No 2 · Nov-Dec 2004
Direct investment: An Attractive Strategy
for Returnsby V. Politis and E. Stambler
Preliminary programme of the 3rd
International Forum of the CIFA
The EU Financial Services
Action Plan by A. Knight
Communist France vs.
Capitalist Franceby Ch. Gave
Deliver us from temptation !
Deliver us from temptation !
Exchange Traded FundsExchange Traded Funds
Trusting2_52p 02.12.2004 16:52 Page c1
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3november 2004
EDITORIAL5 The unabating fight against
conflicts of interest By Pierre Christodoulidis
SPECIAL CONTRIBUTION7 Communist France vs. Capitalist France
By Charles Gave
INDUSTRY EVOLUTION10 2nd International Forum of the CIFA
12 Preliminary programme of the 3rd International Forum of the CIFA
14 Exchange Traded Funds: Deliver us from temptation By Véronique Bühlmann
18 Hedge Funds: Reinventing the industryBy Véronique Bühlmann
20 Investment funds: For better or for worse By Véronique Bühlmann
LEGAL & REGULATORY23 Regulatory-mania:
Five senior investment managers give their opinionBy Mohammad Farrokh
26 The EU Financial Services Action Plan By Angela Knight
28 Is there a limit to taxation?By Vincent J.Derudder
30 International regulation: To encourage progressive convergenceExcerpts from the writings of Michel Prada
32 Regulation: all risk and no reward?By Brendan Nelson, KPMG LLP (UK)
INVESTING – HOW TO NAVIGATE34 Accidents waiting to happen
By François-Eric Perquel
36 The main reasons to invest in emerging markets By François-Eric Perquel
SPECIAL REPORT38 They want to hold your hand
By Peter S. Green, New York Times
40 Insight into the work of a self-regulating bodyBy Hans Baumgartner, VQF
41 The Swiss Association of Asset Managers
42 The Institute of Financial Planning (IFP)
44 The financial services regulatory framework should be open yet firm By Richard Stevens, Cyprus International Financial Services Association
45 Singapore, one of the world’s leading financial centresBy Pierre Baer and Vincent Magnenat, SG Private Banking (Asia Pacific)
OTHER VOICES 48 Direct investment:
An Attractive Strategy for ReturnsBy Victor Politis and Eric Stambler
50 How Google entered the Stock Exchange By François-Eric Perquel
TRUSTING – The IndependentFinancial Advisor
OwnerCIFA FoundationRue du Vieux Collège 3P.O. Box 3255 · 1211 GENEVA 3 SWITZERLANDTel: +41 22 317 11 11Fax: +41 22 317 11 77www.cifafound.ch
Editorial BoardPierre Christodoulidis, Executive President of CIFAVincent J. Derudder, Secretary General of FECIFRené W. Rohner, Secretary General of CIFA
PublisherRoland RayPromoédition SAQuorum CommunicationRue des Bains 35 P.O. Box 5615 · 1211 Geneva 11SWITZERLANDTel: +4122 809 94 70Fax: +4122 809 94 00www.quorum-com.ch
Managing EditorDominique Flaux
Contributors Veronique Bühlmann, PierreChristodoulidis, Marc Dassesse, Vincent J. Derudder, Mohammad Farrokh, Michael Fawcett, Jean-François Fouque, Ray Jovanovich,Jean-Pierre Lagane, Frédéric Lamotte, Susan Middelboe, JohanOlson, Didier Perrin, Didier Planche,Xavier Raufer, Dominique Robin,Gilles-Guy de Salins,Biagio Zoccolillo
AdvertisingJohn J. RolleyCabinet Rolley Bd Helvétique 361207 GenevaTel: +4122 786 47 60Fax: +4122 786 47 [email protected]
Art DirectorMichel Klex
Production Maryse Avidor
Printed in Switzerland
Lead sponsors of CIFACrédit Agricole Indosuez (Suisse) SACrédit Lyonnais (Suisse) SADeutsche BankMirabaud & Cie
Sponsors of CIFABCVCredit Suisse Private BankingJulius BärLombard Odier Darier Hentsch & CieSG Private BankingUBS Wealth Management
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Trusting2_52p 02.12.2004 16:52 Page 3
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Trusting2_52p 02.12.2004 16:52 Page 4
EDITORIAL
The recent scandals in the fund managementindustry placed this recurring theme once morein the limelight. Again the eternal questionwas on all investors-shareholders’ lips: whatis the main concern of fund companies – theirclients’ interests or their own profitability?
Despite the heavy penalties on these unscrupu-lous operators we did not see many of theconcerned actors disclose the corporate gov-ernance steps (the most recent “darling” ofthe auditors) they have taken to secure inpermanent manner the security of their mainraw material – the money that the investorsentrust them with.
The big question remains intact: how to securethe highest degree of transparency, especiallyin times of unprecedented volatility in thesecurities’ markets? At which point will themanager of a fund be tempted to protect hiscompany’s interests and pereniality comparedto those of the investor?
There again we will fall in to the fashionabledebate of internal compliance. Complianceteams often step in after the facts have hap-pened, and in this particular sensitive issuehow would the compliance people react?What are the limits of efficiency of such inter-nal controls? Or should such processes beentrusted to independent or external compli-ance organisms?
One way to address the issue of transparencyderives from the recent regulatory settlementsin the United States where investment bankshad an unacceptable influence on securitiesresearch brokerage firms. The result translatesinto an increasing importance given to trulyindependent research.
An additional positive step forward allowinga more transparent and efficient decision-making by the investor consists in offeringthe client free global access to a large number
of products and execution platforms throughwhich trades can be completed.
Most of the important players involved in a verylarge range of financial services (brokerage,funds, investments, new issues/IPOS) assertthat they have set up Chinese walls betweenthe various divisions which may intervene in the process. Others have developed highlytechnical computer systems that analyse trans-actions performance in real time.
Both those approaches have their merits butas a London consultant puts it bluntly: “thereis more to governance than preventing illegalor unethical conduct. Fund providers need todemonstrate that they know how to run moneybetter than other managers.”
Finally this is the most practical and concreteprinciple to which we can subscribe. Theseare the simple rules of free competition andopen access to markets that would guaranteea safer and less corrupt environment for theinvestor. But observing the gigantic dimen-sions that some financial institutions reachnowadays by takeovers or mergers we may
question this competitive and open environ-ment that the investor must hope for.
In this same way and in relation to the trans-parency issue we can note that in most coun-tries the assets deposited by the investors areconcentrated in the hands of a few very bigplayers. At which point are these large playersready to offer their clients a neutral andobjective choice of a variety of existing prod-ucts and external asset management firmswithout being tempted to put forward their in-house products?
Curiously enough it is in the hedge fundindustry, which is highly segmented andextremely competitive, that we may find themost challenging environment in terms ofinvestment choice. Taking into considerationthe investors’ basic concerns: reasonablereturns on assets yet with a low volatility. Is it because this speciality is “less regulated”(the most frequent accusation against theindustry) or is it because intrinsically the bigplayers cannot keep the best talents withintheir organisations? It is an interesting questionwhich deserves a more thorough reflexion.
As a matter of fact and by simple reasoningwe may observe that the more open the com-petitive environment is and the larger thenumber of participants is, the more the marketbecomes transparent and prevents possiblemanipulation and wrong-doing.
Finally there is a fundamental aspect of theindependent financial advisor’s role, as a U.S.operator describes it, which makes of thesepractitioners a profession in itself in the finan-cial services world: “The independent advisordoes not to have to sell any product. He cantruly be impartial.” Indeed, and we may add:“this is his main duty.”
Pierre ChristodoulidisExecutive President of CIFA
5november 2004
The unabating fight againstconflicts of interest
Trusting2_52p 02.12.2004 16:53 Page 5
WE ARE GRATEFUL
TO ALL WATCHMAKERS
THROUGHOUT THE WORLD
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Trusting2_52p 02.12.2004 16:53 Page 6
SPECIAL CONTRIBUTION
The reason behind our depar-ture was simple: the tensionbetween the various Beijingleaders was so thick, and thecontradictions so apparent,that the air itself felt heavy to
breathe. In half of the meetings with Chineseofficials, we would be given lectures on thegreat strides of Marxism in China by men inMao suits; in the other half of the meetings,officials decked out in investment bankersuits would elaborate on the great prospectsfor the Chinese equity markets. Most impor-tantly, the body language between the speak-ers was such that the fact that they hated eachother’s guts came across rather blatantly.
Three months later, the Tian An Men massacrecleared the decks. At the time, the Marxistswere perceived to have prevailed, but Historynow shows that a section of the “Free Mar-
keters” then gained control of the Chinesestate. Why do we tell this story? Because thesituation in France today reminds us of the situation in China in 1989. Like in China, wehave in France two systems of production whoco-exist in an uneasy cooperation: a capitalistsystem, and a communist one.
However, unlike in China, the communistsystem of production in France is growing ata much faster pace than the capitalist one.Worse yet, the incomprehension between thetwo systems strikes us to be as wide in Francetoday as in China in 1989.
To quickly summarize the characteristics of a Marxist system, we will use a Marxist grid,looking at how the factors of production(Capital and Labour) are allocated, and thenhow the external world , the “user”, is serviced.
A) Capital in the Marxist Grid• There is no such thing as a cost of capital.• Interest rates have no function in such
an economy.• Returns on capital are not considered
before making an investment.• Profits are never a part of the picture.• Capital is available either through direct
access to the government budget or throughborrowing, usually through governmentguarantees.
• There are no bankruptcies.• Savings have no return.
B) Labour in the Marxist Grid• Labour is exploitation, and must be
avoided.• Labour is fungible (all workers are equal,
i.e. not worth a lot, and can be replacedindiscriminately).
• Life employment is the rule; careers move-ments are made according to age and/or
personal involvement in the unions or theparty.
• Unions are heavily subsidized by the gov-ernment. The work force has no choice butto join the unions.
• There is no such thing as a productivitygain accruing to the users.
C) Relation Between the Production System & the Outside World• Prices are not there to clear the market,
but are fixed by government or administra-tive decrees.
• In theory, demand is regulated by adminis-trative means, or by laws.
• In practice, excess demand emerges and wehave queues. Otherwise, we have lack ofdemand, leading to overcapacity and waste.
• Competition is in principle not accepted.As a result, there is no such thing as a“client”. A client can move to a differentprovider, which implies the existence of acompetitive environment. A user cannot.
HOW DOES THE ABOVE APPLYTO FRANCE?
If we decide to apply the criteria outlinedabove to the French economy, we discoverpretty quickly that quite a few sectors areoperating, partly or totally according to thoserules. As we look at it, the French commu-nists sectors are:• The health system (hospitals, social security,
pensions, etc…).• The educational system.
7november 2004
Communist France vs.Capitalist FranceIn 1989, we were in China (a few months before the Tian An Men mas-sacre) on a week-long research trip with other institutional investors.Although clearly on a boondoggle, we left after two days with our mindsmade up to forego the opportunity to invest in China.
Like in China, we have in France two
systems of production who co-exist:
a capitalist system, and a communist one.
Trusting2_52p 02.12.2004 16:53 Page 7
Trusting2_52p 02.12.2004 16:53 Page 8
SPECIAL CONTRIBUTION
• The public transportation system.• General & Local Administrations.• Energy & Waste Management.• The postal system.• The telecom system.The next step is of course to try to evaluate therelative weight of these sectors in the FrenchGDP. Our methodology will be very simple:the GDP is the sum of the value-added by allthe participants in an economy. Through theFrench national accounts, we have access tothe added values of each individual sectors,including the above “communist sectors”. If wesubtract the value added by these communistsectors from the French GDP, we will have arough idea of the split between the communistand non communist sectors. Of course, it willbe imprecise, but as Keynes said, we wouldrather be nearly correct than precisely wrong.
The first fact to emerge (see chart 1) is that,since 1978, the French communist economyhas grown far more than the capitalist one.On average, the communist sectors havegrown by 2.8% per annum while the privatesector has grown by 0.8% per annum.
The second fact to emerge from this break-down is that, since 1978 again, the commu-nist sectors have never had one single reces-sion! Meanwhile, the capitalist sectors had toendure five recessions.
No wonder everyone in France wants to be acivil servant: it pays more, the growth is higherand there are no risks of unemployment. But isthis state of affair sustainable? Could we soonbe getting to the point that Brezhnev describedin 1980 when he said: “they pretend to work,and we pretend to pay them?”
One worrying fact that emerges clearly fromthe above chart is that the communist sectorsare on the verge of their first recession whilethe private sector is close to plumbing new depths. So what happens next? To lookahead, maybe we need to first look back.
WHAT HAPPENS NEXT?
Since 1945, France has been under an unspokensharing of power: the Right and the Socialistswould fight for political power. Meanwhile,control of the communist economy would be vested in the hands of the unions (CGT,CGT-FO or CFLT). These communists (CGT)and Trotskyites unions (CGT-FO) more orless control all the sectors we have identifiedabove as the communist sectors.
The impressive growth of the communist sys-tem we also reviewed above was only madepossible by a constant transfer from the noncommunist to the communist economy throughever increasing subsidies (taxation) and debt.In turn, these transfers led to a structurallydeclining growth rate of the whole of the Frencheconomy, and to a solid accumulation of debt(French government debt is now a solid 60%of GDP).
However, one day, the French economy willstart falling in absolute terms, simply becausethe private sector will no longer be able tofinance the communist economy. The abovechart leads us to believe that this day mightbe approaching fast!
THE COMING POLITICAL CRISIS
And that day, France will confront a massivepolitical crisis; the government willingly orunwillingly, will have to go for the clash, as Mrs. Thatcher did with the miners, or Presi-dent Reagan did with the air-traffic controllers.Last spring, we experienced a few skirmisheswhen PM Raffarin presented his pension planreforms. We believe that these were mearlythe opening salvos of a “war” which couldend up being very long and very bloody forall participants.
Undeniably, the real fight has not even started.But we nevertheless know quite a few things:1. Present trends are unsustainable
2. They will end with a major political clash.3. While we are certain that the clash will
happen, we are not convinced about ourtiming (very modestly, we will point out that Von-Mises and Hayek explainedvery convincingly that the Soviet Unioncould not work and that it would thereforecollapse in the 1920s & 1930s….).
4. There is no certainty that the fight will be won by the “free economy” (i.e.: Argentina, Venezuela…).
5. The trends that we have highlighted in thispaper have not gone unnoticed in theFrench capitalist sectors. Our work withFrench companies re-enforces our beliefthat a number of small French companieshave already delocalized and that a numberof big companies are also considering a move (see Voting With Their Feet).
6. For the first time ever, more than onemillion French citizens are living abroad.The countries where Frenchmen havemoved to in hordes (US, UK, Switzerland,Asia…) are indicative of what they arelooking for. The new entrepreneurs aremoving to the Anglo-Saxon world, to beable to create. The old entrepreneurs whohave been successful, are moving toSwitzerland, to avoid the punitive Frenchtax rates.
CONCLUSION
France, like a number of European countries,is teetering on the brink of a political crisis.With the Tien An Men massacre, we learntthat it was a lot safer to invest after a simmer-ing political problem had erupted to the surfacethan before. With this in mind, we reiterateour underweight recommendation on Europeanequities and currencies. We are especiallyworried about all things French.
Charles GaveGaveKal Research Limitedwww.gavekal.com
9november 2004
General Administration, Education & Health, TransportationFrance Value added, by sector, industry, Value, saFrance Value added, by sector, construction, Value, saFrance Value added, by sector, consumer goods, Value, saFrance Value added, by sector, trade, Value, sa
50
100
150
200
250
300
350
400
450
78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03
Communist & non Communist Parts of the French EconomyThe forward march of the Communist
Sectors crowding out the Private Sector
Communist Sectors recessions since 80 (FR)Capitalist (five private) Sectors recessions since 80 (FR)
Average annual growth rateAverage annual growth rate
-5
-4
-3
-2
-1
0
1
2
3 +2.8%
+0.8%
4
5
6
7
YoY
% c
hang
e
0302 01009998979695949392919089888786858483828180
Trusting2_52p 02.12.2004 16:53 Page 9
10 november 2004
INDUSTRY EVOLUTION
In his opening speech, RichardSmouha, CIFA Forum Chairman,stressed the important role played bythe independent financial advisor asa reassuring human link between theconsumer-investor and the large
banks and financial companies.
Jean-Pierre Diserens, Founding Member ofCIFA, stated that CIFA defends the rights ofthe consumer to invest freely wherever hewishes, to protect himself against expropria-tion, and to benefit from an absolute protec-tion of his privacy. If co-regulation in theconsumer’s interest is indispensable for theharmonious and effective growth of the finan-cial markets, self-regulation among independ-ent financial advisors is the sole alternativewhich can guarantee the consumer a tailor-made quality service at a reasonable cost,Diserens added.
WHERE DOES THE PROFESSIONSTAND?
Under the suggestive title of “ReinventingTrust“, CIFA’s second Forum began with fourround tables on themes that are of majorinterest to the profession: taxation of savings
in Europe, protection of privacy, regulation of the profession in Europe and the means torestore the investor’s confidence.
SELECTED STATEMENTS HEARDTHAT DAY:
“(...) it is my belief that the strategies thatimpact consumers across Europe have not yetbeen thought out by the policy makers.Governments have not followed up their policydesire to get individuals to save with thecoherent tax reliefs that will encourage themto do so. (...) EU policy makers are seeking
to get everyone to do things ‘the same way’rather than recognising equivalence, andchanges have been set in motion which areunlikely to bring little beneficial early impacton the consumer. Meanwhile the professionaladvisor has big opportunities, provided theycan cater for the changing regulatory environ-ment on the one hand and on the other, theincreasing demands of the new clients andpotential clients that welfare changes andincreasing life expectancy are bringing.”Angela Knight, Chief Executive, Associationof Private Client Investment Managers andStockbrokers (APCIMS), London
Europe’s leading IFAs in Geneva
Angela Knight, Pierre Christodoulidis, Jean-Pierre Diserens and Richard Smouha
Peter Spinnler
and Jean-Pierre Diserens
After the success of its first international congress in April 2003, theConvention of Independent Financial Advisors held its 2nd InternationalForum on 22-23 April 2004 in Geneva. The participation of five Euro-pean federations and 24 national associations (vs. respectively twoand eight in 2003) confirmed the growing importance of this event forthe international IFA community and its business partners.
