Current FTSE GM Issue Section1

I S S UE 47 DE CE MBE R 2010 / J ANUARY 2011
THE MALTA REPORT: THE NEW BUSINESS OPPORTUNITY

ROUNDTABLE: WHO REALLY BENEFITS FROM MARKET FRAGMENTATION?
Londons commercial
real estate rebound
Why green bonds
have investor appeal
Irish crisis props up dollar
20-20
ALL STARS:
QIA leads
the pack
PDF_QUADRI_300dpi_txvecto
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1
F TS E GL OBAL MARKETS DE CE MBE R 2010 / J ANUARY 2011
OUTLOOK
C
HANGE IS A big theme in this edition, across the range of markets
from investment flows to market infrastructure. Past editions have
concentrated on regulation. Weve taken a breather this time to focus
on market dynamics across a section of asset classes. Not all change is good;
and there are some notable sub-trends that are beginning to impact the
overall market outlook for 2011 and beyond. The tide of emerging market
Eurobond issuance is starting to concern some investors and analysts, for
example, who fear that the increasing flood of money into emerging markets
will create serious asset bubbles as too much capital chases too few assets.
While this is clearly a bigger risk for equities than bonds, some believe the
pricing on recent issues is starting to make the latter look expensive.
In developed markets, for the first time in more than half a century, yields
on benchmark government bonds in the US, UK and Europe are lower than
the returns of high yield equities. This is due to the investor stampede into
triple-A rated sovereign bonds on the back of fears over the global economy
and the threat of a double-dip recession in the US and UK. Industry reports
reveal that the dividend yields in Europe stand at around 4%, more than 1.5
percentage points above government bonds. Historically, defensive sectors
such as oil and gas, telecoms and consumer staples have been the most
popular dividend plays due to their strong and secure cash flows. We report
on the implications.
Elsewhere, increasing market complexity and the need for risk management
run through this edition like the wording through Blackpool Rock. Weve tried
to include all the main strands, from the infrastructural modifications outlined
by the DTCCs Don Donahue through to the very real market changes
outlined in our bond trading, securities lending and ETF coverage. The theme
of change and evolution also plays through our trading editorial. As speed and
competition have increased in the equity trading world, so has pressure, not
only on incumbent exchanges but also on the multilateral trading facilities in
Europe and alternative trading platforms in the US, to maintain investment in
their technological infrastructure. Inevitably, exchanges that provide a better
service will naturally attract more flow and therefore force others to react to the
demand for continuous improvement.
As we come to the close of the year and a sense of seasonal renewal takes
hold, it is perhaps as well to chart the new configurations of the global
financial markets. Next year looks to be even more complex, challenging and
transformational than this.
To help fill in time in the interim weve accumulated a debate-worthy
selection of high achievers in our annual 20-20 All Stars coverage. Some
contenders are obvious, others less so; with their inclusion based more on
expectation than past performance. The hope of the analysis is the coalescing
of some of the key themes of this year: the seismic shifting of economic power
from West to East, the deepening and broadening of the investor services
product set and the growing emphasis on regulation, transparency and risk
management, particularly in the US and Europe. This is a pivotal year and the
selection of this years star performers reflects the strength of financial cross-
currents. We are already looking forward to next years crop and hope you find
enough in this years selection to open your mind to the potential of 2011.
Francesca Carnevale,
Editor
December 2010/January 2011
Cover photo: Qatar Prime Minister Sheikh Hamad Bin Jassem Bin Jabor Al Thani delivers his speech during the
opening of the 5th Finance and Investment in Qatar Forum in Paris. Photograph by Francois Mori/AP, supplied by
Press Association Images, November 2010.
CONTENTS
2
DEPARTMENTS
COVER STORY
MARKET LEADER
20-20 ALL STARS ..........................................................................................................................................Page 46
The global financial markets remain in flux and this years crop of 20-20 All Stars have all risen
to the challenge. The nominations are not awards, rather a simple acknowledgement of some of
the innovation in the global markets and a nod to individual and group achievements in still-
trying circumstances.
DATA PAGES
DTCC Credit Default Swaps analysis ........................................................................................................Page 119
Fidessa Fragmentation Index....................................................................................................................................Page 120
BlackRock ETFs..............................................................................................................................................Page 122
Market Reports by FTSE Research..........................................................................................................................Page 124
Index Calendar ..............................................................................................................................................................Page 128
DE CE MBE R 2010 / J ANUARY 2011 F TS E GL OBAL MARKETS
DTCC: THE NEW WORLD OF RISK MITIGATION......................................................................Page 6
Don Donahue, chief executive of the DTCC, explains the dynamics of change at the DTCC.
IRISH CRISIS UNDERPINS US TREASURIES..................................................................................Page 12
US bonds rebound as the problems in the eurozone worsen. By Andrew Cavenagh.
WHEN FREDDIE MET FANNIE ..........................................................................................................Page 14
Mark Faithfull writes about the spiralling rescue costs of Americas most expensive bailouts.
THE NEW RISK/RETURN EQUATION ............................................................................................Page 18
Neil OHara reports on the lowlights and highlights of fixed income securities.
THE SHOCK OF THE NEW..................................................................................................................Page 24
Investors are adopting ETFs with enthusiasm but there may be unforseen consequences.
BACK TO THE FUTURE? ......................................................................................................................Page 28
Lynn Strongin Dodds explains why high yield equity returns are better than government bonds.
MORE WOOD THAN TREES..............................................................................................................Page 31
Simon Denham, managing director of Capital Spreads writes on the over-indebted EU nations.
THE MERGED STRENGTH OF RBI ..................................................................................................Page 32
The new Austrian banks emerging markets result.
CLUELESSNESS AND CURRENCY WARS......................................................................................Page 33
Erik Lehtis, president of Dynamic FX Consulting, on the Feds implicit currency manipulation.
A CAPITAL PERFORMANCE ..............................................................................................................Page 34
Mark Faithfull on the rising central Londons real estate prices, despite the recession.
THE STEADY GLOW OF GREEN BONDS ....................................................................................Page 36
The use of green bonds to fund sustainable projects.
THE NEW STRONG SUIT ....................................................................................................................Page 38
Jean-Claude Petard, head of Equity Markets at Natixis, offers a French traders perspective.
CUSTOMER CHOICE IN THE DRIVE FOR BEST EXECUTION ............................................Page 40
UBSs Owain Self explains his views on dark pools, algorithms and trading in the US and Europe.
HARNESSING A RISING TREND ......................................................................................................Page 42
Mohammed Al Omar, chief executive officer of KFH, describes the banks business strategy.
THE PHYSICAL CHALLENGE..............................................................................................................Page 44
The challenges of trading physical commodities place new demands on existing systems and expertise.
IN THE MARKETS
INDEX REVIEW
BANKING REPORT
REAL ESTATE
DEBT REPORT
COMMODITIES
FACE TO FACE
FX VIEWPOINT
PROFIT PROFILES:
A MOULD BREAKING COMPANY QUARTET ................................................Page 66
Through the great recession some companies not only remained profitable but positioned
themselves for continued growth by adhering fiercely to their core principles. Art Detman
profiles four such companiesthree American and one Canadian.
CANADIAN TRADING:
HFT TIPS THE DARK POOL AGENDA ..............................................................Page 70
High-frequency trading has shaken up a Canadian equity market long dominated by
the incumbent exchange and five big banks. Investors anxious to avoid HFT order flow
are turning to dark pools, which have been slow to develop in Canada thanks to its
unusual broker preference trading priority. Neil OHara reports.
STOCK EXCHANGE TECHNOLOGY:
SPEED IS KING..............................................................................................................Page 74
Stock exchanges are now caught in a technology frenzy-seeking lower latency,
introducing more efficient matching engines and new order types. The raison detre is
that the buy side have increasingly dynamic expectations. Is that really true? Or are
the reasons much more diverse? Ruth Hughes Liley reports
EUROPEAN TRADING VENUES ROUNDTABLE:
WHO REALLY BENEFITS FROM MARKET FRAGMENTATION?................Page 79
In the roundtable discussion, Paul Squires, head of trading at AXA IM says: Our market
is complex and technical and not everything has fitted into the principles-based
regulation that is MiFID, and it has created many problems for market participants. It is
no great secret that the buy side is looking at MiFID II to address some of those
concerns. What did the rest of the panel think?
THE NEW FINANCIAL HUB ..........................................................................................Page 95
THE MEDS ATTRACTIVE ALTERNATIVE....................................................................Page 96
MALTAS ONSHORE APPEAL TO FUND MANAGEMENT ....................................Page 100
PUNCHING ABOVE ITS WEIGHT ..............................................................................Page 104
MSE AIMS TO BE A GLOBAL PLAYER......................................................................Page 110
A PRIVATE EQUITY DOMICILE ..................................................................................Page 113
MORE FOR MORE: POSITIONING FUND ADMINISTRATION ..............................Page 115
DIRECTORY....................................................................................................................Page 117
BOND TRADING:
FRATERNITY, LIQUIDITY, TRANSPARENCY......................................................Page 89
The past two years may go down in history as the best fixed-income market seen,
following the confluence of high volatility, low interest rates, tight spreads and high
demand. Ruth Hughes Liley reports.
TRANSITION MANAGEMENT:
A DEEPER PRODUCT SET........................................................................................Page 92
The transition management product set has deepened, now often encompassing a
cradle-to-grave relationship between beneficial owners and their mandated asset
managers. Now that relationship begins much earlier in the asset management process,
explains Mark Dwyer, managing director and head of EMEA at Mellon Transition
Management and Beta Management at BNY Mellon.
FEATURES
THE MALTA REPORT: THE NEW BUSINESS OPPORTUNITY
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Low Carbon 100 Europe Index
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PSI 20
NYSE Euronext Iberian Index
The most prestigious

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6
I
N THE WAKE of the Lehman
Brotherscollapse, the DTCC closed
out more than a half trillion dollars
in open positions, thereby preventing
losses for the industry, and perhaps
ultimately for taxpayers, that could have
been in the hundreds of millions or
billions of dollars. The DTCC did all this
without having to draw on any of the
self-insurance funds on deposit with
us. Many of you, in turn, told us of the
quick actions you took, and the
sometimes painful decisions you made,
to get your firms through the crisis.
Together, our stories made a compelling
tale about our success in fighting a
number of dangerous fires.
Actually, people outside the financial
industry dont care what we had to do to
put the fire out. They want to know why
it started in the first place, why it burned
so fiercely, and why as an industry we
hadnt taken preventive action. The
prevailing view, as far as the public, their
elected representatives and our regulators
are concerned, is that the fire itself was the
product of a shocking and fundamental
failure of risk management and oversight
in the markets we serve. Moreover, they
continue to be very unhappy about it,
because they view our failure as having led
not just to a financial crisis, but also a
harsh global recession, a staggering loss
of jobs and wealth, and extreme damage
to public finances in the developed nations
as they bailed-out failing institutions and
sought to stabilise their economies.
Unavoidably, in the new post-crisis
world, governments and regulators will
understandably be focused on financial
risk to a much greater extent than
previously. To address these issues, the
private sector will have to work with our
regulators as partners, rather than
adversaries, to improve our risk
management operations. After all, the
relationship between regulator and
financial enterprise is symbiotic.
Regulators want the financial services
companies they supervise to be healthy
and safe, and they know that firms cannot
be safe and sound unless they earn strong
risk-adjusted returnsin fact, regulators
have for generations utilised rating
systems that have included earnings,
along with other important factors such
as capital and liquidity, as a key measure
of the health of financial services firms.
Industry context
At the DTCC we understand that the
bar of regulatory expectations on risk
has been raised and what used to be
normal or standard operating procedure
is fast becoming history. As a result,
were now initiating a top-to-bottom
transformation in how the DTCC thinks
about risk, how we oversee risk, how we
manage risk and how we plan to address
riskall aspects of riskboth within the
DTCC and within the financial system
we are a key part of. This is a sweeping
all-hands-on-deck initiative that comes
at the direction of our board.
This journey will be an extremely
ambitious undertaking that forces the
DTCC to rethink many of the
assumptions behind the practices weve
employed and the services weve been
offering our participants for decades.
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Landmark financial reforms are in process globally; banks face
much tougher capital standards and the global financial
industry is involved in a radical reappraisal of how it manages
risk. In that respect, the Depository Trust & Clearing
Corporation (DTCC) is not immune to the metamorphosis taking
place in the global financial markets. Don Donahue, chief
executive of the DTCC, explains in an open letter, the dynamics
and the implications for its clients.
THE NEW WORLD OF
RISK MITIGATION
Don Donahue, chief executive of the DTCC, explains the dynamics, and its implications for its
clients. Photograph kindly supplied by the DTCC, November 2010.

8
In other words, it will alterin some
ways significantlyhow we support
and work with you to further mitigate
risk. We are firm in our understanding
of this new responsibility. We are clear
that our regulators and supervisors view
it as imperative that we address this
new responsibility. We also received a
very similar message from many of you
earlier this year when we polled our
member firms about our strategic
direction and planning. The principal
message that came back to us from
those interviews was to keep focused
on our core services and, above all else,
to ensure risk mitigation.
Risk margining
Those familiar with the DTCCs Enterprise
Risk margining systems know that they
are calibrated against a 99% confidence
level; the margins the systems will require
have to be sufficient to cover 99% or more
of the instances we face. It also serves as
a timely symbol for how we have tended
to think about risk, namely that the
measure of our performance was 99%
and that the last 1% was something we
would handle in the moment rather
than through a systemic solution.
However, in this post-crisis period, the
strong message from governmental
overseers, regulators and bank supervisors
at home and abroad shifts the weighting
a bit. As vital as meeting the 99% standard
is, the public sector is now saying that
the 1% is equally if not more critical. In the
case of another financial meltdown, it
may be that an institution such as the
DTCC is the only thing standing between
our member firms/issuers/investors and
total meltdown. Therefore, we need to
be absolutely sure that we will come
through in that extreme situation. So we
have implemented the DTCC 3.0
programme, which represents the sea
change in our thinking to focus on what
can happen in that last 1% and how we
need to prepare ourselves for that.
I will outline what I call The Seven Habits
of Highly Effective Infrastructures as a guide
to the principles we have to guide us
through this change. First: do no harm; or
what we can think of as the 99% rule.
Very simply, whatever we do, whatever
changes the DTCC may require, we must
still be sure that we can conduct the days
activities, close down tonight and open up
tomorrow with the same level of rock-
solid stability and resilience that we are
expected to deliver day in, day out. As
we think through the changes required to
meet the 1% test, we have to ensure we
keep the system stable and performance
rock solid.
Two: stuff happens. Controls will never
be perfect; that means we cant ever
assume that what exists in terms of our
design or our implementation of controls
and risk management structures is good
enough, because they havent been
designed to be 100% foolproof. Even in
a stable environment, we will have to
cultivate a constant dialogue about how
we can improve controls and risk-
management structures.
Three: the better we get at risk
mitigation, the more risks people will
take. Principle two says even in a stable
system things can go wrong, but of course
systems are not stable, they change and
grow. The better we become in terms of
controls the more those controls will be
tested by new types of assets, new types
of transactions, new activities that our
systems will have to cope with. So we
have to be vigilant about industry trends
and developments. Ironically, we are
keenly aware that the better we become
at identifying this cycle of new risks and
figuring out how to mitigate them, the
faster the cycle will move and the more
people will be willing to take risks,
confident that well be able to continue as
a safety net.
Four: financial systems naturally tend
toward instability. As economist Hyman
Minsky notes, financial systems inherently
are biased towards instability and crisis,
as favourable financial conditions push
people to make riskier financial decisions
and as that dynamic feeds on itself.
Five: lowering the water is as good as
raising the bridge. Sometimes we wont
identify risks that are evolving, or
understand what new controls or
strengthened controls we need to
address them. So, in parallel, we need
to lower the water; finding ways to
make core risk systems stronger, more
resilient, to withstand anything that
gets thrown at it, even when we didnt
see it coming. However good we are
though at identifying and addressing
risks in advance, at some point we are
going to experience another financial
crisis. Therefore, we have to be
absolutely sure about the resilience of
our risk management process; even in
circumstances where the gravitational
forces of a market crash get absolutely
ferocious.
Six: you never know where or who the
next key insight will come from. The point
being that everyone in a company knows
some of the things that are critical to the
success of the new risk-management
paradigm, but no one knows all of them.
How do we create a culture that allows
people to voice their questions and
concerns and then gets all of us to react
to them? It is a key question.
Finally, most of the answers are in
structures, not standards. In other words,
how we institutionalise risk management
changes. We are clear that we need to
make changes, about what the change
involves and where it will take us. We
are clear that change is ongoing,
continuing through cycles of risk
mitigation and risk taking, but it also
needs to be supported by something
structural in the organisation.
Raising our risk-intelligence
quotient
Internally weve used economist Hyman
Minskys theories and other similar
views, to help our staff understand the
challenge of renewal we face at the
DTCC. As a core industry infrastructure,
we must understand and act upon
Minskys insightthat stability itself is
destabilising.
We are also utilising the DTCCs
experience in the wake of 9/11. In that
event, the DTCC realised that as good as
our business continuity planning had
been, it would have to be transformed.
We could no longer focus primarily on
surviving natural disasters, or assume
that the problem to be solved was our
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10
inability to operate; we had to recognise
that we were responsible for safeguarding
against events that caused the system to
become temporarily inoperable.
In that reimagining, we will be working
with the three lines of defence model.
The first line is our individual business
units. They have to identify and measure
risks, and judge how effectively theyre
being controlled. Todays new premise
though is that risks that once might have
been tolerated now must be addressed
and ways to reduce them implemented.
Moreover, every time we reduce particular
forms of risk, we have to go back and
assess the risk picture again with an even
more powerful lens.
Our second and third lines of defence
rest with our specific risk-control areas
the enterprise and operational risk-
management units and our Internal Audit
group, respectively. Their capabilities will
be upgraded to ensure that these areas
are prepared to challenge our thinking
about the levels of risk we think we need
to tolerate. In short, were ratcheting up
the organisations risk-intelligence
quotient (RIQ). Fundamentally, this is a
zero-based remaking of our approach.
Were going to start at the baseline, and
that may force us to rethink many of the
assumptions behind the practices weve
employed and the services weve been
offering our participants for decades.
Customer impact and innovation
I imagine many of you are beginning to
ask: Whats this going to do to my
business and the way I use DTCC services
and what will it cost? Actually, we dont
have all the answers yetand thats the
unpredictable environment well need to
manage in the coming years. For example,
our subsidiary, National Securities
Clearing Corporation (NSCC), has never
applied any kind of debit cap restriction
on the end-of-day net settlement balances
its members can build up during a day;
that has been industry practice since
NSCC was founded. However, that does
impose serious liquidity risk on the
clearing corporation, and we need to find
a way of controlling that.
Remaking an entire process with far
more checks and balances will not be
easy or cheap, and that will likely drive
some increases in fees. Mitigating risk
is not simply a matter of increasing the
margin reserves against it. This new
challenge of mitigating risk will demand
relentless experimentation, and the
bursts of innovation that can flow from
that. In fact, we already have innovative
initiatives under way that will help you
to efficiently use your capital. New York
Portfolio Clearing, for example, our joint
venture with NYSE Euronext, is
designed to provide a simultaneous view
of both futures and cash markets for
government securities and much larger
efficiencies in margining. Or, consider
our intent to launch a new central
counterparty (CCP) for mortgage-
backed securities. It will provide the
safety of a trade guarantee to this market
for the first time ever, but it will also
reduce risk and costs in the handling
of the underlying mortgage pools.
Writing new financial rules
The challenge of overhauling our
systems and processes from the ground
up seems daunting, but we can do it.
Part of the challenge, of course, is that
well be doing it within a regulatory
environment thats already been set in
motion by the Dodd-Frank Act. The
DTCC has long had a close working
relationship with our regulators and the
new world of risk mitigation will
demand that this becomes an even
closer, tightly coordinated relationship.
A new player in the regulatory field
will be the new Financial Stability
Oversight Council which Congress
created in the Dodd-Frank Act; an
independent 10-member committee,
including representatives from the
Treasury Department, the Federal
Reserve, the SEC, and five other
agencies. The council has authority to
determine whether the DTCC is a
systemically significant financial
market utility. If it does, then the Federal
Reserve becomes the prudential
regulator for all of our subsidiaries, as it
is today for The Depository Trust
Company (DTC) and Warehouse Trust
Company (WTC). To back up its powers
for monitoring systemic risk, the new
oversight council will also rely on a new
agency, the Office of Financial Research
(OFR), to collect and standardise data
from financial services companies, to
perform research, and to develop risk
measurement and monitoring tools.
We expect that the OFR will collect
significant amounts of position,
transaction and counterparty exposure
data from throughout the industry.
Given our unique position in the cash
equity and fixed income markets, and
quality of the over-the-counter (OTC)
derivatives data we keep in our Trade
Information Warehouse, we have a role
to play in aggregating data for the OFR.
In Europe, too, we have spent a lot of
time and effort meeting with
policymakers to make sure that the
European regulatory consensus on OTC
derivatives also provides for reporting
those trades to a single repository for
each asset class. Weve taken concrete
steps to allay European concerns about
access to the data that we hold in our
trade repositories. In October, we
launched a European subsidiary called
DTCC Derivatives Repository, which
will maintain global credit default swap
(CDS) data identical to that maintained
in our New York-based Trade Information
Warehouse. This European-based
repository will support a wide variety of
critical functions, including, most
importantly, CDS trade reporting.
Last year, the DTCC won the contract
to build a similar repository for global
OTC equity derivatives, and we have
now opened that facility in London as
well. Our goal is to avoid a proliferation
of redundant trade repositories that
would fragment data and introduce
further systemic risk. Weve made clear
to regulatory agencies that function
outside the US that the data we collect
from across the globe will be available
to any of them with a legitimate interest.
Another step we took in August this
year was to add additional data to what
we already publish about credit default
swaps. Were working hard to expand
transparency in this global market. I
MARKET LEADER
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For the second consecutive year, the global institutional investor community has voted Socit Gnrale Corporate &
Investment Banking the #1 Global Provider in Equity Derivatives in the Risk magazine 2010 Institutional Investor Rankings.
With more than 20 years of experience in Equity Derivatives, SG CIB continues to lead the industry through its
comprehensive coverage of worldwide equity underlyings, consistency and continuity of service and tradition of
innovation. Throughout the world, the challenge of addressing your specic needs and the trust you have placed in us
over the years push our teams to reinvent the Equity Derivatives industry every day. We are driven by our commitment
to our clients and we would like to thank you for your continued loyalty. SG CIB Global Equity Flow Team.
www.sgcib.com
Investors afrm once again
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leadership & expertise
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Risk magazine June 2010 Institutional Investor Rankings
THANK YOU FOR YOUR LOYALTY AND TRUST
YOUR PARTNER IN GLOBAL MARKETS
INVESTMENT BANKING GLOBAL FINANCE GLOBAL MARKETS
Socit Gnrale is a credit institution and an investment services provider (entitled to perform any banking activity and/or to provide any investment service except the operation of Multilateral Trading Facilities) authorised and regulated by the French Autorit
de Contrle Prudentiel ACP (the French Prudential Control Authority) and the Autorit des Marchs Financiers AMF. Socit Gnrale is subject to limited regulation by the Financial Services Authority FSA for the conduct of its business in the UK. Details
of the extent of its regulation by the Financial Services Authority are available from us on request. Socit Gnrale benefits from the EC passport authorizing the provision of investment services within the EEA. This material has been prepared solely for
information purposes and does not constitute an offer from Socit Gnrale to buy or sell or a solicitation of an offer to buy or sell any security or financial instrument, or participate in any trading strategy. Not all financial instruments offered by Socit Gnrale
are available in all jurisdictions. This communication is not intended for or directed at retail customers. It is for professional investors only. Please contact your local office for any further information. 2010 Socit Gnrale Group and its affiliates.
We stand by you

12
A
FTER THE FEDERAL Reserve
announced on November 4th
that it would buy up to a further
$600bn of Treasuries by the end of June
under the QE2 programme, a wave of
selling pushed yields out over the next
two weeks with that on benchmark ten-
year Treasury bond reaching 2.96% on
November 16th, its highest level for
three months.
Yields had come back by the end of
the week (the ten-year bond retrenching
to 2.82%), however, as debt markets
decided that the Irish governments
commitment to support the countrys
stricken banks was insupportable and
would necessitate some form of European
Union bailout. The contagion once again
spread to the sovereign debt of the other
beleaguered euro countriesPortugal,
Spain and Greece.
Michael Woolfolk, senior currency
strategist at BNY Mellon in New York,
says there was no questionthat the
Irish situation had underpinned the US
Treasury market, as the latest panic in the
eurozone had provided hard evidence
that the single European currency still
had fundamental issues to address. The
problem has not been resolved yet,he
says. It has merely been papered over.
Even without a fresh eurozone crisis,
there was little to suggest a sustained
flight from US government bonds was
imminent at this stage. Analysts attributed
much of the sell-off in the first half of
November to a natural correction, as
hedge-fund investors and others
unwound positions they had taken ahead
of the QE2 announcementselling on
the fact of having bought on the rumour.
The latest official figures from the US
Treasury department, published on
November 16th, certainly showed that
foreign demand for long-term
government securities had remained
strong throughout September. Net
foreign purchases of Treasury bonds and
bills came to just under $80bn for the
month, split almost evenly between
private investors ($38.8bn) and central
banks ($39.5bn). While the total was a
decline on the $117.1bn of net purchases
recorded in August, it still represented
the third highest monthly total this year.
Moreover, China and Japan, by far the
two largest investors in US sovereign
debt, actually increased their overall
holdings to $883.5bn (with net purchases
of $15.1bn) and $865bn ($28.4bn)
respectively over the month, despite
market expectations that both countries
would start to scale back their investments
in US Treasuries to reduce their exposure
to the dollar.
Woolfolk says he had been impressed
by the strength of foreign demand for
Treasuries in September, particularly on
the back of the high level of demand seen
in the previous month. He points out that
the surge in purchases by foreign central
banks was largely a move to defend their
own currencies from appreciating against
the dollar.
Nevertheless, QE2 is likely to slew the
market for Treasuries in the months
ahead, because the Feds purchasing
programme is going to focus on bonds
with maturities in the middle of the
curve. The US central bank will not be
buying much debt with a maturity of 17
to 30 years, and this uneven support for
the market will inevitably have an
influence on the future direction of yields.
Kevin Flanagan, chief strategist in the
fixed-income division of Morgan Stanley
in New York, suggests that a trifurcation
of the Treasury market was likely, in
which the Feds commitment to QE and
near-zero interest rates would anchor
the yields on short-term instruments
(with maturities of three years or less),
while those on five to ten-year bonds
would benefit from QE2 purchases but
those on longer-term bondswhich
are vulnerable to inflation expectations
would widen significantly.
Flanagan believes that yields on ten-
year Treasuries could go as low as 2.25%
once the Fed purchases start to kick in.
He then expects them to move within a
range of 2.5%-3.5% between now and
the end of next year.
Long-term pressures
The independent Financial Forecast
Center based in Houston, Texas, is
predicting a slightly tighter range for
the benchmark bond: a fluctuation of
between 2.61% and 2.94% over the next
six months and then a rise to 3.15% in
June 2011.
Yields on longer-term bonds, which
are not impacted by short-term Fed
policy, seem certain to continue rising,
reflecting the real and long-term
pressures on the US economy and
currency, as the government continues
to issue record volumes of further debt
to finance an expected aggregate budget
deficit over the next ten years of $8.5trn.
The very long Treasury yields are a
truer, undistorted picture of the market
price,maintains Mike Riddell, who
manages M&Gs International Sovereign
Bond Fund. The point is that you cant
increase debt levels forever, and at some
point that will be a problem for the US.
They have to address their budget deficit
and debt-to-GDP ratios. I
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US Treasury bonds suffered from a predictableand widely
anticipatedsell-off in the first half of November after the Federal
Reserve confirmed it was to embark on a second round of
quantitative easing. However, the crisis in Ireland provided a sharp
reminder that the problems in the eurozone are far from over, and
the run on the market was short-lived. Andrew Cavenagh reports.
IRISH CRISIS UNDERPINS
US TREASURIES
Photograph Bpro /
Dreamstime.com, supplied
November 2010.
Feeling at home in Central and
Eastern Europe starts right here.
15 million customers have selected us as their bank of choice.
Raiffeisen Bank International represents more than 20 years of experi-
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with subsidiary banks, leasing companies and other financial service
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Over 100 international banking awards validate the groups service
quality. www.rbinternational.com

14
F
ANNIE MAE AND Freddie Mac,
the US government-owned
mortgage finance companies, could
cost the countrys taxpayers as much as
$363bn to the end of 2013, according to
their regulatorless than some of the
worst-case scenarios, but more than
projections by the White House.
Since they were rescued by the
government in 2008, Fannie Mae and
Freddie Mac have drawn $148bn from
the US Treasury to stay afloat as losses
on bad loans underwritten during the
housing boom have continued to turn
bad. In August, the Congressional Budget
Office said Fannie and Freddie would
need $390bn in federal subsidies to the
end of 2019. The White Houses Office
of Management and Budget (OMB) had
in February estimated the cost to be just
$160bn for the same period, providing
the economy continues to strengthen.
The Federal Housing Finance Agency
(FHFA), which regulates the two entities,
says it was possible losses could be less
than $363bn. If house prices rebounded,
interest rates remained low and
unemployment fell, Fannie and Freddie
might only need $221bn in cumulative
aid. However, most analysts believe this
scenario is too optimistic, as the US
economic recovery stalls and the housing
market remains stagnant.
In addition to covering projected losses
on bad loans, an increasing portion of
taxpayer aid will be used to pay dividends
on preferred stock issued by the Treasury
department as part of the terms of its
rescue. Excluding these dividend
payments, Fannie and Freddie would
need less money to stay afloat, $142bn
in the best-case scenario and $259bn in
the worst. Yet if the US housing market
continues to crumble, taxpayers could
face a total bill of more than $400bn to
bailout the duo by 2013. Those two
entities hold about $6.8trn in all
mortgage obligations, or nearly 57% of
outstanding home loans in the US.
Confused? The number of numbers
being bandied around adds to
uncertainty and recently RealtyTrac,
which monitors repossession activity,
confirmed that the foreclosure crisis
in the US had spread across a wider
area than previously thought.
Foreclosure notices increased across
a majority of large metropolitan areas,
including Chicago and Seattle.
Previously, these cities had seen
relatively low levels of activity.
RealtyTracs report says that California,
Nevada, Florida and Arizona remain
the worst affected areas. The trend is
the latest sign that the US foreclosure
crisis is worsening as homeowners
facing high unemployment, slow job
growth and uncertainty about house
pricescontinue to fall behind on their
mortgage payments.
Meanwhile, the announcement from
Wells Fargo that it would re-file
thousands of foreclosure documents is
the first admission from the bank of
possible problems in the way it
repossesses homes. In a statement, the
bank said it had identified instances
where a final step in its processes relating
to the execution of the foreclosure
affidavits ... did not strictly adhere to the
required procedures.
Despite the raft of worrying news, Frank
Nothaft, vice president and chief
economist, Freddie Mac, says: When
rates fall to new lows we typically see
more rate and term refinancers, who
are looking only to reduce their interest
payments, and relatively fewer cash-out
borrowers. Now were also seeing a very
large share of borrowers reduce their
mortgage debt when they refinance.
Consumer debt across the board is down
since the start of the recession, with non-
mortgage consumer debt falling more
than 5% since 2008.
However, US house prices are being
weighed down by an overhang of unsold,
repossessed properties, falling again in
August after the expiry of homebuyers tax
credits. Prices were down 0.3% versus
the previous month, on a seasonally-
adjusted basis, according to the Case-
Shiller index of 20 major US cities.
A tax credit for homebuyers expired in
April, leading to a steep drop in home
sales over the summer. That same effect
now appears to be feeding into house-
price data. Compared with last year, the
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The rescue of Fannie Mae and Freddie Mac is shaping up to be one of Americas most expensive
bailouts, exceeding the cost of the savings and loan crisis that saved small banks and thrifts in the
1980s and the Trouble Asset Relief Program (TARP) of 2008, which threw a lifeline to financial
companies and car-makers. Analysts and government have issued conflicting estimates of the
spiralling bill for the US taxpayer amid questions about whether Freddie Mac and Fannie Mae
should have a future in Americas broken housing market, writes Mark Faithfull.
WHEN FREDDIE
MET FANNIE
Photograph Anthony Furgison /
Dreamstime.com, supplied November 2010.
16
index published by rating agency Standard
& Poors was up 1.7%, somewhat lower
than analystsexpectations of a 2.1% year-
on-year rise. However, prices remain 29%
below their peak of May 2006, according
to the index, having only recovered some
5% since bottoming out in May 2009.
Fannie Maes Economics & Mortgage
Market Analysis Group is in downbeat
mood. The labour market has yet to
make significant progress, which is the
primary reason for our continued weak
growth forecast, says Fannie Mae chief
economist Doug Duncan. With economic
growth slowing, job creation also has
been tepid, keeping the unemployment
rate high. Housing sales will likely be soft
until the labour market strengthens.
The housing market appears to have
stabilised at new lows, adds David Blitzer,
chairman of the index committee at
Standard & Poors. At this time, it does
not seem that any of the markets are
hanging on to the temporary momentum
caused by the homebuyerstax credits.
The FHFA used estimates from rating
agency Moodys to devise its best and
worst-case scenarios. In the best case,
housing prices will have fallen 34% from
their peak in 2006 to their trough in the
third quarter of 2011. The worst case calls
for a deeper decline in prices of 45%.
The results could shape the debate over
the long-term role that the government
should play in the mortgage market.
Some Republicans argue the government
should focus on shrinking Freddie and
Fannie and eventually privatise them.
However, the Obama administration,
which has promised to outline its
proposed overhaul of the broader
housing-finance system by January, has
said a government role may still be
needed to preserve the long-term, fixed-
rate mortgages that have become the
keystone of the US mortgage market.
Under the regulators most positive
home-price scenario, Fannie and Freddie
would lose $6bn over the next three years
and they would still have to ask the
government for 11 times that amount to
make dividend payments. On its most
likely projectionwhich assumes an end
to the housing crisis is close and that
home prices will stop falling soonthey
will lose $19bn in the same period.
On the other hand, if the economy
slides back into recession and home
prices fall by another 20% to 25%, the
companies could cost taxpayers an
additional $124bn, before dividend
payments. Another drop in values could
lead to more delinquent borrowers with
fewer options to avoid foreclosure. Price
declines could also lead to losses on the
almost 200,000 homes the firms have
taken back through foreclosure. The vast
majority of the firms losses stem from
such delinquent and defaulted
mortgages that the firms bought or
guaranteed between 2005 and 2008.
Since then, the companies have
tightened underwriting standards, and
loans made over the past two years are
not expected to lose money.
Mortgage delinquencies
Fannie and Freddie own or guarantee
around half of the nations $10.6trn in
mortgages. While the Obama
administration has said the $700bn
Troubled Asset Relief Program (TARP)
could cost a fraction of the initial
investment, the tab for Fannie and Freddie
has swelled as mortgage delinquencies
have mounted. The National Bureau for
Economic Research warns: The
foreclosure process problems and pause
on foreclosures pose a risk to our outlook
of the housing market as they create
uncertainty for potential homebuyers.
Foreclosed homes account for a
substantial part of the existing home
market and therefore a pause on
foreclosures, if it spreads through the
nation, has the potential to suppress home
sales in the near term and interfere with
the housing recovery.
The legacy of poor mortgage lending
has led bankers into a two-front war,
pitting them against US homeowners
challenging the right to foreclose and
mortgage-bond investors demanding
refunds that could approach $200bn.
While federal regulators and state
attorney generals have focused on flawed
foreclosures, a bigger threat may be the
cost to buy back faulty loans that banks
bundled into securities. JPMorgan Chase,
Bank of America, Wells Fargo and
Citigroup have set aside just $10bn in
reserves to cover future buybacks. Bank
of America alone says pending claims
have jumped 71% from a year ago to
$12.9bn of loans.
The biggest risks for banks may be
loans packaged into mortgage-backed
securities during the housing bubble, of
which $1.3trn remains. The aggrieved
bondholders include Fannie Mae and
Freddie Mac, bond insurers and private
investors. Fannie Mae and Freddie Mac
may be owed as much as $42bn just on
loans they bought directly from lenders,
according to Fitch Ratings.
Pimco, BlackRock, MetLife and the
Federal Reserve Bank of New York are
seeking to force Bank of America to
repurchase mortgages packaged into
$47bn of bonds by its Countrywide
Financial Corp unit.
JPMorgan Chase took a $1bn third-
quarter expense to increase its mortgage-
repurchase reserves to about $3bn.
Citigroup raised its reserves to $952m in
the third quarter, from $727m in the
previous period. Wells Fargo reduced its
repurchase reserves to $1.3bn, from $1.4bn
in the second quarter.
These issues have been somewhat
overstated and to a certain extent,
misrepresented in the marketplace, says
Wells Fargo chief financial officer Howard
Atkins. Our experience continues to be
different than some of our peers in that
our unresolved repurchase demands
outstanding are actually down.
The other front in the battle is the
potential cost to banks of improper
documentation used in foreclosures.
Attorney generals in all 50 states are
investigating foreclosure procedures.
Litigation costs for such cases may reach
$4bn, while a three-month delay in
foreclosures would add an additional
$6bn to industry expenses, FBR Capital
Markets estimated in November. I
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City, State Foreclosures
Las Vegas, Nevada 32,288
Cape Coral, Florida 10,352
Modesto, California 4,825
Stockton, California 5,929
Merced, California 2,072
The top five US metropolitan
foreclosures in Q3 2010
Source: RealtyTrac, supplied November 2010.
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US Sales
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This is a financial promotion and is not intended as investment advice. The information provided within is for use by professional investors and should not be relied upon
by retail investors. All information relating to strategies has been prepared by Mellon Transition Management for presentation by BNY Mellon Asset Management
International Limited. Mellon Transition Management, a division of The Bank of New York Mellon, contracts under BNY Mellon Asset Management International Limited in
EMEA. To help us continually improve our service and in the interest of security, we may monitor and/or record your telephone calls with us. The performance of transition
management services in the UK and Europe is delegated to The Bank of New York Mellon in the USA. This document is issued in the UK by BNY Mellon Asset Management
International Limited. BNY Mellon Asset Management International Limited, 160 Queen Victoria Street, London EC4V 4LA. Registered in England No. 1118580. Authorised
and regulated by the Financial Services Authority. BNY Mellon Asset Management International Limited and The Bank of New York Mellon are ultimately owned by
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18
T
WO YEARS AGO, fixed income
securities lenders couldn't believe
their luck. A gigantic liquidity
squeeze created unprecedented demand
for funding trades just as many lenders
pulled back from the market amid
widespread worries about counterparty
risk. Players who stayed the course
cleaned up, shovelling out general
collateral at spreads normally associated
with specials.
It couldn't last, of course. Two years
later, rock-bottom interest rates, tighter
collateral reinvestment guidelines,
massive issuance by the US Treasury and
persistent deleveraging throughout the
financial system have squeezed lending
margins. The Cinderellamoment for
the ugly stepchild of securities lending
has passed, but bright spots still
sparkle amid the ashes. Lending fixed
income securities has never been as
profitable as equities, a market in which
participants have long been willing to
pay through the nose for the privilege
of borrowing particular names. Until the
last year or two, fixed income borrowers
in the US drew the line at zero rebate
on hard-to-borrow securities; they
refused to incur a negative rebate under
any circumstances. Record low interest
rates and the introduction of a 300 basis
points (bps) penalty on failed trades in
the US Treasury market shattered that
resistance not only for Treasuries but for
other fixed income assets.
The change came even though specials
have virtually disappeared from the
Treasury market. Ever since the issuance
sizes have increased, most off-the-run
Treasuries are financed at or very close
to general collateral levels, says Vincent
Laudati, US fixed income trading
manager, securities lending, at Citi Global
Transaction Services in New York.
The margin squeeze reflects an
extraordinary shift in the balance
between supply and demand. Treasury
issuance was $209bn in the fiscal year
through September 2007, but by 2009
it had ballooned to more than $1.74trn
and was still a whopping $1.47trn in
fiscal 2010. Before 2007 we could
generate an average of 14bps on the
two-year, says Shirley McCoy, global
head of fixed income lending, financing
and markets products at JP Morgan in
New York. Now it is about 7bps.
US Treasury portfolio utilisation rates,
which used to hover close to 100%, have
dropped back to 60% to 65% as a result.
Lender psychology has changed, too.
Before the financial crisis, clients used to
ask Paul Wilson, global head of client
management and sales, financing and
markets products, JP Morgan in London,
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A major liquidity squeeze in 2008 created unprecedented
demand for funding trades, with fixed income securities lenders
who stayed the course cleaning up. Now, with interest rates at
rock bottom, massive issuance by the US Treasury and tight
collateral reinvestment guidelines, the Cinderella moment for
securities lending has passed. However, there are still a few
bright sparks. Neil OHara reports.
THE NEW RISK/RETURN EQUATION
Photograph Beliksk /
Dreamstime.com, November 2010.
The diffe The diffe ence between perform and outperform. ence between perform and outperform. er er and outperform. and outpe form.
20
about utilisation rates all the time. It is
very seldom that clients talk about
utilisation now, he says. They are
more concerned about what level of
overall return we are generating under
what risk parameters.
Fears that lenders would desert the
market altogether in a low interest rate
environment have proved unfounded,
however. After the widely publicised
problems in some cash collateral
reinvestment pools two years ago, every
lenderwhether or not they incurred
lossesreviewed their reinvestment
programme and in most cases revised
the guidelines to focus on shorter
duration and higher quality assets. The
conservative stance combined with low
interest rates has made some financing
transactions uneconomic for borrowers
like banks and securities dealers, but
lenders are happy to pick up a few extra
basis points when investment returns
are so low.
While returns are not what they used
to be, we remind clients that the returns
seen a couple of years ago were created
by extreme market conditions that were
not good for the industry, says Nick
Bonn, head of securities finance at State
Street Corporation in London.
Substantial premium
Opportunities to earn higher returns
do exist for lenders who are willing to
take more risk. New liquidity regulations
for banks and broker-dealers have
boosted borrower interest in term
lending commitments. Citi's Laudati
sees particular interest in three-month
loans; borrowers are seeking to pledge
a wider range of collateral, too. Lenders
willing to extend credit beyond one year,
a period that affords borrowers
regulatory capital relief, can pick up a
substantial premium, as well. The
market is a bit polarised, says JP
Morgan's Wilson. Dealers will pay to
lock up securities for a longer period,
but very few lenders will commit as far
as one year.
Margins may have shrunk in US
Treasuries, but the same cannot be said
for European sovereign debt. Market
fears about parlous public finances in
Portugal, Ireland, Italy, Greece and Spain
drove their sovereign debt securities
well into special pricing territory earlier
this year, although the premiums eased
off over the summer. Borrowers have
snapped up debt securities issued by
core European Union countries, too.
There has been a substantial increase
in demand since 2008, says Bonn.
France and Germany almost trade like
specials instead of general collateral.
Borrowers have also been chasing
sovereign debt in emerging European
countries that have serious fiscal
imbalances, according to Kate Lander,
head of the London trading desk for
fixed income securities lending at
Northern Trust. Volume has risen, albeit
from a low base, and the margins can be
fat. Emerging markets and corporate
high yield have performed as well or
better than equities, she says.
Corporate bonds are another bright
spot in the fixed income lenders'
universe. Kathy Rulong, global head of
securities lending at BNY Mellon, has
seen corporate balances double in the
past two years. The lendable asset base
has increased as clients have raised their
allocations to fixed income securities
and asset values have rebounded, but
higher demand from borrowers has
absorbed enough supply to keep the
utilisation rate fairly steady. Specials
arise either from specific events or
general market sentiment. After the
BP oil spill, energy-related bonds were
in great demand, says Rulong. For a
while it was airline bonds. To some
degree, demand for corporate bonds
parallels equities.
Credit default swaps (CDS), an
alternative way to take short exposure
to corporate credit, tend to siphon off
borrower demand for cash bonds.
Traders can compare the relative cost,
but although they have an incentive to
choose the cheaper alternative, pricing
between the two markets does not move
in lockstep. The choice varies by security
and is not necessarily consistent. A
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Nick Bonn, head of securities finance at State
Street Corporation in London. We remind
clients that the returns seen a couple of years
ago were created by extreme market
conditions that were not good for the
industry, he says. Photograph kindly
supplied by State Street, November 2010.
Kathy Rulong, global head of securities
lending at BNY Mellon. After the BP oil spill,
energy-related bonds were in great demand,
says Rulong. For a while it was airline
bonds. To some degree, demand for corporate
bonds parallels equities. Photograph kindly
supplied by BNY Mellon, November 2010.
Over 17 years ICAP Charity Day has
raised US$119 million for charities
across the globe and changed the
lives of thousands of people.

