Fuhr.“But more importantly, there is an overwhelming concern over liquidity—the ability to be able to get in and out at any time during a trading day. Last year there were 18 trading days when the S&P moved by more than 5%—something that had happened only a total of 17 times during the previous 53 years.” Photograph kindly supplied by Barclays Global Investors April 2009.

awareness among financial advisors and brokers.“Obviously investors are less likely to use the product if they’re not informed about it by their advisors,” notes Fuhr. “Increasingly, however, the high-net worth end of the retail sector is learning about ETFs on their own, and subsequently asking their end broker to help them get involved.” It is rare nowadays to find exchanges that do not include ETFs, and Fuhr expects the current level of uptake to continue, as investors increasingly look to ETFs to provide them with a degree of risk mitigation.“Usage is expanding, and I think at least in the short run, ETFs will be one of the preferred vehicles for all types of investors, whether they be sovereign wealth funds, hedge funds, pension plans or private banks.”

ETF Listings as of End February 2009

Ireland P Listings: T Listings: Managers: AUM:

Germany P Listings: T Listings: Managers: AUM:

Spain P Listings: T Listings: Managers: AUM:

Iceland

1 1 1 US$0.00 Bn

254 408 8 US$57.22 Bn

9 25 2 US$1.94 Bn

117 290 6 US$22.37 Bn

United Kingdom P Listings: T Listings: Managers: AUM:

Belgium P Listings: T Listings: Managers: AUM:

1 1 1 US$0.04 Bn

14 260 5 US$0.92 Bn

1 1 1 US$0.00 Bn

4 76 3 US$0.33 Bn

Netherlands P Listings: T Listings: Managers: AUM:

Portugal P Listings: T Listings: Managers: AUM:

South Africa

25 149 5 US$10.9 Bn

179 328 8 US$33.58 Bn

79 79 3 US$13.87 Bn

6 120 2 US$3.03 Bn

P Listings: T Listings: Managers: AUM:

19 19 5 US$0.75 Bn

Norway P Listings: T Listings: Managers: AUM:

Greece P Listings: T Listings: Managers: AUM:

Turkey P Listings: T Listings: Managers: AUM:

6 6 2 US$0.17 Bn

1 1 1 US$0.06 Bn

6 6 2 US$0.10 Bn

1 1 1 US$0.00 Bn

Indonesia P Listings: T Listings: Managers: AUM:

Sweden P Listings: T Listings: Managers: AUM:

India P Listings: T Listings: Managers: AUM:

Australia

7 7 1 US$1.28 Bn

11 11 6 US$0.68 Bn

Finland P Listings: T Listings: Managers: AUM:

1 1 1 US$0.11 Bn

New Zealand P Listings: T Listings: Managers: AUM:

6 6 2 US$0.27 Bn

Hungary

P Listings: T Listings: Managers: AUM:

Austria

P Listings: T Listings: Managers: AUM:

Japan

P Listings: T Listings: Managers: AUM:

1 1 1 US$0.01 Bn

1 21 1 US$0.04 Bn

61 63 5 US$22.52 Bn

3 3 2 US$0.28 Bn

5 5 4 US$2.58 Bn

37 37 6 US$1.26 Bn

South Korea

P Listings: T Listings: Managers: AUM:

Malaysia

P Listings: T Listings: Managers: AUM:

11 11 2 US$1.27 Bn

6 25 5 US$0.81 Bn

Singapore

P Listings: T Listings: Managers: AUM:

Taiwan

P Listings: T Listings: Managers: AUM:

2 2 2 US$0.05 Bn

11 23 5 US$12.08 Bn

Hong Kong

P Listings: T Listings: Managers: AUM:

Thailand

P Listings: T Listings: Managers: AUM:

Source: ETF Research & Implementation Strategy Team, Barclays Global Investors, Bloomberg.

P Listings: T Listings: Managers: AUM:

4 20 2 US$1.22 Bn

P Listings: T Listings: Managers: AUM:

1 1 1 US$0.04 Bn

Italy P Listings: T Listings: Managers: AUM:

P Listings: T Listings: Managers: AUM:

1 1 1 US$0.01 Bn

China

Slovenia P Listings: T Listings: Managers: AUM:

Switzerland P Listings: T Listings: Managers: AUM:

France P Listings: T Listings: Managers: AUM:

Canada P Listings: T Listings: Managers: AUM:

Mexico P Listings: T Listings: Managers: AUM:

4 4 2 US$1.01 Bn

694 707 18 US$402.16 Bn

United States P Listings: T Listings: Managers: AUM:

Brazil P Listings: T Listings: Managers: AUM:

EXCHANGE TRADED FUNDS: LISTING & DISTRIBUTION

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Worldwide ETF and ETP Growth

Assets US$ Bn

ETF Assets $2,200 Total

# ETFs 1,800

$2,000

1,600

$1,800

1,400

Assets USD Billions

$1,600 1,200

$1,400 $1,200

1,000

$1,000

800

$800

600

$600 400

$400

200

$200 $0 ETF Assets Total

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Feb-09

$0.8

$1.1

$2.3

$5.3

$8.2

$17.6

$39.6

$74.3

$104.8

$141.6

$212.0

$309.8

$412.1

$565.6

$796.7

$711.0

$593.0

ETF Commodity Assets ETF Fixed Income Assets ETF Equity Assets

$0.8

$1.1

$2.3

$5.3

$8.2

$17.6

$39.6

$0.0

$0.1

$0.3

$0.5

$1.2

$3.4

$6.3

$9.9

$12.4

$0.1

$4.0

$5.8

$23.1

$21.3

$35.8

$59.9

$104.0

$108.8

$74.3

$104.7

$137.5

$205.9

$286.3

$389.6

$526.5

$729.9

$596.4

$471.4

$15.6

$28.1

$45.9

$53.2

$68.5

134

271

274

461

714

1171

1590

1603

ETP Assets Total # ETPs # ETFs

202

280

282

336

Source: ETF Research & Implementation Strategy Team, Barclays Global Investors, Bloomberg.

