FTSE Global Markets

I S S U E S I X T E E N • N O V E M B E R / D E C E M B E R 2 0 0 6

CORPORATE-ACTIONS & THE POWER OF TECHNOLOGY

THE NEW FRONT LINE FOR COLLATERAL MANAGERS

Intel makes acomeback

The battle for Heinz

Mattel: Barbie fights back

ATON CAPITALMaking time for the perfect partner

GM Cover Issue 16 16/10/06 19:28 Page FC1

C R O S S - B O R D E R P O O L I N Gand its effect on your daily existence

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GM Cover Issue 16 16/10/06 19:28 Page FC2

EDITORIAL DIRECTOR:Francesca Carnevale, Tel + 44 [0] 20 7680 5152,email: [email protected] EDITORS: Neil O’Hara, David Simons, Art Detman.SPECIAL CORRESPONDENTS: Andrew Cavenagh, Rekha Menon, John Rumsey, Bill Stoneman, Lynn Strongin Dodds, Ian Williams,Ben Seeder.STAFF WRITER: Blazej Karwowski, Tel +44 [0] 20 7680 5154email: [email protected] EDITORIAL BOARD:Mark Makepeace [CEO], Imogen Dillon-Hatcher,Paul Hoff, Paul McLean, Jerry Moskowitz, Gareth Parker, Andy Harvell, Sandra Steel, Rachel Pawson, Nigel Henderson.PUBLISHING & SALES DIRECTOR:Paul Spendiff, Tel + 44 [0] 20 7680 5153, email: [email protected] SALES EXECUTIVE:Ira Cloppenburg, Tel + 44 [0] 20 7680 5156, email: [email protected] OVERSEAS REPRESENTATION:Adil Jilla [Middle East and North Africa], Faredoon Kuka, Ronni Mystry Associates Pvt [India],Leddy & Associates [United States]PUBLISHED BY:Berlinguer Ltd, 1st Floor, Rennie House, 57-60Aldgate High Street, London, EC3N 1AL. Tel: + 44 [0] 20 7680 5151; www.berlinguer.com ART DIRECTION AND PRODUCTION: Russell Smith, IntuitiveDesign, 13 North St.,Tolleshunt D’Arcy, Maldon, Essex CM9 8TF, email: [email protected] PRINTED BY:Southernprint - 17-21 Factory Road, UptonIndustrial Estate, Poole, Dorset BH16 5SNDISTRIBUTION:Air Business Ltd, 4 The Merlin Centre, Acrewood Way, St Albans, AL4 OJY.

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1F T S E G L O B A L M A R K E T S • N O V E M B E R / D E C E M B E R 2 0 0 6

Outlook

IN THE RUN UP to the end-of-year festivities, there is a whiff or twoof something approaching whimsy in this edition. Likely as not it is adeliberate counterpoint to an increasingly worrisome geopolitical

climate and the odd bearish signals issuing from three or more G7markets. In fact, any whimsy is entirely limited to presentation. While oneor more of our stories may look rather lively, two of our seemingly lighterofferings have some very serious messages indeed. Among these are ArtDetman’s profile of Mattel, the world’s largest toy company and home toBarbie, the world’s most successful toy. After an overdue reorganisationand a strategic acquisition, the company now seems to be on the brink ofa comeback, after a prolonged period outside the playpen. It has certainlybeen a testing time for the firm’s management and shareholders. Thequestion now is whether the firm is showing sufficient innovation andspeed to market to reclaim its out and out dominance?

Another highlight is Dave Simon’s searing account of the battle forcontrol of the operating soul of Heinz.This fight for boardroom supremacyis the latest in a series of initiatives by mega-investors such as Carl C Icahnand Kirk Kerkorian, who, like Peltz, have secured large positions in publiccompanies so that they can influence board members and make theirmark on fiscal policy. While their aggressive strategies—which ofteninclude massive labour cuts and reductions in capital expenditures—canyield positive results and boost shareholder value, critics see a significantdownside. In the specific case of Heinz, it could even involve the potentialdisplacement of a regional icon. Who will win out?

A recurring theme in any current edition of this magazine is thesweeping changes taking place in the investment services industry. Thistime Neil O’Hara focuses on prime broking. Once upon a time, a primebroker used to be what the name implies: a central custodian of a hedgefund's assets that processed all its trades, financed positions, arrangedstock loans and provided reports tracking the entire portfolio. Hedgefunds had little leverage over their chosen broker and paid the freight asa cost of doing business. That is no longer the case. The bigger fundstoday have multiple prime broker relationships, sometimes playing firmsagainst one another to get better terms. Who is winning and who islosing in this new battle for business?

Few events this year managed to drag out any last dregs of drama for aslong as the Mexican elections did. With its knife-edge count, legal challengesand street protests it had all the hallmarks of an emerging market gonetopside. Now that it is all over, to all intents and purposes, Mexico’s businesscommunity now seems to have returned to business as usual. Is it really?Incoming president Felipe López Calderón faces some stiff challenges: notleast a shaky relationship with its northern neighbour; and the need to clarifythe country’s approaches to foreign direct investment in the face of aresurgence of extremist nationalism and vested local interests. Can Calderónturn the tide? Ian Williams checks out the strength of the counter-currents.

Our cover story this month focuses on Aton Capital; a gem of aRussian investment bank that has had more offers of marriage thanElizabeth Taylor. If there’s any action in Russia, Aton is usually in thethrong. FTSE Global Markets talks to Alexander Kandel about the firm’ssearch for a perfect partner and its immediate strategic goals.

Francesca Carnevale,Editorial DirectorOctober 2006

GM Cover Issue 16 16/10/06 19:28 Page 1

Contents

2

ENCOURAGING MARKET FORCES ..........................................................................Page 6Craig Donohue, CEO of the Chicago Mercantile Exchange argues for room forinnovation in Europe’s central counterparty clearing services.

INTEREST RATES: ANATHEMAS AND INDICES ........................Page 12Simon Denham, managing director, Capital Spreads, reports on the impact of inflation.

WILL THE UK’s REITs REGIME HELP OR HINDER GUERNSEY? ....Page 14Guernsey banks on UK REITs adding to its property trust reservoir.

ABSOLUTE RETURN UCITs FUND LAUNCHED ..............................................Page 16Why Mellon thinks it’s leading the pack with an innovative UCITs fund.

THE EXPANDING UNIVERSE OF CHINA HEDGE FUNDS ........Page 18Simon Coxeter, managing director, AsiaSource Capital explains the trends.

BAHRAIN’S NEW TRUST LAW LEGISLATION ..................................Page 28Can Bahrain’s comprehensive regulations cement its role as a financial centre?

SOUTH EAST EUROPE: THE BENEFITS OF HARDBALL ......Page 31Lynn Strongin Dodds on the advantages of impending EU membership

LATIN AMERICA’S PRIVATE EQUITY REVIVAL ..........................Page 36John Rumsey reports on the new deals and dealmakers

LATIBEX’S NEW BRAZIL INDEX ..............................................................Page 40The growing family of FTSE Latibex indices

THE PROSPECTS FOR POST ELECTION MEXICO ......................Page 42Ian Williams reports on the challenges facing president-elect Calderon.

RUSSIAN PENSION REFORM ....................................................................Page 45The government has finally woken up to pension reform, just in time for the elections.

UPWARDLY MOBILE ..................................................................................................Page 52Neil O’Hara reports on the relationship between index option trading and ETFs.

WAMU COMES TO EUROPE ....................................................................Page 24Why European covered bonds have appealed to Washington Mutual.

EXOTIC DEBT’S BANDWAGON STARTS ROLLING..................Page 26Blazej Karwowski reports on the rarefied deals of the late summer.

AFTER THE GOLD RUSH ..............................................................................Page 74Prime brokers benefit as hedge funds push into new markets. By Neil O’Hara

Market Reports by FTSE Research ................................................................................Page 86Index Calendar ..................................................................................................................Page 96

REGULARS

COVER STORY

MARKET LEADER

REGIONAL REVIEW

INDEX REVIEW

COVER STORY: ATON: BRIDESMAID OR BRIDE? ........Page 45Bulge bracket banks are now looking to Russia for business growth, bringing with themnew competitive pressures. Many foreign banks are now looking for appropriateacquisitions opportunities and few brokerage houses in Russia are as appealing as Aton.Variously courted by Goldman Sachs and other leading houses, and having rejectedtheir advances, Aton knows it has to find the perfect partner to survive. FrancescaCarnevale talks to Aton’s chief executive officer, Alexander Kandel in Moscow.

N O V E M B E R / D E C E M B E R • F T S E G L O B A L M A R K E T S

DERIVATIVES

DEBT REPORT

ALTERNATIVES

IN THE MARKETS

INDEX REVIEW


METALS

INTEREST RATES

AGRICULTURAL

EQUITIES

MARKET DATA

The information herein is taken from sources believed to be reliable. However, it is intended

for purposes of information and education only and is not guaranteed by the Chicago Board

of Trade as to accuracy, completeness, nor any trading result, and does not constitute trading

advice or constitute a solicitation of the purchase or sale of any futures or options. The Rules

and Regulations of the Chicago Board of Trade should be consulted as the authoritative

source on all current contract specifications and regulations.

©2006 Board of Trade of the City of Chicago, Inc.

All Rights Reserved www.cbot.com

Live Books and Special Metals Report at www.cbot.com/metals

CBOT 100 oz.

Gold

ZGZ6Last:

Change:

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FEATURES

COLLATERAL MANAGEMENT TO THE FORE ................................Page 62Hedge funds, which are always trying to improve their return on capital continue topush for measures that increase the efficiency of their collateral, including firm-widecollateral calculations. Hedge funds are on the cutting edge, of course, but traditionalmoney managers may pose a bigger challenge – and opportunity – for collateralmanagers, who now see a rapid increase in the use of OTC derivatives by a greaterrange of players. Neil O’Hara reports

CORPORATE-ACTIONS TAKES CENTRE STAGE ........................Page 66Over the past several years, the volume of corporate-actions messaging on a globalscale has increased significantly. At the same time it has created a completely new setof challenges for custodians and others entrusted with relaying crucial information tothe end user on time and error-free. While technological solutions continue to bebandied about, experts underscore the need for greater harmonization and increasedcommitment from all parties involved. Dave Simons reports from Boston.

MATTEL MAKES A COMEBACK ............................................................Page 78Chances are Bob Eckert never thought that running a toy company would be so hard,especially one with iconic brands such as Barbie, American Girl, Tickle-Me-Elmo, HotWheels and Matchbox. Revenues peaked in 1999 at $5.5bn, recovering weakly to $5.2bn lastyear. Now, after a long overdue reorganisation and a key acquisition, the company appearson the brink of a strong comeback. Art Detman reports

GLOBAL PLAYERS TAKE THE LEAD IN ASIAN SUB-CUSTODY ....Page 82It is all change in the geography of Asian sub-custody. Increasingly, clients are selectingproviders based on credit ratings, where global players also have an advantage. In mostcases, the choice of provider is not determined by price and as a result it is more difficultfor single market sub-custodians to make the required investment in overheads as theneed to invest in services and people is immense. Rekha Menon reports

INTEL FIGHTS FOR MARKET DOMINANCE ..................................Page 58After fumbles and stumbles that cost it market share, profits and prestige, thedominant maker of semiconductors counterattacks with price cuts, new products, amanagement shakeup, and widespread layoffs. The ensuing struggle with archrivalAdvanced Micro Devices will benefit computer users everywhere. Art Detman reportsfrom California.

HEINZ AND SHAREHOLDER ACTIVISM ..........................................Page 70Earlier this year however, the traditional corporate values espoused by Heinzmanagement came face-to-face with 21st-century shareholder activism. A group ofdissident investors, led by billionaire Nelson Peltz of Trian Fund Management LP, squaredoff against Heinz’s board of directors in an effort to revamp Heinz’s ailing business model.Dave Simons looks at the repercussions for Heinz and corporate America.

4 N O V E M B E R / D E C E M B E R 2 0 0 6 • F T S E G L O B A L M A R K E T S

Contents


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GLOBAL CUSTODIAN



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Market Leader

What is the optimal structure of centralcounterparty clearing (CCP) services? In Europe, thedebate focuses on the relative merits of a singlelarge intermediary-owned (or controlled) CCP overa de-centralised system. Should Europe’s regulatorsactually mandate the establishment of a singlemonopoly provider of central counterparty clearing(CCP) services? Or, as Craig S Donohue, chiefexecutive officer of the Chicago MercantileExchange (CME) believes, should CCPs be allowedto innovate in response to competitive marketforces rather keep to official and centralised dictats?

FOR THE MOST part, the debate in Europe over thefuture of CCP services used to focus on the relativemerits of a single large intermediary owned or

controlled CCP versus a de-centralised structure withcompeting and differently organised CCPs, including forexample, exchange-owned/controlled CCPs. Of course,large intermediaries, and the CCPs owned or controlled bythem, distinctly favoured the so-called horizontal model,which assumes that a single, large intermediary-ownedCCP will reduce clearing and settlement processing costsand cross-border trading expenses.

Surprisingly, the notion of mandating a single monopolyCCP still carries currency, even though an April 2004European Commission (EC) communiqué recommendedthat a structure for clearing and settlement services inEurope should be decided by market forces, rather than bydictat — a position even the European Parliament agreeswith. In February, LCH Clearnet presented a discussionpaper to the European Commission’s Clearing andSettlement Advisory and Monitoring Expert Group(CESAME), calling for the “full consolidation of CCPsserving all European markets and asset classes.” Then, inMay, Europe’s competition commission paper onCompetition in EU Securities Trading and Post Trading arguedthat CCP services could and probably should operate in acompetitive environment. However, both voiced theiropposition to vertical integration and even the competition

commission found that,“vertical integration may result inforeclosure at all levels of the value chain and thereforelead to welfare losses. Whilst there may be efficiencies [sic],so far the commission has seen no convincing evidence tosubstantiate this.”

We need to go even a step further. A directive that createsa single monopoly provider of CCP services is, actually,inconsistent with a call for competition. The proposition, infact, spells the end of competition for providing innovativeand efficient clearing and settlement structures.

If competition is the real goal, then regulators and policymakers should support a competitive environment thatfosters innovation and the development of new andalternative solutions which allow the market to advance.

The case for mandating a single monopoly provider ofCCP services for all asset classes and all European marketshas not been made properly. The true cost savings ofmoving to a single monopoly CCP or of creatinginteroperability among multiple CCPs, for example, has

A CALL FOR THE FREEDOMTO INNOVATE

Craig S Donohue, chief executive officer, Chicago Mercantile Exchange.“Surprisingly, the notion of mandating a single monopoly CCP stillcarries currency, even though an April 2004 European Commission

(EC) communiqué recommended that a structure for clearing andsettlement services in Europe should be decided by market forces,

rather than by dictat—a position even the European Parliament agreeswith,” writes Donohue. Photograph kindly supplied by the Chicago

Mercantile Exchange, September 2006.

REGIONAL REVIEW 16 16/10/06 19:58 Page 6

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not been quantified and explained. Post-trade processing,for instance, is only a small portion of overall trading costsand bid/ask spreads, frictional costs on large orders andintermediaries’ fees far outweigh any clearing andsettlement processing costs.

A single intermediary owned controlled CCP with inter-exchange fungibility could, in fact, fragment marketliquidity and have a negative impact on effective spreadsand frictional costs.

Equally, there has not been enough discussion of thepotential problems associated with an intermediary-owned/controlled CCP.

While exchange-owned CCPs may seek to extractmonopoly rents, it should be noted that intermediary-owned CCPs could limit CCP activities in some markets tomaximise trading and dealing profits for their owners, atthe expense of smaller members of the CCP and true end-users. Additionally, the conflicting interests of the exchangeuser/owners and the intermediary owners of certain CCPscan sometimes impair their efficiency, both in terms oftechnology development and bringing new businessinnovations to market. Advocates for a single monopolyCCP solution appear unconcerned about this potential lossof efficiency. Finally, there is clear evidence of theefficiencies created by exchange-owned CCPs providingtangible value to both intermediaries and end-users.

Let us examine these points in greater detail. Back in2001, the Giovannini group identified fifteen barriers toreducing trading and settlement costs, the majority ofwhich are directly related to differences in national policies(related to finality of settlement, settlement timeframes andtaxation, for example). It is far from clear however thatcreating a single intermediary-owned/controlled CCP willeliminate any of these barriers, or lower costs. The barriersthemselves then are the key. If they are not removed, asingle monopoly CCP will still have to maintain theprocesses and procedures required by each nationalmarket. Today’s CCPs are optimised for the markets inwhich they operate and it is probably more efficient tocontinue in this vein rather than force a central CCP tocreate a superstructure that, by necessity, duplicates whatalready exists.

Arguments in favour of adopting a single intermediary-owned/controlled CCP focus on cost reductions througheconomies of scale and scope and capital efficiencies. LCHClearnet in its presentation on The Need to RemoveStructural Barriers to the Consolidation of CCP Clearing, madeto CESAME in February this year, argues that costreductions achieved by consolidation will drive additionaltrading activity, positively affecting European GDP.

However, this argument falls down on its assertion thatmodest CCP cost savings will have a significant impacton trading activity. To increase trading activitysignificantly, the all-in cost of trading must be reducedsubstantially. CCP-related costs are only a fraction oftotal all-in costs, which include the bid/ask spread;‘frictional costs’ on large orders; intermediaries’ fees, andminor exchange and CCP fees.

In 2005, slightly over 1bn futures and options contractswere traded at CME. If each of those trades happened atone-tick, the smallest possible bid/ask spread, a minimumof $12.7bn would have been paid in bid/ask spread bymarket participants. Each penny saved in clearing andsettlement, however, would only eliminate $11m dollarsfrom the all-in cost of trading, less than 1% of the impactof the bid/ask spread. If we use the 5 cent fee charged bythe Chicago Board of Trade (CBOT) as a proxy for clearingand settlement costs, market innovation that yields a 1%change in the $12.7bn captured in bid/ask spread wouldreduce trading costs by $127m, a result that is almost $20mmore than the $110m that could be achieved with theelimination of all clearing and settlement costs. In otherwords, CCP direct costs are negligible compared to othertrading costs. However, the ownership composition andgovernance structure of CCPs can have a direct bearing onthe adoption of CCP’s policies and practices that are criticalto the creation of efficient markets.

Euroclear’s March 2005 position paper on Clearing andSettlement claimed that “no-one is likely to take a keenerinterest in the controls safeguarding their assets anddemand more innovative services than the user/ownersthemselves.” Even so, large intermediaries are only asubset of market users. The European Central Bank andthe Committee of European Securities Regulators’Standard 13 states that “governance arrangements forentities providing securities & settlement services shouldbe designed to fulfill public interest requirements andpromote the objectives of owners and users”. Thestandard goes on to define public interest as the “safetyand efficiency of the system”. While safety and efficiencyare of paramount concern to all market users, true publicinterest transcends those factors. A single intermediary-owned CCP can and likely will establish policies andpractices that promote the interest of large intermediarieswith little or no regard for the best interests of smallerintermediaries or true end-users.

Experience shows that exchanges with verticallyintegrated clearing functions serve the public interestbetter by developing clearing services that can makemarkets more accessible, transparent and efficient. Why?

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Because exchanges arecentralised transactionprocessors which act asneither principal nor agenton behalf market users. Assuch, exchanges do notseek to capture spreads orprofit from large orders.Moreover, exchanges haveno stakes in taking tradingprofits at the expense ofimproving markettransaction costs.Furthermore, a compellingargument can be presentedthat a demutualised, publicly owned exchange CCPpresents a stronger governance framework for end usersthan an intermediary-owned CCP.

The former will differ from the latter in two importantways. Its shareholders will represent the full spectrum ofparticipants in the trading community and its success willbe measured in terms of shareholder returns and notmerely by its ability to operate “safely and securely.” Bymeasuring success in terms of returns to shareholders,policies will be determined based on their ability to attractadditional trading volume and maintain an appropriatelevel of risk controls. How better then to ensure that CCPstruly serve the public interest than by ensuring they arepublicly owned?

Swapclear is a clear example of how an intermediarycontrolled CCP may not serve the public interest.Swapclear caters to the interests of the 19 largest swapdealers rather than the broader universe of marketparticipants. It has also limited its product set to plainvanilla interest rate swaps in major currencies. Creditderivatives and equity swaps, the highest profit-marginproduct for brokers, have been excluded, benefiting dealerprofitability at the expense of reducing systemic risks andtransaction costs in these markets.

In contrast to the limited participation, limited productapproaches taken at Swapclear, clearing houses controlledby exchanges seek to bring the benefits of CCP services toa significantly wider audience. For example,FXMarketSpace, CME’s soon-to-be-launched joint venturewith Reuters will create an efficient, anonymous andcentrally cleared alternative to the current spot and forwardmarkets. FxMarketSpace will differentiate itself fromexisting platforms by linking to the CME clearinghouse andproviding a level credit playing field to all marketparticipants. The combination of anonymous trading and

CME’s CCP servicesshould enhance liquidityand trading opportunityfor all market users.

Shareholder value-drivenorganisations can takecalculated risks and makespeculative investmentsthat have the potential togenerate returns for theirshareholders. Intermediary-owned or controlled utilitiesare, in contrast, generallyrewarded for costminimisation rather than

growth and value creation for shareholders. In consequence,they neither truly minimise costs nor create value. For thatreason, regulators and policy makers should more carefullyassess the impact of the structure on innovation, marketdevelopment and industry growth.

Can an exchange-owned CCP really create efficienciesand benefits for both intermediaries and end-users? Whilethe EC may not be able to find examples of theseefficiencies in European securities markets, there are clearand compelling examples to learn from in the USderivatives markets. The CME’s common clearing link withthe Chicago Board of Trade (CBOT) for example, hasreduced capital and performance bond requirements formarket users by approximately $2bn, while creatingadditional expense savings for clearing member firms.Cross-margining agreements with the CBOT, SGX, theOptions Clearing Corporation, LCH Clearnet, the NewYork Mercantile Exchange and the Fixed Income ClearingCorporation meanwhile provide capital efficiencies tomarket users by including positions held in otherclearinghouses in the calculation of portfolio risk.

In truth, there is no evidence that either a vertical or ahorizontal market model is the right one in all situationsor that either model is wrong in all situations. CCPbehaviour — rather than the ownership and governancestructure of CCPs — may be a more appropriate focus forensuring the competitiveness of European securitiesmarkets. The only way to ensure that markets developefficiently is to provide sound regulation and allow marketforces to determine the structures and solutions that workbest. The best way to achieve that is to let marketparticipants have a voice in the governance of aclearinghouse. What better way to ensure that clearingand settlement providers truly serve the public interestthan by having them be owned by the public?

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Post-trade processing, for instance, isonly a small portion of overall trading

costs and bid/ask spreads, frictional costson large orders and intermediaries’ feesfar outweigh any clearing and settlementprocessing costs. A single intermediary

owned/controlled CCP with inter-exchangefungibility could, in fact, fragment marketliquidity and have a negative impact oneffective spreads and frictional costs.

551471_FTSE_SwissRe.indd 1 10/4/06 8:33:27 AM


“I need to weather the extremes.”BRIAN O’HEARNE

Managing Director, Environmental & Commodity Markets,Swiss Re Capital Management and Advisory

Managing the risks associated with volatile weather is an integral part of Brian O’Hearne’sjob at Swiss Re, a leading global reinsurer. CME weather derivatives allow him and his counterparts in industries as diverse as energy, insurance, retailing and agriculture, to trade futures on weather in 29 cities in the United States, Europe and Japan — helping them manage the impact of weather on their operations.

By improving the way markets work, CME is a vital force in the global economy, offering futures and options products on interest rates, equity indexes, foreign exchange, commodities and alternativeinvestments. For more about how CME can change your world, visit www.cme.com/info.

IDEAS THATC HANGETHE WORLD™

CME®, the Globe logo and Chicago Mercantile Exchange® are trademarks of CME. Copyright © 2006 CME. All rights reserved.

551471_FTSE_SwissRe.indd 1 10/4/06 8:33:27 AM



WE ARE NOW entering arather more nervousperiod for equities, and

therefore indices, as recent evidencesuggests that the US economy maybe slowing rather faster thanexpected. The US is still the maindriver of the world economy andwhile the old chestnut “whenAmerica sneezes Europe catches acold” may be hoary, but thesentiment is as crisp as ever,although nowadays we might wantto transpose ‘Europe’ with the ‘theFar East’.

China is still forging ahead withdouble digit growth rates. Itsgovernment is doing a handy job ofbalancing inflationary andexpansionary pressure and exerting astrong grip on foreign exchange andinterest rates, but inevitably problemswill arise in such a potentiallyinflationary environment.

Unfortunately, as with all rapidlyexpanding economies, there is alwaysthe danger of boom turningspectacularly to bust—especially if amajor trading partner suddenly cutsback on demand for your goods.China’s economy is still too poor to beable to take up any slack resulting from

a slowdown and is therefore (probably)the economy most in danger in theevent of any US-led recession.

Japan is another story entirely, as itis the only really mature economy inAsia. The country has effectivelystagnated for the last 15 years withdeflationary worries continuallyswirling through the markets. Now,fears are rising that the trade surplus(the mainstay of the economy sincethe mid-1970s) has started to showsigns of slipping. With interest rateseffectively at zero percent (where theyhave languished for six years or more)investors now need to see goodgrowth potential in order to betempted back into the market. Rightnow, that simply does not looklikely—particularly with the Nikkei225 stalled at just below 16000.

The Yen is soaking up pressure. It isparticularly noticeable on a basket-weighted basis as the Yen has fallendramatically against the Euro, Sterlingand even the US Dollar. Over the pastfour years the Euro has increased byalmost 30% against the Yen wiping outmuch of any potential investment gains.

A slowing or even recessionaryeconomy is not necessarily bad forequities. It can in certain

circumstances be taken brightly by themarkets. As economies slow soCentral Banks will reduce rates andreturns from equities will look evermore attractive. Equally, companies arealways loathe to cut dividend levelseven when prudence would suggestthat they do so and, even in theabsence of any identifiable growth,shares can continue to rally. Longerterm investors also like to look throughthe current problems and identifyturning points in rate expectations.

Although the US equity marketshave done reasonably well over thepast few years, price to earnings ratiosare almost at a record low, with theS&P 500 currently in the mid-teensdown from around sixty in 2001/2002.The obvious reason for this is theconstant stream of rate-hikes from theFederal Reserve which have made theholding of cash a much more desirableoption to shares. Now though we areentering a rate-neutral (possiblyeasing) era and in this environmentequities can be king again.

All this presupposes that inflation iskept under control which, in aslowdown, is normally taken as given.Unfortunately for the UK it is only thediscretionary spending inflation that ismuted, the non-discretionary side isdefinitely not. Energy, taxation,housing (rental and sales) are wellabove ‘official’ inflation levels and wemay find that the FTSE is caughtbetween a rock and a hard place.

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INTEREST RATES:ANATHEMAS & INDICESWith inflation in the UK on the rise, the Bank of England has little inits armory to battle against it, say analysts. Money supply in the UKis running (almost) out of control as the government appears to printevermore IOUs in one form or another to keep the economy moving.Some commentators say that if you strip government-related jobsand spending out of the growth equation the UK economy hasbarely moved in the last eight years. Rising interest rates areanathema to equity markets and dealers can be forgiven for takingthe Bear road when other opportunities appear to offer betterprospects. Simon Denham, managing director of spread betting firmCapital Spreads, reports on index trends and expectations.

Simon Denham, managing director, CapitalSpreads. Photograph kindly provided by

Capital Spreads, August 2006.


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GUERNSEY HASESTABLISHED itself as aleading jurisdiction for the

establishment of offshore funds,helped in large party by a regulatoryenvironment. Guernseyhas streamlined itsapplication processconsiderably. The island’sFinancial ServicesCommission (FSC) has afast track process thatmeans that the launch of afund is unlikely to bedelayed by regulatoryapprovals, particularlywhere the promoter of thefund is already known tothe Commission.

According to figuresissued by Guerney’s FSC,funds under managementand administration in

Guernsey stood at just under £115bnat the end of June this year – a year onyear rise of 37%. In an officialstatement, Peter Niven, GuernseyFinance’s chief executive noted, “We

are continuing to see a substantialinflux of new funds business into theIsland despite new records being seteach quarter for the value of funds inGuernsey.” Guernsey finance is thespecialist promotional agency for theisland’s finance industry.

In large part, Guernsey’s expansionhas also been fuelled by the ChannelIslands Stock Exchange (CISX’s)efforts to streamline listingapplications as well as achievingrecognition from variousinternational regulatory authorities.The UK’s Financial Services Authority(FSA) awarded the status ofDesignated Investment Exchange tothe CISX in February 2004.This move,together with its designation as aRecognised Stock Exchange underthe UK’s Income and CorporationTaxes Act 1988, has increased theisland’s appeal as an offshoreinvestment centre.

The CISX, which is based inGuernsey, is carving out something ofa niche for itself in the listing ofproperty funds. The CISX does nothave minimum asset requirements.The spread of risk requirements arerigorous, but not onerous and listing

is cost effective. TheCISX’s listing committeesits on a daily basis andthe exchange isresponsive to listingdocumentation, withresponse times reduced toa minimum.

A working party,chaired by Guernseyadvocate Peter Harwood,recommended earlier thisyear that the focus ofregulation should be onthe licensed Guernseyadministrator, reducingthe number and scope offunds that will be

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In large part, Guernsey’s expansionhas also been fuelled by the Channel

Islands Stock Exchange (CISX’s)efforts to streamline listing

applications as well as achievingrecognition from various international

regulatory authorities. The UK’sFinancial Services Authority (FSA)awarded the status of Designated

Investment Exchange to the CISX inFebruary 2004.

The total number of funds in Guernsey now stands at 845, up by110 from June 2005 (15%). By the end of June 2006, 58Qualifying Investor Funds (QIFs) had been approved since thelaunch of the scheme in February last year. A root and branchreview of investment sector legislation has been conducted thisyear and a set of proposals for revising the system of regulationwill go before Guernsey's parliament early in 2007. Can theIsland’s efforts to dominate the offshore property fund marketcontinue unabated once UK REITS legislation comes in play?



regulated directly and thereforemaking it easier and quicker to listand administer funds in thejurisdiction. Harwood’s working paperalso recommended a number ofregulatory changes that would make iteasier for investment servicesproviders to administer non-Guernsey funds. If the island’sgovernment does pass supportinglegislation, it would broaden the scopeof Guernsey’s remit substantially.

Given the island’s favourableregulatory regime in which toestablish property funds, tax is only apart of the attraction for establishingfunds in Guernsey. In 2007, theUnited Kingdom government isslated to introduce enablinglegislation covering real estateinvestment trusts (REITs), in the hopeof encouraging funds into a newinvestment sector that will effectivelycompete with offshore jurisdictions,such as Guernsey.

That fact puts the island on noticethat it will have to pull theproverbial rabbit out of a magical hatto ensure that, at the very least, itwill be able to play on a level fieldwith the UK market. For the timebeing, Guernsey has time, albeit ashort time, on its side. Right now,even as 2007 draws closer, the UKgovernment still has not clarified thebeneficial tax regime that willsupport the establishment of asubstantive REITs market in the UK.The UK government will have tomove fast, otherwise it could beginto see a further erosion of its fundindustry, which has already newoptions in Dublin and Luxembourgto benefit from.

Equally, property specialists inGuernsey explains that the range ofstructures which are already readilyavailable to UK investors provide mostof the benefits of a REIT, and a numberof houses insist that the evolution of

the UK REITs market will not have adetrimental effect on the island’sspecialist property fund industry.

