Capital International - Quarterly Update Q2 2011

Capital Update

Second Quarter 2011 Volume: 9

Issue: 2

Global Equities A Dull Quarter The period under review has seen low trading volumes across the globe and a gradual rise in anxiety levels amongst investors, notably regarding Greece and the potential threat of contagion across the Euro Zone. As concern over the speed of the economic slowdown has risen in China, there has been a ‘risk off’ mentality and there is probably more downside in asset classes such as commodities.

Economic data released through the period has shown consumers are facing a tough environment with stagnation in spending, a reflection of austerity measures and rising costs, notably in food and fuel. The Federal Reserve still maintain the view that in the US, domestic demand will pick up in the second half of the year.

However they will be ready for more QE, should deflation start to become an issue.

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V l International M isit o a t i p orn ur Ca in

Equity indices are now looking oversold with many more stocks hitting new lows than new highs. However, nor is there any real catalyst to drive markets higher over the summer and the key for any real traction will be the robustness of corporate earnings. The level of growth is certainly slowing but thus far they have managed to maintain high levels. However it has been notable in recent weeks that the number of profit warnings has started to rise.

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FTSE 100 Index 3000 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Continued on page 2

Source: Bloomberg - data as at 30/06/11

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This document has been prepared for information purposes only and does not constitute an offer or an invitation, by or on behalf of Capital International Limited, to buy or sell any security. The information contained herein is believed to be correct, but its accuracy cannot be guaranteed. Any reference to past performance is not necessarily a guide to the future. Opinions constitute our judgement as of this date and are subject to change.

The company, its clients and officers may have a position in, or engage in transactions in any of the securities mentioned. The information contained in this document is provided solely to enable the customer to make their own investment decisions. The price of a security may go down as well as up and its value may be adversely affected by currency fluctuations.

june 2011

Volume: 9

Issue: 2

Continue from page 1

The S&P 500 in the US has lost just over 3.5% on the quarter, whilst the NASDAQ fell 3.4% and the Dow Jones lost 2.3%. Europe has suffered with debt contagion fears and the MSCI Europe ex UK has fallen by just over 5%.

Meanwhile in the UK, the FTSE 100 has declined by 2.4% whilst the Small Cap Index was flat on the quarter.

The Emerging Markets have seen a net outflow of funds as investors became more nervous on the implication of inflation. There is also likely to be a shift towards commodity consumer economies rather than the commodity producers. Brazil has fallen by nearly 11%, the Indian market has lost 5% and the Shenzhen Index in China has lost close to 9%. The key question with China and to some extent, India, is the impact of the tightening cycle on the underlying economies.

A major negative for global equity markets remains Europe and investors are particularly concerned regarding Italy and Spain. They are simply ‘too big to fail’. A more worrying scenario would drag France into the equation. The Financial sector is firmly in the spotlight in this area and we remain underweight the Banks. Recent reports have suggested that around 1 in 6 banks will fail the latest round of stress tests. There is growing concern as to the impact of the declining residential property market and the impact on balance sheets.

Fundamentally dividend yields are still attractive when compared with base interest rates and bond yields. The current yield on the FTSE All Share Index is 3.25% with a P/E ratio of 14x, this is in line with the long run average.

We have highlighted in previous reports the strength of corporate balance sheets and many companies we hold will shortly be debt free. Essentially from an asset allocation point of view it feels like a risk neutral phase, whilst investors should be focussed more on the asset selection. We are certainly moving into the next phase of the equity cycle.

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Fixed Income Review We discussed in the last review that increased global economic uncertainty had led to a fall in bond yields and this trend has continued during the second quarter. The recent phase of the Greek crisis combined with fears that contagion could create another global banking crisis has led to poor investor sentiment. Economic data from many areas has shown slowing growth and the current global ‘soft patch’ could be an extended one. The US housing market remains poor and unemployment continues at ‘elevated’ levels.

However the US authorities still believe that growth will pick up in H2 and so any possible further round of quantitative easing could be some time away. It therefore feels as though yields should gradually rise over the summer as conditions in the Euro Zone normalise.

Interestingly, yield curves are beginning to flatten in countries where interest rate tightening has begun. This potentially highlights underlying deflationary forces.

The current 10 year Gilt yield stands at 3.3%, having begun the period at 3.6% and bottomed recently at 3.1%. Clearly recent inflation figures of 4.5% mean that real returns are materially negative and yields could head back towards 4% as the year progresses and economic growth accelerates. Although, further Bank of England asset purchases could keep yields in a fairly narrow range. We continue to believe that the first interest rate increases will not be until H2 2012, as the austerity measures continue to bite.

5.5 5.0 4.5 4.0 3.5 3.0

10-15 Year UK Gilt Yields

2.5 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Source: Bloomberg - data as at 30/06/11

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In the US, current 10 year yields stand at 3.09%, having hit a low of 2.87%. The performance of US sovereign debt has continued to surprise, as nearly 50% of government debt has to be rolled over in the next four years. Despite cutbacks US government spending was still 24% of GDP in 2010, the second highest figure since 1946. We are still of the view that at some point investors will become deeply concerned by the US debt position, it will not be a pleasant period.

Corporate bonds and notably the junk end still looks interesting, particularly against the backdrop of improving corporate finances. In the last 18 months, Moody’s have upgraded 50% more US high yield companies than they have downgraded. Although non Financials still offer limited upside, the Financials have underperformed in recent weeks and selective issues offer good value. It continues to make sense to keep overall duration short given that investors are not being ‘paid’ enough for the inflation risk.

Also in this issue: • US Housing Market Insight • Europe: Update • Economy in Focus: Russia

China – Hard or Soft Landing?

The Chinese economy has long provided a major conundrum for investors, with seemingly high economic growth rates, offset by corruption and inefficiencies.

There have been signs in recent months that the long cycle of investment could be coming to an end. Indeed, cynics would argue the last phase of growth has been through gross ‘over’ investment. It currently accounts for 50% of GDP and the eminent economist, Nouriel Roubini highlights previous crashes in the Soviet Union and East Asia as being closely correlated to the current issues facing China. China is still emerging as a major superpower and the US should be viewed as a declining power. In the long term there will be outbreaks of geopolitical tensions, particularly as China tries to expand its influence further away from its borders, in areas such as Africa, for instance.

Stories of half empty highways and vast swathes of vacant buildings are hard to quantify but it is clear in the current five year plan that the Chinese authorities are trying to switch the emphasis to boosting the level of domestic demand and to lessen the reliance on exports. The authorities have also reduced the targeted level of GDP expansion. Whilst millions of homes are being built per annum, we need to remember that many Chinese remain under housed while at the same time real incomes are rising rapidly. Indeed there are currently 40 million urban housing units under construction at the moment. Some surveys however, have highlighted that cities such as Tianjin and Dalian could have as much as 20 months of housing inventory.

Manufacturing seems to be changing as well, with the low end, labour intensive plants having already left for lower cost jurisdictions and a subtle shift occurring to high tech manufacturing and an emerging service sector.

The Government clearly want to cool certain areas of the economy by monetary tightening and this may negatively hit sub sectors such as property development, however a broad based collapse seems highly unlikely. Although we study Chinese statistics almost daily, we are still amazed by the sheer size of some of the numbers and we feel globally, investors are still behind the curve.