This year on Wednesday 8th December we
look forward to our customers, staff, suppliers
and of course the charities and their patrons
working together for the big global
ICAP Charity Day.
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WEDNESDAY 8TH DECEMBER
CHARITY DAY
2010
Tsunami Orphans, Ban Talae Nok, Thailand.
Charity Day is proud to support the Annika Linden
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Charity Day funding has provided scholarships for
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ICAP would like to sincerely thank the publication for donating the free media space for this advertisement.
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. s e i n a p m o c f o s p u o r g s t i f o e n o r o

22
security that trades at negative 500bps
rebate may not go to the credit default
swaps market even though one that
trades at zero rebate does, says State
Street's Bonn. It depends on the trade.
The decline in popularity of credit
default swaps since the financial crisis
has revived borrower demand for
corporate bonds. The DX Long-Short
Ratio for corporate bonds, compiled by
London-based DataExplorers, has fallen
from 19.9 in May 2009 to 13.5 in
November 2010 as short interest has risen.
Regulatory pressure to trade
standardised credit default swaps
through a clearing house or on an
exchange may cut credit default swaps
volume even more. McCoy expects
clearing house margins to be set
relatively high, perhaps 15%30% of
the notional amount, more than enough
to push traders back toward corporate
bonds. Market participants have already
taken notice: corporate bond balances
have doubled in the past year at JP
Morganand it's profitable business.
Volumes are much lower than in
government bonds, but corporate bonds
have more intrinsic value, says McCoy.
When you look at where revenue is
being generated, corporate bonds are
the winners.
The credit default swaps market isn't
all bad news for cash bond lenders
anyway. Swaps dealers like to maintain
a near-neutral book, and cash bonds
are an obvious way to offset their
unmatched exposure. Tom Wipf, head
of fixed income financing at Morgan
Stanley in New York, says: It's far from
a one-to-one correlation, but we do see
a lot of hedging of credit default swaps
using cash bonds.
Custodians including BNY Mellon,
State Street and Northern Trust lend
primarily to the big international banks
and prime brokers, putting them at one
remove from the end-users of most
borrowed securities. Wipf is on the front
line, lending to hedge funds, other
broker-dealers and banks to cover fails
or traditional short sale transactions
but also to facilitate financing. Long
holders of securities may lend them out
for a modest fee and take back as
collateral either securities that pay more
than the ones lent out or cash the lender
can reinvest to earn a higher return. A
long holder is sourcing leverage through
the secured financing market,says Wipf.
It's not traditional securities lending, it's
a repo or funding transaction.
Although these trades were more
popular before 2008 when banks and
broker-dealers faced fewer regulatory
capital constraints, funding trades still
drive the lending market in US Treasuries.
In today's low-rate environment, every
basis point matters, which explains why
the market has embraced BondLend, an
electronic fixed income lending and trade
processing platform created by EquiLend.
Brian Lamb, chief executive officer of
BondLend, says volume has risen from
60,000 transactions in the first quarter
of 2010 to 80,000 in the third quarter,
and he expects more growth before year-
end as BondLend signs up additional
customers.
The system can handle any type of
transaction but so far users have focused
primarily on general collateral lending.
Automated lending and straight-through
trade processing allow lenders to place
large volumes of general collateral on
loan fast and efficiently, exactly what is
needed at a time when margins are wafer
thin. We operate as a utility, so we can
compete quite effectively on price, says
Lamb, who anticipates that customers
will use the platform for higher value
trades as well in the future.
That may be a tough sell, however.
While lenders value the BondLend
service, they aren't about to abandon
conventional trading for their most
valuable specials. The hard names trade
by hand, says State Street's Bonn. It's
an open secret that custodian lenders
dole out specials to favoured clients
based on how much general collateral
they are willing to take.
Lenders will use all the technological
help they can get in the high-volume,
low-margin general collateral game, but
for now at least human beings still trade
the crown jewels in the lenders'
portfolios. I
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Brian Lamb, chief executive officer of
BondLend. We operate as a utility, so we can
compete quite effectively on price, says Lamb.
Photograph kindly supplied by BondLend,
November 2010.
Tom Wipf, head of fixed income financing at
Morgan Stanley in New York, says: It's far
from a one-to-one correlation, but we do see a
lot of hedging of credit default swaps using
cash bonds. Photograph kindly supplied by
Morgan Stanley, November 2010.
FTSE. Its how the world says index.
FTSE International Limited (FTSE) 2010. All rights reserved. FTSE is a trade mark owned by the London Stock Exchange Plc and The Financial Times Limited and are used by FTSE under licence.
THE FTSE I WANT THE WORLD INDEX
Spotlight on Norway:
A Q&A Session with Global X Funds founder and CEO Bruno del Ama
Why did you choose the FTSE Norway 30 Index as the basis for Global Xs newest Exchange Traded Fund?
Norway is one of the most developed economies in the world, and is an exporting powerhouse. This has generated an extremely large trade surplus, which
has resulted in one of the largest sovereign wealth funds in the world. Furthermore, Norway has not adopted the Euro, which helps it to maintain its status
as one of the worlds most stable currencies and economies. All of these factors have driven investor demand for a vehicle to invest in Norwegian equities.
The FTSE Norway 30 Index represents the performance of the 30 largest and most liquid Norwegian equities listed on Oslo Bors Stock Exchange. Stocks
are liquidity screened to ensure that the index is tradable, and a unique capping methodology makes it suitable for the use as the basis for investment
products such as derivatives and Exchange Traded Funds (ETFs).
What is the name of the new ETF?
The funds name is the Global X FTSE Norway 30 ETF. It began trading on NYSE Euronext on November 10, 2010, under the ticker symbol NORW.
What is the performance story?
The index has outperformed broader equity benchmarks, including the FTSE Developed Europe index, over the 3-month, Year-to-Date and 12-month periods.
SOURCE: FTSE Group, data as at 29 October 2010
What kinds of companies are found in the FTSE Norway 30 Index?
Companies within the index are classified using the Industry Classification Benchmark (ICB), a global standard developed in partnership between FTSE
and Dow Jones. Hard asset producers represent over half of the index, including Oil & Gas producers with a 41.49% weight, Chemicals with a 5.70%
weight, and Basic Resources with a 4.78% weight of the index. The largest five companies in the index are:
Rank Constituent Name ICB Sector Index Market Cap (USDm) Index Weight (%)
1 Statoil ASA Oil & Gas Producers 21,780 18.60
2 DnB NOR Banks 16,633 14.20
3 Telenor A/S Mobile Telecommunications 13,314 11.37
4 Yara International Chemicals 6,680 5.70
5 SeaDrill Ltd Oil Equipment, Services & Distribution 6,455 5.51
Totals 64,862 55.38
SOURCE: FTSE Group, data as at 29 October 2010
Call 888-GXFUND-1 to request a prospectus, which includes investment objectives, risks, fees, expenses and other information that you
should read and consider carefully before investing. Investing involves risk, including possible loss of principal.
International investing may involve risk of capital loss from unfavorable fluctuations in currency values, from differences in generally accepted
accounting principles, or from economic or political instability in other nations. Narrowly focused investments and securities focusing on a single country
may be subject to higher volatility. Index performance is for illustrative purposes only.
The Funds are distributed by SEI Investments Distribution Co., which is not affiliated with Global X Management Company, FTSE, or any of their affiliates.
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Global markets growmore complex and interconnected every day. To stay abreast, you need a comprehensive index that can slice and
dice markets the way you do. The FTSE Global Equity Index Series was the first benchmark to cover the world seamlessly with a single
consistent and transparent methodology. Because FTSE indices are independently verified by a panel of market practitioners, you can be
sure that they will always be in line with investors needs. Wherever you invest, FTSE gives you the clearest view of how you are doing.
www.ftse.com/invest_world
WINNER
Index provider
of the year

24
T
HE TIDAL FLOWS of cash into
exchanged-traded funds (ETFs)
continue, most notably in the US,
but also in Europe, and even in Asia
where, for example, Ping An Securities
has teamed with Value Traders of Hong
Kong to offer an ETF based on the FTSE
Value-Stocks China Index, which tracks
the performance of 25 quality value stocks
amongst Chinese companies listed on
the Hong Kong Stock Exchange.
Vanguards ETF product line-up attracted
over $5bn, in October, making them the
most successful issuers but iShares also
took in $3.6bn and State Street $1.4bn.
The reasons for investor enthusiasm
are clear. Bob Monks, formerly of the
Lens Fund and long-time campaigner
for investor rights, confidently asserts:
The indexes outperform all but a very
few of the managers every year, and
they have far less costs. So the net to
the investor of buying an index fund
year in and year out compares very
favourably with all but the most gifted
investors, who, after all, invest for
themselves; they don't invest for you.
Monks estimates that if you take
indexing and closet indexingpeople
who charge fees as if they were active,
but are really indexersit's about 40%
of the market. His prognostication is
that once the saturation of indexes/ETFs
reaches around 60%, problems begin
with the market chasing its own tail, as
indexers are indexing themselves.
As is normal in the hothouse ecology
of the financial markets, ETFs have
rapidly evolved under the dual pressures
of investor demand and managerial
ingenuity as funds developed more and
more complex products, for which, of
course, increased fees can be charged.
Despite the explosion in the number of
ETFs and the consequent decline in the
popularity of more actively-managed
funds, managers are rapidly adapting to
the changing environment. As well as
country and regional funds, offerings now
include silver based indexes, airline
indexes, and almost any conceivable
slicing and dicing of region, product and
even time. However, despite the rapid
growth in these more complex offerings
to more adventurous investors, the
liquidity of ETFs seems to be enhancing
customer fickleness as many investors
move to more cheaply run funds.
Vanguards emerging market fund, for
example, has been growing rapidly
compared with competitors using the
same MSCI index, primarily, it would
appear, because its costs are only one
third of theirs. Carl Delfeld of ETF Passport
questions the survival of many of these
new products. Ive never been keen on
issues like retirement year funds. It comes
down to marketing, they want to come up
with new ideas. Obviously there is going
to be a big shakeout, a consolidation of
ETFs at some point. Economics demand
that you have around $100m to make it
worthwhile, depending on how much
you spend on marketing,and I bet most
of them havent. Probably the top ten
ETFs account for about half the funds.
Investors seem to be voting with their
dollars for the more simple, transparent
ETFs that retain ETFs distinctive low
cost transparency. On the face of it, fund
managers should be worried by the
defection of so many of their clients and
their money, but they seem to be
reacting with typical ingenuity to an
unbeatable challengeby setting up
and marketing their own ETFs. The
complexity of some of the offerings,
almost invariably dependent on a more
active and expensive management, has
led to some of the new offerings looking
like a more liquid version of mutuals.
Sea of complexity
Delfeld comments: Even actively-
managed ETFs are different from
mutuals because you can buy and sell
them on an exchange, and use some
risk management tools, such as trailing
stop losses, but actively-managed ETFs
tend to be less transparent, more
expensive, less tax efficient. What was
supposed to be an easy, straightforward
tool is now a sea of complexity with
more than 1,000 ETFs trading on US
exchanges; I guess the future is really
how investment advisers use them. You
have to have some sort of strategy to
use ETFs for your clients and choose
between the pure index ETFs and the
actively managed ETFs.
He thinks that the new complex
products are more of a retail product
than those aimed at professional
managers. There are some interesting
ones out there, but keeping it simple
and transparent, Im not sure that having
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One can never discount the caution of market watchers who worry
about unforeseen destabilising consequences of ETFs being
adopted with such bubbling enthusiasm by investors. Particularly
as they now engender intense interest from hedge funds, not to
mention being the subject of much ingenuity by financial
engineers. Ian Williams reports on the deepening of the asset class.
THE SHOCK OF
THE NEW
Photograph Rolffimages /
November 2010.
26
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a basket of 30 or so ETFs for your clients
is serving them very well.
Lisa Dallmer, chief operating officer
of European Cash Market Execution
Services for NYSE Euronext, is sanguine
about the competition between
traditional mutual funds and ETFs. She
reports that in the US there is some
$900bn in exchange-traded product
assets under management. This
September, consolidated dollar volume
turnover represented approximately
30% of all consolidated US dollar value
traded. By share volume, they
represented approximately 17% of all
US consolidated shares traded.
In Europe, euro value traded in ETFs on
NYSE Euronext grew by 5% over the
previous year while the number of trades
in the same period has grown by 19%;
indicating more trading by more users.
She also considers that the fund managers
have decided that ETFs and mutual funds
can coexist, if you look at the expansion
of ETF offerings from mutual funds
managers. People sometimes prefer the
features of mutual funds, for example
they have dollar cost averaging, while an
ETF doesnt necessarily. Ultimately the
ETF managers do hold the physical
securities. We think that there is room
for expansion out there, as the market
has returned and people are looking for
yield this year, there are a lot more
emerging market ETFs, country specific,
region specific, illustrated as overall asset
gathering expands. Both mutual funds
and ETF providers are trying to meet
demand and expand their products, but
there will always be managed funds, and
room for managers seeking alpha.
Vin Bhattacharjee, head of EMEA
Intermediary Business at State Street
Global Advisors, also stresses that indexes
and ETFs are different products from
mutuals and so do not necessarily
compete in the same space. Even so, he
reports: Retails investors are obviously
moving from mutual, actively-managed
funds with their generally higher costs.
The fundamental issue is the fact that
80% of any portfolio returns come from
asset allocation rather than stock or
security selection, so you will get over
80% of your returns from the equity, bond,
fixed income mix rather than by, picking
say, Coca Cola over General Motors. He
adds: The only way to achieve equivalent
results is by taking huge portfolio risk.
So there is no reason to go for actively-
managed funds; to take beta exposure
from the underlying beta, the best way
to do that is by getting an index.
He agrees that the penetration of the
index funds is causing the correlation
between the underlying securities and
the overall index, and for example, the
correlation between the individual
equities and S&P 500 has gone up over
the years with portfolio trading.
However, while it might look like a dog
chasing its own tail, he stresses: That
will create a lot of active opportunities,
because its impossible for all the stocks
to behave identically since they represent
different businesses, and that will create
arbitrage opportunities, alpha creation
opportunities. Already, we see a lot of
hedge funds are now playing single
stock positions against index.
Rush of funds
So where do ETFs go from here?
Bhattacharjee reflects: There are always
more ways to skin a cat. He discounts
the possibility that the rush of funds
into BRICs and emerging markets-based
indexes and ETFs is causing bubbles.
They are just a way of executing a
position so I dont think they are causing
major inflows, just reflecting underlying
trends. The developed markets face a
major debt overhang which is being
monetised with, for example, QE2 in
the US, whereas the developing markets
have exactly the opposite with very low
leverage ratios, so that is enough to
explain the capital flows, he says,
adding that in reality calling these
markets emerging is a misnomer.
Their capital markets are sounder now
than the so-called developed markets!
He foresees continued interest in the
emerging markets as long as the euro
and dollar maintain their external debt
overhang. Similarly, investors will want
safe havens with other currencies, fixed
income, gold and other precious metals,
commodities and that trend might be
reflected in ETFs. Theres still a lot of
room to grow in fixed income funds,
he suggests.
Lisa Dallmer also foresees even more
offerings, explaining: Indexers can build
a whole portfolio in an ETF there are
now even retirement date ETFs, where
the index adjusts the allocation of assets
between equities and fixed income to
maximise returns for the preferred
retirement year.
She also notes wide room for
geographic expansion. While ETFs are
strongest in the US and growing in
Europe, they are only just taking off in
Asia, and she points out a large expansion
of ETF offerings in, for example, Hong
Kong and Japan over the last three years
from 47 to nearly a hundred.
Dallmer discounts the dangers of a
bubble with the rush into sectors like
commodities and emerging markets.
These products create an access point
where investors can get entry into assets
that would otherwise be difficult unless
you were prepared to build specialised
portfolios with brokers, and this year
weve seen more offerings in emerging
markets, fixed income.
Delfeld differs about the bubble
aspects, considering that the ease of
ETFs, whether in commodities or
emerging markets, has made it easier
for investors to access these classes. For
example, gold and silver have certainly
been boosted since ETFs have made it
easier, rather than gambling on dicey
mining stocks, and it has been the same
with emerging markets.I
Vin Bhattacharjee, head of EMEA
Intermediary Business at State Street Global
Advisors. Retail investors are obviously
moving from mutual, actively-managed funds
with their generally higher costs, he says.
Photograph kindly supplied by State Street,
November 2010.
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LTHOUGH THEY MAY be at
the less exciting end of the
investment scale, high yield
equities have come back into favour.
This trend started as a short-term
defensive play but, increasingly,
institutional investors have hopped on
the bandwagon to tap into steady
returns. Sectors such as oil and gas,
banking, telecoms and pharmaceuticals,
have traditionally been prime targets
but now a broader approach is being
taken.
One of the main contributing factors is
that for the first time in more than 50
years, yields on benchmark government
bonds in the UK, Europe and US are
lower than the returns of high yield
equitiesthose that distribute higher
than average dividends. This is due to the
investor stampede into triple-A rated
sovereign bonds on the back of fears over
the global economy and the threat of a
double-dip recession in the US and UK.
There are also concerns over the plethora
of regulations, the tightening of Chinese
monetary policy and the sovereign debt
crisis in Europe. Irelands negotiations
over a multi-billion dollar loan package
from the International Monetary Fund
and European Union could be followed
by Portugal and Spain making similar
moves. The flight into bonds pushed yields
to new lows while, simultaneously,
company profits rebounded. Equally as
important, a significant number of
companies is sitting on dividend yields
that are higher than what they are paying
on their own debt, which reflects both
the attraction of high-yielding equities
and the equity market overall.
Richard Turnill, manager of
BlackRocks global equities fund, notes:
There is an extraordinary anomaly in
the financial markets today where if
investors want to buy yield in the bond
markets, they have to buy lower quality
assets, but we have the opposite
situation in equities. Institutions now
have the opportunity to invest in the
highest quality businesses at reasonable
prices, plus they are also getting an
inflation hedge. This is why I think
there is such a compelling structural
case today for dividends.
A similar picture
Looking at the big picture, industry
reports reveal that the dividend yields in
Europe stand at around 4%, more than
1.5 percentage points above benchmark
government bonds. They are also
competitive with yields on triple-B rated
investment corporate bonds which are
close to 5%. In the UK, yield in the gilt
fund sector currently averages 2.78%,
although some funds are yielding as
little as 1.4%-1.6% compared to the
3.5% being generated on the FTSE All-
Share index.
A similar picture is being painted in
the US. Calculations by fund management
group Federated Investors show total
returns for dividend-paying companies
have outpaced the broader market by
nearly 190 basis points since January while
data compiled by Bloomberg reveals that
US companies are being the most
generous with their dividends since 2003.
In addition, the S&P 500 Dividend
Aristocrats Index, which tracks large cap
firms that have sought to increase
dividends every year for at least 25
consecutive years, has risen 8.6%
compared with the broader S&P 500
index, which gained 2.5%.
There are also encouraging signs for
the future. The latest figures from fund
management group Fidelity show that
210 companies in the UK have raised
their dividends so far this year while 55
have left them unchanged, and 30 have
cut them. Over the same period in 2009,
only 156 companies reported increases
while 51 left them unchanged and 86
withdrew them.
As for next year, Newton Investment
Manager is predicting dividend growth
between 8% and 22%. The forecast is
predicated on the level that BP reinstates
its dividend which is slated for early 2011
as well as the dollar-pound exchange
rate. The oil giant pulled its dividend
and announced plans to sell $10bn
(8bn) of assets and cut capital
expenditure due to the Gulf of Mexico oil
slick crisis. This came as something of a
surprise to investors who relied on their
regular cheques. According to estimates
from the National Association of Pension
Funds (NAPF), BP stock accounts for
For the first time in more than half a century, yields on benchmark government bonds in the US,
UK and Europe are lower than the returns of high yield equities. This is a result of the investor
stampede into triple-A rated sovereign bonds on the back of fears over the global economy and
the threat of a double-dip recession in the US and UK. Industry reports reveal that the dividend
yields in Europe stand at around 4%, more than 1.5 percentage points above government bonds.
Historically, defensive sectors such as oil and gas, telecoms and consumer staples have been the
most popular dividend plays due to their strong and secure cash flows. They are particularly
appealing today because they did not partake in the rally last year and consequently are the
most undervalued. Lynn Strongin Dodds reports.
BACK TO
THE FUTURE?

