Current FTSE GM Issue Section1

I S S U E 4 7 • D E C E M B E R 2 0 1 0 / J A N U A RY 2 0 1 1

THE MALTA REPORT: THE NEW BUSINESS OPPORTUNITY

ROUNDTABLE: WHO REALLY BENEFITS FROM MARKET FRAGMENTATION?

London’s commercial real estate rebound

Why green bonds have investor appeal

Irish crisis props up dollar

20-20 ALL STARS:QIA leads the pack

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EDITORIAL DIRECTOR:Francesca Carnevale, tel: +44 [0]20 7680 5152, email: [email protected], fax: +44 (0)20 7680 5155

CONTRIBUTING EDITORS: Art Detman, Neil O’Hara, David Simons.

CORRESPONDENTS: Rodrigo Amaral (Emerging Markets); Andrew Cavenagh(Debt); Lynn Strongin Dodds (Securities Services); VanjaDragomanovich (Commodities); Mark Faithfull (Real Estate);Ruth Hughes Liley (Trading Services, Europe); Joe Morgan(Berlin); John Rumsey (Latin America); Ian Williams(US/Emerging Markets/Sector Analysis); David Craig (London).

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1FTSE G LOBAL MARKET S • D E C E M B E R 2 0 1 0 / J A N U A R Y 2 0 1 1

OUTLOOK

CHANGE IS A big theme in this edition, across the range of marketsfrom investment flows to market infrastructure. Past editions haveconcentrated on regulation. We’ve taken a breather this time to focus

on market dynamics across a section of asset classes. Not all change is good;and there are some notable sub-trends that are beginning to impact theoverall market outlook for 2011 and beyond. The tide of emerging marketEurobond issuance is starting to concern some investors and analysts, forexample, who fear that the increasing flood of money into emerging marketswill create serious asset bubbles as too much capital chases too few assets.While this is clearly a bigger risk for equities than bonds, some believe thepricing on recent issues is starting to make the latter look expensive.

In developed markets, for the first time in more than half a century, yieldson benchmark government bonds in the US, UK and Europe are lower thanthe returns of high yield equities. This is due to the investor stampede intotriple-A rated sovereign bonds on the back of fears over the global economyand the threat of a double-dip recession in the US and UK. Industry reportsreveal that the dividend yields in Europe stand at around 4%, more than 1.5percentage points above government bonds. Historically, defensive sectorssuch as oil and gas, telecoms and consumer staples have been the mostpopular dividend plays due to their strong and secure cash flows. We reporton the implications.

Elsewhere, increasing market complexity and the need for risk managementrun through this edition like the wording through Blackpool Rock. We’ve triedto include all the main strands, from the infrastructural modifications outlinedby the DTCC’s Don Donahue through to the very real market changesoutlined in our bond trading, securities lending and ETF coverage. The themeof change and evolution also plays through our trading editorial. As speed andcompetition have increased in the equity trading world, so has pressure, notonly on incumbent exchanges but also on the multilateral trading facilities inEurope and alternative trading platforms in the US, to maintain investment intheir technological infrastructure. Inevitably, exchanges that provide a betterservice will naturally attract more flow and therefore force others to react to thedemand for continuous improvement.

As we come to the close of the year and a sense of seasonal renewal takeshold, it is perhaps as well to chart the new configurations of the globalfinancial markets. Next year looks to be even more complex, challenging andtransformational than this.

To help fill in time in the interim we’ve accumulated a debate-worthyselection of high achievers in our annual 20-20 All Stars coverage. Somecontenders are obvious, others less so; with their inclusion based more onexpectation than past performance. The hope of the analysis is the coalescingof some of the key themes of this year: the seismic shifting of economic powerfrom West to East, the deepening and broadening of the investor servicesproduct set and the growing emphasis on regulation, transparency and riskmanagement, particularly in the US and Europe. This is a pivotal year and theselection of this year’s star performers reflects the strength of financial cross-currents. We are already looking forward to next year’s crop and hope you findenough in this year’s selection to open your mind to the potential of 2011.

Francesca Carnevale,EditorDecember 2010/January 2011

Cover photo: Qatar Prime Minister Sheikh Hamad Bin Jassem Bin Jabor Al Thani delivers his speech during theopening of the 5th Finance and Investment in Qatar Forum in Paris. Photograph by Francois Mori/AP, supplied byPress Association Images, November 2010.

CONTENTS

2

DEPARTMENTS

COVER STORY

MARKET LEADER

20-20 ALL STARS ..........................................................................................................................................Page 46The global financial markets remain in flux and this year’s crop of 20-20 All Stars have all risento the challenge. The nominations are not awards, rather a simple acknowledgement of some ofthe innovation in the global markets and a nod to individual and group achievements in still-trying circumstances.

DATA PAGES

DTCC Credit Default Swaps analysis ........................................................................................................Page 119Fidessa Fragmentation Index....................................................................................................................................Page 120BlackRock ETFs..............................................................................................................................................Page 122Market Reports by FTSE Research..........................................................................................................................Page 124Index Calendar ..............................................................................................................................................................Page 128

D E C E M B E R 2 0 1 0 / J A N U A R Y 2 0 1 1 • F T S E G LOBAL MARKET S

DTCC: THE NEW WORLD OF RISK MITIGATION ......................................................................Page 6Don Donahue, chief executive of the DTCC, explains the dynamics of change at the DTCC.

IRISH CRISIS UNDERPINS US TREASURIES ..................................................................................Page 12US bonds rebound as the problems in the eurozone worsen. By Andrew Cavenagh.

WHEN FREDDIE MET FANNIE ..........................................................................................................Page 14Mark Faithfull writes about the spiralling rescue costs of America’s most expensive bailouts.

THE NEW RISK/RETURN EQUATION ............................................................................................Page 18Neil O’Hara reports on the lowlights and highlights of fixed income securities.

THE SHOCK OF THE NEW ..................................................................................................................Page 24Investors are adopting ETFs with enthusiasm but there may be unforseen consequences.

BACK TO THE FUTURE? ......................................................................................................................Page 28Lynn Strongin Dodds explains why high yield equity returns are better than government bonds.

MORE WOOD THAN TREES ..............................................................................................................Page 31Simon Denham, managing director of Capital Spreads writes on the over-indebted EU nations.

THE MERGED STRENGTH OF RBI ..................................................................................................Page 32The new Austrian bank’s emerging markets result.

CLUELESSNESS AND CURRENCY WARS......................................................................................Page 33Erik Lehtis, president of Dynamic FX Consulting, on the Fed’s “implicit” currency manipulation.

A CAPITAL PERFORMANCE ..............................................................................................................Page 34Mark Faithfull on the rising central London’s real estate prices, despite the recession.

THE STEADY GLOW OF GREEN BONDS ....................................................................................Page 36The use of green bonds to fund sustainable projects.

THE NEW STRONG SUIT ....................................................................................................................Page 38Jean-Claude Petard, head of Equity Markets at Natixis, offers a French trader’s perspective.

CUSTOMER CHOICE IN THE DRIVE FOR BEST EXECUTION ............................................Page 40UBS’s Owain Self explains his views on dark pools, algorithms and trading in the US and Europe.

HARNESSING A RISING TREND ......................................................................................................Page 42Mohammed Al Omar, chief executive officer of KFH, describes the bank’s business strategy.

THE PHYSICAL CHALLENGE ..............................................................................................................Page 44The challenges of trading physical commodities place new demands on existing systems and expertise.

IN THE MARKETS

INDEX REVIEW

BANKING REPORT

REAL ESTATE

DEBT REPORT

COMMODITIES

FACE TO FACE

FX VIEWPOINT

PROFIT PROFILES:

A MOULD BREAKING COMPANY QUARTET ................................................Page 66Through the “great recession” some companies not only remained profitable but positionedthemselves for continued growth by adhering fiercely to their core principles. Art Detmanprofiles four such companies—three American and one Canadian.

CANADIAN TRADING:

HFT TIPS THE DARK POOL AGENDA ..............................................................Page 70High-frequency trading has shaken up a Canadian equity market long dominated bythe incumbent exchange and five big banks. Investors anxious to avoid HFT order floware turning to dark pools, which have been slow to develop in Canada thanks to itsunusual broker preference trading priority. Neil O’Hara reports.

STOCK EXCHANGE TECHNOLOGY:

SPEED IS KING ..............................................................................................................Page 74Stock exchanges are now caught in a technology frenzy-seeking lower latency,introducing more efficient matching engines and new order types. The raison d’etre isthat the buy side have increasingly dynamic expectations. Is that really true? Or are the reasons much more diverse? Ruth Hughes Liley reports

EUROPEAN TRADING VENUES ROUNDTABLE:

WHO REALLY BENEFITS FROM MARKET FRAGMENTATION?................Page 79In the roundtable discussion, Paul Squires, head of trading at AXA IM says: “Our marketis complex and technical and not everything has fitted into the principles-basedregulation that is MiFID, and it has created many problems for market participants. It isno great secret that the buy side is looking at MiFID II to address some of thoseconcerns.” What did the rest of the panel think?

THE NEW FINANCIAL HUB ..........................................................................................Page 95

THE MED’S ATTRACTIVE ALTERNATIVE....................................................................Page 96

MALTA’S ONSHORE APPEAL TO FUND MANAGEMENT ....................................Page 100

PUNCHING ABOVE ITS WEIGHT ..............................................................................Page 104

MSE AIMS TO BE A GLOBAL PLAYER......................................................................Page 110

A PRIVATE EQUITY DOMICILE ..................................................................................Page 113

MORE FOR MORE: POSITIONING FUND ADMINISTRATION ..............................Page 115

DIRECTORY....................................................................................................................Page 117

BOND TRADING:

FRATERNITY, LIQUIDITY, TRANSPARENCY ......................................................Page 89The past two years may go down in history as the best fixed-income market seen,following the confluence of high volatility, low interest rates, tight spreads and highdemand. Ruth Hughes Liley reports.

TRANSITION MANAGEMENT:

A DEEPER PRODUCT SET ........................................................................................Page 92The transition management product set has deepened, now often encompassing acradle-to-grave relationship between beneficial owners and their mandated assetmanagers. Now that relationship begins much earlier in the asset management process,explains Mark Dwyer, managing director and head of EMEA at Mellon TransitionManagement and Beta Management at BNY Mellon.

FEATURES

THE MALTA REPORT: THE NEW BUSINESS OPPORTUNITY

4 D E C E M B E R 2 0 1 0 / J A N U A R Y 2 0 1 1 • F T S E G LOBAL MARKET S

CONTENTS

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©2010 NYSE Euronext. All rights reserved. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of NYSE Euronext. NYSE Euronext and its affi liates do not recommend or make any representation as to possible benefi ts from any securities or investments, or third-party products or services. Investors should undertake their own due diligence regarding securities and investment practices. This material may contain forward-looking statements regarding NYSE Euronext and its affi liates that are based on the current beliefs and expectations of management, are subject to signifi cant risks and uncertainties, and which may differ from actual results.

6

IN THE WAKE of the LehmanBrothers’ collapse, the DTCC closedout more than a half trillion dollars

in open positions, thereby preventinglosses for the industry, and perhapsultimately for taxpayers, that could havebeen in the hundreds of millions orbillions of dollars. The DTCC did all thiswithout having to draw on any of theself-insurance funds on deposit withus. Many of you, in turn, told us of thequick actions you took, and thesometimes painful decisions you made,

to get your firms through the crisis.Together, our stories made a compellingtale about our success in fighting anumber of dangerous fires. Actually, people outside the financial

industry don’t care what we had to do toput the fire out. They want to know whyit started in the first place, why it burnedso fiercely, and why as an industry wehadn’t taken preventive action. Theprevailing view, as far as the public, theirelected representatives and our regulatorsare concerned, is that the fire itself was the

product of a shocking and fundamentalfailure of risk management and oversightin the markets we serve. Moreover, theycontinue to be very unhappy about it,because they view our failure as having lednot just to a financial crisis, but also aharsh global recession, a staggering lossof jobs and wealth, and extreme damageto public finances in the developed nationsas they bailed-out failing institutions andsought to stabilise their economies.Unavoidably, in the new post-crisis

world, governments and regulators willunderstandably be focused on financialrisk to a much greater extent thanpreviously. To address these issues, theprivate sector will have to work with ourregulators as partners, rather thanadversaries, to improve our riskmanagement operations. After all, therelationship between regulator andfinancial enterprise is symbiotic.Regulators want the financial servicescompanies they supervise to be healthyand safe, and they know that firms cannotbe safe and sound unless they earn strongrisk-adjusted returns—in fact, regulatorshave for generations utilised ratingsystems that have included earnings,along with other important factors suchas capital and liquidity, as a key measureof the health of financial services firms.

Industry contextAt the DTCC we understand that thebar of regulatory expectations on riskhas been raised and what used to benormal or standard operating procedureis fast becoming history. As a result, we’re now initiating a top-to-bottomtransformation in how the DTCC thinksabout risk, how we oversee risk, how wemanage risk and how we plan to addressrisk—all aspects of risk—both within theDTCC and within the financial systemwe are a key part of. This is a sweepingall-hands-on-deck initiative that comesat the direction of our board.This journey will be an extremely

ambitious undertaking that forces theDTCC to rethink many of theassumptions behind the practices we’veemployed and the services we’ve beenoffering our participants for decades.

MARKET LEADER

THE DTCC AND RISK MANAGEMENT: C

HANGES AND IMPLIC

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Landmark financial reforms are in process globally; banks facemuch tougher capital standards and the global financialindustry is involved in a radical reappraisal of how it managesrisk. In that respect, the Depository Trust & ClearingCorporation (DTCC) is not immune to the metamorphosis takingplace in the global financial markets. Don Donahue, chiefexecutive of the DTCC, explains in an open letter, the dynamicsand the implications for its clients.

THE NEW WORLD OFRISK MITIGATION


Don Donahue, chief executive of the DTCC, explains the dynamics, and its implications for itsclients. Photograph kindly supplied by the DTCC, November 2010.

8

In other words, it will alter—in someways significantly—how we supportand work with you to further mitigaterisk. We are firm in our understandingof this new responsibility. We are clearthat our regulators and supervisors viewit as imperative that we address thisnew responsibility. We also received avery similar message from many of youearlier this year when we polled ourmember firms about our strategicdirection and planning. The principalmessage that came back to us fromthose interviews was to keep focusedon our core services and, above all else,to ensure risk mitigation.

Risk marginingThose familiar with the DTCC’s EnterpriseRisk margining systems know that theyare calibrated against a 99% confidencelevel; the margins the systems will requirehave to be sufficient to cover 99% or moreof the instances we face. It also serves asa timely symbol for how we have tendedto think about risk, namely that themeasure of our performance was 99%and that the last 1% was something wewould handle “in the moment” ratherthan through a systemic solution.However, in this post-crisis period, thestrong message from governmentaloverseers, regulators and bank supervisorsat home and abroad shifts the weightinga bit. As vital as meeting the 99% standardis, the public sector is now saying thatthe 1% is equally if not more critical. In thecase of another financial meltdown, itmay be that an institution such as theDTCC is the only thing standing betweenour member firms/issuers/investors andtotal meltdown. Therefore, we need tobe absolutely sure that we will comethrough in that extreme situation. So wehave implemented the “DTCC 3.0”programme, which represents the seachange in our thinking to focus on whatcan happen in that last 1% and how weneed to prepare ourselves for that.I will outline what I call The Seven Habits

of Highly Effective Infrastructures as a guideto the principles we have to guide usthrough this change. First: do no harm; orwhat we can think of as the 99% rule.

Very simply, whatever we do, whateverchanges the DTCC may require, we muststill be sure that we can conduct the day’sactivities, close down tonight and open uptomorrow with the same level of rock-solid stability and resilience that we areexpected to deliver day in, day out. Aswe think through the changes required tomeet the 1% test, we have to ensure wekeep the system stable and performancerock solid. Two: stuff happens. Controls will never

be perfect; that means we can’t everassume that what exists in terms of ourdesign or our implementation of controlsand risk management structures is goodenough, because they haven’t beendesigned to be 100% foolproof. Even ina stable environment, we will have tocultivate a constant dialogue about howwe can improve controls and risk-management structures. Three: the better we get at risk

mitigation, the more risks people willtake. Principle two says even in a stablesystem things can go wrong, but of coursesystems are not stable, they change andgrow. The better we become in terms ofcontrols the more those controls will betested by new types of assets, new typesof transactions, new activities that oursystems will have to cope with. So wehave to be vigilant about industry trendsand developments. Ironically, we arekeenly aware that the better we becomeat identifying this cycle of new risks andfiguring out how to mitigate them, thefaster the cycle will move and the morepeople will be willing to take risks,confident that we’ll be able to continue asa safety net. Four: financial systems naturally tend

toward instability. As economist HymanMinsky notes, financial systems inherentlyare biased towards instability and crisis,as favourable financial conditions pushpeople to make riskier financial decisionsand as that dynamic feeds on itself. Five: lowering the water is as good as

raising the bridge. Sometimes we won’tidentify risks that are evolving, orunderstand what new controls orstrengthened controls we need toaddress them. So, in parallel, we need

to “lower the water”; finding ways tomake core risk systems stronger, moreresilient, to withstand anything thatgets thrown at it, even when we didn’tsee it coming. However good we arethough at identifying and addressingrisks in advance, at some point we aregoing to experience another financialcrisis. Therefore, we have to beabsolutely sure about the resilience ofour risk management process; even incircumstances where the gravitationalforces of a market crash get absolutelyferocious. Six: you never know where or who the

next key insight will come from. The pointbeing that everyone in a company knowssome of the things that are critical to thesuccess of the new risk-managementparadigm, but no one knows all of them.How do we create a culture that allowspeople to voice their questions andconcerns and then gets all of us to reactto them? It is a key question.Finally, most of the answers are in

structures, not standards. In other words,how we institutionalise risk managementchanges. We are clear that we need tomake changes, about what the changeinvolves and where it will take us. Weare clear that change is ongoing,continuing through cycles of riskmitigation and risk taking, but it alsoneeds to be supported by somethingstructural in the organisation.

Raising our risk-intelligencequotient Internally we’ve used economist HymanMinsky’s theories and other similarviews, to help our staff understand thechallenge of renewal we face at theDTCC. As a core industry infrastructure,we must understand and act uponMinsky’s insight—that stability itself isdestabilising. We are also utilising the DTCC’s

experience in the wake of 9/11. In thatevent, the DTCC realised that as good asour business continuity planning hadbeen, it would have to be transformed.We could no longer focus primarily onsurviving natural disasters, or assumethat the problem to be solved was our

MARKET LEADER


HANGES AND IMPLIC

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10

inability to operate; we had to recognisethat we were responsible for safeguardingagainst events that caused the system tobecome temporarily inoperable. In that reimagining, we will be working

with the “three lines of defence” model.The first line is our individual businessunits. They have to identify and measurerisks, and judge how effectively they’rebeing controlled. Today’s new premisethough is that risks that once might havebeen tolerated now must be addressedand ways to reduce them implemented.Moreover, every time we reduce particularforms of risk, we have to go back andassess the risk picture again with an evenmore powerful lens. Our second and third lines of defence

rest with our specific risk-control areas—the “enterprise” and “operational” risk-management units and our Internal Auditgroup, respectively. Their capabilities willbe upgraded to ensure that these areasare prepared to challenge our thinkingabout the levels of risk we think we needto tolerate. In short, we’re ratcheting upthe organisation’s risk-intelligencequotient (RIQ). Fundamentally, this is azero-based remaking of our approach.We’re going to start at the baseline, andthat may force us to rethink many of theassumptions behind the practices we’veemployed and the services we’ve beenoffering our participants for decades.

Customer impact and innovationI imagine many of you are beginning toask: “What’s this going to do to mybusiness and the way I use DTCC servicesand what will it cost?” Actually, we don’thave all the answers yet—and that’s theunpredictable environment we’ll need tomanage in the coming years. For example,our subsidiary, National SecuritiesClearing Corporation (NSCC), has neverapplied any kind of “debit cap” restrictionon the end-of-day net settlement balancesits members can build up during a day;that has been industry practice sinceNSCC was founded. However, that doesimpose serious liquidity risk on theclearing corporation, and we need to finda way of controlling that. Remaking an entire process with far

more checks and balances will not beeasy or cheap, and that will likely drivesome increases in fees. Mitigating riskis not simply a matter of increasing themargin reserves against it. This newchallenge of mitigating risk will demandrelentless experimentation, and thebursts of innovation that can flow fromthat. In fact, we already have innovativeinitiatives under way that will help youto efficiently use your capital. New YorkPortfolio Clearing, for example, our jointventure with NYSE Euronext, isdesigned to provide a simultaneous viewof both futures and cash markets forgovernment securities and much largerefficiencies in margining. Or, considerour intent to launch a new centralcounterparty (CCP) for mortgage-backed securities. It will provide thesafety of a trade guarantee to this marketfor the first time ever, but it will alsoreduce risk and costs in the handlingof the underlying mortgage pools.

Writing new financial rulesThe challenge of overhauling oursystems and processes from the groundup seems daunting, but we can do it.Part of the challenge, of course, is thatwe’ll be doing it within a regulatoryenvironment that’s already been set inmotion by the Dodd-Frank Act. TheDTCC has long had a close workingrelationship with our regulators and thenew world of risk mitigation willdemand that this becomes an evencloser, tightly coordinated relationship. A new player in the regulatory field

will be the new Financial StabilityOversight Council which Congresscreated in the Dodd-Frank Act; anindependent 10-member committee,including representatives from theTreasury Department, the FederalReserve, the SEC, and five otheragencies. The council has authority todetermine whether the DTCC is a“systemically significant” financialmarket utility. If it does, then the FederalReserve becomes the prudentialregulator for all of our subsidiaries, as itis today for The Depository TrustCompany (DTC) and Warehouse Trust

Company (WTC). To back up its powersfor monitoring systemic risk, the newoversight council will also rely on a newagency, the Office of Financial Research(OFR), to collect and standardise datafrom financial services companies, toperform research, and to develop riskmeasurement and monitoring tools. We expect that the OFR will collectsignificant amounts of position,transaction and counterparty exposuredata from throughout the industry.Given our unique position in the cashequity and fixed income markets, andquality of the over-the-counter (OTC)derivatives data we keep in our TradeInformation Warehouse, we have a roleto play in aggregating data for the OFR. In Europe, too, we have spent a lot of

time and effort meeting withpolicymakers to make sure that theEuropean regulatory consensus on OTCderivatives also provides for reportingthose trades to a single repository foreach asset class. We’ve taken concretesteps to allay European concerns aboutaccess to the data that we hold in ourtrade repositories. In October, welaunched a European subsidiary calledDTCC Derivatives Repository, whichwill maintain global credit default swap(CDS) data identical to that maintainedin our New York-based Trade InformationWarehouse. This European-basedrepository will support a wide variety ofcritical functions, including, mostimportantly, CDS trade reporting.Last year, the DTCC won the contract

to build a similar repository for globalOTC equity derivatives, and we havenow opened that facility in London aswell. Our goal is to avoid a proliferationof redundant trade repositories thatwould fragment data and introducefurther systemic risk. We’ve made clearto regulatory agencies that functionoutside the US that the data we collectfrom across the globe will be availableto any of them with a legitimate interest.Another step we took in August thisyear was to add additional data to whatwe already publish about credit defaultswaps. We’re working hard to expandtransparency in this global market. �

MARKET LEADER


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For the second consecutive year, the global institutional investor community has voted Société Générale Corporate &

Investment Banking the #1 Global Provider in Equity Derivatives in the Risk magazine 2010 Institutional Investor Rankings.

“With more than 20 years of experience in Equity Derivatives, SG CIB continues to lead the industry through its

comprehensive coverage of worldwide equity underlyings, consistency and continuity of service and tradition of

innovation. Throughout the world, the challenge of addressing your specifi c needs and the trust you have placed in us

over the years push our teams to reinvent the Equity Derivatives industry every day. We are driven by our commitment

to our clients and we would like to thank you for your continued loyalty.” SG CIB Global Equity Flow Team.

www.sgcib.com

Investors affi rm once again Société Générale’s leadership & expertise

#1Global Provider in Equity DerivativesRisk magazine June 2010 Institutional Investor Rankings

THANK YOU FOR YOUR LOYALTY AND TRUST

YOUR PARTNER IN GLOBAL MARKETS

INVESTMENT BANKING – GLOBAL FINANCE – GLOBAL MARKETSSociété Générale is a credit institution and an investment services provider (entitled to perform any banking activity and/or to provide any investment service except the operation of Multilateral Trading Facilities) authorised and regulated by the French Autorité de Contrôle Prudentiel “ACP” (the French Prudential Control Authority) and the Autorité des Marchés Financiers “AMF”. Société Générale is subject to limited regulation by the Financial Services Authority “FSA” for the conduct of its business in the UK. Details of the extent of its regulation by the Financial Services Authority are available from us on request. Société Générale benefits from the EC passport authorizing the provision of investment services within the EEA. This material has been prepared solely for information purposes and does not constitute an offer from Société Générale to buy or sell or a solicitation of an offer to buy or sell any security or financial instrument, or participate in any trading strategy. Not all financial instruments offered by Société Générale are available in all jurisdictions. This communication is not intended for or directed at retail customers. It is for professional investors only. Please contact your local office for any further information. © 2010 Société Générale Group and its affiliates.

We stand by you

Benjamin Fussien

Karl Adm

12

AFTER THE FEDERAL Reserveannounced on November 4ththat it would buy up to a further

$600bn of Treasuries by the end of Juneunder the QE2 programme, a wave ofselling pushed yields out over the nexttwo weeks with that on benchmark ten-year Treasury bond reaching 2.96% onNovember 16th, its highest level forthree months. Yields had come back by the end of

the week (the ten-year bond retrenchingto 2.82%), however, as debt marketsdecided that the Irish government’scommitment to support the country’sstricken banks was insupportable andwould necessitate some form of EuropeanUnion bailout. The contagion once againspread to the sovereign debt of the otherbeleaguered euro countries—Portugal,Spain and Greece. Michael Woolfolk, senior currency

strategist at BNY Mellon in New York,says there was “no question” that theIrish situation had underpinned the USTreasury market, as the latest panic in theeurozone had provided hard evidencethat the single European currency stillhad fundamental issues to address. “Theproblem has not been resolved yet,” hesays. “It has merely been papered over.” Even without a fresh eurozone crisis,

there was little to suggest a sustainedflight from US government bonds wasimminent at this stage. Analysts attributedmuch of the sell-off in the first half ofNovember to a natural correction, ashedge-fund investors and othersunwound positions they had taken aheadof the QE2 announcement—selling onthe fact of having bought on the rumour.

The latest official figures from the USTreasury department, published onNovember 16th, certainly showed thatforeign demand for long-termgovernment securities had remainedstrong throughout September. Netforeign purchases of Treasury bonds andbills came to just under $80bn for themonth, split almost evenly betweenprivate investors ($38.8bn) and centralbanks ($39.5bn). While the total was adecline on the $117.1bn of net purchasesrecorded in August, it still representedthe third highest monthly total this year. Moreover, China and Japan, by far the

two largest investors in US sovereigndebt, actually increased their overallholdings to $883.5bn (with net purchasesof $15.1bn) and $865bn ($28.4bn)respectively over the month, despitemarket expectations that both countrieswould start to scale back their investmentsin US Treasuries to reduce their exposureto the dollar. Woolfolk says he had been “impressed”

by the strength of foreign demand forTreasuries in September, particularly onthe back of the high level of demand seenin the previous month. He points out thatthe surge in purchases by foreign centralbanks was largely a move to defend theirown currencies from appreciating againstthe dollar. Nevertheless, QE2 is likely to slew the

market for Treasuries in the monthsahead, because the Fed’s purchasingprogramme is going to focus on bondswith maturities in the middle of thecurve. The US central bank will not bebuying much debt with a maturity of 17to 30 years, and this uneven support for

the market will inevitably have aninfluence on the future direction of yields.Kevin Flanagan, chief strategist in the

fixed-income division of Morgan Stanleyin New York, suggests that a trifurcationof the Treasury market was likely, inwhich the Fed’s commitment to QE andnear-zero interest rates would anchorthe yields on short-term instruments(with maturities of three years or less),while those on five to ten-year bondswould benefit from QE2 purchases butthose on longer-term bonds—whichare vulnerable to inflation expectations—would widen significantly.Flanagan believes that yields on ten-

year Treasuries could go as low as 2.25%once the Fed purchases start to kick in.He then expects them to move within arange of 2.5%-3.5% between now andthe end of next year.

Long-term pressures The independent Financial ForecastCenter based in Houston, Texas, ispredicting a slightly tighter range forthe benchmark bond: a fluctuation ofbetween 2.61% and 2.94% over the nextsix months and then a rise to 3.15% inJune 2011. Yields on longer-term bonds, which

are not impacted by short-term Fedpolicy, seem certain to continue rising,reflecting the real and long-termpressures on the US economy andcurrency, as the government continuesto issue record volumes of further debtto finance an expected aggregate budgetdeficit over the next ten years of $8.5trn. “The very long Treasury yields are a

truer, undistorted picture of the marketprice,” maintains Mike Riddell, whomanages M&G’s International SovereignBond Fund. “The point is that you can’tincrease debt levels forever, and at somepoint that will be a problem for the US.They have to address their budget deficitand debt-to-GDP ratios.” �

IN THE MARKETS

BONDS: US SOVEREIGN REBOUND HELPED BY EURO FA

LL

US Treasury bonds suffered from a predictable—and widelyanticipated—sell-off in the first half of November after the FederalReserve confirmed it was to embark on a second round ofquantitative easing. However, the crisis in Ireland provided a sharpreminder that the problems in the eurozone are far from over, andthe run on the market was short-lived. Andrew Cavenagh reports.

IRISH CRISIS UNDERPINSUS TREASURIES


Photograph © Bpro /Dreamstime.com, suppliedNovember 2010.

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14

FANNIE MAE AND Freddie Mac,the US government-ownedmortgage finance companies, could

cost the country’s taxpayers as much as$363bn to the end of 2013, according totheir regulator—less than some of theworst-case scenarios, but more thanprojections by the White House.Since they were rescued by the

government in 2008, Fannie Mae andFreddie Mac have drawn $148bn fromthe US Treasury to stay afloat as losseson bad loans underwritten during thehousing boom have continued to turnbad. In August, the Congressional BudgetOffice said Fannie and Freddie wouldneed $390bn in federal subsidies to theend of 2019. The White House’s Officeof Management and Budget (OMB) hadin February estimated the cost to be just$160bn for the same period, providingthe economy continues to strengthen.The Federal Housing Finance Agency

(FHFA), which regulates the two entities,says it was possible losses could be lessthan $363bn. If house prices rebounded,interest rates remained low andunemployment fell, Fannie and Freddiemight only need $221bn in cumulativeaid. However, most analysts believe thisscenario is too optimistic, as the USeconomic recovery stalls and the housingmarket remains stagnant.In addition to covering projected losses

on bad loans, an increasing portion oftaxpayer aid will be used to pay dividendson preferred stock issued by the Treasurydepartment as part of the terms of itsrescue. Excluding these dividend

payments, Fannie and Freddie wouldneed less money to stay afloat, $142bnin the best-case scenario and $259bn inthe worst. Yet if the US housing marketcontinues to crumble, taxpayers couldface a total bill of more than $400bn tobailout the duo by 2013. Those twoentities hold about $6.8trn in allmortgage obligations, or nearly 57% ofoutstanding home loans in the US. Confused? The number of numbers

being bandied around adds touncertainty and recently RealtyTrac,which monitors repossession activity,confirmed that the foreclosure crisisin the US had spread across a widerarea than previously thought.Foreclosure notices increased acrossa majority of large metropolitan areas,including Chicago and Seattle.Previously, these cities had seenrelatively low levels of activity.

RealtyTrac’s report says that California,Nevada, Florida and Arizona remainthe worst affected areas. The trend isthe latest sign that the US foreclosurecrisis is worsening as homeowners—facing high unemployment, slow jobgrowth and uncertainty about houseprices—continue to fall behind on theirmortgage payments.Meanwhile, the announcement from

Wells Fargo that it would re-filethousands of foreclosure documents isthe first admission from the bank ofpossible problems in the way itrepossesses homes. In a statement, thebank said it had identified “instanceswhere a final step in its processes relatingto the execution of the foreclosureaffidavits ... did not strictly adhere to therequired procedures”.Despite the raft of worrying news, Frank

Nothaft, vice president and chiefeconomist, Freddie Mac, says: “Whenrates fall to new lows we typically seemore ‘rate and term’ refinancers, whoare looking only to reduce their interestpayments, and relatively fewer cash-outborrowers. Now we’re also seeing a verylarge share of borrowers reduce theirmortgage debt when they refinance.Consumer debt across the board is downsince the start of the recession, with non-mortgage consumer debt falling morethan 5% since 2008.”However, US house prices are being

weighed down by an overhang of unsold,repossessed properties, falling again inAugust after the expiry of homebuyers’ taxcredits. Prices were down 0.3% versusthe previous month, on a seasonally-adjusted basis, according to the Case-Shiller index of 20 major US cities.A tax credit for homebuyers expired in

April, leading to a steep drop in homesales over the summer. That same effectnow appears to be feeding into house-price data. Compared with last year, the

IN THE MARKETS

FANNIE MAE & FREDDIE MAC:THE SPIRALLIN

G RESCUE COSTS


The rescue of Fannie Mae and Freddie Mac is shaping up to be one of America’s most expensivebailouts, exceeding the cost of the savings and loan crisis that saved small banks and thrifts in the1980s and the Trouble Asset Relief Program (TARP) of 2008, which threw a lifeline to financialcompanies and car-makers. Analysts and government have issued conflicting estimates of thespiralling bill for the US taxpayer amid questions about whether Freddie Mac and Fannie Maeshould have a future in America’s broken housing market, writes Mark Faithfull.

WHEN FREDDIEMET FANNIE

Photograph © Anthony Furgison /Dreamstime.com, supplied November 2010.

16

index published by rating agency Standard& Poor’s was up 1.7%, somewhat lowerthan analysts’ expectations of a 2.1% year-on-year rise. However, prices remain 29%below their peak of May 2006, accordingto the index, having only recovered some5% since bottoming out in May 2009.Fannie Mae’s Economics & Mortgage

Market Analysis Group is in downbeatmood. “The labour market has yet tomake significant progress, which is theprimary reason for our continued weakgrowth forecast,” says Fannie Mae chiefeconomist Doug Duncan. “With economicgrowth slowing, job creation also hasbeen tepid, keeping the unemploymentrate high. Housing sales will likely be softuntil the labour market strengthens.”“The housing market appears to have

stabilised at new lows,” adds David Blitzer,chairman of the index committee atStandard & Poor’s. “At this time, it doesnot seem that any of the markets arehanging on to the temporary momentumcaused by the homebuyers’ tax credits.”The FHFA used estimates from rating

agency Moody’s to devise its best andworst-case scenarios. In the best case,housing prices will have fallen 34% fromtheir peak in 2006 to their trough in thethird quarter of 2011. The worst case callsfor a deeper decline in prices of 45%.The results could shape the debate over

the long-term role that the governmentshould play in the mortgage market.Some Republicans argue the governmentshould focus on shrinking Freddie andFannie and eventually privatise them. However, the Obama administration,

which has promised to outline itsproposed overhaul of the broaderhousing-finance system by January, hassaid a government role may still beneeded to preserve the long-term, fixed-rate mortgages that have become thekeystone of the US mortgage market.Under the regulator’s most positive

home-price scenario, Fannie and Freddiewould lose $6bn over the next three yearsand they would still have to ask thegovernment for 11 times that amount tomake dividend payments. On its mostlikely projection—which assumes an endto the housing crisis is close and that

home prices will stop falling soon—theywill lose $19bn in the same period.On the other hand, if the economy

slides back into recession and homeprices fall by another 20% to 25%, thecompanies could cost taxpayers anadditional $124bn, before dividendpayments. Another drop in values couldlead to more delinquent borrowers withfewer options to avoid foreclosure. Pricedeclines could also lead to losses on thealmost 200,000 homes the firms havetaken back through foreclosure. The vastmajority of the firms’ losses stem fromsuch delinquent and defaultedmortgages that the firms bought orguaranteed between 2005 and 2008.Since then, the companies havetightened underwriting standards, andloans made over the past two years arenot expected to lose money.

Mortgage delinquenciesFannie and Freddie own or guaranteearound half of the nation’s $10.6trn inmortgages. While the Obamaadministration has said the $700bnTroubled Asset Relief Program (TARP)could cost a fraction of the initialinvestment, the tab for Fannie and Freddiehas swelled as mortgage delinquencieshave mounted. The National Bureau forEconomic Research warns: “Theforeclosure process problems and pauseon foreclosures pose a risk to our outlookof the housing market as they createuncertainty for potential homebuyers.Foreclosed homes account for asubstantial part of the existing homemarket and therefore a pause onforeclosures, if it spreads through thenation, has the potential to suppress homesales in the near term and interfere withthe housing recovery.”The legacy of poor mortgage lending

has led bankers into a two-front war,pitting them against US homeownerschallenging the right to foreclose andmortgage-bond investors demandingrefunds that could approach $200bn. While federal regulators and state

attorney generals have focused on flawedforeclosures, a bigger threat may be thecost to buy back faulty loans that banks

bundled into securities. JPMorgan Chase,Bank of America, Wells Fargo andCitigroup have set aside just $10bn inreserves to cover future buybacks. Bankof America alone says pending claimshave jumped 71% from a year ago to$12.9bn of loans. The biggest risks for banks may be

loans packaged into mortgage-backedsecurities during the housing bubble, ofwhich $1.3trn remains. The aggrievedbondholders include Fannie Mae andFreddie Mac, bond insurers and privateinvestors. Fannie Mae and Freddie Macmay be owed as much as $42bn just onloans they bought directly from lenders,according to Fitch Ratings.Pimco, BlackRock, MetLife and the

Federal Reserve Bank of New York areseeking to force Bank of America torepurchase mortgages packaged into$47bn of bonds by its CountrywideFinancial Corp unit. JPMorgan Chase took a $1bn third-

quarter expense to increase its mortgage-repurchase reserves to about $3bn.Citigroup raised its reserves to $952m inthe third quarter, from $727m in theprevious period. Wells Fargo reduced itsrepurchase reserves to $1.3bn, from $1.4bnin the second quarter. “These issues have been somewhat

overstated and to a certain extent,misrepresented in the marketplace,” saysWells Fargo chief financial officer HowardAtkins. “Our experience continues to bedifferent than some of our peers in thatour unresolved repurchase demandsoutstanding are actually down.” The other front in the battle is the

potential cost to banks of improperdocumentation used in foreclosures.Attorney generals in all 50 states areinvestigating foreclosure procedures.Litigation costs for such cases may reach$4bn, while a three-month delay inforeclosures would add an additional$6bn to industry expenses, FBR CapitalMarkets estimated in November. �

IN THE MARKETS

FANNIE MAE & FREDDIE MAC:THE SPIRALLIN

G RESCUE COSTS


City, State Foreclosures

Las Vegas, Nevada 32,288

Cape Coral, Florida 10,352

Modesto, California 4,825

Stockton, California 5,929

Merced, California 2,072

The top five US metropolitan foreclosures in Q3 2010

Source: RealtyTrac, supplied November 2010.

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18

TWO YEARS AGO, fixed incomesecurities lenders couldn't believetheir luck. A gigantic liquidity

squeeze created unprecedented demandfor funding trades just as many lenderspulled back from the market amidwidespread worries about counterpartyrisk. Players who stayed the coursecleaned up, shovelling out generalcollateral at spreads normally associatedwith specials. It couldn't last, of course. Two years

later, rock-bottom interest rates, tightercollateral reinvestment guidelines,massive issuance by the US Treasury andpersistent deleveraging throughout thefinancial system have squeezed lendingmargins. The “Cinderella” moment forthe ugly stepchild of securities lending

has passed, but bright spots still sparkle amid the ashes. Lending fixed income securities has never been asprofitable as equities, a market in whichparticipants have long been willing topay through the nose for the privilegeof borrowing particular names. Until thelast year or two, fixed income borrowersin the US drew the line at zero rebateon hard-to-borrow securities; theyrefused to incur a negative rebate underany circumstances. Record low interestrates and the introduction of a 300 basispoints (bps) penalty on failed trades inthe US Treasury market shattered thatresistance not only for Treasuries but forother fixed income assets.The change came even though specials

have virtually disappeared from the

Treasury market. “Ever since the issuancesizes have increased, most off-the-runTreasuries are financed at or very closeto general collateral levels,” says VincentLaudati, US fixed income tradingmanager, securities lending, at Citi GlobalTransaction Services in New York.The margin squeeze reflects an

extraordinary shift in the balancebetween supply and demand. Treasuryissuance was $209bn in the fiscal yearthrough September 2007, but by 2009it had ballooned to more than $1.74trnand was still a whopping $1.47trn infiscal 2010. “Before 2007 we couldgenerate an average of 14bps on thetwo-year,” says Shirley McCoy, globalhead of fixed income lending, financingand markets products at JP Morgan inNew York. “Now it is about 7bps.” US Treasury portfolio utilisation rates,

which used to hover close to 100%, havedropped back to 60% to 65% as a result.Lender psychology has changed, too.Before the financial crisis, clients used toask Paul Wilson, global head of clientmanagement and sales, financing andmarkets products, JP Morgan in London,

IN THE MARKETS

FIXED INCOME SECURITIES: LO

WLIG

HTS AND HIGHLIG

HTS

A major liquidity squeeze in 2008 created unprecedenteddemand for funding trades, with fixed income securities lenderswho stayed the course cleaning up. Now, with interest rates atrock bottom, massive issuance by the US Treasury and tightcollateral reinvestment guidelines, the “Cinderella” moment forsecurities lending has passed. However, there are still a fewbright sparks. Neil O’Hara reports.

THE NEW RISK/RETURN EQUATION


Photograph © Beliksk /Dreamstime.com, November 2010.

The diffeThe diffe ence between perform and outperform. ence between perform and outperform. er er and outperform. and outpe form.

20

about utilisation rates all the time. “It isvery seldom that clients talk aboututilisation now,” he says. “They aremore concerned about what level ofoverall return we are generating underwhat risk parameters.”Fears that lenders would desert the

market altogether in a low interest rateenvironment have proved unfounded,however. After the widely publicisedproblems in some cash collateralreinvestment pools two years ago, everylender—whether or not they incurredlosses—reviewed their reinvestmentprogramme and in most cases revisedthe guidelines to focus on shorterduration and higher quality assets. Theconservative stance combined with lowinterest rates has made some financingtransactions uneconomic for borrowerslike banks and securities dealers, butlenders are happy to pick up a few extrabasis points when investment returnsare so low.“While returns are not what they used

to be, we remind clients that the returnsseen a couple of years ago were createdby extreme market conditions that werenot good for the industry,” says NickBonn, head of securities finance at StateStreet Corporation in London.

Substantial premiumOpportunities to earn higher returnsdo exist for lenders who are willing totake more risk. New liquidity regulationsfor banks and broker-dealers haveboosted borrower interest in termlending commitments. Citi's Laudatisees particular interest in three-monthloans; borrowers are seeking to pledgea wider range of collateral, too. Lenderswilling to extend credit beyond one year,a period that affords borrowersregulatory capital relief, can pick up asubstantial premium, as well. “Themarket is a bit polarised,” says JPMorgan's Wilson. “Dealers will pay tolock up securities for a longer period,but very few lenders will commit as faras one year.”Margins may have shrunk in US

Treasuries, but the same cannot be saidfor European sovereign debt. Market

fears about parlous public finances inPortugal, Ireland, Italy, Greece and Spaindrove their sovereign debt securitieswell into special pricing territory earlierthis year, although the premiums easedoff over the summer. Borrowers havesnapped up debt securities issued bycore European Union countries, too.“There has been a substantial increasein demand since 2008,” says Bonn.“France and Germany almost trade likespecials instead of general collateral.”Borrowers have also been chasing

sovereign debt in emerging Europeancountries that have serious fiscalimbalances, according to Kate Lander,head of the London trading desk forfixed income securities lending atNorthern Trust. Volume has risen, albeitfrom a low base, and the margins can befat. “Emerging markets and corporatehigh yield have performed as well orbetter than equities,” she says.Corporate bonds are another bright

spot in the fixed income lenders'universe. Kathy Rulong, global head of

securities lending at BNY Mellon, hasseen corporate balances double in thepast two years. The lendable asset basehas increased as clients have raised theirallocations to fixed income securitiesand asset values have rebounded, buthigher demand from borrowers hasabsorbed enough supply to keep theutilisation rate fairly steady. Specialsarise either from specific events orgeneral market sentiment. “After theBP oil spill, energy-related bonds werein great demand,” says Rulong. “For awhile it was airline bonds. To somedegree, demand for corporate bondsparallels equities.”Credit default swaps (CDS), an

alternative way to take short exposureto corporate credit, tend to siphon offborrower demand for cash bonds.Traders can compare the relative cost,but although they have an incentive tochoose the cheaper alternative, pricingbetween the two markets does not movein lockstep. The choice varies by securityand is not necessarily consistent. “A

IN THE MARKETS


WLIG

HTS AND HIGHLIG

HTS


Nick Bonn, head of securities finance at StateStreet Corporation in London. “We remindclients that the returns seen a couple of yearsago were created by extreme marketconditions that were not good for theindustry,” he says. Photograph kindlysupplied by State Street, November 2010.

Kathy Rulong, global head of securitieslending at BNY Mellon. “After the BP oil spill,energy-related bonds were in great demand,”says Rulong. “For a while it was airlinebonds. To some degree, demand for corporatebonds parallels equities.” Photograph kindlysupplied by BNY Mellon, November 2010.

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22

security that trades at negative 500bpsrebate may not go to the credit defaultswaps market even though one thattrades at zero rebate does,” says StateStreet's Bonn. “It depends on the trade.”The decline in popularity of credit

default swaps since the financial crisishas revived borrower demand forcorporate bonds. The DX Long-ShortRatio for corporate bonds, compiled byLondon-based DataExplorers, has fallenfrom 19.9 in May 2009 to 13.5 inNovember 2010 as short interest has risen.Regulatory pressure to trade

standardised credit default swapsthrough a clearing house or on anexchange may cut credit default swapsvolume even more. McCoy expectsclearing house margins to be setrelatively high, perhaps 15%–30% ofthe notional amount, more than enoughto push traders back toward corporatebonds. Market participants have alreadytaken notice: corporate bond balanceshave doubled in the past year at JPMorgan—and it's profitable business.“Volumes are much lower than ingovernment bonds, but corporate bondshave more intrinsic value,” says McCoy.“When you look at where revenue isbeing generated, corporate bonds arethe winners.”The credit default swaps market isn't

all bad news for cash bond lendersanyway. Swaps dealers like to maintaina near-neutral book, and cash bondsare an obvious way to offset theirunmatched exposure. Tom Wipf, headof fixed income financing at MorganStanley in New York, says: “It's far froma one-to-one correlation, but we do seea lot of hedging of credit default swapsusing cash bonds.”Custodians including BNY Mellon,

State Street and Northern Trust lendprimarily to the big international banksand prime brokers, putting them at oneremove from the end-users of mostborrowed securities. Wipf is on the frontline, lending to hedge funds, otherbroker-dealers and banks to cover failsor traditional short sale transactions—but also to facilitate financing. Longholders of securities may lend them out

for a modest fee and take back ascollateral either securities that pay morethan the ones lent out or cash the lendercan reinvest to earn a higher return. “Along holder is sourcing leverage throughthe secured financing market,” says Wipf.“It's not traditional securities lending, it'sa repo or funding transaction.” Although these trades were more

popular before 2008 when banks andbroker-dealers faced fewer regulatorycapital constraints, funding trades stilldrive the lending market in US Treasuries.In today's low-rate environment, everybasis point matters, which explains whythe market has embraced BondLend, anelectronic fixed income lending and tradeprocessing platform created by EquiLend.Brian Lamb, chief executive officer ofBondLend, says volume has risen from60,000 transactions in the first quarterof 2010 to 80,000 in the third quarter,and he expects more growth before year-end as BondLend signs up additionalcustomers.The system can handle any type of

transaction but so far users have focusedprimarily on general collateral lending.Automated lending and straight-throughtrade processing allow lenders to placelarge volumes of general collateral onloan fast and efficiently, exactly what isneeded at a time when margins are waferthin. “We operate as a utility, so we cancompete quite effectively on price,” saysLamb, who anticipates that customerswill use the platform for higher valuetrades as well in the future.That may be a tough sell, however.

While lenders value the BondLendservice, they aren't about to abandonconventional trading for their mostvaluable specials. “The hard names tradeby hand,” says State Street's Bonn. It'san open secret that custodian lendersdole out specials to favoured clientsbased on how much general collateralthey are willing to take.Lenders will use all the technological

help they can get in the high-volume,low-margin general collateral game, butfor now at least human beings still tradethe crown jewels in the lenders'portfolios. �

IN THE MARKETS


WLIG

HTS AND HIGHLIG

HTS


Brian Lamb, chief executive officer ofBondLend. “We operate as a utility, so we cancompete quite effectively on price,” says Lamb.Photograph kindly supplied by BondLend,November 2010.

Tom Wipf, head of fixed income financing atMorgan Stanley in New York, says: “It's farfrom a one-to-one correlation, but we do see alot of hedging of credit default swaps usingcash bonds.” Photograph kindly supplied byMorgan Stanley, November 2010.

FTSE. It’s how the world says index.

© FTSE International Limited (‘FTSE’) 2010. 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.

THE FTSE I WANT THE WORLD INDEX

Spotlight on Norway: A Q&A Session with Global X Funds founder and CEO Bruno del AmaWhy did you choose the FTSE Norway 30 Index as the basis for Global X’s newest Exchange Traded Fund?Norway is one of the most developed economies in the world, and is an exporting powerhouse. This has generated an extremely large trade surplus, whichhas resulted in one of the largest sovereign wealth funds in the world. Furthermore, Norway has not adopted the Euro, which helps it to maintain its statusas one of the world’s most stable currencies and economies. All of these factors have driven investor demand for a vehicle to invest in Norwegian equities.The FTSE Norway 30 Index represents the performance of the 30 largest and most liquid Norwegian equities listed on Oslo Bors Stock Exchange. Stocksare liquidity screened to ensure that the index is tradable, and a unique capping methodology makes it suitable for the use as the basis for investmentproducts such as derivatives and Exchange Traded Funds (ETFs).

What is the name of the new ETF?The fund’s name is the Global X FTSE Norway 30 ETF. It began trading on NYSE Euronext on November 10, 2010, under the ticker symbol NORW.

What is the performance story?The index has outperformed broader equity benchmarks, including the FTSE Developed Europe index, over the 3-month, Year-to-Date and 12-month periods.

SOURCE: FTSE Group, data as at 29 October 2010

What kinds of companies are found in the FTSE Norway 30 Index?Companies within the index are classified using the Industry Classification Benchmark (ICB), a global standard developed in partnership between FTSEand Dow Jones. Hard asset producers represent over half of the index, including Oil & Gas producers with a 41.49% weight, Chemicals with a 5.70%weight, and Basic Resources with a 4.78% weight of the index. The largest five companies in the index are:Rank Constituent Name ICB Sector Index Market Cap (USDm) Index Weight (%)

1 Statoil ASA Oil & Gas Producers 21,780 18.60

2 DnB NOR Banks 16,633 14.20

3 Telenor A/S Mobile Telecommunications 13,314 11.37

4 Yara International Chemicals 6,680 5.70

5 SeaDrill Ltd Oil Equipment, Services & Distribution 6,455 5.51

Totals 64,862 55.38

SOURCE: FTSE Group, data as at 29 October 2010

Call 888-GXFUND-1 to request a prospectus, which includes investment objectives, risks, fees, expenses and other information that youshould read and consider carefully before investing. Investing involves risk, including possible loss of principal.International investing may involve risk of capital loss from unfavorable fluctuations in currency values, from differences in generally acceptedaccounting principles, or from economic or political instability in other nations. Narrowly focused investments and securities focusing on a single countrymay be subject to higher volatility. Index performance is for illustrative purposes only.The Funds are distributed by SEI Investments Distribution Co., which is not affiliated with Global X Management Company, FTSE, or any of their affiliates.