For the moment, fundadministration is higher on the

Guernsey agenda. Proposals are beingdiscussed that will recreate a regimesimilar to that in Jersey, whereprofessional investor funds can be self-certified by Guernsey administrators.



THE MELLON EVOLUTIONGlobal Alpha Fund, a sub-fundwithin the group's Dublin-

domiciled Mellon Global Funds range,claims to set a new standard for UCITSfunds, says Sasha Evers, director ofbusiness development at MellonGlobal Investments. Evers explainsthat the new absolute return fund willuse quantitative techniques to take longand short positions on “highly liquidsecurities, such as index futures”in a bidto capture alpha and manage risk. Headds that the fund will also use leveragewhen risk-adjusted returns are high.The fund is aiming to deliver an

annualised target return of 4% over athree to five-year rolling period aboveits one-month Euro Interbank OfferedRate (Euribor) benchmark.

The fund employs a systematicinvestment strategy, alternatelyknown as global tactical assetallocation (GTAA), which takesadvantage of relative valuationopportunities resulting from marketinefficiencies across equity, bonds andcurrency markets. An “optimiser”, runtwice daily, generates the portfolio’srisk allocation day to day. “Theuniqueness of the fund is that it uses aquantitative hedge fund strategy,

within a traditional UCITs structure,with daily liquidity,” says Evers, “asopposed to traditional hedge fundswhich have monthly liquidity.”

Launched at the end of September,the open ended fund is aimed atinstitutional investors and in the firsttwo weeks following launch hasraised ?50m, tapping into “a hugedemand across Europe for funds withabsolute return objectives,” explainsEvers. “Because the underlyinginstruments are so liquid, utilisingbond and equity index futures,” Eversdoes not envisage any problems withcapacity and expects assets undermanagement by the fund to growrapidly. He also says the fund will berolled out to the retail market by theend of this year, after its registration invarious European countries. The fundis denominated in Euros, but is also onoffer in dollars and carries a 20%performance fee, applied to anyperformance in excess of the one-month Euribor net of annualmanagement charges.

Mellon back-tested the fund'sinvestment strategy over the last fiveyears, using actual returns from arepresentative account managed byMellon Capital in the Global AlphaLow Restriction Strategy Composite-comprising multiple portfolios withinMellon Capital’s GTAA strategy andwhose mandates allow a portfolio tobe long and short in at least one assetclass in at least one country. Mellonclaims the fund outperformed itsbenchmark with a bond-like riskprofile. The test used several riskcontrols, including a 7% active risktarget and a value-at-risk limit of 5%.Evers explains that hedge funds tendto be run on a higher standarddeviation target (between 10% and11%). Evers also points out that “overthe long term” the fund exhibits “agenerally low correlation to traditionalsecurities markets”.

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Photograph supplied by istockphotos.com, September 2006.

Mellon breaks newground with UCITsabsolute return fund Mellon Global Investments, the international distributionsubsidiary of Mellon Financial Corporation, has launched what itclaims to be an innovative global absolute return fund. Run byMellon Capital Management Corporation, the group's quantitativeinvestment subsidiary, the fund will leverage the wider investmentpowers granted by the European UCITs III product directive.


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THERE ARE APPROXIMATELY70 hedge funds with a focusedGreater China mandate,

managing a total of $5bn in assets.The number of funds has almostdoubled since the beginning of lastyear, and in that time assets undermanagement have more thandoubled. While the space is still small,it is evolving rapidly. Its growth will bedriven by a combination of factors.First, the increasing depth andbreadth of the underlying markets iscreating a wider and deeper pool forinvestment. Second, the group ofsophisticated managers tackling thesemarkets is expanding. Third, assetallocators will dedicate more time andresource to this space as the relativelylow correlation exhibited betweenmainland Chinese markets and othermarkets make them valuable as asource of portfolio diversification, andhedge funds are recognised foroffering attractive exposure to thosemarkets. Although marketcorrelations tend to increasedrastically in times of crisis,diversification benefits of China

exposure could still be meaningful.China’s positive long-term growth

prospects are well-researched andreported, as are the risks to China’seconomic stability. We do not addressthese complex issues here but note thatmost economists forecast robust long-term economic growth. This shouldprovide a positive backdrop for themarkets in the Greater China region,although cyclicality may cause sizeableswings around this upward trend.

Greater China equity marketsdisplay relatively high levels ofvolatility, feeding the opportunity forhedge funds. Retail investors canexert considerable influence overasset prices. Walking into a retail bankbranch in China, with dozens ofcustomers transfixed by the equitytrading screens, one often detects asimilar atmosphere to that of a Macaucasino. Inefficient pricing can also beattributed to sell-side research, whichcan be patchy and poor quality. Ingeneral, accurate data is difficult toobtain, creating the possibility of asignificant information edge forsophisticated and experienced

investors with the cultural orlinguistic wherewithal.

The recent strength of China’s A andB share markets reflects a combinationof improving corporate fundamentals,capital market reform, improvingaccess to A shares for foreigners and anarrowing valuation discount of Bshares to A shares. Over the first eightmonths of 2006, the Shanghai A shareindex, Shanghai B share index, HongKong H share index and HIS, forexample, rose by 42.8%, 48.0%, 29.1%and 16.9%, respectively. Taiwan’sTWSE 225 index, by comparison,barely rose by 1.0%. This is against abackdrop of a 4.5% rise in the S&P500, a fall of -1% in the NASDAQ, andlacklustre performances from manyother emerging markets during thesame period. However, this must beput in perspective: at the end ofAugust 2006 the Shanghai A shareindex was still 9% lower than it was atthe end of August 2001.

Hedge funds are quite nimble intaking advantage of marketinefficiencies. They are also unfetteredby benchmarks, which is particularlyrelevant as we believe much of theopportunity lies outside the mostcommon Greater China benchmarks.Approximately 80% of the MSCIChina index, for example, iscomprised of state-owned companies,when much of the exciting activity istaking place in companies run byprivate entrepreneurs. Moreover,nearly 40% of MSCI China consists ofonly three stocks. Other availableindices tend to be skewed to a fewlarge oil and gas companies or banks.

While the Greater China hedgefund universe is long-biased inaggregate, there are funds with lownet market exposure, and the shortingenvironment is improving. Foreigninvestors commonly have theperception that shorting is virtuallynon-existent in the region. Although

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CHINA AND THEOPPORTUNITYFOR HEDGE FUNDS

The markets of the Greater China region (comprising mainlandChina, Hong Kong and Taiwan) by and large have lowrepresentation in global investment portfolios, particularly thoseoriginating in the United States. There are good reasons for this;particularly for mainland China markets with restricted access forforeign investors and historically unattractive valuations.However, much has changed over the last five years. As investorsdirect more resource to the region, hedge funds are providing aviable new investment route. Simon Coxeter, managing directorof AsiaSource Capital in Singapore, explains why.




there is a long way to go before thedepth and breadth of the shortingmarket in the US is reached, weshould not be completely dismissive.There are approximately 280shortable stocks on the Hong Kongexchange, another 200 on theTaiwanese exchange, and the stock-lending market is growing. The costof shorting is similar to mid/small capstocks in the US. In Hong Kong,borrowing costs for large and midcaps average between 0.5% and 1.0%and between 1.5% and 3.0%,respectively. The mechanics ofshorting in Hong Kong and Taiwanstill present barriers to someinvestors, although there areinteresting strategies involving ADRswhich help to circumvent technicaldifficulties. Until recently, there hasbeen no viable way to short mainlandmarkets, but earlier this year thegovernment announced the removalof restrictions on index and individualstock shorting, and on 5 September2006 the Singapore Exchange (SGX)began trading the world’s first indexfutures based on stocks listed inmainland China.

The China Financial FuturesExchange opened in Shanghai on 8September 2006, and it will alsolaunch index futures based ondomestic equity indices. On 27August 2006, the Chicago MercantileExchange (CME), the largest USfutures exchange, introduced futuresand options on the yuan. We expectindividual stock shorting to beintroduced soon.

Generating returns from the shortside is particularly valuable, and iscertainly not achieved consistently byall managers, but it is possible to findsophisticated practitionerssuccessfully utilising what the shortside has to offer. Experience anddiscipline is important, but so isfocus— one fund in the Greater China

hedge fund universe, for example,rewards analysts more for successfulshort ideas than for long ideas.

Liberalising capital marketsOne of the factors weighing ondomestic mainland marketshistorically was the substantial stateownership of many listed companies.With approximately 60% of marketcapitalisation non-tradable and state-owned, concern centered on themanagement and reduction of thisshare overhang. After a couple of falsestarts in 1999 and 2001, thegovernment initiated acomprehensive program which by theend of 2006 will probably havecovered most companies listed on theShenzhen and Shanghai exchanges.The program compensates publicshareholders for the release of non-tradable state shares into the tradablemarket. Each company makes aproposal to public shareholders as tothe terms of compensation, and theyin turn have the right to accept, reject,or negotiate these terms.

Compensation features have varied,including the gifting of state shares topublic shareholders, cash bonuses,warrants, guaranteed share buybacksat a predetermined price, or thesimple cancellation of a portion ofstate shares. In addition, the release ofstate shares into the market will bemanaged in stages – some companieshave, for example, limited the annualrelease of state shares into the marketto 10% of total shares. These types ofcompensation proposals havegenerally been well received byinvestors, with approximately 90% oflisted companies with stateshareholding having successfullycompleted reform.

While international investors havelong had access to China through theHong Kong market, access to themainland exchanges was first limited to

the small and illiquid B share market,and later complemented by restrictedaccess to the A share market through theQualified Foreign Institutional Investor(QFII) scheme. QFII access remainsmodest in size, with the current totalquota of around $10bn representing lessthan 3% of the total domestic marketcapitalisation of over $400bn.

However, the quota is likely to growrapidly over the next few years, andthe restrictive initial terms of thescheme are set to improve. On 26August 2006, QFII rules were relaxed,making it easier for institutionalinvestors to get QFII licenses,reducing custody risks, and betterrecognising the interests of underlyingshareholders in exercising influenceover corporate governance.

Manager selectionThe Greater China hedge fundenvironment will be very dynamicover the coming years given evolutionof the markets, offering the potentialfor attractive and potentiallyuncorrelated returns. Unfortunately,selecting the best managers can be adaunting task in this region, andconventional approaches employed inmature markets do not necessarilyyield intended results.

The first step in approaching thisspace is obviously to identify thefunds. Third party databases, such asthe one provided by EurekaHedge, area good place to start. Other funds canbe identified through conferences,prime broker capital introductionteams, and industry contacts. Someinvestors fail to identify funds with

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Simon Coxeter, managing director ofAsiaSource Capital in Singapore. Photograph

kindly supplied by AsiaSource Capital,September 2006.

Jeannie Lee

Barnard Adams,

Kip Allardt,

Scott Berman,

David Brown,

James P. (Bucky) Canales,

Harry Davis,

Maria DeFalco,

Dan Driscoll,

Basil Godellas,

Nathan Green,

Douglas Hirsch,

Leslie Lake,

Gary Lindford,

Simon Lorne,

George Mazin,

Yolanda McCoy,

Rajni Narasi,

Thao Ngo,

Mitchell Nichter,

Jim O’Hara,

Ananda Radhakrishnan,

Martin Schwartz,

Tim Selby,

James Shannon,

Christy Stagemeyer,

Bibb Strench,

Alan Swersky,

Paul Tiranno,

Regina Thoele,

Patricia Watters,

Christine Woodhouse,

Walter Zebrowski,

Jill Zelenko,

S P E A K E R S I N C L U D E

K E Y N O T E S P E A K E R S M E M B E R S P O N S O R

P L A T I N U M S P O N S O R

G O L D S P O N S O R S

S I L V E R S P O N S O R S

E X H I B I T O R S

Westley D. Chapman,

Bernard Bachmann,

Joel Press,


MARHedge CaymanHedge Fund Best Practices: Operations and Regulatory Compliance

What Every Hedge Fund Needs to Know

The Ritz-Carlton • The Cayman Islands • December 3–5, 2006

Please contact Jeannie Lee at +646.274.6213 or [email protected]

In association withREGULATORY COMPLIANCE ASSOCIATION

Barnard Adams, JD, General Counsel & CCO,

ARX Investment Management, LP

Kip Allardt, CCO, Discovery Capital Management

Scott Berman, Friedman Kaplan Seiler & Adelman LLP

David Brown, JD, Bureau Chief, Investment Protection,

Office of Attorney General, Eliot Spitzer

James P. (Bucky) Canales, COO & Head of Risk,

Octane Research, Inc

Harry Davis, JD, Partner, Schulte, Roth & Zabel

Maria DeFalco, JD, Partner, Lowenstein Sandler PC

Dan Driscoll, EVP and CCO,

National Futures Association (NFA)

Basil Godellas, Partner, Winston & Strawn

Nathan Green, JD, Shearman Sterling

Douglas Hirsch, JD, Partner, Sadis & Goldberg LLC

Leslie Lake, JD, Director, Durus Funds

Gary Lindford, Former Head Investment &

Securities Division, CIMA

Simon Lorne, JD, Vice Chairman & CLO, Millennium Partners

George Mazin, JD, Partner, Dechert

Yolanda McCoy, Acting Head Investment

& Securities Division, CIMA

Rajni Narasi, JD, VP & CCO, DKR Capital Partners

Thao Ngo, JD, ReedSmith LLP

Mitchell Nichter, JD, Partner, Paul, Hastings,

Janofsky & Walker LLP

Jim O’Hara, Director of Operational Due Diligence,

Lighthouse Investment Partners, LLC

Ananda Radhakrishnan, Director, Division of Clearing

and Intermediary Oversight (DCIO),

Commodity Futures Trading Commission (CFTC)

Martin Schwartz, JD, CCO, Millennium Partners

Tim Selby, JD, Partner, , Alston & Bird LLP

James Shannon, COO, Private Advisors

Christy Stagemeyer, Assistant General Counsel,

Alternative Investment Group, Bank of America

Bibb Strench, Partner, Sutherland Asbill & Brennan LLP

Alan Swersky, CPA, COO – North America,

Olympia Capital Management

Paul Tiranno, Head of Operational Due Diligence,

Pioneer Alternative Investments

Regina Thoele, VP of Compliance, NFA

Patricia Watters, COO, Pacific Alternative Asset

Management Company (PAAMCO), LLC

Christine Woodhouse, JD, Taylor Investment Advisors LP

Walter Zebrowski, JD, CPA, Chairman,

Regulatory Compliance Association

Jill Zelenko, CPA, CFO/CRO, EnTrust Capital Inc

S P E A K E R S I N C L U D E

K E Y N O T E S P E A K E R S M E M B E R S P O N S O R

P L A T I N U M S P O N S O R

G O L D S P O N S O R S

S I L V E R S P O N S O R S

E X H I B I T O R S

Westley D. Chapman, Vice President, Goldman, Sachs Hedge Fund Strategies LLC

Bernard Bachmann, Head of Risk Management - Operational Due Diligence, RMF Investment Management

Joel Press, Senior Partner and Founder of the Ernst & Young Hedge Fund Practice



weaker marketing efforts, which isunfortunate as these can be hiddengems. Keeping apace of the funduniverse requires active scouting.

When performing due diligence onfunds, we are mindful of the question:“Does this manager have an edge ingenerating returns, and is this edge likelyto last?”Certainly, an edge is possible inwhat remains an inefficient asset pricingenvironment. Edge can emanate from anumber of sources, whether it is asignificant information edge orexperience and skills in a strategy fewothers have. There are managers in thisuniverse with impressive contactnetworks (government, companymanagement, private equity, sell-sideand buy-side) and superior access toquality information; there are alsomanagers who claim an informationadvantage when no such advantageactually exists. Within the universe,there are managers with skills andexperience in strategies others may takeseveral years to replicate, creating a realwindow of opportunity for superiorreturns. This is likely to remain true forsome time to come, as strategies

proliferate and managers from differentbackgrounds enter the fray.

After meeting with both underlyingmanagers and asset allocators, wesuspect that one useful area of duediligence is neglected, one that ishelpful in verifying the existence of anedge. Discussing investment processwith a manager is far more illuminativeif you have some experience in themarkets. Even a basic understandingof the Greater China markets canreveal weaknesses in a manager’sstrategy. We are not suggesting marketpractitioners have a monopoly onselecting good funds, but we do believecapital is allocated to some funds withan inadequate grasp of strategy andedge. For example, a manager claimsto have an activist approach, thepurported edge in generating returns.It is easy to make this claim, but moredifficult to corroborate. Knowing thestocks involved, perhaps even knowingcompany management or otherindustry contacts familiar with thatcompany, can go a long way insubstantiating that manager’sinvestment strategy.

Operational due diligence on funds inthis space warrants a separate article,but it goes without saying there aregreater challenges than in developedmarkets. The relatively simple processof doing background checks on USmanagers cannot be replicated for amainland Chinese manager who hasnever worked overseas or for aninternational firm. Performing adequatedue diligence is time consuming, andrelies more on information garneredthrough guanxi (relationships) than indeveloped markets, making it hard forinvestors to reach a level of comfort onsome managers. How, for example, doyou efficiently check for criminal recordsin China? Fortunately, many of thefunds in our universe use reputableinternational law firms, accountants,administrators and prime brokers – buteven for a westerner like me whospeaks Chinese, there are areas of duediligence beyond my reach. It is noaccident that one of the partners in ourfirm was a government official in China.

As one would expect with anemergent investment class, trackrecords are short. Of the funds in theGreater China universe, over halfhave a track record of less than twoyears. Obviously, many investorsfocus on track record in evaluating afund. Although research suggestsyounger funds outperform olderfunds (perhaps partly becauseyounger funds assume higher levelsof risk), younger funds also exhibit ahigher failure rate. Some managershave previous track records at long-only funds; others have never runmoney before. There are examples ofgreat sell-side analysts or long-onlymanagers who fail to excel as hedgefund managers. Performingthorough due diligence on managersis essential then, and can bechallenging without the requisiteblend of skills, experience, resourceand focus.

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One of the factors weighing on domestic mainland markets historically was the substantial stateownership of many listed companies. With approximately 60% of market capitalisation non-tradableand state-owned, concern centered on the management and reduction of this share overhang. After acouple of false starts in 1999 and 2001, the government initiated a comprehensive program which by

the end of 2006 will probably have covered most companies listed on the Shenzhen and Shanghaiexchanges. Photograph kindly supplied by istockphotos.com, September 2006.


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WASHINGTON MUTUALINC. (WaMu) is the first US-based bank to complete a

deal in the European covered bondmarket with its sale of $5.1bn of euro-denominated covered bonds; the firstelement in a €30bn covered bondprogram. The issue was arranged byBarclays Capital, with ABN Amro andDeutsche Bank joining Barclays as jointleads and attracted a AAA rating fromStandard & Poor’s.The bank reportedlyintends to follow up the issue with afurther $25bn deal in October.

Covered bonds are securitiesbacked by mortgages or public sectorloans. In this instance, the transactionis collateralised by a pool of mortgageloans secured by first-lien residentialproperties located in the US. The firsttransaction is intended to containfirst-lien mortgages to prime qualityborrowers with a fixed period of fiveyears and an adjustable periodthereafter. At the time of initialissuances, the loans will have aweighted average seasoning ofapproximately 20 months.

The deal could mark a watershed inthe way that US mortgage banks raisecapital. US home lenders are nowlooking to Europe for funding optionsoutside the Federal Home LoanBanking (FHLB) system, as aresponse to proposed changes to howthe system is regulated.

The FHLB, which regulates the 12home loan banks, issued a proposal inMarch, that will cut dividend payouts

until the home loan banks increasedtheir retained earnings. Facing lowerdividend payments, customer banksare expected to sell their stock in thehome loan banks, in turn reducingtheir capital. All 12 banks and theircustomer banks reportedly opposethe scheme, but in the interim WaMuhas led an alternative charge toforeign shores for cheaper funding,that might just attract more followersthat the FHLB might like. WaMu alsocarries some clout as the system’sbiggest single customer. Between2001 and 2004, WAMU grew itsresidential loan-servicing portfoliothrough a series of large-scaleacquisitions and mergers, whichhelped the bank become one of the

three largest mortgage lenders in theUS (please see FTSE Global Markets,Issue 9, page 66). However, the jury isstill out on whether this particulartransaction will open the floodgatesof US home lenders raising funding ineuros. The dollar is still losing valueagainst the European currency and itmay be, that over the medium term,whatever short term problems thebanks face, it may still be cheaper toraise funds in US dollars.

Nonetheless, the deal is interestingon other counts also. The US, like theUnited Kingdom and the Netherlands,has no explicit legal framework forcovered bonds. In some jurisdictions,including Germany, Spain, Ireland,Sweden, Denmark, Norway, Finland,France, Portugal, and Italy, there isdedicated legislation that provides forasset segregation upon issuerinsolvency without having to transferassets off-balance-sheet. In thistransaction a mortgage bond is createdto serve as collateral for the coveredbond.The residential mortgages are notthe direct collateral of the coveredbond, but flow through the mortgagebonds along with an associated swap,

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WaMu leads US issuersin European covered bondWashington Mutual, the federally chartered savings institution,has launched a covered mortgage-backed bond in Europe, makingthe company the first US-based bank to complete a transaction ofthis kind in the $1.7trn European covered bond market.

Washington Mutual BankMortgage Bond Issuer

Covered BondSwap Provider

Covered Bond Investors

Floating-ratemortgage bondproceeds

Floating-ratemortgage bonds

Pledge of floating-rate

mortgage bonds

Covered bond proceeds€ covered bonds

Specified currency covered

bond rate

Deutsche BankTrust Co. Americas

(Mortgage BondIndenture Trustee)

WM Covered Bond Funding

Deutsche BankTrust Co. Americas

(Covered BondIndenture Trustee)

Cover pool

WaMu’s covered bond transaction structure

© Standard & Poor’s 2006.

Reproduced with the kind permission of

Standard & Poor’s, October 2006.



assuring timely interest and ultimateprincipal on the covered bonds. Thismeans that the transaction complieswith existing techniques commonlyused for a Federal Deposit InsuranceCorporation (FDIC) regulatedinstitution, including the pledge ofassets. In US structured financetransactions, an FDIC insured bankmay grant a perfected securityinterest in collateral, and the securityinterest, subject to certain conditions,will be enforceable against the bankand its receiver or conservatornotwithstanding the insolvency ofthe bank.

The deal also carries substantialover-collaterisation. The structureprovides for both a general recourse toWaMu assets and recourse to the

cover pool in an amount greater thanthe outstanding principal amount ofthe mortgage bonds (overcollateralisation). “The structureprovides for the cover pool to bereassessed by Standard & Poor’squarterly, and the overcollateralisation to be reset toStandard & Poor’s levels,”according tothe pre-transaction rating issued bythe ratings agency.

Covered bonds are different fromtraditional mortgage-backedsecurities because the loans used tosecure the obligations remain onWaMu’s balance sheet, which allowsthe bank to maintain control over theassets.The program “should make ourdebt more sought after on a globalbasis, ultimately reducing our

company’s cost of funds, as well asincreasing our investor base beyondthe US,”said Kerry Killinger, chairmanand chief executive officer, in anofficial statement following the issue.

Killinger noted that the depth andliquidity offered by the Europeancovered bond market were compellingas the company considered alternativefunding sources, adding that WaMuplans to be a regular issuer in thismarket to complement its otherborrowings in the US.

The bonds are issued by WMCovered Bond Program, a special-purpose entity which, in turn,purchases floating rate US dollardenominated mortgage bonds issueddirectly by WaMu (please refer to thetransaction chart on the previous page).

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IT’S A GOOD time for exotics.Emerging market borrowers havenever had it quite so good, with

financing cheaper than ever before andissuers showing renewed confidence innegotiating better terms. A readyexample is the $1.2bn financing forMethanol Holdings Trinidad Limited(MHTL), the world’s second largestproducer of methanol secured Trinidad’slargest transaction to date for a newpetrochemical complex in Trinidad andTobago. The entire facility was arrangedand underwritten by KfW IPEX-Bank(IPEX). “While the transaction clearlystands out in comparison to other dealsin Trinidad, it is also an important stepfor the bank, being by far our biggestunderwriting commitment in thepetrochemical sector,”explains MatthiasWietbrock, first vice president, basicindustries at IPEX. Some 75% of the loanis covered by guarantees from EulerHermes, the German export creditagency (ECA) which providedmanufacturing risk mitigation and anexport credit guarantee. The balance offinancing was arranged on commercialterms.“The margins are very competitivefor the Trinidad market. At the sametime, both the margins and the collateralwere attractive enough to ensure strongdemand from lenders,”says Wietbrock.

The deal is the seventh large-scaletransaction arranged by IPEX forTrinidad’s energy sector. According toWietbrock, the deals demonstrate thegrowing sophistication in thestructure of project financingpackages supporting Trinidadian

companies. While a facility in the mid-1990s would have comprised a plainvanilla non-recourse structure, thesedays loans are “much more complexand involve commercial tranches,”

Elsewhere in the region, tapping themarket for the first time as aninvestment grade company, Brazil’sEmbraer secured a $500m stand-byfacility in a deal that is the aircraftmanufacturer’s largest fundraising andintroduces new hedging protectionahead of scheduled debt repayments. Itwas overwritten in syndication,allowing the arranging banks toincrease the size of the loan by $100m.“We initially approached the marketwith $400m. Even with the increase, wewere still oversubscribed,”says CynthiaBenedetto, finance director at Embraer.The stand-by loan comprises two equaltranches. The first is a trade financefacility that can be disbursed within thenext three years. It will have assigned atwo year term from drawdown date andis to be used in either pre-export orimport financing. The margin for pre-export purposes is 40 basis points (bps),while import-related loans pay 45bps.

The other $250m is structured as arevolving credit facility.The term is to bedetermined individually for eachdrawdown, but will not exceed fiveyears. The revolver pays a margin of60bps.“This facility should become a toolin changing the profile of company’sshort and long term debt,” saysBenedetto. “It provides a hedgingprotection for the parts of debt which aresoon due and will not be refinanced.”

BNP Paribas was sole book runner, andthe syndicate featured mandated leadarrangers Banco do Brasil, Banco Bladexplus Sumitomo Mitsui Banking Corp.According to Benedetto, Embraer waseager to get the deal done, as it cashposition (over $500m net cash after firsthalf of the year) is good, says Benedetto.Cheaper financing and more bankswilling to take on emerging market riskwere important factors in the deal’stiming, she adds. The company alsocapitalised on its relatively high creditratings. Embraer, whose production ismainly for export, received BBB- fromStandard and Poor’s and Baa3 fromMoody’s almost a year ago. Brazil israted two notches below investmentgrade by all major rating agencies, butabout a dozen of its largest export-oriented companies are not constrainedby the country ceiling due to their strongcash positions in foreign currency.Embraer receives the bulk of paymentsin foreign exchange, therefore its transferand convertibility risk is perceived to belower than that of Brazil.

Iron producer Samarco Mineração, isanother above-sovereign ratedcorporate issuer and is one of Brazil’stop three mining companies. In August,it closed its largest financing to date, an$800m syndicated loan, which will beused to part-finance a new $1.2bn plantin Ponta Ubu in Espírito Santo state,near to the company’s two existing ironore processing facilities. The plant willincrease company output by 54% andincrease Sanmarco’s share of the globalseaborne pellets trade. It already rankssecond in the world, behind itsstakeholder CVRD. After the upgrade,its annual sales are expected to exceed$1.5bn versus $1bn now. Samarco isowned 50/50 s by CVRD and BHPBilliton and has benefited from arecently revised rating. Following a

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The rolling bandwagon of EM debt issuesA landmark $1.2bn financing for a Trinidad petrochemical projectat the beginning of September; plus a benchmark debut forMongolia culminated in a chain of explosive financings for moreexotic emerging market issuers in the third quarter of this year,with more to come. Blazej Karwowski reports on some of themore rarefied deals of the last eight weeks.



review of some country ceilings, FitchRatings upgraded the company’sforeign currency Issuer Default Ratingto BBB- in June. Two months later theagency raised its rating again, to BBB,placing the company firmly in theinvestment-grade basket. The loan hasan average margin of 60bps overLondon Inter-bank Offered Rate(Libor). “It would have beenimprovident not to take advantage ofthis situation. Despite the fact that itoperates in Brazil, Samarco has a triple Brating,”says Clemente Rocha, Samarco’sfinancial manager for new projects.

Elsewhere, profiting from favourableconditions for many Middle Easternborrowers, Energy Spring LNG CarrierSA, an Omani shipping company,refinanced its debts via a $136m projectfinance facility. The proceeds will beused to repay an outstanding 2004company loan, to buy the liquefiednatural gas (LNG) vessel Sohar. Theoriginal $116m loan still has 10 yearsuntil maturity, but Energy Springdecided to refinance it ahead ofschedule in order to achieve betterterms.The new loan has a 16-year tenorand, although it includes the vessel anda pledge of shares as collateral security,it is non-recourse to Energy Spring’sshareholders. Gulf International Bank(GIB), the merchant bank jointly ownedby the six Gulf Cooperation Councilstates, provided both facilities.“Since thefirst financing, the market has obviouslychanged and there has been animprovement in pricings available toborrowers.The new loan was structuredon an annuity repayment profile basiswith a tenor of 16 years,”says Tarun Puri,vice president for project finance at GIBin Bahrain. Puri says that the 12-yearloan was a standard in Middle Easternshipping finance when it was arrangedin 2004, but it now increasingly gaveway to 18-year or 16-year deals, and theborrower aimed to restructure its debtaccordingly. Puri adds that his team has

just completed another deal in theshipping sector, this time for $350m.

Vessel owners such as Oman ShippingCompany and Mitsui have beenincreasingly active in servicing the needsof the fast-expanding LNG industry inthe Gulf. Operating over 500 vessels,Mitsui is one of the world’s largestshipping organisations and it also acts asa technical adviser to many Omanishipping firms. “Things obviously lookquite bullish as we see a huge demandnot only in shipping, but in othersectors,” Puri says. However as thevolume of new issuance grows, growingcompetition from international shippingfinance specialists is putting a significantdownward pressure on margins.

With costs of fundraising hitting newlows Oman Gas Company is anotherborrower to refinance outstandingdebts. Owned by ministry of Oil andGas (80%) and Oman Oil Company(20%), the firm signed a $234.5m facilitythis September. The loan has a marginof 0.5% over London Inter-bankOffered Rate (Libor) with a six and ahalf year maturity. It was arranged byGulf International Bank (GIB) andsyndicated to eight additional banks:internationals Mizuho Corporate Bankand Calyon participated together withsix local houses, such as OmanInternational Bank or bank Muscat.Oman Gas will use the proceeds torefinance the outstanding balance on its$410m credit facility which it raised in2000.Among other collateral, the loan issecured against commercial mortgageas well as commitments of theshareholders of the company.

Cheap money also tempted Ukraine’sIndustrial Union of Donbass (ISD) tosecure a $350m financing facility that isthe first part of a $2bn plus expenditureprogramme aimed at modernising itssteel production. The move comes assyndicated borrowing is expected toincrease significantly among Ukrainiancorporates, due to the stabilising political

situation and capital needs that areparticularly pressing in heavy industries.

The loan divides into a $250mcommercial tranche and $100m in a longterm investment loan from theInternational Finance Corporation (IFC),the World Bank’s private investmentarm. The commercial tranche has a fiveyear tenor and pays a margin of 2.7%over London Inter-bank Offered Rate(Libor). Meanwhile, the IFC tranche hasa tenor of seven years and is said to paya slightly higher margin. Both tranchesare collateralised with a pledge of fixedassets, namely ISD’s industrial complexAlchevsk Coke. Apart from the threecoordinating mandated lead arrangers,Citigroup, Société Générale and IFC, thesyndication involved 15 banks. Firstdrawdown under the facility took placein late September.