30
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IN THE MARKETS
about 1.5% of a typical UK pension fund
portfolio and, before the crisis at least,
around 6% of the FTSE 100 index.
According to Tineke Frikkee, portfolio
manager of the Newton Higher Income
Fund: If BP reinstates its dividend at
the consensus level of $0.105 per quarter,
at $1.56 to the pound, then 2011 market
dividend growth is likely to be around
14%. If it comes in at the previous level
of $0.14 per quarter at $1.56 then the
figure could be higher at 18%. The dollar-
pound exchange rate is important for
the forecast range of dividend growth as
more than 40% of UK dividends is
declared in dollars. If sterling was to
weaken to its recent low of $1.43 to the
pound, and BP was to reinstate dividends
to previous levels, then UK market
dividend growth could reach 22%.
As for other contributors, Frikkee
points to HSBC, Vodafone, British
American Tobacco, National Grid, Anglo
American, GlaxoSmithKline and Xstrata.
HSBC is the largest company in the UK
in terms of market capitalisation, at 7.4%
of the FTSE All-Share Index, and around
7.8% of expected UK market dividend
income in 2011. Vodafones market
weighting is 5.1% and the company
contributes 8.3% of all UK market
dividend income in 2011.
Recent research from Barclays
supports the view about HSBC as well
as a select group of other European
banks, which includes SEB, Swedbank,
UniCredit, Socit Gnrale, BNP
Paribas, Standard Chartered and BBVA.
The bank believes that instead of
hoarding capital as has been the recent
practice, clarity on Basel III capital rules
should allow some banks to loosen their
grip and deploy surplus capital. The
banks analysts notes say: In the four
years pre-crisis, the sector paid dividends
of 131bn yet only generated free cash
flow of 52bn. Over the next four years,
we estimate free cash flows of 213bn
and dividends of 107bn
Historically, defensive sectors such as
oil and gas, telecoms and consumer
staples have been the most popular
dividend plays due to their strong and
secure cash flows. These companies have
also been the most generous in terms of
payouts and have enjoyed the highest
yields. They are particularly appealing
today because they did not partake in
the rally last year and consequently are
the most undervalued.
However, as the BP experience
demonstrates, past performance should
not always be an indication of future
payouts. As Sonja Schemmann, manager
of Schroders Global Equity Income
Fund, notes: Typically, telecoms, food
producers, big cap oil companies and
healthcare have been the most popular
high-yield investments. However, it is
important to look at companies on an
individual basis and make sure that they
have sustainable growth prospects and
strong management teams.
To that end, Folmer Pietersma, head
of Robecos Property Equities Fund
strategy, recommends real estate
investment trusts (REITs). REITs are on
dividend yields of 4% to 5%, which is
much higher than cash and bond
investments. We think the cash flows
and dividend growth of a significant
number of listed real estate companies
should continue and that real estate will
remain an attractive investment in todays
low interest rate environment. The focus
should be on strong balance sheets and
prime portfolios in good locations.
Overall, though, a long-term view
should be adopted. As John Velis, head
of capital markets research, EMEA, at
Russell Investments, points out,
dividends and dividend growth and not
capital gains drive the performance of
stock markets over several years. I am
a strong believer that if investors hold
equities over a long-term period they
will be able to take advantage of the
profits the companies generate because
they are returned to shareholders in the
form of dividends. History suggests that
stock prices only rise if the market
believes that dividend payouts will rise.
Rate of return
For example, the US equity market
between 1937 and 2009the longest
period of data availableshows that
on average equities returned nearly 16%
per annum over a ten-year holding
period, which in real terms equals 11.5%
per annum. Breaking it down, the rate
of return accounted for by real price
appreciation was only 1.9% or less than
one-eighth of the total real return.
Data for the UK (from 1962 through
2009) reveals a similar story. Of the 13.1%
annualised return over that period, 7.1%
is due to inflation and just 1.1% to price
appreciation. The remaining 4.9% of FTSE
All-Share returns is attributed to a
combination of dividend income and
dividend growth. I
Sonja Schemmann, manager of Schroders
Global Equity Income Fund. Typically,
telecoms, food producers, big cap oil companies
and healthcare have been the most popular
high-yield investments, she notes. Photograph
kindly supplied by Schroders Global Equity
Income Fund, November 2010.
Tineke Frikkee, portfolio manager of the
Newton Higher Income Fund. If BP reinstates
its dividend at the consensus level of $0.105
per quarter, at $1.56 to the pound, then 2011
market dividend growth is likely to be around
14%,she says. Photograph kindly supplied by
Newton Higher Income Fund, November 2010.
31
T
he sums being loaned to the
Irish look almost unbelievable
if you equate it to a per
employed person scale. Some 2.2m
people work in the Republic and this
new bailout will add at least another
40k to the average citizens debt
pile. Thats on top of all the private
and public debt exposure already in
place. With unemployment now
approaching 14% the obvious
question is: how on earth they will
ever get out of the hole that has been
dug for them?
Once again Europe appears to be
pushing problems ever further into
the future in the hope that
something will turn up. The markets
are less sure it will. Irish long term
debt is now yielding over 8%, having
briefly hit 9%. This is the price with
what appears to be a reasonable
European guarantee. In a wider
context though (with German,
French and UK debt at or lower than
3%) it is clear that the international
debt markets remain suspicious of
European political promises.
It is worrying to admit but there is
a growing number of otherwise
sensible people across Europe who
are now drifting into the camp that
holds there is no point in paying all
this debt. After all, they say, it will get
bigger next year, no matter how fast
we pay it off. As a result,
democracies may be put under heavy
pressure from the simple solution
brigade from both the left and right
whose cry of Let the banks die!will
get louder and louder. The argument
that this will bring everything down
around our heads may not count for
much if the general populous feels
that this has already happened.
How is this likely to affect the
equity market? As I mentioned back
in September the search for yield was
possibly a likely beneficial argument
for the FTSEs component parts, as
even the most expensive stock was
giving a reasonable return. This is
especially true when added to the
fact thataside from Southern
Europe, the UK and the USthe
world economy is still looking rather
good, thank you very much.
Commodity prices continue to surge
as demand increases and in many
places the argument is more about
raising interest rates to curb
inflationary pressures rather than
trying to boost growth with vast
amounts of quantitative easing.
While, on the one hand we have
the wealthy First World busily
becoming poorer, emerging high
growth countries surge ever higher
as domestic demand finally starts to
rise above background noise levels
and fuels their rising trajectory in
international markets. Old World
democracies are struggling under
the misplaced need for politicians
and central bankers to deliver
instant, virtually pain free, answers.
Its leading, in many instances, to
good money being thrown after bad.
The idea of cutting losses and
delivering pain in selected, high
cost/low return areas is foregone for
a general one size does not fit all
policy burden.
Growth companies in the UK are
now hampered by this type of
policy. The result is that any portable
business is rightly decamping to the
east. The net effect, of course, is to
move vital tax receipts eastwards as
well, thereby increasing the burden
for those who are forced to remain.
It might not take much to turn this
trickle of tax-jumpers into a flood.
Already, the tax receipts side of the
UKs deficit has been a lot weaker
than the GDP numbers would
suggest. Might we already be seeing
some of the impact of this migration?
It could also frighten the equity
markets over the short term.
However, its reasonable to assume
that globalisation has already been
factored in and stocks remain very
reasonably priced for the longer
horizon. No matter where a
company is based the bigger
economic picture is getting rosier.
However, in the UK we are seeing
rather more wood than trees.
As ever ladies and gentlemen,
place your bets. I
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Theyre back! Those over-indebted European nations, led by
the Celtic Tiger, have come to haunt any prospect of an
optimistic start to the New Year. Usually, the late November to
end December period is rather boring in market terms. This
year the markets may be in for a spook-fest. Simon Denham,
managing director of spread betting firm Capital Spreads,
gives the bearish view.
INDEX REVIEW
Simon Denham, managing director of spread
betting firm, Capital Spreads.
MORE WOOD
THAN TREES
32
O
NE OF THE key arguments for
the merger between RI and
RZB lay in the improved access
to capital and money markets that the
merged bank would enjoy in comparison
to Raiffeisen Internationals prior status.
This step would also contribute to
Raiffeisen Internationals risk
diversification and would make it
possible to further optimise risk
management for the Group in the
future, notes Herbert Stepic, chief
executive officer of the merged entity.
The bank remains listed on the Vienna
Stock Exchange and offers retail (in
CEE), corporate and investment banking
services. The business associated with
RZB's function as central institution of
the Austrian Raiffeisen Banking Group
has now been hived off into a non-listed
bank holding, says Stepic. This merger
strengthens us to the benefit of our
clients and business partners, both of
whom will profit from our optimised
offering of products and services,he
adds. RBI is expected to take full
advantage of the renewed strength of
economic growth in Central and Eastern
Europe, he adds.
To facilitate the merger, a capital
increase was agreed and now RBI's free
float amounts to around 21.5%, (it had
previously amounted to about 27.2%
for Raiffeisen International). RZB's
indirect shareholding in RBI amounts
to around 78.5%. Both entities brought
solid financial credentials to the mix. For
the time being the merged entity is
reporting financials on a pro-form basis.
Third-quarter's consolidated profit more
than doubled compared to preceding
quarter, posting a consolidated profit of
311m for the third quarter of 2010 (Q3),
an increase of 125% over Q2 2010. The
main driver for this increase came from
valuation results for financial investments
and derivatives. By the end of the third
quarter its profit is projected to stand at
997m, while its consolidated profit (after
tax and minorities) is reported as 783m,
with provisioning for impairment losses
reported at 913m.
Our results ... reflect the friendlier
overall macro-economic environment,
notes Stepic.Our non-performing loan
(NPL) ratio stood at 8.8% at the end of
September. This quarter-on-quarter
increase ... was largely attributable to
developments in Central Europeabove
all in Hungary and the Czech Republic.
We assume that NPL volumes have
already reached a peak in some countries,
but that we will only reach that peak at
the Group level during the course of next
year. At the moment, it's not possible to
tell whether that development will take
place at the middle of the year or only
in the second half of 2011,added Johann
Strobl, chief risk officer for RBI as well
as for the RZB Group.
RBI's pro-forma balance sheet total
as per 30 June 2010 stood at 147.9bn,
which represents an increase of 1.3%
since the end of 2009 and return on
equity before tax stood at 12.2%. On
the basis of the same pro forma figures,
RBI's core capital ratio (tier 1), credit
risk stood at 12%, while its core capital
ratio (tier 1), total stood at 9.5%.
The merger brings together Raiffeisen
International's distribution network of
around 3,000 outlets in 17 CEE markets
with RZBs product know-how in capital
markets products for commercial
customers, financial institutions and
sovereigns. More generally, the merger
makes possible a sensible reallocation of
resources towards those CEE markets
with sustainable growth; a substantial
consideration given that the Austrian
bank also has a strong presence in Asia's
emerging markets.
The significant outcome in the merger
is that Herbert Stepic has become chief
executive of the new entity, which will
invariably define the character of the new
entities growth strategy. Stepic is a long
term emerging markets expert and will
likely continue the groups expansion
into high growth markets. When he led
RI, it was one of the first institutions to
break into the CEE zone, initially through
greenfield developments. Only after 2000
did the bank start to look at an accretive
acquisitions-led business growth strategy,
as interest in the CEE from other foreign
financial institutions began to step up.
Stepic has always believed in the potential
of the CEE region, at a very visceral level,
and over the years he has continued to
claim that:It is the future growth engine
of Europe.I
BANKING REPORT
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RZB and Raiffeisen International (RI) announced in late
February that they were looking at possible merger of the two
companies, bringing RZBs business with Austrian and
international corporate customers together with those of
Raiffeisen International. The merged company, launched under
its new moniker as Raiffeisen Bank International AG (RBI) in
early October. The parties expect the merged bank to
strengthen develop as a leading universal bank in Central and
Eastern Europe through the combination of RIs broad
distribution network in the CEE region and RZBs
comprehensive product portfolio.
THE RBI BOUNCE
Photograph Risto Viitanen /
Dreamstime.com, supplied November 2010.
33
P
ERHAPS THE UNITEDStates
policy is less clueless than Herr
Schauble suggests, and the
hypocrisy accusation unfair, given that
any reductions in the value of the
dollar will be side effects rather than
primary objectives? After all, the
marketplace is a funny thing, and one
can never rely on it to react predictably.
Explicit, direct currency manipulation is
hard enough to achieve (just ask
Japan), let alone tangential coercion of
the sort he alleges.
Chances are the market has already
priced in this round of quantitative
easing, and we will begin to see a
market rapprochement with the dollar.
The amount of money involved is not
as massive as it sounds, given the size
of the US economy, and most of it will
remain within American borders. As
such, fresh shorts of the dollar should
be made carefully or may struggle to
show positive results. Weve already
seen some pretty significant
appreciations of the G10 currencies
against the buck, so while some further
moves in that direction are possible, the
momentum has shown signs of fading.
Better shorting luck may be had in
choosing amongst the beneficiaries of
recent dollar weakness. The eurozone
is not lacking for economic warts and
hidden booby traps. With the Greek
panic receding, we need not look far to
find other sources of anxiety: Ireland,
Portugal, Spain and Italy head the A-
list of countries with serious balance
sheet repair issues in the years ahead,
and the amount of domestic pain
awaiting them when the demands of
entitlement reform necessitated by
inevitable austerity measures can no
longer be put off will elicit some very
sharp headline cries. Do not
underestimate the ability of labour
unions and other political groups to
rally sentiment against measures that
threaten hallowed entitlements.
Moreover, German taxpayers will
not continue to finance what they
increasingly perceive to be welfare
states within the eurozone. There is a
large divergence between the
constituent nations in terms of fiscal
rectitude, and the political
consequences of that will now play
out. Truly, there is a reckoning to be
made in the years ahead in Europe,
one that will test the strength of the
bonds that created the euro. This
cross-border political dynamic does not
exist internally for the dollaror any
other currency, for that matter.
Europe needs only look north to see
the way out. Sterling has benefited
from the budget measures envisioned
by UK prime minister David Cameron.
There will be protests, and a gnashing
of the teeth amongst the hoi polloi, but
Great Britain has something Europe
lacks: a sense of collective resolve, not
to mention a history of shared sacrifice.
If the budget measures promulgated by
Cameron prove to be fair, they will
probably be enacted even if harsh.
Hanging on in quiet desperation is the
English way, and so is belt tightening
when facing a national threat; mores
the eurozone simply cannot duplicate.
Commodity currencies have gained
handsomely over the past year, led by
everyones favorite proxy for the RMB,
the AUD. Given the demand for the
kind of natural resources found there,
we can expect the causality between
global growth and AUD strength to
hold for the foreseeable future. As
strong as the Aussie dollar is now,
there is simply no imaginable scenario
short of another global recession under
which it could significantly retrace. The
Kiwi will mostly follow AUD, as usual,
and thus looks to consolidate recent
gains in the months ahead.
The Canadian dollar has also
benefited from worldwide demand for
natural resources that provide the
inputs for manufacturing, and this has
amplified its traditional alternative-to-
the-US status dynamic. Having
reached parity with the US, a period of
consolidation is not out of the
question, even though it has shown an
historic tendency to recoil from
massive psychological barriers. The
emerging markets may be the biggest
beneficiaries of quantitative easing, if a
strengthening currency can be labelled
a benefit. The Asian rim continues to
exhibit impressive growth prospects,
and the launching of QE2 should lift
the local tide with an influx of
investment dollars to the extent they
leave US shores. If you lack the
stomach for long dollar exposure,
consider AUD, KRW, GBP and CAD, all
at the expense of the EUR. I
In the wake of the Federal Reserve Banks announcement of its
plan to spend $600bn buying back US treasuries over the next
eight months, much has been made of the implicit devaluation of
the US dollar this represents. Germany finance minister Wolfgang
Schauble recently described US policy as clueless and
hypocritical, given American rhetoric targeted at China for
artificially pegging the RMB below its natural levels. Erik Lehtis,
president of Dynamic FX Consulting, gives a traders view.
CLUELESSNESS &
CURRENCY WARS
Erik Lehtis, president of DynamicFX
Consulting in Chicago.
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34
A
FTER DISMAL PROJECTIONS
about an exit from the City of
London due to higher personal
tax rates, the UK capital has shrugged off
concerns and forged ahead in 2010. Split
into four main markets, different drivers
have supported growth across the capital
and a severe slowdown in development
has also helped keep availability rates
low. The story of the next two years
is likely to focus on office churn and
redevelopment as investors swoop on
key assets and refurbished premises, if
they can achieve value. That last point is
a big question. Prime office space is in
short supply and a weight of money
chasing the best buildings, meaning prices
for prime are being pushed up and could
force investors to look for better value
elsewhere, such as Paris or Madrid.
However, the central London office
market has seen take-up levels rise well
above trend in the third quarter (Q3) of
2010, according to agent CB Richard Ellis,
which notes that the market saw the return
of large pre-letting deals, which boosted
take-up to 3.5m square feet (sq ft), 27%
above the previous quarter, and an increase
of 12% over the long-term average.
Pre-letting is an important indicator
of development sentiment as pre-lets
both provide investors with the assurances
they need about income streams, post-
construction, and show that demand from
occupiers remains robust.
Supply was squeezed to 15.4m sq ft at
the end of Q3, fuelled by large falls in the
availability of second-hand space, and
led to a sharp increase in prime rents in
the City, Chancery Lane, Covent Garden
and Holborn areas. Availability across the
market as a whole is now nearly 6m sq ft
lower than at the most recent peak at the
end of Q2 2009.
We have had two years of low supply
and we are scheduled to have two
more, reflects Andrew Burrell, partner
in the research team at agent King
Sturge. There is undoubtedly a London
bubble, with very healthy take-up by
occupiers and with the lack of new-
build, growth opportunities will really
lie in the refurbishment market,
especially if landlords can secure pre-
lets. Thats what investors are looking for
and there are plenty of opportunities
to drive rental growth.
According the CB Richard Ellis prime
rent index, annual rental growth in the
City was 19.2%, the largest of any central
London market. The West Endwhich is
influenced by different dynamics to the
Citygrew by 8.5% in the same period,
REAL ESTATE
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Amid the worst of the recession, central London's commercial
real estate sector has achieved an extraordinary performance
compared with the rest of the UK. Prime retail has broken
records and the office market has benefited from a slowdown
in development. Yet with continuing concerns over the health
of the British economy, can the capital's office market continue
to grow as rising prices for prime office space could force
investors to look elsewhere, asks Mark Faithfull.
A CAPITAL
PERFORMANCE
Leasing:
G
The UBS deal of 700,000 sq ft at 4-6 Broadgate, EC2, was the biggest in the market by
a considerable distance. There were five other deals above 50,000 sq ft, including Bovis
Lend Lease taking 79,600 sq ft at British Lands Regents Place: Phase 2, NW1, and
Bloomberg taking 71,900 sq ft at Park House, Finsbury Circus EC2.
G
The banking and finance sector was the driver behind recent deals, accounting for a
45% share of take-up
G
Vacancy rates fell to 5.9%, a fall for the fifth successive quarter.
G
Six schemes completed during the third quarter. The largest of these was the St Botolph
building, EC3, of which 278,000 sq ft is available
G
Rent free periods on a ten-year lease fell slightly over the quarter and are now at 24
months in the City and 20 months in the West End.
Investment:
G
Investment turnover stayed at 1.9bn, constrained by a lack of quality stock.
G
Prime West End yields hardened to 4%.
G
Only three deals were recorded over 200m, with the Carlyle Groups purchase of
Thames Portfolio for 400m and Alban Gate, London Wall, for 271m.
G
Domestic investors maintained a strong interest in the market with UK property
companies (12%) and UK institutions (11%) particularly active, although overseas
investors remain the key driver.
Central London office property: Q3 2010 highlights
35
and to the east, London Docklands
rents rose by 4.2%. With only 0.4m sq ft
of an expected 4m sq ft of scheduled
completions due to be delivered during
the last quarter of the year, there are few
signs of supply problems easing, and a
rapidly diminishing completion rate of
1.6m sq ft is expected in both 2011 and
2012, meaning the squeeze on suitable
space will continue.
In the investment market, CB Richard
Ellis reports strong interest in quality
stock which pushed West End yields to a
very tight 4.0% and left prime City yields
unchanged at 5.5%, although they have
since hardened further. Importantly,
overseas buyers continue to show a strong
interest in central London offices,
accounting for 68% of transactions by
volume in the third quarter. This echoes
general outside interest from investors
about UK prime property, partly driven by
the weak pound but predominantly
because there is a general perception that
the UK has been one of the first European
real estate markets to fully price correct.
Kevin McCauley, head of central
London research at CB Richard Ellis,
reflects: Despite the strength of the
market in 2010, the level of uncertainty
among occupiers has increased recently,
amid a relatively muted economic
outlook. Some cooling in demand can
be anticipated, and this has been
reflected in the amount of space under
offer at the end of the third quarter,
which fell to 0.8 sq ft from 1.6m sq ft in
the previous quarter.
Some analysts are even more bullish.
London offices have been described as
the pin-upsector for the UK market
because of the improvements in both
investment and occupier trends, by
Cushman & Wakefield. Its own estimate
of prime property yields stood at 5.72%
at the end of September. However, it also
notes that investors are still sensitive to lot
size, and points to investments in the
15m to 40m range as the area of
greatest demand.
Investor demand
Second-sell UK private and institutional
investor demand is also strong but most
are still struggling to find the quality of
stock they want, Cushman says. Although
there is an increase in the supply of
investment property for sale, secondary
property is coming forward and banks,
receivers and Irish investors are the most
notable sellers.
Attention is on these players and the
type of stock they will sell, the speed with
which they will want to sell and the price
they hope to achieve versus that which the
market will consider, Cushman points
out. While the demand for City office
property is driven by financial and legal
institutions, in the West End, demand
from property and hedge fund companies
had pushed availability down. Despite a
weakening in these sectors, availability
has continued to decline.
There is currently 4.4m sq ft of available
office accommodation in 248 units in the
West End, which represents a significant
8% decrease on the previous quarter and
a 26% fall over the previous 12 months.
That said, supply remains just above the
25-year average of 4.2m sq ft.
Agent King Sturge points to a fall in
supply in Q2 attributable to above-average
transactional levels and the relatively
limited amount (499,000 sq ft) of newly
marketed space hitting the market in Q3.
This level of supply equates to a vacancy
rate of 5.5%, which represents a 50 basis
point fall over the previous three months.
The vacancy rate remains below 6%,
historically the trigger rate for rental
growth. The reduction in availability seen
over the past six months is set to continue
over the next two years, with availability
falling below the 25-year average by the
year-end.
It is this fall, coupled with the low levels
of speculative space set to be delivered
from the development pipeline, especially
in the core areas, that supports strong
prime rental growth, even in the event
of more muted demand generally.
There are dangers of an economic
dip, admits Burrell. However, there are
few signs of anything that the market
hasnt already coped with.I
B
RITISH LAND, THE UKs second-
largest real estate investment
trust, in October revived a plan to
build the Cheesegrater tower in
Londons main financial district, just a
week after another skyscraper project
was restarted. British Land will develop
the 47-storey building in a joint venture
with Oxford Properties Group, a unit of
Toronto-based Ontario Municipal
Employees Retirement System, at a cost
of about 340m. Land Securities Group,
the countrys largest REIT, announced on
October 19th that the Walkie-Talkie
development, officially known as 20
Fenchurch Street, would proceed.
No tenants have been lined up for
either project but Land Securities said
the 500m Walkie-Talkie tower would
proceed after the company formed a
venture with Canary Wharf Group, which
is backed by Qatar Holding and China
Investment Corp. In June, Land
Securities sold its Park Place
development on Londons Oxford Street
to Qatars Barwa Real Estate Co.
British Land had halted construction
of its 224 metre-high tower officially
named the Leadenhall Building after
completing the demolition and
preliminary basement work. Construction
is scheduled to start in January.
SKYSCRAPERS REACH FOR THE SKY AGAIN
Photograph Roland Nagy /
November 2010.
36
DEBT REPORT
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T TIMES WHEN the financial
press has been full of the Irish
debt crisis and mainstream UK
newspapers carry bleak pictures of
empty houses and the unemployed in
Ireland, it is comforting to find an
investment that is fairly secure and likely
to provide predictably solid returns.
Green bonds are proving just such an
asset. To date, the World Bank and the
International Finance Corporation (IFC)
have issued around $1.5bn of green
bonds, the European Investment Bank
has produced its own version, called the
climate awareness bond, and there is
talk of the UK doing something similar
to finance clean investment.
The World Banks bonds are all plain
vanilla, fixed income products that offer
the opportunity to take part in financing
projects that help mitigate climate
change. They have similar features to
regular bonds issued by the World Bank,
including credit rating and size.
The World Banks first green issue in
2008 was lead managed by SEB bank,
denominated in Swedish krona, and the
main takers were large Swedish
institutional investors, such as the
countrys second and third national
pension funds, AP2 Fonden and AP3
Fonden. Issues in the dollar and 14 other
currencies followed with pension industry
heavyweights coming on board in the
shape of the California Public Employees
Retirement System (CalPERS), the
California Teachers Retirement System
(CalSTRS), the New York City Employees
Retirement System (NYCERS) and the
UN Joint Staff Pension Fund.
One of the key appeals for CalSTRS,
explains spokesman Ricardo Duran, is
that they satisfy CalSTRSstrategic aim
of integrating sustainability into its
investments. He adds: There is a great
deal of confidence in management's
ability to protect the interests of investors
and to keep themselves economically
viable. The pension fund bought $10m
of green bonds from the World Bank and
another $10m from the IFC.
In the equities market there is a
whole host of investment opportunities
for those wanting exposure to sustainable
and environmentally friendly projects. To
start with, there are all the clean-tech
companies such as wind turbine
manufacturers, fuel cell makers or solar
power developers but, alternatively,
investors can opt for indexes such as the
Dow Jones Sustainability Index, the
OkoDAX or the FTSE4Good Index Series.
However, until the World Banks green
bonds there was little in the fixed income
market that was orientated towards
investors interested in green investment.
We have a lot of focus on SRI
[socially-responsible investment] in
equities but it has been hard to find this
kind of investment on the fixed income
side, says Ole-Petter Langeland, head
of fixed income at Swedens AP2
pension fund. When the fund was
approached by the World Bank and SEB
to buy green bonds, AP2 hired an
outside adviser to look at how the
proceeds of the bond would be
channelled and which projects would
be chosen, Langeland adds. The verdict
was positive and over the years AP2
bought more than $100m-worth of
green bonds issued either by the World
Bank or by the associated International
Fundraising Congress (IFC). Though
green bonds constitute a relatively small
portion of the pension funds fixed
income portfolio, which stands at $12bn,
it is not one likely to become smaller.
The SEK-denominated bonds held
by AP2 reach maturity in 2014, and
after that we intend to roll it over, that
is, buy a new issue when it comes out,
says Langeland.
The triple-A rating and the fact that
the World Bank is backed by 186
countries is one of green bonds biggest
selling points, particularly in the current
climate. The coupons are designed to be
slightly above comparable bonds; the
Swedish krona-denominated issue
offers a coupon of 0.25% above the
yield of Swedish government bonds.
This is enough to justify the investment
In the equities market there is an abundance of investment
opportunities for those wanting exposure to sustainable and
environmentally friendly projects. To start with, there are the
clean-tech companies such as wind turbine manufacturers, fuel
cell makers or solar power developers but, alternatively,
investors can opt for indexes such as the Dow Jones
Sustainability Index, the OkoDAX or the FTSE4Good Index
series. However, until the World Banks green bonds there was
little in the fixed income market that was orientated towards
investors interested in green investment. The triple-A rating
and the fact that the World Bank is backed by 186 countries is
one of green bonds biggest selling points, particularly in the
current climate, writes Vanya Dragomanovich.
THE STEADY GLOW
OF GREEN BONDS
Photograph Davidarts /
November 2010.
37
into the bonds while at the same
time fulfilling the rising interest in
environmentally-friendly investment.
What has in the past put off investors
from investing directly into green or
environmental projects, particularly if
those were in emerging markets, was
the high credit risk associated with
financing, for instance, projects in Africa,
says Klas Eklund, a senior economic
adviser for SEB, who was involved in
creating the first green bonds for the
World Bank. Green bonds take that
element of risk away because the projects
have been thoroughly researched by the
World Bank: not only are they are a
known quantity but also the actual
investment is indirect and therefore
carries little risk for institutional investors.
The appeal for investors is that they
know exactly where and how the money
is being spent, they know which project
the World Bank will finance, and there
is transparency that you dont necessarily
have in similar cases that investors
finance directly, says Eklund.
One of the criticisms sustainable and
environmental investment has faced in
the past is that it provided slimmer
returns than comparable mainstream
investments. We naturally dont buy a
lot of green investments but in this case
we didnt have to give up returns for the
sake of green credentials. This was an
interesting investment partly from a yield
perspective and interesting as an
investment that will do some good in the
world, says Lars-Goran Orrevall, head
of asset allocation at Skandia Liv Asset
Management, the investment arm of the
Swedish part of insurance group Skandia.
A disadvantage of green bonds versus
regular bonds is that the secondary
market is fairly thin although it is slowly
getting better because of the sheer size
of the World Banks issuances and also
because other providers are coming on
board. The European Investment Bank
(EIB), also a triple-A borrower, issued
climate awareness bonds and linked their
return to the FTSE4Good Environmental
Leaders Europe 40 Index that consists
of large European companies with top
environmental practices.
Liquidity was one of our concerns
although we have not traded our green
bonds in the secondary market. Liquidity
is getting better, says AP2s Langeland.
Spreads are still fairly wide, certainly
wider than for respective government
bonds, which means that green bonds
are better as a long-term investment,
held until maturity. If you compare
green bonds with Swedish government
bonds, they have so far performed a
little better. However, transaction fees for
these bonds are higher than for
government bonds or even Swedish
mortgage bonds and we dont hold them
in our trading portfolio but rather in the
stable part of our portfolio, says Skandia
Livs Orrevall. My guess is that most
people are sitting on them as a long-
term investment because the extra yield
could be easily taken away if you try
and buy and sell them, he adds.
What does appeal to investors is the
exposure to a number of emerging
market currencies, that, again because
of the World Banks triple-A rating,
buffers out some of the risk involved in
investing in emerging market debt.
Nikko Asset Management issued two
funds in February based on the World
Banks green bonds and was
instrumental in initiating issuances in
11 of the 16 currencies, according to
Stuart Kinnersley, chief investment officer
at Nikko Asset Management in Europe.
The currencies on offer include the South
African rand, the Russian rouble, the
Brazilian real and the Turkish lira. The
two fundsone aimed at Japanese retail
investors and the other at institutions
in Europe and the Middle Eastuse a
composite benchmark with an emerging
markets and developed markets
component. The key aspect is that we
are getting exposure to emerging market
currencies but are not buying the debt of
those governments which have a much
lower credit rating. All of our portfolio will
be AAA, says Kinnersley.
Unlike in the developed markets,
when the World Bank issues in an
emerging market currency, it does so
with a lower yield then the respective
government because the banks credit
rating is so much higher.
Nikkos Kinnersley argues that in the
current climate in the debt markets it
is more appropriate for investors to have
a higher exposure to emerging markets
then developed world debt. The
sovereign debt crisis is really focusing
on the developed world. The fiscal
positions, the debt to GDP ratio, are
really a G7 problem. In contrast, many
of the emerging markets have a much
better fiscal position because they have
reformed their finances over the last ten
years, he adds.
Showing interest
This approach was clearly shared with
Japanese investors who were far more
enthusiastic about Nikkos funds than
institutions in Europe. Nikko AMs fund
aimed at Japanese retail investors has
$250m under management while the one
aimed at institutional investors in Europe
and the Middle East has $25m. However,
now that it has run for six months and
was up 13.5% in that period, which is
more than 1% higher than the benchmark,
more investors are showing interest,
Kinnersley added. The benchmark consists
of 50% of Citigroup World Government
Bond Index (WGBI) and 50% of the JP
Morgan Government Bond Index
Emerging Markets (GBI-EM).
We may be far from the spring but
with the sovereign debt crisis caused
by the Emerald Isles, green is definitely
the colour of the season. I
Stuart Kinnersley, chief investment officer at
Nikko Asset Management in Europe.The key
aspect is that we are getting exposure to
emerging market currencies but are not buying
the debt of those governments, he says.
Photograph kindly supplied by Nikko Asset
Management, November 2010.
38
I
N JUNE, FRENCH banking giant
Natixis completed the merger of its
equity teams to form a single equity
business line and rebuilt the division
from the ravages of the credit-crunch.
The move saw subsidiary Natixis
Securities transfer all of its activities to
Natixis, the parent company. The new
department, which handles all equity
cash products and derivatives, is headed
by Jean-Claude Petard, head of Equity
Markets at the bank.
For Petard, the merger of operations
has signalled the completion of one of
his key priorities when he joined Natixis
from rival Socit Gnrale in February
2009. He explains that the aim of the
reshuffling was not to reduce costs but
to meet changing market and client
needs. We wanted to group together
all the equity units at Natixis, including
the equity derivatives department and
the two cash brokers in New York and
Paris, which were previously acting as
independent and fully autonomous
firms. The thinking was to have one
person in charge of all equity matters
at investment banking board level and
developing an equity strategy,he says.
Most importantly, the objective was
to rebuild the equity division after the
market turmoil in 2008,he adds.
Natixis merged teams now deliver
an improved, wide-ranging and all-
inclusive solutions suite, including
primary market access, broking on
secondary cash and derivatives markets,
structured products and global equity
research and sales. We want to react
properly and immediately to any further
shocks and significant movements in
the market,says Petard. We want to
develop a new fully-integrated
commercial strategy servicing all our
European and US-based institutional
clients as well as retail banking in a one-
stop shop trading platform. The client
is provided with all the equity
investment instruments worldwide that
we can deliver, including emerging
markets, Asia and the US.
Petard says the new structure meets
the post-credit crunch constraints on
the market square on: Until very
recently all investment managers were
investing money outside the equity
market to varying degrees, but no one
was positive. It therefore became
increasingly important to provide asset
allocation tools in order to help clients
limit risk; hence the merger of our
activities. A new market trend is clearly
emerging, with a more flexible approach
to asset allocation within equities and
cross-assets. Clients want to be able to
switch swiftly between assets and enjoy
more diversified exposure.
The main focus is European equities,
based on the banks French foundations,
and its traditional firm hold, or grip
on the market. Petard describes it as a
cornerstoneof the banks new equity
strategy. The sales force has been
organised around cash and flow
derivatives such as straight cash,
convertible bonds, listed derivatives,
OTC derivatives and all forms of Delta
One products. Structured derivatives
resulting in more complex pay-offs
are also offered to institutional investors
or retail networks in a variety of
wrappers such as funds.
The benefit for clients is that they now
have one single account manager covering
their needs and requests. It is no longer
fragmented and as such we have a richer
dialogue,holds Petard. They also have
a new array of quantitative research
products available on our website which
were previously only developed for our
traders. They cover European sectors and
equity strategy.
Moreover, Petard claims that the new
products, such as market predictor and
asset allocation tools, are very technical
and mathematicaland are based on a
new methodology different from those
offered by its competitors.
Principle investments are another
service offering. It hinges on three main
unitsequity finance, flow derivatives
trading and correlation trading, with
baskets of single stocks, indexes and
multi currencies. Petard states: Its
another differentiating factor. There are
not many houses able to deliver a pay-
off based on the correlation of various
asset classes.
The success of the new strategy
depends on high equity trading volumes
and therefore lucrative commission
income. Volumes in France were in the
doldrums for most of the summer with
some increase seen in early autumn.
The market has remained sluggish in
2009 and 2010 with some strong
movements in the second quarter this
year,says Petard. Very recently we
have seen in the results of the main
banks that the movement away from
collecting equities has stopped and that
banks are collecting money again. We
have reached the bottom and are
probably in the middle of a shift of
money from fixed income or foreign
exchange and sovereign debt to equity.
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Jean-Claude Petard, head of Equity Markets at Natixis, stresses the new single business line, which
has resulted from the merger of its equity teams, to deliver a comprehensive and enhanced
range of solutions to its clients. The service set includes access to the primary equity market,
broking on secondary cash and derivative markets, structured products and global equity research
and sales. Jean-Claude Petard, who heads up the new department, says the new structure meets
the post credit-crunch constraints on the market. David Craik reports.
THE NEW STRONG SUIT
39
Yields are higher than those from
government bonds and that is very rare.
However, he cautions: It is a bit too
early and there is still too much
uncertainty in the market for us to see
massive movements of money from the
less risky assets to the most risky ones.
We are at the beginning of this new
movement and we dont anticipate any
brutal shift because of low inflation and
high unemployment and modest
economic forecasts in most countries.
There are also concerns over sovereign
risk from certain weakened European
economies. There has been a strong
improvement in investor sentiment but
it is still negative.
One of the key market pillars this
decade, namely hedge funds, has also
suffered in recent times. Between 1998
and 2008 we lived with an easy way of
reading the market because hedge funds
were the leading industry in flows and
execution. They were the price leaders
for all equities and many asset classes,
Petard explains. Today the hedge fund
industry is recovering. It is re-
establishing itself but it does not
dominate the market as it did before.
There has also been strong divestment
from another key playerinsurance
companies. According to Petard, that
movement has now stopped and he
predicts they will soon return to the
equity market. They cant stay outside
because of the expected performances
of equities,he says. They will have to
come back in a form which meets
regulatory constraints but I am expecting
them to raise funds and we will see a
period of net investment from now on.
With regard to commission incomes,
Petard says they have been falling
slowly every yearfor 15 years; a trend
that continued through 2010. He states:
I dont think it is reversible. The cash
offer is the cornerstone but it has been
unbundled. Because of this, Petard
adds, there is an increased requirement
to improve trading efficiency and
deliver more value added products
such as Delta One to enhance the
efficiency of execution for our clients
and for ourselves.
Yet is the trend in fees really
irreversible? Unless there is massive
merger and acquisitions activity between
all the major investment banks and there
is a cartel forcing up commission fees,
then no, it wont reverse,answers a
frank Petard. It is a fragmented and
very competitive market. There is no
leader who can establish an increase in
fees. The clients themselves are very
fragmented despite the mergers and
acquisitions activity we have seen
recently. I dont envisage a movement
that would push an increase in fees.
Inevitably, competitive pressures are
also at the forefront of Petards thinking.
The French banking sector is indeed
compact and highly competitive. Even
so, Petard suggests that French banks
have also proved more inured to the
recession than other global banks,
especially in those in the United States.
Moreover, he holds that the French
banking sector has been further
strengthened as it has been assiduous
in repaying any and all state payouts.
Equally, Petard is adamant that
Natixis new equity strategy is
successfully differentiating itself from
its peers. We have a fully integrated
chain of skills geared to our clients,
Petard declares. We have a world-
renowned range of equity research. Our
new strategy is proving effective and
working quite well. In the second quarter
of 2010 we proved our ability to trade
and manage our portfolios when we
were probably the only bank on this
planet not to lose money. We have
shown our resilience.
So what lessons has he learned from
the last two years? Equities are the
most liquid asset, whatever happens.
There is always an ability to move the
books when properly managed and
organised,he says. No bank withdrew
from the equity market despite suffering
some massive losses and there were
even newcomers to the market such as
Barclays Capital. We also learned to
service not only niches [sic]. Every asset
class is important.
As for the future, he says: We have
to adjust to [the] new regulatory
hurdles. This will diminish principle
trading activities and that in turn
diminishes liquidity in the market if it
is not replaced by something else.
Nevertheless, we are seeing most of
the industry recovering. The fear of a
double-dip in equities is behind us now
and market valuations are becoming
strongly attractive. We will keep
growing on a healthy basis.I
Jean-Claude Petard, head of Equity Markets at Natixis. Photograph kindly supplied by Natixis,
November 2010. Fabrice Vallon
40
F
TSE GM: What are the salient
differences, if any, in approaches
to trading and, in particular,
utilisation of dark pools between the
US and Europe?
Owain Self: Many of the differences
are a function of differences in market
structure. Alternative liquidity regulations
differ slightly, which has an impact on
how you access alternative venues in
trading strategies. The existence of a
National Best Bid and Offer (NBBO) in
the US makes the process of price
discovery easier and more efficient. The
composition of order flow in the two
marketplaces varies a bit, as well, which
affects how and when you interact with
specific kinds of venues.
As part of the execution process, we
interact with non-displayed liquidity in
a variety of ways. Our sales traders,
traders and systems will source liquidity
to achieve the execution objectives of
the client. Clients will control their access
to non-displayed liquidity predominantly
via their direct use of our algorithms.
This includes access to external venues
as well as internal liquidity, or system
internalisers, such as our own UBS PIN.
Algorithms have come a long way
from the fixed schedule, rigid structures
of the past. They are now fully dynamic
systems, using complex mathematical
models to drive both macro level
decisions of speed and urgency and
micro level order placement. The
sophistication of these models will
continue to adapt and evolve based on
client demand and market structure
change. To some degree technology will
continue to play its part, as calculations
or optimisationswhich were too slow
to be useful in the pastcan now be
performed quickly enough to be
incorporated into the decision process.
FTSE GM: Dark pool trading is now
part of the mainstream: but how
much of dark trading is truly dark?
Owain Self: Dark is not as dark as it
used to be, because in part almost
everyone is connected to almost
everything and many of the industrys
liquidity-seeking algorithms utilise
similar logic and triggers. An execution
in a non-displayed venue demonstrates
an immediacy of market impact now
that was not previously the case. This
is particularly true in the US, given the
existence of a consolidated tape.
Also, the changing nature of dark
liquidityand the preponderance of
short-term liquidity in the current
marketplacemeans that you are, by
definition, interacting with more non-
natural flow. This has a significant
impact on cross rates, particularly
crossing against quality liquidity. If your
cross rates are not being impacted, you
need to question the nature of that
flow youre interacting with and how
intelligently your broker strategy is
interacting with all types of venues and
order flow. Its important to be aware of
the trade-offs youre making between
cross rates, urgency and information
leakage/price impact protectionsand
choose them consciously.
FTSE GM: There seem to be three
main types of dark venues: dark orders
in lit pools, e.g. exchange icebergs;
public or semi-public dark pools such
as Liquidnet; and broker dark pools.
Are there other types evolving?
Owain Self: Its important to
remember that dark is not a virtue unto
itself. But when accessed well, with the
right goals in mind, it can greatly
enhance execution.
There are several ways to access non-
displayed liquidity: The first is through
a brokers internalisation processvia
internal networks of dark liquidity that
exist as a result of our best execution
requirements. A broker has an obligation
to give their diverse clients the
opportunity to achieve the best possible
execution, which means if there is an
opportunity to execute a cross between
two matching orders before they hit the
market; the broker has a responsibility
to make that happen.
The second way is through an ATS
or MTF that operates a fully dark order
book. Based on which type of dark
pool with which youre interacting, the
venues regulatory environment/rules
and the individual business model that
pool operates, a good algorithmic
trading strategy will behave slightly
differently. For example, given the
differences in models within the US
ATS marketplace, our algorithms use
an order management logic that is
influenced at the venue level by their
participant base, the order types they
support and the ways in which crosses
can happen. In EMEA, an MTF is
required to be open to all participants
who meet eligibility requirements, so
our algorithms are more likely to treat
MTFs as if they are somewhat closer
to lit markets.
Finally, one can access dark liquidity
by utilising dark or hidden order types
in grey pools or on lit exchanges. We
tend to judiciously use these venues
and order types based on the clients
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Owain Self, managing director and global head of algorithmic
trading at UBS, explains his views on dark pools, the differences
in trading behaviour between the US and Europe, algorithms,
best execution, technology and, particularly, transparency, of
which he is a champion.
CUSTOMER CHOICE IN THE
DRIVE FOR BEST EXECUTION
41
urgency levels and sensitivity to
information leakage.
FTSE GM: You have been an advocate
of transparency leading ultimately to
best execution: encouraging clients to
understand the full chain of decision
making in order flow, and of
understanding who is on the other
side of a trade. Could you kindly
elucidate your thinking in this regard
with regard to dark pools?
Owain Self: When a client order
matches with a corresponding order in
a non-displayed venue, information
related to that order is thereby provided
to the counterparty and to the
marketplace at the time of execution.
This exchange of information in
consideration of an execution is generally
an acceptable trade from the standpoint
of seeking the orders best execution.
In the US, all equity trades, including
non-displayed, are already required by
regulation to be immediately reported to
the tape. UBS agrees with this important
rule and believes that the transparency
afforded by this requirement is an essential
part of an orderly marketplace. Real-time
trade execution reporting serves an
important price discovery function
allowing the market to gauge relative
actionable demand.
Transparency undoubtedly serves a
vital role in the financial markets, and
the bank is an active proponent of
meaningful transparency at all stages
of the trade cycle. The quest for
transparency, however, must be
balanced with protection from the risks
of gaming.
A functional definition of transparency
as it relates to the markets might be
clarity and fair availability of
information. These should be basic
tenets in non-displayed as well as
displayed venues. Clarity means that
information provided to a participant
must be explicit, factual and unambiguous.
It should be free from pretence or deceit,
and easily understood. No participant
should be misled or misinformed, either
by design or by omission of data.
Information should be delivered in a way
that is consistent. Fair availability means
that no participant should suffer singular
discrimination or arbitrary exclusion from
information. The availability of information
should conform to established rules.
When combined with effective
surveillance, another aspect of
transparency that provides regulatory
agencies with the information they
require to monitor participants rule
compliance will assist the marketplace
in maintaining a level playing field.
Its important to try to strike the right
balance. A 100% pre-trade transparency
rule will drive orders back to the clients
desktops, and decrease overall liquidity
in the market.
As brokers or investors, we are
constantly changing our techniques to
find the best balance between dark and
lit interactions to achieve best execution.
The market structure needs to protect
the less sophisticated investor, but at
the same time allow for natural market
forces to drive positive change. Time
should be spent understanding the cause
of investor appetite for this functionality,
as well as on managing the market place
effect of this demand.
FTSE GM: How does the sell side
help in achieving best execution in an
increasingly complex landscape?
Owain Self: From investment strategy
creation to trading execution, the unique
and ingenious variations and tactics
investors apply all have a meaningful
impact on their ability to seek profit
opportunities. A broker must be a
proactive ally to the investor in that
process, delivering opportunities for
competitive advantage via technological
infrastructure, access to liquidity, and
astutely innovative order execution
capabilities. A basic premise of the
brokers role is to serve the buy side
investing public and deliver best
execution. Thus, it is our obligation to
provide opportunities for reduced price
impact, price improvement, and reduced
trading costs, while additionally
protecting our clients confidentiality.
As we talk with and serve our clients
on a daily basis, we hear consistent
themes from the buy side regarding the
issues that are important to them,
including a variety of choices in non-
displayed liquidity venues, ability to
protect themselves from information
leakage, access to quality internal
crossing opportunities, and high
speed/low latency market access.
On the client front, we see a demand
for a simpler order interface and strategic
decision processes. Our clients tell us that
they want to reduce the need for
unnecessary keystrokesthey want their
decision process to be simpler or more
intuitive, and they want their workflow to
be streamlined as much as possible. I
Owain Self, managing director and global
head of algorithmic trading at UBS. Its
important to remember that dark is not a
virtue unto itself. But when accessed well, with
the right goals in mind, it can greatly enhance
execution, he says. Photograph kindly
supplied by UBS, November 2010.
42
W
HILE ISLAMIC FINANCE
sets a blistering pace of
growth, Kuwait Finance
House (KFH) reckons that it is worth
investing a dollar or two to secure its
international footprint, and the bank
has data to back up its claims. A report
released in September by the bank holds
that the Islamic banking industry
accounts for 35% of total banking assets
in Kuwait and just over 16.6% of banking
assets in the Gulf Cooperation Council
(GCC) countries (as of the end of March
this year). Moreover, the report says,
depending on market factors such as
supporting regulation, economic growth
rates and continued demand, the Islamic
financing industry as a whole should
grow between 15% and 20% a year for
the foreseeable future.
It is food for thought,acknowledges
Mohammed Al Omar, KFHs chief
executive officer. It is clear that Islamic
finance is a growing business segment
and we are set fair to be at the heart of
this growth. The report clearly indicates
that Kuwait ranks first among the GCC
countries in terms of Islamic banks assets
to total banking assets and that there
are many opportunities still available for
Islamic finance solutions in the region.
It is also a call to arms for a region
which has of late been eclipsed
somewhat by south-east Asia in terms
of Islamic finance origination; a trend
which KFH itself has also leveraged this
year through its Kuala Lumpur
operation, having structured and listed
a $100m Ijara (a type of leasing vehicle)
on Bursa Malaysia on behalf of Nomura.
The deal marked the first US dollar-
denominated sukuk for a Japanese
multinational corporation issued out of
Malaysia. The GCCs Islamic banks are
at the heart of the Islamic banking
industry, with some of the worlds largest
Islamic banks originating from the
region, including Kuwait Finance House;
and this is expected to trend higher on
the back of increased demand for Islamic
banking products and services in the
region,avers Al Omar. The local KFH
unit has the parent companys solid
back-up and potential investments in
Malaysia and the Asia-Pacific region are
high on KFHs radar screens, notes Al
Omar, adding: There are some more
issues in the pipeline and we will be
working with our subsidiary banks on
more sukuk issuances.
Fuelling demand
To meet the growing needs of Sharia-
compliant financing in the region, most
conventional banks have either opened
a new subsidiary or introduced an
Islamic window within their existing
infrastructure. A few banks, such as
Saudi Bank in Bahrain and Dubai Bank,
have also converted themselves into
Islamic banks. In terms of financing,
opportunities for Islamic banks in the
GCC include residential mortgages,
underpinned by a high level and still
rising demand for home mortgages
within the local market. Moreover, the
regions high GDP per capita, coupled
with a relatively young population
profile, will continue to support
consumer spending and investment, in
turn fuelling demand for Islamic
financial products and services.
The real estate segment is a key selling
point for the bank. Its international real
estate portfolio is now worth some $1.5bn
and, according to Al Omar, has not been
impacted by the recent financial crisis.
He says KFH is currently considering
numerous markets that have rewarding
revenues, especially in North America,
East Asia, and the Gulfand explains that
the banks approach to investment in the
segment involves consistently observing
markets and foreshadowing their future
limits, particularly investment risks. He
adds that KFHs current investments are
focused in Malaysia, Saudi Arabia,
Canada, America and China, since those
markets enjoy governmental support,
which attracts foreign investors.
FACE TO FACE
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Kuwait Finance House (KFH), the second largest Islamic bank, has
been expanding aggressively over the past few years, purchasing
stakes in companies domestically and abroad. The bank has also
led a slew of benchmark Islamic issues through the year. KFHs
chief executive officer Mohammed Al Omar talked to Francesca
Carnevale about the banks 2010-2011 business strategy.
HARNESSING A
RISING TREND
43
The bank has been expanding its
financing reach in the wider region for
some time, marked by a succession of
benchmark sukuk issuance. In Turkey,
via the banks Liquidity Management
House subsidiary, and working with Citi,
KFH-Turkey arranged a $100m sukuk
(rated BBB- by Fitch), one of the few
substantive sukuk deals to have come
to market in the country. KFH-Turkey
is developing at a dramatic pace and the
market is ripe for new financing tools
and product, especially now that major
corporations in the country are
expanding at home and abroad,explains
Al Omar. The three-year sukuk involved
the participation of some 19 banks and
financial institutions from the Middle
East, Gulf region, Europe and Asia, and
we hope to list the sukuk on the London
Stock Exchange.
Al Omar says the banks international
operations are spearheading the growing
utilisation of Sharia compliant
instruments. Turkey is a particularly ripe
market, holds Al Omar, citing the recent
listing of the first gold Sharia compliant
investment fund on the Istanbul Stock
Exchange. Specifically for KFH, the Ijara
or leasing segment has been particularly
opportune. In May this year the bank
signed a deal with Turkish Airlines to
lease three Airbus A320-200 aircraft for
seven years, where Alafco will finance
the purchase and lease of the aircraft,
in addition to managing the deal on
behalf of KFH.
The bank now has around $5bn worth
of assets in Turkey, which has lately
become a key target market in terms of
generating international business. The
same, explains Al Omar, can be said of
Malaysia, though he points out that he
has high hopes for recently established
entities in Dubai, Bahrain, Kazakhstan
and Germany. While the Sharia
compliant corporate financing has been
a strong point in Malaysia, the bank has
been equally assiduous in encouraging
retail business, including the opening
of three currency exchange operations
in key transportation hubs in the
country. The banks financial coverage
was reinforced after its capital was
increased,explains Al Omar, in order
to meet the growth in its operations
and demand for its services, particularly
that the bank is interested in medium
and long-term investments with high
revenues in the wider region.
With local business growth in mind,
KFH has recently embarked on a set of
local initiatives, ranging from upgrading
staff training, the launch of innovative
retail products and services and the
establishment of a common technology
platform which links all KFH systems
that meets all of KFHs expansion and
business diversification requirements as
well as upgrading data security through
the bank. Al Omar esplains: It is an
inevitable consequence of growing and
fierce competition in the field of Islamic
banking coupled with our desire to offer
best in class service.
As with many emerging market
institutions, the national interest figures
heavily in new business calculations. In
this regard, with its status as a semi-
private institution, the bank is well placed
to build business in the Kuwaiti market
thinks Al Omar, on the basis that, the
governmental initiative of increasing
public expenditure according to an
economic plan that includes major
initiatives, and in allowing the private
sector to participate in it, eliminated the
obstacles and legislations that hinder
the role of the private sector and limit
investment opportunities in the country.
Concerted efforts
Even so, the bank is mindful of its balance
sheet. In spite of some obvious success
in the Islamic capital markets the bank
has enjoyed through 2010, the going has
been challenging, he concedes. It was
only in July that the banks positive A-
/A-2 rating was affirmed by ratings agency
Standard & Poors, and KFH was removed
from the agencys credit watch. In part, the
rating was earned by the banks concerted
efforts to turnaround underlying business;
in part the rating was leveraged by KFHs
status as a Kuwaiti government-owned
entity and the robustness of the bank in
securing liquidity and arranging financing
for its clients.
Al Omar points to the current trend
of positive results. The bank reported
gross profit for the first half of
KWD172.8m ($617m), which includes
net profit payments to shareholders of
KWD80.7m. Assets were up 11% to
KWD12bn, while deposits rose 7% to
KWD7.3bn compared with the same
period in 2009. Al Omar cedes: By
securing the rating, it creates further
motivation. KFH attaches great
importance at this stage to quality and
achievement through governance and
maximum utilisation of the opportunities
extant both in the market and within the
bank itself. We encourage the highest
degree of professionalism while adopting
the highest standards of risk management
and well-advised practices.I
Mohammed Al Omar, KFHs chief executive
officer. It is clear that Islamic finance is a
growing business segment and we are set fair
to be at the heart of this growth, he says.
Photograph kindly supplied by Kuwait
Finance House, November 2010.
44
COMMODITIES
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ANKS AND COMMODITY
trading houses have been long-
standing investors in paper
commodities, but it is against this
backdrop that they, along with energy
and utility companies, are starting to
turn to physical commodities such as
coal, oil, freight and liquid natural gas
(LNG) as a lucrative opportunity to
diversify their portfolios.
However, this is a highly volatile
market. Of course this volatility could put
early movers who call the market correctly
in line for some stellar returns. Yet at the
same time, recent high-profile corporate
failures have illustrated all too well
the perils of falling foul of a volatile
market, driving a fresh emphasis on
risk management as a core part of
organisational strategy for all firms trading
in the energy commodity markets.
Inadequate systems
In many ways, the fundamentals of
trading in physical commodities are
similar to those of their financial
counterparts, but there are some
significant differences when it comes
to the degree of complexity.
Indeed, the very fact of physical delivery
creates a whole new set of implications
and challenges, especially given the fact
that physical supply-chain management
brings with it complex optimisation
problems, which have not always been
fully understood in the financial world.
The institutions considering testing the
waters in the physical commodities
market are therefore beginning to realise
that there is a significant gap both in their
systems and expertise. This leaves them
managing diversified portfolios with one
hand tied behind their back.
Traditionally, many organisations have
relied heavily on resource-intensive,
paper-based processes to manage their
critical information flows on physical
commodities. When combined with a
barrage of systems, these error-prone
processes often led to requests arriving
in disparate formats, with the resulting
action involving multiple steps across
different departments.
Better visibility
The complexities of trading physical
commodities make it more important
than ever that companies have full
visibility and integration throughout the
supply lifecycle. That visibility into key
business processes across the front,
middle and back offices depends on
access to accurate and real-time views
of each stage of the physical commodities
process from demand analysis to delivery
of the commodity.
Take the case of oil. Purchasing the
oil itself is just the start of the story.
Quality and quantity issues can have a
knock-on impact on the invoicing
process. For example, if a lower quality
of oil to that originally requested is
delivered to the end buyer, the value of
the oil will be lower than expected,
leading to a discrepancy in the invoicing
system. This lower value must be
accurately tracked through the system
and reflected in the final invoice.
In another instance, by the time the
cargo is delivered to its disportor final
destinationit could have suffered a
serious leakage. This lower quantity would
also need to be recorded and accounted
for at the end of the invoicing process.
The valuation of floating stock is another
The global commodity markets are undergoing a period of unprecedented change, with some
bumper times in recent years fuelled by buoyant demand for raw materials from a rapidly
industrialising China. This sustained rise in prices is sparking the interest of bullish investors
seeking to sidestep the diminishing margins and falling returns of some other asset classes.
However, the unique challenges of trading physical commodities place new demands on existing
systems and expertise. Stuart Cook and Richard Philcox of Baringa Partners identify the
difficulties and explore the possible approaches.
THE PHYSICAL CHALLENGE
Photograph Jesse-lee Lang /
November 2010.
45
important factor. The difficulty arises when
a cargo of oil is midway between its load
port and disport markets: even if its
destination is known, that destination
can change. The company must take a
decision on whether to establish the value
based on the load or the disport market,
and more importantly, it needs to apply
this decision consistently. There can be
significant liquidity risks present through
transporting cargoes in this way, especially
if there is an inability to hedge, or the
lack of awareness of the opportunity to
do so. This amounts to noteworthy
stranded cargo risk.
Tax is another complicated issue
that must be addressed by a robust
commodities trading and risk
management (CTRM) system. The VAT
paid on a physical commodity changes
according to the jurisdiction to which it
is routed, so extra tax advice will be
needed or a tax-rules engine that can
apply the right rates of VAT depending
on location. Companies also need to
consider the implications for the balance
sheet of holding physical commodities.
However, to do so can be beneficial as
physical stock held can be used as
collateral against trading positions.
Complex trading process
The raft of fees involved in the delivery
process also needs to be efficiently
handled by the energy trading and risk
management (ETRM) system. These are
the non-commodity costs that are
incurred during the process of moving
cargoes between locations, including
port authority fees, insurance and
stevedore fees. Nor can the freight
implications of delivering physical
commodities be ignored, with multiple
considerationsranging from the choice
between time and voyage chartering to
securing bunker fuelwhich need to
be rigorously tracked and recorded.
Contracts are a critical consideration,
with many organisations now looking
to manage structured contract portfolios
in a consistent manner. Unlike paper
commodities, the structured contracts
themselves must be physically delivered
and settled and require daily contract
management to deal with nominations
and deliveries via a system that can
manage different trading horizons.
Contracts can also carry force majeure
clauses which bring with them an
element of operational risk, the most
extreme of which would be failure to
deliver physical stock.
In addition, the high number of non-
standard contracts in physical
commoditiesin part to manage these
complexitiesleads to extended lead
times of months or even years for legal
departments, delays which can obviously
have a knock-on effect on liquidity. In
the LNG market at least, things look
set to change following the LNG DES
Master Sale and Purchase Agreement
for spot transactions from the European
Federation of Energy Traders (EFET).
Industry insiders believe that more
standardised contracts should open up
the LNG market to new players and
facilitate back-to-back trading.
Flexible ETRM system
There is no one-size-fits-all approach
to handling physical commodities within
an ETRM system. Companies have a
variety of options based on their
particular strategy and the extent of their
intended involvement in the market.
For organisations that are making
their first, tentative foray into the market,
integrating physical commodities into
their existing infrastructure may
represent a more cost-effective short-
term option than investing heavily in a
new system. For more active players in
the market, on the other hand, a new
system architecture can often represent
the best way to manage the increasing
operational complexity that comes with
higher trade volumes.
Organisations at this stage of the
development may find that a single CTRM
platform represents an effective way to
handle the complexities of physical
commodities. However, some traditional
platforms are still relatively weak in this
area and so companies looking to dive
deeper into physical commodities might
prefer to take a new system designed to
handle physical commodities. Of course,
if that option is chosen it must be able
to function alongside other systems, with
the ability to be seamlessly integrated
into the organisations enterprise-wide
trading system for consolidated reporting.
Frontline knowledge
The choice of platform is not the only
consideration when it comes to dealing
in physical commodities. This is a specialist
area that requires specialist knowledge.
People working within the operations
area have a different perspective on the
market. As the heaviest users of the
system, their frontline experience of the
day-to-day minutiae gives them access
to valuable knowledge.
Organisations are increasingly seeking
to enhance performance and guarantee
compliance by establishing a coherent
overview of their trading activities. A
far more sophisticated approach to
value-chain optimisation is now the
order of the day, with assets treated as
elements in a single diverse portfolio,
rather than separate asset silos. Above
all, todays portfolio requires integrated
thinking to close the gap between
optimisation and risk management.
With investors of all types engaged
in the relentless pursuit of profit
opportunities, many will rush to ride
the wave in physical commodities. In a
market epitomised by its complexity,
the successful among them will be as
serious about investing in their trading
systems as they are about investing in
physical commodities. I
For organisations that are making their first, tentative foray
into the market, integrating physical commodities into their
existing infrastructure may represent a more
cost-effective short-term option than investing
heavily in a new system.
A
LTHOUGH NOT ONE of the worlds prominent
sovereign wealth funds (SWF) the QIA, which is
reputed to be worth between $85bn and $100bn, has
more than most become a bellwether for change in SWF
investment approaches. It has been some time since the
balance of power between SWF investors and recipient
markets has changed. The financial brouhaha of 2007-2009
pretty much saw to that. The consequences have been
manifold. Among them, investments, once discrete have
become much bigger; prestige investments are no longer
the norm; but instead are mixed with long term strategic
intent and to smooth out inherent volatility as much as
possible. That also means that outright ownership is no
longer a fundamental requirement and instead strategic
stakes are most appropriate.
Regarding investment in real estate, there is a notable shift
from direct acquisition to indirect investment, either via property
equities or through real estate funds. Equally, incipient changes
in the east-west balance of power increasingly encourage a
more diversified approach to emerging markets investment.
In the case of smaller or more discrete funds, such as the QIA,
it enables them to spread risk and not have the inconvenience
of direct costs (through the establishment of local offices and/or
management for example). Historically, London and Paris have
been important investment centres for Qatar, with substantial
investments in real estate, particularly hotels; however in
common with other Middle Eastern SWFs the QIA has spotted
that Asia offers the new main chance. To this end, the QIA
was reported as far back as 2007 to have plans to increase its
Asian investments to 40% of its overall portfolio over the
following decade. QIA this year signed a $5bn preliminary
agreement with Malaysia to invest $5bn in real estate and
energy, as well as a $1bn joint venture with Indonesia focusing
on sectors including natural resources and infrastructure.
Moreover, the QIA put as much as $2.8bn into the initial public
offering by Agricultural Bank of China mid-year when the
banking giant came to market with its long awaited IPO.
In common with other SWFs in largely mono economies,
the QIA is using its investments in real estate, infrastructure,
agriculture and consumer and high end retail entities to help
build capacity in their its home market. In this respect, SWFs
differ markedly from other asset gatherers in that there is a
distinctly political component to proceedings; though on a
day to day basis, the SWF tends to work on a similar basis to
a long term private equity fund. In this regard and as part of
a financial diplomacy drive, Qatar has formed joint investment
links with countries such as Malaysia and is in the process
of establishing comprehensive links with Indonesia and
Greece. Most recently, the QIA reconfirmed its commitment
to invest up to $5bn in Greece, a move announced in an
official statement issued after the meeting of Qatar-Greece Joint
Committee held in Athens earlier this year.
Finally, smaller SWFs are learning that they can walk further
in company than alone. In QIAs case it has a long standing
investment fund (worth in excess of $2bn) together with the
Abu Dhabi sovereign fund. It also has joint venture funds
with Dubai Holding.
Most significant perhaps, as a sign of growing maturity,
the QIA is happily mixing investments in which it holds
either 100% or the majority of the shareholding into a multi-
faceted portfolio which contains investments that are
essentially minority stakes. In September 2007, for instance,
it reckoned on a 20% stake in Chelsfield, to which it added
a 600m stake in the decommissioned Chelsea Barracks, a
14.5% stake in Canary Wharf and a 20% interest in the Shard
of Glass trophy property near London Bridge; a mix of long
term, real estate and one-off opportunistic investments.
The QIA really came into its own in the difficult period of 2007-
2009, when it took strategic stakes in both Barclays and Credit
Suisse providing them with much needed capital and in return
securing their services as regular arrangers and advisors for
most of the SWFs subsequent investments and asset purchases.
Headed by Sheikh Hamad bin Jassim al-Thani, the dealmaker
and prime minister, and spiralling down through a new cadre
of foreign bankers and a small pool of home-grown talent has
subsequently added to its list of high profile investments. Last
year, it ploughed $10bn into Volkswagen and Porsche and there
has also been time to pick up Harrods as a trophy asset.
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Stakes in Santander, Agricultural Bank of China,
J Sainsbury, Harrods, Fairmont Raffles, Credit
Suisse and Barclays and the recent launch of a
$5bn commodities and real estate focused fund
in conjunction with the Malaysian government,
clearly illustrate the Qatar Investment
Authoritys (QIA) dual pillar investment strategy:
high profile stakes in western companies,
accompanied by a fast growing and highly
diversified portfolio in emerging markets. What
now for the sovereign fund?
SHEIKH HAMAD BIN JASSIM AL-THANI
G
QIA
A HIGH STAKES GLOBAL STRATEGY
Qatar's First Deputy Premier and Foreign Minister Sheikh Hamad bin
Jassem bin Jabor Al Thani, answers a question from media during a
news conference with Iranian Foreign Minister Manouchehr Mottaki in
Tehran, Iran. Photograph by AP Photo/Hasan Sarbakhshian, supplied
by Press Association Images, November 2010.
As Qatars gas exports have increased, the government
has also been able to borrow cheaply to underpin its SWFs
investment strategy. Some 70% to 75% of the SWFs funds
are siphoned off into Qatar Holding, with the remainder
destined for global fund managers reporting to QIA. Qatar
Holding is the direct investment arm, run by Ahmed al-
Sayed, which tends to buy strategic stakes in banks and other
high end companies. Remaining funds are either allocated
to third party asset management firms, or allocated to specific
funds, such as the fund. Other active funds in which the QIA
has invested includes Hong Kong-based Primus Pacific
Partners, which invests in financial services companies in
the Asia-Pacific region.
The QIA has extensive expertise in real estate. It has also
established a separate operation to manage real estate
investments: Qatari Diar Real Estate and the Qatari Diar Real
Estate Investment Company and Barwa Real Estate Investment
Company, which is listed on the Doha Securities Market.
Going forward, the emerging markets remain a strong
focus for the SWF. Its recent $2.7bn investment in Santander
Brazil is further proof of its commitment to leveraging high
growth markets. Increasingly, as well, expect to see a
distinctly political sub-text to investments: a natural
evolution of the growing links between the emirate and
the Far East and other buyers of Qatari carbon exports.
The Santander deal comes in the wake of a January trip
by the emir to South America, for example. As the QIA
itself concedes, the SWF: is always ready to partner with
experienced and respected partners where they can add
value in any particular market.I
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CHIEF EXECUTIVE OF CHI-X GLOBAL
A
SK MARAT: LEADERS of revolutions dont always
survive to see the fruits of their labour. Will Chi-X
Global? Change has been brewing for some time.
In September John Lowrey, its chief executive was moved
over to technology company Market Prizm, the infrastructure
service arm of Chi-Tech and which is now also up for sale,
and was replaced by Tal Cohen, who used to head up the
firms Canadian operations. The surprise move comes as
Chi-X Global has been expanding rapidly in Asia, led by
Lowrey. By November, Chi-East, the independent pan-
Asian trading platform, in which Chi-X Global has a joint
venture stake in partnership with the Singapore Exchange
(SGX), announced that it has commenced operations to
support the non-displayed trading of Asian securities to
complement the regions increasingly dynamic trading
environment. Chi-East also represents a number of firsts:
including the introduction of the first Central Counterparty
Clearing (CCP) model for selected securities in Asia, as well
as the first pan-Asian liquidity aggregator focusing on
brokers and high frequency clients.
However, unlike Chi-X, Chi-X Global has been burning
through cash, with questions over how far it can expand
on still limited revenue streams. Chi-X Global operates
Chi-X Canada which competes against the Toronto Stock
Exchange and which has an approximate 10% market share
Chi-X Japan and Chi-Tech. With Chi-X Canada and Chi-
X Japan continuing to build momentum, the launches of
Chi-East and Chi-X Australia and rollout of new initiatives
such as Chi-FX, this is obviously an important time for our
business,explains Tal Cohen, chief executive of Chi-X
Global. Aside from expansion into Japan and Australia, it has
agreed a joint venture pan-Asian dark pool with the
Singapore Stock Exchange.
In Latin America, the firm has made its presence felt
through Chi-FX Brazil, which will develop FX trading platform,
allowing foreign investors to enter orders with limit prices
in their base currency and facilitate the simultaneous paired
execution of the equity and forex legs of the transaction,
thereby mitigating intraday FX risk. Chi-X Global will develop
and help support the platform, and BVMF will market the
service to its participants and provide facilities, expertise
and front line customer support.
Chi-X Global is a subsidiary of electronic trading pioneer
Instinet Incorporated, a wholly-owned subsidiary of Nomura
Holdings, Inc. It is possible that the sale of Chi-X Global
could follow the same ownership model as Chi-X Europe.
Instinet for the time being holds a 34% stake in Chi-X
Europe, but the pan-European MTF has been the subject
of a potential bid, widely believed to be US-based exchange
operator BATS Global Markets. Other shareholders in Chi-
X Europe include BNP Paribas, Citadel, Citigroup, Credit
Suisse, Goldman Sachs, Bank of America Merrill Lynch,
Morgan Stanley, and UBS. I
If any one brand name has struck fear into the hearts of monopoly exchanges it is Chi-X. The
brand has been a harbinger of market change, ultimate fragmentation and a new focus on
technology and cost efficiency. In Europe, for instance, Chi-X dominated the discussion around
market fragmentation even before MiFID came into being. Chi-X Global, part of the same group,
but an entirely different entity, has rolled out more of the same across a large swathe of markets;
a herald of further market diversity, choice and cost efficiency. It has come at a price for both.
How much longer can the moniker ring the changes?
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T
HE FIRST RMB200m 3% notes (due September 2013)
generated good investor interest for its high credit
quality, name recognition and rarity value. Following
on the banks introduction of RMB-denominated structured
investments, we were pleased to bring to market a RMB
bond offering by a globally-recognised household name,
says Neil Daswani, Standard Chartereds managing director,
transaction banking, North Asia. This transaction reinforces
Hong Kongs status as an RMB offshore centre. Right now it
is still at an early stage, but the currency is gaining ground as
a store of value and wealth in Hong Kong.Already one of
the three leading players in RMB trade settlement and offshore
RMB bond trading services (the others being Citi and HSBC),
Standard Chartered is taking a proactive role in increasing
utilisation of the RMB as a regional currency for investment,
trade and reserves.
The banks prominence in RMB cross-border trade settlement
has been more than a year in coming. In a pilot programme
launched in July 2009, Standard Chartered Bank Hong Kong
was the first foreign bank to complete a two-way trade settlement
with China. One month later, Standard Chartered Bank China
was the first foreign bank to be appointed the agent and
settlement bank for RMB cross border settlement. The scheme
has been expanded to Macau, then ASEAN and is now fully
global. Internally the scheme began with five pilot cities and has
now been expanded to 20 provinces,notes Daswani.
The numbers may be small, but the renminbi is quietly
taking more bold steps in its gradual journey towards
internationalisation in bonds, forex trading, and in trade
loans. Standard Chartereds bond deal was the first concrete
offshore renminbi transaction, following a separate
announcement by the Industrial and Commercial Bank of
China in early August that it was ready to sign an RMB50m
line of credit with an Indonesian buyer. Standard Chartered,
maintains Daswani, remains one of the first international
banks to offer cross-border renminbi trade settlement. The
bank began a mission to broaden usage of remnimbi
transactions early in the year, as it organised a roadshow,
together with officials from the Shanghai Municipal Office
of Finance Service, Peoples Bank of China (PBOC) and State
Administration of Foreign Exchange (SAFE) Shanghai in
Malaysia, Thailand, and Singapore; the first partnering of
officials from government and regulatory bodies in China
and an international bank on a roadshow.
Building on the momentum, explains Daswani, the bank
has also been working to expand the reach of RMB trade
settlement to other regions outside ASEAN such as the
Middle East, India, the United Kingdom and Germany, North
America and in selected African countries, such as Zambia.
The growing number of nostros set up by banks from these
markets is indicative of the underlying demand for RMB
trade settlement, enabling banks such as Standard Chartered
to engage effectively with the Chinese government to expand
a scheme initially restricted to ASEAN members.
With the gradual relaxation of regulations for RMB trade
settlement, this presents increasing opportunities for traders
in China and ASEAN to grow their existing businesses
outside of Asia. We are very excited about its growth potential.
Our systems are ready and with our extensive footprint
across Asia, Africa and Middle East, we look forward to
playing a key role in further expanding the scope for RMB
trade settlement,says Daswani.
Redenomination has huge implications. Around $2.2bn
worth of trade is denominated in RMB, though Daswani thinks
that could multiply to around 15% of global trade within the
next three to five years. Moreover, he thinks that Hong Kong
will be the major trading centre, as remnimbi treasury operations
multiply in this jurisdiction. The CNH market, the offshore
Chinese yuan market in Hong Kong, used to be a non-
deliverable forward market (NDF), now it is definitely deliverable
forward (DF). Earlier this year the spot market was worth
between $30m to $50m a day, now you are looking at $350m
to $500m. It is a massive turnaround,he adds. I
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In August this year Standard Chartered Bank
(Hong Kong) Limited launched the first renminbi
(RMB) denominated corporate bond for the
McDonalds Corporation. It is the first ever RMB
bond launched for a foreign multinational
corporate in the Hong Kong debt capital market
signifying the commencement of a new funding
channel for international companies to raise
working capital for their China operations. It is,
holds Neil Daswani, managing director,
transaction banking, North Asia, a significant
contribution to the development of the off-
shore RMB debt capital market in Hong Kong.
ENTER THE
DRAGON
NEIL DASWANI
G
MANAGING DIRECTOR, TRANSACTION BANKING, NORTH ASIA, STANDARD CHARTERED BANK
Neil Daswani,
Standard
Chartereds
managing
director,
transaction
banking, North
Asia. Photograph
kindly supplied
by Standard
Chartered,
November 2010.
51
T
HE STORY OF the Ping An financial group covers the
whole period since Deng Xiaoping began his
momentous experiments with opening up China to
market forces back in 1991. Beginning in Shenzhen, the city
Deng created as the conduit between the worlds markets
and China, Ping An Insurance group has been a market force
in itself. The insurance company and its interrelated
subsidiaries, its bank and securities operations, now joined
by its private asset management branch, reinforce each other.
The groups 3rd Quarter report is almost a paradigm of China
Incs own spectacular growth. Over the first three quarters of
this year its assets grew 17.5% to over RMB1,000bn ($150bn),
its total equity grew by 26.6% and its net profit up 8.4% year
on year to RMB13,bn (approximately $2bn). In Western terms
Ping An could almost be considered a financial conglomerate;
nonetheless, from trying to penetrate the corporate structure
for interview, there are no Chinese Wallsbetween the various
management groups.
In the early summer Ping An Securities finalised the
acquisition of a strategic stake in Shenzhen Development
Bank (SDB), pushing ahead the merger of its Ping An Bank
with SDB, and working towards its strategic goal of creating
a unified business platform for the Ping An Group companies
of which Ping An Securities is a part. More specifically, it has
helped Ping An secure strategic co-operation with a national
commercial bank.
Rionzhuang Xue, head of Ping An Securities, confirms the
drive, citing the investment banks highly-centralised business
management, inter-connected operation system between
main business lines and supporting business lines, and
cooperation between front-line and middle-line businesses.
In this regard, Ping Ans operation services, quality control,
pricing and issuance, external coordination can penetrate
into every single line of business, making team operation
possible and enhancing overall competitiveness [sic].He
also invokes standardised operation procedures and business
model in order to ensure standardisation of the project
workflow of top-tier salespeople, manage operation risk and
effectively enhance service quality.
Certainly in terms of marketing, its integrated operations
give the securities operation almost a captive market! The
numbers are numbing. Xue points to its 50m retail customers
and more than two million corporate clients. He adds, This
has created a platform for the development of the securities
business, for it to maximise the business potential of each
customer. The synergistic effect is immense, and it is crucial
for the development of Ping An Securities.He credits the
companys One Customer, One Account, Multiple Products,
One Stop Shop Servicestrategy,which allows this immense
networkof all the subsidiaries of Ping An to successfully
share the internal resources.
The brokerage has played a large part in the development
of IPOs for the SME, GEM and most recently, the ChiNext
platform, the SME segment of the Shenzhen Stock Exchange.
The brokerages network is well placed to serve the Chinese
retail demand for IPO opportunities. While there have been
some complaints about Chinese founding entrepreneurs
cashing in their IPO chips a little hastily to take advantage
of the high price to earnings (P/E) ratios (over 70 on average
on ChiNext), one cannot help but suspect their profits might
well be heading towards Ping An Trusts private asset
management.
However, with its market almost entirely domestic with only
incipient operations in Hong Kong, and some personnel
outreach, Ping An is relatively unknown outside the PRC. Xue
says In the short term our focus will remain on Chinas capital
market, and on providing customers with better services.
Even so, he also looks ahead, admitting, for example, we
are intent on recruiting certain talent from abroad, so that
we can continue to learn from the experiences of the more
developed markets overseas and apply them to our business,
from corporate governance to strategic management, products
and services to day-to-day operations.
China accounts for more than a third of the $155bn raised
in IPOs this year. Companies have raised over $53bn in
Shanghai and Shenzhen, and Ping An has outstripped historic
China IPO leaders Goldman Sachs and UBS in Shenzhen, as
smaller firms opt for local brokerages. When the colossus
considers itself ready for the global markets, one almost
wonders if Wall St will end up like downtown Detroit in face
of the competition wielding the cash of untold millions of
Chinese savers and investors.I
It has been a banner year so far for Ping An Securities having weathered the financial crisis by
optimising our asset allocation according to chief executive Rionzhuang Xue, in timely manner. It
seems to have reached safe harbour triumphantly, reporting RMB1, 176m ($175m) net profit for the
three quarters of the year, a 111.5% year on year increase, helped by its sponsorship of more than
30 IPOs, while being lead underwriter on seven refinancings of Chinese corporations. We ranked
top in the league table by number of deals and volume of underwriting fees received, boasts a Ping
An Securities official spokesman, playing an innovative role, for example in introducing a new (to
China) ETF and a steady increase in high margin products for individuals.
TEAM DRIVEN GROWTH
RIONZHUANG XUE
G
CEO, PING AN SECURITIES
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N A WORLD of constantly changing faces and places, a
privately held and fully customer funded organisation
such as Brown Brothers Harriman (BBH) is a rare thing
indeed, says Douglas Digger Donahue, BBH managing
partner. He adds: It takes discipline to go against the grain,
to maintain your convictions when others are piling into any
given asset class, but having the ability to think independently
has paid off for us in the long run.
A highly focused market-segment strategy has allowed BBH
to properly position itself in emerging regions such as China,
where the company recently opened a representative Beijing
office in the hope of furthering its already significant mainland
banking businessBBHs clients include seven of the countrys
largest banks; at present, Asia accounts for 20% of BBHs global
revenue. This kind of investment represents a stepping-up in
our commitment to the region, says Donahue. Our approach
to China is consistent with the methods that weve established
in the pastthat is, to work in a complimentary, partnering
fashion with leading local institutions. Based on our long-
standing track record, they can trust us to be true to that strategy
we are happy to remain in the background as a valued and
specialised wholesale partner with excellent cross-border
credentials and domain expertise. Donahue considers the
sustained consolidation within the financial markets an
opportunity for BBH to truly differentiate itself. Having that
kind of continuity within a private-company setting allows you
to pursue your strategies and control your own destiny, without
any interference from outside constituencies, says Donahue.
Some may argue that BBHs model is too constrained to do
battle in todays rapid-fire marketplace; without making dramatic
acquisitions or doubling the business overnight, undue pressure
is placed on the company and its clients. Donahue has a simple
comeback : Is that kind of approach really that good for your
clients, not to mention your staff, many of whom could be
eliminated during a major consolidation? The fact that we
havent grown through a string of acquisitions saves clients
from the need to transition from one system to another and
promotes stability in our service model. We have a single
integrated platform, which allows us to achieve scale at much
lower levels of transactional volume.
Donahue disputes the notion that todays industry is built
for scale players only. In fact, if you pursue it intelligently and
selectively, it can be just the opposite. A decade ago, says
Donahue, BBH was one-tenth the size of the markets largest
playersbefore the various M&As that were supposed to
put some daylight between the haves and the have-nots.
Guess what? Today were still one-tenth the size of the
biggest players. The point being that, through organic growth
and having the right clients and the right products, weve
clearly been able to hold our ground.
For much of that period, BBH managed to outperform the
competition in percentage growth in profits, growth in custody
of assets, improvement in margins and many of the other
standard institutional rubrics, says Donahue. It has been the
leaner, crisis years that have compelled Donahue and his BBH
colleagues to truly earn their keep and differentiate their
approach. During a prolonged period of volatility when all
hell is breaking loose, clients need you to be there for them
like never before, says Donahue. Thats why I believe that this
isnt really an absolute-scale businessrather, how scaled you
are within each of your relationships. If you were to run this like
a utility, youd take all-comers and just throw them all into the
machine. However, there are some things that just arent that
scalable, and can often hold you back. Thats the handicap of
the growth-by-consolidation approachyou spend half of
your time trying to normalise all of these systems youve
inherited, rather than moving your technology forward. So
there are built-in advantages to doing it our wayand the
proof has been in the financial results.
Donahue points to BBHs securities-lending programme,
which had no impairments or realised credit losses during the
credit crisis and has experienced its best new business year in
its 11-year history (with assets increasing by 30%-40%) as
evidence of the companys economies-of-scale in action.
Explains Donahue: It takes discipline to go against the
grain, to maintain your convictions when others are piling into
any given asset class. Having the ability to think independently,
to trust the perspective of your partners and colleagues who
have been working at this business for decades through all
of the ups and downs and the many different market cycles
has paid off for us in the long run. We consider ourselves
stewards of this franchiseand our main goal is to have the
kind of management teams that can keep the business going
for yet another 200 years.I
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Having a privately owned structure that promotes collaboration
is part of what differentiates our culture, says Douglas Digger
Donahue, managing partner at Brown Brothers Harriman (BBH).
If youre going to grow organically as we must, youd better do a
good job on behalf of your clients. There is a lot of discipline
involved with this kind of approachyou have to work much
harder at it in order to make it successful, especially given the
nature of todays markets.
CUSTOMER FOCUS
DOUGLAS DONAHUE
G
MANAGING PARTNER, BBH
Douglas Digger Donahue, managing
partner at BBH. Photograph kindly
supplied by BBH, November 2010.
53
B
RANDING ISSUES ASIDE, Merrin says that his company
has allowed the rapidly evolvingand, at time, liquidity
challengedinstitutional sector to find avenues of
opportunity in markets that might otherwise be impenetrable.
Over the last 30 years weve gone from having a very mom-
and-pop kind of industry, to one that now includes over 100m
investors in the US alone, says Merrin. Yet the market
structure itself hasnt always kept pace with the changes. In
recent years, the orders that were coming in from these
institutional investors were so large, in fact, that they were
capable of regularly moving the markets in a very significant
way. The more the stock moved, the greater the tax was on
our returns. People just assumed that Wall Street is as efficient
as it can possibly bebut in reality, it hasnt been completely
in tune with the problems that these institutions are experiencing
in terms of owning stock and how much their returns have
been affected. As a result, Liquidnet needed to come up with
a different kind of model in order to properly accommodate
the wholesaler. Its that simple.For his part, Merrin, has sought
to allow institutions to act as their own suppliers of liquidity,
thereby creating a wholesale marketplace where there once was
none. The platform is not unlike an eBay for stock trading,
says Merrininstitutions place their order requests, and the
system finds the appropriate buyer or seller worldwide,
instantaneously. There is no manual searching involved, and
all of the liquidity gets re-aggregated into a single pool, says
Merrin. The bottom line is, the less work that people have to
do, the more successful youre likely to be. Obviously weve been
helping to solve a problem that has existed for yearsbecause
weve been pretty successful as a result.
To its credit, he says, the Securities and Exchange Commission
(SEC) has indicated in recent testimony that it understands
not all dark pools are created equal, and has responded
accordingly. When you consider all of the regulatory frenzy thats
been going on, I think it is important that they were able to
step back and re-assess, rather than just make a knee-jerk kind
of pronouncementand the distinction they seem to be making
with dark pools is that if a firm can provide real value above and
beyond what is found on the exchanges, that is true innovation
and should be left alone. If, however, youre not capable of
offering major price improvement, or you cant provide an
execution size that is markedly different from the exchanges,
then there is a problem, because, at that point, the regulators
just perceive a lot of different private exchanges that are only
degrading the pricing mechanism and really arent benefiting
the overall market structure.
Despite his efforts to streamline the global marketplace
through Liquidnet, Merrin understands that change doesnt
always come easy. The notion that a countrys main exchange
isnt the be-all-end-all hits at the heart of national pride,
and helps to explain why the arrival of these new trading
venues has been so disconcerting for local regulators as well
as the countries themselves. Like all aspects of deregulation,
initially there can be problems and annoyanceswe all
remember what it was like to get those weekly calls from
yet another new telecom following the break-up of Ma Bell.
However, in the US the SEC is responsible for ensuring that
the market structure maintains its integritythat no one
gains at someone elses expense.
The company has also found a receptive audience in
countries including Poland, Mexico, New Zealand and Israel.
The fact that we are trading in 37 different markets is
tremendously important to us, particularly when you have
economies such as Singapore, which is currently in the vicinity
of 10% GDP growth.
Like other companies, Liquidnet has been forced to make
some personnel cuts due to weakness in overall global trading
activity. To stay on track, says Merrin, the company has expanded
opportunities in rapidly growing emerging regions such as
Asia Pacific (where trading volume has already surpassed last
years total of $10.2bn), and has expanded its menu of offerings
to include the likes of corporate-access servicing (via its InfraRed
application, launched late last year). I
The sheer magnitude of supply and demand,
combined with the number of competing
interests in todays marketplaceincluding the
surge in high-frequency trading activityrequires
that there be venues where institutions can trade
in a more anonymous unlit manner, says Seth
Merrin chief executive officer, founder and
president of Liquidnet. The problem is that high-
frequency traders in particular can easily take
advantage where there is a supply-demand
imbalance and who pays the price? he asks.
Anyone with a pension plan, a 401k plan, or a
mutual fund. Hence, all the more reason to begin
looking at a real separation of those markets.
THE BUY SIDE
MODEL
SETH MERRIN
G
CHIEF EXECUTIVE OFFICER, FOUNDER AND PRESIDENT OF LIQUIDNET
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Seth Merrin, CEO,
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Photograph kindly
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Liquidnet,
November 2010.
A
KBANKS EUROBOND OPENED up a new world for
Turkish bank borrowers as a host of more diversified
funding structures are now much more likely. Akbanks
deal set other benchmarks; it was the largest security ever sold
by a Turkish issuer excepting sovereign issues and was priced
with the lowest ever coupon for a non-sovereign Turkish issuer.
Ironically, Akbanks Eurobond came at a time when changes
to local financial regulations imposed a 10% withholding
tax on directly issued bonds. There is no withholding tax
charged on syndicated loans, hence their popularity among
local issuers. The bank has a great story, says Hlya Kefeli,
executive vice president, head of international banking at
Akbank. We ended up at the tighter end of the initial
guidance pricing range. Demand was strong, with 165
investors in the transaction and outstripped availability, with
the order book totalling $3bn. In the end, the allocations
were made to long-term investors. The initial price came in
at 99.431, though following the issuance its price has seen
levels around 102.25, giving a yield of 4.70%.
The scarcity of Turkish risk, especially at non-sovereign
level, helped. Investors were also attracted by Akbanks
strong position in the Turkish banking sector. Citis stake in
the bank helped, no doubt about it, says Kefeli.
A month later, Akbank came to market again, securing the
first diversified payments rights (DPR) securitisation worth
$860bn concluded in the EMEA region for a year, under the
banks securitisation programme, backed by foreign export
receivables, cheques and foreign exchange transfers.
The bank also secured a 1bn equivalent, dual tenor, dual
currency term loan facility. The loan extends the banks ability
to secure financing of this type over a longer maturity; a move
that Kefeli thinks other Turkish banks will follow. I
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Turkeys private sector bond sales have been a standout this year; with Akbank taking a good slug of
the years new issuance, led by Hlya Kefeli, the banks head of international banking. Following
permission from Turkeys capital markets supervisory board, in late July, Akbank came to market with
a $1bn senior unsecured Eurobond, offering a yield of 5.256% and a coupon of 5.125%, maturing in
2015. The transaction was the first direct bond issue from a Turkish private sector borrower.
KNOCKING
DOWN BOND
BENCHMARKS
JOSE DARIO URIBE
G
GOVERNOR, CENTRAL BANK OF COLOMBIA
THE TURNAROUND TALE
B
Y Q3 2008, Colombian economic growth, its currency
and consumption were decelerating fast; the result of
previous tight monetary policy and the effect of the
relative price increases of raw materials and foodstuffs. Public
investment fell drastically due to delays in public works. Inflation
was moving well above its target range for the year (3.5%-
4.5%) and Colombias sovereign risk premium jumped to
500bps. Two years on and its a very different story.
Colombias central bank is attempting to push down the
peso by buying a minimum of $20m daily for at least four
months to mop up US currency from the foreign exchange
market and by keeping oil dividends abroad. The central bank
held its benchmark interest rate at 3% for a seventh straight
month at its latest monetary policy meeting, citing low
inflationary readings and a strong economic outlook. It also
expects its inflation target range for next year is 2% to 4%, the
same target range it set for 2010. Prices through the 12 months
through October stood at 2.33%. In terms of gross domestic
product activity, the bank reaffirmed its 2011 forecast of 4.5%
economic growth, compared to 0.8% in 2009
The bank's view of the economy has included political
problems, such as its dispute with Venezuela, which has blocked
bi-lateral trade. Uribe predicts $1.2bn worth of trade with
Venezuela this year, compared with $7bn in 2008. There has
been an increase in confidence among consumers and
businesses. Investment is coming primarily in hydrocarbons,
mining and infrastructure. Mining is particularly attractive as the
country branches out from coal to precious and base metals. I
Once torn by civil unrest and racked by drug
trafficking, Colombia is a modern day tale of a
sound economic turnaround.
Hlya Kefeli.
Photograph
kindly
supplied by
Akbank,
November
2010.
HULYA KEFELI
G
EXECUTIVE VICE PRESIDENT, HEAD OF INTERNATIONAL BANKING, AKBANK
55
G
RAB, BULL ANDhorns spring to mind when it comes
to JP Morgan and its chief executive Jamie Dimon.
Dimon has spearheaded substantive growth in the
treasury services business, a full-service provider of cash
management, trade finance and treasury solutions, particularly
in the Asia Pacific region. Over the last year the bank has
strengthened the organisational structure of its global trade
practice to better address the industrys increasing demand for
supply chain and trade finance solutions; hiring a slew of new
senior managers and upping the trade and supply support
team. Across Asia, the bank has hired an additional 500 staff in
the treasury services segment alone. The new structure introduces
centres of excellence for all trade products across the world;
regional trade advisory teams; and solution delivery teams
supporting trade sales specialists. The bank is positioning itself
for unprecedented growth in its global trade business, leveraging
its US commercial bank franchise and supporting the banks
global corporate bank expansion strategy.
Change has been coursing through JP Morgan for some
years, since it instigated the three year $1bn global investment
plan in late 2008. In line with the incipient economic order,
most of the investment focus has been on Asia. The goal has
been to take a complex multi-currency, multi-regulated
environment and make it easier, cheaper and faster for our
clients to conduct cash management activities. On the ground,
a host of initiatives have included enhancements to the banks
domestic cash management capability in East Asia, mainly
South Korea and a new rep office in Bangladesh. The bank has
built up client networks in India, Nepal, Sri Lanka and the
Maldives and escrow services have been established in Australia
and Singapore. The banks US dollar clearing operations have
been upgraded with Swift MT-103 message formatting,
providing clients with faster, more secure cross-border credit
transfers. A web based receivables management platform
has been rolled out and a freight payment and auditing
capability has been launched to help clients improve control
of global transportation operations. Most recently the bank
has launched an advisory programme in mainland China to
help local corporations improve cost and risk management.
The banks investment banking operations have also seen a
substantive uptick. Led by Jes Staley, who took over the reins
in late 2009, the investment bank has a three pronged growth
strategy, based on lowering return on equity, increasing the
investment banks share of global banking feels and reducing
the error rate for processing trades. The investment bank has
set a 20% return on equity target. Since 2006 it has only reached
this once when it hit 21%. Over the last five years the average
has been 12% and as the bank has increased equity this year
to 40bn, up from $30bn last year, that kind of performance
is a big ask. Asia figured largely in growth play this year, with
a projected doubling of market share in Asia from 4% to 7%.
Its equity and debt capital markets segment has steamed up most
new issuance league tables through 2010, with emerging
markets debt issuance a particular outperformer.
What it all adds up to is that while other banks are struggling
to comply with Basel II and the financial reform process, JP
Morgan is using the hiatus to become more global, offer a
deeper service set across the group, and in the process
dominating emerging market business opportunities. Why
not: particularly now when there are only a handful of banks
that can compete in the space.
The banks 2010 Q3 numbers are doing some satisfying
talk. Through 2010 to date, the company loaned or raised
over $1trn in capital on behalf of its global clients and its
small-business originations have risen 37%. The banks Q3
earnings per share ballooned to $1.01, or 19 cents more than
Q3 of 2009, and the company improved net income ($4.4bn)
by 23% over the year-ago period. Moreover, its balance
sheetwhich went from a Tier 1 common ratio of 7% at the
start of 2008 to a current 9.5%continues to show signs of
strength. Says Dimon: We believe that the quality of our
balance sheet will position us well for the eventual
implementation of new capital standards being developed by
bank regulators,holds Dimon. I
JAMIE DIMON
G
CHIEF EXECUTIVE OFFICER, JP MORGAN
For most financial institutions, growth has been painfully won since the financial rumblings that
began in mid 2007. If there is one bank that, at least on the surface, has grasped the opportunity
of the downturn to establish an extensive global footprint it is JP Morgan. As some of the stars
of the global banking industry have waned, JP Morgan is waxing pretty. In part that is due to
stringent internal risk management discipline which has provided the bank with free capital to
invest in growth; in part it results from a clear determination to build out a dominant global
footprint based in large portion on Asian business growth.
THE ASIAN
PLAY
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JP Morgan chief
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supplied by AP
Photo/PA Photos,
November 2010.
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NDREW ALLI, PRESIDENT and chief executive officer
of Africa Finance Corporation (AFC), would like to
be nowhere else but the country of his birthNigeria.
A distinguished career in finance has taken him from being
an investment banker in the City of London to Washington,
where he served as an investment officer working at the
International Finance Corporation (IFC), the private sector
financing arm of the World Bank Group. However, it is his
passion for developing the finance industry in his homeland
that drives him.
AFC specialises in projects aimed at catalysing investment
in infrastructure within Africa, says Alli. This is hugely
vital for the economic development of the continent.
AFC was formed in 2007 under an international treaty
between sovereign states, with current members including
host-nation Nigeria plus Guinea-Bissau, Sierra Leone, The
Gambia, Liberia and Guinea. The Central Bank of Nigeria
provided anchor capital and holds a 42% stake, with other
shareholders, including African financial institutions and
corporations. Exemplifying the very type of deal that AFC
was set up to do is the project financing of an undersea fiber
optic cable, which stretches from Portugal to Lagos, connecting
West Africa to the information superhighway. AFC is the
largest investor in the $240m Africa-led funded Main One
Cable System, which has provided a tenfold increase in
broadband capacity in the region. Alli describes the project
as being hugely transformational for Africas IT and telecoms
sectors. It will allow companies to start thinking about
opening business process outsourcing operations which they
have not had the bandwidth to do,he says.
AFC last year obtained a 46% controlling stake in Cenpower
Generation Company, which is developing the Kpone
independent power plant in Tema, Ghana. AFC sells power
to the government of Ghana through its electricity company,
Electricity Company of Ghana (ECG). We are putting this
together as a project which can be bankable, says Alli. This
has created considerable interest and is something we hope
to take to financial close next year.
Alli points to the funding of the $450m plantwhich will
help power continued economic growth in Ghanaas an
example of how AFC can bridge the gap that exists between
pent-up demand among international investors to finance
projects in Africa, and the required local expertise among
financial institutions in the region to ensure such initiatives
are well structured. We create transactions, rather than
waiting for others to do so. A lot of investors like to look at
deals that are well-packaged with everything in place. So all
they have to do is write a cheque, says Alli.
Another more long-term focus for AFC is the formation of
capital markets in Africa, developing markets for infrastructure
bonds and project-related bonds in local currencies, which
removes the currency risk international investors can face. Alli
points out that mobilising domestic financial markets is a
proven model to facilitate the flow of foreign investment
into an emerging market economy. We are also looking at
creating private equity funds which specialise in infrastructure,
an asset class we see there being a lot of interest in,he says.
AFC plans to obtain authorisation from the international
credit rating agencies to issue bonds to raise additional
funding and finance projects such as the power plant in
Ghana. If the market is sufficiently well developed, we may
issue local instruments either to wholly or partly refinance
projects, which will lower risk and increase participation in
local capital markets, says Alli. I
While Africa has not been ignored by the
global financial community, Andrew Alli,
president and chief executive officer of Africa
Finance Corporation (AFC), points out that the
flow of foreign investment into the continent
has been heavily skewed towards natural
resources such as oil, gas and mining. There
are huge power deficits across the whole of
Africa, so power is a really important sector to
get growth going in, he says. The Lagos-based
banks capacity to fund such projects and be a
creditable partner to international investors is
bolstered by a strong balance sheet, capitalised
with $1.1bn. Joe Morgan reports.
ANDREW ALLI
G
PRESIDENT AND CHIEF EXECUTIVE OFFICER OF AFRICA FINANCE CORPORATION
PASSION FOR HOMELAND
POWERS AFC BOSS
Andrew Alli,
president and chief
executive officer of
AFC. Photograph
kindly supplied by
AFC, November
2010.
57
U
NDER ITS NEW, charismatic leader, Luiz Carlos
Trabuco Cappi, Bradesco is exploiting its almost
universal presence in the country and its leadership
in key areas, including insurance in which Trabuco has
substantial experience.
Trabucos bet on the local market and lower income
consumers implies that Bradesco will be less diversified than
its main rivals. Family-run Bradesco is conservatively managed
and retains a feel of its early mandate to bring banking to the
masses. The theme is fashionable again thanks to pent-up
demand from Brazils lower income consumers. Trabuco has
said that he believes Brazil may support as many as 220m
accounts by 2020, up from 130m today.
One of Trabucos first moves as president was to re-create
regional centres within the bank to identify client trends in
each region, something that he believes to be impossible from
a centralised location in So Paulo. Another initiative is credit
Bradescos chief executive officer, Luiz Carlos Trabuco Cappi, will need his much vaunted charisma
as the bank stands firmly at a nexus of change for Brazilian banks. The largest private-sector
bank in the country until 2008, Bradesco has never really recovered from the trauma of seeing its
chief rival Ita buy its second biggest rival Unibanco and leapfrog it to gain pole position at the
end of 2008. The move effectively trumped Bradescos 50-year crown as Brazils leading bank.
Trabuco is determined to leapfrog the leapfrogger.
BETTING ON
THE HOUSE
LUIZ CARLOS TRABUCO CAPPI
G
CHIEF EXECUTIVE OFFICER, BRADESCO
card brand Elo, which Bradesco is launching in partnership
with state-owned Caixa Econmica Federal and Banco do
Brasil to challenge Visa and MasterCard for lower spenders
who do not need international services and the bells-and-
whistles embedded in more expensive cards, such as expensive
guarantees and foreign-exchange transactions. Bradesco is a
brand that is being built from the bottom up,says Trabuco.
That Bradesco is doing well and still trailing its rivals points
to the giddy growth rates of Brazilian banks. Although the
financial crisis slowed business in 2008/2009, the 7.5% growth
in GDP this year coupled with rapid growth in Brazils credit
markets, means banks are in optimistic mood. The ratio of
credit-to-GDP is in frank expansion and this year is estimated
to reach 48%, giving scope for further growth. Executives at
Bradesco believe that Brazil offers richer pickings than are
available abroad, not only through consumer credit but more
corporate banking at home and opportunities arising in
infrastructure, especially with the planned World Cup and
Olympics events in Brazil. That is not to say that Bradesco is
completely out of the internationalisation game, but rather
that the company is seeking to do it in a managed, slow way
and only in selected sectors. It is opening offices in London,
including a securities arm, as well as in Luxembourg and
New York to offer asset management and securities activities
for European and US investors. I
A
MONG THE MOST recent of the growing crop of
emerging market issuers this year Jordan launched its
debut Eurobond in November which ended up with
commitments for $750m 3.875% notes due 2015 and listed on
the London Stock Exchange. Originally the country had wanted
to come to market with a $500m bond, but investor demand
outstripped supply and the sovereign upped the value of the
bond. Investors have been eager to buy high-yielding, emerging
and frontier market debt this year to compensate for lower
yields in advanced markets. Lebanon also debuted on the same
day, with a $500m 5.15% notes due 2018 and $225m of 6.10%
notes due 2022. The finer pricing of the Eurobond was clearly
exhibited when Credit Libanais issued $75m worth of
subordinated bonds due January 2018, a few days later, which
came in at 6.75%. A few days earlier, EFG-Hermes holding
stood a 65% interest in the Lebanese bank for $542m, the
largest single foreign investment in Lebanon to date.
Long term tenors are also in play. Russias Vnesheconombank
(VEB) updated its $30bn loan participation notes programme,
with the issue of a $600m 5.45% tranche due 2017 and $1bn
6.80% due 2025 under the programme. Compare that with
pricing of the $1bn 6.902% notes due 2020 issued earlier this
year in the first international debt offering by a Russian state
corporation. Citi, Credit Agricole, HSBC and JP Morgan were
joint lead managers for VEB's latest offerings of Notes, which
were sold in the United States to qualified institutional buyers
under Rule 144A and outside the United States under Regulation
S. Meanwhile JSC National Company KazMunayGas came to
market with a $1.25bn bond due 2021. I
Emerging markets bond issues came to the fore
this year. In November, for example, a slew of
debut sovereign eurobonds were either issued
or in the pipeline.
THE RISE OF EM BONDS
EMERGING MARKET EUROBONDS
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F
ORMED INITIALLY IN the late 1990s to service the
portfolios of the United Asset Management group (UAM),
in October 2000 Boston-based eSecLending opened shop
with a singular mission: to provide institutional investors with
an alternative approach to traditional custody lending
programmes by introducing a unique auction-based lending
model. Back then, many traditional providers actively discouraged
the use of third party agents for lending assets, recalls Chris
Jaynes, co-chief executive officer (along with Karen OConnor)
of eSecLending. It was a concept that the entrenched agents
really fought quite hard against a decade ago, says Jaynes.
While the industry may have ultimately evolved, the onset
of the credit crisis, which infused the markets with a shot of
much-needed scrutiny, has since brought many more investors
around to eSecLendings way of thinking.
Unbundling, transparency, customisation and controlall
common buzzwords in todays environmentare the core
features that our model was designed around and are concepts
weve been promoting for ten years. While the credit crisis has
brought attention to the market for negative reasons, we think
in the long run the increased focus is a positive thing because
it forces everyone to sharpen their level of understanding and
improve their product offerings,says Jaynes.
Today, securities lending is increasingly viewed as an asset-
management and trading process, rather than a back-office
or operational function, says Jaynes. Accordingly, more lenders
are themselves using third-party providers and seeking
alternative routes to market. This evolution has been great for
business; to date, eSecLending has auctioned over $2trn in
global assets and manages more than $300bn in lendable
assets with over $50bn on loan.
Here we are ten years later, and most of the large custodial
banks are now in agreement that third-party lending is a
portable investment product rather than a custody-based
service, says Jaynes. In other words, it is the realisation
that providers should be selected on the merits of their model,
their approach and their productas opposed to whether
or not they are providing custody services. That is a dramatic
change from the world we entered in late 2000.
One thing that hasnt changed over the years is
eSecLendings approach to the mechanics of securities lending.
Right from the start, our goal has been to bring investment-
management-type disciplines to the industry by promoting
transparency, competition, benchmarking and performance
measurement, as well as better service and reporting, all
areas that we felt were lacking in the market. What continues
to differentiate eSecLending from traditional agency providers
is that, rather than utilise a pool or queuing system, we treat
each client as an entirely separate book of businessin short,
ours has been a much more tailored approach to sec-lending
based around each clients unique assets, risk tolerances and
goals, as opposed to a volume-based, one-size-fits-all kind
of operation. Unlike other providers, securities lending on a
third-party basis remains the companys core competency.
Given the fluctuating political climate in the US, it remains
to be seen howand to what degreesome of the recently
drafted regulatory measures will be implemented. However,
Jaynes believes that new regulations will, in general, be
supportive of securities lending, whatever form they should take.
Calls for greater transparency and increased focus on affiliate
transactions certainly works to the advantage of eSecLendings
business model, given that we are independent and therefore
free of some of the perceived conflicts of interest that can exist
in the market. Though the companys basic operating principles
have remained fairly constant throughout, its menu of
capabilities has become much more diverse, says Jaynes.
Where we were once focused almost entirely on exclusive-
based auction programmes, weve since broadened our approach
to include a full discretionary programme, and we are also in
the process of rolling out new products in the treasury-
management space.Under Jayneswatch, eSecLending has also
expanded its global reach; today, the once exclusively domestic
enterprise now has equal parts US and non-US clients, and
maintains offices in both the U.K. and Australia, in addition to
its flagship Boston location. I
Securities lending is today increasingly viewed as
an asset-management and trading process,
rather than a back-office or operational function,
says Chris Jaynes, co-chief executive officer of
eSecLending. Accordingly, more lenders are
themselves using third-party providers and
seeking alternative routes to market. This
evolution has been great for business; to date,
eSecLending has auctioned more than $2trn in
global assets and manages more than $300bn in
lendable assets with over $50bn on loan. Dave
Simons reports from Boston.
eSEC LEADS
THE WAY
CHRIS JAYNES
G
CO-CHIEF EXECUTIVE OFFICER OF eSECLENDING
Chris Jaynes,
co-chief executive
officer of
eSecLending.
Photograph kindly
supplied by
eSecLending,
November 2010.
LAST MOVER ADVANTAGE
CIAN BURKE
G
HSBC GLOBAL HEAD OF PRIME SERVICES AND CO-HEAD OF HSBC SECURITIES SERVICES
59
O
F LATE, THEalternative investment
services space has been a two
carriage highway as hedge funds
have moved money into custodian accounts
because of perceived dangers to their assets;
while prime brokers increasingly have
recognised the need to adopt more custodial-
type processes. The result is a number of
hybrid service structures. In the US, for
example, Northern Trust offers Merlin
Securities prime brokerage clients access
to its global custody and administration
service, and custody behemoths State Street
and BNY Mellon have been promoting securities lending to
hedge fund clients.
The latest buzz is for larger global-service banks to merge their
custody and prime brokerage arms. JP Morgan launched a
prime custody group, which has combined the prime brokerage
unit it acquired when it took on Bear Stearns with its custody
arm. HSBC meantime has attempted a seamless offering
through the merger of its traditional asset servicing business with
a nascent prime broking service that it has been building steadily
since 2009. The Prime Services offering has been led by Cian
Burke, who also now heads up HSBCs Securities Services
(HSS) together with Drew Douglas; reporting directly to Samir
Assaf, group general manager and head of global markets.
By the promotion of a seamless service, the bank hopes to
secure a substantial portion of a market which is still in flux
and at a time hedge funds are still launching long-only funds
and seeking structures that allow them to house certain assets
with custodians and traditional asset managers are executing
long/short strategies that require financing through a prime
broker. We did not want to be Morgan Stanley Mark II, but
to harness market expertise and build something that was right
for HSBC, and meets the needs of hedge fund managers and
their investors,says Burke. Last mover advantage is decisive
in this respect.The question now is how much can HSBC
capitalise on hedge fundsflight to safety (or quality) and create
a lasting template?
Ten years ago, hedge funds with more than one broker were
a rarity. A triumvirate of Goldman Sachs, Bear Stearns and
Morgan Stanley governed a tip over 60% of the business.
Although still highly concentrated, the
prime brokerage club is today somewhat
more inclusive. Recent Hedge Fund
Research figures show that in Q3 2009 six
large global prime brokers (JP Morgan,
Goldman Sachs, Morgan Stanley, Credit
Suisse, Citigroup and Deutsche Bank)
service almost three-quarters of the global
hedge fund market. The trend is confirmed
by consultant Aite research, which holds
that nowadays even larger hedge funds are
gravitating toward firms that offer a broader
service set, including research, securities
lending, investment banking, fund administration, capital
introduction and consulting, leading-edge software and services
in trading, analytics, risk and reporting.
In the post financial crisis world, security is everything, holds
Burke. Now it is entirely about how to segregate customer
accounts. The ability to provide clients with full security and
transparency over their assets in segregated accounts, together
with the opportunity to use some of these assets as security
for financing, enhances the product offering. Add to that
questions around safety and those banks with the strongest
balance sheets have begun to dominate."
HSBCs entry into the market in late 2009 took traditional
prime brokers by surprise. Actually, HSBC has stronger
credentials in the hedge fund segment than it is often given
credit for. Apart from aiding a range of hedge fund investors
through its established private banking division, HSBC is one
of the worlds largest managers of fund of hedge funds assets,
overseeing some $23bn, while its custody arm already holds
over $10bn in hedge fund assets. Burke is clear that the
evolution of the banks prime services offering was entirely
client-driven. There was a desire among investors and clients
to have a prime services provider that could offer them leverage
without transferring the title of their assets. The client
proposition was about taking what wed built in Custody Plus
and wrapping around that a broader prime services offering,
says Burke. Remember we have a significant OTC business,
we have global execution capabilities, we provide funding
and equity financing and we have Custody Plus. All-in, its
a very strong proposition.I
The financial shocks of 2007/2008 forced a sea change in the traditional relationship between a
hedge fund and its prime broker. Although hedge funds became more selective in their prime
broking relationships, they also began to add new prime broker agreements and opened up to a
new set of custodian relationships as they moved unencumbered securities and cash into global
custodians for safekeeping. At the same time, large custodians moved into the prime broking
market at a sustained clip on the back of hedge fund fears over counterparty risk and a desire for
improved collateral management. However, HSBC, under the leadership of Cian Burke, is
attempting a truly seamless offering. Is it the model of the future?
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Photograph
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November 2010.
M
ONTHS BEFORE THE Kerviel episode, the financial
barometer had slowly begun to swing in a different
direction and the management at Socit Gnrale
was already planning how it was going to adapt to the new
financial environment. In July 2009, the bank went live with
a total review of its business model, known internally as
Evolution. In a swoop, it created a flatter business model,
decompartmentalising silos and showing a single face to
the client. It comprised three main areas: Coverage and
Investment Banking for strategic clients; Global Finance
consolidating capital-raising and financing across both debt
and equity; and, finally, Global Markets. With the creation of
Global Markets, all the rates, credit, currencies, commodities
and equities were brought together into one integrated
platform, to deliver a complete range of services and solutions
across all asset classes. Fetta says: Evolution had one main
objective, to focus on clients and as part of this, to beef up the
investment banking capabilities on the advisory side, from
mergers and acquisitions to debt capital markets and coverage
of corporate clients. It has made it easier for stakeholders in the
bank to serve clientsneeds.
Global Markets was organised into two areas: one to service
clients for flow trades on the more standardised products,
divided into the three asset class-based teams of fixed income
and currencies, commodities and equities, under which the
banks Delta One and exchange-traded funds (ETFs) businesses
fall. Second is the cross-asset solutions department, which
provides clients with investment advice and financial
engineering through category-specific teams, for example,
clients with a huge need for advice in the light of Basel III,
which set minimum levels of capital in banks of 7% of their
risk-bearing assets. (Incidentally, while it is expected that most
banks will need to raise hundreds of billions of euros of capital
under Basel III, SocGen announced in November that it was
confident it would not need to do this.)
Fetta says: The cross asset solution team provides clients with
a tailor-made approach drawing on all sections of the bank, but
of course, the solution you propose is fed back for
implementation through the different asset classes. The
reorganisation also created what Escoffier terms the equity
chain. This ensures that from origination, M&A, right down
to equity research through trading and sales departments, we
are fully aligned to deliver the bank to clients, he says.
The banks equity derivatives team, long regarded as industry
leaders, has maintained its position at the top. It has also had
the highest return on equity among all leading investment
banks of 59%, estimates JP Morgan Cazenove in a September
2010 research report. We have a growing equity franchise
unlike our competitors, but its a tough market. says Escoffier.
We are still very cautious and we live quarter by quarter.
A major contributor to the recent success of Global Markets
has been the growth of SocGens Delta One and ETF business.
Delta One products are the simplest type of derivative where
the derivative moves in line with the underlying asset. While
equity volumes and derivative volumes generally have remained
low this year in the industry, Delta One and ETF volumes have
stayed buoyant and Greenwich Associates estimates that 55%
of European institutions are expecting to increase their usage
of flow equity derivatives products in 2011. Additionally, JP
Morgan Cazenove estimates total revenues wallet from this
area in the industry accounted for $10.7bn in 2009 and will
grow 9% to $11bn in 2011, driven by volume growth in ETFs,
equity swaps and certificates. For SocGen, the largest Delta
One player in Europe, it will bring in estimated revenues of
$1.1bn globally, according to Cazenove.
In July 2010, the bank enhanced its lending and borrowing
ETF service for European institutional investors and became
a market maker in five new options on Lyxor sector-based
and emerging markets ETFs. It joined NYSE Liffe for the
launch and is believed to be the first market-maker offering
clients access to the quoted underlyings. A dedicated platform
of options (OTC or listed) on ETF allows investors to set up
strategies to optimise their portfolio management. The banks
expansion and investment outside its traditional marketplace
of Franceit holds the number one market share on
Euronexthas also provided clients with greater choice. I
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If you remember, 2008 was not a good year for
Socit Gnrale. Trader Jrme Kerviel
incurred 4.9bn losses in the January, almost
wiping out all the banks entire annual profits.
Moreover, as the year progressed, along with
other banks, it also began to suffer the fallout
from the sub-prime crisis. The support we
received from clients at that time was really
comforting, says David Escoffier, co-head (with
Gian-Luca Fetta) of the banks Global Equity
Flow team. We had announced a major event
and we had survived. In terms of the business, it
was a big crisis but it has been important to
learn the lessons and we have been investing
heavily in risk systems since then.
EVOLUTIONARY
TRENDS
DAVID ESCOFFIER and GIAN-LUCA FETTA
G
CO-HEADS
OF SOCIT GNRALES GLOBAL EQUITY FLOW TEAM
David Escoffier (left) and Gian-Luca Fetta, co-heads of Socit
Gnrales Global Equity Flow team. Photograph kindly supplied by
Socit Gnrale, November 2010.
61
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LEARSTREAMS GLOBAL PRODUCT suite is a
substantive turnaround for a business which only a
decade ago defined itself as a vertical service set attached
to the Deutsche Brse Group. Clearstream, the ICSD, started
as a provider of the post-trade infrastructure for the Eurobond
market and, as a central securities depository (CSD), providing
post-trade infrastructure for the German securities industry. In
the interim, Clearstream has expanded not only its business
set, but also its business reach and these days the firm is
increasingly defined as a global, rather than regional operator.
Settlement and safekeeping of eurobonds is still Clearstreams
core business, accounting for more than 40% of its revenues,
and with a market share of 37% as of October this year. Jeff
Tessler, Clearstreams chief executive, explains that: One of
Clearstreams goals is about bringing simplicity to the post-trade
services industry by offering the complete range of our services
through a single window. We continue to build competitiveness
in the cross-border securities processing area through
interoperability and partnerships.
That is however, a moveable feast: 2010 alone has been
marked by a stream of initiatives which continue to add to its
diversified product offering. The firm now offers services
covering cross-border securities processing, investment funds
services, and global securities financing, where it is one of
the four global providers of collateral management services.
Within those product sets, the firm has been diligent in
deepening the overall service range. Most recently, carbon
emission rights and the Chinese renminbi held outside
mainland China have become eligible for settlement in
Clearstream; an inevitable development as Asian investors seek
to maximise renminbi denominated investments in their
portfolio. The firm plans to expand its settlement services to
the Brazilian real and the Indian rupee.
Clearstream has been willing to wield a bold brush and
work in partnership with other specialists. For instance, the
company has created the first European trade repository
together with Bolsas y Mercados Espaoles (BME), called
REGIS-TR. The system will collect and administer details of all
OTC transactions, giving market participants and regulators
access to a consolidated global view of OTC derivative positions;
an overview that is currently not available, but which will be
required by European regulators. Moreover, Clearstream
customers can now also cover their margin exposure to Oslo
Clearing through Clearstreams collateral pool, the Global
Liquidity and Risk Management Hub. According to Tessler,
the diversification strategy is a natural evolution of the times:
Life is much more difficult for everyone. In this new normal
our clients and partners are looking for infrastructure which
supports their business at a time when there are substantial shifts
in the global financial system. Providers such as ourselves
must and should differentiate themselves around providing
our clients with improved functionality, safe haven services
and risk management related to counterparty risk.
It is also a function of the semi-regulatory role that traditional
clearing and settlement institutions have always played in the
fungible securities segment, as highly commoditised, rules
based and process centric operations. Clearstream is notable
for breaking out of that mould, while still adhering to a strict
transparency and principles-based operating model. For one,
it has a diversified global client profile that is the envy of many
a national securities depository, that encompasses broker/dealers,
asset managers, asset gatherers and central banks, comprising
2,500 institutions in some 110 countries. Through its latest
initiatives it is also carving a significant role in both the on-
exchange and OTC derivatives market segments, such as its
agreement with CETIP, and through enhancements to its
collateral management services. Finally, it has successfully
rolled out its operations across the globe. In the Middle East
it has secured a strong client base among the regions central
banks. Today, approximately 20% of the Clearstream revenues
are coming from Asia a share that is set to grow. Moreover,
China is amongst Clearstreams top 10 largest markets. I
CETIP, the Brazilian CSD, will have a cross-border collateral management deal with Clearstream up
and running by the second half of 2011. Both companies have agreed to jointly develop, promote
and distribute triparty collateral management services, acknowledging in the process the trend
towards global consolidation of collateral management activities. The agreement is one of a stack of
initiatives which has put Clearstream at the forefront of change in settlement and custody, securities
financing and investment fund services on a global, rather than regional scale.
BOLD BRUSH TACTICS
JEFF TESSLER
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CLEARSTREAMS CHIEF EXECUTIVE
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OB DIAMOND ANDBritish banking is an odd coupling.
In an industry known for conservative tradition, and
hierarchy, Diamond is a maverick. As head of Barclays
Capital (BarCap), he frowned upon limousines, forbade
personalised stationery for senior executives, proposed
eliminating titles from business cards (he was dissuaded from
that), weeded out bankers who were not team players, and
worked feverishly to build BarCap into a major player in
investment banking. He also vigorously defended the concept
of a universal bankone that, like Barclays, combines retail
banking with investment banking. More controversially,
Diamond champions US-size pay packages, its a world view
that has polarised opinion but not diminished his stature.
That Diamond would achieve all this perhaps wasnt apparent
in October of 2003 when Barclays announced a typically orderly
management transition. Retiring chairman Sir Peter Middleton
would be succeeded by chief executive Matthew W Barrett,
who would be replaced by John Varley, an Oxford-educated
lawyer who had been with Barclays for more than 20 years
and was viewed as a highly competent, risk-averse manager.
After BarCaps failed bid for ABN Amro in 2007, questions
were raised about the direction the investment bank would
take. By late 2007 the banking meltdown was well under way
and among its high profile casualties, the collapse of Lehman
Brothers brought Diamond another opportunity to shine.
Diamond, who had written down $3.6bn in bad investments
over the summer, saw Lehman as the vehicle for turning round
BarCap by greatly expanding its presence in the US.
The acquisition became one of the fastest takeovers in Wall
Street history. Diamond quickly sold off Lehmans Asia-Pacific
and European investment banking and equities units and after
only three months Diamond declared that Lehman was fully
integrated into BarCap and contributing to the bottom line.
Investors were sceptical. They feared that Barclays profit
reports would be inflated by one-time gains from the Lehman
deal. By January 2009 Barclays stock was selling for one third
of its tangible book value. Barclays was more prey than predator,
and the UKs Financial Services Authority (FSA) pressed
Barclays to take advantage of the governments asset protection
plan. Varley and Diamond resisted, saying that participating
in the scheme would restrict the banks decision-making
freedom. However, it was clear that Barclays, having taken a
writedown of 5bn in 2008, had to raise more capital. In early
2009 Barclays struck a deal to sell iShares, the exchange-
traded funds operation that was the crown jewel of Barclays
Global Investors, which managed more than $1trn in assets
through offices in 15 countries.
Diamonds success has brought criticism, especially in the
UK. When a BBC business editor asked a British government
official for reaction to Diamonds appointment as Barclays
next chief executive, the answer was: Bank taken over by
casino. Diamond bristles at comments like this. He insists
that its investment banking business is solely client-driven.
There are more substantial problems facing Diamond. One
is the relatively weak performance of the retail side of Barclays,
particularly outside of the UK. Investment banking profits,
hardly existent before Diamond took over BarCap, but now
account for 70% or more of Barclayspre-tax earnings. Diamond
praises the universal bank model because it provides balance,
but 70/30 is not balanced. Some people would prefer to split
retail and investment banking, as the Glass-Steagall Act did
in the US until 1999.
Diamond remains adamant in his advocacy of universal
banking and large size. Defending both are political battles
hes likely to face soon after taking office as Barclaysboss. The
fight ahead might even Diamond another chance to sparkle. I
LAST MAN STANDING?
When Robert E Diamond Jr, an energetic and entrepreneurial American, was passed over as chief
executive of Barclays in 2003 in favour of a younger and much more reserved Englishman, he put on
a brave face. Im not disappointed, he told the press. Im all pumped up. Would he remain at
the bank even six months? I promise, he said. He not only stayed but, as Barclays number two
executive, built an investment banking profit machine, guided it through the worldwide financial
crisis of 2007-08, acquired Lehman Brothers for a song, avoided government bailouts, and generated
praise and criticism on both sides of the Atlantic. Next April he takes over as chief executive of a
Barclays that is much different from the one he joined 15 years ago and is largely of his own making.
Art Detman explains why Diamonds greatest challenge may lie ahead.
ROBERT E DIAMOND JR
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CEO, BARCLAYS CAPITAL
Robert E Diamond Jr,
CEO of Barclays
Capital. Photograph
kindly supplied by
Barclays Capital,
November 2010.
63
P
REVIOUSLY CHIEF EXECUTIVE of BM&F, Edemir
Pinto, has led BM&FBovespa since the merger with
Bovespa in 2008. According to Pinto, the merger of the
exchanges was a pivotal event, helping to strengthen the
Brazilian capital markets, offering a vertical exchange/clearing
model, that incorporates four clearing houses (equity,
derivatives, foreign exchange and other securities) as well
as a full service central securities depositary. Certainly, the
BM&FBovespa walks tall these days; its managers reel off
impressive statistics about growth, market capitalisation
and local rankings. This year, it pulled off the worlds largest
secondary offering, from oil giant Petrobras worth BRL$120bn.
The launch of the Novo Mercado soon after the turn of the
new century is seen as a turning point. Companies that wished
to join the new market had to obey much higher governance
standards, including tag along rights in the event of a take-over.
The merger between Bovespa and BM&F was the second
pivotal event. A third pillar is the local regulator, the Comisso
de Valores Mobilirios (CVM). Both the exchange and its
regulator have built a reputation as the most solid managers
of markets in Latin America, notes Sandra Guerra, founder
of So Paulo-based Better Governance and coordinator of the
company circle Latin America.
The exchange recorded net revenue of BRl$486.9m, an
increase of 27.1% year-over-year, says Eduardo Refinetti
Guardia, CFO and investor relations officer at the exchange.
That came primarily due to a 70.7% surge in volumes traded
on the BM&F. In October, trading hit the highest daily volume
on record at BRl$7.7bn, he notes.
Even so, the crisis has, however, acted as a wakeup call.
Management has understood that it is necessary to broaden
out the shallow base of foreign capital by attracting in new
foreign investors, particularly from Asia and the Middle East.
Meanwhile, the exchanges BRAiN initiative was launched
this year, spearheaded by Paulo Oliveira, the exchanges chief
business development officer. BRAiN is a more sophisticated
operation than its market promoting predecessor BEST.
Strategic relationships have been a cornerstone of the
exchanges deepening of its service offering; though its key
stakeholders were in place prior to the merger. BM&F had a
cross-share swap with the CME Group. In practice, an order
routing agreement enables customers in more than 80 countries
using CME Globex, CME Groups electronic trading platform,
to trade BM&FBOVESPA products directly, via the Brazilian
exchanges electronic trading platform, GTS. These products
include futures and options on one day inter-bank deposits,
the Bovespa Stock Index, commodities, energy, and metals.
The partnership between CME Group and BM&FBOVESPA
also allows Brazilian investors to trade CME Group products
directly through the GTS system.
Investment in technology is another element, involving the
upgrading of trading platforms, which offer greater capacity and
safer systems and will encourage new trading strategies,
including high frequency trading, which the exchange views
as a prestige programme. The exchange is also working to
develop its nascent non-sponsored Brazilian Depository Receipt
(BDR) programme, notes Guardia.
Myriad challenges remain: from deepening the culture of retail
shareholding on the one hand and respect for minority
shareholder rights on the other; driving down trading prices
for clients; and building a range of new products. The last area
for work is to deepen some of the markets. Brazils corporate
bond market, for example, has struggled to develop. That is
in part thanks to high interest rates and plenty of government
issuance which have provided sufficient risk-free returns to
deter diversification. But it is also because the secondary bond
market lacks transparency, liquidity and efficiency.
According to Pinto, the vertically integrated systems at
BM&FBovespa are a cornerstone of the enlarged exchanges
success. That can play either one of two ways: either it can
adopt the monopolistic heavy hand that its strategic investor
CME Group plays to great effect in the United States as a
driver of future growth or, it will have to change and evolve even
more as it faces growing competition from newcomers anxious
to leverage the very real opportunities in the market. I
THE MONOPOLY
PLAY
Since the merger between BM&F and Bovespa back in 2008, the exchange has transformed itself from
an investment backwater to one of the worlds hottest exchanges, having made strides in regulation,
market development and building links with other international exchanges. Even so, the exchange
needs to continue to manage fast growth and possibly gear up for competition. John Rumsey reports.
EDEMIR PINTO
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CEO, BM&FBOVESPA
Edemir Pinto (left), CEO of BM&FBovespa. Photograph kindly
supplied by BM&FBovespa, November 2010.
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CONRAD KOZAK
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CEO, JP MORGAN SECURITIES SERVICES
O
NE OF THE things that annoy Conrad Kozak, chief
executive of JP Morgans securities services business,
is the charge of commoditisation. If you are
delivering services on a global basis, without screwing up,
thats not a commoditised offering,he avers. It is a particular
truth as the one time gulf between traditional and alternative
investment approaches narrows to nothing. The approach
to business and our business models have not changed, he
explains, rather we used to be able to draw a line between
hedge funds and traditional asset managers; and it has
meant that we have to be fleet of foot in tying our suite of
services together to provide the same set of services to both.
We sometimes might struggle with the complexity of
reporting, for instance. The fact remains however: the events
of the last few years have accelerated the need for us to
become integrated across asset types and all geographies.
It has resulted in a slew of services upgrades. In the US,
for instance, the bank recently enhanced its offering of
regulatory reporting services for money market funds to
assist asset managers in complying with SEC revised Rule
2a-7 requirements. Thereby ensuring higher credit quality,
improved liquidity, and shorter maturity limits, including the
calculation of weighted average life. The bank is also helping
advisors meet enhanced disclosures of fund level, class level
and security level data requirements. Equally, it has ratcheted
up services to assist clients prepare new financial statement
derivatives disclosures.
Elsewhere, the bank has introduced Auto Substitution, a
new functionality that helps reduce the sizeable credit risks
historically associated with the $2trn tri-party repo market,
while allowing dealers to retain access to securities required
for intra-day trading. The move is part of the banks efforts
to help investors and dealers mange their collateral and
mitigate risk through its Global Collateral Engine initiative,
a strategic investment programme to deliver enterprise-
wide collateral management.
The trend is picking up helter-skelter. Theres a
requirement for counterparty risk analysis and all of a
sudden an asset manager wakes up to the need to know
what the risk is to all his counterparties and if he is using
multiple custodians its more complicated,adds Kozak.
Other trends are also in train. Because the world is a
more dangerous and complex place, it has encouraged the
bank to refocus on the sub-custody business, at least where
it makes sense and can be done as cheaply as local providers.
Two years ago, we would not have looked at it; now we feel
more comfortable and it has changed the way we think
about and approach risk,he explains. It is also symptomatic
of a sea-change in the sources of new business. Some 60%
of revenue is now outside the US,says Kozak, with Europe
and Asia dominating new business.
China is the bellwether of this change: It is a very different
market, where the award of custody business is traded off
distribution. We have been successful in capturing a clutch
of outbound businesses, but a huge amount is inbound
and is captive with local banks that distribute. In North
Asia and Australia however, it is like the rest of the world,
cedes Kozak.
For now the struggle is between the excitement of the
opportunity of new growth models, such as that presented
by the recent Nordic deal (JP Morgan two years ago acquired
Nordeas institutional custody business) and new offices
in places such as Abu Dhabi, and the need to maintain the
integrity of the overall service offering and a centralised
operational structure based on regional administrative and
processing hubs. Essentially we want to be as local as
possible, with maximum usage of big factories.
Added to this, is the ability to provide a long suite of
products utilising specialist skills available elsewhere, such
as investment banking operations.
Strength in depth of service offering is key in this regard,
cedes Kozak, who points to the recent agreement with
NASDAQ OMX Stockholm AB, through which JP Morgan
became the first non-Nordic custodian for the NASDAQ
OMX Derivatives Markets. If we are going to be a winner
in the securities services business, it has to be based on the
connection with our investment bank and the cross-business
opportunities that presents. If we get that right, as we are
doing with the prime broking segment, for instance, it is a
massive uplift for the client, who benefits from one point of
contact across a slew of high quality products, not some of
the time, not most of the time, but all of the time.I
We are now back in that mould of developing new strategies to leverage cross currents of change
in the global financial markets. The difference is that this time around there is a greater emphasis on
better quality data, market transparency, risk management and operational risk, holds Conrad
Kozak, chief executive officer of JP Morgans securities services business. It provides us all with
opportunity and challenges. The tip in 2010 has been in local custody; a move encouraged by the
shift of responsibility onto depositary banks and away from the sub-custodian. Moreover, the bank is
stepping up its global risk and collateral management offerings to the nth degree: it is re-writing the
business book and JP Morgan is leading the charge.
DOWN AND DUTIFUL
65
O
UTDATED TECHNOLOGY TURNED the TSE into
a quaint relic anchored in the previous century. That
all changed in January 2010, when the TSE launched
its arrowhead trading system, designed to cut order execution
times to five milliseconds (ms) and achieve 3ms data
distribution times. The amount of market data made available
was increased, too, from five quotes either side of the central
price to eightall made available in real time through a new
data service called FLEX Full. In practice, the arrowhead
system has performed even better than expected in the ten
months since its launch, notching up average execution times
of 2ms to 3ms and 2.5 ms for data latency.
Its no exaggeration to say that arrowhead has transformed
how the TSE functions. The number of daily orders has
jumped from 6m to 10m, driven in part by high frequency
trading firms, which have come from nowhere to account
for an estimated 30% of trading based on the volume routed
through the TSEs new co-location facilities.
Although the development of arrowhead began in March
2006, 15 months before Saito was appointed TSE president and
chief executive officer, he played a crucial role in shepherding
the project to its successful conclusion. He took a personal
interest, repeatedly emphasising to the chief executive officer
of Fujitsu, which designed the system, the importance of top
quality reliability and the lowest possible latency in both
execution and data distribution. Saito also spearheaded
marketing to both domestic and international brokers and
investors, an effort that has borne fruit in wider participation
by non-Japanese investors after the arrowhead launch.
The introduction of high-frequency trading has had the
familiar effects observed in other markets of cutting average
ticket size and narrowing bid-offer spreads. The TSE also
amended its trading rules to permit narrower tick sizes and
streamline the operation of daily price limits and opening
price auctions. It also eliminated half-day trading sessions.
The increased flexibility has not yet translated into higher
share trading volume, however; in the first ten months of
2010, the TSEs First Section traded a daily average of 42.8bn
shares versus 46.6bn in the same period in 2009although
without the new trading system share volume might well
have fallen even more.
Tighter dealing spreads translate into lower trading costs,
of course; by some third party consultantsestimates, execution
costs for Japanese equities have tumbled 30% this year thanks
to arrowhead. The biggest reduction has been for mid-
capitalisation stocks, where tick sizes have tightened the
most, but liquidity has improved across the whole market.
Domestic and foreign investors alike have welcomed the
new system, which has proved its operational resilience: no
significant problems have occurred during the first ten months.
While arrowhead was essential to prevent the TSE losing
ground to other financial centers in the region, it has also
opened up new business opportunities for the exchange.
Co-location has attracted high-frequency trading firms
particularly from abroadwhich pay for the privilege, an
entirely new revenue stream derived from market participants
whose share of trading volume has shot up from zero to 30%
and is still growing. A 65% increase in order flow has generated
incremental trading fees for the TSE, too.
The transformation of trading on the TSE is part of Saitos
wider vision for the future of Tokyo as the pre-eminent financial
centre in a region destined to play an increasingly important
role in the global economy. Asia is a massive economic bloc,
home to two-thirds of the worlds labour force, whose rising
prosperity has unleashed local consumer demand that will
shift the balance of economic activity permanently eastward.
Regional financial centres that have long played second fiddle
to New York and London will gain in stature, and Saitos
mission is to ensure that the TSE capitalises on expertise and
experience gained over many years as a leading international
market to propel Tokyo to the fore against stiff competition from
Shanghai, Hong Kong, Singapore and others.
The liberalisation of Chinese markets will have a large
impact on international financial markets,says Saito. We
view them as worthy rivals and valued business partners. I
believe this provides an opportunity for the TSE, Hong Kong
and Shanghai to consider what can be done to benefit all
our markets in the long term.I
TAKING IT TO
THE LIMIT
When Atsushi Saito, an industry veteran who spent 35 years at Nomura Securities, took over as
president and chief executive officer (CEO) of the Tokyo Stock Exchange (TSE) in June 2007, the
leading Japanese equity market was on its way to becoming a financial backwater. Average order
execution times were measured in seconds, a Stone Age standard compared to leading
international markets in Europe and the United States where milliseconds (ms) were already the
norm. Moreover, co-location services did not exist, which prevented high frequency trading firms
from bringing their expertise and liquidity to the TSE.
ATSUSHI SAITO
G
TOKYO STOCK EXCHANGE CEO
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Atsushi Saito, CEO,
Tokyo Stock Exchange.
Photograph kindly
supplied by TSE,
November 2010.
T
EXANS LIKE TO brag about how everything is bigger in
their state, but Richard Evans Jr made his company better,
and in the long run almost certainly bigger as well, by
giving up a large chunk of business. Dick Evans is chief executive
of San Antonio-based Cullen/Frost Bankers (CFR), and back
in 2000as a boom in home loans began that eight years
later would nearly bring down the worlds financial system
he stopped making residential mortgage loans. We had no
crystal ball, Evans says. We did exit that business, which
was about $200m a year in mortgages we were creating,
because we felt that it did not stay focused on our mission.
Evans emphasises that Cullen/Frost was built on long-term
relationship banking, not on transactional banking. So as
homeowners began refinancing their loans nearly as casually
as they applied for new credit cards, he saw trouble ahead.
Our mission statement says that we will grow and prosper
by building long-term relationships based on top-quality
service, high ethical standards, and safe, sound assets, he says.
Thats not a mission statement that just hangs on the wall
and nobody pays attention towe live it. Our core values
are caring, integrity and excellence. Our value proposition
that has come out of all this is that we want all our customers
and staff to feel significant and to recognise that were about
excellence at a fair price and that were a safe, sound place to
work and do business.
In describing Cullen/Frost, Evans again and again uses
the term safe, sound. It describes not only the banks
decision to walk away from the booming home loans market
but its overall approach to lending. The companys Frost
National Bank subsidiary aggressively seeks business
customers, but it is uncommonly judicious in making loans.
Its safe and sound policy is a throwback to another era, when
bankers actually felt responsible and accountable for how
their banks operated. Although Cullen/Frost has suffered
through some tough times during its 142-year-history, it has
not only survived, it has triumphed. Today, with $17bn in
assets, it is the largest bank headquartered in Texas and ranks
fifth among all banks doing business in the state.
As recently as 1985 it was among the states smaller banks,
but as the boom in oil prices turned into a bustthe price of
crude fell 60% in seven monthscommercial real estate
loans tanked. Meanwhile, the savings-and-loan (S&L) crisis
was unfolding, bringing down S&Ls that had depended too
much on volatile short-term deposits to finance shaky long-
term loans. Of the ten largest Texas-based banks, Cullen/Frost
was the only one that survived intact.
Although it got pretty beat up during that time, the
managementwhich is pretty much in place todaylearned
a lot of lessons, says Bain Slack, an analyst at Keefe, Bruyette
& Woods. So as credit became very easy during this decade,
specifically during the middle part, the Cullen/Frost
management team quickly realised that theyd seen this
movie before and were determined not to get caught in the
same cycle that had caught many of their brethren in the
previous cycle. When a lot of banks were lowering their
standards to get loan growth, Cullen/Frost kept its standards
fairly high with regard to its underwriting.
When the financial crisis struck, hitting many small Texas
banks as well as US national giants like Wachovia and
Washington Mutual, the impact on Cullen/Frost was relatively
mild. Loan-loss provisions rose and per share earnings declined
in 2009, but dividends, book value and assets all increased.
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A MOULD
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In a period where good news is at a premium,
heres some welcome uplift. Through the great
recession some companies not only remained
profitable but positioned themselves for
continued growth by adhering fiercely to their
core principles. Their success offers lessons for
other companies. Art Detman profiles four such
companiesthree American and one Canadian.
67
When the US Treasury came calling to enroll Cullen/Frost in the
Troubled Assets Relief Program (TARP), which has since become
a four-letter word, Evans said no. We did not take TARP
because it was not in the best interests of our shareholders.
We had strong capital and our financial analysis of the cost
showed it was 11% in the early years, not 5%. We were the
first bank to publicly say: Thank you, but no thank you.
Today, Cullen/Frost is sitting pretty. It has 110 banking
offices throughout Texas, including ones in three of Americas
ten most populous cities (Houston, San Antonio and Dallas).
Its market share is not quite 3%, so there is plenty of room
for growth. We could double the size of the bank if we took
less than 5% of the business away from the top banks that
operate in Texas, Evans says.
Whereas Cullen/Frost sees opportunity for further expansion
within the state of Texas, RPM International (RPM) of Medina,
Ohio, seeks growth on a global scale. It manufactures in
more than 20 countries and sells in nearly 150. Founded in
1947 as Republic Powdered Metals, RPM is the very model
of an industrial company, manufacturing a wide variety of
specialty chemicals, sealants, preservatives, caulks, coatings,
roofing systems, adhesives and other products that protect
the surfaces of buildings, bridges and other structures. About
65% of its products go into the industrial market, while 35%
are sold through hardware stores and other retailers to
consumers. DAP, Flowcrete, illbruck, Rust-Oleum, and Tremco
are among its many brands.
The housing crash barely fazed RPM, whose sales fell just
7.6% in fiscal 2009 and edged up to $3.4bn in the following
12 months. For most shareholders, the most important thing
was an increase in dividend, the 37th consecutive annual
increase. Elliott Schlang, an analyst with Soleil Securities,
reckons that during the past five years RPMs dividend has
grown at the compounded rate of about 6.5%, and the 4.5%
yield, or whatever it is right now, looks extremely attractive,
especially given the strong cash flow that the country has
and the consistency of its growth historically.
RPM chief executive officer Frank Sullivan attributes the
consistency and profitability to the companys entrepreneurial
operating structure and philosophy. Were big believers in
pushing decision-making to the market, he says. We
operate with 50 independent companies, and a third of our
businesses are operated by the original founder-owner or a
second or third generation family member. Versus our big
peers in either building materials or paints-and-coatings,
we are the only one who has this very decentralised,
entrepreneurial operating philosophy.
When RPM makes an acquisition, sometimes it buys a
specific product, occasionally manufacturing capacity, and
more often than not a distribution channel. However, whats
most important is management. Sullivan says: We look for
companies with good management teams who want to stay
and operate the business as part of RPM, and I think we
have enough of a hands-off approach to encourage and
energize them to continue to run their business.
One example is Euclid Chemical, which was a small
Cleveland-based company when RPM acquired it in 1984.
Founder Larry Korach handed management to his son Jeff.
When Jeff moved up to run the Buildings Solutions Group
(which includes Euclid), his brother Ken took over at Euclid.
Both recently retired and Jeffs son, Randy (a 15-year company
veteran), succeeded him as head of Building Solutions Group.
This is a great example of the kind of family heritage were
looking for, Sullivan says. Fortunately for us at RPM, weve
had three generations of Korach entrepreneurial zeal. So I dont
think its just a coincidence that the original business, which
was about eight million bucks in sales when we acquired it,
is now more than a billion dollars.
RPM typically has years of experience in dealing with a
company before it makes an offer to acquire it. In some
cases, a couple of years, says Sullivan. In others, 10 or 15
years. During this time we develop a very good understanding
of their business and what drives their growth, and they
develop a good understanding of RPM and how we operate.
As a result of this careful courtship, acquisitions almost
always go smoothly. I cant think of a time when we had to
replace a founder or a founding family member who was
there when we acquired the company. Weve never had an
entrepreneur walk away, and weve never fired one. The
challenge comes down the road, when the entrepreneur is set
to retire. We have had instances where we have struggled
to find leadership that would continue running the business
with the same passion as the management that was in place
when we acquired it.
From left to right: Dick Evans from Cullen/Frost Bankers, Scott Di
Valerio of Coinstar, Frank Sullivan from RPM International and
Dennis ChipWilson from Lululemon Athletica.
RPMs strategy is to achieve first or second place in each
of the niche markets it serves. They do this through savvy,
strategic acquisitions and internal product development,
says Schlang. They have done a wonderful job, in roof
coatings especially. No matter how bad the real estate
market is, the last thing any owner of an office building or
industrial plant is going to do is not put something on the
roof to prevent water damage. That replacement business
is golden for them.
The sealants and coatings business is fragmented, so there
is plenty of room for RPM to grow. For the past 25 years,
including the recessionary periods, our annual compounded
revenue growth has been around 11.9%, Sullivan says.
About five percentage points of that is from acquisitions,
and slightly more than 6% has been from internal growth.
If Cullen/Frost and RPM demonstrate how businesses can
be built on personal relationships, Coinstar (CSTR) shows
how success can come from providing services in an
impersonal but highly convenient way. Based in Bellevue, just
east of Seattle, this young company (founded in 1991) is heir
to more than a century of vending machine development,
stretching back to the early 1880s, when coin-operated
dispensers of postcards were introduced in London.
As its name suggests, Coinstars original product is a coin-
counting machine that accepts loose change and issues a
voucher that can be redeemed in whichever store the machine
is located. The fee, which is shared with the retailer, ranges
up to 9.9%, depending on the country. If the coins are donated
to a charity, their full face value is credited. If the coins are
redeemed as a gift card, to be used at the participating retailer,
again the full face value is credited.
Publicity coup
About 19,000 machines are in use in the US and UK, both of
which have enough compulsive hoarders to support a
profitable if modest level of business. John Kraft, an analyst
at DA Davidson, expects the coin business to bring in $272m
in revenues this year compared with $1.7bn for DVD rentals.
Our 2011 estimate is $278m for the coin businessalmost
flat, he says. Our estimate for the DVD business is $2.38bn,
up almost 20%. Coin-counting is a steady, humdrum business
that once in a while produces a human interest story, such as
that of the penny-saver in Alabama whose local bank refused
his 1.3m coins$13,000 worth. Sensing a publicity coup,
Coinstar sent an armoured truck to pick up the pennies,
which weighed 4.5 tons. The truck sank in mud in front of the
house and had to be towed out.
There arent any stories like that about Redbox. The concept
was developed at McDonalds, which was seeking products
that would drive traffic into its fast-food outlets. Because of
its experience in placing automated machines in retail
locations, Coinstar got involved and, when McDonalds
decided Redbox was too much of a diversion, became the
dominant partner. In February 2009 Redbox acquired
McDonalds remaining interest for $175m. McDonalds
didnt want the distraction of this little company, so Coinstar
got Redbox for what basically was a steal, says Kraft.
Maybe so, but until then the company had struggled to
achieve clarity in its business model. At one time it owned a
grab bag of businesses, including coin-operated arcade games,
pre-paid credit card kiosks, and a money-transfer operation.
All are gone, and a new management team headed by chief
executive officer Paul Davis is in place. Today, the company
is focused on providing self-service kiosks for the fourth
wallthat area of a store, restaurant, bank or similar
establishment that normally is empty. We convert what
otherwise would be dead space into the highest profit per
square foot in their stores, says Scott Di Valerio, Coinstars
chief financial officer.
We look at that space and use it to fulfill unmet needs
that the consumer has by serving the consumer in a self-
service fashion, he explains. If you think about our coin
business, where we process $3bn-worth of coins a year, and
our Redbox business, where we are serving up new-release
DVDs at a dollar a night, its really all about meeting unmet
consumer demand from a self-service perspective in an
efficient way that represents value and convenience.
Each Redbox kiosk stocks around 210 titles, and in some
locations Coinstar has installed a second unit. By the end of
fiscal 2010, Di Valerio expects the company to have 30,000
Redboxes in 26,000 locations. This should increase further
in the next few years as the result of an agreement reached
recently with CVS Caremark, which has more than 7,000
pharmacies across America.
The growth of Redbox and its competitor Netflix (which sells
by mail and through internet downloads) may spell doom for
traditional bricks-and-mortar outlets. Last February smallish
Movie Gallery filed for bankruptcy and in September giant
Blockbuster, a chain of 3,300 stores that once dominated the
DVD rental business, also entered bankruptcy (although, for
now at least, many of its stores will remain open).
Should Blockbuster liquidate, any markdowns in its
inventory would hurt Redbox rentals. Yet this would be
temporary and likely be offset by new business from the CVS
deal. However, if Redbox and Netflix can bring down
Blockbuster, will video-on-demand (VOD) over the internet
bring down Redbox? Its a question management has clearly
pondered. One response may be a link-up with a hi-tech
company such as Apple in order to provide VOD. Davis has
acknowledged a long-standing relationship with Apple, and
said that Coinstar is exploring multiple opportunities in
online delivery.
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When the financial crisis struck, the impact on
Cullen/Frost was relatively mild. Loan-loss
provisions rose and per share earnings
declined in 2009, but dividends, book value
and assets all increased. When the US
Treasury came calling to enroll Cullen/Frost in
the Troubled Assets Relief Program (TARP),
chief executive Richard Evans said no.
69
Another response is further diversification in the self-
service automated kiosk business. We have a number of
initiatives to drive internal growth in new concepts, says
Di Valerio. One is coffee. Coinstar has hired a Starbucks
executive and is working with the coffee company to develop
kiosks that would dispense Starbucks Seattles Best brand.
Another promising area involves recycling cell phones.
We made an investment in a company in San Diego called
ecoATM, Di Valerio says. Its a small company, five or six
kiosks, that is leveraging the second-hand market for cell
phones, predominately in developing countries.
The idea is that a cell phone owner could take an existing
phone to a kiosk, which would run a number of automated
inspections and then make an offer to purchase the phone.
If accepted, the phone would be deposited into the kiosk and
its seller would receive a voucher that could be used to buy
a new phone. Its a good example of a business that meets
a need in the automated retail space, Di Valerio says.
In contrast to Coinstar, Lululemon Athletica (LULU)
another Pacific Coast company, this one based in Vancouver,
British Columbiais intensely people-oriented. Founded
by Dennis ChipWilson in 1998, this designer and retailer
of yoga-inspired apparel is expected to have sales of perhaps
$630m this year, on which it will net $87m, for an after-tax
profit margin of 13.8%. Wilson, who once headed a
sportswear company, created Lululemon after taking up
yoga. He became convinced that yoga provides optimum
exercise for people of all ages but thought its apparel
heavy cottons and polyester blendscould be improved.
Today, he is chairman and chief designer. His chief executive
officer is Christine Day, a 20-year Starbucks veteran who
joined the company in 2008.
Neither was willing to talk to FTSE Global Markets, which
may be just as well. The company is flushed with its initial
success and parts of its press kit read like statements from the
early days of Google, which Chip and Chris might find a bit
difficult to explain with a straight face to journalists. Example:
At Lululemon Athletica, we have an original intentto
elevate the world from mediocrity to greatness.
So far, theres no sign of that, but without a doubt the
company has achieved remarkable success in a very tough
business, and it has done so by creating superior products for
a specific audience and marketing those products very
effectively to this audience. As a result, it has built up an
enthusiastic following among Wall Street analysts, some of
whom flatly state that Lululemon, small as it is, already is a
great company.
The product is unique, differentiated, technologically
advanced and highly effective for its intended taskyoga,
indoor athletics, that sort of thing, says Richard Jaffe,
managing director of Stifel Nicholaus, who ticks off specific
product advantages: Four-way stretch, breathable, lightweight,
wicking, functional pockets, non-binding waistbands.
Another Lululemon advantage: The corporate culture
within the stores, within the company itself. This creates a
unique in-store experience, a unique shopping experience,
and a unique attribute in the brand. The company has
about 130 stores in the US, Canada and Australia, but has
been adding stores at a steady clip and expects to open at
least 15 more in 2011. Because the apparel designs are
mainly function-driven rather than fashion-driven,
markdowns are infrequent.
This is offset partly by the high degree of personal service
provided by the sales clerks, or educators, in Lulu-lingo,
who are both knowledgeable and passionate about yoga.
Another extra cost is working with yogis and athletes on
a local basis, which provides product feedback. In early
2009 the company began selling through its website, and
analysts expect sales here to increase sharply, with a resulting
boost to margins.
Relentless focus
Lululemon caters primarily to young, affluent urban women
who are health conscious and can afford the companys
premium prices. Jaffe and others believe that the company can
grow from this base into other areas, such as skiwear,
swimwear, casual clothing and footwear. They have expanded
to include some running gear, and theyve experimented in
a very small way with apparel for biking, he says. Their
mens business is a very small part of their franchise and
could be further developed.
In just four years Lululemons sales have increased threefold,
while its gross margin has held steady and its operating
margin and net profit margin have climbed. The key, analysts
believe, is managements relentless focus on its corporate
identity. The company has been very judicious in its growth,
says Edward Yruma, a vice president at KeyBanc Capital
Markets. It has really strived to protect that unique in-store
culture, where employees offer great customer service that we
dont see in many other places in retail. As for Chip Wilson
and Christine Day: They are one of the best management
teams in specialty retail.
So there you have it: A Texas bank that doesnt make
mortgage loans, an Ohio manufacturer that strives for multi-
generational management, a Washington State company
that focuses on monetising the fourth wall of retailing, and
a Canadian apparel maker that has a quirky press kit and
great clothes. They might seem like a diverse lot, but actually
they are more alike than different. Each has a clearly defined
sense of purpose, a strong corporate culture, and a
determination to adhere to core values in good times and
bad. The world could use more companies like these. I
Lululem Athletica is flushed with its initial
success and parts of its press kit read like
statements from the early days of Google,
which Dennis Chip Wilson and Christine Day
might find a bit difficult to explain with a straight
face to journalists. Example: At Lululemon
Athletica, we have an original intentto elevate
the world from mediocrity to greatness.
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N CANADA, LIKE other markets where high-frequency
trading has taken hold, bid-offer spreads have collapsed
and trading volumes have soared. Advocates often cite
the benefit increased liquidity brings; and for retail investors,
the advantage may be real. They can trade against other
market participants on a more equal footing. Its a different
story for institutions that want to trade blocks, however
and its a nightmare for traditional broker-dealers, who face
soaring trade processing costs.
High-frequency trading firms use small orders, which drive
down the average ticket size per trade. Executions get broken
up across multiple trading venues, too, which makes it harder
for brokers to process multiple fills on a single ticket. Broker-
dealers must connect to every venue in order to meet best
execution obligationsand face ongoing costs for market
data at each venue as well. For regulators to monitor high-
frequency trading they will have to increase their technology
spend significantly. This investment will largely be paid for
by the sell side broker-dealers,explains Greg Mills, managing
director of global equity sales and trading at RBC Capital
Markets. It is just wrong.
Mills argues that the liquidity high-frequency trading
provides is illusory for anyone trading in size. Algorithms
typically tap the cheapest venues first, which may not be
where the high-frequency trading order flow rests. As soon
as a buyer or seller begins to absorb cheap liquidity, high-
frequency traders will cancel their offers or bids on other
venues, raising the market impact cost. You will see one
million shares of a big liquid stock offered across several
venues, but you cant buy that much,says Mills. High-
frequency trading firms take the information advantage but
dont have any commitment to trade. RBC is fighting back,
however. In April, it introduced its Thor algorithm, which
delivers an order simultaneously to every selected venue so
that bids and offers cannot be pulled. Mills says Thor grabs
100% of the displayed liquidity in most cases.
To Dan Kessous, chief operating officer of Chi-X Canada,
high-frequency traders just have a different profile. Whether
investors buy and hold a stock for a few seconds, a week or
a month, they are all trying to make money,he says. High-
frequency traders are willing to trade with other participants.
It is in my mind real liquidity.Chi-X Canada handles about
9% of Canadian share volume, making it the second largest
alternative trading venue (after Alpha Group, owned by the
five major Canadian banks, which handles about 15%).
Kessous attributes Chi-Xs success to its strong brand
recognition among global investors and its introduction of
innovative order typeshidden orders and pegged orders,
for examplethat other venues didnt have at the time and
in some cases are still not available anywhere else.
The first alternative trading system launched in Canada
was Pure Trading, a subsidiary of CNSX Markets, but the
firm hasnt capitalised on its first mover advantage. Pure
captured just 2.9% of trading volume in October even
though it was the first venue to facilitate high-frequency
trading. At the time Pure was developed, Canadian trading
infrastructure was not up to the latency or capacity demands
of electronic market making, statistical arbitrage, pairs
trading, cash vs. derivative index arbitrage, ETF arbitrage,
all of which are ordinary course activities today, says
Richard Carleton, who is responsible for the operations,
technology and sales at Pure.
HFT TIPS
THE DARK
POOL AGENDA
High-frequency trading has shaken up a
Canadian equity market long dominated by the
incumbent exchange and five big banks. In late
2008, the Toronto Stock Exchange (TSX) beefed
up its infrastructure and embraced maker-taker
pricing in an attempt to blunt the challenge
from alternative venues such as Pure Trading
and Chi-X Canada that already accommodated
high-frequency trading. The TSX has still lost
market shareby late October 2010, it had
slipped below 70%though probably less than
if it had not changed its pricing model.
Investors anxious to avoid high-frequency
trading order flow are turning to dark pools,
which have been slow to develop in Canada
thanks to its unusual broker preference trading
priority. Neil OHara reports.
Photograph Eugenesergeev / Dreamstime.com,
supplied November 2010.
71
Regulators fostered alternative trading systems to break
the incumbent exchange monopolies, but in so doing they
opened the door to high-frequency tradingan even bigger
regulatory concern. The irony is not lost on Steve Grob,
director of group strategy at Fidessa in London, who says
that regulation and technology are being combined in different
ways in different countries in a huge global experiment.
In Canada, the best execution obligation extends only to
Canadian trading venuesbut for the 220 stocks that are
interlisted in the United States the best price may be on
NASDAQ, the New York Stock Exchange, BATS or Direct
Edge. What is the broker supposed to do?asks Grob.
Maybe he can do a better job for his customer by not
following Canadian best execution obligations and trading
south of the border. In one week in late October, for example,
the Fidessa Fragulator tool shows most of the trading in
Research in Motion, the Canadian maker of Blackberry
devices, took place on US venues. Real trading patterns
simply dont fit the tidy boxes regulators want to put them in.
High-frequency trading is the latest iteration of a well-
worn market strategy. Grob argues it is similar to firms that
located their offices closer to the exchange, put more traders
on the exchange floor, or invested in hand-held devices. In
every case, the goal was faster executiononly today, the
edge is measured in microseconds rather than physical
distance. Some Fidessa customers argue that high-frequency
trading firms, which have become the de facto default liquidity
providers, should have an obligation to make a market at all
times, not just when they want to. Others are not worried
who is on the other side as long as their orders get filled.
Grob wont take sides, though he acknowledges it is a
legitimate question.
Rogue orders
Every microsecond counts to high-frequency trading firms,
which explains their preference for co-located direct access
to trading venues, which minimises latency. Best of all from
their point of view is so-called naked access, in which they
rent a brokers identification number and enter their trades
without any prior intervention by the broker. Canadian
regulators have so far refused to clarify their attitude toward
naked access despite confusion among market participants.
CIBC has aggressively pursued the business, but the other big
banks have stayed on the sidelines pending regulatory
clarification. In early November the SEC adopted a rule that
requires brokers to pre-filter trades, a policy Canada is widely
expected to follow.
A filter at the broker level may not eliminate the risk of
rogue orders, however. Although most high-frequency trading
firms are not registered as broker-dealers, they could do so
in which case they would still have access to the exchanges
without third party review of their trades. Where do you put
the fuse box?asks Grob. Is it at the sender of the flow, the
broker in whose name the flow goes through, or the venue
where it is matched?He suggests the responsibility should
lie with the exchanges, which have an obligation to maintain
an orderly marketa solution that would prevent high-
frequency trading firms from skirting the SECs new rule.
Pure Tradings Carleton believes Canadian regulators may
prefer the model proposed by IOSCO in its August 2010
paper on electronic trading. It requires brokers to have
sophisticated risk management controls to protect against
Jackie Allen, a director at Bank of America Merrill Lynch. Algorithms
and buy side self-execution is becoming a bigger percentage of the
volume traded, says Allen, but the information sell side traders can
provide is still a valuableand valuedservice in Canada.
Photograph kindly supplied by BofAML, November 2010.
Greg Mills, managing director of global equity sales and trading
at RBC Capital Markets. High-frequency trading firms take the
information advantage but dont have any commitment to trade, he
says. Photograph kindly supplied by RBC Capital Markets,
November 2010.
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aberrant trades, but markets could still provide hosting
services. That does not necessarily mean a ban on naked
access,he says. As a general rule, the best risk management
systems in the securities industry are at the high-frequency
trading firms. They far exceed the capabilities of any agency
broker I have ever seen.
Institutions in Canada have begun to adapt their trading
techniques to prevent high-frequency traders from gaming
their orders. Jackie Allen, a director at Bank of America Merrill
Lynch, sees clients using urgent order types and sophisticated
algorithms that take into account live market conditions as
well as historical statistics. Upstairs block trading has dwindled
as buy side traders turn to algorithms and the banks cut back
the capital they commit to facilitate trades. The upstairs desks
still have a role to play, however, particularly in less liquid
stocks that attract little interest from high-frequency traders.
Algorithms and buy side self-execution is becoming a bigger
percentage of the volume traded, says Allen, but the
information sell side traders can provide is still a valuable
and valuedservice in Canada.
The rise of dark pools
The broker preference priority of trades that applies on every
venue except Chi-X allows brokers to jump the queue if they
have the other side of a trade, even if another broker was
there already at the same price. In effect, the rule lets brokers
internalise order flow on an exchange, forestalling the need
for the broker-owned dark pools that achieve the same result.
Moves are afoot to bring more dark pools to Canada, however,
and Allen expects innovation with dark order types as well.
The trading community tells us that dark can offer
tremendous added value in illiquid names,she says. Dark
has a long way to go in Canada.
Liquidnet launched its Canadian dark pool in 2006 but
the product has struggled, although volume did pick up this
year. Lower average ticket sizes have reduced the threshold
at which market impact costs kick in; one customer told
Robert Young, chief executive officer of Liquidnet Canada,
that a 50,000 share handled by an algorithm today can have
as much impact as a 500,000 share block had in the past.
The flash crash also made portfolio managers and plan
sponsors aware of how toxic some liquidity can be, something
traders already knew. It empowers the buy side trader to
use tools like Liquidnet more when others on the investment
team see the value,he explains.
International investors accustomed to the strict price-time
priority that applies in most other markets worldwide see
broker preference as unfair. Chi-X Canada doesnt allow it,
but the rule enjoys strong support among local investors as
well as brokers. Rather than removing broker preference
entirely, venues will offer an alternative, and let traders make
the choice,says Bryan Blake, vice president at Bank of America
Merrill Lynch. The TSX recently announced plans to launch
TMX Select, a parallel liquidity pool that will apply strict
price time priority. The new venue, which will use existing TSX
infrastructure to minimise costs, will go live in the second
quarter of 2011 if regulators give the go-ahead.
Another new facility expected to go live in late 2010 is
Alpha IntraSpread, a dark order type proposed by Alpha
Group that would allow brokers to keep their entire order flow
internal as long as it matches or beats the National Best Bid
and Offer (NBBO) at the moment the trade takes place.
Broker preference on lit venues today allocates any unmatched
portion of an order to other participants based on price time
priority. The Alpha IntraSpread facility takes internalisation
to the next level,says Allen.
Some market participants are concerned that dark pools
designed to exclude high-frequency trading could harm the
lit markets. If regulators amend the rules selectively to
accommodate dark pools, the diverted liquidity will no longer
aid price discovery on the exchanges. Allowing sub-penny
pricing and relief from the order disclosure rule on dark
markets would potentially disadvantage visible markets,
says Evan Young, head of DMA and algorithmic trading at
Scotia Capital. We think market regulation should promote
visible liquidity.
High-frequency trading has renewed interest in dark pools
among brokers in Canada, notwithstanding the broker
preference. Clients have approached RBC about creating a dark
pool that would allow them to expose orders without being
picked off by high-frequency traders. The idea appeals to Mills,
who recognises that a liquidity pool free from toxic elements
would be a compelling proposition. It is all about whether
someone is getting an information advantage without a
commitment,he says. That creates an unlevel playing field.
The future for Canadian trading may well lie in the dark. I
Richard Carleton, who is responsible for the operations, technology and
sales at Pure, comments: As a general rule, the best risk management
systems in the securities industry are at the high-frequency trading
firms. They far exceed the capabilities of any agency broker I have ever
seen. Photograph kindly supplied by Pure, November 2010.
Every microsecond counts to high-frequency
trading firms, which explains their preference
for co-located direct access to trading
venues, which minimises latency.
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But a single VaR number is not the whole story
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LIKED IT SO much, I bought the company. So said
Victor K Kiam, the American entrepreneur, who famously
bought Remington after liking the performance of his
new electric razor. It seems large stock exchanges are doing
just that in order to have the latest electronic capacity: the
London Stock Exchange (LSE) bought super-fast Sri
Lankan-based platform MillenniumIT and rolled it out in
November as its new trading platform; Nasdaq bought
OMX, which sells technologies around the world; Nasdaq
OMX is buying Australia-based Smarts Group, a global
leader in surveillance technology; and two-year-old NYSE
Technologies combines several technology companies
bought over the years by NYSE Euronext.
As speed and competition have increased in the equity
trading world, so has the pressure on not only the incumbent
exchanges, but also multilateral trading facilities in Europe and
alternative trading platforms in the US, to maintain investment
in their technological infrastructure.
Gerhard Lessmann, board member, Deutsche Brse
Systems, believes it is the demand for higher speeds and
state-of-the-art risk management, as well as greater
competition, which is driving the development of technology
at the heart of exchanges: We have customers who are
interested in the lowest possible latency, so we will continue
to focus our technology efforts in this area.
Certainly lower latency lies at the heart of much upgrading.
In April 2010 the Toronto Stock Exchange (TSX) announced
completion of the first phase of its equity enterprise expansion
project, migrating the TSX and TSX Venture Exchange trading
engines on to infrastructure which more than doubled its
speed, giving TMX group clients record low latencies, claims
the exchange.
This drive to lower latency comes at a cost as Lessmann
points out: Computer system matching engines need to be
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SPEED
IS KING
Stock exchanges are now
caught in a technology
frenzy-seeking lower latency,
introducing more efficient
matching engines and new order
types. The raison detre is that the
buy side have increasingly dynamic
expectations. Is that really true? Or are
the reasons much more diverse?
Ruth Hughes Liley reports
Photograph Kheng Ho Toh /
Deutsche Bank
Equity
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faster and smarter and these things are very expensive. For
a small exchange, it becomes more and more difficult to keep
up. Its mostly a fixed-cost business so once you have the
technology, you can trade ten times the volume at pretty
much the same cost, but it is costly to keep it up to date.
This cost has led some exchanges to set up partnership
arrangements with other exchanges to ensure they have the
latest technology. Warsaw Stock Exchange, for example, is
to migrate to NYSE Euronexts global Universal Trading
Platform as part of a multi-year commercial agreement.
In addition, consolidation has begun to occur in Europe.
The London Stock Exchanges purchase earlier this year of
a majority stake in Turquoise brought together a 300-year-old
incumbent exchange with one of its new MTF rivals, which
has its own implications.
Richard Balarkas, chief executive officer of agency broker
Instinet Europe, is baffled why exchange technology is
considered complex: They match buy and sell orders. It
really is that simple. Its a very commoditised process and
all that has changed is that its much faster than it used to be.
The acquisition of Turquoise by the LSE should become a
text-book example of a reverse takeover as, if the Turquoise
platform and pricing works, why wouldnt you just switch
to the more efficient model? When it comes to their transaction
matching services, this downsized model is the long-term
direction in which the large exchanges are heading.
Nonetheless, acquisition does seem to be one of the ways
that exchanges are diversifying and expanding their
technology. Through its acquisition of Smarts Group, Nasdaq
OMX has entered the surveillance and compliance market.
In a statement in July when the group announced a 39%
rise in profits in the second quarter, chief executive officer
Bob Greifeld said: These results demonstrate that our
diversified business model is capable of delivering solid
results while simultaneously allowing us to pursue growth
initiatives to drive our business forward.
Operational savings
The LSE purchase of MillenniumIT at a cost of $30m has
given the LSE a platform with sub-millisecond trading
latencies, a footprint in Asia and a replacement for TradeElect,
Infolect and other interfaces. MillenniumITs in-house
software development team will also gradually replace the
LSEs current suppliers and bring intellectual property
within the company despite glitches when it was introduced
in November.
In July, while the LSE announced a fall in turnover at its UK
cash equities business over the previous year, the acquisition
of MillenniumIT pushed sales from the technology services
business to 12.7m. It is also expected to create operational
savings of 10m from 2011-12.
Rollout of the new platform to Turquoise and the LSE was
due to begin in November, while Borsa Italiana, also part of LSE
Group, will migrate later. The Johannesburg Stock Exchange,
which has a technology agreement with the LSE going back
to 2001, expects to migrate to MillenniumIT in April 2011.
LSE Group claims MillenniumIT is the worlds fastest platform,
turning messages round in fewer than 100 microseconds.
Tony Weeresinghe, chief executive of MillenniumIT and
director of global development at LSE Group, says: The
implication for members will essentially be to change to the
FIX or Native gateway. Theyll also have to connect to the
FIX/FAST or ITCH market data gateways and might also
have to tune their performance to accept orders at a high
rate and quick response time. The two protocols, FIX/FAST
and ITCH, are already a recognised standard in the industry
and offer clients a choice of feeds with different attributes.
FIX/FAST takes up less bandwidth than ITCH, while ITCH
is low latency and streaming.
Deutsche Brse Group, meanwhile, has for some years
been developing a new global trading infrastructure. At a
technology open day in September, the group launched two
new interfaces in its bid to simplify the way its customers link
to Xetra and Eurex, the exchanges electronic trading platforms.
Lessmann says one of the interfaces offers differentiation
for the exchanges high-frequency customers, optimised for
low latency, while the other is a basic FIX-enabled interface
for the more traditional members. In addition, theres also
a graphical user interface with solutions for traders to be
able to connect via a browser from their desktops. This reduces
clients infrastructure costs and means less effort for them.
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Richard Balarkas, chief executive officer of agency broker Instinet
Europe. They match buy and sell orders. It really is that simple. Its a
very commoditised process and all that has changed is that its much
faster than it used to be. Photograph kindly supplied by Instinet,
November 2010.
77
Exchanges are also benefiting from sales of their technology.
Deutsche Brse, where around 1,200 people are employed in
IT in its various locations, has sold its Xetra platform technology
to customers including the Irish and Bulgarian stock exchanges,
Wiener Brse and the EEX European Energy Exchange. LSE
Groups MillenniumIT platform sales are growing at 100% and
Weeresinghe, not surprisingly, praises the benefits of off-
the-shelf technology: It makes the most sense for the
majority of exchanges as it tends to be the most cost effective.
The core requirements of most regulated markets are quite
similar. Why re-invent the wheel? Why go through an
expensive, time-consuming and potentially risky internal
build when you can simply buy a solution.
Also, revenues can be significant. NYSE Euronexts
information and technology solutions division revenue rose
$24m in the second quarter of 2010 to $107m or 29%
compared to the second quarter of 2009 and in the same
three months, NYSE Technologies closed several lucrative
multi-year software and infrastructure deals including one with
Tokyo Stock Exchange to build and support a new futures
trading platform for the exchange.
Meanwhile, Nasdaq OMX market technology business,
which sells technology to more than 70 market places,
announced total order valuethe value of orders signed
that have not yet been recognised as revenueof $453m
in the second quarter of 2010, up from $315m in the second
quarter of 2009. As competition increases between exchanges,
Owain Self, UBSs global head of algorithmic trading, notes
its impact. Exchanges are having to evolve to compete in
an increasingly demanding market place with enhancements
such as latency reduction, for example. We are seeing a lot
of innovation with improvements in matching engine
technology, new order types, etc. The driving force for this
change doesnt come from the sellside, per se. The buy side
have dynamic expectations of what constitutes best execution,
and they expect their brokers to determine where to trade
in order to achieve it. So while we dont tell the exchanges
what they need to do, the exchanges that provide a better
service will naturally attract more flow and therefore force
others to react to the demand for continuous improvement.
In Canada, where fragmentation has taken hold, and there
are four lit alternative trading systems, market places are
also feeling the competition. Three-year-old Omega ATS
saw a 1,134% volume increase in the year to July 2010, for
example. The best price obligation law, which currently puts
the onus on brokers, has been robustly enforced since January
2010. In February 2011, this onus will switch from the dealers
to the exchanges.
This is a big change in Canada, says Omegas new
president and chief compliance officer, Mike Bignell, who
believes regulation is one of the main drivers behind
advancement of technology. Its a compliance-driven industry
and it used to be a sales-driven industry. These days you
need to be a compliance officer with sales skills. If you are a
stock market you have to put yourself in a position to succeed.
The highly-automated, low-staffed multilateral trading
facilities in Europe owe their very existence to a change in
regulation. Florian Miciu, chief technology officer, Chi-X
Europe, explains the relationship: An exchange is very, very
complex. On the one hand you fine tune to the investment
community and on the other hand you fine tune to the
regulatory aspects and the geopolitical situation.
He believes an exchange can only compete successfully
when it has its own technology and its own pool of
knowledge. Its critical to be able to respond fast to the
regulatory and business environment and the problem with
a system supplied by a vendor is that the vendor will respond
Florian Miciu, chief technology officer,
Chi-X Europe, explains the relationship:
An exchange is very, very complex. On the
one hand you fine tune to the investment
community and on the other hand you fine
tune to the regulatory aspects and the
geopolitical situation.
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to this only when the majority of clients are requesting a
change.While Nasdaq OMX is buying Smarts Group to
provide market surveillance technology, Chi-X Europe took
the decision last year to build its own. Deutsche Brse has
had a variety of surveillance technology in place since 2002,
including automatic circuit breakers or volatility interruptions,
similar to those launched on Nasdaq OMX in September. If
a stock price moves too quickly, an automatic stop comes
into place and the trade reverts to an auction model that gives
all participants time to readjust.
We are pretty certain that something like the flash crash
in the US couldnt happen on our platform, says Heiner
Seidel, a spokesman for Deutsche Brse.
The so-called flash crash on May 6th, when the Dow Jones
plummeted, was the subject of an investigation by the US
regulator, the Securities and Exchange Commission. On
September 30th it published its findings, among which it
highlighted the integrity and reliability of market data
centres processes, especially those that involve the publication
of trades and quotes to the consolidated market data feeds.
Weeresinghe says: One of the main things surveillance
technology is looking for is to perform real-time surveillance
and a system that can handle a large volume of data.
Surveillance is also looking for automated pattern recognition,
automated relationship recognition and online case
management. It also needs flexibility to perform intra-day
alerts. Threats come from many anglesfrom a bad algorithm,
from a rogue trader, from market manipulation practices or
even from system hackers. We deal with this on a daily basis
but our system is a highly flexible, real-time surveillance
system which has many algorithms to trace the unexpected.
With messages travelling down fibre optic cables at 67%
of the speed of light, or 200,000km per second, according to
Chi-X Europe figures, technology connecting to the exchange
has to be sound. Chi-X Europe handles 225,000 messages a
second, for example, while MillenniumIT has been tested to
1m orders a second.
Speed is indeed king and one aspect often overlooked is
the time to cancel an order. Miciu says: Traders like to live in
a deterministic world. They need to shoulder a great deal of risk
and typically, they have to wait a few seconds between sending
messages and confirmation of receipt. In those few seconds the
landscape can be dramatically different. Exchanges have to
respond much faster to the incoming orders and cancellations.
Its a fine line: many people think about how fast did
you get my order and confirm it?but the risk carried in a
decision to buy an order is primarily an opportunity risk.
Whereas if you have taken a decision and have exposure to
a few hundred million euros, the question to be answered is:
How quickly can you cancel my order? Many of the trading
systems in the world dont even mention the time to cancel.
On Chi-X Europe theres only a 15 microsecond difference
between the time a new order is acknowledged and the time
an existing order is cancelled.
Time-sensitive strategies
High-frequency traders seek their route to speed through
co-location, where brokers servers are placed as close as
possible to the exchange. While brokers are busy lining up for
space in specific exchanges data centresone is being
upgraded in Frankfurt for Deutsche Brses clients at a cost
of 12mthey are also identifying where to locate their
servers to service two or more exchanges.
Co-location is critical for time-sensitive strategies, says
Chi-X Europes Miciu. You want to be there first and you want
to be sure your order is received as fast as possible. The best
place for a UK-side trading strategy might not be in the
middle of London for the LSE and Chi-X Europe, but might
be nearer its periphery. Its not a geographical decision, its
more in terms of community networks and in terms of how
direct the route is.I
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With messages travelling down fibre optic
cables at 67% of the speed of light, or
200,000km per second, according to Chi-X
Europe figures, technology connecting to the
exchange has to be sound. Chi-X Europe
handles 225,000 messages a second, for
example, while MillenniumIT has been tested
to 1m orders a second.
Mike Bignell,Omegas new president and chief compliance officer. Its a
compliance-driven industry and it used to be a sales-driven industry.
These days you need to be a compliance officer with sales skills. If you
are a stock market you have to put yourself in a position to succeed, he
says. Photograph kindly supplied by Omega, November 2010.
79
EUROPEAN TRADING VENUES ROUNDTABLE
WHO REALLY BENEFITS
FROM MARKET
FRAGMENTATION?
Attendees
(Front row, from left to right)
DAVID MILLER, senior dealer, Invesco Perpetual
ALAN CAMERON, head of client segment, broker dealers & investment banks,
BNP Paribas Securities Services
PAUL SQUIRES, head of trading, AXA IM
(Back row, from left to right)
STEVE GROB, director, Group Strategy, Fidessa
MARK MONTGOMERY, director, Barclays Capital
LISA DALLMER, chief operating officer, European cash market execution services, NYSE Euronext
Supported by:
THE RUN UP TO MiFID II:
DID MiFID I HELP OR HINDER
MARKET TRANSPARENCY?
PAUL SQUIRES, HEAD OF TRADING, AXA IM: It is very
easy to dismiss MiFID as something that was badly thought
through. Nonetheless, its fair comment that MiFID has resulted
in some unintended consequences. Our market is complex
and technical and not everything has fitted into the principles-
based regulation that is MiFID, and it has created many problems
for market participants. It is no great secret that the buy side is
looking at MiFID II to address some of those concerns. Id like
to highlight an important example. Transparency has really
deteriorated. I want to be clear about what this means in
practice. While there is a mechanism for price discoverythe
almost investigative work that is undertaken by traders because
of the proliferation of different types of venues as a result of
MiFIDthe buy side trader has nevertheless subsequently
found it very difficult to get a true picture as to where and at what
price genuine investment trading is taking place. Knowing
where to find liquidity is a key component of the buy side
tradersadded value to their organisation and that added value
has been marginalised. However, there have been positive
developments, such as the reduction in spreads. Even there,
while spreads may look like they have narrowed, when you
are trading institutional-size orders, reduced spreads are not really
relevant due to the smaller order sizes at those prices. Finally,
another important issue right now is that the depth of markets
is not there anymore and therefore fragmentation is a concern.
STEVE GROB, DIRECTOR, GROUP STRATEGY,
FIDESSA: When we talk to any of our buy side customers
and ask them: Do you feel youre getting a better deal since the
introduction of MiFID?Almost unanimously, they say No.
Actually, they say it quite vociferously. Sometimes they might
say: I dont know. Thats usually in the context of Pauls point
about transparency. Now all this might be down to the fact
that much of their trading style is trading large blocks which are
hidden in a much wider variety of different dark venues.
Therefore, the answer ultimately depends on your perspective
as a market participant. However, for the people MiFID was
supposed to be good for, which are either institutional investors
or retail investors like me, the answer is that it has been fallen
somewhat short of the mark.
LISA DALLMER, CHIEF OPERATING OFFICER,
EUROPEAN CASH MARKET EXECUTION SERVICES,
NYSE EURONEXT: The real question here is: what is
liquidity? Its not just the price on the screen; its depth of
quote, the opportunity cost, the search cost and its also the
cost of technology to connect to these fragmented places.
Innovation in a vacuum can be fantastic and wonderful; but
innovation that is disharmonious with the environment can
cause problems. MiFID did not apply like regulation for like
activity, and therefore doesnt yet create a level playing field.
Sometimes disruption can be good if at first it brings
competition. Even so, you do have to look at the whole value
chain. Although, as Steve mentioned, there might be lower
costs at the dealer level, you have to follow that through and
wonder: how do those lower transaction costs on 200 shares
at the dealer level translate to a buy side trader?
STEVE GROB: When you say: like regulation for like activities,
was there one specific thing you were thinking about?
LISA DALLMER: For example: we have MTFs, systematic
internalisers and broker crossing networks. Not all are clearly
defined in MiFID and actually, some of the regulators across
Europe apply it differently. So if youre matching trades, we
think that like activity should have a like level of regulation
to the extent that liquidity right now is impacted by many
things: the depth of quote is not what it used to be, institution
order size is not what it used to be, opportunity cost has
gone up, search costs have gone up; it is all of that. To some
degree, because theres an unlevel playing field and like
activity is not getting like regulation that, call it implicit
subsidy if you will, it has created the opportunity for costs
to go up in ways that we arent yet ready to analyse. The
issues facing institutional traders is where you really see that
friction in the outcomes of MiFID.
DAVID MILLER, SENIOR DEALER, INVESCO
PERPETUAL: Speaking as a buy side dealer, we see liquidity
as a mixture of retail flow blended with proprietary flow from
the likes of Barclays Capital and other large trading houses.
We understand the delayed trade reporting regime, and we
have to accept it as a cost of utilising capital. In an ideal world
Im going to deal all day anonymously through whatever system
is available; we just need to find the other side.
STEVE GROB: It becomes meaningless because the crucial
difference, to my mind, is the matching; its not about whether
youre matching orders, its whether its discretionary or non-
discretionary. So if I put an order in to an MTF dark pool at
the mid-point, it will match if theres the other side to it. Thats
completely different from a broker-operated crossing network
which is operating on a discretionary basis. It's a different
service that should be charged for on a different basis and
reported on a different basis. A lot of people are trying to call
for the same regulation between those two entities and I simply
dont think they are the same thing at all.
MARK MONTGOMERY, DIRECTOR, BARCLAYS
CAPITAL: There are a number of moving parts to this. The
government and politicians are engaged with the debate as
are market participants, so MiFID II will certainly get to the
nub of some of these issues. We are thoroughly engaged in
the process and we feel that things are moving in the right
direction because the regulatory issues getting raised are cutting
to some of the difficulties the financial market has encountered.
We continue to innovate and evolve for our clients and were
carefully balancing the cost of that development against the
need to deliver a profitable revenue stream.
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David Miller,
senior dealer,
Invesco Perpetual
81
CHANGING LANES: THE SELL SIDE-
BUY SIDE DYNAMIC MORE CHOICE
BUT FEWER OPTIONS
STEVE GROB: If you were to speak to a large bank or
broker, theyd say that, whatever it is that they spend on
technology in order to smart route flow across all these
venues that extra cheque they write out is more than offset
by the lower trading costs that theyre getting around the
world. So, where theres a potential problem is that, for the
big guys, it does make sense to incur this extra cost as they
achieve the economies of scale, whereas some of the smaller
and mid-tier brokers are finding themselves under a lot of
pressure to invest in the appropriate technology. On top of
this they have to deal with more complicated downstream
workflow, but they havent necessarily got any more net flow
coming in through the front door to compensate. This could
be a worry for the buy side as well, as they are going to find
fewer larger brokers perhaps to trade with.
DAVID MILLER: It seems to us that sales trading desks in
general are shrinking. We are still getting multiple market
flow and news flow emails and other forms of communication.
There is a perception that we are using far more electronic
access to markets than we really are. Because of the added
expense of establishing direct market access and of providing
algorithmic trading, it is understandable why this is happening.
The number of phone calls I get in the morning has more
than halved in the last year or so. We still value high-touch
broking where we can get it. Institutional trading is pretty
labour intensive and we are constantly looking for liquidity
or for the other side of the trade.
STEVE GROB: Is it the case you want to split it into one
pile thats the easy stuff, you just want to DMA out; and
then the other pile is the tricky stuff where you want a
high-touch approach?
DAVID MILLER: To be fair, every order, whether its for 1,000
shares or 1,000,000, is handheld. Tactics, such as DMA, algo
or whether we should consider using a specialist broker, are
decided on a number of factors. Some orders do lend themselves
to electronic access so we may use a combination of tactics.
There are many more tools at our disposal than in the past.
PAUL SQUIRES: We miss the balance sheet/principle/capital
commitment approach we used to have with some of the
bigger banks. It is part of a relationship. I also agree we have
seen a really savage reduction in sales trading resource among
our bigger brokers. The explanation might be that everyone
thought the buy side were fairly quickly going to evolve and
50%-plus of their order flow would be electronic. Unfortunately,
there are so few sales traders that you end up empowering your
own buy side traders to self-direct trades. We talk now about
best selection rather than best execution. Today, the buy side
trader is doing a lot of due diligence before they release an order
anywhere. In the past you would have a sense of who has
been active in a stock, whos got a good market share, or who
has good market intelligence in a stock or a sector, and there
was a time when you would pick up the phone to someone
and have an intelligent discussion with them before you
decided on your strategy. You cant do that anymore. Its hard
to know whether we have a voice and can ask for those sales
traders back because we feel theyre better resourced to inform
us on the best strategy, or whether they can ask a trader for
the best risk price, for example. Although we have invested a
lot of money in technology it is not at the same level as the
bigger brokers. We see high-frequency traders in some of
those gaps now rather than the old market makers. We also
see other institutional dealers being wary of opening up their
order size so even institution to institution flow has become
fragmented. It seems very hard to get back to the previous
landscape where we felt quite empowered, with a few key
relationships to help us do what we feel we were paid to do.
DAVID MILLER: Back in the late 1980s and into the 1990s
it certainly seemed that there were certain monopolistic
characteristics surrounding the national incumbent stock
exchanges. This helped pave the way for new crossing
networks and alternative exchanges such as Tradepoint to
come into being.
STEVE GROB: Yes, but do you think Tradepoint would have
been more impactful if that had regulatory support?
DAVID MILLER: Of course it had regulatory support. It was
regulated by the SFA, predecessor to the FSA; it had a full
exchange licence and so provided a proper functional and
regulated exchange. Unfortunately nobody used it but it was
there and it set the tone. It was one of the first fully functioning
order-driven stock exchanges in this country.
MARK MONTGOMERY: Weve seen an interesting
development here: because of technology, the buy side have,
in some ways, evolved more effectively in their day-to-day
working tools and day-to-day duties to their own clients, than
on the sell side. The reason I say that is because many buy side
traders now have an order management system (OMS) that
enables them to manage their order flow across asset classes
and to trade electronically in all these instruments from a single
desk. A few years ago this would have been managed by
different teams often manually over the telephone. The OMS
or EMS sees an instrument, a quantity and direction and can
route to the optimal destination smartly through FIX. The
contrast for sell side work flow is that weve created dedicated
silos, partly for the benefit of protecting buy side anonymity
and confidentiality of orders, to operate programme trading, cash
trading and electronic trading separately. We think youll see
hybrid sales traders develop out of this. Why? Because the
thing that makes your relationship with the cash sales trader
work is trust. The difference between sales trading a block of stock
and finding the other side in a dark pool is not that great; but
the sales trader has the skill and market knowledge to minimise
information leakage. By the same token, an electronic sales
Alan Cameron, head
of client segment,
broker dealers &
investment banks,
BNP Paribas
Securities Services
trader should be able to give you coverage on the market,
information about IPOs and everything else that goes with it
that a traditional cash sales trader does. I can see the two roles
merging over time.
PAUL SQUIRES: How much has technology benefited our
clients? Actually I am struggling to say that was our cost and
therefore this is the net benefit to our end usersat least in
equities alone. Certainly our TCA numbers look great and we
can dazzle people with our suite of algorithms and smart-order
routing, but it has come at a large investment cost on our part.
However, when this infrastructure is rolled out to other asset
classes, in fixed income and foreign exchange, its been fantastic.
Of course, for us the key initial step was to put in a multi-asset
class OMS platform. We trade fixed income and FX through
the same OMS platform as for equities. Weve established STP
in those other asset classes because you can use the stand-
alone platforms and integrate them within the OMS. So we
now do over 50% of our buy orders (by number) in fixed income
electronically. They are smaller in size but still thats a significant
amount of our business. In foreign exchange as well we have
used the OMS to get to a stand-alone platform and thereby
reduce user error, trader error, manual error, and that is a very
tangible benefit. Technology has been fantastically advantageous
in the multi-asset space and dealing errors hardly ever occur
now as a result. To my own mind this justifies the expense from
the outset, but in the equity space it seems so loaded, so
technology-based, compared to those other asset classes, and
for only marginal benefit.
LISA DALLMER: It is not unusual in fixed income and FX. Paul
is able to effectively bring his costs down quickly using the
existing lessons learned in technology for equities. Certainly,
technology is the enabler but the key is how youre applying it
to fixed income or FX or futures, to give you the greatest gains.
Although technology is already fairly well entrenched in the
equities space it is harder, to use a sporting metaphor, to bring
your golf handicap down that last couple of points. Dont
underestimate what weve seen over the past 15 years, starting
all the way back at the beginning of the supply chain. For
example: 15 years ago IBM would announce earnings and
youd get out your papers and your Lotus 1-2-3 spreadsheets
to rerun the model and it might take days to drop in inputs. A
week later you would formulate a view to buy or sell IBM. Now
IBM files electronically in XML or XBRL, that digital information
is fed into the model, and bam, you know exactly where you price
the next trade. Information is getting faster and more compressed
therefore it is no surprise that technology enables the buy side
to get closer to the sell side. To some degree Pauls decision
making (with regard to algorithm models or which dark pool)
is about choice: the buy side contemplating decisions that were
traditionally sell side core competencies. Meanwhile the sell
side is asking exchanges to implement smarter market structure
and make the technology footprint smaller and cheaper. As a
collective industry we are more interlinked than ever, so we
have to look at the whole process to evaluate if the end-client
has benefited, or if the regulatory environment is harming
investors and those who look after their assets.
STEVE GROB: I agree with your sentiment but the idea that
the trading process is solely about people looking at the
performance of a stock as the basis of their buy/sell decision is
perhaps misplaced. In the US, for example, 60% of whats
traded is by HFT players who dont care much about IBMs
earning statement. Theyre just arbitraging from one venue to
another and, while they are completely legitimate market
participants, they create noise that can distract the traditional
institutional investor, because they are not making decisions
based around the fundamentals of a stock.
MARK MONTGOMERY: As a provider we see our role as
helping to equalise or normalise the way different market
participants integrate together. As exchanges evolved, the
nature of their membership has changed dramatically. For
example, we have clients who are broker dealers, who are
without their own exchange membership and use our pipes
for DMA. Moreover, weve got institutional clients who have their
own membership on exchanges or MTFs. Years ago, that would
never have been the case, because to be a broker dealer youd
have to have your own membership on the exchange.
STEVE GROB: I challenge the whole level playing field
argument. It seems to me that its always been uneven. People
make money out of having an information advantage, whether
it's having an office nearer the exchange, more traders on the
floor or more handheld devices in the pit. People have always
sought gain by exploiting technology or information, and the
only thing thats different now is that instead of measuring
things in miles or people, were measuring them in nanoseconds,
but the game is still the same.
LISA DALLMER: It is a level playing field on those aspects
because you can choose to invest in technology or not. Its just
chosen investment. Where do you want to put your office? The
answer might be right next to the exchange. How many people
do you want to have on the floor? Those are business decisions
but from an access perspective it is the same set of choices.
MARK MONTGOMERY: People evolve, or rather, people
have had to evolve. If you take some of the traditional mid tier
brokers whove actually really invested in making their retail
offering work. Theyve got a research channel and can provide
a personal service combined with the key addition of robust
technology and a website that a diverse audience can interact
with. There are other firms, who had a strong retail franchise
20 years ago, but who have not invested and now feel theyre
too small to survive. Now, take a look at what happened in
the US a few years back and find that through technology
small can be beautiful. Three or four guys with a server can
now not only survive but can take 20%/30% market share
because theyre small, because theyre nimble, and because the
market has evolved. It is a question of looking at where the
market is going to be in three or four years time and then
shaping and adapting to that view.
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AXA IM
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CLEARING & SETTLEMENT:
WHERE NOW?
ALAN CAMERON, HEAD OF CLIENT SEGMENT,
BROKER DEALERS & INVESTMENT BANKS, BNP
PARIBAS SECURITIES SERVICES: Clearing follows what
happens on the trading side and in many ways the story is
similar. We saw Chi-X and Turquoise set up and they looked at
pan-European clearing and couldnt find any of the existing
CCPs capable of doing it at the price that they wanted. They
therefore appointed EMCF and EuroCCPboth effectively
start-up entities. So we have had fragmentation in clearing
just like the fragmentation on the trading side of the business
and the outcome has been determined by the MTFs who have
become king-makers in the process. We got into a rather strange
situation where the fees were falling dramatically on a trade
basis but we had to deal with a proliferation of CCPs. There
are now 20 CCPs in Europe and theres another five or so on
the way. So the savings that were being made on one side from
this quasi-competitive market are being eaten up by the costs
of connectivity and the additional margins being paid as a
result of competition; hence the requirement for interoperability,
and thats really where we are today. Achieving interoperability
is not easy. This is because CCPs are being asked to cooperate
rather than to compete, which is quite an unnatural thing to do.
Also, youre dealing with risk rather than just processing. The
real question is where does the risk end up and can you get
interoperability without increasing risk as well? So todays
objectives are rather curtailed. The Code of Conduct wants
participants to be able to choose where to clear and settle
independently at each part of the trade life cycle. What were
seeing right now is a debate about interoperability among four
CCPs. So, hopefully, we will see interoperability for a rather
small group of CCPs sometime next year, but its not the
interoperability that people envisaged right at the beginning.
FRANCESCA CARNEVALE: Alan, how does Clearstreams
initiative, Linked-Up Markets, fare as an interoperability exercise?
ALAN CAMERON: It really is about the CSDs dealing in a
more efficient manner with each other. Over time, it might be
an important development but it will need to make progress not
just with settlements but also with asset servicingand that
tends to be harder. For now, the jury is out. With T2S coming
along there will be a very fundamental shift towards interoperable
CSDs. Of course, the other interesting thing about Clearstream
is that they are part of a group that participates at different
levels of the trade life cycle and the whole question of vertical
and horizontal integration remains unresolved. Three years
ago everyone was saying we must have horizontal competition,
we dont want vertical silos. Theres been so little progress and
interoperability that this debate has kicked-off again.
FRANCESCA CARNEVALE: Lisa, NYSE Euronext has always
been keen on the horizontal model, hasnt it?
LISA DALLMER: Weve always believed in the most
appropriate market model and so we recently announced
intention to open a clearing house that will be able to mix
equity derivatives with equities clearing. In part, we are
motivated by the total lack of clearing innovation and real
activity on interoperability; we could not control our destiny.
We felt it was more important to actually manage the
technology and clearing functions ourselves and be able to
bring in equity derivatives with equities as it will generate
efficiencies that are not currently available. Since it was such
a crucial part of our process, many people looked at where
we did clearance and settlement as part of our collective
trade costs for members and until we could control it and
bring that down, it was going to be a hindrance. So weve
decided that influencing consolidation in clearing and adding
innovative technology are the primary reasons we want to
venture into the clearing space and we will have an open
platform that will allow us to add flow, scale and in turn
reduce fees. It is something we are planning for 2012.
ALAN CAMERON: I guess most participants in the market
would say that the onus really has to be on the exchanges to
show why this integration makes sense and the general
feeling is that that hasnt really happened as yet. Im not
saying its not going to happen, but its an argument that
hasnt been made in such a coherent fashion as yet. We look
forward to hearing it.
FRANCESCA CARNEVALE: From the buy side perspective,
have any gains that you have made in trading costs been lost
or negated by the rise in clearing and settlement costs?
PAUL SQUIRES: We have not specifically gone to our brokers
and said, as a result of all the different MTFs and the reduction
in execution costs, we want to lower our commission costs with
you. We dont micro-manage commission costs. There are a
number of different entry points into our organisation from
the brokers, and therefore with our key counterparts having
a relationship is the most important element. Secondly, if you
put it in the context of what were trying to do, which is either
reduce or add significant positions for our fund managers
with minimal market impact, it might only constitute a basis
point of savings in execution costs. When you look at our
transactional cost analysis and see that on some orders we beat
the benchmark by 100 basis points you will realise that focusing
on the venue costs to the broker is really missing the point.
The second limitation is a practical one. Do we want to carve
up an order into multiple commission rates applied to each
individual trade fill according to the venue? We are not a
quant house doing thousands of small trades a day, but even
so theres a practical limit. Of course, we are aware that we
should be slightly more commercial for our brokers now but,
equally, when you enter those dialogues, theyll point out
that because of fragmentation the costs of clearing are that
much higher. So youre right. You need to be aware of the
downstream aspects as well as the execution.
DAVID MILLER: We dont micro-manage the settlement
side and while costs associated with trading do have a bearing
Lisa Dallmer, chief
operating officer,
European cash
market execution
services, NYSE
Euronext
on best execution; it is the price that is more important. Our
job is simply to buy or sell a particular stock at the best
available price. Trading costs are encompassed within the
fully bundled rate; were not looking for a change here.
STEVE GROB: If you do what we do, which is providing a
workflow-based system to both the sell side and buy side, you
have to deal with the added complexity of multiple clearers
and multiple venues. We take a client order, split it into different
destinations, receive a bunch of different fills associated with
different clearers, different fees and different pricing structures,
and seamlessly manage the whole process. The secret to all
this is ensuring that the experience is as straightforward as
possible and that the trader is protected from all this complexity.
LISA DALLMER: There is a cost of re-aggregating the
fragmentation on both the pre-trade and the post-trade basis.
It looks seamless but at the point of trading it is fairly fragmented
while the software providers, vendor packaging and middle
office costs are real for re-aggregating information.
FRANCESCA CARNEVALE: Given that much current
regulation is around transparency and managing counterparty
risk, as the clearing and settlement side does fragment, doesnt
it make it harder for institutional investors and their trading
desks to manage their exposure effectively?
MARK MONTGOMERY: One of the big differences between
Europe and the US is a lack of institutional investors clearing
securities for their OTC leg with the investment bank. Thats a
very hard thing to get to today in Europe when we have all
these different CCPs. Some of the CCPs are pushing hard to
try and get that conversation going. When I speak to institutional
investors about it, they all say its a great idea but its not at the
top of my list of things I want to do. So theres an
acknowledgement that we want to get there but theres no
real urgency behind it right now.
PAUL SQUIRES: All of our dialogue is about CCPs. Right
now, when you actually get to the point of trade execution,
youve only got the legal documentation with one broker, so
guess what? Youve only got one place to ask for a competitive
price. Thats not great. So definitely, the move to CCPs is good
but then its fairly evident that we would have to bear a lot of
the cost of change. That invariably influences the investment
decision of the fund managers. They might want to trade some
CDS, for example, but the costs of adapting your architecture
to enable a CCP process? When considered against the likely
performance gains and relative amount of activity in OTC it
might look expensive. What starts off looking like a great way
forward starts to be affected by cost considerations and thats
something we need to be careful about.
POST-TRADE ANALYSIS:
UNDERSTANDING
FRAGMENTED DATA
STEVE GROB: There are two problems. One is the fact that
different participants are using the different categories under
MiFID (OTC, dark pools, etc) in different ways. The other is
that all the venues that have been created have, for completely
benign reasons, come up with their own trade-type definitions.
To deal with this we've put together a whole team of analysts
that spend their time mapping and cross-referencing these
codes in order to provide the best view we can of whats going
on. On top of this, different brokers will naturally provide their
own analysis of their smart order routing (SOR) and algo
performance, produced in different ways and reflecting different
formulae. So the buy side must find it pretty hard to form a
truly objective view as to which broker is doing the best job.
LISA DALLMER: The first step is to decide what aspects of
pre and post-trade data can be consolidated in order to do the
mapping. Then we have to figure out what is the minimum
set we can agree to. There are several steps before we even get
to have a record to reflect against for benchmarking TCA and
other things. I believe theres a CESR working group that is
identifying the trade flags, the mappings; actually we have had
a small army working on it too.
DAVID MILLER: Were looking for some sort of consolidated
best bid and ask, which were now getting through technology,
whether its via Reuters, or Bloomberg. Theyre all presenting
us with the right sort of display to enable effective price discovery.
However, within that, of course, youve got all the dark and
semi-dark liquidity You can time stamp and recreate the best
bid-and-ask on the lit exchanges, but that still leaves a big gap
and weve got to be able to prove what weve done within that
gap. Were getting pressure from our clients, the funds we trade
for, to prove that weve gone to the right venue. As Paul says,
best selection really is the most we can achieve. Its almost
impossible nowadays to actually prove best execution.
LISA DALLMER: Because best execution is about many
things and not only price, from our perspective, we understand
the buy side and the sell sides needs for providing risk trades.
We believe the large in scale waivers is an appropriate mechanism
for providing confidentiality. However, we are observing
significant OTC activity that is retail sized and its happening
away from the best-bid-and-offer. Notwithstanding the need
for confidentiality, we should evaluate the appropriateness of
who needs this confidentiality and why its needed.
DAVID MILLER: In some respects thats always been a bit of
an issue. When a risk trade is taken on, the question is how
long and how deserved is the delay in trade reporting that the
market allows to protect the provider of risk? Another challenge
at the moment comes from fund managers who are keen to
pursue a certain tactic, such as working an order as a percentage
of volume. While I do not have an issue with that tactic, the
trade reports we or the broker are following can have a dramatic
influence on final price, especially if, the broker is unable to
participate in all available liquidity.
STEVE GROB: Thats the thing about transparency; you want
it for everybody else but not yourself! One of the things that
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85
puzzle me is people calling for a European version of the NBBO
that exists in the States in terms of pre-trade transparency. This
is because any broker in Europe is allowed to determine its
own best execution policy in terms of what it includes and
excludes. Vendors like us already provide a custom virtual
market that allows traders to switch venues on or off in order
to reflect whatever their best execution policy is. The real problem
lies in post-trade transparency and that's important because it's
the basis for tomorrow's pre-trade decision.
PAUL SQUIRES: Im not too concerned about pre trade.
Were kind of getting there. For me it is all about post trade.
Its about getting the right definitions of certain types of trade
to determine standard reporting timeframes, whether its retail,
OTC, risk, broker pricing, crossing, or anything else.
HOW MANY trading VENUES DO
YOU really NEED?
FRANCESCA CARNEVALE: To the outsider, post-MiFID,
a host of new trading venues cropped up. Few have made
money and they skew liquidity every which way. Does the
market really need this level of differentiation? Whats the
point? I can see, for example, the need for dark pools, but do
you need every major broker/dealer to provide its own dark
pool? How many is enough?
LISA DALLMER: Youre asking a macroeconomics question
that happens in every industry. How many competitors is the
right number in the pharmaceutical industry? How many knee
replacement providers does the world need?
DAVID MILLER: You cant blame people setting up dark
pools because they perceive theres value in it. Theres a lot of
money to be matching trades within an ever widening spread.
LISA DALLMER: The question becomes is their business
model sustainable and at what point does consolidation appear
in the industry? As an industry player, looking at the opportunities
as consolidation takes place, its about the timing. During this
time when we have a lot of providers in the market, there is
innovation. Had we not experienced some of the innovations
emerging in the industry in recent years, we wouldnt be able
to cope quite as well with the downturn in trading turnover
that we are facing today. So theres a lot of value, but yes, I
agree, in the long run, stand alone businesses cant operate at
a loss. They cant even operate at near loss. Moreover, taking into
account some of the issues weve raised; uneven regulation,
and to the extent that the regulatory landscape creates essentially
an implicit subsidy for a period of time, Id ask to consider the
disadvantages and risk to investors.
STEVE GROB: I guess the question is whether people think
that LSE and NYSE Euronext would have cut their fees, and
introduced new business models, without the competition they
now face. You only have to look at the Tokyo Stock Exchange
and its introduction of arrowhead and what's going on at the
ASX in Australia for further confirmation of this. Moreover,
the idea that you need hundreds and hundreds of people to run
a market venue just isnt true. The alternative venues are
completely entitled to come up with newer, faster technology
and lower overhead businesses. While you're right that you
have to question the viability of their business models, the
same applies within primary markets where they can look at
their less performant platforms in the overall scheme of the
business. If NYSE Arca and Smartpool were standalone
businesses, should they be closed down because they are not
making any money yet? When you are looking at the profit
and loss of a platform, you have to view it in the broadest
context and the long-term interests of its shareholders.
LISA DALLMER: Exchanges have clear rules about when
and how to manage the conflicts of having brokers as owners
or shareholders. Im not sure all the MTFs have those. Were
talking about motives of keeping the businesses running,
and I agree, as an exchange, we embrace the competition,
the innovation, and therefore have a multi product offering
in regulated markets and MTFs. Would it have happened
without competition? Its hard to say. Innovation always
creeps its way into every industry. Sometimes youre reacting
to change; sometimes youre leading that change. Remember
that trading is just one part of capital raising in the exchange
business, keep in mind there is a whole value chain there
and market quality across all those services is different than
market share just in the top 20 stocks.
MARK MONTGOMERY: Theres also the subject of data
ownership and selling it which seems to have helped certain
exchanges have a different model to some of the new arrivals.
Its always interesting to hear people, particularly on the buy side,
saying they havent just had to buy trade data from one source;
theyve had to go and buy from other venues as well in order
to get a consolidated view. Thats certainly a frustration when
its their trades in the first place. This is another area where
were going to see costs forced down.
FRANCESCA CARNEVALE: Regulators are encouraging
a lot of derivatives to be on exchanges in future: is that fair
or unfair competition? Will it reduce choice for the buy side
and the sell side? Alan.
ALAN CAMERON: Its not just into the exchanges; the
regulators appear keen to see these instruments moved
into the CCPs as well. This should simplify risk management
for participants.
LISA DALLMER: There are two points. Is the encouragement
pre trade or is it post trade? These are two different aspects,
two different dimensions, and theyre very much targeting the
post-trade aspect for the counterparty risk management
issues we talked about.
ALAN CAMERON: Ultimately, it will bring the end investor
clients in to the CCP world, although the easiest and most
cost-effective route may be through General Clearing
members. Long dated instruments will need to be cleared
for a long period in the CCPs.
Steve Grob,
director, Group
Strategy, Fidessa
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STEVE GROB: As long as they can be standardised to the
point that theres sufficient volume in it to make it
worthwhile, then that makes sense. However, there is a
level of OTC business that is so obscure that it will never fit
a centralised clearing model.
MARK MONTGOMERY: The ETF market has expanded
dramatically to fill a gap here. It presents an opportunity for
people to be innovative in the product suite and has given the
buy side greater flexibility around how they can invest in these
markets in a balanced and risk controlled way.
PAUL SQUIRES: We want this sort of CCP progress, but we
have a strong feeling that its going to cost us money. Weve
got to decide whether thats worth the extra cost.
tomorrows world
PAUL SQUIRES: Do I expect to go into work after MiFID
II and find everythings much easier, more transparent and
people are happier? No, but Im mildly optimistic. The
dialogue in the lead up to MiFID II has actually been framed
the right way. However, I do have concerns. Theres too
much stereotyping and there are too many negative
connotations: high frequency is bad, dark pools are bad
and monopolies are bad, for instance. The other thing that
concerns me is that there is so much lobbying going on by
the MTFs, the exchanges and by the brokers, that it is really
hard for the buy side to be represented.
DAVID MILLER: We are all far more engaged in MiFID II
than I believe we were for MiFID I. Many on the buy side
let it happen the first time round and weve seen whats
happened, some of it is good but some is not so good. So
with MiFID II there is a considerable increase in engagement
and with the help of various trade bodies we are able to have
continued involvement in its progress. There are even more
vested interests at stake this time, whether its from the buy
side or the sell side or all those between the two. At least
we cant turn round and say, we didnt try and make our
point this time.
FRANCESCA CARNEVALE: Do you think that MiFID II
will evolve in your favour this time around?
DAVID MILLER: I hope so, but the process of buying and
selling shares is constantly evolving. I must admit that my
perennial dream would be to have a single, consolidated
marketplace for everything financial, stocks, bonds, and
futures, in harmony, which in some ways is what MiFID
was designed for. That, of course, would be the buy side
dealers version of the Holy Grail. Equities are an important
investment for us, its what we do. I believe in the long term,
the retail investor will remain interested in owning shares,
whether he does it individually as a shareholder, or collectively
through a unit trust.
MARK MONTGOMERY: It us up to us, the practitioners,
to provide constructive feedback where we can. I feel that
Pauls definitely got a point that perhaps the voices of the
banks will be louder than areas of the buy side. Hopefully, we
have a lot of interests that are aligned and certainly if we
can eradicate some common misconceptions about our
business, then that can only be for the good. As far as the
future, some of the things weve discussed have to inevitably
progress: some form of consolidated symbology around trade
data is a must. We want to see costs of clearing opened up,
and we hope the markets learn from whats happened in
the US in terms of economies of scale. In that regard, the
market should become cheaper and more efficient now.
There will be areas of fragmentation and while we are seeing
signs of consolidation with MTFs, someone else will pop up.
Therell be some new innovation with technology that will
allow someone else to come into the space. As we have all
acknowledged, we need to see the status quo challenged.
Im bullish in the medium term, but no doubt there will be
a little bit of pain along the way before we reach a conclusion
where all the issues are dealt with and the landscape is clear.
ALAN CAMERON: On the clearing side, I cant see
interoperability or consolidation happening quickly enough
to get us where we need to be. We are going to continue to
face a fragmented, comparatively expensive infrastructure.
On the settlement side, Id like to think that T2S will usher
in a new era of harmonisation and simplicity; perhaps even
a shortened settlement cycle is coming. I would imagine that
could happen quite quickly and that well see T+2 across
Europe much more quickly than we would probably have
envisaged a year ago.
LISA DALLMER: The important trend is that there will
always be innovation, therell always be change and sometimes
it takes a disruptive event to kick that off and get that going.
MiFID has tended to benefit the wholesale level, the
professional market, and therefore I hope MiFID II will
include changes that are more specific, and that it contains
prescriptions that protect retail investors. We also have to
look carefully at having an indisputable price reference so
that all investors can reasonably ask: how do I feel about
that activity, that trade? How do I evaluate it? As Steve noted,
yesterdays post-trade data is todays pre-trade information
in terms of decision making. To bring it all together, as an
exchange we are committed to listening to clients to facilitate
the required innovation with regard to the rules, the
fragmentation, and the industrys health. Overall, this is the
best place you can hope to be.
STEVE GROB: Im optimistic but unfortunately its got
nothing to do with my view of regulators. Really, there are two
problems: one is that they have to separate political polemic
from the factsthat seems pretty crucial to me. Someone
made the point that monopolies are inherently bad. I challenge
that. Theres a view that HFT is bad and dark pools are bad.
I challenge that too. All those things are just way more
complicated and subtle than is sometimes acknowledged
and even if some people do figure that out, theres a bigger
problem in play, namely the pace that regulation can move
just gets outstripped by technical innovation and commercial
interests. So, by the time MiFID II has sorted out all the
problems of today, everyone around this table will be thinking
about completely different things and doing completely
different things. Thats just a fact of life. The regulatory process
will never keep pace but we just have to live with that. I
87
F
IXED INCOME OPERATIONS of banks and
investors continue continue to face the double
challenge of staying abreast of market
developments and addressing demands for
increasingly precious liquidity. Against this backdrop,
the benefits of e-trading fixed income have come
into the spotlight as institutions seek to satisfy their
compliance and risk requirement and gain access to
liquidity, pricing transparency and tools to deliver their
business models.
Although they remain somewhat unpredictable,
the bond markets would appear to have made a
steady recovery since the shoulder of the credit
crunch in 2008 when liquidity all but evaporated and
trades had to be negotiated over the phone.
However, the risk still remains as recent pressure on
peripheral markets shows.
As a result of the bank bailouts, governments
have issued huge amounts of debt to finance their
infrastructure and fiscal deficits. Likewise, corporates
have also issued bonds to make up for the shortfall
in bank credit available to them, resulting in increased
liquidity and narrower spreads.
Now, with record levels of government debt
being issued across the eurozone, there is an
increased emphasis on ensuring open and
transparent markets, which has led to a renewed
focus on e-trading and in turn is driving volumes.
More than half of buy side respondents (53%)
to the fixed-income section of a trading poll,
conducted by the Association for Financial Markets
in Europe, recently reported year-on-year increased
volumes in electronic trading of fixed income, with
nearly 60% believing the trend is set to continue.
When this poll was last conducted in 2008, 71%
of respondents said they had the systems to trade
fixed income electronically, but only 10% had done
so. The story is now very different. With improving
market conditions and an uptick in equity markets,
demand for fixed-income products has grown and
likewise e-traded volumes.
Government bond issuances have soared and
there has also been a rebound in credit, with around
$1.4trn of non-financial corporate investment-grade
bonds issued globally last year. This figure was up 72%
from 2008, and 40% of it came from Europe, the
Middle East and Africa, according to data provider
Dealogic. Taking a look at buy side volumes alone
over the last couple of months reveals that a good
percentage of e-trading volumes in bonds has come
from the traditional fund management industry as
well as hedge funds, as they recover momentum.
The European fixed income arena
There remain clear differences between the US
and European fixed income markets, which is having
an effect on the evolution from traditional voice
dealing to electronic trading.
In the US there is a single issuer and a
predominantly cash market while in Europe the
picture is more complicated the market is more
fragmented, more futures-led and with multiple
issuers reflecting the various sovereign states.
Coupled with this are historical fragmentation issues
clearing, settlement and benchmark bonds in
each of these markets, while Germany remains the
benchmark market in terms of liquidity, credit and
the link between cash and futures.
There are also different requirements across
Europe for post-trade, clearing and settlement,
although the introduction of MiFID is bringing a
homogenous set of standards closer still.
Despite this complexity, Europe has taken to
e-trading fixed income. The past decade has seen
the adoption of e-trading in fixed income securities
expanding to the buy side. This is a trend which
looks set to continue as regulatory and compliance
needs push in that direction.
The benefits of e-trading fixed income
Electronic trading in fixed income securities provides
investors better pre-trade transparency in terms
of price discovery with a higher quality trading
experience and the benefits of post-trade
transparency and straight-through processing.
Electronic fixed income platform, MTS, became
established during the last decade of strong
economic growth and has grown to become the key
source for price discovery and trading in European
national government securities.
Fabrizio Testa, Head of Product Development
at MTS, comments: Trading European debt through
an established and effective platform gives each
counterparty access to the source of European
debt liquidity and the confidence of a regulated
and orderly market.
Whether you are a frequent and active trader
or not, the advantages of e-trading in bonds are
evident: pre-trade transparency, STP and audit trail
to satisfy risk management and compliance needs,
including best execution.
e-trading fixed income for the interdealer
community
MTS delivers electronic venues to two core fixed
income customer segments - the interdealer market,
with its MTS Cash offering, and the professional
dealer-to-client (B2C) market, with BondVision.
MTS Cash is now the leading e-market for
European government bonds, combining straight
through processing with a completely automated
settlement network through links to all of the major
European depositories and central clearing houses.
As a result, market participants gain access to
the most liquid, transparent and efficient European
bond marketplace with an expanding range of
product classes and tradable securities including
e-trading in fixed
income across Europe
is here to stay
The evolution into electronic broking across fixed income markets has been a steady but inevitable process,
writes Fabrizio Testa, head of product development, MTS.
Sponsored Article: MTS
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Figure 1: Year Total Return Performance of EuroMTS Eurozone Govt Broad Index vs Eurozone AAA Govt and Eurozone x-AAA Govt
Eurozone Govt Broad
Eurozone AAA Govt
Eurozone ex-AAA Govt
88
Sponsored Article: MTS
fixed coupons, floating coupons, zero coupons and
index linked coupons.
In terms of capacity, the level of throughput that
MTS Cash can sustain is continuously improving
and considered first class in the fixed income arena.
The average round trip time of transactions is
currently less then 1 millisecond (see Figure 1).
In the interdealer market, MTS supports an auto-
matching system with participants streaming prices.
On execution, MTS sends the relevant information
directly to the central counterparty or depository
to be cleared or settled.
e-fixed income trading for the
dealer-to-client segment
MTS has also developed BondVision for the buy
side, giving funds and other clients direct access to
the source of the market and the major players in
Eurozone debt.
The majority of primary dealers in Europe now use
the MTS-run BondVision platform to connect with
clients, such as real money managers, central banks
and hedge funds and demand continues to grow.
MTS has developed single dealer pages on
BondVision to enable banks to stream either
indicative or executable quotes directly to their
clients. A buy side client using BondVision to manage
its fixed income portfolio has access to optimal
trading and workflow technology together with a
range of functionality including the ability to make
requests for quotes (RFQs) for up to 20 legs of a
trade at any time.
MTS delivers both its interdealer and dealer-to-
client solutions across an open architecture for
seamless integration with ISV solutions and existing
internal systems, delivering significant cost benefits.
This ensures MTS attracts professional counterparties
with real interest in the fixed income arena, which
creates a virtuous circle of liquidity.
The B2C market in e-bond trading is primarily
bilaterally settled. The STP capabilities of a system
such as BondVision allows a fund manager to
generate an order from their portfolio management
system (PMS) or order management system (OMS),
stage it in BondVision and then execute the trade
which will then be uploaded automatically.
Settlement is then handled outside of the trading
venue itself.
The importance of market data and latency
Irrespective of asset class, informed trading and
management decisions rely on access to the optimal
market data.
MTS supports pre-trade, trade execution and
post-trade capabilities across cash and repo markets,
and delivers independent benchmark market data
and comprehensive fixed income indices. Fabrizio
Testa says: In the B2C market, counterparties can
engage electronically with more confidence in a
professional market if they have superb market data
based on real executable prices, not calculated or
derived. That is a pre-requisite to e-trading.
The independence and quality of MTS data is
unique. The interdealer MTS Cash market generates
electronic market prices which in turn feed back
into our system, so users are assured they have the
best information available.
Latency remains a key issue in all electronic
markets and minimising it continues to be a focus
for all professional trading platforms, irrespective
of asset class. The interdealer market in particular has
a constant need for performance and low latency
to better manage the risk of quoting a high number
of securities. European debt, as an example, is trading
against other products like swaps and futures. Traders
need the performance of a bond on the platform
to accurately reflect the performance in all relevant
hedging products.
In the B2C space, latency between a fund manager
and MTS BondVision platform has shor tened
dramatically. It used to take a phone call, email or fax
for execution, then the trader on the execution desk
would run the trade through over the phone, a
process which could sometimes takes several minutes.
Anything can happen in the markets during that time.
BondVisions functionality now enables dealers to
stream prices back to clients with the same
performance, speed and minimal latency as the
core interdealer market.
The time between a por tfolio management
system giving the order to execute and the time
it gets to the front end has been shor tened
dramatically. Once integration between a PMS and
the trading venue is in place, counterparties get a
huge range of efficiencies as they can manage
more orders in less time with less manual
intervention.
The future for e-fixed income
Recent market upheaval and the resultant regulatory
push have led to demands for more standardised
traded products with a focus on post-trade and
clearing.
Fabrizio Testa adds: Investors have become more
confident in using e-solutions for trading. At the
beginning clients traded smaller deals electronically
and still picked up the phone to handle larger
amounts. Then we star ted seeing the trend of
bigger size deals on our dealer-to-client BondVision
system, which means their confidence grew to trade
these larger tickets electronically as well as multi-leg
switch, butterfly and basket.
Of course, there will always be multi-asset deals,
which may naturally be transacted over the phone,
while standardised products are much more suited
to be traded electronically.
Overall, I think we will continue to see the
electronic fixed income market evolve and grow.
Our role and responsibility is to respond to the
needs of our clients.
It is our main focus to ensure they get robust and
stable trading technology with access to optimal
pricing, liquidity and workflow to help them deliver
their chosen fixed income business model with
precision, control and confidence.
There is no doubt that electronic trading in
European fixed income will continue to grow. It is
a pattern we have observed in other asset classes
as institutions have seen the benefits.
Investors are attracted to MTS as the key venue
for fixed-income investments of strong credit quality
with a very high degree of liquidity, possibly the
most prized factor of all.
The increasing volumes were seeing both in
terms of deal tickets and daily activity is mirrored by
feedback from both the buy and sell side that e-
trading is the way forward for European fixed income
and these are ser vices they want. MTS is well
positioned to continue to facilitate this need. I
Figure 2: CMF transaction capacity and average response time
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89
G
REENWICH ASSOCIATES ESTIMATES that 38% of
US fixed-income trading volume is now executed
through electronic platforms and the figure in Europe
is 41%. About half of US institutions use e-trading systems for
fixed income, and 60% in Europe, the two biggest users being
real-money investors and central banks. Much of the growth
in electronic trading volume in the US was generated in interest-
rate derivatives, investment grade credit and short-term fixed
income, says Greenwich Associates consultant Andrew Awad.
In Europe, the products traded most are government bonds,
followed by interest rate differentials (IRDs).
Tim Blake, head of North American interest rate products
at Credit Suisse, says the period since 2008 has been exciting:
Market participants will probably look back on these two
years and see it as a boom for electronic trading in fixed income
because the concept held up well when bonds were one of the
most active parts of the financial markets. While weve had
electronic bond trading for ten to 15 years, weve really been at
a plateau in terms of technology. Now its really the time for the
next evolution.
In this atmosphere, many third-party providers of trading
platforms and electronically aggregated data and prices have
seen a direct correlation between volumes and business
conducted electronically. For example, MTS, majority-owned
by the London Stock Exchange and a leading platform for
government bond trading in the eurozone, has a daily turnover
of 85bn and has seen trading volumes double in France over
the past 12 months and rise 75% in the Netherlands and Spain.
MTS chief executive officer Jack Jeffery says: Liquidity and
transparency have become more and more important and have
resulted in inter-dealer brokers directing trade on to electronic
platforms. Also, in the last three months, bid-offer spreads
have narrowed and there is a clear correlation between bid-
offer spreads narrowing and volumes increasing. The advantages
for people trading on an electronic platform are that you can
clearly see the price changes in the market.
Client access to liquidity has been the driving force behind
Credit Suisse Onyx, the banks algorithmic fixed-income trading
platform, which since 2006 has executed more than $10trn
notional of government bonds and exchange-traded futures
contracts. Originally developed for internal use by its own
traders, in June 2010, the bank decided to give clients access to
it with a suite of algorithmic execution for pairs strategies
between cash US Treasuries and futures. In November, the
firm added the ability to conduct direct trading of cash US
Treasuries, providing an alternative to traditional request-for-
quote systems by allowing clients to enter their own trade
parameters directly to access the firms pool of liquidity. The
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FRATERNITY, LIQUIDITY,
TRANSPARENCY
The past two years may go down in history as the best fixed-income market seen, following the
confluence of high volatility, low interest rates, tight spreads and high demand. In fact, in 2009,
according to a JP Morgan Cazenove report, fixed income amounted to 55% of the total
investment bank revenue, while that from equities lanquished at 27%. Although the bank expects
the total fixed-income wallet to fall to $130bn, down 23% on 2009, the proportion of electronic
trading in fixed income has leapt forward over the same period. Ruth Hughes Liley reports.
Photograph Saniphoto /
November 2010.
firm plans to roll out the same capability in Europe next year.
Blake says that the liquidity offered through Onyx is
anchored by the banks position as a primary dealer of US
government bonds and by its broad client base. We have
brought in electronic market makers from the ranks of hedge
funds, the equity world and a lot from rates. This is really
prime time for rates and we think Credit Suisse Onyx is a
very powerful model.
Derrick Herndon, European head of credit at UBS, which
gives prices on 8,000 bonds, believes that fixed income liquidity
is not really driven by delivery method: Over the last 18
months, dealers have been carrying more inventory, but in
May and June 2010 liquidity evaporated quickly. It didnt matter
whether it was voice or electronic. In fact the more volatile the
market is, and the more the market is influenced by external
factors such as Greece or Ireland, its that macro risk focus
which generally shrinks the breadth of names traded.
Jeffery, meanwhile, believes electronic trading is in fact
changing the very nature of the market. Following the European
debt crisis, I think we will move increasingly to an order-driven
market and away from a quote-driven market. These markets
of natural interest are where people will trade on the platform
because they want to trade, not because they have to. The
market place will drive this change. As liquidity thrives, it
becomes self-fulfilling and you have a secondary market place
that operates itself.
Certainly the traditional process of seeking prices via request-
for-quotes (RFQs) has been simplified, mainly through use of
technology; with the improvement of trading platforms and
electronic methods to aggregate prices and allow investors to
compare prices with a few clicks. TradeWeb and Bloomberg
ALLQ, for example, have offered electronic trading for more than
ten years. Majority-owned by Thomson Reuters and ten banks,
TradeWeb offers a mechanism to automate RFQs for European
government bonds under its well-established TradeWeb Plus
enabling comparisons of either several bonds from one dealer
or one bond from different dealers.
However, the more complex a trade, the harder it is to
automate and Robin Strong, director of buy side strategy at
Fidessa, which has recently been signing up sell side customers
to its fixed income platform, says: Portfolio managers often don't
really mind exactly which bond they buy, as long as it meets their
underlying strategy: they might want to increase portfolio
duration using, say, German bonds in a specific sector with
the right duration and credit rating. There may be a choice of
suitable cash bonds or the manager may choose to use a
derivative to give his portfolio the desired exposure profile.
These trades are harder to automate as you are no longer
dealing with a specific instrument.
Other clients will keep their corporate bond portfolios fully
invested in less risky government bonds until the right
opportunities arise, then will do a switch trade to sell exactly the
right number of government bonds to buy the corporate bond.
[However,] it has to be exactly the right amount and this can
get quite complex with a number of different legs to the trade.
In this respect, it's more like auctioning a mini programme
trade. They are harder to automate as the pricing is often quoted
as a yield spread between the different bonds, says Strong.
Undaunted, MTS recently launched Multi-Leg, new
functionality of the BondVision platform that enables trade in
up to 20 legs. Jeffery says: It is moving away from commoditised
simple trades to more complex ones. Although its fairly limited
at the moment, it shows that theres a demand for electronic
trading in an even more complex structure.
While most electronic trading is in government bonds,
electronic trading in corporate bonds is also developing. Market
Axess, a leading platform for corporate bonds trading, has seen
record volumes in 2009 and 2010, In October it announced a
record third-quarter trading volume of $100.5bn, up 25% on the
same period in 2009, while revenues of $37.4m were up 24.7%.
Major stock exchanges are also upping their game. Deutsche
Brse resumed trading in 700 corporate bonds on Xetra in
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Tim Blake, head of North American interest rate products at Credit
Suisse. Weve really been at a plateau in terms of technology. Now its
really the time for the next evolution,he says. Photograph kindly
supplied by Credit Suisse, November 2010.
Jack Jeffery, MTS chief executive officer. Liquidity and transparency have
become more and more important and have resulted in inter-dealer
brokers directing trade on to electronic platforms,he says. Photograph
kindly supplied by MTS, November 2010.
91
October, the same month Singapore Exchange began offering
corporate bond trading for smaller listed issues to retail investors.
In February 2010 the London Stock Exchange also launched
an electronic order book for retail bonds. Introduced, it says, in
response to strong private investor demand for greater access
to fixed income, the platform offers continuous two-way pricing
for trading in UK gilts and retail-size corporate bonds on-
exchange. Before this order book, none of the 10,000 listed
bonds on the LSE system was traded electronically.
Initially, 49 gilts and ten corporate bonds were available for
trading, including securities issued by Tesco, BT, National Grid,
GlaxoSmithKline, Morgan Stanley, GE Capital, Enterprise Inns
and a bond issued specifically for the service by Royal Bank of
Scotland. Since then the number of bonds available on the
platform has risen to 141. Investors can see prices on-screen,
and trade in increments as low as 1 for gilts and 1,000 for
corporate bonds, in a process similar to share dealing.
The initiative is modelled on Borsa Italianas fixed-income
platform, MOT, which conducted 230bn-worth of trading in
2009. Since June 2009, ExtraMOT, the segment of MOT dedicated
to corporate bonds issued by Italian and foreign companies,
has announced new additions to the platform around six times
a month. Moreover, in November 2010, MTS announced plans
to launch a pan-European corporate bond trading platform
for the wholesale market. The proposed market will be open for
the listing and trading of euro-denominated debt instruments
and will operate on an electronic order-driven model. It will
be managed by the EuroMTS multilateral trading facility and
offer straight-through processing to Europes major clearing
houses and central securities depositories.
Even though the capacity to trade corporate bonds
electronically is increasing, the complexity remains. UBSs
Herndon explains: If you want to express an opinion in equities,
theres one stock for each company. For that same companys
bonds, there might be many different bond issues outstanding
as much as 20 or more for larger issuers. Each deal may have
its own characteristics and different breadth of ownership,
hence different liquidity. The different liquidity characteristics
of each issue may lead to price discrepancies between them, and
also the ability to transact in desired sizes.
The bulge bracket firms, which have invested heavily in
electronic equity trading platforms, seem to have the edge over
smaller rivals because of their greater ability to invest in
technological infrastructure. Deutsche Bank and JP Morgan
have both emerged as the two largest players in the fixed-
income scene in the US, and Greenwich Associates says it is no
accident that these two dealers lead in rates products and that
they both deploy top-notch electronic trading platforms.
However, Greenwich Associates consultant Frank Feenstra
points out: Complicating the issue for large and small dealers
alike is the question of whether future trading volumes and
sell side margins will meet the expectations of firms that are now
making large investments in their fixed income platforms.
Theres no doubt its easier for investment banks to invest,
says Herndon. The more seamless the linkage from investor
to trader to trade processing and settlement and the more it can
be automated, the more effective it is. However, I view electronic
trading as an extension to the mix. Its not necessarily a substitute
for voice. Electronic may be a supplement for execution with large
accounts and a more efficient way to reach the smaller or less
active part of an accounts list, for example.
Canadas fledgling Omega ATS is squaring up to its larger rivals
as it is about to begin electronic trading in Canadian government
bonds including the ten-year benchmark bond. Theres no
transparency in bond trading in Canada and the retail investor
takes what they are given, says Michael Bignell, Omegas
president and chief executive officer. Regulators in Canada
have been looking for ways to promote transparency in the
bond markets, but as much as they say they would like to, they
cant just walk into a darkened room and turn the lights on.
At the major banks the profits from the fixed-income desks
dwarf the equities desks so they are not motivated to change.
Its about time that someone threw the lights on.
Slowdown expected
In Canada, overall fixed income trading surged ahead by 42%
on a matched sample basis from 2009 to 2010an extraordinary
period, according to Greenwich Associates. In a matched
sample of 80 of Canadas largest institutions, trading volume
in government bonds increased 93%, although a slowdown is
expected. Electronic trading saves time and adds to transparency.
While it might help transparency, it can still be hard to prove
best execution, points out Robin Strong. Soliciting quotes
from multiple brokers is the accepted method of price discovery
and accepting the best quote is generally considered best
execution. Yet it is hard to prove best execution for more complex
trades that have multiple legs and include swaps or other
derivatives. Some will delegate this to the broker or use internal
models to analyse how the bonds should cost, but these models
can only provide a guide and at this level of complexity the
bond market struggles in the area of best execution.
Over time there will be a movement to benchmark prices
and US and Europe will move closer together, says Jeffery.
Thats not to say there will never be a place for over-the-
counter trading and I think it would be unreasonable to expect
a platform to cope with some of the complex product structures
around today. I
Robin Strong, director of buy side strategy at Fidessa. He says:
Portfolio managers often don't really mind exactly which bond they
buy, as long as it meets their underlying strategy. Photograph kindly
supplied by Fidessa, November 2010.
F
TSE GM: The transition management industry
has changed significantly. What are the factors
driving change?
Mark Dwyer: The industry has changed beyond recognition;
both in depth of service and in terms of when transition
managers become involved in the investment cycle. Five
or ten years ago, you would typically only use a transition
manager when doing an equity to equity transition. Now,
transition management teams provide a substantially broader
range of services such as fixed income transitions; project
management, hedging, interim management, and beta
overlay; sometimes we also help investors with asset
allocation decisions. Many of our clients consult with us
throughout the entire process. Moreover, there was a time
when you called your transition manager after the investment
manager selection process was complete. Now investors
create panels of transition managers that they can turn to
much earlier in the decision process, making it much easier
to access transition expertise.
92
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Transition management has undergone
substantive changes over the past two years as
long established teams have merged, divided,
or folded. Even so, the transition management
product set has deepened, now often
encompassing a cradle-to-grave relationship
between beneficial owners and their mandated
asset managers. At one time, beneficial owners
called in transition teams to facilitate the
movement of a portfolio from legacy to
destination managers only after the manager
selection process was completed. Now that
relationship begins much earlier in the asset
management process, explains Mark Dwyer,
managing director and head of EMEA at
Mellon Transition Management and Beta
Management at BNY Mellon.
A DEEPER
PRODUCT
SET
Mark Dwyer, managing director and head of EMEA at Mellon
Transition Management and Beta Management at BNY Mellon.
Photograph kindly provided by BNY Mellon, November 2010.
93
FTSE GM: Transition managers are not necessarily seen as
experts at asset allocation or manager selection, are they?
Mark Dwyer: Certainly not all transition managers should
advise on asset allocation, and cannot credibly claim that
they should be part of the process. Asset allocation and
manager selection involve decisions about risk and return over
the long term. Transition managers tend to focus on shorter
time frames, but can contribute to understanding risk and
return and investors benefit when they have access to a
different perspective. In this regard, we leverage the BNY
Mellon Asset Management platform. Not only can we offer
best in class ideas on asset allocation to clients, but it also gives
us the capability to manage assets on short-term, interim,
or long-term mandates. There are many factors that drive the
change of an asset allocation or asset managers and each
factor involves different kinds of costs. The benefit of bringing
in transition expertise as early as possible can be significant
to the end value of a portfolio. It is a significant piece of
additional information that should be factored into the
decision making process.
FTSE GM: Is this information not available elsewhere?
Mark Dwyer: Transition managers have specialist systems
and access to analytics that may not otherwise be available
to investors. The information we can provide is not limited
to cost and details market and operational risk. The cost
and risk of a transition should not be the decisive factor in
an asset allocation or fund manager selection process, but
it is an important piece of information, needs to be readily
accessible, and explicitly considered. In some cases we have
gone much further than looking simply at the cost and risk
of a proposed transition. In one recent case, we examined the
cost of establishing and also the ongoing costs of maintaining
a small cap index portfolio compared to a large cap one. We
then generated a set of expected returns using our models
from the asset management business, and were able to
discuss with our client the expected returns after both
immediate and ongoing maintenance transaction costs. Our
approach is consultative, and we are able to show a broader
picture around implementation, and provide metrics to
support our view.
FTSE GM: Can you give us an example of these project
management services?
Mark Dwyer: For a complex transition where project
management was a large element of our involvement we
were recently involved in a fiduciary manager change. This
involved a pension fund moving all its assets from one
fiduciary manager to another. The asset allocation and asset
managers were all different and the operational risks involved
were huge. We also had to ensure cash flows and liquidations
were co-ordinated so that the client, and more importantly
the funds beneficiaries, remained fully invested. There are
many moving parts in a large scale transition such as this,
but we have the experience and capability to identify and
manage all those operational risks.
FTSE GM: What are some of those risks?
Mark Dwyer: Aside from operational risks, the investment-
related risks are complex (bonds, equities, currencies, derivatives,
etc) and require a well thought out strategy, as well as the
aforementioned capability for practical, tactical execution.
FTSE GM: How does it work in practice?
Mark Dwyer: The determination of the optimal path from
legacy to target portfolio can readily be compared to rocket
science. You know where you are starting from, and where
you are going. To get there, several paths will be considered,
trajectories calculated and compared, so as to arrive at a
proposed optimal path, where advantages are clear and
pitfalls known in advance. In a transition, multiple models
of spread levels and market impact calculations must be
used against historical and forward looking data with due
considerations for the existing market environment, with
sensitivities closely aligned to the potential trade execution
methods, in a manner that can be employed equally for each
individual security. Maximisation of in-kind opportunities is
the first step, as these incur no market impact or opportunity
costs. Yet operational considerations can have significant
effect even at this stage, particularly in international securities
where ownership transfer rules and custodial fees vary
widely. Crossing opportunities must be carefully analysed
against the metrics of market impact and opportunity risk
(adverse price movement costs of delaying transactions) as
unintended costs can accumulate.
FTSE GM: How does interim management work in
practice and what are the benefits?
Mark Dwyer: Interim management is about finding efficient
short-term solutions and can involve a combination of
securities and derivatives. Take a client looking to exit a
portfolio invested in European equities where the target
portfolio is global equity. The investment committee has
made the re-allocation decision, but the target manager has
not been selected. There is often a substantial time lag between
an investment committees decision and its implementation.
According to a study released in October by consulting firm
Mercer, the majority of respondents say it took about one to
three months to execute a decision. With interim management,
the risk that there is a change in the relative value of the
legacy and target can be substantially reduced. In this example,
one option would be to liquidate the European portfolio and
create an overlay to the relevant global equity index until
the new manager is funded. The disadvantage of this approach
is that in-kind transfers, often a very significant means to
reduce total transaction costs, are lost. An alternative is to
create an optimised basket of both physical equities and
derivatives. The advantage of this interim portfolio is that it
The determination of the optimal path from
legacy to target portfolio can readily be
compared to rocket science. You know where
you are starting from, and where you are going.
To get there, several paths will be considered,
so as to arrive at a proposed optimal path.
can have a low tracking error to the target portfolio, and
some securities can be retained for in-kind transfer to the
new target portfolio. Another type of interim management
is the overlay of free cash, sometimes referred to as equitisation.
The cash could have been generated from the investment
portfolio or by new injections of cash into the fund. Using a
derivatives overlay, this cash can be put to workin the
market both fast and efficiently. Moreover, the overlay can be
constructed in such a way as to move the actual portfolio
closer to the target asset allocation.
FTSE GM: Are you suggesting that a transition manager
should also be involved in transitions for assets which
are not transferable, such as derivatives?
Mark Dwyer: Transition managers tend to offer much more
value when they can directly trade the securities in the
transition. However, there are significant exceptions, where
the transition manager can offer cost and risk minimisation
where no securities are traded directly. We were recently
involved in a transition where there was a significant element
of liability-driven investment (LDI). The LDI legacy portfolio
and target portfolio were swaps which were non-transferable.
In this particular case, we were asked to examine the
liquidation process of the legacy manager and the swap
construction process for the target manager. The optimal
approach was to provide detailed instructions to the legacy
manager on the date and swaps to liquidate with associated
price limits. As the swaps were liquidated, we created a
duration hedge, which we subsequently unwound as soon
as a target manager established his own swap portfolio.
FTSE GM: Have you changed your business model to
adapt to client requirements or do you claim to lead the
product development process?
Mark Dwyer: Client portfolios are becoming increasingly
complex and an expert transition manager can deliver more
value in this instance. To some extent, the client demand
for more complex asset classes has driven the transition
manager product development process. However, we have
also developed new products and services. We offer products
now that were once traditionally looked after by asset
management rather than a transition manager. It is our
responsibility to stay ahead of the developments in asset
class diversification. We cannot let the complexity of the
investment or asset processes trap our clients in a particular
investment structure. The more complex the investment
structure the more sophisticated the transition solutions we
must provide. That is why transition management is constantly
evolving and that in turn makes it fascinating.
FTSE GM: BNY Mellons transition team in London has
changed over the past year. Where do you now see
opportunity, and how does the composition of the current
team support your forward business plan?
Mark Dwyer: We have the opportunity to bring our approach
to transition management to the broadest global audience, and
we have made great strides to reflect this in the structure of
our business. A foundation of our approach is to use specialists,
creating a clear separation of duties, eliminating key-man
risk and enabling us to handle great complexity. Now, our
presence in London can fulfil all of the key roles we utilise
during a transition. We also have an incredibly experienced
team, covering the full gamut of sales, operations and
investments. We are confident about the team in place, and
feel that we have one of the strongest regional transition
management team, with experience in every major region
EMEA, Australia/Asia, and the USA. Deep experience, common
infrastructure and processes, and a consistent application of
our approach form the premise of our truly global offering. I
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If you need reprints for your marketing needs
Simply call or email
Contact: Paul Spendiff
Tel: 44 [0] 20 7680 5153
Email: paul.spendiff@berlinguer.com
We will be pleased to tailor our reprints to
your specific requirements.
95
F
OR MALTA, THE recession has proved short and shallow,
with a peak-to-trough decline in GDP of 3.4%, as against
5.3% in the euro area. While GDP contracted by 2.1% in
2009, it rebounded to a very positive 4% in the first half of
2010, which suggests, says the central bank, the outturn for
the full year could top 3%, driven by brisk export activity and
a strong accumulation of inventories.
The country has been relatively inured to the vagaries of the
global recession, for good reasons. The first is the governments
commitment to diversifying the economy towards high value
services, which have proved resilient to the downturn impacting
the rest of Europe. Two, the jurisdiction is emerging as a natural
fund domicile. Figures released by the MFSA indicate a 13%
growth in the Net Asset Value (NAV) of investment funds
domiciled in Malta during the first six months of 2010, confirming
a same trend seen in the second half of 2009. Total NAV at the
end of June stood at 7.93bn (up from 6bn at the height of the
crisis in June 2009). The strongest expansion is in the Professional
Investor Fund (PIF) segment, despite the restructuring that
has been taking place in this area to reflect changes in investor
appetite. All 51 funds licensed by the MFSA in the first six
months of 2010 were PIFs, bringing the total of PIFs in Malta
to 331. UCITS funds in comparison stood still at 45, while the
number of non-UCITS stood at 33, three down on December
2009. Another 26 overseas funds are authorised to be retailed
in Malta. Out of 104 Schemes into which the funds are grouped,
72 are multi-fund structures, 20 are stand-alone funds and 12
are Master/Feeder structures. Diversified funds were the largest
asset category, accounting for almost 51% of all the locally
based funds. Equity funds were the second most common
category with a share of 19% of the total number of funds
while derivative funds accounted for 12%.
Maltas stable financial sector also remains a key strength,
albeit, as a banking centre Maltas credentials are perforce
modest, with total banking assets as at the end of 2009 standing
at a tip over 41bn. Substantially liquid, Maltas banks have
however avoided the toxic shocks which have rocked the
industry just about everywhere else; instead they have taken a
largely old-fashioned approach, preferring to act as intermediaries
between retail borrowers and depositors. According to the
World Economic Forums Competitiveness Index 2010-2011, the
soundness of Maltese banks is now ranked 10th globally, up two
notches from the previous report. Moreover, Malta itself has
moved into 11th position in financial market development.
Admittedly not everything is rosy. A continued weakness
is the slow growth in productivity and private consumption,
which has undermined economic performance in recent
years. The public sector also remains relatively over-manned.
Additionally, too few people in Malta participate in the formal
labour market (55%), compared to the rest of Europe (65%),
with the activity rate among women and older workers
particularly low.
Not all the issues are domestic. Given continued strains in
the global economy Malta can only expect modest growth in
export markets in the near term, particularly as the Eurozone
is expected to grow a mere 1.5% in 2011.
However, the government has acted fast. Aside from
introducing new work incentives, a restructuring of the pension
system is in hand, thereby boosting incomes in retirement,
and encouraging private saving to close the saving/investment
gap. While the continued repercussions of the financial crisis will
continue its low level impact on the countrys domestic growth
statistics, Maltas stable appeal as a fund management centre
continues apace and the jurisdiction expects 2011 to provide a
new raft of funds utilising the jurisdictions robust regulatory
environment, market flexibility and low cost services. I
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THE NEW FINANCIAL HUB
Finance and related administrative services account for around 12% of Maltas GDP, with the
government aiming to build this segment to around a quarter of GDP by 2015. The financial sectors
gross value added in nominal terms grew by a rather respectable 22% last year and net financial
inflows have contributed substantially to the contraction in the countrys long standing current
account deficit. Over the decade, Malta has distinguished itself as a cost effective, serious and
adaptable jurisdiction in the field of financial services, backed by The Investment Services Act, 1994
and a robust regulatory environment, overseen by the Malta Financial Services Authority (MFSA).
2011 promises to be a challenging year, though the jurisdiction expects continued robust growth,
despite some internal stresses. By Kenneth Farrugia, chairman, Finance Malta.
Kenneth Farrugia, chairman, Finance Malta. Photograph kindly
supplied by Finance Malta, November 2010.
W
HAT MAKES MALTA so attractive? Malta, as a
jurisdiction, has been firmly placed on the map of
financial centres within the European Union. It
has a number of attractions which include a robust yet
dynamic legal and regulatory environment with an
independent judiciary, where innovation is encouraged. It
also has the benefit of a single regulator, the Malta Financial
Services Authority (MFSA), which is very approachable and
committed to providing an expeditious and prompt service
to new fund applications.
The island also offers political and economic stability. Malta
joined the EU in 2004 and adopted the euro as its national
currency in 2008. It has emerged from the financial crisis
virtually unscathed and, in spite of the economic downturn,
was one of the best performing EU countries with above plan
GDP growth; in fact, Malta was one of two EU countries that
managed to reduce its deficit in 2009. Despite the global
recession, the financial services industry in Malta grew by 22%
last year, and employment in the sector rose to almost 7,000.
Malta offers a well developed infrastructure, a skilled and
sophisticated work pool and service providers with excellent
language skills. Moreover, its infrastructure and work pool are
also competitively priced. Skilled labour, professional fees
and excellent office space with relatively low rents, are cost
competitive, especially when compared to other EU
jurisdictions. Malta provides good telecommunications and
air/sea transportation links with a high usage of Information
Communication Technology (ICT). Malta is also within the
Central European Time (CET) zonea somewhat
underestimated yet quite important factor.
Favourable fiscal and tax considerations including
exemptions from tax and stamp duties at both fund and
investor levels, together with potential benefits from Maltas
extensive tax treaty network with over 50 countries, add to
the jurisdictions appeal. Equally, it offers other no less
important benefits, such as a unique culture, rich in historical
treasures, an enviable Mediterranean climate and a socially
enjoyable and secure environment.
This compelling package is increasingly attracting the
attention of fund investors and managers, particularly at a time
when the pressure for a higher level of supervision,
transparency, reporting and organisational requirements is
increasing. On the banking front some 25 licensed credit
institutions have already established operations in Malta of
which 20 are EU-country based.
An October 2010 survey The future of manager migration,
fund servicing and domiciliation in the Mediterranean: The
alternative to Ireland & Luxembourg? carried out by the
London-based International Fund Investment Limited,
underscores Maltas growing appeal and a salient trend for
funds to re-domicile to onshore jurisdictions with
comprehensive yet flexible legislation. Some 76% of
participants interviewed in the survey acknowledge that
Malta offers significant potential as a base for their funds or
to open an office, while the majority of investors (83%) are
aware that Malta is becoming a sought after alternative to
Ireland and Luxembourg. When asked if they would consider
relocating funds to Malta or Gibraltar as an alternative to
Luxembourg or Ireland, 18% said they are looking at moving
funds to Malta or Gibraltar while a further 26% are open to
the idea, particularly if these locations continue to offer
fund servicing on the same level as Ireland or Luxembourg
but at lower costs.
When questioned about their views on the regulatory
environment in the Mediterranean domiciles, all those
respondents who visited the Malta Financial Services Authority
had positive comments to make about the proactive approach
that the Maltese regulator has taken. One manager said that
this was Maltas biggest selling point. When asked if investors
have any views on the quality of fund service provision in
the Mediterranean domiciles, one interviewee said that he was
aware of the fact that several international fund administrators
had recently launched offices in Malta and regarded this as
a positive step for the country.
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ATTRACTIVE
ALTERNATIVE
Malta has a new status in financial circles as it
emerges as a sought after and reputable
international financial services centre. Hailed
by the City of Londons Global Financial
Services Index (2010) as one of the five
financial centres to grow in importance over
the coming years, the island is carving a niche
for itself in the global funds industry. In the
light of impending regulation in both Europe
and the US, fund investors and managers are
evaluating ever more carefully the jurisdiction
of their choice. In the emerging new financial
order, Malta is regarded as a feasible
alternative financial centre. Charles Azzopardi,
managing director, HSBC Securities Services
(Malta) Limited outlines the opportunities.
Charles Azzopardi,
managing director,
HSBC Securities
Services (Malta) Ltd.
Photograph kindly
supplied by HSBC
Malta, November 2010.
FinanceMalta - Garrison Chapel, Castille Place, Valletta VLT1063 - Malta | info@nancemalta.org | tel. +356 2122 4525 | fax. +356 2144 9212
more information on:
www.fnancemalta.org
FinanceMalta is the public-private initiative set up to promote Maltas International Financial Centre
E f f e c t i v e l S e c u r e l S k i l l e d
secure
stable
robust
7 reasons why international
nancial institutions are dropping
anchor in Malta:
English as an ofcial language;
Cost competitive skilled workforce;
EU member with euro as its currency;
Consistently highly ranked quality of life;
Meticulous yet accessible single regulator;
Robust yet exible legal and regulatory framework;
Secure and stable business environment and a world class IT infrastructure.

