Fundamentals 02

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Fundamentals
Securities Services & Securities Lending for Funds, Managers and Investors
Fundamentalsmagazine.com
ISSUE 02 WINTER 2011
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Exclusive Interviews
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CRISIS TALKS
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Editor's Letter
Welcome to the ﬁrst Fundamentals of 2011
Many may have hoped that 2011 would be the year that the world moved from the ﬁnancial crisis that ﬁrst reared its head in 2007, but with the debt crisis in the eurozone, among other developments, it seems that we may not be out of the woods yet. In this issue of Fundamentals, we talk to some leading ﬁgures from the world of politics and economics about what the crisis meant for funds and where the future may lie. Elsewhere in FundFront State Street’s Wade McDonald looks at the future of the life insurance industry and we investigate the return of ABN AMRO. In the InvestorServices section, we have an exclusive proﬁle with Tim Keaney, CEO of BNY Mellon Asset Servicing, who tells us about the past and future of custody. InvestorServices also takes a look at the latest developments in data management, as well as a focus on the CEE and Nordic regions. SecuritiesLending continues the debate begun in the last issue about the use of lending within exchange-traded funds, while the impact on prime brokers of proprietary traders moving into the hedge fund space is investigated. Finally, in BackOfﬁce, we provide our solution to the issue of bankers’ bonuses. All of us at Fundamentals hope you had a great New Year, and we wish you a prosperous 2011. Craig McGlashan, Editor
From our readers
In your recent Fundamentals article on performance measurement, you quote Fraser Priestley, managing director, Performance and Risk Analytics at BNY Mellon Asset Servicing: "For example, if you wanted to calculate a true rate of return that is 100% accurate, you would have to value the assets every single time a cash ﬂow occurs, but that clearly isn't practical. However, we have seen for some time now the requirement to have market values when major cash ﬂows occur." This comment is relevant when evaluating monthly returns. However, due to the fact that fund trades do not settle till after the close of each day, the time during the trading day at which a trade occurs is not relevant. So valuing all the assets every single time a cash ﬂow occurs during a day is superﬂuous. Recognizing the importance of daily settlement makes accuracy not dependent on the data problem of valuing all holdings in the fund and benchmark at each instant of each cash ﬂow. Rather, daily fund returns are straightforward, but obtaining the 100% accurate weight and return of fund components each day becomes dependent on employing the correct model for the calculation of the weights and returns of components of a fund when the only relevant information is the quantity and price of each opening and closing position and each transaction for the day. Applying any version of Dietz or IRR to obtain a single day’s weight and return for fund components is demonstrably inadequate. More advance methods are required for daily component-level weights and returns.
Dr. Andre Mirabelli is the Managing Director of Performance Analytics for Opturo and an independent consultant in the area of ﬁnancial decision evaluation
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FundFront
Contents
P.3 People Moves P.4 News Round P.7 Mandates P.28 2011 Outlook P.30 Executive Proﬁle: Tim Keaney P.32 Keeping up to data P.36 Taking corporate action P.38 Say what you CEE P.42 Nordic essentials P.58 2011 Outlook P.60 ETFs: The underlying lending P.63 2011: Be prepared P.64 CCP: Off centre P.66 Quadriserv update P.68 Prime brokerage: Hedging the props P.70 Bas Cohen proﬁle P.72 Talking collateral P.75 Market Movements P.76 Sunil Daswani proﬁle P.78 Recruitments: Finding a way back in P.80 The China angle P.81 PASLA preview P.10 Crisis talks P.18 Life insurance: The new product proposition P.20 ABN AMRO: The resurgance P.23 Fees high for funds?
Editor Craig McGlashan Craig.McGlashan@eFunds.tv Editorial Advisory Board Chairman Clive Gande Clive.Gande@eFunds.tv Investor Services Editor Brian Bollen Brian.Bollen@eFunds.tv Correspondent Stephanie Baxter Stephanie.Baxter@eFunds.tv Contributors Roy Zimmerhansl Michael Mooney Cherry Reynard John Sandman Design Luke Merryweather
Luke.Merryweather@eFunds.tv
New colour coordinated sections, making it easier to ﬁnd what you want to read
InvestorServices
P.44
The ETF pie P.46 Stock transfer: A brave new world P.48 Calastone Q&A P.50 Alternative payment systems P.56 Outsourcing
Senior Account Manager Gary Allen Gary.Allen@eFunds.tv Senior Account Manager Neil McPhee Neil.McPhee@eFunds.tv Finance Elliot Ainley ﬁnance@2i.tv Chief Technology Ofﬁcer Peter Ainsworth Peter.Ainswoth@eFunds.tv Sales Director Marc Young Marc.Young@eFunds.tv Non-Executive Director Jon Hewson Jon.Hewson@eFunds.tv Publisher Mark Latham Mark.Latham@eFunds.tv
SecuritiesLending
P.24 Fund management: Changing times P.26 Selection & survival
BackOfﬁce
P.82 Glossary P.84 Directory P.88 National service: Think of the bonuses
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2011
People Moves
People M o ve s
Investment manager Kellner DiLeo appointed Rory Zirpolo as principal and head of securities lending, a role which will seem him act as portfolio manager of KDC Alpha, a matched book securities lending portfolio. Zirpolo moves from Credit Suisse, where he was managing director of prime services, with a responsibility of managing a $50bn supply-side securities lending business. Zirpolo has worked within securities lending for more than 25 years and chaired the Risk Management Association's US stock loan conferences in 2006, 2007 and 2008. Additionally, he served four years on the board of EquiLend. Castlerock Capital founder Mark Whitehead moved from the ﬁrm he started in 2005 to head up the equity ﬁnance business at MF Global. Whitehead has more than 16 years’ experience in the international equity ﬁnance industry, having previously held roles at Bank of America, Merrill Lynch and Lehman Brothers. Among the key hires was the appointment of Chris Venables as partner of PwC, where he will focus on the infrastructure and utilities sector to help organisations respond to pension challenges. “These appointments are a coup for our everexpanding pensions business, bringing a wealth of further expertise to supplement our award winning practice,” commented Marc Hommel, head of pensions. CIBC World Markets hired Greg King as executive director of its securities lending desk in Toronto in plans to expand the business. King, who joins from Omega ATS, will focus on improving the bank’s securities lending services and value-add offerings for the CIBC’s prime brokerage clients and internal partners, according to an internal note. Daiwa Capital Markets appointed Martial Rouyere as global head of equity derivatives in plans to strengthen management. Rouyere, who was previously head of retail structured products at the ﬁrm, will be reporting from Daiwa’s London ofﬁces to Dominique Blanchard, global head of derivatives in Hong Kong. The move is part of plans to boost the derivatives management team following Daiwa’s $1.2bn acquisition of KBC’s Asian equity derivatives and global convertible bonds units in November. manager for the Nordic region, while Roel van de Wiel joined as business development executive for the Netherlands. Based in Amsterdam, Ståhl is responsible for managing business development activities for the Nordic region with a focus on institutional investors in Scandinavia, Iceland and Finland; van de Wiel will focus on growing State Street’s Global Services business in the Netherlands. Nomura global head of prime services Tim Wannenmacher has exited the ﬁrm. No reason was given for Wannenmacher’s departure and an ofﬁcial replacement has not been announced at the time of going to press. Rob Scott resigned from his role as co-head of global sales & relationship management at Deutsche Bank. Societe Generale Securities Services (SGSS) promoted Guillaume Heraud to head of clearing services, from his former role as deputy head. In another move, Jeanne Duvoux was appointed deputy CEO of SGSS S.p.A. and legal representative for SGSS in Italy. Heraud will report to Alain Closier, global head of SGSS, and also joined the international management committee of the ﬁrm. He has been employed by Societe Generale since 1990 and was appointed deputy head of clearing services in July 2008. | 3
Citi made two key hires as Peter Orszag joined as vice chairman of global banking and Benjamin Poor became manager of market intelligence for securities and fund services (SFS). The New York-based bank said that Orszag, who was previously worked under US president Barack Obama as director of the Ofﬁce of Management and Budget (OMB), has expertise in economic policy that Citi claims will be an asset to its global investment banking business. BNY Mellon Asset Servicing appointed Jon Willis as head of EMEA transfer agency services, a role which will seek him take charge of the ﬁrm’s UK and offshore transfer agent activities. Willis will report to Paul Bodart, head of global operations for EMEA at BNY Mellon. He previously spent 12 years at International Financial Data Services (IFDS), State Street and DST System’s joint venture global transfer agency business. His most recent role at IFDS was chief administration ofﬁcer and head of transfer agent operations. State Street appointed Per Ståhl as sales
PricewaterhouseCoopers (PwC) hired a team of 10 from several rival ﬁrms in plans to expand its UK pension advisory business.
Chris Venables
Peter Orszag
2011 | Fundamentals
News round
FundFront
NEWS
7th November 2010 The UK’s Pension Protection Fund latest Statement of Investment Principles allowed for the fund to take part in securities lending and bond repurchase agreements. The PPF provides for pensioners in the event that their previous employer becomes insolvent and the remaining pension fund is inadequate to service its liabilities. It was set up by an act of Parliament but is considered an “arm’s length” body, separate from the government. The news was welcomed by many in the securities lending industry, which had come under ﬁre from various sections of the press since the onset of the ﬁnancial crisis 8th November 2010 Första AP-fonden (AP1) ﬁled a lawsuit over $35.5m of losses made through the reinvestment of cash collateral by Bank of New York Mellon at the Commercial Court in London. The suit alleged that during 2008 BNY Mellon, the fund’s agent securities lender, reinvested some of AP1’s cash collateral in notes issued by Sigma Finance, a ﬁrm which went into receivership in October 2008. AP1 claims that this investment was “negligent” and in breach of its investment guidelines. On November 19th 2009 BNY Mellon deducted $35.5m from the fund’s managed account in respect of these losses. BNY Mellon said the claims were “without merit” and that it would defend itself “vigorously”. 11th November 2010 The European Fund and Asset Management Association (EFAMA) said it welcomed the end to the uncertainty that has faced fund managers of all non-UCITS investment funds since the European Commission’s initial proposals for legislation in April 2009, following the approval in November of the Alternative Investment Fund Managers Directive (AIFMD) by the European Parliament. “This Directive has been erroneously labelled as a ‘hedge fund directive’,” said EFAMA. “In reality the wide scope of the AIFMD also covers real estate funds, investment trusts and non-UCITS retail funds along with many other kinds of nationally regulated investment funds, all of which now will have to restructure their activities to comply with the AIFMD.”
The top stories from
Fundamentalsmagazine.com
this quarter
Fundamentals’ Brian Bollen and Craig McGlashan were recognised for their achievements over the past year at the State Street Institutional Press Awards. Investor services section editor Bollen won the Investor Services & Technology – Online/ Wires section, while Fundamentals editor McGlashan was shortlisted in the Best Newcomer category. The State Street Awards, launched in 2002, recognise “outstanding performance” in reporting of categories ranging from investments and pensions to investor services and technology. 12th November 2010 Nomura launched its NXT product suite in the US in a bid to reach out to clients in the Americas. The package, now live in Asia, Europe and the US, includes NXT Direct, an “ultra-low latency” platform with direct market access, an exchange co-location (NXT Host), market data (NXT Data) and network connectivity services (NXT Ring). "The results are impressive – the wire-towire latency of our patent pending direct market access platform leads the industry at below
3 microseconds,” said Emad Morrar, global head of product strategy and principal investments at Nomura. 19th November 2010 Daiwa Capital Markets and KBC Group ﬁnalised a deal which will see the latter ﬁrm sell its global convertible bond and Asian equity derivatives businesses to Daiwa for around $1.2bn. A breakdown of the deal reveals that roughly $0.2bn will be spent on staff, IT infrastructure and other assets, with $1bn covering trading positions. According to the ﬁrms, the deal – ﬁrst revealed in July this year – will allow KBC to free up capital resources, as part of its strategy to focus on home markets and reduce risk proﬁle, while Daiwa will see a boost to its global derivatives business 24th November 2010 TLG Capital invested in Iroko Financial Products Limited (IFP). TLG described IFP as a UK-based FSA regulated ﬁrm and one of Africa's leading ﬁxed income boutiques focusing on the sub-Saharan African region. It says that this investment is a move to expand its network and operations in subSaharan Africa.
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2011
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News round
25th November 2010 Alternative UCITS funds saw a 70% growth in net new ﬂows in 2010 to September, and were on track to ﬁnish 2010 with 33bn net new inﬂows, a study by Strategic Insight, commissioned by the Association of Luxembourg Funds Industry (Alﬁ) with the support of LuxembourgForFinance, found. ALFI added that most of these funds represent hedge-style strategies adapted to the growing need for absolute return solutions. New alternative UCITS launched this year have already captured 6bn. The Tokyo Stock Exchange (TSE) announced it will consider changing short-selling regulation in a bid to tackle unfair trading and reinvigorate Japan’s securities market. In light of recent allegations of insider trading, the TSE said it will explore ways to strengthen the surveillance of suspicious trading. Among proposals to shorten the duration of a trading halt and extend trading hours, the bourse said it plans to investigate short selling – when an investor sells an asset they have borrowed, aiming to make a proﬁt by buying it back at a lower price. The TSE said it would consider removing barriers that prevent global investors from participating in the Japanese market. 14th December 2010 The US Senate Special Committee on Aging launched an investigation into securities lending after a number of media reports on large collateral reinvestment losses suffered by retirement funds in 2008 and 2009. A spokesperson for the Senate Aging Committee told Fundamentals that the initiative was launched after a speciﬁc Wall Street Journal article that outlined withdrawal restrictions related to 401(k) plans. Later it emerged that the US Government Accountability Ofﬁce (GAO) was assisting the Committee with its investigation The GAO expects to publish a report on its ﬁndings on its website by mid-February 2011. 6th December 2010 The UK pension sector should look up to collective deﬁned contribution (DC) pension schemes in the Netherlands and Denmark as models, said a report published by the Royal Society for the encouragement of Arts, Manufactures and Commerce (RSA). In the ‘Tomorrow’s Investor’ report, David Pitt-Watson, chairman of Hermes Focus Asset Management, outlined the RSA’s vision for an ideal pension system. 21st December 2010 New York attorney general Andrew Cuomo ﬁled a lawsuit against Ernst & Young, alleging that the accounting ﬁrm helped Lehman Brothers hide its weak position through Repo 105 transactions According to the $150m suit, E&Y spent seven years helping Lehman hide its shaky position before the bank collapsed in September 2008. Included in the suit is the allegation that the auditor allowed Lehman to make misleading ﬁnancial ﬁlings about its risk exposure. E&Y said that its accounting was in no way responsible for the collapse of the failed bank. It said that it would “vigorously defend” the claims, adding that there was “no factual or legal basis” for the claim and the transaction in question, i.e. Repo 105, was in line with the Generally Accepted Accounting Principles (GAAP). 21st December 2010 State Street Corporation and International Financial Data Services (IFDS), the international transfer agency joint venture between State Street and DST Systems, introduced a new solution to support Offshore T+0 Money Market Funds to be accepted on the National Securities Clearing Corporation platform (NSCC). The IFDS group, along with State Street, provides market-leading transfer agency, wealth management and investor record-keeping solutions for a wide range of institutions, distributors, advisors and investors in Australia, Canada, Germany, Hong Kong, Ireland, Italy, Japan, Luxembourg, Singapore, Switzerland, the UK and the US. 22nd December 2010 J.P. Morgan’s Worldwide Securities Services (WSS) announced it would offer direct custody services in Ireland, further expanding the ﬁrm’s direct custody and clearing footprint. The move builds on J.P. Morgan’s existing local presence in a number of markets including Australia, India, New Zealand, Taiwan, Russia, UK and US with on-the-ground coverage and expertise for clearing, settlement, custody and asset servicing. The move also follows the previously reported completion of the successful migration of the direct and master custody clients from ANZ Custodian Services which further strengthened its position as a leading provider of third party custodial services in the Australian and New Zealand marketplace. 5th January 2011 State Street Investment Analytics announced preliminary WM UK pension fund and charity fund universe results for 2010, suggesting that trustees of the average pension and charity fund will be looking at returns of around 13%. “There was a general upward trend in the equity markets in 2010, although continued volatility often resulted in moves of 1% in a day,” said Jeanette Patrizio, vice president of State Street Investment Analytics. “Most pension funds and charities maintained their investment strategies and were rewarded as markets generally continued to recover. Local authority pension funds also beneﬁtted from a higher commitment to equities and outperformed corporate schemes last year.”
FundFront
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Mandates
Altrinsic Global Advisors has chosen State Street Corporation to service its new Irish-domiciled UCITS compliant fund. State Street’s operation in Dublin will provide the Altrinsic Global Equity Fund with custody and fund administration services. BNP Paribas Securities Services claims to have secured its ﬁrst direct UK pension fund client after winning a £685m mandate to act as master custodian for ATOS Origin’s three UKdomiciled pension schemes. The custodian also announced it will provide global custody services in the UK for Brevan Howard Asset Management, the largest hedge fund manager in Europe. BNP Paribas Securities Services trumpets that it has been mandated by Standard Bank Plc to provide custodial services in the United Kingdom and Switzerland. Standard Bank plans to grow beyond its African roots into other markets. BNY Mellon has been appointed as depositary bank for Orascom Construction Industries’ (OCI) American depositary receipt programme. Each OCI ADR represents one ordinary share and trades on the over-the-counter (OTC) market, while the company's ordinary shares trade on the Egyptian Stock Exchange. Based in Egypt, OCI is a construction contractor active in emerging markets. BNY Mellon Asset Servicing has been selected by China Construction Bank (CCB) as global custodian for the Qualiﬁed Domestic Institutional Investor (QDII) fund in China, to be launched by Yinhua Fund Management Company (Yinhua). The new fund will be called Yinhua Anti-Inﬂation Theme Fund (LOF).