Syndicated loans are a primary sourceof funding for Ukrainian metal andmining industries, says Ilia Poliakov,director, structured commodity finance -metals and minerals, CIS and EasternEurope at Société Générale Corporateand Investment Banking (SGCIB). Thesector has produced just one Eurobondissue to date, leaving syndications todominate corporate financing needs —mostly because they can be securedagainst export-related receivables. Up to80% of Ukrainian steel production issold on the international markets.“Thereason why this latest loan isuncharacteristically secured againstfixed assets is that ISD [has] already[been involved in two] largesyndications in 2004 and 2005 both ledby SGCIB, which were collateralisedwith receivables,” says Poliakov. Thislatest transaction is ISD’s longest-maturity loan to date; although in size itmatches last year’s benchmark pre-export finance facility, which was worth$350m. Analysts, however, indicate themarket is far from saturated, noting abroad need for capital in the steel andmining industries.



BAHRAIN’S NEW TRUST lawopens the doors for financialinstitutions to offer a broad range

of services using the trust mechanism,such as real estate investment trustsand private pension schemes.“The lawis aimed at providing a clear and soundlegal foundation for trust business,which is showing potential for growthin the Middle East region,” says Mr.Abdul Rahman Al Baker, executivedirector, financial institutionssupervision, at the CBB.

While trusts are a widely used formof wealth preservation in developedcountries, it is a fairly newphenomenon in the Middle East.. Thepotential for growth, however, istremendous as the region boasts theworld’s highest concentration of highnet worth individuals, whosecollective wealth is estimated at over$1.3trn.“The establishment of a trust,in a well-regulated environment, willbroaden the available options for the

transfer of business, property or otherassets from one generation to another.It will also enable the Bahrain-basedwealth management industry todevelop and extend more innovativeproducts and solutions,”he adds.

In Bahrain, nearly 20 bankscurrently offer wealth managementservices. “We hope the enactment ofthe trust law in Bahrain will encouragesome of these institutions to offersuch a service to their clients in theMiddle East region,”says Al Baker.

The new legislation provides for atrust to be established for a duration ofa maximum of 100 years. It requires atrust, to be registered with the CBB.The trust property may comprise anyform of property, moveable orimmoveable, tangible or intangible.Additionally, a trust may have one ormore trustees, and the law details atrustees obligations quite thoroughlyand requires a licence from the CBB forexercising the functions of a trustee. It

also expressly provides for high levelsof confidentiality in the execution andadministration of the trust.

The law is part of a raft of regulatoryand supervisory rules coveringinvestment business licensees that willlay out specific rules to be followed byinvestment firms in managing high-level controls, risk identification andrisk controls as well as regular and ad-hoc notifications to the CBB.The moveis part of a comprehensive overhaul ofBahraini investment, insurance andbanking regulation. “The newrulebook, in particular that elementservicing asset management, fundadministration and custody will createan environment of flexibility andencourage international best practice,”says Al Baker.

The CBB has just completed aconsultation period, which ended at theend of September, prior to finalising therules in their final form; the moduleswill ultimately be included in the CBBRulebook, probably at the end of thisyear. “The current consultationadvances CBB’s work on the

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Armed with growing confidence and a new moniker,the Central Bank of Bahrain (CBB), formerly theBahrain Monetary Agency (BMA) has introduced araft of legislation addressing financial services, Islamicfinancing, insurance and asset management thatbrings Bahrain in line with global standards andencourages a new breed of asset managers as thecountry’s investment business grows. The latestinitiative is a new trust law, governing trustees andtrust administration, that the CBB hopes willencourage an industry around the establishment,management and administration of private businessinterests and wealth in estates and trusts as well asreinforcing the Kingdom’s efforts to establishManama as an international financial centre.

AbdulRahman Al Baker, executive director, financial institutionssupervision, at the CBB. Photograph kindly supplied by the CBB,

October 2006.

CBB deepens investmentservices regulation



Investment Business Rulebook, whichconstitutes Volume 4 of the CBBRulebook,” explains Al Baker. “Whilemost of the key regulatoryrequirements were issued in April 2006,this second phase will complete the fullscope of rules applicable to investmentbusiness activities.” The CBB is seeingstrong demand for its investmentbusiness licenses, says Al Baker, andonce finalised, it will be the strongestand most comprehensive framework inthe region,”he adds.

“If you want to be a financial centre,you must create investor confidence.We have worked hard over the last 35years to do just that and this latestround of regulation will encourage

that,”explains Al Baker. The trust law isanother foundation stone to helpdeepen the Bahraini investment markethe says, and in particular encouragingthe development of alternativeinvestment vehicles. For one, he says,“We understand private equity and wethink there is a good appetite for it aswell as private placements supportingprivate equity funds. We are also in theprocess of introducing professionalinvestor schemes, catering for theestablishment of alternative investmentvehicles, such as private equity fundsand REITs.” However, he notes thatREITs will be “listed and will notoperate as Islamic style trusts. Islamictrusts are aimed more at the family trust

market; and in some instances will bemarketed to the retail sector”. It is atheme close to Al Baker’s heart. “Thereis a growing army of interested,educated, professionals in the GulfRegion and in Bahrain in particularwho are looking for new investmentopportunities, he maintains and hebelieves that the BMA has an importantrole in providing the right kind ofenvironment to encourage the growthof a local retail investment market. “Itcould involve as much as 50% of thewhole asset base of the region and it isof a size that we simply cannot ignore.Therefore it is incumbent upon us toprovide those professionals with asecure and long term investment

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environment. Proper regulation is acrucial element in that effort,” stressesAl Baker.

Al Baker believes that theapplications of the trust law are wide-ranging. For one it “will help makeBahrain the place for establishingIslamic trusts in the Middle East,”thinks Al Baker. In the past, “it hasbeen difficult to establish trusts thatcan operate in line with Shariaprinciples, we think this latest elementin our strategy to make Bahrain thecentre of innovation in the region notjust for Islamic investment products,but also conventional and alternativeinvestment products supported viathe establishment of a trust.”

Bahrain has emerged as anincreasingly popular centre for thelisting of Islamic funds. In August, theBMA authorised the Islamic equityfund, sponsored by Global InvestmentHouse, the Kuwait-based assetmanagement firm. The Global GCCIslamic Fund has raised $300m forinvestment in a portfolio of Shari’a-compliant companies in the GCCregion. The Bahrain-domiciled, USdollar-denominated open-ended fund,is the 23rd fund to be incorporated inBahrain by Global Investment House, aleading asset management firm in theMiddle East region. Global InvestmentHouse currently manages assets inexcess of $6.3bn, and is listed on threebourses in the GCC region, includingthe Bahrain Stock Exchange.

There are around 100 Islamic equityinvestment funds, with combinedassets of just under $6bn says ArabBanking Corporation (ABC). Growingat between 12% and 15% a year, theyprovide one of the fastest growingsectors within the Islamic financialsystem. Equally, the Islamic fundindustry is a fast growing segment ofBahrain’s overall mutual fundsindustry, which has been postingphenomenal growth in recent years.

The total assets under managementby BMA-authorised mutual fundshave grown 55% to $8.3bn in the pastone year alone, while growth in thelast four years has exceeded 180%.

Typically, Islamic equity funds tendto target high net worth individualswith investments in the funds rangingbetween $50,000 and $1m. Targetmarkets for Islamic funds vary; somecater for their local markets, such asMalaysia and GCC-based investmentfunds, while others range morewidely. The launch of Islamic equityfunds in the early 1990s, has alsospurred global index providers to setequity benchmarks, such as the FTSEGlobal Islamic Index Series and theDown Jones Islamic market index.

Regulations governing CollectiveInvestment Schemes (CIS), issued bythe BMA in 1992, are the cornerstone ofmutual fund regulation in Bahrain, saysAl-Baker. CIS rules regulate thestructure and operation of mutualfunds and provide a modern, forward-looking platform for registering andmanaging mutual funds in and fromBahrain. The number of collectiveinvestment schemes (CIS) authorisedby the BMA totaled 2,094 at March-end2006, compared with 1,657 in 2005 and1,256 funds in 2002.

Locally domiciled funds, particularlyIslamic funds, have driven some of thegrowth in fund registrations in Bahrain,

says Mohammed Ayman Al Tajer,director, financial institutionssupervision, at the CBB. Moreover, saysAl Tajer, “Bahrain is fast becoming aprominent destination in the region forcollective investment schemesparticularly locally-incorporatedinvestment funds.” There were 92locally incorporated mutual fundsauthorised in Bahrain by the end ofMarch this year, compared with 63 lastyear and 28 back in 2002. The assetsunder management of these locallyincorporated funds were $2.8bn atMarch-end 2006.

Of this locally incorporated CIS 36were Islamic funds, with a value of over$915m. “The average size of Bahrain-domiciled funds, authorised during 2006,was $60m and the sponsors/managers ofthese funds are prominent institutionsfrom outside Bahrain, including UK andother GCC states,”says Al- Tajer. Amongthe funds authorised by the BMA so farthis year include those sponsored byKuwait-based Gulf InvestmentCorporation, Mashreqbank (UAE), DTZFinance (UK), Unicorn Investment Bank(Bahrain), Global Investment House(Kuwait) and Al Tawfeek Company forInvestment Funds (Cayman Islands),among others. “Strong investmentopportunities in the GCC and MENAregion are increasingly attractinginvestors looking for portfoliodiversification,”says Al Tajer. As a result,mutual funds with a regional investmentfocus have increased dramatically inrecent years, with Bahrain proving amajor destination for registration of suchfunds. The CBB is also implementingthe Securities Settlement System (SSS),which will facilitate real-time, onlinesettlement of all Government securitiestransactions, including sale/purchase,auction (issue/settlement) and Repo(repurchase) transactions. Both systemswill be seamlessly integrated and areexpected to go live during the first halfof 2007.

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EACH COUNTRY POSES it ownchallenges but there is no doubtthat the prospect of European

Union membership is giving South-eastern Europe its new found lustre.Romania and Bulgaria are slated tojoin the club in 2007. Croatia is next inline, set for a 2009 entry althoughmost analysts believe 2010 is morelikely. Serbia and Bosnia meanwhilewill probably not be members foranother five to six years. Albania,

Macedonia and Montenegro are evenfurther down the EU curve but arecurrently laying the groundwork. Thelatest potential roadblock for fullfledged membership for Romania andBulgaria is the respective four and sixconditions set out by the EuropeanCommission this past May.

As Sandor Gardo, an economistwith Bank Austria Creditanstalt,which is a member of UniCreditGroup, notes, “I think both countries

will be ready by 2007. Ed Parker,sovereign credit analysts of FitchRatings adds, “EU membership is astrong underpinning for the currentinvestment climate. It offers investorsthe protection of stability,transparency and a legal andregulatory framework. The corruptionthat has dogged many of thesecountries will not disappear overnightbut there will be laws to deal with it.”However, Parker notes that, “Given

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Ed Parker, sovereign credit analysts of Fitch Ratingsadds,“EU membership is a strong underpinning forthe current investment climate. It offers investorsthe protection of stability, transparency and a legaland regulatory framework.The corruption that hasdogged many of these countries will not disappearovernight but there will be laws to deal with it.”

Playing hardball getsresultsNow that Central and Eastern European markets are looking more

mainstream, investors are scouting around for alpha generatingopportunities in the less developed South-eastern European region.Bulgaria and Romania are the jewels in the crown, but hidden gemsmay be found in Croatia, Serbia and Bosnia and Herzegovina. Aswith any emerging market country, though, fund managers areadvised to tread carefully. Lynn Strongin Dodds reports.



the timescale, it is unlikely thatBulgaria will solve all its corruptionproblems at home but not every EUcountry is corruption free. I think themost important thing is that theBulgarian government shows it ismaking progress.”

Bulgaria’s particular check list islonger and more sensitive than itsSouth Eastern neighbour whoseissues are mainly technical andfocused on agricultural criteria.Romania needs to finish setting upfully operational agencies for EUfarm aid and to maintain properveterinary standards and properfacilities to collect and treat animalby-products. Last but not least, thecountry must ensure its electronic taxsystem is compatible with the EU toallow proper collection of valueadded tax.

Several of Bulgaria’s so-called redflags also involve agricultural issuessuch as the animal registration

mechanism and the lack of facilitiesfor collection and treatment ofanimal by products. However,tackling corruption is top of itspriority list if it wants to join theexclusive EU fold. The country hasmade significant progress and wonplaudits for its recent constitutionalamendments reducing the scope ofimmunity of members of parliamentand moves to launch high level anticorruption investigations. There isalso a new legal framework to dealwith high-level corruption andorganised crime, including a new unitin the prosecutor’s office, a newgeneral director of police andundercover agents.

There is still a lot of work thatneeds to be done. Europe’sCommission wants to see clearactions and not just words in battlingorganised crime networks. It is alsopushing for more effective andefficient laws to be implemented that

fight against both fraud and moneylaundering. Over 100 mafia stylecontract killings were recorded since2001 and they have all remainedunpunished. The Commission notedin its latest report card that“indictments, prosecutions, trials,convictions and dissuasive sentencesremain rare in the fight against highlevel corruption.”

In response, the BulgarianParliament this past June put anotherscrew in its anti-money-launderinglaw. Amendments to the Measuresagainst Money Laundering Act obligebanks to ask for informationconcerning the individuals behindcompany accounts, the origin offunds, and the reason for spending.Financial institutions must also informauthorities of suspicious activity bytheir clients while offshore transferswill be closely monitored. Despite thechallenges that lie ahead, the financialcommunity are bullish on the

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European Commission’s President Jose Manuel Barroso, left, listens to Romanian president Traian Basescu, right, at the Cotroceni presidential palace inBucharest Romania on September 27th, 2006. Barroso visited Romania a day after Romania and Bulgaria were cleared to join the European Union on

January 1st, 2007. Photograph by Vadim Ghirda, supplied by EMPICs/Associated Press, October 2006.


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prospects for both countries and theregion in general. Romania andBulgaria followed by Croatia andSerbia have made great strides on theeconomic reform front. Impendingmembership of the EU club hasalready paid dividends in terms offoreign direct investments as well asinvestor confidence.

Romania was the main destinationin the region for overseas investmentsattracting over 50% of foreign directinvestment (FDI) flow of SouthEastern Europe in 2005. This yearanalysts expect the country to doublelast year’s FDI figure to about€10bn on the back of its flat16% income tax and pendingaccession to the EU. Bulgariawas the second favourite spotwith €1.8bn last year and thisis predicted to rise to €2.4 bnthis year.

Michael Massourakis,senior manager of AlphaBank in Greece says, “Weare talking about a regionthat has over 60m people, with athird of the population in Romania.They are also quite different fromthe underdeveloped countries suchas Greece was 20 to 30 years ago.The countries have been quicker toadapt Western market practices,state of the art technology, economicand legal structures plus they havethe benefit of advice frominternational organisations. EUmembership will also mean morestable economic growth which setsthese countries apart from otheremerging market countries.”

For now and most likely in thefuture Romania will remain the mostpopular hunting ground forinstitutional investors. The country’spolitical stability combined with aneconomic growth rate of about 5%and a domestic consumer base ofmore than 20m people are some of its

main attractions. The Bucharest StockExchange also turned in the mostimpressive performance in the region,boasting a 60% gain last year.Investors can invest directly inRomania as well as Bulgaria, Croatia,Serbia and Bosnia if they have asecurity account at the RaiffeisenZentralbank in Austria or via globaldepositary receipts (GDRs).

Investors, though, are advised toexert more caution than usualnavigating their way around theseemerging market bourses. In the pastcouple of months, the BSE as well as

the rest of the region’s exchanges haveall been hit by the same volatility thathas impacting on their moredeveloped counterparts. JacobGrapengiesser, fund manager of EastCapital Asset Management based inSweden, says “I think one of theproblems for these markets in generalis that they are small. They need to listone to two more telecommunicationcompanies and large banks to be moredeveloped. Romania will continue tobe the favourite because it has thelargest companies and an activeprivatisation programme that hasseen companies listed from a widerange of sectors including utilities,telecoms and banks.”

This perhaps explains why the$245m initial public offering of powergrid company Transelectrica in Julywas almost six times oversubscribed,with both local and foreign investors

snapping up shares in the Black Seastate’s electricity monopoly. Morepower firms are in the pipeline for thisyear as well as the eagerly anticipated$920m IPO of state telecom companyRomtelecom, slated for a dual listing -the other market probably being thehe London Stock Exchange - later inthe year.

The Romanian government is set tosell its entire 46% stake in thetelecommunication firm within thenext six months. Greece’s largestphone company, the Hellenictelecommunications Organisation,

owns the remaining 54%.Although not as popular asRomania, the BulgarianStock Exchange (BSE) hasalso captured investors’imagination, according toWolfgang Steger, an analystwith Austria basedRaiffeisen InternationalBank-Holding. He points tothe success of the recent IPOof Bulgarian-American

Credit Bank (BACB), whereby 30% ofits shares were sold for $67.5m.International institutional investorsbought 85% of the shares on offerwhile the remainder went toBulgarian institutional and retailinvestors. Fund managers initiallyfocused their attention on Bulgariancompanies included in the blue-chipSofix index, which has risen morethan ten-fold since 2000 and in 2004took the first place in growth on aglobal scale.

However, they have also been luredby the potential of the broader BG40index of the most traded stocks whichwas launched in early 2005. The 40most liquid stocks represent a diversegroup ranging from BulgarianTelecommunications Company (BTC)to Sopharma, DZI Bank, Sofia BT,Zlatni Pyassatsi, a tourism companyand Biovet, a veterinarian

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Michael Massourakis, seniormanager of Alpha Bank in Greece

says, “We are talking about a regionthat has over 60m people, with a

third of the population in Romania.



pharmaceuticals firm. For the moreadventurous investors, there is Croatia,Bosnia and Herzegovina and to a lesserextent Serbia due to political tensions.Albania, Macedonia and Montenegro,which recently won its independencefrom Serbia are still too small andunderdeveloped to be on investors’radar screens. The next crop of EUhopefuls, however, also have economicand social hurdles to overcome.

Croatia is in the best shape but thegovernment still needs to pushthrough painful reforms in healthcareand reducing state subsidies to publiccompanies, according toMartin Stelzeneder, ananalyst with RaiffeisenInternational. More workalso needs to be done inthe privatisation arenawhere activity has beenmore or less dormant forthe past two years. All thebig deals were delayedalthough there has beensome movement in theinsurance, bank, steel andshipyard sectors to sell offremaining governmentstakes. The second IPOphase of INA, a domesticoil company, is alsoscheduled for some time this year.The lack of large, headline grabbingIPOs has not hurt the Zagreb StockExchange. The market has beenbooming thanks to the takeover fevercircling around domestic drugproducer Pliva. The company isbeing courted by two suitors,Icelandic drug maker Actavis and USrival Barr, both of whom have beengradually raising their offers in a$2.3bn bid battle.This has pushed theindex to an all time high, with otherblue chip companies such as sugarmanufacturer Viro and shippingcompany Tankerska Plovidba baskingin the limelight.

Bosnia and Herzegovina is alsoacting as a magnet for yield hungryinvestors with discounted stockswhose prices promise double digitannual growth in the medium term,on the back of continual GDP growth,stable domestic currency and animproving business environment. InJanuary, the ex-Yugoslav countrybegan talks with the EU on aStabilisation and Association (SAA)agreement, designed to forge closerties with the EU and seen as the firststep toward eventual EU membership.Although the timeframe is unclear for

possible EU accession – some analystspoint to 2015 - foreign investors arenot wasting time buying Bosnianequities in anticipation of a so-calledconvergence play. The country is stillrecovering from the 1992-1995 civilwar, in which a significant part of itsindustrial, road and socialinfrastructure was destroyed. Thegovernment is busily forging aheadrebuilding the country and economy.

The country’s two exchanges – theSarajevo Stock Exchange and theBanja Luka Stock Exchange – wereestablished in 2002 to service thevoucher privatisation programme inthe country. This past March, the

SASE forged closer ties with theVienna Stock Exchange through amemorandum of understanding. Thisis not only expected to boost liquiditybut market transparency which willmake the market even more attractiveto foreign investors. As for Serbia, lastyear the Belgrade Stock Exchangeintroduced a new index, the Belex 15,comprising of the 15 most liquidstocks. However, for now there is toomuch uncertainty over the country’sEU future mainly because pre-entrytalks have been suspended due to thecountry’s reluctance to hand over

General Ratko Mladic, formerBosnian Serb commander, tothe U.N. war crimes tribunal.There are also question marksover the future status ofKosovo which is currentlybeing debated and discussedin the United Nations.

Stelzeneder, an analystwith Raiffeisen International,says, “Serbia’s stock markethas been a strong performerbut there is a cloud over thecountry. Talks with the EUhave been put on hold andthe Kosovo situation remainsunclear. There are alsoconcerns that nationalistic

parties might gain a majority in nextyear’s elections and that could createfurther tension. ”Peter Sanfey, leadeconomist of the European Bank forReconstruction and Development(EBRD) adds, “The country also stillfaces some difficult challenges interms of restructuring the economyand moving ahead. It has to catch upafter a lost decade in the 1990s wherethere was no reform. The country wasin isolation due to sanctions.Although there has been rapid growthover the last five years, it is not asimple task to turn a country around.We are, however, optimistic about itslong term future.”

Croatia is in the best shape butthe government still needs to push

through painful reforms inhealthcare and reducing statesubsidies to public companies,

according to Martin Stelzeneder, ananalyst with Raiffeisen International.More work also needs to be done inthe privatisation arena where activityhas been more or less dormant for

the past two years.



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THIRTEEN OUT OF the 20 IPOsin the Brazilian market since early2005 “have been in the portfolios

of venture capital or private equity firmsat some stage,” according to MarcusRegueira, president of the Associationfor Brazilian Venture Capital and PrivateEquity. These are not minnows either,with substantial deals including thelikes of Lupatech, the parent companyfor Valmicro and MNA valves which islocated in the industrial southern partof Brazil, and electronic commercespecialist Submarino.

It is a big turn-around. Until recently,Brazilian private equity had faded togrey. The 1999 devaluation began theprocess of decline. Reverses in globalmarkets with the resultant lack of

liquidity and concerns over regionalpolitical instability— especially withthe election of President Luiz InácioLula da Silva in 2002—hastened it.Then also, there were more interestingopportunities in Asia. Those Latinprivate equity firms that depended oncapital markets to exit their positionsfound they were locked in as themarket fell and consequently all partiesand partners (both limited andgeneral) fell into near silence.

In 2003, the pendulum of globalliquidity began to swing back in favourof Latin markets. To the mix was addedincreased macroeconomic stability.That enabled private equity firms tobegin selling off their investmentsthrough the equity markets. In turn,

they posted positive results to theirinvestors and began to generate moreinterest in their asset class.

By 2005 private equity fund raisingbegan to show some brio. AlexBurgess, managing editor of VentureCapital Latin America, explains therapid transformation of the industry.In 2004, the value of private equityexits reached $600m throughout LatinAmerica. One year later and the valueof exits reached $1.5bn. By the middleof this year, exits have totalled $2bnand Brazil—the largest market byfar— has dominated, with $1.25bnworth of IPO exits in the period.

According to Innes Meek, portfoliodirector for Latin America and China atCDC Group, the UK government-

PRIVATEEQUITY IN MOTION

When Brazil’s TAM Linhas Aéreas airline wentpublic in March, comparisons were made withthe 2004 initial public offering (IPO) of its arch-rival, discounter Gol Linhas Aéreas Inteligentes.Both were Brazilian, both were airlines, bothlisted on the Bovespa. The IPOs also had anotherthing in common. Both were successful andlucrative exits for private equity funds. TAM, forexample, raised close to $700m, with most ofthe monies split between five investment funds.After an extended period in the doldrums, itlooks like private equity in Latin America isbeginning to pick up in momentum. JohnRumsey reports from São Paulo.

For many private equity firmsworking in Latin America,

which take minorityshareholdings and seek an exit

through capital markets,proving a track record has

been hard. The lack is aroadblock for drumming up

more business. In particular,track records for private equity

funds are poor over the shortto medium-term. Photograph

by John Leaver, supplied byDreamstime.com photography

agency, October 2006.



owned fund of funds with net assets of$2.9bn,“Valuations are still reasonablein Brazil and are still in single digitmultiples of earnings, and exitpossibilities have improved, especiallywith the creation of the NuovoMercado.”The market has improved inMexico as well. Even though Mexico’scapital markets are much thinner thanBrazil’s, there have already been twosignificant offerings in the year toSeptember, says Burgess. HomebuilderHomex, for example, raised $246m andMexican furniture and householdgoods retailer Grupo Famsa $230m inMexico and the United States.

Fund raising opensThe improved picture on the exit

front has started to feed through tomore interest in fund raising, albeitwith a time lag. One of the largestprivate equity firms is sitting up andtaking notice. Ernest Lambers ofAlpInvest Partners, the Dutch giantwith €30bn in private equityinvestments, is now looking at LatinAmerica closely after being broadlyabsent.“We are more optimistic on theregion now and expect to becomemore active in the near future. Weclearly see positive signs, both interms of the economies as well as theenvironment.” And Ernest Bachrach,chief executive of AdventInternational’s Latin American dealgroup, which has led $1.5bn ofinvestments in the region over the last10 years, says that investment trackrecords are now sufficient to attractinstitutional investors. According toMeek, a notable feature of this particularcycle is the participation of hedge funds,“which has given firms, such as GPInvestimentos, a much more substantialpool of funds from which to invest. Theproblem is that hedge funds tend tohave short term horizons and currentlytheir interest is stimulated by the rise inthe stock exchange.”

Bachrach however sounds anadditional note of caution. Althoughthe $1.3bn in private equity raised forLatin America last year is upconsiderably from the low of the 2002to 2003 period, it is still well below thepeak reached in 1998 and is minisculecompared to the amount raised inAsia: “This is not a boom, but it is apick-up in activity.”

For many private equity firmsworking in Latin America, which takeminority shareholdings and seek anexit through capital markets, proving atrack record has been hard. The lack isa roadblock for drumming up morebusiness. In particular, track recordsfor private equity funds are poor overthe short to medium-term. Antonio

Gledson de Carvalho, professor offinance at EAESP in São Paulo,explains why. In the early years of thelife of a private equity fund, the onlyinvestments the firms divest areusually those where the investmentshave gone sour and need to be writtendown. “We have a saying. ‘Lemonsmature faster than pearls,’” he says.Successful investments tend to stay ina portfolio for a more orderly exit oncethe business has been properlyprepared for sale, usually several yearsinto the life of the fund.

Advent, whose funds concentrateon majority shareholdings andtypically sell to strategic investors,largely escaped the capital marketsdownturn and has a strong trackrecord in the region, according toBachrach. He claims the firm hasmade compound annual returns of35-40%. That would be more thanenough to woo more investors. Incomparison, local pension fundPETROS, the pension fund ofPetrobras, expects a real return ofsome 13.5% net of fees from itsinfrastructure investments, 16% forother private equity investments and22.5% for venture capital investments,says Ricardo Malavazi, director.

As sentiment improves, privateequity funds are getting larger. GiantConduit Capital Partners raised$400m in July for a power fund andAdvent International closed a $375mfund in autumn last year. Still, this issmall beer compared to the size offunds in the buoyant late-1990s whichproduced some funds with aninvestment value of more than $1bn.

Local participationThe participation of stable, local

institutional funds in private equity iskey for the industry to enjoy sustainablegrowth. Regueira thinks this localmoney is critical. Pension funds such asPrevi (from the Banco do Brasil), Funcef

Ernest Bachrach, chief executive of AdventInternational’s Latin American deal group.

Advent has led $1.5bn of investments in theregion over the last 10 years, and Bachrach saysthat investment track records are now sufficientto attract institutional investors. Still, he sounds

a note of caution. Although the $1.3bn inprivate equity raised for Latin America last year

is up considerably from the low of the 2002 to2003 period, it is still well below the peak

reached in 1998 and is miniscule compared tothe amount raised in Asia: “This is not a boom,

but it is a pick-up in activity.”Photograph kindlysupplied by Advent International, October 2006.



(Caixa Econômica Federal), and fundsrun by BNDES are scrutinising orentering the market, he says. The re-entrance of institutional funds is verypromising as these were the kind offunds that were responsible for thegrowth of the private equity industry inthe US in the late 1980s. Bachrachagrees. “Private equity in the region isgoing to remain a volatile source offunds until local investors are amore significant presence,” hesays. Still, the amounts localinstitutions are investingneeds to be put intoperspective. Foreignerscontinue to dominate, buying68% of the total value of IPOson Bovespa since 2001.According to CDC’s InnesMeek, Brazil’s local privateequity scene is dominated byfour big investment firms: GPInvestimentos, Patria, Dynamoand TMG. “In terms of internationalplayers, Advent and AIG are the mainones, with Darby also looking atmezzanine finance. Others come andgo, still wary of Latin America.”

By and large, local activity is risingand it is likely to prove a growing force.The pension fund industry in Brazil, forinstance, is still in its infancy, but likelyto grow fast. “We are seeing newinvestments in private equity byBrazilian pension funds. Two years ago,they would not have looked at suchinvestments; now they are makingdedicated allocations,”says de Carvalho.One reason for the circumspection isthe sometimes blurred relationshipbetween limited and generalpartnerships in Brazil: an issue thatcame to the fore in the long-runningdispute over the governance of BrasilTelecom. Back in 1997, OpportunityAsset Management, together withCitibank, through its vehicle in BrazilCVC/Opportunity, Telecom Italia andBrazilian pension funds, cast the

successful bid for the acquisition ofBrasil Telecom (at the time called TeleCentro-Sul), as well as the mobiletelephone companies Tele Amazôniaand Telemig Celular, with Citibank andthe Canadian Telesystems InternationalWireless. In 2001 a falling out betweenpartners mired all concerned in lengthyand costly legal battles, with allegationsand counter-allegations of improper

influence. The case also highlighted thesometimes blurred distinction betweengeneral and limited partners in themanagement of thetelecommunications giant. The issue isstill not resolved and has cast asometime shadow over private equityinvestment in the country; particularlyas the case has involved some of thecountry’s leading pension andinvestment funds.

For now, Brazilian private equityfunds remain circumspect for otherreasons as well. Malavazi explains, as afurther example, that PETROS startedto invest in privatisations at the end ofthe 1990s, in line with many otherBrazilian funds. The fund found itselflocked in to these private equityinvestments between 1999 and 2002and only in 2003 did the situation startto improve. Since then, PETROS hascommitted some R$850m (about$396m) to private equity investments,of which R$70m is in venture capital,he says. The fund was attracted to the

asset class because of the likelihood offalling interest rates in Brazil, a lowexposure to floating rate investmentsand the rich seam of opportunities,especially in infrastructure.

There are other reasons to be moreoptimistic about the longer-termprospects for private equity in the region.Ther is a strong consensus that privateequity teams are now stronger and

more professional.The faminein the early years of thisdecade winnowed out weakerand less dedicated firms andteams. Burgess believes:“There is a commitment tobuilding strong, high qualityprivate equity teamsnowadays, which are able towork very closely with themanagements of thecompanies in which they takea stake. This is now seen askey to the success of private

equity investments and represents a newgeneration of talent in the region.”Lambers adds a nuance. His funds’investments are focused on growthcapital and buyouts because he does notyet see many quality managers focusedon venture capital, which is a verydifferent business.