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130

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24

THE TIDAL FLOWS of cash intoexchanged-traded funds (ETFs)continue, most notably in the US,

but also in Europe, and even in Asiawhere, for example, Ping An Securitieshas teamed with Value Traders of HongKong to offer an ETF based on the FTSEValue-Stocks China Index, which tracksthe performance of 25 quality value stocksamongst Chinese companies listed onthe Hong Kong Stock Exchange.Vanguard’s ETF product line-up attractedover $5bn, in October, making them themost successful issuers but iShares alsotook in $3.6bn and State Street $1.4bn. The reasons for investor enthusiasm

are clear. Bob Monks, formerly of theLens Fund and long-time campaignerfor investor rights, confidently asserts:“The indexes outperform all but a veryfew of the managers every year, andthey have far less costs. So the net tothe investor of buying an index fundyear in and year out compares veryfavourably with all but the most giftedinvestors, who, after all, invest forthemselves; they don't invest for you.”Monks estimates that if you take

indexing and closet indexing—peoplewho charge fees as if they were active,but are really indexers—it's about 40%

of the market. His prognostication isthat once the saturation of indexes/ETFsreaches around 60%, problems beginwith the market chasing its own tail, asindexers are indexing themselves. As is normal in the hothouse ecology

of the financial markets, ETFs haverapidly evolved under the dual pressuresof investor demand and managerialingenuity as funds developed more andmore complex products, for which, ofcourse, increased fees can be charged.Despite the explosion in the number of

ETFs and the consequent decline in thepopularity of more actively-managedfunds, managers are rapidly adapting tothe changing environment. As well ascountry and regional funds, offerings nowinclude silver based indexes, airlineindexes, and almost any conceivableslicing and dicing of region, product andeven time. However, despite the rapidgrowth in these more complex offeringsto more adventurous investors, theliquidity of ETFs seems to be enhancingcustomer fickleness as many investorsmove to more cheaply run funds.Vanguard’s emerging market fund, forexample, has been growing rapidlycompared with competitors using thesame MSCI index, primarily, it would

appear, because its costs are only onethird of theirs. Carl Delfeld of ETF Passportquestions the survival of many of thesenew products. “I’ve never been keen onissues like retirement year funds. It comesdown to marketing, they want to come upwith new ideas. Obviously there is goingto be a big shakeout, a consolidation ofETFs at some point. Economics demandthat you have around $100m to make itworthwhile, depending on how muchyou spend on marketing,—and I bet mostof them haven’t. Probably the top tenETFs account for about half the funds.”Investors seem to be voting with their

dollars for the more simple, transparentETFs that retain ETFs’ distinctive lowcost transparency. On the face of it, fundmanagers should be worried by thedefection of so many of their clients andtheir money, but they seem to bereacting with typical ingenuity to anunbeatable challenge—by setting upand marketing their own ETFs. Thecomplexity of some of the offerings,almost invariably dependent on a moreactive and expensive management, hasled to some of the new offerings lookinglike a more liquid version of mutuals.

Sea of complexityDelfeld comments: “Even actively-managed ETFs are different frommutuals because you can buy and sellthem on an exchange, and use somerisk management tools, such as trailingstop losses, but actively-managed ETFstend to be less transparent, moreexpensive, less tax efficient. What wassupposed to be an easy, straightforwardtool is now a sea of complexity withmore than 1,000 ETFs trading on USexchanges; I guess the future is reallyhow investment advisers use them. Youhave to have some sort of strategy touse ETFs for your clients and choosebetween the pure index ETFs and theactively managed ETFs.”He thinks that the new complex

products are more of a retail productthan those aimed at professionalmanagers. “There are some interestingones out there, but keeping it simpleand transparent, I’m not sure that having

IN THE MARKETS

ETFS: NEW PARADIGMS IN ETF INVESTING

One can never discount the caution of market watchers who worryabout unforeseen destabilising consequences of ETFs beingadopted with such bubbling enthusiasm by investors. Particularlyas they now engender intense interest from hedge funds, not tomention being the subject of much ingenuity by financialengineers. Ian Williams reports on the deepening of the asset class.


THE SHOCK OFTHE NEW

Photograph © Rolffimages /Dreamstime.com, suppliedNovember 2010.

26

IN THE MARKETS

ETFS: NEW PARADIGMS IN ETF INVESTING


a basket of 30 or so ETFs for your clientsis serving them very well.”Lisa Dallmer, chief operating officer

of European Cash Market ExecutionServices for NYSE Euronext, is sanguineabout the competition between traditional mutual funds and ETFs. Shereports that in the US there is some$900bn in exchange-traded productassets under management. “ThisSeptember, consolidated dollar volumeturnover represented approximately30% of all consolidated US dollar valuetraded. By share volume, theyrepresented approximately 17% of allUS consolidated shares traded.” In Europe, euro value traded in ETFs on

NYSE Euronext grew by 5% over theprevious year while the number of tradesin the same period has grown by 19%;indicating more trading by more users.She also considers that the fund managershave decided that ETFs and mutual fundscan coexist, “if you look at the expansionof ETF offerings from mutual fundsmanagers. People sometimes prefer thefeatures of mutual funds, for examplethey have dollar cost averaging, while anETF doesn’t necessarily. Ultimately theETF managers do hold the physicalsecurities. We think that there is roomfor expansion out there, as the markethas returned and people are looking foryield this year, there are a lot moreemerging market ETFs, country specific,region specific, illustrated as overall assetgathering expands. Both mutual fundsand ETF providers are trying to meetdemand and expand their products, butthere will always be managed funds, androom for managers seeking alpha.” Vin Bhattacharjee, head of EMEA

Intermediary Business at State StreetGlobal Advisors, also stresses that indexesand ETFs are different products frommutuals and so do not necessarilycompete in the same space. Even so, hereports: “Retails investors are obviouslymoving from mutual, actively-managedfunds with their generally higher costs.The fundamental issue is the fact that80% of any portfolio returns come fromasset allocation rather than stock orsecurity selection, so you will get over

80% of your returns from the equity, bond,fixed income mix rather than by, pickingsay, Coca Cola over General Motors.” Headds: “The only way to achieve equivalentresults is by taking huge portfolio risk.So there is no reason to go for actively-managed funds; to take beta exposurefrom the underlying beta, the best wayto do that is by getting an index.” He agrees that the penetration of the

index funds is causing the correlationbetween the underlying securities andthe overall index, and for example, thecorrelation between the individualequities and S&P 500 has gone up overthe years with portfolio trading.However, while it might look like a dogchasing its own tail, he stresses: “Thatwill create a lot of active opportunities,because it’s impossible for all the stocksto behave identically since they representdifferent businesses, and that will createarbitrage opportunities, alpha creationopportunities. Already, we see a lot ofhedge funds are now playing singlestock positions against index.”

Rush of fundsSo where do ETFs go from here?Bhattacharjee reflects: “There are alwaysmore ways to skin a cat.” He discountsthe possibility that the rush of fundsinto BRICs and emerging markets-basedindexes and ETFs is causing bubbles.“They are just a way of executing aposition so I don’t think they are causingmajor inflows, just reflecting underlyingtrends. The developed markets face amajor debt overhang which is beingmonetised with, for example, QE2 in

the US, whereas the developing marketshave exactly the opposite with very lowleverage ratios, so that is enough toexplain the capital flows,” he says,adding that in reality calling thesemarkets “emerging” is a misnomer.“Their capital markets are sounder nowthan the so-called developed markets!”He foresees continued interest in the

emerging markets as long as the euroand dollar maintain their external debtoverhang. Similarly, “investors will wantsafe havens with other currencies, fixedincome, gold and other precious metals,commodities and that trend might bereflected in ETFs”. “There’s still a lot ofroom to grow in fixed income funds,”he suggests.Lisa Dallmer also foresees even more

offerings, explaining: “Indexers can builda whole portfolio in an ETF… there arenow even ‘retirement date’ ETFs, wherethe index adjusts the allocation of assetsbetween equities and fixed income tomaximise returns for the preferredretirement year.”She also notes wide room for

geographic expansion. While ETFs arestrongest in the US and growing inEurope, they are only just taking off inAsia, and she points out a large expansionof ETF offerings in, for example, HongKong and Japan over the last three yearsfrom 47 to nearly a hundred.Dallmer discounts the dangers of a

bubble with the rush into sectors likecommodities and emerging markets.“These products create an access pointwhere investors can get entry into assetsthat would otherwise be difficult unlessyou were prepared to build specialisedportfolios with brokers, and this yearwe’ve seen more offerings in emergingmarkets, fixed income.”Delfeld differs about the bubble

aspects, considering that the ease ofETFs, whether in commodities oremerging markets, has made it easierfor investors to access these classes. “Forexample, gold and silver have certainlybeen boosted since ETFs have made iteasier, rather than gambling on diceymining stocks, and it has been the samewith emerging markets.”�

Vin Bhattacharjee, head of EMEAIntermediary Business at State Street GlobalAdvisors. “Retail investors are obviouslymoving from mutual, actively-managed fundswith their generally higher costs,” he says.Photograph kindly supplied by State Street,November 2010.

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IN THE MARKETS

HIGH YIELD EQUITIES: A BETTER BET THAN GOVERNMENT BONDS


ALTHOUGH THEY MAY be atthe less exciting end of theinvestment scale, high yield

equities have come back into favour.This trend started as a short-termdefensive play but, increasingly,institutional investors have hopped onthe bandwagon to tap into steadyreturns. Sectors such as oil and gas,banking, telecoms and pharmaceuticals,have traditionally been prime targetsbut now a broader approach is beingtaken.One of the main contributing factors is

that for the first time in more than 50years, yields on benchmark governmentbonds in the UK, Europe and US arelower than the returns of high yieldequities—those that distribute higherthan average dividends. This is due to theinvestor stampede into triple-A ratedsovereign bonds on the back of fears overthe global economy and the threat of adouble-dip recession in the US and UK.There are also concerns over the plethoraof regulations, the tightening of Chinesemonetary policy and the sovereign debtcrisis in Europe. Ireland’s negotiationsover a multi-billion dollar loan packagefrom the International Monetary Fundand European Union could be followedby Portugal and Spain making similarmoves. The flight into bonds pushed yieldsto new lows while, simultaneously,

company profits rebounded. Equally asimportant, a significant number ofcompanies is sitting on dividend yieldsthat are higher than what they are payingon their own debt, which reflects boththe attraction of high-yielding equitiesand the equity market overall.Richard Turnill, manager of

BlackRock’s global equities fund, notes:“There is an extraordinary anomaly inthe financial markets today where ifinvestors want to buy yield in the bondmarkets, they have to buy lower qualityassets, but we have the oppositesituation in equities. Institutions nowhave the opportunity to invest in thehighest quality businesses at reasonableprices, plus they are also getting aninflation hedge. This is why I thinkthere is such a compelling structuralcase today for dividends.”

A similar pictureLooking at the big picture, industryreports reveal that the dividend yields inEurope stand at around 4%, more than1.5 percentage points above benchmarkgovernment bonds. They are alsocompetitive with yields on triple-B ratedinvestment corporate bonds which areclose to 5%. In the UK, yield in the giltfund sector currently averages 2.78%,although some funds are yielding aslittle as 1.4%-1.6% compared to the

3.5% being generated on the FTSE All-Share index.A similar picture is being painted in

the US. Calculations by fund managementgroup Federated Investors show totalreturns for dividend-paying companieshave outpaced the broader market bynearly 190 basis points since January whiledata compiled by Bloomberg reveals thatUS companies are being the mostgenerous with their dividends since 2003.In addition, the S&P 500 DividendAristocrats Index, which tracks large capfirms that have sought to increasedividends every year for at least 25consecutive years, has risen 8.6%compared with the broader S&P 500index, which gained 2.5%.There are also encouraging signs for

the future. The latest figures from fundmanagement group Fidelity show that210 companies in the UK have raisedtheir dividends so far this year while 55have left them unchanged, and 30 havecut them. Over the same period in 2009,only 156 companies reported increaseswhile 51 left them unchanged and 86withdrew them. As for next year, Newton Investment

Manager is predicting dividend growthbetween 8% and 22%. The forecast ispredicated on the level that BP reinstatesits dividend which is slated for early 2011as well as the dollar-pound exchangerate. The oil giant pulled its dividendand announced plans to sell $10bn(€8bn) of assets and cut capitalexpenditure due to the Gulf of Mexico oilslick crisis. This came as something of asurprise to investors who relied on theirregular cheques. According to estimatesfrom the National Association of PensionFunds (NAPF), BP stock accounts for

For the first time in more than half a century, yields on benchmark government bonds in the US,UK and Europe are lower than the returns of high yield equities. This is a result of the investorstampede into triple-A rated sovereign bonds on the back of fears over the global economy andthe threat of a double-dip recession in the US and UK. Industry reports reveal that the dividendyields in Europe stand at around 4%, more than 1.5 percentage points above government bonds.Historically, defensive sectors such as oil and gas, telecoms and consumer staples have been themost popular dividend plays due to their strong and secure cash flows. They are particularlyappealing today because they did not partake in the rally last year and consequently are themost undervalued. Lynn Strongin Dodds reports.

BACK TO THE FUTURE?

30

HIGH YIELD EQUITIES: A BETTER BET THAN GOVERNMENT BONDS


IN THE MARKETS

about 1.5% of a typical UK pension fundportfolio and, before the crisis at least,around 6% of the FTSE 100 index.According to Tineke Frikkee, portfolio

manager of the Newton Higher IncomeFund: “If BP reinstates its dividend atthe consensus level of $0.105 per quarter,at $1.56 to the pound, then 2011 marketdividend growth is likely to be around14%. If it comes in at the previous levelof $0.14 per quarter at $1.56 then thefigure could be higher at 18%. The dollar-pound exchange rate is important forthe forecast range of dividend growth asmore than 40% of UK dividends isdeclared in dollars. If sterling was toweaken to its recent low of $1.43 to thepound, and BP was to reinstate dividendsto previous levels, then UK marketdividend growth could reach 22%.”As for other contributors, Frikkee

points to HSBC, Vodafone, BritishAmerican Tobacco, National Grid, AngloAmerican, GlaxoSmithKline and Xstrata.HSBC is the largest company in the UKin terms of market capitalisation, at 7.4%of the FTSE All-Share Index, and around7.8% of expected UK market dividendincome in 2011. Vodafone’s marketweighting is 5.1% and the companycontributes 8.3% of all UK marketdividend income in 2011.Recent research from Barclays

supports the view about HSBC as wellas a select group of other Europeanbanks, which includes SEB, Swedbank,UniCredit, Société Générale, BNPParibas, Standard Chartered and BBVA.The bank believes that instead ofhoarding capital as has been the recentpractice, clarity on Basel III capital rulesshould allow some banks to loosen theirgrip and deploy surplus capital. Thebank’s analysts’ notes say: “In the fouryears pre-crisis, the sector paid dividendsof €131bn yet only generated free cashflow of €52bn. Over the next four years,we estimate free cash flows of €213bnand dividends of €107bnHistorically, defensive sectors such as

oil and gas, telecoms and consumerstaples have been the most populardividend plays due to their strong andsecure cash flows. These companies have

also been the most generous in terms ofpayouts and have enjoyed the highestyields. They are particularly appealingtoday because they did not partake inthe rally last year and consequently arethe most undervalued. However, as the BP experience

demonstrates, past performance shouldnot always be an indication of futurepayouts. As Sonja Schemmann, managerof Schroders Global Equity IncomeFund, notes: “Typically, telecoms, foodproducers, big cap oil companies andhealthcare have been the most popularhigh-yield investments. However, it isimportant to look at companies on anindividual basis and make sure that theyhave sustainable growth prospects andstrong management teams.” To that end, Folmer Pietersma, head

of Robeco’s Property Equities Fundstrategy, recommends real estateinvestment trusts (REITs). “REITs are ondividend yields of 4% to 5%, which ismuch higher than cash and bondinvestments. We think the cash flowsand dividend growth of a significantnumber of listed real estate companiesshould continue and that real estate willremain an attractive investment in today’slow interest rate environment. The focusshould be on strong balance sheets andprime portfolios in good locations.” Overall, though, a long-term view

should be adopted. As John Velis, headof capital markets research, EMEA, atRussell Investments, points out,dividends and dividend growth and notcapital gains drive the performance ofstock markets over several years. “I ama strong believer that if investors holdequities over a long-term period theywill be able to take advantage of theprofits the companies generate becausethey are returned to shareholders in theform of dividends. History suggests thatstock prices only rise if the marketbelieves that dividend payouts will rise.”

Rate of returnFor example, the US equity marketbetween 1937 and 2009—the longestperiod of data available—shows thaton average equities returned nearly 16%per annum over a ten-year holdingperiod, which in real terms equals 11.5%per annum. Breaking it down, the rateof return accounted for by real priceappreciation was only 1.9% or less thanone-eighth of the total real return. Data for the UK (from 1962 through

2009) reveals a similar story. Of the 13.1%annualised return over that period, 7.1%is due to inflation and just 1.1% to priceappreciation. The remaining 4.9% of FTSEAll-Share returns is attributed to acombination of dividend income anddividend growth. �

Sonja Schemmann, manager of SchrodersGlobal Equity Income Fund. “Typically,telecoms, food producers, big cap oil companiesand healthcare have been the most popularhigh-yield investments,” she notes. Photographkindly supplied by Schroders Global EquityIncome Fund, November 2010.

Tineke Frikkee, portfolio manager of theNewton Higher Income Fund. “If BP reinstatesits dividend at the consensus level of $0.105per quarter, at $1.56 to the pound, then 2011market dividend growth is likely to be around14%,” she says. Photograph kindly supplied byNewton Higher Income Fund, November 2010.


The sums being loaned to theIrish look almost unbelievableif you equate it to a per

employed person scale. Some 2.2mpeople work in the Republic and thisnew bailout will add at least another€40k to the average citizens’ debtpile. That’s on top of all the privateand public debt exposure already inplace. With unemployment nowapproaching 14% the obviousquestion is: how on earth they willever get out of the hole that has beendug for them?Once again Europe appears to be

pushing problems ever further intothe future in the hope thatsomething will turn up. The marketsare less sure it will. Irish long termdebt is now yielding over 8%, havingbriefly hit 9%. This is the price withwhat appears to be a reasonableEuropean guarantee. In a widercontext though (with German,French and UK debt at or lower than3%) it is clear that the internationaldebt markets remain suspicious ofEuropean political promises. It is worrying to admit but there is

a growing number of otherwisesensible people across Europe whoare now drifting into the camp thatholds there is no point in paying allthis debt. After all, they say, it will getbigger next year, no matter how fastwe pay it off. As a result,democracies may be put under heavy

pressure from the simple solutionbrigade from both the left and rightwhose cry of “Let the banks die!” willget louder and louder. The argumentthat this will bring everything downaround our heads may not count formuch if the general populous feelsthat this has already happened.How is this likely to affect the

equity market? As I mentioned backin September the search for yield waspossibly a likely beneficial argumentfor the FTSE’s component parts, aseven the most expensive stock wasgiving a reasonable return. This isespecially true when added to thefact that—aside from SouthernEurope, the UK and the US—theworld economy is still looking rathergood, thank you very much.Commodity prices continue to surgeas demand increases and in manyplaces the argument is more aboutraising interest rates to curbinflationary pressures rather thantrying to boost growth with vastamounts of quantitative easing.While, on the one hand we have

the wealthy First World busilybecoming poorer, emerging highgrowth countries surge ever higheras domestic demand finally starts torise above ‘background noise’ levelsand fuels their rising trajectory ininternational markets. Old Worlddemocracies are struggling underthe misplaced need for politicians

and central bankers to deliverinstant, virtually pain free, answers.It’s leading, in many instances, togood money being thrown after bad.The idea of cutting losses anddelivering pain in selected, highcost/low return areas is foregone fora general “one size does not fit all”policy burden.Growth companies in the UK are

now hampered by this type ofpolicy. The result is that any portablebusiness is rightly decamping to theeast. The net effect, of course, is tomove vital tax receipts eastwards aswell, thereby increasing the burdenfor those who are forced to remain.It might not take much to turn thistrickle of tax-jumpers into a flood. Already, the tax receipts side of the

UK’s deficit has been a lot weakerthan the GDP numbers wouldsuggest. Might we already be seeingsome of the impact of this migration? It could also frighten the equity

markets over the short term.However, it’s reasonable to assumethat globalisation has already beenfactored in and stocks remain veryreasonably priced for the longerhorizon. No matter where acompany is based the biggereconomic picture is getting rosier.However, in the UK we are seeingrather more wood than trees. As ever ladies and gentlemen,

place your bets. �

THE OVERBEARING HEAVINESS OF EUROPEAN DEBT

They’re back! Those over-indebted European nations, led bythe Celtic ‘Tiger’, have come to haunt any prospect of anoptimistic start to the New Year. Usually, the late November toend December period is rather boring in market terms. Thisyear the markets may be in for a spook-fest. Simon Denham,managing director of spread betting firm Capital Spreads,gives the bearish view.

INDEX REVIEW

Simon Denham, managing director of spreadbetting firm, Capital Spreads.

MORE WOODTHAN TREES

32

ONE OF THE key arguments forthe merger between RI andRZB lay in the improved access

to capital and money markets that themerged bank would enjoy in comparisonto Raiffeisen International’s prior status.“This step would also contribute toRaiffeisen International’s riskdiversification and would make itpossible to further optimise riskmanagement for the Group in thefuture,” notes Herbert Stepic, chiefexecutive officer of the merged entity.The bank remains listed on the ViennaStock Exchange and offers retail (inCEE), corporate and investment bankingservices. The business associated withRZB's function as central institution ofthe Austrian Raiffeisen Banking Grouphas now been hived off into a non-listedbank holding, says Stepic. “This mergerstrengthens us to the benefit of ourclients and business partners, both ofwhom will profit from our optimisedoffering of products and services,” headds. RBI is expected to take fulladvantage of the renewed strength ofeconomic growth in Central and EasternEurope, he adds.To facilitate the merger, a capital

increase was agreed and now RBI's freefloat amounts to around 21.5%, (it hadpreviously amounted to about 27.2%for Raiffeisen International). RZB'sindirect shareholding in RBI amountsto around 78.5%. Both entities broughtsolid financial credentials to the mix. For

the time being the merged entity isreporting financials on a pro-form basis.Third-quarter's consolidated profit morethan doubled compared to precedingquarter, posting a consolidated profit of€311m for the third quarter of 2010 (Q3),an increase of 125% over Q2 2010. Themain driver for this increase came fromvaluation results for financial investmentsand derivatives. By the end of the thirdquarter its profit is projected to stand at€997m, while its consolidated profit (aftertax and minorities) is reported as €783m,with provisioning for impairment lossesreported at €913m. “Our results ... reflect the friendlier

overall macro-economic environment,”notes Stepic.”Our non-performing loan(NPL) ratio stood at 8.8% at the end ofSeptember. This quarter-on-quarterincrease ... was largely attributable to

developments in Central Europe—aboveall in Hungary and the Czech Republic.We assume that NPL volumes havealready reached a peak in some countries,but that we will only reach that peak atthe Group level during the course of nextyear. At the moment, it's not possible totell whether that development will takeplace at the middle of the year or onlyin the second half of 2011,” added JohannStrobl, chief risk officer for RBI as wellas for the RZB Group.RBI's pro-forma balance sheet total

as per 30 June 2010 stood at €147.9bn,which represents an increase of 1.3%since the end of 2009 and return onequity before tax stood at 12.2%. Onthe basis of the same pro forma figures,RBI's core capital ratio (tier 1), creditrisk stood at 12%, while its core capitalratio (tier 1), total stood at 9.5%.The merger brings together Raiffeisen

International's distribution network ofaround 3,000 outlets in 17 CEE marketswith RZB’s product know-how in capitalmarkets products for commercialcustomers, financial institutions andsovereigns. More generally, the mergermakes possible a sensible reallocation ofresources towards those CEE marketswith sustainable growth; a substantialconsideration given that the Austrianbank also has a strong presence in Asia'semerging markets. The significant outcome in the merger

is that Herbert Stepic has become chiefexecutive of the new entity, which willinvariably define the character of the newentities growth strategy. Stepic is a longterm emerging markets expert and willlikely continue the group’s expansioninto high growth markets. When he ledRI, it was one of the first institutions tobreak into the CEE zone, initially throughgreenfield developments. Only after 2000did the bank start to look at an accretiveacquisitions-led business growth strategy,as interest in the CEE from other foreignfinancial institutions began to step up.Stepic has always believed in the potentialof the CEE region, at a very visceral level,and over the years he has continued toclaim that:”It is the future growth engineof Europe.” �

BANKING REPORT

RAIFFEISEN BANK INTERNATIONAL: A

NEW OUTLOOK

RZB and Raiffeisen International (RI) announced in lateFebruary that they were looking at possible merger of the twocompanies, bringing RZB’s business with Austrian andinternational corporate customers together with those ofRaiffeisen International. The merged company, launched underits new moniker as Raiffeisen Bank International AG (RBI) inearly October. The parties expect the merged bank tostrengthen develop as a leading universal bank in Central andEastern Europe through the combination of RI’s broaddistribution network in the CEE region and RZB’scomprehensive product portfolio.

THE RBI BOUNCE


Photograph © Risto Viitanen /Dreamstime.com, supplied November 2010.


PERHAPS THE UNITED States’policy is less clueless than HerrSchauble suggests, and the

hypocrisy accusation unfair, given thatany reductions in the value of thedollar will be side effects rather thanprimary objectives? After all, themarketplace is a funny thing, and onecan never rely on it to react predictably.Explicit, direct currency manipulation ishard enough to achieve (just askJapan), let alone tangential coercion ofthe sort he alleges. Chances are the market has already

priced in this round of quantitativeeasing, and we will begin to see amarket rapprochement with the dollar.The amount of money involved is notas massive as it sounds, given the sizeof the US economy, and most of it willremain within American borders. Assuch, fresh shorts of the dollar shouldbe made carefully or may struggle toshow positive results. We’ve alreadyseen some pretty significantappreciations of the G10 currenciesagainst the buck, so while some furthermoves in that direction are possible, themomentum has shown signs of fading. Better shorting luck may be had in

choosing amongst the beneficiaries ofrecent dollar weakness. The eurozoneis not lacking for economic warts andhidden booby traps. With the Greekpanic receding, we need not look far tofind other sources of anxiety: Ireland,Portugal, Spain and Italy head the A-

list of countries with serious balancesheet repair issues in the years ahead,and the amount of domestic painawaiting them when the demands ofentitlement reform necessitated byinevitable austerity measures can nolonger be put off will elicit some verysharp headline cries. Do notunderestimate the ability of labourunions and other political groups torally sentiment against measures thatthreaten hallowed entitlements.Moreover, German taxpayers will

not continue to finance what theyincreasingly perceive to be welfarestates within the eurozone. There is alarge divergence between theconstituent nations in terms of fiscalrectitude, and the politicalconsequences of that will now playout. Truly, there is a reckoning to bemade in the years ahead in Europe,one that will test the strength of thebonds that created the euro. Thiscross-border political dynamic does notexist internally for the dollar—or anyother currency, for that matter. Europe needs only look north to see

the way out. Sterling has benefitedfrom the budget measures envisionedby UK prime minister David Cameron.There will be protests, and a gnashingof the teeth amongst the hoi polloi, butGreat Britain has something Europelacks: a sense of collective resolve, notto mention a history of shared sacrifice.If the budget measures promulgated by

Cameron prove to be fair, they willprobably be enacted even if harsh.Hanging on in quiet desperation is theEnglish way, and so is belt tighteningwhen facing a national threat; moresthe eurozone simply cannot duplicate. Commodity currencies have gained

handsomely over the past year, led byeveryone’s favorite proxy for the RMB,the AUD. Given the demand for thekind of natural resources found there,we can expect the causality betweenglobal growth and AUD strength tohold for the foreseeable future. Asstrong as the Aussie dollar is now,there is simply no imaginable scenarioshort of another global recession underwhich it could significantly retrace. TheKiwi will mostly follow AUD, as usual,and thus looks to consolidate recentgains in the months ahead.The Canadian dollar has also

benefited from worldwide demand fornatural resources that provide theinputs for manufacturing, and this hasamplified its traditional alternative-to-the-US status dynamic. Havingreached parity with the US, a period ofconsolidation is not out of thequestion, even though it has shown anhistoric tendency to recoil frommassive psychological barriers. Theemerging markets may be the biggestbeneficiaries of quantitative easing, if astrengthening currency can be labelleda benefit. The Asian rim continues toexhibit impressive growth prospects,and the launching of “QE2” should liftthe local tide with an influx ofinvestment dollars to the extent theyleave US shores. If you lack thestomach for long dollar exposure,consider AUD, KRW, GBP and CAD, allat the expense of the EUR. �

In the wake of the Federal Reserve Bank’s announcement of itsplan to spend $600bn buying back US treasuries over the nexteight months, much has been made of the implicit devaluation ofthe US dollar this represents. Germany finance minister WolfgangSchauble recently described US policy as “clueless” and“hypocritical”, given American rhetoric targeted at China forartificially pegging the RMB below its natural levels. Erik Lehtis,president of Dynamic FX Consulting, gives a trader’s view.

CLUELESSNESS &CURRENCY WARS

Erik Lehtis, president of DynamicFXConsulting in Chicago.

FX: W

ILL A RECEDING TIDE CONTINUE TO LO

WER ALL B

OATS?

FX VIEWPOINT

34

AFTER DISMAL PROJECTIONSabout an exit from the City ofLondon due to higher personal

tax rates, the UK capital has shrugged offconcerns and forged ahead in 2010. Splitinto four main markets, different drivershave supported growth across the capitaland a severe slowdown in developmenthas also helped keep availability rateslow. The story of the next two years is likely to focus on office churn andredevelopment as investors swoop onkey assets and refurbished premises, ifthey can achieve value. That last point isa big question. Prime office space is inshort supply and a weight of moneychasing the best buildings, meaning pricesfor prime are being pushed up and couldforce investors to look for better valueelsewhere, such as Paris or Madrid.However, the central London office

market has seen take-up levels rise wellabove trend in the third quarter (Q3) of2010, according to agent CB Richard Ellis,which notes that the market saw the returnof large pre-letting deals, which boostedtake-up to 3.5m square feet (sq ft), 27%above the previous quarter, and an increaseof 12% over the long-term average.Pre-letting is an important indicator

of development sentiment as pre-letsboth provide investors with the assurancesthey need about income streams, post-construction, and show that demand fromoccupiers remains robust.

Supply was squeezed to 15.4m sq ft atthe end of Q3, fuelled by large falls in theavailability of second-hand space, andled to a sharp increase in prime rents inthe City, Chancery Lane, Covent Gardenand Holborn areas. Availability across themarket as a whole is now nearly 6m sq ftlower than at the most recent peak at theend of Q2 2009.“We have had two years of low supply

and we are scheduled to have twomore,” reflects Andrew Burrell, partnerin the research team at agent KingSturge. “There is undoubtedly a London

bubble, with very healthy take-up byoccupiers and with the lack of new-build, growth opportunities will reallylie in the refurbishment market,especially if landlords can secure pre-lets. That’s what investors are looking forand there are plenty of opportunitiesto drive rental growth.”According the CB Richard Ellis prime

rent index, annual rental growth in theCity was 19.2%, the largest of any centralLondon market. The West End—which isinfluenced by different dynamics to theCity—grew by 8.5% in the same period,

REAL ESTATE

LONDON BUBBLE: COMMERCIAL P

ROPERTY SECTOR BREAKS RECORDS

Amid the worst of the recession, central London's commercialreal estate sector has achieved an extraordinary performancecompared with the rest of the UK. Prime retail has brokenrecords and the office market has benefited from a slowdownin development. Yet with continuing concerns over the healthof the British economy, can the capital's office market continueto grow as rising prices for prime office space could forceinvestors to look elsewhere, asks Mark Faithfull.

A CAPITALPERFORMANCE


Leasing:

� The UBS deal of 700,000 sq ft at 4-6 Broadgate, EC2, was the biggest in the market bya considerable distance. There were five other deals above 50,000 sq ft, including BovisLend Lease taking 79,600 sq ft at British Land’s Regents Place: Phase 2, NW1, andBloomberg taking 71,900 sq ft at Park House, Finsbury Circus EC2.

� The banking and finance sector was the driver behind recent deals, accounting for a45% share of take-up

� Vacancy rates fell to 5.9%, a fall for the fifth successive quarter. � Six schemes completed during the third quarter. The largest of these was the St Botolph

building, EC3, of which 278,000 sq ft is available � Rent free periods on a ten-year lease fell slightly over the quarter and are now at 24

months in the City and 20 months in the West End.

Investment:

� Investment turnover stayed at £1.9bn, constrained by a lack of quality stock. � Prime West End yields hardened to 4%. � Only three deals were recorded over £200m, with the Carlyle Group’s purchase of

Thames Portfolio for £400m and Alban Gate, London Wall, for £271m. � Domestic investors maintained a strong interest in the market with UK property

companies (12%) and UK institutions (11%) particularly active, although overseasinvestors remain the key driver.

Central London office property: Q3 2010 highlights

35

and to the east, London Docklands rents rose by 4.2%. With only 0.4m sq ft of an expected 4m sq ft of scheduledcompletions due to be delivered duringthe last quarter of the year, there are fewsigns of supply problems easing, and arapidly diminishing completion rate of1.6m sq ft is expected in both 2011 and2012, meaning the squeeze on suitablespace will continue.In the investment market, CB Richard

Ellis reports strong interest in qualitystock which pushed West End yields to avery tight 4.0% and left prime City yieldsunchanged at 5.5%, although they havesince hardened further. Importantly,overseas buyers continue to show a stronginterest in central London offices,accounting for 68% of transactions byvolume in the third quarter. This echoesgeneral outside interest from investorsabout UK prime property, partly driven bythe weak pound but predominantlybecause there is a general perception thatthe UK has been one of the first Europeanreal estate markets to fully price correct. Kevin McCauley, head of central

London research at CB Richard Ellis,reflects: “Despite the strength of themarket in 2010, the level of uncertaintyamong occupiers has increased recently,amid a relatively muted economicoutlook. Some cooling in demand canbe anticipated, and this has beenreflected in the amount of space under

offer at the end of the third quarter,which fell to 0.8 sq ft from 1.6m sq ft inthe previous quarter.”Some analysts are even more bullish.

London offices have been described asthe “pin-up” sector for the UK marketbecause of the improvements in bothinvestment and occupier trends, byCushman & Wakefield. Its own estimateof prime property yields stood at 5.72%at the end of September. However, it alsonotes that investors are still sensitive to lotsize, and points to investments in the£15m to £40m range as the area ofgreatest demand.

Investor demandSecond-sell UK private and institutionalinvestor demand is also strong but mostare still struggling to find the quality ofstock they want, Cushman says. Althoughthere is an increase in the supply ofinvestment property for sale, secondaryproperty is coming forward and banks,receivers and Irish investors are the mostnotable sellers.“Attention is on these players and the

type of stock they will sell, the speed withwhich they will want to sell and the pricethey hope to achieve versus that which themarket will consider,” Cushman pointsout. While the demand for City officeproperty is driven by financial and legalinstitutions, in the West End, demandfrom property and hedge fund companies

had pushed availability down. Despite aweakening in these sectors, availabilityhas continued to decline.There is currently 4.4m sq ft of available

office accommodation in 248 units in theWest End, which represents a significant8% decrease on the previous quarter anda 26% fall over the previous 12 months.That said, supply remains just above the25-year average of 4.2m sq ft.Agent King Sturge points to a fall in

supply in Q2 attributable to above-averagetransactional levels and the relativelylimited amount (499,000 sq ft) of newlymarketed space hitting the market in Q3.This level of supply equates to a vacancy

rate of 5.5%, which represents a 50 basispoint fall over the previous three months.The vacancy rate remains below 6%,historically the trigger rate for rentalgrowth. The reduction in availability seenover the past six months is set to continueover the next two years, with availabilityfalling below the 25-year average by theyear-end. It is this fall, coupled with the low levels

of speculative space set to be deliveredfrom the development pipeline, especiallyin the core areas, that supports strongprime rental growth, even in the eventof more muted demand generally. “There are dangers of an economic

dip,” admits Burrell. “However, there arefew signs of anything that the markethasn’t already coped with.” �

F T S E G LOBAL MARKET S • D E C E M B E R 2 0 1 0 / J A N U A R Y 2 0 1 1

BRITISH LAND, THE UK’s second-largest real estate investmenttrust, in October revived a plan to

build the “Cheesegrater” tower inLondon’s main financial district, just aweek after another skyscraper projectwas restarted. British Land will developthe 47-storey building in a joint venturewith Oxford Properties Group, a unit ofToronto-based Ontario MunicipalEmployees Retirement System, at a costof about £340m. Land Securities Group,the country’s largest REIT, announced onOctober 19th that the “Walkie-Talkie”development, officially known as 20Fenchurch Street, would proceed.

No tenants have been lined up foreither project but Land Securities saidthe £500m “Walkie-Talkie” tower wouldproceed after the company formed aventure with Canary Wharf Group, whichis backed by Qatar Holding and ChinaInvestment Corp. In June, LandSecurities sold its Park Placedevelopment on London’s Oxford Streetto Qatar’s Barwa Real Estate Co.

British Land had halted constructionof its 224 metre-high tower officiallynamed the Leadenhall Building aftercompleting the demolition andpreliminary basement work. Constructionis scheduled to start in January.

SKYSCRAPERS REACH FOR THE SKY AGAIN

Photograph © Roland Nagy /Dreamstime.com, supplied

November 2010.

36

DEBT REPORT

GREEN BONDS: ONE WAY TO CLEAN-UP IN AN UNSTABLE MARKET


AT TIMES WHEN the financialpress has been full of the Irishdebt crisis and mainstream UK

newspapers carry bleak pictures ofempty houses and the unemployed inIreland, it is comforting to find aninvestment that is fairly secure and likelyto provide predictably solid returns.Green bonds are proving just such an

asset. To date, the World Bank and theInternational Finance Corporation (IFC)have issued around $1.5bn of greenbonds, the European Investment Bankhas produced its own version, called theclimate awareness bond, and there istalk of the UK doing something similarto finance clean investment. The World Bank’s bonds are all plain

vanilla, fixed income products that offerthe opportunity to take part in financingprojects that help mitigate climatechange. They have similar features toregular bonds issued by the World Bank,including credit rating and size. The World Bank’s first green issue in

2008 was lead managed by SEB bank,denominated in Swedish krona, and themain takers were large Swedishinstitutional investors, such as thecountry’s second and third nationalpension funds, AP2 Fonden and AP3Fonden. Issues in the dollar and 14 other

currencies followed with pension industryheavyweights coming on board in theshape of the California Public Employees’Retirement System (CalPERS), theCalifornia Teachers Retirement System(CalSTRS), the New York City Employees’Retirement System (NYCERS) and theUN Joint Staff Pension Fund.One of the key appeals for CalSTRS,

explains spokesman Ricardo Duran, isthat “they satisfy CalSTRS’ strategic aimof integrating sustainability into itsinvestments”. He adds: “There is a greatdeal of confidence in management'sability to protect the interests of investorsand to keep themselves economicallyviable.” The pension fund bought $10mof green bonds from the World Bank andanother $10m from the IFC.In the equities market there is awhole host of investment opportunitiesfor those wanting exposure to sustainableand environmentally friendly projects. Tostart with, there are all the clean-techcompanies such as wind turbinemanufacturers, fuel cell makers or solarpower developers but, alternatively,investors can opt for indexes such as theDow Jones Sustainability Index, theOkoDAX or the FTSE4Good Index Series.However, until the World Bank’s greenbonds there was little in the fixed income

market that was orientated towardsinvestors interested in green investment.“We have a lot of focus on SRI

[socially-responsible investment] inequities but it has been hard to find thiskind of investment on the fixed incomeside,” says Ole-Petter Langeland, headof fixed income at Sweden’s AP2pension fund. When the fund wasapproached by the World Bank and SEBto buy green bonds, AP2 hired anoutside adviser to look at how theproceeds of the bond would bechannelled and which projects wouldbe chosen, Langeland adds. The verdictwas positive and over the years AP2bought more than $100m-worth ofgreen bonds issued either by the WorldBank or by the associated InternationalFundraising Congress (IFC). Thoughgreen bonds constitute a relatively smallportion of the pension fund’s fixedincome portfolio, which stands at $12bn,it is not one likely to become smaller.The SEK-denominated bonds held

by AP2 reach maturity in 2014, “andafter that we intend to roll it over, thatis, buy a new issue when it comes out,”says Langeland.The triple-A rating and the fact that

the World Bank is backed by 186countries is one of green bonds’ biggestselling points, particularly in the currentclimate. The coupons are designed to beslightly above comparable bonds; theSwedish krona-denominated issueoffers a coupon of 0.25% above theyield of Swedish government bonds.This is enough to justify the investment

In the equities market there is an abundance of investmentopportunities for those wanting exposure to sustainable andenvironmentally friendly projects. To start with, there are theclean-tech companies such as wind turbine manufacturers, fuelcell makers or solar power developers but, alternatively,investors can opt for indexes such as the Dow JonesSustainability Index, the OkoDAX or the FTSE4Good Indexseries. However, until the World Bank’s green bonds there waslittle in the fixed income market that was orientated towardsinvestors interested in green investment. The triple-A ratingand the fact that the World Bank is backed by 186 countries isone of green bonds’ biggest selling points, particularly in thecurrent climate, writes Vanya Dragomanovich.

THE STEADY GLOWOF GREEN BONDS

Photograph © Davidarts /Dreamstime.com, suppliedNovember 2010.


into the bonds while at the same time fulfilling the rising interest inenvironmentally-friendly investment.What has in the past put off investorsfrom investing directly into green orenvironmental projects, particularly ifthose were in emerging markets, wasthe high credit risk associated withfinancing, for instance, projects in Africa,says Klas Eklund, a senior economicadviser for SEB, who was involved increating the first green bonds for theWorld Bank. Green bonds take thatelement of risk away because the projectshave been thoroughly researched by theWorld Bank: not only are they are aknown quantity but also the actualinvestment is indirect and thereforecarries little risk for institutional investors.“The appeal for investors is that they

know exactly where and how the moneyis being spent, they know which projectthe World Bank will finance, and thereis transparency that you don’t necessarilyhave in similar cases that investorsfinance directly,” says Eklund.One of the criticisms sustainable and

environmental investment has faced inthe past is that it provided slimmerreturns than comparable mainstreaminvestments. “We naturally don’t buy alot of green investments but in this casewe didn’t have to give up returns for thesake of green credentials. This was aninteresting investment partly from a yieldperspective and interesting as aninvestment that will do some good in theworld,” says Lars-Goran Orrevall, headof asset allocation at Skandia Liv AssetManagement, the investment arm of theSwedish part of insurance group Skandia.A disadvantage of green bonds versus

regular bonds is that the secondarymarket is fairly thin although it is slowlygetting better because of the sheer sizeof the World Bank’s issuances and alsobecause other providers are coming onboard. The European Investment Bank(EIB), also a triple-A borrower, issuedclimate awareness bonds and linked theirreturn to the FTSE4Good EnvironmentalLeaders Europe 40 Index that consistsof large European companies with topenvironmental practices.

“Liquidity was one of our concernsalthough we have not traded our greenbonds in the secondary market. Liquidityis getting better,” says AP2’s Langeland. Spreads are still fairly wide, certainly

wider than for respective governmentbonds, which means that green bondsare better as a long-term investment,held until maturity. “If you comparegreen bonds with Swedish governmentbonds, they have so far performed alittle better. However, transaction fees forthese bonds are higher than forgovernment bonds or even Swedishmortgage bonds and we don’t hold themin our trading portfolio but rather in thestable part of our portfolio,” says SkandiaLiv’s Orrevall. “My guess is that mostpeople are sitting on them as a long-term investment because the extra yieldcould be easily taken away if you tryand buy and sell them,” he adds. What does appeal to investors is the

exposure to a number of emergingmarket currencies, that, again becauseof the World Bank’s triple-A rating,buffers out some of the risk involved ininvesting in emerging market debt.Nikko Asset Management issued two

funds in February based on the WorldBank’s green bonds and wasinstrumental in initiating issuances in11 of the 16 currencies, according toStuart Kinnersley, chief investment officerat Nikko Asset Management in Europe.The currencies on offer include the SouthAfrican rand, the Russian rouble, the

Brazilian real and the Turkish lira. Thetwo funds—one aimed at Japanese retailinvestors and the other at institutionsin Europe and the Middle East—use acomposite benchmark with an emergingmarkets and developed marketscomponent. “The key aspect is that weare getting exposure to emerging marketcurrencies but are not buying the debt ofthose governments which have a muchlower credit rating. All of our portfolio willbe AAA,” says Kinnersley. Unlike in the developed markets,

when the World Bank issues in anemerging market currency, it does sowith a lower yield then the respectivegovernment because the bank’s creditrating is so much higher.Nikko’s Kinnersley argues that in the

current climate in the debt markets itis more appropriate for investors to havea higher exposure to emerging marketsthen developed world debt. “Thesovereign debt crisis is really focusingon the developed world. The fiscalpositions, the debt to GDP ratio, arereally a G7 problem. In contrast, manyof the emerging markets have a muchbetter fiscal position because they havereformed their finances over the last tenyears,” he adds.

Showing interestThis approach was clearly shared withJapanese investors who were far moreenthusiastic about Nikko’s funds thaninstitutions in Europe. Nikko AM’s fundaimed at Japanese retail investors has$250m under management while the oneaimed at institutional investors in Europeand the Middle East has $25m. However,now that it has run for six months andwas up 13.5% in that period, which ismore than 1% higher than the benchmark,more investors are showing interest,Kinnersley added. The benchmark consistsof 50% of Citigroup World GovernmentBond Index (WGBI) and 50% of the JPMorgan Government Bond IndexEmerging Markets (GBI-EM).We may be far from the spring but

with the sovereign debt crisis causedby the Emerald Isles, green is definitelythe colour of the season. �

Stuart Kinnersley, chief investment officer atNikko Asset Management in Europe.”The keyaspect is that we are getting exposure toemerging market currencies but are not buyingthe debt of those governments,” he says.Photograph kindly supplied by Nikko AssetManagement, November 2010.

38

IN JUNE, FRENCH banking giantNatixis completed the merger of itsequity teams to form a single equity

business line and rebuilt the divisionfrom the ravages of the credit-crunch.The move saw subsidiary NatixisSecurities transfer all of its activities toNatixis, the parent company. The newdepartment, which handles all equitycash products and derivatives, is headedby Jean-Claude Petard, head of EquityMarkets at the bank. For Petard, the merger of operations

has signalled the completion of one ofhis key priorities when he joined Natixisfrom rival Société Générale in February2009. He explains that the aim of thereshuffling was not to reduce costs butto meet changing market and clientneeds. “We wanted to group togetherall the equity units at Natixis, includingthe equity derivatives department andthe two cash brokers in New York andParis, which were previously acting asindependent and fully autonomousfirms. The thinking was to have oneperson in charge of all equity mattersat investment banking board level anddeveloping an equity strategy,” he says.“Most importantly, the objective was

to rebuild the equity division after themarket turmoil in 2008,” he adds. Natixis’ merged teams now deliver

an improved, wide-ranging and all-inclusive solutions suite, includingprimary market access, broking onsecondary cash and derivatives markets,structured products and global equityresearch and sales. “We want to reactproperly and immediately to any furthershocks and significant movements inthe market,” says Petard. “We want to

develop a new fully-integratedcommercial strategy servicing all ourEuropean and US-based institutionalclients as well as retail banking in a one-stop shop trading platform. The clientis provided with all the equityinvestment instruments worldwide thatwe can deliver, including emergingmarkets, Asia and the US.”Petard says the new structure meets

the post-credit crunch constraints onthe market square on: “Until veryrecently all investment managers wereinvesting money outside the equitymarket to varying degrees, but no onewas positive. It therefore becameincreasingly important to provide assetallocation tools in order to help clientslimit risk; hence the merger of ouractivities. A new market trend is clearlyemerging, with a more flexible approachto asset allocation within equities andcross-assets. Clients want to be able toswitch swiftly between assets and enjoymore diversified exposure. The main focus is European equities,

based on the bank’s French foundations,and its traditional firm hold, or “grip”on the market. Petard describes it as a“cornerstone” of the bank’s new equitystrategy. The sales force has beenorganised around cash and flowderivatives such as straight cash,convertible bonds, listed derivatives,OTC derivatives and all forms of DeltaOne products. Structured derivativesresulting in “more complex pay-offs”are also offered to institutional investorsor retail networks in a variety ofwrappers such as funds. “The benefit for clients is that they now

have one single account manager covering

their needs and requests. It is no longerfragmented and as such we have a richerdialogue,” holds Petard. “They also havea new array of quantitative researchproducts available on our website whichwere previously only developed for ourtraders. They cover European sectors andequity strategy.”Moreover, Petard claims that the new

products, such as market predictor andasset allocation tools, are “very technicaland mathematical” and are based on anew methodology different from thoseoffered by its competitors. Principle investments are another

service offering. It hinges on three mainunits—equity finance, flow derivativestrading and correlation trading, withbaskets of single stocks, indexes andmulti currencies. Petard states: “It’sanother differentiating factor. There arenot many houses able to deliver a pay-off based on the correlation of variousasset classes.”The success of the new strategy

depends on high equity trading volumesand therefore lucrative commissionincome. Volumes in France were in thedoldrums for most of the summer withsome increase seen in early autumn.“The market has remained sluggish in2009 and 2010 with some strongmovements in the second quarter thisyear,” says Petard. “Very recently wehave seen in the results of the mainbanks that the movement away fromcollecting equities has stopped and thatbanks are collecting money again. Wehave reached the bottom and areprobably in the middle of a shift ofmoney from fixed income or foreignexchange and sovereign debt to equity.

FACE TO FACE

NATIXIS: EQUITY MERGER AIMED TO MEET CHANGING MARKET NEEDS

Jean-Claude Petard, head of Equity Markets at Natixis, stresses the new single business line, whichhas resulted from the merger of its equity teams, to deliver a “comprehensive and enhanced”range of solutions to its clients. The service set includes access to the primary equity market,broking on secondary cash and derivative markets, structured products and global equity researchand sales. Jean-Claude Petard, who heads up the new department, says the new structure meetsthe post credit-crunch constraints on the market. David Craik reports.