BNY Mellon Asset Servicing has also been selected by Banco Nacional de Costa Rica to provide global custody for an $800m investment portfolio of equities, ﬁxed income and US treasury bonds. The custodian has provided Treasury services to the bank since 2003. Daiwa Fund Asset Services has chosen BNY Mellon Trustee & Depositary to act as depositary for its UK-authorised funds within its fund hosting service. The appointment is part of Daiwa’s plans to extend its hosting service for Irish-domiciled funds to include UK-domiciled collective investment schemes targeted towards institutional or high net worth investors. CIBC Mellon has been awarded a mandate to provide custody, fund accounting, securities lending and performance & risk analytics to the Canadian Christian School Pension Trust Fund. Citi has been appointed by Global X Funds to provide third-party securities lending services for its group of exchange traded funds (ETFs). The appointment is part of Citi’s plans to strengthen its relationship with Global X Funds. Deutsche Bank has been appointed depositary bank for the NYSElisted American Depositary Receipt programme of China Xiniya Fashion Limited, as a leading provider of men’s business casual apparel in China. Tokai Tokyo Financial Holdings has chosen Deutsche Bank as depositary bank for its Sponsored Level I American Depositary Receipt Programme. Tokai Tokyo Financial Holdings, Inc. is the holding company of the Tokai Tokyo Financial Group,
whose core company is Tokai Tokyo Securities Co., Ltd. The Group focuses on the securities business and provides ﬁnancial products, services, and solutions that meet the needs of customers. Deutsche Bank has also been chosen by Daiwa Capital Markets Europe to be its Austrian securities clearer and custodian. GoldenSource has announced it will provide a wider range of services to Macquarie Securities Group after winning a mandate with the ﬁrm in 2009 to provide services for Macquarie’s equity and equity derivatives business. J.P. Morgan will provide custody services to BankInvest’s 28 listed investment funds with around $9bn assets under custody. The mandate follows a tender of both Danish and global custody providers at BankInvest. Brazilian mining company Vale S.A has chosen J.P. Morgan as the sole sponsor and depositary bank for its landmark HDR listing. Vale S.A became Hong Kong’s ﬁrst ever Hong Kong depositary receipt (HDR) listing on the Stock Exchange of Hong Kong (SEHK) after listing by way of introduction in September 2010. J.P. Morgan says that the HDR listing framework is expected to boost Hong Kong’s long-term reputation as a leading exchange for global corporates looking to develop their business in Greater China. J.P. Morgan has also been appointed depositary bank China-based education services company, TAL Education Group, which raised $138m through an American Depositary Shares listing on the New York Stock Exchange last year. TAL Education’s president Cao
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Mandates
Yundong says this listing is a big part of the ﬁrm’s long-term growth strategy in China. Northern Trust has been named global custodian for $800m group of funds at John Muir Health of Walnut Creek. The bank will service the Californian organisation’s pension, endowment and operating funds as well as beneﬁt payment services for its pension plan. Tawuniya (the Company for Co-operative Insurance) has selected Northern Trust manage a segregated passive equity portfolio, benchmarked to the Dow Jones Global Titans 100 index. The appointment, which also includes transition management services, builds on Northern Trust’s existing asset servicing relationship with Tawuniya. Northern Trust has also been appointed by Premier Asset Management to provide custody, transfer agency and fund accounting services to its latest range of OEIC (open-ended investment company) funds, valued at $1.4bn (£906m). This appointment adds to an existing $1.6bn (£980m) custody and fund administration mandate held by Northern Trust for a number of years. Northern Trust has won a £881m mandate to provide global custody and related services to The National Trust as part of the custodian’s strategy to support charities around the globe. Phoenix Fund Services has won a contract to provide TCF Investment with ACD, fund accounting and transfer agency services for its fund range, as part of TCF’s goal to put clients at the centre of its business. “This is now a competitive market with integration of systems and technology key to delivering a quality service at low cost,” said Phoenix. RBC Dexia Investor Services has been mandated by SEI Canada provide shareholder recordkeeping services for its 19 portfolio programs and 31 mutual funds in Canada, representing over C$9bn in client assets. RBC Dexia Investor Services has also been selected by Paratum Inc, based in Beverly Hills, California, U.S.A., to provide custody, fund administration, shareholder services, domiciliary and ﬁnancial reporting services for a new Luxembourgbased private equity SICAV-SIF fund. RBC Dexia says that this umbrella fund will include several sub-funds, the ﬁrst being the US Renewable Energy Feeder Fund, designed to generate attractive risk adjusted returns by investing in renewable power generation, clean fuels and renewable energy. RCM has extended its UK local authority portfolio with a global equity high alpha mandate from the London Borough of Wandsworth valued at £100m. Société Générale Securities Services (SGSS) has won a mandate to provide trade processing, reconciliation, reporting, collateral management and independent pricing services to Finnish pensions ﬁrm Ilmarinen Mutual Pension Insurance. SGSS has also been mandated by the Paris branch of Credit Suisse Securities Europe to provide independent secondary pricing services to a number of its institutional clients. The securities services provider said that the move will enable Credit Suisse to meet increasingly tough requirements by regulators. The Italian Investment Fund for Small and Medium-sized Enterprises has appointed SGSS to act as its depository bank and provide other complementary services. It is a mutual fund restricted to institutional investors with a target to raise 3bn, and its main objective is to provide ﬁnancial support for the development of small and medium-sized companies in Italy. State Street has been appointed by the General Synod Pension Plan of the Anglican Church of Canada to provide custody, securities lending and other services for CAD $600 million in assets. In other news, Libremax Capital has chosen State Street to provide hedge fund administration services for its newly-launched hedge fund. Libremax Capital, which was founded by former Deutsche Bank executives Fred Brettschneider and Greg Lippmann, will be able to focus entirely on achieving investment results, said Lippmann. State Street Australia has also won a mandate to provide a full set of superannuation services to REST Industry Super as part of the custodian’s commitment to meet the needs of Australia’s growing superannuation sector. State Street will provide custody, fund accounting and complex tax services to REST, which its chief executive Damian Hill claims will help keep the super fund at the top of the $1.3 trillion Australian superannuation market. Knight Clearing Services has chosen SunGard’s Apex securities ﬁnance solution to help with the processing of its international securities lending and repo businesses across the front, middle and back ofﬁces.
FundFront
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2011
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Crisis talks
FundFront
CRISIS TALKS
Craig McGlashan investigates the effects of the ﬁnancial crisis on the funds industry and how the future needs to change
Laurence J Kotlikoff is a William Fairﬁeld Warren professor at Boston University, a professor of economics at Boston University, a fellow of the American Academy of Arts and Sciences, a fellow of the Econometric Society and a research associate of the National Bureau of Economic Research. His book, Jimmy Stewart is Dead, coined the phrase Limited Purpose Banking, a set of proposals he believes are necessary to keep the ﬁnancial system from collapse
A rose by any other name
Any article on the events in the ﬁnancial world of the last few years must overcome their lack of an agreed name anything that history has not yet ascribed a title cannot really be said to be over. Plenty of people have tried to, however. For instance, in a speech to the Westchester County Bankers Association in June 2010, Joseph S Tracy, executive vice president at the Federal Reserve Bank of New York, said: "I begin with the simple exercise of what name we should assign to this past crisis." This is important, he says, because “as Shakespeare reminded us", names are important because of the meaning they convey. It is interesting that as recently as June 2010, Tracy could talk of these events as in the past. This came after the Greek bailout was agreed, but before the enormity of the problems in Ireland were revealed, and before whatever else may have happened in the time between this article being written and it being published (Portugal potentially needing a bailout is currently the hot topic). For the sake of moving forward, this article will refer to "the ﬁnancial crisis", or just "the crisis", and will talk of "before, during and after", with the due acknowledgement that it is currently impossible to tell whether the crisis is closer to the before or closer to the after. (For the record, Tracy settled on the "Panic of 2007" as the most "instructive" name. Given recent events, that seems to be the kind of sweet-smelling euphemism that Shakespeare himself would have been proud of.)
Alistair Darling has been a UK member of parliament since 1987. He served as the chancellor of the exchequer from 2007 to 2010, during which time he was involved in the bailouts of a number of leading British ﬁnancial institutions. Before becoming chancellor, Darling served in a number of cabinet posts from Labour’s election victory in 1997 until its defeat in 2010 Paul Martin was the 21st prime minister of Canada, from 2003 until 2006, and served as a member of parliament from 1988 until he retired in 2008. From 1993 to 2002, as minister of ﬁnance, he oversaw a number of policies that altered the ﬁnancial structure of the government and saw the elimination of Canada’s large ﬁscal deﬁcit
All that glitters is not gold
The impact of credit default swaps, subprime mortgages and the like on the crisis are well documented and perhaps there is nothing much more to add on those subjects. What can be argued, however, is that from a fund point of view, those were not the major issues. Alistair Darling does make clear that much of the crisis must still be laid at the door of the banks, with the boards of these institutions “primarily culpable” from that angle, but adds that regulators and central banks should also take some blame.
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Crisis talks
“Lots of people now say they saw it coming but perhaps didn’t shout loud enough at the time. People were quite happy to go along trading with each other, with conﬁdence with each other, but all the time there was this problem building up which manifested itself with the failure of the American subprime mortgages which then within weeks spread right across the world.” But is there an argument that funds themselves should have taken a more introspective look at their own responsibilities? “One of the criticisms that can be levelled against some of the institutional shareholders is that they were quite happy to let the management to get on with it,” Darling says. “Whereas if you own a company, you should do more than just ﬁnd out what the dividend policy is – you should ﬁnd out what they are investing in and put pressure on banks to account for themselves.” Laurence Kotlikoff believes that funds should “have a share of the blame”, given that any entity investing in risky securities “has a ﬁduciary duty to make sure you have safe assets to back up the liability”. However, he believes that the main responsiblity lies elsewhere. “The fact is that a lot of the pension funds were investing in securities they were told were AAA by the rating agencies and insurance ﬁrms. “How can the people running those funds be blamed for investing in what was a high-yield but very safe security? We have massive fraud and corruption underlying the ﬁnancial system. It may get dampened down in the near term because the regulators are being told to do their job, but basically the fundamentals are no disclosure, full proprietary information, and that is just a breeding ground for fraud, as we’ve seen.” Both men feel that the problems being experienced by funds go back a lot further. In the 1940s, the end of the Second World War, national governments made promises to their electorate of the state caring for them into their twilight years; a good promise, an achievable promise. However, given the rise in life expectancy, this model may well be in need of massive overhaul, and indeed governments have begun to look at this problem. Darling agrees that these problems can be attributed to these changes in demographics, as much as any ﬁnancial hocus pocus taking place on banks' trading ﬂoors. “In the early part of this decade, rather than talking about why people did not notice what was going on in the banking system, why did people not spot the fact that the population was growing much older?” he says. “Frankly a lot of the problems with the pension funds were that there was not enough money in them to support all these people. In 1945 the life expectancy of a man who retired was a year, now it is maybe 30 years – there were bigger structural problems.” Kotlikoff believes that this problem was noticed by the people in charge of pension funds, however. The problem, he says, has been “dramatic underfunding”. On the US private sector, he says: “With our government insurance, people have insurance on their funds and take risks because they can put the obligation back to the government through the Pension Beneﬁt Guaranty Corporation. That organisation holds liabilities that could get much bigger if the economy continues to underperform. “People running these pension funds are gambling on making high returns in the stock market and on risky bonds, whereas their liabilities are to a large extent much more certain, so they could have been investing in inﬂation index bonds to hedge their risk but instead they are taking on risk in order to get the upside and if the downside occurs it is a problem for the federal governments.” Moving on to US state pensions, he continues: “They are trying to put the problem on to future taxpayers because they are even more underfunded as a group; we’re talking about thousands of state and local municipal pension funds that are in a terrible state. Again, they have been investing in very risky ways and a lot of them lost a lot of money in the market.” However, according to Kotlikoff, the federal government is “the worst violator of prudence”, suggesting that it has been running a “massive Ponzi scheme”. He continues: “It’s taking from young people, giving to old people, and telling young people, ‘You’ll get yours later.’ It’s left the country effectively bankrupt.”
FundFront
A man loves the meat in his youth that he cannot endure in his age
The idea that the older generation has been in effect stealing from the young is an interesting one, particularly given the mainstream media view of today’s youth as lethargic and cynical, both traits that could be attributed to a sense of injustice. Recently, both the French and Irish governments have dipped into their pension pots to help alleviate debt problems. Indeed one of the major criticisms levelled against the Labour government of which Darling was a member was the abolition of advanced corporation tax relief for pension funds, with some estimates suggesting this cost UK funds as much as £100 billion. However, these criticisms are not just of the Labour government - other legislative impacts include the previous Conservative government’s decision to tax pension fund surpluses. Darling responds: "There is always going to be a healthy debate between the industry and the government, from time to time. If you take the abolition of the dividend tax relief, that was part of the changes in relation to advance corporation tax which at the time everybody said was a ridiculous system. Actually, if you look at the performance of the insurance industry after it was removed, it was ﬁne." An isolated case answered, perhaps. But no one can deny that governments often make decisions that are
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popular with those who vote in numbers, but may have an impact on those too young to vote, be it because of the voting age being too high or youthful indifference. So is there an inherent tension between the short-termism of government and the long-termism of pension funds? Paul Martin admits that, in politics, there is a trend where politicians can view pensions as a problem that can be dealt with 10 years down the line – and successive governments taking this view mean that the problem only becomes exacerbated. However, he does believe that there comes a “tipping point”, at which “most political people will act”. For him, this time came in Canada the mid-1990s: “One more crisis or recession in the USA and we were at the tipping point and that’s why we acted. It wasn’t just me - it was my colleagues at the provinces. “For 25 years, ministers of ﬁnance at the federal and provincial level had essentially put things off, hadn’t dealt with deﬁcits, but nor had they dealt with “I was in a debate in a church basement and a woman really started to give me heck because of the cuts that were coming and I said, ‘Ma’am, you’re really asking your children and your grandchildren to buy your groceries.' She stopped and you saw the room change. “It was the single biggest issue in our campaign here, certainly in the pension plan, because if we hadn’t changed our pension plan then our children would have been paying massive premiums for virtually no pension at all and we would have been living off the fat of the land.”
All the world's a stage
Despite Canada working to sort out its pension fund, Martin’s description of a “tipping point” whereby one country’s recession could result in terminal disaster for another is perhaps the neatest way of describing the main problem behind the ﬁnancial crisis. At Sibos 2010 in Amsterdam, RBS CEO Stephen Hester
I said, ‘Ma’am, you’re really asking your children and your grandchildren to buy your groceries.' She stopped and you saw the room change
their pension plans. “When I called the provincial ﬁnance ministers, my message was, ‘This issue has been put off for 25 years and we could put it off for another 10 or 15 and leave it to somebody else, but why don’t we do the right thing. The vast majority of those provincial ﬁnance ministers said, ‘Yes, let’s do it.’ “I think that that happens. Every so often you’ll get a generation who’ll say, ‘Look we’re going to face this down and we’re going to do it. And they did.” [For more exclusive content from Martin on this period, visit www.Fundamentalsmagazine.com/PaulMartin] Ensuring that the Canadian pension plan survived involved cutting beneﬁts and raising premiums, the result of which being that it then became the best funded pension plan of all the G7 countries. However, the word “cuts” never goes down well with the public, as has been seen of late in the UK and Greece, to name but two countries, so how did Martin deal with the backlash? Interestingly, he used the idea that this section opened with – that the old were effectively stealing from the young.
described the crisis as not a ﬁnancial crisis at all, but instead “the ﬁrst crisis of globalisation”. Darling, who presided over the near-collapse of British bank Northern Rock, said that one thing the crisis “brought home” was “just how interconnected all these banks are, and that does change your way of thinking”. He continues: “In the olden days, in America, which had 3,000 odd banks you could have a small bank in the middle of Florida could collapse and it’s a calamity for that town, or that city, or even that state, but other than that nobody notices. Now you can get a small bank collapsing – and Northern Rock, unfortunately, became known throughout the world – and not for the good reasons.” Darling recounts attending various international
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gatherings after the Northern Rock incident, and being told “you had it coming”, adding there was “a touch of schadenfreude about it”. However, he would reply by telling people to look at their own banks and eventually it became clear that Northern Rock was “a symptom of a problem”; it needed to secure American wholesale funding to support its lending – a perfect example of the interconnected nature of the banking system. Of course, the world cannot go back to the days when banks were truly local entities, and it is this truth that inspired the title of Kotlikoff’s book, Jimmy Stewart is Dead. “If you are dealing with ﬁnancial companies run by a neighbour, the Jimmy Stewart-type who is your local banker that you trust, you’ve lived together for years, then it is not so important to know exactly what he is up to because you can rely on him,” Kotlikoff says. “But we can’t rely on Dick Fuld and that is why the title of the book came to me. This is a whole new world. “You look at the guy inside my local Bank of America, he’s a young clerk, he might move to another branch next week – this is a town of maybe 50,000 people. That’s a lot of people; he’s not going to get to know them. The world is too big – that’s the reality.” While funds deal with a different level of banking than retail customers, this theory can be taken to that level, in that many fund managers did not have the kind of relationships with the investment banking world that they would have done in years gone by. Kotlikoff adds: “Funds were lied to because the rating companies were on the take and misrating, then you had the regulators asleep at the wheel - probably being bribed by the hope of a job on Wall Street, you had the government being bribed, and you had directors who were deﬁnitely being bribed, and then you had CEOs stealing from the shareholders of these major ﬁnancial companies.” However, Martin has a difference with Hester’s proclamation, albeit “one of nuance”. He cites the Roman and British Empires as examples of how globalisation has existed in the past, but now there is a “fundamental difference”, one that requires the very word “globalisation” to be redeﬁned. “We are now dealing with the complete interdependence of nations,” he explains. “When you have the sub-prime crisis in the USA and Asian markets suffer. I think you might well say that it is the ﬁrst real manifestation of the interdependence of nations in the ﬁnancial area. “The real key words are the interdependence of nations. At the time of the Roman or British Empire you didn’t have this seamless interdependence of nations that you have today. I think that there has never been a time in history when contagion was the major problem, or was so much the major problem.”
FundFront
No legacy is so rich as honesty
Undoubtedly the biggest factor behind this new world order of interdependency is the advancement in the twentieth century of technology. However, in many ways, technology has advanced faster than human beings have been able to keep up and this is particularly true for the ﬁnancial services world, Kotlikoff thinks. “There is a lot of technology being used by the ﬁnancial industry, but not for good; it’s being used for bad,” he says. “It’s helping them perpetuate insider trading, hide their secrets and make money off their secrets. The whole idea that we should be investing with people who aren’t going to tell us what they are doing with our money - that’s a huge red ﬂag.” But this same technology can now be used to help investors make good decisions, Kotlikoff believes. “You can have full disclosure on the web of all the securities that the mutual funds are holding, that’s part of what I’m proposing. We can take advantage of technology to allow people to see exactly what it is the mutual funds are investing in. “We can move to something very straightforward, simple and effective.”
l do desire we be better strangers
While technology may well aid transparency, it is clear from the events of the crisis that more root and branch reform will be required to avoid a similar situation in the future. One initiative is the new Basel III capital requirements for banks, which are scheduled to be introduced fully by 2019. This will not solve the problem completely, according to Darling. “The general proposition, the idea that banks should hold more capital, I think is a good one. But the amount of capital they hold is not the only thing you need to look at. Northern Rock was one of the best capitalised banks in Europe and a fat lot of good it did it.” While new regulations have been discussed and debated as after any ﬁnancial crisis, the events of the last few years have perhaps been unique in the amount of calls for changes to the regulatory bodies themselves. As an example, at the start of 2011 the European Securities and Markets Authority (ESMA) came into effect, replacing the Committee of European Securities Regulators (CESR).
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However, there have been calls for a worldwide regulator to be introduced to deal with what is truly a global system. As a forerunner to these calls, the G20 meetings between the world’s ﬁnance ministers during the crisis were seen by many as helping to avert full worldwide collapse. Darling was present at these meetings. “There is no doubt that at a time when the world was looking over the edge, having 20 of the largest economies sitting around a table and more importantly 20 people who could take decisions - that made a huge difference.” But as with any collection of sovereign states, it has not been without its problems, he continues. “I’m very concerned that the progress appears to have stalled. Even 18 months ago China would be at the table playing a very active part whereas now you have the standoff between China and America over the currencies and the imbalance, which is a big problem and is only going to get sorted out internationally. “But my experience in 2008/09 is the G20, although it had no democratic basis whatsoever, worked as an ad hoc body because you happened to have the people that mattered sitting in the same room.” Martin was heavily involved in the creation of the G20 in the late 1990s; a process which he says was required because of problems in Asia, Brazil and Russia. “I spoke to Larry Summers [then US Treasury secretary] and Gordon Brown [then UK chancellor] and made the point that we were all going to be sideswiped by problems in the emerging economies because of the economic interdependence of countries, if we didn’t expand the size of the tent.” This meant bringing to the table not only those countries that were in trouble, but the likes of China and India who were becoming major players. Martin then became its ﬁrst chairman and he believes the organisation is now vital. Despite his support for the organisation, Martin does admit that it will have to evolve over time, otherwise it will become like the G8 – passé. However, he does feel that it will have a “relatively permanent makeup” for the foreseeable future. But Martin believes more is needed than just the steering committee of the G20. The body must give the Financial Stability Board (FSB) “the authority, scope and stafﬁng to monitor banking regulation globally”, he says – not becoming a global regulator, but instead a watchdog for national regulators. “What happened in the USA, the UK, in Europe, was that the national regulators did not do their job,” he explains. “You need a global body that will basically ensure globally that the national regulators are doing their job.” But, as Darling pointed out with the problems of the G20, any question of a global overseer of national regulators introduces questions of sovereignty. How does Martin respond to this problem? “The argument that has to be made is that 100 years ago you could say you were protecting your sovereignty by staying alone in territorial isolation. Today, when the actions of one country could damage your economy, the only way to protect your sovereignty is to ensure that every country is living up to its responsibilities, and you can only do that through an international institution like the FSB. “Every European or North American who would question whether the FSB is going to damage their sovereignty, I would say to them that the two biggest banks in the world are Chinese – wait till they stumble and if you don’t have global monitoring, so that you know the Chinese are doing the right thing, as today we want to know that the Europeans and North Americans are doing the right thing, you need a FSB, and that’s the only way you’re going to protect your sovereignty.”