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international bank, HSBC Bank
Malta p.l.c. provides global
custody services to investment funds,
whilst HSBC Securities Services (Malta)
Limited provides a full range of services
including fund accounting and transfer
agency. Both these companies form part
of the HSBC Group which has one of the
strongest balance sheets in the industry
and which has the people and the
technology necessary to provide an
exceptional client service to investment
funds seeking re-domiciliation to Malta.
HSBC Malta is connected to the
Groups global network to tap best of
class products, systems and customer
service, and is committed to playing a
pivotal role in the development of the
Maltese financial services sector. HSBC
Malta has not only found Malta to be a
good country in which to do business, but
also a country where the potential exists
to expand operations and to diversify into
new areas. Malta offers a compelling
package and we are convinced that Malta
has a very bright future.
HSBC at the financial heart of Malta
To reinforce the point: Malta is now ranked 50th among 139
economies in a World Competitiveness Report issued by the
World Economic Forum for 2010-2011. The same report ranks
the soundness of Maltese banks in 10th place.
The Vision 2015 strategy
The government of Malta has set an ambitious target to
double the financial sectors contribution to the islands GDP
to 25% over the next five years as part of its Vision 2015
strategy. So far, so good: over the first six months of the year
the financial services sectors gross value-added increased
by a significant 75%, suggesting that Malta is on the right
track. No surprise then that that the number of funds registered
in Malta rose by 26% in 2008 and 27% in 2009.
Redomiciliation of Funds
Since 2002, Malta has set up a statutory framework that
allows the re-domiciliation of companies in and out of the
island in a seamless manner. The utilisation of these rules
for re-domiciliation of a fund to Malta has a number of
advantages. For one, the corporate existence of the fund
remains undisturbed and it is therefore not necessary to wind
up the existing fund and set up a new structure in Malta. As
a consequence of this continuity the investors capital
gains/losses are not crystallised and therefore there should
not be any tax consequences to investors. Investors can also
continue to measure the performance of the fund by reference
to their original investment. Equally, the fund can maintain
its same service providers (fund administrators, custodians,
prime brokers etc) and existing agreements can remain
unchanged. Additionally, investors in the fund are not impacted
and their holding in the fund will not change in any way.
Likewise, the portfolio of the fund can continue to be managed
in the usual manner without any liquidations or transfers.
Moreover, funds that are already listed outside Malta can
continue to retain their existing listing (subject to approval
of the exchange where the fund is listed).
Malta adopts international financial reporting and auditing
standards and because of that no major financial reporting
changes may be required post re-domiciliation. Fund managers
also have the opportunity to change the regulatory status of
their fund to a UCITS scheme (provided the funds investment
strategy can be accommodated within this structure). The
UCITS brand will undoubtedly enhance the marketing reach
of the fund as it is a brand that affords higher significant
investor protection and transparency.
Reporting and regulation
The requirements set out by the Malta Financial Services
Authority to enable the re-domiciliation of funds to Malta are
comprehensive and include the following requirements:
G The existing fund has to be incorporated under the laws of
an approved jurisdiction (including EU, EEA, OECD) as
well as most offshore centres such as Cayman Islands,
British Virgin Islands, etc;
G The legal vehicle has to be similar in nature to a company;
G Re-domiciliation is possible under the laws of the jurisdiction
where the fund is currently domiciled;
G Re-domiciliation is permitted in the funds Memorandum
and Articles of Association; and
G Re-domiciliation is approved by way of an extraordinary
resolution.
Naturally, once the fund is re-domiciled to Malta, the
licensing requirements that would apply to a new fund will
have to be met as well.
Malta has also taken a balanced approach towards the
hedge fund segment. Hedge funds have been regulated in the
jurisdiction since the introduction of the Investment Services
Act, which came into law in the mid-1990s. The approach to
hedge funds by the local regulator has been flexible and
while stringent due diligence procedures are obligatory both
in the licensing procedures and reporting regimes, different
categories of alternative investment funds have been
recognised and regulations in the jurisdiction are tailored to
meet the needs of different types of investors.
Malta is also cognisant of the globalisation of the funds
industry and funds are allowed to have external administrators
and custodians in recognised jurisdictions.
Both the regulator and local service institutions are geared
to interface with the emerging regulatory structure in the
European Union and will be sufficiently equipped to deliver
effective services to the financial sector as Malta grows in
stature and confidence as a new global financial market
structure starts to take new form and shape. I
I
T WAS NOT too long ago that Malta did not appear on
the radar screens of fund service providers. They were
more interested in setting up shop in the larger domiciles
of Luxembourg and Ireland. Today, Malta is a firm feature
on the map thanks to a thriving fund industry and a relatively
healthy economy. Hedge funds are the main focus but other
funds are expected to be included as the country expands
its product and geographical reach.
Brendan Conlon, business development director at SGGG
Fexco Fund Services, Malta, says: At the moment fund servicing
mainly caters to the hedge fund industry but I expect that will
change with UCITS IV and the Alternative Investment Fund
Managers (AIFM) directive. They both will help to broaden
the fund set and investor base and in the future I think we
will see both hedge fund and long only managers setting up
funds in Malta because of the lower cost of doing business
here and the strong regulatory framework.
Dr David Griscti, head partner and founder of law firm
David Griscti & Associates, says: The real driver of growth
in Malta is, and will be for now, the alternative investment fund
area. Although hedge funds have been the most popular, we
have also worked on setting up funds in a variety of other
alternative asset classes such as private equity, property,
commodities, alternative energy and even art. Professional
investment fund (PIF) regulation is flexible enough to
accommodate different structures.
Market participants also expect to see further growth from
re-domiciliation. As Anthony ODriscoll, managing director
of Apex Fund Services, Malta, notes: There has been a move
from offshore to onshore jurisdictions over the past two years
because investors want to see greater transparency and
reporting processes as well as the internal controls and risk
management systems of their fund managers. In many cases,
what we are seeing is not so much pure re-domiciling but
instead fund managers setting up onshore funds in Malta
while keeping their offshore fund in the Caymans or Bermuda.
One of the main attractions of Malta is that it is a low-
cost jurisdiction that offers a favourable taxation system for
investor funds. This is not only due to the exemption of
income tax and capital gains tax at the fund and non-resident
investor level but the country also has about 50 double
taxation treaties in place.
Joseph Camilleri, head of Valletta Fund Services Business
Development Unit, adds: The financial crisis has been a major
catalyst for fund managers who have had to rethink their
strategies in relation to the domicile of their investment vehicles.
Investors are placing more emphasis on risk and as a result
fund managers are looking for well-regulated jurisdictions
with a strong reputation for high quality people and professional
support. To date, the most popular types of funds have been
PIFs set up by mainly Europe-based fund managers, but we
are now seeing other fund managers set up UCITS schemes.
According to recent research conducted by research and
publishing group International Fund Investment, regulation
is a driving force behind the move onshore. Its latest study
found that 62% of alternative fund managers canvassed
in the US and Europe either haveor are planning tore-
domicile their funds or launch mirror funds in the European
Union (EU). Breaking it down, 18% have already re-
domiciled their funds or are planning to, while 44% have
launched EU-domiciled mirrorfunds or expecting to. In
terms of the domicile, Ireland emerged as the most popular
choice by half of respondents, followed by Luxembourg
(27%) and Malta (20%).
However, many are considering Malta as well as Gibraltar
as viable alternatives to Luxembourg or Ireland, with 18%
saying they are thinking of moving to the smaller jurisdictions
while a further 26% are open to the idea, particularly if these
locations continue to offer fund servicing on the same level
as Ireland or Luxembourg but at lower costs. Respondents also
saw the increase in the number of international fund
administrators in Malta as a positive step.
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MALTAS ONSHORE APPEAL
TO FUND MANAGEMENT
The real driver of growth in Malta is, and will be for the foreseeable future, the alternative
investment fund area, according to Dr David Griscti, head partner and founder of law firm David
Griscti & Associates. Although hedge funds have been the most popular, he says the country has also
worked on setting up funds in a variety of other alternative asset classes, including private equity,
property, commodities, alternative energy and even art. Market participants also expect to see
further growth from re-domiciliation. There has been a move from offshore to onshore jurisdictions
over the past two years, says Anthony ODriscoll, managing director of Apex Malta, because investors
want to see greater transparency and reporting processes as well as the internal controls and risk
management systems of their fund managers. In many cases, what we are seeing is not so much
pure re-domiciling but instead fund managers setting up onshore funds in Malta while keeping their
offshore fund in the Caymans or Bermuda. Lynn Strongin Dodds reports.
Bank of Valletta