ETF LISTINGS BY EXCHANGE (As of End February 2009) Region Listed

Country

Exchange

Australia China

Australian Securities Exchange Shanghai Stock Exchange Shenzhen Stock Exchange Hong Kong Stock Exchange Bombay Stock Exchange National Stock Exchange Jakarta Stock Exchange Osaka Securities Exchange Tokyo Stock Exchange Bursa Malaysia Securities Berhad New Zealand Stock Exchange Singapore Stock Exchange Korea Stock Exchange Taiwan Stock Exchange Stock Exchange of Thailand

Asia Pacific

Hong Kong India Indonesia Japan Malaysia New Zealand Singapore South Korea Taiwan Thailand Americas Brazil Canada Mexico US

Sao Paulo Toronto Stock Exchange Mexican Stock Exchange BATS Boston CBOE Chicago Cincinnati ISE FINRA ADF NASDAQ NYSE NYSE Alt NYSE Arca Philadelphia

EMEA (Europe, Middle East and Africa) Austria Belgium Finland France Germany Greece Hungary Iceland Ireland Italy Netherlands Norway Portugal Slovenia South Africa Spain Sweden Switzerland Turkey United Kingdom

Grand Total

Wiener Borse Euronext Brussels Helsinki Stock Exchange Euronext Paris Deutsche Boerse Athens Exchange Budapest Stock Exchange Iceland Stock Exchange Irish Stock Exchange Borsa Italiana Euronext Amsterdam Oslo Stock Exchange Euronext Lisbon Ljubljana Stock Exchange Johannesburg Stock Exchange Bolsa de Madrid Stockholm Stock Exchange SIX Swiss Exchange SWX Europe Istanbul Stock Exchange London Stock Exchange Chi-X (not an official exchange) European reported OTC

# Primary ETF

# Total ETF

AUM ($bn)

20 Day ADV ($m)

158

207

43.05

816.15

4 3 2 11 2 9 1 6 55 3 6 6 37 11 2

20 3 2 23 2 9 1 6 57 3 6 25 37 11 2

1.22 1.16 1.43 12.08 0.37 0.31 0.00 7.88 14.64 0.28 0.27 0.81 1.29 1.27 0.05

13.94 249.40 62.43 242.97 0.00 1.53 0.00 80.21 56.58 0.02 0.34 3.00 88.03 17.06 0.64

783

897

420.06

86,966.33

4 79 6 48 4 642 -

4 79 120 48 4 642 -

1.01 13.87 3.03 13.11 67.85 321.19 -

2.38 623.93 97.01 14,397.72 350.26 500.87 691.21 388.49 649.51 17,012.56 30,536.19 0.00 0.00 21,716.19 0.00

662

1,616

129.92

2,042.29

1 1 1 178 254 1 1 1 14 15 4 6 1 1 19 9 7 25 6 117 -

21 1 1 328 408 1 1 1 14 260 76 6 1 1 19 25 7 131 18 6 290 -

0.03 0.04 0.11 33.57 57.22 0.06 0.01 0.00 0.14 0.93 0.33 0.17 0.00 0.01 0.75 1.94 1.28 10.86 0.00 0.10 22.37 -

0.87 0.15 1.26 324.98 544.11 0.28 0.28 0.00 0.21 217.43 43.47 63.68 0.00 0.00 5.59 14.28 145.30 109.31 5.59 20.37 424.35 29.39 91.39

1,603

2,720

593.03

89,823.00

Source: ETF Research & Implementation Strategy Team, Barclays Global Investors, Bloomberg.

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EXCHANGE TRADED FUNDS: LISTING & DISTRIBUTION

Global ETF Assets by Type of Exposure, as at end February 2009 Number of ETFs

Total Listings

AUM ($bn)

% Total

North America - Equity 473 Fixed Income - All (ex-Cash) 156 Europe - Equity 344 Emerging Markets - Equity 233 Asia Pacific - Equity 133 Global (ex-US) - Equity 60 Commodities 53 Fixed Income - Cash (Money Market) 13 Global - Equity 99 Currency 13 Mixed (Equity & Fixed Income) 26 Total 1,603

630 276 703 454 216 63 91 25 223 13 26 2,720

$261.76 $97.10 $62.75 $61.98 $42.83 $32.03 $12.37 $11.66 $10.02 $0.27 $0.26 $593.03

44.1% 16.4% 10.6% 10.5% 7.2% 5.4% 2.1% 2.0% 1.7% 0.0% 0.0% 100.0%

Region of exposure

Fixed Income Cash (Money Market) Global - Equity Commodities

2.0%

1.7%

2.0%

Currency

Global (ex-US) Equity

5.4%

Mixed (Equity & Fixed Income)