Trusting2_52p 02.12.2004 16:53 Page 10
INDUSTRY EVOLUTION
“Today, our professional activities (adviceand mediation) are penalised by extremelyconstraining regulations, the soaring cost of compliance procedures, the developmentof unreliable new technologies, and thedemands of a generally distressed and ill-informed clientele.”Vincent J. Derudder, General Secretary,European Federation of Financial Advisersand Financial Intermediaries (FECIF)
“I observe that the respect of privacy and theprotection of personal data are values which,far from being old-fashioned, are on the con-trary gaining importance in the mind of thepublic.”Pierre Mirabaud, Partner, Mirabaud & Cie;Chairman, Swiss Bankers Association
“(...) Are the small players going to continueto find their savings threatened by the manip-ulations of unscrupulous dealers? No. Bettercoordination between corporate bodies anx-ious to preserve the reputation of their profes-sion with the monitoring authorities, backedby the judicial authorities, could lead to along-term effective reduction in such crimes. No purely repressive system has ever suc-ceeded with active coopreation between allinterested parties, namely the professionals,
the monitoring authorities and the judicialsystem.“Pierre Christodoulidis, Executive President of CIFA
“(...) Regulation: since the early nineties, en ever increasing avalanche of rules, whichincreased both in volume and intensity duringthe last years, (...) has lead to costs – directlyand indirectly related to supervision – to risemore by than 22-fold since 1996!”Wilfred Aalders, Deputy Chairman,Dutch Association of Assets Managers
WORKSHOPS AND PRESENTATIONS
The second day began with workshops on therespective themes of regulation, education,investment techniques and the selection ofinvestment funds. Later on, the Forum partic-ipants learned all about the intricacies ofhedge funds, before discovering an innovativeconcept for the transfer of funds, and partici-pating in the final debate.
René W. RohnerSecretary General of CIFA
The views shared by participants lead to thefollowing declaration of intent, made at theend of the Forum:
11november 2004
Hansjörg Pack
Carlo Lamprecht Daniel Penseyres
Josep Soler, Xavier Raufer and Michel TisonPierre Mirabaud
Declaration of intentmade by the participantsof the CIFA Forum 2004CIFA is pledged to the establishement of an orderly, transparent and efficient Europeanmarket of financial services that theconsumer may approach with confidence.
CIFA therefore would like to invite represen-tative bodies of relevant financial associa-tions to join in an umbrella organisation thatpresents the reasonable expectations of the consumer and the objectives of the retailinvestment industry, in a manner that is productive and equable to both parties.
To this aim CIFA has enlisted the supportand assistance of its over 30 partner federa-tions and associations operating throughoutEurope, and looks forward to discussionswith further representative bodies of similarprofessional interest groups.
Trusting2_52p 02.12.2004 16:53 Page 11
12 november 2004
INDUSTRY EVOLUTION
Trusting2_52p 02.12.2004 16:53 Page 12
INDUSTRY EVOLUTION
13november 2004
Trusting2_52p 02.12.2004 16:53 Page 13
14 november 2004
INDUSTRY EVOLUTION
Upon entering the Europeanmarket, ETFs were expectedto sound the trumpet formore traditional index fundsdue to their highly competi-tive management fees.
Yet, traditional index funds are still flying highand even more have been created since then.Why? State Street Global Advisors (SsgA), a department of the State Street group focusedon asset management, is the organisationmost apt to answer this question. First runnerup on the ETF market with a 27.33% shareand 65.6 billion dollars under management1),SsgA was the first to launch an ETF on theS&P 500 in 1993. This fund, the SPDR orSpider, represents some 26 billion dollars .The asset management company has twoproduct lines in Europe: ETFS that are collec-tively known under “streetTRACKS” label,and traditional index funds under the “Balzac”label. The latter currently represent a volumethree to four times greater than the ETFs’1 billion. Head of index fund management atState Street's head office in France, FrédéricJamet notes that ETFs have sustained steadiergrowth than those under the Balzac label. He surmises that this is due primarily to theinfancy of streetTRACK funds relative tothose of Balzac that represent a “more mature”industry. However, Jamet has not ruled outthe hypothesis that this growth may be a resultof the lack of direction among today’s markets– a phenomenon that can provoke activism.
COMMISSIONS ARE TO BE NEGOTIATED
As to whether or not these two types of fundsare actually competitors, Frédéric Jamet thinksotherwise: “Technically speaking, they arealmost the same but each of them addresses
Exchange Traded Funds:Deliver us from temptationPortfolio diversification is expected to be a piece of cake for exchangetraded funds (ETFs). But are they really invincible in terms of cost?Diversification is essentially ensuring not to put all your eggs in onebasket. But has anyone paused to consider the dangers of having too many baskets?
Trusting2_52p 02.12.2004 16:53 Page 14
INDUSTRY EVOLUTION
very specific needs. Large institutions that havea long term investment horizon tend to buyfunds, while investors that focus on trading ,particularly hedge funds, prefer ETFs.” Contrary to popular belief, and as long as theinvestor is in a position to negotiate commis-sions, traditional funds are not significantlymore onerous than ETFs. In the case of StateStreet, the gap in management fees is around10 basis points. In general, concludes Jamet,this gap basically depends on the promoters’business policies.
NEED SOME HELP?
What then are the advantages and disadvan-tages of each in relation to the other? TheETFs have the advantages of speed and sim-plicity. They do not require extensive rela-tions with banks and allow for anonymity (an important factor for hedge fund managerswho are by no means eager to share theirmanagement strategies with others). On theother hand, ETFs demand some degree ofprofessionalism of the investor. Stock listingsoffer a great deal of flexibility and also pro-vides the possibility of using short-selling.However, order execution poses some risk.ETFs are negotiated with a spread to theirNet Asset Value (NAV). It is therefore incum-bent upon the investor to ensure that the exe-cution of his orders are conducted at a fair price as it is upon this price, whichcannot be determined beforehand, that thefinal cost of the ETFs lies (2). Traditionalindex funds do not pose such risks as pur-chases and sales are conducted according tothe NAV. In addition, the fact that they origi-nate from a promoter guarantees the investorsome level of advice, information, and report-ing which are virtually absent in the case of ETFs. And if any cost gap should appear
between the two types of funds, it basicallyrepresents the cost of these “decision-makingaids”. Such were the arguments presented by Jamet. However, a number of specialistsinterviewed about the Swiss market do notshare his opinion. According to them, ETFsoffer a clear advantage in terms of manage-ment fees. On these grounds, some recommendETFs for institutional investors with long-term horizons as well as for assuming corepositions in global portfolios. To demonstratethe merit of this point of view, they offer theexample of an ETF on the S&P whose annualmanagement fee is 10 BP while that of asuperior index fund ranges from 40 to 50 BP. Obviously, in the long run, this divideproves to be far from insignificant.
POPULARITY IS A GOOD SIGN
To these “visible” costs may be added othersthat complicate comparisons and, consequently,the search for alternatives. Last May, StateStreet announced the closing of streetTracksMSCI UK ETF due to a “lack of volume”.According to Frédéric Jamet, the choice of an index plays a crucial role: for investors on the British market, it would indeed seemthat the FT 100 index is a lot more popularthan the equivalent MSCI. In the event that an ETF is closed, reimbursement is conductedin cash or, if the amount invested is sufficient,in stocks of the underlying portfolio.From the perspective of the investor, in bothcases, this presumes reinvestment and thus,additional costs. Keeping in mind that theEuropean ETF market is generally consideredto be too segmented, and that the industry is still in its infancy, closures are more fre-quent than on the more mature market of tra-ditional funds.
A SOLUTION TO RISK-BUDGETING?
Outside of their weak cost, ETFs are generallypresented as the panacea of diversification. In its brochure devoted to trackers, Euronextwrites: “Investing is making choices. Yet, onthe Stock market, the right choice is oftendiversification, a solution that can provecostly in terms of time, arbitrage , analysis,and immobilised assets . Trackers enable fast,simple, and economical investment in a diver-sified stock portfolio that is representative of an industry or market.” More specifically,Pictet notes: “The current highly competitiveasset management environment is charac-terised by growing interest in investmentsolutions that reconcile increasing revenuepressure with the proliferation of risk controlmeasures. With a view to improving theefficiency of asset allocation, investors arelooking for an appropriate balance betweenhigh-alpha (satellites) and index (core) prod-ucts. Depending on the active manager riskbudget that investors want to allocate to aportfolio at a given time, this approach fits inthe need to make asset allocation shifts on aregular basis. Including index funds in a wrapinvestment vehicle is a mean of fine-tuningthe risk trade-off between alpha-generatinginvestments (carrying high stock-specific andrelative risk) and the portion of the portfoliotracking the market (market risk only).”
NOTHING BEATS AN ORIGINAL
Whether it be via ETFs or traditional funds,passive investing is recommended as an“efficient” solution to diversification. In theory, certainly. In practice, however, passive investing is not without some draw-backs. There are several types of indexing
15november 2004
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16 november 2004
INDUSTRY EVOLUTION
(see graph 1) and replicating the performanceof an index does not necessarily mean tograsp all its constituents. ETFs favour flaw-less replication but, as BCV’s Frank Hirschiadds: occasionally, one is unable to use purereplication because of too low volumes, the underlying markets’ inadequate liquidity,or legal limitations (for example, according toLuxemburger law, a security may not surpass10 % of the total NAVof the fund). In a sce-nario such as this, replication by “sampling”is used. However, this method poses thedrawback of slightly increasing the trackingerror” 3), which, in turn, has a destabilizingeffect on asset allocation.
TRACK THE ERROR!
Launched by Pictet last March, the index fundPF-Emerging Market Index offers an example,which, though extreme, demontsrates whathappens in low-liquidity markets. This indexfund comprises 400 stocks selected to repre-sent the index as faithfully as possible bymeans of a replication method developedinternally. With 400 stocks, the fund recreatesan MSCI Emerging Market Index that hasover 600 constituents. As Pictet MarketingManager Stephen Brülisauer explains: “onemust strike a balance between as firm a graspas possible on the index and the costs that this might entail.” This concept is furtherexplained in the fund’s brochure: “Investingin emerging markets is clearly more complexthan engaging traditional markets. Indeed,one must take the specific demands of localmarkets, and investment regulations and pro-cedures into consideration. Hence, it provesmore advantageous to avoid onerous transac-tions and maintain a high tracking error. The expected tracking error will standbetween 3% and 5% while that of traditionalindex funds is less than 1%.” Can an ETF doany better? It is hardly likely since the mostdiversified funds in that sector seem to haveonly 250 stocks.
THE SMI: COMPLETELY OFF BALANCE
The above demonstrates that the copy orreplication of indexes is not always ideal due to both the cost and legal factors involved.In an effort to diversify one's portfolio,selecting just about any ETF based on costconsiderations simply will not do. In selectinga fund, one must take into account both thequality of replication methods as well as thelegal constraints that are applicable to thesevehicles. More importantly, one must addressthe question of whether or not an index isnecessarily diversified. Investopedia proposesa basic definition of diversification: “A risk
management technique that mixes a widevariety of investments within a portfolio. It isdesigned to minimize the impact of any onesecurity on overall portfolio performance”.Yet, indexes are not only created to minimizethe impact of one stock in their particularuniverse. The Swiss Market Index illustratesthis marvellously: its five dominant positionsrepresent almost 75% of the index. On itsown, Novartis make up 21.73% of the SMI.From an sector standpoint, these five stocksrepresent three industries - pharmaceuticals,finance, and foods. No “traditionally” diversi-fied fund would be as densely concentratedper stock or sector!
INDEX SEEKS PARTNER
As we saw earlier, ETFs are particularly welladapted to markets with the highest liquidityand those which enjoy the highest volumes.Thus, on the Swiss stock market, there areseveral ETFs on the SMI but none on the SPI.The only index fund listed on this index is a traditional index fund, Synchrony MarketFund Swiss Equity. One can therefore assumethat ETFs will present a bias towards big caps . In and of itself this is not problematic.However, from a diversification point ofview, it calls for the precise definition of thescope of the underlying index of the ETF and measures necessary to find its complementon the market.
20000 0
20406080100120140
5
10
15
20
25
30
2001 2002 2003 Aug 04
0.68 5.66 10.69 20.44 25.316
Assets USD Billions
Asse
ts U
SD B
illio
ns
Number of ETFs
Num
ber
of E
TFs
71 118 104 108
Source : Morgan Stanley Institutional Equity, Exchange Traded Funds Strategies, Global Summary a of August 31, Deborah A. Fuhr, 2004, Septembre 9, 2004, page 27
European Listed ETF Growth
USETF Assets Under Management: $175 Bn
Number of Equity ETFs: 137Number of fFixed Income ETFs: 6
EUROPEETF Assets Under Management: $26.3 Bn
Number of Equity ETFs: 100Number of Fixed Income ETFs: 12
Commodity ETFs: 1
JAPANETF AUM: $26.1 Bn
Equity ETFs: 15Fixed Income ETFs: 0
CANADAETF AUM: $5.8 BnEquity ETFs: 14
Fixed Income ETFs: 2
ASIA PACIFIC (ex JPN)ETF AUM: $6.4 BnEquity ETFs: 17
Fixed Income ETFs: 1
OTHER (incl ISRAEL, Sth AFRICA, MEXICO, PERU, VENEZUELA
ETF AUM: $1.6 BnEquity ETFs: 13
Fixed Income ETFs: 2
Source: Global ETF Market Map- A guide to Exchange Traded Funds around the World – Merrill Lynch Global ETF Strategy Group, September 2004
Overwiew of the Global ETF Marketplace and Regional Assets Under Management (Bn US$) – As of August 31, 2004
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INDUSTRY EVOLUTION
To choose the Dow Jones Euro Stoxx 50 is toopt for a a blue-chip representation of marketsector leaders in the Eurozone, that is to say,for 63% of the Dow Jones Euro Stoxx whichin turn covers approximately 95% of the free-float market capitalization of the representedcountries. If one means to cover all or a partof the 37% remaining on the European mar-ket, which complement will be most adaptedto the Dow Jones Euro Stoxx 50? How can an investor who has already invested on theSwiss market will be able to cope with thefact that the DJ Euro Stoxx 50 includes stockssuch as Novartis, Nestle, UBS, Roche and CSwhose weightings are not to be overlooked?Finding solutions among the wider array ofETFs that exist is no easy task.
NEITHER SIMPLE NOR STABLE
As these indexes are not all equal, the investormust then select those that are most advanta-geous to his strategy. Yet, all is not black andwhite in the world of the index fund. One needonly apply any one of the myriad of indexcalculation methods currently in existence:the Dow Jones Stoxx guide offers some thirtypages, some of which provide complex math-ematical formulas beyond the grasp of meremortals, and probably even that of seasonedinvestors. One can also compare the indexescovering seemingly similar areas. Detectingthe biases that might result from their respec-tive designs is not a process of elementarymathematics.
Finally, indexes are by no means stable. In aresearch report judiciously entitled “Compar-ing Apples” 4), the author analyses the impactof Dow Jones index revisions. He writes,“The Select Sector Indexes were heavilyrevised June 24, 2002, substantially alteringthe makeup of several of them […] Some havebeen so heavily revised as to raise the question
of whether their performance post-revisioncan legitimately be compared to performancepre-revision.” This type of revision or modifi-cation of calculation methods is far fromexceptional and it adds performance devia-tions that are completely independent of themarkets’ evolution.
WHAT CONSTITUTES PERFORMANCE?
The last pernicious characteristic of these“light” vehicles known as ETFs is that this very“lightness” of character reduces the impor-tance of one of the most difficult decisions in asset management, namely asset allocation.I buy Turkey for breakfast and sell it by snacktime - that is the tempting game that resultsfrom these tools - running the risk of losingsight of the structure of one's portfolio,gambling unthinkingly in sector or capitalisa-tion-based risks. Nowhere in the literatureproposed by ETF promoters is there the
slightest mention of correlations analysis or reflection on the potential risk of portfoliodispersion. This is even more surprising inlight of the fact that there is currently muchupheaval in the arena of modern portfolio theory, not to mention increasing doubt aboutthe sense behind diversification as it has beenconducted thus far. Should one really strivefor geographic diversification or, on the con-trary, apply a sector-based approach on aglobal scale? What is optimal diversification?Does one not tend to dilute performance byover-diversification? These are questions thatare far from being answered and yet crucialas, in the final analysis, almost 80% of portfo-lio performance relies on the sensible alloca-tion of assets.
Véronique Bühlmann
1) Figures cited from the Morgan Stanley Report –Global Summary as of August 31, 2004. Accordingto this report,Barclays Global Investors (BGI) is thelargest ETF manager globally with assets of US$94.2 billion or 39.25% market share. In terms ofnumber of products, BGI is ranked first with 121products - more than three times that of SsgA.
2) A maximum spread is defined by the stockexchange regulatory authorities. It is a maximum of +/-1% on the SWX and +/-1.5% on Euronext.But as Frank Hirschi notes about the BCV(see note 3): “ETFs being a relatively recent devel-opment, no one knows if the market markers willbe able to bear the ETFs’ trading in the event of ahuge stock market crash.”
3) Les ETF de A à Z, Les Cahiers de la Finance,Frank Hirschi, Banque Cantonale Vaudoise, September 2003 (20 pages). E-mail: [email protected]
4) “Comparing Apples: Sector indexes are not allthe same”, Research Report by Harry Seneker,Dow Jones Indexes, November 2003.