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According to Kenneth Farrugia, chairman of FinanceMalta
and chief officer, Valletta Fund Services, the number of
investment services licence holders totals 88, a significant jump
from 59 in 2006. There are about 15 fund administrators but the
past two years has been particularly busy with Apex, SGGG
Fexco Fund Services, Custom House and Praxis setting up
shop. Meanwhile, Bank of Valletta, which had been the leading
player, spun off its fund services operation as a separate business
to capitalise on the growing trend for fund administration.
Under the PIF regime where hedge funds fall, funds can
chose service providers such as investment managers, fund
administrators, custodians and prime brokers established
outside Malta. These providers in turn can also tend to funds
authorised in other jurisdictions if the rules comply with
Malta. However, the latest survey taken in December 2009
shows that domestic players are gaining momentum with
around 47% of the total funds located in Malta being
administered by local firms.
Overall, according to figures from the Malta Financial
Services Authority, there are about 431 funds domiciled in the
country. Although activity dipped during the recession,
HSBCs statistics show that the industry regained its lustre with
the number of new funds rising 26% in the first quarter of this
year compared to 22% in 2009 and 30% in 2008. This is a far
cry from the 104 registered funds ten years ago.
Although both the number of funds and administrators
continue to rise, the industry seems to still be dominated by
four players, with Valletta and HSBC being frontrunners
followed by Custom House and Apex. This is expected to
change as the fund business widens and develops. Camilleri
of VFS, says: Competition is definitely increasing but this
is healthy and one which I deem as being the evolutionary
process. The result is the industry is set to grow exponentially
by way of not only the establishment of new fund
administrators but also the increasing incidence of fund
management companies setting up in Malta.
Chris Bond, head of global banking and markets at HSBC
in Malta, adds: The dynamic growth of the fund
administrator business has prompted us to sharpen our
pencil. We have the advantage of being one of the global
players and also being able to leverage off the strengths and
global footprint of the HSBC group. However, the growth of
the market and new entrants means that we need to ensure
that we continue to have the best products and services.
HSBC has the full range of products, including net asset
value calculations, investor record processing, corporate
management services and turnkey fund solutions for new
launches. Outsourcing has also become a major theme
especially in the middle office arena.
ODriscoll says: The collapse of Lehman Brothers and
emphasis on counterparty risk forced fund managers in Europe
and the US to look towards the multi-prime broker models.
This requires support for multiple execution platforms, complex
reconciliation, trade allocation and counterparty risk. As a
result, many managers find it more cost-effective and efficient
to outsource these activities to administrators who can provide
not only post-trade services but also pre-settlement trade
processing and support, position and trade reconciliation, fund
accounting and risk management reporting.
Camilleri echoes these sentiments: Currently, at Valletta
Fund Services, we provide our fund management clients
with a comprehensive suite of fund services to include turnkey
fund formation solutions, as well as the determination of
net asset value and transfer agency services, anti-money
laundering reporting services and company secretarial services.
We are also experiencing an increased demand for middle-
office reporting services as a result of fund managers deciding
to outsource this function to their administrators.
Although market participants are optimistic about the
future growth prospects of Malta, many see the dearth of
custodians on the island as a stumbling block to further
development in the UCITS space. This is because under
UCITS IV, managers can set up funds in any EU domicile,
and manage these cross border, but the custodian has to be
based in the same domicile as the UCITS.
All eyes are on Deutsche Bank, which recently upgraded
its licence in the country. The German bank is keeping tight-
lipped about its plans, only issuing a statement confirming
that it was granted a credit institution licence in March 2010,
replacing its existing financial institution licence. The bank
currently continues with its existing business and might also
look into further business opportunities in the future.
Farrugia says: The industry is experiencing the development
of a cluster by way of the setting up of international fund
administration companies as well as fund management
organisations. It is however yet to experience growth in the
depositary/custody sector. I am confident that over the course
of next year, Malta will experience the setting up of other
international custody service providers. I
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Joseph Camilleri, head of Valletta Fund Services Business Development
Unit. Investors are placing more emphasis on risk and as a result fund
managers are looking for well-regulated jurisdictions with a strong
reputation for high quality people and professional support, he says.
Photograph kindly supplied by Valletta Fund Services, November 2010.
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ALTA MAY BE a fraction of the size of Luxembourg
and Ireland, but it has enjoyed success on the global
alternative investment fund stage. The country plans
to increase its market share in the wake of regulatory calls for
greater transparency and the ensuing migration to onshore
jurisdictions. The funds setting up shop may be small today
but the goal is to provide the right environment for them to
flourish. Since its entry to the European Union in 2004 and
the adoption of the euro four years later, the countrys profile
as an onshore jurisdiction has been cemented. The latest
2010 Global Financial Centre Index (GFCI) named Malta
along with Dubai and Shanghai as one of the top three
financial centres most likely to succeed over the next two to
three years. In addition, as the country continues to punch
above its weight, it climbed to 11th from 13th in financial
market development on the World Economic Forums Global
Competitiveness Index 2010-2011.
Kenneth Farrugia, chairman of FinanceMalta, and chief
officer of Valletta Fund Services, says: Malta's fund industry
is fast gaining growth traction and is today being increasingly
recognised as an EU-based fund domicile alongside
Luxembourg and Ireland. Malta sits in a unique geographical
position as a member of the EU and very close to the south
and south-east fascia of the Mediterranean. This inherently
means that Malta is positioned to act as an important gateway
to the European market and at the same time to North Africa
and the Middle East. This makes the country a highly
compelling proposition for both EU and non-EU financial
institutions seeking to gain access to European investors and
the Arab world at the same time.
Low costs have also been a major selling point. Industry
estimates place professional fees, salaries and office expenses
at roughly two-thirds of those in the more established centres.
Anthony ODriscoll, managing director of Apex Malta, which
is part of the Apex Fund Services, says: Although Malta will never
be a Dublin or Luxembourg because it will not attract the same
deal volume, the country is a viable option. The main attractions
are not only the low set-up costs, but a strong regulatory
framework, fast-track approval process, quality global service
providers and an extensive double tax treaty network. The
average size of the fund may start small5 to 20mbut we
have in the past seen clients grow their assets under management
quite quickly having started at that base.
Dr David Griscti, lead partner and founder of law firm
David Griscti & Associates, a specialist in investment services
law, says: The fund industry took off after our entry into the
EU. Some would say that it has been a negative that we did
not initially attract the larger players. I, however, see it as a
positive because the country was not then in a position to
handle it. Attracting the smaller players allowed the
professional service firms to grow their internal resources
and as a result we are now able to deal with the larger funds.
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Since its accession to the European Union six
years ago, and the adoption of the euro in
2008, Maltas profile as an onshore jurisdiction
has been firmly established. The latest 2010
Global Financial Centre Index named the island
in the top three financial centres most likely to
succeed in the next couple of years, along with
Dubai and Shanghai. Also, Malta climbed to
11th from 13th in financial market
development on the World Economic Forums
Competitiveness 2010-2011 Index. Lynn
Strongin Dodds explains how a small country
with a population of less than half a million is
building up the financial muscle to be able to
compete with the big boys.
Photograph Ronfromyork /
Chris Bond, head of global banking and markets at HSBC in
Malta, agrees that Malta has a strong professional infrastructure
as well as a robust regulatory framework which is aligned with
EU requirements. He adds: Our regulator in general has
adopted a firm but flexible approach. The other benefits of
working in Malta are a multilingual and educated workforce and
a well capitalised and sound banking system. Due to a strong
liquidity position and prudent asset/liability management,
none of the banks needed a bailout from the government.
Prof Joseph Bannister, who has been chairman of the Malta
Financial Services Authority (MFSA) since 1998, concurs that
its hands-on approach has been one of the secrets of Maltas
success on the fund scene. He has been instrumental in
navigating the country from being an offshore domicile in
the pre-EU days to its current onshore status. With him at the
helm, the MFSA implemented a raft of reforms in preparation
for EU membership, plus it became a single regulator
amalgamating the work carried out by several agencies.
More recently, the MFSA underwent a further restructuring
and shed its silo-based structures in favour of an integrated
and harmonised organisation. The main thrust was removing
the authorisation and regulatory development oversight
functions from each of its three supervisory groupssecurities
and markets, banking and insurance and occupational
pensionsand creating two separate units. This was to ensure
greater consistency in licensing, supervision and internal
communications.
Bannister notes: The nature of the regulatory regime is
one of the key things that financial institutions look at when
they are considering setting up in a new jurisdiction. I think
our model as a single regulator is unique. We cherry-picked
the best practices from countries such as Germany and
Sweden and have been very proactive in the development of
both EU as well as national legislation. Our goal is to enact
laws that allow business to develop innovative practices.
Griscti adds: The fund industry took off post-EU
membership, mainly driven by flexible and market sensitive
regulation that reacts swiftly to market changes and issues
that arise. However, the key drivers are the professional firms,
like ourselves, whom are extremely proactive in going out
to get the business. We, for example, target asset managers
and visit them in their offices to discuss how we can help
them set up funds.
In terms of regulation, the linchpin has been the Investment
Services Act, which is a comprehensive regulatory regime
for investment services and collective investment schemes
(CIS), including professional investment funds. Overall, the
fund industry has enjoyed significant growth since ten years
ago when the net asset value (NAV) of the funds domiciled
in Malta stood at just 500m. The recession took its toll but
total NAV has recovered, climbing steadily from its low point
of about 6bn during the height of the crisis in June 2009 to
7bn in December 2009 and 7.9bn for the first half of 2010.
Personal investment funds (PIFs) continue to account for
the bulk of the 431 funds domiciled in Malta and the 51
funds that were granted licences during the first half of 2010.
By contrast, the number of Undertakings for Collective
Investments in Transferable Securities (UCITs) funds remained
the same at 45 while non-UCITs fell three to 33. Joseph
Camilleri, partner at PricewaterhouseCoopers in Malta, says:
Asset managers can choose from a range of fund structures,
including UCITs, but PIFs have been the most popular to
date. The PIF regime is flexible and allows for a smooth and
efficient application process. The vast majority are start-up
funds and most of the investors are from Europe, although
we are seeing some interest from North America.
Minimum threshold
PIFs are broken down into three categories, with the
experienced investment fund at one end of the scale. It
requires a minimum investment threshold of 10,000. These
funds are not bound by any investment restrictions as is the
case with retail funds but they are still required to appoint a
custodian and can only leverage up to 100% of NAV.
In the middle is the most commonthe qualifying investor
fundwhich requires a minimum investment of 75,000. These
funds are not subject to investment or borrowing restrictions
and may make unlimited use of leverage. They also do not
need to appoint a custodian or prime broker provided adequate
safekeeping arrangements are implemented. Last but not least
is the extraordinary investors category, which joined the fold in
2007. They are geared towards private equity investors and
family offices with the minimum investment threshold standing
at 750,000. The turnaround process is faster than the other
two and they have proved popular for those looking to move
from an offshore to onshore location.
According to Farrugia: The MFSA has ensured the presence
of a comprehensive legal and regulatory framework to cater
for the different needs of fund managers and their clients. The
regulatory framework for PIFs is highly flexible and
accommodates a variety of fund structures to cater for a wide
range of fund strategies, which amongst others include long
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Dr David Griscti, lead partner and founder of law firm David Griscti &
Associates. Attracting the smaller players allowed the professional
service firms to grow their internal resources and as a result we are
now able to deal with the larger funds, he says. Photograph kindly
supplied by David Griscti & Associates, November 2010.
Ganado & Associates Advocates, a leading law rm with a predominantly
international practice, provides integrated legal services across all practice
areas. Our multi-disciplinary team takes a constructive hands-on approach
to deliver a bespoke service to our international business clients.
For more information on how we can help please call +356 2123 5406/7/8,
email lawrm@jmganado.com or visit www.jmganado.com
INVESTMENT FUNDS
SECURITIES LAW
TRUSTS
CAPTIVE REINSURERS
PENSIONS QROPS
INTERNATIONAL BANKING
CORPORATE FINANCE
MERGERS ACQUISITIONS
JOINT VENTURES
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TAXATION
EU PASSPORTING
SHIPPING
AVIATION
CORPORATE SERVICES
LITIGATION ARBITRATION
EMPLOYMENT
INDUSTRIAL LABOUR
TELECOMS, MEDIA TECHNOLOGY
INTELLECTUAL PROPERTY
COMPETITION
PUBLIC PROCUREMENT
ENVIRONMENTAL LAW
RESIDENCY
PROPERTY CONVEYANCING
MEDICAL HEALTH
ENERGY RENEWABLES
Eyes see opportunity
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A D V O C A T E S
where minds comprehend