Asia Pacific Equity

7.2%

Emerging Markets - Equity

10.5%

Europe - Equity

10.6%

North Americas Equity

44.1%

Fixed Income - All (ex-Cash)

16.4%

Source: ETF Research & Implementation Strategy, Barclays Global Investors, Bloomberg

TOP 25 ETF PROVIDERS AROUND THE WORLD: ranked by AUM, as of end February 2009 February 2008 PROVIDER

iShares State Street Global Advisors Vanguard Lyxor Asset Management db x-trackers ProShares PowerShares Nomura Asset Management Van Eck Associates Corp Bank of New York Nikko Asset Management Credit Suisse Asset Management Daiwa Asset Management Zurich Cantonal Bank EasyETF ETFlab Investment WisdomTree Investments Hang Seng Investment Management Nacional Financiera Commerzbank BBVA Asset Management UBS Global Asset Management Direxion Shares Credit Agricole Structured AM Claymore Securities

2008 Change

# ETFs

AUM ($bn)

% Total

# Planned

# ETFs

% ETFs

AUM ($bn)

363 101 38 115 101 64 143 29 19 1 8 8 23 8 57 10 50 3 1 50 8 8 16 24 56

$271.34 $104.16 $40.05 $28.71 $22.81 $21.42 $18.66 $12.93 $5.65 $5.12 $4.81 $4.71 $4.53 $4.38 $3.95 $3.92 $2.66 $2.65 $2.57 $2.21 $1.89 $1.83 $1.83 $1.61 $1.49

45.8% 17.6% 6.8% 4.8% 3.8% 3.6% 3.1% 2.2% 1.0% 0.9% 0.8% 0.8% 0.8% 0.7% 0.7% 0.7% 0.4% 0.4% 0.4% 0.4% 0.3% 0.3% 0.3% 0.3% 0.3%

14 30 5 2 0 88 43 0 12 0 0 0 1 0 12 0 64 0 0 0 0 0 38 11 14

2 3 0 0 3 0 1 0 3 0 0 0 0 4 3 0 0 0 0 0 0 0 2 0 2

0.6% 3.1% 0.0% 0.0% 3.1% 0.0% 0.7% 0.0% 18.8% 0.0% 0.0% 0.0% 0.0% 100.0% 5.6% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 14.3% 0.0% 3.7%

-$53.51 -$41.84 -$5.11 -$4.52 -$1.26 $1.10 -$3.62 -$2.00 $1.20 -$1.57 -$1.38 -$1.23 -$1.52 $1.08 -$0.52 $1.41 -$0.57 -$0.17 -$1.07 -$0.38 -$0.19 $0.43 $0.89 -$0.25 -$0.12

% % Market AUM Share

-16.5% -28.7% -11.3% -13.6% -5.2% 5.4% -16.2% -13.4% 27.0% -23.4% -22.3% -20.7% -25.1% 32.7% -11.7% 55.8% -17.5% -5.9% -29.4% -14.7% -9.2% 31.0% 95.6% -13.5% -7.6%

0.1% -3.0% 0.4% 0.2% 0.5% 0.8% 0.0% 0.1% 0.3% -0.1% -0.1% 0.0% -0.1% 0.3% 0.0% 0.3% 0.0% 0.1% -0.1% 0.0% 0.0% 0.1% 0.2% 0.0% 0.0%

Source: ETF Research & Implementation Strategy, Barclays Global Investors, Bloomberg. All data supplied February 2008.

NOTES At the end of February 2009 the ETF industry had 1,603 ETFs with 2,720 listings, assets of $593.03 billion, from 85 providers on 42 exchanges around the world. • YTD assets have fallen by 26.9% which is greater than the 18.4% fall in the MSCI World index in US dollar terms. The number of ETFs increased by 0.8% with 25 new ETFs launched, while 19 ETFs were de-listed. The average daily trading volume in US dollars increased by 11.7% to US$89.8 Bn YTD. European ETF AUM has fallen by 9.6% while the MSCI Europe Index is down 20.7% YTD in USD terms. In Europe net sales of mutual funds (excluding ETFs) were $18.1 billion while net sales of ETFs domiciled in Europe were $10.0 billion during January 2009 according to Lipper FMI. Important Information Source: ETF Research & Implementation Strategy Team, Barclays Global Investors, Various ETF Managers, Bloomberg. Please contact Deborah Fuhr on +44 20 7668 4276 or email Deborah.Fuhr@barclaysglobal.com if you have any questions or comments. This communication is being made available to persons who are investment professionals as that term is defined in Article 19 of the Financial Services and Markets Act 2000 (Financial Promotion Order) 2005 or its equivalent under any other applicable law or regulation in the relevant jurisdiction. It is directed at persons who have professional experience in matters relating to investments. These materials are not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use is contrary to local law or regulation. Although Barclays Global Investors Limited (“BGIL”) endeavours to update and ensure the accuracy of the content of this document, BGIL does not warrant or guarantee its accuracy or correctness. Despite the exercise of all due care, some information in this document may have changed since publication. Investors should obtain and read the ETF prospectuses from ETF managers and confirm any relevant information with ETF managers before investing. Neither BGIL, nor any affiliate, nor any of their respective officers, directors, partners, or employees accepts any liability whatsoever for any direct or consequential loss arising from any use of this publication or its contents. © 2009 Barclays Global Investors. All rights reserved.