The quality of teams is especiallyimportant this time round, thinks deCarvalho. The late 1990s saw privateequity firms focus on the low hangingfruit: mature companies needed helprestructuring as the Brazilian economywas opened up, he says. Investorsfocused on late-stage opportunities,cases in which the firm already had aviable, established business model.Although the opportunities still exist,many of the more obvious investmentshave been made. That means moreprivate equity funds are going toearlier stage firms. These require muchmore nurturing and specialised skills(typically, they might need help indeveloping a business model to staff

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The quality of teams is especiallyimportant this time round, thinks de

Carvalho. The late 1990s sawprivate equity firms focus on the

low hanging fruit: maturecompanies needed help

restructuring as the Brazilianeconomy was opened up, he says.



hires and product development).Meek acknowledges that CDC has yetto finalise an investment in Brazil,although it has committed some $20mto Mexican investment firm Nexxus.“The issue we have with Brazil is thediscipline of investment. Because theindustry went through a difficultperiod, you now find that you aredealing with a variegated investmentmodel which can include investmentadvisory work as well as hedge fundinvesting. It makes the overalldecision more complex.” CDC has alsolooked at smaller funds, operating inthe north eastern region,“although theissue here is the desire of local pensionfunds to be represented on managers’investment committees, which wedon’t like”adds Meek.

Sectoral FocusThe predicted wave of investments, if

indeed it comes, arrives at a time whenthere is keen interest in several micro-sectors of the Brazilian economy. Themost obvious is renewable energysources, where Brazil is a world leaderwith its long experience of biomassenergy, or energy derived from plants.“In clean energy and biomass, Brazil iscompeting with the best of the world,”says Bachrach. Regueira thinks thatroughly one third of the planned privateequity investment is likely to be in thesector. Renewable energy is a buzzwordright now and foreign investors areflocking to the country to learn moreabout the technologies with Japan andthe US likely to be very significantimporters of ethanol. Owners ofsugarcane, distilleries and hydro energyplants are attracting most interest.

Bachrach argues that “It’s a win-winsituation. It’s labour intensive and job-producing for Brazil, and reducesAmerican oil dependence on countriessuch as Venezuela and Iran. There is amajor initiative to look at thisseriously.”The biggest downside risk for

alternative investments is a fall in oilprices. At $70 a barrel, there is a short-term incentive to turn to biomass fuels.With recent price decreases, that logic islooking less secure. If prices were tosink back to $50, “investments inalternative fuels such as ethanol wouldbe a lot less interesting,”he reckons.

Infrastructure is popular too. Firmsare raising funds to invest in sanitation,roads and logistics. This is a nexus ofinvestment for PETROS, for example.Malavazi explains that a sound rule-based structure for investment in thesector has encouraged PETROS toparticipate and its portfolio isconcentrated in electricity, includingtransmission lines, civil construction,transport and ports. Another of themost talked about sectors is utilities.The sector offers high yields (attractiveto long-term funds), is relatively wellregulated and has become attractive

now that inflation and sovereign riskare under control. Biotechnology,agribusiness, with development ofpest- and weather-resistant crops andtourism, especially in the North eastand north, are likely to benefit too.

Malavazi remains positive onprospects for private equity in Brazil. Hesees the return of international investorsafter years of absence, the consolidationof macroeconomic gains andimprovements in regulations, especiallywithin capital markets as Bovespa andthe market regulator refine listingrequirements, as vital to further growthin private equity in the region.“Frankly,institutional investors are bound to findLatin America more compelling as theother alternative regions becomesaturated and start to produce moremarginal returns,” adds Bachrach.“It ishard to believe that all those funds willproduce satisfactory returns.”

Marcus Regueira, president of the Association forBrazilian Venture Capital and Private Equity.Thirteenout of the 20 IPOs in the Brazilian market since early2005 “have been in the portfolios of venture capital orprivate equity firms at some stage,”he says.These arenot minnows either, with substantial deals including

the likes of Lupatech, the parent company for Valmicroand MNA valves which is located in the industrious

southern part of Brazil, and electronic commercespecialist Submarino. Photograph kindly supplied by

the Association for Brazilian Venture Capital andPrivate Equity, October 2006.



THE NEW FTSE Latibex Brasilindex is the only Euro-denominated tradable index

covering Brazilian stocks, and ranks themost liquid Brazilian stocks listed onLatibex. The FTSE Latibex Brasil indexwill offer investors worldwide a newtool which is specifically designed tosupport structured products and ETFs.On launch the index comprises 13stocks, although this number isexpected to rise at future index reviews.Weightings in the index’s constituents iscapped at 20%. Index reviews for thenew index will take place bi-annually inMay and November.

The FTSE Latibex Brasil index is ananswer to growing interest byinstitutional investors in Brazil andmeets current demand for an index ofBrazilian blue chips listed on Latibex.Constituents of the index are “liquidity-screened to make the index suitable forthe creation of financial products, suchas certificates and Exchange TradedFunds (ETFs),”explains Pablo Ybarra, keyaccount manager at Latibex. Accordingto Ybarra the launch of the index will bequickly followed with the issue of ETFsbased on FTSE Latibex Brasil, as well ason the FTSE Latibex Top, which will belisted on the ETF market segment of theSpanish Stock Exchange. Otherproducts supported by FTSE Latibex Top

are available on different markets, suchas: Belgium, Czech Republic, Finland,Germany, Italy, Estonia, Lithuania,Norway, Spain and Switzerland.“This isa decisive step forward in the process ofbringing Latin American companiescloser to new global liquidity poolsthrough Latibex,”says Ybarra.

The FTSE Latibex Brasil index is partof a growing family of FTSE Latibexindices, which includes the FTSELatibex All Share Index and the FTSELatibex Top. FTSE Latibex’s All ShareIndex has achieved a strongcorrelation with the behaviour of theLatin American markets, which hasmeant no small degree of volatility.The shares comprising the FTSELatibex All Share Index have a totalcapitalisation of €200bn, equivalent toover one fourth of the entire value ofthe rest of the Spanish market.

Latibex was established in 1999 as aneasier way to channel Europeaninvestment efficiently towards LatinAmerica and was established by Spain’sfour stock exchanges. Latibex lists Latin-American companies withcapitalisations of more €300m and isopen to members of the four exchangeswith equal conditions of access as well asto members of certain Latin Americanexchanges. Shares admitted to Latibexmust have previously been accepted by aLatin American exchange; however, thesecurities listed on Latibex are tradedand settled like any other Spanishsecurity. Unlike the way ADRs work, theLatibex trades original shares in euroselectronically via SIBE, guaranteeing

speed and transparency. However,under certain circumstances, ADRs mayalso be eligible to list on Latibex as hasbeen the recent case of La Electricidadde Caracas. It also provides attractivetime zone characteristics, allowinginvestors to continuously trade in LatinAmerican shares over a ten to twelvehour window. This means thatincreasingly American based investmentfirms have begun to access exposure toLatin America through Latibex, as wellas a rising European consistuency.

Equally, Latibex gives LatinAmerican companies easy andefficient access to the Europeancapital market and the exchange nowboasts a broad representation of LatinAmerican stock exchanges. One of themost highly publicised measures hasbeen the creation of the FTSE LatibexTop index, which brings together the15 most liquid or tradable shares, andcomprises mainly Brazilian, Mexicanand Chilean companies.

Latibex has succeeded throughsome testing times, including theeruption of the Argentinian crisis andthe subsequent suspension of itsforeign debt payments, the globalshock generated by the September 11attached and the 2002 crisis in Brazil.Those issues have long faded and nowBrazil is among the four leadingemerging markets (Brazil, Russia,India and China).

Currently, 38 stocks from sevendifferent countries (Mexico, Brazil,Argentina, Chile, Peru, Panama, andPuerto Rico) are quoted on Latibex,

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In spite of short term volatility, interest in Latin American stocks—and in Brazilian stocks in particular— is resurgent. The Mercado deValores Latinoamericanos en Euros (Latibex) the Euro-denominatedmarket for Latin American stocks, owned by the Bolsas y MercadosEspañoles (BME), is an increasingly popular vehicle for foreigninvestors and investment institutions to access the region’s growthstory. In a new development, Latibex and FTSE Group havecollaborated on the development of FTSE Latibex Brasil, a newtradable index focused entirely on liquid Brazilian stocks.



including some of the largestcompanies in the continent, such asTelmex, América Móvil, Petrobras,Valedo Rio, and Bradesco and according toYbarra, 37 of these are now includedin the FTSE Latibex All Share.

“Getting onto Latibex has allowedthese companies to diversify theirshareholders and reach both privateand institutional investors. As well, ithas allowed investors to access abroader range of securities which givethem exposure to the Latin Americangrowth story”, he adds.

Practically before it was created, theindex was used to create warrants.Thesederivatives permit investments at specificprices for a specific period and allow

investors to bet on a specific trend. Theycan lead to much higher returns oninvestment, but there are equivalent highrisks involved. The warrants on LatibexTop were the first to be launched on anegotiable index in Latin America. Thederivatives were also indirectly useful inhelping drive liquidity as contractvolumes have increased. Ybarra points tofirms such as Société Générale, whichhas issued certificates and warrants onthe Deutsche Börse, Euronext and theSpanish exchanges based on the FTSELatibex Top Index. Other banks issuingproduct based on the same index includeABN AMRO, Merrill Lynch, SEB,Nordea, and Goldman Sachs.

Latin American companies have been

strengthening their profitability as awhole while local regulators have beentightening measures to improvecorporate governance standards.Macroeconomic indicators such as thecurrent account, the government budgetdeficit and inflation are all much betterbehaved than in the past and, perhapsmost importantly, the banking systemsin Latin America have never been assound and as poised to support futurecredit growth as they are today. As aresult, Latin indices such as the FTSELatibex skyrocketed by more than 80%last year, although this year the overallperformance has been more variable,with volatility in the index related to thevagaries of global energy prices.



MEXICAN FINANCEMINISTER Francisco GilDiaz announced to

journalists in Mexico City at the end ofAugust that his country’s economywould grow by 4.2% in 2006 comparedwith 3% last year. He attributed thegood showing to growing oil revenuesand increased car exports. His goodnews however was somewhatovershadowed by the seeminglyinterminable electoral crisis. Even if

many Mexicans were clearly notbowled over with his good news, thefinancial sector (arguably his realconstituency) certainly was. “Thecurrency is stable, stocks continue torise and bond yields are falling. Themarkets are showing that not only thatthere’s confidence but also that [theeconomy] is growing,”he said.

On the face of it, backed by arelatively strong economic story, it wassomething of a surprise that the PAN

candidate, Felipe Calderón, shouldhave struggled so hard in such a hotlycontested election victory. However,there was much at stake. ManyMexicans, for one, have not necessarilyfelt the benefits of the country’sgrowth, and it is the incomingadministration’s challenge to steerdevelopment so that they do. Thebruising election campaign will also bedifficult for Mexicans to forget. Widelycriticised for extravagant spending andmud-slinging in place of seriousdebate, allegations of vote-peddling,money-laundering, manipulation ofvoter rolls, intimidation, and evenillegal church interference flew fastand furious in newspapers, on theratio and on television. Moreover, forthe first time in decades, a pronouncedleft-right polarisation in Mexicanpolitics has resurfaced, rekindlinglong-standing divisions that had been

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Mexico’s President-elect Felipe Calderon waves tojournalists after arriving at the Air Force Base inGuatemala City, Guatemala, on Monday,October 2nd 2006. Calderon was on a one-daystate visit. Photograph taken by AlexandreMeneghini and supplied by EMPICs/AssociatedPress, October 2006.

Crises often look less critical as they drag on and few recentevents dragged on as long as the Mexican elections, with itsknife-edge count, legal challenges and street protests. Once theNational Action Party’s (PAN) Felipe López Calderón was declaredthe winner in early September, and the defiant loser, theDemocratic Revolution Party’s (PRD’s) Andrés Manuel Obrador,backed down from his threatened insurgent unconstitutionalchallenge, Mexican business seems to return to normal. Clearly,the drama has not turned into a crisis—at least so far. IanWilliams reports.

Business as Usual



submerged during the ousting of theold Institutional Revolutionary Party(PRI) from power.

Pamela Starr of the Eurasian groupthinks that: “The markets are a bit toosanguine about how successful FelipeCalderón is going to be in governmentbecause they think he has a majority inCongress. [They] think that LópezObrador is backing downbecause he has decampedfrom downtown Mexico City.Both of those are incorrectassumptions.” However, Starrreckons that the otherextreme—that Mexico is goingto become ungovernable—isequally incorrect.“In any case,it is going to be a tough slog,”she concedes.

Starr had been one of those analystswho did not see the sky falling downif Obrador were elected, and is nowequally sanguine about Mexico’s post-electoral prospects.“After all, you nowhave a president elect and the vastmajority of Mexicans accept him at thelegitimate president. It allows him togo forward and structure his cabinet.”

As for the reforms that so manyWall Streeters would like to seeimplemented in Mexico, Starrsuggests that the markets willgradually realise that Calderón “isnot going to be as strong andeffective a president as Mexico needsat this present economicconjunction” Starr thinks thatbecause Calderón is “unlikely to havea functioning legislative majority, hewill have to make a lot ofconcessions to get reforms, issue byissue [sic], so his reforms will beinteresting but not stunning.”

The power of Obrador’s party inlocal and state institutions and hisability to mobilise millions on thestreets will certainly have an influenceon implementation of Calderon’spolicies. Already there are indications

that the President-elect is planning touse a larger proportion of swellinggovernment revenues on socialspending to help avert some of thosepotential confrontations.

Bun-fighting aside, Calderón hasinherited significant domestic policychallenges and a bumpy relationshipwith the United States. The way in

which he approaches these problemsmay provide a bellwether for otherLatin American leaders. Geographymay lie on Calderón’s side. The stakesin this post election period are high forthe United States as well. A politicallyand economically stable Mexico iscritical for finding a solution to theperennial migration question andproper coordination of bi-nationalefforts to combat drug trafficking.

However, at home, Calderón facesissues that are more complex andperhaps even pricklier. Governmentrevenues may be rising on the back ofwindfall oil profits, but this level ofincoming revenue cannot be reliedupon over the long term. Moreover,the present dilemma over allowingforeign investment in Mexico’s oilsector and in particular PetróleosMexicanos (PEMEX) remains thorny.

Observers now want to see seriousstructural reforms in the economy,particularly in the national oil companyPEMEX. That may not necessarily beforthcoming. Both Calderón andObrador were considered potentialreformers, as they did not have closeties to the PRI (the party that had ruledthe country for the best part of the last

century and which has vested interestsin the state owned oil sector). Thatassessment now appears optimistic. Itseems that the PRI’s local party leaders,anticipating their disastrous defeat inboth the presidential andcongressional elections, had cooked upa deal with Calderón. IndeedObrador’s supporters accuse local PRI

officials, particularly in theNorthern states, of fixing thevote for PAN and Calderón.

With the balance of powerin the legislature, Calderóncan only govern in coalitionwith the PRI. That meansthat the tough bedrock ofMexican nationalismmarried with and exploited

by the PRI-dominated managementof PEMEX and the oil sector unionsprecludes any outright privatisation ofthe company, no matter how muchWall St may slaver at the prospect.

On the other hand, Starr suggeststhat Obrador’s strategy is not togenerate social instability or to getpeople on the streets but to preventCalderón and the PRD implementingits preferred neo-liberal agenda and“to try to force Calderón to accept adramatic reconstruction of Mexico’spolitical institutions. The PRD will useits power in the legislature, and amongvarious governors and mayors, andwhere required the party will bringactivists on to the streets, probably ledby the unions and Obrador. On keyissues they can make a heck of a lot ofnoise and create significant obstaclesto legislative reforms.”

“Even so, we will see more resultsfrom Calderón than we saw from Fox,”predicts Starr. “I think there will be alabour reform, there will be a reform ofthe state workers pension system, andof the administration of Pemex. Butthey will be hard fought and watereddown, and he is always going to haveObrador nipping at his heels.”

Observers now want to see seriousstructural reforms in the economy,

particularly in the national oilcompany PEMEX. That may not

necessarily be forthcoming.



Carlos Moctezuma of Homex, the lowcost homebuilder that recently listed inthe US foresees the shape of thecompromises ahead.“There is room for[a] more efficient structure of PEMEXwithout breaking the constitutionallymandated state ownership. There isroom for private investment in refineriesor transportation. That is something heneeds to work out.”

Local commentators are moreoptimistic than the more detachedobservers, such as Starr.“Calderon willhave a better chance of governing thanFox, since there is now more of anenvironment for coalition governing,and the PRI will agree to more thanthey did before. On the other handthere will be more moderation fromthe PRD, because they won a lot, andthey won’t want to continue the noisefactor if it jeopardizes the gains they’vemade when the mid-term electionscome,” says a senior executive of amajor Mexican company who prefersto remain anonymous.

He adds,“Everyone agrees the last sixyears have been a transition and thenext six years will be the same. Somethings, but not all will be achieved, andmaybe not even to the extent that’srequired. That’s life; you do not changea body politic that has been around forseventy years overnight. People arelooking for stability economic growth,modest prosperity. They are notlooking for someone to turn the houseupside down.”

In a similar mode of confidence –but in muted expectations, heidentifies Calderón’s task for the nextsix years as, “building consensusbetween his own party and the PRI,otherwise it will be impossible for himto govern the country, wasting years oftime for macroeconomic reform.

Homex’s Moctezuma dismissessome of the doomsayers who feel thatMexico was already heading for aneconomic fall before the elections.

“That is a little too pessimistic. We doneed structural changes to grow faster.We are growing at a rate of 3% to 4%when we should be growing atsomewhere between 7% and 8% butwe are nevertheless growing, althoughwe do need the reforms to accelerategrowth to compete externally.”

Furthermore, he believes, “The nextstep is to tackle the infrastructure. Notmany of us accept the fact that we haveenjoyed more than ten years ofmacroeconomic stability after the TequilaCrisis and that is becoming evident inconsumer confidence and spendingpower. Even though we have ourproblems we do not have yet a socialproblem, as long as we keep ourselveson the cool side of the equation andkeep the macro-economics.”

The combination of remittances fromMexican workers abroad and general

economic growth are reflected in theresults for local producers such asCemex, Mexico’s multinational cementproducer and Homex. Moctezuma feltsure that whichever candidate won,he would encourage homebuilding.Indeed, some economists suggestthat the concentration on exports andthe external account neglects thegrowth possible from internaleconomic development.

There are indeed many poor peoplein Mexico, but many of them arebenefiting, not just from local growth.They also continue to benefit fromcontinuing growth north of the border,where, despite the noise aboutimmigration, the flood of remittancescontinues to run at about $20bn andupwards a year. That is “free”money inthe sense that the government and thePRI led institutions cannot control it.

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Photograph of a refreshment vendor in Xochimilco Lagoon in Mexico City. However, there wasmuch at stake in the recent presidential elections. Many Mexicans, for one, have not

necessarily felt the benefits of the country’s growth, and it is the incoming administration’schallenge to steer development so that they do. The bruising election campaign was also

criticised for extravagant spending and mud-slinging in place of serious debate, allegations ofvote-peddling, money-laundering, manipulation of voter rolls, intimidation, and even illegalchurch interference flew fast and furious in newspapers, on the ratio and on television. The

photograph was taken by Richard Gunion and was supplied by the Dreamstime.comphotography agency, October 2006.



WITH THE MOSTimportant electionsin a decade just

around the corner, pressure isincreasing on Russia’sgovernment to pay moreattention to those left behindby the post-Soviet miracle.“There is compelling pressureon the government to spendmore on social services, andthat will have big effects on thiseconomy,” states VladimirPantyushin, an economist withMoscow broking firmRenaissance Capital. While thecost of these reforms couldhave a detrimental impact onthe country’s burgeoningeconomy, in the final analysis,the government may have nochoice but to implement them.It is already under pressure,particularly in the run up to next year’sparliamentary elections and thepresidential elections in 2008.

That pressure has its roots invarious government efforts in the1990s and early 2000s to reform thecountry’s pension system. The set of

social challenges facing Russia issimilar to those in other Europeancountries: burgeoning numbers ofretirees, falling birth rates and a statesystem that cannot afford its futurepension liabilities.

The Soviet pension system wasbased on a pay-as-you-go (PAYG)

system and provided decentpension benefits, with areplacement ratio up to 75%.By the 1990s however,Russian birth rates felldramatically and these daysthe ratio of workingindividuals to retirees is a ratioof 1.6/1 compared with five toone in the 1970s. According toVnesheconombank, thespecialist state banksupporting the government’scentralised foreign economicoperations, which ration willfurther reduce to one to one by2020, making it obvious thatPAYG has run its course.

It was only when PresidentPutin took office in 2000 thatpension reform took centrestage. Based on the advice ofeconomy minister GermanGrev, a new retirement pensionformula was established,consisting of a basic pension, aninsured pension, and a fundedpension, collectively comprisinga three-pillar system.

The first pillar is financedthrough social securitycontributions, the so-calledUnified Social Tax (UST) madeby employers and first pillarpension benefits areguaranteed by the state andequal approximately $100 permonth. Benefit payments aremade by the State PensionFund of Russia. The secondpillar covers individuals bornafter 1967 and is financed via

employer social security contributions.These second pillar pensions, whichaffect around 54.6m Russians, are alsotransferable to private providers –private asset managers or non-statepension funds depending on eachindividual’s decision. However onlyaround 4% of eligible individuals have

Russian president Vladimir Putin speaks at the internationaleconomic forum opened in the Black Sea resort of Sochi,

southern Russia, September 29th 2006. It was only whenPresident Putin took office in 2000 that pension reform took

centre stage. Based on the advice of economy ministerGerman Grev, a new retirement pension formula was

established, consisting of a basic pension, an insured pension,and a funded pension, collectively comprising a three-pillar

system. Photograph by Dmitry Astakhov, supplied byEMPICS/Associated Press/ITAR-TASS.

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Everyone agrees Russianpensions need to rise andaccess to healthcarefacilities andpharmaceuticals shouldbe made easier. Equally,everyone also knows thatsuch policies could alsohave a negative effect onthe economy. Thatdichotomy puts theRussian authorities underpressure, particularly inthe run up to next year’sparliamentary electionsand the presidentialelection in 2008. Whatnow? Benjamin Seederreports from Moscow.

ELECTIONSBRING PENSIONSINTO FOCUS



transferred this part of their labourpension to one of the 98 non-statepension funds or 55 assetmanagement companies allowed toparticipate in second pillar pensionschemes. The third pillar is non-statepension provision for both individualsand corporations. The market forcorporate pensions in Russia coversover 65m people.

A peculiar feature of the Russianmarket is the existence of captive non-state pension funds, which belong tolarge industrial corporations andoccupy a substantial market share. Infact, the second and third pillars aremarked by a high penetration ofcaptive non-state pension funds,which currently enjoy a 25% marketshare. Even so, there is still potentialfor new entrants in the small tomedium sized enterprise (SME) sector.

Additionally, there is enormousscope for foreign insurance andpension companies to enter themarket: though here the potential islimited by Russia’s distributioncapacity. Although the countryremains over-banked, by and largeoutside the specialist capital marketsinstitutions, such as Renaissance

Capital, the country’s financial systemis still relatively unsophisticated andRussia’s retail savers have little ininvestment choices before them.

Equally, corporate pensions havenot been commonly provided byRussian employers due to acombination of factors—the mostimportant of which is lack ofunderstanding of the pensionproducts by employees andcontinuing developments in Russiantaxes and investments. However, theprovision of corporate pensions isbecoming increasingly widespread, asmore companies, mainly foreign-owned, are introducing corporatepension plans for their Russian staff.The provision of corporate pensionsby employers becomes anindispensable part of theirremuneration packages by 2008-2010,as more and more individuals born inthe 1950s and 1960s are coming closerto retirement.

In an effort to cover the deficit ofstate pension fund liabilities in 2002the Russian government cut theUST. While the measure wasintended to liberalise income, itfailed entirely. ‘Grey’ salary schemes

have not been legalised and thebudget deficit did not shrink. In fact,it exploded and this year it isexpected to exceed $3bn. Then in2005, the government introduced alaw that converted various Soviet-era social benefits into cashpayments, which created a popularbacklash. Putin’s administration hitan all-time low and the reform waswidely criticised. It was unfair andits implementation was botched, saidcritics. Mass protests–some of thelargest in Russia’s history—werestaged around the country. For thefirst time, Putin’s and thegovernment’s approval rating beganto slip.“So now they are planning tospend their way out of trouble. Theywant to buy their way through theelection cycle,”says Pantyushin.

The recently unveiled draft 2007budget increases overall spending by26% and includes a 50% increase inall public sector salaries, which alonewill cost Rb127bn. Meanwhile,Rb206bn will be allocated on specificprojects, such as boosting access tohealthcare and increasing statesupport to farmers. The budget willalso increase defence spending byRb70bn, not including increases insoldiers’ pay. There’s nothinginsignificant about that, saysPantyushin – pork-barrel budgetshappen in every democracy.

In Russia’s case though, where thelevers of control in the economy aremore restricted, the macroeconomicblowback may be bigger anddecidedly negative. Combined withincreasing calls to use Russia’swindfall oil profits on infrastructureand social services spending,economists fear a massiveappreciation of the rouble or (at thevery least) spiraling inflation.

Classical economic thinkingsupposes that increased governmentspending leads to higher inflation or a

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Mark van Loon, a broker with MDMBank in Moscow says the government has

been “printing money and managing theexchange rate by buying dollars andselling roubles. But with fiscal policy

loosening now, this may not work in thefuture, which could lead to some tough

decision-making.” Photograph kindlysupplied by MDM Bank, October 2006.



stronger currency: two outcomes theRussian central bank is keen to avoid.Either outcome could lead to a declinein domestic industries outside oil andgas production, at a time when Russianeeds to diversify away from itsenergy-exporting habit. “The centralbank has been walking a very finebalance in the past few years, it hasnot been an easy job for them,” saysMark van Loon, a broker with MDMBank in Moscow. “They have beenprinting money and managing theexchange rate by buying dollars andselling roubles. But with fiscal policyloosening now, this may not work inthe future, which could lead to sometough decision-making.”

The central bank’s official inflationtarget is around 9% for 2006, thoughstatistics released in August showed thatconsumer price index prices are alreadyon schedule to surpass this target.

“The thinking now is that theCentral Bank is likely to focus more onfighting inflation. It is hated by thepopulation and really defeats thepurpose of raising pensions andsalaries. And the only way to do that

may be to let the Rouble appreciate,”van Loon says. The Rouble has beenrising anyway. It appreciated some 6%against the Central Bank’s own basketof trade-weighted currencies in thefirst half of the year, and 7.8% (innominal terms) against the dollar.

Aside from the prospect ofincreased spending from the budget,analysts are also worried about thegrowing pressure to spend some ofthe money accrued in the StabilisationFund – a vehicle set up in 2004 tomanage excess oil revenues receivedfrom oil export taxes. Many of thegovernment’s critics have attacked thepolicy of spiriting away the windfall oilrevenues in the Stabilisation Fund,which is expected to reach some$80bn in value by the end of the year.

Since its establishment, financeminister Kudrin and other liberalisteconomists in the cabinet have beenfighting off calls to spend the money.One of their main arguments wasthat the money should be used to payoff foreign debt – an argument thatwas grudgingly accepted as prudentby even the fiercest critics. The last

$22.6bn of Russia’s Paris Club debtwas paid off in August, and whileother sovereign debt exists, it will notbe possible to pay it off in bulk.Analysts say this will promptrenewed calls for the StabilisationFund to be spent domestically,instead of being invested abroad, aswas originally planned.

One proponent of spending thefund domestically is Vladimir Isayev,the director of the Oriental StudiesInstitute. Asked recently in aninterview on Russian radio as to whyRussia should sell oil if it was to lock itin a fund and then send the moneyabroad, Isayev answered: “We exportraw materials, receive the money, andput it into a fund - in order to send itback to the same countries that buyour oil and gas ... and this, in a countrythat has practically no decent roads!”He went on to say that the moneyshould be invested in roads andinfrastructure, which would, in turn,stimulate jobs in construction in theregions, and open up newdevelopment opportunities for landalongside the new roads.

KEY ORGANISATIONS IN THE RUSSIAN PENSION FUND SYSTEM

The Russian Federation Pension Fund: responsible for forming a funded portion of the labour pension, and formaking arrangements to invest pension assets by entering into trust management agreements with trustmanagement companies and with the state trust management company;

Non-governmental Pension Funds: responsible for forming a funded portion of the labour pension, and formaking arrangements to invest pension assets by entering into trust management agreements with trustmanagement companies;

State Trust Management Company (STMC): responsible for investing pension funds of the persons who failed tochoose a trust management company and who chose the state trust management company;

Trust Management Companies (TMC): responsible for investing pension funds;

Special Depository: charged with monitoring whether trust management companies manage pension savings incompliance with applicable legislation, normative documents and investment declaration, to keep records ofsecurities and of the transfer of entitlements to securities purchased through investing pension assets transferredby the Russian Pension Fund to trust management companies.



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NAccording to Dealogic, the financial services data provider, Russia’s equitycapital markets deals have totalled nearly $10bn so far this year, up 47% of thetotal for the whole of 2005. No wonder then that bulge bracket banks are nowlooking to Russia for business growth, bringing with them new competitivepressures, which domestic institutions are gradually coming to terms with.Many foreign banks are looking for appropriate acquisitions opportunities inthe country and few investment banks in Russia are as appealing as AtonCapital. Variously courted by Goldman Sachs and other leading houses, andhaving rejected their advances, Aton knows it has to find the perfect partnerto survive and grow in the newly emergent Russia. What will it take for it tobecome a bride? Or will it always remain a bridesmaid? Francesca Carnevaletalks to Aton’s chief executive officer (CEO), Alexander Kandel in Moscow.

one/halfof a perfect

partnership

GM EDITORIAL 16 16/10/06 13:28 Page 48


SERIOUSLY, IT WAS on Arbat—a noted local landmark—when I looked into the eyes of an owl manacled to a polethat I began to understand the predicament of Russia’s

leading investment banks. An imposing animal that shouldhave roamed free was instead pinned down for the benefit ofwestern tourists paying for a touch of something once wild andnow (perhaps tragically) tamed. One thing for sure: for thatparticular bird, things will never be the same. With clippedwings, it cannot go back to the hunt. I guess being in Russia forthe first time does funny things to your thinking. However, onegenuinely felt for the owl and in a lesser, more realistic way,one feels for Russia’s investment banks, which are increasinglychained to foreign interests.

In the scramble for a cornerof Russia’s growth story, Atonis potentially a star buy.Reportedly, Italian bankUniCredit’s central Europeaninvestment banking arm, CAIB, is working on a deal to buyAton Capital as this magazinegoes to press. It is the latest ina long running saga that hasinvolved a number of leadingglobal players. Talks withUniCredit have beenproceeding for some time,though Aton is still playingcoy. Alexander Kandel, Aton’sCEO has variously stressed that it is talking about possiblepartnership deals with more than one foreign financialinstitution.“It would be wrong to say that the deal is closed orthat documents are signed. However, we are not denying thatwe are holding talks to set up a partnership based on ourinstitutional block of business. CA IB is one of those Westerncompanies,”he told local reporters in late September.

Established in 1991, Aton Capital ranks among Russia’sleading investment banks, together with Renaissance Capitaland Troika Dialog. The bank’s broking operations by tradingvolume on both the RTS and MICEX exchanges regularlyranks among the top three in Russia. The bank, for instance,ranked second among the country’s top three Russian brokersin 2005, according to an annual rating compiled byRosBusinessConsulting agency, which bases its results on theturnover of 50 investment companies working on MICEX andRTS. In that year, Aton’s turnover was $20.2bn—equivalent toaround 10.3% of the total volume, compared with $18bn a yearearlier. However, while total volume increased Aton’spercentage of the total fell somewhat, down from an 11.6%market share in 2004. However, says Kandel, the Russiantrading market has seen a much expanded field of players andtotal trading volume has escalated dramatically.