In the last 30 years the economy is yet to experience a full down year and in the last credit crisis a massive stimulus package kept the momentum intact. The recent May economic data showed that it was the rate of inflation that was now viewed as the prime concern. The CPI gained at an annualised rate of 5.5%, up from 5.3% in April, with food inflation the main driver. Food prices rose at an incredible 12% annualised rate and have not been helped by a serious drought in southern China. Unfortunately this has now been followed by major flooding.

Our central premise for the current calendar year GDP is 7% but the time lag effect of the tightening monetary policy will be a key influence on the ultimate outcome. Any sign of a sharp slowdown in construction and infrastructure related spending will clearly be negative to the theory of a commodity super cycle. Although there have already been signs that the commodity markets have begun to cool, with investors pulling in the money at risk. It has been unclear as to the extent of Chinese stockpiles, particularly in Aluminium and Copper.

The reserve ratio for China’s largest banks has now been increased to 21.5% and some businesses have already voiced concerns over the impact on credit conditions. In a recent report, Credit Suisse believes that the outlook for the banking sector is deeply negative. Previous loans could be of questionable asset quality and this will lead to far higher levels of provisioning in the future. This area does concern us and it will need to be monitored to ensure the current ‘healthy’ slowdown does not develop in to something more serious.

In conclusion, the current slowdown in Chinese economic growth would appear to be healthy and ensure that not too many asset bubbles appear. Global investors will be nervous on the extent of monetary tightening and will be watching economic data very carefully. There are not too many other growth stories to take up the global economic slack.

© Capital International Limited 2011

Volume: 9

Issue: 2

The Isle of Man Business Incubator The Capital International Group manages the Isle of Man Business Incubator for the Department of Economic Development. The Isle of Man Business Incubator business incubator is based in the Isle of Man Business Centre and provides a range of support services, resources and accommodation to new business ventures so that they grow into successful, sustainable businesses.

The Isle of Man Business Incubator sometimes receives details of innovative new products and ventures looking for start up funding. The business incubator does not provide funding but does try to help start ups and early stage ventures to connect with potential investors and business partners. Often the level of funding required is modest and the start ups are also looking for investors who can bring their previous business experience or contacts to the new venture.

In order to support the work of the Isle of Man Business Incubator we are interested to hear from those who might be interested in: • investing in Isle of Man start-ups or inward investment companies • being part of an entrepreneurial management team - perhaps as CEO, director or as a non-executive director • partnering with other entrepreneurs to identify innovative new products or business opportunities • working with young entrepreneurs • finding a new venture or product and helping to bring this to market If you would like to receive details of innovative new products and ventures looking for start up funding then please contact us and we will ensure that you are included on the circulation list being developed by the Isle of Man Business Incubator.

The Capital International Group is pleased to support the work of the Isle of Man Business Incubator.

However, attention is drawn to the fact that individuals choosing to invest must be prepared to carry out their own due diligence.

Additional information on the Isle of Man Business Incubator can be found at their website www.iombic.im

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US Housing Market Insight It is clear that despite major falls from the peak levels of US house prices that the market remains very difficult and is struggling to gain positive momentum. In fact our new favourite phrase to describe the market is ‘volatile flatness’ which was the headline of a recent US broker report on the sector. In recent May data, purchases of new homes declined for the first time in three months, falling at an annualised rate of 2.1%. Consumer confidence remains at low levels, notably in the face of continuing unemployment and rising fuel/food costs. Interestingly food and energy costs now account for 57% of income of the lowest 20% of earners and 27% of the next 20%.

Indeed in his recent address, the Fed Chairman, Ben Bernanke highlighted that concern continues on the downside risks to the US economy. On a positive note, the interest rate tightening cycle will once again be delayed and investors are now considering mid 2012 as the most likely date. In fact it was noted that another round of quantitative easing was not on the agenda at the moment, but we would not totally dismiss the option, particularly if the current ‘soft patch’ turns into something more serious.

There remains a large overhang of unsold housing inventory, although there were some signs that distressed properties not currently for sale, the so called ‘shadow inventory, actually fell 18% in April. However, total foreclosures still amount to 2.2m with the average discount for a distressed home being 20%.

It is evident that such low prices are now attracting investors with this group accounting for nearly 20% of recent purchases.

It certainly feels as though the market is bouncing around the bottom. Many lenders have also tightened their lending standards, with borrowers struggling to secure mortgages.

Bernanke is acutely aware of the situation and is seeking to speed up the foreclosures, simply to get rid of the glut of distressed properties and modify as many bad loans as possible. Thus far 600,000 homeowners have gained modified loans, however critics argue there is no emphasis on the servicer to undertake such action and a change in legislation is required.

As well as the decline in sales volumes, May also saw a fall in the median sales price of a new home of 3.4% to £140,000 sterling equivalent. This was the biggest monthly fall saw since October 2010. There are certain geographical areas which are performing well, notably Texas and Washington. The worst performing areas with average declines of 16% in the last year have been Atlanta, Chicago and Detroit. We would urge caution in recent funds we have seen launched focussing on distressed ‘Motor City’ housing.

Longer term the US is in a similar position to the UK, in that the current build rate of new houses is lagging behind the demographic trends and long term natural demand levels.

Clearly at some point confidence will return but for now there are few catalysts to drive recovery.

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“...the major fear is contagion, with many European institutions intertwined and countries such as Italy and Spain remain a real concern...”

Europe: Update The further potential increases in the level of European peripheral bond yields we highlighted in last year’s Q4 review have duly accelerated in recent weeks. Indeed the prospect of a near term default on Greek sovereign debt has increased greatly in probability.

At the time of writing the 10 year yield on Greek debt is nearly 17%, with Portuguese yields standing at 10.6% and Ireland at 11%. Meanwhile the Greek Government are facing huge opposition from voters and there could be snap elections called. In a recent survey, nearly 50% called for any rescue package to be rejected and elections called. If there is a default in Greece, it could actually lead to the need for the ECB to be recapitalised, with European taxpayers footing the bill. The scenarios are unpalatable to say the least.

Any revised bailout is likely to exceed £106 billion and the mixture of emphasis between the public and private sector burden is a key area of contention. The German Government has been particularly keen on at least £35 billion of ‘private sector’ involvement. The Greeks have been playing a hardball game, using the threat of leaving the Euro as a bargaining chip.

Policy confusion within the Euro area has acted as a major impediment to the speedy resolution of the crisis. The key to solve the situation will be structural reforms that will ultimately reduce the debt burden whilst, crucially, permitting economic growth to occur.

The major fear is contagion, with many European institutions intertwined and countries such as Italy and Spain remain a real concern. Fundamentally Spain is simply too big to bail. Spanish bond yields have spiked to levels last seen in 2000 and recent auctions have been barely covered. It is an uncomfortable situation when the long term borrowing costs greatly exceed the current nominal economic growth rates. It looks likely that budget deficits will rise and there also could be further downward pressure on the housing market. It is a worrying recipe for the region’s banks and fresh liquidity injections seem inevitable.

Much of the above has been detracting from the fact that many European countries are still experiencing respectable economic growth rates. Germany, which accounts for more than 20% of the region’s GDP, has been in rude health, although there are some signs of increased caution even here. Other economies such as Austria, The Netherlands and Sweden are also displaying positive GDP growth. For instance, even after two years of recovery, Sweden still managed a 6.5% year on year increase in GDP for the first quarter of 2011.