So wise so young, they say do never live long
However, another issue is that in the minds of many in those upcoming countries such as India and China, the ﬁnancial crisis was a problem of the West. Darling explains: “If you speak to ministers from Asian countries they’ll say this is a Western problem, they say to the banks come here because we don’t have a population that gets hung up with large bonuses or various other things that people in the West ﬁnd sometimes distasteful.” The idea that Asia will never see a banking crisis again is “fanciful”, according to Darling, so it will be in their interest to be part of a global regulatory effort. But Martin reveals that he has outlined his proposals for the FSB in talks in South Korea. How did they go down there? “The reception in Korea was very good to what I said. There is the issue with China and India, although the Chinese have called for an international supervisory body. But there have been no details so nobody knows exactly what they are referring to.” Martin concedes that at points he has had the response from emerging powers that the crisis was not their problem, to which his reply was that “the FSB is a successor to the Financial Stability Forum”. The Forum was created at the same time as the G20 but, according to Martin: “It was given no teeth, because the Europeans and the Americans said, ‘Our banks are perfect, the problem is those Asian banks in
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Thailand and Indonesia.' To which I say 15 years later take a look at what your good regulation did. You may think you have it today, but your banks are going to go through the same cycles the American or European banks did.” In terms of the makeup of the FSB, Martin stresses that it should not include central bankers or economists and instead should feature the “crème de la crème” of regulators, with 20 years’ experience – “hard bitten and with not a lot of compassion”, to be speciﬁc. How does Martin envisage the FSB exerting its authority? “The sanction that people are talking about is public shaming. A peer review is a very good thing, so for the sake of discussion if you were looking at Swiss banks, you’d appoint a peer review of three other countries. “They would review the Swiss regulation then publish a report. The expectation would be that if the regulation was not up to snuff then the Swiss would change it. If they didn’t, then my recommendation is you would say the Swiss banks cannot operate in the other G20 countries. If that were the case, you’d ﬁnd the Swiss banks would put pressure on their government to improve the regulation. “We’ve already seen it, the G20 has gone after tax havens and they’ve done more than simply naming and shaming so the precedent is there.” governor Mervyn King. Kotlikoff outlines the problems of the American banking system: “Limited liability, fractional reserves, off-balancesheet bookkeeping, insider-rating, kickback accounting, sales-driven bonuses, non-disclosure, director sweetheart deals, pension beneﬁt guarantees, and government bailouts,” a system which, as he argues earlier in this article, allows for corruption. Instead, Kotlikoff’s proposals can be summarised as follows: if depositors want their money to be completely safe, they can have an account matched 100% by cash held by the bank; if investors want more risks, or insurance, then mutual funds are created to deal with these distinct needs, and created in such a way as to avoid systemic risk, such as not allowing the funds to borrow. From the regulatory angle, one single super regulator will be required to carry out just one task: ensuring that fund managers must disclose what they are holding at all times – something which, as outlined earlier, technology can now make possible. Kotlikoff explains further: “If the only job of the banker is to buy securities at auction that are fully disclosed and independently appraised, rated and veriﬁed, then there is not too much for regulators to do. So that is why my idea is for regulators to have a much smaller job to do and the ﬁnancial system will never collapse again. “I’m taking out the proprietary information so if somebody’s a good picker of bonds or mortgages or stocks they’ll be able to get rewarded as a mutual fund manager but they won’t be able to get bonuses independent of their performance which is what we have in the current system.” [To ﬁnd out more about Kotlikoff's proposals, visit www.kotlikoff.net] Kotlikoff thinks that this work must be done soon, before it is too late. In a speech at the GSL Boston Summit in November 2010, he cited the hypothetical situation of a swine ﬂu epidemic that targeted the young and a cure for cancer being discovered. Such a situation would bring the ﬁnancial system to its knees, as the current predicament of the young paying for the old would suddenly be exacerbated. He provides another example: “Suppose the US Treasury bond market collapsed this afternoon because the Chinese were dumping US bonds and so interest rates spike up, the dollar falls, the Fed comes in to print money to try to keep interest rates down and that just fuels the ﬁre because people are worried about too much money being
FundFront
To be, or not to be
Some commentators feel that the crisis has not been an issue of regulators or regulation, however; it goes much deeper than that. Kotlikoff believes that the complexity of ﬁnancial markets now makes it impossible for regulators to operate, whether as one super body or as a number of different entities. He suggests that current efforts towards improving regulators and regulation are like “putting a band aid on a patient that needs open heart surgery” – they do not nearly go far enough. “You are asking them to babysit bankers on every transaction,” he explains. “We’re allowing the banks to gamble, to borrow short and lend long and then we’re telling the regulators to inspect every investment which is not a job that they’re really able to do. We could still have a Lehman Brothers or Bear Stearns situation. “You could have the most honest, conscientious regulators and the system would still have collapsed.” Instead, Kotlikoff believes that the US should have a single regulator with an achievable task. He outlines his proposals for what he calls “limited purpose banking” in his book, Jimmy Stewart is dead, and has already won support for his proposals from the likes of Bank of England
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printed and then they start worrying about inﬂation and start heading to the banks to get their money out and buy something. Then you have a massive bank run in the USA, a massive run on money market accounts, a massive run on life insurance cash surrender value policies. “You could have the Federal Reserve have to print $12 trillion in a matter of weeks and then the entire system would be over. Game over for the US economy. “Under limited purpose banking you wouldn’t have any runs. They wouldn’t be possible. Even if the US government got into trouble it wouldn’t have any implications for the ﬁnancial sector because things are marked to market, people would be able to get their cash out because they’d have cash mutual funds and they’d be backed to the buck, and basically monetary base would be guaranteed because they’d be a buck for dollar in monetary base.” While many would favour the breakup of the giant banks that dominate the system, although not perhaps to the extent that Kotlikoff proposes, there have been arguments against this move, particularly given that, for instance, RBS saw itself return to proﬁtability thanks to its so-called “casino banking” – i.e. investment – division. Darling agrees with this sentiment: “There is nothing wrong with investment banking per se and whatever system we have in the future these functions are going to be discharged by somebody. There is an argument – do you break up the banks? I have great reservations about that because I do not think that is dealing with the problem. “If you look at RBS, it has suffered colossal losses and now things are better although it is not out of the woods yet, as recent ﬁgures attest. It will need all the money it can get to repay it. The real problem RBS had is, it had toxic assets before, but most of them were in ABN AMRO and if someone had looked into the books there before going after it then they might have decided it was better to leave it to someone else.” Again, an argument for transparency. be the deﬁning factor in avoiding the conﬂicts that have arisen of other ﬁnancial crises - but the world must realise that everyone else on the planet is now a neighbour, and knowing how the other side of the world operates is just as important as understanding what is happening on the other side of the street. So far, through a mixture of imagination, action and effort on the part of regulators, governments and the ﬁnancial industry, the crisis has not created any true catastrophes. Alistair Darling can rightly point to this fact as the highlight of his time in ofﬁce. But this was a case of needs must. Paul Martin can conﬁdently say that his reforms meant Canada is now in a healthier position than many of its peers but again these reforms, no matter how much effort was exerted to introduce them, were only possible as a result of the problems Canada was facing at the time - the same problems the rest of the western world would face a decade later. Laurence Kotlikoff has offered a solution to avoid all this happening again. Whether or not his is the correct solution, the concerns he raises are real and must be dealt with before they can fester. However, certainly in the West, the demographics paint a concerning picture, something that all pension funds should consider, especially when looking at their liabilities. Martin makes this point succintly: “When you have aging populations like all of us do it’s a contradiction in terms to talk about a surplus in your pension plan. When you look at the difﬁculties that people are having because of corporate pension plans, I think that you should leave those surpluses and what you really have to do is build them up.” Of course, governments should also heed that warning and refrain from using pensions as a source of funding for short-term populist projects. But the lessons from the crisis should not just be picked up by governments, CEOs and fund managers. Fighting corruption via improved regulation of wholesale systematic changes is one thing, but everyone must have the education and the understanding to know when they are getting a raw deal, be it as a pension fund trustee or as a member of the public. As Darling says: “When the good times were rolling people didn’t ask questions. For the public’s part, they were getting cheap mortgages, they were getting loans to do this and that, and nobody asked any questions. Traditionally people asked questions when things go wrong, we should get in the habit of asking questions when things are going right. Why is someone able to lend you money so cheaply? There must be a reason for it if no one else is doing it.” People do tend to let the good times roll. They should remember that rolling objects tend to take a downward direction.
Tomorrow, and tomorrow, and tomorrow
It is impossible to guess what historians will glean from this crisis in the decades to come. What really happened in any great historical event can only ever become clear later. But one thing that can be said for certain is that the speeding up of all aspects of life, in technology, social mobility and globalisation, has not been matched by the forethought required to ensure that the beneﬁts these shifts offer are not overtaken by the potential havoc they can wreak. No one can deny that the greater longevity human beings now enjoy is a good thing, but to ignore the impact this will have on funding the increasing numbers of elderly people is foolhardy. Technological advances have allowed markets to run more efﬁciently than ever before, but leaving such an important function solely in the hands of automatons is lazy. And the links that are now shared between humans across the globe who 100 years ago would never have met is perhaps the greatest advance of this age - and may well
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Life insurance
FundFront
Life Insurance:
The New Product Proposition
Life insurers face a series of powerful factors that are reshaping their competitive environment. Product innovation will be critical to success, says Wade McDonald at State Street.
he life insurance industry ﬁnds itself at a crossroads as a series of powerful forces — both secular and related to the ﬁnancial crisis — reshapes its competitive environment. Ageing societies and rising longevity are changing consumers’ retirement planning needs, as the trend from deﬁned beneﬁt (DB) to deﬁned contribution (DC) plans shifts the investment risk onto individuals. The crisis has depleted balance sheets, heightened regulatory scrutiny, and led to an increased focus on absolute returns. Meanwhile, technology is transforming the way people make ﬁnancial planning decisions and how organisations operate. These forces have been a major catalyst for change. They are promoting the emergence of a long-term savings industry where life insurance and pensions converge. The challenge for life insurers is to retain and redeﬁne their role in the value chain, particularly amid growing competition from DC pension providers. To that end, there is scope for signiﬁcant ongoing innovation in the product space, as insurers seek products that ﬁnd the optimal balance between risk and performance, and generate differentiated value for the end consumer. Those insurers that adapt to this new product paradigm will emerge as the winners. The Challenge of Providing Retirement Income Product innovation is happening in a number of areas. Demographic shifts, the pressures on private and public sector pension schemes, and the shift to DC have all increased the appetite for products that generate a more certain income stream in retirement, while ensuring that people do not outlive their assets. At the same time, regulatory, tax and capital issues 18 | Fundamentals
| 2011
are inﬂuencing the type of retirement products that will be required in future. For example, the UK government is ending compulsory annuitisation at the age of 75. Planned tax changes will reduce the relief on pension contributions for higher earners and may discourage those affected from saving in a traditional pension. In addition, pressure on capital in the wake of the ﬁnancial crisis, particularly with the advent of Solvency II in Europe in 2012, means that capitalintensive products, such as old-style annuities, may be on the way out. All of these factors are driving the search for new savings solutions. Variable annuities may be part of the answer. Although well established in the US, they are relatively new to Europe. Like ﬁxed annuities, they offer a guaranteed accumulation of interest and a payout in retirement, with the added death beneﬁt of a life insurance policy. The primary difference is that the policyholder takes on investment risk. In addition to a ﬁxed interest-rate account, the return on a variable annuity is tied to an underlying portfolio of assets such as equities. This means it can earn a higher rate of return but it is also riskier. There is still more work to do on improving variable annuity products. These products hurt US insurers’ balance sheets during the crisis because of the high guarantees in place. Most are likely to adjust the guarantees to allow for greater downside protection on the insurer’s part. These and other investment products with guarantees are seeing increased interest on the part of bancassurers and ﬁnancial advisors. The challenge in introducing and further expanding the use of variable and other annuities into new markets will be in educating sales forces to properly explain the beneﬁts of these complicated products.
Life insurance
A Holistic Approach to Financial Planning
One way in which insurers are seeking to reassert their position in the value chain is by providing a holistic ﬁnancial planning solution, incorporating both pension and non-pension products — the “corporate wrap” platform. Already well established in some markets, this concept is rising in importance in the UK and US, in line with consumers’ desire for greater transparency and cost effectiveness, and the shift away from individual product sales towards ﬁnancial planning, as underscored by the Retail Distribution Review in the UK. In some markets, wrap programmes have long been used by ﬁnancial intermediaries working with individuals. Now they are gaining ground with corporations looking to provide integrated employee beneﬁts, from investment for retirement right through to everyday ﬁnancial planning. Wrap programmes offer a number of advantages, as more individuals take charge of their retirement planning and investing. Employees can transfer their existing ﬁnancial assets, such as Individual Savings Accounts (ISAs), into the wrap. This allows them to manage their entire portfolio, including their DC scheme assets, through an online portal, so they can monitor it every day. Wraps also provide an avenue to get ﬁnancial advice, and offer greater choice and ﬂexibility than some other beneﬁts programmes. Options can include savings products (to narrow the savings gap and fund longer retirements), equity release schemes to pay for long-term care and variable annuities. Wraps can also be portable, if individuals move to a new employer. Importantly, these programmes help to maximise tax-advantaged investing by using ”wrappers” such as the UK’s ISAs and Self-Invested Personal Pensions. With the shift away from product selling to ﬁnancial planning, consumers will be less likely to pay for advice unless it signiﬁcantly mitigates their tax bill. Corporate wrap platforms require scale and a signiﬁcant investment in technology to be
successful. Yet they are fast becoming the best way for life insurers to compete in a crowded wealth management industry. By owning the holistic planning space through the wrap concept, life insurers can ensure their place in the value chain and, by extension, their future success. Capital Usage and Efﬁciency are Also Critical while developing the right products is key, life insurers also have other concerns. The ﬁnancial crisis shrunk their balance sheets and Solvency II will increase the pressure on capital. Insurers’ business models will have to be much more efﬁcient, starting with a new operating platform that is technology-dependent and globally consistent. To compete effectively, insurers will also need to take a hard look at which activities are core to their business and which should be outsourced to reduce costs and capital burden. With a strong track record in providing solutions to the long-term savings industry, State Street can help life insurers meet these challenges. We are focused on being a global partner to life insurers, helping our clients to develop differentiated products and services, optimise their use of capital by outsourcing their non-core activities across the broadest functional spectrum, and leverage scale and investment in navigating regulatory and industry change.
Wade McDonald is Head of Client Management and Sales for State Street Global Services in the UK and Africa.
2011 | Fundamentals
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ABN AMRO
ABN AMRO: The Resurgence
FundFront
Craig McGlashan visits Bas Cohen, newly appointed head of trading at ABN AMRO, as the bank ofﬁcially launches its new trading ﬂoor and seeks to move forward from the events of the last two years
aking the short train ride to the Amsterdam ﬁnancial district where ABN AMRO is headquartered, it struck me that trying to explain the bank’s story over the last few years to any of the other passengers would have taken far longer than the actual journey, regardless of my complete lack of Dutch language skills. However, if any one tale could sum up the wider ﬁnancial crisis as a whole it may well be ABN AMRO’s. A takeover launched during the overconﬁdent times of early 2007, the shock of ﬁnding a bunch of assets that were soon to be worthless and a number of government bailouts. I arrived at ABN AMRO’s ofﬁces to meet Bas Cohen, former head of securities ﬁnancing at Fortis Bank Nederland and now heading up the whole of ABN AMRO’s trading ﬂoor – a shiny trading ﬂoor that the day before I arrived had just had its ofﬁcial relaunch (although it had been operating for a number of months). While waiting in the lobby, I picked up a Dutch newspaper, which carried a picture of the new trading ﬂoor, under a headline that roughly translated meant “back in honour” – a sign that the Dutch ﬁnancial press, at least, were behind the relaunched bank. As I met Cohen he seemed buoyant, despite his beloved Feyenoord having been beaten 10-0 by rivals PSV Eindhoven a few days before. It became apparent that this positive feeling was not simply the result of a glitzy opening ceremony, but rather the progression the bank has made over a longer period. “There has been a lot of negative press about what happened with Fortis and ABN,” he says, before handily providing me with a translation of the Dutch newspaper I had been reading. “’Back in honour’ – that is what we all feel and we can go forward.” So has the ofﬁcial opening drawn a line under the events of the last two years and a half? “We have already started going forward but this is an ofﬁcial opening with a lot of VIPs, yesterday we had the press and they were all very positive. “The people should also be proud of what has been done. Not just the front ofﬁce but also the enablers, all the IT people, all the people that helped moving, the risk people – everyone.” Cohen talks of the “respect” those on the trading ﬂoor had for the people that enabled what he calls “such an efﬁcient move” after 1st July 2010, the legal merger date. It involved nearly 300 people moving via buses and removal ﬁrms from Fortis Bank’s old ofﬁce in the centre of Amsterdam to ABN AMRO’s headquarters. He adds: “It was a massive assignment. Work had to done on the weekends and overnight – but people would come into the ofﬁce in the morning and everything would be working.” Integrating IT systems is never easy, particularly when two distinct entities are being joined over a period of two weeks and Cohen reveals that the bank is still “in the middle” of completing the systematic merger. “Three weeks ago we separated from Brussels [Cohen was speaking at the end of October] so we are not dependant on those systems anymore and the old ABN guys separated from RBS on 1st April of this year. “One of the last pieces is the FX options book and then we are completely separated from Brussels. There are still a couple of areas where within ABN AMRO we have two different systems for the same product because we still need to merge them, but we are now one group.” Cohen explains that ABN AMRO opted to deal with its systems this way rather than merging everything in the beginning to ensure that it could continue operating while the systems integration was taking place. “With the structure we have chosen there is no harm to any commercial potential; we are unleashing the potential and are not restricted by the system. If we had chosen to merge everything ﬁrst, then we would have been,” he says. While the major work in integrating the different systems is now complete, Cohen admits that it was quite galling the day he found out that what had been Fortis Group would now be two separate entities. “It was pretty shocking to ﬁnd out on that day (3rd October 2008) that our colleagues in Brussels were not
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ABN AMRO our colleagues anymore, that the guys in New York where we had set up a securities ﬁnancing desk were not part of our group anymore and we had to split P&Ls, adjust fees - that was very strange,” he says. However, the real process took a period of two weeks. “The ﬁrst week we all know that the Belgian, Dutch and Luxembourg governments decided to invest money in the two legal entities. That was the ﬁrst feeling of separation. “We had a big golﬁng event on the Friday where we were supposed to have a lot of international clients and my feeling on the Tuesday before was that this was going to be a full separation so I cancelled the event. It would have been very strange on the Friday to sit with clients at a golf event and at the same time ﬁnd out that those clients were now trading with two counterparties rather than one. “On the Friday it was announced and I remember staying until 2am in the ofﬁce preparing all the different documents – we created a memorandum of understanding between myself and the head of trading in Brussels to make sure that we would not have back to back positions. And on Monday it was there. It was very strange – a very weird situation.” But to paraphrase Albert Einstein, in the middle of weird situations lies opportunity, and both ABN AMRO and Fortis Bank Nederland soon realised that the merger may be mutually beneﬁcial. “We had two handicapped trading ﬂoors, one at Fortis Bank Nederland and one at ABN, but funnily enough they were very complementary,” Cohen explains. “At ABN AMRO the focus was a lot more on rates trading while for Fortis that focus was in Brussels, so it was gone. At Fortis Bank Nederland we had the equities part, the securities ﬁnance part and the commodities part, and now these parts have all been put together onto the ﬂoor. So suddenly we have all the asset classes represented again - it was a very nice puzzle that ﬁtted with only 10 redundancies on the overlaps that we had.” These 10 redundancies came out of a trading population of 400; an impressively low ﬁgure given that other departments of the two banks saw redundancies of between 10% to 12% as a result of the merger. All of that has passed and ABN AMRO can concentrate on the future, but what will that future look like? Will the bank’s business plan resemble those of its forerunners? It would appear not, according to Cohen. “If you look back four years ago then the environment has completely changed,” he says. “First of all there was the impact of the separation with RBS and Santander and the separation with Fortis Group, and then there was the credit crisis which caused a different risk appetite and a different awareness of risk. “All of that has come together in a new mandate which is very client focused, which tries to transfer risk from clients into the bank and we try to offset that risk again into the market – that is our primary focus.”
This avoidance of risk means that ABN AMRO will not be indulging in proprietary trading and will avoid the kind of products that were blamed for the credit crisis – the kind of products that are “only understood by the front ofﬁce while risk management and the rest of the bank have no clue what they are”, in Cohen’s words.