More significantly, perhaps, Aton has emerged as one ofRussia’s leading local market makers, particularly in RussianADRs and GDRs, blue chips and second-tier stocks. Todaythe company provides a full range of investment bankingservices, and has consolidated its reputation as a pioneer in

Russia’s rapidly expanding financial sector. The companyemploys around 500 people and is represented in more than30 regions of Russia through a specialised network of dealingcentres and subsidiaries. Aton International Ltd represents itin London, its US subsidiary, Aton Securities Inc., has aNASD licence, and last year Aton opened operations inFrankfurt. It is also the only Russian member of the FSE.

All in all, it is an attractive package for a foreign investor andthe firm is expected to command a price of somewherearound $400m to $500m for anything up to a half share. AsKandel notes: "We work with more than 5,000 clients.Uniquely, we collaborate with more than 400 investment

funds in the West, as well aswith vast numbers of clientsin Russia, including morethan 3,000 domestic privateand investment customers.”

Pragmatic and straight-talking, Kandel also typifiesthe confident, financial elitethat has redrawn thefinancial landscape in Russiaover the last fifteen years andwho have helped rebuildconfidence in the country’sfinancial market followingthe 1998 crisis. A graduate ofMoscow Engineering PhysicsInstitute and earning an

MBA from the Academy of National Economy under theRussian Government, Kandel joined Aton in 1994 as aportfolio manager, rising quickly and steadily through theranks to become head of operations in 1997. He becamechief financial officer (CFO) the following year and in early2003 assumed the mantle of chief executive. Kandel ischarged with building relationships between Aton Capitaland prominent Russian and international companies, as wellas bolstering the company’s profile within the local capitalmarkets. As if that was not enough to keep him busy, Kandelis a board member of both the National Association ofSecurities Market Participants (NAUFOR: Russia’s equivalentto the US NASD) and the Russian Trading System (RTS)exchange; and is also president of the country’s DepositaryClearing Company (DKK).

That level of drive and energy has also been appliedliberally to the management of Aton Capital. Kandel iscredited with pushing through a major restructuring drive,which he launched in the autumn of 2004, to define moreclearly the firm’s businesses. Three clear business streamsemerged.The first was asset management, which the firm hadbeen trying to spin off for some time. It was a timely move, ascrucially, Kandel felt it was imperative to give a clearerdirection to the firm’s broking operations.

In fact, up to the point when Kandel took over the runningof the firm in 2003, Aton had been marketed, in the main, as apure brokerage company. However, the different demands ofAton’s Russian clients and overseas clients began to impinge

In the scramble for a corner ofRussia’s growth story, Aton is

potentially a star buy. Reportedly,Italian bank UniCredit’s central

European investment banking arm,CA IB, is working on a deal to buy

the brokerage as this magazine goesto press. The brokerage has beenholding talks with many partners,

including UniCredit, and talks havebeen proceeding for some time.



on business and it became increasingly obvious that it requireda redefinition of the firm’s activities. Aton’s local institutionaland high net worth accounts simply wanted it to provideexecution services. Its foreign clients, on the other hand, wereincreasingly pushing the firm into investment bankingactivities. By the end of last year the restructuring wascompleted, a move that was essential if the firm was to beginto work in partnership with a foreign financial institution. Thefirm had realised early on that any strategic tie-ups could onlybe reached in the firm’s investment banking area.

Kandel is nothing is not thorough and following therestructuring of the holding, then went and restructuredAton’s subsidiary operations, a process that was completedin August this year. ZAO Aton Broker now servicesinstitutional investors and OOO Aton services retailinvestors, says Kandel. The upshot is a wide-ranging uptickin revenues. Revenue from the retail business of Russia’sOOO Aton, the flagship company of Aton Capital Group, isexpected to double on the year to between $22m and $25min 2006, although a larger portion of the group’s revenue willcome from Aton Broker. In September, the firm announcedthat it would merge the operations of OOO Aton withinternet broker Aton-Line, with the combined operationworking under the moniker OOO Aton-Line; headed by theformer RTS exchange president and chairman of NAUFOR,

Ivan Tyrishkin. Aton’s net profit from its retailbroking business is expected to increase tobetween $12m and $15m this year, comparedwith $5m in 2005. Most of the revenue expectedto be generated in 2006 will come from brokeragecommissions. Additionally, the firm intends toopen an office in Kazakhstan before the end ofthis year and is considering buying someUkrainian investment firms.

The scramble for market shareFor the time being, the focus is on whether Atonwill take the plunge and sell a portion of its sharesto a foreign partner. UniCredit might just be theone. The bank itself is no stranger to Russia.Historically, Italy has had extensive trading linkswith the country and the bank already has acontrolling stake in Moscow International Bank.UniCredit’s move is typical of this year’s over-arching trend by foreign financial institutions tosecure market share through acquisition ratherthan market accretion in both the retail andwholesale securities sectors.

That scramble has not left Aton’s peersunaffected. Troika Dialog, for instance, anotherleading independent broker, is reportedly beingcourted by JP Morgan (and, some reports addCitigroup). Deutsche Bank meantime bought acontrolling 60% share in United Financial Group(UFG) at the end of last year. Earlier in 2005, UBSbought out local broker Brunswick, while LehmanBrothers has established a joint venture with

Renaissance Capital, the Russian investment bank.It has not stopped there. Citigroup already has a Russian

subsidiary; Raffeisen International bought out Impexbankearlier this year, Sociètè Gènèrale owns SKT Bank and has a10% stake in Rosbank and hopes to acquire full control by2008. Germany’s Commerzbank is taking a 15% stake inPromsvyasbank and eventually plans to increase itsshareholding to 50%, while Credit Suisse recently launched anew wealth management business in Russia and GoldmanSachs (an ex-suitor of Aton) was granted a licence to tradesecurities in August this year.“The bulge bracket banks havebeen expanding and investing more heavily in the past in thepast two years to capitalise on the country’s natural resourcesboom and burgeoning corporate sector. The market isgrowing in both size and the number of institutions servicingthe market, and it is only the beginning,” says AlexanderKandel, Aton’s chief executive officer.“However, on the flipside, the foreign banks have introduced strong competitivepressure into the market.”

Kandel acknowledges that change is in the air. “As astandalone entity, it is unlikely we will gain access to thebiggest accounts. If we do not act then our client base willeventually consist of Russian corporates ignored by big guyslike Goldman Sachs.” Given that selling shares to a foreignplayer is one way forward, Kandel is precise about the kind of

Kandel is credited with pushing through a major restructuring drive, which helaunched in the autumn of 2004 to define more clearly the firm’s businesses.

Three clear business streams emerged. The first was asset management, whichthe firm had been trying to spin out for some years. Equally importantly, Kandel

felt it was imperative to give clearer direction to the firm’s broking operations.Photograph kindly supplied by Aton Capital, October 2006.

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deal that Aton is looking for. The model, he says is DeutscheBank’s deal with UFG: “in other words a two stage deal inwhich UFG is reaping the benefit of Deutsche Bank’sresources,”explains Kandel.“As you probably know we spentlast year discussing possibilities with Goldman Sachs. Theywanted 100% straightaway; but would not have allowed us tobenefit from any synergies. We are looking for partners.”

Aton has variously signalled that while it understands therequirement for a partnership, it will not accede at any cost.The firm is also choosy.“Not every single Western bank is fit tobe our partner. It is two-way traffic; a marriage of convenience.Both they and we should agree on our joint strategy. We mustshare views on the client base, on the kinds of transaction wewant to make, we must agree on what we want to focus onjointly and where we want to reap the synergies,”says Kandel.

One of the points of contention with Goldman Sachs wasthat Aton wanted to focus on mid-size local businesses andnot solely on blue chip companies. “We want to offer themiddle market our investment banking services, and helpthem grow. However, global banks often say that they arenot interested; they want to service the top ten Russiancorporates. There are no synergies that we could offer in sucha partnership. A prerequisite for a deal is that potentialbusiness partners share our vision of how we should developthe business,”explains Kandel.

There are three sectors that Aton focuses on. Naturalresources companies, “small oil plays, which have beenoffering triple digit returns,”says Kandel. The second area isconsumer goods and retail chains,“where we are searching

for companies in the range of $100m to $200m. These areinvariably outside of Moscow, in the regions,”he adds. Thethird focus is Aton’s signature business, which specialises in“gold, silver and zinc,”according to Kandel. “We have closeda number of high profile deals in companies which haveinterests in Kazakhstan, Armenia.” Last year the houseclosed 10 deals in the minerals and mining sector.

While mergers and acquisitions within the Russia’s financialsector remains buoyant, for Aton, the bulk of recent businesshas centred in equity capital markets (ECM). “Ironically, wehave seen more ECM deals than M&A, which take longer andare less transparent. I can tell you,”he says laughing,“that it ishard to bring two parties together in agreement.” That aside,Kandel acknowledges that these days it is much easier to getECM mandates and the firm boasts expertise in bringing smalland medium sized firms to market in a range of overseasexchanges, including Toronto, London and Frankfurt.

By the end of this year, it will become clearer whether Atonwill be a reluctant bridesmaid, or finally become a bride.Irrespective, Kandel remains irrepressibly optimistic. “Eitherway the opportunities are only just beginning in Russia,”hemaintains. “As investor requirements become more complexand we move towards full convertibility of the rouble, there isa big upside on the fixed income side and we will see anexplosion of rouble denominated issues. I even anticipate atrend: that in a few years foreign companies will bring inforeign exchange and convert it into roubles. We will still behere to leverage whatever comes.” There is one owl, it seems,that still intends to fly free.

Don’t work in the dark, who knows what you might find

Paul Spendiff

Tel:44 [0] 20 7680 5153

Fax:44 [0] 20 7680 5155

Email:[email protected]

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INDEX OPTION VOLUME has grown by leaps and boundsover the past five years (please refer to Table: Index optionvolume by exchange). It’s no coincidence that hedge fund

assets have shot up in the same period. Index options provide aconvenient and inexpensive way to manage risk,a task at whichhedge funds excel. Traditional asset managers are playing abigger role, too. Better liquidity and transparency have attractedinstitutions, which can now trade in size without disrupting themarket, at least in the more liquid contracts.

Market participants have many more index-relatedoption contracts to choose from these days thanks to theexplosive growth in exchange traded funds (ETFs).According to Ashok Shah, chief investment officer atLondon & Capital, a boutique, UK-based asset manager,which is about to launch its own investment productsbased around MarketGrader, an algorithmic investment

tool; “ETFs are a form of indexation in the way the peoplemanage assets and are the quickest way to manage risk ina volatile quarter,” says Shah. The firm currently offersMarketGrader 40, a basket of 40 North American equitiesselected by computer algorithms, based on fundamentalanalysis. In the first quarter of 2007, the firm will launch anextended suite of MarketGrader products that will belaunched as ETFs.

Options on ETFs provide an alternative to options onwhatever underlying index the ETF tracks, says Shah. Theyare not identical, however. ETF options settle in kind, bydelivery of shares in the ETF, while traditional indexoptions settle in cash. Contract sizes differ as well. In mostcases, the cash settled index options represent a largernotional principal. The SPX contract on the Standard &Poor’s 500 Index (S&P500) represents 10 times the value ofoptions on the SPDR ETF that tracks that index, while theNDX contract on the NASDAQ 100 Index is 40 timesbigger that the QQQQ ETF option.

Physical delivery makes ETF options available to retailinvestors who would not otherwise qualify to trade indexoptions. A portfolio must meet minimum size anddiversification standards – in effect, be a plausible proxy forthe index – before an investor can write index call options

UPWARDLYMOBILE

Market participants have many more index-related option contracts to choose from thesedays thanks to the explosive growth in exchangetraded funds (ETFs). As ETFs themselves becomemore numerous, diversified and sophisticated,index option trading is growing in tandem. Whatnext? Neil O’Hara reports.

Among options on ETFs, the International Securities Exchange (ISE) ismaking inroads after a federal district court ruled in 2005 that ISE’sunlicensed trading of options on ETFs that track the performance of stockmarket indices does not infringe the intellectual property rights of the indexproviders, a ruling unanimously affirmed in 2006 by a federal appealscourt. Multiple listings for ETF options have proliferated as a result.


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without being considered nakedshort. ETFs eliminate the problem;short calls are covered as long as theaccount holds enough ETF shares todeliver upon exercise.

Even so, while London &Capital’s Shah believes that ETFs arestill in their exponential growthphase, the best is yet to come, withsignificant implications for the indexoptions industry.“Actively managedETFs are definitely the next step andon the back of that development thevolume of index options trading willrise accordingly.”

Lower nominal values and wideravailability may explain why volumein ETF options has outstripped thegrowth in cash settled indexoptions. “I have long believed thatETF options are a superior product,”says Michael T Bickford, senior vicepresident of options at theAmerican Stock Exchange (AMEX).Not for everyone, though. Bickfordpoints out that institutionalinvestors may prefer the larger sizeof cash settled options becausecommissions depend on thenumber of contracts traded; thefewer contracts needed to hedge afixed dollar amount the lower the transaction costs will be.

Traders may lose some of that benefit at expiration however.An in-the-money cash settled option lifts one leg of a hedgedposition: the day before expiration a portfolio long SPDRs andshort SPX options has zero delta, but the next day delta is 100.Institutional investors can manage that risk, of course; they canroll the option out to a future month, or settle in cash andadjust the portfolio to maintain the desired exposure – but theywill incur transaction costs. “You have to trade out and youcreate friction when you do that,”says Bickford.

An in-the-money ETF covered write takes care of itself atexpiration: delta is zero going in and zero coming out,

according to Paul Stephens,director of international andinstitutional business developmentat the Chicago Board OptionsExchange (CBOE). He notes thatcash settled options provide greatercertainty if the index goes out closeto the strike price: the options willsettle for a token cash payment andthe portfolio will be long the nextday. A manager short at-the-money ETF calls does not knowhow many will be assigned – if any– the so-called pin risk. “Somepeople find ETF options’ physicalsettlement easier for them andothers prefer the cash settlement,”Stephens says, “It is a case ofdifferent strokes for different folks.Index options tend to be preferredby people doing the bigger clip.”

Stephens believes hedge fundshave propelled the growth intrading volume. Index options givethem a cost-effective way to hedgeexposures to stocks as well as otherasset classes, such as credit defaultswaps and convertible bonds. Hesees more traditional institutionsparticipating, too. “Covered callwriting is popular now and has

been over the last few years because performance has beenvery good,” Stephens says. CBOE commissioned a study byIbbotson that showed a rolling one-month at-the-money buy-write strategy delivered returns comparable to the S&P 500with much lower volatility. The exchange now trades optionson proprietary indices that track buy-write returns on the S&P500, NASDAQ 100 and Dow Jones Industrial Average (DJIA).

The CBOE still has by far the largest market share inindex options, thanks in part to exclusive licences it holdsto trade the most popular contracts: SPX options on theS&P 500, OEX on the Standard & Poor’s 100 and DJX onthe DJIA. Among options on ETFs, the International

Michael T Bickford, senior vice president ofoptions at the American Stock Exchange (AMEX),says,“I have long believed that ETF options are a

superior product.” Not for everyone, though.Bickford points out that institutional investors

may prefer the larger size of cash settled optionsbecause commissions depend on the number ofcontracts traded; the fewer contracts needed to

hedge a fixed dollar amount the lower thetransaction costs will be. Photograph kindly

supplied by AMEX, October 2006.

INDEX OPTION VOLUME BY EXCHANGE

Year CBOE AMEX PHLX PCX ISE BOX Total2005 192,536,695 46,744,753 23,555,581 17,158,819 64,674,471 16,883,720 361,554,0392004 136,679,303 42,337,503 25,769,498 14,353,054 38,085,408 4,284,223 261,508,9892003 110,822,092 37,890,154 23,366,215 15,039,960 19,149,997 206,268,4182002 94,383,545 40,828,126 10,891,670 14,005,412 12,060,836 172,169,5802001 52,009,919 37,329,121 8,366,266 6,991,130 6,152,766 110,849,202

CBOE – Chicago Board Options Exchange, AMEX – American Stock Exchange

PHLX – Philadelphia Stock Exchange, PCX – Pacific Exchange

ISE – International Stock Exchange, BOX – Boston Options Exchange

Source: CBOE Market Statistics 2005




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Securities Exchange (ISE) is making inroads after a federaldistrict court ruled in 2005 that ISE’s unlicensed trading ofoptions on ETFs that track the performance of stock marketindices does not infringe the intellectual property rights ofthe index providers, a ruling unanimously affirmed in 2006by a federal appeals court. Multiple listings for ETF optionshave proliferated as a result.

ISE’s electronic trading platform lowered costs,tightened spreads and introduced greater transparency tothe options market, which attracted more institutionalinvestors. Most recently, the ISE launched two sets ofindex options: a set of cash-settled index options based onthe FTSE 100 Index and a second set that trades the FTSE250 through an innovative‘Mini’ contract structure.The Mini FTSE 100 andthe Mini FTSE 250 indicesrepresent 1/10th of thevalue of the full-size FTSE100 and FTSE 250 Indices.

Bruce Goldberg, chiefmarketing officer at the ISE,believes that institutionsnow account for about 40%of total options tradingvolume, up from anestimated 15% to 20% inthe pre-ISE era.“A lot of thefriction that existed in this

marketplace has come out,” he says,“Institutional investorscan get done what they need to get done in the size theywant with immediacy and low transaction costs.”

ISE’s success demonstrates that multiple listings boosttrading volume. Goldberg notes that average daily volume inthe DIAMONDS ETF that tracks the DJIA has more thandoubled to 68,000 in the year since ISE started trading thecontract. Options on the SPDR ETF were introduced onmultiple exchanges in January 2005 and have already becomethe third most actively traded ETF options. ISE is looking torepeat its success in equity options; in just three years from itsinception the ISE displaced the CBOE as the leading marketfor those contracts.“Multiple listing is what drove growth in

the equity and ETF optionsmarket,” says Goldberg,“You have more liquidity.The bid-ask spreadnarrows.” He believes thatcash settled index optionshave not grown as fast asETF options because themost popular contracts arelisted on a single exchange.

Experience suggeststhat the addition of ETFoptions may improveliquidity in cash settledoptions on the underlyingindex. Scott Ebner, head of

Srikant Dash, index strategist at Standard & Poor’s. For an indexwith relatively few components, each of which has a liquid single

stock option, investors can calculate the theoretical value of theETF option. If the market price differs – or disperses – from that

value, traders can capture the arbitrage opportunity. “For nowdispersion trading is concentrated in proprietary trading desks,

hedge funds and options arbitrageurs,” says Dash, adding: “Thatstrategy has not gone retail.” Photograph kindly supplied by

Standard & Poor’s, October 2006.

Scott Ebner, head of new product development at the American StockExchange (AMEX), cites the Russell 2000 Index as an example.The ETFassets have grown over the last two years, trading volume on the ETF isup, ETF option volume has gone through the roof and the index option is

still thriving.“People are able to incorporate strategies that use bothinstruments,”Ebner says,“With many indices, index options, ETF options

and ETFs, futures on those products and options on the futures cansucceed – and not necessarily at the expense of one another.”Photograph

kindly supplied by AMEX, October 2006.

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Source: FTSE Group. Data as at October 2006



new product development at the AMEX cites the Russell2000 Index as an example. The ETF assets have grownover the last two years, trading volume on the ETF is up,ETF option volume has gone through the roof and theindex option is still thriving. “People are able toincorporate strategies that use both instruments,” Ebnersays,“With many indices, index options, ETF options andETFs, futures on those products and options on thefutures can succeed, and not necessarily at the expense ofone another.”

The number of ETF option listings continues to growapace at the AMEX, but new index option listings havetapered off over the last two years, according to Ebner. It isa more mature market in which opportunities forinnovation are limited and many contracts have establishedname recognition and followings. AMEX keeps looking,though. The exchange has a pending application to tradeoptions on the Nuveen Municipal Closed End Bond FundIndex and is considering several other new index options.

Although the number of ETF options keeps growing,trading volume remains concentrated in a few big names.QQQQ (NASDAQ 100), IWM (Russell 2000) and SPY(S&P 500) lead the pack, followed by DIAMONDS (DJIA)and then sector ETFs such as OIH (oil services), XLE(energy) and SMH (technology).

The increasing popularity of dispersion trading is drivinggrowth in the most active sector ETF option volumes,according to Srikant Dash, index strategist at Standard &Poor’s. For an index with relatively few components, eachof which has a liquid single stock option, investors cancalculate the theoretical value of the ETF option. If themarket price differs – or disperses – from that value, traderscan capture the arbitrage opportunity.“For now dispersiontrading is concentrated in proprietary trading desks, hedgefunds and options arbitrageurs,” Dash says,“That strategyhas not gone retail.”

Retail investors have contributed to the growth in coveredwriting, however. Income is becoming more important asthe retiree population grows. It is a demographic shift thatwill continue for years as baby boomers age. Buy-writeprograms packaged into structured notes can provide yieldsof 5% or more compared toa yield of 1.8% on theStandard & Poor’s 500 –and leave investors withsome of the upside.“That iswhat is driving theincreased interest,” Dashsays,“People want yield.”

Another strategy isgaining ground in theinstitutional market.Volatility tends to creep upin a rising market, but itspikes up when the marketfalls. “You have negativecorrelation between

volatility and equities,” Dash explains, “That is the idealcompanion you could have for a cash equity portfolio.”Backtests have shown that a portfolio long 90% cash equities

and 10% volatility wouldhave beaten a pure cashequity portfolio handsdown over the past 10 to20 years.

It will not take WallStreet’s financialengineers long topackage that concept forthe retail market. With somuch energy applied todevising new optionsstrategies and ways toexploit them, the indexoptions market looks setfor further growth.

Bruce Goldberg, chief marketing officer at the International SecuritiesExchange (ISE), believes that institutions now account for about 40% oftotal options trading volume, up from an estimated 15% to 20% in the

pre-ISE era.“A lot of the friction that existed in this marketplace hascome out,” he says,“Institutional investors can get done what they needto get done in the size they want with immediacy and low transaction

costs.” Photograph kindly supplied by the ISE, October 2006.

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FILE:INTEL

ONLY THE PARANOID survive” is the catchphraseof the legendary Andrew S. Grove, who built IntelCorporation into the world’s largest and most

respected designer and manufacturer of microprocessors—the silicon-based electronic brains of desktop computers,laptops, and servers (used to power corporate computernetworks). Before he retired in 1998 (he now has the title ofsenior advisor), he even wrote a book called Only theParanoid Survive. If his successors did not take his basicmessage to heart immediately, and which included suchnuggets as: “Business success contains the seeds of its owndestruction,” it was because Intel was both extraordinarilysuccessful and seemingly indestructible.

At the peak of the dot-com boom in 2000, Intel stocksoared above $75, giving the company a marketcapitalisation of more than $500bn. On sales of $33.7bnthat year, Intel earned after-tax profits of nearly $10.7bn, fora net profit margin of 31.6%. Its closest competitor,Advanced Micro Devices, Inc. (AMD), had revenues ofabout $4.6bn, net income of $797m, a market capitalisationthat peaked at $15.3bn, and a reputation as an Intelimitator, not as an innovator.

Today, all this has changed. At a recent share price ofaround $21, Intel is valued at $118.6bn. Revenues for 2006are expected to come in around $37.5bn, and net earningswill likely be under $6bn. Meanwhile, AMD now has a

market cap of $12.1bn and analysts expect 2006 revenuesof $5.3bn with earnings of perhaps $645m. Of course, AMDis still just a fraction as big as Intel, but the story is in thetwo company’s bottom lines. This year Intel will earn notonly far less than what it did during the fantasy world of2000, it will earn less than it did last year . . . and the yearbefore. Meanwhile, AMD may be on its way to its secondmost profitable year ever, after only 2000.

Go back to the days of Andy Grove. A charismatic, drivenleader, he recognised that Intel could not compete with theJapanese in memory chips, at that time Intel’s main business.He bet the company on microprocessors just as the personalcomputer boom began, and he placed unrelenting emphasison manufacturing efficiency. Soon “Intel Inside”became oneof the world’s best-known sales slogans. In 1993, Grovenamed Craig R Barrett, an accomplished electrical engineer,chief operating officer (COO) and in 1998 handed over thechief executive officer (CEO) title to Barrett as well.However, Barrett was the antithesis of Grove — at onceoverly confident and overly cautious. The company driftedfor several years and in May 2005 the board named a new

After fumbles and stumbles that cost it market share, profitsand prestige, the dominant maker of semiconductorscounterattacks with price cuts, new products, a managementshakeup, and widespread layoffs. The ensuing struggle witharchrival Advanced Micro Devices will benefit computerusers everywhere. Art Detman reports from California.

FIGHTSBACK“

Intel chief executive officer(CEO) Paul Otellini during

his keynote at IntelDeveloper Forum in SanFrancisco, August 23rd,

2005. Photograph kindlysupplied by Intel Press

Relations, October 2006.



CEO, Paul S Otellini, who had led the highly successfullaunch of the Pentium chip in 1993. Barrett stayed on as non-executive chairman of the board.

Otellini — not an electrical engineer — had beenpresident and COO since 2002, so Intel’s problems were nosurprise. Sales of desktop computers, Intel’s single biggestmarket, were slowing. AMD’s line of Opteron chips forservers, introduced in 2003, were 20% to 30% more energy-efficient than Intel’s Itanium chips, a 2001 product launchthat never gained traction. Intel’s XScale line of chips for cellphones and hand-held computers was losing money, aswas the NOR flash chip business. Texas Instruments, whichIntel forced out of the personal computer (PC) chip marketin the 1980s, had reinvented itself and pushed Intel out ofthe market for plasma TV semiconductors in 2004.

At AMD, in an audacious undertaking, the company putits advertising and salespromotion dollars not intobrand advertising but into a“War in the Store”strategy. Byincreasing its line of productsand improving configurations— to gain an advantage overIntel’s Prescott chip in termsof heat reduction, for example— it persuaded computermakers such as Gateway,Hewlett-Packard and Toshibato offer PCs and laptops withAMD chips. Then it usedrebates, in-store promotions,employee training programsand advertising support to gethundreds of retailers to boardthe AMD bandwagon.

In mid 2005, Intel’s stockprice, around 28, began a longslide. AMD’s stock price, thenaround 18, moved up sharply,passing Intel’s at year-end.The turnabout reflectedAMD’s improved share of the total microprocessor market,which by mid 2006 had reached 22%, up from 16% a yearearlier. Intel’s share meantime slipped to 73%, down from82%. An even more dramatic illustration of Intel’s reversalof fortune was revealed when first quarter results wereannounced. For the first time ever, AMD’s gross profitmargin exceeded Intel’s, 58.5% to 55.1%. One culprit wasIntel’s bloated management corps, which under COOOtellini had grown faster than the number of employees.Indeed, even overall employment had gotten out ofbalance, growing by 17% in 2005 (to 99,900) even thoughsales rose only 13.5%.

An energised Otellini began taking action. In the springhe announced a comprehensive review of all thecompany’s operations, with a goal of increasing efficiency,cutting costs and speeding decision-making.

In June Otellini announced a deal to sell Intel’sstruggling mobile communications business, which makesXScale chips for cell phone and handheld devices, toMarvell Technology Group Ltd. for $600m. Intel hadacquired the technology in 1998 and 1999 throughlicensing and the purchase of DSP Communications Inc.for $1.6bn. However, despite a customer list that includedResearch in Motion (BlackBerry), Palm (Treo) andMotorola, Intel was never able to win sufficient marketshare from Texas Instruments and Qualcomm to turn aprofit. Security analyst Mark Edelstone of Morgan Stanleyestimates Intel lost $80m annually on sales of $400m.

In July 1,000 managers got layoff notices, a first in thecompany’s 38-year history. Later in September, Otellinirevealed that he expects job cuts to total 10,500 over thenext two years—through attrition, layoffs and sale of

business units—enough to save $3bn by 2008. Silicon Valleywas stunned, and Wall Street yawned. Intel shares fell 3.4%on the news, reflecting both a belief that the cuts were notdeep enough and scepticism about Otellini’s long-termstrategy. Meanwhile, Otellini also reorganised his corps ofsenior officers. The number of “two-in-a-box”co-managerswas reduced, a new business unit was created, two vicepresidents retired, and the number of executives reportingto Otellini was reduced.

In anticipation of new product introductions, Intelannounced price cuts of up to 60% on its existing models.The cuts became effective in July, which meant thatsecond quarter sales were hit hard as customers waitedfor the new products or the price reductions. AMD was, ofcourse, forced to match Intel’s price cuts almost to thepercentage point.

Louis J. Burns vice president, general manager, Digital Health Group, (right) places medical monitoringdevices to a member of the Intel’s staff during a demonstration of a prototype computer that helps

medical staff to monitor a patient’s medical information. Burns’s keynote dealt with the opportunitiesfor information technology products, platforms, and solutions in the healthcare industry. Photograph

kindly supplied by Intel Press Relations, October 2006.



In June Intel’s formidableproduct developmentlaboratories began releasing astream of new chips: a newXeon 5100 chip for servers,code-named Woodcrest; animproved high-end Itaniumchip, also for servers, code-named Montecito; a new chipfor desktop computers, code-named Conroe; a new chip forlaptops, code-named Merom;and — expected just aboutwhen you get this magazine —a device for servers that willcomprise at least four chips,code-named Tulsa. Code namesare very big in Silicon Valley,where new product launchestake on the importance ofmilitary invasions.

Intel says that, withoutexception, every one of itsnewly launched productsoffers substantial operatingimprovements and costadvantages over existingmodels. For example, the Xeon5100 is 60% faster than AMD’sOpteron and provides aperformance per wattadvantage of 80%. It is the firstItanium with a dual-processorchip — two electronic brainson a single silicon wafer —and has 1.7bn transistors. TheConroe PC chip is available aseither a conventional single-processor or dual-processorchip. The latter model is calledthe Core 2 Duo (hardly asgood a name as Pentium) andchips provides theperformance of a Pentium 4chip but has the energy-savingfeatures of Intel’s chip fornotebook computers. Aversion for the mobile market,also called the Core Duo, willalso be introduced.

“This is a pretty exciting timefor us,” says AnandChandrasekher, senior vicepresident and general managerof Intel’s new business unitfocused on the ultra-mobile PCmarket (i.e., computers you can

lose nearly as easily as cellphones).“We have launched thefirst three products in our nextgeneration of micro-architectureproducts. These includeWoodcrest for servers, Core Duofor desktops and Core Duo forthe mobile marketplace. Takentogether, these are not so muchan evolutionary move for us asthey are a revolutionary move.This is as big an event for thecompany as the original Pentiumwas because of the kinds ofcapabilities we will be able tooffer.The range of improvementswe will be able to see, on a pureperformance basis, will be 40%,which is dramatic.”

Chandrasekher is quick tonote that pure speed is no longerthe primary goal of Intelengineers.“Performance is still adriving metric in themarketplace. All you have to dois visit websites of gamingmagazines to see how enthralledthey are by performance. Whatyou are seeing us do is shiftingnot toward pure performanceper se but toward performanceper watt.”

When Intel introduced thePentium chip for desktops andservers in 2000 and later thePrescott, it focused on purespeed. “That was what themarket demanded at that time,”Chandrasekher says.“We madea different bet in notebooks withour Centrino chip, where we betthat performance coupled withthermal efficiency would yieldgreat results, because battery lifeand other things make adifference in notebooks. It was ahome run.”

It was more than that.Centrino also provided thebasis for both the new CoreDuo series of chips for PCs andthe Xeon chips for servers.“Backin 2003, when we launchedCentrino, we also made a betthat the entire world wouldmove toward energy-efficientperformance, and that is the

Intel’s Pat Gelsinger, senior vice president, general manager,Digital Enterprise Group, shows attendees The Next

Generation:Tulsa silicon wafer during the Digital Enterprisekeynote at the Fall Intel Developer Forum held at MosconeWest on Wednesday, August 24th, 2005 in San Francisco,

California. Photograph kindly supplied by Intel PressRelations, October 2006.