Overall the Q2 GDP forecasts for the region have been marginally downgraded to 0.3%, down from the 0.8% registered in Q1. For now the Euro will probably stay intact but it does not mask the problems of the ECB having to adopt a one size fits all monetary policy. For this reason the recent increase in interest rates could well be a short lived event if economies soften further as 2011 progresses. In a recent interview, the former Chancellor Lamont summarised the current problems well, ‘the can for now will be kicked down the road, and unfortunately it will become increasingly battered’. There is a real likelihood that Europe will stay intact, it will be interesting if potential entrants such as Latvia, Lithuania and Poland are still keen to join.

for further information, visit us at www.capital-iom.com © Capital International Limited 2011

June 2011

Volume: 9

Issue: 2

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Economy in Focus: Russia Russia has undergone significant changes since the collapse of the Soviet Union, moving from a globallyisolated, centrally-planned economy to a more marketbased and globally-integrated economy. Economic reforms in the 1990s privatized most industry, with notable exceptions in the energy and defence-related sectors. The protection of property rights is still weak and the private sector remains subject to heavy state interference. Russian industry is primarily split between globally-competitive commodity producers - in 2009 Russia was the world’s largest exporter of natural gas, the second largest exporter of oil, and the third largest exporter of steel and primary aluminium - and other less competitive heavy industries that remain dependent on the Russian domestic market.

This reliance on commodity exports makes Russia vulnerable to boom and bust cycles that follow the highly volatile swings in global commodity prices. The government since 2007 has embarked on an ambitious program to reduce this dependency and build up the country’s high technology sectors, but with few results so far. The economy had averaged 7% growth since the 1998 Russian financial crisis, resulting in a doubling of real disposable incomes and the emergence of a middle class. The Russian economy, however, was one of the hardest hit by the 2008-09 global economic crisis as oil prices plummeted and the foreign credits that Russian banks and firms relied on dried up.

The Central Bank of Russia spent one-third of its $600 billion international reserves, the worlds third largest, in late 2008 to slow the devaluation of the rouble. The government also devoted $200 billion in a rescue plan to increase liquidity in the banking sector and aid Russian firms unable to roll over large foreign debts coming due. The economic decline bottomed out in mid-2009 and the economy began to grow in the first quarter of 2010. However, a severe drought and fires in central Russia reduced agricultural output, prompting a ban on grain exports for part of the year, and slowed growth in other sectors such as manufacturing and retail trade.

High oil prices buoyed Russian growth in the first quarter of 2011 and could help Russia reduce the budget deficit inherited from the lean years of 2008-09, but inflation and increased government expenditures may limit the positive impact of these revenues. Russia’s long-term challenges include a shrinking workforce, a high level of corruption, difficulty in accessing capital for smaller, non-energy companies, and poor infrastructure in need of large investments.

Growth has picked up, supported by surging commodity prices, and domestic demand is expected to strengthen in the near term. Output is projected to grow by nearly 5% in 2011 and by 4½% in 2012. As the effect of last year’s food price shock dissipates, disinflation should resume. The budget is projected to return to surplus this year, as revenues will exceed projections by a large margin due to higher-than-expected oil prices, but the non-oil deficit will remain large.

The budgeted reduction of the non-oil deficit over 2011-13 is sensible. Pressure to spend the oil price windfalls should be resisted, not because fiscal sustainability is in immediate danger, but to avoid fiscal policy becoming procyclical and, more generally, to reduce the budget’s dependence on fluctuations in commodity prices. Restoring a fiscal rule would be helpful in this regard. Even in the absence of financing needs, the government should pursue its privatisation agenda, while also undertaking other structural reforms to reduce entry barriers and improve the business climate Russia of late is standing out as a relative haven on higher trending oil, an improving image and economic/market outlook.

High beta names are certain to weaken as investors lock in some profits and/or shift money into defensive themes, primarily telecoms, utilities, dividend and inflation hedge plays.

Thereafter we could see a shift back into high beta sectors, oils, natural gas and banks. Sentiment has been tempered recently by multiple headwinds, some old, some new but each speaking to risk aversion and slower growth. The strongest include politico-economic uncertainty in the MENA countries, insolvency risks resurfacing in peripheral euro-zone countries, inflationary pressures rise in China and a lower than expected trade surplus in Germany.

Against this backdrop, expect risk aversion to be operative as investors are reminded that the global recovery is fragile, markets are artificially inflated and slower global growth is inevitable. Given the current headwinds we would expect the bearish to interpret any additional negative data points as sign the long anticipated slowdown is emerging. Hence, expect profit taking to be in play as well as rebalancing from high beta names to defensive themes.

The operative drivers, however, trump the headwinds, at least in the short term. Owing to the global turbulence, investors are particularly keen to find safer harbours. On oil, image and outlook Russia is emerging as a relative haven.

Also in this issue: • Sector Focus: UK Domestic Banks • Market Focus: IPOs • Economy in Focus: Australia

Revolts and rumours of revolts in the MENA countries have elevated current crude prices far above $75/bbl budgeted by Russia for 2011. Given signals that the conflict in Libya may escalate, the price of crude is more likely than not to find support a current levels or track higher.

The MENA revolts have again underscored the world’s high dependence on Arab oil and concern over energy security has intensified commensurate with the potential for a disrupted supply. Against this backdrop, the Kremlin has assured net energy importers that Russia stands ready to offset shortfalls, which has burnished the country’s image as a more reliable energy supplier. The move is telling as it complements and evidences the authenticity of the Kremlin’s campaign to rebrand Russia as a responsible economic partner and an attractive market for investors.

Already improving, Russia’s investment case is receiving a boosts as oil and image further strengthen Russia’s fiscal status and economic prospects. Indeed, on MENA supply disruption fears, net energy importers are under increasing pressure to source energy from less unstable regimes such as Russia.

Russia stands to benefit from increased oil / LNG revenue and foreign capital (cash, technology) from strategic partners keen to diversify away from Arab oil and tap into Russia’s sizable reserves, and potentially increased access long coveted foreign markets via energy and public-private partnership deals. Windfall oil revenue, arguably, will be allocated to meet the Kremlin’s commitment to economic development via diversification, innovation and modernisation.

Regarding the equity markets, the MICEX Index is actually down YTD dropping -4.4%, however year on year the index has advanced by +20.20%. Most of this performance is driven by just 5 companies who account for nearly 60% of the MICEX and of those 5 companies, 3 of them are energy producers.

Gazprom (Gas), Lukoil (Oil) and Rosneft Oil Co (Oil/Gas) account for 35% of the index.

In May, Gazprom increased production by 11.7% y-o-y.

Moreover, in recent months Gazprom has boosted gas exports to the EU which has increased by 56% y-o-y, compared to an increase of 39% y-o-y in April. Although it is expected that export dynamics will slow in the second half of the year, an increase of 8-10% is expected for the full year, which should support Gazprom’s performance in the short term. Gazprom is +2.91% YTD. Recently Lukoil signed a long term cooperation agreement with Rosneft, covering the joint development of Rosneft’s fields in the Timan-Pechora region with total recoverable reserves of 1.5 bbl. This, together with Lukoil’s overseas projects in Iraq and Ghana, as well as the deal with Bashneft on the TrebsTitov deposits, should have a positive impact on the company’s declining production. Lukoil is +0.82% YTD On Tuesday May 17, Rosneft and BP announced that the joint development Artic shelf deal was cancelled, an in addition, the shares cancelled as well. This means that the strategic alliance between Rosneft and BP has fallen apart. The period set by the companies to negotiate the deals has expired, and a consensus was not reached. Both companies had announced that they were close to reaching a consensus, but simply ran out of time. Rosneft now has two options. It can resume negotiations with BP, and set a new deadline. Another option is to start negotiations with other global oil majors on the same Arctic project. So far, four big companies have expressed their desire to make an alliance with Rosneft, Exxon-Mobil, Chevron, Shell and CNPC. It is believed that Rosneft is most likely to resume negotiations with BP. Rosneft is +5.85% YTD. On balance, the market outlook for oil and gas producers and banks (on a strengthening ruble and as proxy into the broader economy) is biased to the upside, hence cautious buying and select rebalancing expected.