17november 2004
Characteristics
Pricing
Liquidity
Maturity
Short-selling
Purchase/ sale cost
Management fees (TER)
Dividend payments
ETF
continuous
strong
None
Yes
Spread + brokerage costs
0.3 – 0.7% (CH)0.1-0.3% (USA)
Generally twice a year
Index Funds
Daily NAV
No stock market negotiation
None
No
Issue/Redemption commission
0.4-1.2%
Generally annual
Index forecasts
continuous
strong
Limited life
Yes
Initial + variation margin payments + rollover costs
No
No
Index certificates
continuous
average
Limited life
No
Issue/Redemption commission
Approx. 0.5%
No
Source: BCV (les ETF de A à Z cf. note 3)
Differences between ETFs and other funds/financial products
-4.218.01
-3.7
-3.2
-2.2
-2.2
-1.7
-1.2
17.8117.6117.4117.2117.01Annu
al A
vera
ge, 2
8 Fe
b 01
– 2
7 Fe
b 04
Annual Volatility, 28 Feb 01 – 27 Feb 04, USD
S&P 500 Net Divs ReinvestedCS IM (Lux) on S&P 500 B
Pictet F-USA Index-PCleorne Index USA
Frank Russell US Eq ABarclays IF N A Equity
UBS (Lux) EF-USASource: Micropal · PF- Emerging Market Index, Pictet Funds SA
Risk/Return Profile: the PF – USA Index Fund (net costs)
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18 november 2004
INDUSTRY EVOLUTION
Hedge Funds: Reinventing the industry
‘‘Learn and adjust” – thatis essentially what 1997Nobel Economics prizewinner and LTCM part-ner Myron Scholesstated at the BSI
Gamma Foundation conference on HedgeFunds1). His speech on “Risk Management ina chaotic environment”, came to the conclu-
sion that we have a dictionary (of risks), butthat is not enough to master the language. Inother words, corporations and investmentmanagers do not use the tools of risk manage-ment efficiently. The incorporation of risk management tools intomanagement is a growth area that will changeinvestment management and corporate activi-ties. Competition will create the need for
them to incorporate risk management tools ineveryday management.
BARELY OUT OF THE HIGH CHAIR
Returning to and broadening her commentaryon this issue, Tribeca Investments CEO,Tanya Styblo Beder2), sought to describe“The changing face of hedge funds”, hedge
Can the current pace of new product creation last? That’s the press-ing question on the lips of investors…and some of the most eminentspecialists such as Tanya Beder, Tribeca Investments CEO, not onlysee it lasting, but speeding up!
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INDUSTRY EVOLUTION
funds which are certainly among the largestusers of risk management tools. While criticsseem increasingly acerbic, deplore the decline in hedge fund performance, questiontheir efficiency in terms of diversification,and wonder whether or not alternative man-agement can yield high returns in periods of trendless markets, Beder placed thesetroubling issues within the framework of thefundamentals of an industry which, like allindustries, experiences periods of reorganisa-tion and significant development resultingfrom innovation.
According to Tanya Styblo Beder, comparedto an industry that dates back thousands ofyears such as transportation, hedge funds isvirtually infantile having only begun in 1940.But like in transportation, it has undergonemonumental technological advances, particu-larly in telecommunications and data process-ing, and also major deregulation. It is onthese bases that one could develop new toolsand quantitative management methods.
HALF EMPTY OR HALF FULL
As in the transportation industry, “inventionsare driven by those who discover and pursuethe frontiers of knowledge” states Beder.However, she goes on to add that “it can be arough ride.” Indeed, “new discoveries requirelarger investment and may not yield greatgains and knowledge dissipation and compe-tition drive early profits down to modestgains, maybe losses.” Therefore, in the worldof hedge funds, one can consider the glass tobe either half full or half empty. The pes-simist is likely to say that there are too manyentities using similar strategies and that, con-sequently, one should expect meagre returnsand a permanent reduction in alphas. But, tothe optimist, the fact that many are using sim-ilar strategies can only lead to new types ofarbitrage and, therefore, very high returns onthe very outskirts of overcrowded strategies.And if historical trends no longer hold, newones are emerging. In other words, alternativeinvestment resumes its basic form: invest-ment off the beaten track.
DATA WITH EXPONENTIALGROWTH
Why should one side with the optimist? From an industrial point of view, arguesBeder, the hedge funds sector is in its infancy.Relatively little time has elapsed between thefirst computer, the ENIAC that filled severalrooms, and our modern computers. Yet, theircapacity for calculation and data storage hasgrown exponentially. Each year, we doublethe amount of data collected. This process of
constant evolution has enabled our investorstoday to get 80% of their information for 1% ofthe former cost. Communication lines continueto improve: whereas it was once at 1 terabit persecond in 1996, in 2001 it leaped to 100 tera-bits per second and continues to evolve quitequickly. Executing orders is now done almostentirely by electronic means and over 80% ofthe world ‘s exchanges are electronic.
UNCHARTED TERRITORY EXISTS YET
The hedge fund industry was among the firstto take advantage of this infrastructuralevolution, but it still remains extremely frag-mented. Currently, hedge funds make up15,000 employees. The average hedge fundamounts to less than $100 million and lastsless than 5 years. In comparison, in more“traditional” management funds, the top 100managers run18 times the assets of HF with9,500 personnel. They also last much longer.These findings led Tanya Beder to concludethat a host of new opportunities awaitsexploration. She stresses all the unexploredpossibilities created by new technologies,particularly in systematic trading, high fre-quency trading, and new data mining. In thisarea, big players have the advantage of sizewhich enables them to harness highly power-ful computing and date processing systems.Beder also sees new possibilities in creditarbitrage and catastrophe strategies. Lastly,she finds that some areas have not been fully explored, particularly fundamentalglobal macro and value-driven strategies.
INSTITUTIONALIZE IT!
Structural change (in asset management) “isdriven by the very success of the hedge fundbusiness,” argues Styblo Beder. Formally toosmall to attract major financial institutions, its size is no longer a hindrance as the demandamong institutional investors has become toosignificant to ignore. Drawing from the DBSurvey of 323 institutions with more than$380 billion in hedge fund assets, the TribecaInvestments CEO notes indeed that in all the “traditional” hedge fund strategies,institutional investors plan to increase theirallocations. She foresees hedge fund assetsleaping from $700 billion dollars in 2004 to $2 trillion by 2010.
Styblo Beder finds that, in this pattern ofgrowth, large financial institutions enjoy a structural advantage provided they manage to overcome a certain number of obstacles: • identify and put new talent to work quickly• create the right infrastructure under
talented traders
• provide economies of scale for costly – but necessary – technology platforms
• solve HF survivorship challenges• solve capacity issues inherent to current
HF industry
IN SEARCH OF INEFFICIENCY
Regardless of their size, all the hedge fundindustry players are more than aware of theneed to overhaul the industry. As Dr. PhillipCottier, “At Harcourt, we do think that Q2was unusual in that not one single marketevent but rather many simultaneous, coinci-dent events led to the drawdown… We alsothink that going forward, top-down strategyallocation will become even more importantthan in the past… Fortunately, new strategiesare appearing on the fringes of today’s hedgefund industry… On its constant strive forreturns and search for the next pocket ofinefficiencies, the hedge fund industry willmove into these new, uncorrelated areas. Withaccelerating inflows from investors, the need for the hedge funds to constantlyreinvent themselves will increase.” 3)
Véronique Bühlmann
1) Hedge Funds : Theories and Practices, ConferenceBSI GAMMA FOUNDATION, 16 September 2004,Lugano
2) Tanya Styblo Beder joined Citigroup AlternativeInvestments in May 2004 as Managing Directorand CEO of their single manager proprietary hedgefund unit, Tribeca Investments LLC. Previous toher move to Citigroup, she was a Managing Direc-tor and Head of the Strategic Quantitative Invest-ment Division of Caxton Associates, LLC.
3) swissHEDGE, 3rd Quarter 2004, QuarterlyReview, Dr. Philipp Cottier, “Reinventing thehedge fund industry” page 7.
19november 2004
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20 november 2004
INDUSTRY EVOLUTION
Independeant asset manager and president ofInvestissima, Jean-Michel Genin has gained awealth of experience in asset management,working for large Swiss and foreign corpora-tions as well as a small private bank in Lausanne.
INTERVIEW
TRUSTING: Is there no getting away frominvestment funds?J.-M. Genin: Why try to get away from them?Funds are as much a part of the investmentworld as shares, bonds, structured products,ETFs and so on. But I think one must avoidtaking extreme positions that entail managingassets only by way of funds. To do that isessentially giving up in the sense that perform-ance is wholly “delegated.” Personally, I willseek out funds that have outdone my ownperformance in the past and provide adequatediversification opportunities. This argument isvery important. Take a fund on the Swissstock market – with Nestle, Roche, Novartis,and UBS making up more than half of theindex, I don’t see how it is diversified.
TRUSTING: That case is rather beyond thenorm. The question ought to be: does directmanagement enable one to achieve sounddiversification? J-M Genin: The first obstacle lies in thevolume under management. With anythingless than 300,000 francs, I fail to see how to attempt diversified management without
funds. Beyond that, it all depends on theclientele’s demand. What is certain, however,is that I don’t see the point of funds on marketsin which one already has a stronghold. Forexample, I don’t see why one would still turnto Swiss franc bond funds today, with returnsthat average between 1.5 and 1.8% per annumand Total Expense Ratios of around 1.3%. It’sall in the figures: at the end of the day, theinvestor will be left with nothing at all.
TRUSTING: Aside from the cost issue, do you think that one can invest directly inbonds and still stay sufficently diversified?? J-M Genin: Yes. Funds are only worthwhilein one instance – when one seeks to makeone’s performance more dynamic, such as by entering the high-yield bond market.However, in the AAA bonds, regardless of theinterest rates level, it is a waste of time to use funds.
TRUSTING: Even on foreign markets, such as the United States’?J-M Genin: Yes. And if one isn’t necessarilyfamiliar with all the American borrowers,there are enough European companies thatconduct loans in dollars. For a portfolio, five to six AAA bonds are more than adequate.
TRUSTING: And that would constitute a diversified portfolio?J-M Genin: Certainly. Statistics show that inthe AAA investment grade universe, the riskof bankruptcy is 0.001%, that is virtually nil.
Furthermore, between AAA and bankruptcy,there is often a decline in rating which acts asa buffer, thus limiting the credit risk.
TRUSTING: If you buy a bond in dollars andyou’re supposed to hedge the exchange risk,what do you do? J-M Genin: You have the same problem witha fund denominated in US dollars. The onlyfund that may prove promising would be afund that is diversified across the totality ofthe bond market and hedges its exchange risksagainst its reference currency. In theory, it ispossible to make its own hedging, but, in myopinion, the asset manager who believeshimself capable of this feat has never done so in the first place. Hedging takes money.We tend to hedge for a given time-frame: six months, or a perhaps a year, and then, tiredof paying for no reason, we stop doing so –just when hedging would have been necessary!
TRUSTING: Going back to stocks, let’s takethe Swiss small caps . How would you handlethat market?J-M Genin: I would rush back to funds andwould seek a Swiss equity product ex-SMI.In this specific case, there is also the volumefactor to consider. On the Swiss stock exchange,some days, significant increases occur on theexchange of a mere 25 or even 10 stockcertificates. With such low volumes, it is bestto opt for a specialized fund. Furthermore, the small caps pose a higher degree of riskthan blue chips. Consequently, the diversifica-tion of the portfolio will have to assume a wider scope. One would have to keep aminimum of 15 companies. For an individualportfolio, this would lead to far too insignifi-cant positions.
TRUSTING: Because the array of fundsavailable is immense, does one not tend toover-diversify portfolios?J-M Genin: When I hear some people say thattheir portfolios are adequately diversifiedbecause they placed their assets in three dif-
Investment fundsFor better or for worseFlooded with investment tools, the privateasset manager has to stand his ground for his very freedom. Bonds, shares, ETFs,guaranteed capital products, and hedgefunds: for each of these assets, it boils downto one thing – a “fund” amental question.
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INDUSTRY EVOLUTION
ferent banks – UBS, CS, and BCV – I amindeed doubtful. If I examine their portfolios,the funds of the various promoters are virtu-ally identical. In a case like that, one’s portfo-lio would actually be under-diversified.
For diversification purposes, some recommendfund of funds. Perhaps it’s a solution, but aslong as it doesn’t turn out to be “a fees of fees”construction.! Obviously, if I have a hedgefund that yields 8 – 10% per annum, the costissue becomes minor at best.
TRUSTING: Back to the over-diversificationissue. J-M Genin: It boils down to cost. When onegoes solely down the investment funds’path,this comes with a price. If in the final analysis,one achieves one’s objectives, the cost of fundsare of no concern to me.
TRUSTING: The Unites States representsapproximately half of the world’s stock market capitalisation. Should one work thismarket directly or through funds? J-M Genin: One can deal directly. When youdecide to enter a sector, such as the high-tech industry for example, you can select a fund that comprises all the big names ofthat sector – Intel, Apple Hewlett, and so on.Or, as I have, after all it is my profession,you choose two or three among them that are sufficiently visible. Of course, in thisinstance, I don’t diversify across the industry.But I can’t imagine considering one’s self to be an asset manager and not ever buyingshares directly.
TRUSTING: Is it not right then to think thatthe investor is better served by using funds?There is a whole army of asset managementexperts of the high tech industry. What, compared to them, is the value added throughyour own stock-picking? J-M Genin: I bring my knowledge of the mar-kets to the table. This enables me to say thatchoosing a few blue chips is no greater a riskthan opting for a basket full of 50 or moredifferent stocks, of which 20 are pretty muchunknown and pose a great deal of risk.
TRUSTING: You don’t trust the basket? J-M Genin: Sure I do, but there are timeswhen some stocks are really quite outsidetheir historical price range. For example,they might be clearly under-valued. In a casesuch as this, the idea is to buy them with athree months perspective in mind. It’s a trad-ing strategy that cannot be applied whileinvesting via funds as the cost factors of thatroute are simply too great. In the currentmarket conditions, it is vital to bounce backand forth.
TRUSTING: Don’t you think that the currenttrend is towards portfolio over-diversifica-tion. Last week, an ETF on Turkey went onthe market. Which portfolio really needs tohave the Turkish index? J-M Genin: I agree. Diversification is whole-some and good, that doesn’t mean that onehas to cover every geographical zone andstrategy. In the end one attempts everythingand nothing, running the risk of losing sightof one’s asset management objectives.Besides, one mustn’t forget that the more one diversifies, the more one falls prey to alot of follow-up work. And I don’t think thatone person can really manage today withmore than around 50 funds.
TRUSTING: Among the investment tools thatyou use, you mentioned guaranteed capitalproducts. How do you incorporate them intoyour portfolio? J-M Genin: It’s a fairytale example of whatmarketing can do!!! That being said, I thinkthat guaranteed capital products should be inone’s portfolio when everything seems tonearing the peak. This enables one to enjoy apotential increase and, in the case of a signifi-cant decline, the investment is protected.
As things stand currently, there is little justifi-cation for the use of guaranteed capital prod-ucts, except for one instance. Let’s say that I invest in Swiss francs over three years. I would have an average annual return of1.5%, or approximately 5% over three years.In this case, if I opt for guaranteed capital, it would be in order to make things moredynamic. Rather than to say to my client thatin three years you’ll have 5%, I suggest thathe take the risk of having a zero performancebut possibly gains a return that would be farsuperior to that of bonds. This can be done byopting, through capital guaranteed products,for raw materials, crude oil, or stock indexes.But careful – I take this risk on a short-termbasis, three years, because the capital is onlyguaranteed at maturity and, in the interim,prices of the guaranteed product can varydrastically.
Guaranteed capital products can’t be used as a cushion. It is extremely expensive and,after commissions to the issuer , and retro-cessions to the asset manager, little remainsfor the final investor.
TRUSTING: Would you take guaranteed capital on hedge funds?J-M Genin: Yes, I would at the moment.Outside of funds of hedge funds proposed bybig names and well-established promoters, I believe one must be very careful. In light of the swarm of new asset managers in the
industry, I am inclined to think that we are infor some nasty surprises.
TRUSTING: Let’s touch on traditional funds.Are they not over-diversified? J-M Genin: One can’t generalize. One must-n’t forget that if you’re an active manager,volume is fundamental. Today, there are morefunds on the market than there are quotedcompanies. Thus, to have volume, activemanagers are essentially sentenced to over-diversification.
TRUSTING: The Swiss Federal law on invest-ment funds protects the investor. The fundsare required to clearly state their strategies, and offer high-quality reporting. Direct man-agement has none of these constraints andtherefore poses some “risk”. J-M Genin: Information provided by the fundsis limited. For example, the final investornever has direct acces to the asset manager, if not the latter would spend all his time oncustomer relations. This is not the case indirect asset management as it relies on a rela-tionship of trust between the manager and the client. And then reporting isn’t every-thing. Look at Swiss, ABB, Parlamat, andothers. Their reporting was first class, but inmagic ink! ,
I believe that the client who desires dailyreporting and permanent control must not hirean independent asset manager as that wouldmean that there is no trust between them, and, in this case, the manager’s work wouldbe futile. Having reporting is certainly a goodthing, but one must also be able to analyzeinformation and that is a profession in and ofitself. For example : I really like cars. If onewere to send me all the documentation imagi-nable about them tomorrow, I wouldn’t be inany position to make an educated decision asthe information would, for the most part, goright over my head.
TRUSTING: So reporting is almost like a booby-trap?J-M Genin: Basically, it’s a parachute thatopens once you hit the ground!
Véronique Bühlmann
21november 2004
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LEGAL & REGULATORY
Peter H. Buxdorf: England is very much on the forefront
“In England, there has always been an under-standing that the U.K. was on the forefront ofregulation,” says Paul H. Buxdorf. His firm,Lacomp plc in Bagshot, specializes in portfo-lio fund management. In recent years the roleof the Financial Services Authority (FSA) hasbeen expanding, and it is no longer possible toengage in asset management without adequatesupervision. “Such an obligation was neededsince too many people were setting up whilelacking an appropriate background.” As far asthe fight against money laundering is con-cerned, U.K. regulations are also very strict.“There is a huge discrepancy between theU.K. and Europe,” Paul Buxdorf thinks. He iswell placed to measure the gap, since he him-self came from Switzerland many years ago. However fussy regulations may be, they arenot always as effective as they should be,dwelling exceedingly on paperwork rather thanon proper risk assessment. Compliance is notthe only aspect of wealth management wherethe U.K. regulations have gone so far. Indeed,England is very much on the forefront ofclient compensation as well. Indemnity insur-ance exists since the 1980s, allowing for anyclient unhappy about the services which havebeen provided to him to file a complaint. The firm is under an obligation to investigate,following such claims, and to offer appropri-ate redress. If he still not satisfied, the clientcan put the matter forward to the FinancialOmbudsman Service which may instruct thefirm to award him up to £100’000. Such com-pensations may in turn be covered by indem-nity insurance, but even under fairly restric-tive conditions, the market is far fromattractive. Several insurers have withdrawnfrom the market which has shrunk, leading toa lack of capacity. Since every companyengaging in asset management has to have anindemnity insurance for bad advice, costs aregoing up dearly. Undeterred by this and otherdebatable aspects of the British experience,European regulators are increasingly turningtoward the U.K. for inspiration.