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ABN AMRO
It is clear that ABN AMRO are not alone in their planned focus on clients needs – a number of discussions that had taken place at Sibos 2010, being held in Amsterdam the same time week as the ofﬁcial opening of ABN AMRO’s new trading ﬂoor, had been in a similar vein. Cohen cites a number of factors that are behind this trend, namely the credit crisis, risk awareness, regulation and Basel III. “If you take all that together, the impact is that we should focus on what we are good at and make sure that ﬁts with what clients need.” Taking this further, Cohen uses a word that normally has negative connotations: consolidation. However, for ABN AMRO, this is a “very positive” word. “Are we going to chase foreign clients in foreign locations? Try to do every product? Try to set up big systems to do different trades, or because a couple of clients want this or that? The main thing here is consolidation. “Consolidation for us means being good in what we are really good at, accelerating what we are good at, for a select number of clients that really are the core clients of the bank.” Cohen explains that these core clients are: private and retail, a space which ABN AMRO and Fortis Mees Pierson were always strong in; small to mediumsized enterprises, a traditionally active market for ABN AMRO; and ﬁnally the large corporate and institutional investor markets, the latter of which Cohen describes as “very crucial”. He adds: “Those are the main clients that we want to focus on. We will focus on trying to be number one here in Holland for all those clients and we will focus on their subsidiaries and branches in foreign locations.” At this point I am struck how much the ABN AMRO/Fortis story mirrors Cohen as a person: “Rotterdam born and bred”, he has an Egyptian father and Dutch mother, and his father had an Iraqi mother and Turkish father. He travelled all over the world as a child and, after working in various countries, has been based ﬁrmly in the Netherlands for a number of years now – similar to the picture of the new ABN AMRO: a varied global experience from a Dutch base with a renewed focus on the home market. That said, ABN AMRO’s focus will not be entirely on the Netherlands. Cohen explains: “In a couple of products at which we excel we will also have a global focus. This is very much on energy, commodities and transportation clients. That is a value change that has always been very crucial. “Additionally, securities ﬁnancing is of course a global product where we want to accelerate, also the broker clearing and custody business, and of course we have always said that the foreign exchange and rates business is becoming a global business where we want to target all the foreign locations of Dutch corporates. We have made a list of roughly 500 companies and we want to make sure they know our capabilities in that area. “Again, consolidation - for me meaning focus – making sure that the clients understand what we can do, and we will offer the best of what we can do, but we will not offer any more than that. “We are also very keen on staying independent and remaining as a normal Dutch system bank, because ABN belongs in the ﬁnancial landscape of Holland and the other areas where we operate. The name recognition is still very, very high – if I compare it to Fortis then you do see different advantages of being ABN now. With all respect to Fortis Bank Nederland the brand name of ABN is deﬁnitely bigger.” Despite the recurring theme of focusing on Holland and cementing its position as a Dutch entity, Cohen does admit that further in the future the bank may look more keenly beyond the borders of the Netherlands. “By stating that we want to focus on what we are really good at, and offer just that, we are creating a basis, and that basis should be the starting point for expanding our product palette and our ambitions,” he explains. “Of course our ambitions are very high and if we are honest enough our ambitions will reach into different locations, different client types, going beyond what we focus on just now. But the difference between ﬁve years ago, whether it was at ABN or Fortis, and now, is that we ﬁrst want to create a solid basis which is a track record for us and for the clients, and then we build on that as far as our ambitions can go – and of course they are big enough.” With that, the interview is over and Cohen heads off to a meeting with the Dutch Central Bank, just one meeting among many as ABN AMRO seeks to continue its re-launch and strengthen its position in the Netherlands. One thing that became clear during the interview is that if the bank consolidates its position in the Netherlands it will look to become more of a global player once again in a few speciﬁc global markets (ECT, BCC and Private Banking). ABN AMRO’s immediate future may be “Oranje” but, if all goes to plan, the longer term could be even brighter.
FundFront
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Fees high for funds?
Fees high for funds?
Damian Burleigh, managing director at S&P Valuations & Risk Strategies, looks at the hot topic of fund fees and whether they can be justiﬁed by performance
und managers have come under heavy criticism in recent weeks due to the headline grabbing statistic that fees of 1% can, on average, consume 38% of returns over the lifetime of an investment fund. This is clearly a signiﬁcant amount, but is it defensible? The only way fund managers can justify the fees they charge is by strong and consistent portfolio performance. Yet ensuring a strong performance is not easy: making the right bond selection in the right sector will always partly rely on an element of intuition, as will correctly timing trades and foreseeing the full implications of important impact-events. And there is also of course a signiﬁcant amount of resource required in researching and interpreting relevant information to inform both the investment decision making and risk management processes. Managers that allocate more resources to data, research and analytics tools should be capable of performing more robust scenario analysis, stress testing and risk monitoring across their portfolios. Poor portfolio performance is often a result of managers using analytics and research tools that are unﬁt for purpose. Indeed, in some cases the problem of overcharging can be at least partly attributed to managers taking bond bets without completing a full and comprehensive scenario analysis. If this is the case it would be near impossible to understand how the portfolio selected would perform in volatile economic conditions – leading to very expensive looking fees. However, some worthwhile excuses can be made in this instance. Each organisation will have its own analytical capabilities, although larger ﬁrms have an inherent advantage. They have a deeper research capability – largely through the employment of the most sophisticated databases, quant systems and valuation analytics. And larger ﬁrms are also able to attract the best and brightest industry names. But smaller organisations can have the upper hand in certain respects. For example, they are less inhibited by the kind of bureaucracy that can weigh down large outﬁts. Unfortunately, the proprietary analytics and systems some managers of smaller funds are forced to employ are fraught with IT investment and maintenance issues. These problems can be mitigated with an improvement in software infrastructure, which is why industry leaders in market analytics such as S&P Valuation & Risk Strategies are committed to delivering powerful but intuitive scenario-based analytics with deep stress testing mixed with forecasting correlation analytics. Such tools are becoming essential for portfolio managers undertaking surveillance and stress testing across asset classes and, indeed, across the entire capital structure. Tools are also being developed to help inform investment decisions in speciﬁc asset classes. A good example is S&P Valuation & Risk Strategies’ new risk-to-price scoring system for both high-yield and investment grade corporate bonds. Risk-to-price was originally developed as a direct response to the credit crisis of 2008/2009 and is now being widely adopted for day-to-day use by managers in the US and EMEA. The methodology aids fund managers with both risk management and alpha generation by combing through a growing universe of 7,000 ﬁxed income instruments to rank bonds according to how well they compensate investors – through yield – for their respective market and credit risks. Of course, proﬁting in a trending market is relatively easy and may not require complex analytics tools. Getting the most value out of investment portfolios while reducing risk during unstable market periods is much harder, meanwhile, and successful managers in this environment earn their dues. In fact, investors have been seeking riskier investment strategies in recent months –for example through increased durations in the ﬁxed income markets – putting more of an onus on robust risk/reward analysis. Certainly, the dip in the average duration of a bond portfolio after the ﬁnancial crisis – when tenors slid from ﬁve to three years – has since been reversed, with between four-and-a-half and ﬁve years now the norm. And it is possible we will see further increases soon. In fact, pay-downs have signiﬁcantly reduced portfolios’ compositions and the term of replacement bonds currently tends to be in the range of ﬁve to seven years. The idea that there are many contributing factors in the creation of a successful portfolio is hardly controversial. Everyone knows good data, research, analytics tools and a dose of intuition are all necessities. Investors looking at these more aggressive strategies would do well to turn to discerning and well-equipped fund managers if they are to obtain a healthy return. This is especially true in the current economic climate: without a capable manager using sophisticated tools the total return is unlikely to amount to much.
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The Times, they are a changin'
FundFront
The Times, they are a-changin'
Fund managers are urged to ramp up their systems to adapt to the changing landscape of regulation. By Eric Roux, managing director - fund reporting, KNEIP
he ﬁnancial crisis has had a signiﬁcant impact on the fund management industry as well as the investment community. After the turbulence of the past few years, it has become apparent that today’s focus needs to be on restoring the market’s trust by enhancing transparency across the board. Consequently, fund managers, distributors and independent ﬁnancial advisers (IFAs) must all place an emphasis on creating a true partnership with their investors, one in which communications are improved, processes are standardised and documentation is simpliﬁed. Against this backdrop, fund managers must also face increasing regulation determined by the European Union. Indeed, as has been exceedingly well documented, a raft of legal reforms is underway and planned for full implementation in 2011. These include of course UCITS IV and the introduction of the Key Investor Information Document (KIID). Instead of regarding these regulations as unnecessarily burdensome, the investment community can regard them as a real opportunity to redeﬁne investor communications. The way in which asset managers plan to implement UCITS IV will very much depend on their existing funds, business model and strategy. Internal organisational strategy and distribution policies will be the main drivers for asset managers in choosing their fund domicile and their asset servicing providers. The only mandatory measure is the replacement of the Simpliﬁed Prospectus by the Key Investor Information Document (KIID) from July 2011. The introduction of the KIID responds to market needs for transparency, uniformity and standardisation as it is intended to help end investors make more meaningful comparisons between UCITS funds. In line with this objective, the KIID is basically a two sided fact sheet-style document with a prescribed format following ﬁve headings: (1) Objectives and Investment Policy, (2) Risk and Reward Proﬁle, (3) Charges, (4) Past Performance, and (5) Practical Information. It also introduces new types of information such as synthetic risk and rewards indicator. On the surface, the KIID appears to be straightforward and a more efﬁcient document than the Simpliﬁed Prospectus. However, its development also raises the following concerns, which we believe must be addressed by the industry as whole if the potential beneﬁts of the KIDD are to be fully realised.
Shifting towards a more standardised fund management industry
UCITS IV, which aims to create a more efﬁcient, ﬂexible and competitive European fund sector while offering greater investor protection, represents one of the most extensive regulatory upheavals the fund management industry has seen to date. But while this legislation is a very important step toward more cooperation and transparency between asset manager, distributor and investor, it is certainly not without its challenges.
Key hurdles to overcome
With less than 250 days to go before the regulation is fully implemented, KNEIP recently surveyed members of the fund management community on their concerns and expectations ahead of the introduction of the KIID.
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The Times, they are a changin'
According to our ﬁndings, cost is a critical issue. Almost 70% believe that producing the KIID will cost more than the current cost of producing the simpliﬁed prospectuses, with 50% of respondents stating that the increase in production costs would be in the range of 10-20%. This increase in costs could come from a wide range of areas including timing, volume, operations and delivery. This is particularly signiﬁcant, given not all countries will implement UCITS IV at the same time. EU countries have until 2012 to adopt the regulation at which point every fund launched in the country will have a KIID. Until they do, fund managers will need to produce both the Simpliﬁed Prospectus and the KIID simultaneously, essentially duplicating costs. Translation and production of the KIID is an additional cost and concern for the asset management industry, with questions around quality, quantity, timeliness and the workﬂow. UCITS IV requires yearly production every January, timely delivery and conﬁrmation of receipt, compliance with prospectus and translation coherence. As a result, a third of fund managers surveyed were considering outsourcing the KIID with almost 90% citing translations as the number one area to outsource, followed by production (75%). Fund structures will also be affected and strategies need to be revised in relation to representative share class (RSC). This directive allows for KIID production to be grouped into representative share classes. While grouping carries some risks, not grouping share classes will increase costs for producing the KIIDs due to the number of documents to be produced. However, 40% of the fund managers surveyed plan to create a KIID for each share class and another 40% are
currently undecided. Only 13% plan to group share classes wherever possible while 8% are considering combining the two strategies. Distribution and document production were also cited as primary concerns by 75% of asset managers surveyed. Of those that cited distribution as a concern, 35% worry about getting the latest version of the KIID to the end investor through their distribution network. In addition, 60% of respondents are concerned about producing KIIDs within the ﬁxed time frame, while 35% are troubled about getting the latest version of the KIID to the investor through the distributor network. Distribution is crucial as it is the ﬁnal link in the chain of informing the end investor, and not doing so potentially undermines the most basic tenant of the KIID directive, to ensure that the end investor always has up-to-date information.
The way to better communications
While fund managers are pressured to quickly understand, assimilate and adapt to the regulatory requirement and signiﬁcant systemic changes that it involves, they also acknowledge that UCITS IV is a step in the right direction for the industry. The last two years have demonstrated that transparency and greater information provision with less complexity is being demanded by investors and UCITS IV has the potential to streamline the fund industry, as well as encourage greater efﬁciencies for fund managers offering investment products in European markets. Increasing comparability of products, greater disclosure, regular updates and clearer information provision are all key beneﬁts of the KIID and answer the need for more efﬁcient communication.
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Selection and Survival
FundFront
Selection and Survival
The size of the ﬁght is more important than the size of the ﬁrm, according to the CEO of Schroders, Markus Ruetimann as he looks at the future of the asset manager
imes have certainly changed in the asset management community in the space of just a couple of years. Firms have been forced to plump up their client services to gently coax investors into trusting the industry again. But the trust is still not there, says Markus Ruetimann, chief operating ofﬁcer of Schroders. Callous jokes about investment bankers are in full ﬂow on the internet and investors are still asking “how safe are my assets?”. This is just the start of a huge transformation for the industry, said Ruetimann as he addressed an audience at the ISJ London Summit ‘10. We are far from exiting the ﬁnancial crisis, he says, where market volatility has been driven by investor fear and is set to continue. Using Darwin’s theory of evolution as a template to explain what fund managers need to take on board, Ruetimann said that it’s all about ‘selection and survival’ and that those who are careful to make the right choices will rise above the rest. The industry is entering the renaissance age, he says. As the client becomes more important to business, investment solutions and fee structures must evolve to regain the investor’s trust, but Ruetimann goes further than that to suggest the introduction of a ‘duty of care’ where custodians become stewards instead of agents. Investors have moved from greed to fear, he says, so the industry must ensure it implements measures to ease that anxiety. Adopting a standard of care, which is a-given in other sectors such as healthcare, is one way of meeting the needs of the long-term ‘buy and hold’ investor and maintaining respect for the ‘risk vs reward’ seesaw in clients’ portfolios. According to Ruetimann, ﬁrms should be asking questions such as ‘Is this product ﬁt for purpose?’ and ‘Do we understand and respect the risk and reward balance?’ It’s also about educating your client about how their investments are segregated and why, says Ruetimann. The industry has come under criticism in recent times for not being open enough with clients about what happens with their money. “Be open with your client about the things you can and can’t do,” Ruetimann advises. He even calls into question the way that clients’ money is segregated because it involves a high amount of default risk. “It’s unbelievable how many clients are asking us ‘how safe are our assets?’” But providing a good service for your client must go further than this, he adds. Being aware of your client’s lifestyle and age is paramount to meeting the needs of the long-term ‘buy and hold’ investor. Ruetimann points towards operational management as the industry’s biggest challenge. As the industry cries out for more accuracy and automation, the back ofﬁce is morphing into the front ofﬁce. Firms are spending huge chunks on data management, where ﬁnding ‘talent’ is key to coping with future operational challenges. Operations departments are usually out-shored, but this will be undoubtedly become more difﬁcult as the demand for operational integrity intensiﬁes. But we must avoid out-shoring the overall responsibility of ensuring reliable operations, says Ruetimann. “This will mean that relationships between ofﬁces will have to become more challenging, intense, transparent and more inclusive,” he adds. Despite his belief that the industry needs to change, Ruetimann criticises regulatory bodies for adopting an “aggressive” response that resembles a tsunami wave. Their response should be proportional, not forced, he says, to avoid a “new ice-age” where innovation, ambition and healthy competition would be compromised by excessive regulation and bureaucracy. “We’ve lost the ability to live in a self-regulated world,” he laments. “Forced regulation will kill a huge level of innovation in terms of products and give a false sense of security.” Ruetimann seems to be particularly concerned about how new regulations will provide better protection for clients than rules in place before the ﬁnancial crisis. Even the trade associations - which represent industry professionals and campaign on their behalf to regulators – are not in touch with the ﬁnancial world anymore, says Ruetimann. This follows claims
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Selection and Survival
from other industry insiders that the high proportion of retired professionals in many associations weakens their relationship with the immediate world. There are global fears that excessive regulation will only add to the pressure on ﬁrms as the industry struggles to recover. Ruetimann predicts that as ﬁnancial renumeration goes down and the pressure falls upon proﬁtability, providers will have to specialise and globalise. But it will still be difﬁcult for new providers to crack into the market, particularly custody providers, which he claims will still be dominated by the big custodian banks in the future. Yet he predicts that smaller boutiques will continue to make a stand on the asset management stage, where the multiboutique and multi-pool theme will prevail. “Is big really beautiful?” asks Ruetimann, which brings to mind the recent attack on the big banks. “We must avoid a situation where strong balance sheets and good legal terms become more important than the quality and choice of providers.” He suggests that smaller providers are the future and that their emergence will be essential to allow the industry to move forward. Quoting the famous American author
Mark Twain, Ruetimann says, “after all, it’s not the size of the dog in the ﬁght but the size of the ﬁght in the dog.”
Ruetimann predicts
• Absolute return funds will be occupied by hedge funds to a large degree, around the 5,000 mark. Hedge funds will be a prime distribution channel. New technology investments will be on ﬁrms’ top costs for some time Asset allocation will be more unpredictable and opportunistic Alpha data will be essential for success Greece will be defaulting pretty soon China will not provide the ‘nirvana’
• • • • •
•
Fundamentals
World Summit Series
• • • • • • •
27th January GSL & ISJ London Summit, London 24th February GSL & ISJ Nordic Summit, Stockholm 7th April GSL Asian Summit, Shanghai/Beijing 12th May GSL North American Summit, Chicago 15th September GSL & ISJ Boston Summit, Boston 6th October GSL & ISJ Dutch Summit, Amsterdam 3rd November GSL & ISJ London Summit, London 1st December GSL Middle East Summit, Abu Dhabi
2011 | Fundamentals | 27
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For more on the outlook for 2011 see www.Fundamentalsmagazine.com/2011ISJOutlook
Outlook
Alain Closier, global head, Societe Generale Securities Services
Ulf Noren, global head of sub-custody, SEB
Regulatory initiatives and Target 2 Securities (T2S) are driving post-trade development. We will see a break-up of fee structures into an unbundled structuring. There will be much more focus on risk management and collateral management. Single market providers will come under intense pressure from regional providers, both in sub regions and the whole of Europe. Europe will also have to do something with its fragmented CCP models: consolidation is needed.
InvestorServices
I would expect - with the downward pressure on prices emanating from clients’ myriad difﬁculties - we will see more steps taken to improve efﬁciency and to stay focused on meeting those needs in a timely fashion. Timeliness is a key issue as external events impact upon the providers of securities services. For example, as an industry our business timeframe does not align well with the regulatory timeframe which is much longer; while US, Asian, European and individual countries strive to overhaul their regulatory framework, we face the day-to-day task of looking after our clients’ needs, in the style to which they have been long accustomed.
Sameer Shalaby, CEO, Paladyne Systems
Today’s investor is now much more aware of the potential downside and has made capital preservation their primary goal. In this new climate if a hedge fund manager cannot demonstrate to a potential investor that it has adequately protected itself against all possible downside risks, including operational risk, they will ﬁnd it very difﬁcult to attract capital.
Charles Cock, head of client development, BNP Paribas Securities Services
We are not out of the woods yet. There is pressure on government debt and doubt over the long-term sustainability of public pension schemes. This means there is greater opportunity for custodians to help investors manage their risk. There will be continued demand for asset safety, for example assiduous due diligence over custodian networks. Proprietary networks are now considered safer by the regulators. Also, as a result of the crisis, stable ﬁnancially strong partners are being favoured.
Steven Smit, head of State Street’s Global Services in the UK, Middle East and Africa
What [the traditional custody business model] requires is for asset servicers to reﬁne their operational models to extract still greater efﬁciencies, by further increasing the levels of automation and ﬁne-tuning the way in which they deploy existing technology. Interconnectivity and linkages between custodians, clients, exchanges, trading venues and depositaries are obvious areas for further improvement.
Scott Somerville, CEO, Maples Fund Services
The needs of institutional investors will continue to become more complex and demanding. Pension funds will remain under pressure to ﬁnd ways to increase funding levels and reduce volatility. In order to address unfunded liabilities that have remained high in the aftermath of the ﬁnancial crisis that began in 2008 traditionally conservative pension funds will increasingly implement strategies that have different operational and information needs than has been traditionally required.
Jonathan Davis, director, Jonathan Davis Wealth Management
Investors may have to get used to a period of disappointing UK economic growth and the difﬁcult environment that goes with it, but thankfully warnings of a double-dip recession from economic indicators are still few and far between. It may prove necessary to diversify into a range of different assets in order to achieve either income or growth from investments.
Tom Davis, CEO, Meridian Global Fund Services
Those administrators who have a good understanding of the breadth of services they will be expected to provide to their clients and investors and who understand that the relationship among these three parties involves ﬁduciary oversight will continue to grow and prosper. The administrators who will be left behind are those who think they have a competitive advantage by being the lowest cost service provider. This type of administrator sees administration services as a commodity and fails to grasp the value add when money is spent on resources that enhance, rather than just process, information.
Paul Stillabower, global head of business development, fund services, HSBC Securities Services
We will continue to see a challenging industry in 2011 and beyond, principally because it seems as if stock exchanges won’t be co-operating any time soon in terms of returning to what the industry had come to perceive as normal. With interest rates at record low levels, and clients focusing on risk rather than price, it is a challenging environment for the US securities services business model, which was largely built in a long bull market with assets growing by 15% or more each year.