© Capital International Limited 2011

June 2011

Volume: 9

Issue: 2

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Sector Focus: UK Domestic Banks At the end of the 1950’s, around 100 banks provided information to the Radcliffe Committee, which had been established to review the workings of the UK monetary system. Of these, the 16 London and Scottish clearing banks held around £8.3 billion in assets, amounting to 85% of total UK banking assets and more than 30% of UK GDP. The clearing banks were relatively narrowly focused on the provision of payment services, deposit taking activities and short term corporate lending. They were almost entirely funded by customer deposits, 60% of which were held in current accounts. These deposits generally funded low risk and liquid assets. Indeed, in 1960, 35% of London’s clearing banks’ assets were held in cash, Treasury bills and discounted bills, with a further 28% of assets held in gilt edged securities.

Customer loans constituted just 30% of the London clearing banks’ assets.

Banks’ and Building societies sterling assets grew steadily over the next two decades, together increasing from around 50% of GDP to 65% between 1962 and 1979. One of the most striking trends in this period was the emergence of London as a truly international financial centre. During the 1960’s and 1970’s, foreign owned banks began to expand their presence in the UK. This contributed to a sharp increase in holdings of foreign currency assets by both domestically and foreign owned banks operating in the UK. Indeed, by 1979, UK monetary and financial institutions held $172 billion of foreign currency assets, over half of their total assets. Foreign owned banks were predominately engaged in wholesale activity, in part reflecting the rise of the Eurocurrency market.

Today more than 300 banks and building societies are licensed to accept deposits in the UK. However, the provision of retail banking services is highly concentrated. Of the 16 clearing banks present in 1960, fifteen are now owned by the four big UK banking groups: RBS, Barclays, HSBC and Lloyds Banking Group. These banks, along with Nationwide and Santander, together account for almost 80% of the stock of UK customer lending and deposits. Collectively, however, the four largest groups account for a smaller share of the market for these services than the banks from which they originated.

As the clearing banks have grown and consolidated over recent decades, they have also taken on a broader range of functions.

The largest banks have become truly universal banks, their activities encompassing securities underwriting and trading, fund management, derivatives trading and general insurance.

This expansion coincided with a period of significant growth in securities markets and the markets for foreign exchange and derivatives. The UK banks have established themselves as major global players in these markets. For instance, recent market surveys place three UK banks among the top ten worldwide in several markets, including bond underwriting, foreign exchange trading and interest rate swaps.

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The evolution to universal banking is reflected in an increase in the contribution to non-interest income to bank’s earnings.

Today, non-interest income accounts for more than 60% of banks earnings, having been a minor share three decades ago.

Collectively, UK banks balance sheets are now more than 500% of annual UK GDP, with much of this growth having occurred over the past decade. Three of the four largest banks individually have assets in excess of annual UK GDP. Relative to the size of the national economy, the UK banking system is second only to Switzerland among G20 economies, and is an order of magnitude larger than the US system. The expansion of the UK banking sector, particularly in the 1990’s, far exceeds that in orther financial sectors.

Expansion has given rise to a banking system with large balance sheets, significant functional and geographical diversity and complexity, a high level of leverage, and extensive network interconnectivity. The emergence of large institutions that are deemed “too important to fail” presents important challenges for public policy. Before the crisis, commentators emphasised the efficiency gains associated with these structural changes, in terms of the availability of credit to households and businesses, the decline in lending spreads, and the availability of a broad array of risk insurance services. The IMF, for example, observed that globalisation and financial innovation had increased credit availability to the economy.

Since the Crisis, however policymakers and governments have begun to examine the social cost of pursuing such efficiencies.

And it is increasingly recognised that having too important to fail institutions is a paradox that must be tackled.

In response, an independent commission on banking has been established in the UK to consider the case for structural reform in the banking sector. And, internationally, the Financial Stability Board is examining a broad range of policy options to mitigate the financial stability risks posed by systemically important financial institutions.

“...expansion has given rise to a banking system with large balance sheets, significant functional and geographical diversity and complexity...”

Barclays Many still view Barclays as a simple high street bank. Basically, the one with the blue eagle. But these days Barclays is less about local banking and much more about global trading. Since acquiring the US operations of Lehman Brothers in 2008, Barclays can now compete with the ‘Bulge Bracket’ (Wall Street’s biggest players).

In fact, the vast majority of its profits are coming from trading debt, commodities and currencies. In reality, Barclays has far more in common with Goldman Sachs than it does with Lloyds.

Barclays’ big push into investment banking has really stirred up a hornets nest. The Coalition government is under pressure to split lower-risk retail banking from higher risk investment banking as a way of making Britain’s banking system safer.

Vince Cable in particular has been championing this issue, describing investment banks as “casinos”. He’s even made special mention of Barclays.

However, the interim report from the Independent Commission on Banking came as a relief to the big diversified banks: Barclays, RBS and HSBC. The recent talk is about “ringfencing” the retail and investment banking divisions, rather than a full blown split. Despite the general sense of relief, analysts at HSBC believe the changes with cost Barclays, Lloyds and RBS around £10 billion each. The final report from the Commission isn’t due out until September, so the banks will face further uncertainty until then. Barclays has not had an easy year so far.

Its first quarter results didn’t go down well with investors. Profits fell 9% overall. Its investment banking arm, Barclays Capital, was the main culprit with revenue dropping 15%.

Following that, there was the high court ruling against the UK banks on the misspelling of payment protection insurance (PPI). Barclays has calculated this will cost them around £1 billion. More recently, Bob Diamond (CEO) has tried to reassure investors at the recent investor seminar. He made all the right noises – costs are to be cut and Barclays will continue to shift away from riskier activities and back towards their more traditional banking services. He is also aiming for a 20% increase in overall revenue within two years.

While the City seemed to warm to the plans, they have been overshadowed by the ongoing Eurozone debt crisis. While Greece remains the focal point at the moment, the more important issue is the overall exposure to the PIGS. So far the UK banks have remained tight lipped about their exposure, leaving City analysts to make their own estimates. This tactic of silence is only serving to fuel fear. Credit Suisse have estimated that Barclays has £40 billion of exposure to Spain, Portugal and Greece – the largest of the UK banks. The majority of Barclays’ exposure is thought to come from private sector loans in Spain (mainly mortgages on properties) due to their strong Spanish network of 550 branches.

Barclays have leaked a vague statement to the press that they have significantly reduced their exposure to the PIGS, but as no numbers have been given, the City is right to be sceptical. In the near-term the ongoing Eurozone crisis, regulatory backlash and lack of earnings momentum are keeping investors away from Barclays for the time being. But standing back from the immediate problems, Barclays looks a more attractive prospect.

The fact is it has an enviable portfolio of quality assets: • One of the four leading UK high street banks; • Barclays Capital – one of the world’s leading investment banks; • Barclaycard – Europe’s leading credit card provider; • A majority stake in Absa - the largest consumer bank in South Africa; and • A 19.9% stake in BlackRock, the world’s largest asset manager.