MF
Laurent Ashenden: toward a consolida-tion of the profession
“Quite a number of small asset managementcompanies will have to merge in the comingyears,” says Laurent Ashenden, ManagingDirector of Ashenden Asset Management SAin Geneva. Even though regulations wereneeded at the outset to fill a void, obligationimposed by the law, especially as far as com-pliance and due diligence are concerned, is likely to prove too heavy a burden formany small asset management companies.Still one third of the firms active in Switzer-land have less than 50 mios sfr under man-agement, while costs are on the rise. An audit,under the new regulations which have latelycome into force pursuant to the law againstmoney laundering, represents up to 15’000 sfrcharges, not allowing for the time consumed.At 5000 sfr a month per subscription toBloomberg is becoming too expensive forsome, at the expense of part of their credibil-ity with clients. Now, asset management isbecoming more demanding, not only as far astechnical equipement is concerned, but also inview of further regulations which are likely to
be enacted in a not too distant future. Thus,background checks and competence assess-ment are likely to be introduced on would-beasset managers which will make the profes-sion less accessible to newcomers. Minimumcapital requirements may be also imposed inthe future, in order to make sure that compa-nies engaging in wealth management arestrong enough to face up to their responsibili-ties if needed. Last but not least, indemnityinsurance, covering clients for bad advice ordeparture from agreed investment policy, is also on the regulatory agenda. Such ascheme, however will be very difficult toadjust to prevailing market conditions, so asto enable insurance companies to operate in a way that would prove both profitable forthem and effective for the clients.
MF
Vicente Ferro: in the client’s interest
“As professor Jean-Baptiste Zufferey has said,it would be advisable to set up an institution tooversee the operation of the non-bankingfinancial sector as a whole,” says VicenteFerro, as Managing Director of the GroupeBeaulac SA, in Geneva. Cooperation with theauthorities is of the essence for all financialinstitutions, since it would be very negative toshow reluctance in the fight against moneylaundering. Appropriate means of gatheringinformation in the process of due diligence doexist, even with clients based in remote coun-tries. Custodians will as a rule oblige withdata pertaining to the source of funds entrustedto them. To this effect, the two big Swissbanks entertain a worldwide network of sub-sidiaries, representative offices and correspon-dents. Moreover, other means of performingbackground checks are also available throughspecialized societies and data bases. Banksuse readily a system such as World Checkwhich allows for wide screening possibilitieswith its 2 mios names on file. Running namesagainst such systems act as a first clearance
23november 2004
Regulatory-maniaFive senior investment managersgive their opinion
Laurent Ashenden
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even though it should be regarded more as a prerequisite. One always has to go back tothe source of funds in the country of origin,and this requires the cooperation of the client.Sometimes, he will have to appear in person at the offices of a local subsidiary of the bank.Clients may not always be very pleased about this, but such caution works in their best interest.
MF
Jean-Claude Mourad: KYC should not beabout only going through the motions
“One must differentiate between the letter ofthe law against money laundering, and whatwould really be needed in terms of financialsecurity,” says Jean-Claude Mourad, compli-ance officer of Suntrust Investment CompanySA. As far as the regulatory environment isconcerned, Switzerland is well endowed withlegal instruments and codes of conduct. Butthe implementation is not always as effectiveas it should be. Indeed, excessive checks andneedless paperwork may sometimes run atcounter purposes with the alertness which areal understanding of the meaning of KYCwould presuppose. Sometimes, financial inter-mediaries have to go through the motions forthe sake of it, for instance when due diligencehas to be performed three or four times for thesame client, first by the bank, then by the assetmanager, then by a lawyer. These and otheraspects of the law should undergo a review. To this end, the establishment of a genuine“Financial Services Authority”, such as existin other countries, would certainly showprogress. This new set-up would be only afirst step since loopholes would have to beclosed. There should be a rethinking of such akey concept as KYC, relying more on a betterappraisal of the client’s personality. Indeed,appropriate documentation should not alwaysbe taken as conclusive evidence of good char-acter, and allowance must sometimes be madefor other, less formal factors. Thus, asset man-agers are sometimes led to refuse clients whohave already gone successfully through rou-tine checks at the counters of a bank. Suchchecks do not shed enough light on what canbe termed as the economic history of anaccount holder. Needless to say, such an alert-ness has a cost and represents an added bur-den for wealth managers. But the tendencytoward increased sophistication will be felt byall members of the profession, even leavingaside the requirements of the fight againstmoney laundering. In Switzerland, affiliationwith a recognized association, pursuant to thelaw against money laundering, is still the soleprerequisite for managing assets. In Franceand in Monaco, however, companies have to
meet minimal capital requirements, dependingon the amount of funds under management.And that is not all: asset managers must beable to provide the client with a clear invest-
ment policy, adherence to which will be moni-tored by an audit firm. In Switzerland, thingsare undoubtedly moving in this direction.
MF
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Franz de Planta: Self-regulation shouldremain the key.
Franz de Planta is Chairman of the OAR-G(Organisme d’autorégulation), that is the selfregulatory body of the Swiss Association ofIndependent Financlal Adviser (GSCGI) and of the Geneva Corporative Employers’Association of Wealth Managers (GPCGFG).
As such the OAR-G, under licence granted by the Swiss Department of Finance in Berne,authorizes its affiliated members to exerciseand supervises them as to the due fulfilmentof their legal obligations and compliance withthe Money Laundering Act (LBA).
He argues that reliance on self-regulation, as it is enshrined in the LBA, has sufficientlydemonstrated its practical value over the lastfew years. Indeed, it would be paradoxical if Switzerland was to renounce a conceptwhich increasingly appears as a model forother juridictions.
Self-regulation is no easy way and the costs it entails are fairly high for the 6,000 nonbanking “Financial Intermediaries” (or IFA’s)registered as such with the Swiss Ministry of Finance.
Globally, the costs of compliance in Switzer-land are situated somewhere between 1 and 2 billion Swiss Francs on a yearly recurrentbasis. This burden might even increase in thefuture, as a prospective compensation couldbe levied as of 2006 by the Swiss Departmentof Finance to allegedly cover the administra-tive costs of overseeing the fight againstmoney laundering and the expenses of itsControl Authority (AdC).
This could add up an important extra financialcharge for the self-regulatory bodies orOARs. While not very costly for a start, sucha scheme would open the door to subsequentincreases with uncertain limits on the upside.
Hopes are that there will not be a growingpressure on the existing OARs to fall in linewith the politically thought out strategydecided in Berne, without making sufficientallowance for the experience of those who are immersed in the day-to-day activity ofwealth management.
Thus, the Federal administration seems not to worry about the consolidation in the num-ber of self-regulatory bodies making themless representative of what is regarded by theindustry as vested interests. In the eyes ofFranz de Planta and almost all the IFAs, com-pliance should on the contrary rely on profes-
sional organizations responsive to specificneeds, so as to make them more effective inthe global fight against money laundering.
Increasingly, the Administration’s trend towardmore regulation contradicts the avowedreliance on self-regulation. At the end of theday, the establishment of a large centralizedauthority to oversee the entire financial sectorincluding banks and non banks, insurancecompanies and financial intermediaries, notonly in LBA-compliance but in other mattersas well, is likely to make the existing systemredundant.
Wealth managers would have to spend anever increasing amount of time dischargingadministrative duties and filing innumerable
forms to cover against impending action onthe part of hyperactive and evermore intru-sive State agencies, thus soon outpricing theSwiss market place over their much lessdemanding partners about these same aspectsin the global financial landscape.Needless to say, such an environment woulddoubtlessly drive many clients away. And itwill not really contribute to improve the market place Switzerland.
Mohammad Farrokh
25november 2004
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(A keynote speech delivered on 1st Octoberduring the PIMS International Conference,reproduced with the kind authorisation of itsauthor).
Let me first trail my coat. I amChief Executive of APCIMS,the Association of PrivateClient Investment Managersand Stockbrokers. We have229 member firms operating
on over 500 sites with €400bn under man-agement for the private investor. Last yearour members did 13.7 million trades in equityfor their clients.
Our members are firms and these firmsemploy some 10,000 regulated people – regu-lated that is to undertake investment business.Two years ago, the European Association ofSecurities Dealers, or EASD for short, votedto merger with our organisation. I think it iswith some justification that I can say thatAPCIMS is the largest association of firms inEurope who act for the private investor.
Now the reason I trail my coat is because I am going to talk about the size and nature of the changes that are going to affect allEuropean markets and financial firms regard-less of size starting from next year – that isfrom 2005.
No EU country has responsibility any longerfor policy relating to its financial markets.Decisions were taken by all our governments5 years or so ago to place this responsibilitywith the European authorities and instruct the Commission to put together a FinancialServices Action Plan, the intention of whichis to create a single market in financial serv-ices across Europe.
Like so many announcements of politicians –and as an ex-politician I can say this withcomplete honesty and truth – these sort ofhigh levels commitments are given with littleunderstanding of what they are is going tomean in practice.
Charged with the responsibility of the FSAP,the Commission quite rightly decided that itneeded to find a way of doing things ratherquicker and rather better than it had in thepast. Alexander Lamfalussy was asked to puttogether a group of “wise men” to come upwith a method for speeding up the Europeandirectives process. He did so, and what isnow known as “The Lamfalussy Process” haspassed into the common language of Europe.
The Lamfalussy process proposed that direc-tives should be short and consist of articlescontaining only high-level principles. Then for a Committee of European SecuritiesRegulators comprising the heads of everycountry’s securities regulators to recommendtechnical details to be established. Thesetechnical details would be submitted to theCommission for inclusion in the directive and should be subject to easy and quick changeas and when required.
National regulators were to implement theserequirements with the intention of reaching a common goal. Lastly, there needed to besome enforcement procedures if a country didnot implement or did not implement properly. Good process but with a couple of flaws.Firstly, it did not properly include the EuropeanParliament which is the only European insti-tution with a democratic mandate. Not sur-prisingly, the European Parliament decidedthrough its EMAC Committee that it must getinvolved and, as they were removed entirelyfrom input into the technical measures stage,
then they would need to address theirs andthe industry concerns by way of amending the directive itself.
The second flaw is that the process is notbeing properly followed. Let me explain byexample. What is arguably the first majordirective to be Lamfalussy-ed is the newInvestment Services Directive (now known as MiFID) – the framework all our marketswork within. It is in fact over 60 pages long.It was subject to much consultation with themarket which is good, but many of the rec-ommendations made by market practitionerswere not included. When it had its airing in the European Parliament, the industry(wherever it was quartered) lobbied exten-sively. The European Parliament agreed a largenumber of very practical changes throughamendments to the directive but sadly theCommission only accepted about half of theParliament’s amendments.
The directive was agreed by the agriculturalcommissioner and then arrived at CESR, the Committee of European Securities Regu-lators, for consultation of the technical meas-ures. I cannot fault any of the European groupsin terms of their consultation. What hampersall their consultations though, is that the EUis many countries with many different marketpractices and cultures. The absence of adetailed review of the various practices todetermine what is similar and what is differentin the first instance means that policy makershave been hampered by the absence of thatknowledge. The result is that some changesmay well be over-aggressive for some coun-tries and unnecessary for others. The theoryof open markets is good but if it badly affectsa particular country’s industry, then the indus-try and politicians get concerned and compro-mises made.
The likely outcome of the CESR proposals willbe recommendations to the Commission that will have the result of increasing the sizeof the directive substantially.
There will inevitably be a great number ofdetailed changes to industry practice, fromhow a firm trades to whom they can trade
The EU Financial Services Action PlanPay attention: the FSAP is destined to have agreater impact on your country’s regulatorysystem than has been seen for many years.Be prepared.
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with. From a client (or customer) agreementto the protections a firm gives them. Fromwhat is an exchange, a crossing network orECN, to whether a trade is on market or offmarket. From what can be traded, and in whatsize, to price disclosure. And what is morethose differences will be legislation with thepower of enforcement behind them.
Not a lot will be left to national regulators andyet the role of these national authorities isvital because markets have grown up differ-ently and there are more ways than one ofgetting to the end result.
In the Financial Services Action Plan there are42 proposed changes and the Commission’swell-publicised statement is that 39 of the 42 measures of the FSAP have now beencompleted. However, it is only the Commissionthat has finished as none of them have yet beenfully implemented by the industry. The indus-try should not accept that this Financial Services Action Plan is nearly complete whenfor those for whom it is intended are yet tostart their implementation.
I was honoured to be asked to be a member of the Commission’s securities expert group.This was a group of about 26 individuals frommost of the EU countries who met on severaloccasions in Brussels and produced a report onwhat should be the next changes for the securi-ties industry. The practitioners in that group all had very similar views – a regulating pausewas essential. Instead implementation of theFSAP in a clear, transparent, flexible and assensible a way as possible was proposed.Systems to unmake what needs to be unmadewas on the list, the need for transition periodsand in future an evidence based approach toany new legislation was essential.
There will certainly be some benefits from theFSA, particularly for the wholesale firms.Although the big multinational firms alreadyhave managed to overcome most nationalbarriers and in so doing provide a service for those who cannot overcome the nationalbarriers as easily, for the mid-sized firms whomay well currently have to use a big whole-saler in order to access certain countries infuture, are likely to have better and cheapercross border access than it has at the moment.
For many tens of thousands of firms thoughwho fall within the definitions of MiFID, most of them do little or no direct cross borderbusiness at present and this will be slow toincrease. For them in particular – and theseinclude those who service the needs of theprivate investor – the costs will come early andthe benefits could be as many as ten years out.
What is to be done? Well there are five things. 1. Give more time. The most expensive way
of introducing something is to do it tooquickly. If further time is given to thewhole of the implementation process, andthat includes the consultations, then changecould be staggered and in so doing the costof change could be much reduced.
2. National regulators and the industry needto trust each other and be trusted more byCESR. CESR has already brought every-body together; it has already started knowl-edge dissemination from one country regu-lator to another, and from the industry to allnational regulators. Now CESR must trustthose national regulators and the industryto get to the same end but by differentmeans if those different means are moreappropriate.
3. Understanding each other’s differences isessential. Even now with the programme ofchange underway, if we understand eachother’s differences better then it is easier tocreate more appropriate technical measures.
4. Cost everything. I know that it is very diffi-
cult to do good cost benefit analyses butchange does have a cost and so costing thebenefits is paramount and is a process thathas been sadly given too little attention todate.
5. The industry needs to participate and saywhat it thinks. If the industry lets the bigidea go unquestioned then the industry canonly blame itself for not having said earlyenough that the practical issues must havefull consideration in advance of final deci-sions being made.
The FSAP and post FSAP is destined to have a greater impact on every EU countryregulatory arrangements than has been seenfor many years.
Angela KnightChief ExecutiveAPCIMS
27november 2004
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Clearly, the answer is: “yes”.“At 100% tax rate, any kind of economicactivity would be pointless…” but what are thepoliticians doing seriously to limit the level of taxation?
Clearly, the answer is: “nothing” – or to be generous, rather little…It is obvious that our European countries withtax levels of more than 50% of nationaloutput are experiencing serious problems anda general lack of confidence in the economyand more seriously for the democraty, thepoliticians in charge of the mismanagementof our interests…
The limit on taxes is probably what? 20% of national output? 30%? As a matter of fact, in Europe, we find threeplayers’ leagues:• Corporate tax less than 19% – most of the
new EU member states• Average corporate tax – 30%• Big “spenders” – member states with
corporate tax in excess of 36% – France/Germany/Italy/Benelux
Will voters rebel one day as it happened in a distant past?Some people think that high tax burden is theinevitable result of widespread democracy.When wealth was concentrated in relativelyfew hands, and the wealthy tended to controlthe government, they had no incentive to taxthemselves. Today, most of the wealth isconcentrated in the hands of the middle class,but apparently the middle class does not con-trol the government…
The politicians have to attract voters by offer-ing “goodies”, spending on social security,health, roads, education etc. The money had to be found somewhere and taxes riseinexorably…
Taxes are a brake on economic activity.There are adverse incentives to work, to save,and to seek and offer employment.Social security benefits may make it pointlessfor workers to seek employment; hence adecline in the proportion of adult men inwork over the last 30 years.
The high costs of collecting taxes and com-plying with the tax system undermine theworkings of the machinery.
Taxes create a challenge to civic institutionsencouraging tax avoidance and evasion.Taxes (and bureaucracy) are so excessive that the temptation is high to break the laweven for any of us…
Many of us have built a growing exasperationover the way concerns over tax avoidance,crime money laundering and the financing ofterrorism have resulted in an explosion of theregulation, compliance procedures and costs,with little or no regard for the efficiency ofthe measures implemented.
Let me be provocative: the solution may betax-exemption for all savings and a freesystem that would allow the citizen the choiceto pay for the entire cost of his retirement, the education of his children, and his medicalcare…
Today, our professional activities (advice andmediation) are penalised by extremely con-straining regulations, the soaring cost ofcompliance procedures, the development ofnew technologies (rarely 100% reliable…),and the demands of a generally distressed and ill- informed clientele.
In 2004, financial advisers and financial inter-mediaries will collect worldwide more thanUS$ 300 billion worth of savings from the“mass affluent” individual customer segmentwith liquid assets between €100,000 and €1 million.
The “time bomb”, which, in the very shortterm, is the pensions problem, reinforces thepolitical need to attack the ensuing problemssooner than later, even if the politicians areshowing an unfortunate reluctance for a moreliberal European direction, and be moregenuinely concerned with consumer interests,than certain national administrations mightwish.
The failure of the state pension systems willopen unprecedented prospects for European
financial advisers and intermediaries calledupon to assist the anxious consumer in theright choice of options and alternatives for the sound management of his or her wealth.
The European Commission plan addressesbroader issues concerning an optimal singlefinancial market, including the elimination of tax obstacles and distortions.