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Ten markets, ten cultures, one bank.
For further information please contact: Global Head of GTS Banks: Göran Fors, goran.fors@seb.se Global Head of Sub-Custody, GTS Banks: Ulf Norén, ulf.noren@seb.se Global Head of Client Relations and Sales, GTS Banks: Patrik Thiis, patrik.thiis@seb.se
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Executive Proﬁle: Tim Keaney
Executive Proﬁle: Tim Keaney
Craig McGlashan talks to the CEO of BNY Mellon Asset Servicing about the past and future of the business
s a “career asset servicing person” with nearly 25 years in the business who is in charge of the world’s largest asset services provider by assets serviced, Tim Keaney is perhaps more ably placed than anyone else to describe where the industry has been and where it is headed. Unlike many in the business, Keaney has worked for “very few ﬁrms” – even fewer when considering the various mergers and acquisitions involving those ﬁrms he has been a part of. Beginning his career at Boston Safe Deposit and Trust Company, he found himself working for Mellon after the latter acquired the former. Later, while at The Bank of New York, he would be at the forefront of the merger between Bank of New York and Mellon Financial Corporation – the result of which was BNY Mellon, where he is CEO of Asset Servicing, among other chairmanship roles. Keaney describes his journey through the industry over the last 25 years as having come “full circle”, a description that is also apt for how he has seen the business develop over this time, although he believes his greatest success was what he achieved with Jim Palermo as co-CEOs after the creation of BNY Mellon. “He was legacy Mellon asset servicing head and I was the legacy Bank of New York person. Little did anyone know that Jim was one of my best friends, I’ve known him for 25 years,” he says. “We were co-CEOs from July of 2007 up until two months ago. Very rarely in ﬁnancial services do coCEOs succeed but we formed a partnership where we made every decision together and created something really special.” In the beginning though, Keaney believes his time at Boston Safe was pivotal in how his business life turned out, with Tom Lucy, who ran the ﬁrm’s institutional business, a major factor in this. Keaney began in sales and was required to be a jack of all trades – selling everything from active equity to master custody. “That’s what made the business very interesting. The range of products I had to know about pushed me up a massive learning curve, much quicker than I otherwise normally might have had to climb. For that I’ve been enormously grateful.” During his time the sales model has altered from the broad knowledge that he required to a deeper, more specialised role, he says. “I don’t think I’d be qualiﬁed to be in sales today because it demands so much knowledge,” he admits. “You need to know not just what you do but how you do it. Everything is based on technology so those in sales today, and relationship management, are amongst the smartest in our company. You are only as good as the way you present yourself to a prospective client so we have tremendous respect for the importance of those roles.” This shift has been caused by a trend Keaney identiﬁes over the last two decades, where, like him, the industry has come full circle, particularly given events like the Madoff fraud, Lehman Brothers default and the current problems in the eurozone. “It used to be that a client’s relationship with a custodian was like expecting ice in the ice machine when you opened the fridge door – it just always worked. Now, with these events, it is clear that what we do is incredibly important because we ensure the safety and security of people’s assets,” he says. “What makes me run into the elevator every day is that each day throws up new challenges because of all the external factors. It makes the business exciting. It’s come full circle and it’s a reminder of how important it is.” Even the name of the game has changed, Keaney believes, from a term “rarely mentioned” – custody - to asset servicing. Why was this? “It’s because clients had both a need and an opportunity to outsource non-core functions to ﬁrms who spend an enormous amount of money on technology and have found a way to create repeatable processes, a scalable platform and a nimble organisation that can respond to clients’ needs, faster than clients could support themselves. “First, you were a custodian, then funds asked for you to do their accounting, then people started investing cross-border, giving birth to global custody and the requirement for foreign exchange. Then you add
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Executive Proﬁle: Tim Keaney
performance measurement and risk management, and new and very sophisticated online systems that give people access to important decision making tools. “That transformation took two and a half decades, and it continues. The value chain is only limited by our creativity, our willingness to evolve and the ability to understand clients’ changing needs.” This is also reﬂected in attitudes towards pricing models, Keaney believes. In late 2007 and early 2008, he says clients were well aware of the earnings being made by the likes of BNY Mellon in foreign exchange and securities lending, although this has now gone back to a “normalised, pre-bubble environment”. However, this has led to a change in clients’ focus. “They are really smart about ﬁguring out how much money we make in fees and other capital marketsrelated revenue and now they want a better deal; a fairer share of that pie. When we enter into negotiations with a client we do so with that new reality very much in mind. I personally have a bias towards seeing more of how I’m being paid in very straightforward fees that are very transparent to our client.” This transparency is one area that Keaney cites as a major change in client expectation; however, the other area – one where he believes BNY Mellon “distinguished” itself during the crisis – is that customers are looking for real-time information on questions “that weren’t even asked before”. He offers an example: “Across billions of assets invested globally they’d like to know right now what their exposure is to certain counterparties. They want to be able to run their own scenario analysis on what happens in different interest rate scenarios, or under different risk scenarios, just like banks do. Clients answer to boards that are asking very good questions now because people understand risk in a different way than they did pre-crisis.” One example of the “full circle” history of the business is that after years of giving up responsibilities to service providers, clients are now asking for the data and tools to empower themselves. This is not true in every case, however. “We have very sophisticated clients that have the staff, means and intellectual capacity to do it themselves and we provide them with the tools to do so,” he says. “Other clients, such as funds under pressure to do more with less, may ask us to carry out the analysis for them. This gives renewed energy to our business model because it puts us in a position to be able to do more on behalf of our clients.” Continually providing those new technologies comes at a cost, however – roughly $600 million was spent by BNY Mellon on technology in each of the last two years, Keaney reveals. This, combined with increased scrutiny from regulators, will lead to further consolidation within the industry, he believes. Keaney is well placed to speak about consolidation, given his past career and two recent moves by BNY Mellon to strengthen its position, namely the acquisition of PNC Global Investment Servicing (GIS) in July 2010 and the asset servicing business of BHF Bank in August 2010. With the likes of State Street also making purchases, consolidation within the industry is a reality, he says. “There are two factors. One is forced sellers; as large global ﬁnancial institutions have to recapitalise themselves under Basel III, they sell assets to raise capital. There is a re-examination of the asset servicing business by large players, where it might be a very small contributor to their overall P&L. “The other is the ever increasing level of reinvestment one needs to make. I can’t imagine how players smaller than us can afford to keep making the investments needed in their operations, expanding globally, meeting new regulatory requirements, building more efﬁcient and scalable platforms, building new and ﬂexible information tools for clients. “This is not a business for the faint of heart; the bar has been raised and if you don’t spend on people and technology, watch out – because you won’t be in the business for very long.” However, this increased growth presents the biggest challenge Keaney has met in his career, namely balancing the beneﬁts of scale (BNY Mellon’s asset servicing business today has 16,000 employees and provides 33% of total pre-tax income across the whole company), but still being viewed as “nimble, small, effective and entrepreneurial”. If that is the current challenge, then what does the future hold both for BNY Mellon and the wider asset servicing business? Keaney cites the “explosion” in alternative assets, from derivatives to private equity, and believes there is a “huge opportunity” to service these customers in the same way as the traditional client base. “In the next ﬁve years you are going to see an increasing percentage of assets being deployed to maybe higher risk but higher earning potential,” he adds. Elsewhere, Keaney expects a “whole rebirth” in performance measurement and risk information tools, while he also anticipates the global expansion of exchange-traded funds to continue. “I think they will become the standard for low-cost, efﬁcient and very transparent core equity and core ﬁxed income investments for pension plans and for deﬁned contribution schemes.” Keaney has been at the forefront of asset servicing during the massive changes the industry has seen over the last two decades; few would bet against his predictions for the next evolution of the business.
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Keeping up to data
Keeping up to data
Brian Bollen investigates just how high up the corporate ladder data management concerns have reached
nhance your data management, reduce your capital requirements Could improvements in data management help reduce the need for banks and other ﬁnancial institutions to raise fresh equity? This is one of the key claims made to reinforce the irresistible rise of data management up the corporate decision-making hierarchy. If data management tsars are not already sitting with their feet up in the boardroom, they are at the very least knocking on the door of the C-suite, eager to add the key to the executive toilet to their already extensive range of baubles. The claim does, almost inevitably, come from the data management solutions supply side of the industry, but it still merits some consideration. Anything that represents an alternative to further capital issuance and dilution deserves at least a hearing. “We strongly believe that over the past 18-24 months it has made its way into the C-suite,” says Daniel Simpson, CEO of Cadis, brieﬂy proﬁled elsewhere in this issue. Sally Hinds, global head, enterprise data management at Thomson Reuters, agrees wholeheartedly. “Five years ago reference data weren’t even on the radar,” she says. “It was in the background. Part of the plumbing. Nobody cared. But its proﬁle has soared since the credit crunch and everyone has at least a programme in place to enhance their capabilities. In fact, data management is now so much in vogue that it is being included in graduate training programmes. That is a major step forward from ﬁve years ago.” Simpson identiﬁes a number of reasons, beginning with the creation of dedicated data management departments. “This is a relatively new concept,” he says. “Traditionally dedicated departments didn’t exist. You either had a business problem or a technology problem, and never the twain did meet. The importance of data management has been highlighted and escalated by events of the past few years, leading to the post-Lehman growth in regulatory activity surrounding Solvency II, Basel III and UCITS IV, et alia, coupled with the demands for greater transparency. “Institutions generally know they have the data, but not how to pull it together,” Simpson continues. “Data Management has been Cinderella, but Cinderella is now going to the ball.” What, then, might be the implications of this change in direction? First off there will be organisational implications. “Institutions need to assign responsibility for data, to appoint ‘Data Tsars’ or ‘Data Stewards’, who know where to turn to if they are to source the most appropriate tools and data management software,” suggests Simpson. “The whole issue is forcing people to look at their business in a hard way, and they often don’t like what they see.” What does he mean by that? “The front, middle and back ofﬁces, for instance, are not as joined-up as they’d like,” he says. “They might ﬁnd they are buying the same data eight times over, spending more money and time than they need to. They can also ﬁnd that their exposure to a particular counterparty is greater than they previously thought. On the positive side, if they approach the problem in the right way, they can reduce the amount of capital they need to hold. Banks could save billions in Tier 1 capital if they can get it right.” Stuart Grant, EMEA business development manager, ﬁnancial services, at Sybase, addressed the topic in the debut issue of Fundamentals, highlighting the problems that could arise as long as the back ofﬁce moves at a slower pace than the front ofﬁce as it deals with the conﬁrmation, settlement and accounting of the front ofﬁce activity. “The importance of both timeliness and accuracy are paramount to this conﬁrmation, settlement and accounting process to prevent future loss of revenue through inaccurate exposure analysis,” he observed.
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Tension and conﬂict
This inevitably led to tension and even outright conﬂict within organisations, which the creation of dedicated units cross-pollinated by both business specialists and technology experts has helped to reduce.
Severely out of sync
“The concept of straight-through processing (STP), which has existed for over 10 years, should, theoretically, address this issue of ensuring that a
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Keeping up to data transaction is progressed efﬁciently from the front to the back ofﬁce,” continued Grant. “However, it is far from reality. As a result, the middle and back ofﬁce accuracy and timeliness are often severely out of sync with the front ofﬁce position. The implications of an out-of-sync front and back ofﬁce can clearly impact the entire business’s proﬁtability. The inconsistency between front and back ofﬁce is largely down to a combination of issues, such as: disparate internal and external data sources; misinterpretation of data descriptions or metadata; and lack of scalable quantitative processes used in the front ofﬁce for functions like asset valuation as they cannot easily be replicated in the middle ofﬁce in a robust or auditable way. “In addition, timing has a big effect on the front, middle and back ofﬁce systems. All of these systems are rarely in sync within a 24-hour period leading to data inaccuracies and an inability to maintain an agile workﬂow. The ‘knock-on’ effect is a ﬁrm’s inability to understand its actual position at group level within a given 24-hour period, thus reducing its ability to react to Black Swan or other unexpected systemic events. “The biggest challenge faces ﬁrms that are called upon to understand their exposures and position on an intra-day basis,” added Grant. An event such as the collapse of a major counterparty relies most heavily on the ﬁrm’s actual position, and this in turn is down to the middle and back ofﬁce functions having consistent and up to date information. However when the ofﬁces are out of sync and do not run on the same clock, knowing a ﬁrm’s exposure immediately, as with the case of a collapsed counterparty, is almost impossible. “As the general pace of the ﬁnancial markets increases and individuals as well as institutional investors become more au fait with how to monitor and invest in markets, ﬁrms will need to ensure they are not only seen as stable but can prove it in times of stress to maintain their customer loyalty,” he adds. However, dealing with a lack of insight into a ﬁrm’s actual position by overcompensating for potential short falls or volatile movements in the market will make a ﬁrm uncompetitive in the long term. for development and production. Executives participating in the survey frequently pointed to increasing efforts within their own businesses to bring these environments closer together. “There is clearly the recognition that dangers are present and a need exists to rectify this situation, however the severity needs to be understood fully. Failure to truly understand intra-day positions and also funding requirements could easily translate in to failure,” Grant said. The role of the solutions provider as summarised by Simpson is to join up the data to present a more accurate overview of exposures and capital requirements. But are banks taking the potential lessons on board? “They are embracing it,” states Simpson. “They know it has to be done, and working to ensure that they do it properly.” Aside from reducing the cost of capital and the need to raise new capital, enhanced data management has other useful by-products. It can reduce operational risk, increase the efﬁciency of straight-through processing and reduce the volume of trade breaks. “Everything ﬂows from good quality data,” he adds. “Compliance, risk, margin collateral, client reporting. Everything.” Data is good. Quality data is better.
Power to the people
Once a dedicated data management department has been created, it has to be given power if it is to rectify the problems that have grown with the passing of time. “Information in back ofﬁce systems can look very different from information in the front ofﬁce,” says Simpson. “If the back ofﬁce technology is 20 years old, which is quite possible, it won’t even be able to recognise modern instruments being traded by the front ofﬁce, which in itself creates data reconciliation problems. You need a good process to resolve discrepancies, and bad data can easily overwhelm you, forcing you to assign priorities to breaks to show which ﬁres you need to ﬁght ﬁrst.” This hardly sounds like an ideal state of affairs in a world that will surely only become more and more complex. What major developments can we expect next? “As I said before, we are now starting to see people embrace data management across the board, especially enterprise-wide data. People are looking up from tactical everyday problems and beginning to appreciate the bigger issues.” What must happen is that industry players will need to comply with the fast-growing regulatory thicket. Potential further complications lurk in the sidelines, as yet not even embryonic. Potential problems are mutating at the sub-atomic level even as we speak.
The growing reconciliation burden
Grant stated that if the gap between front ofﬁce and post-trade activities is allowed to grow, the future costs of maintaining reconciliation teams and processes will become a major burden, and one which may require signiﬁcant investment to ﬁx. However, in a recent Sybase survey, nearly half of respondents downplayed risk to the model creation and execution process imposed by using separate environments
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Keeping up to data With increased consolidation likely to place on both the buy- and sell-side of the ﬁnancial services industry, mergers and acquisitions will create hosts of new issues. “M&A always throws up new problems,” says Simpson. “You think you have your house in order then, wham, someone develops a new instrument and someone makes an acquisition. Flexibility is essential. Data is changing not only on a daily basis, but on an intra-day basis. You can’t afford to be rigid. And regulations are changing almost on a weekly basis. We’re all trying to hit a series of rapidly moving targets with brand new weapons purpose-built for the task.” “A fundamental change in infrastructure is required,” concludes Grant. “Having a number of different management applications is no longer good enough. The information in a trading environment is critical to the existing environment and centralised management and visibility of this information is a necessity.” Des Gallacher, head of data management and analytics, DST Global Solutions, in conversation with Stephanie Baxter “Data: there is so much of it! Companies that are ahead of the game and have a solid data management infrastructure in place will ﬁnd themselves with a competitive advantage. One of the key drivers behind data management is cost reduction and risk reduction.” Is data management rising up the corporate ladder? Yes, the ‘data management’ term is widely used now. The very forward-thinking asset manager has put teams and budgets in place for data management – it’s very high on the agenda. It ultimately powers what they can deliver to their clients, to the regulator. Regulators are looking for more and more, and without control you’re going to be playing catch up all the time. You need to get ahead of the game to focus on your role as an asset manager – to make money for clients and drive revenue. because you don’t have the right data management infrastructure in place. The wealth management space is growing very competitive – clients are much more demanding. If they don’t get what they want, it is very easy for them to move. Everything is online now, which means clients can easily pack up and leave. The forward-thinking asset manager already has all this in place. Recent issues in the economy and tougher regulation have only increased the velocity. It has made clients more aware of what they can get in the market place, more aware of ﬁnancial terms. One of our clients provides stock level multicurrency attribution, which some asset managers don’t even provide to their large clients. Some get left behind. Globalisation is key. Clients are looking for alternative strategies. Large asset managers will start to buy boutique providers to bring new capabilities in. As they pull in all these boutiques, they need a platform to consolidate all the extra information.
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How can companies improve their data management?
They ﬁrstly need to make sure that all the engines in the business are producing from the same starting point. Then they can quickly react to new changes in the market, such as moving into a new asset class. Once you’ve expanded and your organisation becomes more complex, then you need a system to bring everything together. Then you need to put a strategy in place to help you look at your organisation’s positions today and what they will look like in the future. Asset managers who are ahead of the game are already doing this.
How much should be automated?
Workﬂow is key here. Automation is a primary objective for workﬂow. Automate it so you only have to get people involved when there’s an exception, when you have to take action. But automate it in a way that tracks what happened over time, looking at the trends. It’s not a case of letting it run itself – you need check points to maintain control. Workﬂow has been lacking in asset management for a long time. It’s going to be the next big focus.
Has it reached board level?
Yes, it has reached many boards. But not every asset manager has budgets or teams in place. Anova (our new platform) brings power of data to board level. Once data management starts impacting them negatively or positively, then it starts to become more important.
Is it inevitable?
Absolutely, everything is about data. It powers everything that goes to the clients, who are ultimately the recipients of your end goods. The market is very competitive. Your clients can move if they are insecure about not enough exposure or transparency around what you are doing 34 | Fundamentals
And outsourcing?
There’s no right or wrong answer, it depends on what you want to achieve. Data management is usually outsourced with the middle ofﬁce and custodian services. But some aspects still need to be sourced by the asset managers – you can’t outsource everything. You need to keep certain parts of data management, such as risk infrastructure.
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Keeping up to data There is more disparity when you outsource – you’ve got things going on on the client side and custodian side which are all generating data. All of that needs to be brought together through a platform. The company plays a big part in data management - it’s the asset manager who decides what they need to provide clients. Asset managers will always have some kind of responsibility around data management, around what is going in and out of the organisation. so the global challenge doesn’t really affect them. People are looking for more ﬂexible, conﬁgurable solutions as opposed to large, massive products which can be costly and take years to develop. There needs to be more transparency into how data is managed. Everywhere you go, data management is high on agenda. It’s not necessarily higher in one region, but different regulations affect it, which adds to complexity. For example, if a US organisation wants to expand into Europe they need to look more at UCITS and regulation.
What is the next step?
In the messaging space and the core reference data management space there are strong vendors who supply that market and those that are moving with it. Regulators will undoubtedly have a hand in where that goes. As regulators put more pressure on asset managers, this will drive vendors to provide more capabilities. There will be more platforms like Anova, tackling the data management problem. Solutions are giving asset managers the conﬁdence to make their business more complex, but the problem is ‘how do you bring it back together and make best use of the data?’. The next level of the data management challenge will be to get the data in front of the CIOs etc – so they can see the fruits of their labour. They have spent all that money, put systems in place to solve problems, and can now bring all that together, to get what they need and monitor the business effectively.
So data management is no longer the ‘Cinderella’ of the ﬁnancial services?
Lots of people used to think so, saying “the IT people will take care of that”. But as the market grows in complexity, data becomes more important and expensive. Data is at the top of the list on company costs.
What must happen?
There is no underlying necessity, but more governance and regulation will inevitably come into place. There is the possibility that data management could have its own global standard in the future. Other pressures could come from government agencies, the SEC, demanding speciﬁc information from asset managers and banks. They may put in place regulation that says ‘this is how we want the data.’ I’m not saying it must happen, but it will happen, slowly. Regulators will take a bigger role. Government agencies may want to see the full picture of what asset managers are reporting to their clients. Regulation will undoubtedly get stronger; I don’t know where or when it will stop. It may take another ﬁve years of positive performance. The velocity of change may even slow down as people become more conﬁdent again.
Does the importance of data management differ from one country to another?