Intel CEO Paul Otellini during his keynote at Intel DeveloperForum in San Francisco, August 23, 2005. Photograph kindly

supplied by Intel Press Relations, October 2006.

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architecture that you see us now bringing to market.”All well and good, but is the era of rapid growth in

personal computer sales coming to an end? The year-over-year growth rate has been almost steadily downhill, and in2006 is expected to come in around 10%. Many people inthe high-tech industry — analysts and CEOs alike —believe future growth will do no better than track growthin the overall economy.

“I could not disagree more with that,” Chandrasekhersays.“Let me give you some data. The PC was introducedin 1981. In 1999, the PC market hit about 100m units. Soit took 18 years to get to 100m units. In 2005, last year, thePC market broke 200m units. So, the first 18 years, 100munits; the next hundred million, six years. Industryforecasts have the PC market growing to 300m units by2008. Therefore, the time intervals between 100m-unitincrements are shrinking as time goes on.

“I do not think that growth engine stops. Why do I saythat? A couple of reasons. One, as the PC market grows, areplacement cycle factor kicks in. Over the past eightyears, the mature population of microcomputers has beenshifting from desktops to notebooks. The replacementcycle of a notebook is more aggressive than that of adesktop. Therefore, as the installed base of notebooksgrows, the replacement cycle of the PC market actuallyincreases. So you have the compounding effect of aninstalled base that continues to grow and an increasingportion of that accounted for by notebooks, which have afaster replacement cycle.”

Then there are emerging markets, countries such asChina and India. “In the aggregate, PC penetration ofemerging markets is around 4%, and it is growing. Whenthe PC’s penetration of any given emerging market reaches8% or 9%, you hit a hockey stick. The network effect takesplace, and growth just skyrockets. And we are going to beapproaching that 8% to 9% range in emerging marketsover the next couple of years.”

As Chandrasekher is quick to note, Intel’s new productshave received a warm reception by people who have testedthem in actual applications. For example, in the video gameindustry, where AMD has largely supplanted Intel, a reversalis likely.“We absolutely lovethe guys at AMD,” onemaker of gaming PCs toldThe Wall Street Journalwhen the Core 2 Due wasintroduced. “But they aregoing to get hammeredhere at the end of July.”Thefirm of Thomas WeiselPartners ran extensive testscomparing two Woodcrestserver chips from Intelagainst two Opteron chipsand found that “Woodcresthas superior performanceto Opteron systems.”

Here’s the view of Gus Richard, head of research at FirstAlbany Capital: “Intel is about to reassert its leadership in themicroprocessor market.”Richard also believes that Intel has atleast a year’s lead, maybe two, in manufacturing processes.“Moreover, due to Intel’s adoption of proactive process control,the company has driven defect densities to new lows.”

Backed by a research and development budget thatnearly matches AMD’s total revenues, Intel remains theGoliath of the semiconductor industry. Almost certainly itsnew series of chips will win back some market share acrossthe board, in servers, PCs and notebooks. Even so, do notbe surprised if Intel falls short of regaining all lost marketshare. AMD is not the laggard of years past, and with itspending acquisition of ATI Technologies — a controversialdeal in which AMD is criticised for over-paying — AMDwill become a major player in the graphics chips business,with a smaller market share than Intel’s but with thepotential provided by ATI’s more advanced technology.

Two things are certain. First, computers of all kinds, fromhigh-end servers topocketsize devices yet tobe invented, will continueto provide improvedperformance at ever-lowerprices thanks to the Intel-AMD rivalry. Second,although any number offamous names — namessuch as DigitalEquipment, CommodoreComputer, and WangLaboratories — havedisappeared from themarketplace, Intel won’tbe among them.

Delegates look at exhibits at the Fall Intel Developer Forum held atMoscone West on Wednesday, August 24th, 2005 in San Francisco.Photo kindly supplied by Intel Press Relations, October 2006.

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Hedge funds, which are always trying to improvetheir return on capital continue to push formeasures that increase the efficiency of theircollateral, including firm-wide collateralcalculations. Hedge funds are on the cuttingedge, of course, but traditional money managersmay pose a bigger challenge – and opportunity –for collateral managers, who now see a rapidincrease in the use of OTC derivatives by agreater range of players. Neil O’Hara reports.

COLLATERAL MANAGERS FOR OTC derivativesmust envy their colleagues who handle securitieslending and repo programmes for which public

markets determine prices and computers calculate requiredcollateral margins according to standard formulae.

In the OTC derivatives world, securities do not tradepublicly so counterparties have to agree on pricing. Eachcontract has negotiated non-standard margin provisionsand, with computerisation in its infancy, collateralmanagement still relies on phone, fax and e-mail.Traditional securities lending and repo dominate themarket for third party collateral management services butOTC derivatives are growing fast.

The International Swaps and Derivatives Association(ISDA) estimates that the notional value of outstandingcollateralised contracts reached $1.33trn in 2006, up from$719bn three years ago. Kirit Bhatia, global head of productfor collateral management at JPMorgan WorldwideSecurities Services, says that technology and operationalinfrastructures have failed to keep pace not just for collateralmanagement but for the end-to-end process for managingOTC derivatives, including valuations. That growth hasbrought the headache that always plagues manualprocesses: human error. Scott Linden, vice president andglobal product manager for derivatives collateralmanagement at The Bank of New York (BNY), points out thatcollateral managers have to track contract terms for everytrade, value the trade and then step through the margincalculation. “Your technology requirements include a tradecapture work flow as well as linkage to settlement to drivethis process,”says Linden,“It is rife with operational risk.”

Automation took a big step forward in 2005 when JPMorganintroduced its CommanD product, driven by SunGard’s Adaptiv

software and designed to handle OTC derivatives through the entirelife cycle from settlement to maturity.“It’s a compelling proposition forboth existing and target clients,” says Bhatia.“As the first player in the

market to do this, we are an outlier.” JPMorgan will not have themarket to itself for much longer, however. BNY isdeveloping a similar offering in partnership with

another software vendor. Photograph by ScottMaxwell, supplied by Dreamstime.com

photography agency, October 2006.

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As Bhatia notes, “The high level of investment spendneeded, access to market professionals and thecomplexities of integrating with existing internal systemspresent significant barriers and challenges in buildinginfrastructures in-house.” It could be worse. The ISDAMargin Survey 2006 reported that 75% of collateral postedagainst OTC derivatives contracts is still cash, which leavesno room for disputes over its value and eliminates haircutcalculations on collateral securities.

The numbers do not show it yet, but Linden expects theproportion of cash to fall now that interest rates have risenfrom historic lows. “Counterparties may begin to see otheropportunities,” he says, “They may invest cash elsewhererather than receive the Fed funds rate under an ISDA. Thenthey can use securities to satisfy their collateral requirements.”

However, Bhatia explains that, “While interest rates arepart of the reason cash dominates today, collateraldecisions are driven by infrastructure limitations ratherthan a calculated assessment of the risks involved andopportunity cost of collateral. This is clearly not ideal.”Yetcurrent accounting rules for many sell-side institutionsfavour the use of cash for collateral, he says.

Operational responsibilities do not stop at valuation andhaircuts for securities collateral, either. Linden saysrehypothecation (the pledging of securities in customermargin accounts as collateral for a brokerage’s bank loan)is rampant. Therefore collateral managers have to keeptrack of where posted securities have gone. Managers mustcheck that the securities meet eligibility requirementsspelled out in each contract, too; most specify US treasurybonds, US agencies and G7 sovereign debt. If the marketmoves away from cash collateral, Linden believescounterparties may embrace the broader range of securitiesalready accepted in securities lending and repo programs.

That will not happen in the burgeoning credit defaultswaps (CDS) market, of course. These contracts guaranteethe principal and interest payments on bond issues inexchange for an insurance premium so if the collateral is notcash it has to be the highest quality AAA paper. “We arelooking for assets that cannot be credit impinged,”says LouLucido, group managing director at TCW Credit MortgageGroup, a leading manager of collateralised debt obligations,“You do not want to have an underlying obligation which issupposed to be credit secure develop credit volatility.”Indeed,if anything happens to impair a collateral credit TCW insiststhe CDS counterparty replace that bond with top rated paper.

Unlike securities lending and repos, market price changesdo not trigger collateral movements in the CDS world.Prepayments do, however; if the outstanding principalembedded in a CDS based on asset-backed or mortgage-backed securities drops more than a threshold amount theparties agree to reduce the amount of collateral to match theremaining balance outstanding.“You are not trying to createan arbitrage,”Lucido says,“The collateral is supposed to beright-sized to the notional.”It is a manual process that willprobably stay that way because unpredictable prepaymentsdo not trigger adjustments every day.

Collateral use continues to grow due to the forthcomingimplementation of the Basel II capital adequacy framework.Although the Bank for International Settlements hasdelayed the effective date for another year, the prospectgives banks a powerful incentive to favour secured lending.Under Basel II, banks must set aside more capital againstunsecured commitments; its risk-based approach linkscapital charges to the type of collateral, too. Governmentbonds require less capital than asset-backed securities, forexample. “Collateral managers will have to monitorconcentration limits and sort through highly-rated paperversus unrated paper,”says Jim Malgieri, managing directorand product manager for global collateral management atBNY. The purpose of collateral is to mitigate credit risk, ofcourse. Counterparties have to value each derivativecontract and aggregate the margin requirements under eachcredit support annex to an ISDA master agreement beforethey arrange to move collateral as necessary.

Although the 14 major swaps dealers either have their ownsophisticated tracking systems or employ third party collateralmanagers, many smaller organisations use spreadsheets.Malgieri reckons spreadsheets do not cut it for more thanabout 25 ISDA contracts.“You begin to look to outsource thoseduties,”he says,“That is the service we are trying to offer.”It’sa function for which the big custodian banks are well-suitedeven though economies of scale do not yet play a major role

Kirit Bhatia, global head of product for collateral management atJPMorgan Worldwide Securities Services, says that technology and

operational infrastructures have failed to keep pace not just forcollateral management but for the end-to-end process for managing

OTC derivatives, including valuations. Photograph kindly supplied byJP Morgan Chase, October 2006.



in what remains a labour intensive process. As BNY rolled outits OTC derivatives collateral management product, it found aready market among custody clients.“It is not a technologyscale as much as it is a people and an expertise advantage thecustodian banks have,” Malgieri says,“We have the contactswithin these organisations already. We can lever up ourexpertise and experience in handling collateral.”

Elsewhere in the market, JPMorgan has for over a yearbeen offering an integrated service that includes custody,derivatives processing, valuation and collateral management.The service enables asset managers to include complexinstruments like derivatives into the same portfolio as morestandard instruments, making it seamless for clients as theydevelop more diversified portfolios. This capability wasinstrumental in Threadneedle Asset Management earlier thisyear choosing JPMorgan as its outsourcing partner.

BNY manages over $1trn in collateral for repo andsecurities lending programmes, primarily for clients who donot use the bank’s custody services: the funding desks ofbulge bracket securities houses that provide equity financeand fixed income repo to their customers.“OTC derivativesdovetail in with corporate treasury, corporations that haveinterest rate swaps contracts on their books, pension fundsthat are in the interest rate swaps game and mutual funds,”says Malgieri,“The opportunities are presenting themselvesthrough the custodian relationship.”

That has opened the market to new entrants. Nobodylikes to change their custody relationship — it’s anadministrative nightmare — so clients are pressing theirexisting custodians to seize the opportunity. As the use ofOTC derivatives spreads through the investment universe,money managers want their custodians to shoulder theadministrative burden by providing third party collateralmanagement. That is one reason why, in August, Chicago-based Northern Trust hired Stephen Andress as global headof derivatives operations (he previously fulfilled a similarrole at Commerzbank). Northern Trust has seen 30%compound annual growth in OTC derivatives volumeamong custody clients for the last three years, but growth isaccelerating: the bank processed as many contracts in thefirst quarter of 2006 as in all 2005.

Northern Trust is building a complete collateralmanagement platform and expects to tap existing custodyclients in the first instance. “We have their trade details.Now we can take this process out of their back office anddeliver it more cost effectively,”Andress says,“I think that isgoing to be attractive to a lot of people, that they won’thave to deal with these issues.”Once the infrastructure is inplace, the marginal cost of adding new clients will be low— as it is for most custodian bank services.

Collateral managers either have or are developingsystems to track trade details and contract administration.The Depository Trust and Clearing Corporation (DTCC) iscompiling a trade data warehouse for CDS and has plans toextend the project to other OTC derivatives. Althoughcollateral managers applaud the initiative, it will not helpthem much until the warehouse covers the whole suite ofderivatives and includes a valuation service.

Even then it will only help if both parties trade throughDTCC – and at the moment market participants use DTCCmainly for CDS, according to Andress.“The portfolio you arecollateralising usually includes all types of trades so you areonly getting part of it from the trade warehouse,” he says.The ISDA master agreement governs collateral between twocounterparties, so automating one class of contracts won’tsave much time if people still have to get on the phone everyday to resolve valuation discrepancies in other parts of theportfolio. Differences arise not only from pricing but alsopopulations: the contracts each counterparty is trackingunder the ISDA master agreement may not match – aproblem that has bedevilled the industry’s efforts to work offthe confirmation backlog in OTC derivatives. Andress saysISDA is working on an electronic protocol to facilitateportfolio matching between counterparties.

Singing from the same hymn sheet would not eliminatevaluation disputes, however. Accepted pricing algorithmsexist for plain vanilla derivatives contracts, but valuingnewer contracts like structured products is complicated.“It’s like flying blind. If they do not know the exactly whatthe price might be, the brokers over-collateralise,” saysDushyant Shahrawat, a senior analyst at Tower Group,consultants to the financial services industry based inNeedham, Mass.

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Jim Malgieri, managing director andproduct manager for global collateralmanagement at BNY thinks thatgovernment bonds require less capitalthan asset-backed securities, forexample.“Collateral managers willhave to monitor concentration limitsand sort through highly-rated paperversus unrated paper,” he says.Photograph kindly supplied by Bankof New York, October 2006.



Shahrawat does not expect a bigpush to automate collateralmanagement for OTC derivatives foranother two to three years. Volumesare still modest compared tosecurities lending and repo and whilemargins for OTC derivatives remainhigh dealers have less incentive toautomate an already profitablebusiness. A lack of software hampersthe effort, too; relatively few vendorshave developed products for what isstill a young market.

That is starting to change,however. Automation took a bigstep forward in 2005 whenJPMorgan introduced itsCommanD product, driven bySunGard’s Adaptiv software anddesigned to handle OTCderivatives through the entire lifecycle from settlement to maturity.“It’s a compelling proposition forboth existing and target clients,”says Bhatia. “As the first player inthe market to do this, we are anoutlier.”JPMorgan will not have themarket to itself for much longer,however. BNY is developing asimilar offering in partnership withanother software vendor.

Bhatia expects automation willimprove collateral utilisation as well.Once the people, technology anddata are in place, collateralmanagers can focus on calculatingthe thresholds, haircuts and triggersthat address credit and counterpartyrisk. “Without such infrastructure,participants may make decisionsbased on limitations on their abilityto manage a diverse collateral setrather than risk based parameters,”Bhatia says.

Automated systems wouldfacilitate collateral calculationsacross asset classes, although neitherJPMorgan nor BNY has seen ademand for that service yet. Bhatiabelieves the market will move in thatdirection as firms seek to optimisetheir collateral and free up capital todeploy in other investments.

For now, prime brokers offercross-asset class collateralisationonly to their largest hedge fundclients. At most dealers, repo,

designed to handle OTCderivatives through the entire lifecycle from settlement to maturity.“It’s a compelling proposition forboth existing and target clients,”adds Bhatia. “As the first player inthe market to do this, we are anoutlier.”JPMorgan will not have themarket to itself for much longer,however. BNY is developing asimilar offering in partnership withanother software vendor,”he adds.

Equally, at most dealers, repo,securities lending, futures and OTCderivatives are separate businessunits, according to BNY’s Malgieri.“Even internally the organisationshave difficult time moving collateralaround among those internal units,”he says,“It’s almost viewed as stand-alone.” Linden points out that theindustry has no umbrella agreementfor cross collateralisation, either, sodealers who do offer the servicehave to develop their own legaldocuments and negotiate the termswith each client.

Brad Bailey, a senior analyst atAite Group, a research firm basedin Boston, Mass., expects hedgefunds, which are always trying toimprove their return on capital, willcontinue to push for measures thatincrease the efficiency of theircollateral, including firm-widecollateral calculations. He seesmore talk than action so far, butbelieves collateral managers couldgain a competitive advantage ifthey develop the capability.

Hedge funds are on the cuttingedge, of course, but traditionalmoney managers may pose abigger challenge – and opportunity– for collateral managers. “Whathas suddenly come upon us is therapid increase in the use of OTCderivatives by a greater range ofplayers,”Bailey says.

The day may come whencustodians who develop OTCderivatives collateral managementplatforms to serve money managersapply their newfound skills toencroach on the traditionalsecurities lending and repo turf longdominated by JPMorgan and BNY.

Lou Lucido, group managing director,TCW CreditMortgage Group, a leading manager of collateraliseddebt obligations, says,“We are looking for assets that

cannot be credit impinged …You do not want tohave an underlying obligation which is supposed to

be credit secure develop credit volatility.” Indeed, ifanything happens to impair a collateral credit TCWinsists the CDS counterparty replace that bond with

top rated paper. Photograph kindly supplied by TCWCredit Mortgage Group, October 2006.

Stephen Andress, global head of derivativesoperations at Northern Trust, has seen 30%

compound annual growth in OTC derivativesvolume among custody clients for the last three

years, but growth is accelerating: the bankprocessed as many contracts in the first quarter of

2006 as in all 2005. Photograph kindly suppliedby Northern Trust, October 2006.



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Over the past several years, the volume of corporate-actions messaging on a global scale hasincreased significantly. At the same time it has created a completely new set of challenges forcustodians and others entrusted with relaying crucial information to the end user on time anderror-free. While technological solutions continue to be bandied about, experts underscore theneed for greater harmonisation and increased commitment from all parties involved. Dave Simonsreports from Boston.

The power of

technologyWith corporate-actions volume doubling since 2003, key players have

championed continued investments in automation technology aimed atreducing the manual transmission of news feeds via fax and other hard-

copy components, while eliminating redundant sources of information.And with good reason. Photograph by Kokkinis Konstantinos, supplied

by Dreamstime.com photography agency, October 2006.



AS UNIT DIRECTOR of global corporate-actions forBoston-based Investors Bank & Trust, TomBroderick has been at the forefront of a growing

movement to streamline the manner in which corporate-actions news — including stock splits, buybacks,reorganizations, mergers and the like — is disseminated.“We like to believe that one day we will all be able to cometo work, just push some buttons and everything will betaken care of,”says Broderick with a casualness that beliesthe challenges that lay ahead.“It is wishful thinking, but weare making strides toward that goal.”

The inception of the International Standard ISO 15022corporate-actions event types six years ago provided theindustry with a globally recognised mechanism to begin toautomate the various links in the corporate-actions chain.To date, the industry primarily utilises only two of the fivemessage types — MT564 (notification) and MT566(confirmation). Moreover, in an effort to increaseawareness as well as encourage greater use of the SWIFTnetwork, the corporate-actions division of the SecuritiesMarket Practice Groups (SMPG) recently finalised its EventInterpretation Grid, which provides definition and addsclarification for all 15022-message types.

With corporate-actionsvolume doubling since2003, key players such asBroderick championcontinued investments inautomation technologyaimed at reducing themanual transmission ofnews feeds via fax andother hard-copycomponents, whileeliminating redundantsources of information.And with good reason.While actual loss estimatesvary, among globalcustodians, corporate-actions related operationalrisk remains a majorsource of concern.Additionally, a new reportby British consulting groupOxera, in conjunction withthe Depository Trust &Clearing Corporation(DTCC), found that eventhe most seeminglyinnocuous corporate-action events can have asignificant impact ontrading, as reflected in share price, volume and volatility.

Yet, despite efforts to address inefficiencies and achieve asatisfactory level of straight-through processing (STP),corporate-actions remains a manually intensive practice,with operational issues exacerbated by regional variationsand a lack of a universally accepted set of standards.“Thereis an obvious interest among global custodians in reducingthe time and expense associated with providing corporate-actions information to clients and processing corporate-actions related transactions,” says Amy G Harkins, seniorvice president and director of global asset servicing forMellon Financial. “The parties with the most at stake arethe owners of the securities associated with corporate-actions, so it is hardly surprising that broker dealers andasset managers are playing a primary role in pushing theindustry toward better solutions.”

Automation campaignResponding to the demand for innovative technologies,leading companies such as TCS and Xcitek have beenjoined by a growing list of upstart vendors that includeCheckFree, SmartStream, GoldenSource and InformationMosaic. They all now provide third-party software

applications covering theentire spectrum ofc o r p o r a t e - a c t i o n sprocesses. “We subscribeto seven or eightelectronic vendors, withthe idea that the moreproviders of thatinformation you have,the less chance thatsomething is going to bemissed,” says Broderick.“Of course, the Internethas also been incrediblyhelpful, just in terms ofbeing able to access thewebsite of a company,depository or stock-exchange to sometimesto second source thatdata. Our philosophy isthat we are not going tosend out a notice to ourclients unless it has beenproperly validated by atleast two commerciallyrecognised vendors.”

At Mellon, the use ofimaging allows clients tonot only receivenotification of acorporate-action eventbut also the supportingdocumentation. Thisallows them to act with

Justin Chapman, senior vice president, process management worldwideoperations at Northern Trust says,“Historically corporate-actions has been a

very manual process. Because of the number of variants within the majorregions—including all of the different event types requiring all sorts of paper

disclaimers and so forth—the cost of achieving automation is very high.”Photograph kindly supplied by Northern Trust, October 2006.



the best information possible. “We see these kinds ofenhancements as an extension of our commitment to clientservice, and as an important part of executing on ourstrategy of differentiating ourselves on the basis of ourtechnology,”says Harkins.

Experts agree that a significant infusion of investmentcapital aimed at boosting automation services will berequired in order to address fundamental weaknesseswithin the corporate-actions chain. A report by consultinggroup Celent estimates that automation related spendingcould approach $1bn by the end of the decade.“Historicallycorporate-actions has been a very manual process,”says Justin Chapman, senior vice president, processmanagement worldwide operations at Northern Trust.“Andbecause of the number of variants within the majorregions—including all of the different event types requiringall sorts of paper disclaimers and so forth—the cost ofachieving automation is very high.”

Chapman, who chairs the European corporate-actions

working group for the IndustryStandardisation for InstitutionalTrade Communication (ISITC), saysthat developing industry widestandards is a crucial part of theautomation initiative. “We areworking directly with the clients inorder to educate them and helpthem incorporate SWIFT messagingor use their proprietary solutions,which gives them risk reductions intheir own operations as well asgiving us a level of STP for thingssuch as decision capture.”

Even if standardisation were tobe achieved, idiosyncrasies maystill exist that most likely wouldhave to be dealt with on a case-by-case basis, says Broderick.“Onmessage notification type 564, forinstance, there may be somedifferences among the variousplayers regarding the treatmentof options. Right there, you havethe potential for all thatautomation to go right down thedrain. It may just be that whenyou have some naturaldifferences and can’t reach amutual agreement, that event justgets marked with an asterisk.”

At last summer’s ManagingGlobal Corporate-Actions Processingconference, Harkins, who served aschairperson, addressed the issuedirectly. “We all need to decidewhat we are going to callsomething, and then call it that,”he

said. “Event names differ; issuers give something onename, and then it is held as something else. Let us all justcall it the same thing.”

The issuer’s issueAt present, the job of sanitising the fundamental dataelements in corporate-actions communications is primarilyup to organisations such as Northern Trust and other largeglobal custodians, says Chapman, who must act asconsolidators of information, taking multiple data feedsand creating a “prime record” of information of thecorporate action event. While the investment manager is,to some degree, responsible for making the right decisionshould the client not properly understand or misinterpretsthe corporate-actions instructions. “The liability modeltends to sit in the middle of the equation, not at eitherend,”says Chapman.

Accordingly, many believe that the push for corporateaction efficiency should begin at the top of the corporate-

Tom Broderick, unit director of global corporate-actions for Boston-based Investors Bank & Trust,has been at the forefront of a growing movement to streamline the manner in which corporate-

actions news—including stock splits, buybacks, reorganizations, mergers and the like—isdisseminated.“We like to believe that one day we will all be able to come to work, just push some

buttons and everything will be taken care of,” he says. Photograph kindly supplied by InvestorsBank & Trust, October 2006.

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actions ladder—beginning with the issuer. “The singlegreatest obstacle in the way of improving the handling ofcorporate-actions in the US continues to be the reluctanceof issuers to establish a standardized, ISO-compliantformat for reporting corporate-actions,”maintains Harkins.“We need to be mindful of the law of unintendedconsequences in looking at third-party solutions—none ofus wants to see the industry take one step forward in termsof a standardized format for corporate-action messages,only to take two steps back in terms of adapting that formatto a myriad of competing solutions.”

To that end, proponents have been pushing for issuerguidelines that might include setting time limits on eventnotifications, or establishing a minimum data requirement fortender offers. Still, without the presence of a governing body,issuers cannot be held accountable from a punitivestandpoint, leaving sub-custodians and others along thecommunications chain bearing the brunt of the risk.“As theyare not party to the actual process, and without any currentregulation, it is true that there is minimal incentive for issuersto get on board at thispoint,” says Chapman.Attacking the problemon a global scale isdaunting, to say the least.However, Chapman seesprogress being maderegion by region. “InEurope, we are using theessence of theGiovannini G30 reportsin order to promoteconsistency of messagingfrom the issuer to aninvestor and back to theissuer, using an industrystandard for messaging.”If the industry cannotmove sufficiently says Chapman, someform of pan-Europeanlegislation may need tobe adopted.

Broderick believes itwill be something of achallenge to get all theissuers on board.“Unless you canestablish greaterharmonisation thatmakes it possible formultiple markets totrade together andsome level ofconsistency is created,you won’t have theability to govern a

broader spectrum of the market,”he says.“It is going to betough, but I think we need to make the effort. Becauseeveryone realises that this is the point where it all begins.”

Clearly it is in the issuing company’s best interest toaddress any potential breakdown in information transferfrom the point of origin, adds Chapman.“By streamliningthis part of the process hopefully sometime in the nearfuture, it will really be a win for everyone else.”

Europe takes the leadUnlike in Europe, where multiple-market variants haveaccelerated the need for modernisation in order to reducethe level of actuarial risk, the relative stability within the UShas made the move towards automation andstandardisation a much tougher sell. Despite the potentialfor incurring catastrophic losses, a report recently issued byconsulting firm TowerGroup asserts that regulatoryintervention may be required before a definitive set ofstandards is adopted within the industry.

“One of the ironies surrounding the search for moreefficient ways to handlecorporate-actions is thegreat success we haveachieved as an industry,handling corporate-actions issued bycompanies registered oninternational exchanges,compared with the slowprogress the industry ismaking with companiesregistered with USexchanges,” remarksMellon’s Harkins. Tosome degree a reflectionon the more pervasive useof SWIFT messagingoutside of the US, saysHarkins is required.

“Attributing the lack ofprogress here in the US toresistance on the part ofissuers to buy into SWIFTbegs the question as towhy we cannot come upwith a better solution,”shesays. “It is clearly in theinterest of all parties tohave corporate-actionshandled more quickly andefficiently. As the efficiencyvariance between the USand global marketscontinues grow, thepressure to find a bettersolution here in the US issure to intensify.”

Amy Harkins, senior vice president and director of global asset servicing forMellon Financial thinks that “the parties with the most at stake are the

owners of the securities associated with corporate-actions, so it is hardlysurprising that broker dealers and asset managers are playing a primaryrole in pushing the industry toward better solutions.” Photograph kindly

supplied by Mellon Financial, October 2006.



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HJ Heinz chief executive officer William R. Johnsongestures in his office in Pittsburgh, Monday, July 25, 2006.

Johnson has consistently defended his company’srestructuring efforts in recent years and dismissed as

unrealistic profit demands by a group led by billionaireinvestor Nelson Peltz. Photograph taken by Gene J. Puskar,

supplied by EMPICS/Associated Press, October 2006.

Until recently, HJ Heinz had been a source of frustration for its shareholders; its stock movement asstubborn as a full bottle of its famous ketchup. That is until one highly ambitious dissident investordecided to take on the board of directors — and at long last, things are looking up for thecondiment company. Coincidence? From Boston, Dave Simons reports.

FOR OVER A century, the name Heinz has been afixture at roadside bistros and ballpark concessionstands, its ubiquitous “57 Varieties” logo as American

as cheeseburgers and fries. But in Pittsburgh, where HenryJohn Heinz Company first set up shop 134 years ago, Heinzhas come to mean much more than beans, ketchup, or tatertots. During football season, Steelers fans take in the actionfrom Heinz Field, while a few blocks away the world-classPittsburgh Symphony Orchestra performs in theacoustically superior Heinz Hall. In a city still reeling fromthe demise of the once-powerful steel industry, Heinzremains an integral part of the region’s economic vitality,and is regarded as one of the last great vestiges of goodold-fashioned business loyalty.

Earlier this year however, that traditionalism came face-to-face with 21st-century shareholder activism when agroup of dissident investors, led by billionaire Nelson Peltzof Trian Fund Management LP, squared off against Heinz’sboard of directors in an effort to revamp Heinz’s ailingbusiness model. Following a rancorous proxy battle, Trian,which is Heinz’s second-largest shareholder, succeeded inousting incumbent directors Peter Coors, vice-chairman ofMolson Coors Brewing, and Mary Choksi, managingdirector of Strategic Investment Partners, in favour of Peltz’scolleague Michael Weinstein, a former executive withbeverage maker Snapple, and Peltz himself. Trian membersreceived backing from such influential proxy advisory firmsas Institutional Shareholder Services (ISS) and Glass Lewis.

THE BATTLE FOR

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It is not the first time that Peltz, a noted turnaroundexpert, has been down this road. In 1997, Peltz snapped upSnapple for $300m, and then sold the company three yearslater for a cool $1.5bn. In recent years, restaurant chains thatinclude Cracker Barrel, Arby’sand Wendy’s have been partyto Peltz’s singular brand of“operational activism.”

The battle for Heinz is thelatest in a series of initiativesby mega-investors such asCarl C Icahn and KirkKerkorian, who, like Peltz,have secured large positionsin public companies in orderto influence board membersand make their mark onfiscal policy. While theiraggressive strategies—whichoften include massive labour cuts and reductions in capitalexpenditures—can yield positive results and boostshareholder value, critics see a significant downside,including, in the case of Heinz, the potential displacementof a regional icon.

Seeing redAfter trading near $60 during the high-flying late 1990s,over the next several years Heinz’s stock began its ketchup-like descent, losing nearly half its value as the companystruggled to find its feet. Although its shares had recoveredslightly by the start of this year, David Nelson, food analystfor Credit Suisse, noted that Heinz still ranked below everylarge-cap US-based packaged foods company except SaraLee in terms of sales per employee and sales permanufacturing facility.“This is still an inefficient company,in our view,”added Nelson.

Enter Peltz, longtime partner Peter W May and variousother confidantes from Peltz’s Trian Group, an investment-management firm that seeks to revamp under-performingcompanies through aggressive hands-on involvement. Inearly 2006, Trian took up a 5.5% position in Heinz, andthen began its dissident campaign in earnest. Using a seriesof meticulously crafted white papers, Peltz laid out his planto address Heinz’s listless shares and lacklustre financials:buy back stock, cut spending by $575m, sell assets, andraise dividend payments. At the same time, Peltz proposedboosting the visibility of core products such as HeinzKetchup and A1 Steak Sauce while cutting allowances toretailers by $300m.