But, adoption of a minimum effective taxationthat everybody would eventually happily payfrom savings and implementation of a code of conduct penalising the politicians’ “bigspenders” would have be a strong positivesignal. Unfortunately, the last Commissionfailed short of achieving anything in thisrespect…
Clarity of regulatory requirements, consistency(but not necessarily homogeneity), simplicityof application, maximisation of fair competi-tion, to serve investors and citizens throughincreasing choice, the flexibility to encourageinnovation should be the objective of the EU.
Needless to say that European legislation,made too often of political compromise, is far from meeting these goals.
Vincent J. DerudderSecretary GeneralFECIF (European Federation of FinancialAdvisers & Financial Intermediaries)
Is there a limit to taxation?
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Numerous are they who callfor the creation of regula-tory measures at the interna-tional level, without pausingto carefully consider thelegal and operational limita-
tions of this battle cry. In the meantime, thepress has taken this complaint and made it itsanthem, sensationalizing the archaism andinefficiency of national regulatory bodies cur-rently in place.
WHY REGULATIONS ARE NECESSARY FOR THE EU
In the last ten years or so, the consideration ofinternational regulations for European mar-kets jas become a categorical imperative, andfor two reasons: The first is due to the irresistible nature ofcross-border operational development andthe ineptitude of regulators to act only at thenational level. More than a third of EuronextParis’ stock market capital is indeed tied upby foreign carriers, and the figure would beeven higher were one to include CAC 40companies in this equation. Consequently,the overseeing of market operations calls intoquestion the presence of intecedants beyondsthe border, a development which presumesthat the scope of inquiry is being extended bycooperation with foreign authorities in orderto restore the chain of outsider influence andobtain necessary explanations. Hence, in2003, out of 85 inquiries launched by theCOB and the AMF, 30 were conducted at therequest of foreign authorities. However, asthe COB addressed nearly 200 requests forinformation to its counterparts, half of whomwere submitted for possibles operationsd’initiés.
Another example – out of 9,500 funds offeredto the public, 3,000 are funds of foreign ori-gins; funds that are said to be “coordinated”.
The second reason, no doubt more importantin the eyes of those in the sector, is due tooptimization of the cost and efficiency of themarket system. The fragmentation of markets that it linked tothe preeminence of the national factor poses a handicap in light of their development andthe reduction in the cost of capital. This is oneof the main arguments of the Lamfalussyreport and the plan of action in financial serv-ices launched by the European Commissionin 1999.On the other hand, international regulationwould benefit competition and increase thefield of operatives, thus encouraging innova-tion, economies of scale, and user access to a larger array of products and services.It is therefore only logical to pursue the imple-mentation of international regulations, whichenables both the standardization of rules, theunification of their application, and the provi-sion of a coherent interface for local operators’first steps in the international market.
Without a doubt, no one still foresees the cre-ation of a global market authority. But it isapparent that the issue is at least being talkedabout in political spheres such as Europe thatare en route to integration.
… AND THE OBSTACLES?
International regulations must resolve certaindifficulties that inhibit the planning of rapidoperational integration.
First of all, I will insist that a fundamentaldistinction be made between the establishingregulations, which should remain in the handsof legislators and governments, and the appli-cation of these regulations which is handledby administrations and, increasingly, inde-pendent administrative authorities. Each mustthoroughly understand that the market regula-tory body only issues third level regulations
and that a sole regulatory body, one that isPan-European for example, could not secure,on its own, a standardized norm for everyone. Consequently, I anticipate two types of prob-lems which, in my estimation, make the unifi-cation of market regulation in the form of asupranational operational system an aspira-tion that is largely idyllic. �The first obstacle arises from the principle
of sovereignty which still influences rela-tions among the member states. Marketregulation, as with all social regulation, isbased on a legal foundation for which itlacks the technical modalities needed for itsimplementation. Even in the context of Europe, the notionof sovereignty remains prevalent. Indeed,this trend arguably extends to the world atlarge. Certainly, the trend towards integration atthe European level is advancing, but onecan already see the difficulty and slow pace
International regulationTo encourage progressive convergence“In this period of increasingly integrated financial market implementa-tion, the issue of regulatory measures at a European level has nowbecome paramount,” stated Edmond Alphandéry before ceding thefloor to the superintendent of French financial markets, Michel Prada,president of the AMF.
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that this requires. Hence, it would beabsurd to daydream about total operationalstandardization for many years to come.
�There is second set of obstacles to tqke intoaccount, factors that are much more practi-cal and concrete in significance. Unlikeprudential regulation which concernsdefined professions and middlemen that arecertainly numerous, though limited andresponsible for the creation of specific andincreasingly internally framed norms, mar-ket regulation is a daily affair, on the theinfinite relations among all the entities thatplay a part in the market – businesses,investors, and middlemen from all walks oflife – all engaged in the commerce of a hostof products. Essentially micro-administrative in char-acter, it assumes an optimal proximity to the site, operational decentralization, a capacity for direct communication thatproves less favorable in cases of distantparties who are appear foreign due to their unique culture and language, whosevery integration would require a mon-strous bureaucracy that would quickly tire its users. Whatsmore, one must not forget that mar-ket regulation is executed in collaborationwith numerous national and ministerial reg-ulatory bodies, not to mention the represen-tatives of associations that express the needsof the many players in a given market.
THE INITIAL STEPS TO TAKE
It seems to me that the adaptation of marketregulations to accommodate globalization hasto be conducted in keeping with a progressiveand realistic strategy of creating a network ofnational systems intended to organize theconvergence of concepts and regulations aswell as operational cooperation among regu-lators. This is the starting point that has beenundertaken since 1997 on a European scale,on whose history I would like to offer a per-spective.
With the exception of a few directives,including the DSI of 1993, no system forinteraction among European regulatorsexisted in the mid 90s. It was upon this real-ization that, with Mario Monti, the idea forthe Forum Européen des Régulateurs,FESCO, supported initially by the COB,which suggested its creation in Paris duringits 30th anniversary celebrations in late 1997,was born.
Equipped with a president, a secretary gen-eral, a charter of cooperation, FESCO quicklygot to work and suggested to the DG 15,
under the direction of Georg Wittich, its sec-ond president, some ideas that were to consti-tute the future plan of action for financialservices adopted by the Commission in 1999.What follows is actually quite remarkable. Onthe initiative of the French presidency, the“Lamfalussy process” is launched, validatedin Stockholm, the creation of the EuropeanCommittee of Securities Regulators, theCESR, in 2001, leading to the issuing of sev-eral major directives. Professionals who fiveyears earlier had demanded the rapid stan-dardization of the market, plead for “mercy”before this onslaught and the task of consulta-tion and reform that it engenders. As a side note, it is interesting to note that, inthe five years since this all began, this aspira-tion has steadily deleted from its meaning, theclash of ideologies between the consumeristtradition of Continental Europe and thecaveat emptor philosophy of the United King-dom.
Now firmly established in Paris, CESR hasdone its homework in the banking and insur-ance sectors. It is breathing life into a networkof regulators for which it is gradually becom-ing the central nervous system, with its triplerole of advising European authorities, stan-dardizing regulatory practices, and cooperat-ing in an operational capacity in supervision.
One must go farther and, in keeping withwhat IIMG, the group of experts in charge ofthe evaluation of the Lamfalussy process’,over which I had the honour of presiding in2003, ensure to reinforce the CESR’s author-ity, be it in the legitimization of its standards,the resolution of en conflicts that may arisebetween members, and the organization of amore integrated supervision of the market.Perhaps, later on, it will be necessary to haveCESR assume the responsibility of direct reg-ulation in areas that are clearly pan-Europeansuch as the recognition of rating agencies orthe handling of some conglomerate cases.
GLOBAL PERSPECTIVES
Of course, globally speaking, we are far behind.And yet, who can overlook the progressaccomplished since the 1997 Asian marketcrisis?
Encouraged by the demands of a market facingthe 1997 Asian market crisis, Russia’s in1998, and then the net economy mayhem provoked by the scandals that occurred from2001 to 2003, all global regulatory organiza-tions intensified their efforts in standardization,using internationally recognized guidelines,and put the control of this process in the handsof their members.
IOSCO, IAIS, Comité de Bâle. All of theseregulatory organizations constitute the archi-tectural foundation of a global structure towhich the participation of the IMF, the WorldBank, the BRI and the OCDE, intergovern-mental organizations, add credibility andcoherence.
The Financial Stability Forum, created in1999, a union of governmental, bank, inter-governmental, and regulatory bodies becamesomething akin to the permanent GeneralSecretariat of the 8 super powers, and conse-quently widened to accommodate to leadingemerging nations such as Brazil and China.The meeting of the Evian summit in 2003thus marked a remarkable step in the direc-tion of international cooperation between reg-ulators and the index organization of non-cooperative jurisdictions that compromise theinefficiency and the stability of the system.
To conclude then, it seems to me that onemust consider international regulation realis-tically and willingness. A great deal has beendone and a lot remains to be done. I wouldlike to note that French regulators play a sig-nificant role in this effort which could notadvance without the agreement of the Ameri-cans who, one must not overlook, “weigh”more than half of the world’s total stock mar-ket capital.
Convergence is in the making. Bound to theprinciple of mutual recognition, it constitutes,in my opinion, the only secure path to take,even if it is slower, and more gradual than thetheoretically construction of a more ambitiousinstitutional framework.
As far as France is concerned, we haveadvanced in market economy and, to add tothe debate, but we are lagging quite farbehind our friends – the G4+1- the appella-tion for the international collective of“Anglo-Saxon” economies: the USA, UK,Canada, Australia, and New Zealand. It is lesshomogenous than it appears, but is neverthe-less active, productive, and powerfully con-nected to the other financial communitiesclose to the Commonwealth, Hong-Kong, andSingapore, among others.
In this context, it is evident that we must playthe card we hold – Europe. It is in this contextParis must pursue its ambition of being pres-ent and recognized in the network of the mainfinancial centers of the global market.
Excerpts from the writings of Michel Prada
31november 2004
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Much has happened ininternational financialservices in the past sixmonths. Business con-fidence has improvedas the economies of the
world’s richest countries have recovered,most noticeably in Asia, North America andthe UK. There are still weaknesses in theeconomies of continental Europe, but theOrganisation for Economic Co-operation andDevelopment (OECD) is predicting real GDPgrowth in the eurozone of 1.8 percent this year,and 2.5 percent in 2005. Financial marketsaround the world got off to a good start in 2004,adding to the impressive gains of last year.“Improvements in global growth prospectsand corporate finances, coupled with a robustappetite for risk, underpinned increases inequity and credit prices,” says the Bank forInternational Settlements (BIS) in its firstquarter review. “Not even further revelationsof corporate malfeasance seemed to unsettleinvestors.”
It would be hard to get more bullish than this,which is why merger and acquisition activityin the financial services sector has started upin earnest after two years in the doldrums.Much of this is confined to domestic markets,but we are seeing significant cross-borderactivity too, with banks and insurers pursuingacquisitions in Europe and the US. And thereis intense activity in emerging markets,particularly in China which is drawing directand indirect foreign investment into its banksand insurance companies. Unfortunately, with all this renewed activity comes not justthe promise of reward, but the risk of failure.Market risk, credit risk, operational risk – you name them, all these risks and many moreloom larger on risk managers’ radar screenswhen their companies are in expansion mode.And in an environment of change and height-ened risk the regulators are monitoring thesituation ever more closely to maintain thestability of the financial system, prevent
financial crime and protect the interests ofcustomers.
REGULATORY RISK IS ON THE INCREASE…
So from a financial institution’s point of view,regulatory risk must be high on the risk agenda.Despite globalization, we still live in a verydiverse world when it comes to financial serv-ices regulation. In some countries, intensiveregulation has been around a very long time,and although the issues change and best prac-tice evolves, the art of compliance is gener-ally well developed. But in others, where reg-ulations and regulators are much younger –especially in the area of dealing with cus-tomers as opposed to prudential and capitalissues – even the concept of a compliancefunction and what it should do is quite new.
It is key for readers in all regulatory environ-ments – from the mature to the recently cre-ated – to understand the issues that affectthem. Any firm that falls foul of the regulatorsfaces not only having to pay fines and com-pensation, it also faces major reputational
damage. In the US, we have seen very largefines and remedial actions imposed on majorfinancial institutions for conflicts of interestbetween their research and investment bank-ing activities, and on mutual fund companiesfor late trading and market timing abuses. In the UK, retail banks and insurers continueto be punished for mis-selling financial prod-ucts to consumers. And in various jurisdic-tions, institutions have been disciplined forfailing to comply with anti-money launderingmeasures. There are countless other recentexamples of regulatory failure and regulatorenforcement action across the globe.
…BUT THERE ARE REWARDS
So regulatory risk has become, perhaps, thebiggest risk of all. But it does not have to be a case of ‘all risk and no reward’. There arebenefits to be had, if it is managed properly. Ifa bank achieves higher risk management stan-dards under the new Basel Capital Accord, itwill benefit from lower capital requirements.If, as insurance regulation moves to a morerisk-based approach, an insurer handles itsrisk management issues effectively, it willbecome more capital efficient. If firms con-sider their compliance arrangements as strate-gically critical, there is great scope for bene-fits in technology leverage, business andfunctional integration, resource optimizationand cost reduction.
If, in dealing with consumers, retail financialservices providers take on the spirit andobjectives of regulation, not just the letter ofthe law, there are great opportunities for rewardfrom consumers with their continued customand loyalty. And if groups set themselves, anddemonstrably maintain, high standards of governance, customer treatment and com-pliance, they are entitled to expect the ‘regu-latory dividend’ of less onerous and intrusivesupervision from the regulators. We believethat regulators should be seen to be providingsuch an incentive more extensively.
Regulation: all risk and no reward?
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REGULATORY RISK MUST BE MANAGED
We are dealing with a number of themes, but four in particular stand out. The first is theincreasing globalization of regulation. Thereis an increasing degree of coordinationbetween national regulators on policy, super-vision and enforcement matters. The rippleeffect should not be underestimated. On theother hand, detailed rules still differ widelyfrom country to country. Both phenomenacreate extra risk for global groups.
The second key theme is the regulators’ focuson effective corporate governance, the role of the board and especially the accountabilityof senior management, with regulators mak-ing it clear (in a variety of ways and with avariety of powers) that they will hold seniormanagers responsible for any significant reg-ulatory failures in their organization.
The third theme is rising consumer protection.As Sir Brian Pitman, Senior Adviser toMorgan Stanley, pointed out at a Europeanretail banking conference recently, “caveatemptor, buyer beware, is steadily beingeroded in most of the western world.” We aremoving towards a principle of ‘let the sellerbeware’, with the onus falling on personalfinancial services firms to ensure that customersbuy the appropriate products.
The fourth theme is the convergence of regu-lation across different financial sectors. Therehas been a trend, with notable exceptions, for countries to merge their various financialregulatory bodies into a single regulator. And although there are still big differences in the way different sectors are supervised,moves are being made in many countries toput all sectors on similar supervisory footings.One consequence is that an issue or expecta-tion arising in one industry sector is rapidlyextended across all other sectors.
But, as with all types of risk, there is anupside as well as a downside. The essence ofany type of business – and financial servicesis no exception – is that if regulatory risks areproperly identified and managed, then theregulatory environment can be turned to busi-ness advantage.
So regulation is definitely not ‘all risk and noreward’. The rewards are there to be taken.
Financial services regulation is at differentstages of development around the world.Readers in countries where it is a relativelynew concept may want to learn more aboutwhat good compliance looks like. Readersoperating in jurisdictions where regulationhas long been a fact of life may want tobenchmark themselves against best practices
33november 2004
Last summer, KPMG Switzerland commis-sioned a survey on the regulation of the Swisseconomy and the trust in its business leaders. The survey shows that the Swiss people do
not want more regulation. However, the con-fidence of the Swiss in their business leadersis rather weak.
operating in other companies to ensure theirregulatory risk management is up to scratch.
Brendan Nelson, KPMG LLP (UK)Global Chairman, KPMG’s Financial Ser-vices Practice
© 2004 KPMG International
Switzerland: enough regulation
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Regularly, large numbers ofinvestors become concernedabout losing money at thesame time and scramble toliquidate their position.They are therefore subject to
the dominant subjective opinion about thefuture among them. This is why markets canoften react very rapidly to any type of factors(sometimes even non correlated to the invest-ment). When markets are brusquely andadversely affected, they face a crash. Arethese accidents predictable? Why do theyhappen? What are the current risks?
FULLY IRRATIONAL
Some accidents are totally unpredictable likethe assassination of Kennedy in 1963 thatprovoked a crash in the financial markets, but had no economic implications. It was there-fore fully irrational in financial terms. Most ofthese unpredictable accidents only generateopportunity for the savvy buyer. They shouldnot worry investors as a whole as they haveno long term impact. The question is totallydifferent when an accident is due to a changeof perception that is linked to an unperceivedbut real asset overvaluation problem. In sucha case, it is commonly said that a financialbubble has developed and that the crash is areaction to it. This has happened frequently inthe past. The Dutch Tulipomania in the 17th
century, the British South Sea bubble in the18th and the 1929 crisis have all generatedmany analyses. It has repeated itself recentlyin the 1987 Japanese crash or in the 2000internet one, etc… The consequences of thesecrashes are often a financial crisis and it takesa certain time for investors who have beenscared off by their losses to come back to themarket. It is therefore much more interestingto try to anticipate these events and to identifyexisting bubbles.
Irrationality and the herd like behavior ofinvestors (or their misperception of potentialeconomic returns) are certainly one of thecauses of these bubbles, but it is certainly notthe only one. As Kindelberger demonstrated,the easy availability of money has alwaysaccompanied the bubbles. Sometimes, this iseven worsened by corruptions of the financialsystem. This has been the case in the Roaring20’s, in Japan in the 1980’s and more recentlyin the Dot.com boom and bust.
Since 1980, the monetary mass (M3) grew ata yearly rate inferior to 7% in the United satesaccording to the Federal Reserve. It acceler-ated to more than 10% between 1998 and2001 As the dollar is the world reference currency, this growth might very well havefueled the dot com bubble. The current yearlyrate for 2003 and 2004 is under the 4,5%threshold. This argument is therefore lessstrong than three years ago. Probably one hasto look at the easy money sources elsewhereif there are bubbles currently existing or inthe making.