M AY 2 0 0 9 • F T S E G L O B A L M A R K E T S

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Page 91

Number of Securities

Value of Securities (US$ Bln)

177,401

8,343

31,828

1,663

Securities Available for Lending Securities On Loan Securities Transactions

1,824,010

Group Results (USD): The following table details the aggregated group results for all Performance Explorer participants and provides a high level summary of the activity in particular assets. This table represents a summary of the 305 separate asset classes in the data set. Security Type

Lendable Assets (M)

Balance Balance vs vs Cash Non Cash (M) (M)

Total Utilisation Balance (%) (M)

SL Fee (Bp)

Daily SL Return (K)

Daily RI Return (K)

All Securities

6,531,472

779,367

528,636

1,308,003

All Bonds

3,651,977

474,369

344,265

818,635

Corporate Bonds

1,799,170

64,864

46,891

Government Bonds

17,43,336

405,170

296,474

Total Daily Revenue Return Share from (K) SL (%)

SL Return to Lendable Assets (Bp)

Total Return Lendable Assets (Bp)

SL Tenure (days)

16.83

22.56

53.2

8,197.7

19,340.6

20.85

4.29

37.0

976.0

8,407.2

42.39

2.94

9.06

104

11.61

0.79

8.12

111,755

5.62

9.11

42.62

282.8

119

1,323.0

21.38

0.52

2.60

701,644

37.62

3.46

36.00

142

674.6

7,017.4

9.61

1.09

14.19

116

All Equities

2,902,190

304,997

184,086

489,083

11.79

53.15

80.5

7,221.3

10,933.0

66.05

5.66

10.26

Americas Equities

1,754,240

197,720

32,512

230,231

10.63

41.92

83.80

2681.2

5,359.3

50.03

4.19

9.69

Asian Equities

322,843

25,418

26,178

51,596

10.92

79.46

97.53

1,138.8

1,397.8

81.47

7.37

10.26

European Equities

680,677

54,318

120,431

174,749

15.18

63.39

74.40

3,077.2

3,611.7

85.20

8.98

11.81

105

Depository Receipts

78,006

13,858

1,646

15,504

13.41

59.85

88.65

257.8

381.8

67.52

5.02

10.74

Exchange Traded Funds

47,414

12,460

2,178

14,639

11.89

1.07

26.98

4.4

109.7

3.98

0.30

8.30

Size isn’t everything, but the scale of activity in a security can be interesting, particularly if you hold that security.

Equities

Top 10 by Total Balance

Top 10 by Increase in Balance (Balance > 10 Mln Euro)

Rank

Stock description

Rank

Stock description

Novartis Ag

Tracker Fund Of Hong Kong

Total Sa

T&D Holdings Inc

Eni Spa

Xstrata Plc

Nestle Sa

Nomura Holdings Inc

Bayer Ag

Catlin Group Ltd

Sanofi-Aventis Sa

Ing Canada Ltd

Mizuho Financial Group Inc

Reuters Group Plc

Volkswagen Ag

Kone Oyj

Roche Holding Ag

Tyco International Ltd

E.On Ag

Hutchison Whampoa Ltd

Corporate Bonds

Top 10 by Total Balance

Top 10 by Increase in Balance (Balance > 10 Mln Euro)

Rank

Stock description

Rank

Stock description

Goldfish Master Issuer Bv (4.721% 28-Nov-2099)

Landeskreditbank BW-Forderbank (4.578% 30-Aug-2010)

Canada Housing Trust No 1 (4.55% 15-Dec-2012)

Goldman Sachs Group Inc (1.625% 15-Jun-2011)

European Investment Bank (6% 07-Dec-2028)

Metlife Inc (6.817% 15-Aug-2018)

Canada Housing Trust No 1 (2.7% 15-Dec-2013)

Caja De Ah. Y P. De Barc. (La Caixa) (3.625% 18-Jan-2021)

Canada Housing Trust No 1 (3.6% 15-Jun-2013)

Citigroup Inc (3.479% 14-Jun-2012)

European Investment Bank (5.625% 07-Jun-2032)

John Deere Capital Corp (2.875% 19-Jun-2012)

Kfw International Finance No 1 (6% 07-Dec-2028)

Ers. Eur. Pfan.-Und Kom. Ag In Lux. Sa (2.5% 03-Dec-2010)

Canada Housing Trust No 1 (3.95% 15-Dec-2011)

European Investment Bank (2% 10-Feb-2012)

Canada Housing Trust No 1 (4.6% 15-Sep-2011)

General Electric Capital Corp (1.625% 07-Jan-2011)

Canada Housing Trust No 1 (3.55% 15-Sep-2010)

Johnson Controls Inc (5.25% 15-Jan-2011)

SECURITIES LENDING DATA by DATA EXPLORERS

KEY PERFORMANCE EXPLORER STATISTICS as of 25 February 2009

Disclaimer and copyright notice The above data is provided by Data Explorers Limited and is underpinned by source data provided by Performance Explorer participants and also market data. However, because of the possibility of human or mechanical errors, neither Data Explorers Limited nor the providers of the source or market data can guarantee the accuracy, adequacy, or completeness of the information. This summary contains information that is confidential, and is the property of Data Explorers Limited. It may not be copied, published or used, in whole or in part, for any purpose other than expressly authorised by the owners. Data Explorers Limited www.performanceexplorer.com

F T S E G L O B A L M A R K E T S • M AY 2 0 0 9

info@performanceexplorer.com © Copyright Data Explorers Limited February 2009

DATA PAGES 33.qxd:.