THE NEW STRONG SUIT


39

Yields are higher than those fromgovernment bonds and that is very rare.”However, he cautions: “It is a bit too

early and there is still too muchuncertainty in the market for us to seemassive movements of money from theless risky assets to the most risky ones.We are at the beginning of this newmovement and we don’t anticipate anybrutal shift because of low inflation andhigh unemployment and modesteconomic forecasts in most countries.There are also concerns over sovereignrisk from certain weakened Europeaneconomies. There has been a strongimprovement in investor sentiment butit is still negative.” One of the key market pillars this

decade, namely hedge funds, has alsosuffered in recent times. “Between 1998and 2008 we lived with an easy way ofreading the market because hedge fundswere the leading industry in flows andexecution. They were the price leadersfor all equities and many asset classes,”Petard explains. “Today the hedge fundindustry is recovering. It is re-establishing itself but it does notdominate the market as it did before. “There has also been strong divestment

from another key player—insurancecompanies. According to Petard, that

movement has now stopped and hepredicts they will soon return to theequity market. “They can’t stay outsidebecause of the expected performancesof equities,” he says. “They will have tocome back in a form which meetsregulatory constraints but I am expectingthem to raise funds and we will see aperiod of net investment from now on.” With regard to commission incomes,

Petard says they have been falling“slowly every year” for 15 years; a trendthat continued through 2010. He states:“I don’t think it is reversible. The cashoffer is the cornerstone but it has beenunbundled.” Because of this, Petardadds, there is an increased requirementto improve trading efficiency anddeliver more value added productssuch as Delta One to “enhance theefficiency of execution for our clientsand for ourselves”. Yet is the trend in fees really

irreversible? “Unless there is massivemerger and acquisitions activity betweenall the major investment banks and thereis a cartel forcing up commission fees,then no, it won’t reverse,” answers afrank Petard. “It is a fragmented andvery competitive market. There is noleader who can establish an increase infees. The clients themselves are very

fragmented despite the mergers andacquisitions activity we have seenrecently. I don’t envisage a movementthat would push an increase in fees.”Inevitably, competitive pressures are

also at the forefront of Petard’s thinking.The French banking sector is indeedcompact and highly competitive. Evenso, Petard suggests that French bankshave also proved more inured to therecession than other global banks,especially in those in the United States.Moreover, he holds that the Frenchbanking sector has been furtherstrengthened as it has been assiduousin repaying any and all state payouts.Equally, Petard is adamant that

Natixis’ new equity strategy issuccessfully differentiating itself fromits peers. “We have a fully integratedchain of skills geared to our clients,”Petard declares. “We have a world-renowned range of equity research. Ournew strategy is proving effective andworking quite well. In the second quarterof 2010 we proved our ability to tradeand manage our portfolios when wewere probably the only bank on thisplanet not to lose money. We haveshown our resilience.”So what lessons has he learned from

the last two years? “Equities are themost liquid asset, whatever happens.There is always an ability to move thebooks when properly managed andorganised,” he says. “No bank withdrewfrom the equity market despite sufferingsome massive losses and there wereeven newcomers to the market such asBarclays Capital. We also learned toservice not only niches [sic]. Every assetclass is important.”As for the future, he says: “We have

to adjust to [the] new regulatoryhurdles. This will diminish principletrading activities and that in turndiminishes liquidity in the market if itis not replaced by something else.Nevertheless, we are seeing most ofthe industry recovering. The fear of adouble-dip in equities is behind us nowand market valuations are becomingstrongly attractive. We will keepgrowing on a healthy basis.” �


Jean-Claude Petard, head of Equity Markets at Natixis. Photograph kindly supplied by Natixis,November 2010. © Fabrice Vallon

40

FTSE GM: What are the salientdifferences, if any, in approachesto trading and, in particular,

utilisation of dark pools between theUS and Europe?Owain Self: Many of the differencesare a function of differences in marketstructure. Alternative liquidity regulationsdiffer slightly, which has an impact onhow you access alternative venues intrading strategies. The existence of aNational Best Bid and Offer (NBBO) inthe US makes the process of pricediscovery easier and more efficient. Thecomposition of order flow in the twomarketplaces varies a bit, as well, whichaffects how and when you interact withspecific kinds of venues.As part of the execution process, we

interact with non-displayed liquidity ina variety of ways. Our sales traders,traders and systems will source liquidityto achieve the execution objectives ofthe client. Clients will control their accessto non-displayed liquidity predominantlyvia their direct use of our algorithms.This includes access to external venuesas well as internal liquidity, or systeminternalisers, such as our own UBS PIN. Algorithms have come a long way

from the fixed schedule, rigid structuresof the past. They are now fully dynamicsystems, using complex mathematicalmodels to drive both macro leveldecisions of speed and urgency andmicro level order placement. Thesophistication of these models willcontinue to adapt and evolve based onclient demand and market structurechange. To some degree technology will

continue to play its part, as calculationsor optimisations—which were too slowto be useful in the past—can now beperformed quickly enough to beincorporated into the decision process.FTSE GM: Dark pool trading is nowpart of the mainstream: but howmuch of dark trading is truly dark? Owain Self: “Dark” is not as dark as itused to be, because in part almosteveryone is connected to almosteverything and many of the industry’sliquidity-seeking algorithms utilisesimilar logic and triggers. An executionin a non-displayed venue demonstratesan immediacy of market impact nowthat was not previously the case. Thisis particularly true in the US, given theexistence of a consolidated tape.Also, the changing nature of dark

liquidity—and the preponderance ofshort-term liquidity in the currentmarketplace—means that you are, bydefinition, interacting with more non-natural flow. This has a significantimpact on cross rates, particularlycrossing against quality liquidity. If yourcross rates are not being impacted, youneed to question the nature of thatflow you’re interacting with and howintelligently your broker strategy isinteracting with all types of venues andorder flow. It’s important to be aware ofthe trade-offs you’re making betweencross rates, urgency and informationleakage/price impact protections—andchoose them consciously.FTSE GM: There seem to be threemain types of dark venues: dark ordersin lit pools, e.g. exchange icebergs;

public or semi-public dark pools suchas Liquidnet; and broker dark pools.Are there other types evolving? Owain Self: It’s important toremember that dark is not a virtue untoitself. But when accessed well, with theright goals in mind, it can greatlyenhance execution. There are several ways to access non-

displayed liquidity: The first is througha broker’s internalisation process—viainternal networks of dark liquidity thatexist as a result of our “best execution”requirements. A broker has an obligationto give their diverse clients theopportunity to achieve the best possibleexecution, which means if there is anopportunity to execute a cross betweentwo matching orders before they hit themarket; the broker has a responsibilityto make that happen. The second way is through an ATS

or MTF that operates a fully dark orderbook. Based on which type of darkpool with which you’re interacting, thevenue’s regulatory environment/rulesand the individual business model thatpool operates, a good algorithmictrading strategy will behave slightlydifferently. For example, given thedifferences in models within the USATS marketplace, our algorithms usean order management logic that isinfluenced at the venue level by theirparticipant base, the order types theysupport and the ways in which crossescan happen. In EMEA, an MTF isrequired to be open to all participantswho meet eligibility requirements, soour algorithms are more likely to treatMTFs as if they are somewhat closerto lit markets.Finally, one can access dark liquidity

by utilising dark or hidden order typesin grey pools or on lit exchanges. Wetend to judiciously use these venuesand order types based on the client’s

FACE TO FACE

OWAIN SELF, U

BS INVESTMENT BANK

Owain Self, managing director and global head of algorithmictrading at UBS, explains his views on dark pools, the differencesin trading behaviour between the US and Europe, algorithms,best execution, technology and, particularly, transparency, ofwhich he is a champion.

CUSTOMER CHOICE IN THEDRIVE FOR BEST EXECUTION


41

urgency levels and sensitivity toinformation leakage.FTSE GM: You have been an advocateof transparency leading ultimately tobest execution: encouraging clients tounderstand the full chain of decisionmaking in order flow, and ofunderstanding who is on the otherside of a trade. Could you kindlyelucidate your thinking in this regardwith regard to dark pools? Owain Self: When a client ordermatches with a corresponding order ina non-displayed venue, informationrelated to that order is thereby providedto the counterparty and to themarketplace at the time of execution.This exchange of information inconsideration of an execution is generallyan acceptable “trade” from the standpointof seeking the order’s best execution.In the US, all equity trades, including

non-displayed, are already required byregulation to be immediately reported tothe tape. UBS agrees with this importantrule and believes that the transparencyafforded by this requirement is an essentialpart of an orderly marketplace. Real-timetrade execution reporting serves animportant price discovery functionallowing the market to gauge relativeactionable demand.Transparency undoubtedly serves a

vital role in the financial markets, andthe bank is an active proponent ofmeaningful transparency at all stagesof the trade cycle. The quest fortransparency, however, must bebalanced with protection from the risksof gaming. A functional definition of transparency

as it relates to the markets might be“clarity and fair availability ofinformation”. These should be basictenets in non-displayed as well asdisplayed venues. “Clarity” means thatinformation provided to a participantmust be explicit, factual and unambiguous.It should be free from pretence or deceit,and easily understood. No participantshould be misled or misinformed, eitherby design or by omission of data.Information should be delivered in a waythat is consistent. “Fair availability” means

that no participant should suffer singulardiscrimination or arbitrary exclusion frominformation. The availability of informationshould conform to established rules.When combined with effective

surveillance, another aspect oftransparency that provides regulatoryagencies with the information theyrequire to monitor participants’ rulecompliance will assist the marketplacein maintaining a level playing field.It’s important to try to strike the right

balance. A 100% pre-trade transparencyrule will drive orders back to the clients’

desktops, and decrease overall liquidityin the market.As brokers or investors, we are

constantly changing our techniques tofind the best balance between dark andlit interactions to achieve best execution.The market structure needs to protectthe less sophisticated investor, but atthe same time allow for natural marketforces to drive positive change. Timeshould be spent understanding the causeof investor appetite for this functionality,as well as on managing the market placeeffect of this demand.FTSE GM: How does the sell sidehelp in achieving best execution in anincreasingly complex landscape? Owain Self: From investment strategycreation to trading execution, the uniqueand ingenious variations and tacticsinvestors apply all have a meaningfulimpact on their ability to seek profitopportunities. A broker must be aproactive ally to the investor in thatprocess, delivering opportunities forcompetitive advantage via technologicalinfrastructure, access to liquidity, andastutely innovative order executioncapabilities. A basic premise of thebroker’s role is to serve the buy sideinvesting public and deliver bestexecution. Thus, it is our obligation toprovide opportunities for reduced priceimpact, price improvement, and reducedtrading costs, while additionallyprotecting our clients’ confidentiality. As we talk with and serve our clients

on a daily basis, we hear consistentthemes from the buy side regarding theissues that are important to them,including a variety of choices in non-displayed liquidity venues, ability toprotect themselves from informationleakage, access to quality internalcrossing opportunities, and highspeed/low latency market access. On the client front, we see a demand

for a simpler order interface and strategicdecision processes. Our clients tell us thatthey want to reduce the need forunnecessary keystrokes—they want theirdecision process to be simpler or moreintuitive, and they want their workflow tobe streamlined as much as possible. �


Owain Self, managing director and globalhead of algorithmic trading at UBS. “It’simportant to remember that dark is not avirtue unto itself. But when accessed well, withthe right goals in mind, it can greatly enhanceexecution,” he says. Photograph kindlysupplied by UBS, November 2010.

42

WHILE ISLAMIC FINANCEsets a blistering pace ofgrowth, Kuwait Finance

House (KFH) reckons that it is worthinvesting a dollar or two to secure itsinternational footprint, and the bankhas data to back up its claims. A reportreleased in September by the bank holdsthat the Islamic banking industryaccounts for 35% of total banking assetsin Kuwait and just over 16.6% of bankingassets in the Gulf Cooperation Council(GCC) countries (as of the end of Marchthis year). Moreover, the report says,depending on market factors such assupporting regulation, economic growthrates and continued demand, the Islamicfinancing industry as a whole shouldgrow between 15% and 20% a year forthe foreseeable future. “It is food for thought,” acknowledges

Mohammed Al Omar, KFH’s chiefexecutive officer. “It is clear that Islamicfinance is a growing business segmentand we are set fair to be at the heart ofthis growth. The report clearly indicatesthat Kuwait ranks first among the GCCcountries in terms of Islamic banks assetsto total banking assets and that thereare many opportunities still available forIslamic finance solutions in the region.”It is also a call to arms for a region

which has of late been eclipsedsomewhat by south-east Asia in termsof Islamic finance origination; a trendwhich KFH itself has also leveraged thisyear through its Kuala Lumpur

operation, having structured and listeda $100m Ijara (a type of leasing vehicle)on Bursa Malaysia on behalf of Nomura.The deal marked the first US dollar-denominated sukuk for a Japanesemultinational corporation issued out ofMalaysia. “The GCC’s Islamic banks areat the heart of the Islamic bankingindustry, with some of the world’s largestIslamic banks originating from theregion, including Kuwait Finance House;and this is expected to trend higher onthe back of increased demand for Islamicbanking products and services in theregion,” avers Al Omar. The local KFHunit has the parent company’s solidback-up and potential investments inMalaysia and the Asia-Pacific region arehigh on KFH’s radar screens, notes AlOmar, adding: “There are some moreissues in the pipeline and we will beworking with our subsidiary banks onmore sukuk issuances.”

Fuelling demandTo meet the growing needs of Shari’a-compliant financing in the region, mostconventional banks have either openeda new subsidiary or introduced anIslamic window within their existinginfrastructure. A few banks, such asSaudi Bank in Bahrain and Dubai Bank,have also converted themselves intoIslamic banks. In terms of financing,opportunities for Islamic banks in theGCC include residential mortgages,underpinned by a high level and still

rising demand for home mortgageswithin the local market. Moreover, theregion’s high GDP per capita, coupledwith a relatively young populationprofile, will continue to supportconsumer spending and investment, inturn fuelling demand for Islamicfinancial products and services.”The real estate segment is a key selling

point for the bank. Its international realestate portfolio is now worth some $1.5bnand, according to Al Omar, has not beenimpacted by the recent financial crisis.He says KFH is currently considering“numerous markets that have rewardingrevenues, especially in North America,East Asia, and the Gulf” and explains thatthe bank’s approach to investment in thesegment involves “consistently observingmarkets and foreshadowing their futurelimits, particularly investment risks”. Headds that KFH’s current investments arefocused in Malaysia, Saudi Arabia,Canada, America and China, “since thosemarkets enjoy governmental support,which attracts foreign investors”.

FACE TO FACE

KUWAIT FINANCE HOUSE: NEW BENCHMARKS IN ISLAMIC FINANCE

Kuwait Finance House (KFH), the second largest Islamic bank, hasbeen expanding aggressively over the past few years, purchasingstakes in companies domestically and abroad. The bank has alsoled a slew of benchmark Islamic issues through the year. KFH’schief executive officer Mohammed Al Omar talked to FrancescaCarnevale about the bank’s 2010-2011 business strategy.

HARNESSING ARISING TREND


43

The bank has been expanding itsfinancing reach in the wider region forsome time, marked by a succession ofbenchmark sukuk issuance. In Turkey,via the bank’s Liquidity ManagementHouse subsidiary, and working with Citi,KFH-Turkey arranged a $100m sukuk(rated BBB- by Fitch), one of the fewsubstantive sukuk deals to have cometo market in the country. “KFH-Turkeyis developing at a dramatic pace and themarket is ripe for new financing toolsand product, especially now that majorcorporations in the country areexpanding at home and abroad,” explainsAl Omar. “The three-year sukuk involvedthe participation of some 19 banks andfinancial institutions from the MiddleEast, Gulf region, Europe and Asia, andwe hope to list the sukuk on the LondonStock Exchange.”Al Omar says the bank’s international

operations are spearheading the growingutilisation of Shari’a compliantinstruments. Turkey is a particularly ripemarket, holds Al Omar, citing the recent

listing of the first gold Shari’a compliantinvestment fund on the Istanbul StockExchange. Specifically for KFH, the Ijaraor leasing segment has been particularlyopportune. In May this year the banksigned a deal with Turkish Airlines tolease three Airbus A320-200 aircraft forseven years, where Alafco will financethe purchase and lease of the aircraft,in addition to managing the deal onbehalf of KFH. The bank now has around $5bn worth

of assets in Turkey, which has latelybecome a key target market in terms ofgenerating international business. Thesame, explains Al Omar, can be said ofMalaysia, though he points out that hehas high hopes for recently establishedentities in Dubai, Bahrain, Kazakhstanand Germany. While the Shari’acompliant corporate financing has beena strong point in Malaysia, the bank hasbeen equally assiduous in encouragingretail business, including the openingof three currency exchange operationsin key transportation hubs in thecountry. “The bank’s financial coveragewas reinforced after its capital wasincreased,” explains Al Omar, “in orderto meet the growth in its operationsand demand for its services, particularlythat the bank is interested in mediumand long-term investments with highrevenues in the wider region.” With local business growth in mind,

KFH has recently embarked on a set oflocal initiatives, ranging from upgradingstaff training, the launch of innovativeretail products and services and theestablishment of a common technologyplatform which links all KFH systems“that meets all of KFH’s expansion andbusiness diversification requirements aswell as upgrading data security throughthe bank”. Al Omar esplains: “It is aninevitable consequence of growing andfierce competition in the field of Islamic

banking coupled with our desire to offerbest in class service.” As with many emerging market

institutions, the national interest figuresheavily in new business calculations. Inthis regard, with its status as a semi-private institution, the bank is well placedto build business in the Kuwaiti marketthinks Al Omar, on the basis that, “thegovernmental initiative of increasingpublic expenditure according to aneconomic plan that includes majorinitiatives, and in allowing the privatesector to participate in it, eliminated theobstacles and legislations that hinderthe role of the private sector and limitinvestment opportunities in the country”.

Concerted effortsEven so, the bank is mindful of its balancesheet. In spite of some obvious successin the Islamic capital markets the bankhas enjoyed through 2010, the going hasbeen challenging, he concedes. It wasonly in July that the bank’s positive A-/A-2 rating was affirmed by ratings agencyStandard & Poor’s, and KFH was removedfrom the agency’s credit watch. In part, therating was earned by the bank’s concertedefforts to turnaround underlying business;in part the rating was leveraged by KFH’sstatus as a Kuwaiti government-ownedentity and the robustness of the bank insecuring liquidity and arranging financingfor its clients. Al Omar points to the current trend

of positive results. The bank reportedgross profit for the first half ofKWD172.8m ($617m), which includesnet profit payments to shareholders ofKWD80.7m. Assets were up 11% toKWD12bn, while deposits rose 7% toKWD7.3bn compared with the sameperiod in 2009. Al Omar cedes: “Bysecuring the rating, it creates furthermotivation. KFH attaches greatimportance at this stage to quality andachievement through governance andmaximum utilisation of the opportunitiesextant both in the market and within thebank itself. We encourage the highestdegree of professionalism while adoptingthe highest standards of risk managementand well-advised practices.” �


Mohammed Al Omar, KFH’s chief executiveofficer. “It is clear that Islamic finance is agrowing business segment and we are set fairto be at the heart of this growth,” he says.Photograph kindly supplied by KuwaitFinance House, November 2010.

44

COMMODITIES

ENERGY MARKET:HOW TO MANAGE RISK


BANKS AND COMMODITYtrading houses have been long-standing investors in “paper”

commodities, but it is against thisbackdrop that they, along with energyand utility companies, are starting toturn to physical commodities such ascoal, oil, freight and liquid natural gas(LNG) as a lucrative opportunity todiversify their portfolios. However, this is a highly volatile

market. Of course this volatility could putearly movers who call the market correctlyin line for some stellar returns. Yet at thesame time, recent high-profile corporatefailures have illustrated all too well the perils of falling foul of a volatilemarket, driving a fresh emphasis on risk management as a core part oforganisational strategy for all firms tradingin the energy commodity markets.

Inadequate systemsIn many ways, the fundamentals oftrading in physical commodities aresimilar to those of their financialcounterparts, but there are somesignificant differences when it comesto the degree of complexity. Indeed, the very fact of physical delivery

creates a whole new set of implicationsand challenges, especially given the factthat physical supply-chain managementbrings with it complex optimisationproblems, which have not always beenfully understood in the financial world.The institutions considering testing thewaters in the physical commoditiesmarket are therefore beginning to realisethat there is a significant gap both in theirsystems and expertise. This leaves them

managing diversified portfolios with onehand tied behind their back. Traditionally, many organisations have

relied heavily on resource-intensive,paper-based processes to manage theircritical information flows on physicalcommodities. When combined with abarrage of systems, these error-proneprocesses often led to requests arrivingin disparate formats, with the resultingaction involving multiple steps acrossdifferent departments.

Better visibilityThe complexities of trading physicalcommodities make it more importantthan ever that companies have fullvisibility and integration throughout thesupply lifecycle. That visibility into keybusiness processes across the front,middle and back offices depends onaccess to accurate and real-time views

of each stage of the physical commoditiesprocess from demand analysis to deliveryof the commodity. Take the case of oil. Purchasing the

oil itself is just the start of the story.Quality and quantity issues can have aknock-on impact on the invoicingprocess. For example, if a lower qualityof oil to that originally requested isdelivered to the end buyer, the value ofthe oil will be lower than expected,leading to a discrepancy in the invoicingsystem. This lower value must beaccurately tracked through the systemand reflected in the final invoice. In another instance, by the time the

cargo is delivered to its disport—or finaldestination—it could have suffered aserious leakage. This lower quantity wouldalso need to be recorded and accountedfor at the end of the invoicing process.The valuation of floating stock is another

The global commodity markets are undergoing a period of unprecedented change, with somebumper times in recent years fuelled by buoyant demand for raw materials from a rapidlyindustrialising China. This sustained rise in prices is sparking the interest of bullish investorsseeking to sidestep the diminishing margins and falling returns of some other asset classes.However, the unique challenges of trading physical commodities place new demands on existingsystems and expertise. Stuart Cook and Richard Philcox of Baringa Partners identify thedifficulties and explore the possible approaches.

THE PHYSICAL CHALLENGEPhotograph © Jesse-lee Lang /

Dreamstime.com, suppliedNovember 2010.


important factor. The difficulty arises whena cargo of oil is midway between its loadport and disport markets: even if itsdestination is known, that destinationcan change. The company must take adecision on whether to establish the valuebased on the load or the disport market,and more importantly, it needs to applythis decision consistently. There can besignificant liquidity risks present throughtransporting cargoes in this way, especiallyif there is an inability to hedge, or thelack of awareness of the opportunity todo so. This amounts to noteworthystranded cargo risk.Tax is another complicated issue

that must be addressed by a robustcommodities trading and riskmanagement (CTRM) system. The VATpaid on a physical commodity changesaccording to the jurisdiction to which itis routed, so extra tax advice will beneeded or a tax-rules engine that canapply the right rates of VAT dependingon location. Companies also need toconsider the implications for the balancesheet of holding physical commodities.However, to do so can be beneficial asphysical stock held can be used ascollateral against trading positions.

Complex trading processThe raft of fees involved in the deliveryprocess also needs to be efficientlyhandled by the energy trading and riskmanagement (ETRM) system. These arethe non-commodity costs that areincurred during the process of movingcargoes between locations, includingport authority fees, insurance andstevedore fees. Nor can the freightimplications of delivering physicalcommodities be ignored, with multipleconsiderations—ranging from the choicebetween time and voyage chartering tosecuring bunker fuel—which need tobe rigorously tracked and recorded.Contracts are a critical consideration,

with many organisations now lookingto manage structured contract portfoliosin a consistent manner. Unlike papercommodities, the structured contractsthemselves must be physically deliveredand settled and require daily contract

management to deal with nominationsand deliveries via a system that canmanage different trading horizons.Contracts can also carry force majeureclauses which bring with them anelement of operational risk, the mostextreme of which would be failure todeliver physical stock.In addition, the high number of non-

standard contracts in physicalcommodities—in part to manage thesecomplexities—leads to extended leadtimes of months or even years for legaldepartments, delays which can obviouslyhave a knock-on effect on liquidity. Inthe LNG market at least, things lookset to change following the LNG DESMaster Sale and Purchase Agreementfor spot transactions from the EuropeanFederation of Energy Traders (EFET).Industry insiders believe that morestandardised contracts should open upthe LNG market to new players andfacilitate back-to-back trading.

Flexible ETRM system There is no one-size-fits-all approachto handling physical commodities withinan ETRM system. Companies have avariety of options based on theirparticular strategy and the extent of theirintended involvement in the market. For organisations that are making

their first, tentative foray into the market,integrating physical commodities intotheir existing infrastructure mayrepresent a more cost-effective short-term option than investing heavily in anew system. For more active players inthe market, on the other hand, a newsystem architecture can often representthe best way to manage the increasingoperational complexity that comes withhigher trade volumes.Organisations at this stage of the

development may find that a single CTRM

platform represents an effective way tohandle the complexities of physicalcommodities. However, some traditionalplatforms are still relatively weak in thisarea and so companies looking to divedeeper into physical commodities mightprefer to take a new system designed tohandle physical commodities. Of course,if that option is chosen it must be ableto function alongside other systems, withthe ability to be seamlessly integratedinto the organisation’s enterprise-widetrading system for consolidated reporting.

Frontline knowledge The choice of platform is not the onlyconsideration when it comes to dealingin physical commodities. This is a specialistarea that requires specialist knowledge.People working within the operationsarea have a different perspective on themarket. As the heaviest users of thesystem, their frontline experience of theday-to-day minutiae gives them accessto valuable knowledge. Organisations are increasingly seeking

to enhance performance and guaranteecompliance by establishing a coherentoverview of their trading activities. Afar more sophisticated approach tovalue-chain optimisation is now theorder of the day, with assets treated aselements in a single diverse portfolio,rather than separate asset silos. Aboveall, today’s portfolio requires integratedthinking to close the gap betweenoptimisation and risk management. With investors of all types engaged

in the relentless pursuit of profitopportunities, many will rush to ridethe wave in physical commodities. In amarket epitomised by its complexity,the successful among them will be asserious about investing in their tradingsystems as they are about investing inphysical commodities. �

For organisations that are making their first, tentative forayinto the market, integrating physical commodities into their

existing infrastructure may represent a more cost-effective short-term option than investing

heavily in a new system.

ALTHOUGH NOT ONE of the world’s prominentsovereign wealth funds (SWF) the QIA, which isreputed to be worth between $85bn and $100bn, has

more than most become a bellwether for change in SWFinvestment approaches. It has been some time since thebalance of power between SWF investors and recipientmarkets has changed. The financial brouhaha of 2007-2009pretty much saw to that. The consequences have beenmanifold. Among them, investments, once discrete havebecome much bigger; prestige investments are no longerthe norm; but instead are mixed with long term strategicintent and to smooth out inherent volatility as much aspossible. That also means that outright ownership is nolonger a fundamental requirement and instead strategicstakes are most appropriate.Regarding investment in real estate, there is a notable shift

from direct acquisition to indirect investment, either via propertyequities or through real estate funds. Equally, incipient changesin the east-west balance of power increasingly encourage amore diversified approach to emerging markets investment.In the case of smaller or more discrete funds, such as the QIA,it enables them to spread risk and not have the inconvenienceof direct costs (through the establishment of local offices and/ormanagement for example). Historically, London and Paris havebeen important investment centres for Qatar, with substantialinvestments in real estate, particularly hotels; however incommon with other Middle Eastern SWF’s the QIA has spottedthat Asia offers the new main chance. To this end, the QIAwas reported as far back as 2007 to have plans to increase itsAsian investments to 40% of its overall portfolio over thefollowing decade. QIA this year signed a $5bn preliminaryagreement with Malaysia to invest $5bn in real estate andenergy, as well as a $1bn joint venture with Indonesia focusingon sectors including natural resources and infrastructure.Moreover, the QIA put as much as $2.8bn into the initial publicoffering by Agricultural Bank of China mid-year when thebanking giant came to market with its long awaited IPO.In common with other SWF’s in largely mono economies,

the QIA is using its investments in real estate, infrastructure,

agriculture and consumer and high end retail entities to helpbuild capacity in their its home market. In this respect, SWFsdiffer markedly from other asset gatherers in that there is adistinctly political component to proceedings; though on aday to day basis, the SWF tends to work on a similar basis toa long term private equity fund. In this regard and as part ofa financial diplomacy drive, Qatar has formed joint investmentlinks with countries such as Malaysia and is in the processof establishing comprehensive links with Indonesia andGreece. Most recently, the QIA reconfirmed its commitmentto invest up to $5bn in Greece, a move announced in anofficial statement issued after the meeting of Qatar-Greece JointCommittee held in Athens earlier this year.Finally, smaller SWFs are learning that they can walk further

in company than alone. In QIA’s case it has a long standinginvestment fund (worth in excess of $2bn) together with theAbu Dhabi sovereign fund. It also has joint venture fundswith Dubai Holding.Most significant perhaps, as a sign of growing maturity,

the QIA is happily mixing investments in which it holdseither 100% or the majority of the shareholding into a multi-faceted portfolio which contains investments that areessentially minority stakes. In September 2007, for instance,it reckoned on a 20% stake in Chelsfield, to which it addeda £600m stake in the decommissioned Chelsea Barracks, a14.5% stake in Canary Wharf and a 20% interest in the Shardof Glass trophy property near London Bridge; a mix of longterm, real estate and one-off opportunistic investments. The QIA really came into its own in the difficult period of 2007-

2009, when it took strategic stakes in both Barclays and CreditSuisse providing them with much needed capital and in returnsecuring their services as regular arrangers and advisors formost of the SWF’s subsequent investments and asset purchases.Headed by Sheikh Hamad bin Jassim al-Thani, the dealmaker

and prime minister, and spiralling down through a new cadreof foreign bankers and a small pool of home-grown talent hassubsequently added to its list of high profile investments. Lastyear, it ploughed $10bn into Volkswagen and Porsche and therehas also been time to pick up Harrods as a trophy asset.

46 DECEMBER 2 0 1 0 / J ANUARY 2 0 1 1 • F T S E G L O B A L M A R K E T S

20-20 ALL S

TARS: QIA: THE NEW SWF TEMPLATE

Stakes in Santander, Agricultural Bank of China,J Sainsbury, Harrods, Fairmont Raffles, CreditSuisse and Barclays and the recent launch of a$5bn commodities and real estate focused fundin conjunction with the Malaysian government,clearly illustrate the Qatar InvestmentAuthority’s (QIA) dual pillar investment strategy:high profile stakes in western companies,accompanied by a fast growing and highlydiversified portfolio in emerging markets. Whatnow for the sovereign fund?

SHEIKH HAMAD BIN JASSIM AL-THANI � QIA

A HIGH STAKES GLOBAL STRATEGY

Qatar's First Deputy Premier and Foreign Minister Sheikh Hamad binJassem bin Jabor Al Thani, answers a question from media during anews conference with Iranian Foreign Minister Manouchehr Mottaki inTehran, Iran. Photograph by AP Photo/Hasan Sarbakhshian, suppliedby Press Association Images, November 2010.

As Qatar’s gas exports have increased, the governmenthas also been able to borrow cheaply to underpin its SWF’sinvestment strategy. Some 70% to 75% of the SWF’s fundsare siphoned off into Qatar Holding, with the remainderdestined for global fund managers reporting to QIA. QatarHolding is the direct investment arm, run by Ahmed al-Sayed, which tends to buy strategic stakes in banks and otherhigh end companies. Remaining funds are either allocatedto third party asset management firms, or allocated to specificfunds, such as the fund. Other active funds in which the QIAhas invested includes Hong Kong-based Primus PacificPartners, which invests in financial services companies inthe Asia-Pacific region. The QIA has extensive expertise in real estate. It has also

established a separate operation to manage real estate

investments: Qatari Diar Real Estate and the Qatari Diar RealEstate Investment Company and Barwa Real Estate InvestmentCompany, which is listed on the Doha Securities Market. Going forward, the emerging markets remain a strong

focus for the SWF. Its recent $2.7bn investment in SantanderBrazil is further proof of its commitment to leveraging highgrowth markets. Increasingly, as well, expect to see adistinctly political sub-text to investments: a naturalevolution of the growing links between the emirate andthe Far East and other buyers of Qatari carbon exports.The Santander deal comes in the wake of a January tripby the emir to South America, for example. As the QIAitself concedes, the SWF: “is always ready to partner withexperienced and respected partners where they can addvalue in any particular market.” �


20-20 ALL S

TARS: CHI-X GLOBAL: T

HE CHANGE AGENT

TAL COHEN � CHIEF EXECUTIVE OF CHI-X GLOBAL

ASK MARAT: LEADERS of revolutions don’t alwayssurvive to see the fruits of their labour. Will Chi-XGlobal? Change has been brewing for some time.

In September John Lowrey, its chief executive was movedover to technology company Market Prizm, the infrastructureservice arm of Chi-Tech and which is now also up for sale,and was replaced by Tal Cohen, who used to head up thefirm’s Canadian operations. The surprise move comes asChi-X Global has been expanding rapidly in Asia, led byLowrey. By November, Chi-East, the independent pan-Asian trading platform, in which Chi-X Global has a jointventure stake in partnership with the Singapore Exchange(SGX), announced that it has commenced operations tosupport the non-displayed trading of Asian securities tocomplement the region’s increasingly dynamic tradingenvironment. Chi-East also represents a number of firsts:including the introduction of the first Central CounterpartyClearing (CCP) model for selected securities in Asia, as wellas the first pan-Asian liquidity aggregator focusing onbrokers and high frequency clients.However, unlike Chi-X, Chi-X Global has been burning

through cash, with questions over how far it can expandon still limited revenue streams. Chi-X Global operates

Chi-X Canada – which competes against the Toronto StockExchange and which has an approximate 10% market share– Chi-X Japan and Chi-Tech. With Chi-X Canada and Chi-X Japan continuing to build momentum, the launches ofChi-East and Chi-X Australia and rollout of new initiativessuch as Chi-FX, this is obviously an important time for ourbusiness,” explains Tal Cohen, chief executive of Chi-XGlobal. Aside from expansion into Japan and Australia, it hasagreed a joint venture pan-Asian dark pool with theSingapore Stock Exchange. In Latin America, the firm has made its presence felt

through Chi-FX Brazil, which will develop FX trading platform,allowing foreign investors to enter orders with limit pricesin their base currency and facilitate the simultaneous pairedexecution of the equity and forex legs of the transaction,thereby mitigating intraday FX risk. Chi-X Global will developand help support the platform, and BVMF will market theservice to its participants and provide facilities, expertiseand front line customer support. Chi-X Global is a subsidiary of electronic trading pioneer

Instinet Incorporated, a wholly-owned subsidiary of NomuraHoldings, Inc. It is possible that the sale of Chi-X Globalcould follow the same ownership model as Chi-X Europe.Instinet for the time being holds a 34% stake in Chi-XEurope, but the pan-European MTF has been the subjectof a potential bid, widely believed to be US-based exchangeoperator BATS Global Markets. Other shareholders in Chi-X Europe include BNP Paribas, Citadel, Citigroup, CreditSuisse, Goldman Sachs, Bank of America Merrill Lynch,Morgan Stanley, and UBS. �

If any one brand name has struck fear into the hearts of monopoly exchanges it is Chi-X. Thebrand has been a harbinger of market change, ultimate fragmentation and a new focus ontechnology and cost efficiency. In Europe, for instance, Chi-X dominated the discussion aroundmarket fragmentation even before MiFID came into being. Chi-X Global, part of the same group,but an entirely different entity, has rolled out more of the same across a large swathe of markets;a herald of further market diversity, choice and cost efficiency. It has come at a price for both.How much longer can the moniker ring the changes?

THE HERALDOF CHANGE

*References the 2008 Forbes Tax Misery & Reform Index

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THE FIRST RMB200m 3% notes (due September 2013)generated good investor interest for its high creditquality, name recognition and rarity value. “Following

on the bank’s introduction of RMB-denominated structuredinvestments, we were pleased to bring to market a RMBbond offering by a globally-recognised household name,”says Neil Daswani, Standard Chartered’s managing director,transaction banking, North Asia. “This transaction reinforcesHong Kong’s status as an RMB offshore centre. Right now itis still at an early stage, but the currency is gaining ground asa store of value and wealth in Hong Kong.” Already one ofthe three leading players in RMB trade settlement and offshoreRMB bond trading services (the others being Citi and HSBC),Standard Chartered is taking a proactive role in increasingutilisation of the RMB as a regional currency for investment,trade and reserves. The bank’s prominence in RMB cross-border trade settlement

has been more than a year in coming. In a pilot programmelaunched in July 2009, Standard Chartered Bank Hong Kongwas the first foreign bank to complete a two-way trade settlementwith China. One month later, Standard Chartered Bank Chinawas the first foreign bank to be appointed the agent andsettlement bank for RMB cross border settlement. “The schemehas been expanded to Macau, then ASEAN and is now fullyglobal. Internally the scheme began with five pilot cities and hasnow been expanded to 20 provinces,” notes Daswani.The numbers may be small, but the renminbi is quietly

taking more bold steps in its gradual journey towardsinternationalisation in bonds, forex trading, and in tradeloans. Standard Chartered’s bond deal was the first concreteoffshore renminbi transaction, following a separateannouncement by the Industrial and Commercial Bank ofChina in early August that it was ready to sign an RMB50m

line of credit with an Indonesian buyer. Standard Chartered,maintains Daswani, remains one of the first internationalbanks to offer cross-border renminbi trade settlement. Thebank began a mission to broaden usage of remnimbitransactions early in the year, as it organised a roadshow,together with officials from the Shanghai Municipal Officeof Finance Service, People’s Bank of China (PBOC) and StateAdministration of Foreign Exchange (SAFE) Shanghai inMalaysia, Thailand, and Singapore; the first partnering ofofficials from government and regulatory bodies in Chinaand an international bank on a roadshow. Building on the momentum, explains Daswani, the bank

has also been working to expand the reach of RMB tradesettlement to other regions outside ASEAN such as theMiddle East, India, the United Kingdom and Germany, NorthAmerica and in selected African countries, such as Zambia.The growing number of nostros set up by banks from thesemarkets is indicative of the underlying demand for RMBtrade settlement, enabling banks such as Standard Charteredto engage effectively with the Chinese government to expanda scheme initially restricted to ASEAN members.“With the gradual relaxation of regulations for RMB trade

settlement, this presents increasing opportunities for tradersin China and ASEAN to grow their existing businessesoutside of Asia. We are very excited about its growth potential.Our systems are ready and with our extensive footprintacross Asia, Africa and Middle East, we look forward toplaying a key role in further expanding the scope for RMBtrade settlement,” says Daswani.Redenomination has huge implications. Around $2.2bn

worth of trade is denominated in RMB, though Daswani thinksthat could multiply to around 15% of global trade within thenext three to five years. Moreover, he thinks that Hong Kongwill be the major trading centre, as remnimbi treasury operationsmultiply in this jurisdiction. “The CNH market, the offshoreChinese yuan market in Hong Kong, used to be a non-deliverable forward market (NDF), now it is definitely deliverableforward (DF). Earlier this year the spot market was worthbetween $30m to $50m a day, now you are looking at $350mto $500m. It is a massive turnaround,” he adds. �


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TARS: STANDARD CHARTERED: RIDING THE REMNIMBI W

AVE

In August this year Standard Chartered Bank(Hong Kong) Limited launched the first renminbi(RMB) denominated corporate bond for theMcDonald’s Corporation. It is the first ever RMBbond launched for a foreign multinationalcorporate in the Hong Kong debt capital marketsignifying the commencement of a new fundingchannel for international companies to raiseworking capital for their China operations. It is,holds Neil Daswani, managing director,transaction banking, North Asia, “a significantcontribution to the development of the off-shore RMB debt capital market in Hong Kong”.

ENTER THEDRAGON

NEIL DASWANI � MANAGING DIRECTOR, TRANSACTION BANKING, NORTH ASIA, STANDARD CHARTERED BANK

Neil Daswani,Standard

Chartered’smanagingdirector,

transactionbanking, North

Asia. Photographkindly suppliedby StandardChartered,

November 2010.

51F T S E G L O B A L M A R K E T S • D EC EMBER 2 0 1 0 / J ANUARY 2 0 1 1

THE STORY OF the Ping An financial group covers thewhole period since Deng Xiaoping began hismomentous experiments with opening up China to

market forces back in 1991. Beginning in Shenzhen, the cityDeng created as the conduit between the world’s marketsand China, Ping An Insurance group has been a market forcein itself. The insurance company and its interrelatedsubsidiaries, its bank and securities operations, now joinedby its private asset management branch, reinforce each other.The group’s 3rd Quarter report is almost a paradigm of ChinaInc’s own spectacular growth. Over the first three quarters ofthis year its assets grew 17.5% to over RMB1,000bn ($150bn),its total equity grew by 26.6% and its net profit up 8.4% yearon year to RMB13,bn (approximately $2bn). In Western termsPing An could almost be considered a financial conglomerate;nonetheless, from trying to penetrate the corporate structurefor interview, there are no “Chinese Walls” between the variousmanagement groups. In the early summer Ping An Securities finalised the

acquisition of a strategic stake in Shenzhen DevelopmentBank (SDB), pushing ahead the merger of its Ping An Bankwith SDB, and working towards its strategic goal of creatinga unified business platform for the Ping An Group companiesof which Ping An Securities is a part. More specifically, it hashelped Ping An secure strategic co-operation with a nationalcommercial bank.Rionzhuang Xue, head of Ping An Securities, confirms the

drive, citing the investment bank’s “highly-centralised businessmanagement, inter-connected operation system betweenmain business lines and supporting business lines, andcooperation between front-line and middle-line businesses.In this regard, Ping An’s operation services, quality control,

pricing and issuance, external coordination can penetrateinto every single line of business, making team operationpossible and enhancing overall competitiveness [sic].” Healso invokes “standardised operation procedures and businessmodel in order to ensure standardisation of the projectworkflow of top-tier salespeople, manage operation risk andeffectively enhance service quality.”Certainly in terms of marketing, its integrated operations

give the securities operation almost a captive market! The

numbers are numbing. Xue points to its 50m retail customersand more than two million corporate clients. He adds, “Thishas created a platform for the development of the securitiesbusiness, for it to maximise the business potential of eachcustomer. The synergistic effect is immense, and it is crucialfor the development of Ping An Securities.” He credits thecompany’s “One Customer, One Account, Multiple Products,One Stop Shop Service” strategy,” which allows “this immensenetwork” of all the subsidiaries of Ping An “to successfullyshare the internal resources.”The brokerage has played a large part in the development

of IPOs for the SME, GEM and most recently, the ChiNextplatform, the SME segment of the Shenzhen Stock Exchange.The brokerage’s network is well placed to serve the Chineseretail demand for IPO opportunities. While there have beensome complaints about Chinese founding entrepreneurscashing in their IPO chips a little hastily to take advantageof the high price to earnings (P/E) ratios (over 70 on averageon ChiNext), one cannot help but suspect their profits mightwell be heading towards Ping An Trust’s private assetmanagement. However, with its market almost entirely domestic with only

incipient operations in Hong Kong, and some personneloutreach, Ping An is relatively unknown outside the PRC. Xuesays “In the short term our focus will remain on China’s capitalmarket, and on providing customers with better services.” Even so, he also looks ahead, admitting, for example, “we

are intent on recruiting certain talent from abroad, so thatwe can continue to learn from the experiences of the moredeveloped markets overseas and apply them to our business,from corporate governance to strategic management, productsand services to day-to-day operations.”China accounts for more than a third of the $155bn raised

in IPOs this year. Companies have raised over $53bn inShanghai and Shenzhen, and Ping An has outstripped historicChina IPO leaders Goldman Sachs and UBS in Shenzhen, assmaller firms opt for local brokerages. When the colossusconsiders itself ready for the global markets, one almostwonders if Wall St will end up like downtown Detroit in faceof the competition wielding the cash of untold millions ofChinese savers and investors.�

It has been a banner year so far for Ping An Securities having weathered the financial crisis by“optimising our asset allocation” according to chief executive Rionzhuang Xue, in timely manner. Itseems to have reached safe harbour triumphantly, reporting RMB1, 176m ($175m) net profit for thethree quarters of the year, a 111.5% year on year increase, helped by its sponsorship of more than30 IPOs, while being lead underwriter on seven refinancings of Chinese corporations. “We rankedtop in the league table by number of deals and volume of underwriting fees received,” boasts a PingAn Securities official spokesman, playing an innovative role, for example in introducing a new (toChina) ETF and a steady increase in “high margin products” for individuals.

TEAM DRIVEN GROWTHRIONZHUANG XUE � CEO, PING AN SECURITIES

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TARS: PING AN SECURITIES: THE CHINA IPO KINGS

IN A WORLD of constantly changing faces and places, aprivately held and fully customer funded organisationsuch as Brown Brothers Harriman (BBH) is a rare thing

indeed, says Douglas “Digger” Donahue, BBH managingpartner. He adds: “It takes discipline to go against the grain,to maintain your convictions when others are piling into anygiven asset class, but having the ability to think independentlyhas paid off for us in the long run.” A highly focused market-segment strategy has allowed BBH

to properly position itself in emerging regions such as China,where the company recently opened a representative Beijingoffice in the hope of furthering its already significant mainlandbanking business—BBH’s clients include seven of the country’slargest banks; at present, Asia accounts for 20% of BBH’s globalrevenue. “This kind of investment represents a stepping-up inour commitment to the region,” says Donahue. “Our approachto China is consistent with the methods that we’ve establishedin the past—that is, to work in a complimentary, partneringfashion with leading local institutions. Based on our long-standing track record, they can trust us to be true to that strategy—we are happy to remain in the background as a valued andspecialised wholesale partner with excellent cross-bordercredentials and domain expertise.” Donahue considers thesustained consolidation within the financial markets anopportunity for BBH to truly differentiate itself. “Having thatkind of continuity within a private-company setting allows youto pursue your strategies and control your own destiny, withoutany interference from outside constituencies,” says Donahue. Some may argue that BBH’s model is too constrained to do

battle in today’s rapid-fire marketplace; without making dramaticacquisitions or doubling the business overnight, undue pressureis placed on the company and its clients. Donahue has a simplecomeback : “Is that kind of approach really that good for yourclients, not to mention your staff, many of whom could beeliminated during a major consolidation? The fact that wehaven’t grown through a string of acquisitions saves clientsfrom the need to transition from one system to another andpromotes stability in our service model. We have a singleintegrated platform, which allows us to achieve scale at muchlower levels of transactional volume.” Donahue disputes the notion that today’s industry is built

for scale players only. “In fact, if you pursue it intelligently and

selectively, it can be just the opposite.” A decade ago, saysDonahue, BBH was one-tenth the size of the market’s largestplayers—before the various M&As that were supposed toput some daylight between the haves and the have-nots.“Guess what? Today we’re still one-tenth the size of thebiggest players. The point being that, through organic growthand having the right clients and the right products, we’veclearly been able to hold our ground.” For much of that period, BBH managed to outperform the

competition in percentage growth in profits, growth in custodyof assets, improvement in margins and many of the otherstandard institutional rubrics, says Donahue. It has been theleaner, crisis years that have compelled Donahue and his BBHcolleagues to truly earn their keep and differentiate theirapproach. “During a prolonged period of volatility when allhell is breaking loose, clients need you to be there for themlike never before,” says Donahue. “That’s why I believe that thisisn’t really an absolute-scale business—rather, how scaled youare within each of your relationships. If you were to run this likea utility, you’d take all-comers and just throw them all into themachine. However, there are some things that just aren’t thatscalable, and can often hold you back. That’s the handicap ofthe growth-by-consolidation approach—you spend half ofyour time trying to normalise all of these systems you’veinherited, rather than moving your technology forward. Sothere are built-in advantages to doing it our way—and theproof has been in the financial results.” Donahue points to BBH’s securities-lending programme,

which had no impairments or realised credit losses during thecredit crisis and has experienced its best new business year inits 11-year history (with assets increasing by 30%-40%) asevidence of the company’s economies-of-scale in action. Explains Donahue: “It takes discipline to go against the

grain, to maintain your convictions when others are piling intoany given asset class. Having the ability to think independently,to trust the perspective of your partners and colleagues whohave been working at this business for decades through allof the ups and downs and the many different market cycleshas paid off for us in the long run. We consider ourselvesstewards of this franchise—and our main goal is to have thekind of management teams that can keep the business goingfor yet another 200 years.”�


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TARS: BBH: HIGHLY FOCUSED, MARKET SEGMENTED STRATEGY

“Having a privately owned structure that promotes collaborationis part of what differentiates our culture,” says Douglas “Digger”Donahue, managing partner at Brown Brothers Harriman (BBH).“If you’re going to grow organically as we must, you’d better do agood job on behalf of your clients. There is a lot of disciplineinvolved with this kind of approach—you have to work muchharder at it in order to make it successful, especially given thenature of today’s markets.”

CUSTOMER FOCUSDOUGLAS DONAHUE � MANAGING PARTNER, BBH

Douglas “Digger” Donahue, managingpartner at BBH. Photograph kindlysupplied by BBH, November 2010.


BRANDING ISSUES ASIDE,Merrin says that his companyhas allowed the rapidly evolving—and, at time, liquiditychallenged—institutional sector to find avenues of

opportunity in markets that might otherwise be impenetrable.“Over the last 30 years we’ve gone from having a very mom-

and-pop kind of industry, to one that now includes over 100minvestors in the US alone,” says Merrin. “Yet the marketstructure itself hasn’t always kept pace with the changes. Inrecent years, the orders that were coming in from theseinstitutional investors were so large, in fact, that they werecapable of regularly moving the markets in a very significantway. The more the stock moved, the greater the tax was onour returns. People just assumed that Wall Street is as efficientas it can possibly be—but in reality, it hasn’t been completelyin tune with the problems that these institutions are experiencingin terms of owning stock and how much their returns havebeen affected. As a result, Liquidnet needed to come up witha different kind of model in order to properly accommodate

the wholesaler. It’s that simple.” For his part, Merrin, has soughtto allow institutions to act as their own suppliers of liquidity,thereby creating a wholesale marketplace where there once wasnone. The platform is not unlike an eBay for stock trading,says Merrin—institutions place their order requests, and thesystem finds the appropriate buyer or seller worldwide,instantaneously. “There is no manual searching involved, andall of the liquidity gets re-aggregated into a single pool,” saysMerrin. “The bottom line is, the less work that people have todo, the more successful you’re likely to be. Obviously we’ve beenhelping to solve a problem that has existed for years—becausewe’ve been pretty successful as a result.” To its credit, he says, the Securities and Exchange Commission

(SEC) has indicated in recent testimony that it understandsnot all dark pools are created equal, and has respondedaccordingly. “When you consider all of the regulatory frenzy that’sbeen going on, I think it is important that they were able tostep back and re-assess, rather than just make a knee-jerk kindof pronouncement—and the distinction they seem to be makingwith dark pools is that if a firm can provide real value above andbeyond what is found on the exchanges, that is true innovationand should be left alone. If, however, you’re not capable ofoffering major price improvement, or you can’t provide anexecution size that is markedly different from the exchanges,then there is a problem, because, at that point, the regulatorsjust perceive a lot of different private exchanges that are onlydegrading the pricing mechanism and really aren’t benefitingthe overall market structure.”Despite his efforts to streamline the global marketplace

through Liquidnet, Merrin understands that change doesn’talways come easy. “The notion that a country’s main exchangeisn’t the ‘be-all-end-all’ hits at the heart of national pride,and helps to explain why the arrival of these new tradingvenues has been so disconcerting for local regulators as wellas the countries themselves. Like all aspects of deregulation,initially there can be problems and annoyances—we allremember what it was like to get those weekly calls fromyet another new telecom following the break-up of Ma Bell.However, in the US the SEC is responsible for ensuring thatthe market structure maintains its integrity—that no onegains at someone else’s expense.”The company has also found a receptive audience in

countries including Poland, Mexico, New Zealand and Israel.“The fact that we are trading in 37 different markets istremendously important to us, particularly when you haveeconomies such as Singapore, which is currently in the vicinityof 10% GDP growth. Like other companies, Liquidnet has been forced to make

some personnel cuts due to weakness in overall global tradingactivity. To stay on track, says Merrin, the company has expandedopportunities in rapidly growing emerging regions such asAsia Pacific (where trading volume has already surpassed lastyear’s total of $10.2bn), and has expanded its menu of offeringsto include the likes of corporate-access servicing (via its InfraRedapplication, launched late last year). �

The sheer magnitude of supply and demand,combined with the number of competinginterests in today’s marketplace—including thesurge in high-frequency trading activity—requiresthat there be venues where institutions can tradein a more anonymous unlit manner, says SethMerrin chief executive officer, founder andpresident of Liquidnet. “The problem is that high-frequency traders in particular can easily takeadvantage where there is a supply-demandimbalance and who pays the price?” he asks.Anyone with a pension plan, a 401k plan, or amutual fund. Hence, all the more reason to beginlooking at a real separation of those markets.”

THE BUY SIDEMODEL

SETH MERRIN � CHIEF EXECUTIVE OFFICER, FOUNDER AND PRESIDENT OF LIQUIDNET

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TARS: LIQ

UIDNET: S

ERVING THE BUY SIDE IN THE DARK

Seth Merrin, CEO,founder and president

of Liquidnet.Photograph kindly

supplied by Liquidnet,

November 2010.

AKBANK’S EUROBOND OPENED up a new world forTurkish bank borrowers as a host of more diversifiedfunding structures are now much more likely. Akbank’s

deal set other benchmarks; it was the largest security ever soldby a Turkish issuer excepting sovereign issues and was pricedwith the lowest ever coupon for a non-sovereign Turkish issuer.

Ironically, Akbank’s Eurobond came at a time when changesto local financial regulations imposed a 10% withholdingtax on directly issued bonds. There is no withholding taxcharged on syndicated loans, hence their popularity amonglocal issuers. “The bank has a great story,” says Hülya Kefeli,executive vice president, head of international banking atAkbank. “We ended up at the tighter end of the initialguidance pricing range. Demand was strong, with 165investors in the transaction and outstripped availability, withthe order book totalling $3bn. In the end, the allocations

were made to long-term investors. The initial price came inat 99.431, though following the issuance its price has seenlevels around 102.25, giving a yield of 4.70%.” The scarcity of Turkish risk, especially at non-sovereign

level, helped. “Investors were also attracted by Akbank’sstrong position in the Turkish banking sector. Citi’s stake inthe bank helped, no doubt about it,” says Kefeli. A month later, Akbank came to market again, securing the

first diversified payments rights (DPR) securitisation worth$860bn concluded in the EMEA region for a year, under thebank’s securitisation programme, backed by foreign exportreceivables, cheques and foreign exchange transfers. The bank also secured a €1bn equivalent, dual tenor, dual

currency term loan facility. The loan extends the bank’s abilityto secure financing of this type over a longer maturity; a movethat Kefeli thinks other Turkish banks will follow. �


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TARS: AKBANK: BREAKING ACROSS THE BOND BARRIERS

Turkey’s private sector bond sales have been a standout this year; with Akbank taking a good slug ofthe year’s new issuance, led by Hülya Kefeli, the bank’s head of international banking. Followingpermission from Turkey’s capital markets supervisory board, in late July, Akbank came to market witha $1bn senior unsecured Eurobond, offering a yield of 5.256% and a coupon of 5.125%, maturing in2015. The transaction was the first direct bond issue from a Turkish private sector borrower.