The US asset management landscape is a different data management challenge. Domestic asset managers don’t have the complexity of other regions
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Taking corporate action
Taking corporate action
Brian Bollen talks to Daniel Simpson, CEO of Cadis, about the “desperate” need for automation in the corporate actions space
he challenge of corporate actions is CEO of Cadis, a global is often to reconcile EDM specialist. Based in the data to that of a London, he is responsible custodian or record for all global operations keeper who may be and oversees the strategic supplying a message development of the in ISO 15022 . It is company. Having joined in therefore important to December 2007, Simpson has overseen rapid growth automate the collection and expansion across process and view Europe, the US and Asiadisparate sources of Paciﬁc, including 20 new information side by Cadis clients so far in 2010. side then apply rules Simpson is also a partner in Indigo Limited, an angel to cross-check the data. Many current legacy investment fund focusing systems in place are on ﬁnancial technology companies. unable to handle crossborder, multicurrency transactions. The user is therefore often forced to manipulate the corporate action, and in turn, manipulating the corporate action becomes a nightmare to reconcile further down the line. The entire corporate action process is still desperate for automation and by using technology solutions to increase automation, non-standard corporate actions can be manually checked and validated at a lower cost centre. Some corporate actions result in a new security being formed so need to be able to quickly set up new instruments with your data management system. Speed is of the essence in this instance, and automation is key here.
Daniel Simpson
unacceptably low level. And while we can expect to inch forward from the current 60-70% range over the next few years, very high levels of automation are still a long, long way off. “It has been very much the Cinderella of the ﬁnancial services industry,” says Daniel Simpson, chief executive ofﬁcer of Cadis, a global EDM specialist, adopting a much-loved analogy. He does, though, point to developments in the treatment of data management which could well have positive implications for corporate actions. “As an area of activity, data management now has budgets that it didn’t have before, and corporate actions come under the umbrella of data management,” he observes. “There is not one institution we know that doesn’t have a data management issue somewhere, and it is now getting the attention it needs. Our clients need quality data to meet increasing regulatory requirements and increased corporate actions automation could come under the radar as part of that phenomenon.” It is best, though, to consider corporate actions not in isolation but as part of the broader picture. “Corporate actions feed into a lot of other processes, and you should consider them as how they ﬁt in with those,” he continues. “Stock splits affect valuations. And if a company is spun out from a parent, that creates a new instrument, and the industry needs to adapt to that.”
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Industry stands on the cusp
The industry stands on the cusp of getting it right, he adds, by way of encouragement, but adds an immediate word of warning, to the effect that we’ve been here before, and that ﬁnancial institutions have other more urgent priorities,
Automation levels unacceptable
Automation in the often complex world of corporate actions remains stuck at an
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Taking corporate action
from preparing for Solvency 2, Basel III and UCITS IV. Pressure on costs, though, is a major driving force, as is the need to reduce operational risk. “The industry is demonstrating a willingness to embrace data management at all levels, and to put in place systems to automate corporate actions.” He points to the existence of the XBRL standard that allows companies to report corporate actions in a standard electronic format as something of a step in the right direction. But one forms the impression that it faces a long slog to achieve broad acceptance. “It can deliver and consume messages, and would certainly help if it took off, but it is very much in its infancy,” he says.
And it is not, after all, in the naked commercial self-interests of data vendors to standardise too much, and so work themselves out of employment. For another thing, the market is almost impossibly fragmented with literally hundreds of corporate actions likely to present themselves at any one time. His conclusion? That it probably needs a regulator to mandate it, but regulators, like the ﬁnancial institutions they are supposed to supervise, have far more important priorities on their current agenda than automating corporate actions. Progress is more likely to be tortoise-like than hare-like.
What is holding things back?
For one thing, there are too many standards. Remember, SWIFT has also been working on ISO 15022 for years.
Custody services with a broader horizon
Are you looking for a single point of entry to the Nordic and Baltic region? Or do you have your eyes set on a speciﬁc local market? Nordea is the leading Nordic custodian and the only truly Nordic player with well-established banks in Finland, Denmark, Sweden and Norway as well as a strong presence in the Baltic countries. A dedicated relationship manager supported by a specialist team will always be able to offer you a winning combination of regional competence and local insight. Our size, experience and connections with key players make us a sustainable provider in the evolving Nordic and Baltic securities markets. To capitalise on our expertise, please contact Ms. Anne-Lise Kristiansen, tel +47 2248 6238, email: anne-lise.kristiansen@nordea.com, Ms. Nina Groth, tel +45 3333 6124, email: nina.groth@nordea.com or Mr. Teemu Pihlatie, tel +358 9 165 51008, email: teemu.pihlatie@nordea.com.
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2011 | Fundamentals
Making it possible
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Nordea Bank
Say what you CEE
Say what you CEE
Brian Bollen outlines the 2010 Transition Report on central and eastern Europe from the European Bank for Reconstruction and Development, and what it means for custody in the area Anecdotal evidence versus the EBRD
Anecdotal evidence is all very well for parties and evenings spent in the bar. Who cares overmuch about hard facts when a story is gripping and entertaining? Real life does, though, have a rather disconcerting habit of biting the rear end of people who have over relied on the anecdotal. This is arguably more applicable to investment than to any other sphere of human activity. If a picture is worth a thousand words when trying to tell a story, then surely a well sustained opinion based on long experience is worth a similar volume of ﬂimsy personal tales. And who better to turn to when it comes to economic activity in central and eastern Europe (CEE) than the European Bank for Reconstruction and Development (EBRD)? It was after all, set up in the immediate aftermath of the collapse of Communism and the arrival of hard-core investment in the region. If the EBRD is not intimately aware of the current ﬁnancial reality and future ﬁnancial prospects of the countries that make up CEE, then who is? One might ask, but still, the long shadow of its original leader Jacques Attali and his fondness for expensively ﬁtted-out ofﬁces is for some long-term market watchers a barrier to its own credibility. Investors and custodians who have to make longterm strategic and tactical decisions on investment in the region would perhaps, then, be well advised not to take the EBRD’s word as gospel, although it is nothing if not comprehensive. For what it is worth, the EBRD sounds almost optimistic about the outlook for CEE, but strikes an immediate note of caution. In introducing its Transition Report 2010, it says: “The EBRD region is emerging from the crisis but there can be no return to its pre-crisis dynamism without new reform to the region’s growth model.” This could qualify easily as a classic ‘on the one hand, on the other, the outlook is unclear’ statement from a certain salmon pink globally respected international ﬁnancial publication. improvement of the business environment. The report also unveils a new set of sectoral transition indicators, notes the EBRD. The A-Z examination of the countries that make up the region (or, more accurately, the A-U, from Albania to Uzbekistan) is simply fascinating, and impossible to do justice to in these pages. The best we can hope to do is communicate some of the essence and ﬂavour of key parts of the report in a way that will encourage investors, fund managers, custodians and other relevant parties to study the original closely, if they have not already done so. During the past year most of the countries in the EBRD region have begun to recover from their worst recessions since the early transition years. The recovery, however, has been more sluggish than in other emerging markets and has been heterogeneous within the EBRD region. The countries of southeastern Europe, in particular, suffered output declines well into the ﬁrst half of 2010. By contrast, most other countries have beneﬁted from exportled recoveries to varying degrees; particularly those that are commodity exporters, and central European countries with high export shares to Germany. In a few cases, such as Armenia, Moldova, Poland and Turkey, renewed remittance inﬂows or capital inﬂows have contributed to growth in 2010. In contrast, the recovery in most south-eastern European countries is progressing slowly. An early part of the report attempts to shed light on this heterogeneity and the factors that drive it, says the EBRD. It begins by asking why some countries seem to have been in a better position to beneﬁt from the global recovery of international trade than others. It then analyses the reasons why domestic demand has generally not recovered, focusing particularly on the role of credit and ﬁscal policy, and examines recent trends in inﬂation. It considers the atypical behaviour of international capital ﬂows during the crisis and post-crisis period. Lastly, it examines the implications of this analysis for the short-term outlook.
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Transition 2010
The Transition Report 2010 focuses on two main reform areas, the EBRD’s introduction goes on to say. These are (one) the development of domestic capital markets and local currency ﬁnance and (two) the 38 | Fundamentals
An export-led recovery
As early as the second quarter of 2009, real GDP began to increase (in seasonally adjusted quarteron-quarter terms) in most countries. The return to
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Say what you CEE growth was lagged by a couple of quarters in the Baltic countries, where the need to unwind pre-crisis imbalances remained substantial. South-eastern Europe, however, has struggled to emerge from recession. Real GDP continued to contract through much of 2009 and into early 2010 in Bulgaria, Croatia and Romania. In addition, domestic events such as political turmoil in Kyrgyz Republic; uncertainty surrounding presidential elections in Ukraine; and the closure of a nuclear reactor in Lithuania depressed growth during the ﬁrst The recovery was initially mostly driven by net exports. By the ﬁrst quarter of 2010, exports had recovered from their collapse in the winter of 2008-09, in line with the recovery in global trade. Commodity exporters (Armenia, Kazakhstan, Mongolia and Russia) beneﬁted from rebounding commodity prices, while countries with a heavy export concentration on machinery (Czech and Slovak Republics, Hungary, Poland and, to a lesser extent, Romania) beneﬁted from the global cyclical rebound. Exports from countries whose real exchange rates depreciated during 2009 and 2010 increased disproportionately. With few exceptions, export growth offset a rebound in imports from their compression in winter 2008-09. As a result, the contribution of net exports to growth was positive in most countries until the ﬁrst quarter of 2010, leading to lower current account deﬁcits or even surpluses across the region and easing exchange rate pressures. However, beginning in the second quarter of 2010, import growth has begun to outpace export growth in several countries, reﬂecting a steady recovery in domestic demand. Investment growth has been sluggish as business conﬁdence has recovered only gradually. The global ﬁnancial crisis weakened business conﬁdence sharply; in most countries conﬁdence in the manufacturing or industrial sectors dropped by 20-50% from the fourth quarter of 2007. By the third quarter of 2010, conﬁdence had recovered to pre-crisis levels only in Estonia, Hungary and Turkey. As a result of the weak recovery, non-performing loans (NPLs) of banks have stabilised at high levels or, in some cases, continued to rise. Despite the gradual recovery of economic activity in many countries, private sector credit growth has mostly stagnated or continued to shrink. This has especially been the case in countries with large pre-crisis credit booms and weakly capitalised precrisis banking systems: two factors that turn out to be strikingly correlated with the behaviour of credit since late 2009. This group includes the Baltic countries, most countries in south-eastern Europe, Kazakhstan and – because of its household lending segment – Russia. In Kazakhstan credit has stagnated as banks remained cut off from foreign funding. In Ukraine, too, credit shrank until the presidential elections in February 2010, after which time capital inﬂows returned and credit to corporates began to grow slowly.
What drove the reovery in export growth?
Not every country beneﬁtted to the same extent from the rebound in global trade, observes the EBRD. To better understand the reasons, year-on-year real export growth for a sample of 55 advanced and emerging markets was analysed at two points in time: the ﬁrst quarter of 2009 – when global trade had dropped to its nadir – and the ﬁrst quarter of 2010, to capture the recovery from the trough to one year later. Two cross-country regressions, one for each of the two periods, describe the shift in the key factors driving the export collapse and the recovery. In both cases, real export growth was regressed on trade-weighted real GDP growth of trading partners as a proxy for external demand, on year-on-year real effective appreciation (Consumer Price Index-based) to capture changes in competitiveness, the share of machinery in total merchandise exports as a measure for export structure, and a ‘Herﬁndahl index’ of the share of individual export markets in total exports. The latter measures how concentrated exports are in terms of export destinations.
Legacy of the crisis weighs on private domestic demand
Until the ﬁrst quarter of 2010, domestic demand continued to contract in many countries as unemployment remained high and business prospects uncertain. The drop in domestic demand was particularly pronounced in the Baltic states and south-eastern Europe, where recessions have been deep and the recovery has lagged. As early as mid2008, unemployment rates soared in the Baltic states and other economies where growth had begun to slow in 2007 (for example, Turkey and Ukraine). In contrast, in central and south-eastern Europe, unemployment rates started to increase only in mid2009, and even later in south-eastern Europe. Despite gradual declines by the second quarter of 2010 in some countries, unemployment remains high. Fortunately, its effect on demand is being mitigated by a resumption of worker remittance ﬂows to key recipient countries (the Caucasus, Central Asia and FYR Macedonia).
The main results are as follows:
• When global trade collapsed in winter 2008-09, a country’s product structure played a key role: exporters of machinery were hit the hardest.
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Say what you CEE Real depreciation did not mitigate the collapse. More diversiﬁed export markets may have buffered the collapse, but its statistical signiﬁcance is weak. • In recovery the export product structure seems to have lost some of its overwhelming importance, although there is still some indication that exporters of intermediate inputs may have recovered faster than other countries. Rather, gains in competitiveness (real depreciations) both during the crisis and thereafter seem to be the main factor that helps explain cross-country variations in the recovery. Hungary, Latvia, Moldova and Romania). In Turkey, the expiry of a stimulus-related excise tax cut added to inﬂation. • Global energy price increases, adjustments to regulated prices, and the closure of the Ignalina nuclear reactor in Lithuania led to steep hikes in electricity and/or gas prices for households in net energy-importing countries (Albania, Armenia, the Baltic states, Belarus, Bulgaria, FYR Macedonia, Kyrgyz Republic and Serbia). Core inﬂation, however, has mostly continued to shrink, suggesting that most of the recent increases in inﬂation could be one-off events. The notable exception has been Turkey, where core inﬂation has remained stubbornly high as the recovery gained momentum. This group includes countries with state-directed or state-subsidised lending (Armenia, Belarus, Serbia) or lending to state-owned enterprises (Slovenia). It also includes a few countries that beneﬁted from exceptionally large returns in balance of payments inﬂows, either in the form of capital inﬂows (Turkey) or remittances (for example, Armenia and Moldova).
Where is credit growth beginning to recover?
A cross-country ordinary least squares (OLS) regression of growth in private sector credit between January and June 2010 on measures of pre-crisis banking system structures, the pre-crisis build-up of macroeconomic vulnerabilities, cyclical variables and institutional variables help identify the patterns in credit to the private sector. The focus is on the EBRD region only. The regressions results suggest the following patterns: • banking systems that were better capitalised before the crisis in 2007 show stronger post-crisis (2010) credit growth; • post-crisis credit growth is lower in countries that experienced larger pre-crisis credit booms; • banking systems with the closest client relationships, that is, extensive branch networks, have increased credit the fastest. These effects are robust to the inclusion of institutional controls, such as the cost of contract enforcement. A possible interpretation is that the recovery has so far been “credit-less”, as is typical after ﬁnancial crises in advanced countries.
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Fiscal tightening, monetary loosening
Fiscal consolidation packages were approved in many transition countries even before the eurozone sovereign debt market turmoil highlighted the risks of continued high deﬁcits. Following large crisisrelated revenue declines and interruptions in market access, many 2010 budgets in the region included measures to consolidate ﬁscal deﬁcits by 0.5 to 5.0% of GDP, most sharply in the Baltic states and Montenegro. In contrast, commodity producers with pre-crisis ﬁscal surpluses (Azerbaijan, Kazakhstan and Russia) or larger emerging markets (Poland, Slovak Republic and Turkey) implemented ﬁscal stimulus packages in 2009 and/or 2010 that are expected to be reversed gradually over the next few years. Fiscal tightening was mitigated by accommodative monetary policy. Monetary policy rates, sharply reduced between mid-2008 and mid-2009, were either cut further or kept on hold with few exceptions. Armenia, Georgia, Kyrgyz Republic, Mongolia, Serbia and Turkey have begun to raise policy rates, either on concerns about inﬂation or to ease exchange rate pressures, and some central banks (especially those of Hungary and Poland) have made statements holding out the prospect of policy rate increases. Exchange rates had depreciated sharply in the fourth quarter of 2008 and/or the ﬁrst quarter of 2009 in all countries in the region with some degree of exchange rate ﬂexibility (currency boards and
Core inﬂation remains subdued
The region disinﬂated sharply in 2009 as economies slid into deep recessions, notes the EBRD. In 2010, however, inﬂation increased again in several countries, for three main reasons: • Adverse summer weather conditions destroyed signiﬁcant portions of the wheat harvests in Kazakhstan, Russia and Ukraine. An export ban by Russia and export restrictions by Ukraine, imposed in response to rising local wheat prices, drove up global wheat prices by 70% between early June and mid-August 2010, feeding into price levels across the region. • As part of ﬁscal consolidation, many countries in south-eastern and central Europe and the Baltic states increased value-added taxes or excise taxes on tobacco and alcohol sharply (Belarus, Croatia,
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Say what you CEE ofﬁcial pegs were maintained). In the larger emerging markets (Czech Republic, Hungary, Poland, Romania, Russia and Turkey) and in some countries in the Caucasus, exchange rates have since appreciated again, although they remain weaker than their pre-crisis levels of August 2008. In contrast, in the smaller countries and Ukraine, pressures on the exchange rate have continued, especially since the turmoil in the western European sovereign debt markets in the spring of 2010. insurers, they will have to pay a suitable premium, and that would be far in excess of current fees. If the EBRD is right in its assessment and analysis, and investor demand rises, and clear understanding can be established between them and their safekeeping agents on the allocation of risk, might we be seeing more ofﬁces being opened in the region in the near future? Time will surely tell, but will it be sooner rather than later? As always, we are very interested in hearing from readers, especially if they disagree with anything we have published. It is often more proﬁtable to learn from what people DON’T like than to hear about what they DO like. My direct email is brianbollen@mac.com I look forward to hearing from you.