That’s quite a collection of trophy assets. On that basis, it seems easy to justify a long-term bullish stance. Barclays have traded in a broad range over the past twelve months.

April’s negative price gap occurred through the 200 day moving average, giving a clear warning signal of what was to come.

The negative gap created momentum which saw the share price break below its 52 week low of 252p. The share price remains in a clear descending channel. The price momentum indicator RSI stands at a low level of 34. Though this is not yet technically ‘oversold’, it’s not far off either.

While the short-term technicals appear bearish, it is noted US investment banking peers, Goldman Sachs and Morgan Stanley, are showing some signs of life. Like Barclays, both these US investment banks have been in a sustained downtrend since the start of the year. However, Goldman and Morgan Stanley shares are consolidating around long-term support levels – hinting at signs of a possible reversal. Active traders should keep a close eye on Barclays as a trend reversal may be approaching.

© Capital International Limited 2011

June 2011

Volume: 9

Issue: 2

The UK’s first “super-bank” is under attack.

Lloyds was the only bank singled out in the interim report from the Independent Commission on Banking. The Commission wants Lloyds to sell hundreds more branches. That’s in addition to the 600 that they had already agreed to sell off to keep the European Union off their back. The fact that the UK is taking a tougher stance than Europe is incredible when you consider the UK government is the biggest shareholder in Lloyds. While the Commission’s final report is not due until September, we see a complete U-turn as unlikely. Lloyds’ shareholders have every right to feel cheated.

The HBOS takeover caused obscene losses, but at least it was meant to bring enormous longer-term benefits – increased market share gains and major cost savings. Now the benefits are being eroded. The first quarter results didn’t make pleasant reading. Ignoring one-offs, profits were down 75% compared to last year. This was partly due to a bad debt charge of £1.1 billion on Irish loans as well as efforts to replace cheap government funding with more expensive commercial sources. Net interest margin, a key driver for a retail bank like Lloyds, also unexpectedly shrunk. Some analysts believe the soft numbers are a result of the new CEO, Antonio Horta-Orsorio, getting all the bad news out of the way. New CEO’s have been known to paint a bleak picture when taking over the reigns. It sets investors expectations low.

That way the new CEO can claim all the credit when things get better. But it’s unclear if that’s actually what’s happened at Lloyds because the previous CEO, Eric Daniels, was quite conservative in his accounting policies.

Near-term sentiment on Lloyds certainly hasn’t been helped by a string of bad news. Settling PPI claims is expected to cost Lloyds a whopping £3.2 billion – more than the rest of the UK banks put together. And Morgan Stanley’s latest research sent shockwaves across the City. Based on their view that UK house prices will fall by 10% over the next 2 years, they estimate Lloyds will have £90 billion of mortgages in negative equity. By comparison, the rest of UK banks put together would have less than half this level of mortgages underwater. Big is not always better. While this research is based on a somewhat bearish assumption on UK property prices, it shows the vulnerability of the Lloyds balance sheet. Over three quarters of these fragile loans were inherited from HBOS – the nightmare just won’t go away. The Eurozone crisis has also brought other vulnerabilities back to the surface. While Lloyds is the least exposed of the UK banks to Greece, Spain and Portugal, it is estimated to have €30 billion of exposure to Ireland - second only to RBS.

Capital International

www.capital-iom.com

The next key event for Lloyds will be the new strategy to be announced by Mr Horta-Orsorio in June. Will he stand by the previous targets for net interest margin and merger cost savings? Lloyds’ shareholders better hope so. Looking further out, Lloyds is well positioned to benefit from a recovery in the UK economy. It has leading positions in current accounts, savings, mortgages and personal loans as well as strong positions in business banking, insurance and fund management. While regulators may try and chip away at their market share, history shows it’s very hard to shake up retail and commercial banking. Put simply, customers tend to stick with their bank (better the devil you know). And cost savings from the merger will be substantial no matter what. One factor that could drive the share higher over the medium term would be the reinstatement of the dividend.

Brussels banned Lloyds from paying dividends until 2012, but that deadline is growing nearer. Lloyds hope to resume dividends as soon as the ban is lifted and we would expect management to reward shareholders for their patience. While we have short-term reservations, over the longer term, we think Lloyds has plenty of recovery potential. The bank has a good track record of delivering cost savings and paying out generous dividends. Lloyds appear trapped in a long term downtrend. The 50 day moving average is now well established below its 200 day moving average. The formation of this technical ‘DeathCross’ is considered to have bearish implications. The negative price gap created at the start of May should provide significant long-term resistance to any upward spikes in the share price.

Recent price action suggests that Lloyds have just started their next leg lower, breaking below 47p short-term support. We remain bearish for the time being as we can see no technical catalyst to reverse the downtrend.

“...many have wondered if we are witnessing similar conditions to the ‘dot com bonanza’ of 1999/2000. ...”

Market Focus: IPOs Two years into its five-year turnaround, RBS looks back on track. Hats off to Stephen Hester, he’s had a hell of a job cleaning up the mess left behind by man-in-hiding Sir Fred Goodwin. The first quarter results from RBS came as a bit of a surprise, they were pretty decent. In fact, there were quite a few encouraging signs. In stark contrast to Lloyds, its Retail division delivered a stable net interest margin. The Corporate division, previously a cause of concern, was actually the star of the show. Overall, these two divisions produced profits around 20% higher than this time last year. Investment banking was down by around a third, but this was widely expected given the industry wide trends. And bad debts, once the biggest number in RBS’s results, continue to shrink.

The interim report from the Independent Commission on Banking also came as a relief to RBS. So certainly in relative terms, RBS looks to be doing OK. RBS is estimated to have over €50 billion of exposure to Ireland and hasn’t made the same sort of bad debt provisions that Lloyds has. Ireland’s just had its third bailout and looks caught in a death spiral, trying to cure its debt with more debt. RBS also has funding issues to sort out and is likely to take around a £1 billion hit to settle PPI claims. Part of our reservation on RBS is that it’s not an easy company to understand. Firstly, it’s being forced by Brussels to sell major divisions, making it difficult to gauge what the underlying earnings will be going forward.

Secondly, its balance sheet is split into core and non-core.

The bits it wants to keep are in the core, and the rest has been placed in the non-core. As you would expect, the core part is doing a lot better than the non-core part. The core business is also what the management team spend most of their time talking about. But wait a second. The noncore part is hardly insignificant, and it’s not a pretty sight. While RBS still has plenty to do, overall it has its attractions: a good management team and some good brands. Of all the UK banks, the management team at RBS have the clearest plan of where their bank is going. Short-term, RBS is on a roll.

The key metrics are pointing in the right direction. And there’s little doubt that the traditional retail and commercial divisions in the UK and US are picking up, while its bad debts are clearly falling. So while it has its fair share of near-term problems such as funding issues, a fragile balance sheet and over-exposure to investment banking, it looks the pick of the sector right now.

RBS started 2011 strongly, making a high of 49p back on the 18th of February. The shares then quickly gave up their gains before forming a base at 40p. RBS put up a hell of a fight at the 40p level for over 3 months, but has eventually been dragged down with the rest of the banking sector. While the break below 40p must be taken as a bearish sign, we note the shares are moving towards a ‘double bottom’ support level of 37p – this will be a key test of their resilience. The poor sentiment in the banking sector means RBS is fighting an uphill battle, but the shares still look the best of a bad lot.