short strategies, arbitrage funds, directional, global macro
and algorithmic funds. The MFSA also has in place policies
to accommodate property funds which may likewise be
structured as PIFs. We have also experienced the PIF regulatory
framework being used to structure private equity and venture
capital funds.
Looking ahead, market participants expect to see further
growth opportunities on the back of UCITS IV and the
Alternative Investment Fund Managers Directive (AIFM)
which was recently approved by the European Parliament. On
the UCITS IV front, Malta hopes to capture business from
changes within the master and feeder structure. Under the
new rules, the master and feeder funds are not required to be
situated in the same member state plus they may also have
different depositories and auditors, subject to implementing
adequate information-sharing arrangements. For example,
fund providers could establish a management company under
UCITs IV in Malta while keeping their fund administration
in Luxembourg or Ireland.
There is also hope that both pieces of legislation will bring
different types of funds to the country as well as accelerate
the trend of hedge funds wrapping certain strategies in a
UCITs umbrella. Farrugia says: We have seen an increase
in the number of so called Newcitsfunds in Malta, or hedge
funds that create UCIT funds to mirror their strategies. This
is being driven by investors who want a more transparent
and tightly-regulated product in the wake of the Madoff
scandal and financial crisis.
Liquidity for investors
Bond, however, is more circumspect about the Newcit product:
Newcits account for a relatively small percentage of the
5.5trn UCITs market. There are still constraints, bans on
short selling and OTC derivatives rules which will make
certain hedge fund strategies ineligible for a UCITs structure.
Liquidity for investors is also a major issue. Having said that,
Malta is still seeing growth in the UCITS space.
Although Europe is an important region, Malta is also
hoping to capitalise on its ties with its North African and
Middle Eastern neighbours. To that end, Farrugia notes:
Malta is also seeking to attract the setting up of Shariah-
compliant funds. Within this context, in March 2010, the
MFSA published a guidance note for Shariah-compliant
funds, which enable the setting up in Malta of such funds. This
regulation allows these funds to be set up either as retail
funds (UCITS or non-UCITS) or as PIFs. However, in the
specific case of Ijarah funds (which are structured around a
specific asset, such as a building, property, or infrastructure),
commodity funds, and Murabaha fundsa method of
financing the purchase of a house according to Islamic
principlesthese can only be set up as PIFs, due to the
largely non-conventional assets in which these funds invest.
The country is also looking towards Asia and the MFSA
signed a memorandum of understanding (MoU) earlier this
year with the China Securities Regulatory Commission to
protect and promote the development of the securities markets
by providing a framework for co-operation, increased mutual
understanding and the exchange of information. According to
Bannister, the deal allows Chinese qualified domestic
institutional investors(fund managers) to invest on behalf of
Chinese investors into Malta-domiciled investment funds, both
PIFs and UCITS, while Maltese fund managers will also be
able to tap into Chinese investments under certain circumstances.
As for the obstacles ahead, economic uncertainty is of
course a concern. Bond notes: As Malta has an open economy
it was not isolated from the global downturn. However, we
did not shrink as much as others. Our GDP growth rate is
currently estimated at about 3.4% this year, which is better
than the European average.
The other big challenge is a skills shortage which might not
be surprising in a population of around 413,000. Companies
as well as MFSA and trade organisations are trying to rectify
the problem by running professional development courses and
retraining to ensure members of the sector are up to speed
with the latest developments and techniques. Bannister notes:
Although our population is small, there are over 10,000 full-
time university students and an additional 11,000 in vocational
training. We also have several training institutes which have
come together to design programmes aimed to train the
middle layer; asset managers, risk managers, fund accountants
and underwriters.
Expats are also coming back but as Camilleri notes: Human
resources and a limited talent pool in a dynamic and growing
sector is one of the biggest problems the financial services
sector in general faces. Over the past five to ten years, we
exported our graduates but recently, due to the growth in
financial services, there has been a huge demand for the best
and brightest and we are now importing people from other
European countries to meet the demand. We are still sending
people on long-term strategic deployments to different countries
to learn certain skills and bring back their expertise.I
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Chris Bond, head of global banking and markets at HSBC in Malta.
Malta has a strong professional infrastructure as well as a robust
regulatory framework which is aligned with EU requirements, he says.
Photograph kindly supplied by HSBC, November 2010.
Sparkasse Bank Malta plc is authorised to conduct Banking business
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18:20
T
HE EXTERIOR OF the 19th century British Garrison
Chapel, which is home to the Borza Malta or Malta
Stock Exchange, may have retained its period features
but the offices inside are anything but old-fashioned. State-
of-the-art technology coupled with innovative ideas and a
determination to be a player on the global stage are its
hallmarks. The MSE may be small in stature but its plans are
on a much larger scale.
Eileen Muscat, chief executive of the MSE, says: European
Union membership and entry into the euro was transformational
because it helped us attract a wider investor and issuer base.
However, the performance of our stock market during the
financial crisis combined with the 2010 Global Financial Centre
Index Report, which named Malta as one of the top three financial
centres for the future, has definitely raised our profile and
boosted investor as well as issuer confidence. We are not
complacent and what we are doing now is trying to capitalise
on our positions in the league tables.
Muscat, who took over the helm this year and has been with
the exchange since it opened in 1992, is driving the changes
laid down by her predecessor, Mark Guillaumier. The objective
is to internationalise and promote the exchange to investors
as well as issuers. It has taken its show on the road and has
been proactively marketing its pre and post-trade wares to
an audience which is more interested in onshore locales in
the wake of the financial crisis.
She says: To date, the exchange has been largely a domestic
operation with activities geared towards the local market.
However, growth is finite because we are a small country and
our strategy has been to push for international listings and
participants. We see ourselves as acting as a gateway for issuers
from non-European countries to tap into a European investor
base and vice versa. This is especially true of North Africa
and the Middle East investors and issuers who we have cultural
ties with because of our geographical position in the
Mediterranean. We are currently holding several discussions
to see what fund managers in the region are doing and what
products clients would like to see being developed.
Muscat notes that the MSEs plan to expand its reach and
product offering is part of the governments 2015 Vision
initiative which aims to make financial services account for
25% of the countrys GDP. She says: Financial services along
with healthcare, tourism, information technology and
communications are the four pillars of growth that the
government is targeting for development. We think that
attracting more local and foreign companies onto the exchange
will have a domino effect. We are looking to not only list
more funds and bonds but also smaller cap companies. We
believe that they may find it easier to deal with us than some
of our larger competitors. We offer a fast, efficient and personal
service at very cost competitive prices.
The MSE, which is small by international standards with a
market capitalisation of about 7.6bn, operates two markets
the Regular Market, consisting of equities, corporate and
government bonds, and the Treasury Bill Marketbut it has
come a long way in its almost 20 years. Muscat recalls: When
we started there were only about 8,313 accounts in the central
securities depository. Today we have about 170,000 accounts.
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MSE AIMS TO BE A
GLOBAL PLAYER
The Malta Stock Exchange intends
to capitalise on its positions in the
league tables with the objective of
internationalising and promoting
itself to investors as well as issuers.
It has taken its show on the road
and has been proactively
marketing its pre and post-trade
wares to an audience which is
more interested in onshore locales
in the wake of the financial crisis.
Eileen Muscat, chief executive of
the MSE, says: We see ourselves
as acting as a gateway for issuers
from non-European countries to
tap into a European investor base
and vice versa. Lynn Strongin
Dodds reports.
Photograph Solarseven /
What is the significance of Deloitte becoming the worlds largest professional services firm? In all honesty, we believe very little.
Our focus is on helping our clients establish, define and achieve their vision so that they can step ahead with confidence in all
aspects of their business. And our aim has always been, and will always be, to put our clients first.
At Deloitte we have a dedicated team of individuals specialised in providing assurance, advisory and tax services
to companies operating in the investment services sector. For more information on how we can help, please contact Steve
Paris at sparis@deloitte.com.mt or Andrew Manduca at amanduca@deloitte.com.mt or visit ww.deloitte.com/mt
Step ahead.
2010 Deloitte