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5-Year Total Return Performance Graph

Index Level Rebased (30 March 2004=100)

600 500

FTSE All-World Index

400

FTSE Emerging Index

300

FTSE Global Government Bond Index

200

FTSE EPRA/NAREIT Global Index

100

FTSE4Good Global Index FTSE GWA Developed Index ar -0 9

08 p-

FTSE RAFI Emerging Index

ar -0 8

07 pSe

ar -0 7

06 pSe

05 p-

ar -0 6 M

ar -0 5

04 pSe

ar -0 4

MARKET DATA BY FTSE RESEARCH

Global Market Indices

Table of Total Returns Index Name

Currency

Constituents

Value

3 M (%)

6 M (%)

12 M (%)

YTD (%)

Actual Div Yld (%pa)

FTSE All-World Index

USD

2,792

160.17

-10.5

-30.4

-42.6

-10.5

4.09

FTSE World Index

USD

2,363

378.12

-10.9

-30.5

-42.3

-10.9

4.13

FTSE Developed Index

USD

1,947

152.20

-11.7

-30.7

-42.0

-11.7

4.10

FTSE All-World Indices

FTSE Emerging Index

USD

845

353.19

1.3

-27.4

-46.9

1.3

3.98

FTSE Advanced Emerging Index

USD

416

331.57

1.4

-27.0

-45.8

1.4

4.45

FTSE Secondary Emerging Index

USD

429

409.02

1.2

-27.9

-48.4

1.2

3.27

3.99

FTSE Global Equity Indices FTSE Global All Cap Index

USD

7,516

254.33

-10.3

-30.7

-43.0

-10.3

FTSE Developed All Cap Index

USD

5,854

243.54

-11.6

-31.1

-42.4

-11.6

3.98

FTSE Emerging All Cap Index

USD

1,662

463.23

1.6

-27.3

-47.6

1.6

4.00

FTSE Advanced Emerging All Cap Index

USD

874

444.21

2.0

-26.4

-46.3

2.0

4.45

FTSE Secondary Emerging Index

USD

788

512.37

0.9

-28.5

-49.5

0.9

3.31

USD

716

171.25

-4.9

3.9

-2.9

-4.9

2.60

Fixed Income FTSE Global Government Bond Index Real Estate FTSE EPRA/NAREIT Global Index

USD

260

1359.87

-22.1

-47.3

-56.8

-22.1

7.63

FTSE EPRA/NAREIT Global REITs Index

USD

180

450.90

-26.3

-53.4

-58.8

-26.3

9.60

FTSE EPRA/NAREIT Global Dividend+ Index

USD

230

953.15

-22.1

-48.7

-56.5

-22.1

8.66

FTSE EPRA/NAREIT Global Rental Index

USD

217

510.06

-25.1

-52.1

-58.4

-25.1

9.11

FTSE EPRA/NAREIT Global Non-Rental Index

USD

630.61

-13.3

-30.1

-52.5

-13.3

3.88

FTSE4Good Global Index

USD

668

4057.40

-12.9

-32.0

-43.0

-12.9

4.75

FTSE4Good Global 100 Index

USD

103

3561.46

-12.5

-31.5

-41.5

-12.5

4.79

FTSE GWA Developed Index

USD

1,947

2181.53

-12.9

-33.3

-45.6

-12.9

5.54

FTSE RAFI Developed ex US 1000 Index

USD

1,020

3651.22

-14.9

-33.0

-47.6

-14.9

7.46

FTSE RAFI Emerging Index

USD

362

3758.96

0.1

-25.9

-43.3

0.1

4.27

SRI

Investment Strategy

SOURCE: FTSE Group and Thomson Datastream, data as at 31 March 2009

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Americas Market Indices 5-Year Total Return Performance Graph FTSE Americas Index

Index Level Rebased (31 March 2004=100) M ar -0 4

250

FTSE Americas Government Bond Index

200

FTSE EPRA/NAREIT North America Index

150

FTSE EPRA/NAREIT US Dividend+ Index

100

FTSE4Good USIndex FTSE GWA US Index 9 ar -0

FTSE RAFI US 1000 Index

Se p-

8 ar -0 M

07 Se p-

7 ar -0 M

06 Se p-

6 ar -0 M

05 Se p-

ar -0 M

Se p-

Table of Total Returns Index Name

Currency

Constituents

Value

3 M (%)

6 M (%)

12 M (%)

YTD (%)

Actual Div Yld (%pa)