With the usual sense of irony, the global IPO market has picked up just as global equity markets begin to go the other way. Global filings for new issues are at levels last seen in 2007 with an incredible $67 billion of estimated funds being raised in Q2 alone.

Indeed, it has not only been the level of issuance that has grown dramatically but also the level of the valuations. This has led, more recently, to the biggest increase since 2006 of postponed IPO’s as investors begin to shun such highly priced issues.

So outraged have Blackrock, the major institutional investor, been that they have sent a letter to a series of investment banks complaining that companies are being given far too optimistic valuation levels. In a sense, it is 2011 but investors are being asked to pay 2015 prices. Of the 69 completed issues in Europe, more than half are currently trading below their issue price. There are now simply too many book runners on the major issues and this has pushed up the costs to the corporate as well.

In the UK, the largest IPO in UK history, Glencore International, which has gone straight into the FTSE 100 Index, had no fewer than 23 banks in the syndicate. The company raised $10 billion on the back of the rising commodity markets in 2010.It floated at 530p and the price has been below the offering price virtually for the entire period, the price recently has settled at 485p. The company is the world’s largest commodity trader and there have been vastly different opinions as to the best valuation methodology. We have found share price targets ranging from 390p to 620p!

In the US, arguably the most talked about new issue was LinkedIn, the business social networking site. At the listing price, the market value of the company represented twenty times 2010 revenues! The shares enjoyed a very strong day of first trading, moving to a 100% premium over the $45 per share placing price. Supporters of the company point to the fact that the business element of the social networking aspect is the key differentiator from Facebook.

Many have wondered if we are witnessing similar conditions to the ‘dot com bonanza’ of 1999/2000. Notably as this was a business which has been heavily loss making and valuation metrics are hard to establish. Major forthcoming technology listings include the online coupon company, Groupon and the online games company, Zynga.

There has also been an interesting trend of Western companies listing in Hong Kong, to take advantage of the China angle.

A recent example of this was Prada, the Italian luxury goods manufacturer, which has nearly 50% of its outlets in the Asia Pacific region. It recently achieved a listing on 23x 2011 earnings and raised just over $2 billion. Other companies which have achieved such listings are the French cosmetics company, L’Occitane and luggage company, Samsonite. © Capital International Limited 2011

June 2011

Volume: 9

Issue: 2

www.capital-iom.com

Economy in Focus: Australia Prior to the 1970’s much of Australia’s trade was held with the European and North American markets. During this period, Australia was also considered as a relatively closed and protectionist economy. However, as key economic reforms were gradually being introduced by the Australian government, the Australian economy also started to turn their attention away from trade with the western markets to trade within the Asia Pacific region. This shift has turned Australia into one of the fastest growing advanced economies in the world.

Australia is the 13th largest economy in the world according to nominal GDP and the 17th largest according to GDP. In 2010, Australia’s GDP was $882.344 billion, a 3.94% increase from 2009. Australia’s nominal GDP growth during the same period was even more amazing, GDP grew from $994.25 billion in 2009 to $1.219 trillion, a 22.68% increase.

In the past two decades, Australia has enjoyed a period of uninterrupted economic growth, an average of 3.3% in real GDP growth annually. Australia possesses a well diversified economy boosted by the strength of its services and resources industries. This has been obtained through a stable and modern institutional and regulatory structure. Australia was ranked third in the 2011 Economic Freedom Index behind Hong Kong and Singapore and continues to provide an ideal environment for business and environment.

Domestically, Australia’s economy can also be characterised by an east/west divide. The eastern part of Australia is home to the majority of Australia’s service and financial industries. It also contains Australia’s capital city Canberra, the heart of Australia’s political and economic policies. Western Australia, on the other hand, controls the majority of Australia’s natural resources, including iron ore, gold, oil and natural gas.

The contrast between these two regions has often led to disagreements within the Australian government over developmental plans. Although Australia’s GDP is still dominated by its service and financial industries, these industries have been struggling in recent years. On the other hand, Australia’s resources and commodities industries are currently experiencing a boom period. According to Canberra based Access Economics, growth in regions endowed with minerals and oil and gas will far outstrip growth in the country’s more populous states next year. However, concerns have also been raised on whether the resource and commodities industries are too reliant on exports to China.

In 2009, China became Australia’s largest export market, surpassing Japan. Resources continue to underpin Australia’s exports to China. Australia exported 266.2 million tonnes of iron ore to China in 2009, an increase of 45.2% over the same period. China is also Australia’s largest source of imports.

The vast scale of trade with China has seen massive investments by Chinese companies in Australia. From 2007 to 2010, Chinese investment in Australia amounted to nearly $60 billion. Australia’s mineral exports also grew by 55% to $139 billion in 2010 and are projected to reach $180 billion in 2011, thanks to China’s strong economic performance. Chinese companies have also started to lease land from the Australian government to mine resources on their own.

Along with their relationship with China, Australia holds multiple free trade agreements with numerous other countries such as the US, Singapore, Chile and Thailand. Australia is also a member of numerous organisations such as APEC, the G20, WTO and OECD. In 2010, Australia’s GDP composition was 3.8% agriculture, 24.9% industry and 71.3% services.

As with most advanced economies, Australia has a dynamic services sector. This includes industries such as banking, insurance and finance, media and entertainment, consulting, tourism, retail and services provided by government, such as education, health, welfare, and other personal and business services.

Policy Changes: Clearing Charges Over the last two years, and in the shadow of the banking crisis, banks have been increasing their fees across the board.

Capital International Limited’s clearers, Pershing Securities Limited, have been finding that their local custodial relationships have not been exempt from these increases and are now passing these increased settlement charges on to ourselves.

New Clearing Charges Region

Charge

Australia France

£20.00

Netherlands Austria Greece Spain

£50.00

Switzerland Singapore

Capital International

£80.00

These changes are not applicable to all overseas markets but for those that are affected we are also going to have to pass these increases on.

With regret therefore, the new clearing charges will apply from the end of the summer 2011 to custody accounts in the listed markets - all other markets will remain unchanged. Formal notification will be going out under separate cover shortly.

Also in this issue: • Product Focus: Bridge - Payment Services • Discussion - The Nuclear Power Debate • Back Page Article

Among these industries, banking, finance and insurance are the best performers, providing the highest gross value as well as being among the fastest growing industries in Australia. The Australian share market is the second largest in the Asia-Pacific region behind Japan, based on free float market capitalisation.

The Australian Securities Exchange is also the 11th largest stock exchange in the world based on market capitalisation.

While the service industry remains the backbone of Australia’s economy, Australia’s mining industry has been the catalyst for economic growth in the past decade. Large quantities of minerals and resources can be found in Australia. Australia has the world’s largest resources of recoverable brown coal, lead, rutile, zircon, nickel, tantalum, uranium and zinc, and ranks second in the world for bauxite, copper, gold, ilmenite and silver.

Iron ore is another extremely valuable asset, with high demand from China.

Australia’s economy shrank 1.2% in the first quarter, its biggest decline in 20 years, after extensive flooding hit coal exports, but a once in a lifetime mining boom is expected to help growth bounce back quickly this year. Damage from the flooding and Cyclone Yasi came at a time when rising utility and fuel prices were already crimping household spending and a strong local dollar was taking a toll on industries such as manufacturing and tourism. Add to that the impact of earthquakes in Japan and New Zealand, the nation’s major trading partners, and it was not surprising to see the economy going into reverse gear.