THE RISK OF A CRASH
We will try to analyze if some of the assetsenjoying the reputation of having boomed
recently have in fact developed a bubble. We will do it for the Chinese Stock markets,for the private investments in China and India,for the commodity markets and more closerto us for the junk bonds and for the real estateinvestments.
In 2000, the Chinese stocks rocketed 136,6%at a time when most markets were depressedby the fall of western tech stocks. In 2002,these markets have experienced their first realfall since their inception in 1990. The ques-tion remaining is to know if these fluctuationsare just due to the high volatility of thesemarkets or if there is still a risk of a crashlooming.
The yuan peg to the dollar, officially meant to protect the Chinese banking system fromfalling apart, is preventing the yuan fromrevaluing itself, creating an excess of liquiditydomestically. Conscious of the risk, theChinese have tried to tighten their monetarypolicy. In July 2004, the growth of M2 wasreduced to 15.3% which is 5% lower thaneight months before. At that time, the Chineseforeign reserve reached US$ 483 billion. This is more than three times their level 6years ago. There is no doubt that the monetarycondition enabled the creation of a bubble.
The PER of Chinese technology companieslisted on the NASDAQ are high, between 20 and 35. Although this may sound quitehigh, one has to take into consideration twomoderating factors: most of them seem to beenjoying very high growth and they are in ahighly volatile environment: From June 2003, the Hang Seng China Enterprises Index passedfrom 2500 to 5,391.280 on January 5th, 2004.since then the market has been falling and haseven reached 3,546.250 in May 2004 and hasrecovered since then being at the end of Sep-tember higher than 4500. From the available
Accidents waiting to happen: Junkbonds, Chinese stocks, reits, etc.Financial markets are nothing but the anticipation of value changes. Thewhole problem of these predictions’ made by the market lies in the factthat they are submitted to the investors perception. According to CharlesP. Kindleberger, in Manias, Panics and Crashes: A History of FinancialCrises crashes and crises are created by irrational market behavior.
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information it is therefore hard to say thatthere already is a Chinese bubble.
THE CHINESE FINANCIAL SYSTEM IS STILL FAR FROMEFFICIENT
But there is no doubt that the Chinese finan-cial system is still far from efficient, as thelegal and fiscal environment is very complexwith many different classes of stocks. The reduced number of stocks in class B(listed in dollar and open to foreign investors)limit their liquidity and create differentiatedprices with the “A” stocks of the same com-pany. This is even worsened by the fact thatsome “many fraudulent companies reportfalse earnings and boast the popularity oftheir products to innocent investors” accord-ing to the China Investment Newsletter. We might end up discovering at one point thatas the Chinese corporate information is notreliable, the prices are in fact far over theiractual value.
This situation is probably even clearer in pri-vate equity in China and in India. Together,They accounted for USD 2.1 billion in privateequity investments in 2003. This is the sameamount as in Australia, even if the latter has amuch more developed economy and struc-tured financial infrastructure. According toone of the FDI specialists in Mumbai,“nobody is really looking for investors any-more: there is too much money available andmanagers are becoming peaky when it comesto conceding time to investor representatives.” But at the same time the Indian economy startsto face difficulties in providing sufficienttrained personnel to fuel the boom. This shouldsoon create some cost increase in the sectorsconcerned hence reducing the competitiveadvantage and probably at one point creatinga real financial problem to the investors thathave come to fuel the bubble.
The commitment of international privateequity investors in China nearly doubled lastyear as this country is considered as a newheaven for investors as there is an importantdeal flow (plenty of new technology compa-nies fuelled by the local universities and moststate owned enterprises needing a turnaround)as it is possible to exit the investments on theHong-Kong Stock exchange, on NASDAQand on the NYSE. But the story is not so easy,problems can arise at: identifying the righttarget, obtaining a fair valuation of the com-panies, having a certain degree of controlover the participating companies, finding and maintaining talents, exiting the deals ifNASDAQ investors become reluctant one dayto accept new Chinese equity. Even though it
is less visible than on a stock market, we mightcurrently have a bubble forming in the privateequity sector dedicated to China and India.
The Chinese industrial boom has created astrong increase in commodities and in oilprices. As its financial market, this is fuelledby the financial capacity excesses of thecountry. For example, its oil imports haveincreased by around 40% in the first eightmonths of 2004 in comparison with the sameperiod of the previous year. As a result, its oilbill increased by 64% pushing up world oilprices to record highs. This has been true inthe past year not only for energy prices butalso for other commodities like iron ore lead-ing to a high inflationary pressure as Chinesewholesale prices rose 9,5% in the twelvemonths to September 2004. Even if thisincrease in prices is due to a change in eco-nomic equilibriums and a higher demand ofthe Chinese industry, this industry is partlyfinanced by a nearly bankrupt banking sys-tem. It is growing thanks to a competitivelabor force, whose cost might rise if inflationis effectively developing as the currency ispegged to the dollar!
Even if any inflationary pressure on industrialgoods has been wiped away until now thanksto the huge increment in Chinese low costproduction capacity, the high money availabil-ity might have created another type of infla-tion in western economies: the one of assets.The annualized growth of Credit in theUnited States in the first nine month s of 2004have been higher than 9% and real estate loanhas risen 14%. During the first quarter of thisyear, home mortgage borrowings reached anhistorical level representing 5.5 times theaverage amount of the 1990s! Lenders arenow putting a pressure on 10-year Treasurynote futures as they are deeply in need to hedgetheir position. The money factor to create areal estate bubble in the United States is nodoubt here. The average price for new housesales went up from $ 175,000 in 1997 to $ 250,000 in 2004 according to the censusbureau and the real estate industry has, in thesame period of time, more than doubled itsvolume to reach $ 2,000 billion according tothe National Association of Realtors.
THE CURRENT BUBBLE
In fact, it has been the same in most westerneconomies. The Banque de France recognizedthat the current prices were much higher thanthe ones of 1991 in real terms (the last realestate bubble). Spanish real estate prices havegained more than 120% in seven years... With a lack of other interesting investmentsavailable, institutional investors have followed
suite and this has led to the huge growth ofReal Estate Investment Trusts. As a resultthey have even reinforced the current bubble.
The murky financial structure that sometimesexists in a bubble might come from US gov-ernment sponsored enterprises (GSE) likeFreddie Mac, which had to review itsaccounting procedure in mid 2003. Anotherone, Fannie Mae, which used creativelyhedge accounting as demonstrated by theinspection by the Office of Federal HousingEnterprise Oversight which pointed that at theend of 2003, Fannie Mae notional derivativeposition had reached $1.04 trillion and $ 12.2billion in deferred loss related to its cash flowhedge! This will certainly open a new area inwhich GSE will reduce drastically their lever-age and, as a result, the market might be leftwithout its security net in term of last resortbuyers.
TOO MUCH CASH AND TOO LITTLE PROFITABLEINVESTMENTS AVAILABLE
For the same reasons as those of the develop-ment of the real estate bubble (too much cashand too few profitable investments available),the junk bonds (high yeld bonds rated underBBB) have known a new golden area in thepast two years. In 2003, investors bought arecord of $125 billion worth of junk bondsdoubling the 2002 issuance according toThomson Financial. The whole issue is toknow if the tightening of the monetary policyby the Federal Reserve, the interest spreadwill not reduce itself at a time when the insol-vency rate might increase due to more diffi-cult refinancing. Anterior issuance booms(1990 and 2001) resulted in afterward a highdefault period.
The current instabilities generated by theoverflow in money availability worldwide has enabled certain asset classes (Chinastocks, Chinese and Indian private equity, realestate, junk bonds, etc.) to grow very quicklyin size and in price. This gives good reasonsto “bears”to think that these assets might beheading for a fall that could shake the whole financial system like the Peso crisis in 1982 or in the Asian currency in 1997.
François-Eric PerquelFinancial Consultant
35november 2004
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In order to know why to invest inmarkets of emerging countries, itwould be good to explain what theyare. Even if many lists of these coun-tries are available, it remains hard todefine why they are emerging. There
have been many definitions of emerging mar-kets since the inception of the expression inthe 1980’s. At first, it was thought of as a wayto describe the financial markets of countrieslike the “Asian tigers” whose economy actu-ally started to take off. Now, the more gener-alized definition is the one used by the WorldBank and the IFC, which turns out to be apolitically correct description of the lesserdeveloped countries. As a result, all the coun-tries that are not considered developed fit intothe lot. This increases the range of countriesconcerned and the complexity of a rationalanalysis of them and therefore it becomesessential to understand why invest in them.
“MODERN PORTFOLIO THEORY”
Diversity is the best way to characterize invest-ments in these emerging markets: �They form a macro asset class which
includes nearly all types of traditional assetclasses. This is due to the fact that theirdefinition does not come from the type ofinvestment vehicles but from the geograph-ical place where they are used. Apart fromfixed income (sovereign and non sovereign)and equity assets, they also encompassforex, derivatives and private equity. Someeven include commodities in the picture!
� It is also geographically very diversified asit covers countries on nearly all the conti-nents and with totally different macro-eco-nomic patterns.
This diversity has a main advantage. It fitsvery well the investors need for investmentdiversification to improve its return andreduce risk according to the so-called “mod-ern portfolio theory”. However, one has toremember two hypotheses: This theory worksin efficient markets and with uncorrelatedassets. As a result, one cannot be 100% surethat the diversification works for this assetclass as the emerging markets are far frombeing efficient. They tend also to be highlycorrelated when there is a crisis at the timewhen people need them to be uncorrelated.As a result the diversification is an interestingargument but it remains imperfect.
A better argument lies perhaps with thehigher returns one can expect from a morerisky environment. This will have to beproven depending on the asset class. We willreview it for fixed income and equity.
Like any other fixed income, the cost of thedebt is highly linked to the possibility of thecorresponding debtor obtaining a certain rat-ing. Even if rating agencies are far from beingperfect, they all tend to be highly cautioustoward countries which do not belong to themost developed ones’ club. Hence the rule ofthumb that higher risk is related to higherreward tend to be true in this asset class even
if it is to be analyzed on a case by case basisto see if the extra reward compensates for theadditional risk.
NOT SO EVIDENT
In the case of equity, things are not so evi-dent. Companies tend to operate in more diffi-cult environments and to be less transparentthan the ones in financial markets of devel-oped countries. Most of them would onlyqualify as mid or small caps in these markets.It is therefore essential to have primary qual-ity information about these companies andtheir environment. On average, the returns ofemerging equity markets do not offer a pre-mium that really offsets the risk. ADRs andGDRs are only American or internationalsynthetic securities that replicate the stock ofone company. Their only advantage lies in thefact of being legally American or interna-tional instruments, of being listed in a hardcurrency (generally the USD) and, therefore,of enjoying better market conditions (reducedtransaction cost and sometimes more liquid-ity). This advantage is often paid at a sensiblepremium to the underlying equity.
Adding to the former advantage of a higherreturn (at least in fixed income), emergingmarkets tend to offer discounted asset values.They are also another possible opportunity inthese countries. In the case of fixed income,the reason why such a discount might appearis highly related to the evolution of the mar-ket appreciation of the default risk of thedebtor. This is normally more or less reflectedin their ratings. It is therefore difficult tospeak of a discount related to the theoreticalmarket value in fixed income except in spe-cific cases. In equity, this tends to be differ-ent: due to the already mentioned issues(harder environment, company transparency,profitability and eventually size) emergingmarket corporations often have strong assets.The share value ratio to assets tends to belower than in western companies. In the cases
The main reasons to invest in emerging markets
36 november 2004
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In order to know why to invest in markets ofemerging countries, it would be useful toexplain what they are. Even if many lists ofthese countries are available, it remains hardto define why they are emerging.
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37november 2004
of utilities and raw material extraction (oil and mining), the substantial discount toassets is a reason to invest in theses countriesinvoked by many specialized managers.
EMERGING MARKET CORPORA-TIONS OFTEN HAVE STRONGASSETS.
This main issue with emerging markets is toknow if it is a never-ending situation or ifsome countries can become mature and how.If Africa has never really started to take off(perhaps with the exception of South Africa)and if South America is maintaining itself in aself-perpetuating cycle of booms and busts,there seems to be more hope for Europeanand Asian emerging markets.
In the first case, the European integration inthe European Union has enabled countrieslike Spain, Portugal and to a lesser extentGreece to quit the emerging countries cate-gory and to be recognized as developed
nations. As a result their assets have revaluedthemselves dramatically over the past twentyyears. This could also happen with the Cen-tral and Eastern European countries that arenow entering the EU, and perhaps Turkey in anot so distant future.
THE CAPACITY TO TAKE OFF BY THEMSELVES
In the second case, some Asian countrieshave demonstrated the capacity to take off bythemselves following a model that has beenJapanese in the first place. This model isbased on the use of low labor costs and cur-rency undervaluation to boost imports in afirst stage and to reinvest the proceeds of theprofits into improved productivity to innovateand to generate a local market for goods. Thissystem has proved highly successful in Japan,in Korea, in Hong-Kong and now it isadopted nearly everywhere in Asia includingin China. It is not without risks, as havedemonstrated the Japanese and the Korean
crises which have had not only a tremendouslocal effect, but also some repercussionsworldwide. This raises the question of a Chi-nese crisis in the process of this type of takingoff.The emerging markets are certainly not effi-cient: There are tremendous inequalities inthe access to information and that is why it isessential to be well informed to be active inthese markets. The best informed might havein the quality of their information a reason toinvest in them.
As a whole, it is easy to see the risks linked toinvesting in emerging markets, but it is notalways as easy to find ways to compensatethese risks. In fixed income this seems a bitmore obvious than in equity which except forcompanies from Asia and from countriesentering the European Union does not tend tooffer a suitable compensation for it.
François-Eric PerquelFinancial Consultant
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SPECIAL REPORT
The stock market bubble of thelate 1990s was not kind to Al,a retired furniture designerliving in central New Jersey.He had entrusted a lifetime of savings and investments
to a big brokerage firm near his home, and when the bubble finally burst, he foundhe had lost close to $230,000, nearly two-thirds of his nest egg.
Many people lost a large portion of their savings during that period, but Al, who askedthat his full name not be used, feltparticularly aggrieved. His moneywas lost largely on investments far beyond the risk he says he hadagreed to assume, and most of thoseinvestments were in mutual fundsbelonging to the brokerage firm.
On top of that, he later discovered,much of what ought to have beenprofit was swallowed up in commis-sions and fees to his stock broker.After the dust cleared, Al asked aroundand found Eve Kaplan, a former fundmanager who now runs a small inde-pendent financial advisory service inBerkeley Heights, New Jersey, calledKaplan Financial Advisers.
Kaplan is one of the growing breed of independent financial advisers –counselors unaffiliated with any bankor brokerage firm who help individu-als with their financial planning for a fee.
Once, such advice was available onlyto the very wealthy, who had finan-cial lives complex enough to need itand pockets deep enough to afford it.
In today’s shareholder culture, though,more investors need sophisticated and personalized advice to know how best to diversify their portfolios andsurvive in an uncertain market.
And with personal computers and the Internetmaking sophisticated analytical tools cheaplyand widely available, personal financial adviceis now affordable even for people with mod-erate incomes.
Many of these individuals have relied on stock-brokers to manage their money – a relianceencouraged by many of the big investmenthouses, which often use the term “advisers”to refer to their brokers.
But as more investors like Al have felt burned– and as the links between advice and a firm’sother businesses have come under scrutiny byregulators – independent financial advice thatcomes without strings attached has becomeincreasingly popular.
“The independent adviser does not have to sellany product,” said Thomas Muldowney, the president of Savant Capital Management,a small firm of independent advisers. “He cantruly be impartial.”
The first thing Kaplan did was poreover Al’s brokerage statements andshowed him what he had paid in fees.She also helped him consider alterna-tives like outsourcing his portfolio to a manager who would rebalanceand monitor the portfolio for a nominalfee – 20 basis points, or two-tenths of one percent of the assets undermanagement.
Kaplan’s role was to oversee the port-folio manager – an “extra set of eyes”as many advisers call it. For this,she charged a flat fee that was set outin advance and not tied to the invest-ments she advised Al to buy.
“It’s all about transparency,”Kaplan said.
Independent financial advisers can befound around the world, but the mostdeveloped markets appear to be the United States and Britain, the twocountries with the most dynamicshareholder culture. In the UnitedStates, the National Association of Personal Financial Advisers is a group of about 1,100 practitionerswho are subject to state securitiesregulations.
“The function we perform is one ofcounseling,” says Richard Glickman,a partner in Family Office Advisers,
They want to hold your hand
Independent financial counselors offer guidance in a hazardous shareholder culture
The independent adviser does not have to
sell any product. He can truly be impartial.
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a two-person advisory firm in New York. “We look at the total wealth posture of a family and help them create a long-rangewealth picture of the family – the houses theyown, insurance policies, stocks and bonds,annuities.”
Glickman and his partner, Charles Comer,take a holistic approach, looking at “the totalwealth posture of a family” to create a long-term financial plan. They help clients selectinsurance policies, mortgages, and evenaccountants and lawyers. But they draw theline at picking stocks or other individualinvestments because, Glickman said, receiv-ing commissions from the institutions sellingstocks or mutual funds could put him in con-flict with his clients’ interests.
“We are not selling anything,” Glickmansaid. “We simply make sure all the partsare talking to one another.”
The British profession is organized slightlydifferently from its U.S. counterpart. InBritain, advisers, who number about 10,000,work out of independent firms but acceptcommissions from the banks, brokerages andinsurance companies whose products theysell. Some 60 percent of all life insurance,private pensions and personal investments aresold through such firms, according to industryfigures from IFA Promotion, a trade group.The profession is regulated by the FinancialServices Authority, the national marketwatchdog.
The key to financial success, say many inde-pendent financial advisers, lies not in pickingthe stocks or mutual funds that will outperformthe market, but in understanding what impactthe fundamental forces of the economy canhave on a client’s financial goals, and distrib-uting investments – from homes to stocks – to take advantage of those forces.
What this boils down to is asset allocation –how much of your portfolio to keep in stocks,bonds and other investments to meet yourgoals.
“Asset allocation is 90 percent of thestory,” Kaplan said. “What you own is only 10 percent.”