FTSE Americas Index

USD

806

FTSE North America Index

USD

670

507.75

-9.5

-30.8

560.84

-10.1

-30.7

-38.6

-9.5

3.05

-38.0

-10.1

FTSE Latin America Index

USD

136

605.09

5.0

3.01

-30.7

-47.8

5.0

3.83

FTSE Americas All Cap Index FTSE North America All Cap Index

USD

2,650

229.80

USD

2,449

222.28

-9.6

-31.3

-39.0

-9.6

2.93

-10.2

-31.3

-38.5

-10.2

FTSE Latin America All Cap Index

USD

201

840.77

2.88

4.7

-30.8

-48.1

4.7

3.86

FTSE Americas Government Bond Index

USD

155

FTSE USA Government Bond Index

USD

138

188.78

-0.7

6.0

6.6

-0.7

2.57

185.90

-0.5

6.8

7.6

-0.5

2.54

FTSE EPRA/NAREIT North America Index

USD

FTSE EPRA/NAREIT US Dividend+ Index

USD

114

1436.06

-31.5

-58.7

-59.5

-31.5

9.14

785.03

-33.5

-59.8

-60.0

-33.5

9.32

FTSE All-World Indices

FTSE Global Equity Indices

Fixed Income

Real Estate

FTSE EPRA/NAREIT North America Rental Index

USD

111

486.81

-30.9

-57.7

-58.1

-30.9

9.02

FTSE EPRA/NAREIT North America Non-Rental Index

USD

168.11

-51.8

-81.9

-86.1

-51.8

16.13

FTSE NAREIT Composite Index

USD

113

1476.26

-29.9

-55.7

-56.2

-29.9

9.72

FTSE NAREIT Equity REITs Index

USD

3472.97

-31.9

-58.3

-58.2

-31.9

9.02

FTSE4Good US Index

USD

138

3313.43

-10.7

-31.6

-37.4

-10.7

3.02

FTSE4Good US 100 Index

USD

101

3194.15

-10.7

-31.6

-37.4

-10.7

3.00

SRI

Investment Strategy FTSE GWA US Index

USD

616

1986.77

-12.9

-34.2

-42.5

-12.9

3.39

FTSE RAFI US 1000 Index

USD

1,002

3233.06

-13.9

-34.8

-42.7

-13.9

3.39

FTSE RAFI US Mid Small 1500 Index

USD

1,496

2790.20

-15.4

-39.5

-42.8

-15.4

4.43

SOURCE: FTSE Group and Thomson Datastream, data as at 31 March 2009

F T S E G L O B A L M A R K E T S • M AY 2 0 0 9

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5-Year Total Return Performance Graph 500

FTSE Europe Index FTSE All-Share Index

400

Index Level Rebased (31 March 2004=100) M ar -0 4

FTSEurofirst 80 Index

300

FTSE/JSE Top 40 Index FTSE Gilts Fixed All-Stocks Index

200

FTSE EPRA/NAREIT Europe Index

100

FTSE4Good Europe Index

09 Se p-

08 Se p-

8 ar -0 M

07 Se p-

7 ar -0 M

06 Se p-

6 ar -0 M

Se p-

5 ar -0 M

FTSE GWA Developed Europe Index Se p-

MARKET DATA BY FTSE RESEARCH

Europe, Middle East & Africa Indices

FTSE RAFI Europe Index

Table of Total Returns Index Name

Currency

Constituents

Value

3 M (%)

6 M (%)

12 M (%)

YTD (%)

Actual Div Yld (%pa)