To underscore his message, a letter was issued to Heinzshareholders, stating, “The sad reality is you would havebeen better off financially keeping your money in apiggybank than investing it in Heinz stock.”

Taking understandable umbrage, Heinz CEO WilliamJohnson argued that Peltz’s plan went too far, too fast andrevealed a distinct lack of understanding of the company’sprinciples and history. Johnson maintained that his board

had all intentions of making their business plan work.“Weare confident that we have the brands and the people tobuild on our business momentum and create a strong andprosperous future for Heinz,” said Johnson. In the three

years leading up to Peltzarrival, Johnson noted thatmanagement had“dramatically transformed”the company, which hadexceeded the performance ofthe S&P Packaged Foodspeer-group through theperiod with an 18.9% totalshareholder return. Inanticipation of August’sproxy vote, Heinz initiated ano-holds-barred publicrelations campaign thatincluded a $14m advertising

blitz dubbed “Project Steelers,”aimed at shoring up supportamong company shareholders.

Had Heinz been more assertive in years past, theencounter with Trian could have been avoided altogether,argues Dominic Jones, principal of ClarityCommunications of Canada Inc. and the founder of IRWeb Report. According to Jones, such proxy fights are aprime example of what can happen when companies donot properly convey their business intentions toinvestors. “They become sitting ducks, easy targets forpeople who know how to exploit situations wherecompanies have failed to earn the support andunderstanding of their shareholders,” says Jones. In arecent review of Heinz’s online investor-relationscommunications conducted by Jones’ firm, Heinz rankeda poor 44th out of 51 consumer-staples sector firms.“While the company was probably complying with everysecurities law it was required to,” observes Jones,“it justwas not communicating.”

Although most observers believed Heinz’s business planwas in need of repair, not everyone agrees that Peltz is theright man for the job. Nell Minow, editor of the CorporateLibrary, a research company that promotes shareholderrights, cautions against casting Peltz as “the lone ranger, theguy who is going to come to town and make everythingbetter,’’ and instead calls the Trian Group a case where “thecure is worse than the disease.” Noting Peltz’s history ofbuying, fixing and then flipping companies for a substantialprofit, Minow concurs,“He’s been better at taking care ofhimself instead of other shareholders.”

Peltz’s choice of nominees, which included son-in-lawEd Garden, another Trian partner, as well as close friendgolfer Greg Norman to the board of directors at Heinz,raised more than a few eyebrows within the industry. In aletter to shareholders, CEO Johnson and presiding directorThomas Usher called Peltz’s group “a self-interested votingbloc” that “cannot be expected to fairly represent theinterests of all Heinz shareholders.”

To underscore [the] message, aletter was issued to Heinz

shareholders, stating, “The sadreality is you would have been betteroff financially keeping your money in

a piggybank than investing it inHeinz stock.”



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ISM Yet it appears that Peltz has been at least partiallysuccessful in selling his bill of goods to Heinzmanagement. Though not nearly as deep as Peltz hadproposed, in June Heinz management announced it wouldcut 2,700 jobs over the coming year, or roughly 8% of itstotal workforce, resulting in savings of over $355m over atwo-year period, and will close several plants in 2008. Atthe same time, Johnson announced a 17% increase inHeinz’s dividend payment, along with a $1bn increase toits existing buyback program.

“If we lived in a vacuum, we probably would side with Peltz’sinterests,”notes Ted di Stefano of Rhode Island-based CapitalSource Partners.“The fact is that other issues are involved, suchas the possible number of employees who would be laid off,and the reduction of pension benefits to retirees. Also,community interests may not be well served.” Besides, saysanalyst Christopher Growe of AG Edwards, “Firing everysalaried employee still would not produce the $400m in SG&Asavings that stood as thecentral theme of the Trianplan, casting some doubt onits legitimacy.”

Peltz spells resultsIn the aftermath of theHeinz proxy vote, analystssay the issue is not so muchabout how many seats Peltzand company secured, butthe overall impact on thecompany as a result of theinitiative. At least for thetime being, the charts

speak in Peltz’s favour. In the three months since Triansecured its stake in the company, Heinz’s stock has movedup an astonishing 35%. It is not an isolated case, sayobservers, who note that while proxy contests often fail toseat any dissidents at all, on balance share prices usuallyjump a good 10 percent during the proceedings.

Meanwhile, the company reported 2006 first quarterearnings of 58 cents a share, some five cents ahead ofexpectations, with profit totaling $194.1m (versus 45 centsand $157.3m, respectively, for the year-ago period). Thecompany is confident it will achieve 10% earnings growth forthe full year, according to Heinz spokesman Michael Mullen.

“Behind all the name-calling and finger-pointing,something positive is going on,” notes columnist RachelBeck. “Heinz is being forced to rethink the way it doesbusiness — its operations and its accountability. Thatcould make it a better company in the long run.”By forcingmanagement to come up with a plan of action thatenables the business to operate more efficiently,“Peltz hasmade it nearly impossible for Heinz’s executives or boardto hide behind promises of change that then fail tomaterialize,” says Beck, adding that Heinz is in a muchdifferent position now than it was just months ago.“All ofthat is good news for investors, who have suffered while

the company’s previous restructuring moves fell flat.”While he disagrees with Peltz’s strong-arm tactics,

Credit Suisse’s Nelson gives kudos to Trian for acceleratingthe company’s containment campaign, which, saidNelson, “has boosted share price and called attention tocompany weaknesses.”

The dissident-investor trend underscores the belief that allboards should have independent members, maintainsCapital Source Partners’ Di Stefano, who can act as the eyesand ears for the average stockholder. Di Stefano cites recentstudies that show that corporations with strong independentdirectors typically fare better than those without independentrepresentation in terms of profits and corporate governance.

“The days of the directorship as sinecure — a tradition thatallowed directors to sit back and collect fat fees for minimalservices — are gone,”notes Di Stefano in a recent commentaryin E-Commerce Times.“Directors must be vigilant and active.There is simply no other way.The bottom line, as I see it, is that

dissident directors,assuming that they areacting in a professionalmanner and are not simplybeing gadflies ormalcontents, are muchneeded on today’s boardsand in today’s regulatoryenvironment. Therefore, Ilook at dissidence as apositive thing that helpsprotect the shareholders of acompany. Hopefully, theshareholders will be all thebetter for it.”

Nelson Peltz of Trian Fund Management LP,Heinz’s second-largest investor, sits amongshareholders before the annual meeting inPittsburgh on Wednesday, August 16th, 2006.Photograph by Keith Srakocic, supplied byEMPICS/Associate Press, October 2006.

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PRIM

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APRIME BROKER USED to be what the nameimplies: a central custodian of a hedge fund’sassets that processed all its trades, financed

positions, arranged stock loans and provided reportstracking the entire portfolio. Hedge funds had only a littleleverage over their chosen broker and paid the freight asa cost of doing business.

Not these days. The bigger funds today have multipleprime broker relationships, sometimes playing firmsagainst one another to get better terms. Adam Sussman, asenior analyst at TABB Group, suggests funds typicallybranch out when assets reach about $500m.“Managers donot want to be completely dependent on one serviceprovider,”he says,“They use the secondary relationship asleverage and as backup in case the communication linkwith the original firm fails.”

Prime broker relationships tend to proliferate as fundsgrow larger and move into additional strategies, assetclasses or geographic regions. Sussman says a managermay end up using five or six firms for a while, but once thefund matures the number starts to drop.“They want to pickbest of breed,” he says, “They consolidate most of theirprime broker business back down with three or four firms.”

The switch to multiple prime brokers opens the door tonew entrants, of course. Credit Suisse has made inroads byoffering a full range of services to a select group of fundsthat are either already well established, or which the firmbelieves are poised for rapid growth. For the last threeyears, its prime broker assets have increased at triple therate for hedge funds overall, according to Philip Vasan, headof prime services at Credit Suisse. At a time when hedgefunds have extended their reach into international markets,a global footprint has helped Credit Suisse, Deutsche Bank,and UBS build market share.

With only 400 managers in its stable by design—lessthan a third the number at the big three, estimates Vasan—Credit Suisse aims to provide its clients high focus andknow their evolving needs well. The bank takes a creativeapproach to financing, too, an important competitive edgeas hedge funds move into less liquid asset classes.

Although the three leaders have lost market share,Edward Hawthorne, a partner at Capco, a financial servicesresearch and consulting firm, estimates that MorganStanley, Goldman Sachs and Bear Stearns still controlabout 60% of prime brokerage revenues and assets. Hebelieves that new players have muscled in by focusing on

Bangles,BaublesandPrime Brokers

Like merchants of yore ingold rush towns who madetheir fortunes selling shovelsand pickaxes to aspiringminers, prime brokersprovide essential services tohedge funds – and makemore money than all buttheir most successful clients.The growth in hedge fundassets has brought newplayers into a business longdominated by three firms inthe United States, namelyMorgan Stanley, GoldmanSachs and Bear Stearns. Thegood times just keep onrolling as the ever evolvingrequirements of hedge fundsas they push into newmarkets becomes ever morecomplex and despite growingpressure on margins.



particular niches. Deutsche Bank andCredit Suisse have specialised insynthetics, for example; while SociétéGénérale and BNP Paribas instructured products. These firms haveleveraged their existing capitalmarkets expertise to win primebroker mandates.

San Francisco-based MerlinSecurities has focused instead on itsmulti-prime performance attributionreporting capability. “When wecreated the company (in 2004) wethought we could add value byproviding the most advancedreporting technology in thebusiness,” says Stephan P Vermut,Merlin Securities’ chief executiveofficer (CEO). Merlin has reportingcapability including “attributionreporting,” explains Vermut, whichallows the hedge fund to attributeexactly where it made excess returns.Not only that. Hedge funds will beable to determine exemplaryperformance relative to underlyingmarket dynamics. Merlin Securities’platform can handle any asset classand is multi-currency, says Vermut.The icing on the cake however,according to Vermut, is that itsproprietary systems allows multi-prime hedge funds to calculateexactly how much risk they took inimplementing a buy strategy.“Beingable to calculate the beta and excessreturn of a particular portfolio versusan index such as the Russell can helpfirms better manage both theirportfolio as well as operationalissues.” As a prime of primesMerlin’s system gives the portfoliomanager full transparency, on anaggregated level, and by account,across all of a fund’s multi-primebroker relationships.

Market acceptance may hinge inpart on whether hedge funds will beable to cross-margin positions held atdifferent prime brokers. Hawthorneacknowledges that some primebrokers are still struggling tointegrate margin and netting acrossdifferent asset classes, a capabilityclients have long sought. “Cross-margining creates a strongerargument for consolidating with a

single player,” he says. If a primebroker combines its margincalculation – including OTCderivatives and structured productsas well as equities and fixed income –clients need less capital to supportcomplex hedged positions.

Getting multiple prime brokers toaccept margin based on positionsheld elsewhere will be a tall order,however. “These OTC derivativespresent risk and credit issues with asingle prime broker,”says Brad Baileya senior analyst at Aite Group, aresearch firm based in Boston,Massachusetts, “As you get tomultiple prime brokers it becomeshard to see where exactly theexposure is and get a global picture ofthe risk.” Regulators may take somepersuading, too; a complex hedgemay survive a volatile marketunscathed overall but a losing legcould leave a particular prime brokerunder-collateralised.

Prime brokers traditionally lendagainst assets held in custody. Theyrun daily “what if” scenarios tomeasure how client portfolios wouldperform in a volatile market. For riskmanagement purposes, prime brokerswant to be sure a forced liquidationunder adverse market conditions willcover any outstanding loans. Ascompetition heats up, though, creditstandards may be slipping. A sourceat Morgan Stanley complains thatsome new entrants will lend againstilliquid assets and demand lesscollateral against traditional assetclasses, too. He suggests the upstartsare providing credit-driven unsecuredloans rather than conservative asset-based financing.

That may be just sour grapes froma leader feeling threatened. JonHitchon, global head of primeservices at Deutsche Bank, believesthat hedge funds’ move into exoticassets and international marketsplays to the strength of global bankslike Deutsche. Clients who seekfinancing for new asset typesrecognise that a single transactionthat stays on the books for threemonths does not justify the work abank has to do on research, valuation

Adam Sussman, a senior analyst at TABBGroup, suggests funds typically branch out

when assets reach about $500m.“Managersdo not want to be completely dependent on

one service provider,” he says,“They use thesecondary relationship as leverage and as

backup in case the communication link withthe original firm fails.” Photograph kindly

supplied by TABB Group, August 2006.

Brad Bailey a senior analyst at Aite Group, aresearch firm based in Boston, Massachusetts

says that: “As you get to multiple primebrokers it becomes hard to see where exactly

the exposure is and get a global picture of therisk.” Regulators may take some persuading,too; a complex hedge may survive a volatile

market unscathed overall but a losing legcould leave a particular prime broker under-collateralised. Photograph kindly supplied by

Aite Group, August 2006.



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and obtaining a validsecurity interest. “Clientswill reward us by shippingin easier financing businessas a quid pro quo for thevalue we have added,”Hitchon explains.

He finds client prioritiesvary by strategy. Statisticalarbitrage players focus oncost, speed of latency indirect market access,securities lending andconfidentiality, while multi-strategy managers wantleverage, cross-margining,letters of credit andsynthetic access to markets.Deutsche Bankaccommodates them all. Ineffect, banks are using theirbalance sheet muscle tograb prime broker assetsaway from the broker-dealers. Hitchon estimatesthat Deutsche Bank, UBSand Bear Stearns now haveroughly equal marketshares. US-oriented firmswith a weak internationalpresence have proved vulnerable as hedge funds allocate agreater percentage of their trading assets outside the USDeutsche Bank’s multi-asset cross-margin capability andrelatively simple corporate structure give the bank’sfinancing package a competitive edge, Hitchon says.

Financing long and short positions still delivers the lion’sshare of prime broker revenues, but firms have broadened theirservices in less profitable areas to keep pace. Execution servicesnow extend beyond US equities and bonds to internationalmarkets and derivatives. Prime brokers provide riskmanagement software andother technology support tohelp hedge funds meetdemands for greatertransparency frominstitutional investors. Theyorganise meet-and-greetevents at which hedge fundsand potential investorsmingle, too. “You are seeingmore wrapped-aroundservices from prime brokersas a means of differentiatingthemselves,” Bailey says.Vermut, who in fact,introduced the first cap introprogramme, thinks the choice

is starker.“I do not think thatthese days you should get intothe capital introductionsgame. You cannot have 500hedge funds and promisethem all you will raise moneyfor them,” he says. MerlinSecurities, explains Vermut isconcentrating on two keylevels of service: “helpinghedge funds grow theirbusiness and providingthem with top flightanalytics.” Merlin Securitiesraises money for its hedgefund clients through“working with a number ofstrategic, independentpartners,” says Vermut. “Itkeeps it clean and they getpaid only if they succeed.”

Most hedge fund strategiesemploy short selling so thechoice of prime broker oftendepends on its securitieslending prowess. Althoughprime brokers continue tounearth new sources ofsupply, the growth in hedgefund demand has driven up

the cost of “specials” – securities that are hard to borrow.“Specials have become very expensive for the hedge fundsand quite profitable for prime brokers that have that stock tolend,” says Bailey. Higher margins on stock lending partlyoffset pricing pressure in other parts of the business.

It is neither hard nor expensive to hedge market risk, ofcourse. Index futures, ETFs, options, swaps or even ashorting a portfolio of securities from the generalcollateral pool will do that. Most hedge funds generate asignificant part of their excess return from individual

shorts, however. If fundscannot borrow securitiesthat they either identify asovervalued, or which theyneed to hedge merger orconvertible arbitragepositions, the bottom linewill suffer. Worse,institutional investors willnot tolerate the fees hedgefunds charge for marketshort positions they couldreplicate at lower cost.

Securities lending is soimportant that Sussmanbelieves it contributes to theconcentration of hedge fund

Stephan P Vermut, Merlin Securities’ chief executive officer (CEO).Merlin has reporting capability including “attribution reporting,”

explains Vermut, which allows a hedge fund to attribute exactlywhere it made excess returns. Not only that. Hedge funds will beable to determine exemplary performance relative to underlying

market dynamics. Merlin Securities’ platform can handle any assetclass and is multi-currency, says Vermut. Photograph kindly

supplied by Merlin Securities, October 2006.

If you want to compete with thebig boys you have to have global

reach and provide executionservices, financing and securitieslending for a variety of different

asset classes,” says Sussman. Ofthe second tier full service prime

brokers, he sees UBS gainingmarket share based on its

extensive international network andinvestment in technology.



assets at the largest firms. (A recent Alphamagazine survey found that the top 100hedge funds account for two-thirds ofindustry assets.) “If you want access to shortsyou are not going to go to a small primebroker that doesn’t have the custodial assetsor the same pull at the larger custodianfirms,” Sussman says, “That is why the bigkeep winning.”

Even so, the big three are not resting ontheir laurels. They have invested heavily ininformation technology to accommodatethe proliferation of asset types andgeographic exposure. “If you want tocompete with the big boys you have tohave global reach and provide executionservices, financing and securities lendingfor a variety of different asset classes,”saysSussman. Of the second tier full serviceprime brokers, he sees UBS gaining marketshare based on its extensive internationalnetwork and investment in technology.

Although – or perhaps because – primebrokers make little money from thereports they provide to clients, qualityvaries dramatically from one firm toanother. Among the hedge funds TABBinterviewed, satisfaction with primebrokers’ technology and reporting variedfar more than for custody or clearingservices.“Some have been investing a lot of money in theirreporting capabilities and others have not,”Sussman says.

The quick and easy solution to hedge fund reportingmerely adds short positions to an existing system designedfor long-only portfolios. One telltale sign: a jerry-rigged long-only system thinks a long put is a long position. A report likethat is no help to a hedge fund trying to track its net marketexposure. In a true long/short portfolio accounting system –such as the system Morgan Stanley built from scratch 10years ago – long puts show up where they belong, with theother shorts. Morgan Stanley’s reports can also handlemultiple currencies, animportant feature as hedgefunds expand their tradingon major European andAsian bourses and inemerging markets.

Thanks to its integratedapproach, Credit Suisse candeliver long/short portfolioreports consolidated acrossmultiple asset classes andcurrencies, too.Vasan viewsintegration and innovationas weapons to gain marketshare. “We haveconcentrated in areas that

we think are going to be game-changers, where we feel wecan make some jumps ahead,”he says.

The enormous and increasing IT infrastructure required inprime brokerage raises the barriers to entry and tilts theplaying field in favor of the established firms. Althoughpricing has come under pressure from new entrants andthird parties that offer some services traditionally thepreserve of prime brokers – eSecLending in securitieslending, for example – profit margins remain robust.“Thereis not some bogey out there ready to take it down,”Sussmansays,“Prime brokerage is not coming under the same kind of

pressure as the equitytrading model.”

Prime brokers have iteven better than thoseold-time gold rushmerchants. When a goldvein ran out, theprospectors left town andthe merchants’ businessvanished. Asset flows intohedge funds show no signof abating, however – andif net inflows were to stop,prime brokers would coinmoney for years to comeoff the existing assets.

Philip Vasan, head of prime services at Credit Suisse says that for the last three years, thebank’s prime broker assets have increased at triple the rate for hedge funds overall. At a

time when hedge funds have extended their reach into international markets, a globalfootprint has helped Credit Suisse, Deutsche Bank, and UBS build market share.

Photograph kindly supplied by Credit Suisse, August 2006.

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Most of us could do with a makeover.Surprisingly, so too did the perennialy beautifulBarbie. Blonde, beautiful and according to themarketing blurb, brainy enough to run forpresident, Barbie’s future seemed full ofpromise. However, looks aren’t everything.Barbie and Mattel’s shareholders have notenjoyed the best of days over the last eightyears. Now, after a long overdue reorganisationand a key acquisition, Mattel and Barbie appearto be on the brink of a strong comeback. ArtDetman reports.

TOYTURNAROUNDTOYTURNAROUND

Mattel’s chief financial officer Kevin M.Farr says.“We have not connected with

consumers as well as we could have.” But heis encouraged by early reaction to this

season’s product, Barbie & the 12 DancingPrincesses, a $24.99 product that “is off to agreat start.” And do not forget the matching

horse and carriage set at an additional$32.99! Photograph kindly supplied by

Mattel, October 2006.



CHANCES ARE BOBEckert never thoughtthat running a toy

company would be sohard—especially one withiconic brands such asBarbie, American Girl,Tickle-Me-Elmo, HotWheels and Matchbox.After a 23-year career atKraft Foods, where he roseto chief executive, he joinedMattel, Inc., as chiefexecutive officer (CEO) in2000. At the time, thecompany was something ofa shambles. It had sufferedfrom two years of decliningearnings capped by asomewhat ill starredacquisition, in 1999, ofLearning Company, aconsumer-oriented softwarepublisher second in sizeonly to Microsoft.

Despite its hefty $3.4bnprice tag—equivalent to4.5 times revenues at thetime of purchase—Learning Company was adog, an agglomeration ofvarious companies thatproduced aging educational and entertainment CD-ROMs.As consumer interest shifted to DVDs and free Internetgames, Learning Company’s $30 titles ended up inretailers’ $5.99 bargain bins. Barely a year later Mattelpractically gave away Learning Company to a turnaroundfirm for $21.3m and a share of future profits.

This was not Eckert’s only problem. Barbie had comeunder attack by Bratz, a line of edgy, ethnically conflated andcontroversial dolls from privately held MGA Entertainment.Like Mattel, MGA Entertainment is a Los Angeles area toymaker but in 2000, it appeared to be more hip and farhungrier. “That was the first doll that was able to take onMattel,”says Richard Gottlieb, a New York-based consultant.

Mattel took 14 months to respond to Bratz, an eternity inthe toy business. Mattel’s My Scene line of dolls, whichhave various skin tones and whose facial expressions canbe altered to show different emotions, are successful—butat best have only halted the advance of Bratz. In America,which is becoming more ethnically diverse by the day,Barbie remains not only tall and slim but also white andblonde.“That is where her struggle is,”says Gottlieb.

Mattel’s numbers tell a sad tale. Revenues peaked in 1999at $5.5bn, recovering weakly to $5.2bn last year. Net earningstopped out at $553m in 2003, then fell in 2004 and in 2005and are expected to decline yet again in 2006, to $465m by

one estimate. Despite anaggressive stock buy-backprogram, earnings pershare fell two yearsrunning, from $1.25 in 2003to $1.18 in 2005. Forshareholders, the worstnews lies in the stock price.From a high of $45.625 in1998, shares dropped below$9 in 2000 and recentlytraded at under $20.

“We have beenchallenged in the pastcouple of years,”concedesMattel’s chief financialofficer Kevin M. Farr.“Our goal this year is tomake progress againstthat challenge.”

Mattel’s shareholders cantake heart in Barbie’s USsales, which rose slightly inboth the first and secondquarter. What is moreimportant is thereorganisation that Eckerteffected in October of 2005.He consolidated the USoperations of Mattel Girls& Boys Brands and the pre-school Fisher-Price Brands

into a single unit under Neil B. Friedman. As head of TycoToys, Friedman launched the fabulously successful Tickle-Me-Elmo plush stuffed bear in 1996. Mattel bought Tyco thefollowing year, folded it into Fisher-Price, and madeFriedman president of Fisher-Price.

Last year’s consolidation reduced headcount by morethan 200 and cut annual overhead by $10m. Perhaps moreimportant, it also allows Friedman—one of the industry’smost respected executives—to work his magic on theentire Mattel line, especially Barbie.

At the ripe age of 47, Barbie remains by far thecompany’s most important and most profitable product. IfMattel is to recover next year, the next edition of Barbie—created on Friedman’s watch and to be shipped in early‘07—must be successful. Barbie was introduced in 1959 byMattel’s co-founder, Ruth Handler, who adapted it from acollectible doll she had seen in Europe. With her adultcurves and super model proportions, Barbie made manyparents uneasy at first. “What made her successful was,when you looked past her measurements, that she reallydid empower little girls,” says Tim Walsh, a Florida-basedconsultant and game designer.“She has run for presidenttwice, been a NASA scientist, an astronaut, a NASCARdriver — just about any career you can imagine. She reallyhas allowed girls to envision themselves’ being anything.”

Bob Eckert, Mattel’s chief executive officer (CEO. Chances are thatEckert never thought that running a toy company would be so hard—

especially one with iconic brands such as Barbie, American Girl,Tickle-Me-Elmo, Hot Wheels and Matchbox. After a 23-year career atKraft Foods, where he rose to chief executive. He joined Mattel, Inc., in

2000. Photograph kindly supplied by Mattel Inc., October 2006.



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A decade or so ago, Barbie accounted for 30% of Mattel’ssales and 35% to 40% of earnings. However, says analystTimothy A Conder of AG Edwards & Sons,“Barbie’s saleshave been declining while a lot of other products in thecompany have been growing. Therefore, as a percentage ofrevenues, Barbie has been coming down in recent years. Weestimate that Barbie accounts for somewhere in the low tomid 20s as a percent of revenues and a little bit more as apercent [sic] of profits.”

Even in her weakened condition, Barbie remainsformidable, accounting for well over $1bn in sales eachyear.“We have lost market share,”admits CFO Farr.“But weare in business to gain market share. Barbie is the mostsuccessful toy brand in history. The Number One brand inthe toy industry today is Barbie. That is true globally, and itis true for every retailer—Wal-Mart, Target, Toys R Us.Moreover, it is the Number One Website for girls, with 54mhits per month on Barbie.com. So it is a very strong brand.”

Consultants such as Gottlieb and Walsh say Barbie lost herway in recent years because Mattel failed to createcompelling stories to go along with each year’s costumechange; stories that would make the doll fun. Farr agrees.“We have not connected with consumers as well as we couldhave.” Nevertheless, he is encouraged by early reaction tothis season’s product, Barbie & the 12 Dancing Princesses, a$24.99 product that “is off to a great start.”And do not forgetthe matching horse and carriage set at an additional $32.99!

Farr is even more upbeat about the tenth iteration ofElmo, named TMX for Tickle Me Extreme. In response to abelly rub, the doll not only laughs but also stands up, sitsdown, rolls over, and stands up again. “The product isblowing off retailers’ shelves,”says Jim Silver, co-publisherof Toy Wishes, an influential trade publication.“I know that

some stores are already sold out. It is going to be a toughtoy to find during this holiday season.”

TMX Elmo has a suggested retail price of $39.99; ten dollarsmore than last year’s far simpler Shout model. Because TMX isso complex, Silver believes Mattel may be able to manufactureonly 700,000 or so instead of the 1.5m units it has produced inpast years.“If you can sell another 800,000 pieces, you do notleave that kind of volume of the table,”Silver says.“So Mattel ismaking as many TMXs as it possibly can.”

Both Barbie & the 12 Dancing Princesses and Elmo TMXare on this year’s Toy Wishes list of the industry’s dozenhottest toys, along with Fisher-Price’s Kid-Tough DigitalCamera and Digi Makeover from Radica, a maker ofelectronic toys that Mattel is acquiring. Mattel is the onlycompany with four products on the list, evidence that it stillhas product magic. Alas for Mattel, MGA’s latest set ofBratz dolls, Forever Diamondz, has also made the same list.

The Kid-Tough Digital Camera and Digi Makeover wellillustrates two relentless and evidently unstoppable trendsthat affect all toy makers. First, children’s toys are becomingincreasingly high tech. “Kids consider cell phones toys,”says one analyst. The Kid-Tough camera, with a 1.3-inchliquid crystal display screen, is a real digital cameradesigned for the eager but clumsy hands of young children.The Digi Makeover product allows a young girl to take aphoto of her face, display it on her home TV and then alterit with more than 50 hairstyles.

Second, age compression has steadily shrunk thewindow for traditional children’s toys.“Kids grow up fasterthan they used to,”says Walsh, a father of two young girls.“Girls of 12, 13 and 14 years old used to play with Barbie.But as the years have gone by, kids have gravitated to morehigh-tech toys, and now many girls are done with Barbie bythe time they are only seven or eight years old.”

Walsh cites the example of Fisher-Price’s View-Master.“When it first came out in 1939, View-Master was a gadgetfor adults to look at the Grand Canyon and other places theycould not afford to visit in person. Over time, it evolved intoan item for teenagers—the lunar landings and all those1960s TV shows that teenagers loved. As years went on, theView-Master’s audience got younger and younger. It startedas an adult product and now is almost a preschool item. So,it is pretty amazing how age compression can affect toys.”

Mattel has responded by acquiring Radica, a relatively small($163m in annual sales) but highly regarded maker of high-tech toys for both boys and girls.“The fastest-growing categoryin the toy industry is electronic games,”says Farr,“and Radicahas done very well in creating innovative electronic games.They are one of the leading players in this area. Strategically,this acquisition makes a lot of sense for Mattel and from afinancial perspective, I think we have made a great deal.”

Net of Radica’s cash on hand, Mattel is paying $180m or$11.55 per share, a relatively modest 12% premium overmarket price. Citigroup’s senior leisure time analyst, ElizabethOsur, was surprised by the deal but likes it.“This acquisitionwill not make Mattel dominant in this market because ofRadica’s fairly small size. I think this is indicative of a greater

Mattel’s chief financial officer Kevin M. Farr.“We have lost market share,”admits Farr.“But we are in business to gain market share. Barbie is themost successful toy brand in history.The Number One brand in the toy

industry today is Barbie.That is true globally, and it is true for everyretailer—Wal-Mart,Target,Toys R Us. Moreover, it is the Number One

Website for girls, with 54m hits per month on Barbie.com. So it is a verystrong brand.”Photograph kindly supplied by Mattel Inc., October 2006.


willingness on Mattel’s part to acquire companies in order toenter market segments they are not now in [sic]. So, yes, I thinkwe could see other similar acquisitions. I think electronic toyswill become a more significant part of Mattel’s business.”

Osur and others expect that Mattel will be able to effectcost savings in terms of freight and other charges and alsoaccelerate Radica’s growth in many foreign markets whereMattel has established distribution channels.

Meanwhile, one of Mattel’s earlier acquisitions—the 1998purchase of Pleasant Company, a Wisconsin maker of thehigh-end American Girl line of dolls—continues to grow,approaching the half-billion-dollar mark in sales.The unit sellsdirect to consumers by mail order, over the Internet, and atthree elaborate American Girl retail stores, in New York,Chicago and Los Angeles.There are two lines of American Girldolls. Dolls in the historical group represent specific ethnicgroups and time periods, while the Here and Now dolls arecontemporary. At the retail stores, girls can buy not only dolls,doll clothes and doll furniture but also matching children’sclothes and books. Plus, each of the stores has a doll hospital,a theater for doll-related musical shows, and a restaurantwhere girls and their parents can enjoy a meal—with, ofcourse, the doll sitting on a special chair at the table.

It can be a pricey visit, easily topping $200.“You get whatyou pay for,”says Walsh, who has treated his daughters toa visit to the Chicago store.“The dolls are very high quality,and parents will spend the money for them because theyare so well made and have such a rich play pattern.”

Not many markets can support a full-fledged AmericanGirl Place, so the company is considering opening up to 20boutique stores over the next several years. Eckert is mumon how big these stores will be (the flagship stores are40,000 square feet) or where they will be located. An evenmore promising avenue is expanding overseas sales.“Some97% of the world’s kids live outside the United States, andcurrently only about 44% of our sales are outside theUnited States,”says Farr.“And that is up from 2000, whenwe were at about 31%. So there is a great opportunity forthis company to grow globally.”