KNOCKINGDOWN BOND

BENCHMARKS

JOSE DARIO URIBE � GOVERNOR, CENTRAL BANK OF COLOMBIA

THE TURNAROUND TALE

BY Q3 2008, Colombian economic growth, its currencyand consumption were decelerating fast; the result ofprevious tight monetary policy and the effect of the

relative price increases of raw materials and foodstuffs. Publicinvestment fell drastically due to delays in public works. Inflationwas moving well above its target range for the year (3.5%-4.5%) and Colombia’s sovereign risk premium jumped to500bps. Two years on and it’s a very different story. Colombia’s central bank is attempting to push down the

peso by buying a minimum of $20m daily for at least fourmonths to mop up US currency from the foreign exchangemarket and by keeping oil dividends abroad. The central bank

held its benchmark interest rate at 3% for a seventh straightmonth at its latest monetary policy meeting, citing lowinflationary readings and a strong economic outlook. It alsoexpects its inflation target range for next year is 2% to 4%, thesame target range it set for 2010. Prices through the 12 monthsthrough October stood at 2.33%. In terms of gross domesticproduct activity, the bank reaffirmed its 2011 forecast of 4.5%economic growth, compared to 0.8% in 2009 The bank's view of the economy has included political

problems, such as its dispute with Venezuela, which has blockedbi-lateral trade. Uribe predicts $1.2bn worth of trade withVenezuela this year, compared with $7bn in 2008. There hasbeen an increase in confidence among consumers andbusinesses. Investment is coming primarily in hydrocarbons,mining and infrastructure. Mining is particularly attractive as thecountry branches out from coal to precious and base metals. �

Once torn by civil unrest and racked by drugtrafficking, Colombia is a modern day tale of asound economic turnaround.

Hülya Kefeli.Photograph

kindlysupplied by

Akbank,November

2010.

HULYA KEFELI � EXECUTIVE VICE PRESIDENT, HEAD OF INTERNATIONAL BANKING, AKBANK


GRAB, BULL ANDhorns spring to mind when it comesto JP Morgan and its chief executive Jamie Dimon.Dimon has spearheaded substantive growth in the

treasury services business, a full-service provider of cashmanagement, trade finance and treasury solutions, particularlyin the Asia Pacific region. Over the last year the bank hasstrengthened the organisational structure of its global tradepractice to better address the industry’s increasing demand forsupply chain and trade finance solutions; hiring a slew of newsenior managers and upping the trade and supply supportteam. Across Asia, the bank has hired an additional 500 staff inthe treasury services segment alone. The new structure introducescentres of excellence for all trade products across the world;regional trade advisory teams; and solution delivery teamssupporting trade sales specialists. The bank is positioning itselffor unprecedented growth in its global trade business, leveragingits US commercial bank franchise and supporting the bank’sglobal corporate bank expansion strategy. Change has been coursing through JP Morgan for some

years, since it instigated the three year $1bn global investmentplan in late 2008. In line with the incipient economic order,most of the investment focus has been on Asia. The goal hasbeen to take a complex multi-currency, multi-regulatedenvironment and make it easier, cheaper and faster for ourclients to conduct cash management activities. On the ground,a host of initiatives have included enhancements to the bank’sdomestic cash management capability in East Asia, mainlySouth Korea and a new rep office in Bangladesh. The bank hasbuilt up client networks in India, Nepal, Sri Lanka and theMaldives and escrow services have been established in Australiaand Singapore. The bank’s US dollar clearing operations havebeen upgraded with Swift MT-103 message formatting,providing clients with faster, more secure cross-border credittransfers. A web based receivables management platformhas been rolled out and a freight payment and auditingcapability has been launched to help clients improve controlof global transportation operations. Most recently the bankhas launched an advisory programme in mainland China tohelp local corporations improve cost and risk management.The bank’s investment banking operations have also seen a

substantive uptick. Led by Jes Staley, who took over the reinsin late 2009, the investment bank has a three pronged growthstrategy, based on lowering return on equity, increasing theinvestment bank’s share of global banking feels and reducingthe error rate for processing trades. The investment bank hasset a 20% return on equity target. Since 2006 it has only reachedthis once – when it hit 21%. Over the last five years the averagehas been 12% and as the bank has increased equity this yearto £40bn, up from $30bn last year, that kind of performanceis a big ask. Asia figured largely in growth play this year, witha projected doubling of market share in Asia from 4% to 7%.Its equity and debt capital markets segment has steamed up mostnew issuance league tables through 2010, with emergingmarkets debt issuance a particular outperformer.What it all adds up to is that while other banks are struggling

to comply with Basel II and the financial reform process, JPMorgan is using the hiatus to become more global, offer adeeper service set across the group, and in the processdominating emerging market business opportunities. Whynot: particularly now when there are only a handful of banksthat can compete in the space. The bank’s 2010 Q3 numbers are doing some satisfying

talk. Through 2010 to date, the company loaned or raisedover $1trn in capital on behalf of its global clients and itssmall-business originations have risen 37%. The bank’s Q3earnings per share ballooned to $1.01, or 19 cents more thanQ3 of 2009, and the company improved net income ($4.4bn)by 23% over the year-ago period. Moreover, its balancesheet—which went from a Tier 1 common ratio of 7% at thestart of 2008 to a current 9.5%—continues to show signs ofstrength. Says Dimon: “We believe that the quality of ourbalance sheet will position us well for the eventualimplementation of new capital standards being developed bybank regulators,” holds Dimon. �

JAMIE DIMON � CHIEF EXECUTIVE OFFICER, JP MORGAN

For most financial institutions, growth has been painfully won since the financial rumblings thatbegan in mid 2007. If there is one bank that, at least on the surface, has grasped the opportunityof the downturn to establish an extensive global footprint it is JP Morgan. As some of the starsof the global banking industry have waned, JP Morgan is waxing pretty. In part that is due tostringent internal risk management discipline which has provided the bank with free capital toinvest in growth; in part it results from a clear determination to build out a dominant globalfootprint based in large portion on Asian business growth.

THE ASIANPLAY

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TARS: JP

MORGAN: STRENGTH IN DEPTH

JP Morgan chiefexecutive officer,Jamie Dimon.Photograph byLawrence Jackson,supplied by APPhoto/PA Photos,November 2010.


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TARS: AFC: PROMOTING AFRICA’S CAPITA

L MARKETS

ANDREW ALLI, PRESIDENT and chief executive officerof Africa Finance Corporation (AFC), would like tobe nowhere else but the country of his birth—Nigeria.

A distinguished career in finance has taken him from beingan investment banker in the City of London to Washington,where he served as an investment officer working at theInternational Finance Corporation (IFC), the private sectorfinancing arm of the World Bank Group. However, it is hispassion for developing the finance industry in his homelandthat drives him.“AFC specialises in projects aimed at catalysing investment

in infrastructure within Africa,” says Alli. “This is hugelyvital for the economic development of the continent.”AFC was formed in 2007 under an international treaty

between sovereign states, with current members includinghost-nation Nigeria plus Guinea-Bissau, Sierra Leone, TheGambia, Liberia and Guinea. The Central Bank of Nigeriaprovided anchor capital and holds a 42% stake, with othershareholders, including African financial institutions andcorporations. Exemplifying the very type of deal that AFCwas set up to do is the project financing of an undersea fiberoptic cable, which stretches from Portugal to Lagos, connectingWest Africa to the information superhighway. AFC is thelargest investor in the $240m Africa-led funded Main OneCable System, which has provided a tenfold increase inbroadband capacity in the region. Alli describes the projectas being “hugely transformational” for Africa’s IT and telecomssectors. “It will allow companies to start thinking aboutopening business process outsourcing operations which theyhave not had the bandwidth to do,” he says. AFC last year obtained a 46% controlling stake in Cenpower

Generation Company, which is developing the Kpone

independent power plant in Tema, Ghana. AFC sells powerto the government of Ghana through its electricity company,Electricity Company of Ghana (ECG). “We are putting thistogether as a project which can be bankable,” says Alli. “Thishas created considerable interest and is something we hopeto take to financial close next year.”Alli points to the funding of the $450m plant—which will

help power continued economic growth in Ghana—as anexample of how AFC can bridge the gap that exists betweenpent-up demand among international investors to financeprojects in Africa, and the required local expertise amongfinancial institutions in the region to ensure such initiativesare well structured. “We create transactions, rather thanwaiting for others to do so. A lot of investors like to look atdeals that are well-packaged with everything in place. So allthey have to do is write a cheque,” says Alli.Another more long-term focus for AFC is the formation of

capital markets in Africa, developing markets for “infrastructurebonds” and project-related bonds in local currencies, whichremoves the currency risk international investors can face. Allipoints out that “mobilising” domestic financial markets is aproven model to facilitate the flow of foreign investmentinto an emerging market economy. “We are also looking atcreating private equity funds which specialise in infrastructure,an asset class we see there being a lot of interest in,” he says.AFC plans to obtain authorisation from the international

credit rating agencies to issue bonds to raise additionalfunding and finance projects such as the power plant inGhana. “If the market is sufficiently well developed, we mayissue local instruments either to wholly or partly refinanceprojects, which will lower risk and increase participation inlocal capital markets,” says Alli. �

While Africa has not been ignored by theglobal financial community, Andrew Alli,president and chief executive officer of AfricaFinance Corporation (AFC), points out that theflow of foreign investment into the continenthas been “heavily skewed” towards naturalresources such as oil, gas and mining. “Thereare huge power deficits across the whole ofAfrica, so power is a really important sector toget growth going in,” he says. The Lagos-basedbank’s capacity to fund such projects and be acreditable partner to international investors isbolstered by a strong balance sheet, capitalisedwith $1.1bn. Joe Morgan reports.

ANDREW ALLI � PRESIDENT AND CHIEF EXECUTIVE OFFICER OF AFRICA FINANCE CORPORATION

PASSION FOR HOMELANDPOWERS AFC BOSS

Andrew Alli,president and chiefexecutive officer ofAFC. Photographkindly supplied byAFC, November

2010.


UNDER ITS NEW, charismatic leader, Luiz CarlosTrabuco Cappi, Bradesco is exploiting its almostuniversal presence in the country and its leadership

in key areas, including insurance in which Trabuco hassubstantial experience. Trabuco’s bet on the local market and lower income

consumers implies that Bradesco will be less diversified thanits main rivals. Family-run Bradesco is conservatively managedand retains a feel of its early mandate to bring banking to themasses. The theme is fashionable again thanks to pent-updemand from Brazil’s lower income consumers. Trabuco hassaid that he believes Brazil may support as many as 220maccounts by 2020, up from 130m today. One of Trabuco’s first moves as president was to re-create

regional centres within the bank to identify client trends ineach region, something that he believes to be impossible froma centralised location in São Paulo. Another initiative is credit

Bradesco’s chief executive officer, Luiz Carlos Trabuco Cappi, will need his much vaunted charismaas the bank stands firmly at a nexus of change for Brazilian banks. The largest private-sectorbank in the country until 2008, Bradesco has never really recovered from the trauma of seeing itschief rival Itaú buy its second biggest rival Unibanco and leapfrog it to gain pole position at theend of 2008. The move effectively trumped Bradesco’s 50-year crown as Brazil’s leading bank.Trabuco is determined to leapfrog the leapfrogger.

BETTING ONTHE HOUSE

LUIZ CARLOS TRABUCO CAPPI � CHIEF EXECUTIVE OFFICER, BRADESCO

card brand Elo, which Bradesco is launching in partnershipwith state-owned Caixa Econômica Federal and Banco doBrasil to challenge Visa and MasterCard for lower spenderswho do not need international services and the bells-and-whistles embedded in more expensive cards, such as expensiveguarantees and foreign-exchange transactions. Bradesco is a“brand that is being built from the bottom up,” says Trabuco. That Bradesco is doing well and still trailing its rivals points

to the giddy growth rates of Brazilian banks. Although thefinancial crisis slowed business in 2008/2009, the 7.5% growthin GDP this year coupled with rapid growth in Brazil’s creditmarkets, means banks are in optimistic mood. The ratio ofcredit-to-GDP is in frank expansion and this year is estimatedto reach 48%, giving scope for further growth. Executives atBradesco believe that Brazil offers richer pickings than areavailable abroad, not only through consumer credit but morecorporate banking at home and opportunities arising ininfrastructure, especially with the planned World Cup andOlympics events in Brazil. That is not to say that Bradesco iscompletely out of the internationalisation game, but ratherthat the company is seeking to do it in a managed, slow wayand only in selected sectors. It is opening offices in London,including a securities arm, as well as in Luxembourg andNew York to offer asset management and securities activitiesfor European and US investors. �

AMONG THE MOST recent of the growing crop ofemerging market issuers this year Jordan launched itsdebut Eurobond in November which ended up with

commitments for $750m 3.875% notes due 2015 and listed onthe London Stock Exchange. Originally the country had wantedto come to market with a $500m bond, but investor demandoutstripped supply and the sovereign upped the value of thebond. Investors have been eager to buy high-yielding, emergingand frontier market debt this year to compensate for loweryields in advanced markets. Lebanon also debuted on the sameday, with a $500m 5.15% notes due 2018 and $225m of 6.10%notes due 2022. The finer pricing of the Eurobond was clearly

exhibited when Credit Libanais issued $75m worth ofsubordinated bonds due January 2018, a few days later, whichcame in at 6.75%. A few days earlier, EFG-Hermes holdingstood a 65% interest in the Lebanese bank for $542m, thelargest single foreign investment in Lebanon to date.Long term tenors are also in play. Russia’s Vnesheconombank

(VEB) updated its $30bn loan participation notes programme,with the issue of a $600m 5.45% tranche due 2017 and $1bn6.80% due 2025 under the programme. Compare that withpricing of the $1bn 6.902% notes due 2020 issued earlier thisyear in the first international debt offering by a Russian statecorporation. Citi, Credit Agricole, HSBC and JP Morgan werejoint lead managers for VEB's latest offerings of Notes, whichwere sold in the United States to qualified institutional buyersunder Rule 144A and outside the United States under RegulationS. Meanwhile JSC National Company KazMunayGas came tomarket with a $1.25bn bond due 2021. �

Emerging markets bond issues came to the forethis year. In November, for example, a slew ofdebut sovereign eurobonds were either issuedor in the pipeline.

THE RISE OF EM BONDSEMERGING MARKET EUROBONDS

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TARS: BRADESCO: HOME GROWN SOLUTIONS


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TARS: eS

ECLENDING: THE LO

NG VIEW AUCTIONEERS

FORMED INITIALLY IN the late 1990s to service theportfolios of the United Asset Management group (UAM),in October 2000 Boston-based eSecLending opened shop

with a singular mission: to provide institutional investors withan alternative approach to traditional custody lendingprogrammes by introducing a unique auction-based lendingmodel. Back then, many traditional providers actively discouragedthe use of third party agents for lending assets, recalls ChrisJaynes, co-chief executive officer (along with Karen O’Connor)of eSecLending. “It was a concept that the entrenched agentsreally fought quite hard against a decade ago,” says Jaynes. While the industry may have ultimately evolved, the onset

of the credit crisis, which infused the markets with a shot ofmuch-needed scrutiny, has since brought many more investorsaround to eSecLending’s way of thinking. “Unbundling, transparency, customisation and control—all

common buzzwords in today’s environment—are the corefeatures that our model was designed around and are conceptswe’ve been promoting for ten years. While the credit crisis hasbrought attention to the market for negative reasons, we thinkin the long run the increased focus is a positive thing becauseit forces everyone to sharpen their level of understanding andimprove their product offerings,” says Jaynes.Today, securities lending is increasingly viewed as an asset-

management and trading process, rather than a back-officeor operational function, says Jaynes. Accordingly, more lendersare themselves using third-party providers and seekingalternative routes to market. This evolution has been great forbusiness; to date, eSecLending has auctioned over $2trn inglobal assets and manages more than $300bn in lendableassets with over $50bn on loan. “Here we are ten years later, and most of the large custodial

banks are now in agreement that third-party lending is aportable investment product rather than a custody-based

service,” says Jaynes. “In other words, it is the realisationthat providers should be selected on the merits of their model,their approach and their product—as opposed to whetheror not they are providing custody services. That is a dramaticchange from the world we entered in late 2000.”One thing that hasn’t changed over the years is

eSecLending’s approach to the mechanics of securities lending.“Right from the start, our goal has been to bring investment-management-type disciplines to the industry by promotingtransparency, competition, benchmarking and performancemeasurement, as well as better service and reporting, allareas that we felt were lacking in the market. What continuesto differentiate eSecLending from traditional agency providersis that, rather than utilise a pool or queuing system, we treateach client as an entirely separate book of business—in short,ours has been a much more tailored approach to sec-lendingbased around each client’s unique assets, risk tolerances andgoals, as opposed to a volume-based, one-size-fits-all kindof operation. Unlike other providers, securities lending on athird-party basis remains the company’s core competency.”Given the fluctuating political climate in the US, it remains

to be seen how—and to what degree—some of the recentlydrafted regulatory measures will be implemented. However,Jaynes believes that new regulations will, in general, besupportive of securities lending, whatever form they should take.“Calls for greater transparency and increased focus on affiliatetransactions certainly works to the advantage of eSecLending’sbusiness model, given that we are independent and thereforefree of some of the perceived conflicts of interest that can existin the market.” Though the company’s basic operating principleshave remained fairly constant throughout, its menu ofcapabilities has become much more diverse, says Jaynes.“Where we were once focused almost entirely on exclusive-based auction programmes, we’ve since broadened our approachto include a full discretionary programme, and we are also inthe process of rolling out new products in the treasury-management space.” Under Jaynes’ watch, eSecLending has alsoexpanded its global reach; today, the once exclusively domesticenterprise now has equal parts US and non-US clients, andmaintains offices in both the U.K. and Australia, in addition toits flagship Boston location. �

Securities lending is today increasingly viewed asan asset-management and trading process,rather than a back-office or operational function,says Chris Jaynes, co-chief executive officer ofeSecLending. Accordingly, more lenders arethemselves using third-party providers andseeking alternative routes to market. Thisevolution has been great for business; to date,eSecLending has auctioned more than $2trn inglobal assets and manages more than $300bn inlendable assets with over $50bn on loan. DaveSimons reports from Boston.

eSEC LEADSTHE WAY

CHRIS JAYNES � CO-CHIEF EXECUTIVE OFFICER OF eSECLENDING

Chris Jaynes, co-chief executiveofficer ofeSecLending.Photograph kindlysupplied byeSecLending,November 2010.

LAST MOVER ADVANTAGECIAN BURKE � HSBC GLOBAL HEAD OF PRIME SERVICES AND CO-HEAD OF HSBC SECURITIES SERVICES


OF LATE, THE alternative investmentservices space has been a twocarriage highway as hedge funds

have moved money into custodian accountsbecause of perceived dangers to their assets;while prime brokers increasingly haverecognised the need to adopt more custodial-type processes. The result is a number ofhybrid service structures. In the US, forexample, Northern Trust offers MerlinSecurities’ prime brokerage clients accessto its global custody and administrationservice, and custody behemoths State Streetand BNY Mellon have been promoting securities lending tohedge fund clients. The latest buzz is for larger global-service banks to merge their

custody and prime brokerage arms. JP Morgan launched aprime custody group, which has combined the prime brokerageunit it acquired when it took on Bear Stearns with its custodyarm. HSBC meantime has attempted a seamless offeringthrough the merger of its traditional asset servicing business witha nascent prime broking service that it has been building steadilysince 2009. The Prime Services offering has been led by CianBurke, who also now heads up HSBC’s Securities Services(HSS) together with Drew Douglas; reporting directly to SamirAssaf, group general manager and head of global markets.By the promotion of a seamless service, the bank hopes to

secure a substantial portion of a market which is still in fluxand at a time hedge funds are still launching long-only fundsand seeking structures that allow them to house certain assetswith custodians and traditional asset managers are executinglong/short strategies that require financing through a primebroker. “We did not want to be Morgan Stanley Mark II, butto harness market expertise and build something that was rightfor HSBC, and meets the needs of hedge fund managers andtheir investors,” says Burke. “Last mover advantage is decisivein this respect.” The question now is how much can HSBCcapitalise on hedge funds’ flight to safety (or quality) and createa lasting template?Ten years ago, hedge funds with more than one broker were

a rarity. A triumvirate of Goldman Sachs, Bear Stearns andMorgan Stanley governed a tip over 60% of the business.

Although still highly concentrated, theprime brokerage club is today somewhatmore inclusive. Recent Hedge FundResearch figures show that in Q3 2009 sixlarge global prime brokers (JP Morgan,Goldman Sachs, Morgan Stanley, CreditSuisse, Citigroup and Deutsche Bank)service almost three-quarters of the globalhedge fund market. The trend is confirmedby consultant Aite research, which holdsthat nowadays even larger hedge funds aregravitating toward firms that offer a broaderservice set, including research, securities

lending, investment banking, fund administration, capitalintroduction and consulting, leading-edge software and servicesin trading, analytics, risk and reporting. In the post financial crisis world, security is everything, holds

Burke. “Now it is entirely about how to segregate customeraccounts. The ability to provide clients with full security andtransparency over their assets in segregated accounts, togetherwith the opportunity to use some of these assets as securityfor financing, enhances the product offering. Add to thatquestions around safety and those banks with the strongestbalance sheets have begun to dominate."HSBC’s entry into the market in late 2009 took traditional

prime brokers by surprise. Actually, HSBC has strongercredentials in the hedge fund segment than it is often givencredit for. Apart from aiding a range of hedge fund investorsthrough its established private banking division, HSBC is oneof the world’s largest managers of fund of hedge funds assets,overseeing some $23bn, while its custody arm already holdsover $10bn in hedge fund assets. Burke is clear that theevolution of the bank’s prime services offering was entirelyclient-driven. “There was a desire among investors and clientsto have a prime services provider that could offer them leveragewithout transferring the title of their assets. The clientproposition was about taking what we’d built in Custody Plusand wrapping around that a broader prime services offering,”says Burke. “Remember we have a significant OTC business,we have global execution capabilities, we provide fundingand equity financing and we have Custody Plus. All-in, it’sa very strong proposition.”�

The financial shocks of 2007/2008 forced a sea change in the traditional relationship between ahedge fund and its prime broker. Although hedge funds became more selective in their primebroking relationships, they also began to add new prime broker agreements and opened up to anew set of custodian relationships as they moved unencumbered securities and cash into globalcustodians for safekeeping. At the same time, large custodians moved into the prime brokingmarket at a sustained clip on the back of hedge fund fears over counterparty risk and a desire forimproved collateral management. However, HSBC, under the leadership of Cian Burke, isattempting a truly seamless offering. Is it the model of the future?

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TARS: HSBC: A SEAMLESS SERVICE SUITE

Cian Burke.Photograph

kindly suppliedby HSBC,

November 2010.

MONTHS BEFORE THE Kerviel episode, the financialbarometer had slowly begun to swing in a differentdirection and the management at Société Générale

was already planning how it was going to adapt to the newfinancial environment. In July 2009, the bank went live witha total review of its business model, known internally asEvolution. In a swoop, it created a flatter business model,decompartmentalising silos and showing a single face tothe client. It comprised three main areas: Coverage andInvestment Banking for strategic clients; Global Financeconsolidating capital-raising and financing across both debtand equity; and, finally, Global Markets. With the creation ofGlobal Markets, all the rates, credit, currencies, commoditiesand equities were brought together into one integratedplatform, to deliver a complete range of services and solutionsacross all asset classes. Fetta says: “Evolution had one mainobjective, to focus on clients and as part of this, to beef up theinvestment banking capabilities on the advisory side, frommergers and acquisitions to debt capital markets and coverageof corporate clients. It has made it easier for stakeholders in thebank to serve clients’ needs.”Global Markets was organised into two areas: one to service

clients for flow trades on the more standardised products,divided into the three asset class-based teams of fixed incomeand currencies, commodities and equities, under which thebank’s Delta One and exchange-traded funds (ETFs) businessesfall. Second is the cross-asset solutions department, whichprovides clients with investment advice and financialengineering through category-specific teams, for example,clients with a huge need for advice in the light of Basel III,which set minimum levels of capital in banks of 7% of their

risk-bearing assets. (Incidentally, while it is expected that mostbanks will need to raise hundreds of billions of euros of capitalunder Basel III, SocGen announced in November that it wasconfident it would not need to do this.)Fetta says: “The cross asset solution team provides clients with

a tailor-made approach drawing on all sections of the bank, butof course, the solution you propose is fed back forimplementation through the different asset classes.” Thereorganisation also created what Escoffier terms the “equitychain”. “This ensures that from origination, M&A, right downto equity research through trading and sales departments, weare fully aligned to deliver the bank to clients,” he says.The bank’s equity derivatives team, long regarded as industry

leaders, has maintained its position at the top. It has also hadthe highest return on equity among all leading investmentbanks of 59%, estimates JP Morgan Cazenove in a September2010 research report. “We have a growing equity franchiseunlike our competitors, but it’s a tough market.” says Escoffier.“We are still very cautious and we live quarter by quarter.”A major contributor to the recent success of Global Markets’

has been the growth of SocGen’s Delta One and ETF business.Delta One products are the simplest type of derivative wherethe derivative moves in line with the underlying asset. Whileequity volumes and derivative volumes generally have remainedlow this year in the industry, Delta One and ETF volumes havestayed buoyant and Greenwich Associates estimates that 55%of European institutions are expecting to increase their usageof flow equity derivatives products in 2011. Additionally, JPMorgan Cazenove estimates total revenues wallet from thisarea in the industry accounted for $10.7bn in 2009 and willgrow 9% to $11bn in 2011, driven by volume growth in ETFs,equity swaps and certificates. For SocGen, the largest DeltaOne player in Europe, it will bring in estimated revenues of$1.1bn globally, according to Cazenove.In July 2010, the bank enhanced its lending and borrowing

ETF service for European institutional investors and becamea market maker in five new options on Lyxor sector-basedand emerging markets ETFs. It joined NYSE Liffe for thelaunch and is believed to be the first market-maker offeringclients access to the quoted underlyings. A dedicated platformof options (OTC or listed) on ETF allows investors to set upstrategies to optimise their portfolio management. The bank’sexpansion and investment outside its traditional marketplaceof France—it holds the number one market share onEuronext—has also provided clients with greater choice. �


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TARS: SOCIÉTÉ GÉNÉRALE: EVOLUTIONARY DYNAMISM

If you remember, 2008 was not a good year forSociété Générale. Trader Jérôme Kervielincurred €4.9bn losses in the January, almostwiping out all the bank’s entire annual profits.Moreover, as the year progressed, along withother banks, it also began to suffer the falloutfrom the sub-prime crisis. “The support wereceived from clients at that time was reallycomforting,” says David Escoffier, co-head (withGian-Luca Fetta) of the bank’s Global EquityFlow team. “We had announced a major eventand we had survived. In terms of the business, itwas a big crisis but it has been important tolearn the lessons and we have been investingheavily in risk systems since then.”

EVOLUTIONARYTRENDS

DAVID ESCOFFIER and GIAN-LUCA FETTA � CO-HEADS OF SOCIÉTÉ GÉNÉRALE’S GLOBAL EQUITY FLOW TEAM

David Escoffier (left) and Gian-Luca Fetta, co-heads of SociétéGénérale’s Global Equity Flow team. Photograph kindly supplied bySociété Générale, November 2010.


CLEARSTREAM’S GLOBAL PRODUCT suite is asubstantive turnaround for a business which only adecade ago defined itself as a vertical service set attached

to the Deutsche Börse Group. Clearstream, the ICSD, startedas a provider of the post-trade infrastructure for the Eurobondmarket and, as a central securities depository (CSD), providingpost-trade infrastructure for the German securities industry. Inthe interim, Clearstream has expanded not only its businessset, but also its business reach and these days the firm isincreasingly defined as a global, rather than regional operator.Settlement and safekeeping of eurobonds is still Clearstream’score business, accounting for more than 40% of its revenues,and with a market share of 37% as of October this year. JeffTessler, Clearstream’s chief executive, explains that: “One ofClearstream’s goals is about bringing simplicity to the post-tradeservices industry by offering the complete range of our servicesthrough a single window. We continue to build competitivenessin the cross-border securities processing area throughinteroperability and partnerships.”That is however, a moveable feast: 2010 alone has been

marked by a stream of initiatives which continue to add to itsdiversified product offering. The firm now offers servicescovering cross-border securities processing, investment fundsservices, and global securities financing, where it is one ofthe four global providers of collateral management services.Within those product sets, the firm has been diligent indeepening the overall service range. Most recently, carbonemission rights and the Chinese renminbi held outsidemainland China have become eligible for settlement inClearstream; an inevitable development as Asian investors seekto maximise renminbi denominated investments in theirportfolio. The firm plans to expand its settlement services tothe Brazilian real and the Indian rupee.Clearstream has been willing to wield a bold brush and

work in partnership with other specialists. For instance, thecompany has created the first European trade repositorytogether with Bolsas y Mercados Españoles (BME), calledREGIS-TR. The system will collect and administer details of allOTC transactions, giving market participants and regulatorsaccess to a consolidated global view of OTC derivative positions;an overview that is currently not available, but which will berequired by European regulators. Moreover, Clearstreamcustomers can now also cover their margin exposure to OsloClearing through Clearstream’s collateral pool, the Global

Liquidity and Risk Management Hub. According to Tessler,the diversification strategy is a natural evolution of the times:“Life is much more difficult for everyone. In this ‘new normal’our clients and partners are looking for infrastructure whichsupports their business at a time when there are substantial shiftsin the global financial system. Providers such as ourselvesmust and should differentiate themselves around providingour clients with improved functionality, safe haven servicesand risk management related to counterparty risk.”It is also a function of the semi-regulatory role that traditional

clearing and settlement institutions have always played in thefungible securities segment, as highly commoditised, rulesbased and process centric operations. Clearstream is notablefor breaking out of that mould, while still adhering to a stricttransparency and principles-based operating model. For one,it has a diversified global client profile that is the envy of manya national securities depository, that encompasses broker/dealers,asset managers, asset gatherers and central banks, comprising2,500 institutions in some 110 countries. Through its latestinitiatives it is also carving a significant role in both the on-exchange and OTC derivatives market segments, such as itsagreement with CETIP, and through enhancements to itscollateral management services. Finally, it has successfullyrolled out its operations across the globe. In the Middle Eastit has secured a strong client base among the region’s centralbanks. Today, approximately 20% of the Clearstream revenuesare coming from Asia – a share that is set to grow. Moreover,China is amongst Clearstream’s top 10 largest markets. �

CETIP, the Brazilian CSD, will have a cross-border collateral management deal with Clearstream upand running by the second half of 2011. Both companies have agreed to jointly develop, promoteand distribute triparty collateral management services, acknowledging in the process the trendtowards global consolidation of collateral management activities. The agreement is one of a stack ofinitiatives which has put Clearstream at the forefront of change in settlement and custody, securitiesfinancing and investment fund services on a global, rather than regional scale.

BOLD BRUSH TACTICS

JEFF TESSLER � CLEARSTREAM’S CHIEF EXECUTIVE

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TARS: CLEARSTREAM: AN ENHANCED GLOBAL O

FFERING

Jeff Tessler,Clearstream’s chief

executive. Photographkindly supplied by

Clearstream,November 2010.


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TARS: BARCLAYS: THE IMPACT OF REGIME CHANGE

BOB DIAMOND ANDBritish banking is an odd coupling.In an industry known for conservative tradition, andhierarchy, Diamond is a maverick. As head of Barclays

Capital (BarCap), he frowned upon limousines, forbadepersonalised stationery for senior executives, proposedeliminating titles from business cards (he was dissuaded fromthat), weeded out bankers who were not team players, andworked feverishly to build BarCap into a major player ininvestment banking. He also vigorously defended the conceptof a universal bank—one that, like Barclays, combines retailbanking with investment banking. More controversially,Diamond champions US-size pay packages, it’s a world viewthat has polarised opinion but not diminished his stature.That Diamond would achieve all this perhaps wasn’t apparent

in October of 2003 when Barclays announced a typically orderlymanagement transition. Retiring chairman Sir Peter Middletonwould be succeeded by chief executive Matthew W Barrett,who would be replaced by John Varley, an Oxford-educatedlawyer who had been with Barclays for more than 20 yearsand was viewed as a highly competent, risk-averse manager. After BarCap’s failed bid for ABN Amro in 2007, questions

were raised about the direction the investment bank wouldtake. By late 2007 the banking meltdown was well under wayand among its high profile casualties, the collapse of LehmanBrothers brought Diamond another opportunity to shine.Diamond, who had written down $3.6bn in bad investmentsover the summer, saw Lehman as the vehicle for turning roundBarCap by greatly expanding its presence in the US. The acquisition became one of the fastest takeovers in Wall

Street history. Diamond quickly sold off Lehman’s Asia-Pacificand European investment banking and equities units and afteronly three months Diamond declared that Lehman was fullyintegrated into BarCap and contributing to the bottom line.Investors were sceptical. They feared that Barclays’ profit

reports would be inflated by one-time gains from the Lehmandeal. By January 2009 Barclays stock was selling for one thirdof its tangible book value. Barclays was more prey than predator,and the UK’s Financial Services Authority (FSA) pressedBarclays to take advantage of the government’s asset protectionplan. Varley and Diamond resisted, saying that participating

in the scheme would restrict the bank’s decision-makingfreedom. However, it was clear that Barclays, having taken awritedown of £5bn in 2008, had to raise more capital. In early2009 Barclays struck a deal to sell iShares, the exchange-traded funds operation that was the crown jewel of BarclaysGlobal Investors, which managed more than $1trn in assetsthrough offices in 15 countries. Diamond’s success has brought criticism, especially in the

UK. When a BBC business editor asked a British governmentofficial for reaction to Diamond’s appointment as Barclaysnext chief executive, the answer was: “Bank taken over bycasino.” Diamond bristles at comments like this. He insiststhat its investment banking business is solely client-driven.There are more substantial problems facing Diamond. One

is the relatively weak performance of the retail side of Barclays,particularly outside of the UK. Investment banking profits,hardly existent before Diamond took over BarCap, but nowaccount for 70% or more of Barclays’ pre-tax earnings. Diamondpraises the universal bank model because it provides balance,but 70/30 is not balanced. Some people would prefer to splitretail and investment banking, as the Glass-Steagall Act didin the US until 1999. Diamond remains adamant in his advocacy of universal

banking and large size. Defending both are political battleshe’s likely to face soon after taking office as Barclays’ boss. Thefight ahead might even Diamond another chance to sparkle. �

LAST MAN STANDING?When Robert E Diamond Jr, an energetic and entrepreneurial American, was passed over as chiefexecutive of Barclays in 2003 in favour of a younger and much more reserved Englishman, he put ona brave face. “I’m not disappointed,” he told the press. “I’m all pumped up.” Would he remain atthe bank even six months? “I promise,” he said. He not only stayed but, as Barclays’ number twoexecutive, built an investment banking profit machine, guided it through the worldwide financialcrisis of 2007-08, acquired Lehman Brothers for a song, avoided government bailouts, and generatedpraise and criticism on both sides of the Atlantic. Next April he takes over as chief executive of aBarclays that is much different from the one he joined 15 years ago and is largely of his own making.Art Detman explains why Diamond’s greatest challenge may lie ahead.

ROBERT E DIAMOND JR � CEO, BARCLAYS CAPITAL

Robert E Diamond Jr,CEO of BarclaysCapital. Photographkindly supplied byBarclays Capital,November 2010.


PREVIOUSLY CHIEF EXECUTIVE of BM&F, EdemirPinto, has led BM&FBovespa since the merger withBovespa in 2008. According to Pinto, the merger of the

exchanges was a pivotal event, helping to strengthen theBrazilian capital markets, offering a vertical exchange/clearingmodel, that incorporates four clearing houses (equity,derivatives, foreign exchange and other securities) as wellas a full service central securities depositary. Certainly, theBM&FBovespa walks tall these days; its managers reel offimpressive statistics about growth, market capitalisationand local rankings. This year, it pulled off the world’s largestsecondary offering, from oil giant Petrobras worth BRL$120bn. The launch of the Novo Mercado soon after the turn of the

new century is seen as a turning point. Companies that wishedto join the new market had to obey much higher governancestandards, including tag along rights in the event of a take-over.The merger between Bovespa and BM&F was the secondpivotal event. A third pillar is the local regulator, the Comissãode Valores Mobiliários (CVM). Both the exchange and itsregulator have built a reputation as the most solid managersof markets in Latin America, notes Sandra Guerra, founderof São Paulo-based Better Governance and coordinator of thecompany circle Latin America.The exchange recorded net revenue of BRl$486.9m, an

increase of 27.1% year-over-year, says Eduardo RefinettiGuardia, CFO and investor relations officer at the exchange.That came primarily due to a 70.7% surge in volumes tradedon the BM&F. In October, trading hit the highest daily volumeon record at BRl$7.7bn, he notes. Even so, the crisis has, however, acted as a wakeup call.

Management has understood that it is necessary to broadenout the shallow base of foreign capital by attracting in newforeign investors, particularly from Asia and the Middle East.Meanwhile, the exchange’s BRAiN initiative was launchedthis year, spearheaded by Paulo Oliveira, the exchange’s chiefbusiness development officer. BRAiN is a more sophisticatedoperation than its market promoting predecessor BEST. Strategic relationships have been a cornerstone of the

exchange’s deepening of its service offering; though its keystakeholders were in place prior to the merger. BM&F had across-share swap with the CME Group. In practice, an orderrouting agreement enables customers in more than 80 countriesusing CME Globex, CME Group’s electronic trading platform,

to trade BM&FBOVESPA products directly, via the Brazilianexchange’s electronic trading platform, GTS. These productsinclude futures and options on one day inter-bank deposits,the Bovespa Stock Index, commodities, energy, and metals.The partnership between CME Group and BM&FBOVESPAalso allows Brazilian investors to trade CME Group productsdirectly through the GTS system. Investment in technology is another element, involving the

upgrading of trading platforms, which offer greater capacity andsafer systems and will encourage new trading strategies,including high frequency trading, which the exchange viewsas a prestige programme. The exchange is also working todevelop its nascent non-sponsored Brazilian Depository Receipt(BDR) programme, notes Guardia. Myriad challenges remain: from deepening the culture of retail

shareholding on the one hand and respect for minorityshareholder rights on the other; driving down trading pricesfor clients; and building a range of new products. The last areafor work is to deepen some of the markets. Brazil’s corporatebond market, for example, has struggled to develop. That isin part thanks to high interest rates and plenty of governmentissuance which have provided sufficient risk-free returns todeter diversification. But it is also because the secondary bondmarket lacks transparency, liquidity and efficiency. According to Pinto, the vertically integrated systems at

BM&FBovespa are a cornerstone of the enlarged exchange’ssuccess. That can play either one of two ways: either it canadopt the monopolistic heavy hand that its strategic investorCME Group plays to great effect in the United States as adriver of future growth or, it will have to change and evolve evenmore as it faces growing competition from newcomers anxiousto leverage the very real opportunities in the market. �

THE MONOPOLYPLAY

Since the merger between BM&F and Bovespa back in 2008, the exchange has transformed itself froman investment backwater to one of the world’s hottest exchanges, having made strides in regulation,market development and building links with other international exchanges. Even so, the exchangeneeds to continue to manage fast growth and possibly gear up for competition. John Rumsey reports.

EDEMIR PINTO � CEO, BM&FBOVESPA

Edemir Pinto (left), CEO of BM&FBovespa. Photograph kindlysupplied by BM&FBovespa, November 2010.

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TARS: BM&FBOVESPA: A NEW STRATEGIC OUTLOOK


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TARS: JP

MORGAN: THE TRENDSETTER

CONRAD KOZAK � CEO, JP MORGAN SECURITIES SERVICES

ONE OF THE things that annoy Conrad Kozak, chiefexecutive of JP Morgan’s securities services business,is the “charge of commoditisation. If you are

delivering services on a global basis, without screwing up,that’s not a commoditised offering,” he avers. It is a particulartruth as the one time gulf between traditional and alternativeinvestment approaches narrows to nothing. “The approachto business and our business models have not changed,” heexplains, “rather we used to be able to draw a line betweenhedge funds and traditional asset managers; and it hasmeant that we have to be fleet of foot in tying our suite ofservices together to provide the same set of services to both.We sometimes might struggle with the complexity ofreporting, for instance. The fact remains however: the eventsof the last few years have accelerated the need for us tobecome integrated across asset types and all geographies.”It has resulted in a slew of services upgrades. In the US,

for instance, the bank recently enhanced its offering ofregulatory reporting services for money market funds toassist asset managers in complying with SEC revised Rule2a-7 requirements. Thereby ensuring higher credit quality,improved liquidity, and shorter maturity limits, including thecalculation of weighted average life. The bank is also helpingadvisors meet enhanced disclosures of fund level, class leveland security level data requirements. Equally, it has ratchetedup services to assist clients prepare new financial statementderivatives disclosures. Elsewhere, the bank has introduced Auto Substitution, a

new functionality that helps reduce the sizeable credit riskshistorically associated with the $2trn tri-party repo market,while allowing dealers to retain access to securities requiredfor intra-day trading. The move is part of the bank’s effortsto help investors and dealers mange their collateral andmitigate risk through its Global Collateral Engine initiative,a strategic investment programme to deliver enterprise-wide collateral management.The trend is picking up helter-skelter. “There’s a

requirement for counterparty risk analysis and all of asudden an asset manager wakes up to the need to knowwhat the risk is to all his counterparties and if he is usingmultiple custodians it’s more complicated,” adds Kozak.

Other trends are also in train. Because the world is amore dangerous and complex place, it has encouraged thebank to refocus on the sub-custody business, at least whereit makes sense and can be done as cheaply as local providers.“Two years ago, we would not have looked at it; now we feelmore comfortable and it has changed the way we thinkabout and approach risk,” he explains. It is also symptomaticof a sea-change in the sources of new business. “Some 60%of revenue is now outside the US,” says Kozak, with Europeand Asia dominating new business.China is the bellwether of this change: “It is a very different

market, where the award of custody business is traded offdistribution. We have been successful in capturing a clutchof outbound businesses, but a huge amount is inboundand is captive with local banks that distribute. In NorthAsia and Australia however, it is like the rest of the world,”cedes Kozak. For now the struggle is between the excitement of the

opportunity of new growth models, such as that presentedby the recent Nordic deal (JP Morgan two years ago acquiredNordea’s institutional custody business) and new officesin places such as Abu Dhabi, and the need to maintain theintegrity of the overall service offering and a centralisedoperational structure based on regional administrative andprocessing hubs. “Essentially we want to be as local aspossible, with maximum usage of big factories.”Added to this, is the ability to provide a long suite of

products utilising specialist skills available elsewhere, suchas investment banking operations.Strength in depth of service offering is key in this regard,

cedes Kozak, who points to the recent agreement withNASDAQ OMX Stockholm AB, through which JP Morganbecame the first non-Nordic custodian for the NASDAQOMX Derivatives Markets. “If we are going to be a winnerin the securities services business, it has to be based on theconnection with our investment bank and the cross-businessopportunities that presents. If we get that right, as we aredoing with the prime broking segment, for instance, it is amassive uplift for the client, who benefits from one point ofcontact across a slew of high quality products, not some ofthe time, not most of the time, but all of the time.”�

“We are now back in that mould of developing new strategies to leverage cross currents of changein the global financial markets. The difference is that this time around there is a greater emphasis onbetter quality data, market transparency, risk management and operational risk,” holds ConradKozak, chief executive officer of JP Morgan’s securities services business. “It provides us all withopportunity and challenges.” The tip in 2010 has been in local custody; a move encouraged by theshift of responsibility onto depositary banks and away from the sub-custodian. Moreover, the bank isstepping up its global risk and collateral management offerings to the nth degree: it is re-writing thebusiness book and JP Morgan is leading the charge.

DOWN AND DUTIFUL


OUTDATED TECHNOLOGY TURNED the TSE intoa quaint relic anchored in the previous century. Thatall changed in January 2010, when the TSE launched

its arrowhead trading system, designed to cut order executiontimes to five milliseconds (ms) and achieve 3ms datadistribution times. The amount of market data made availablewas increased, too, from five quotes either side of the centralprice to eight—all made available in real time through a newdata service called FLEX Full. In practice, the arrowheadsystem has performed even better than expected in the tenmonths since its launch, notching up average execution timesof 2ms to 3ms and 2.5 ms for data latency. It’s no exaggeration to say that arrowhead has transformed

how the TSE functions. The number of daily orders hasjumped from 6m to 10m, driven in part by high frequencytrading firms, which have come from nowhere to accountfor an estimated 30% of trading based on the volume routedthrough the TSE’s new co-location facilities.Although the development of arrowhead began in March

2006, 15 months before Saito was appointed TSE president andchief executive officer, he played a crucial role in shepherdingthe project to its successful conclusion. He took a personalinterest, repeatedly emphasising to the chief executive officerof Fujitsu, which designed the system, the importance of topquality reliability and the lowest possible latency in bothexecution and data distribution. Saito also spearheadedmarketing to both domestic and international brokers andinvestors, an effort that has borne fruit in wider participationby non-Japanese investors after the arrowhead launch.The introduction of high-frequency trading has had the

familiar effects observed in other markets of cutting averageticket size and narrowing bid-offer spreads. The TSE alsoamended its trading rules to permit narrower tick sizes andstreamline the operation of daily price limits and openingprice auctions. It also eliminated half-day trading sessions.The increased flexibility has not yet translated into highershare trading volume, however; in the first ten months of2010, the TSE’s First Section traded a daily average of 42.8bnshares versus 46.6bn in the same period in 2009—although

without the new trading system share volume might wellhave fallen even more.Tighter dealing spreads translate into lower trading costs,

of course; by some third party consultants’ estimates, executioncosts for Japanese equities have tumbled 30% this year thanksto arrowhead. The biggest reduction has been for mid-capitalisation stocks, where tick sizes have tightened themost, but liquidity has improved across the whole market.Domestic and foreign investors alike have welcomed thenew system, which has proved its operational resilience: nosignificant problems have occurred during the first ten months.While arrowhead was essential to prevent the TSE losing

ground to other financial centers in the region, it has alsoopened up new business opportunities for the exchange.Co-location has attracted high-frequency trading firms—particularly from abroad—which pay for the privilege, anentirely new revenue stream derived from market participantswhose share of trading volume has shot up from zero to 30%and is still growing. A 65% increase in order flow has generatedincremental trading fees for the TSE, too.The transformation of trading on the TSE is part of Saito’s

wider vision for the future of Tokyo as the pre-eminent financialcentre in a region destined to play an increasingly importantrole in the global economy. Asia is a massive economic bloc,home to two-thirds of the world’s labour force, whose risingprosperity has unleashed local consumer demand that willshift the balance of economic activity permanently eastward.Regional financial centres that have long played second fiddleto New York and London will gain in stature, and Saito’smission is to ensure that the TSE capitalises on expertise andexperience gained over many years as a leading internationalmarket to propel Tokyo to the fore against stiff competition fromShanghai, Hong Kong, Singapore and others.“The liberalisation of Chinese markets will have a large

impact on international financial markets,” says Saito. “Weview them as worthy rivals and valued business partners. Ibelieve this provides an opportunity for the TSE, Hong Kongand Shanghai to consider what can be done to benefit allour markets in the long term.” �

TAKING IT TOTHE LIMITWhen Atsushi Saito, an industry veteran who spent 35 years at Nomura Securities, took over aspresident and chief executive officer (CEO) of the Tokyo Stock Exchange (TSE) in June 2007, theleading Japanese equity market was on its way to becoming a financial backwater. Average orderexecution times were measured in seconds, a Stone Age standard compared to leadinginternational markets in Europe and the United States where milliseconds (ms) were already thenorm. Moreover, co-location services did not exist, which prevented high frequency trading firmsfrom bringing their expertise and liquidity to the TSE.

ATSUSHI SAITO � TOKYO STOCK EXCHANGE CEO

20-20 ALL S

TARS: TSE: ARROWHEAD, THE GAME CHANGER

Atsushi Saito, CEO,Tokyo Stock Exchange.Photograph kindlysupplied by TSE,November 2010.

TEXANS LIKE TO brag about how everything is bigger intheir state, but Richard Evans Jr made his company better,and in the long run almost certainly bigger as well, by

giving up a large chunk of business. Dick Evans is chief executiveof San Antonio-based Cullen/Frost Bankers (CFR), and backin 2000—as a boom in home loans began that eight yearslater would nearly bring down the world’s financial system—he stopped making residential mortgage loans. “We had nocrystal ball,” Evans says. “We did exit that business, whichwas about $200m a year in mortgages we were creating,because we felt that it did not stay focused on our mission.”Evans emphasises that Cullen/Frost was built on long-termrelationship banking, not on transactional banking. So ashomeowners began refinancing their loans nearly as casuallyas they applied for new credit cards, he saw trouble ahead.“Our mission statement says that we will grow and prosper

by building long-term relationships based on top-qualityservice, high ethical standards, and safe, sound assets,” he says.“That’s not a mission statement that just hangs on the walland nobody pays attention to—we live it. Our core valuesare caring, integrity and excellence. Our value propositionthat has come out of all this is that we want all our customersand staff to feel significant and to recognise that we’re aboutexcellence at a fair price and that we’re a safe, sound place towork and do business.”In describing Cullen/Frost, Evans again and again uses

the term “safe, sound”. It describes not only the bank’sdecision to walk away from the booming home loans marketbut its overall approach to lending. The company’s FrostNational Bank subsidiary aggressively seeks businesscustomers, but it is uncommonly judicious in making loans.

Its “safe and sound” policy is a throwback to another era, whenbankers actually felt responsible and accountable for howtheir banks operated. Although Cullen/Frost has sufferedthrough some tough times during its 142-year-history, it hasnot only survived, it has triumphed. Today, with $17bn inassets, it is the largest bank headquartered in Texas and ranksfifth among all banks doing business in the state.As recently as 1985 it was among the state’s smaller banks,

but as the boom in oil prices turned into a bust—the price ofcrude fell 60% in seven months—commercial real estateloans tanked. Meanwhile, the savings-and-loan (S&L) crisiswas unfolding, bringing down S&Ls that had depended toomuch on volatile short-term deposits to finance shaky long-term loans. Of the ten largest Texas-based banks, Cullen/Frostwas the only one that survived intact.“Although it got pretty beat up during that time, the

management—which is pretty much in place today—learneda lot of lessons,” says Bain Slack, an analyst at Keefe, Bruyette& Woods. “So as credit became very easy during this decade,specifically during the middle part, the Cullen/Frostmanagement team quickly realised that they’d seen thismovie before and were determined not to get caught in thesame cycle that had caught many of their brethren in theprevious cycle. When a lot of banks were lowering theirstandards to get loan growth, Cullen/Frost kept its standardsfairly high with regard to its underwriting.”When the financial crisis struck, hitting many small Texas

banks as well as US national giants like Wachovia andWashington Mutual, the impact on Cullen/Frost was relativelymild. Loan-loss provisions rose and per share earnings declinedin 2009, but dividends, book value and assets all increased.


PROFIT PROFILE

S:NORTH AMERICAN QUARTET SHINES

A MOULDBREAKINGCOMPANYQUARTETIn a period where good news is at a premium,here’s some welcome uplift. Through the “greatrecession” some companies not only remainedprofitable but positioned themselves forcontinued growth by adhering fiercely to theircore principles. Their success offers lessons forother companies. Art Detman profiles four suchcompanies—three American and one Canadian.