According to the Reserve Bank of Australia, Australian miners have received higher contract prices for the June quarter with iron ore contract prices estimated to have been 23% higher than the March quarter and coking coal contracts 45% higher.

That in turn is fuelling a massive expansion in mining investment, which should support growth for years to come. Data at the end of May showed mining firms plan to spend A$51.3 billion for the year to June and a record A$83.3 billion for 2011/12, 6.4% of Australia’s A$1.3 trillion in GDP. Mining investment is already more than double the historic average at 4% of Australia’s GDP, and the RBA now sees that rising to over 6% by 2012/13.

This investment boom is already straining the supply of skilled labour. The economy is close to full employment with a jobless rate at just 4.9%, a situation the RBA is closely watching. The RBA expects the economy will expand at a rapid 4.25% for all of 2011 and grow around 3.75% annually for the next two years. It mentioned a few weeks ago that rates will have to go up keep a lid on inflation.

The most recently released data showed the real value of goods and services produced amounted to A$1.3 trillion for the year to March, or A$58,091 for every man woman and child in the nation of 22.6 million. The Australian Dollar rose nearly half a cent to $1.0737, relieved the contraction was not as dire as some had predicted.

However, it remained well below a 29 year peak of $1.1012 set a month ago. Interbank futures slipped, but still implied no chance of an interest rate hike in near future and just a 50-50 prospect of a quarter point tightening by October.

The Reserve Bank of Australia has already said it would look past the weather induced slowdown in growth when setting monetary policy, believing the effects will be temporary. Indeed, coal exports showed signs of recovering in March, helping push the nation’s trade balance back into surplus.

Analysts polled by Reuters expect data to show the surplus growing to A$2.0 billion in April from A$1.74 billion as the recovery continues. Solid demand from China and other parts of Asia has led to huge price increases for coal and iron ore, Australia’s two biggest exports, helping lift the country’s terms of trade to the highest in over a century. Recent data showed the terms of trade, or the ratio of export to import prices, rose a further 5.8% in the first quarter to be huge 22.4% higher for the year. This is set to increase in the second quarter to a fresh record high. © Capital International Limited 2011

June 2011

Volume: 9

Issue: 2

www.capital-iom.com

Product Focus: Bridge - Payment Services Capital Treasury Services (CTS) has become one of the Island’s first international investment services providers to be licensed by the Financial Services Commission to conduct payment service business. The move comes after the FSC made the provision and execution of payment services a regulated activity from 1st January 2011.

In response CTS has launched Bridge, its Internet Payment and Cash Management Service (IPCM), a business-to-business offering compliant with the FSC ruling.

CTS Managing Director John Cookson said: ‘Receiving regulatory approval to provide payment services adds to the existing suite of investment business and service licenses from the FSC held by the underlying regulated companies within Capital International Group.

‘The Bridge IPCM product employs cutting edge technology and has been designed expressly to accommodate this latest expansion of money transmission legislation and provide added value to our client proposition. We see it being of particular benefit to the trust and corporate service provider sector and, increasingly, the e-gaming industry to facilitate those occasions when there is a requirement to make payments to local or international recipients.

‘Drawing on Capital Treasury Services’ global relationships, we can access low cost, domestic clearing systems in most major currencies and cater for all payments methods, including CHAPS, BACS, SWIFT and SEPA. ‘Importantly, when clients choose to make payments through our IPCM service they benefit from the security of dealing with a trusted partner and also from increased efficiency by not having to arrange transfers via a third party, which leaves them free to concentrate on developing their business.’

Capital International Group Chief Executive, Anthony Long added ‘This cost effective, flexible, efficient and secure payment solution completes CTS’ portfolio of treasury products and services, offering the client greater choice, economy and speed of execution. CTS becoming one of the first companies to be licensed for this new regulated activity, combined with the launch of our IPCM service, are the latest demonstrations of the Capital International Group’s values of innovation, integrity and excellence, where the client is the focus of all that we do.’

Giving you control over your cash flow, around the world, we offer a variety of secure services to help you improve the way you manage funds and make payments, whilst maintaining your records and importing data directly into your company’s own accounting system.

In today’s global economy, organisations are finding an increasing requirement to be financially agile and responsive, reacting to wherever the business is being taken. Bridge, our Internet Payment & Cash Management service (IPCM) helps make this possible. IPCM enables businesses to access and control cash quickly and efficiently around the world. Our specialist team works closely with you to develop a secure, cost-effective solution to your overseas investment and payment needs.

The key benefits • View balances and transactions or issue payment instructions on your Capital Treasury Services accounts • Cut your transaction costs by using a single point of access to local clearing systems in the overseas markets where you operate • Speed up invoice receipts by enabling overseas customers to pay direct into your account through their local bank Features • Upload balance and transaction information directly into your accounting systems – reducing delays and costly mistakes caused by re-keying data • Consolidate bank balances to optimise your return • Help improve your overall cash position using the most upto-date account information • Free up your team to concentrate on growing your international business Solutions in Payments The IPCM Bridge offers you a simple, convenient and costeffective way to make regular payments via the Internet. The service’s dynamic and intuitive interface guides you through the payment creation process, enabling you to submit Straight Through Processing (STP) payments that will require no intervention by us. These are charged at a reduced cost when compared to the standard tariff for non-STP transactions.

Capital Treasury Services

Payment Services Tariffs

Effective from 5th January 2011

NOTE: Any sums received do not constitute a deposit as defined in Regulated Activities Order 2009, as amended and are not covered by any compensation scheme.

One off Service Charges

Tariff per item

Initial electronic interface implementation fee GBP Domestic Payments

Faster Payment - For GBP payments <£10,000 - Normally received by the beneficiary same day* CHAPS Payment - Guaranteed same day payment for any amount Non Domestic Payments

EURO SEPA Payment - For EURO payments going to participating banks only in other SEPA member countries Foreign Currency Local Payments - A cost effective method of remitting foreign currencies to beneficiaries in the currencies domestic arena.*** Additional Payment Services

Capital International

£0.50 £4.50 £15.00 Tariff per item

SWIFT Payment - Currency Priority Payment for urgent Non-GBP payments**

Bridge

£500.00 Tariff per item

BACS Payment - For GBP payments >£10,000 - normally received by the beneficiary within three working days

Internet Payment & Cash Management

Capital Treasury Services

This tariff sheet sets out our standard payment charges for this service. These will apply, subject to any special arrangements that we may make for any particular transaction or series of transactions, in relation to all transactions effected for you on and following the above date until further notice. This rate sheet forms a part of the Terms of Business issued by us and where applicable replaces any relevant rate sheet previously issued. We reserve the right to vary these rates by written notice to you from time to time.

£15.00 £7.50 £8.00 Tariff per item

Payment Repair - Any payment which does not follow the 'Straight Through Process' due to insufficient or incorrect payment details

£25.00

Payer to pay all Charges - Where you request that you, the payer, pay all charges for the selected payment, you irrevocably give Capital Treasury Services the right to claim any subsequent agents charges relating to this payment from your CTS account

£1.00 > £100.00

Post Payment Investigations

Tariff per item

Payment Trace - Where the beneficiary claims non-receipt Payment Recall - Where funds are to be returned to your account at your request Payment Return - Where a payment has been returned by the correspondent or receiving bank

£28.00

Adding Additional Information - Where either you, or the receiving bank or their correspondent request additional information to be added to the payment *

Faster payments are only available when payment is being remitted to a Faster Payment Enabled Sort Code, if in any doubt please contact a member of the CTS team.