We started with government bonds and then moved to corporate
bonds and equities. Aside from government bonds and treasury
bills, we have about 20 listed equities and 40 corporate bonds
as well as over 300 funds from global players including HSBC,
Fidelity and Lloyds TSB. Culturally, Maltese people are buy
and hold investors but that is slowly changing and the numbers
who are regular traders is growing.
Although Malta navigated the financial storm better than
many of its larger contemporaries, the stock market did take a
hit on the equity trading side with turnover dropping to 23.5m
in 2009 compared to 49.1m the previous year. Total turnover
though climbed 13.3% to 553m, an increase of 13.3% compared
to 2008, mainly thanks to record activity in the corporate bond
arena which saw 12 new listings, 11 new government securities
issues as well as a 1.6bn treasury bill listing.
The MSE is building upon its successes and is currently
undertaking four to five major projects, including the
development of investor access facilities, improvement of
connectivity and the revamping of research and marketing
functions. It is also looking at listing a wider selection of
funds, including exchange traded and Shariah-compliant.
While it has been successful in listing retail collective
investment schemes, it has had less luck with hedge funds
and the alternative sector. The hope is that it will be able to
tap into a new vein of business on the back of regulatory
changes that are encouraging products to be exchange traded
instead of traded over the counter.
The other major plank in its strategy is to the replacement
of its trading platform. Unlike many of its contemporaries
though, latency is not the main focus. Muscat says: Although
there have been several discussions around high-frequency
traders, they have not been an issue in Malta because we do
not generate the same level of volumes on the equity side. We
do not see technology as an end in itself but a means to an
end in order to improve our connectivity and functionality.
The main goal is to attract more liquidity.
We are also working on our first cross listing, which we
hope will happen by the end of the year or the first quarter of
next year. I am on a learning curve from an operational point
of view but I hope that once it is finished it will raise our profile.
The MSE has also been working on the finer points. It
recently revised trading limits to plus or minus 10%, giving
a daily range of 20% in order to allow market participants to
react faster when a company announcement is made.
Although trade ranges had been revised several times since
the exchanges inception 18 years ago, many believed the
methodology and procedures needed to be more proactive.
In addition, the MSE launched a product in line with the
EUs shareholder directive, that enables shareholders to take
part in annual general meetings electronically. It will be rolled
out initially to domestically-listed companies before going to
non-listed companies such as fund managers and administrators
who need to maintain company records and a share register.
On the post-trade front, the MSE has been busy forging
technical links with other exchanges, depositories and
settlement systems. It recently joined Euroclears FundSettle,
a system that facilitates order routing, cash settlement and fund
servicing across national, European and international borders.
It is used as a settlement platform between fund distributors
and transfer agents acting for fund promoters. The platform
provides access to more than 50,000 funds and 520 transfer
agents in 24 domiciles, including Malta.
The MSE also struck a partnership with Clearstream, the
post-trade arm of Deutsche Brse Group, to offer settlement
for Maltese domestic securities. Both parties will be working
closely together with the aim to improve cross-border
settlement ahead of the implementation of Target2-Securities,
the settlement system that the European Central Bank plans
to introduce in 2014 for cross-border settlement.
A work in progress
Although the deal is still a work in progress, Clearstream
and the MSE will offer settlement in Clearstream via the
Maltese Central Securities Depository (MCSD) for all types
of Maltese securities including stocks, government securities
and investment funds against Central Bank money.
Muscat says: The Clearstream deal will be done in phased
stages but it allows us to offer a wider range of services to our
clients. All Maltese stocks will be cleared and settled in
Clearstream, which will make them more marketable and
easier for international investors to invest in. The most difficult
part of the process was the legal, regulatory and operational
framework and that part has been completed.
As for its involvement in TS2, Muscat notes: We are
currently involved because we are one of the 27 CSDs, although
we are one of the smallest. Although no one is arguing against
the common principle there are still fundamental questions,
particularly pricing and governance structures. These are all
open to discussion and agreements may not be easy because
of the diverse needs of the various users.
In terms of the MSEs challenges, Muscat points to human
resources as the biggest obstacle. It is a problem in Malta
overall but like any small organisation we need the resources
in order to achieve these goals. With the best will in the
world, you can only stretch as far as your finances and people.
Also, as the market becomes more international and
sophisticated, you need people with greater expertise and
knowledge. This is changing and we have sent many people
for training but it takes time. I
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Eileen Muscat, chief executive of the MSE. Financial services along with
healthcare, tourism, information technology and communications are the
four pillars of growth that the government is targeting for development,
she says. Photograph kindly supplied by MSE, November 2010.
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P
RIVATE EQUITY FUNDS have traditionally used
Maltese special purpose vehicles to invest in target
companies in view of Maltas common law based
company law regime, favourable fiscal environment for
holding entities bolstered by the benefits of the relevant EU
tax directives and an extensive OECD based double taxation
treaty network (56 in number with effect from the first of
January 2011). However Malta has rarely, up until now, been
resorted to as the domicile of choice for the main fund vehicle
itself or for its general partner.
Maltas regulatory framework allows private equity funds
to be set up as so called professional investor funds which may
be made available to different types of investors. From a
structural point of view most private equity funds are typically
set up as limited partnerships. Limited partnership legislation
has formed part of the Maltese Companies Act for a number
of years. A Maltese limited partnership has its obligations
guaranteed by the unlimited and joint and several liability
of one or more partners, called general partners, and by the
liability, limited to the amount, if any, unpaid on the
contribution, of one or more partners, called limited partners.
In 2003 new provisions were introduced in the Companies
Act which specifically provided for the possibility for collective
investment schemes to be set up as limited partnerships with
a partnership capital divided into shares. Indeed such
partnerships fall within a clean and concise corporate framework
which allows a limited liability company to act as the general
partner of the fund, albeit the general partner would be
unlimitedly liable for the obligations of the fund. The general
partner would not be required to obtain a licence or other
authorisation from the Malta Financial Services Authority
(MFSA) so long as it is not providing investment management
services to the fund.
Nevertheless, the Companies Act was still unclear where
limited partnerships with a partnership capital which is not
divided into shares were concerned. Indeed the law did not
specifically provide that such partnerships could also be
collective investment schemes so doubt subsisted as to
whether it was indeed possible for investment funds to be set-
up as such types of partnerships. In addition the general
partners of such a vehicle had to be an individual or else a body
corporate (i.e. an entity with separate legal personality) which
has its obligations guaranteed by the unlimited and joint
and several liabilities of one or more of its members.
These somewhat archaic rules made it unrealistic for
promoters to set up their fund in Malta as a limited partnership
not divided into shares since the general partner could not
be a limited liability company in its own right. So while the
issue of the corporate form of the general partner was resolved
in 2003 with regard to limited partnerships with a partnership
capital which is divided into shares it remained for those
limited partnerships with participation rights rather than
share capital. Considering that the vast majority of private
THE NEW PE DOMICILE
The uncertainty created by the AIFM Directive together with the changes which are expected to
occur to the European regulatory landscape have encouraged private equity funds to seek
alternative onshore domiciles to what has traditionally been an offshore industry. The success of
the Channel Islands in attracting private equity funds from all over the globe is a well known fact
and a statistic which speaks for itself. Now Malta is setting out its stall as a natural home for the
private equity segment. Steve Paris, head of Financial Services at Deloitte and Dr. Andre Zerafa,
partner, Ganado and Associates, Advocates outline the advantages.
Photograph Chrisharvey / Dreamstime.com,
supplied November 2010.
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equity funds are set up as limited partnerships with
participation rights this meant that Malta has not always
been perceived to be a viable domicile of choice for limited
partnerships without share capital.
These limitations are now being addressed through new
regulations which will enable a Maltese limited partnership
with a partnership capital which is not divided into shares to
have a general partner in the form of a Maltese or a foreign
constituted limited liability company.
Furthermore if the fund is constituted under a foreign law
(such as Cayman, English or Scottish law) then it would still
be subject to licensing in Malta so long as it is carrying on
any activity in Malta. The MFSA has taken the view that the
active marketing of such funds in Malta to Maltese professional
clients would trigger a licensing requirement in Malta. It is
then the choice of the promoter whether to incorporate the
general partner in Malta or elsewhere, although it is necessary
for the general partner to be a company resident in Malta in
order for the fund to be resident in Malta for Malta tax purposes.
Another alternative used over the years by some promoters
was to set up the fund as a SICAV which is a variable share
capital company. SICAVs are generally open ended investment
vehicles however the Maltese Companies Act provides for
sufficient flexibility for SICAVS to lock-in investors for a
number of years as long as a mechanism is included in the
funds memorandum and articles on the manner in which the
fund will handle redemption requests. Specific regulations have
also been issued on the manner in which SICAVs can make
drawdowns from investors. This was a welcome clarification
since SICAVs are not allowed to issue partly paid shares nor
are they allowed to issue shares at a discount.
The MFSA have also issued supplementary conditions
which apply across the board to all types of funds which
have a drawdown mechanism embedded in their structure.
The main principles of these conditions stipulate that any
request on committed funds shall be effected pro-rata among
all relevant investors in the fund and that the fund may only
make a fresh call for further commitments once all outstanding
commitments from existing investors have been requested.
Apart from the regulatory and structural aspects, the tax
treatment of fund vehicles in Malta is also fundamental and
should be considered up front. In terms of Maltese tax law the
income of a collective investment scheme is exempt from
tax at the level of the fund. Taxpayers also deriving income from
other activities or sources remain liable to tax in Malta but the
income or gains derived from the funds activities represent
an exempt category of income. Certain limitations do apply
to the blanket tax exemption, but they should be of no concern
to funds investing primarily in assets situated outside Malta.
The Malta tax exemption on income or gain derived by
the funds activities is supported by a zero withholding tax on
outbound distributions to all persons, whether individuals or
companies, regardless of their country of residence and a
exemption from tax in Malta upon the disposal or redemption
of the interest held in the fund regardless of its legal form.
Similarly no withholding taxes are levied in Malta on the
provision of services to persons resident in Malta by persons
resident outside Malta, regardless of their country of residence,
provided that the supplier does not have, in Malta, a
permanent establishment with which the relevant service is
effectively connected.
Tax exemption at the level of the fund coupled with the
possibility of source country withholding tax mitigation
through resort to Maltas tax treaty network and no taxes in
Malta on distributions to, or gains realised by, investors brings
together the benefits of an onshore location without the
costs typically associated therewith.
As an EU member state, Malta has implemented the
European VAT directive and is thus exempt from VAT
transactions in securities and the provision of services relating
to the management and administration of funds. While the
workings of the EU VAT system may, in practice, result in
an element of unrecoverable VAT at the level of the fund or
the fund manager, the extension of the VAT exemption to
also cover qualifying outsourced services considerably reduces
the instances which may give risk to unrecoverable Malta
VAT. This aspect coupled with a reasonable degree of
appropriate planning typically ensures that Malta VAT does
not in fact represent a material cost to a fund or fund manager
established in Malta.
Malta is rapidly establishing itself as an attractive domicile
for private equity funds. The planned innovations to its
corporate laws, which are imminently expected, will increase
Maltas attractiveness in an interesting and challenging phase
of European regulation where funds will be expected to be
more transparent in their dealings and opt for onshore
structures, particularly for their European based clients.
Maltas legislative framework should be able to address and
accommodate the business models preferred by private equity
fund promoters within a robust regulatory framework. I
Dr. Andre Zerafa, partner, Ganado and Associates, Advocates. Photograph
kindly supplied by Ganado and Associates, Advocates, November 2010.
Steve Paris, head of Financial Services at Deloitte. Photograph kindly
supplied by Deloitte, November 2010.
115
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ALTA IS ONE of the locations looking to establish
itself as a domicile of choice for the funds industry.
It faces a challenging time in an environment of
fewer new fund start-ups, but it is possible that there are
advantages to its emergence in period where there is such a
seismic shift in what investors are demanding when they
choose to allocate. The drive towards greater transparency,
relevant and robust regulation and the increasing importance
of the role of the administrator provides this relatively new
jurisdiction with an opportunity create a model that will
specifically cater to these demands.
The hedge fund industry has had to react to the events of
recent years and nowhere is this more evident than in the
support industries that service it. Specifically, the role of an
independent administrator has moved from a position of
almost being seen as a necessary expense to playing a critical
role in the legitimacy of a fund product. The domicile of the
fund and the requirements it puts on the administrator
therefore are key elements in the evaluation of the fund and
in providing comfort to the investor.
Administrators today are presented with increasing
challenges to provide more for less. The advance in the
demands for further transparency has led to increases in
technology requirements as the profile of the average
administrator moves from a traditional accounting services
only provider to a partner in an overall complex fund product.
The challenge for the administrator is to meet these increasing
requirements without adding extra cost to the fund and a
flexible, low cost, EU centre such as Malta can become a
useful tool for a global administrator. As well as servicing
local Maltese funds there is an opportunity for Malta to
position itself to service funds of other jurisdictions as part of
a global operating model. There are no regulatory barriers
to this and the abundant availability of knowledgeable local
staff it is possible that we may see Malta emerge as a location
for the wider funds industry to take advantage of.
Malta has attempted to position itself as an alternative for
the industry that offers the experience of what could be called
the offshore product but with the benefits of an onshore
approach. The global trend as we have mentioned is for
increased transparency and regulation and empowering the
investor. Combining these distinct requirements in a flexible
operating environment is where Malta has an advantage.
Practical regulation
The Maltese regulator has been quick to identify that the
combination of EU membership and a practical regulatory
environment will be key factors in its favour to attract managers
who look to create a product that can compete with the
traditional jurisdictions. When choosing who to partner with
in Malta, the fund looks for a local presence with a global reach.
There is a challenge when selling Malta to the global
market as to why one would choose to do business there
and therefore the global recognition of the service provider
provides comfort. This is why we now see more and more of
the major providers opening offices in Malta.
To date the experience has been for the administrator to
react to the requirement of the funds to establish in Malta
MORE
FOR
MORE
The evolution of financial markets and how specific regions react is one of the more interesting
observations one can make today. What makes one location more appealing than the next? Why
do new centres emerge and others fade and why are some enduring and what will happen in the
future? The criteria that define these trends evolve in response to market conditions and also as
reactions to successes and failures in the response to these drivers. By Mark Hedderman, chief
operating officer, Custom House.
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Photograph Madmaxer /
rather than the funds choosing to locate there because of the
proximity of service providers. This is evident in the concentration
of the small number of existing providers around large fund
structures. As with all new trends there may be a requirement
for a period of time to elapse to establish a footprint and prove
that there is substance to what is taking shape.
One of the key advantages that Malta has is the presence
of some of the major names in the financial services world that
exist in a capacity outside the funds industry but are positioned
there to support it. The big fouraudit firms have operations
there and have already shown a willingness to engage with
the administrators in assisting them to support their clients.
An interesting new dynamic that we have seen is an
openness to assist the administrator outside traditional audit
services. A major challenge for hedge fund administrators
is the preparation of financial statements as per the stated
accounting standards of the fund. It used to be the case that
the administrator would hand over their NAV valuations to
the auditor who would then prepare the audited financials
to IFRS, US GAAP etc.
This obvious conflict of interests was identified in recent
years as a dilution of the auditors function and specific reference
was made to this in the famous Sarbanes Oxley Act of 2002. The
culmination of this was a move away from the preparation of
the financial statements by the auditors and the onus was,
correctly, placed on the administrator to provide prepare the
statements for audit. This placed challenges on the administrator
who was not positioned to handle it and responses varied from
the development of an in house function to the full outsourcing
to specialist (not big four) accounting houses.
What has been refreshing in Malta, which we have not
witnessed elsewhere yet, is the willingness of the audit firms
to prepare financial statements for funds that they are not
the designated auditor of and therefore facilitate the
administrator in their responsibilities. This practical and
flexible approach has been very useful in the establishment
of a new administrative operation where the pressures to
start from scratch can sometimes lead to an overlooking of
this vital function.
SICAV structures
The use of the SICAV in Malta and its ability to handle
multiple sub funds with their own cross collateral risk
protection has been popular for both the institutional and
start up structures. As the administrator of the largest number
of funds in Malta, Custom House has been exposed to both
ends of this spectrum. On one hand there is the Innocap
structure which offers investors access to a wide variety of
underlying managers via a suite of products at a feeder level.
This structure has approximately one hundred valuations in
its overall composition and is valued daily, making it one of
the most high volume and complex products for an
administrator to handle. At the other end we have the
Nascent Fund SICAV which is a new umbrella product
specifically designed for emerging managers to cut their
teeth in a protected structure that offers legitimacy while
they establish their track record.
The flexibility in the structure means that managers can
break free and establish their own stand-alone vehicle once
they have reached a suitable size. The SICAV allows for both
of these models to exist and the flexibility and protection
offered make them attractive in their respective worlds.
The impact of UCITS IV
There are already a number of UCITS structures operating
successfully in Malta where they have targeted the Italian,
Spanish and French markets. Adopting the UCITS IV directive
and in particular its impact on the master-feeder structure will
place additional reporting requirements on administrators.
Efforts are already underway to align reporting requirements
with existing models and the successful administrators will
be the ones who have flexible report writing capabilities
which has become an essential element of any business these
past few years as reporting requirements ever expand.
The financial services industry grew by over 20% in Malta
in 2009. In the context of an environment of fewer fund start-
ups there is obviously traction gaining to the Maltese story.
Malta needs to position itself as a brand and also as a legitimate
alternative to Dublin and/or Luxembourg. Prioritising the
flexible and practical nature of the regulatory environment is
vital to ensuring that Malta continues to separate itself from
the more established locations.
Membership of the EU and what this entails for the
international managers and investors should be put to the front
along with the adoption of the UCITS IV directive. Malta
must ensure that it retains its evolving reputation as a can-
dobusiness centre for both funds and their service providers.
It must focus on reigning in inflationary pressures that impact
the cost effectiveness of locating there while at the same
time continuing to make significant investment in its
technology infrastructure. When canvassing potential clients
about where they wish to set up their fund the first questions
they always ask relate to the nature of the regulation, the
cost, the administrators presence and the ability to do business
there. The future is bright for Malta if they keep these factors
in mind while they expand and do not lose sight of the
reasons why other locations are becoming less popular. I
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Mark Hedderman, chief operating officer, Custom House. Photograph
kindly supplied by Custom House, November 2010.
117
Investment Promotion
Address: Garrison Chapel, Castille Place, Valletta,
VLT 1063, Malta
G
Web: www.financemalta.org
Tel: +356 2122 4525
G
Fax: +356 2144 9212
Contact: Bruno Lecuyer, Head of Business
Development
G
Email: info@financemalta.org
FINANCEMALTA
FinanceMalta, a non-profit public-private initiative, was formally set up to promote Maltas international
Business & Finance Centre, both within, as well as outside Malta. It brings together, and harnesses,
the resources of the industry and government, to ensure that Malta maintains a modern and effective
legal, regulatory and fiscal framework in which the financial services sector can continue to grow and
prosper. The Board of Governors, together with the six founding associations, four expert groups, its
corporate members and executive staff are committed to promote Malta as a centre of excellence in
financial services and international business
Bank / Financial Institution
Address: 101 Town Square, Qui-Si-Sana, Sea
Front, Sliema, SLM 3112, Malta
Web: www.sparkasse-bank-malta.com
Tel: +356 2133 5705
G
Fax: +356 2133 5710
Contact:Paul Mifsud, Managing Director
Email:paul.mifsud@sparkasse-bank-malta.com
SPARKASSE BANK MALTA PLC
Sparkasse Bank Malta plc forms part of the Austrian Savings Banks and the Ertse Group Bank AG
network. The Sparkasse Brand is known to be one of Central Europes foremost Savings and Financial
Services Group.
From Malta, the banks main focus is on private banking, wealth management and custody services to
a range of international private, corporate as well as institutional clients.
The bank thrives on providing a highly personalised and efficient service backed by experience,
competence and robust support services.
Financial Services Regulation
Address: MFSA, Notabile Road, Attard,
BKR 3000, Malta
G
Web: www.mfsa.com.mt
Tel: +356 2548 5386
G
Fax: +356 2144 1189
Contact: Communications Unit
Email: communications@mfsa.com.mt
MALTA FINANCIAL SERVICES AUTHORITY
The Malta Financial Services Authority (MFSA) was established by law on 23rd July, 2002. The
Authority is the single regulator for the financial services sector, which includes credit and financial
institutions, securities and investment services companies, recognised investment exchanges,
insurance companies, pension schemes and trustees. The MFSA incorporates the Registry of
Companies and the Board of Governors also acts as the Listing Authority.
Fund Administration
Address: Tigne Towers, Tigne Street, Sliema,
SLM 3172, Malta
Web: www.customhousegroup.com
Tel: +356 2380 5100
G
Fax: +356 2702 2899
Contact: Lisa Byrne, PR Coordinator
Email: lisa.byrne@customhousegroup.com
CUSTOM HOUSE GLOBAL FUND SERVICES LTD
Custom House Global Fund Services Ltd (CHGFS) is the Malta based parent company of the Custom
House Group of Companies (Custom House). The Custom House Group offers a full 24/5, round the
world and round the clock administration service out of its offices in Amsterdam, Chicago, Dublin,
Guernsey, Luxembourg, Malta and Singapore. This service, which enables Custom House to offer
daily dealing NAVs, covers all aspects of day to day operations, including maintaining the funds books
and records, carrying out the valuations, calculating the NAV and handling all subscriptions and
redemptions, as well as over-seeing payment of the funds expenses. Reporting can be effected
through CHARIOT, Custom Houses secure web-reporting platform for managers and investors.
CHGFS is recognised as a fund administrator and licensed under a Category 4 license as a custodian
for funds of funds. CHGFS is also an authorised trustee for trusts.
Address: 80 Mill Street, Qormi, QRM 3101,
Malta
G
Web: www.hsbc.com.mt
Tel: +356 2380 5100
G
Fax: +356 2380 5190
Contact: Charles Azzopardi, Managing Director
Email: charlesazzopardi@hsbc.com
HSBC SECURITIES SERVICES (MALTA) LTD
HSBC Securities Services (Malta) Ltd provides a full range of administration services to investment
funds. We have significant experience, knowledge and understanding of the industry and we can
therefore provide a high quality service to investment funds, leveraging on the HSBC Groups scale
and capabilities where this is necessary. We hold fund administration mandates across most asset
classes (bonds, equities, property, etc.) and strategies (long, absolute returns, etc) and our offering
consists of fund accounting and valuation, investor services and corporate management services.
Address: Alpine House, Naxxar Road, San
Gwann, SGN 9032, Malta
Web: www.sgggfexcofsmalta.com
Tel: +356 2576 2121 / +353 868 398 133
Fax: +356 2576 2131
G
Contact: Brendan
Conlon, Director
G
Email: bconlon@fexco.com
SGGG FEXCO FUND SERVICES (MALTA) LIMITED
SGGG Fexco Fund Services (Malta) Ltd is recognised as a fund administrator by the Malta Financial
Services Authority. SGGG Fexco is your administrative partner for all your fund management
requirements, bringing together the international experience of SGGG Fund Services Inc. and Fexserv
Financial Services.
SGGG has been established in the fund administration business since June 1997. It is headquartered
in Toronto and also operates in the Cayman Islands. SGGG Fund Services is responsible for the
administration of over CAD12bn including 220 alternative strategy funds of various structures and
offers a comprehensive range of fund administration services.
DIRECTORY
118
DIRECTORY
Address: G Complex, Suite 2 Level 3,
Brewery Street, Mriehel, BKR 3000 Malta
Web: www.vfs.com.mt
G
Tel: +356 2122 7148
Fax: +356 2123 4565 Contact: Joseph Camilleri,
Head - Business Development Division
Email: jcamilleri.vfs@bov.com
VALLETTA FUND SERVICES
Valletta Fund Services ("VFS") is a fully-owned subsidiary of Bank of Valletta plc, and the largest fund
administrator in Malta. As at November 2010, VFS provided its fund administration services to 90
professional investor and retail funds representing $2.2bn worth of assets.
VFS was incorporated in 2006 and provides a comprehensive range of fund administration services
underpinned by the presence of sophisticated IT platforms. The Companys clients included fund
management organisations based in the UK, Italy, Czech Republic, Holland, Latvia, Turkey, South
Africa and Switzerland.
The Company's website at http://www.vfs.com.mt provides useful information on the full range of fund
Law Firm
Address: Level 3, Valletta Buildings, South
Street, Valletta, VLT 1103, Malta
Web: www.camilleripreziosi.com
Tel: +356 2123 8989
G
Fax: +356 2122 3048
Contact: Louis de Gabriele, Partner
Email:louis.degabriele@camilleripreziosi.com
CAMILLERI PREZIOSI
Camilleri Preziosi is a leading Maltese law firm with a commitment to deliver an efficient service to
clients by combining technical excellence with a solution driven approach to the practice of law.
There can be no compromise on striving for excellencenot only in recruiting and training the best
lawyers but in embracing a work ethic founded on the core values of honesty, integrity and quality of
service. We take a multi-disciplinary approach to our practice and all lawyers advise across a broad
range of areas. Each lawyer within the firm deals with a specific area or areas of practice that indicates
a particular competence and experience in that sector, but he or she does not practice exclusively in
that area, thus allowing our lawyers a wider scope of knowledge.
Our clients work with lawyers they know well, and who know them and their businesses. The close
relationships we develop and the keen interest we take in our clients businesses enable us to give
practical and effective advise with the aim of adding value.
Address: 168 St Christopher Street, Valletta,
VLT 1467, Malta
G
Web: www.dglawfirm.com.mt
Tel: +356 2569 3000
G
Fax: +356 2122 7731
Contact: David Griscti, Parter
Email: info@dglawfirm.com.mt
DAVID GRISCTI & ASSOCIATES / QUBE SERVICES LIMITED
David Griscti & Associates is focused, by design, on investment services law, and we are proud to be
one of the leading firms. We advise our international fund, fund management and other investment
service clients at pre-licensing stage, offering them structuring solutions and advice, taking them
through the registration and licensing stage, and offering them a full range of post-licensing services
through our specialised team of professionals, including legal and tax services, fund accounting
services, company secretarial, compliance and AML services, directorship services and other back
office administration services. Our associated company QUBE Services Limited also offers full
corporate, trust, tax advisory and administration services, essentially offering a highly dedicated one-
stop shop solution to our non-investment service clients.
Address: 171 Old Bakery Street, Valletta,
VLT 1455, Malta
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Web: www.jmganado.com
Tel: +356 2123 5406
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Fax: +356 2123 2372
Contact: Dr. Andre Zerafa, Advocate
Email: lawfirm@jmganado.com
GANADO & ASSOCIATES, ADVOCATES
Ganado & Associates, Advocates was founded in Valletta, Malta and traces its roots to the early
1900s. It enjoys a successful international legal practice, advising on the whole spectrum of corporate
and commercial law activities. From its earliest days, it has been one of the protagonists in local legal
practice and has contributed specifically to Maltas internationally recognised reputation as a centre for
financial services.The firm is currently made up of a team of over 50 lawyers supported by a growing
complement of managerial, administrative and secretarial staff.
The firms financial services practice has experienced extensive growth since Malta joined the
European Union particularly in areas of investment services & funds, banking and insurance. The
Investment Services & Funds practice within the firm is considered a leader in this sector in Malta.
Ganado & Associates is a Lex Mundi member firm and also a member of AIMA.
Professional Services Provider
Address: Deloitte Place, Mriehel Bypass,
Mriehel, BKR 3000, Malta
Web: www.deloitte.com/mt
Tel: +356 2343 2000
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Fax: +356 2133 2606
Contact: Stephen Paris, Head of Financial
Services
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Email: sparis@deloitte.com.mt
DELOITTE
Deloitte provides audit, tax consulting and financial advisory services to public and private clients
spanning multiple industries. With a globally connected network of member firms in more than 140
countries, Deloitte brings world-class capabilities and deep local expertise to help clients succeed
wherever they operate. Deloittes more than approximately 169,000 professionals are committed to
becoming the standard of excellence. In Malta, the firm services large significant international and
national clients as well as smaller owner-managed businesses. Over the years, the practice expanded
steadily. We are now firmly established as one of Maltas leading providers of professional services,
reporting among the highest of any professional services firm. We have the largest international tax
practice and a dedicated financial services practice, serving a range of multinationals that oeprate
through Malta to take advantage of our skills, competitive cost base, regulatory environment, EU
membership and attractive tax system.
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All data 2010 The Depository Trust & Clearing Corporation
This data is being provided as is and can only be used by you pursuant to the terms
posted on the DTCC website at dtcc.com/products/derivserv/data_table_i.php
Top 10 number of contracts
(Week ending 12 November 2010)
Reference Entity Sector Market Type Net Notional (USD EQ) Gross Notional (USD EQ) Contracts DC Region
Federative Republic of Brazil Government Sov 15,778,455,085 155,322,092,241 11,278 Americas
Bank of America Corporation Financials Corp 6,016,491,889 85,276,974,379 9,631 Americas
JPMorgan Chase & Co. Financials Corp 5,242,548,337 86,103,342,333 9,302 Americas
United Mexican States Government Sov 7,724,638,180 110,510,395,907 9,175 Americas
Republic of Turkey Government Sov 5,736,163,605 138,476,475,722 8,137 Europe
General Electric Capital Corporation Financials Corp 12,404,095,828 98,697,521,778 8,011 Americas
Italia Spa Telecommunications Corp 2,807,684,111 73,247,548,878 7,991 Europe
Republic of Italy Government Sov 29,459,912,523 268,743,422,676 7,838 Europe
Daimler AG Consumer Goods Corp 3,034,521,517 65,938,064,800 7,683 Europe
Deutsche Telekom AG Telecommunications Corp 3,144,760,975 68,739,108,339 7,587 Europe
Top 10 net notional amounts
Reference Entity Sector Market Type Net Notional (USD EQ) Gross Notional (USD EQ) Contracts DC Region
Republic of Italy Government Sov 29,459,912,523 268,743,422,676 7,838 Europe
Kingdom of Spain Government Sov 16,894,313,123 131,160,967,970 5,875 Europe
French Republic Government Sov 15,931,749,016 79,738,372,845 3,871 Europe
Federative Republic of Brazil Government Sov 15,778,455,085 155,322,092,241 11,278 Americas
Federal Republic of Germany Government Sov 13,893,841,322 81,464,579,597 2,443 Europe
General Electric Capital Corporation Financials Corp 12,404,095,828 98,697,521,778 8,011 Americas
UK and Northern Ireland Government Sov 11,511,083,020 59,079,612,005 4,204 Europe
Republic of Austria Government Sov 8,455,439,585 48,864,749,561 2,085 Europe
Portuguese Republic Government Sov 7,909,277,957 69,505,488,289 3,430 Europe
United Mexican States Government Sov 7,724,638,180 110,510,395,907 9,175 Americas
Ranking of industry segments by gross
notional amounts
Single-Name References Entity Type Gross Notional (USD EQ) Contracts
Corporate: Financials 3,344,503,722,407 437,845
Sovereign / State Bodies 2,437,062,607,388 180,487
Corporate: Consumer Services 2,234,680,407,993 370,058
Corporate: Consumer Goods 1,656,277,373,006 264,015
Corporate: Technology / Telecom 1,400,849,265,665 217,883
Corporate: Industrials 1,338,075,416,705 230,204
Corporate: Basic Materials 1,013,198,573,110 163,227
Corporate: Utilities 792,090,875,888 125,192
Corporate: Oil & Gas 467,646,233,622 86,290
Corporate: Health Care 343,080,124,929 61,657
Corporate: Other 165,903,006,322 18,812
Residential Mortgage Backed Securities 77,317,907,676 15,553
CDS on Loans 69,487,809,864 18,242
Commercial Mortgage Backed Securities 20,356,389,800 1,955
Other 2,909,921,510 271
Top 10 weekly transaction activity
by gross notional amounts
References Entity Gross Notional (USD EQ) Contracts
Kingdom of Spain 9,675,232,600 494
Republic of Italy 3,207,819,442 169
French Republic 3,067,418,167 131
Ireland 2,729,775,810 277
Federative Republic of Brazil 2,070,398,000 120
MBIA Insurance Corporation 1,931,857,196 197
Republic of Turkey 1,863,300,000 153
Federal Republic of Germany 1,605,699,000 69
Portuguese Republic 1,417,086,800 126
UK and Northern Ireland 1,410,513,000 48
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Figures are compiled from lit order book trades only. Totals only include stocks contained within the major indices.
*This index is also traded on US venues. For more detailed information, visit http://fragmentation.fidessa.com/fragulator/.
market share < 0.01%.
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Fidessa Fragmentation Index (FFI) and Fragulator
The Fidessa Fragmentation Index (FFI) was launched to provide a simple, unbiased measure of how different stocks are fragmenting
across primary markets and alternative venues.
In short, it shows the average number of venues you should visit in order to achieve best execution when completing an order. So
an index of 1 means that the stock is still traded at one venue. Increases in the FFI indicate a fragmentation of trading across multiple
venues and as such any firm wishing to effectively trade that security must be able to execute across more venues. Once a stocks
FFI exceeds 2 liquidity in that stock has fragmented to the extent that it no longer belongs to its originating venue.
FFI
INDICES
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FTSE 100 CAC 40 DAX OMX S30 SMI
2.53 2.00 1.94 2.05 2.02
Amsterdam 4.68%
BATS Europe 11.79% 5.54% 6.59% 6.24% 9.23%
Burgundy 5.33%
Chi-X Europe 25.88% 21.72% 20.08% 18.63% 20.73%
London 55.57%
Madrid
Milan 0.16% 0.06%
NYSE Arca Europe 0.29% 0.17% 0.14% 0.29%
Paris 62.26%
SIX Swiss 65.31%
Stockholm 66.54%
Turquoise 6.47% 5.36% 3.78% 3.12% 4.44%
Xetra 0.27% 69.31%
FFI
INDICES
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DOW JONES S&P 500
4.68 4.31
BATS US 12.67% 11.37%
BYXX 1.30% 0.74%
CBOE 0.12% 0.12%
Chicago Stock Exchange 0.49% 0.49%
EDGA 6.26% 5.69%
EDGX 5.94% 6.07%
NASDAQ 27.17% 27.21%
NASDAQ BX 2.75% 2.08%
NQPX 0.88% 0.82%
NSX 1.04% 1.05%
NYSE 23.59% 25.67%
NYSE Amex 0.20% 0.36%
NYSE Arca 17.41% 18.11%
FFI
INDICES
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S&P ASX 200 HANG SENG
1.00 1.00
ASX Trade Match 100% -
Hong Kong - 100%
FFI
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S&P TSX Composite S&P TSX 60
2.00 2.02
Alpha ATS 15.04% 14.45%
Chi-X Canada 10.14% 11.32%
Omega ATS 0.46% 0.49%
Pure Trading 4.40% 2.61%
Toronto 66.57% 67.89%
TriAct MATCH Now 2.90% 2.82%
FFI
INDICES
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NIKKEI 225
1.21
Chi-X Japan 0.14%
JASDAQ 0.00%
Kabu.com 0.08%
Nagoya 0.00%
Osaka 0.00%
SBI Japannext 0.63%
Tokyo 90.70%
ToSTNet-1 8.45%
ToSTNet-2 0.00%
Index market shares by volume
Week ending 12th of November, 2010
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All data Fidessa Group plc.
All opinions and data here are entirely the responsibility of Fidessa Group plc. If you require more information
on the data provided here or about FFI, please contact: fragmentation@fidessa.com.
COMMENTARY
By Steve Grob, Director of Group Strategy, Fidessa
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HIS MONTH'S REPORT focuses on what is happening in
Canada. The two charts below show two very different
pictures of exactly which lit venues the constituents of
Canada's TSX 60 Index traded on during the month of October.
The first shows the complete breakdown across all Canadian lit
venues and reveals a relatively "healthy" spread of trading
between TSX, Alpha and Chi-X Canada (TSX being the primary
market incumbent).
The second chart shows the same thing but "zoomed out" to
include trading in the same stocks, irrespective of currency. Many
Canadian stocks (such as RIM, the makers of Blackberry smart
phones) are heavily traded south of the border in the USA. So now
a very different picture emerges and TSX total market share
effectively halves along with that of Chi-X Canada and Alpha. This
market share is taken up by NASDAQ and NYSE which now
assume 2nd and 3rd place respectively. In fact, the constituents of
the TSX 60 were actually traded on more than 27 different lit
venues around the world, including a modest 8,600 shares
executed on the Philippines Stock Exchange.
1 ASTRAL MEDIA INC CLASS'A'NON-VTG COM NPV 2.932
2 HORIZONS BETAPRO N TRANSFERABLE CLASS'A' UNITS 2.913
3 YELLOW PAGES INCOM TRUST UNITS 2.89
4 ANDEAN RESOURCES NPV 2.8
5 ONEX CORP SUB VTG NPV 2.764
6 DUNDEE WEALTH INC 4.75% 1ST PRF 13/03/16 SR 1 2.719
7 COMINAR REAL ESTAT TRUST UNITS 2.689
8 BOMBARDIER INC CLASS'B'S/VTG NPV 2.669
9 URANIUM ONE INC COM NPV 2.619
10 HORIZONS BETAPRO N TRANSFERABLE CLASS'A' UNITS 2.614
Top five lit venues TSX 60 (by value) - Oct 2010 (Canada only)
Lit Venues
Omega ATS
Pure Trading
Chi-X Canada
Alpha ATS
TSX
0.4%
2.56%
12.13%
15.85%
66.45%
Market Share
by Category
2.3%
DARK
0.3%
OTC
97.4%
LIT