Custodians say
Custodians routinely say that a key part of their core mission is to enable their clients, or their clients’ agents, to do business in those parts of the world where they want to do business. Custodians follow rather than lead. They also increasingly vociferously argue that they are not in the insurance business, meaning that if their clients decide to invest in a certain geography or industry sector, then the investment risk lies ﬁrmly with the investor. It is not transferred to the custodian, as some investors would like to believe. If investors want custodians to act as
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Nordic essentials: Mats Råstedt
essentials
A special focus on the Nordic region
he Nordic region is going through a period of profound changes in the market infrastructure. On the trading side we can see the same pattern in our region as has happened on many other markets already, i.e. the fragmentation of trading is continuously increasing, and especially for many of the blue-chip shares the multilateral trading facilities (MTFs) regularly have more than 30% of the total trading volumes. The implementation of equity central counterparty (CCP) clearing during 2009 and 2010, which in itself is common practise in Europe and thus naturally a key component of all major markets' infrastructure, has been the biggest infrastructural change in the region for decades. CCP clearing has certainly reduced the counterparty risk as such, and also reduced the total cost of trading on the Nordic exchanges. As a consequence of this we have seen an increased number of new trading members on the local exchanges, and hence we should see further improved liquidity on the market which in the end will directly beneﬁt the end investors as this should among others lead to narrowed spreads. In the Nordics we usually like to portray ourselves as a coherent region rather than individual markets when it concerns securities markets. We must however remember that the Nordic markets are still quite different; we have a fragmented post-trade market infrastructure, local legislation and market practices, different currencies etc. As an example, several initiatives have been started over the years to consolidate the CSD infrastructure in the region, however due to various reasons - sometimes political, sometimes technical - nothing concrete has happened on this front. The latest initiative that has been closed is the Euroclear platform consolidation in the Finnish and Swedish markets, ﬁrst as the overall single platform programme was discontinued, and second as the potential back-up plan, to consolidate the Finnish and Swedish CSDs by reusing legacy platforms, was recently considered to be too complex. Now the focus in all four markets is more and more on Target 2 Securities (T2S), and on analysing what is the most efﬁcient model for each market. A lot of the work is concentrating on how to adapt the direct holding structure to T2S in a way that on one hand secures a cost efﬁcient process, while still meeting the eligibility criteria set forth by the European Central Bank (ECB), and on securing a legally sound process, including among others settlement ﬁnality. related to the direct holding structure, however as there are market differences we are likely to end up with slight variations in the models. The starting point is that currently in the Nordic markets we have in total around 10 million end-investor accounts that are held with the local CSDs. In Finland as well as in Norway the legislation prohibits the nominee registration of local investors’ holdings. One model that all Nordic countries are investigating at the moment is a ‘layered model’, where a large number of the accounts at the CSD level would be pooled in T2S, thereby limiting the number of accounts in T2S. As a consequence the Nordic markets would from a T2S perspective be more similar to the so-called omnibus markets. It would naturally still be possible for individual end investors to have direct accounts in T2S if they so wish. One of the most important targets with T2S is that by effectively consolidating all national settlement systems in Europe into one, it should be as easy to settle trades from any market in T2S as it is to settle domestic trades. For Nordic investors this will bring clear beneﬁts as it will make it easier and more cost-efﬁcient to invest in other European markets. Equally, there is a clear expectation that T2S will make the Nordic capital markets more attractive for the non-Nordic investors. One must however remember that the settlement processes in Europe are already today well harmonised and efﬁcient, and hence the further beneﬁts that can be extracted from the settlement process are limited. Today the risk and complexity, and hence the costs, are to a large extent in the so-called asset servicing area, which includes among others corporate actions processing. These processes are still very much dependent upon variations in local legislation and practices, and will remain so even when T2S is implemented. As a consequence the total beneﬁts from T2S to investors may be quite small, at least in the beginning. Even though custodians are able to run the settlement processes more efﬁciently in T2S, in practice removing the need to use sub-custodians in the settlement ﬂow, they naturally still need to handle the asset servicing part with the same quality and care as today. In order to do so the most efﬁcient way forward is likely to include using local sub-custodians as is the practice today. These institutions are today and for the foreseeable future best placed to handle processes such as complex corporate actions, handling the reporting obligations to local authorities, consultation on local market development etc., i.e. tasks that require strong local expertise and a meaningful local presence. Mats Råstedt, head of business infrastructure, Nordea
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Close co-operation central
The Nordic markets co-operate closely to solve the matters
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Nordic essentials: Ulf Noren
clearer. In the Nordics, we see that many small and midsized member ﬁrms are experiencing cost and complexity increases instead of the wanted cost efﬁciencies and simplicity gains. It is time for Europe to make a choice of what CCP model is wanted – the silo model or the userowned user-governed option. As a personal opinion, I would prefer one CCP – the efﬁciency gains would widely beat the competition aspects. It is not possible to discuss Europe today without spending time on T2S. For the Nordics and the Baltics, all markets have signed the MoU (but the exciting time will be when full commitment is expected). We have mainly non-Euro currencies as only Finland (and as of Jan 2011 also Estonia) currently use the euro. All markets are direct holding markets so ﬁnding a layered account structure is crucial to T2S commitment. The CSDs in the markets are concerned that they can continue to provide and further develop investor accounts and related services. Another possible stumbling block is the governance structure. Being a buyer in a T2S world is very interesting and we ﬁnd seven different scenarios for how institutional sub-custody buyers might behave. These range from: doing everything themselves, via use of one European provider, a limited number of regional providers, to mixed strategies and ﬁnally to continue as is. The settlement cost will become very transparent in the T2S environment and we believe that the commercial value of a settlement transaction in the future will be fairly limited. On the other hand, risks previously assumed by sub-custodians will now be highlighted and transparent and we ﬁrmly believe that we are going towards an unbundled fee structure in the not too distant future. Will T2S happen? We think so but there are some question marks. The business case is to a large extent building on UK participation. Without the UK, the business case looks weak but still not weak enough to be a stopper. The direct holding market will be very important and as said, we believe there is a sentiment among those to sign, eventually. The project needs further harmonisation and the governance structure must be appropriate for all participating countries.
he situation in the Nordics does not differ that much from the situation in Europe as a whole. We do notice that we experience a map where there are too many CSDs and CSD platforms and too many agent banks. There is a ﬁerce competition for volume and lower transaction fees. This will drive consolidation so in a Machiavellian way it is good. We applaud all efforts in Europe to dismantle national barriers – it is not that the effort is being made but how that can cause some doubts. The development in the post trade arena is driven by political and regulatory forces in Europe, so also in the Nordics.
We think that a lot will happen in the next few years and some of the major features can be found here:
CSDs: Will lose revenues and they will be subject to increased competition following T2S. The domestic monopolies are threatened and especially so if the obligation to issue securities in the national CSD is removed. This will force CSDs to consolidate and among these we will see attempts to move to other places in the value chain, especially so by starting to compete in the asset servicing space and develop further in issuer services areas. We expect some CSDs to try to become banks and for those that already are, to enhance their bank offering. We also fear that some will apply the utility view and just raise fees in order to compensate revenue losses. In the Nordics, we had hoped for more of the Single Platform project but as things stand right now, the only single platform within that project is CCI. The rest is fragmented. Sweden and Finland will remain as two platforms with some assimilation in the jurisdictional model, in the merging of ﬁxed income and equity platforms locally and with some adoption to European standards. No more than that. The Link Up markets project has been very silent lately so also here were one of the markets that signed up (Norway) seemingly has abandoned the whole thing. Agent Banks: Operational models must be re-engineered. Winners can be found among those that manage to drive operational costs down and still keep innovation and safety levels high. Agent banks need to demonstrate safety in this unsecure environment and in addition to sound and strong ﬁnancials, risk and collateral models will be essential. Agent banks must grow regionally in order to replace revenue lost to netting effects and as a result of fee pressure. This will make it very challenging to be a single market provider. We see that the search for quality in agent banks has been re-introduced (it is not only reciprocity and price any more) and so is the agent banks’ ability to visualise the future state of the industry and to take us there. Banks will have more than a handful to deal with the regulatory ﬂood and effects of the T2S discussion. CCPs: It is not much of a business case in being a CCP today. It is in very bad need of consolidation and we believe it will start to happen - soon. The European CCPs work with very difﬁcult and complicated risk models and eventual interoperability initiatives are not making it any
By the way, SEB believes that changes triggered by the T2S discussion will become reality even if T2S fails!
Going into regulations and their effects would require more space so let’s just agree that there are a lot of them at various stages of implementation and shaping. This is a politically driven process that gives very little room for the industry to inﬂuence. More of the spending in investments becomes mandatory and many players feel and will feel increased strain in ﬁnding investments innovation. Management time is to a great extent consumed by regulatory work and compliance areas are burning the midnight oil. It is very important that the custody industry does not let itself be trapped by regulators and regulators only. Some common ground must be found and some actions must be concerted. Ulf Noren, global head of sub-custody, SEB
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The ETF pie
The ETF pie swells, but can the back ofﬁce keep up?
By Eamonn Ryan, director, Equities Product Management, Euroclear
or anyone who thinks ETFs are a ﬂash in the pan, the following statistics should change their mind. Over the past three years, the value of European ETF assets has doubled to $225bn. In the past ﬁve years, the global ETF market has tripled to $1.2 trillion according to asset manager BlackRock. And the explosive growth shows no signs of relenting with more and more fund houses looking to launch new ETF products. Many of the advantages ETFs have over traditional mutual funds derive from the similarities they share with equities in terms of liquidity, ﬂexibility and so on. However, in Europe, ETFs are plagued by substantially more post-trade challenges than for equities, to the point where these problems are beginning to hinder their growth as a ﬁnancial product. Clues to the origins of these operational issues can be found in the different patterns of stock exchange listings used by ETFs, compared with equities. Whereas most equities are listed only on the stock exchange in the home market of the issuer, it is common for ETFs to be listed on several stock exchanges, regional or trans-continental. Because Europe’s post-trade infrastructure is highly fragmented, it is often the case that these tracker instruments must be moved in and out of the central securities depository (CSD) linked to each stock exchange where the ETF is traded in order for settlement to take place. Managing deposits of the same security in multiple locations poses challenges at the best of times, but with ETFs there is an additional factor to consider. When a broker ﬁnds itself unable to deliver equities that it has sold, the broker will usually borrow the missing stock so that it can fulﬁll its obligations. However, despite recent initiatives to automate lending & borrowing for ETFs, there are limited opportunities for stock borrowing because liquidity is so fragmented across multiple markets and because it is relatively easy to go back to the primary market and create more of the same ETF units instead. Original and supplementary issues of ETFs are always created in the ‘issuer’ CSD of the ETF, which is often not the market where the broker is trying to deliver the ETF it sold. Furthermore, because ETFs are typically multi-listed securities, a broker will frequently have holdings of the same ETF in more than one market. In both cases – whether creating new securities or using securities held in another market - the broker will need to transfer ETFs from one market to another as quickly and efﬁciently as possible. Otherwise, it will face penalties such as settlement ﬁnes or ﬁnd itself being ‘bought in’ by the trading counterparty or the central counterparty involved in the deal.
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The right structure
Furthermore, transferring ETFs from one market to another is startlingly problematic. The main reason is that not all ETFs use the same depository holding structure, as is the case for equities. Three of the most commonly used ETF holding structures today, which co-exist simultaneously across markets, are discussed next. In the classic multi-deposit structure, the ETF issuer, or rather its transfer agent/registrar, has a relationship with only one ‘issuer’ CSD. One or more remote CSDs, known as 'investor’ CSDs, may hold the ETF via settlement links with the issuer CSD. This means that the investor CSDs have an account with the issuer CSD and hold the ETFs through this account structure or they may hold the ETFs through an intermediary, i.e. an international CSD such as Euroclear Bank, via what is sometimes called a relayed link. In either case, ETF transfers are normally very easy and efﬁcient using this structure, with only one settlement instruction needed between CSDs. The transaction is usually done on a straightthrough process (STP) basis. This structure is most commonly used for equities that are multi-listed across Europe. In the depositary receipt-like structure, which is largely used to comply with German legal requirements, this model is used to facilitate a listing in Germany for ETFs that are issued in, for example, the Irish CSD. It is DR-like in that there are secondary issuers, which hold the underlying in the home CSD and issue a new synthetic security in the remote CSD. In the Irish-German example, the issuance of
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The ETF pie
new securities, called global bearer certiﬁcates, are required which are assigned a different international securities identifying number (ISIN) than the original ETF issued in the Irish CSD. The fact that the same ETF carries two different ISINs obviously complicates the management of securities reference databases and makes cross-market transfers more complex and expensive. Furthermore, transfers are less instantaneous than in the multi-deposit structure, although high levels of STP are still possible. The split structure differs as the link between the issuer and investor CSDs are not made via cross-CSD links, but via a third party such as a transfer agent or registrar. In effect, these ETFs have more than one issuer CSD. So, in order to execute a transfer from one CSD to another, the ETF must be withdrawn from one CSD and deposited in the other, which is not usually executed on an STP basis. This invariably takes several days and requires special, extra instructions often by fax - to the third party. This structure is particularly onerous for brokers needing to transfer ETFs across markets because of the time lag often involved. Moreover, if they suffer a penalty due to late transaction settlement, they have no recourse against the third party. Transfer agents and registrars work on behalf of the issuer and have service level agreements only with them.
sufﬁcient cross-CSD linkages to support the ﬁrst model, ETF issuance and post-trade processing will still need to rely on variants of the DR-like and split structures. Consideration should also be given as to which CSD – or international CSD – should play the role of issuer CSD. If a new ETF is not issued in the local CSD of the issuer, a split structure may later be needed in order to make the appropriate transfers.
Post-trade challenges, such as those described, may inﬂuence both the liquidity of an ETF and its appeal within the trading community. Selecting the right holding structure is one of the key elements for success.
Mastering growth
Because of the exponential growth in ETFs and the ﬂurry of new entrants, large international broker/dealers are now actively looking for ways to alleviate operational headaches. In essence, they have little choice but to better understand the different holding structures. If one were able to create the optimal processing environment for ETFs, the future state would not include split structures. Rather, the market would do well to beneﬁt from the safety and efﬁciency of the multi-deposit model. That said, if there aren’t
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Stock transfer
Stock transfer: a brave new world
The transfer agent has gone through enormous change due to the advent of technology and the drive to eliminate paper certiﬁcates. Stephanie Baxter looks back at its evolution over the past 40 years and considers what the future may hold.
The technological evolution has completely transformed ﬁnancial services as a whole, but no sector has seen more change than the transfer agency business. It is hard to imagine that only 25 years ago paper stock certiﬁcates were still in abundance. The transfer agent has seen enormous transformation in its working environment where dematerialisation, regulation and changes in ownership have been signiﬁcant drivers for change.
Rise of Electronic Systems
As central depositories started to offer these kinds of services, the transfer agent’s job inevitably changed. Another catalyst for change has been the introduction of electronic book-entry register systems, mainly in the UK, US and Australia during the 1990s. Paul Conn, president of global capital markets at Computershare, says: “The Australian market went through signiﬁcant change with CHESS (the Australian Clearing House Electronic Subregister System) and when CREST entered the UK market it put huge demands on registration services and was a catalyst for consolidation, helping to drive banks to exit the transfer agency market.” In the US, the DTC introduced the Direct Registration System (DRS) in 1996 as an addition to the FAST system. In a bid to move the industry away from certiﬁcates, the SEC made it compulsory for all securities listed on US exchanges, including inter-listed Canadian ﬁrms and their transfer agents, to be eligible for DRS from 2008. Although there is currently no automatic participation, there has been talk that the SEC could require issuers to fully participate in the future. But the industry still has some time to go before physical certiﬁcates are completely eliminated. Although investors do not receive certiﬁcates in book-entry-only (BEO) form, the custodian holds global certiﬁcates. Dematerialised securities, where no certiﬁcate exists, are becoming more popular however.
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A Paperless Society
Over the last ﬁve years printed certiﬁcates have been driven out by the electronic book entry register, which allows for a more efﬁcient transfer of shares and reduces the risk associated with physical certiﬁcates. In 2006 there were even discussions among US and UK regulators that paper issuance should be eliminated, a process called dematerialisation which several EU countries had already opted for. In the US, the Securities and Exchange Commission has supported dematerialisation since the early 1990s when the Group of Thirty (G30) – an international body of leading ﬁnanciers and academics – made recommendations to reduce the dependency on printed certiﬁcates. According to Charles Rossi, president of the Stock Transfer Association (STA), the G30’s proposal was an important catalyst in the transfer agent’s evolution. In the late 1960s, particularly in the US, brokerage ﬁrms were overwhelmed by the large volume of physical certiﬁcates as trading peaked to nearly 15 million shares a day on the New York Stock Exchange (NYSE). This led to the creation of the Central Certiﬁcate Service (CCS) in 1968 by the NYSE with an aim to eliminate up to 75% of the physical handling of stock certiﬁcates between brokers. Although many brokers refused to use it at ﬁrst, the idea of a ‘certiﬁcate-less society’ seemed inevitable with the establishment of The Depository Trust Company (DTC) in 1973 to hold all paper stock certiﬁcates in one centralised location and automate the process by providing electronic services through the Fast Automated Securities Transfer (FAST) system, which was a major turning point for the industry. 46 | Fundamentals
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Industry Consolidation
Banks have progressively exited the transfer agency business in the last decade or so, including Lloyds TSB, CIBC and the Bank of Montreal. Consolidation has been happening in almost all transfer agency markets, says Conn. As banks continued to leave the business, professional providers started to emerge to provide services for investors. Over a timeframe from 2000 to 2007 a number of transfer agencies have been sold, or combined due to new mergers, which has inevitably been a driver for the reduction in the number of transfer agencies. For example, when the Bank of New York and Mellon Financial Corporation merged in 2007, both transfer agency businesses
Stock transfer merged into one. In the UK, Lloyds TSB Registrars was a huge business but was sold by the bank in 2007 to the private equity ﬁrm Equiniti. A similar trend emerged in Hong Kong in the late 1990s when Computershare entered the city’s share registration market by acquiring Jardine Matheson and HSBC Holdings – which was by far the largest share registry in Hong Kong. In the Australian market in particular, auditing ﬁrms were driven out by new SEC regulation which said that auditors could not provide professional services to companies, says Conn. This then paved the way for professional service providers to enter the market, he added. Another important change in the industry has been the shift from registered ownership to ‘street name’ (nominee shareholding), says Rossi. Thirty years ago the majority of shares were held in registered form and very few were held in street name. Now it is the complete opposite: most shares are held in institutions, or in street name which is preferred for its simpler trading and ability to hide the owner’s true identity. Rossi also talks about a shift from registered ownership to modern products offered by other brokers, ﬁrms and funds, for example the proliferation of mutual funds and the introduction of 401(k) saving plans. regulation. One pending issue in the US is proxy reform, which the SEC proposed in a concept release in July 2010 after reviewing the current regulatory framework around proxy voting and shareholder communications. Industry professionals and organisations such as the Shareholder Communication Commission (SCC) have criticised the existing proxy system which has been in place for nearly 30 years. The SCC, which consists of organisations such as the Business Roundtable, the STA and the National Investor Relations Institute, has been campaigning for changes to proxy mechanics for some time. One of its proposals is to give companies direct access to their beneﬁcial shareholders to enable them to have a say in who distributes their proxy materials and counts up their votes. Current proxy law means that companies are usually tied to choosing who the banks and brokerage ﬁrms holding their shares want. According to Rossi, if proxy reform goes ahead, transfer agents will be able to compete for the shareholder communications services which are currently controlled by ﬁnancial intermediaries who usually outsource to one main provider. This would revolutionise the transfer agent’s role in what would become a more competitive market. Although Rossi is in favour of renewing outdated rules, he says that the regulatory environment is growing more difﬁcult. From January 2011 new US regulations from the Internal Revenue Service will require ﬁnancial intermediaries such as brokers and transfer agents to report adjusted cost basis to investors and the IRS for securities transactions. “This is a major piece of legislation which will have a huge impact on transfer agents who will have to do more programming to support it,” said Rossi. For the last few years the SEC has been talking about enhancing rules governing transfer agents, most of which date back to the 1970s before the digitalisation of paper. This has created uncertainty in the industry and there are fears that if some transfer agencies are not as committed to the business, they may sell, which would further the consolidation trend. “But the rules do need to be updated and tightened given some of the issues present in the current market,” added Rossi. Regulation will need to reﬂect modern changes as more and more shareholder positions are recorded electronically. With ongoing pressure from technology, regulators and new mergers, it is hard to predict what the transfer agent industry will look like in the next few years. But it is clear that further change is inevitable and that transfer agents will have to continue to adapt if they want to survive.
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Modern Issues
However, transfer agencies and registrars still play a very important role in the orderly operation of securities markets in the US, UK, Canada and Australia, says Conn. In those markets, transfer agents are still important to record keeping and they continue to record transactions in their books, he adds. But in other markets, in continental Europe for example, Conn claims that the transfer agent’s role is quite narrow due to dominant central depositories. What is interesting is that transfer agents have had to increase the breadth of their services to adjust to the new landscape. Some have dipped into employee plan and proxy services to meet client demand. Another US trend that has emerged in recent years is the merging of duties of both transfer agents and registrars, which were previously segregated. According to Computershare, many transfer agents now take on the registrar’s duties, such as ensuring that the corporation issues the right amount of stock shares, maintaining records of authorised, issued and outstanding shares, and also tracking the issuance and cancellation of shares.
Regulatory Pressure
The next big issue facing transfer agents is
2011 | Fundamentals
Kevin Lee interview
Can you describe the Calastone offering? We have three core services: order routing, launched in May 2008; settlements, launched in March 2010; and reconciliations, which is currently in start-up phase. We are also planning a number of announcements in 2011. How have these products fared since launch? Our services have been successful because of the ease of connection, the growth in the fund management industry both on and offshore, the ability to trade all asset classes within those particular funds and because we also had massive growth in institutional funds. Order routing has been a tremendous success. We are experiencing up to 10% month-on-month growth from a messaging point of view. That is predominantly because we now have most UK fund managers connected and we have continued to expand into Ireland and Luxembourg. Volumes on our settlement solution are doubling month-on-month. We have the IFDS fund managers all live, Baring Asset Management live at Northern Trust and as we move into the early part of 2011 we will have Capita fully live with both order routing and settlement. The reconciliation service goes fully live in January but we have clients using the service now. So the full lifestyle of a mutual fund transaction will for the ﬁrst time be fully automated, which I think is a great success. Are clients opting for speciﬁc services or the full offering? You don’t need one part of the suite to utilise the other, otherwise it would defeat our objective of global interoperability. We provide the services and clients choose what they require. However, because clients want full front-to-back STP they tend to take all three at once. Is the product now widely accepted by the mutual fund industry? We held an event in March called the Tipping Point, because Calastone was on the verge of being fully recognised as an integral part of the funds industry infrastructure. Since then, the momentum has been incredible. I was paid a nice compliment by a client, who said that when I ﬁrst went to see them they really didn’t think it would happen, yet three years later they said they had been proved wrong. Has the ﬁnancial crisis helped uptake of your products? Indeed. One of the attributes of the Calastone service is that it reduces risk, a major talking point since the Lehman collapse. Because Calastone offers full-STP, it minimises the amount of human intervention required in a trade.