When the US Treasury came calling to enroll Cullen/Frost in theTroubled Assets Relief Program (TARP), which has since becomea four-letter word, Evans said no. “We did not take TARPbecause it was not in the best interests of our shareholders.We had strong capital and our financial analysis of the costshowed it was 11% in the early years, not 5%. We were thefirst bank to publicly say: ‘Thank you, but no thank you.’”Today, Cullen/Frost is sitting pretty. It has 110 banking

offices throughout Texas, including ones in three of America’sten most populous cities (Houston, San Antonio and Dallas).Its market share is not quite 3%, so there is plenty of roomfor growth. “We could double the size of the bank if we tookless than 5% of the business away from the top banks thatoperate in Texas,” Evans says.Whereas Cullen/Frost sees opportunity for further expansion

within the state of Texas, RPM International (RPM) of Medina,Ohio, seeks growth on a global scale. It manufactures inmore than 20 countries and sells in nearly 150. Founded in1947 as Republic Powdered Metals, RPM is the very modelof an industrial company, manufacturing a wide variety ofspecialty chemicals, sealants, preservatives, caulks, coatings,roofing systems, adhesives and other products that protectthe surfaces of buildings, bridges and other structures. About65% of its products go into the industrial market, while 35%are sold through hardware stores and other retailers toconsumers. DAP, Flowcrete, illbruck, Rust-Oleum, and Tremcoare among its many brands.The housing crash barely fazed RPM, whose sales fell just

7.6% in fiscal 2009 and edged up to $3.4bn in the following12 months. For most shareholders, the most important thingwas an increase in dividend, the 37th consecutive annual

increase. Elliott Schlang, an analyst with Soleil Securities,reckons that during the past five years RPM’s dividend hasgrown at the compounded rate of about 6.5%, “and the 4.5%yield, or whatever it is right now, looks extremely attractive,especially given the strong cash flow that the country hasand the consistency of its growth historically”.RPM chief executive officer Frank Sullivan attributes the

consistency and profitability to the company’s entrepreneurialoperating structure and philosophy. “We’re big believers inpushing decision-making to the market,” he says. “Weoperate with 50 independent companies, and a third of ourbusinesses are operated by the original founder-owner or asecond or third generation family member. Versus our bigpeers in either building materials or paints-and-coatings,we are the only one who has this very decentralised,entrepreneurial operating philosophy.”When RPM makes an acquisition, sometimes it buys a

specific product, occasionally manufacturing capacity, andmore often than not a distribution channel. However, what’smost important is management. Sullivan says: “We look forcompanies with good management teams who want to stayand operate the business as part of RPM, and I think wehave enough of a hands-off approach to encourage andenergize them to continue to run their business.”One example is Euclid Chemical, which was a small

Cleveland-based company when RPM acquired it in 1984.Founder Larry Korach handed management to his son Jeff.When Jeff moved up to run the Buildings Solutions Group(which includes Euclid), his brother Ken took over at Euclid.Both recently retired and Jeff’s son, Randy (a 15-year companyveteran), succeeded him as head of Building Solutions Group.“This is a great example of the kind of family heritage we’relooking for,” Sullivan says. “Fortunately for us at RPM, we’vehad three generations of Korach entrepreneurial zeal. So I don’tthink it’s just a coincidence that the original business, whichwas about eight million bucks in sales when we acquired it,is now more than a billion dollars.”RPM typically has years of experience in dealing with a

company before it makes an offer to acquire it. “In somecases, a couple of years,” says Sullivan. “In others, 10 or 15years. During this time we develop a very good understandingof their business and what drives their growth, and theydevelop a good understanding of RPM and how we operate.”As a result of this careful courtship, acquisitions almost

always go smoothly. “I can’t think of a time when we had toreplace a founder or a founding family member who wasthere when we acquired the company. We’ve never had anentrepreneur walk away, and we’ve never fired one. Thechallenge comes down the road, when the entrepreneur is setto retire. We have had instances where we have struggledto find leadership that would continue running the businesswith the same passion as the management that was in placewhen we acquired it.”

From left to right: Dick Evans from Cullen/Frost Bankers, Scott DiValerio of Coinstar, Frank Sullivan from RPM International andDennis “Chip” Wilson from Lululemon Athletica.

RPM’s strategy is to achieve first or second place in eachof the niche markets it serves. “They do this through savvy,strategic acquisitions and internal product development,”says Schlang. “They have done a wonderful job, in roofcoatings especially. No matter how bad the real estatemarket is, the last thing any owner of an office building orindustrial plant is going to do is not put something on theroof to prevent water damage. That replacement businessis golden for them.”The sealants and coatings business is fragmented, so there

is plenty of room for RPM to grow. “For the past 25 years,including the recessionary periods, our annual compoundedrevenue growth has been around 11.9%,” Sullivan says.“About five percentage points of that is from acquisitions,and slightly more than 6% has been from internal growth.”If Cullen/Frost and RPM demonstrate how businesses can

be built on personal relationships, Coinstar (CSTR) showshow success can come from providing services in animpersonal but highly convenient way. Based in Bellevue, justeast of Seattle, this young company (founded in 1991) is heirto more than a century of vending machine development,stretching back to the early 1880s, when coin-operateddispensers of postcards were introduced in London.As its name suggests, Coinstar’s original product is a coin-

counting machine that accepts loose change and issues avoucher that can be redeemed in whichever store the machineis located. The fee, which is shared with the retailer, rangesup to 9.9%, depending on the country. If the coins are donatedto a charity, their full face value is credited. If the coins areredeemed as a gift card, to be used at the participating retailer,again the full face value is credited.

Publicity coupAbout 19,000 machines are in use in the US and UK, both ofwhich have enough compulsive hoarders to support aprofitable if modest level of business. John Kraft, an analystat DA Davidson, expects the coin business to bring in $272min revenues this year compared with $1.7bn for DVD rentals.“Our 2011 estimate is $278m for the coin business—almostflat,” he says. “Our estimate for the DVD business is $2.38bn,up almost 20%.” Coin-counting is a steady, humdrum businessthat once in a while produces a human interest story, such asthat of the penny-saver in Alabama whose local bank refusedhis 1.3m coins—$13,000 worth. Sensing a publicity coup,Coinstar sent an armoured truck to pick up the pennies,which weighed 4.5 tons. The truck sank in mud in front of thehouse and had to be towed out.There aren’t any stories like that about Redbox. The concept

was developed at McDonald’s, which was seeking productsthat would drive traffic into its fast-food outlets. Because ofits experience in placing automated machines in retaillocations, Coinstar got involved and, when McDonald’sdecided Redbox was too much of a diversion, became thedominant partner. In February 2009 Redbox acquiredMcDonald’s remaining interest for $175m. “McDonald’sdidn’t want the distraction of this little company, so Coinstargot Redbox for what basically was a steal,” says Kraft.

Maybe so, but until then the company had struggled toachieve clarity in its business model. At one time it owned agrab bag of businesses, including coin-operated arcade games,pre-paid credit card kiosks, and a money-transfer operation.All are gone, and a new management team headed by chiefexecutive officer Paul Davis is in place. Today, the companyis focused on providing self-service kiosks for the “fourthwall”—that area of a store, restaurant, bank or similarestablishment that normally is empty. “We convert whatotherwise would be dead space into the highest profit persquare foot in their stores,” says Scott Di Valerio, Coinstar’schief financial officer.“We look at that space and use it to fulfill unmet needs

that the consumer has by serving the consumer in a self-service fashion,” he explains. “If you think about our coinbusiness, where we process $3bn-worth of coins a year, andour Redbox business, where we are serving up new-releaseDVDs at a dollar a night, it’s really all about meeting unmetconsumer demand from a self-service perspective in anefficient way that represents value and convenience.”Each Redbox kiosk stocks around 210 titles, and in some

locations Coinstar has installed a second unit. By the end offiscal 2010, Di Valerio expects the company to have 30,000Redboxes in 26,000 locations. This should increase furtherin the next few years as the result of an agreement reachedrecently with CVS Caremark, which has more than 7,000pharmacies across America.The growth of Redbox and its competitor Netflix (which sells

by mail and through internet downloads) may spell doom fortraditional bricks-and-mortar outlets. Last February smallishMovie Gallery filed for bankruptcy and in September giantBlockbuster, a chain of 3,300 stores that once dominated theDVD rental business, also entered bankruptcy (although, fornow at least, many of its stores will remain open).Should Blockbuster liquidate, any markdowns in its

inventory would hurt Redbox rentals. Yet this would betemporary and likely be offset by new business from the CVSdeal. However, if Redbox and Netflix can bring downBlockbuster, will video-on-demand (VOD) over the internetbring down Redbox? It’s a question management has clearlypondered. One response may be a link-up with a hi-techcompany such as Apple in order to provide VOD. Davis hasacknowledged “a long-standing relationship with Apple”, andsaid that Coinstar is “exploring multiple opportunities” inonline delivery.


PROFIT PROFILE

S:NORTH AMERICAN QUARTET SHINES

When the financial crisis struck, the impact onCullen/Frost was relatively mild. Loan-lossprovisions rose and per share earnings

declined in 2009, but dividends, book valueand assets all increased. When the US

Treasury came calling to enroll Cullen/Frost inthe Troubled Assets Relief Program (TARP),

chief executive Richard Evans said no.


Another response is further diversification in the self-service automated kiosk business. “We have a number ofinitiatives to drive internal growth in new concepts,” saysDi Valerio. One is coffee. Coinstar has hired a Starbucksexecutive and is working with the coffee company to developkiosks that would dispense Starbucks’ Seattle’s Best brand.Another promising area involves recycling cell phones.

“We made an investment in a company in San Diego calledecoATM,” Di Valerio says. “It’s a small company, five or sixkiosks, that is leveraging the second-hand market for cellphones, predominately in developing countries.”The idea is that a cell phone owner could take an existing

phone to a kiosk, which would run a number of automatedinspections and then make an offer to purchase the phone.If accepted, the phone would be deposited into the kiosk andits seller would receive a voucher that could be used to buya new phone. “It’s a good example of a business that meetsa need in the automated retail space,” Di Valerio says.In contrast to Coinstar, Lululemon Athletica (LULU)—

another Pacific Coast company, this one based in Vancouver,British Columbia—is intensely people-oriented. Foundedby Dennis “Chip” Wilson in 1998, this designer and retailerof yoga-inspired apparel is expected to have sales of perhaps$630m this year, on which it will net $87m, for an after-taxprofit margin of 13.8%. Wilson, who once headed asportswear company, created Lululemon after taking upyoga. He became convinced that yoga provides optimumexercise for people of all ages but thought its apparel—heavy cottons and polyester blends—could be improved.Today, he is chairman and chief designer. His chief executiveofficer is Christine Day, a 20-year Starbucks veteran whojoined the company in 2008.Neither was willing to talk to FTSE Global Markets, which

may be just as well. The company is flushed with its initialsuccess and parts of its press kit read like statements from theearly days of Google, which Chip and Chris might find a bitdifficult to explain with a straight face to journalists. Example:“At Lululemon Athletica, we have an original intent—toelevate the world from mediocrity to greatness.”So far, there’s no sign of that, but without a doubt the

company has achieved remarkable success in a very toughbusiness, and it has done so by creating superior products fora specific audience and marketing those products veryeffectively to this audience. As a result, it has built up anenthusiastic following among Wall Street analysts, some of

whom flatly state that Lululemon, small as it is, already is agreat company.“The product is unique, differentiated, technologically

advanced and highly effective for its intended task—yoga,indoor athletics, that sort of thing,” says Richard Jaffe,managing director of Stifel Nicholaus, who ticks off specificproduct advantages: “Four-way stretch, breathable, lightweight,wicking, functional pockets, non-binding waistbands.”Another Lululemon advantage: “The corporate culture

within the stores, within the company itself. This creates aunique in-store experience, a unique shopping experience,and a unique attribute in the brand.” The company hasabout 130 stores in the US, Canada and Australia, but hasbeen adding stores at a steady clip and expects to open atleast 15 more in 2011. Because the apparel designs aremainly function-driven rather than fashion-driven,markdowns are infrequent. This is offset partly by the high degree of personal service

provided by the sales clerks, or “educators,” in Lulu-lingo,who are both knowledgeable and passionate about yoga.Another extra cost is working with yogis and athletes ona local basis, which provides product feedback. In early2009 the company began selling through its website, andanalysts expect sales here to increase sharply, with a resultingboost to margins.

Relentless focusLululemon caters primarily to young, affluent urban womenwho are health conscious and can afford the company’spremium prices. Jaffe and others believe that the company cangrow from this base into other areas, such as skiwear,swimwear, casual clothing and footwear. “They have expandedto include some running gear, and they’ve experimented ina very small way with apparel for biking,” he says. “Theirmen’s business is a very small part of their franchise andcould be further developed.”In just four years Lululemon’s sales have increased threefold,

while its gross margin has held steady and its operatingmargin and net profit margin have climbed. The key, analystsbelieve, is management’s relentless focus on its corporateidentity. “The company has been very judicious in its growth,”says Edward Yruma, a vice president at KeyBanc CapitalMarkets. “It has really strived to protect that unique in-storeculture, where employees offer great customer service that wedon’t see in many other places in retail.” As for Chip Wilsonand Christine Day: “They are one of the best managementteams in specialty retail.”So there you have it: A Texas bank that doesn’t make

mortgage loans, an Ohio manufacturer that strives for multi-generational management, a Washington State companythat focuses on monetising the fourth wall of retailing, anda Canadian apparel maker that has a quirky press kit andgreat clothes. They might seem like a diverse lot, but actuallythey are more alike than different. Each has a clearly definedsense of purpose, a strong corporate culture, and adetermination to adhere to core values in good times andbad. The world could use more companies like these. �

Lululem Athletica is flushed with its initialsuccess and parts of its press kit read likestatements from the early days of Google,

which Dennis “Chip” Wilson and Christine Daymight find a bit difficult to explain with a straight

face to journalists. Example: “At LululemonAthletica, we have an original intent—to elevate

the world from mediocrity to greatness.”


CANADIAN TRADING:ISTHE FUTURE THE DARK SIDE?

IN CANADA, LIKE other markets where high-frequencytrading has taken hold, bid-offer spreads have collapsedand trading volumes have soared. Advocates often cite

the benefit increased liquidity brings; and for retail investors,the advantage may be real. They can trade against othermarket participants on a more equal footing. It’s a differentstory for institutions that want to trade blocks, however—and it’s a nightmare for traditional broker-dealers, who facesoaring trade processing costs. High-frequency trading firms use small orders, which drive

down the average ticket size per trade. Executions get brokenup across multiple trading venues, too, which makes it harderfor brokers to process multiple fills on a single ticket. Broker-dealers must connect to every venue in order to meet bestexecution obligations—and face ongoing costs for marketdata at each venue as well. “For regulators to monitor high-frequency trading they will have to increase their technologyspend significantly. This investment will largely be paid forby the sell side broker-dealers,” explains Greg Mills, managingdirector of global equity sales and trading at RBC CapitalMarkets. “It is just wrong.”

Mills argues that the liquidity high-frequency tradingprovides is illusory for anyone trading in size. Algorithmstypically tap the cheapest venues first, which may not bewhere the high-frequency trading order flow rests. As soonas a buyer or seller begins to absorb cheap liquidity, high-frequency traders will cancel their offers or bids on othervenues, raising the market impact cost. “You will see onemillion shares of a big liquid stock offered across severalvenues, but you can’t buy that much,” says Mills. “High-frequency trading firms take the information advantage butdon’t have any commitment to trade.” RBC is fighting back,however. In April, it introduced its Thor algorithm, whichdelivers an order simultaneously to every selected venue sothat bids and offers cannot be pulled. Mills says Thor grabs100% of the displayed liquidity in most cases.To Dan Kessous, chief operating officer of Chi-X Canada,

high-frequency traders just have a different profile. “Whetherinvestors buy and hold a stock for a few seconds, a week ora month, they are all trying to make money,” he says. “High-frequency traders are willing to trade with other participants.It is in my mind real liquidity.” Chi-X Canada handles about9% of Canadian share volume, making it the second largestalternative trading venue (after Alpha Group, owned by thefive major Canadian banks, which handles about 15%).Kessous attributes Chi-X’s success to its strong brandrecognition among global investors and its introduction ofinnovative order types—hidden orders and pegged orders,for example—that other venues didn’t have at the time andin some cases are still not available anywhere else.The first alternative trading system launched in Canada

was Pure Trading, a subsidiary of CNSX Markets, but thefirm hasn’t capitalised on its first mover advantage. Purecaptured just 2.9% of trading volume in October eventhough it was the first venue to facilitate high-frequencytrading. “At the time Pure was developed, Canadian tradinginfrastructure was not up to the latency or capacity demandsof electronic market making, statistical arbitrage, pairstrading, cash vs. derivative index arbitrage, ETF arbitrage,all of which are ordinary course activities today,” saysRichard Carleton, who is responsible for the operations,technology and sales at Pure.

HFT TIPS THE DARKPOOL AGENDA

High-frequency trading has shaken up aCanadian equity market long dominated by theincumbent exchange and five big banks. In late2008, the Toronto Stock Exchange (TSX) beefedup its infrastructure and embraced maker-takerpricing in an attempt to blunt the challengefrom alternative venues such as Pure Tradingand Chi-X Canada that already accommodatedhigh-frequency trading. The TSX has still lostmarket share—by late October 2010, it hadslipped below 70%—though probably less thanif it had not changed its pricing model.Investors anxious to avoid high-frequencytrading order flow are turning to dark pools,which have been slow to develop in Canadathanks to its unusual broker preference tradingpriority. Neil O’Hara reports.

Photograph © Eugenesergeev / Dreamstime.com,supplied November 2010.


Regulators fostered alternative trading systems to breakthe incumbent exchange monopolies, but in so doing theyopened the door to high-frequency trading—an even biggerregulatory concern. The irony is not lost on Steve Grob,director of group strategy at Fidessa in London, who saysthat regulation and technology are being combined in differentways in different countries in a “huge global experiment”.In Canada, the best execution obligation extends only to

Canadian trading venues—but for the 220 stocks that areinterlisted in the United States the best price may be onNASDAQ, the New York Stock Exchange, BATS or DirectEdge. “What is the broker supposed to do?” asks Grob.“Maybe he can do a better job for his customer by notfollowing Canadian best execution obligations and tradingsouth of the border.” In one week in late October, for example,the Fidessa Fragulator tool shows most of the trading inResearch in Motion, the Canadian maker of Blackberrydevices, took place on US venues. Real trading patternssimply don’t fit the tidy boxes regulators want to put them in.High-frequency trading is the latest iteration of a well-

worn market strategy. Grob argues it is similar to firms thatlocated their offices closer to the exchange, put more traderson the exchange floor, or invested in hand-held devices. Inevery case, the goal was faster execution—only today, theedge is measured in microseconds rather than physicaldistance. Some Fidessa customers argue that high-frequencytrading firms, which have become the de facto default liquidityproviders, should have an obligation to make a market at alltimes, not just when they want to. Others are not worriedwho is on the other side as long as their orders get filled.Grob won’t take sides, though he acknowledges it is a“legitimate question”.

Rogue ordersEvery microsecond counts to high-frequency trading firms,which explains their preference for co-located direct accessto trading venues, which minimises latency. Best of all fromtheir point of view is so-called naked access, in which theyrent a broker’s identification number and enter their tradeswithout any prior intervention by the broker. Canadianregulators have so far refused to clarify their attitude towardnaked access despite confusion among market participants.CIBC has aggressively pursued the business, but the other bigbanks have stayed on the sidelines pending regulatoryclarification. In early November the SEC adopted a rule thatrequires brokers to pre-filter trades, a policy Canada is widelyexpected to follow.A filter at the broker level may not eliminate the risk of

rogue orders, however. Although most high-frequency tradingfirms are not registered as broker-dealers, they could do so—in which case they would still have access to the exchangeswithout third party review of their trades. “Where do you putthe fuse box?” asks Grob. “Is it at the sender of the flow, thebroker in whose name the flow goes through, or the venuewhere it is matched?” He suggests the responsibility shouldlie with the exchanges, which have an obligation to maintainan orderly market—a solution that would prevent high-

frequency trading firms from skirting the SEC’s new rule.Pure Trading’s Carleton believes Canadian regulators mayprefer the model proposed by IOSCO in its August 2010paper on electronic trading. It requires brokers to havesophisticated risk management controls to protect against

Jackie Allen, a director at Bank of America Merrill Lynch. “Algorithmsand buy side self-execution is becoming a bigger percentage of thevolume traded,” says Allen, “but the information sell side traders canprovide is still a valuable—and valued—service in Canada.”Photograph kindly supplied by BofAML, November 2010.

Greg Mills, managing director of global equity sales and trading at RBC Capital Markets. “High-frequency trading firms take theinformation advantage but don’t have any commitment to trade,” hesays. Photograph kindly supplied by RBC Capital Markets, November 2010.

CANADIAN TRADING:ISTHE FUTURE THE DARK SIDE?

aberrant trades, but markets could still provide hostingservices. “That does not necessarily mean a ban on nakedaccess,” he says. “As a general rule, the best risk managementsystems in the securities industry are at the high-frequencytrading firms. They far exceed the capabilities of any agencybroker I have ever seen.”Institutions in Canada have begun to adapt their trading

techniques to prevent high-frequency traders from gamingtheir orders. Jackie Allen, a director at Bank of America MerrillLynch, sees clients using urgent order types and sophisticatedalgorithms that take into account live market conditions aswell as historical statistics. Upstairs block trading has dwindledas buy side traders turn to algorithms and the banks cut backthe capital they commit to facilitate trades. The upstairs desksstill have a role to play, however, particularly in less liquidstocks that attract little interest from high-frequency traders.“Algorithms and buy side self-execution is becoming a biggerpercentage of the volume traded,” says Allen, “but theinformation sell side traders can provide is still a valuable—and valued—service in Canada.”

The rise of dark poolsThe broker preference priority of trades that applies on everyvenue except Chi-X allows brokers to jump the queue if theyhave the other side of a trade, even if another broker wasthere already at the same price. In effect, the rule lets brokersinternalise order flow on an exchange, forestalling the needfor the broker-owned dark pools that achieve the same result.Moves are afoot to bring more dark pools to Canada, however,and Allen expects innovation with dark order types as well.“The trading community tells us that dark can offertremendous added value in illiquid names,” she says. “Darkhas a long way to go in Canada.”Liquidnet launched its Canadian dark pool in 2006 but

the product has struggled, although volume did pick up thisyear. Lower average ticket sizes have reduced the thresholdat which market impact costs kick in; one customer toldRobert Young, chief executive officer of Liquidnet Canada,that a 50,000 share handled by an algorithm today can haveas much impact as a 500,000 share block had in the past.The flash crash also made portfolio managers and plansponsors aware of how toxic some liquidity can be, somethingtraders already knew. “It empowers the buy side trader touse tools like Liquidnet more when others on the investmentteam see the value,” he explains.International investors accustomed to the strict price-time

priority that applies in most other markets worldwide seebroker preference as unfair. Chi-X Canada doesn’t allow it,but the rule enjoys strong support among local investors aswell as brokers. “Rather than removing broker preferenceentirely, venues will offer an alternative, and let traders make

the choice,” says Bryan Blake, vice president at Bank of AmericaMerrill Lynch. The TSX recently announced plans to launchTMX Select, a parallel liquidity pool that will apply strictprice time priority. The new venue, which will use existing TSXinfrastructure to minimise costs, will go live in the secondquarter of 2011 if regulators give the go-ahead. Another new facility expected to go live in late 2010 is

Alpha IntraSpread, a dark order type proposed by AlphaGroup that would allow brokers to keep their entire order flowinternal as long as it matches or beats the National Best Bidand Offer (NBBO) at the moment the trade takes place.Broker preference on lit venues today allocates any unmatchedportion of an order to other participants based on price timepriority. “The Alpha IntraSpread facility takes internalisationto the next level,” says Allen.Some market participants are concerned that dark pools

designed to exclude high-frequency trading could harm thelit markets. If regulators amend the rules selectively toaccommodate dark pools, the diverted liquidity will no longeraid price discovery on the exchanges. “Allowing sub-pennypricing and relief from the order disclosure rule on darkmarkets would potentially disadvantage visible markets,”says Evan Young, head of DMA and algorithmic trading atScotia Capital. “We think market regulation should promotevisible liquidity.”High-frequency trading has renewed interest in dark pools

among brokers in Canada, notwithstanding the brokerpreference. Clients have approached RBC about creating a darkpool that would allow them to expose orders without beingpicked off by high-frequency traders. The idea appeals to Mills,who recognises that a liquidity pool free from toxic elementswould be a compelling proposition. “It is all about whethersomeone is getting an information advantage without acommitment,” he says. “That creates an unlevel playing field.”The future for Canadian trading may well lie in the dark. �

Richard Carleton, who is responsible for the operations, technology andsales at Pure, comments: “As a general rule, the best risk managementsystems in the securities industry are at the high-frequency tradingfirms. They far exceed the capabilities of any agency broker I have everseen.” Photograph kindly supplied by Pure, November 2010.

Every microsecond counts to high-frequencytrading firms, which explains their preference

for co-located direct access to tradingvenues, which minimises latency.


But a single VaR number is not the whole story

Excerpt

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I LIKED IT SO much, I bought the company.” So saidVictor K Kiam, the American entrepreneur, who famouslybought Remington after liking the performance of his

new electric razor. It seems large stock exchanges are doingjust that in order to have the latest electronic capacity: theLondon Stock Exchange (LSE) bought super-fast SriLankan-based platform MillenniumIT and rolled it out inNovember as its new trading platform; Nasdaq boughtOMX, which sells technologies around the world; NasdaqOMX is buying Australia-based Smarts Group, a globalleader in surveillance technology; and two-year-old NYSE

Technologies combines several technology companiesbought over the years by NYSE Euronext.As speed and competition have increased in the equity

trading world, so has the pressure on not only the incumbentexchanges, but also multilateral trading facilities in Europe andalternative trading platforms in the US, to maintain investmentin their technological infrastructure.Gerhard Lessmann, board member, Deutsche Börse

Systems, believes it is the demand for higher speeds andstate-of-the-art risk management, as well as greatercompetition, which is driving the development of technologyat the heart of exchanges: “We have customers who areinterested in the lowest possible latency, so we will continueto focus our technology efforts in this area.” Certainly lower latency lies at the heart of much upgrading.

In April 2010 the Toronto Stock Exchange (TSX) announcedcompletion of the first phase of its equity enterprise expansionproject, migrating the TSX and TSX Venture Exchange tradingengines on to infrastructure which more than doubled itsspeed, giving TMX group clients record low latencies, claimsthe exchange.This drive to lower latency comes at a cost as Lessmann

points out: “Computer system matching engines need to be


STOCK EXCHANGE TECHNOLOGY:GLOBAL E

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STEST

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Photograph © Kheng Ho Toh /Dreamstime.com, November 2010.

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faster and smarter and these things are very expensive. Fora small exchange, it becomes more and more difficult to keepup. It’s mostly a fixed-cost business so once you have thetechnology, you can trade ten times the volume at prettymuch the same cost, but it is costly to keep it up to date.”This cost has led some exchanges to set up partnership

arrangements with other exchanges to ensure they have thelatest technology. Warsaw Stock Exchange, for example, isto migrate to NYSE Euronext’s global Universal TradingPlatform as part of a multi-year commercial agreement.In addition, consolidation has begun to occur in Europe.

The London Stock Exchange’s purchase earlier this year ofa majority stake in Turquoise brought together a 300-year-oldincumbent exchange with one of its new MTF rivals, whichhas its own implications. Richard Balarkas, chief executive officer of agency broker

Instinet Europe, is baffled why exchange technology isconsidered complex: “They match buy and sell orders. Itreally is that simple. It’s a very commoditised process andall that has changed is that it’s much faster than it used to be.The acquisition of Turquoise by the LSE should become atext-book example of a reverse takeover as, if the Turquoiseplatform and pricing works, why wouldn’t you just switchto the more efficient model? When it comes to their transactionmatching services, this downsized model is the long-termdirection in which the large exchanges are heading.”Nonetheless, acquisition does seem to be one of the ways

that exchanges are diversifying and expanding theirtechnology. Through its acquisition of Smarts Group, NasdaqOMX has entered the surveillance and compliance market.In a statement in July when the group announced a 39%rise in profits in the second quarter, chief executive officerBob Greifeld said: “These results demonstrate that ourdiversified business model is capable of delivering solidresults while simultaneously allowing us to pursue growthinitiatives to drive our business forward.”

Operational savingsThe LSE purchase of MillenniumIT at a cost of $30m hasgiven the LSE a platform with sub-millisecond tradinglatencies, a footprint in Asia and a replacement for TradeElect,Infolect and other interfaces. MillenniumIT’s in-housesoftware development team will also gradually replace theLSE’s current suppliers and bring intellectual propertywithin the company despite glitches when it was introducedin November. In July, while the LSE announced a fall in turnover at its UK

cash equities business over the previous year, the acquisitionof MillenniumIT pushed sales from the technology servicesbusiness to £12.7m. It is also expected to create operationalsavings of £10m from 2011-12.Rollout of the new platform to Turquoise and the LSE was

due to begin in November, while Borsa Italiana, also part of LSEGroup, will migrate later. The Johannesburg Stock Exchange,which has a technology agreement with the LSE going backto 2001, expects to migrate to MillenniumIT in April 2011.LSE Group claims MillenniumIT is the world’s fastest platform,

turning messages round in fewer than 100 microseconds. Tony Weeresinghe, chief executive of MillenniumIT and

director of global development at LSE Group, says: “Theimplication for members will essentially be to change to theFIX or Native gateway. They’ll also have to connect to theFIX/FAST or ITCH market data gateways and might alsohave to tune their performance to accept orders at a highrate and quick response time.” The two protocols, FIX/FASTand ITCH, are already a recognised standard in the industryand offer clients a choice of feeds with different attributes.FIX/FAST takes up less bandwidth than ITCH, while ITCHis low latency and streaming.Deutsche Börse Group, meanwhile, has for some years

been developing a new global trading infrastructure. At atechnology open day in September, the group launched twonew interfaces in its bid to simplify the way its customers linkto Xetra and Eurex, the exchange’s electronic trading platforms.Lessmann says one of the interfaces offers differentiation

for the exchange’s high-frequency customers, optimised forlow latency, while the other is a basic FIX-enabled interfacefor the more traditional members. “In addition, there’s alsoa graphical user interface with solutions for traders to beable to connect via a browser from their desktops. This reducesclients’ infrastructure costs and means less effort for them.”




STEST

Richard Balarkas, chief executive officer of agency broker InstinetEurope. “They match buy and sell orders. It really is that simple. It’s avery commoditised process and all that has changed is that it’s muchfaster than it used to be.” Photograph kindly supplied by Instinet,November 2010.


Exchanges are also benefiting from sales of their technology.Deutsche Börse, where around 1,200 people are employed inIT in its various locations, has sold its Xetra platform technologyto customers including the Irish and Bulgarian stock exchanges,Wiener Börse and the EEX European Energy Exchange. LSEGroup’s MillenniumIT platform sales are growing at 100% andWeeresinghe, not surprisingly, praises the benefits of off-the-shelf technology: “It makes the most sense for themajority of exchanges as it tends to be the most cost effective.The core requirements of most regulated markets are quitesimilar. Why re-invent the wheel? Why go through anexpensive, time-consuming and potentially risky internalbuild when you can simply buy a solution.”Also, revenues can be significant. NYSE Euronext’s

information and technology solutions division revenue rose$24m in the second quarter of 2010 to $107m or 29%compared to the second quarter of 2009 and in the samethree months, NYSE Technologies closed several lucrativemulti-year software and infrastructure deals including one withTokyo Stock Exchange to build and support a new futurestrading platform for the exchange.Meanwhile, Nasdaq OMX market technology business,

which sells technology to more than 70 market places,announced total order value—the value of orders signedthat have not yet been recognised as revenue—of $453min the second quarter of 2010, up from $315m in the secondquarter of 2009. As competition increases between exchanges,Owain Self, UBS’s global head of algorithmic trading, notesits impact. “Exchanges are having to evolve to compete inan increasingly demanding market place with enhancementssuch as latency reduction, for example. We are seeing a lotof innovation with improvements in matching enginetechnology, new order types, etc. The driving force for thischange doesn’t come from the sellside, per se. The buy sidehave dynamic expectations of what constitutes best execution,and they expect their brokers to determine where to tradein order to achieve it. So while we don’t tell the exchangeswhat they need to do, the exchanges that provide a betterservice will naturally attract more flow and therefore force

others to react to the demand for continuous improvement.”In Canada, where fragmentation has taken hold, and thereare four lit alternative trading systems, market places arealso feeling the competition. Three-year-old Omega ATSsaw a 1,134% volume increase in the year to July 2010, forexample. The best price obligation law, which currently putsthe onus on brokers, has been robustly enforced since January2010. In February 2011, this onus will switch from the dealersto the exchanges. “This is a big change in Canada,” says Omega’s new

president and chief compliance officer, Mike Bignell, whobelieves regulation is one of the main drivers behindadvancement of technology. “It’s a compliance-driven industryand it used to be a sales-driven industry. These days youneed to be a compliance officer with sales skills. If you are astock market you have to put yourself in a position to succeed.”The highly-automated, low-staffed multilateral trading

facilities in Europe owe their very existence to a change inregulation. Florian Miciu, chief technology officer, Chi-XEurope, explains the relationship: “An exchange is very, verycomplex. On the one hand you fine tune to the investmentcommunity and on the other hand you fine tune to theregulatory aspects and the geopolitical situation.” He believes an exchange can only compete successfully

when it has its own technology and its own pool ofknowledge. “It’s critical to be able to respond fast to theregulatory and business environment and the problem witha system supplied by a vendor is that the vendor will respond

Florian Miciu, chief technology officer, Chi-X Europe, explains the relationship:

“An exchange is very, very complex. On theone hand you fine tune to the investmentcommunity and on the other hand you fine

tune to the regulatory aspects and thegeopolitical situation.”

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to this only when the majority of clients are requesting achange.” While Nasdaq OMX is buying Smarts Group toprovide market surveillance technology, Chi-X Europe tookthe decision last year to build its own. Deutsche Börse hashad a variety of surveillance technology in place since 2002,including automatic circuit breakers or “volatility interruptions”,similar to those launched on Nasdaq OMX in September. Ifa stock price moves too quickly, an automatic stop comesinto place and the trade reverts to an auction model that givesall participants time to readjust.“We are pretty certain that something like the flash crash

in the US couldn’t happen on our platform,” says HeinerSeidel, a spokesman for Deutsche Börse.The so-called flash crash on May 6th, when the Dow Jones

plummeted, was the subject of an investigation by the USregulator, the Securities and Exchange Commission. OnSeptember 30th it published its findings, among which ithighlighted “the integrity and reliability of market datacentres’ processes, especially those that involve the publicationof trades and quotes to the consolidated market data feeds”. Weeresinghe says: “One of the main things surveillance

technology is looking for is to perform real-time surveillanceand a system that can handle a large volume of data.Surveillance is also looking for automated pattern recognition,automated relationship recognition and online case

management. It also needs flexibility to perform intra-dayalerts. Threats come from many angles—from a bad algorithm,from a rogue trader, from market manipulation practices oreven from system hackers. We deal with this on a daily basisbut our system is a highly flexible, real-time surveillancesystem which has many algorithms to trace the unexpected.”With messages travelling down fibre optic cables at 67%

of the speed of light, or 200,000km per second, according toChi-X Europe figures, technology connecting to the exchangehas to be sound. Chi-X Europe handles 225,000 messages asecond, for example, while MillenniumIT has been tested to1m orders a second.Speed is indeed king and one aspect often overlooked is

the time to cancel an order. Miciu says: “Traders like to live ina deterministic world. They need to shoulder a great deal of riskand typically, they have to wait a few seconds between sendingmessages and confirmation of receipt. In those few seconds thelandscape can be dramatically different. Exchanges have torespond much faster to the incoming orders and cancellations.“It’s a fine line: many people think about ‘how fast did

you get my order and confirm it?’—but the risk carried in adecision to buy an order is primarily an opportunity risk.Whereas if you have taken a decision and have exposure toa few hundred million euros, the question to be answered is:‘How quickly can you cancel my order?’ Many of the tradingsystems in the world don’t even mention the time to cancel.On Chi-X Europe there’s only a 15 microsecond differencebetween the time a new order is acknowledged and the timean existing order is cancelled.”

Time-sensitive strategiesHigh-frequency traders seek their route to speed throughco-location, where brokers’ servers are placed as close aspossible to the exchange. While brokers are busy lining up forspace in specific exchanges data centres—one is beingupgraded in Frankfurt for Deutsche Börse’s clients at a costof €12m—they are also identifying where to locate theirservers to service two or more exchanges.“Co-location is critical for time-sensitive strategies,” says

Chi-X Europe’s Miciu. “You want to be there first and you wantto be sure your order is received as fast as possible. The bestplace for a UK-side trading strategy might not be in themiddle of London for the LSE and Chi-X Europe, but mightbe nearer its periphery. It’s not a geographical decision, it’smore in terms of community networks and in terms of howdirect the route is.” �




STEST

With messages travelling down fibre opticcables at 67% of the speed of light, or

200,000km per second, according to Chi-XEurope figures, technology connecting to the

exchange has to be sound. Chi-X Europehandles 225,000 messages a second, for

example, while MillenniumIT has been testedto 1m orders a second.

Mike Bignell,Omega’s new president and chief compliance officer. “It’s acompliance-driven industry and it used to be a sales-driven industry.These days you need to be a compliance officer with sales skills. If youare a stock market you have to put yourself in a position to succeed,” hesays. Photograph kindly supplied by Omega, November 2010.


EUROPEAN TRADING VENUES ROUNDTABLE

WHO REALLY BENEFITSFROM MARKETFRAGMENTATION?

Attendees (Front row, from left to right)

DAVID MILLER, senior dealer, Invesco Perpetual

ALAN CAMERON, head of client segment, broker dealers & investment banks, BNP Paribas Securities ServicesPAUL SQUIRES, head of trading, AXA IM

(Back row, from left to right)

STEVE GROB, director, Group Strategy, Fidessa

MARK MONTGOMERY, director, Barclays Capital

LISA DALLMER, chief operating officer, European cash market execution services, NYSE Euronext

Supported by:

THE RUN UP TO MiFID II: DID MiFID I HELP OR HINDERMARKET TRANSPARENCY?

PAUL SQUIRES, HEAD OF TRADING, AXA IM: It is veryeasy to dismiss MiFID as something that was badly thoughtthrough. Nonetheless, it’s fair comment that MiFID has resultedin some unintended consequences. Our market is complexand technical and not everything has fitted into the principles-based regulation that is MiFID, and it has created many problemsfor market participants. It is no great secret that the buy side islooking at MiFID II to address some of those concerns. I’d liketo highlight an important example. Transparency has reallydeteriorated. I want to be clear about what this means inpractice. While there is a mechanism for price discovery—thealmost investigative work that is undertaken by traders becauseof the proliferation of different types of venues as a result ofMiFID—the buy side trader has nevertheless subsequentlyfound it very difficult to get a true picture as to where and at whatprice genuine investment trading is taking place. Knowingwhere to find liquidity is a key component of the buy sidetraders’ added value to their organisation and that added valuehas been marginalised. However, there have been positivedevelopments, such as the reduction in spreads. Even there,while spreads may look like they have narrowed, when youare trading institutional-size orders, reduced spreads are not reallyrelevant due to the smaller order sizes at those prices. Finally,another important issue right now is that the depth of marketsis not there anymore and therefore fragmentation is a concern.STEVE GROB, DIRECTOR, GROUP STRATEGY,FIDESSA:When we talk to any of our buy side customersand ask them: “Do you feel you’re getting a better deal since theintroduction of MiFID?” Almost unanimously, they say “No”.Actually, they say it quite vociferously. Sometimes they mightsay: “I don’t know”. That’s usually in the context of Paul’s pointabout transparency. Now all this might be down to the factthat much of their trading style is trading large blocks which arehidden in a much wider variety of different dark venues.Therefore, the answer ultimately depends on your perspectiveas a market participant. However, for the people MiFID wassupposed to be good for, which are either institutional investorsor retail investors like me, the answer is that it has been fallensomewhat short of the mark. LISA DALLMER, CHIEF OPERATING OFFICER,EUROPEAN CASH MARKET EXECUTION SERVICES,NYSE EURONEXT: The real question here is: what isliquidity? It’s not just the price on the screen; it’s depth ofquote, the opportunity cost, the search cost and it’s also thecost of technology to connect to these fragmented places.Innovation in a vacuum can be fantastic and wonderful; butinnovation that is disharmonious with the environment cancause problems. MiFID did not apply like regulation for likeactivity, and therefore doesn’t yet create a level playing field.Sometimes disruption can be good if at first it bringscompetition. Even so, you do have to look at the whole valuechain. Although, as Steve mentioned, there might be lowercosts at the dealer level, you have to follow that through and

wonder: how do those lower transaction costs on 200 sharesat the dealer level translate to a buy side trader? STEVE GROB: When you say: “like regulation for like activities”,was there one specific thing you were thinking about? LISA DALLMER: For example: we have MTFs, systematicinternalisers and broker crossing networks. Not all are clearlydefined in MiFID and actually, some of the regulators acrossEurope apply it differently. So if you’re matching trades, wethink that like activity should have a like level of regulationto the extent that liquidity right now is impacted by manythings: the depth of quote is not what it used to be, institutionorder size is not what it used to be, opportunity cost hasgone up, search costs have gone up; it is all of that. To somedegree, because there’s an unlevel playing field and likeactivity is not getting like regulation that, call it implicitsubsidy if you will, it has created the opportunity for coststo go up in ways that we aren’t yet ready to analyse. Theissues facing institutional traders is where you really see thatfriction in the outcomes of MiFID.DAVID MILLER, SENIOR DEALER, INVESCOPERPETUAL: Speaking as a buy side dealer, we see liquidityas a mixture of retail flow blended with proprietary flow fromthe likes of Barclays Capital and other large trading houses.We understand the delayed trade reporting regime, and wehave to accept it as a cost of utilising capital. In an ideal worldI’m going to deal all day anonymously through whatever systemis available; we just need to find the other side. STEVE GROB: It becomes meaningless because the crucialdifference, to my mind, is the matching; it’s not about whetheryou’re matching orders, it’s whether it’s discretionary or non-discretionary. So if I put an order in to an MTF dark pool atthe mid-point, it will match if there’s the other side to it. That’scompletely different from a broker-operated crossing networkwhich is operating on a discretionary basis. It's a differentservice that should be charged for on a different basis andreported on a different basis. A lot of people are trying to callfor the same regulation between those two entities and I simplydon’t think they are the same thing at all. MARK MONTGOMERY, DIRECTOR, BARCLAYSCAPITAL: There are a number of moving parts to this. Thegovernment and politicians are engaged with the debate asare market participants, so MiFID II will certainly get to thenub of some of these issues. We are thoroughly engaged inthe process and we feel that things are moving in the rightdirection because the regulatory issues getting raised are cuttingto some of the difficulties the financial market has encountered.We continue to innovate and evolve for our clients and we’recarefully balancing the cost of that development against theneed to deliver a profitable revenue stream.



David Miller,senior dealer,Invesco Perpetual


CHANGING LANES: THE SELL SIDE-BUY SIDE DYNAMIC MORE CHOICEBUT FEWER OPTIONS

STEVE GROB: If you were to speak to a large bank orbroker, they’d say that, whatever it is that they spend ontechnology in order to smart route flow across all thesevenues that extra cheque they write out is more than offsetby the lower trading costs that they’re getting around theworld. So, where there’s a potential problem is that, for thebig guys, it does make sense to incur this extra cost as theyachieve the economies of scale, whereas some of the smallerand mid-tier brokers are finding themselves under a lot ofpressure to invest in the appropriate technology. On top ofthis they have to deal with more complicated downstreamworkflow, but they haven’t necessarily got any more net flowcoming in through the front door to compensate. This couldbe a worry for the buy side as well, as they are going to findfewer larger brokers perhaps to trade with. DAVID MILLER: It seems to us that sales trading desks ingeneral are shrinking. We are still getting multiple marketflow and news flow emails and other forms of communication.There is a perception that we are using far more electronicaccess to markets than we really are. Because of the addedexpense of establishing direct market access and of providingalgorithmic trading, it is understandable why this is happening.The number of phone calls I get in the morning has morethan halved in the last year or so. We still value high-touchbroking where we can get it. Institutional trading is prettylabour intensive and we are constantly looking for liquidityor for the other side of the trade. STEVE GROB: Is it the case you want to split it into onepile that’s the easy stuff, you just want to DMA out; andthen the other pile is the tricky stuff where you want ahigh-touch approach?DAVID MILLER: To be fair, every order, whether it’s for 1,000shares or 1,000,000, is handheld. Tactics, such as DMA, algoor whether we should consider using a specialist broker, aredecided on a number of factors. Some orders do lend themselvesto electronic access so we may use a combination of tactics.There are many more tools at our disposal than in the past. PAUL SQUIRES: We miss the balance sheet/principle/capitalcommitment approach we used to have with some of thebigger banks. It is part of a relationship. I also agree we haveseen a really savage reduction in sales trading resource amongour bigger brokers. The explanation might be that everyonethought the buy side were fairly quickly going to evolve and50%-plus of their order flow would be electronic. Unfortunately,there are so few sales traders that you end up empowering yourown buy side traders to self-direct trades. We talk now aboutbest selection rather than best execution. Today, the buy sidetrader is doing a lot of due diligence before they release an orderanywhere. In the past you would have a sense of who hasbeen active in a stock, who’s got a good market share, or whohas good market intelligence in a stock or a sector, and therewas a time when you would pick up the phone to someoneand have an intelligent discussion with them before you

decided on your strategy. You can’t do that anymore. It’s hardto know whether we have a voice and can ask for those salestraders back because we feel they’re better resourced to informus on the best strategy, or whether they can ask a trader forthe best risk price, for example. Although we have invested alot of money in technology it is not at the same level as thebigger brokers. We see high-frequency traders in some ofthose gaps now rather than the old market makers. We alsosee other institutional dealers being wary of opening up theirorder size so even institution to institution flow has becomefragmented. It seems very hard to get back to the previouslandscape where we felt quite empowered, with a few keyrelationships to help us do what we feel we we’re paid to do.DAVID MILLER: Back in the late 1980s and into the 1990sit certainly seemed that there were certain monopolisticcharacteristics surrounding the national incumbent stockexchanges. This helped pave the way for new crossingnetworks and alternative exchanges such as Tradepoint tocome into being.STEVE GROB: Yes, but do you think Tradepoint would havebeen more impactful if that had regulatory support?DAVID MILLER: Of course it had regulatory support. It wasregulated by the SFA, predecessor to the FSA; it had a fullexchange licence and so provided a proper functional andregulated exchange. Unfortunately nobody used it but it wasthere and it set the tone. It was one of the first fully functioningorder-driven stock exchanges in this country.MARK MONTGOMERY: We’ve seen an interestingdevelopment here: because of technology, the buy side have,in some ways, evolved more effectively in their day-to-dayworking tools and day-to-day duties to their own clients, thanon the sell side. The reason I say that is because many buy sidetraders now have an order management system (OMS) thatenables them to manage their order flow across asset classesand to trade electronically in all these instruments from a singledesk. A few years ago this would have been managed bydifferent teams often manually over the telephone. The OMSor EMS sees an instrument, a quantity and direction and canroute to the optimal destination smartly through FIX. Thecontrast for sell side work flow is that we’ve created dedicatedsilos, partly for the benefit of protecting buy side anonymityand confidentiality of orders, to operate programme trading, cashtrading and electronic trading separately. We think you’ll seehybrid sales traders develop out of this. Why? Because thething that makes your relationship with the cash sales traderwork is trust. The difference between sales trading a block of stockand finding the other side in a dark pool is not that great; butthe sales trader has the skill and market knowledge to minimiseinformation leakage. By the same token, an electronic sales

Alan Cameron, headof client segment,broker dealers &investment banks,

BNP ParibasSecurities Services

trader should be able to give you coverage on the market,information about IPOs and everything else that goes with itthat a traditional cash sales trader does. I can see the two rolesmerging over time.PAUL SQUIRES: How much has technology benefited ourclients? Actually I am struggling to say that was our cost andtherefore this is the net benefit to our end users—at least inequities alone. Certainly our TCA numbers look great and wecan dazzle people with our suite of algorithms and smart-orderrouting, but it has come at a large investment cost on our part.However, when this infrastructure is rolled out to other assetclasses, in fixed income and foreign exchange, it’s been fantastic.Of course, for us the key initial step was to put in a multi-assetclass OMS platform. We trade fixed income and FX throughthe same OMS platform as for equities. We’ve established STPin those other asset classes because you can use the stand-alone platforms and integrate them within the OMS. So wenow do over 50% of our buy orders (by number) in fixed incomeelectronically. They are smaller in size but still that’s a significantamount of our business. In foreign exchange as well we haveused the OMS to get to a stand-alone platform and therebyreduce user error, trader error, manual error, and that is a verytangible benefit. Technology has been fantastically advantageousin the multi-asset space and dealing errors hardly ever occurnow as a result. To my own mind this justifies the expense fromthe outset, but in the equity space it seems so loaded, sotechnology-based, compared to those other asset classes, andfor only marginal benefit.LISA DALLMER: It is not unusual in fixed income and FX. Paulis able to effectively bring his costs down quickly using theexisting lessons learned in technology for equities. Certainly,technology is the enabler but the key is how you’re applying itto fixed income or FX or futures, to give you the greatest gains.Although technology is already fairly well entrenched in theequities space it is harder, to use a sporting metaphor, to bringyour golf handicap down that last couple of points. Don’tunderestimate what we’ve seen over the past 15 years, startingall the way back at the beginning of the supply chain. Forexample: 15 years ago IBM would announce earnings andyou’d get out your papers and your Lotus 1-2-3 spreadsheetsto rerun the model and it might take days to drop in inputs. Aweek later you would formulate a view to buy or sell IBM. NowIBM files electronically in XML or XBRL, that digital informationis fed into the model, and bam, you know exactly where you pricethe next trade. Information is getting faster and more compressedtherefore it is no surprise that technology enables the buy sideto get closer to the sell side. To some degree Paul’s decisionmaking (with regard to algorithm models or which dark pool)is about choice: the buy side contemplating decisions that weretraditionally sell side core competencies. Meanwhile the sell

side is asking exchanges to implement smarter market structureand make the technology footprint smaller and cheaper. As acollective industry we are more interlinked than ever, so wehave to look at the whole process to evaluate if the end-clienthas benefited, or if the regulatory environment is harminginvestors and those who look after their assets. STEVE GROB: I agree with your sentiment but the idea thatthe trading process is solely about people looking at theperformance of a stock as the basis of their buy/sell decision isperhaps misplaced. In the US, for example, 60% of what’straded is by HFT players who don’t care much about IBM’searning statement. They’re just arbitraging from one venue toanother and, while they are completely legitimate marketparticipants, they create noise that can distract the traditionalinstitutional investor, because they are not making decisionsbased around the fundamentals of a stock. MARK MONTGOMERY: As a provider we see our role ashelping to equalise or normalise the way different marketparticipants integrate together. As exchanges evolved, thenature of their membership has changed dramatically. Forexample, we have clients who are broker dealers, who arewithout their own exchange membership and use our pipesfor DMA. Moreover, we’ve got institutional clients who have theirown membership on exchanges or MTFs. Years ago, that wouldnever have been the case, because to be a broker dealer you’dhave to have your own membership on the exchange. STEVE GROB: I challenge the whole level playing fieldargument. It seems to me that it’s always been uneven. Peoplemake money out of having an information advantage, whetherit's having an office nearer the exchange, more traders on thefloor or more handheld devices in the pit. People have alwayssought gain by exploiting technology or information, and theonly thing that’s different now is that instead of measuringthings in miles or people, we’re measuring them in nanoseconds,but the game is still the same.LISA DALLMER: It is a level playing field on those aspectsbecause you can choose to invest in technology or not. It’s justchosen investment. Where do you want to put your office? Theanswer might be right next to the exchange. How many peopledo you want to have on the floor? Those are business decisionsbut from an access perspective it is the same set of choices.MARK MONTGOMERY: People evolve, or rather, peoplehave had to evolve. If you take some of the traditional mid tierbrokers who’ve actually really invested in making their retailoffering work. They’ve got a research channel and can providea personal service combined with the key addition of robusttechnology and a website that a diverse audience can interactwith. There are other firms, who had a strong retail franchise20 years ago, but who have not invested and now feel they’retoo small to survive. Now, take a look at what happened inthe US a few years back and find that through technologysmall can be beautiful. Three or four guys with a server cannow not only survive but can take 20%/30% market sharebecause they’re small, because they’re nimble, and because themarket has evolved. It is a question of looking at where themarket is going to be in three or four years’ time and thenshaping and adapting to that view.