This may sound like something most investorscan do for themselves – and, in fact, it is. But allocating assets can be complex, and theportfolio will need to be rebalanced to takeaccount of changes in the investor’s cashneeds, goals and tolerance for risk. Most indi-viduals, advisers say, do not have that kind ofstaying power.
“People aren’t so much lazy, in my experi-ence, as reluctant to work on anything finan-cial,” Kaplan said. “It gives some people aterrible taste in their mouth and they let iner-tia take care of their asset allocation needs.You can imagine the drift over time awayfrom an optimal mix.”
Typically, an independent financial adviserwill hold several meetings of an hour or morewith a potential client, discussing financialhistory and financial goals.
“If you came to see me,” said Susan Spraker,a financial adviser in Orlando, Florida,“you’d be here between one and two hours,talking with me about why you are here andwhat you are looking for, what you have done in the past, why you’re looking for a change and your history of handling yourinvestments.”
The aim, Spraker said, is “put a price tagon your financial goals.”
“We help people try to get on track, talkingabout what they want to achieve and howrealistic the goal is,” she said. She will “lookat what the portfolio needs to do and whatthey need to add to the portfolio to get there.”
Ron, a social worker and consultant inOrlando, Florida, with an annual income ofabout $80,000 and a net worth he estimates at about $500,000, signed on with Sprakertwo years ago. He said his previous financialadviser, from a regional brokerage firm, had stuffed his portfolio with stocks likeEnron and WorldCom, even as their prices hit rock bottom.
Spraker rebuilt his portfolio, helped Ron save money on a car (she found him a deal on a year-old used car) and health insurance, and gave him a clear financial plan for theyears ahead.
“She can be very honest with you, not pie-in-the-sky,” said Ron, who also asked to beidentified only by his first name. “She said,‘Here is what you are going to do when youare 60, 65, 70 and so on.’ That’s not my forteand I don’t expect it to be.”
Not every adviser can work well withevery investor. “It’s a courtship,” saidMichael Haubrich of Financial ServiceGroup in Racine, Wisconsin.
Frances Bedford had let her husband handlemuch of their joint income – she was a musicteacher and he was a professor of English lit-erature. When he died suddenly, she learned
that at Haubrich’s urging, her husband had setup a trust fund to support her. Haubrich alsohelped Bedford later sell her house andnavigate the tricky tax and financial waters of her remarriage. At his suggestion, she eventook some of her inheritance and establisheda scholarship in her husband’s memory.
“That was a real basic transition of life –along the way he was a very objectiveadviser – both of those transitions thereinvolved substantial amounts of moneyand he showed me how can you maximizeit to eliminate the risks,” Bedford said.
Haubrich said he might charge $1,500 for aninitial set of four to eight meetings to dis-cover the client’s financial history and needs,then charge an annual management fee of$5,000 to $10,000.
Not everyone wants such a strong guidinghand with his or her personal finances. Do-it-yourselfers can turn to an online per-sonal asset manager called Financial Engines,devised by William Sharpe, the Nobel econo-mist from Stanford University who developedthe concept of capital allocation. Originallydesigned to help fund managers allocate assetsefficiently, Sharpe took his concept to thegeneral public. Used mainly by large firms tohelp employees better manage their finances,Financial Engines is available for about $300a year to individual investors. The companysays many advisers use its Web site to balancetheir clients’ portfolios.
Peter S. Green
©2004 New York TimesIllustration by William Rankin
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The “VQF” – the Associationfor the Quality Assurance ofFinancial Services (a voca-tional organisation of SwissAsset Managers supervisedby the Swiss Government) –
was the first self-regulating body (SRO)recognised by the Control Authority for com-bating money laundering. It complies with the Money Laundering Act (GwG) for finan-cial intermediaries, which came into force on1 April 2000, pursuant to Art. 2 Paragraph 3of the Money Laundering Act (GwG). Sincethat point in time all financial intermediariesin Switzerland must comply with the obliga-tions of due diligence implicit in Art. 3 andthereafter of the Money Laundering Act(GwG). Since then, they must undertake eitherto become an affiliated member of an SRO orsubmit to direct monitoring by the ControlAuthority for combating money laundering(Kontrollstelle). No financial intermediary isallowed to operate any longer in Switzerlandwithout an affiliation of this kind or without alicence from the Control Authority.
Over 1,600 of the approximate 6,000 licensedSwiss financial intermediaries are affiliated tothe VQF. More than a quarter of all Swissfinancial intermediaries are thus accountableto the VQF. The majority of the others areaffiliated to the other 11 self-regulating bod-ies. Only around 270 are directly subordinateto the Control Authority.
These figures impressively illustrate theimportance which must be attached to theself-regulating body in the fight by the Swissfinancial centre against the risk of being usedfor money laundering. In order to manage thisfight as successfully as possible, the self-reg-ulating bodies have at the same time beenassigned various different tasks and duties.
IN-DEPTH AUDITS
Their primary legal duty consists of effec-tively checking that their affiliated membersare complying with the obligations of duediligence by means of regular controls. In thisrespect the VQF is successfully pursuing newmethods – despite occasionally encounteringofficial suspicion. It is the first, and so far theonly, self-regulating body to have developeda so-called “risk-orientated audit concept”.Instead of stubbornly keeping to a set annualrhythm of controls, it puts its members in riskcategories with the help of the respectiveindividual audit reports. The date of the nextaudit is determined on the basis of theseassessments. It varies as a rule between 1-3years. More importantly, small companiesbenefit from this, once they have proved thatthey take their duties seriously and alsoproved that they do not, for example, becomemixed up with “risky” customers. They savethemselves substantial audit costs, if theseaudits do not have to take place on an annualbasis, thanks to their proven seriousness. Inorder to guarantee the efficiency and qualityof the controls, the VQF makes particularlyhigh demands on the audit system. Apartfrom its own auditors which it employs, itentrusts only an exclusive circle of personallyaccredited external auditors with this task.These people undertake to take part in thevocational training offered by the VQF and to
carry out a minimum number of audits peryear. The VQF determines which auditoraudits which member. A financial intermedi-ary therefore cannot pick and choose hisMoney Laundering Act (GwG) auditor him-self. The VQF also demands very detailedaudit reports, which are all taken off by themembers of its supervisory committee andindividually analysed in terms of risk cate-gory. Last year the VQF carried out over 800audits.
The audits can also have serious conse-quences. Penalties are imposed on memberswho do not fulfil their duties. This is also thelegal duty of a self-regulating body. Thepenalties range from reprimands to fines andcan lead to expulsion, which can have veryserious consequences for a financial interme-diary. Without affiliation to a self-regulatingbody or a licence from the Control Authority,it could no longer operate. Over the last fewyears the VQF has handed out over 100penalties and also resorted to a few expul-sions. It is also crucial to eradicate the few“black sheep”, who unfortunately occur inevery occupational genre, and can harm theentire financial centre of Switzerland. Themost effective way, of course, would be not toallow them to operate from the outset. Withthis in mind the VQF has deliberately steppedup the acceptance procedure, which hasrecently led to an increase in rejections.
ON-GOING EDUCATION AND FURTHER VOCATIONALTRAINING
The clearly pleasanter work of the SRO is theon-going education and further vocationaltraining of its members. The main focus, ofcourse, is the training required in connectionwith implementation of the obligations of duediligence. In this respect it is crucial to makefinancial intermediaries continually moreaware of the current risks and dangers–alsowith practical examples–and familiarise themwith the constant developments, includingconstantly amended national and internationalspecifications. Although the legislator hasonly obliged the self-regulating body to check
Insight into the work of a self-regulating body
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impending risks will guarantee that our finan-cial centre can operate with a “clean bill ofhealth” and is not used as a happy hunting-ground by criminals for their dishonest business.
We should also mention the daily (predomi-nantly phone) consulting service for mem-bers. The hotlines have been particularly busyconcerning new unofficial reports from theControl Authority on the subject of who shouldbe regarded as a financial intermediary, andunder what circumstances. An important serv-ice also offered by the VQF is its assistancein critical situations. The specialist, individualadvice of the VGF is greatly appreciated,more especially in terms of the delicate matterof whether there is sufficient evidence forsuspecting potential money laundering. Afterall, it is then a matter of reporting a customerto the authorities, accusing them of possible
money laundering. Last year, VQF members reported more than 40 of these kinds of suspicions.
The VQF fulfils these core tasks with arounda dozen employees, compared with statesupervision, where the Control Authorityemploys six people in the section responsiblefor around 270 financial intermediaries whichare directly accountable to it. They do thiswithout any feeling of responsibility for edu-cating and training these financial intermedi-aries themselves, and delegate audits toanother independent section or external audit-ing authorities.
Hans BaumgartnerChief Executive Officer VQF
41november 2004
the educational/training standard of its mem-bers, by concerning itself with the educationand further vocational training of its mem-bers, the VQF nevertheless considers it morein the sense of Quality Assurance than as amatter of course. Its members must undertaketo undergo further vocational training on anannual basis, and this is permanently moni-tored. The VQF trains around 1,500-1,700financial intermediaries every year in almost30 events. In addition, the VQF operates ahomepage, in which it informs members aboutthe latest news in the scope and province ofthe Money Laundering Act (GwG). A pam-phlet appearing 2-3 times a year containingcurrent contributions rounds off this informa-tion system. The VQF convincingly makeslight of the huge associated cost, because onlywell-informed and trained financial interme-diaries who have been made aware of the
The Swiss Association of AssetManagers (SAAM)
IfSwitzerland is excelling inone particular economicsector it certainly is render-ing financial services forhigh net worth individuals.In the course of time it has
developed into a symbol for Swiss excellence.Speaking of financial services one inevitablyassociates asset management, which in pri-vate banking has top priority. Also in respectthereof the financial centre Switzerlandoccupies a leading position by internationalcomparison, for which we are envied bymany countries.
Doubtless the big banking establishments areoccupying the “pole position” in the privatebanking industry. It would be decidedlywrong, though, to infer that the part of inde-pendent asset managers is of no real impor-tance for our financial market. Latest esti-mates assume that the market share of thesespecialists has increased in the course of thelast 15 years from 3 to 10% of all the assetsmanaged in Switzerland. Said share approxi-mates a sum of 400 billion francs!
PRIME BUSINESS PARTNERS
Independent asset management in the impor-tant position it currently occupies in the Swiss
private banking industry – and is set to occupyin the future as well – would be unthinkablewithout a representative professional associa-tion. In 1986 the Swiss Association of Asset
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Managers (SAAM) was therefore establishedas a professional association in order toaccompany its members, assist them andinform them about all activities of the industry.
The mission of SAAM also consists in explain-ing and commenting complex laws and regula-tions as well as the latest market developmentsand products; on the one hand in advancedtraining programmes and forum, on the otherhand in regularly published professional arti-cles. The SAAM keeps offices in Zurich,Geneva and Lugano and is committed to thehighest standard of quality, professionalismand ethics and its own rules of professionalconduct demanding irreproachable exertionof their business activities.
With 780 active members and over 60 banksas passive members the SAAM constitutes aprime business partner and interlocutor forthe public authorities as well as for all otherparticipants in the banking centre Switzer-land. The members are divided into approx.600 one-man companies and 200 legal enti-ties with up to 100 employees each. The vol-ume of assets under management ranges fromsome 100,000 CHF to several dozen billions.275 active members are based in the Frenchpart of Switzerland, close to 100 in the Italianpart and close to 400 in the German part.SAAM is an actor who doesn’t lose sight of the constant new challenges in view of an increasingly significant internationalcompetition.
INDEPENDENCE, FLEXIBILITY,TRUST
If the SAAM has become indispensable forthe Swiss financial centre it is also due to anincreasing demand for independent assetmanagement. Those clients who care about atrusting relation to their financial managerhave come to appreciate the independence,attention and friendliness of an independentasset manager. Since it concerns one of themost demanding clienteles with regard tomaterial and personal accomplishment, theasset managers joined in the Swiss AssetManagement Association have been able tocontinually complete and widen their profes-sional knowledge.
SOPHISTICATED SERVICES
Independent asset managers and members ofthe SAAM usually are professionals with pro-found experience acquired in one of the bigSwiss banks. Conscious of their commitmenttowards the clients (clienting) they exercisetheir mandate exclusively in their interest,respecting the contractual liabilities like loy-alty, transparency and due diligence. Accord-ing to latest developments in the privatebanking industry the client’s expectations arebecoming more widely spread and complexwith regard to extensive and long-term finan-cial planning: wealth-, tax- and inheritance-planning have to be included, if necessary byconsulting external specialists. It is not sur-
prising therefore, that about 7,000 people –employed by almost 2,500 Swiss companies –are committed daily to furnishing added valuein the field of global wealth management.
SELF REGULATION AND CODE OFCONDUCT
In addition SAAM fulfils a crucial task imple-menting the Swiss anti money laundering law,enacted since April 1st 1998. According tosaid law financial intermediaries are obligedto be regulated by either the Money Launder-ing Control Authority (Kontrollstelle) or byprivately organised self-regulating organisa-tion. In accomplishment of said law SAAMhas set up its own self-regulating organisationrecognized since 1999. It supervises all affili-ated financial intermediaries, i.e. asset man-agers, ensuring the correct implementation ofthe Swiss anti money laundering law and, ifnecessary, to emanate sanctions. The self-reg-ulating organisation of SAAM is constitutedby the executive board. The code of conductcontains a listing of all duties appropriate toefficiently combat money laundering as wellas the rules for professional ethics, indispen-sable to warrant high quality wealth manage-ment for high net worth individuals. Onlywhen these rules and requirements are ful-filled will the Swiss financial centre, with itshigh ranking standards, continue to keep the“pole position” that it owes to a substantialpart to its independent asset managers.
The Institute of Financial Planning is the UKprofessional body of those committed to thedevelopment of the multi-discipline profes-sion of Financial Planning. The vision is toachieve recognition for the Financial Planningprofession.
The Institute was formed in 1986 to:• Promote the profession and practice of
Financial Planning• Increase public awareness of the need for
Financial Planning• Create a recognised professional qualifica-
tion for its members• Ensure ethical standards through its Code
of Ethics and Code of Practice• Ensure professional standards through its
Practice Standards for CFP® Licensees• Encourage education in the theory and
practice of Financial Planning• Share members’ knowledge and skills with
other professionals for the benefit of theirclients
• Establish a Registry of Certified FinancialPlannerTM licensed practitioners
The Institute’s mission statement is:“to develop and promote the profession ofFinancial Planning to the general public andto those people involved in providing advice
The Institute of Financial Planning(IFP) at a glance
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43november 2004
and guidance to their clients, in order to mosteffectively fulfil every client’s financial andlifestyle objectives”.
The Institute of Financial Planning Ltd is anot-for-profit company limited by guaranteeand has no shareholders. The Board of theInstitute is made up of individuals from avariety of practice backgrounds and with avariety of qualifications. All serve in a per-sonal capacity – there is no representationfrom regulatory bodies or from any of themany professional bodies represented in themembership. Membership of the Board isrestricted, to those members of the Institutewho are qualified to minimum of CertifiedFinancial Planner licensee level.
The Institute of Financial Planning is a sittingmember of the Financial Planning StandardsBoard (FPSB). This international body, whichwas launched in London in October has over45,000 qualified licensees Worldwide, andincludes similar standard setting organisationsfrom Austria, Australia, Brazil, Canada,France, Germany, Japan, Korea, Malaysia,Singapore, South Africa, Hong Kong, India,Taiwan, Switzerland and New Zealand. TheCouncil exists to:• promote the professionalism of individuals
and organisations offering personal Finan-cial Planning services
• ensure that such services are offered in anethical and competent manner throughoutthe world.
The Institute of Financial Planning has theexclusive rights to the CFP licence in the UK.
The Institute is multi-disciplinary in its mem-bership. It draws its members from the relateddisciplines of accountancy, insurance, taxa-tion, stockbroking, education and legal pro-fessions, amongst others. It is keen to con-tinue this mix of different professionals and
to encourage business relationships betweenmembers who have come to Financial Plan-ning through a variety of routes.
The synergy of these major professionswithin one body will lead to the emergence ofnew multi-discipline professionals who canbe proud to serve their clients in a wayunheard of before. The Institute is committedto the development of such individuals.
Membership is available to anyone interestedin the development of Financial Planning as aprofession or in their own professional devel-opment. All levels of entry from studentupwards are available. The Institute has highstandards, but it offers membership to all whoare interested in:
• Aspiring to higher standards in educationand ethics.
• Achieving higher standards (by takingexaminations ultimately leading to the Certified Financial Planner Licence).
• Adhering to those higher standards (by embracing the Code of Ethics and Professional Practice).
The Institute exists to encourage the highestpossible standards of education and ethicalbehaviour and believes that it is only by mem-bership of a professional body such as thisthat this can be encouraged. A special schemeoperates for young members (under 25).
Membership offers a wide range of benefits,including regular meetings at local branches.There are 16 branches at present. Such meet-
ings offer an opportunity to develop techni-cal, interpersonal and business skills. Meetings are usually held in the evenings, but some branches hold occasional half-dayworkshops as well.
Professionally qualified Financial Plannerswho fulfil a rigorous set of additional require-ments are eligible to apply for CertifiedFinancial Planner Licensed status, entitlingthem to use the designatory letters CFP. The Certified Financial Planner has additionalduties in addition to the general requirementsimposed upon members, including a willing-ness to abide by the detailed Code of Ethicsand Professional Practice, and undertake con-tinuing education. CFP Licensees are alsoable to use the CFP trademark.
The CFP Licence is not a “get it and forget it”qualification. It must be applied for each year,and renewal is conditional upon the ethicaland educational requirements having beenmet and after full disclosure of any com-plaints against either the Licensee or anyonesupervised directly by the Licensee during thelast year.
Nick CannChief Executive, IFP
Nick Cann, Chief Executive of the IFP
Maureen Tsu, Chair of the FPSB, and David Diesslin, Chair of the CFP Board of Standards, signing the
licence at the recent launch of the FPSB.
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Here in Cyprus, the introduc-tion of a set of rules for the financial services indus-try comes to a market of600,000 people. It alsocomes to a market which
has been a currency exchange controlledeconomy since 1974.