Despite the reorganisation and Radica acquisition, WallStreet is taking a wait-and-see attitude generally. The toybusiness is, after all, highly volatile. The benefits from fallinggasoline prices may be more than offset by America’s rapidlycooling housing market. The just-in-time delivery schedulesof major retailers leave little cushion for bad weather or otherproblems. Even so, it appears that finally Mattel has gottenpast most of its recent problems, and in years to come perhapsshareholders can be as happy as TMX Elmo.


A selection of Mattel toys. The Kid-Tough Digital Camera and DigiMakeover well illustrates two relentless and evidently unstoppabletrends that affect all toy makers. First, children’s toys are becoming

increasingly high tech.“Kids consider cell phones toys,” says one analyst.The Kid-Tough camera, with a 1.3-inch liquid crystal display screen, isa real digital camera designed for the eager but clumsy hands of young

children. The Digi Makeover product allows a young girl to take a photoof her face, display it on her home TV and then alter it with more than

50 hairstyles. Photographs kindly supplied by Mattel, October 2006.



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It is all change in the geography of Asian sub-custody—partly because global players are changingthe rules of the game. Increasingly, clients are also selecting providers based on credit ratings, whereglobal players also have an advantage. In most cases, the choice of provider is not determined byprice, although service quality and range of products influence prices. Consequently, these days it ismore difficult for single market sub-custodians to make the required investment in overheads as theneed to invest in services and people is immense. Rekha Menon reports.

IN AUGUST THIS year, Westpac Banking Corporation,Australia’s fourth largest bank, announced its decisionto sell its sub-custody and clearing business to HSBC.

With assets under custody of over $300bn, Westpac wasregarded as a premier provider of sub-custody services inAustralia and New Zealand.

According to David Morgan, Westpac’s chief executiveofficer, the bank’s decision to exit out of a business which ithad been operating for over six decades was prompted by thedesire to focus only on areas where it could achieve asustainable comparative advantage. Custody, this indicates, isnot a business where the bank thought it could remaincompetitive. “We believe that custody is increasingly aninternational business and that natural owners require globalscale,”says Morgan. Global scale is something that the newowner certainly does not lack. HSBC operates in 37 marketsglobally in the sub-custody arena, and is responsible for

In Asia, apart from afew countries where there are

strong local sub-custodianbanks, such as Mizuho inJapan, DBS Bank in Singaporeand Maybank in Indonesia, itis the global providers with amulti-market presence in theregion that hold sway.Photograph by MicheleGoglio, provided byDreamstime.com,September 2006.

GLOBAL PLAYERSLINE UP TO

DOMINATE ASIANSUB-CUSTODY



servicing client sub-custody assets ofover $1trn.

The HSBC-Westpac deal isinteresting, not only because it makesHSBC the leading sub-custody andclearing player in Australia and NewZealand, but also because it capturesin a nutshell the key trends in the sub-custody business – the need for scalein order to survive and the growingdominance of global players. Thesetrends are well evident in theneighbouring countries of Asia aswell, where HSBC ranks among thelargest sub-custodians along withother international players such asStandard Chartered and Citigroup.

Among them, HSBC leads the rollsin terms of geographic reach in Asia,with a presence in over 20 countries,followed by the other two that have apresence in 17 and 15 countriesrespectively. Deutsche Bank, whichretained its Asian sub-custodybusiness after selling parts of its globalsecurities services business to StateStreet in 2002, too is another leadingplayer in the Asian sub-custody arena,and has its footprint across 13countries in the region.

Mike Sleightholme, head of directcustody and clearing, Asia Pacific atCitigroup global transactions services,says that the sub custody businessrequires scale, which is why multi-country, multi-region; sub-custodyproviders are much better placed tocompete than others.

Citigroup’s own efforts to increase its reach in Asiareceived a significant boost two years back when throughthe acquisition of ABN AMRO’s direct custody units inEurope and Asia, the global giant gained access to keycountries such as India, Indonesia, South Korea andTaiwan.“There are not too many single market providers ofsub-custody in Asia any more,”notes James Hogan, globalhead of custody and clearing at HSBC. “Earlier, severalbanks offered sub-custody in a single market. But now, ifyou do not provide sub-custody in more than one market,it is very difficult to effectively compete.”

In Asia, apart from a few countries where there arestrong local sub-custodian banks, such as Mizuho in Japan,DBS Bank in Singapore and Maybank in Indonesia, it is theglobal providers with a multi-market presence in theregion that hold sway.

One indigenous Asian sub-custodian that is hoping tobreak the mould is DBS Bank. DBS currently provides sub-custody and clearing services in Hong Kong and

Singapore, where it is the leading sub-custodian. Now,taking a leaf from the global players, the bank is pursuingan ambitious strategy of building a pan-Asian sub-custodypresence on the back of the regional retail and commercialbanking network that the bank is building. Rajan Raju,managing director and head of South and South East Asia,and head of global transaction services at DBS Bank, says,“As the markets in Asia grow deeper, there is a growingneed for regional sub-custody services. We aim to providea single point of contact to global custodians and fundmanagers for domestic and cross-border custody servicesacross the region.”

Notably, DBS hopes to carve a unique identify for itselfamong other pan-Asian sub-custody service providers.Unlike the global players, it is positioning itself as anAsian bank that understands the Asian market and itsunique requirements.

The biggest challenge in Asia says Raju, is that the equitymarkets are fragmented and there is no consistent

Rajan Raju, managing director and head of South and South East Asia, and head of globaltransaction services at DBS Bank, says,“As the markets in Asia grow deeper, there is a

growing need for regional sub-custody services. We aim to provide a single point of contact toglobal custodians and fund managers for domestic and cross-border custody services across

the region.” Photograph kindly supplied by DBS Bank, October 2006.



infrastructure and standards.This is a common refrain acrossall the multi-market players. Hogan of HSBC says,“One ofthe biggest challenges of doing business in Asia is thefragmented infrastructure and the different stages ofevolution of market maturity. Unlike Europe, there is nosimilarity between the markets.”The key from a sub-custodyprovider, he suggests, is therefore to provide a standardisedset of services and to have a single platform that providesproducts and reports that look and feel the same irrespectiveof the location.

Raju concurs,“Technology is the maincompetitive weapon tomanage the differentmarket conventions anddeliver a consistentservice across allmarkets.” DBS hasinvested in a custodyplatform which waslaunched early this year.This technology solutionfrom Tata ConsultancyServices, Raju adds, isuniquely designed to the

Asian context and will help give DBS a criticaledge by helping create a robust custodyproduct suited to the Asian market. Alongwith the right technology, Raju thinks that it isessential to have the right presence on theground. To that end, DBS has identified fiveother key markets over and above Singaporeand Hong Kong, where it plans to expand itsoperations. These markets are China, India,Indonesia, Korea and Taiwan. In the firstphase, DBS is targeting China, India andIndonesia where it has already applied forregulatory clearances and is investing inpeople and technology on the field to beginoperations by the end of this year. The othertwo markets will be targeted later.

Like DBS, other pan-regional sub-custodyproviders are also focusing their efforts oncreating on-the-ground presence in the mainmarkets. Citigroup for instance, opened itsoffice in Vietnam early this year.Sleightholme of Citigroup describes Vietnamas an exciting, fast growing market. “Thefundamentals of the Vietnam market are verystrong, just like China and India. The threemarkets Citigroup is very bullish about areChina, India and Vietnam.” Interestingly,opinions about the potential of individualdifferent markets among the key playersmight vary, HSBC’s Hogan for instance,mentions Korea and Taiwan too as marketsto watch out for, but all players are

unanimous in their focus on China and India.However, despite promising exciting growth

opportunities, both China and India offer radically differentexperiences. While India presents a more straightforwardgrowth story with its booming stock market, a solid base ofdomestic retail and institutional investors, steady growth inforeign investments and improving payment andsettlement infrastructure, the reality in China is verydifferent. Much of the focus on China is pinned on the

hope of an open financialmarket – in the future. TheQualified ForeignInstitutional Investor(QFII) programme, whichallows foreign investorsaccess to the Chinesedomestic A-share market,is still very restrictive whilethe Qualified DomesticInstitutional Investor(QDII) program, whichallows Chinese investorsaccess to foreign markets isyet to properly take off.

The domestic sub-

Mike Sleightholme, head of direct custody and clearing, Asia Pacific at Citigroupglobal transactions services, says that the sub custody business requires scale, whichis why multi-country, multi-region, sub-custody providers are much better placed to

compete than others. Photograph kindly supplied by Citigroup, October 2006.

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Global custodians make it big in Asia




custody space is dominated bythe so called ‘Big Four’ stateowned Chinese banks, includingthe Bank of China (BOC), theChina Construction Bank (CCB),the Agricultural Bank of China(ABC), and the Industrial andCommercial Bank of China(ICBC). Furthermore, the cross-border sub-custody space hasseen very limited activity — tosay the very least. In such anenvironment, much of the effortof global players is targeted atdeveloping relationships,interacting with regulatorybodies and providing consultingservices on best practices.

“China poses an interestingchallenge for global sub-custodians today,” says PaulineBanks, head of networkmanagement for Asia at JPMorgan, which provides sub-custody services only in Taiwanand Australia. “Despite thepresence of the usual set ofleading sub-custodians, foreignfund managers investing inChina often select local banks forsub-custody in order todistribute their funds throughthem. Local banks have hugebranch networks such as 25,000branches or even more which theforeign players cannot hope tocompete with,”she says.

Sleightholme of Citigroupacknowledges that some globalinstitutions go with domesticChinese banks for custodyservices. However, butSleightholme would have it thatthey cannot match the quality ofservice offered by the largerproviders. “These banks do nothave our kinds of experience nordo they have the advantage ofbeing able to deploy globalpractices like we do.” China, headds, has a huge potential but ithas not been properly openedyet. Nonetheless, Citigroup isoffering a full range of services inChina from domestic and globalcustody to securities lending andfund administration.

The strategy of offering a widerange of services beyond plainvanilla custody and clearing isthe hallmark of Citigroup’s sub-custody product offering in theregion. Recently the banklaunched a comprehensive suiteof automated clearing andsettlement of exchange tradedderivatives in India, andlaunched third party clearingservices in Australia whichenables its broker dealer clientsto trade securities listed on theAustralian Stock Exchange(ASX) from offshore locations.“In order to grow and stay aheadof competition, it is important toinnovate and have a diversifiedportfolio,”says Sleightholme.

A product diversificationstrategy has been adopted invarying degrees by most leadingsub-custody players. In addition,given the growth in the domesticmutual fund industry in variouscountries, the leading banks areseriously looking at theincreasingly attractive domesticcustody business. Deustche Bank,which for long has focused on thedomestic custody market, hasbeen steadily coming out withnew services. For instance, inIndonesia the bank is certified tobe a custodian and anadministrator of funds that arecompliant with the IslamicShariah law and in India, it islaunching a transfer agency serviceby the end of the year, becomingthe first custodian to do so.“We arecontinuously refining our servicesto meet the requirements of thedomestic markets,” says Thibaudde Maintenant, head of productand client management fordomestic custody in Asia Pacific atDeustche Bank.

“Given the margin pressures,sub-custody on its own is nolonger enough,” states Banks ofJP Morgan. Sub-custodians needto offer a wider range of servicesnot only to gain additionalrevenue from existing clients butto gain a wider clientele as well.

James Hogan, global head of custody and clearing atHSBC.“Earlier, several banks offered sub-custody in a

single market. But now, if you do not provide sub-custody in more than one market, it is very difficult to

effectively compete,” he says. Photograph kindly suppliedby HSBC, October 2006.

Thibaud de Maintenant, head of product and clientmanagement for domestic custody in Asia Pacific at

Deustche Bank. Photograph kindly supplied byDeutsche Bank, October 2006.



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Key: AC = All Cap, LC = Large Cap, MC = Mid Cap, SC = Small Cap, LC/MC = Large and Mid Cap

FTSE Global Equity Index Series – Global30 December 2005 to 29 September 2006

FTSE All Cap Regional Indices (USD)

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140FTSE Global AC

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FTSE Middle East & Africa AC

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FTSE Latin America AC

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MARKET REPORTS 16.qxd 13/10/06 17:31 Page 86


FTSE All-Emerging Country Indices – Capital Returns YTD

FTSE Global All Cap Sector Indices – Capital Returns YTD (USD)

Stock PerformanceBest Performing FTSE All-World Index Stocks (USD/%) Worst Performing FTSE All-World Index Stocks (USD/%)Great Wall Motor Company (H) CHN 154.0 ITV PCL THAI -72.0Shenzhen Investment (Red Chip) HK 153.4 Mills Corp USA -60.2Yantai Changyu Pioneer Wine (B) CHN 139.2 Optimax Technology Corp TWN -60.8Boliden SWED 132.2 Privee Investment Holdings JA -59.1Samsung Techwin KOR 129.6 Yukos RUS -69.7

Overall Index Return (USD) No. of Value 3 M (%) 6 M (%) 12 M (%) YTD (%) Actual DIvConsts Yld (%)

FTSE Global AC Index 8,077 367.90 3.9 2.3 13.2 9.8 2.08FTSE Global LC Index 1,198 341.87 4.5 3.4 12.8 9.8 2.22FTSE Global MC Index 1,731 440.49 3.3 0.8 15.1 10.0 1.77FTSE Global SC Index 5,148 440.51 1.5 -2.3 13.0 9.4 1.63FTSE All-World Index 2,929 219.76 4.3 2.9 13.2 9.9 2.14FTSE Asia Pacific AC ex Japan Index 1,804 452.56 5.2 4.1 17.0 12.3 2.81FTSE Latin America AC Index 209 788.80 5.7 0.8 21.1 16.1 3.12FTSE All Emerging Europe AC Index 115 746.37 2.4 -2.5 21.9 15.8 1.64FTSE Developed Europe AC Index 1,705 415.46 5.3 6.6 20.8 18.6 2.72FTSE Middle East & Africa AC Index 210 509.48 -1.8 -17.3 3.3 -6.4 2.90FTSE North Americas AC Index 2,657 324.89 4.1 1.9 8.9 7.0 1.74FTSE Japan AC Index 1,377 391.17 -1.6 -6.6 10.8 -1.2 1.02

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Stock PerformanceBest Performing FTSE Developed ex US Index Stocks (USD/%) Worst Performing FTSE Developed ex US Index Stocks (USD/%)Shenzhen Investment (Red Chip) HK 153.4 Privee Investment Holdings JA -59.1Boliden SWED 132.2 Invoice Inc JA -57.0CNPC Hong Kong (Red Chip) HK 129.3 GMO Internet JA -54.6Minara Resources AU 119.0 Aiful JA -53.6Tencent Holdings HK 115.1 Softbank JA -50.9

Overall Index Return (USD) No. of Value 3 M (%) 6 M (%) 12 M (%) YTD (%) Actual DivConsts Yld (%)

FTSE Developed ex US Index (LC/MC) 1,351 248.01 3.6 3.5 16.9 12.9 2.44FTSE USA Index (LC/MC) 708 553.50 5.0 3.0 8.9 6.9 1.80FTSE Developed Index (LC/MC) 2,059 213.38 4.3 3.3 12.8 9.8 2.12FTSE All-Emerging Index (LC/MC) 870 381.57 4.3 -0.9 19.5 10.7 2.45FTSE Developed Europe Index (LC/MC) 516 248.35 5.3 6.7 20.1 17.9 2.83FTSE Developed Asia Pacific Index (LC/MC) 773 228.04 0.3 -2.5 11.6 3.7 1.72FTSE Developed Asia Pacific ex Japan Index (LC/MC) 286 366.32 3.9 6.0 11.4 12.8 3.44FTSE Developed ex US AC Index 3,922 417.80 3.5 3.2 17.1 13.0 2.37FTSE Developed ex US LC Index 574 386.63 3.4 3.6 15.8 12.4 2.54FTSE Developed ex US MC Index 1,731 502.58 4.7 3.3 22.2 15.4 1.77FTSE Developed ex US SC Index 5,148 532.05 2.6 0.7 18.8 13.5 1.63

FTSE Global Equity Index Series – Asia Pacific30 December 2005 to 29 September 2006

FTSE Asia Pacific All-Cap (AC) Regional Indices (USD)

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FTSE Asia Pacific Regional Sector Indices – Capital Returns YTD (USD)

FTSE Asia Pacific All Cap Sector Indices – Capital Returns YTD (USD)

Stock PerformanceBest Performing FTSE Asia Pacific Index Stocks (USD/%) Worst Performing FTSE Asia Pacific Index Stocks (USD/%)Great Wall Motor Company (H) CHN 154.0 ITV PCL THAI -72.0Shenzhen Investment (Red Chip) HK 153.4 Optimax Technology Corp TWN -60.8Yantai Changyu Pioneer Wine (B) CHN 139.2 Privee Investment Holdings JA -59.1Samsung Techwin KOR 129.6 Invoice Inc JA -57.0CNPC Hong Kong (Red Chip) HK 129.3 TPI Polene Co THAI -55.0

Overall Index Return (USD)No. of Value 3 M (%) 6 M (%) 12 M (%) YTD (%) Actual DIvConsts Yld (%)

FTSE Global AC Index 8077 367.90 3.9 2.3 13.2 9.8 2.08FTSE Asia Pacific AC Index 3181 416.92 1.5 -1.9 13.6 4.7 1.86FTSE Asia Pacific Index (LC/MC) 1302 237.58 1.6 -1.2 14.1 5.6 1.86FTSE Asia Pacific LC Index 523 402.32 1.7 -0.6 14.1 6.4 1.87FTSE Asia Pacific MC Index 779 459.57 1.4 -3.9 13.9 1.6 1.76FTSE Asia Pacific SC Index 1879 460.48 0.5 -7.2 10.2 -1.7 1.87FTSE Developed Asia Pacific ex Japan Index (LC/MC) 286 366.32 3.9 6.0 11.4 12.8 3.44FTSE Developed Asia Pacific Index (LC/MC) 773 228.04 0.3 -2.5 11.6 3.6 1.72FTSE All-Emerging Asia Pacific Index (LC/MC) 529 277.78 6.2 3.4 22.9 12.3 2.29FTSE Japan Index (LC/MC) 487 146.59 -1.2% -5.7 11.7 0.2 1.01

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FTSE Global Equity Index Series – Europe30 December 2005 to 29 September 2006

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FTSE Europe All Cap Indices – Capital Returns YTD (EUR)

FTSE Developed Europe All Cap Sector Indices – Capital Returns YTD (EUR)

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Stock PerformanceBest Performing FTSE Developed Europe Index Stocks (EUR/%) Worst Performing FTSE Developed Europe Index Stocks (EUR/%)Boliden SWED 132.2 Thomson SA FRA -24.8Vallourec FRA 112.4 EADS FRA -23.7Metrovacesa SP 99.2 Tietoenator Oyj FIN -19.3Euronext FRA 95.7 Emporiki Bank of Greece GRC -17.5Sacyr-Vallehermoso SP 93.8 A P Moller - Maersk B DEN -17.0

Overall Index Return (EUR)No. of Value 3 M (%) 6 M (%) 12 M (%) YTD (%) Actual DivConsts Yld (%)

FTSE Global AC Index 8077 334.43 4.9 -2.3 7.7 2.3 2.08FTSE Europe AC Index 1820 381.38 6.2 1.6 15.0 10.4 2.69FTSE Europe LC Index 246 350.45 5.8 1.6 12.7 8.7 2.90FTSE Europe MC Index 334 467.51 7.8 2.2 22.3 15.0 2.22FTSE Europe SC Index 1240 516.89 6.4 1.0 20.5 15.7 1.92FTSE Developed Europe AC Index 1705 377.66 6.3 1.8 14.9 10.5 2.72FTSE All-Emerging Europe AC Index 115 678.47 3.4 -6.8 16.0 7.8 1.64FTSE Eurobloc AC Index 873 396.66 7.1 1.0 16.3 12.0 2.71FTSE Developed Europe ex UK AC Index 1214 401.69 7.1 1.2 16.8 11.5 2.53FTSEurofirst 300 Index 300 1396.45 6.3 1.9 13.7 9.5 2.84FTSEurofirst 80 Index 80 4910.08 7.0 1.4 14.7 10.0 3.09FTSEurofirst 100 Index 100 4484.83 4.9 1.5 10.1 7.3 3.17

FTSE UK Index Series30 December 2005 to 29 September 2006

FTSE UK Index Series (GBP)

FTSE All-Share Sector Indices – Capital Returns YTD (GBP)

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FTSE UK Indices – Capital Return YTD (GBP)

Stock PerformanceBest Performing FTSE All-Share Index Stocks (GBP/%) Worst Performing FTSE All-Share Index Stocks (GBP/%)Ashley (Laura) Holdings 116.7 Stanelco -88.8Chemring Group 106.5 iSOFT Group -87.1London Stock Exchange Group 100.6 Plasmon -64.7Soco International 89.3 Instore -51.1Lookers 89.2 SkyePharma -50.8

Overall Index Return (GBP)No. of Value 3 M (%) 6 M (%) 12 M (%) YTD (%) Actual Div Net P/EConsts Yld (%) Cover Ratio

FTSE 100 Index 100 5960.81 2.2 -0.1 8.8 6.1 3.24 2.54 12.17FTSE 250 Index 250 9996.78 6.1 1.5 25.7 13.7 2.29 2.38 18.31FTSE 350 Index 350 3103.74 2.7 0.2 11.1 7.1 3.10 2.52 12.8FTSE SmallCap Index 333 3541.89 4.4 -2.0 12.1 7.2 1.88 1.36 39.13FTSE All-Share Index 683 3050.44 2.8 0.1 11.1 7.1 3.06 2.50 13.09FTSE Fledgling Index 256 3978.00 6.1 -2.4 10.6 6.1 1.81 -1.26 0FTSE AIM Index 1180 1016.40 -5.9 -15.2 -7.1 -2.8 0.55 -0.35 0FTSE techMARK 100 Index 100 1418.14 4.9 -4.7 10.7 -0.9 1.44 - -

FTSE Xinhua Index Series30 December 2005 to 29 September 2006

FTSE Xinhua Index Series (CNY/HKD)

FTSE Xinhua Index SeriesActual Div

Index Name Consts Value 3 M (%) 6 M (%) 12 M (%) YTD (%) Yld (%)FTSE/Xinhua 25 Index (HKD) 25 12012.99 6.2 8.5 27.7 30.5 2.44FTSE/Xinhua China 50 Index (CNY) 50 5506.57 2.8 25.8 43.1 41.0 2.05FTSE Xinhua All-Share Index (CNY) 966 3398.02 2.1 39.8 60.1 61.2 1.63FTSE Xinhua 600 Index (CNY) 600 3621.78 1.4 37.4 58.6 59.0 1.77FTSE Xinhua Small Cap Index (CNY) 366 2609.56 6.2 55.6 70.2 75.2 0.70FTSE Xinhua China Bond Total Return Index (CNY) 33 97.30 1.6 1.1 2.4 2.0 2.94


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FTSE Hedge Index SeriesFTSE Hedge Management Styles (USD) – 5-Year Performance

FTSE Hedge – Management Styles & Strategies (NAV Terms)Index 3 M 6 M 12 M YTD 5-Year Ann 3-Year Level (%) (%) (%) (%) Return (%) Volatility (%)

FTSE Hedge Index * 5362.63 0.8 0.2 5.3 3.9 4.9 3.2Directional 3198.52 0.5 -2.0 4.5 2.5 6.2 5.4Equity Hedge 2239.48 1.5 -2.0 4.0 2.9 6.7 4.9Commodity Trading Association (CTA) / Managed Futures 2032.49 -2.3 -1.6 5.1 0.9 6.1 11.7Global Macro 1975.80 0.1 -1.3 6.3 2.3 5.0 6.3Event Driven 3389.66 2.2 2.9 7.4 6.8 4.2 3.0Merger Arbitrage 2188.83 2.6 4.4 7.5 8.0 2.0 2.2Distressed & Opportunities 2326.16 1.9 1.8 7.5 6.0 6.2 4.6Non-directional 3113.02 0.8 1.6 4.8 4.3 3.2 1.4Convertible Arbitrage 2068.35 2.5 4.0 6.9 7.2 6.7 3.1Equity Arbitrage 2110.49 -0.1 1.9 7.4 6.2 3.6 2.3Fixed Income Relative Value 2056.80 0.2 0.7 2.3 1.9 1.2 1.4* Based on daily indicative values

FTSE EPRA/NAREIT Global Real Estate Index SeriesFTSE EPRA/NAREIT Global Real Estate Indices (Total Return Basis)

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EPRA/NAREIT EuropeTotal Return Index (EUR)

Asia Total Return Index (USD)

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Index Name Consts Value 3 M (%) 6 M (%) 12 M (%) YTD (%) Yld (%)FTSE EPRA/NAREIT Global Index (USD) 328 3146.86 9.9 9.5 30.6 24.8 3.32FTSE EPRA/NAREIT North America Index Index (USD) 142 3797.64 9.9 9.2 27.8 24.8 3.89FTSE EPRA/NAREIT Europe Index (EUR) 97 3297.04 12.8 8.5 31.0 27.7 2.31FTSE EPRA/NAREIT Euro Zone Index (EUR) 41 3538.65 13.8 8.8 26.4 32.1 2.71FTSE EPRA/NAREIT Asia Index (USD) 89 2272.91 8.7 7.6 31.1 17.6 3.10

FTSE Bond IndicesFTSE Bond Indices (Total Return Basis)

FTSE Bond Indices (Total Return)Actual Div

Index Name Consts Value 3 M (%) 6 M (%) 12 M (%) YTD (%) Yld (%)FTSE Eurozone Government Bond Index (EUR) 244 155.30 3.0 2.2 -0.1 0.0 3.85FTSE Pfandbrief Index (EUR) 361 177.78 2.4 1.9 -0.2 0.3 3.90FTSE Euro Emerging Markets Bond Index (EUR) 40 211.68 3.7 1.4 1.3 1.4 4.82FTSE Euro Corporate Bond Index (EUR) 306 144.33 2.6 2.0 -0.3 0.3 4.34FTSE Gilts Index Linked All Stocks Index (GBP) 11 2065.52 4.0 3.3 6.2 2.7 1.39*FTSE Gilts Fixed All-Stocks Index (GBP) 29 1953.77 2.7 1.6 3.7 0.9 4.30FTSE US Government Bond Index (USD) 123 150.40 3.9 3.5 2.9 2.0 4.79FTSE Japan Government Bond Index (JPY) 242 110.40 1.8 1.4 0.2 0.0 1.51FTSE China Government Bond Index (CNY) 33 97.30 1.6 1.1 2.4 2.0 2.94* Based on 0% inflation

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FTSE Gilts Index Linked All Stocks (GBP)FTSE Japan Government Bond Index (JPY)

FTSE Gilts Fixed

FTSE Euro Emerging Markets Bond Index (EUR)

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FTSE Euro CorporateBond Index (EUR)

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All-Stocks (GBP)

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FTSE Research Team contact detailsAndy Harvell Andreas Elia Kamila LewandowskiHead of Research Research Executive Index Development [email protected] [email protected] [email protected]+44 20 7866 8986 +44 20 7866 8013 +44 20 7866 1877


96 M A R C H / A P R I L 2 0 0 6 • F T S E G L O B A L M A R K E T S

Index Reviews November – December 2006

Date Index Series Review Type Effective Data Cut-off(Close of business)

Oct/Nov FTSE/ ATHEX 20 Semi-annual review 30-Nov 29-Sep

10-Nov Hang Seng Quarterly review 8-Dec 29-Sep

16-Nov MSCI Quarterly review 30-Nov 31-Oct

Early Dec CAC 40 Quarterly review 15-Dec 30-Nov

Early Dec ATX Quarterly review 15-Dec 30-Nov

Early Dec IBEX 35 Semi-annual review 1-Jan

Early Dec OBX Semi-annual review 15-Dec 30-Nov

1-Dec OMX C20 Semi-annual review 16-Dec 30-Nov

4-Dec DAX Quarterly review 15-Dec 30-Nov

6-Dec FTSE JSE Africa Index Series Quarterly review 15-Dec 1-Dec

6-Dec FTSE All-Share Annual review 15-Dec 5-Dec

6-Dec FTSE UK Index Series Quarterly review 15-Dec 5-Dec

6-Dec FTSE techMARK 100 Quarterly review 15-Dec 30-Nov

6-Dec FTSE Euromid Quarterly review 15-Dec 1-Dec

6-Dec FTSEurofirst 300 Quarterly review 15-Dec 1-Dec

6-Dec FTSE eTX Quarterly review 15-Dec 1-Dec

6-Dec FTSE Global Equity Index Series

(incl. FTSE All-World) Annual review / North America 15-Dec 30-Sep

8-Dec NASDAQ 100 Annual review 15-Dec 30-Nov

11-Dec NZSX 50 Quarterly review 29-Dec 30-Nov

11-Dec Russell US Indices Quarterly review / Additions 15-Dec 30-Nov

12-Dec S&P MIB Quarterly review - shares & IWF 15-Dec

13-Dec S&P US Indices Quarterly review 15-Dec

13-Dec S&P Europe 350/ S&P Euro Quarterly review 15-Dec

13-Dec S&P/ ASX 200 Quarterly review 15-Dec

13-Dec S&P/ TSX Quarterly review 15-Dec 15-Dec

13-Dec S&P 500 Quarterly review 15-Dec

13-Dec S&P Midcap 400 Quarterly review 15-Dec

13-Dec DJ STOXX Quarterly review 15-Dec 14-Nov

15-Dec PSI 20 Semi-annual review 2-Jan 30-Nov

Mid Dec Norex All-Share Semi-annual review 31-Dec 30-Nov

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

CA

LEND

AR


Unlock China.

FOR FURTHER INFORMATION VISIT WWW.FTSE.COM, E-MAIL [email protected] OR CALL YOUR LOCAL FTSE OFFICE:BEIJING +86 10 6515 9265 BOSTON +(1) 888 747 FTSE (3873) FRANKFURT +49 (0) 69 156 85 143 HONG KONG +852 2230 5800LONDON + 44 (0 )20 7866 1810 MADRID +34 91 411 3787 NEW YORK +(1 ) 888 747 FTSE (3873 )PARIS +33 (0) 1 53 76 82 88 SAN FRANCISCO +(1) 888 747 FTSE (3873) SHANGHAI +86 21 3401 5526 TOKYO +81 3 3581 2840

“FTSE™” is a trade mark of the London Stock Exchange Plc and The Financial Times Limited and is used by FTSE under licence. “Xinhua” is a trade mark of Xinhua Finance(“XFN”) and is used by FTSE under licence. The FTSE/Xinhua Indices are calculated by FTSE in conjunction with FXI and XFN in accordance with a standard set of groundrules. The FTSE/Xinhua Indices are the proprietary interest of FTSE, FXI and/or its licensors. Neither FTSE, XFN or FXI shall be responsible for any error or omission in the FTSE Xinhua Indices. Distribution of FTSE/Xinhua Indices index values and the use of the FTSE/Xinhua Indices to create financial products requires a licence with FXI.

At FTSE Xinhua Index we believe in developing the products that can unlock Chinafor you.

The FTSE/Xinhua China 25 and FTSE/Xinhua China A50 are the leading tradable indicesfor the world’s fastest growing market. They are part of the most comprehensiveindex data set available, giving you access to the market using the internationallyrecognised standards you understand and rely upon.

If you are entering the Chinese market, we hold the key.

To find out more about the FTSE Xinhua Index Series,visit www.ftsexinhua.comemail [email protected] or call.

GM EDITORIAL 16 16/10/06 15:22 Page IBC1

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GM EDITORIAL 16 16/10/06 15:22 Page OBC1

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