Paul Squires, head of trading,AXA IM


CLEARING & SETTLEMENT:WHERE NOW?

ALAN CAMERON, HEAD OF CLIENT SEGMENT,BROKER DEALERS & INVESTMENT BANKS, BNPPARIBAS SECURITIES SERVICES:Clearing follows whathappens on the trading side and in many ways the story issimilar. We saw Chi-X and Turquoise set up and they looked atpan-European clearing and couldn’t find any of the existingCCPs capable of doing it at the price that they wanted. Theytherefore appointed EMCF and EuroCCP—both effectivelystart-up entities. So we have had fragmentation in clearingjust like the fragmentation on the trading side of the businessand the outcome has been determined by the MTFs who havebecome king-makers in the process. We got into a rather strangesituation where the fees were falling dramatically on a tradebasis but we had to deal with a proliferation of CCPs. Thereare now 20 CCPs in Europe and there’s another five or so onthe way. So the savings that were being made on one side fromthis quasi-competitive market are being eaten up by the costsof connectivity and the additional margins being paid as aresult of competition; hence the requirement for interoperability,and that’s really where we are today. Achieving interoperabilityis not easy. This is because CCPs are being asked to cooperaterather than to compete, which is quite an unnatural thing to do.Also, you’re dealing with risk rather than just processing. Thereal question is where does the risk end up and can you getinteroperability without increasing risk as well? So today’sobjectives are rather curtailed. The Code of Conduct wantsparticipants to be able to choose where to clear and settleindependently at each part of the trade life cycle. What we’reseeing right now is a debate about interoperability among fourCCPs. So, hopefully, we will see interoperability for a rathersmall group of CCPs sometime next year, but it’s not theinteroperability that people envisaged right at the beginning.FRANCESCA CARNEVALE: Alan, how does Clearstream’sinitiative, Linked-Up Markets, fare as an interoperability exercise?ALAN CAMERON: It really is about the CSDs dealing in amore efficient manner with each other. Over time, it might bean important development but it will need to make progress notjust with settlements but also with asset servicing—and thattends to be harder. For now, the jury is out. With T2S comingalong there will be a very fundamental shift towards interoperableCSDs. Of course, the other interesting thing about Clearstreamis that they are part of a group that participates at differentlevels of the trade life cycle and the whole question of verticaland horizontal integration remains unresolved. Three yearsago everyone was saying we must have horizontal competition,we don’t want vertical silos. There’s been so little progress andinteroperability that this debate has kicked-off again.

FRANCESCA CARNEVALE: Lisa, NYSE Euronext has alwaysbeen keen on the horizontal model, hasn’t it?LISA DALLMER: We’ve always believed in the mostappropriate market model and so we recently announcedintention to open a clearing house that will be able to mixequity derivatives with equities clearing. In part, we aremotivated by the total lack of clearing innovation and realactivity on interoperability; we could not control our destiny.We felt it was more important to actually manage thetechnology and clearing functions ourselves and be able tobring in equity derivatives with equities as it will generateefficiencies that are not currently available. Since it was sucha crucial part of our process, many people looked at wherewe did clearance and settlement as part of our collectivetrade costs for members and until we could control it andbring that down, it was going to be a hindrance. So we’vedecided that influencing consolidation in clearing and addinginnovative technology are the primary reasons we want toventure into the clearing space and we will have an openplatform that will allow us to add flow, scale and in turnreduce fees. It is something we are planning for 2012.ALAN CAMERON: I guess most participants in the marketwould say that the onus really has to be on the exchanges toshow why this integration makes sense and the generalfeeling is that that hasn’t really happened as yet. I’m notsaying it’s not going to happen, but it’s an argument thathasn’t been made in such a coherent fashion as yet. We lookforward to hearing it.FRANCESCA CARNEVALE: From the buy side perspective,have any gains that you have made in trading costs been lostor negated by the rise in clearing and settlement costs? PAUL SQUIRES: We have not specifically gone to our brokersand said, as a result of all the different MTFs and the reductionin execution costs, we want to lower our commission costs withyou. We don’t micro-manage commission costs. There are anumber of different entry points into our organisation fromthe brokers, and therefore with our key counterparts havinga relationship is the most important element. Secondly, if youput it in the context of what we’re trying to do, which is eitherreduce or add significant positions for our fund managerswith minimal market impact, it might only constitute a basispoint of savings in execution costs. When you look at ourtransactional cost analysis and see that on some orders we beatthe benchmark by 100 basis points you will realise that focusingon the venue costs to the broker is really missing the point.The second limitation is a practical one. Do we want to carveup an order into multiple commission rates applied to eachindividual trade fill according to the venue? We are not aquant house doing thousands of small trades a day, but evenso there’s a practical limit. Of course, we are aware that weshould be slightly more commercial for our brokers now but,equally, when you enter those dialogues, they’ll point outthat because of fragmentation the costs of clearing are thatmuch higher. So you’re right. You need to be aware of thedownstream aspects as well as the execution.DAVID MILLER:We don’t micro-manage the settlementside and while costs associated with trading do have a bearing

Lisa Dallmer, chiefoperating officer,European cash

market executionservices, NYSE

Euronext

on best execution; it is the price that is more important. Ourjob is simply to buy or sell a particular stock at the bestavailable price. Trading costs are encompassed within thefully bundled rate; we’re not looking for a change here.STEVE GROB: If you do what we do, which is providing aworkflow-based system to both the sell side and buy side, youhave to deal with the added complexity of multiple clearersand multiple venues. We take a client order, split it into differentdestinations, receive a bunch of different fills associated withdifferent clearers, different fees and different pricing structures,and seamlessly manage the whole process. The secret to allthis is ensuring that the experience is as straightforward aspossible and that the trader is protected from all this complexity. LISA DALLMER: There is a cost of re-aggregating thefragmentation on both the pre-trade and the post-trade basis.It looks seamless but at the point of trading it is fairly fragmentedwhile the software providers, vendor packaging and middleoffice costs are real for re-aggregating information.FRANCESCA CARNEVALE: Given that much currentregulation is around transparency and managing counterpartyrisk, as the clearing and settlement side does fragment, doesn’tit make it harder for institutional investors and their tradingdesks to manage their exposure effectively? MARK MONTGOMERY:One of the big differences betweenEurope and the US is a lack of institutional investors clearingsecurities for their OTC leg with the investment bank. That’s avery hard thing to get to today in Europe when we have allthese different CCPs. Some of the CCPs are pushing hard totry and get that conversation going. When I speak to institutionalinvestors about it, they all say it’s a great idea but it’s not at thetop of my list of things I want to do. So there’s anacknowledgement that we want to get there but there’s noreal urgency behind it right now.PAUL SQUIRES: All of our dialogue is about CCPs. Rightnow, when you actually get to the point of trade execution,you’ve only got the legal documentation with one broker, soguess what? You’ve only got one place to ask for a competitiveprice. That’s not great. So definitely, the move to CCPs is goodbut then it’s fairly evident that we would have to bear a lot ofthe cost of change. That invariably influences the investmentdecision of the fund managers. They might want to trade someCDS, for example, but the costs of adapting your architectureto enable a CCP process? When considered against the likelyperformance gains and relative amount of activity in OTC itmight look expensive. What starts off looking like a great wayforward starts to be affected by cost considerations and that’ssomething we need to be careful about.

POST-TRADE ANALYSIS:UNDERSTANDING FRAGMENTED DATA

STEVE GROB: There are two problems. One is the fact thatdifferent participants are using the different categories underMiFID (OTC, dark pools, etc) in different ways. The other isthat all the venues that have been created have, for completelybenign reasons, come up with their own trade-type definitions.

To deal with this we've put together a whole team of analyststhat spend their time mapping and cross-referencing thesecodes in order to provide the best view we can of what’s goingon. On top of this, different brokers will naturally provide theirown analysis of their smart order routing (SOR) and algoperformance, produced in different ways and reflecting differentformulae. So the buy side must find it pretty hard to form atruly objective view as to which broker is doing the best job. LISA DALLMER: The first step is to decide what aspects ofpre and post-trade data can be consolidated in order to do themapping. Then we have to figure out what is the minimumset we can agree to. There are several steps before we even getto have a record to reflect against for benchmarking TCA andother things. I believe there’s a CESR working group that isidentifying the trade flags, the mappings; actually we have hada small army working on it too. DAVID MILLER: We’re looking for some sort of consolidatedbest bid and ask, which we’re now getting through technology,whether it’s via Reuters, or Bloomberg. They’re all presentingus with the right sort of display to enable effective price discovery.However, within that, of course, you’ve got all the dark andsemi-dark liquidity You can time stamp and recreate the bestbid-and-ask on the lit exchanges, but that still leaves a big gapand we’ve got to be able to prove what we’ve done within thatgap. We’re getting pressure from our clients, the funds we tradefor, to prove that we’ve gone to the right venue. As Paul says,best selection really is the most we can achieve. It’s almostimpossible nowadays to actually prove best execution.LISA DALLMER: Because best execution is about manythings and not only price, from our perspective, we understandthe buy side and the sell side’s needs for providing risk trades.We believe the large in scale waivers is an appropriate mechanismfor providing confidentiality. However, we are observingsignificant OTC activity that is retail sized and it’s happeningaway from the best-bid-and-offer. Notwithstanding the needfor confidentiality, we should evaluate the appropriateness ofwho needs this confidentiality and why it’s needed.DAVID MILLER: In some respects that’s always been a bit ofan issue. When a risk trade is taken on, the question is howlong and how deserved is the delay in trade reporting that themarket allows to protect the provider of risk? Another challengeat the moment comes from fund managers who are keen topursue a certain tactic, such as working an order as a percentageof volume. While I do not have an issue with that tactic, thetrade reports we or the broker are following can have a dramaticinfluence on final price, especially if, the broker is unable toparticipate in all available liquidity.STEVE GROB:That’s the thing about transparency; you wantit for everybody else but not yourself! One of the things that



MarkMontgomery,

director, BarclaysCapital


puzzle me is people calling for a European version of the NBBOthat exists in the States in terms of pre-trade transparency. Thisis because any broker in Europe is allowed to determine itsown best execution policy in terms of what it includes andexcludes. Vendors like us already provide a custom virtualmarket that allows traders to switch venues on or off in orderto reflect whatever their best execution policy is. The real problemlies in post-trade transparency and that's important because it'sthe basis for tomorrow's pre-trade decision.PAUL SQUIRES: I’m not too concerned about pre trade.We’re kind of getting there. For me it is all about post trade.It’s about getting the right definitions of certain types of tradeto determine standard reporting timeframes, whether it’s retail,OTC, risk, broker pricing, crossing, or anything else.

HOW MANY trading VENUES DOYOU really NEED?

FRANCESCA CARNEVALE: To the outsider, post-MiFID,a host of new trading venues cropped up. Few have mademoney and they skew liquidity every which way. Does themarket really need this level of differentiation? What’s thepoint? I can see, for example, the need for dark pools, but doyou need every major broker/dealer to provide its own darkpool? How many is enough?LISA DALLMER: You’re asking a macroeconomics questionthat happens in every industry. How many competitors is theright number in the pharmaceutical industry? How many kneereplacement providers does the world need? DAVID MILLER: You can’t blame people setting up darkpools because they perceive there’s value in it. There’s a lot ofmoney to be matching trades within an ever widening spread.LISA DALLMER: The question becomes is their businessmodel sustainable and at what point does consolidation appearin the industry? As an industry player, looking at the opportunitiesas consolidation takes place, it’s about the timing. During thistime when we have a lot of providers in the market, there isinnovation. Had we not experienced some of the innovationsemerging in the industry in recent years, we wouldn’t be ableto cope quite as well with the downturn in trading turnoverthat we are facing today. So there’s a lot of value, but yes, Iagree, in the long run, stand alone businesses can’t operate ata loss. They can’t even operate at near loss. Moreover, taking intoaccount some of the issues we’ve raised; uneven regulation,and to the extent that the regulatory landscape creates essentiallyan implicit subsidy for a period of time, I’d ask to consider thedisadvantages and risk to investors.STEVE GROB: I guess the question is whether people thinkthat LSE and NYSE Euronext would have cut their fees, andintroduced new business models, without the competition theynow face. You only have to look at the Tokyo Stock Exchangeand its introduction of arrowhead and what's going on at theASX in Australia for further confirmation of this. Moreover,the idea that you need hundreds and hundreds of people to runa market venue just isn’t true. The alternative venues arecompletely entitled to come up with newer, faster technologyand lower overhead businesses. While you're right that you

have to question the viability of their business models, thesame applies within primary markets where they can look attheir less performant platforms in the overall scheme of thebusiness. If NYSE Arca and Smartpool were standalonebusinesses, should they be closed down because they are notmaking any money yet? When you are looking at the profitand loss of a platform, you have to view it in the broadestcontext and the long-term interests of its shareholders.LISA DALLMER: Exchanges have clear rules about whenand how to manage the conflicts of having brokers as ownersor shareholders. I’m not sure all the MTFs have those. We’retalking about motives of keeping the businesses running,and I agree, as an exchange, we embrace the competition,the innovation, and therefore have a multi product offeringin regulated markets and MTFs. Would it have happenedwithout competition? It’s hard to say. Innovation alwayscreeps its way into every industry. Sometimes you’re reactingto change; sometimes you’re leading that change. Rememberthat trading is just one part of capital raising in the exchangebusiness, keep in mind there is a whole value chain thereand market quality across all those services is different thanmarket share just in the top 20 stocks.MARK MONTGOMERY: There’s also the subject of dataownership and selling it which seems to have helped certainexchanges have a different model to some of the new arrivals.It’s always interesting to hear people, particularly on the buy side,saying they haven’t just had to buy trade data from one source;they’ve had to go and buy from other venues as well in orderto get a consolidated view. That’s certainly a frustration whenit’s their trades in the first place. This is another area wherewe’re going to see costs forced down.FRANCESCA CARNEVALE: Regulators are encouraginga lot of derivatives to be on exchanges in future: is that fairor unfair competition? Will it reduce choice for the buy sideand the sell side? Alan.ALAN CAMERON: It’s not just into the exchanges; theregulators appear keen to see these instruments movedinto the CCPs as well. This should simplify risk managementfor participants.LISA DALLMER: There are two points. Is the encouragementpre trade or is it post trade? These are two different aspects,two different dimensions, and they’re very much targeting thepost-trade aspect for the counterparty risk managementissues we talked about. ALAN CAMERON:Ultimately, it will bring the end investorclients in to the CCP world, although the easiest and mostcost-effective route may be through General Clearingmembers. Long dated instruments will need to be clearedfor a long period in the CCPs.

Steve Grob,director, GroupStrategy, Fidessa



STEVE GROB: As long as they can be standardised to thepoint that there’s sufficient volume in it to make itworthwhile, then that makes sense. However, there is alevel of OTC business that is so obscure that it will never fita centralised clearing model. MARK MONTGOMERY: The ETF market has expandeddramatically to fill a gap here. It presents an opportunity forpeople to be innovative in the product suite and has given thebuy side greater flexibility around how they can invest in thesemarkets in a balanced and risk controlled way. PAUL SQUIRES: We want this sort of CCP progress, but wehave a strong feeling that it’s going to cost us money. We’vegot to decide whether that’s worth the extra cost.

tomorrow’s world

PAUL SQUIRES: Do I expect to go into work after MiFIDII and find everything’s much easier, more transparent andpeople are happier? No, but I’m mildly optimistic. Thedialogue in the lead up to MiFID II has actually been framedthe right way. However, I do have concerns. There’s toomuch stereotyping and there are too many negativeconnotations: high frequency is bad, dark pools are badand monopolies are bad, for instance. The other thing thatconcerns me is that there is so much lobbying going on bythe MTFs, the exchanges and by the brokers, that it is reallyhard for the buy side to be represented. DAVID MILLER: We are all far more engaged in MiFID IIthan I believe we were for MiFID I. Many on the buy sidelet it happen the first time round and we’ve seen what’shappened, some of it is good but some is not so good. Sowith MiFID II there is a considerable increase in engagementand with the help of various trade bodies we are able to havecontinued involvement in its progress. There are even morevested interests at stake this time, whether it’s from the buyside or the sell side or all those between the two. At leastwe can’t turn round and say, we didn’t try and make ourpoint this time. FRANCESCA CARNEVALE: Do you think that MiFID IIwill evolve in your favour this time around?DAVID MILLER: I hope so, but the process of buying andselling shares is constantly evolving. I must admit that myperennial dream would be to have a single, consolidatedmarketplace for everything financial, stocks, bonds, andfutures, in harmony, which in some ways is what MiFIDwas designed for. That, of course, would be the buy sidedealer’s version of the Holy Grail. Equities are an importantinvestment for us, it’s what we do. I believe in the long term,the retail investor will remain interested in owning shares,whether he does it individually as a shareholder, or collectivelythrough a unit trust. MARK MONTGOMERY: It us up to us, the practitioners,to provide constructive feedback where we can. I feel thatPaul’s definitely got a point that perhaps the voices of thebanks will be louder than areas of the buy side. Hopefully, wehave a lot of interests that are aligned and certainly if wecan eradicate some common misconceptions about our

business, then that can only be for the good. As far as thefuture, some of the things we’ve discussed have to inevitablyprogress: some form of consolidated symbology around tradedata is a must. We want to see costs of clearing opened up,and we hope the markets learn from what’s happened inthe US in terms of economies of scale. In that regard, themarket should become cheaper and more efficient now.There will be areas of fragmentation and while we are seeingsigns of consolidation with MTFs, someone else will pop up.There’ll be some new innovation with technology that willallow someone else to come into the space. As we have allacknowledged, we need to see the status quo challenged.I’m bullish in the medium term, but no doubt there will bea little bit of pain along the way before we reach a conclusionwhere all the issues are dealt with and the landscape is clear.ALAN CAMERON: On the clearing side, I can’t seeinteroperability or consolidation happening quickly enoughto get us where we need to be. We are going to continue toface a fragmented, comparatively expensive infrastructure.On the settlement side, I’d like to think that T2S will usherin a new era of harmonisation and simplicity; perhaps evena shortened settlement cycle is coming. I would imagine thatcould happen quite quickly and that we’ll see T+2 acrossEurope much more quickly than we would probably haveenvisaged a year ago. LISA DALLMER: The important trend is that there willalways be innovation, there’ll always be change and sometimesit takes a disruptive event to kick that off and get that going.MiFID has tended to benefit the wholesale level, theprofessional market, and therefore I hope MiFID II willinclude changes that are more specific, and that it containsprescriptions that protect retail investors. We also have tolook carefully at having an indisputable price reference sothat all investors can reasonably ask: how do I feel aboutthat activity, that trade? How do I evaluate it? As Steve noted,yesterday’s post-trade data is today’s pre-trade informationin terms of decision making. To bring it all together, as anexchange we are committed to listening to clients to facilitatethe required innovation with regard to the rules, thefragmentation, and the industry’s health. Overall, this is thebest place you can hope to be.STEVE GROB: I’m optimistic but unfortunately it’s gotnothing to do with my view of regulators. Really, there are twoproblems: one is that they have to separate political polemicfrom the facts—that seems pretty crucial to me. Someonemade the point that monopolies are inherently bad. I challengethat. There’s a view that HFT is bad and dark pools are bad.I challenge that too. All those things are just way morecomplicated and subtle than is sometimes acknowledgedand even if some people do figure that out, there’s a biggerproblem in play, namely the pace that regulation can movejust gets outstripped by technical innovation and commercialinterests. So, by the time MiFID II has sorted out all theproblems of today, everyone around this table will be thinkingabout completely different things and doing completelydifferent things. That’s just a fact of life. The regulatory processwill never keep pace but we just have to live with that. �


F IXED INCOME OPERATIONS of banks andinvestors continue continue to face the doublechallenge of staying abreast of market

developments and addressing demands forincreasingly precious liquidity. Against this backdrop,the benefits of e-trading fixed income have comeinto the spotlight as institutions seek to satisfy theircompliance and risk requirement and gain access toliquidity, pricing transparency and tools to deliver theirbusiness models.

Although they remain somewhat unpredictable,the bond markets would appear to have made asteady recovery since the shoulder of the creditcrunch in 2008 when liquidity all but evaporated andtrades had to be negotiated over the phone.However, the risk still remains as recent pressure onperipheral markets shows.

As a result of the bank bailouts, governmentshave issued huge amounts of debt to finance theirinfrastructure and fiscal deficits. Likewise, corporateshave also issued bonds to make up for the shortfallin bank credit available to them, resulting in increasedliquidity and narrower spreads.

Now, with record levels of government debtbeing issued across the eurozone, there is anincreased emphasis on ensuring open andtransparent markets, which has led to a renewedfocus on e-trading and in turn is driving volumes.

More than half of buy side respondents (53%)to the fixed-income section of a trading poll,conducted by the Association for Financial Marketsin Europe, recently reported year-on-year increasedvolumes in electronic trading of fixed income, withnearly 60% believing the trend is set to continue.

When this poll was last conducted in 2008, 71%of respondents said they had the systems to tradefixed income electronically, but only 10% had doneso. The story is now very different. With improvingmarket conditions and an uptick in equity markets,demand for fixed-income products has grown andlikewise e-traded volumes.

Government bond issuances have soared andthere has also been a rebound in credit, with around$1.4trn of non-financial corporate investment-gradebonds issued globally last year. This figure was up 72%from 2008, and 40% of it came from Europe, theMiddle East and Africa, according to data providerDealogic. Taking a look at buy side volumes aloneover the last couple of months reveals that a good

percentage of e-trading volumes in bonds has comefrom the traditional fund management industry aswell as hedge funds, as they recover momentum.

The European fixed income arenaThere remain clear differences between the USand European fixed income markets, which is havingan effect on the evolution from traditional voicedealing to electronic trading.

In the US there is a single issuer and apredominantly cash market while in Europe thepicture is more complicated – the market is morefragmented, more futures-led and with multipleissuers reflecting the various sovereign states.Coupled with this are historical fragmentation issues– clearing, settlement and benchmark bonds ineach of these markets, while Germany remains thebenchmark market in terms of liquidity, credit andthe link between cash and futures.

There are also different requirements acrossEurope for post-trade, clearing and settlement,although the introduction of MiFID is bringing ahomogenous set of standards closer still.

Despite this complexity, Europe has taken to e-trading fixed income. The past decade has seenthe adoption of e-trading in fixed income securitiesexpanding to the buy side. This is a trend whichlooks set to continue as regulatory and complianceneeds push in that direction.

The benefits of e-trading fixed incomeElectronic trading in fixed income securities providesinvestors better pre-trade transparency in termsof price discovery with a higher quality trading

experience and the benefits of post-tradetransparency and straight-through processing.

Electronic fixed income platform, MTS, becameestablished during the last decade of strongeconomic growth and has grown to become the keysource for price discovery and trading in Europeannational government securities.

Fabrizio Testa, Head of Product Developmentat MTS, comments: “Trading European debt throughan established and effective platform gives eachcounterparty access to the source of Europeandebt liquidity and the confidence of a regulatedand orderly market.

“Whether you are a frequent and active traderor not, the advantages of e-trading in bonds areevident: pre-trade transparency, STP and audit trailto satisfy risk management and compliance needs,including best execution.”

e-trading fixed income for the interdealercommunityMTS delivers electronic venues to two core fixedincome customer segments - the interdealer market,with its MTS Cash offering, and the professional‘dealer-to-client’ (B2C) market, with BondVision.

MTS Cash is now the leading e-market forEuropean government bonds, combining straightthrough processing with a completely automatedsettlement network through links to all of the majorEuropean depositories and central clearing houses.

As a result, market participants gain access tothe most liquid, transparent and efficient Europeanbond marketplace with an expanding range ofproduct classes and tradable securities including

e-trading in fixedincome across Europe

is here to stayThe evolution into electronic broking across fixed income markets has been a steady but inevitable process,

writes Fabrizio Testa, head of product development, MTS.

Sponsored Article: MTS

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Sponsored Article: MTS

fixed coupons, floating coupons, zero coupons andindex linked coupons.

In terms of capacity, the level of throughput thatMTS Cash can sustain is continuously improvingand considered first class in the fixed income arena.The average round trip time of transactions iscurrently less then 1 millisecond (see Figure 1).

In the interdealer market, MTS supports an auto-matching system with participants streaming prices.On execution, MTS sends the relevant informationdirectly to the central counterparty or depositoryto be cleared or settled.

e-fixed income trading for the dealer-to-client segmentMTS has also developed BondVision for the buyside, giving funds and other clients direct access tothe source of the market and the major players inEurozone debt.

The majority of primary dealers in Europe now usethe MTS-run BondVision platform to connect withclients, such as real money managers, central banksand hedge funds and demand continues to grow.

MTS has developed single dealer pages onBondVision to enable banks to stream eitherindicative or executable quotes directly to theirclients. A buy side client using BondVision to manageits fixed income portfolio has access to optimaltrading and workflow technology together with arange of functionality including the ability to makerequests for quotes (RFQs) for up to 20 legs of atrade at any time.

MTS delivers both its interdealer and dealer-to-client solutions across an open architecture forseamless integration with ISV solutions and existinginternal systems, delivering significant cost benefits.This ensures MTS attracts professional counterpartieswith real interest in the fixed income arena, whichcreates a virtuous circle of liquidity.

The B2C market in e-bond trading is primarilybilaterally settled. The STP capabilities of a system

such as BondVision allows a fund manager togenerate an order from their portfolio managementsystem (PMS) or order management system (OMS),stage it in BondVision and then execute the tradewhich will then be uploaded automatically.Settlement is then handled outside of the tradingvenue itself.

The importance of market data and latencyIrrespective of asset class, informed trading andmanagement decisions rely on access to the optimalmarket data.

MTS supports pre-trade, trade execution andpost-trade capabilities across cash and repo markets,and delivers independent benchmark market dataand comprehensive fixed income indices. FabrizioTesta says: “In the B2C market, counterparties canengage electronically with more confidence in aprofessional market if they have superb market databased on real executable prices, not calculated orderived. That is a pre-requisite to e-trading.

“The independence and quality of MTS data isunique. The interdealer MTS Cash market generateselectronic market prices which in turn feed backinto our system, so users are assured they have thebest information available.”

Latency remains a key issue in all electronicmarkets and minimising it continues to be a focusfor all professional trading platforms, irrespectiveof asset class. The interdealer market in particular hasa constant need for performance and low latencyto better manage the risk of quoting a high numberof securities. European debt, as an example, is tradingagainst other products like swaps and futures. Tradersneed the performance of a bond on the platformto accurately reflect the performance in all relevanthedging products.

In the B2C space, latency between a fund managerand MTS’ BondVision platform has shorteneddramatically. It used to take a phone call, email or faxfor execution, then the trader on the execution desk

would run the trade through over the phone, aprocess which could sometimes takes several minutes.Anything can happen in the markets during that time.

BondVision’s functionality now enables dealers tostream prices back to clients with the sameperformance, speed and minimal latency as thecore interdealer market.

The time between a por tfolio managementsystem giving the order to execute and the timeit gets to the front end has been shor teneddramatically. Once integration between a PMS andthe trading venue is in place, counterparties get ahuge range of efficiencies as they can managemore orders in less time with less manualintervention.

The future for e-fixed incomeRecent market upheaval and the resultant regulatorypush have led to demands for more standardisedtraded products with a focus on post-trade andclearing.

Fabrizio Testa adds: “Investors have become moreconfident in using e-solutions for trading. At thebeginning clients traded smaller deals electronicallyand still picked up the phone to handle largeramounts. Then we star ted seeing the trend ofbigger size deals on our dealer-to-client BondVisionsystem, which means their confidence grew to tradethese larger tickets electronically as well as multi-leg– switch, butterfly and basket.

“Of course, there will always be multi-asset deals,which may naturally be transacted over the phone,while standardised products are much more suitedto be traded electronically.

“Overall, I think we will continue to see theelectronic fixed income market evolve and grow.Our role and responsibility is to respond to theneeds of our clients.

“It is our main focus to ensure they get robust andstable trading technology with access to optimalpricing, liquidity and workflow to help them delivertheir chosen fixed income business model withprecision, control and confidence.

“There is no doubt that electronic trading inEuropean fixed income will continue to grow. It isa pattern we have observed in other asset classesas institutions have seen the benefits.

“Investors are attracted to MTS as the key venuefor fixed-income investments of strong credit qualitywith a very high degree of liquidity, possibly themost prized factor of all.

“The increasing volumes we’re seeing both interms of deal tickets and daily activity is mirrored byfeedback from both the buy and sell side that e-trading is the way forward for European fixed incomeand these are services they want. MTS is wellpositioned to continue to facilitate this need.” �

Figure 2: CMF transaction capacity and average response time

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GREENWICH ASSOCIATES ESTIMATES that 38% ofUS fixed-income trading volume is now executedthrough electronic platforms and the figure in Europe

is 41%. About half of US institutions use e-trading systems forfixed income, and 60% in Europe, the two biggest users beingreal-money investors and central banks. “Much of the growthin electronic trading volume in the US was generated in interest-rate derivatives, investment grade credit and short-term fixedincome,” says Greenwich Associates consultant Andrew Awad.In Europe, the products traded most are government bonds,followed by interest rate differentials (IRDs).Tim Blake, head of North American interest rate products

at Credit Suisse, says the period since 2008 has been exciting:“Market participants will probably look back on these twoyears and see it as a boom for electronic trading in fixed incomebecause the concept held up well when bonds were one of themost active parts of the financial markets. While we’ve hadelectronic bond trading for ten to 15 years, we’ve really been ata plateau in terms of technology. Now it’s really the time for thenext evolution.”In this atmosphere, many third-party providers of trading

platforms and electronically aggregated data and prices haveseen a direct correlation between volumes and businessconducted electronically. For example, MTS, majority-ownedby the London Stock Exchange and a leading platform forgovernment bond trading in the eurozone, has a daily turnoverof €85bn and has seen trading volumes double in France overthe past 12 months and rise 75% in the Netherlands and Spain. MTS chief executive officer Jack Jeffery says: “Liquidity and

transparency have become more and more important and haveresulted in inter-dealer brokers directing trade on to electronicplatforms. Also, in the last three months, bid-offer spreadshave narrowed and there is a clear correlation between bid-offer spreads narrowing and volumes increasing. The advantagesfor people trading on an electronic platform are that you canclearly see the price changes in the market.”Client access to liquidity has been the driving force behind

Credit Suisse Onyx, the bank’s algorithmic fixed-income tradingplatform, which since 2006 has executed more than $10trnnotional of government bonds and exchange-traded futures

contracts. Originally developed for internal use by its owntraders, in June 2010, the bank decided to give clients access toit with a suite of algorithmic execution for pairs strategiesbetween cash US Treasuries and futures. In November, thefirm added the ability to conduct direct trading of cash USTreasuries, providing an alternative to traditional request-for-quote systems by allowing clients to enter their own tradeparameters directly to access the firm’s pool of liquidity. The

BOND TRADING:READY FOR THE NEXT EVOLUTION

FRATERNITY, LIQUIDITY,TRANSPARENCY

The past two years may go down in history as the best fixed-income market seen, following theconfluence of high volatility, low interest rates, tight spreads and high demand. In fact, in 2009,according to a JP Morgan Cazenove report, fixed income amounted to 55% of the totalinvestment bank revenue, while that from equities lanquished at 27%. Although the bank expectsthe total fixed-income wallet to fall to $130bn, down 23% on 2009, the proportion of electronictrading in fixed income has leapt forward over the same period. Ruth Hughes Liley reports.

Photograph © Saniphoto /Dreamstime.com, supplied

November 2010.

firm plans to roll out the same capability in Europe next year.Blake says that the liquidity offered through Onyx is

anchored by the bank’s position as a primary dealer of USgovernment bonds and by its broad client base. “We havebrought in electronic market makers from the ranks of hedgefunds, the equity world and a lot from rates. This is reallyprime time for rates and we think Credit Suisse Onyx is avery powerful model.”Derrick Herndon, European head of credit at UBS, which

gives prices on 8,000 bonds, believes that fixed income liquidityis not really driven by delivery method: “Over the last 18months, dealers have been carrying more inventory, but inMay and June 2010 liquidity evaporated quickly. It didn’t matterwhether it was voice or electronic. In fact the more volatile themarket is, and the more the market is influenced by externalfactors such as Greece or Ireland, it’s that macro risk focuswhich generally shrinks the breadth of names traded.”Jeffery, meanwhile, believes electronic trading is in fact

changing the very nature of the market. “Following the Europeandebt crisis, I think we will move increasingly to an order-drivenmarket and away from a quote-driven market. These marketsof natural interest are where people will trade on the platformbecause they want to trade, not because they have to. Themarket place will drive this change. As liquidity thrives, itbecomes self-fulfilling and you have a secondary market placethat operates itself.”Certainly the traditional process of seeking prices via request-

for-quotes (RFQs) has been simplified, mainly through use oftechnology; with the improvement of trading platforms andelectronic methods to aggregate prices and allow investors tocompare prices with a few clicks. TradeWeb and BloombergALLQ, for example, have offered electronic trading for more thanten years. Majority-owned by Thomson Reuters and ten banks,TradeWeb offers a mechanism to automate RFQs for Europeangovernment bonds under its well-established TradeWeb Plusenabling comparisons of either several bonds from one dealeror one bond from different dealers.However, the more complex a trade, the harder it is to

automate and Robin Strong, director of buy side strategy atFidessa, which has recently been signing up sell side customersto its fixed income platform, says: “Portfolio managers often don'treally mind exactly which bond they buy, as long as it meets theirunderlying strategy: they might want to increase portfolioduration using, say, German bonds in a specific sector withthe right duration and credit rating. There may be a choice ofsuitable cash bonds or the manager may choose to use aderivative to give his portfolio the desired exposure profile.These trades are harder to automate as you are no longerdealing with a specific instrument. “Other clients will keep their corporate bond portfolios fully

invested in less risky government bonds until the rightopportunities arise, then will do a switch trade to sell exactly theright number of government bonds to buy the corporate bond.[However,] it has to be exactly the right amount and this canget quite complex with a number of different legs to the trade.In this respect, it's more like auctioning a mini programmetrade. They are harder to automate as the pricing is often quoted

as a yield spread between the different bonds,” says Strong.Undaunted, MTS recently launched Multi-Leg, new

functionality of the BondVision platform that enables trade inup to 20 legs. Jeffery says: “It is moving away from commoditisedsimple trades to more complex ones. Although it’s fairly limitedat the moment, it shows that there’s a demand for electronictrading in an even more complex structure.”While most electronic trading is in government bonds,

electronic trading in corporate bonds is also developing. MarketAxess, a leading platform for corporate bonds trading, has seenrecord volumes in 2009 and 2010, In October it announced arecord third-quarter trading volume of $100.5bn, up 25% on thesame period in 2009, while revenues of $37.4m were up 24.7%. Major stock exchanges are also upping their game. Deutsche

Börse resumed trading in 700 corporate bonds on Xetra in


BOND TRADING:READY FOR THE NEXT EVOLUTION

Tim Blake, head of North American interest rate products at CreditSuisse. “We’ve really been at a plateau in terms of technology. Now it’sreally the time for the next evolution,” he says. Photograph kindlysupplied by Credit Suisse, November 2010.

Jack Jeffery, MTS chief executive officer. “Liquidity and transparency havebecome more and more important and have resulted in inter-dealerbrokers directing trade on to electronic platforms,”he says. Photographkindly supplied by MTS, November 2010.


October, the same month Singapore Exchange began offeringcorporate bond trading for smaller listed issues to retail investors. In February 2010 the London Stock Exchange also launched

an electronic order book for retail bonds. Introduced, it says, inresponse to strong private investor demand for greater accessto fixed income, the platform offers continuous two-way pricingfor trading in UK gilts and retail-size corporate bonds on-exchange. Before this order book, none of the 10,000 listedbonds on the LSE system was traded electronically.Initially, 49 gilts and ten corporate bonds were available for

trading, including securities issued by Tesco, BT, National Grid,GlaxoSmithKline, Morgan Stanley, GE Capital, Enterprise Innsand a bond issued specifically for the service by Royal Bank ofScotland. Since then the number of bonds available on theplatform has risen to 141. Investors can see prices on-screen,and trade in increments as low as £1 for gilts and £1,000 forcorporate bonds, in a process similar to share dealing.The initiative is modelled on Borsa Italiana’s fixed-income

platform, MOT, which conducted €230bn-worth of trading in2009. Since June 2009, ExtraMOT, the segment of MOT dedicatedto corporate bonds issued by Italian and foreign companies,has announced new additions to the platform around six timesa month. Moreover, in November 2010, MTS announced plansto launch a pan-European corporate bond trading platformfor the wholesale market. The proposed market will be open forthe listing and trading of euro-denominated debt instrumentsand will operate on an electronic order-driven model. It willbe managed by the EuroMTS multilateral trading facility andoffer straight-through processing to Europe’s major clearinghouses and central securities depositories.Even though the capacity to trade corporate bonds

electronically is increasing, the complexity remains. UBS’sHerndon explains: “If you want to express an opinion in equities,there’s one stock for each company. For that same company’sbonds, there might be many different bond issues outstanding—as much as 20 or more for larger issuers. Each deal may haveits own characteristics and different breadth of ownership,hence different liquidity. The different liquidity characteristicsof each issue may lead to price discrepancies between them, andalso the ability to transact in desired sizes.”The bulge bracket firms, which have invested heavily in

electronic equity trading platforms, seem to have the edge oversmaller rivals because of their greater ability to invest intechnological infrastructure. Deutsche Bank and JP Morganhave both emerged as the two largest players in the fixed-income scene in the US, and Greenwich Associates says it is noaccident that these two dealers lead in rates products and thatthey both deploy “top-notch electronic trading platforms”.However, Greenwich Associates consultant Frank Feenstra

points out: “Complicating the issue for large and small dealersalike is the question of whether future trading volumes andsell side margins will meet the expectations of firms that are nowmaking large investments in their fixed income platforms”.“There’s no doubt it’s easier for investment banks to invest,”

says Herndon. “The more seamless the linkage from investorto trader to trade processing and settlement and the more it canbe automated, the more effective it is. However, I view electronic

trading as an extension to the mix. It’s not necessarily a substitutefor voice. Electronic may be a supplement for execution with largeaccounts and a more efficient way to reach the smaller or lessactive part of an accounts list, for example.”Canada’s fledgling Omega ATS is squaring up to its larger rivals

as it is about to begin electronic trading in Canadian governmentbonds including the ten-year benchmark bond. “There’s notransparency in bond trading in Canada and the retail investortakes what they are given,” says Michael Bignell, Omega’spresident and chief executive officer. “Regulators in Canadahave been looking for ways to promote transparency in thebond markets, but as much as they say they would like to, theycan’t just walk into a darkened room and turn the lights on.At the major banks the profits from the fixed-income desksdwarf the equities desks so they are not motivated to change.It’s about time that someone threw the lights on.”

Slowdown expectedIn Canada, overall fixed income trading surged ahead by 42%on a matched sample basis from 2009 to 2010—”an extraordinaryperiod”, according to Greenwich Associates. In a matchedsample of 80 of Canada’s largest institutions, trading volumein government bonds increased 93%, although a slowdown isexpected. Electronic trading saves time and adds to transparency.While it might help transparency, it can still be hard to prove

best execution, points out Robin Strong. “Soliciting quotesfrom multiple brokers is the accepted method of price discoveryand accepting the best quote is generally considered bestexecution. Yet it is hard to prove best execution for more complextrades that have multiple legs and include swaps or otherderivatives. Some will delegate this to the broker or use internalmodels to analyse how the bonds should cost, but these modelscan only provide a guide and at this level of complexity thebond market struggles in the area of best execution.”“Over time there will be a movement to benchmark prices

and US and Europe will move closer together,” says Jeffery.“That’s not to say there will never be a place for over-the-counter trading and I think it would be unreasonable to expecta platform to cope with some of the complex product structuresaround today.” �

Robin Strong, director of buy side strategy at Fidessa. He says:“Portfolio managers often don't really mind exactly which bond theybuy, as long as it meets their underlying strategy.” Photograph kindlysupplied by Fidessa, November 2010.

FTSE GM: The transition management industryhas changed significantly. What are the factorsdriving change?

Mark Dwyer:The industry has changed beyond recognition;both in depth of service and in terms of when transitionmanagers become involved in the investment cycle. Fiveor ten years ago, you would typically only use a transitionmanager when doing an equity to equity transition. Now,transition management teams provide a substantially broaderrange of services such as fixed income transitions; projectmanagement, hedging, interim management, and betaoverlay; sometimes we also help investors with assetallocation decisions. Many of our clients consult with usthroughout the entire process. Moreover, there was a timewhen you called your transition manager after the investmentmanager selection process was complete. Now investorscreate panels of transition managers that they can turn tomuch earlier in the decision process, making it much easierto access transition expertise.


TRANSITION MANAGEMENT: N

EW SERVICE DEFINITIONS

Transition management has undergonesubstantive changes over the past two years aslong established teams have merged, divided,or folded. Even so, the transition managementproduct set has deepened, now oftenencompassing a cradle-to-grave relationshipbetween beneficial owners and their mandatedasset managers. At one time, beneficial ownerscalled in transition teams to facilitate themovement of a portfolio from legacy todestination managers only after the managerselection process was completed. Now thatrelationship begins much earlier in the assetmanagement process, explains Mark Dwyer,managing director and head of EMEA atMellon Transition Management and BetaManagement at BNY Mellon.

A DEEPERPRODUCTSET

Mark Dwyer, managing director and head of EMEA at MellonTransition Management and Beta Management at BNY Mellon.Photograph kindly provided by BNY Mellon, November 2010.


FTSE GM:Transition managers are not necessarily seen asexperts at asset allocation or manager selection, are they? Mark Dwyer: Certainly not all transition managers shouldadvise on asset allocation, and cannot credibly claim thatthey should be part of the process. Asset allocation andmanager selection involve decisions about risk and return overthe long term. Transition managers tend to focus on shortertime frames, but can contribute to understanding risk andreturn and investors benefit when they have access to adifferent perspective. In this regard, we leverage the BNYMellon Asset Management platform. Not only can we offerbest in class ideas on asset allocation to clients, but it also givesus the capability to manage assets on short-term, interim,or long-term mandates. There are many factors that drive thechange of an asset allocation or asset managers and eachfactor involves different kinds of costs. The benefit of bringingin transition expertise as early as possible can be significantto the end value of a portfolio. It is a significant piece ofadditional information that should be factored into thedecision making process.FTSE GM: Is this information not available elsewhere?Mark Dwyer:Transition managers have specialist systemsand access to analytics that may not otherwise be availableto investors. The information we can provide is not limitedto cost and details market and operational risk. The costand risk of a transition should not be the decisive factor inan asset allocation or fund manager selection process, butit is an important piece of information, needs to be readilyaccessible, and explicitly considered. In some cases we havegone much further than looking simply at the cost and riskof a proposed transition. In one recent case, we examined thecost of establishing and also the ongoing costs of maintaininga small cap index portfolio compared to a large cap one. Wethen generated a set of expected returns using our modelsfrom the asset management business, and were able todiscuss with our client the expected returns after bothimmediate and ongoing maintenance transaction costs. Ourapproach is consultative, and we are able to show a broaderpicture around implementation, and provide metrics tosupport our view. FTSE GM: Can you give us an example of these projectmanagement services?Mark Dwyer: For a complex transition where projectmanagement was a large element of our involvement wewere recently involved in a fiduciary manager change. Thisinvolved a pension fund moving all its assets from onefiduciary manager to another. The asset allocation and assetmanagers were all different and the operational risks involvedwere huge. We also had to ensure cash flows and liquidationswere co-ordinated so that the client, and more importantlythe fund’s beneficiaries, remained fully invested. There aremany moving parts in a large scale transition such as this,but we have the experience and capability to identify andmanage all those operational risks.FTSE GM: What are some of those risks?Mark Dwyer:Aside from operational risks, the investment-related risks are complex (bonds, equities, currencies, derivatives,

etc) and require a well thought out strategy, as well as theaforementioned capability for practical, tactical execution.FTSE GM: How does it work in practice?Mark Dwyer:The determination of the optimal path fromlegacy to target portfolio can readily be compared to rocketscience. You know where you are starting from, and whereyou are going. To get there, several paths will be considered,trajectories calculated and compared, so as to arrive at aproposed optimal path, where advantages are clear andpitfalls known in advance. In a transition, multiple modelsof spread levels and market impact calculations must beused against historical and forward looking data with dueconsiderations for the existing market environment, withsensitivities closely aligned to the potential trade executionmethods, in a manner that can be employed equally for eachindividual security. Maximisation of in-kind opportunities isthe first step, as these incur no market impact or opportunitycosts. Yet operational considerations can have significanteffect even at this stage, particularly in international securitieswhere ownership transfer rules and custodial fees varywidely. Crossing opportunities must be carefully analysedagainst the metrics of market impact and opportunity risk(adverse price movement costs of delaying transactions) asunintended costs can accumulate.

FTSE GM: How does interim management work inpractice and what are the benefits? Mark Dwyer: Interim management is about finding efficientshort-term solutions and can involve a combination ofsecurities and derivatives. Take a client looking to exit aportfolio invested in European equities where the targetportfolio is global equity. The investment committee hasmade the re-allocation decision, but the target manager hasnot been selected. There is often a substantial time lag betweenan investment committee’s decision and its implementation.According to a study released in October by consulting firmMercer, the majority of respondents say it took about one tothree months to execute a decision. With interim management,the risk that there is a change in the relative value of thelegacy and target can be substantially reduced. In this example,one option would be to liquidate the European portfolio andcreate an overlay to the relevant global equity index untilthe new manager is funded. The disadvantage of this approachis that in-kind transfers, often a very significant means toreduce total transaction costs, are lost. An alternative is tocreate an optimised basket of both physical equities andderivatives. The advantage of this interim portfolio is that it

The determination of the optimal path fromlegacy to target portfolio can readily be

compared to rocket science. You know whereyou are starting from, and where you are going.To get there, several paths will be considered,

so as to arrive at a proposed optimal path.

can have a low tracking error to the target portfolio, andsome securities can be retained for in-kind transfer to thenew target portfolio. Another type of interim managementis the overlay of free cash, sometimes referred to as equitisation.The cash could have been generated from the investmentportfolio or by new injections of cash into the fund. Using aderivatives overlay, this cash can be “put to work” in themarket both fast and efficiently. Moreover, the overlay can beconstructed in such a way as to move the actual portfoliocloser to the target asset allocation. FTSE GM: Are you suggesting that a transition managershould also be involved in transitions for assets whichare not transferable, such as derivatives? Mark Dwyer:Transition managers tend to offer much morevalue when they can directly trade the securities in thetransition. However, there are significant exceptions, wherethe transition manager can offer cost and risk minimisationwhere no securities are traded directly. We were recentlyinvolved in a transition where there was a significant elementof liability-driven investment (LDI). The LDI legacy portfolioand target portfolio were swaps which were non-transferable.In this particular case, we were asked to examine theliquidation process of the legacy manager and the swapconstruction process for the target manager. The optimalapproach was to provide detailed instructions to the legacymanager on the date and swaps to liquidate with associatedprice limits. As the swaps were liquidated, we created aduration hedge, which we subsequently unwound as soonas a target manager established his own swap portfolio. FTSE GM: Have you changed your business model toadapt to client requirements or do you claim to lead theproduct development process? Mark Dwyer: Client portfolios are becoming increasingly

complex and an expert transition manager can deliver morevalue in this instance. To some extent, the client demandfor more complex asset classes has driven the transitionmanager product development process. However, we havealso developed new products and services. We offer productsnow that were once traditionally looked after by assetmanagement rather than a transition manager. It is ourresponsibility to stay ahead of the developments in assetclass diversification. We cannot let the complexity of theinvestment or asset processes trap our clients in a particularinvestment structure. The more complex the investmentstructure the more sophisticated the transition solutions wemust provide. That is why transition management is constantlyevolving and that in turn makes it fascinating. FTSE GM: BNY Mellon’s transition team in London haschanged over the past year. Where do you now seeopportunity, and how does the composition of the currentteam support your forward business plan?Mark Dwyer:We have the opportunity to bring our approachto transition management to the broadest global audience, andwe have made great strides to reflect this in the structure ofour business. A foundation of our approach is to use specialists,creating a clear separation of duties, eliminating key-manrisk and enabling us to handle great complexity. Now, ourpresence in London can fulfil all of the key roles we utiliseduring a transition. We also have an incredibly experiencedteam, covering the full gamut of sales, operations andinvestments. We are confident about the team in place, andfeel that we have one of the strongest regional transitionmanagement team, with experience in every major region –EMEA, Australia/Asia, and the USA. Deep experience, commoninfrastructure and processes, and a consistent application ofour approach form the premise of our truly global offering. �


TRANSITION MANAGEMENT: N

EW SERVICE DEFINITIONS

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FOR MALTA, THE recession has proved short and shallow,with a peak-to-trough decline in GDP of 3.4%, as against5.3% in the euro area. While GDP contracted by 2.1% in

2009, it rebounded to a very positive 4% in the first half of2010, which suggests, says the central bank, the outturn forthe full year could top 3%, driven by brisk export activity anda strong accumulation of inventories.

The country has been relatively inured to the vagaries of theglobal recession, for good reasons. The first is the government’scommitment to diversifying the economy towards high valueservices, which have proved resilient to the downturn impactingthe rest of Europe. Two, the jurisdiction is emerging as a naturalfund domicile. Figures released by the MFSA indicate a 13%growth in the Net Asset Value (NAV) of investment fundsdomiciled in Malta during the first six months of 2010, confirminga same trend seen in the second half of 2009. Total NAV at theend of June stood at €7.93bn (up from €6bn at the height of thecrisis in June 2009). The strongest expansion is in the ProfessionalInvestor Fund (PIF) segment, despite the restructuring thathas been taking place in this area to reflect changes in investorappetite. All 51 funds licensed by the MFSA in the first sixmonths of 2010 were PIFs, bringing the total of PIFs in Maltato 331. UCITS funds in comparison stood still at 45, while thenumber of non-UCITS stood at 33, three down on December2009. Another 26 overseas funds are authorised to be retailedin Malta. Out of 104 Schemes into which the funds are grouped,72 are multi-fund structures, 20 are stand-alone funds and 12are Master/Feeder structures. Diversified funds were the largestasset category, accounting for almost 51% of all the locallybased funds. Equity funds were the second most commoncategory with a share of 19% of the total number of fundswhile derivative funds accounted for 12%.

Malta’s stable financial sector also remains a key strength,albeit, as a banking centre Malta’s credentials are perforcemodest, with total banking assets as at the end of 2009 standingat a tip over €41bn. Substantially liquid, Malta’s banks havehowever avoided the toxic shocks which have rocked theindustry just about everywhere else; instead they have taken alargely old-fashioned approach, preferring to act as intermediariesbetween retail borrowers and depositors. According to theWorld Economic Forum’s Competitiveness Index 2010-2011, thesoundness of Maltese banks is now ranked 10th globally, up two

notches from the previous report. Moreover, Malta itself hasmoved into 11th position in financial market development.

Admittedly not everything is rosy. A continued weaknessis the slow growth in productivity and private consumption,which has undermined economic performance in recentyears. The public sector also remains relatively over-manned.Additionally, too few people in Malta participate in the formallabour market (55%), compared to the rest of Europe (65%),with the activity rate among women and older workersparticularly low.

Not all the issues are domestic. Given continued strains inthe global economy Malta can only expect modest growth inexport markets in the near term, particularly as the Eurozoneis expected to grow a mere 1.5% in 2011.