Top six lit venues TSX 60 (by value) - Oct 2010 (Global)
Lit Venues
Chi-X Canada
NYSE Arca
Alpha ATS
NYSE
NASDAQ
TSX
9.15%
10.08%
32.54%
Market Share
by Category 12.09%
OTC
1.13%
DARK
86.78%
LIT
7.74%
7.76%
5.94%
Top 10 fragmented Canadian stocks
October 2010
FFI for TSX 60 and TSX Composite
October 2010

01 04 05 06 07 08 12 13 14 15 18 19 20 21 22 25 26 27 28 29
2.5
2.0
1.5
October 2010
S&P / TSX 60
S&P / TSX Composite
TSX 60 trading venues in October 2010
TSX, NASDAQ, NYSE, Alpha ATS, NYSE Arca, Chi-X Canada, BATS, EDGX, EDGA, Pure Trading, NASDAQ BX, Chicago Stock Exchange, NSX,
Omega ATS, Hong Kong, CBOE, NQPX, NYSE Amex, BYXX, Frankfurt, Deutsche Brse, LSE, Munich, Hamburg, Berlin, Dusseldorf, Philippines
This highlights an important point in the world of global
fragmentation in that the trading patterns of stocks dont fit
neatly into the same geographies as the regulators operate in.
Canada has its own regulations that combine elements of
MiFID with an Order Protection Rule that is going to be in force
early next year. Should a Canadian broker follow purely
Canadian regulations or engage in regulatory arbitrage in order
to offer a better service to his customers?
The Canadian situation illustrates an interesting global
phenomenon as new country or region specific regulations
continue to emerge. Most of this regulation is focussed around
offering choice and, in so doing, makes it easier from a
regulatory standpoint to set up alternative venues. When this is
coupled with the low cost matching technology that is now
available then we may see the emergence of more "off shore"
venues that enable traders to circumvent local regulations. I
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Top 5 global ETF providers by average daily turnover
As at end of Q3 2010
Average Daily Turnover (US$ Mil)
Provider Dec-09 % Mkt Share Q3-10 % Mkt Share Change (US$ Mil) Change (%)
SSgA $19,861.8 39.2% $25,756.9 44.3% $5,895.1 29.7%
iShares $14,572.0 28.7% $15,828.2 27.2% $1,256.2 8.6%
ProShares $3,891.8 7.7% $4,064.8 7.0% $173.0 4.4%
PowerShares $3,219.9 6.4% $3,440.0 5.9% $220.2 6.8%
Direxion Shares $3,446.7 6.8% $3,030.9 5.2% -$415.8 -12.1%
Others $5,712.8 11.3% $6,058.7 10.4% $345.9 6.1%
Total $50,705.0 100.0% $58,179.5 100.0% $7,474.5 14.7%
Global ETF assets by index provider ranked by AUM
Q3 2010 YTD Change
Index Provider No. of ETFs Total Listings AUM (US$ Bn) % Total No. of ETFs Total Listings AUM (US$ Bn) % AUM % TOTAL
MSCI 359 1214 $292.6 24.8% 94 460 $48.8 20.0% 1.2%
S&P 290 530 $260.9 22.1% 57 154 $11.7 4.7% -2.0%
Barclays Capital 82 193 $113.1 9.6% 12 34 $25.7 29.3% 1.1%
Russell 67 108 $68.5 5.8% 6 8 $2.5 3.8% -0.6%
FTSE 168 367 $50.9 4.3% 42 83 $8.1 19.1% 0.2%
STOXX 218 743 $47.2 4.0% 14 117 -$3.7 -7.3% -0.9%
Markit 93 244 $46.0 3.9% 23 86 $7.8 20.4% 0.2%
Dow Jones 151 277 $42.4 3.6% 15 57 $1.5 3.6% -0.4%
NASDAQ OMX 63 99 $30.7 2.6% 20 36 $4.2 15.9% 0.0%
Deutsche Boerse 40 147 $26.2 2.2% 10 56 $2.8 11.8% 0.0%
Topix 53 64 $17.6 1.5% 0 0 $5.1 41.4% 0.3%
Hang Seng 12 33 $13.9 1.2% 3 10 $2.1 17.7% 0.0%
Nikkei 9 16 $12.1 1.0% 1 5 -$0.4 -2.9% -0.2%
EuroMTS 29 104 $10.9 0.9% 7 53 -$0.1 -1.2% -0.1%
NYSE Euronext 18 36 $8.3 0.7% 8 24 $2.2 35.1% 0.1%
SIX Swiss Exchange 17 30 $8.2 0.7% 4 7 $0.9 12.0% 0.0%
WisdomTree 35 42 $7.1 0.6% -10 -3 $1.3 22.4% 0.0%
CAC 15 30 $6.8 0.6% -3 4 -$0.7 -9.4% -0.1%
Indxis 6 7 $4.4 0.4% -1 -1 $1.7 60.7% 0.1%
CSI 27 28 $3.0 0.3% 16 17 $0.6 24.4% 0.0%
BNY Mellon 11 12 $2.5 0.2% 0 0 $0.2 8.6% 0.0%
Intellidex 38 41 $2.4 0.2% -4 -11 -$0.2 -8.9% -0.1%
Morningstar 10 10 $1.7 0.1% 0 0 $0.0 -0.9% 0.0%
S-Network 15 33 $1.2 0.1% 2 2 $0.0 1.3% 0.0%
Zacks 12 13 $0.7 0.1% -2 -2 $0.1 20.9% 0.0%
Value Line 3 3 $0.2 0.0% -2 -2 -$0.1 -17.1% 0.0%
Other 538 780 $101.7 8.6% 122 183 $23.2 29.6% 1.0%
Total 2,379 5,204 $1,181.3 100.0% 434 1,377 $145.2 14.0%
Top 20 ETFs worldwide with the largest change in AUM
AUM (US$ Mil) AUM (US$ Mil) Change
ETF Country listed Bloomberg Ticker Q3 2010 December 2009 (US$ Mil)
Vanguard Emerging Markets US VWO US $36,107.6 $19,398.7 $16,709.0
SPDR S&P 500 US SPY US $78,243.9 $85,676.3 $-7,432.4
iShares MSCI Emerging Markets Index Fund US EEM US $44,906.1 $39,178.3 $5,727.9
TOPIX ETF Japan 1306 JP $10,392.7 $5,910.7 $4,482.0
PowerShares QQQ Trust US QQQQ US $22,249.5 $18,735.8 $3,513.7
Vanguard Total Bond Market ETF US BND US $9,072.2 $6,268.4 $2,803.8
iShares S&P U.S. Preferred Stock Index Fund US PFF US $5,689.4 $3,122.6 $2,566.8
SPDR Barclays Capital High Yield Bond ETF US JNK US $5,920.2 $3,444.5 $2,475.7
iShares Barclays 1-3 Year Credit Bond Fund US CSJ US $7,318.5 $4,908.3 $2,410.2
iShares iBoxx $ High Yield Corporate Bond Fund US HYG US $6,889.3 $4,569.2 $2,320.2
SPDR S&P Dividend ETF US SDY US $3,455.1 $1,252.4 $2,202.7
iShares iBoxx $ Investment Grade Corporate Bond Fund US LQD US $14,874.4 $12,755.9 $2,118.5
iShares Barclays Short Treasury Bond Fund US SHV US $3,869.1 $1,752.1 $2,116.9
ZKB Gold ETF (CHF) Switzerland ZGLD SW $7,174.2 $5,125.8 $2,048.4
Vanguard Short-Term Bond ETF US BSV US $5,687.0 $3,696.6 $1,990.4
E Fund SZSE 100 China 159901 CH $3,286.5 $1,321.3 $1,965.2
Market Vectors Gold Miners US GDX US $7,465.1 $5,534.3 $1,930.8
S&P 400 MidCap SPDR US MDY US $10,384.3 $8,485.1 $1,899.2
iShares EURO STOXX 50 (DE) Germany SX5EEX GY $4,561.7 $6,425.0 $-1,863.3
iShares Barclays TIPS Bond Fund US TIP US $20,373.5 $18,551.8 $1,821.7
SSgA
44.3%
iShares
27.2%
Others
10.4%
Direxion
Shares
5.2%
Power-
Shares
5.9%
ProShares
7.0%
Source: Global ETF Research and Implementation Strategy Team, BlackRock, Bloomberg.
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Global ETF listings
ASSETS UNDER CHANGE
MANAGEMENT (US$ Bn) IN ASSETS
No. Primary New in New in Total No. of No. of Planned
Location Listings 2009 2010 Listings 2009 2010 US$ Bn % Providers Exchanges New
US 890 121 149 890 $705.5 $797.2 $91.7 13.0% 29 2 789
Europe 1,030 215 212 3,396 $226.9 $256.2 $29.3 12.9% 37 21 92*
Austria 1 - - 21 $0.1 $0.1 $0.0 -27.4% 1 1
Belgium 1 - - 23 $0.1 $0.1 $0.0 -24.6% 1 1
Finland 1 - - 1 $0.3 $0.2 $0.0 -4.7% 1 1
France 259 55 43 421 $53.5 $55.5 $2.0 3.8% 9 1
Germany 375 80 46 1,094 $96.2 $101.5 $5.3 5.5% 9 2
Greece 2 1 - 2 $0.1 $0.1 $0.0 -32.8% 2 1
Hungary 1 - - 1 $0.0 $0.0 $0.0 -2.0% 1 1
Ireland 14 - - 14 $0.2 $0.3 $0.1 53.5% 2 1
Italy 23 - 12 488 $1.9 $2.1 $0.2 11.7% 4 1
Netherlands 11 7 1 106 $0.2 $0.3 $0.0 20.3% 4 1
Norway 6 - - 6 $0.8 $0.8 -$0.1 -7.4% 2 1
Poland 1 - 1 1 $0.0 $0.1 $0.1 100.0% 1 1
Portugal 2 - 2 2 $0.8 $0.0 -$0.8 -96.5% 1 1
Russia 1 - 1 1 $0.0 $0.0 $0.0 0.0% 1 1
Slovenia 1 - - 1 $0.0 $0.0 $0.0 6.1% 1 1
Spain 10 1 - 44 $2.4 $1.5 -$1.0 -40.5% 2 1
Sweden 24 7 12 64 $2.1 $2.4 $0.2 10.5% 2 1
Switzerland 102 20 52 495 $21.7 $32.7 $11.0 50.9% 7 1
Turkey 11 2 2 11 $0.2 $0.1 $0.0 -8.0% 5 1
United Kingdom 184 42 40 600 $47.1 $58.4 $11.3 24.1% 9 1
Canada 152 32 44 178 $28.5 $34.0 $5.4 19.1% 4 1 9
Japan 74 7 6 77 $24.6 $30.7 $6.0 24.4% 6 2 0
Hong Kong 38 11 16 67 $20.7 $25.0 $4.3 20.8% 10 1 1
China 12 5 5 12 $6.3 $11.0 $4.7 75.6% 10 2 16
Mexico 14 7 1 290 $8.1 $8.3 $0.2 2.0% 2 1 1
South Korea 60 17 13 60 $3.2 $4.9 $1.8 56.0% 12 1 7
Australia 12 1 8 33 $2.4 $3.3 $0.9 38.8% 4 1 10
Singapore 22 2 13 73 $2.6 $3.2 $0.6 24.3% 8 1 1
Taiwan 12 1 - 14 $2.7 $2.6 $0.0 -1.8% 2 1 5
South Africa 24 6 1 24 $1.8 $2.0 $0.2 12.5% 7 1 12
Brazil 7 - 3 7 $1.7 $1.7 $0.0 1.0% 2 1 0
New Zealand 6 - - 6 $0.5 $0.4 -$0.1 -22.9% 2 1 0
Malaysia 4 - 1 5 $0.3 $0.4 $0.0 9.5% 3 1 3
India 15 1 3 15 $0.2 $0.3 $0.1 42.8% 7 2 15
Thailand 3 1 - 3 $0.1 $0.1 $0.0 2.4% 2 1 0
Saudi Arabia 2 - 1 2 $0.0 $0.0 $0.01 100.0% 1 1 0
UAE 1 - 2 1 $0.0 $0.0 $0.01 100.0% 1 1 3
Indonesia 1 - - 1 $0.0 $0.0 $0.0 -5.2% 1 1 0
Chile - - - 50 - - - - - 1 0
Israel - - - - - - - - - - 5
Egypt - - - - - - - - - - 1
Sri Lanka - - - - - - - - - - 1
Philippines - - - - - - - - - - 1
ETF Total 2,379 427 478 5,204 $1,036.0 $1,181.3 $145.2 14.0% 129 45 972
Regulatory Information BlackRock Advisors (UK) Limited (BlackRock), which is authorised and regulated by the Financial Services Authority in the United Kingdom, has issued this document for access by professional clients and for information purposes only.
This document or any portion hereof may not be reprinted, sold or redistributed without authorisation from BlackRock. This communication is being made available to persons who are investment professionals as that term is defined in Article 19 of the Financial
Services and Markets Act 2000 (Financial Promotion Order) 2005 or its equivalent under any other applicable law or regulation in the relevant jurisdiction. It is directed at persons who have professional experience in matters relating to investments. This document is
an independent market commentary document based on publicly available information and is produced by the ETF Research & Implementation Strategy team. Specifically, this is not marketing nor is it an offer to buy or sell any security or to participate in any trading
strategy. Affiliated companies of BlackRock may make markets in the securities of ETFs and provide ETFs in the form of iShares. Further, BlackRock and/or its affiliated companies and/or their employees may from time to time hold shares or holdings in the underlying
shares of, or options on, any security of ETFs and may as principal or agent buy securities in ETFs. The opinions expressed are those of BlackRock as of September 2010, and are subject to change at any time due to changes in market or economic conditions. They
should not be construed as a recommendation, investment advice, offer or solicitation to buy or sell any securities or to adopt any investment strategy. In particular, BlackRock has not performed any due diligence on products which are not managed by BlackRock
and accordingly does not make any remark on their suitability. Prospective investors should take their own independent advice prior to making an investment decision. This document does not provide investment advice and the information contained within should
not be relied upon in assessing whether or not to invest in the products mentioned. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The securities discussed in this commentary may not be suitable
for all investors. BlackRock recommends that investors independently evaluate each issuer, security or instrument discussed in this publication and encourages investors to seek the advice of a financial adviser. The appropriateness of a particular investment or strategy
will depend on an investors individual circumstances and objectives The value of and income from any investment may go up or down and an investor may not get back the amount invested. The value of the investment involving exposure to foreign currencies can
be affected by exchange rate movements. We also remind you that the levels and bases of, and reliefs from, taxation can change and is dependent upon individual circumstances. Although BlackRock endeavours to update and ensure the accuracy of the content of this
document BlackRock does not warrant or guarantee its accuracy or correctness. Despite the exercise of all due care, some information in this document may have changed since publication. Investors should obtain and read the ETF prospectuses from the ETF Providers
and confirm any relevant information with ETF Providers before investing. Neither BlackRock, nor any affiliate, nor any of their respective, officers, directors, partners, or employees accepts any liability whatsoever for any direct or consequential loss arising from any
use of this publication or its contents. The trademarks and service marks contained herein are the property of their respective owners. Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness
of the data they provide and shall not have liability for any damages of any kind relating to such data. 2010 BlackRock Advisors (UK) Limited. Registered Company No 00796793. All rights reserved. Calls may be monitored or recorded.
*Includes 21 undisclosed RBS ETFs, 5 undisclosed HSBC/Hang Seng ETFs. Source: Global ETF Research and Implementation Strategy Team, BlackRock, Bloomberg.
To avoid double counting, assets shown above refer only to primary listings.
124
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Global Market Indices
5-Year Performance Graph (USD Total Return)
Table of Total Returns
Index Name Currency No. of Index 3 M (%) 6 M (%) 12 M (%) YTD (%) Yield
Constituents Value (%pa)
FTSE All-World Indices
FTSE All-World Index USD 2,774 262.80 9.7 4.3 14.6 7.9 2.43
FTSE World Index USD 2,298 611.19 9.4 3.7 13.9 7.1 2.46
FTSE Developed Index USD 1,996 242.04 9.3 3.3 13.4 6.9 2.44
FTSE Emerging Index USD 778 732.00 12.4 11.1 24.1 15.0 2.33
FTSE Advanced Emerging Index USD 302 671.23 11.6 8.7 22.4 10.6 2.76
FTSE Secondary Emerging Index USD 476 871.28 13.1 13.3 25.5 19.2 1.94
FTSE Global Equity Indices
FTSE Global All Cap Index USD 7,295 424.80 10.0 4.5 16.0 8.9 2.32
FTSE Developed All Cap Index USD 5,777 394.72 9.6 3.5 14.8 8.0 2.32
FTSE Emerging All Cap Index USD 1,518 977.44 12.8 11.5 25.3 15.6 2.31
FTSE Advanced Emerging All Cap Index USD 638 908.61 11.8 9.1 23.3 10.8 2.74
FTSE Secondary Emerging All Cap Index USD 880 1122.43 13.8 13.8 27.1 20.3 1.91
Fixed Income
FTSE Global Government Bond Index USD 749 199.63 5.7 10.5 6.8 9.0 2.34
Real Estate
FTSE EPRA/NAREIT Developed Index USD 280 2851.93 12.6 10.9 24.7 18.2 3.65
FTSE EPRA/NAREIT Developed REITs Index USD 187 975.73 10.9 9.6 30.6 20.4 4.47
FTSE EPRA/NAREIT Developed Dividend+ Index USD 226 2088.50 12.1 11.9 29.1 20.6 4.21
FTSE EPRA/NAREIT Developed Rental Index USD 229 1115.67 11.9 11.0 31.3 21.9 4.17
FTSE EPRA/NAREIT Developed Non-Rental Index USD 51 1183.24 14.4 10.4 9.2 9.0 2.20
SRI
FTSE4Good Global Index USD 657 6522.97 9.1 3.7 10.7 4.8 2.75
FTSE4Good Global 100 Index USD 103 5407.15 8.3 2.9 7.9 1.9 2.92
Investment Strategy
FTSE GWA Developed Index USD 1,996 3724.54 8.0 2.7 11.5 5.9 2.63
FTSE RAFI Developed ex US 1000 Index USD 1,011 6492.50 10.2 5.7 7.6 5.1 3.07
FTSE RAFI Emerging Index USD 357 7755.44 11.1 10.0 23.1 13.6 2.58
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Americas Market Indices
5-Year Performance Graph (USD Total Return)
FTSE Americas Index USD 777 801.29 8.3 1.2 17.1 8.1 1.99
FTSE North America Index USD 644 869.90 8.2 0.8 17.0 8.1 1.95
FTSE Latin America Index USD 133 1318.78 11.3 10.0 23.3 11.8 2.48
FTSE Americas All Cap Index USD 2,488 372.78 8.8 1.7 19.5 9.7 1.88
FTSE North America All Cap Index USD 2,306 353.76 8.6 1.1 19.1 9.5 1.84
FTSE Latin America All Cap Index USD 182 1878.19 11.8 10.9 24.7 12.6 2.42
Fixed Income
FTSE Americas Government Bond Index USD 197 201.80 2.0 6.3 7.4 8.7 2.27
FTSE USA Government Bond Index USD 184 197.39 1.9 6.3 7.2 8.6 2.24
Real Estate
FTSE EPRA/NAREIT North America Index USD 124 3476.50 8.9 7.1 43.4 25.5 3.69
FTSE EPRA/NAREIT US Dividend+ Index USD 88 1880.52 7.7 6.3 42.0 24.6 3.90
FTSE EPRA/NAREIT North America Rental Index USD 120 1182.80 8.6 7.2 43.9 26.2 3.68
FTSE EPRA/NAREIT North America Non-Rental Index USD 4 362.76 22.4 3.6 23.9 3.6 4.22
FTSE NAREIT Composite Index USD 134 3332.10 7.7 6.2 41.1 23.9 4.46
FTSE NAREIT Equity REITs Index USD 112 8135.44 7.9 6.0 42.8 24.7 3.61
SRI
FTSE4Good US Index USD 133 5229.35 7.9 0.2 15.6 6.0 1.81
FTSE4Good US 100 Index USD 102 4981.37 7.9 0.2 15.2 5.8 1.83
Investment Strategy
FTSE GWA US Index USD 588 3231.00 6.7 -0.9 14.8 6.9 1.96
FTSE RAFI US 1000 Index USD 994 5913.99 7.0 -0.8 19.8 10.9 2.11
FTSE RAFI US Mid Small 1500 Index USD 1,448 5906.66 7.7 -3.5 28.2 14.9 1.19
IPO Indices
FTSE Renaissance IPO Composite Index USD 169 258.29 7.7 -3.5 28.2 14.9 0.96
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FTSE Americas Government Bond Index
FTSE EPRA/NAREIT North America Index
FTSE EPRA/NAREIT US Dividend+ Index
FTSE4Good USIndex
FTSE GWA US Index
FTSE RAFI US 1000 Index
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Europe, Middle East & Africa Indices
5-Year Total Return Performance Graph
FTSE Europe Index EUR 566 246.62 4.5 3.8 15.8 7.8 3.17
FTSE Eurobloc Index EUR 279 130.43 5.1 4.5 10.5 2.9 3.46
FTSE Developed Europe ex UK Index EUR 376 246.06 4.9 4.3 13.8 6.3 3.23
FTSE Developed Europe Index EUR 490 242.67 4.6 4.1 15.6 7.5 3.24
FTSE Europe All Cap Index EUR 1,510 388.30 4.9 4.1 16.9 8.9 3.07
FTSE Eurobloc All Cap Index EUR 746 388.76 5.5 4.6 11.3 3.8 3.34
FTSE Developed Europe All Cap ex UK Index EUR 1,022 413.41 5.4 4.5 14.7 7.4 3.11
FTSE Developed Europe All Cap Index EUR 1,367 384.42 5.0 4.3 16.6 8.7 3.13
Region Specific
FTSE All-Share Index GBP 627 3926.44 9.0 4.2 17.5 9.3 3.10
FTSE 100 Index GBP 102 3692.92 8.8 3.9 16.5 7.9 3.23
FTSEurofirst 80 Index EUR 80 4896.48 4.9 4.8 9.8 1.4 3.72
FTSE/JSE Top 40 Index SAR 42 3124.08 8.6 7.0 17.0 10.6 2.11
FTSE/JSE All-Share Index SAR 165 3501.18 8.6 7.8 18.3 12.5 2.28
FTSE Russia IOB Index USD 15 942.22 3.9 -2.6 8.6 1.5 1.23
Fixed Income
FTSE Eurozone Government Bond Index EUR 245 177.81 1.0 2.8 4.8 4.8 3.36
FTSE Pfandbrief Index EUR 405 212.86 1.0 1.0 3.6 3.4 3.65
FTSE Actuaries UK Conventional Gilts All Stocks Index GBP 38 2470.25 2.4 6.1 6.1 8.0 3.54
Real Estate
FTSE EPRA/NAREIT Developed Europe Index EUR 82 2120.06 11.3 15.1 17.7 15.5 4.18
FTSE EPRA/NAREIT Developed Europe REITs Index EUR 36 767.33 11.0 14.7 16.3 13.5 4.77
FTSE EPRA/NAREIT Developed Europe ex UK Dividend+ Index EUR 41 2752.43 14.4 21.9 24.2 22.8 4.66
FTSE EPRA/NAREIT Developed Europe Rental Index EUR 72 835.02 11.6 15.6 18.4 15.9 4.27
FTSE EPRA/NAREIT Developed Europe Non-Rental Index EUR 10 533.14 5.1 3.3 0.4 4.5 2.09
SRI
FTSE4Good Europe Index EUR 274 4785.42 3.9 3.5 13.5 6.1 3.46
FTSE4Good Europe 50 Index EUR 52 4035.80 3.8 3.0 10.7 3.0 3.69
Investment Strategy
FTSE GWA Developed Europe Index EUR 490 3434.15 3.0 3.1 11.9 5.1 3.57
FTSE RAFI Europe Index EUR 503 5390.78 4.2 3.1 11.8 6.7 3.34
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Asia Pacific Market Indices
5-Year Total Return Performance Graph
FTSE Asia Pacific Index USD 1,293 307.58 9.9 5.1 15.3 11.0 2.37
FTSE Asia Pacific ex Japan Index USD 840 642.37 13.5 10.2 22.1 14.6 2.56
FTSE Japan Index USD 453 69.34 -3.4 -17.0 -7.1 -9.3 2.03
FTSE Asia Pacific All Cap Index USD 3,098 523.24 10.1 5.2 15.7 11.2 2.36
FTSE Asia Pacific All Cap ex Japan Index USD 1,865 798.10 13.9 10.4 23.0 14.9 2.52
FTSE Japan All Cap Index USD 1,233 219.29 -3.8 -17.2 -7.5 -9.2 2.04
Region Specific
FTSE/ASEAN Index USD 144 739.46 14.6 18.5 41.7 31.6 2.67
FTSE Bursa Malaysia 100 Index MYR 100 11384.59 11.8 13.8 25.4 22.2 2.41
TSEC Taiwan 50 Index TWD 50 7536.49 7.7 6.2 13.5 3.2 3.60
FTSE China All-Share Index CNY 1,156 9538.93 19.2 13.0 12.4 1.6 0.85
FTSE China 25 Index CNY 25 25713.06 9.3 9.1 6.7 6.5 2.25
Fixed Income
FTSE Asia Pacific Government Bond Index USD 232 163.60 7.7 18.6 16.2 18.1 1.04
Real Estate
FTSE EPRA/NAREIT Developed Asia Index USD 73 2352.20 14.4 13.7 14.7 14.0 3.41
FTSE EPRA/NAREIT Developed Asia 33 Index USD 33 1525.74 15.1 13.6 15.3 13.8 3.58
FTSE EPRA/NAREIT Developed Asia Dividend+ Index USD 57 2520.80 14.3 15.6 19.7 17.0 4.25
FTSE EPRA/NAREIT Developed Asia Rental Index USD 36 1120.25 14.8 15.4 25.3 22.1 5.46
FTSE EPRA/NAREIT Developed Asia Non-Rental Index USD 37 1296.72 14.1 12.7 9.0 9.4 2.12
Infrastructure
FTSE IDFC India Infrastructure Index IRP 107 1040.74 7.5 2.4 18.9 6.8 0.82
FTSE IDFC India Infrastructure 30 Index IRP 30 1160.31 7.8 2.5 16.7 6.1 0.81
SRI
FTSE4Good Japan Index JPY 178 3282.30 -3.7 -17.1 -8.9 -10.5 2.21
Shariah
FTSE SGX Shariah 100 Index USD 100 5605.01 7.6 3.0 12.6 5.4 2.12
FTSE Bursa Malaysia Hijrah Shariah Index MYR 30 12043.16 9.3 9.3 15.7 13.7 2.79
FTSE Shariah Japan 100 Index JPY 100 959.98 -1.6 -15.2 -5.8 -10.5 1.92
Investment Strategy
FTSE GWA Japan Index JPY 453 2498.00 -3.7 -16.5 -6.2 -7.4 2.12
FTSE GWA Australia Index AUD 101 4101.09 4.6 -1.9 3.5 -1.4 4.28
FTSE RAFI Australia Index AUD 56 6494.43 4.3 -1.7 3.2 -3.3 4.29
FTSE RAFI Singapore Index SGD 18 9115.27 2.6 3.3 19.7 7.1 3.11
FTSE RAFI Japan Index JPY 250 3517.11 -2.9 -16.8 -5.2 -7.5 2.02
FTSE RAFI Kaigai 1000 Index JPY 1,022 3918.74 1.3 -11.5 -0.2 -7.4 2.81
FTSE RAFI China 50 Index HKD 49 7662.98 10.9 12.4 7.8 7.9 2.77
IPO Indices
FTSE Renaissance Asia Pacific ex Japan IPO Index USD 129 1947.43 11.6 8.9 25.2 15.8 0.93
FTSE Renaissance Hong Kong/China Top IPO Index HKD 38 2755.72 12.9 9.9 18.2 11.2 0.69
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Index Reviews December 2010 - February 2011
Date Index Series Review Frequency/Type Effective Data Cut-off
(Close of business)
Early Dec CAC 40 Quarterly review 17-Dec 15-Dec
Early Dec ATX Quarterly review 31-Dec 30-Nov
Early Dec OBX Semi-annual review 17-Dec 30-Nov
Early Dec S&P / TSX Quarterly review 17-Dec 30-Nov
Early Dec RTSI Quarterly review 14-Dec 30-Nov
02-Dec FTSE Global Equity Index Series
(incl. FTSE All-World) Annual review / North America 17-Dec 30-Sep
03-Dec DAX Quarterly review 17-Dec 30-Nov
03-Dec S&P / ASX Indices Quarterly review 17-Dec 03-Dec
04-Dec NZX 50 Quarterly review 17-Dec 30-Nov
07-Dec TOPIX Annual review (constituents) 28-Jan 31-Dec
08-Dec FTSE MIB Quarterly review - shares & IWF 17-Dec 30-Dec
08-Dec FTSE/JSE Africa Index Series Quarterly review 17-Dec 30-Nov
08-Dec FTSE UK Index Series Annual review 17-Dec 07-Dec
08-Dec FTSE techMARK 100 Quarterly review 17-Dec 30-Nov
08-Dec FTSE Euromid Quarterly review 17-Dec 30-Nov
08-Dec FTSEurofirst 300 Quarterly review 17-Dec 30-Nov
08-Dec FTSE Italia Index Series Quarterly review 17-Dec 30-Nov
09-Dec FTSE EPRA/NAREIT
Global Real Estate Index Series Annual review 17-Dec 30-Nov
10-Dec FTSE Bursa Malaysia Index Series Annual review 17-Dec 30-Nov
10-Dec OMX I15 Semi-annual review 03-Jan 31-Dec
10-Dec DJ STOXX Quarterly review 17-Dec 23-Nov
12-Dec S&P BRIC 40 Annual review 18-Dec 20-Nov
12-Dec S&P US Indices Quarterly review 18-Dec 04-Dec
12-Dec S&P Europe 350 / S&P Euro Quarterly review 18-Dec 04-Dec
13-Dec S&P Topix 150 Quarterly review 17-Dec 03-Dec
12-Dec S&P Asia 50 Quarterly review 18-Dec 04-Dec
12-Dec S&P Latin 40 Quarterly review - shares & IWF 18-Dec 04-Dec
12-Dec S&P Global 1200 Quarterly review - shares & IWF 18-Dec 04-Dec
12-Dec S&P Global 100 Quarterly review - shares & IWF 18-Dec 04-Dec
Mid Dec VINX 30 Semi-annual review 17-Dec 30-Nov
Mid Dec OMX C20 Semi-annual review 20-Dec 30-Nov
Mid Dec OMX S30 Semi-annual review 31-Dec 30-Nov
Mid Dec OMX N40 Semi-annual review 17-Dec 30-Nov
Mid Dec Baltic 10 Semi-annual review 31-Dec 30-Nov
15-Dec BNY Mellon DR Indices Quarterly Review 20-Dec 30-Nov
17-Dec Russell US Quarterly review - IPO additions only 24-Dec 30-Nov
17-Dec Russell Global Indices Quarterly review - IPO additions only 24-Dec 30-Nov
Late Dec IBEX 35 Semi-annual review 31-Dec 30-Nov
07-Jan TOPIX Monthly review - additions
& free float adjustment 28-Jan 31-Dec
11-Jan FTSE/Xinhua Index Series Quarterly review 21-Jan 20-Dec
13-Jan TSEC Taiwan 50 Quarterly review 21-Jan 31-Dec
Mid Jan OMX H25 Semi-annual review consitutents 31-Jan 31-Dec
27-Jan Russell US & Global Indices Monthly review - shares in issue change 31-Jan 26-Jan
04-Feb TOPIX Monthly review - additions &
free float adjustment 25-Feb 31-Jan
10-Feb Hang Seng Quarterly review 04-Mar 31-Dec
14-Feb MSCI Standard Index Series Quarterly review 28-Feb 31-Jan
14-Feb Russell/Nomura Indices Quarterly IPO addtions 28-Feb 31-Dec
22-Feb DJ Stox Quarterly review 18-Mar 31-Jan
24-Feb Russell US & Global Indices Monthly review - shares in issue change 28-Feb 23-Feb
Sources: Berlinguer, FTSE, JP Morgan, Standard & Poors, STOXX
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With 18 new pan-Asia sector-based indices to choose from, its never been
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www.ftse.com/asiansector
FTSE. Its how the world says index.
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I S S UE 47 DE CE MBE R 2010 / J ANUARY 2011

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