The existence of directives passed by the EUParliament mean that any regulator has toadopt the technical aspects of the directives.Regulators may be potentially judged how-ever on the way the spirit of a directive isemployed, and in a state with little develop-ment of financial services for the public thismeasure is as important as the former.
That there should be regulation as to theinvestments available to the public is clear.That there should be effective controls overthe manner in which investment opportunitiesare presented to the public and over the prac-tises of the firms that deal with the public isequally clear. What is not clear is when dosuch controls upset the market place betweenadviser and client.
Regulators are a fast breeding progeny ofmodern government. Dealing in the imple-mentation of law rather than the framing oflaw they are therefore appointed rather thanelected and hence are impartial to the public.Yet being human they bring their own preju-dices, and therein lies the danger, becausetheir prejudices and perceptions are not sub-
ject to public disapproval. They only normallyare replaced upon death, retirement or moreworryingly, when they have caused theframework they were regulating to fail.Quite quietly the regulation of financial serv-ices may be one of the most important regula-tory features of the next 20 years or more.Governments have at last admitted that thesocial system envisaged in the 1950’s and60’s is now unaffordable. People, the EU citi-zens, cannot rely on their governments to carefor them. This is not only in retirement, butextends to medical and social care. Simulta-neously governments are suffering from thereduction of taxation that has accompaniedthe 80’s and 90’s and are facing loweringtaxation revenues with tighter fiscal constraintsbeing imposed by monetary unification.
In a nut shell, Governments need people tosave. Governments will also have to realisethat they should not be the savings depositoryof the people and thus should aim to removethemselves from the arena, concentratinglargely on the well being of those incapableof caring for themselves and incentivisingthose who are by framing simple and attractivetax allowances. To assist this, the financialservices regulatory framework should beopen yet firm. The government needs the pub-lic to save; the government funds the regula-tor; ergo the regulator needs the public to save; the regulator needs to make access to financial advice easy and ensure that theproducts available are tightly monitored. The regulator should never be a judge.
Financial advice will soon come into the coreactivity field of financial services under the2004 directive, and by 2006 should have beenimplemented by all member states. The regu-lator should remember that being able toexplain the interest swaps being held in ahedge fund and how they will react if equitiesrise by 2% is what the regulator should behearing from those who design and manageinvestment products. It is not what the personwishing to save for his pension or his childs’university education wants to, or needs to,hear. What is required there is clarity, disclo-sure and understanding of the individualsrequirements and how they may be achievedwithin the social framework. Frankly theinterest swaps are easier to regulate on, the latter probably lies in the spirit.
Richard StevensBoard Member of CIFSA (Cyprus Inter-national Financial Services Association)
The financial services regulatoryframework should be open yet firm
One of the attractions of being in a memberstate that has just joined the EU is that thenation starts with a clean slate concerningregulation. This however, is also one of theworst characteristics of a new member state.
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45november 2004
This growth has come from a country that is politicallystable and has a well-educatedand qualified work force ofprofessionals together with a highly efficient business
infrastructure. Today Singapore boasts over600 banks and financial institutions and hasbeen the traditional banking center for Asianclients and now with increasing demand hasbecome a preferred financial centre for non-Asian clients. As a result, SG Private Bankinghas set its Asia-Pacific regional centre inSingapore.
THE REGIONAL HUB IN ASIAPACIFIC
Within this framework, the Wealth Manage-ment Industry has over the last few yearsdeveloped at an ever-increasing pace with pri-vate banking assets estimated to be in theregion of USD150 billion at the end of 2003.Private Wealth Management now encom-passes both active advisory, discretionaryportfolio management and fiduciary servicesand with a resultant increase in the numbersemployed in the industry.
Within the development of Private WealthManagement there has also been an increasein the number of Approved Trust Companiesso that at the end of 2003 there were 16 suchcompanies. There continues to be further stronginterest from financial institutions to establisha Singapore based and regulated trust com-pany. Many financial institutions have madeSingapore the regional hub in Asia Pacific fortheir wealth management business.
With this growth, Singapore is continuallyseeking to improve the regulatory frameworkand at the same time have clients consider itas one of the pre-eminent jurisdictions for theestablishment of trusts and related structuresfor the purposes of inheritance and tax plan-ning together with asset protection. The Mon-
etary Authority of Singapore (“MAS”) hasbeen in the forefront of these developmentswith the overall aim of reducing the risk ofabuse for money laundering and other illicitactivities, screen out incompetent and disrep-utable service providers and promote thegrowth of the trust industry as well as thebroader private wealth management business.
To aid the development of the Trust Industrya Trustees Amendment Bill containing pro-posed changes to the Trustees Act was releasedfor public consultation in June 2004 togetherwith the proposed introduction of a TrustCompanies Bill.
A MORE ATTRACTIVE FINANCIALAND TRUST CENTRE
The proposed changes aim to make Singaporea more attractive financial and trust centre inthe international arena. The key changes pro-posed are:• Introduction of a Statutory Duty of Care;
• Introduction of a General Power of Invest-ment;
• Introduction of Powers to appoint Agents,Nominees & Custodians;
• Changes to Forced Heirship Rules;• Other changes will include amendments
to a trustees’ power to insure, powers todelegate, introduction of a fixed perpetuityperiod, clarification on the laws relating to dispositions to defraud creditors and changes in the laws on accumulation of income
• Whilst these changes will impose a furtherburden on Trustees they will as well makeSingapore a more attractive jurisdictionparticularly for those clients coming fromCivil Law jurisdictions i.e. ContinentalEurope and Central and South America.Whilst certain areas of the proposed lawcould inconvenience those clients whowish to be more involved in the manage-ment of investments there are provisionsthat would allow the Trustee to accommo-date these clients’ requirements.
Singapore, one of the world’s leading financial centresSince its founding as an independent republic in 1965, Singapore hasdeveloped in such a way as to be considered today one of the world’smajor financial centres.
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A GROUP OF PROFESSIONALS
… WHICH CULTIVATES QUALITYWITH PATIENCE AND WHICH REINFORCES ITS
PRINCIPLES WITH CARE …
Groupement Suisse des Conseils en Gestion Indépendants
3, rue du Vieux-CollègeP.O. Box 32551211 Geneva 3
Tel. +41 22 317 11 11Fax +41 22 317 11 [email protected]
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47november 2004
Additionally, SG Trust (Asia) Ltd notedchanges in the Trustees Amendment Act Billtogether with the proposed provisions to becontained in the Trust Companies Bill willensure that the Trust Industry in Singaporewill be regulated and administered to a highstandard of professionalism and competence.
Further planned legislation will cover theissue of Business Trusts (to allow greaterflexibility in the management and control of active businesses) and Limited LiabilityPartnerships. Both when utilised togetherwith other areas of legislation, i.e. theamended Trust Law and amended CompaniesLaw, will only add to the ability of Singaporeto provide the appropriate solutions to manyclients requirements when structures for estateplanning, inheritance planning, financial engi-neering are being considered.
Recent changes in the Companies Law willalso serve to make Singapore companiesmore attractive. We have highlighted thefollowing major changes: • Only one director required but there must
be one who is resident.• Corporate directors are not allowed.• Single shareholder who can be a corpora-
tion. Director may also be a shareholder.• No annual audit required for dormant
or small exempt private companies (a turnover of less than S$ 5,000,000).
• A full tax exemption on first S$ 100,000 of
reportable income for newly incorporatedcompanies (available for the first 3 years).
• Private companies may by resolution dis-pense with an AGM.
• Additionally income earned abroad by anon-resident company is exempt from taxeven if remitted to Singapore.
• There is no withholding tax on Singaporedividends.
• A non-resident company cannot benefitfrom Singapore’s tax treaty network. This is only available to a resident company.
Tax cuts and exemptions in the 2004 Budgethave sought to ensure that Singapore remainscompetitive and attractive to foreign investors.Principal among these has been the exemp-tion of income of a foreign trust or eligibleinvestment holding company established for such foreign trust of which the trustee is an Approved Trustee Company or isproviding trust management or administra-tion services.
Additionally for foreign investors looking atSingapore as a centre for placing part of theirassets as a non-resident such individuals donot suffer capital Gains/Profits tax, there is no tax on interest income or dividends onSingapore dividends, no Estate Duty (otherthan on Singapore immovable property) andno tax upon the entry or repatriation of funds.All these advantages should make Singaporean ideal centre for investment.
SINGAPORE HAS NEVER BEENON ANY OF THE LISTS OF NON-COOPERATIVE JURISDICTIONS
Add to these the fact that Singapore has neverbeen on any of the lists of non-cooperativejurisdictions issued by FATF, the EU andOECD and is not viewed as a tax haven beingdeemed to have a comprehensive tax system.For many Latin American countries such asMexico, Argentina and Chile to name a few,Singapore is not viewed as a tax heaven anddoes not feature on these countries “black lists”.
Given the above, SG Private Banking (AsiaPacific) has noted a steady flow of funds fromthe traditional European centres for manage-ment to Singapore. In response to this, we offerextended access to all its services; in additionto the team of professionals in Singaporeavailable during both European and Asianworking hours, private bankers based inEurope assure responsiveness and qualityservice. Well versed in the major Europeanlanguages and with a global network, we alsooffer all services covering trust, estate planningand wealth management services.
Pierre Baer, Executive Directorand Vincent Magnenat, Senior Vice PresidentGlobal Wealth ManagementSG Private Banking (Asia Pacific)
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48 november 2004
OTHER VOICES
Iam writing this article while inIstanbul where PRI has been activesince 1999. Turkey is just one ofseveral examples of developingeconomies that attract relativelylittle foreign direct investment,
compared to the opportunities that it offers. It has a population of almost 70 million andworld-class companies in dynamic Export,Construction and Tourism sectors. It has notyet reached FDI of $2bn per year. It hasopportunities that can absorb multiples ofthat. However, very few of its companieshave experience dealing with foreigninvestors and lenders. And most foreigninvestors have no idea, or the wrong idea of the opportunities the country offers and its culture. As usual, a bridge is needed.
NEWS OF THE DAY
Since the fall of the Soviet Union, and even afew years earlier, volatility and crises havebecome a global phenomenon. We are linkedto each other’s problems by satellite TV andwaves of money going in and out of marketsas a reaction to the news of the day. Thelargest crises have hit the largest and most“stable” economies. Almost $1trillion inequity disappeared from the US during theyears of the Savings and Loan crisis whichfollowed the Tax Law change of 1986. Whilethe more recent dot-com, Enron and othercorporate revelations crises were of muchsmaller proportions, they were clearreminders that “political stability” does notguarantee transparency and safe investment.
Within the next few years we are likely toexperience another major crisis in the US,which will impact on many other economies.The unprecedented debt and trade deficit situ-ations are worrisome, at a minimum. Theproblem of the virtual disappearance of the
mid-sized industrial sector by 2006 is very realand will not be solved by the next President.
In the 90s and early 00s, we lived througheconomic earthquakes in Mexico, South EastAsia, Japan, Russia and Central Europe,Turkey and Argentina. We will continue toexperience major peaks and valleys. We arecreating them by pushing and pulling vastsums of capital, in and out of Markets.
On the front page of the October 14 issue ofthe Financial Times the main headline read:“Emerging market borrowing boom. Bondissuance of 270bn Euros breaks last year’srecord with two months to run. Institutionsseek refuge from poor returns elsewhere.Warning of risk in oil price. The amounts arenot really impressive, when we look at theactual size of the “Emerging Markets” andtheir needs, but the statistic points to the mak-ing of yet another wave driven greatly by theeagerness to achieve better returns.
TO ELIMINATE SOME OF THE MYTHS
The time is right to eliminate some of the mythsand to prepare Investors and their representa-tives to diversify and get involved in directinvestment opportunities in Emerging Eco-nomies. There are many small and mediumsize (often large, by local standards) qualitycompanies and projects in countries outsideof North America and Western Europe.
They present as good, if not better, opportuni-ties for investors than the stock markets wherethey have been playing.
Direct Investment in Emerging Markets offersIFAs and Private Bankers diversification fromthe usual target markets and instruments.From time to time clients are interested inbecoming involved in a certain country thatseems interesting and promising. The chal-lenge is to be ready with the right relation-ships, on the ground to be able to participatein the opportunities.
The question is how to choose where to goand how to get involved in a productive andprofitable way. How do you take your clients there? What aresome of the obstacles that need to be over-come?
You will choose the country or regiondepending on the profile of your clients andthe distance that your resources allow you totravel. Distance and lack of local know-howare the main obstacles to safe direct invest-ment. Finding compatible and experiencedlocal associates in the country of choice iscritical for success.
ESTABLISH YOUR NETWORK
Co-Investors: From our experience, theInvestor who is new to a market benefits fromco-investing in a well structured transaction,where a local Investor, say a Fund with alocal presence, is interested as well. It is eas-ier to do due diligence on someone else’s duediligence than to do your own. In all countrieswhere opportunities exist, there are Interna-tional funds that have local infrastructure.Among their concerns, when they considerInvestment proposals, are returns and exit.Yours are likely to be the same.
Direct investment An Attractive Strategy for ReturnsIn the increasingly diversified investment landscape, how can oneapproach emerging markets beyond the classic forms offered by theofficial markets?Is the solution in direct investment, and if so, how?
“Political stability” does not guarantee
transparency and safe investment
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OTHER VOICES
49november 2004
The International Finance Corporation of theWorld Bank also has local or Regional officesin most countries worth considering. They arebeing approached by many companies look-ing for Investors. They do thorough due dili-gence. Some of the projects that they turndown are actually worth looking at throughmore entrepreneurial eyes. Pay them a visit inParis and get a reference to their countrymanager. EBRD and EIB are also active inthe same markets and sometimes co-investwith the IFC. The most interesting to yourclients may be the Investment Funds estab-lished by private organizations, which aremore flexible than the multilaterals.
Lawyers: Contact a law firm that has solidexperience working with International Banksand Investors. They would be eager to answeryour initial questions, especially if they are awell established local firm.Banks: There are always Banks that stand outfrom the crowd. They are either top qualityDomestic Banks or International Banks withdomestic presence. They have senior execu-tives responsible for international relation-ships. They are always prepared to meet andshare their knowledge. Since they live in thecountry, they are often cautious about theirrecommendations.
Travel: Go to the country. Be a tourist for acouple of days. Feel the people. There isnothing like the reality on the ground. It beatsanalysts’ and country reports, or at least itcomplements them nicely.
SIGNIFICANTLY HIGH RETURNS
In the early stages of your involvement in acountry, you may want to focus on the worldof Exporters that have demonstrated that they
have the capacity and quality standards thatsatisfy international customers. The profes-sionals that you will be contacting will knowwho is who and will be able to comment onthe credibility of the companies.
All the above assumes that you wish to beproactive so that you become a sort of “spe-cialist” in certain markets. If you prefer to bereactive to opportunities that come to you,identify the people that you will need to beassociated with and let them know what typeof opportunities you are interested in seeing.Do it in writing and be as specific as possible.
THE RISKS CAN BE QUANTIFIED
Direct investing is an opportunity to offeryour clients a truly innovative asset class,apart from simply diversifying into “Emerg-ing Market” stock funds, which are often
Due DiligenceRequired: Review of Comprehensive Information aboutthe Project, outlining:• Uses of Funds• Target Markets and Rationale• Management and Organizational Structure• Marketing and Sales Strategy• Manufacturing Process and Equipment• Advantages of Geographic Positioning • Financial Projections and Valuation
mature local blue chip firms with minimalgrowth opportunities. This is a play on con-vergence with the developed markets, ratherthan looking for the potential of a superiorbusiness model, or sustainable low-cost man-ufacturing advantages, or unique local prod-ucts that will be in demand from import mar-kets worldwide.
Victor Politis, President and CEO and Eric Stambler, Senior Vice President
PRI Project Development LLC, a 10-year oldNew York based firm that develops projectsfor its clients in “Emerging Markets”, obtainsStrategic Partners, Equity and Debt financingfor their implementation.
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50 november 2004
OTHER VOICES
By any measure Google is an exception. Origi-nally its name was a play on the word googol,a word referring to the number represented bythe numeral 1 followed by 100 zeros. If manynew leading products have seen their namebecome the generic name of the product theyrepresent like Kleenex, it has become a verb,to google, meaning to look for (on the inter-net). Except for a one million dollar seedfinanced by friends, family and fools in 1998and a first round at $25 million in 1999 bySequoia Capital and Kleiner Perkins Caufield& Byers, the company has never raised anymore money during the internet crisis. Thisoriginality is also to be found in the way itcarried out its IPO.
A ONE MILLION DOLLAR SEEDFINANCED BY FRIENDS, FAMILYAND FOOLS
Its first filing with the SEC in April 29th, 2004generated near euphoria with investors. It wasthe first really significant IT IPO since thebubble burst in 2000. Its originality was notso much in the IPO but in the way it was tobe carried out: • without splitting the share ahead of the
offering to reduce its value, • opting for an original Dutch auction
process, that disfavors the underwritersobliging them to cut fees by half and not enabling them to offer the shares totheir best clients and
• making a few legal mistake including notstating some of the personnel stock options,giving an interview to Playboy during thesilence period.
As a result, the critics of the offering werevocal and the filing was restated on Wednes-day August, 18th to reduce the number ofoffered share to 19,6 million from 25.7 mil-lion and the offer price to $85 when the origi-nal range was between $108 and $135.Nearly 30% of the shares were sold by formershareholders. Most of the main Wall Street
names were involved in the operation (Mor-gan Stanley, CSFB, as joint book-runningmanagers. Goldman, Sachs, Citigroup, LehmanBrothers, Allen & Co, J.P. Morgan., UBS,WR Hambrecht and Thomas Weisel Partners)and the main shareholder ended up beingFidelity! Merrill Lynch is the sole intermedi-ary which refused to participate in the dealunder such conditions even if it was thebiggest ever technology stock IPO
After so many difficulties in the IPO processthe shares quoted $100.01 on their debut on
NASDAQ a 17.8% surge. On October 4th, the share price reached $135, which was thehighest limit of the first proposed valuation…which was probably not so bad. The example set by Google in the processwill be hard to follow for other IPO candi-dates with less bargaining power, but thereare smaller underwriters that might be willingto change their business model to adapt tothis new possibility and gain market share.
François-Eric PerquelFinancial Consultant
How Google entered the Stock Exchange
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