However, the government has acted fast. Aside fromintroducing new work incentives, a restructuring of the pensionsystem is in hand, thereby boosting incomes in retirement,and encouraging private saving to close the saving/investmentgap. While the continued repercussions of the financial crisis willcontinue its low level impact on the country’s domestic growthstatistics, Malta’s stable appeal as a fund management centrecontinues apace and the jurisdiction expects 2011 to provide anew raft of funds utilising the jurisdictions robust regulatoryenvironment, market flexibility and low cost services. �

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THE NEW FINANCIAL HUB

Finance and related administrative services account for around 12% of Malta’s GDP, with thegovernment aiming to build this segment to around a quarter of GDP by 2015. The financial sector’sgross value added in nominal terms grew by a rather respectable 22% last year and net financialinflows have contributed substantially to the contraction in the country’s long standing currentaccount deficit. Over the decade, Malta has distinguished itself as a cost effective, serious andadaptable jurisdiction in the field of financial services, backed by The Investment Services Act, 1994and a robust regulatory environment, overseen by the Malta Financial Services Authority (MFSA).2011 promises to be a challenging year, though the jurisdiction expects continued robust growth,despite some internal stresses. By Kenneth Farrugia, chairman, Finance Malta.

Kenneth Farrugia, chairman, Finance Malta. Photograph kindlysupplied by Finance Malta, November 2010.

WHAT MAKES MALTA so attractive? Malta, as ajurisdiction, has been firmly placed on the map offinancial centres within the European Union. It

has a number of attractions which include a robust yetdynamic legal and regulatory environment with anindependent judiciary, where innovation is encouraged. Italso has the benefit of a single regulator, the Malta FinancialServices Authority (MFSA), which is very approachable andcommitted to providing an expeditious and prompt serviceto new fund applications.

The island also offers political and economic stability. Maltajoined the EU in 2004 and adopted the euro as its nationalcurrency in 2008. It has emerged from the financial crisisvirtually unscathed and, in spite of the economic downturn,was one of the best performing EU countries with above planGDP growth; in fact, Malta was one of two EU countries thatmanaged to reduce its deficit in 2009. Despite the globalrecession, the financial services industry in Malta grew by 22%last year, and employment in the sector rose to almost 7,000.

Malta offers a well developed infrastructure, a skilled andsophisticated work pool and service providers with excellentlanguage skills. Moreover, its infrastructure and work pool arealso competitively priced. Skilled labour, professional feesand excellent office space with relatively low rents, are costcompetitive, especially when compared to other EUjurisdictions. Malta provides good telecommunications andair/sea transportation links with a high usage of InformationCommunication Technology (ICT). Malta is also within the

Central European Time (CET) zone—a somewhatunderestimated yet quite important factor.

Favourable fiscal and tax considerations includingexemptions from tax and stamp duties at both fund andinvestor levels, together with potential benefits from Malta’sextensive tax treaty network with over 50 countries, add tothe jurisdiction’s appeal. Equally, it offers other no lessimportant benefits, such as a unique culture, rich in historicaltreasures, an enviable Mediterranean climate and a sociallyenjoyable and secure environment.

This compelling package is increasingly attracting theattention of fund investors and managers, particularly at a timewhen the pressure for a higher level of supervision,transparency, reporting and organisational requirements isincreasing. On the banking front some 25 licensed creditinstitutions have already established operations in Malta ofwhich 20 are EU-country based.

An October 2010 survey The future of manager migration,fund servicing and domiciliation in the Mediterranean: Thealternative to Ireland & Luxembourg? carried out by theLondon-based International Fund Investment Limited,underscores Malta’s growing appeal and a salient trend forfunds to re-domicile to onshore jurisdictions withcomprehensive yet flexible legislation. Some 76% ofparticipants interviewed in the survey acknowledge thatMalta offers significant potential as a base for their funds orto open an office, while the majority of investors (83%) areaware that Malta is becoming a sought after alternative toIreland and Luxembourg. When asked if they would considerrelocating funds to Malta or Gibraltar as an alternative toLuxembourg or Ireland, 18% said they are looking at movingfunds to Malta or Gibraltar while a further 26% are open tothe idea, particularly if these locations continue to offerfund servicing on the same level as Ireland or Luxembourgbut at lower costs.

When questioned about their views on the regulatoryenvironment in the Mediterranean domiciles, all thoserespondents who visited the Malta Financial Services Authorityhad positive comments to make about the proactive approachthat the Maltese regulator has taken. One manager said thatthis was “Malta’s biggest selling point”. When asked if investorshave any views on the quality of fund service provision inthe Mediterranean domiciles, one interviewee said that he wasaware of the fact that several international fund administratorshad recently launched offices in Malta and regarded this asa positive step for the country.


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THE MED’S ATTRACTIVE ALTERNATIVEMalta has a new status in financial circles as itemerges as a sought after and reputableinternational financial services centre. Hailedby the City of London’s Global FinancialServices Index (2010) as one of the fivefinancial centres to grow in importance overthe coming years, the island is carving a nichefor itself in the global funds industry. In thelight of impending regulation in both Europeand the US, fund investors and managers areevaluating ever more carefully the jurisdictionof their choice. In the emerging new financialorder, Malta is regarded as a feasiblealternative financial centre. Charles Azzopardi,managing director, HSBC Securities Services(Malta) Limited outlines the opportunities.

Charles Azzopardi,managing director,HSBC SecuritiesServices (Malta) Ltd.Photograph kindlysupplied by HSBCMalta, November 2010.

FinanceMalta - Garrison Chapel, Castille Place, Valletta VLT1063 - Malta | [email protected] | tel. +356 2122 4525 | fax. +356 2144 9212

more information on:

securestable

robust

7 reasons why international financial institutions are dropping

anchor in Malta:

English as an official language;

Cost competitive skilled workforce;

EU member with euro as its currency;

Consistently highly ranked quality of life;

Meticulous yet accessible single regulator;

Robust yet flexible legal and regulatory framework;

Secure and stable business environment and a world class IT infrastructure.


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AS MALTA’S LEADINGinternational bank, HSBC BankMalta p.l.c. provides global

custody services to investment funds,whilst HSBC Securities Services (Malta)Limited provides a full range of servicesincluding fund accounting and transferagency. Both these companies form partof the HSBC Group which has one of thestrongest balance sheets in the industry

and which has the people and thetechnology necessary to provide anexceptional client service to investmentfunds seeking re-domiciliation to Malta.

HSBC Malta is connected to theGroup’s global network to tap best ofclass products, systems and customerservice, and is committed to playing apivotal role in the development of theMaltese financial services sector. HSBC

Malta has not only found Malta to be agood country in which to do business, butalso a country where the potential existsto expand operations and to diversify intonew areas. Malta offers a compellingpackage and we are convinced that Maltahas a very bright future.

HSBC at the financial heart of Malta

To reinforce the point: Malta is now ranked 50th among 139economies in a World Competitiveness Report issued by theWorld Economic Forum for 2010-2011. The same report ranksthe soundness of Maltese banks in 10th place.

The Vision 2015 strategyThe government of Malta has set an ambitious target todouble the financial sector’s contribution to the island’s GDPto 25% over the next five years as part of its Vision 2015strategy. So far, so good: over the first six months of the yearthe financial services sector’s gross value-added increasedby a significant 75%, suggesting that Malta is on the righttrack. No surprise then that that the number of funds registeredin Malta rose by 26% in 2008 and 27% in 2009.

Redomiciliation of FundsSince 2002, Malta has set up a statutory framework thatallows the re-domiciliation of companies in and out of theisland in a seamless manner. The utilisation of these rulesfor re-domiciliation of a fund to Malta has a number ofadvantages. For one, the corporate existence of the fundremains undisturbed and it is therefore not necessary to windup the existing fund and set up a new structure in Malta. Asa consequence of this continuity the investor’s capitalgains/losses are not crystallised and therefore there shouldnot be any tax consequences to investors. Investors can alsocontinue to measure the performance of the fund by referenceto their original investment. Equally, the fund can maintainits same service providers (fund administrators, custodians,prime brokers etc) and existing agreements can remainunchanged. Additionally, investors in the fund are not impactedand their holding in the fund will not change in any way.Likewise, the portfolio of the fund can continue to be managedin the usual manner without any liquidations or transfers.Moreover, funds that are already listed outside Malta cancontinue to retain their existing listing (subject to approvalof the exchange where the fund is listed).

Malta adopts international financial reporting and auditingstandards and because of that no major financial reportingchanges may be required post re-domiciliation. Fund managersalso have the opportunity to change the regulatory status oftheir fund to a UCITS scheme (provided the fund’s investment

strategy can be accommodated within this structure). TheUCITS brand will undoubtedly enhance the marketing reachof the fund as it is a brand that affords higher significantinvestor protection and transparency.

Reporting and regulationThe requirements set out by the Malta Financial ServicesAuthority to enable the re-domiciliation of funds to Malta arecomprehensive and include the following requirements: � The existing fund has to be incorporated under the laws of

an approved jurisdiction (including EU, EEA, OECD) aswell as most offshore centres such as Cayman Islands,British Virgin Islands, etc;

� The legal vehicle has to be similar in nature to a company;� Re-domiciliation is possible under the laws of the jurisdiction

where the fund is currently domiciled;� Re-domiciliation is permitted in the fund’s Memorandum

and Articles of Association; and� Re-domiciliation is approved by way of an extraordinary

resolution.Naturally, once the fund is re-domiciled to Malta, the

licensing requirements that would apply to a new fund willhave to be met as well.

Malta has also taken a balanced approach towards thehedge fund segment. Hedge funds have been regulated in thejurisdiction since the introduction of the Investment ServicesAct, which came into law in the mid-1990s. The approach tohedge funds by the local regulator has been flexible andwhile stringent due diligence procedures are obligatory bothin the licensing procedures and reporting regimes, differentcategories of alternative investment funds have beenrecognised and regulations in the jurisdiction are tailored tomeet the needs of different types of investors.

Malta is also cognisant of the globalisation of the fundsindustry and funds are allowed to have external administratorsand custodians in recognised jurisdictions.

Both the regulator and local service institutions are gearedto interface with the emerging regulatory structure in theEuropean Union and will be sufficiently equipped to delivereffective services to the financial sector as Malta grows instature and confidence as a new global financial marketstructure starts to take new form and shape. �

IT WAS NOT too long ago that Malta did not appear onthe radar screens of fund service providers. They weremore interested in setting up shop in the larger domiciles

of Luxembourg and Ireland. Today, Malta is a firm featureon the map thanks to a thriving fund industry and a relativelyhealthy economy. Hedge funds are the main focus but otherfunds are expected to be included as the country expandsits product and geographical reach.

Brendan Conlon, business development director at SGGGFexco Fund Services, Malta, says: “At the moment fund servicingmainly caters to the hedge fund industry but I expect that willchange with UCITS IV and the Alternative Investment FundManagers (AIFM) directive. They both will help to broadenthe fund set and investor base and in the future I think wewill see both hedge fund and long only managers setting upfunds in Malta because of the lower cost of doing businesshere and the strong regulatory framework. “

Dr David Griscti, head partner and founder of law firmDavid Griscti & Associates, says: “The real driver of growthin Malta is, and will be for now, the alternative investment fundarea. Although hedge funds have been the most popular, wehave also worked on setting up funds in a variety of otheralternative asset classes such as private equity, property,commodities, alternative energy and even art. Professionalinvestment fund (PIF) regulation is flexible enough toaccommodate different structures.”

Market participants also expect to see further growth fromre-domiciliation. As Anthony O’Driscoll, managing directorof Apex Fund Services, Malta, notes: “There has been a movefrom offshore to onshore jurisdictions over the past two yearsbecause investors want to see greater transparency andreporting processes as well as the internal controls and riskmanagement systems of their fund managers. In many cases,what we are seeing is not so much pure re-domiciling butinstead fund managers setting up onshore funds in Maltawhile keeping their offshore fund in the Caymans or Bermuda.

“One of the main attractions of Malta is that it is a low-cost jurisdiction that offers a favourable taxation system forinvestor funds. This is not only due to the exemption ofincome tax and capital gains tax at the fund and non-residentinvestor level but the country also has about 50 doubletaxation treaties in place.”

Joseph Camilleri, head of Valletta Fund Services BusinessDevelopment Unit, adds: “The financial crisis has been a majorcatalyst for fund managers who have had to rethink theirstrategies in relation to the domicile of their investment vehicles.Investors are placing more emphasis on risk and as a resultfund managers are looking for well-regulated jurisdictionswith a strong reputation for high quality people and professionalsupport. To date, the most popular types of funds have beenPIFs set up by mainly Europe-based fund managers, but weare now seeing other fund managers set up UCITS schemes.”

According to recent research conducted by research andpublishing group International Fund Investment, regulationis a driving force behind the move onshore. Its latest studyfound that 62% of alternative fund managers canvassedin the US and Europe either have—or are planning to—re-domicile their funds or launch mirror funds in the EuropeanUnion (EU). Breaking it down, 18% have already re-domiciled their funds or are planning to, while 44% havelaunched EU-domiciled “mirror” funds or expecting to. Interms of the domicile, Ireland emerged as the most popularchoice by half of respondents, followed by Luxembourg(27%) and Malta (20%).

However, many are considering Malta as well as Gibraltaras viable alternatives to Luxembourg or Ireland, with 18%saying they are thinking of moving to the smaller jurisdictionswhile a further 26% are open to the idea, particularly if theselocations continue to offer fund servicing on the same levelas Ireland or Luxembourg but at lower costs. Respondents alsosaw the increase in the number of international fundadministrators in Malta as a positive step.


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MALTA’S ONSHORE APPEAL TO FUND MANAGEMENT

The real driver of growth in Malta is, and will be for the foreseeable future, the alternativeinvestment fund area, according to Dr David Griscti, head partner and founder of law firm DavidGriscti & Associates. Although hedge funds have been the most popular, he says the country has alsoworked on setting up funds in a variety of other alternative asset classes, including private equity,property, commodities, alternative energy and even art. Market participants also expect to seefurther growth from re-domiciliation. There has been a move from offshore to onshore jurisdictionsover the past two years, says Anthony O’Driscoll, managing director of Apex Malta, because investorswant to see greater transparency and reporting processes as well as the internal controls and riskmanagement systems of their fund managers. “In many cases, what we are seeing is not so muchpure re-domiciling but instead fund managers setting up onshore funds in Malta while keeping theiroffshore fund in the Caymans or Bermuda.” Lynn Strongin Dodds reports.

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According to Kenneth Farrugia, chairman of FinanceMaltaand chief officer, Valletta Fund Services, the number ofinvestment services licence holders totals 88, a significant jumpfrom 59 in 2006. There are about 15 fund administrators but thepast two years has been particularly busy with Apex, SGGGFexco Fund Services, Custom House and Praxis setting upshop. Meanwhile, Bank of Valletta, which had been the leadingplayer, spun off its fund services operation as a separate businessto capitalise on the growing trend for fund administration.”

Under the PIF regime where hedge funds fall, funds canchose service providers such as investment managers, fundadministrators, custodians and prime brokers establishedoutside Malta. These providers in turn can also tend to fundsauthorised in other jurisdictions if the rules comply withMalta. However, the latest survey taken in December 2009shows that domestic players are gaining momentum witharound 47% of the total funds located in Malta beingadministered by local firms.

Overall, according to figures from the Malta FinancialServices Authority, there are about 431 funds domiciled in thecountry. Although activity dipped during the recession,HSBC’s statistics show that the industry regained its lustre withthe number of new funds rising 26% in the first quarter of thisyear compared to 22% in 2009 and 30% in 2008. This is a farcry from the 104 registered funds ten years ago.

Although both the number of funds and administratorscontinue to rise, the industry seems to still be dominated byfour players, with Valletta and HSBC being frontrunnersfollowed by Custom House and Apex. This is expected tochange as the fund business widens and develops. Camilleriof VFS, says: “Competition is definitely increasing but thisis healthy and one which I deem as being the evolutionary

process. The result is the industry is set to grow exponentiallyby way of not only the establishment of new fundadministrators but also the increasing incidence of fundmanagement companies setting up in Malta.”

Chris Bond, head of global banking and markets at HSBCin Malta, adds: “The dynamic growth of the fundadministrator business has prompted us to sharpen ourpencil. We have the advantage of being one of the globalplayers and also being able to leverage off the strengths andglobal footprint of the HSBC group. However, the growth ofthe market and new entrants means that we need to ensurethat we continue to have the best products and services.”

HSBC has the full range of products, including net assetvalue calculations, investor record processing, corporatemanagement services and turnkey fund solutions for newlaunches. Outsourcing has also become a major themeespecially in the middle office arena.

O’Driscoll says: “The collapse of Lehman Brothers andemphasis on counterparty risk forced fund managers in Europeand the US to look towards the multi-prime broker models.This requires support for multiple execution platforms, complexreconciliation, trade allocation and counterparty risk. As aresult, many managers find it more cost-effective and efficientto outsource these activities to administrators who can providenot only post-trade services but also pre-settlement tradeprocessing and support, position and trade reconciliation, fundaccounting and risk management reporting.”

Camilleri echoes these sentiments: “Currently, at VallettaFund Services, we provide our fund management clientswith a comprehensive suite of fund services to include turnkeyfund formation solutions, as well as the determination ofnet asset value and transfer agency services, anti-moneylaundering reporting services and company secretarial services.We are also experiencing an increased demand for middle-office reporting services as a result of fund managers decidingto outsource this function to their administrators.”

Although market participants are optimistic about thefuture growth prospects of Malta, many see the dearth ofcustodians on the island as a stumbling block to furtherdevelopment in the UCITS space. This is because underUCITS IV, managers can set up funds in any EU domicile,and manage these cross border, but the custodian has to bebased in the same domicile as the UCITS.

All eyes are on Deutsche Bank, which recently upgradedits licence in the country. The German bank is keeping tight-lipped about its plans, only issuing a statement confirmingthat it was granted a “credit institution licence in March 2010,replacing its existing financial institution licence. The bankcurrently continues with its existing business and might alsolook into further business opportunities in the future.”

Farrugia says: “The industry is experiencing the developmentof a cluster by way of the setting up of international fundadministration companies as well as fund managementorganisations. It is however yet to experience growth in thedepositary/custody sector. I am confident that over the courseof next year, Malta will experience the setting up of otherinternational custody service providers”. �


Joseph Camilleri, head of Valletta Fund Services Business DevelopmentUnit. “Investors are placing more emphasis on risk and as a result fundmanagers are looking for well-regulated jurisdictions with a strongreputation for high quality people and professional support,” he says.Photograph kindly supplied by Valletta Fund Services, November 2010.

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MALTA MAY BE a fraction of the size of Luxembourgand Ireland, but it has enjoyed success on the globalalternative investment fund stage. The country plans

to increase its market share in the wake of regulatory calls forgreater transparency and the ensuing migration to onshorejurisdictions. The funds setting up shop may be small todaybut the goal is to provide the right environment for them toflourish. Since its entry to the European Union in 2004 andthe adoption of the euro four years later, the country’s profileas an onshore jurisdiction has been cemented. The latest2010 Global Financial Centre Index (GFCI) named Maltaalong with Dubai and Shanghai as one of the top threefinancial centres most likely to succeed over the next two tothree years. In addition, as the country continues to punchabove its weight, it climbed to 11th from 13th in financialmarket development on the World Economic Forum’s GlobalCompetitiveness Index 2010-2011.

Kenneth Farrugia, chairman of FinanceMalta, and chiefofficer of Valletta Fund Services, says: “Malta's fund industryis fast gaining growth traction and is today being increasinglyrecognised as an EU-based fund domicile alongsideLuxembourg and Ireland. Malta sits in a unique geographicalposition as a member of the EU and very close to the southand south-east fascia of the Mediterranean. This inherentlymeans that Malta is positioned to act as an important gatewayto the European market and at the same time to North Africa

and the Middle East. This makes the country a highlycompelling proposition for both EU and non-EU financialinstitutions seeking to gain access to European investors andthe Arab world at the same time.”

Low costs have also been a major selling point. Industryestimates place professional fees, salaries and office expensesat roughly two-thirds of those in the more established centres.Anthony O’Driscoll, managing director of Apex Malta, whichis part of the Apex Fund Services, says: “Although Malta will neverbe a Dublin or Luxembourg because it will not attract the samedeal volume, the country is a viable option. The main attractionsare not only the low set-up costs, but a strong regulatoryframework, fast-track approval process, quality global serviceproviders and an extensive double tax treaty network. Theaverage size of the fund may start small—€5 to €20m—but wehave in the past seen clients grow their assets under managementquite quickly having started at that base.”

Dr David Griscti, lead partner and founder of law firmDavid Griscti & Associates, a specialist in investment serviceslaw, says: “The fund industry took off after our entry into theEU. Some would say that it has been a negative that we didnot initially attract the larger players. I, however, see it as apositive because the country was not then in a position tohandle it. Attracting the smaller players allowed theprofessional service’ firms to grow their internal resourcesand as a result we are now able to deal with the larger funds.”


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PUNCHINGABOVE ITSWEIGHT

Since its accession to the European Union sixyears ago, and the adoption of the euro in2008, Malta’s profile as an onshore jurisdictionhas been firmly established. The latest 2010Global Financial Centre Index named the islandin the top three financial centres most likely tosucceed in the next couple of years, along withDubai and Shanghai. Also, Malta climbed to11th from 13th in financial marketdevelopment on the World Economic Forum’sCompetitiveness 2010-2011 Index. LynnStrongin Dodds explains how a small countrywith a population of less than half a million isbuilding up the financial muscle to be able tocompete with the big boys.

Photograph © Ronfromyork /Dreamstime.com, November 2010.

Chris Bond, head of global banking and markets at HSBC inMalta, agrees that “Malta has a strong professional infrastructureas well as a robust regulatory framework which is aligned withEU requirements”. He adds: “Our regulator in general hasadopted a firm but flexible approach. The other benefits ofworking in Malta are a multilingual and educated workforce anda well capitalised and sound banking system. Due to a strongliquidity position and prudent asset/liability management,none of the banks needed a bailout from the government.”

Prof Joseph Bannister, who has been chairman of the MaltaFinancial Services Authority (MFSA) since 1998, concurs thatits hands-on approach has been one of the secrets of Malta’ssuccess on the fund scene. He has been instrumental innavigating the country from being an offshore domicile inthe pre-EU days to its current onshore status. With him at thehelm, the MFSA implemented a raft of reforms in preparationfor EU membership, plus it became a single regulatoramalgamating the work carried out by several agencies.

More recently, the MFSA underwent a further restructuringand shed its silo-based structures in favour of an integratedand harmonised organisation. The main thrust was removingthe authorisation and regulatory development oversightfunctions from each of its three supervisory groups—securitiesand markets, banking and insurance and occupationalpensions—and creating two separate units. This was to ensuregreater consistency in licensing, supervision and internalcommunications.

Bannister notes: “The nature of the regulatory regime isone of the key things that financial institutions look at whenthey are considering setting up in a new jurisdiction. I thinkour model as a single regulator is unique. We cherry-pickedthe best practices from countries such as Germany andSweden and have been very proactive in the development ofboth EU as well as national legislation. Our goal is to enactlaws that allow business to develop innovative practices.”

Griscti adds: “The fund industry took off post-EUmembership, mainly driven by flexible and market sensitiveregulation that reacts swiftly to market changes and issuesthat arise. However, the key drivers are the professional firms,like ourselves, whom are extremely proactive in going outto get the business. We, for example, target asset managersand visit them in their offices to discuss how we can helpthem set up funds.”

In terms of regulation, the linchpin has been the InvestmentServices Act, which is a comprehensive regulatory regimefor investment services and collective investment schemes(CIS), including professional investment funds. Overall, thefund industry has enjoyed significant growth since ten yearsago when the net asset value (NAV) of the funds domiciledin Malta stood at just €500m. The recession took its toll buttotal NAV has recovered, climbing steadily from its low pointof about €6bn during the height of the crisis in June 2009 to€7bn in December 2009 and €7.9bn for the first half of 2010.

Personal investment funds (PIFs) continue to account forthe bulk of the 431 funds domiciled in Malta and the 51funds that were granted licences during the first half of 2010.By contrast, the number of Undertakings for CollectiveInvestments in Transferable Securities (UCITs) funds remainedthe same at 45 while non-UCITs fell three to 33. JosephCamilleri, partner at PricewaterhouseCoopers in Malta, says:“Asset managers can choose from a range of fund structures,including UCITs, but PIFs have been the most popular todate. The PIF regime is flexible and allows for a smooth andefficient application process. The vast majority are start-upfunds and most of the investors are from Europe, althoughwe are seeing some interest from North America.”

Minimum thresholdPIFs are broken down into three categories, with theexperienced investment fund at one end of the scale. Itrequires a minimum investment threshold of €10,000. Thesefunds are not bound by any investment restrictions as is thecase with retail funds but they are still required to appoint acustodian and can only leverage up to 100% of NAV.

In the middle is the most common—the qualifying investorfund—which requires a minimum investment of €75,000. Thesefunds are not subject to investment or borrowing restrictionsand may make unlimited use of leverage. They also do notneed to appoint a custodian or prime broker provided adequatesafekeeping arrangements are implemented. Last but not leastis the extraordinary investors category, which joined the fold in2007. They are geared towards private equity investors andfamily offices with the minimum investment threshold standingat €750,000. The turnaround process is faster than the othertwo and they have proved popular for those looking to movefrom an offshore to onshore location.

According to Farrugia: “The MFSA has ensured the presenceof a comprehensive legal and regulatory framework to caterfor the different needs of fund managers and their clients. Theregulatory framework for PIFs is highly flexible andaccommodates a variety of fund structures to cater for a widerange of fund strategies, which amongst others include long


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Dr David Griscti, lead partner and founder of law firm David Griscti &Associates. “Attracting the smaller players allowed the professionalservice’ firms to grow their internal resources and as a result we arenow able to deal with the larger funds,” he says. Photograph kindlysupplied by David Griscti & Associates, November 2010.

Ganado & Associates Advocates, a leading law �rm with a predominantly international practice, provides integrated legal services across all practice areas. Our multi-disciplinary team takes a constructive hands-on approach to deliver a bespoke service to our international business clients.

For more information on how we can help please call +356 2123 5406/7/8, email law�[email protected] or visit www.jmganado.com

INVESTMENT FUNDS SECURITIES LAW TRUSTS CAPTIVE RE-INSURERS PENSIONS & QROPS INTERNATIONAL BANKING CORPORATE FINANCE MERGERS & ACQUISITIONS JOINT VENTURES PRIVATISATION TAXATION EU PASSPORTING SHIPPING AVIATION CORPORATE SERVICES LITIGATION & ARBITRATION EMPLOYMENT INDUSTRIAL & LABOUR TELECOMS, MEDIA & TECHNOLOGY INTELLECTUAL PROPERTY COMPETITION PUBLIC PROCUREMENT ENVIRONMENTAL LAW RESIDENCY PROPERTY CONVEYANCING MEDICAL & HEALTH ENERGY & RENEWABLES

Eyes see opportunity

Ganado& AssociatesA D V O C A T E S

where minds comprehend

short strategies, arbitrage funds, directional, global macroand algorithmic funds. The MFSA also has in place policiesto accommodate property funds which may likewise bestructured as PIFs. We have also experienced the PIF regulatoryframework being used to structure private equity and venturecapital funds.”

Looking ahead, market participants expect to see furthergrowth opportunities on the back of UCITS IV and theAlternative Investment Fund Managers Directive (AIFM)which was recently approved by the European Parliament. Onthe UCITS IV front, Malta hopes to capture business fromchanges within the master and feeder structure. Under thenew rules, the master and feeder funds are not required to besituated in the same member state plus they may also havedifferent depositories and auditors, subject to implementingadequate information-sharing arrangements. For example,fund providers could establish a management company underUCITs IV in Malta while keeping their fund administrationin Luxembourg or Ireland.

There is also hope that both pieces of legislation will bringdifferent types of funds to the country as well as acceleratethe trend of hedge funds wrapping certain strategies in aUCITs umbrella. Farrugia says: “We have seen an increasein the number of so called ‘Newcits’ funds in Malta, or hedgefunds that create UCIT funds to mirror their strategies. Thisis being driven by investors who want a more transparentand tightly-regulated product in the wake of the Madoffscandal and financial crisis.”

Liquidity for investorsBond, however, is more circumspect about the Newcit product:“Newcits account for a relatively small percentage of the€5.5trn UCITs market. There are still constraints, bans onshort selling and OTC derivatives rules which will makecertain hedge fund strategies ineligible for a UCITs structure.Liquidity for investors is also a major issue. Having said that,Malta is still seeing growth in the UCITS space.”

Although Europe is an important region, Malta is alsohoping to capitalise on its ties with its North African andMiddle Eastern neighbours. To that end, Farrugia notes:“Malta is also seeking to attract the setting up of Shari’ah-compliant funds. Within this context, in March 2010, theMFSA published a guidance note for Shari’ah-compliantfunds, which enable the setting up in Malta of such funds. Thisregulation allows these funds to be set up either as retailfunds (UCITS or non-UCITS) or as PIFs. However, in thespecific case of Ijarah funds (which are structured around aspecific asset, such as a building, property, or infrastructure),commodity funds, and Murabaha funds—a method offinancing the purchase of a house according to Islamicprinciples—these can only be set up as PIFs, due to thelargely non-conventional assets in which these funds invest.”

The country is also looking towards Asia and the MFSAsigned a memorandum of understanding (MoU) earlier thisyear with the China Securities Regulatory Commission to“protect and promote the development of the securities marketsby providing a framework for co-operation, increased mutual

understanding and the exchange of information”. According toBannister, the deal allows Chinese “qualified domesticinstitutional investors” (fund managers) to invest on behalf ofChinese investors into Malta-domiciled investment funds, bothPIFs and UCITS, while Maltese fund managers will also beable to tap into Chinese investments under certain circumstances.

As for the obstacles ahead, economic uncertainty is ofcourse a concern. Bond notes: “As Malta has an open economyit was not isolated from the global downturn. However, wedid not shrink as much as others. Our GDP growth rate iscurrently estimated at about 3.4% this year, which is betterthan the European average.”

The other big challenge is a skills shortage which might notbe surprising in a population of around 413,000. Companiesas well as MFSA and trade organisations are trying to rectifythe problem by running professional development courses andretraining to ensure members of the sector are up to speedwith the latest developments and techniques. Bannister notes:“Although our population is small, there are over 10,000 full-time university students and an additional 11,000 in vocationaltraining. We also have several training institutes which havecome together to design programmes aimed to train themiddle layer; asset managers, risk managers, fund accountantsand underwriters.”

Expats are also coming back but as Camilleri notes: “Humanresources and a limited talent pool in a dynamic and growingsector is one of the biggest problems the financial servicessector in general faces. Over the past five to ten years, weexported our graduates but recently, due to the growth infinancial services, there has been a huge demand for the bestand brightest and we are now importing people from otherEuropean countries to meet the demand. We are still sendingpeople on long-term strategic deployments to different countriesto learn certain skills and bring back their expertise.” �


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Chris Bond, head of global banking and markets at HSBC in Malta.“Malta has a strong professional infrastructure as well as a robustregulatory framework which is aligned with EU requirements,” he says.Photograph kindly supplied by HSBC, November 2010.

Sparkasse Bank Malta plc is authorised to conduct Banking business and to conduct Investment Services business by the Malta Financial Services Authority (MFSA).

P R I V A T E & C O R P O R A T E B A N K I N G / W E A L T H M A N A G E M E N T / C U S T O D Y

18:20

THE EXTERIOR OF the 19th century British GarrisonChapel, which is home to the Borza Malta or MaltaStock Exchange, may have retained its period features

but the offices inside are anything but old-fashioned. State-of-the-art technology coupled with innovative ideas and adetermination to be a player on the global stage are itshallmarks. The MSE may be small in stature but its plans areon a much larger scale.

Eileen Muscat, chief executive of the MSE, says: “EuropeanUnion membership and entry into the euro was transformationalbecause it helped us attract a wider investor and issuer base.However, the performance of our stock market during thefinancial crisis combined with the 2010 Global Financial CentreIndex Report, which named Malta as one of the top three financialcentres for the future, has definitely raised our profile andboosted investor as well as issuer confidence. We are notcomplacent and what we are doing now is trying to capitaliseon our positions in the league tables.”

Muscat, who took over the helm this year and has been withthe exchange since it opened in 1992, is driving the changeslaid down by her predecessor, Mark Guillaumier. The objectiveis to internationalise and promote the exchange to investorsas well as issuers. It has taken its show on the road and hasbeen proactively marketing its pre and post-trade wares toan audience which is more interested in onshore locales inthe wake of the financial crisis.

She says: “To date, the exchange has been largely a domesticoperation with activities geared towards the local market.However, growth is finite because we are a small country and

our strategy has been to push for international listings andparticipants. We see ourselves as acting as a gateway for issuersfrom non-European countries to tap into a European investorbase and vice versa. This is especially true of North Africaand the Middle East investors and issuers who we have culturalties with because of our geographical position in theMediterranean. We are currently holding several discussionsto see what fund managers in the region are doing and whatproducts clients would like to see being developed.”

Muscat notes that the MSE’s plan to expand its reach andproduct offering is part of the government’s 2015 Visioninitiative which aims to make financial services account for25% of the country’s GDP. She says: “Financial services alongwith healthcare, tourism, information technology andcommunications are the four pillars of growth that thegovernment is targeting for development. We think thatattracting more local and foreign companies onto the exchangewill have a domino effect. We are looking to not only listmore funds and bonds but also smaller cap companies. Webelieve that they may find it easier to deal with us than someof our larger competitors. We offer a fast, efficient and personalservice at very cost competitive prices.”

The MSE, which is small by international standards with amarket capitalisation of about €7.6bn, operates two markets—the Regular Market, consisting of equities, corporate andgovernment bonds, and the Treasury Bill Market—but it hascome a long way in its almost 20 years. Muscat recalls: “Whenwe started there were only about 8,313 accounts in the centralsecurities depository. Today we have about 170,000 accounts.


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MSE AIMS TO BE AGLOBAL PLAYER

The Malta Stock Exchange intendsto capitalise on its positions in theleague tables with the objective ofinternationalising and promotingitself to investors as well as issuers.It has taken its show on the roadand has been proactivelymarketing its pre and post-tradewares to an audience which ismore interested in onshore localesin the wake of the financial crisis.Eileen Muscat, chief executive ofthe MSE, says: “We see ourselvesas acting as a gateway for issuersfrom non-European countries totap into a European investor baseand vice versa.” Lynn StronginDodds reports.

Photograph © Solarseven /Dreamstime.com, November 2010.

What is the significance of Deloitte becoming the world’s largest professional services firm? In all honesty, we believe very little.

Our focus is on helping our clients establish, define and achieve their vision so that they can step ahead with confidence in all

aspects of their business. And our aim has always been, and will always be, to put our clients first.

At Deloitte we have a dedicated team of individuals specialised in providing assurance, advisory and tax services

to companies operating in the investment services sector. For more information on how we can help, please contact Steve

Paris at [email protected] or Andrew Manduca at [email protected] or visit ww.deloitte.com/mt

Step ahead.

© 2010 Deloitte

We started with government bonds and then moved to corporatebonds and equities. Aside from government bonds and treasurybills, we have about 20 listed equities and 40 corporate bondsas well as over 300 funds from global players including HSBC,Fidelity and Lloyds TSB. Culturally, Maltese people are buyand hold investors but that is slowly changing and the numberswho are regular traders is growing.”

Although Malta navigated the financial storm better thanmany of its larger contemporaries, the stock market did take ahit on the equity trading side with turnover dropping to €23.5min 2009 compared to €49.1m the previous year. Total turnoverthough climbed 13.3% to €553m, an increase of 13.3% comparedto 2008, mainly thanks to record activity in the corporate bondarena which saw 12 new listings, 11 new government securitiesissues as well as a €1.6bn treasury bill listing.

The MSE is building upon its successes and is currentlyundertaking four to five major projects, including thedevelopment of investor access facilities, improvement ofconnectivity and the revamping of research and marketingfunctions. It is also looking at listing a wider selection offunds, including exchange traded and Shari’ah-compliant.While it has been successful in listing retail collectiveinvestment schemes, it has had less luck with hedge fundsand the alternative sector. The hope is that it will be able totap into a new vein of business on the back of regulatorychanges that are encouraging products to be exchange tradedinstead of traded over the counter.

The other major plank in its strategy is to the replacementof its trading platform. Unlike many of its contemporariesthough, latency is not the main focus. Muscat says: “Althoughthere have been several discussions around high-frequencytraders, they have not been an issue in Malta because we donot generate the same level of volumes on the equity side. Wedo not see technology as an end in itself but a means to anend in order to improve our connectivity and functionality.The main goal is to attract more liquidity.

“We are also working on our first cross listing, which wehope will happen by the end of the year or the first quarter ofnext year. I am on a learning curve from an operational pointof view but I hope that once it is finished it will raise our profile.”

The MSE has also been working on the finer points. Itrecently revised trading limits to plus or minus 10%, giving

a daily range of 20% in order to allow market participants toreact faster when a company announcement is made.Although trade ranges had been revised several times sincethe exchange’s inception 18 years ago, many believed themethodology and procedures needed to be more proactive.

In addition, the MSE launched a product in line with theEU’s shareholder directive, that enables shareholders to takepart in annual general meetings electronically. It will be rolledout initially to domestically-listed companies before going tonon-listed companies such as fund managers and administratorswho need to maintain company records and a share register.

On the post-trade front, the MSE has been busy forgingtechnical links with other exchanges, depositories andsettlement systems. It recently joined Euroclear’s FundSettle,a system that facilitates order routing, cash settlement and fundservicing across national, European and international borders.It is used as a settlement platform between fund distributorsand transfer agents acting for fund promoters. The platformprovides access to more than 50,000 funds and 520 transferagents in 24 domiciles, including Malta.

The MSE also struck a partnership with Clearstream, thepost-trade arm of Deutsche Börse Group, to offer settlementfor Maltese domestic securities. Both parties will be workingclosely together with the aim to improve cross-bordersettlement ahead of the implementation of Target2-Securities,the settlement system that the European Central Bank plansto introduce in 2014 for cross-border settlement.

A work in progressAlthough the deal is still a work in progress, Clearstreamand the MSE will offer settlement in Clearstream via theMaltese Central Securities Depository (MCSD) for all typesof Maltese securities including stocks, government securitiesand investment funds against Central Bank money.

Muscat says: “The Clearstream deal will be done in phasedstages but it allows us to offer a wider range of services to ourclients. All Maltese stocks will be cleared and settled inClearstream, which will make them more marketable andeasier for international investors to invest in. The most difficultpart of the process was the legal, regulatory and operationalframework and that part has been completed.”

As for its involvement in TS2, Muscat notes: “We arecurrently involved because we are one of the 27 CSDs, althoughwe are one of the smallest. Although no one is arguing againstthe common principle there are still fundamental questions,particularly pricing and governance structures. These are allopen to discussion and agreements may not be easy becauseof the diverse needs of the various users.”

In terms of the MSE’s challenges, Muscat points to humanresources as the biggest obstacle. “It is a problem in Maltaoverall but like any small organisation we need the resourcesin order to achieve these goals. With the best will in theworld, you can only stretch as far as your finances and people.Also, as the market becomes more international andsophisticated, you need people with greater expertise andknowledge. This is changing and we have sent many peoplefor training but it takes time. “ �


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Eileen Muscat, chief executive of the MSE. “Financial services along withhealthcare, tourism, information technology and communications are thefour pillars of growth that the government is targeting for development,”she says. Photograph kindly supplied by MSE, November 2010.


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PRIVATE EQUITY FUNDS have traditionally usedMaltese special purpose vehicles to invest in targetcompanies in view of Malta’s common law based

company law regime, favourable fiscal environment forholding entities bolstered by the benefits of the relevant EUtax directives and an extensive OECD based double taxationtreaty network (56 in number with effect from the first ofJanuary 2011). However Malta has rarely, up until now, beenresorted to as the domicile of choice for the main fund vehicleitself or for its general partner.

Malta’s regulatory framework allows private equity fundsto be set up as so called professional investor funds which maybe made available to different types of investors. From astructural point of view most private equity funds are typicallyset up as limited partnerships. Limited partnership legislationhas formed part of the Maltese Companies Act for a numberof years. A Maltese limited partnership has its obligationsguaranteed by the unlimited and joint and several liabilityof one or more partners, called general partners, and by theliability, limited to the amount, if any, unpaid on thecontribution, of one or more partners, called limited partners.

In 2003 new provisions were introduced in the CompaniesAct which specifically provided for the possibility for collectiveinvestment schemes to be set up as limited partnerships witha partnership capital divided into shares. Indeed suchpartnerships fall within a clean and concise corporate frameworkwhich allows a limited liability company to act as the generalpartner of the fund, albeit the general partner would beunlimitedly liable for the obligations of the fund. The generalpartner would not be required to obtain a licence or otherauthorisation from the Malta Financial Services Authority(MFSA) so long as it is not providing investment managementservices to the fund.

Nevertheless, the Companies Act was still unclear wherelimited partnerships with a partnership capital which is notdivided into shares were concerned. Indeed the law did notspecifically provide that such partnerships could also becollective investment schemes so doubt subsisted as towhether it was indeed possible for investment funds to be set-up as such types of partnerships. In addition the generalpartners of such a vehicle had to be an individual or else a bodycorporate (i.e. an entity with separate legal personality) whichhas its obligations guaranteed by the unlimited and jointand several liabilities of one or more of its members.

These somewhat archaic rules made it unrealistic forpromoters to set up their fund in Malta as a limited partnershipnot divided into shares since the general partner could notbe a limited liability company in its own right. So while theissue of the corporate form of the general partner was resolvedin 2003 with regard to limited partnerships with a partnershipcapital which is divided into shares it remained for thoselimited partnerships with participation rights rather thanshare capital. Considering that the vast majority of private

THE NEW PE DOMICILE

The uncertainty created by the AIFM Directive together with the changes which are expected tooccur to the European regulatory landscape have encouraged private equity funds to seekalternative onshore domiciles to what has traditionally been an offshore industry. The success ofthe Channel Islands in attracting private equity funds from all over the globe is a well known factand a statistic which speaks for itself. Now Malta is setting out its stall as a natural home for theprivate equity segment. Steve Paris, head of Financial Services at Deloitte and Dr. Andre Zerafa,partner, Ganado and Associates, Advocates outline the advantages.

Photograph © Chrisharvey / Dreamstime.com,supplied November 2010.


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equity funds are set up as limited partnerships withparticipation rights this meant that Malta has not alwaysbeen perceived to be a viable domicile of choice for limitedpartnerships without share capital.

These limitations are now being addressed through newregulations which will enable a Maltese limited partnershipwith a partnership capital which is not divided into shares tohave a general partner in the form of a Maltese or a foreignconstituted limited liability company.

Furthermore if the fund is constituted under a foreign law(such as Cayman, English or Scottish law) then it would stillbe subject to licensing in Malta so long as it is carrying onany activity in Malta. The MFSA has taken the view that theactive marketing of such funds in Malta to Maltese professionalclients would trigger a licensing requirement in Malta. It isthen the choice of the promoter whether to incorporate thegeneral partner in Malta or elsewhere, although it is necessaryfor the general partner to be a company resident in Malta inorder for the fund to be resident in Malta for Malta tax purposes.

Another alternative used over the years by some promoterswas to set up the fund as a SICAV which is a variable sharecapital company. SICAVs are generally open ended investmentvehicles however the Maltese Companies Act provides forsufficient flexibility for SICAVS to lock-in investors for anumber of years as long as a mechanism is included in thefund’s memorandum and articles on the manner in which thefund will handle redemption requests. Specific regulations havealso been issued on the manner in which SICAVs can makedrawdowns from investors. This was a welcome clarificationsince SICAVs are not allowed to issue partly paid shares norare they allowed to issue shares at a discount.

The MFSA have also issued supplementary conditionswhich apply across the board to all types of funds whichhave a drawdown mechanism embedded in their structure.The main principles of these conditions stipulate that anyrequest on committed funds shall be effected pro-rata amongall relevant investors in the fund and that the fund may onlymake a fresh call for further commitments once all outstandingcommitments from existing investors have been requested.

Apart from the regulatory and structural aspects, the taxtreatment of fund vehicles in Malta is also fundamental andshould be considered up front. In terms of Maltese tax law theincome of a collective investment scheme is exempt fromtax at the level of the fund. Taxpayers also deriving income fromother activities or sources remain liable to tax in Malta but the

income or gains derived from the fund’s activities representan exempt category of income. Certain limitations do applyto the blanket tax exemption, but they should be of no concernto funds investing primarily in assets situated outside Malta.

The Malta tax exemption on income or gain derived bythe fund’s activities is supported by a zero withholding tax onoutbound distributions to all persons, whether individuals orcompanies, regardless of their country of residence and aexemption from tax in Malta upon the disposal or redemptionof the interest held in the fund regardless of its legal form.Similarly no withholding taxes are levied in Malta on theprovision of services to persons resident in Malta by personsresident outside Malta, regardless of their country of residence,provided that the supplier does not have, in Malta, apermanent establishment with which the relevant service iseffectively connected.

Tax exemption at the level of the fund coupled with thepossibility of source country withholding tax mitigationthrough resort to Malta’s tax treaty network and no taxes inMalta on distributions to, or gains realised by, investors bringstogether the benefits of an onshore location without thecosts typically associated therewith.

As an EU member state, Malta has implemented theEuropean VAT directive and is thus exempt from VATtransactions in securities and the provision of services relatingto the management and administration of funds. While theworkings of the EU VAT system may, in practice, result inan element of unrecoverable VAT at the level of the fund orthe fund manager, the extension of the VAT exemption toalso cover qualifying outsourced services considerably reducesthe instances which may give risk to unrecoverable MaltaVAT. This aspect coupled with a reasonable degree ofappropriate planning typically ensures that Malta VAT doesnot in fact represent a material cost to a fund or fund managerestablished in Malta.

Malta is rapidly establishing itself as an attractive domicilefor private equity funds. The planned innovations to itscorporate laws, which are imminently expected, will increaseMalta’s attractiveness in an interesting and challenging phaseof European regulation where funds will be expected to bemore transparent in their dealings and opt for onshorestructures, particularly for their European based clients.Malta’s legislative framework should be able to address andaccommodate the business models preferred by private equityfund promoters within a robust regulatory framework. �

Dr. Andre Zerafa, partner, Ganado and Associates, Advocates. Photographkindly supplied by Ganado and Associates, Advocates, November 2010.

Steve Paris, head of Financial Services at Deloitte. Photograph kindlysupplied by Deloitte, November 2010.


MALTA IS ONE of the locations looking to establishitself as a domicile of choice for the funds industry.It faces a challenging time in an environment of

fewer new fund start-ups, but it is possible that there areadvantages to its emergence in period where there is such aseismic shift in what investors are demanding when theychoose to allocate. The drive towards greater transparency,relevant and robust regulation and the increasing importanceof the role of the administrator provides this relatively newjurisdiction with an opportunity create a model that willspecifically cater to these demands.

The hedge fund industry has had to react to the events ofrecent years and nowhere is this more evident than in thesupport industries that service it. Specifically, the role of anindependent administrator has moved from a position ofalmost being seen as a necessary expense to playing a criticalrole in the legitimacy of a fund product. The domicile of thefund and the requirements it puts on the administratortherefore are key elements in the evaluation of the fund andin providing comfort to the investor.

Administrators today are presented with increasingchallenges to provide more for less. The advance in thedemands for further transparency has led to increases intechnology requirements as the profile of the averageadministrator moves from a traditional accounting servicesonly provider to a partner in an overall complex fund product.The challenge for the administrator is to meet these increasingrequirements without adding extra cost to the fund and aflexible, low cost, EU centre such as Malta can become a

useful tool for a global administrator. As well as servicinglocal Maltese funds there is an opportunity for Malta toposition itself to service funds of other jurisdictions as part ofa global operating model. There are no regulatory barriersto this and the abundant availability of knowledgeable localstaff it is possible that we may see Malta emerge as a locationfor the wider funds industry to take advantage of.

Malta has attempted to position itself as an alternative forthe industry that offers the experience of what could be calledthe ‘offshore product’ but with the benefits of an onshoreapproach. The global trend as we have mentioned is forincreased transparency and regulation and empowering theinvestor. Combining these distinct requirements in a flexibleoperating environment is where Malta has an advantage.

Practical regulationThe Maltese regulator has been quick to identify that thecombination of EU membership and a practical regulatoryenvironment will be key factors in its favour to attract managerswho look to create a product that can compete with thetraditional jurisdictions. When choosing who to partner within Malta, the fund looks for a local presence with a global reach.

There is a challenge when selling Malta to the globalmarket as to why one would choose to do business thereand therefore the global recognition of the service providerprovides comfort. This is why we now see more and more ofthe major providers opening offices in Malta.

To date the experience has been for the administrator toreact to the requirement of the funds to establish in Malta

MORE FOR MORE

The evolution of financial markets and how specific regions react is one of the more interestingobservations one can make today. What makes one location more appealing than the next? Whydo new centres emerge and others fade and why are some enduring and what will happen in thefuture? The criteria that define these trends evolve in response to market conditions and also asreactions to successes and failures in the response to these drivers. By Mark Hedderman, chiefoperating officer, Custom House.

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Photograph © Madmaxer /Dreamstime.com, November 2010.

rather than the funds choosing to locate there because of theproximity of service providers. This is evident in the concentrationof the small number of existing providers around large fundstructures. As with all new trends there may be a requirementfor a period of time to elapse to establish a footprint and provethat there is substance to what is taking shape.

One of the key advantages that Malta has is the presenceof some of the major names in the financial services world thatexist in a capacity outside the funds industry but are positionedthere to support it. The ‘big four’ audit firms have operationsthere and have already shown a willingness to engage withthe administrators in assisting them to support their clients.

An interesting new dynamic that we have seen is anopenness to assist the administrator outside traditional auditservices. A major challenge for hedge fund administratorsis the preparation of financial statements as per the statedaccounting standards of the fund. It used to be the case thatthe administrator would hand over their NAV valuations tothe auditor who would then prepare the audited financialsto IFRS, US GAAP etc.

This obvious conflict of interests was identified in recentyears as a dilution of the auditor’s function and specific referencewas made to this in the famous Sarbanes Oxley Act of 2002. Theculmination of this was a move away from the preparation ofthe financial statements by the auditors and the onus was,correctly, placed on the administrator to provide prepare thestatements for audit. This placed challenges on the administratorwho was not positioned to handle it and responses varied fromthe development of an in house function to the full outsourcingto specialist (not big four) accounting houses.

What has been refreshing in Malta, which we have notwitnessed elsewhere yet, is the willingness of the audit firmsto prepare financial statements for funds that they are notthe designated auditor of and therefore facilitate theadministrator in their responsibilities. This practical andflexible approach has been very useful in the establishmentof a new administrative operation where the pressures tostart from scratch can sometimes lead to an overlooking ofthis vital function.

SICAV structuresThe use of the SICAV in Malta and its ability to handlemultiple sub funds with their own cross collateral riskprotection has been popular for both the institutional andstart up structures. As the administrator of the largest numberof funds in Malta, Custom House has been exposed to bothends of this spectrum. On one hand there is the Innocapstructure which offers investors access to a wide variety ofunderlying managers via a suite of products at a feeder level.This structure has approximately one hundred valuations inits overall composition and is valued daily, making it one ofthe most high volume and complex products for anadministrator to handle. At the other end we have theNascent Fund SICAV which is a new umbrella productspecifically designed for emerging managers to cut theirteeth in a protected structure that offers legitimacy whilethey establish their track record.

The flexibility in the structure means that managers canbreak free and establish their own stand-alone vehicle oncethey have reached a suitable size. The SICAV allows for bothof these models to exist and the flexibility and protectionoffered make them attractive in their respective worlds.

The impact of UCITS IVThere are already a number of UCITS structures operatingsuccessfully in Malta where they have targeted the Italian,Spanish and French markets. Adopting the UCITS IV directiveand in particular its impact on the master-feeder structure willplace additional reporting requirements on administrators.Efforts are already underway to align reporting requirementswith existing models and the successful administrators willbe the ones who have flexible report writing capabilitieswhich has become an essential element of any business thesepast few years as reporting requirements ever expand.

The financial services industry grew by over 20% in Maltain 2009. In the context of an environment of fewer fund start-ups there is obviously traction gaining to the Maltese story.Malta needs to position itself as a brand and also as a legitimatealternative to Dublin and/or Luxembourg. Prioritising theflexible and practical nature of the regulatory environment isvital to ensuring that Malta continues to separate itself fromthe more established locations.