** United Nations sanctions and Currency Restrictions apply - value date of receipt dependent on currency of payment, see separate document entitled Capital Treasury Services - International Payment Services Cut off times and Value Dates for further details. *** Foreign Currency Local Payments currently available for in USD, CAD, ZAR and AUD going to beneficiaries in their domestic countries. This list will be added to on an ongoing basis, please contact a member of the CTS team for information on the latest additions.

Internet Payment & Cash Management

Bridge™

Internet Payment & Cash Management

International Cash & Payment Management

Bridge™

Terms of Business

International Cash & Payment Management Capital Treasury Services - Web Usage & Payment Services

Capital Treasury Services Limited is a Member of the Capital International Group Capital Treasury Services Limited is licensed by the Isle of Man Financial Supervision Commission Registered Office: Capital House, Circular Road, Douglas, Isle of Man, IM1 1AG

“...arguably the most dramatic reaction to the Japanese crisis has been the German decision to shut all nuclear reactors by 2022...”

The Nuclear Power Debate The nuclear power industry has been brought back into focus this year with the ramifications of the Japanese earthquake and tsunami being widely felt. Some countries have put a temporary freeze on development; others have materially changed their long term power generation plans.

It does appear now that three of the four reactors have experienced full meltdown and with water/air contamination evident, the anti nuclear lobby is growing in stature.

Certainly for countries such as China and India, nuclear power represents the only real viable option to provide sufficient power without the environmental and health issues of fuels such as coal. In the UK, the Government have recently drawn up plans for the next generation of nuclear plants which will be located at existing sites. There are eight possibilities to be built by 2025.

Following the Chernobyl disaster in 1986 there was a lengthy period of no new developments. It has only been in the last decade that nuclear has enjoyed a renaissance, partly driven by the expensive reality of some of the renewable fuels such as wind and wave power. Indeedthe share of total energy use is only 6% provided by nuclear and before this year this figure had been estimated to rise to only 8% share by 2035. The recent issues with the second generation reactors at Fukushima could lead to another push for gas fired power stations as well.

Arguably the most dramatic reaction to the Japanese crisis has been the German decision to shut all nuclear reactors by 2022. In fact, the eight oldest reactors have already been shutdown and will remain so permanently. Before the shutdown the country got 23% of its power from nuclear plants, there is clearly a large hole to fill. It will throw up a major opportunity for France which has strong public support for nuclear power and relies on it the most of any developed nation. Nuclear accounts for 80% of power requirements. There are some major industrial losers in Germany, with companies such as E.ON and RWE lobbying hard to get the decision reversed. Indeed RWE has stated that it is looking at ‘all legal possibilities’ to counter the Government move.

In the US there is also strong support for nuclear, although any new safety measures are likely to stretch the economics of the majority of the current proposed developments. It was only in February that President Obama had called for $36 billion in federal loan guarantees for the new reactors. Despite widespread power cuts across India, there are also signs that public opinion is turning very negative, particularly with terrorist attacks in mind.

China currently accounts for 27 of the 62 reactors that are in the process of being built globally and it has 13 reactor units in operation. The country is studying new safety standards which are unlikely to be released until the end of 2011 and this could well slow the construction programme. However there are in total, 425 existing plants operating across the world and whilst some nations may become more cautious, there will still be opportunities within the nuclear power sector.

for our Morning Spread market news visit www.capital-iom.com © Capital International Limited 2011

June 2011

Volume: 9

Also in this issue: • China Hard or Soft Landing • Global Equities - A very dull quarter • Fixed Income Review

Issue: 2

From Capital to Capital The Capital International Group are pleased to report that in mid-May Manx resident Steven Primrose-Smith reached his latest capital city, Brussels, in his amazing cycling journey - cycling to every capital city in Europe between 2011 and 2013.

Steven set off on his challenge 31st March 2011 and has already passed through Douglas, London, St Helier, Paris, Luxembourg City and now Brussels. But Steven is not content only with his travel challenge.

As if spending each day cycling through Europe was not enough, Steven is a forty year-old full-time student with the Open University and the University of Wales studying for two degrees. While he is cycling to every one of the fifty capital cities in Europe he is also raising money for three charities (The Blood Pressure Association, Action for Animals and OUSET)!

The Capital International Group is delighted to be supporting Steven on his venture.

Capital International Group Head of Marketing & Business Development, Antony Kelsey said: “Steven’s challenge was spotted by some of the staff here and it seemed obvious that it should be one of the many worthy causes we wanted to support as a business.” Antony continued: “We are delighted to be tracking Steven’s progress and if you look at his blog you can see it has been far from a Sunday afternoon cycle in the country! We wish him continued success in his challenge.”

Capital International Group

Upon inspection of Steven’s blog, you will find stories of culinary delights including kangaroo steaks, ostrich burgers and jellied eels, tales of unsolicited generosity from strangers, the trials of navigating capital cities without signposts, plus the very scary experience of cycling along Parisian roads, and of course the delights of weather (too wet, too windy, too hot!).

Capital International Group Chief Executive, Anthony Long added ‘This is an outstanding instance of personal generosity and sacrifice undertaken by Steven. We are delighted to be supporting him through this enduring task and continue to wish him every success in this venture and his studies.’

To find out more on Steven’s progress or if you would like detailed stories of his travels then please visit his website at unicycle50.com. If you would like to sponsor Steven on his inspirational cycle challenge, please visit justgiving.com/unicycle50.

CELEBRATING

BUSINESS 15 YEARS SUCCESSFUL IN THE ISLE OF MAN

Rates & Commodities

30-Jun-11

Price at 31-Mar-11

30-Jun-10

Price at 31-Mar-11

30-Jun-10

% Chg Quarterly

% Chg 1 Year

GBP/USD

1.6067

1.6064

1.4963

0.02%

7.38%

FTSE -100

GBP/EUR

1.1071

1.132

1.2206

-2.20%

-9.30%

Dow Jones

5,945.71

5,908.76

4,916.87

0.63%

20.92%

12,414.34

12,319.73

9,774.02

0.77%

GBP/JPY

129.433

133.056

132.548

-2.72%

-2.35%

NASDAQ

27.01%

2,773.52

2,781.07

2,109.24

-0.27%

SILVER

34.690

37.650

18.615

-7.86%

86.36%

31.49%

S&P 500

1,320.64

1,325.83

1,030.71

-0.39%

GOLD

1508.00

1431.00

1240.50

5.38%

28.13%

21.56%

DAX

7,376.24

7,057.15

5,965.52

4.52%

EUR Crude Oil

111.68

117.25

73.87

23.65%

-4.75%

51.18%

CAC 40

3,982.21

3,989.18

3,442.89

-0.17%

US Fed Funds

0.25

0.25

15.66%

0.25

0.00%

0.00%

Nikkei 225

9,816.09

9,708.79

9,382.64

1.11%

UK Base Rate

0.50

4.62%

0.50

0.50

0.00%

0.00%

Hang Seng

22,398.10

23,451.43

20,128.99

-4.49%

11.27%

ECB Base Rate

1.25

1.00

1.00

25.00%

25.00%

FT All Gilts

155.68

153.17

157.44

1.64%

-1.12%

Capital International

% Chg Quarterly

% Chg 1 Year

World Indices

30-Jun-11

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CIL - Capital Update - V2.03-07.11

August 1996 - 2011