6.04

FTSE All-World Indices FTSE Europe Index

EUR

555

152.96

-10.2

-30.8

-40.6

-10.2

FTSE Eurobloc Index

EUR

1,986

84.89

-13.7

-31.7

-42.5

-13.7

5.12

FTSE Developed Europe ex UK Index

EUR

381

155.61

-12.2

-30.0

-40.4

-12.2

6.46

FTSE Developed Europe Index

EUR

495

151.85

-10.5

-30.1

-39.8

-10.5

6.11

FTSE Global Equity Indices FTSE Europe All Cap Index

EUR

1,635

236.92

-9.6

-30.9

-41.2

-9.6

5.95

FTSE Eurobloc All Cap Index

EUR

814

249.62

-13.3

-31.7

-42.8

-13.3

7.09

FTSE Developed Europe All Cap ex UK Index

EUR

1,110

257.13

-11.9

-30.3

-41.1

-11.9

6.41

FTSE Developed Europe All Cap Index

EUR

1,519

236.66

-9.9

-30.3

-40.4

-9.9

6.02

Region Specific FTSE All-Share Index

GBP

620

2508.94

-9.1

-18.3

-29.3

-9.1

5.12

FTSE 100 Index

GBP

102

2411.45

-10.3

-18.1

-28.2

-10.3

5.23

FTSEurofirst 80 Index

EUR

3214.71

-15.4

-31.9

-41.2

-15.4

7.62

FTSEurofirst 100 Index

EUR

2898.09

-12.4

-30.7

-39.1

-12.4

6.71

FTSEurofirst 300 Index

EUR

311

1003.73

-11.1

-30.0

-39.4

-11.1

6.07

FTSE/JSE Top 40 Index

SAR

2056.64

-4.1

-13.7

-30.3

-4.1

4.63

FTSE/JSE All-Share Index

SAR

165

2255.54

-4.2

-13.0

-28.5

-4.2

4.82

FTSE Russia IOB Index

USD

495.41

15.4

-40.7

-63.8

15.4

4.14

FTSE Eurozone Government Bond Index

EUR

234

173.42

0.8

6.9

7.6

0.8

3.73

FTSE Pfandbrief Index

EUR

393

193.00

0.9

5.6

5.1

0.9

4.49

FTSE Gilts Fixed All-Stocks Index

GBP

2295.86

-0.8

9.4

10.3

-0.8

3.74

FTSE EPRA/NAREIT Europe Index

EUR

1141.19

-15.4

-44.4

-55.7

-15.4

8.36

FTSE EPRA/NAREIT Europe REITs Index

EUR

417.87

-16.2

-45.2

-53.1

-16.2

8.53

FTSE EPRA/NAREIT Europe ex UK Dividend+ Index

EUR

1445.06

-9.8

-32.3

-44.4

-9.8

8.73

FTSE EPRA/NAREIT Europe Rental Index

EUR

446.28

-16.0

-44.4

-55.2

-16.0

8.54

FTSE EPRA/NAREIT Europe Non-Rental Index

EUR

348.53

4.4

-40.0

-63.5

4.4

2.97

FTSE4Good Europe Index

EUR

272

3042.50

-10.4

-30.0

-38.6

-10.4

6.41

FTSE4Good Europe 50 Index

EUR

2745.03

-10.5

-29.4

-36.1

-10.5

6.20

FTSE GWA Developed Europe Index

EUR

495

2002.84

-11.5

-32.9

-43.5

-11.5

8.54

FTSE RAFI Europe Index

EUR

527

3101.40

-12.5

-33.0

-42.9

-12.5

8.36

Fixed Income

Real Estate

SRI

Investment Strategy

SOURCE: FTSE Group and Thomson Datastream, data as at 31 March 2009

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Asia Pacific Market Indices 1200 5-Year Total Return Performance Graph

FTSE Asia Pacific Index FTSE/ASEAN 40 Index FTSE/Xinhua China 25 Index

800

FTSE Asia Pacific Government Bond Index

600

FTSE EPRA/NAREIT Asia Index 400

FTSE IDFC India Infrastructure Index 200

FTSE4Good Japan Index

9 ar -0

FTSE RAFI Kaigai 1000 Index

Se p-

8 ar -0 M

07 Se p-

7 ar -0 M

06 Se p-

6 M

ar -0

05 Se p-

5 M

ar -0

04 Se p-

ar -0

FTSE GWA Japan Index

Index Level Rebased (31 March 2004=100)

1000

Table of Total Returns Index Name

Currency

Constituents

Value

3 M (%)

6 M (%)

12 M (%)

YTD (%)

Actual Div Yld (%pa)