Membership of the EU and what this entails for theinternational managers and investors should be put to the frontalong with the adoption of the UCITS IV directive. Maltamust ensure that it retains its evolving reputation as a ‘can-do’ business centre for both funds and their service providers.It must focus on reigning in inflationary pressures that impactthe cost effectiveness of locating there while at the sametime continuing to make significant investment in itstechnology infrastructure. When canvassing potential clientsabout where they wish to set up their fund the first questionsthey always ask relate to the nature of the regulation, thecost, the administrators presence and the ability to do businessthere. The future is bright for Malta if they keep these factorsin mind while they expand and do not lose sight of thereasons why other locations are becoming less popular. �


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Mark Hedderman, chief operating officer, Custom House. Photographkindly supplied by Custom House, November 2010.


Investment Promotion

Address: Garrison Chapel, Castille Place, Valletta, VLT 1063, Malta � Web: www.financemalta.orgTel: +356 2122 4525 � Fax: +356 2144 9212Contact: Bruno L’ecuyer, Head of BusinessDevelopment � Email: [email protected]

FINANCEMALTAFinanceMalta, a non-profit public-private initiative, was formally set up to promote Malta’s internationalBusiness & Finance Centre, both within, as well as outside Malta. It brings together, and harnesses,the resources of the industry and government, to ensure that Malta maintains a modern and effectivelegal, regulatory and fiscal framework in which the financial services sector can continue to grow andprosper. The Board of Governors, together with the six founding associations, four expert groups, itscorporate members and executive staff are committed to promote Malta as a centre of excellence infinancial services and international business

Bank / Financial Institution

Address: 101 Town Square, Qui-Si-Sana, SeaFront, Sliema, SLM 3112, MaltaWeb: www.sparkasse-bank-malta.comTel: +356 2133 5705 � Fax: +356 2133 5710Contact:Paul Mifsud, Managing DirectorEmail:[email protected]

SPARKASSE BANK MALTA PLCSparkasse Bank Malta plc forms part of the Austrian Savings Banks and the Ertse Group Bank AGnetwork. The ‘Sparkasse’ Brand is known to be one of Central Europe’s foremost Savings and FinancialServices Group.

From Malta, the bank’s main focus is on private banking, wealth management and custody services toa range of international private, corporate as well as institutional clients.

The bank thrives on providing a highly personalised and efficient service backed by experience,competence and robust support services.

Financial Services Regulation

Address: MFSA, Notabile Road, Attard, BKR 3000, Malta � Web: www.mfsa.com.mtTel: +356 2548 5386 � Fax: +356 2144 1189Contact: Communications UnitEmail: [email protected]

MALTA FINANCIAL SERVICES AUTHORITYThe Malta Financial Services Authority (MFSA) was established by law on 23rd July, 2002. TheAuthority is the single regulator for the financial services sector, which includes credit and financialinstitutions, securities and investment services companies, recognised investment exchanges,insurance companies, pension schemes and trustees. The MFSA incorporates the Registry ofCompanies and the Board of Governors also acts as the Listing Authority.

Fund Administration

Address: Tigne Towers, Tigne Street, Sliema,SLM 3172, MaltaWeb: www.customhousegroup.comTel: +356 2380 5100 � Fax: +356 2702 2899Contact: Lisa Byrne, PR CoordinatorEmail: [email protected]

CUSTOM HOUSE GLOBAL FUND SERVICES LTDCustom House Global Fund Services Ltd (CHGFS) is the Malta based parent company of the CustomHouse Group of Companies (Custom House). The Custom House Group offers a full 24/5, “round theworld” and “round the clock” administration service out of its offices in Amsterdam, Chicago, Dublin,Guernsey, Luxembourg, Malta and Singapore. This service, which enables Custom House to offerdaily dealing NAVs, covers all aspects of day to day operations, including maintaining the fund’s booksand records, carrying out the valuations, calculating the NAV and handling all subscriptions andredemptions, as well as over-seeing payment of the fund’s expenses. Reporting can be effectedthrough CHARIOT, Custom House’s secure web-reporting platform for managers and investors.CHGFS is recognised as a fund administrator and licensed under a Category 4 license as a custodianfor funds of funds. CHGFS is also an authorised trustee for trusts.

Address: 80 Mill Street, Qormi, QRM 3101, Malta � Web: www.hsbc.com.mtTel: +356 2380 5100 � Fax: +356 2380 5190Contact: Charles Azzopardi, Managing DirectorEmail: [email protected]

HSBC SECURITIES SERVICES (MALTA) LTDHSBC Securities Services (Malta) Ltd provides a full range of administration services to investmentfunds. We have significant experience, knowledge and understanding of the industry and we cantherefore provide a high quality service to investment funds, leveraging on the HSBC Group’s scaleand capabilities where this is necessary. We hold fund administration mandates across most assetclasses (bonds, equities, property, etc.) and strategies (long, absolute returns, etc) and our offeringconsists of fund accounting and valuation, investor services and corporate management services.

Address: Alpine House, Naxxar Road, SanGwann, SGN 9032, Malta Web: www.sgggfexcofsmalta.comTel: +356 2576 2121 / +353 868 398 133Fax: +356 2576 2131 � Contact: BrendanConlon, Director � Email: [email protected]

SGGG FEXCO FUND SERVICES (MALTA) LIMITEDSGGG Fexco Fund Services (Malta) Ltd is recognised as a fund administrator by the Malta FinancialServices Authority. SGGG Fexco is your administrative partner for all your fund managementrequirements, bringing together the international experience of SGGG Fund Services Inc. and FexservFinancial Services.

SGGG has been established in the fund administration business since June 1997. It is headquarteredin Toronto and also operates in the Cayman Islands. SGGG Fund Services is responsible for theadministration of over CAD12bn including 220 alternative strategy funds of various structures andoffers a comprehensive range of fund administration services.

DIRECTORY

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DIRECTORY


Address: G Complex, Suite 2 Level 3, Brewery Street, Mriehel, BKR 3000 Malta Web: www.vfs.com.mt � Tel: +356 2122 7148Fax: +356 2123 4565 Contact: Joseph Camilleri,Head - Business Development DivisionEmail: [email protected]

VALLETTA FUND SERVICESValletta Fund Services ("VFS") is a fully-owned subsidiary of Bank of Valletta plc, and the largest fundadministrator in Malta. As at November 2010, VFS provided its fund administration services to 90professional investor and retail funds representing $2.2bn worth of assets.

VFS was incorporated in 2006 and provides a comprehensive range of fund administration servicesunderpinned by the presence of sophisticated IT platforms. The Company’s clients included fundmanagement organisations based in the UK, Italy, Czech Republic, Holland, Latvia, Turkey, SouthAfrica and Switzerland.

The Company's website at http://www.vfs.com.mt provides useful information on the full range of fundadministration services.

Law Firm

Address: Level 3, Valletta Buildings, SouthStreet, Valletta, VLT 1103, MaltaWeb: www.camilleripreziosi.comTel: +356 2123 8989 � Fax: +356 2122 3048Contact: Louis de Gabriele, PartnerEmail:[email protected]

CAMILLERI PREZIOSICamilleri Preziosi is a leading Maltese law firm with a commitment to deliver an efficient service toclients by combining technical excellence with a solution driven approach to the practice of law.

There can be no compromise on striving for excellence—not only in recruiting and training the bestlawyers but in embracing a work ethic founded on the core values of honesty, integrity and quality ofservice. We take a multi-disciplinary approach to our practice and all lawyers advise across a broadrange of areas. Each lawyer within the firm deals with a specific area or areas of practice that indicatesa particular competence and experience in that sector, but he or she does not practice exclusively inthat area, thus allowing our lawyers a wider scope of knowledge.

Our clients work with lawyers they know well, and who know them and their businesses. The closerelationships we develop and the keen interest we take in our clients’ businesses enable us to givepractical and effective advise with the aim of adding value.

Address: 168 St Christopher Street, Valletta, VLT 1467, Malta � Web: www.dglawfirm.com.mtTel: +356 2569 3000 � Fax: +356 2122 7731Contact: David Griscti, ParterEmail: [email protected]

DAVID GRISCTI & ASSOCIATES / QUBE SERVICES LIMITEDDavid Griscti & Associates is focused, by design, on investment services law, and we are proud to beone of the leading firms. We advise our international fund, fund management and other investmentservice’ clients at pre-licensing stage, offering them structuring solutions and advice, taking themthrough the registration and licensing stage, and offering them a full range of post-licensing servicesthrough our specialised team of professionals, including legal and tax services, fund accountingservices, company secretarial, compliance and AML services, directorship services and other backoffice administration services. Our associated company QUBE Services Limited also offers fullcorporate, trust, tax advisory and administration services, essentially offering a highly dedicated one-stop shop solution to our non-investment service’ clients.

Address: 171 Old Bakery Street, Valletta, VLT 1455, Malta � Web: www.jmganado.comTel: +356 2123 5406 � Fax: +356 2123 2372Contact: Dr. Andre Zerafa, AdvocateEmail: [email protected]

GANADO & ASSOCIATES, ADVOCATESGanado & Associates, Advocates was founded in Valletta, Malta and traces its roots to the early1900s. It enjoys a successful international legal practice, advising on the whole spectrum of corporateand commercial law activities. From its earliest days, it has been one of the protagonists in local legalpractice and has contributed specifically to Malta’s internationally recognised reputation as a centre forfinancial services.The firm is currently made up of a team of over 50 lawyers supported by a growingcomplement of managerial, administrative and secretarial staff.

The firm’s financial services practice has experienced extensive growth since Malta joined theEuropean Union particularly in areas of investment services & funds, banking and insurance. TheInvestment Services & Funds practice within the firm is considered a leader in this sector in Malta.Ganado & Associates is a Lex Mundi member firm and also a member of AIMA.

Professional Services Provider

Address: Deloitte Place, Mriehel Bypass, Mriehel, BKR 3000, MaltaWeb: www.deloitte.com/mtTel: +356 2343 2000 � Fax: +356 2133 2606Contact: Stephen Paris, Head of FinancialServices � Email: [email protected]

DELOITTEDeloitte provides audit, tax consulting and financial advisory services to public and private clientsspanning multiple industries. With a globally connected network of member firms in more than 140countries, Deloitte brings world-class capabilities and deep local expertise to help clients succeedwherever they operate. Deloitte’s more than approximately 169,000 professionals are committed tobecoming the standard of excellence. In Malta, the firm services large significant international andnational clients as well as smaller owner-managed businesses. Over the years, the practice expandedsteadily. We are now firmly established as one of Malta’s leading providers of professional services,reporting among the highest of any professional services firm. We have the largest international taxpractice and a dedicated financial services practice, serving a range of multinationals that oepratethrough Malta to take advantage of our skills, competitive cost base, regulatory environment, EUmembership and attractive tax system.

119F T S E G L O B A L M A R K E T S • D E C E M B E R 2 0 1 0 / J A N U A R Y 2 0 1 1

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All data © 2010 The Depository Trust & Clearing CorporationThis data is being provided as is and can only be used by you pursuant to the termsposted on the DTCC website at dtcc.com/products/derivserv/data_table_i.php

Top 10 number of contracts (Week ending 12 November 2010)

Reference Entity Sector Market Type Net Notional (USD EQ) Gross Notional (USD EQ) Contracts DC Region

Federative Republic of Brazil Government Sov 15,778,455,085 155,322,092,241 11,278 Americas

Bank of America Corporation Financials Corp 6,016,491,889 85,276,974,379 9,631 Americas

JPMorgan Chase & Co. Financials Corp 5,242,548,337 86,103,342,333 9,302 Americas

United Mexican States Government Sov 7,724,638,180 110,510,395,907 9,175 Americas

Republic of Turkey Government Sov 5,736,163,605 138,476,475,722 8,137 Europe

General Electric Capital Corporation Financials Corp 12,404,095,828 98,697,521,778 8,011 Americas

Italia Spa Telecommunications Corp 2,807,684,111 73,247,548,878 7,991 Europe

Republic of Italy Government Sov 29,459,912,523 268,743,422,676 7,838 Europe

Daimler AG Consumer Goods Corp 3,034,521,517 65,938,064,800 7,683 Europe

Deutsche Telekom AG Telecommunications Corp 3,144,760,975 68,739,108,339 7,587 Europe

Top 10 net notional amounts(Week ending 12 November 2010)

Reference Entity Sector Market Type Net Notional (USD EQ) Gross Notional (USD EQ) Contracts DC Region

Republic of Italy Government Sov 29,459,912,523 268,743,422,676 7,838 Europe

Kingdom of Spain Government Sov 16,894,313,123 131,160,967,970 5,875 Europe

French Republic Government Sov 15,931,749,016 79,738,372,845 3,871 Europe

Federative Republic of Brazil Government Sov 15,778,455,085 155,322,092,241 11,278 Americas

Federal Republic of Germany Government Sov 13,893,841,322 81,464,579,597 2,443 Europe

General Electric Capital Corporation Financials Corp 12,404,095,828 98,697,521,778 8,011 Americas

UK and Northern Ireland Government Sov 11,511,083,020 59,079,612,005 4,204 Europe

Republic of Austria Government Sov 8,455,439,585 48,864,749,561 2,085 Europe

Portuguese Republic Government Sov 7,909,277,957 69,505,488,289 3,430 Europe

United Mexican States Government Sov 7,724,638,180 110,510,395,907 9,175 Americas

Ranking of industry segments by grossnotional amounts(Week ending 12 November 2010)

Single-Name References Entity Type Gross Notional (USD EQ) Contracts

Corporate: Financials 3,344,503,722,407 437,845

Sovereign / State Bodies 2,437,062,607,388 180,487

Corporate: Consumer Services 2,234,680,407,993 370,058

Corporate: Consumer Goods 1,656,277,373,006 264,015

Corporate: Technology / Telecom 1,400,849,265,665 217,883

Corporate: Industrials 1,338,075,416,705 230,204

Corporate: Basic Materials 1,013,198,573,110 163,227

Corporate: Utilities 792,090,875,888 125,192

Corporate: Oil & Gas 467,646,233,622 86,290

Corporate: Health Care 343,080,124,929 61,657

Corporate: Other 165,903,006,322 18,812

Residential Mortgage Backed Securities 77,317,907,676 15,553

CDS on Loans 69,487,809,864 18,242

Commercial Mortgage Backed Securities 20,356,389,800 1,955

Other 2,909,921,510 271

Top 10 weekly transaction activity by gross notional amounts(Week ending 12 November 2010)

References Entity Gross Notional (USD EQ) Contracts

Kingdom of Spain 9,675,232,600 494

Republic of Italy 3,207,819,442 169

French Republic 3,067,418,167 131

Ireland 2,729,775,810 277

Federative Republic of Brazil 2,070,398,000 120

MBIA Insurance Corporation 1,931,857,196 197

Republic of Turkey 1,863,300,000 153

Federal Republic of Germany 1,605,699,000 69

Portuguese Republic 1,417,086,800 126

UK and Northern Ireland 1,410,513,000 48

120 D E C E M B E R 2 0 1 0 / J A N U A R Y 2 0 1 1 • F T S E G L O B A L M A R K E T S

Figures are compiled from lit order book trades only. Totals only include stocks contained within the major indices.*This index is also traded on US venues. For more detailed information, visit http://fragmentation.fidessa.com/fragulator/.† market share < 0.01%.

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Fidessa Fragmentation Index (FFI) and FragulatorThe Fidessa Fragmentation Index (FFI) was launched to provide a simple, unbiased measure of how different stocks are fragmentingacross primary markets and alternative venues.

In short, it shows the average number of venues you should visit in order to achieve best execution when completing an order. Soan index of 1 means that the stock is still traded at one venue. Increases in the FFI indicate a fragmentation of trading across multiplevenues and as such any firm wishing to effectively trade that security must be able to execute across more venues. Once a stock’sFFI exceeds 2 liquidity in that stock has fragmented to the extent that it no longer “belongs” to its originating venue.

FFI

INDICES

Europe

VENUES INDICES

FTSE 100 CAC 40 DAX OMX S30 SMI

2.53 2.00 1.94 2.05 2.02

Amsterdam 4.68% †

BATS Europe 11.79% 5.54% 6.59% 6.24% 9.23%

Burgundy 5.33%

Chi-X Europe 25.88% 21.72% 20.08% 18.63% 20.73%

London 55.57%

Madrid † †

Milan 0.16% 0.06%

NYSE Arca Europe 0.29% 0.17% 0.14% 0.29%

Paris 62.26%

SIX Swiss 65.31%

Stockholm 66.54%

Turquoise 6.47% 5.36% 3.78% 3.12% 4.44%

Xetra 0.27% 69.31%

FFI

INDICES

US

VENUES INDICES

DOW JONES S&P 500

4.68 4.31

BATS US 12.67% 11.37%

BYXX 1.30% 0.74%

CBOE 0.12% 0.12%

Chicago Stock Exchange 0.49% 0.49%

EDGA 6.26% 5.69%

EDGX 5.94% 6.07%

NASDAQ 27.17% 27.21%

NASDAQ BX 2.75% 2.08%

NQPX 0.88% 0.82%

NSX 1.04% 1.05%

NYSE 23.59% 25.67%

NYSE Amex 0.20% 0.36%

NYSE Arca 17.41% 18.11%

FFI

INDICES

Asia

VENUES INDICES

S&P ASX 200 HANG SENG

1.00 1.00

ASX Trade Match 100% -

Hong Kong - 100%

FFI

INDICES

Canada

VENUES INDICES*

S&P TSX Composite S&P TSX 60

2.00 2.02

Alpha ATS 15.04% 14.45%

Chi-X Canada 10.14% 11.32%

Omega ATS 0.46% 0.49%

Pure Trading 4.40% 2.61%

Toronto 66.57% 67.89%

TriAct MATCH Now 2.90% 2.82%

FFI

INDICES

Japan

VENUES INDEX

NIKKEI 225

1.21

Chi-X Japan 0.14%

JASDAQ 0.00%

Kabu.com 0.08%

Nagoya 0.00%

Osaka 0.00%

SBI Japannext 0.63%

Tokyo 90.70%

ToSTNet-1 8.45%

ToSTNet-2 0.00%

Index market shares by volumeWeek ending 12th of November, 2010


All data © Fidessa Group plc.All opinions and data here are entirely the responsibility of Fidessa Group plc. If you require more informationon the data provided here or about FFI, please contact: [email protected].

COMMENTARYBy Steve Grob, Director of Group Strategy, Fidessa

THIS MONTH'S REPORT focuses on what is happening inCanada. The two charts below show two very differentpictures of exactly which lit venues the constituents of

Canada's TSX 60 Index traded on during the month of October.The first shows the complete breakdown across all Canadian litvenues and reveals a relatively "healthy" spread of tradingbetween TSX, Alpha and Chi-X Canada (TSX being the primarymarket incumbent).

The second chart shows the same thing but "zoomed out" toinclude trading in the same stocks, irrespective of currency. ManyCanadian stocks (such as RIM, the makers of Blackberry smartphones) are heavily traded south of the border in the USA. So nowa very different picture emerges and TSX total market shareeffectively halves along with that of Chi-X Canada and Alpha. Thismarket share is taken up by NASDAQ and NYSE which nowassume 2nd and 3rd place respectively. In fact, the constituents ofthe TSX 60 were actually traded on more than 27 different lit

venues around the world, including a modest 8,600 sharesexecuted on the Philippines Stock Exchange.

1 ASTRAL MEDIA INC CLASS'A'NON-VTG COM NPV 2.9322 HORIZONS BETAPRO N TRANSFERABLE CLASS'A' UNITS 2.9133 YELLOW PAGES INCOM TRUST UNITS 2.894 ANDEAN RESOURCES NPV 2.85 ONEX CORP SUB VTG NPV 2.7646 DUNDEE WEALTH INC 4.75% 1ST PRF 13/03/16 SR 1 2.7197 COMINAR REAL ESTAT TRUST UNITS 2.6898 BOMBARDIER INC CLASS'B'S/VTG NPV 2.6699 URANIUM ONE INC COM NPV 2.61910 HORIZONS BETAPRO N TRANSFERABLE CLASS'A' UNITS 2.614

Top five lit venues TSX 60 (by value) - Oct 2010 (Canada only)

Lit VenuesOmega ATS

Pure TradingChi-X Canada

Alpha ATSTSX

0.4%

2.56%

12.13%

15.85%66.45%

Market Share by Category

2.3%DARK

0.3%OTC

97.4%LIT

Top six lit venues TSX 60 (by value) - Oct 2010 (Global)

Lit VenuesChi-X Canada

NYSE ArcaAlpha ATS

NYSENASDAQ

TSX

9.15%10.08%

32.54%

Market Share by Category 12.09%

OTC

1.13%DARK

86.78%LIT

7.74%7.76%

5.94%

Top 10 fragmented Canadian stocksOctober 2010

FFI for TSX 60 and TSX CompositeOctober 2010

01 04 05 06 07 08 12 13 14 15 18 19 20 21 22 25 26 27 28 29

2.5

2.0

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October 2010

S&P / TSX 60S&P / TSX Composite

TSX 60 trading venues in October 2010TSX, NASDAQ, NYSE, Alpha ATS, NYSE Arca, Chi-X Canada, BATS, EDGX, EDGA, Pure Trading, NASDAQ BX, Chicago Stock Exchange, NSX,Omega ATS, Hong Kong, CBOE, NQPX, NYSE Amex, BYXX, Frankfurt, Deutsche Börse, LSE, Munich, Hamburg, Berlin, Dusseldorf, Philippines

This highlights an important point in the world of globalfragmentation in that the trading patterns of stocks don’t fitneatly into the same geographies as the regulators operate in.Canada has its own regulations that combine elements ofMiFID with an Order Protection Rule that is going to be in forceearly next year. Should a Canadian broker follow purelyCanadian regulations or engage in regulatory arbitrage in orderto offer a better service to his customers? The Canadian situation illustrates an interesting global

phenomenon as new country or region specific regulationscontinue to emerge. Most of this regulation is focussed aroundoffering choice and, in so doing, makes it easier from aregulatory standpoint to set up alternative venues. When this iscoupled with the low cost matching technology that is nowavailable then we may see the emergence of more "off shore"venues that enable traders to circumvent local regulations. �


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Top 5 global ETF providers by average daily turnoverAs at end of Q3 2010

Average Daily Turnover (US$ Mil)Provider Dec-09 % Mkt Share Q3-10 % Mkt Share Change (US$ Mil) Change (%)

SSgA $19,861.8 39.2% $25,756.9 44.3% $5,895.1 29.7%

iShares $14,572.0 28.7% $15,828.2 27.2% $1,256.2 8.6%

ProShares $3,891.8 7.7% $4,064.8 7.0% $173.0 4.4%

PowerShares $3,219.9 6.4% $3,440.0 5.9% $220.2 6.8%

Direxion Shares $3,446.7 6.8% $3,030.9 5.2% -$415.8 -12.1%

Others $5,712.8 11.3% $6,058.7 10.4% $345.9 6.1%

Total $50,705.0 100.0% $58,179.5 100.0% $7,474.5 14.7%

Global ETF assets by index provider ranked by AUMAs at end of Q3 2010

Q3 2010 YTD Change

Index Provider No. of ETFs Total Listings AUM (US$ Bn) % Total No. of ETFs Total Listings AUM (US$ Bn) % AUM % TOTALMSCI 359 1214 $292.6 24.8% 94 460 $48.8 20.0% 1.2%S&P 290 530 $260.9 22.1% 57 154 $11.7 4.7% -2.0%Barclays Capital 82 193 $113.1 9.6% 12 34 $25.7 29.3% 1.1%Russell 67 108 $68.5 5.8% 6 8 $2.5 3.8% -0.6%FTSE 168 367 $50.9 4.3% 42 83 $8.1 19.1% 0.2%STOXX 218 743 $47.2 4.0% 14 117 -$3.7 -7.3% -0.9%Markit 93 244 $46.0 3.9% 23 86 $7.8 20.4% 0.2%Dow Jones 151 277 $42.4 3.6% 15 57 $1.5 3.6% -0.4%NASDAQ OMX 63 99 $30.7 2.6% 20 36 $4.2 15.9% 0.0%Deutsche Boerse 40 147 $26.2 2.2% 10 56 $2.8 11.8% 0.0%Topix 53 64 $17.6 1.5% 0 0 $5.1 41.4% 0.3%Hang Seng 12 33 $13.9 1.2% 3 10 $2.1 17.7% 0.0%Nikkei 9 16 $12.1 1.0% 1 5 -$0.4 -2.9% -0.2%EuroMTS 29 104 $10.9 0.9% 7 53 -$0.1 -1.2% -0.1%NYSE Euronext 18 36 $8.3 0.7% 8 24 $2.2 35.1% 0.1%SIX Swiss Exchange 17 30 $8.2 0.7% 4 7 $0.9 12.0% 0.0%WisdomTree 35 42 $7.1 0.6% -10 -3 $1.3 22.4% 0.0%CAC 15 30 $6.8 0.6% -3 4 -$0.7 -9.4% -0.1%Indxis 6 7 $4.4 0.4% -1 -1 $1.7 60.7% 0.1%CSI 27 28 $3.0 0.3% 16 17 $0.6 24.4% 0.0%BNY Mellon 11 12 $2.5 0.2% 0 0 $0.2 8.6% 0.0%Intellidex 38 41 $2.4 0.2% -4 -11 -$0.2 -8.9% -0.1%Morningstar 10 10 $1.7 0.1% 0 0 $0.0 -0.9% 0.0%S-Network 15 33 $1.2 0.1% 2 2 $0.0 1.3% 0.0%Zacks 12 13 $0.7 0.1% -2 -2 $0.1 20.9% 0.0%Value Line 3 3 $0.2 0.0% -2 -2 -$0.1 -17.1% 0.0%Other 538 780 $101.7 8.6% 122 183 $23.2 29.6% 1.0%Total 2,379 5,204 $1,181.3 100.0% 434 1,377 $145.2 14.0%

Top 20 ETFs worldwide with the largest change in AUMAs at end of Q3 2010

AUM (US$ Mil) AUM (US$ Mil) Change

ETF Country listed Bloomberg Ticker Q3 2010 December 2009 (US$ Mil)

Vanguard Emerging Markets US VWO US $36,107.6 $19,398.7 $16,709.0

SPDR S&P 500 US SPY US $78,243.9 $85,676.3 $-7,432.4

iShares MSCI Emerging Markets Index Fund US EEM US $44,906.1 $39,178.3 $5,727.9

TOPIX ETF Japan 1306 JP $10,392.7 $5,910.7 $4,482.0

PowerShares QQQ Trust US QQQQ US $22,249.5 $18,735.8 $3,513.7

Vanguard Total Bond Market ETF US BND US $9,072.2 $6,268.4 $2,803.8

iShares S&P U.S. Preferred Stock Index Fund US PFF US $5,689.4 $3,122.6 $2,566.8

SPDR Barclays Capital High Yield Bond ETF US JNK US $5,920.2 $3,444.5 $2,475.7

iShares Barclays 1-3 Year Credit Bond Fund US CSJ US $7,318.5 $4,908.3 $2,410.2

iShares iBoxx $ High Yield Corporate Bond Fund US HYG US $6,889.3 $4,569.2 $2,320.2

SPDR S&P® Dividend ETF US SDY US $3,455.1 $1,252.4 $2,202.7

iShares iBoxx $ Investment Grade Corporate Bond Fund US LQD US $14,874.4 $12,755.9 $2,118.5

iShares Barclays Short Treasury Bond Fund US SHV US $3,869.1 $1,752.1 $2,116.9

ZKB Gold ETF (CHF) Switzerland ZGLD SW $7,174.2 $5,125.8 $2,048.4

Vanguard Short-Term Bond ETF US BSV US $5,687.0 $3,696.6 $1,990.4

E Fund SZSE 100 China 159901 CH $3,286.5 $1,321.3 $1,965.2

Market Vectors Gold Miners US GDX US $7,465.1 $5,534.3 $1,930.8

S&P 400 MidCap SPDR US MDY US $10,384.3 $8,485.1 $1,899.2

iShares EURO STOXX 50 (DE) Germany SX5EEX GY $4,561.7 $6,425.0 $-1,863.3

iShares Barclays TIPS Bond Fund US TIP US $20,373.5 $18,551.8 $1,821.7

SSgA44.3%

iShares27.2%

Others10.4%

DirexionShares

5.2%

Power-Shares

5.9%

ProShares7.0%

Source: Global ETF Research and Implementation Strategy Team, BlackRock, Bloomberg.




Global ETF listingsAs at end of Q3 2010

ASSETS UNDER CHANGEMANAGEMENT (US$ Bn) IN ASSETS

No. Primary New in New in Total No. of No. of PlannedLocation Listings 2009 2010 Listings 2009 2010 US$ Bn % Providers Exchanges New

US 890 121 149 890 $705.5 $797.2 $91.7 13.0% 29 2 789

Europe 1,030 215 212 3,396 $226.9 $256.2 $29.3 12.9% 37 21 92*

Austria 1 - - 21 $0.1 $0.1 $0.0 -27.4% 1 1

Belgium 1 - - 23 $0.1 $0.1 $0.0 -24.6% 1 1

Finland 1 - - 1 $0.3 $0.2 $0.0 -4.7% 1 1

France 259 55 43 421 $53.5 $55.5 $2.0 3.8% 9 1

Germany 375 80 46 1,094 $96.2 $101.5 $5.3 5.5% 9 2

Greece 2 1 - 2 $0.1 $0.1 $0.0 -32.8% 2 1

Hungary 1 - - 1 $0.0 $0.0 $0.0 -2.0% 1 1

Ireland 14 - - 14 $0.2 $0.3 $0.1 53.5% 2 1

Italy 23 - 12 488 $1.9 $2.1 $0.2 11.7% 4 1

Netherlands 11 7 1 106 $0.2 $0.3 $0.0 20.3% 4 1

Norway 6 - - 6 $0.8 $0.8 -$0.1 -7.4% 2 1

Poland 1 - 1 1 $0.0 $0.1 $0.1 100.0% 1 1

Portugal 2 - 2 2 $0.8 $0.0 -$0.8 -96.5% 1 1

Russia 1 - 1 1 $0.0 $0.0 $0.0 0.0% 1 1

Slovenia 1 - - 1 $0.0 $0.0 $0.0 6.1% 1 1

Spain 10 1 - 44 $2.4 $1.5 -$1.0 -40.5% 2 1

Sweden 24 7 12 64 $2.1 $2.4 $0.2 10.5% 2 1

Switzerland 102 20 52 495 $21.7 $32.7 $11.0 50.9% 7 1

Turkey 11 2 2 11 $0.2 $0.1 $0.0 -8.0% 5 1

United Kingdom 184 42 40 600 $47.1 $58.4 $11.3 24.1% 9 1

Canada 152 32 44 178 $28.5 $34.0 $5.4 19.1% 4 1 9

Japan 74 7 6 77 $24.6 $30.7 $6.0 24.4% 6 2 0

Hong Kong 38 11 16 67 $20.7 $25.0 $4.3 20.8% 10 1 1

China 12 5 5 12 $6.3 $11.0 $4.7 75.6% 10 2 16

Mexico 14 7 1 290 $8.1 $8.3 $0.2 2.0% 2 1 1

South Korea 60 17 13 60 $3.2 $4.9 $1.8 56.0% 12 1 7

Australia 12 1 8 33 $2.4 $3.3 $0.9 38.8% 4 1 10

Singapore 22 2 13 73 $2.6 $3.2 $0.6 24.3% 8 1 1

Taiwan 12 1 - 14 $2.7 $2.6 $0.0 -1.8% 2 1 5

South Africa 24 6 1 24 $1.8 $2.0 $0.2 12.5% 7 1 12

Brazil 7 - 3 7 $1.7 $1.7 $0.0 1.0% 2 1 0

New Zealand 6 - - 6 $0.5 $0.4 -$0.1 -22.9% 2 1 0

Malaysia 4 - 1 5 $0.3 $0.4 $0.0 9.5% 3 1 3

India 15 1 3 15 $0.2 $0.3 $0.1 42.8% 7 2 15

Thailand 3 1 - 3 $0.1 $0.1 $0.0 2.4% 2 1 0

Saudi Arabia 2 - 1 2 $0.0 $0.0 $0.01 100.0% 1 1 0

UAE 1 - 2 1 $0.0 $0.0 $0.01 100.0% 1 1 3

Indonesia 1 - - 1 $0.0 $0.0 $0.0 -5.2% 1 1 0

Chile - - - 50 - - - - - 1 0

Israel - - - - - - - - - - 5

Egypt - - - - - - - - - - 1

Sri Lanka - - - - - - - - - - 1

Philippines - - - - - - - - - - 1

ETF Total 2,379 427 478 5,204 $1,036.0 $1,181.3 $145.2 14.0% 129 45 972

Regulatory Information BlackRock Advisors (UK) Limited (‘BlackRock’), which is authorised and regulated by the Financial Services Authority in the United Kingdom, has issued this document for access by professional clients and for information purposes only.This document or any portion hereof may not be reprinted, sold or redistributed without authorisation from BlackRock. This communication is being made available to persons who are investment professionals as that term is defined in Article 19 of the FinancialServices 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. This document isan independent market commentary document based on publicly available information and is produced by the ETF Research & Implementation Strategy team. Specifically, this is not marketing nor is it an offer to buy or sell any security or to participate in any tradingstrategy. Affiliated companies of BlackRock may make markets in the securities of ETFs and provide ETFs in the form of iShares. Further, BlackRock and/or its affiliated companies and/or their employees may from time to time hold shares or holdings in the underlyingshares of, or options on, any security of ETFs and may as principal or agent buy securities in ETFs. The opinions expressed are those of BlackRock as of September 2010, and are subject to change at any time due to changes in market or economic conditions. Theyshould not be construed as a recommendation, investment advice, offer or solicitation to buy or sell any securities or to adopt any investment strategy. In particular, BlackRock has not performed any due diligence on products which are not managed by BlackRockand accordingly does not make any remark on their suitability. Prospective investors should take their own independent advice prior to making an investment decision. This document does not provide investment advice and the information contained within shouldnot be relied upon in assessing whether or not to invest in the products mentioned. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The securities discussed in this commentary may not be suitablefor all investors. BlackRock recommends that investors independently evaluate each issuer, security or instrument discussed in this publication and encourages investors to seek the advice of a financial adviser. The appropriateness of a particular investment or strategywill depend on an investor’s individual circumstances and objectives The value of and income from any investment may go up or down and an investor may not get back the amount invested. The value of the investment involving exposure to foreign currencies canbe affected by exchange rate movements. We also remind you that the levels and bases of, and reliefs from, taxation can change and is dependent upon individual circumstances. Although BlackRock endeavours to update and ensure the accuracy of the content of thisdocument BlackRock 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 the ETF Providersand confirm any relevant information with ETF Providers before investing. Neither BlackRock, 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 anyuse of this publication or its contents. The trademarks and service marks contained herein are the property of their respective owners. Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timelinessof the data they provide and shall not have liability for any damages of any kind relating to such data. © 2010 BlackRock Advisors (UK) Limited. Registered Company No 00796793. All rights reserved. Calls may be monitored or recorded.

*Includes 21 undisclosed RBS ETFs, 5 undisclosed HSBC/Hang Seng ETFs. Source: Global ETF Research and Implementation Strategy Team, BlackRock, Bloomberg.To avoid double counting, assets shown above refer only to primary listings.


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Global Market Indices5-Year Performance Graph (USD Total Return)

Table of Total Returns Index Name Currency No. of Index 3 M (%) 6 M (%) 12 M (%) YTD (%) Yield

Constituents Value (%pa)

FTSE All-World Indices

FTSE All-World Index USD 2,774 262.80 9.7 4.3 14.6 7.9 2.43

FTSE World Index USD 2,298 611.19 9.4 3.7 13.9 7.1 2.46

FTSE Developed Index USD 1,996 242.04 9.3 3.3 13.4 6.9 2.44

FTSE Emerging Index USD 778 732.00 12.4 11.1 24.1 15.0 2.33

FTSE Advanced Emerging Index USD 302 671.23 11.6 8.7 22.4 10.6 2.76

FTSE Secondary Emerging Index USD 476 871.28 13.1 13.3 25.5 19.2 1.94

FTSE Global Equity Indices

FTSE Global All Cap Index USD 7,295 424.80 10.0 4.5 16.0 8.9 2.32

FTSE Developed All Cap Index USD 5,777 394.72 9.6 3.5 14.8 8.0 2.32

FTSE Emerging All Cap Index USD 1,518 977.44 12.8 11.5 25.3 15.6 2.31

FTSE Advanced Emerging All Cap Index USD 638 908.61 11.8 9.1 23.3 10.8 2.74

FTSE Secondary Emerging All Cap Index USD 880 1122.43 13.8 13.8 27.1 20.3 1.91

Fixed Income

FTSE Global Government Bond Index USD 749 199.63 5.7 10.5 6.8 9.0 2.34

Real Estate

FTSE EPRA/NAREIT Developed Index USD 280 2851.93 12.6 10.9 24.7 18.2 3.65

FTSE EPRA/NAREIT Developed REITs Index USD 187 975.73 10.9 9.6 30.6 20.4 4.47

FTSE EPRA/NAREIT Developed Dividend+ Index USD 226 2088.50 12.1 11.9 29.1 20.6 4.21

FTSE EPRA/NAREIT Developed Rental Index USD 229 1115.67 11.9 11.0 31.3 21.9 4.17

FTSE EPRA/NAREIT Developed Non-Rental Index USD 51 1183.24 14.4 10.4 9.2 9.0 2.20

SRI

FTSE4Good Global Index USD 657 6522.97 9.1 3.7 10.7 4.8 2.75

FTSE4Good Global 100 Index USD 103 5407.15 8.3 2.9 7.9 1.9 2.92

Investment Strategy

FTSE GWA Developed Index USD 1,996 3724.54 8.0 2.7 11.5 5.9 2.63

FTSE RAFI Developed ex US 1000 Index USD 1,011 6492.50 10.2 5.7 7.6 5.1 3.07

FTSE RAFI Emerging Index USD 357 7755.44 11.1 10.0 23.1 13.6 2.58

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Americas Market Indices5-Year Performance Graph (USD Total Return)

Table of Total ReturnsIndex Name Currency No. of Index 3 M (%) 6 M (%) 12 M (%) YTD (%) Yield



FTSE Americas Index USD 777 801.29 8.3 1.2 17.1 8.1 1.99

FTSE North America Index USD 644 869.90 8.2 0.8 17.0 8.1 1.95

FTSE Latin America Index USD 133 1318.78 11.3 10.0 23.3 11.8 2.48


FTSE Americas All Cap Index USD 2,488 372.78 8.8 1.7 19.5 9.7 1.88

FTSE North America All Cap Index USD 2,306 353.76 8.6 1.1 19.1 9.5 1.84

FTSE Latin America All Cap Index USD 182 1878.19 11.8 10.9 24.7 12.6 2.42

Fixed Income

FTSE Americas Government Bond Index USD 197 201.80 2.0 6.3 7.4 8.7 2.27

FTSE USA Government Bond Index USD 184 197.39 1.9 6.3 7.2 8.6 2.24

Real Estate

FTSE EPRA/NAREIT North America Index USD 124 3476.50 8.9 7.1 43.4 25.5 3.69

FTSE EPRA/NAREIT US Dividend+ Index USD 88 1880.52 7.7 6.3 42.0 24.6 3.90

FTSE EPRA/NAREIT North America Rental Index USD 120 1182.80 8.6 7.2 43.9 26.2 3.68

FTSE EPRA/NAREIT North America Non-Rental Index USD 4 362.76 22.4 3.6 23.9 3.6 4.22

FTSE NAREIT Composite Index USD 134 3332.10 7.7 6.2 41.1 23.9 4.46

FTSE NAREIT Equity REITs Index USD 112 8135.44 7.9 6.0 42.8 24.7 3.61

SRI

FTSE4Good US Index USD 133 5229.35 7.9 0.2 15.6 6.0 1.81

FTSE4Good US 100 Index USD 102 4981.37 7.9 0.2 15.2 5.8 1.83

Investment Strategy

FTSE GWA US Index USD 588 3231.00 6.7 -0.9 14.8 6.9 1.96

FTSE RAFI US 1000 Index USD 994 5913.99 7.0 -0.8 19.8 10.9 2.11

FTSE RAFI US Mid Small 1500 Index USD 1,448 5906.66 7.7 -3.5 28.2 14.9 1.19

IPO Indices

FTSE Renaissance IPO Composite Index USD 169 258.29 7.7 -3.5 28.2 14.9 0.96

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Europe, Middle East & Africa Indices5-Year Total Return Performance Graph




FTSE Europe Index EUR 566 246.62 4.5 3.8 15.8 7.8 3.17

FTSE Eurobloc Index EUR 279 130.43 5.1 4.5 10.5 2.9 3.46

FTSE Developed Europe ex UK Index EUR 376 246.06 4.9 4.3 13.8 6.3 3.23

FTSE Developed Europe Index EUR 490 242.67 4.6 4.1 15.6 7.5 3.24


FTSE Europe All Cap Index EUR 1,510 388.30 4.9 4.1 16.9 8.9 3.07

FTSE Eurobloc All Cap Index EUR 746 388.76 5.5 4.6 11.3 3.8 3.34

FTSE Developed Europe All Cap ex UK Index EUR 1,022 413.41 5.4 4.5 14.7 7.4 3.11

FTSE Developed Europe All Cap Index EUR 1,367 384.42 5.0 4.3 16.6 8.7 3.13

Region Specific

FTSE All-Share Index GBP 627 3926.44 9.0 4.2 17.5 9.3 3.10

FTSE 100 Index GBP 102 3692.92 8.8 3.9 16.5 7.9 3.23

FTSEurofirst 80 Index EUR 80 4896.48 4.9 4.8 9.8 1.4 3.72



FTSE/JSE Top 40 Index SAR 42 3124.08 8.6 7.0 17.0 10.6 2.11

FTSE/JSE All-Share Index SAR 165 3501.18 8.6 7.8 18.3 12.5 2.28

FTSE Russia IOB Index USD 15 942.22 3.9 -2.6 8.6 1.5 1.23

Fixed Income

FTSE Eurozone Government Bond Index EUR 245 177.81 1.0 2.8 4.8 4.8 3.36

FTSE Pfandbrief Index EUR 405 212.86 1.0 1.0 3.6 3.4 3.65

FTSE Actuaries UK Conventional Gilts All Stocks Index GBP 38 2470.25 2.4 6.1 6.1 8.0 3.54

Real Estate

FTSE EPRA/NAREIT Developed Europe Index EUR 82 2120.06 11.3 15.1 17.7 15.5 4.18

FTSE EPRA/NAREIT Developed Europe REITs Index EUR 36 767.33 11.0 14.7 16.3 13.5 4.77

FTSE EPRA/NAREIT Developed Europe ex UK Dividend+ Index EUR 41 2752.43 14.4 21.9 24.2 22.8 4.66

FTSE EPRA/NAREIT Developed Europe Rental Index EUR 72 835.02 11.6 15.6 18.4 15.9 4.27

FTSE EPRA/NAREIT Developed Europe Non-Rental Index EUR 10 533.14 5.1 3.3 0.4 4.5 2.09

SRI

FTSE4Good Europe Index EUR 274 4785.42 3.9 3.5 13.5 6.1 3.46

FTSE4Good Europe 50 Index EUR 52 4035.80 3.8 3.0 10.7 3.0 3.69

Investment Strategy

FTSE GWA Developed Europe Index EUR 490 3434.15 3.0 3.1 11.9 5.1 3.57

FTSE RAFI Europe Index EUR 503 5390.78 4.2 3.1 11.8 6.7 3.34

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FTSE All-Share Index (GBP)

FTSEurofirst 80 Index (EUR)

FTSE/JSE Top 40 Index (SAR)

FTSE Actuaries UK Conventional Gilts All Stocks Index (GBP)

FTSE EPRA/NAREIT Developed Europe Index (EUR)

FTSE4Good Europe Index (EUR)

FTSE GWA Developed Europe Index (EUR)

FTSE RAFI Europe Index (EUR)

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Asia Pacific Market Indices5-Year Total Return Performance Graph




FTSE Asia Pacific Index USD 1,293 307.58 9.9 5.1 15.3 11.0 2.37

FTSE Asia Pacific ex Japan Index USD 840 642.37 13.5 10.2 22.1 14.6 2.56

FTSE Japan Index USD 453 69.34 -3.4 -17.0 -7.1 -9.3 2.03


FTSE Asia Pacific All Cap Index USD 3,098 523.24 10.1 5.2 15.7 11.2 2.36

FTSE Asia Pacific All Cap ex Japan Index USD 1,865 798.10 13.9 10.4 23.0 14.9 2.52

FTSE Japan All Cap Index USD 1,233 219.29 -3.8 -17.2 -7.5 -9.2 2.04

Region Specific

FTSE/ASEAN Index USD 144 739.46 14.6 18.5 41.7 31.6 2.67

FTSE Bursa Malaysia 100 Index MYR 100 11384.59 11.8 13.8 25.4 22.2 2.41

TSEC Taiwan 50 Index TWD 50 7536.49 7.7 6.2 13.5 3.2 3.60

FTSE China All-Share Index CNY 1,156 9538.93 19.2 13.0 12.4 1.6 0.85

FTSE China 25 Index CNY 25 25713.06 9.3 9.1 6.7 6.5 2.25

Fixed Income

FTSE Asia Pacific Government Bond Index USD 232 163.60 7.7 18.6 16.2 18.1 1.04

Real Estate

FTSE EPRA/NAREIT Developed Asia Index USD 73 2352.20 14.4 13.7 14.7 14.0 3.41

FTSE EPRA/NAREIT Developed Asia 33 Index USD 33 1525.74 15.1 13.6 15.3 13.8 3.58

FTSE EPRA/NAREIT Developed Asia Dividend+ Index USD 57 2520.80 14.3 15.6 19.7 17.0 4.25

FTSE EPRA/NAREIT Developed Asia Rental Index USD 36 1120.25 14.8 15.4 25.3 22.1 5.46

FTSE EPRA/NAREIT Developed Asia Non-Rental Index USD 37 1296.72 14.1 12.7 9.0 9.4 2.12

Infrastructure

FTSE IDFC India Infrastructure Index IRP 107 1040.74 7.5 2.4 18.9 6.8 0.82

FTSE IDFC India Infrastructure 30 Index IRP 30 1160.31 7.8 2.5 16.7 6.1 0.81

SRI

FTSE4Good Japan Index JPY 178 3282.30 -3.7 -17.1 -8.9 -10.5 2.21

Shariah

FTSE SGX Shariah 100 Index USD 100 5605.01 7.6 3.0 12.6 5.4 2.12

FTSE Bursa Malaysia Hijrah Shariah Index MYR 30 12043.16 9.3 9.3 15.7 13.7 2.79

FTSE Shariah Japan 100 Index JPY 100 959.98 -1.6 -15.2 -5.8 -10.5 1.92

Investment Strategy

FTSE GWA Japan Index JPY 453 2498.00 -3.7 -16.5 -6.2 -7.4 2.12

FTSE GWA Australia Index AUD 101 4101.09 4.6 -1.9 3.5 -1.4 4.28

FTSE RAFI Australia Index AUD 56 6494.43 4.3 -1.7 3.2 -3.3 4.29

FTSE RAFI Singapore Index SGD 18 9115.27 2.6 3.3 19.7 7.1 3.11

FTSE RAFI Japan Index JPY 250 3517.11 -2.9 -16.8 -5.2 -7.5 2.02

FTSE RAFI Kaigai 1000 Index JPY 1,022 3918.74 1.3 -11.5 -0.2 -7.4 2.81

FTSE RAFI China 50 Index HKD 49 7662.98 10.9 12.4 7.8 7.9 2.77

IPO Indices

FTSE Renaissance Asia Pacific ex Japan IPO Index USD 129 1947.43 11.6 8.9 25.2 15.8 0.93

FTSE Renaissance Hong Kong/China Top IPO Index HKD 38 2755.72 12.9 9.9 18.2 11.2 0.69

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FTSE EPRA/NAREIT Developed Asia Index (USD)

FTSE IDFC India Infrastructure Index (IRP)

FTSE4Good Japan Index (JPY)

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Index Reviews December 2010 - February 2011

Date Index Series Review Frequency/Type Effective Data Cut-off(Close of business)

Early Dec CAC 40 Quarterly review 17-Dec 15-DecEarly Dec ATX Quarterly review 31-Dec 30-NovEarly Dec OBX Semi-annual review 17-Dec 30-NovEarly Dec S&P / TSX Quarterly review 17-Dec 30-NovEarly Dec RTSI Quarterly review 14-Dec 30-Nov02-Dec FTSE Global Equity Index Series

(incl. FTSE All-World) Annual review / North America 17-Dec 30-Sep03-Dec DAX Quarterly review 17-Dec 30-Nov03-Dec S&P / ASX Indices Quarterly review 17-Dec 03-Dec04-Dec NZX 50 Quarterly review 17-Dec 30-Nov07-Dec TOPIX Annual review (constituents) 28-Jan 31-Dec08-Dec FTSE MIB Quarterly review - shares & IWF 17-Dec 30-Dec08-Dec FTSE/JSE Africa Index Series Quarterly review 17-Dec 30-Nov08-Dec FTSE UK Index Series Annual review 17-Dec 07-Dec08-Dec FTSE techMARK 100 Quarterly review 17-Dec 30-Nov08-Dec FTSE Euromid Quarterly review 17-Dec 30-Nov08-Dec FTSEurofirst 300 Quarterly review 17-Dec 30-Nov08-Dec FTSE Italia Index Series Quarterly review 17-Dec 30-Nov09-Dec FTSE EPRA/NAREIT

Global Real Estate Index Series Annual review 17-Dec 30-Nov10-Dec FTSE Bursa Malaysia Index Series Annual review 17-Dec 30-Nov10-Dec OMX I15 Semi-annual review 03-Jan 31-Dec10-Dec DJ STOXX Quarterly review 17-Dec 23-Nov12-Dec S&P BRIC 40 Annual review 18-Dec 20-Nov12-Dec S&P US Indices Quarterly review 18-Dec 04-Dec12-Dec S&P Europe 350 / S&P Euro Quarterly review 18-Dec 04-Dec13-Dec S&P Topix 150 Quarterly review 17-Dec 03-Dec12-Dec S&P Asia 50 Quarterly review 18-Dec 04-Dec12-Dec S&P Latin 40 Quarterly review - shares & IWF 18-Dec 04-Dec12-Dec S&P Global 1200 Quarterly review - shares & IWF 18-Dec 04-Dec12-Dec S&P Global 100 Quarterly review - shares & IWF 18-Dec 04-DecMid Dec VINX 30 Semi-annual review 17-Dec 30-NovMid Dec OMX C20 Semi-annual review 20-Dec 30-NovMid Dec OMX S30 Semi-annual review 31-Dec 30-NovMid Dec OMX N40 Semi-annual review 17-Dec 30-NovMid Dec Baltic 10 Semi-annual review 31-Dec 30-Nov15-Dec BNY Mellon DR Indices Quarterly Review 20-Dec 30-Nov17-Dec Russell US Quarterly review - IPO additions only 24-Dec 30-Nov17-Dec Russell Global Indices Quarterly review - IPO additions only 24-Dec 30-NovLate Dec IBEX 35 Semi-annual review 31-Dec 30-Nov07-Jan TOPIX Monthly review - additions

& free float adjustment 28-Jan 31-Dec11-Jan FTSE/Xinhua Index Series Quarterly review 21-Jan 20-Dec13-Jan TSEC Taiwan 50 Quarterly review 21-Jan 31-DecMid Jan OMX H25 Semi-annual review consitutents 31-Jan 31-Dec27-Jan Russell US & Global Indices Monthly review - shares in issue change 31-Jan 26-Jan04-Feb TOPIX Monthly review - additions &

free float adjustment 25-Feb 31-Jan10-Feb Hang Seng Quarterly review 04-Mar 31-Dec14-Feb MSCI Standard Index Series Quarterly review 28-Feb 31-Jan14-Feb Russell/Nomura Indices Quarterly IPO addtions 28-Feb 31-Dec22-Feb DJ Stox Quarterly review 18-Mar 31-Jan24-Feb Russell US & Global Indices Monthly review - shares in issue change 28-Feb 23-Feb

Sources: Berlinguer, FTSE, JP Morgan, Standard & Poor’s, STOXX

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With 18 new pan-Asia sector-based indices to choose from, it’s never beeneasier to create a diversified portfolio to spread your risk. From straight sectorallocations to sophisticated strategies such as sector rotation and long/shortsector plays FTSE’s Asian Sector Index Series is the first of its kind to be builtground up from an Asian investors’ perspective. www.ftse.com/asiansector

FTSE. It’s how the world says index.

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