FTSE Asia Pacific Index

USD

1,281

180.88

-8.2

-23.5

-40.5

-8.2

3.95

FTSE Asia Pacific ex Japan Index

USD

824

320.59

-0.1

-23.2

-44.2

-0.1

4.71

FTSE Japan Index

USD

457

64.10

-8.9

-29.1

-36.0

-8.9

3.01

FTSE Asia Pacific All Cap Index

USD

3,035

304.46

-8.1

-23.3

-41.1

-8.1

3.96

FTSE Asia Pacific All Cap ex Japan Index

USD

1,781

391.41

0.1

-23.7

-45.5

0.1

4.77

FTSE Japan All Cap Index

USD

1,254

203.12

-8.8

-28.2

-35.3

-8.8

2.98

FTSE All-World Indices

FTSE Global Equity Indices

Region Specific FTSE/ASEAN Index

USD

148

300.47

-5.5

-27.7

-46.7

-5.5

5.40

FTSE Bursa Malaysia 100 Index

MYR

100

6163.36

0.7

-13.3

-29.3

0.7

4.36

TSEC Taiwan 50 Index

TWD

4666.50

11.2

-13.7

-35.7

11.2

7.54

FTSE Xinhua All-Share Index

CNY

970

6503.65

40.8

19.0

-31.7

40.8

1.26

FTSE/Xinhua China 25 Index

CNY

15674.43

0.2

-14.4

-35.4

0.2

3.55

USD

252

128.57

-8.4

9.3

2.1

-8.4

1.31

FTSE EPRA/NAREIT Asia Index

USD

1246.37

-13.4

-30.9

-50.8

-13.4

6.08

FTSE EPRA/NAREIT Asia 33 Index

USD

826.71

-13.6

-32.3

-48.8

-13.6

10.99

Fixed Income FTSE Asia Pacific Government Bond Index Real Estate

FTSE EPRA/NAREIT Asia Dividend+ Index

USD

1251.34

-9.3

-30.2

-51.1

-9.3

7.80

FTSE EPRA/NAREIT Asia Rental Index

USD

584.42

-15.6

-39.7

-54.0

-15.6

9.88

FTSE EPRA/NAREIT Asia Non-Rental Index

USD

691.57

-11.8

-24.0

-48.6

-11.8

3.61

Infrastructure FTSE IDFC India Infrastructure Index

IRP

544.92

-10.3

-34.0

-56.8

-10.3

1.08

FTSE IDFC India Infrastructure 30 Index

IRP

608.22

-7.8

-31.3

-55.1

-7.8

1.11

JPY

189

3062.82

-9.5

-31.0

-37.2

-9.5

3.23

FTSE SGX Shariah 100 Index

USD

100

3636.01

-9.5

-22.3

-38.7

-9.5

3.86

FTSE Bursa Malaysia Hijrah Shariah Index

MYR

7507.13

2.6

-10.3

-30.0

2.6

4.45

JPY

100

843.39

-7.2

-28.2

-37.3

-7.2

3.28

3.25

SRI FTSE4Good Japan Index Shariah

FTSE Shariah Japan 100 Index Investment Strategy FTSE GWA Japan Index

JPY

457

2207.82

-5.2

-27.4

-34.0

-5.2

FTSE GWA Australia Index

AUD

102

1986.77

-33.5

-46.4

-52.6

-33.5

7.66

FTSE RAFI Australia Index

AUD

4732.27

-0.6

-17.8

-25.6

-0.6

11.35

FTSE RAFI Singapore Index

6.50

SGD

4637.36

-4.8

-28.9

-39.4

-4.8

FTSE RAFI Japan Index

JPY

279

3066.12

-9.7

-28.8

-34.8

-9.7

3.34

FTSE RAFI Kaigai 1000 Index

JPY

1,023

2650.96

-7.0

-39.8

-47.4

-7.0

6.00

HKD

4496.02

1.2

-16.3

-32.9

1.2

3.46

FTSE RAFI China 50 Index

SOURCE: FTSE Group and Thomson Datastream, data as at 31 March 2009

F T S E G L O B A L M A R K E T S â&#x20AC;˘ M AY 2 0 0 9

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Page 96

CALENDAR

Index Reviews May - June 2009 Date

Index Series

Review Frequency/Type

Effective Data Cut-off (Close of business)

07-May

TOPIX

Monthly review - additions & free float adjustment

28-May

30-Apr

08-May

Hang Seng

Quarterly review

01-Jun

31-Mar

Mid-May

FTSE Med 100 Index

Semi-annual review

15-May

30-Apr

15-May

MSCI Standard Index Series

Annual review

29-May

30-Apr

Early Jun

ATX

Quarterly review

30-Jun

31-May

Early Jun

KOSPI 200

Annual review

08-Jun

31-May

Early Jun

IBEX 35

Semi-annual review

30-Jun

31-May

Early Jun

CAC 40

Quarterly review

19-Jun

31-May

Early Jun

OBX

Semi-annual review

19-Jun

31-May

Early Jun

S&P / TSX

Quarterly review

19-Jun

29-May

01-Jun

DJ Global Titans 50

Annual review of index composition

19-Jun

30-Apr

03-Jun

DAX

Quarterly review

19-Jun

31-May

05-Jun

S&P / ASX Indices

Quarterly Review

19-Jun

29-May

05-Jun

TOPIX

Monthly review - additions & free float adjustment

29-Jun

28-May

10-Jun

OMX I15

Semi-annual review

30-Jun

31-May

19-Jun

09-Jun

10-Jun

FTSE UK Index Series

Quarterly review

10-Jun

FTSE Global Equity Index Series (incl. FTSE All-World)

Annual review - Emgng Eur, ME, Africa, Latin America

19-Jun

31-Mar

10-Jun

FTSE techMARK 100

Quarterly review

19-Jun

29-May

10-Jun

FTSEurofirst 300

Quarterly review

19-Jun

29-May

10-Jun

FTSE eTX

Quarterly review

19-Jun

29-May

10-Jun

FTSE/JSE Africa Index Series

Quarterly review

19-Jun

29-May

10-Jun

FTSE EPRA/NAREIT Global Real Estate Index Series

Quarterly review

19-Jun

29-May

10-Jun

FTSE Bursa Malaysia Index Series

Semi-annual review

19-Jun

29-May

12-Jun

DJ STOXX

Quarterly review (components)

19-Jun

26-May

12-Jun

NASDAQ 100

Quarterly review/ shares adjustment

19-Jun

31-May

13-Jun

S&P BRIC 40

Semi-annual review - constituents

19-Jun

05-Jun

13-Jun

S&P US Indices

Quarterly review - shares

19-Jun

05-Jun

13-Jun

S&P Europe 350 / S&P Euro

Quarterly review - shares

19-Jun

05-Jun

13-Jun

S&P Topix 150

Quarterly review - shares

19-Jun

05-Jun

12-Jun

S&P Asia 50

Quarterly review - shares

19-Jun

05-Jun

13-Jun

S&P Global 1200

Quarterly review - shares

19-Jun

05-Jun

13-Jun

S&P Global 100

Quarterly review - shares

19-Jun

05-Jun

13-Jun

S&P Latin 40

Quarterly review - shares

19-Jun

05-Jun

Mid Jun

VINX 30

Semi-annual review

19-Jun

29-May

Mid Jun

OMX S30

Semi-annual review

30-Jun

29-May

Mid Jun

Baltic 10

Semi-annual review

30-Jun

31-May

Mid Jun

OMX C20

Semi-annual review

19-Jun

29-May

Mid Jun

OMX N40

Semi-annual review

19-Jun

31-May

16-Jun

S&P MIB

Quarterly review - IWF

19-Jun

08-Jun

19-Jun

Russell US Indices

Annual / Quarterly review

26-Jun

31-May

24-Jun

NZX 50

Quarterly review

30-Jun

31-May

Sources: Berlinguer, FTSE, JP Morgan, Standard & Poors, STOXX

M AY 2 0 0 9 â&#x20AC;˘ F T S E G L O B A L M A R K E T S

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