Although one would say launching a new business in the middle of a recession is not smart, the type of business that we offer, i.e. risk reduction from a trading point of view, with no capital costs for a client to engage with us, means it is a win-win. The circumstances have helped organisations focus their minds, look for a solution and I think Calastone was in the right place at the right time. Where does your focus lie for the next few years? In March this year we opened our Luxembourg ofﬁce. That has expanded, from a client-base point of view, and we now have up to about 20 clients. In Dublin, Calastone was the ﬁrst organisation to carry the SWIFT SHarP certiﬁcate for hedge funds. Because Ireland and Luxembourg are very different to the UK, we have had to change some of our technology to meet the processes and regulations of these other domiciles. But because of our agility and the cloud-computing technology that we use, we are able to deliver new services in short time frames. What has been your biggest challenge in the last 12 months? Managing growth is the thing that keeps me awake at night, because you only have one reputation. That involves investing in staff to make sure you can still give the same level of service that you promised in the ﬁrst place. That has been a challenge, but I think we’ve been successful. How much more efﬁcient can things get? What is the next step? We want to implement a new service to help the retail investor for reregistration. Very soon we will be launching a service that will enable investors to re-register their portfolios very quickly, very easily, and with signiﬁcant reduction in the amount of paper and processing that takes place. That’s good for both the industry and the end investor.
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Fundamentals talk to Kevin Lee, CEO of Calastone
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What’s missing?
Admi is r tor
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A Banker's nightmare?
A banker’s nightmare? Or the ultimate challenge/opportunity?
The rise and rise of alternative payment systems by Brian Bollen
ny subject that grabs the attention of busy head corporate treasurers as a means of increasing efﬁciency and reducing costs must at least ﬂicker on the radar of investors, their fund managers and even their custodians. If there is a lesson to be learnt by custodians, they really ought to position themselves to make the most of the experience. These are just some of the initial reactions to hearing about recent developments for corporate clients and their banks in the ﬁeld of mobile technology, especially as it relates to mobile payments and directly or indirectly related services. For investors the attractions of growth in mobile payments operating on a transaction-based model are obvious. It is potentially enormously cash-generative, global in scale, and as scalable a business as even the choosiest provider of ﬁnance could hope to see. “Companies can have a truly ‘productised’ offering,” says Georg Fasching, vice president, products and solutions at Luup, a Norwegian company whose foundations are built on a range of existing mobile payment capabilities: mobile payment solutions, network enablers, technology development. “They can bring on new customers quickly and simply, helping them achieve higher margins,” he adds. Corporate treasurers have shown great enthusiasm for Luup’s invoice presentation and payment product, which can help replace cash across an entire corporate network, delivering cost savings of 20%-plus, he says. A key advantage is that mobile technology can help corporates in geographies where purely electronic options dependent upon good internet accessibility just do not work. Luup is also pushing its remote authorisation product which, it says, is enabling corporate treasurers to concentrate more on the underlying business of the company for which they work. There is a positive role for banks in particular to play in the rapidly expanding world of mobile payments. If they play that role well, public trust in the ﬁnancial services just might begin to return. Possibly accompanied by respect. Affection will likely remain out of reach, at least for now, even if the industry succeeds in transforming Africa’s ﬁnancial ecology in ways that decades of traditional foreign aid have failed to do. If they play their cards right, banks can help the continent ﬁnally emerge from a catastrophic dependency culture. If banks can commit to working with telecoms companies to solve the problems that their success in introducing mobile communications in general to Africa, and mobile payments in particular have created, they could help reshape the continent’s commercial, economic and social future. It is a challenge - a huge challenge. But one that some industry players are convinced they will face up to. Successfully. Mobile technology is spreading further into other areas of activity in the ﬁnancial services industry. Proxy voting, for instance, moved to the next generation of advanced technology with the recent announcement by Broadridge Financial Solutions that its ProxyVote.com platform will be available on mobile data devices such as smartphones and tablets in early 2011. The announcement and demonstration was made at Broadridge's annual Investor Communications Conference, held in New York City, which attracts hundreds of top executives from the nation's leading ﬁnancial services ﬁrms, institutional investors and corporate issuers. "Mobile ProxyVote is yet another of the technological innovations Broadridge has pioneered to improve and encourage more shareholder voting and enhanced shareholder communications," said Joseph Vicari, vice president, business strategy and development, Broadridge. "The sophisticated graphical user interface is customized to be used with an array of mobile devices - including the market leading iPhone, iPad, BlackBerry smartphones, and Android phones - and will
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A Banker's nightmare?
seamlessly integrate with Broadridge's ProxyVote. com platform," he stated. Broadridge calculates that 20m proxy votes were recorded through ProxyVote.com for the 12 months ending June 2010. ProxyVote offers street name and registered shareowners, as well as 401(k), ESOP and ESPP participants, the convenience of voting their shares on the internet, and now with the introduction of Mobile ProxyVote, through compatible mobile devices. Until now, shareowners who had registered for electronic delivery of proxy materials and were notiﬁed via e-mail, would only be able to cast electronic votes via their personal computers. Broadridge says that e-mail delivery of proxy materials is growing exponentially, nearly tripling from the annualised period ending 30th June, 2006 of 27m deliveries to almost 78m deliveries for the annualised period ending 30th June, 2010. "Shareholder preference is shifting towards using technology to improve both their access to information and their ability to act upon it," explained Robert Schifellite, president, investor communication solutions, Broadridge. "This introduction signals a signiﬁcant shift forward for shareholders and will increase participation, especially among individual investors," he concluded. Luup has been developing and operating mobile payment solutions since 2002, but changed its business model in 2008 to reﬂect the realities of the industry. The chief executive of the time, Thomas Borston Jorgenson, realised there was little point in trying to reinvent the banking wheel. Banks had taken, years, decades, centuries, to build the networks that are needed to achieve what could be possible in mobile payments. It is clear that the bank-led model for mobile payments is the way forward, at least in developed markets, he explained, not long before he left the company in 2010. It makes much more sense to work with them rather than try to compete with them. It is a different story entirely in developing markets, many of which have bypassed ﬁxed line networks almost completely, and gone straight to mobile. In such markets, it is telecoms companies who hold the whip hand.
Traditionally, these workers have been paid in cash and have then used money exchanges to remit a signiﬁcant proportion of their salary home. This is time-consuming, both in terms of the time it takes for the money to reach the home country and the time it takes for the migrant worker to go to the money exchange. Another key factor to consider is legislation making it compulsory for companies to pay salaries electronically, which was only relatively recently introduced in the UAE. Mobile payments provide a cost-effective salary payment solution for corporates, at the same time as being a convenient and secure remittance solution for their employees. The telco-led mobile payment models are all aimed at the unbanked in developing countries. The unbanked market is addressed using ‘mobile wallets’. Some telcos also offer the service to customers of other telcos. The service provider has to secure a network of agents for cash-in and cash-out. This is one of the major obstacles for unbanked mobile payments and involves serious issues like securing them liquidity and support. Regulators throughout Africa are starting to relax their stance on the telco-led model. The telco industry is making enormous efforts to lobby regulators and highlight the socioeconomic beneﬁts that they can bring to a country (i.e. 10% mobile penetration increases GDP by 1.2%). Different types of technologies can be used for mobile payments but effectively rolling out an agent network is a massive task for mobile network operators (MNOs). All highlight training and education of agents as a major issue not to be overlooked. One obstacle is that running agent networks have to compete for agents’ attention. Retailers typically receive 20% commission selling soft drinks versus 8% acting as cash-out agents for mobile payments.
Luup highlights UAE as key mobile remittances gateway
The mobile money service market is growing at a phenomenal pace and a report by analysts Gartner states that transactions will total $4.5bn by 2012. Further, an estimated annual growth of remittances in the Gulf Cooperation Council region alone is pegged at over 20% in the next ﬁve years. At the recent Mobile Money Transfer (MMT) Global Conference in Dubai, United Arab Emirates (UAE), Luup highlighted how it is establishing the UAE as a key mobile remittances gateway by partnering with companies across the ecosystem. In a speech given together with the National Bank
Build it and they will come
A large part of the potential market in areas such as the United Arab Emirates (UAE) and in what some people might still insist on calling lesser developed countries is the low status foreign worker population, made up of economic migrants from India, Pakistan, Bangladesh, the Philippines, Sri Lanka and Egypt.
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A Banker's nightmare? of Abu Dhabi (NBAD), Luup shared the successful case study of the ﬁrst launch of international money transfer using MoneyGram via mobile phones in the Middle East. Luup also pointed to its strategy of expanding the ecosystem further by building partnerships with countries receiving remittances from the GCC region. “With an exceptionally large migrant population, the size of the remittance market in the Gulf Cooperation Council (GCC) alone is nearly $50bn,” said Morten Hofstad, regional director Middle East, Northern Africa and Asia at Luup. “The region also has one of the highest mobile phone penetration rates in the world, as mobile phones are a key tool for these mostly unbanked migrants. Based on the region’s potential, the MMT conference is a great opportunity to share experiences and ideas that can pave the way for mobile money transfer initiatives globally.” Luup has a successful partnership in place across the UAE with the National Bank of Abu Dhabi (NBAD). Recently a tie-up between NBAD and MoneyGram was added, enabling mobile phone international remittances to more than 200,000 locations across 190 countries and territories around the globe. This was the ﬁrst launch of international money transfer via mobile phones in the Middle East. The agreement between MoneyGram and NBAD makes it even easier and even more convenient for consumers in the UAE to send international money transfers via their mobile phones. Through this service, migrants and other consumers can transfer funds directly from their NBAD or prepaid account to persons outside the UAE via mobile phones. At the heart of service is NBAD’s Arrow service, developed with Luup and launched two years ago as the country’s ﬁrst mobile phone money transfer and payment service for current account holders. NBAD and Luup then increased the range of Arrow services to include transfers from general prepaid cards. Offering international remittances through MoneyGram was the culmination of intensive work the partners undertook in developing this new service. Ahmed Alnaqbi, senior manager channels and electronic banking services at NBAD commented: "NBAD is proud to play a signiﬁcant role in this project which paves the way for a smoother, secure and convenient electronic money transfers." The service is growing in popularity with an increased customer base, and trust in mobile payments has increased since the launch. With a seamless mobile payments gateway established in the region, Luup is 52 | Fundamentals well on its way to expand with new partners in the ecosystem to set the trend for future growth. With some prediction saying that there could be over seven billion mobile phones on the globe by 2015 mobile payments will undoubtedly play a key role in the future of ﬁnancial services. NBAD was quick to see the potential of mobile technology and by working with Luup is now is in a great position to capitalise on the beneﬁts that mobile payments offer. Luup is also co-operating with Emirates International Exchange (EIE), a leading exchange house in the United Arab Emirates, on a project to enable EIE customers to transfer money across the globe from their mobile handset. At the risk of sounding like an echo of a large international mobile telecoms provider, it is just about possible to argue that the future is bright. The future is exciting. The future is challenging. But banks must ask themselves: Are they ready to face that future? Are they willing to invest the time and money required? Are they able to prepare properly to take the maximum advantage? Do they have the resources? Do they have the technology? After three and a half years of devastation caused to much of the ﬁnancial services industry, do they even have the credibility? In short, are they up for it? In a world where Qatar can be awarded the right to stage football’s most prestigious event, the quadrennial World Cup, anything can surely happen. Meanwhile, in what it billed as an industry ﬁrst, Luup joined forces with Microsoft to showcase an industry ﬁrst at the annual Sibos gathering in Amsterdam at the end of October. The newlylaunched Luup Mobile Remote Authorisations product is interactively demoed on the Windows Phone 7, enabling people to discover ﬁrst-hand how remote authorisations via a mobile device work and the operational beneﬁts the new product delivers. Workforce mobility means that employees increasingly rely on smartphones to keep on top of workﬂows. Be it purchase orders, travel or budget requests, payment runs, budget reconciliations or cash replacement solutions, the Luup product enables authorisations to take place remotely by multiple peer or hierarchical signatories at different locations, all within seconds via a mobile device. Such innovation is set to bring even greater operational changes than the electronic channel brought, predicts Luup. Financial institutions and their corporate customers will beneﬁt from revenue generation and cost reduction opportunities across multiple business areas.
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A Banker's nightmare? "Corporate payments innovations are gaining considerable momentum at Sibos and our collaboration with Luup is a natural step as Microsoft expands in the payments integration market," said Karen Cone, general manager of Worldwide Financial Services at Microsoft. "Luup's solutions offer sophisticated workﬂow management tools and directly increase efﬁciencies in banking operations and treasury functions. Microsoft BizTalk Server is a core-part of Luup's banking-grade platform, delivering complex business process mapping, enabling integration with mission-critical core banking and treasury systems."
Case study 1: Mobile payment: A new universal means of payment or a way to ﬁnancial inclusion in emerging markets?
Jean Michel Guillaumond, head of research and development at Société Générale’s international retail banking division, is another with clear strategic views about the beneﬁts of reaching the unbanked population, a subject relating to which he has developed the concept of a need for disruptive innovation. In developing countries, he observes, the “classical” model of banks does not succeed in satisfying the needs of a widely unbanked population: The density of bank branch networks is low, card payment infrastructures are insufﬁcient and ﬁnancial services remain costly. Today, these weaknesses can largely be solved thanks to the cell phone - a large percentage of the population owns at least one and telecommunication networks are extensive and efﬁcient. Technology makes it possible to access daily banking services via the mobile in a secured way. Once ﬁduciary money is transformed into electronic money, it becomes easy to carry out money transfers as well as pay goods and services by mobile phone, anywhere and at anytime. Telecommunication operators were the ﬁrst to take close interest in the subject as it seemed easy for them to make a switch from transfer of airtime credit to transfer of electronic money. Setting up an integrated payment tool allowing to top up airtime also enables operators to decrease their costs. In addition, it represents a new trafﬁc generating service as well as a way to develop consumer loyalty. Therefore many projects were initiated and today, several of them such as M-Pesa by Safaricom, Mobile Money by MTN or Orange Money - are operational. In many countries operators cannot launch a mobile payment service on their own. For regulatory reasons they have to conclude partnership agreements with ﬁnancial institutions who ensure the issuance of electronic money and guarantee transaction security and compliance towards Central Banks. In this context, several Société Générale subsidiaries are participating in such projects, e.g. in Ivory Coast and Madagascar. However, operator-driven initiatives are closedloop systems dedicated to their own customers. Operators’ objectives are different from banks’ objectives. Moreover, these projects can eventually become a threat to banks. Not only are bank revenues on payment threatened, but so is the banking activity on the whole – especially for one such as Société Générale - given that operators could start using consumer ﬁles to commercialise credit and deposit products in partnership with competitors. The Safaricom example, with the recent launch of M-Kesho in Kenya (a banking offer including micro- savings, micro-credit and micro-insurance) in partnership with Equity Bank, is edifying enough.
A new means of payment: universal, handy and safe
In emerging markets tomorrow’s banker will surely be the one distributing and processing means of payment, and the most widespread payment means will probably not be by card. According to several consumer surveys, payment is considered as a natural extension of everyday mobile use, and therefore mobile payment is eventually likely to develop on a large scale. Based on these convictions, Société Générale decided to develop a new simpliﬁed banking service of its own that would combine a prepaid electronic money account and related means of payment in order to reach the unbanked segment by using a different business model. These are the principles on which this new service is built: • The service must be open to everyone regardless of the operator and the telephone, without the need to change the SIM card to access the service; • The service must enable the client to send money to any recipient owning a telephone; • The service is shared between partners; in order to be universal and open to a number of uses, alliances with complementary partners are build in order to create a ‘payment ecosystem’; • The service must be a true banking service because clients must enjoy the same level of security and protection as traditional banking customers;
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• The service name must stick to the economic and social life of the country where it is marketed because there are strong ties between the access to banking services, economic exchange and in ﬁne economic development.
A ﬁrst pilot launch in Senegal
Senegal is the ﬁrst country in which the service was launched in June 2010. The company Obopay supplies the underlying technology and brings its expertise in the processing of transactions by mobile phone. Senegal presented the perfect conditions allowing the project to succeed: a widely unbanked population (only about 7% have a bank account) and an extended network of mobile phone users (50%). The service is named “Yoban’tel by Obopay”. Yoban’tel means send by telephone in Wolof, a name that can easily be adopted by local partners. We add “by Obopay” to stress the belonging to the network which will, in the future, interconnect cell phone owners of all countries. Today the service includes person-to-person money transfer and bill payment. Any mobile device is eligible for the service. A simple SMS is enough to send a transfer or payment request, without having to install an application on the phone. Person-to-person money transfer and payment of bills were evaluated as the two most important use cases. So we developed them ﬁrst. Yoban’tel makes person-to-person money transfer simple. For a person who works in Dakar, it is essential to be able to regularly send money, in a safe, easy and immediate way, to his family living outside the capital. Beneﬁciaries do not even have to subscribe to the service. All they need is a mobile phone. Bill payment via mobile phone has two advantages. On the one hand, it prevents the remitter from having to go to a branch and queue for hours to pay his bill in cash. On the other hand, it is easier for the provider to manage payments, as transactions are are e automatically processed. To ensure the development of Yoban’tel, Société té Générale’s local subsidiary (Société Générale des es Banques au Sénégal) has entered into partnerships hips ip with major actors in the Senegalese market: • Crédit Mutuel du Sénégal, the largest microrooﬁnance institution in the country with 450,000 ,000 000 ions on customers and 180 branches, for subscriptions and cash-in cash-out facilities; s via ia • Canal Plus Sénégal for payment of TV bills via mobile phone; f the h • Tigo, a mobile operator, for distribution of the topopservice at its points of sale and for airtime topount ount. up debited directly from the Yoban’tel account. 54 | Fundamentals
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Towards an international mobile payment network? The idea that an international mobile payment network can be created seems reasonable. This is true for Sub-Saharan Africa and is also valid for other parts of the world. In semi-mature and developed markets, such as North Africa and Europe, the payment platform is to be enhanced with the internet channel for subscription and e-commerce. For illustration, portals such as iTunes or Ovi show a trend of the business in intangible goods, for which payment (especially micro-payment) is a compulsory component. This payment platform will have to be able to process such micro-payment transactions at a low cost. In addition, the deployment of mobile payment services offers great perspective for the international remittance market. For Société Générale, this type of service would be valuable as many of its subsidiaries are located in countries with large migrant populations.
A new banking distribution model?
Payment and money transfer might only be the tip of the iceberg. Besides this service, Société Générale aims to offer ﬁnancial services to everyone, including those who have not had access so far. Based on the initial model set up for payments, the range of products could be extended, for example the disbursement of micro-loans and repayments via mobile phone; the payment of a premium to customers keeping a minimum balance on their prepaid electronic money account balance. Société Générale says that Yoban'tel's launch in Senegal is the ﬁrst step towards the full-scale deployment throughout the continent of a universal payment service accessible to all - including those without a bank account - before becoming the solution for payment by mobile phone for Société Générale group worldwide.
A Banker's nightmare?
Case study 2: The attractions of Africa
Africa is popular with bankers and technicians pushing the development of alternative payment networks. The GSM Association (GSMA) and Citi Global Transactions Services hosted a timely Mobile Money Policy Forum in Nairobi, Kenya, on 30th November 30 and 1st December, with participation from the US Department of State. In recent years, mobile commerce has grown in popularity in Africa due to the high level of mobile penetration. Recent advances in mobile technology have the potential to radically change the payments landscape and, in fact, are making new payment infrastructure not only possible, but a reality. This is enabling ﬁnancial inclusion and improving Africa's social and economic development. All of these changes have created myriad opportunities for market participants but also a lot of questions as to the right strategy to execute. The two-day event was designed to discuss regulatory frameworks to enable mobile commerce in Africa. Mobile commerce, and speciﬁcally the use of e-money, is enabling the unbanked populations of many countries in Africa to conduct ﬁnancial transactions via a mobile phone, including personal and business transactions which can replace cash transactions. Maria Otero, undersecretary for democracy and global affairs, US Department of State, and James Wolfensohn, ninth president of the World Bank (or International Bank for Reconstruction and Development, to give its formal name) and chairman of Citi International, were featured speakers at the forum. Representatives from Kenya, Tanzania and Uganda – including Professor Njuguna N'dungu, the governor of the Central Bank of Kenya - shared best practices from the implementation of mobile commerce in East Africa with representatives of participating countries from Central Africa including DRC, Cameroon and Gabon. The agenda also included a review of the regulatory landscape in the region, critical success factors to promote ﬁnancial inclusion, and working group sessions to implement these practices. Ade Ayeyemi, head of Citi Global Transaction Services, Africa, said: “The provision of mobile commerce is enabling ﬁnancial inclusion broadly in Africa. The mobile phone’s ubiquity provides an existing and cost efﬁcient channel for the unbanked to reach the market and the market to reach the unbanked.” Gabriel Solomon, senior vice president, public policy, GSMA, said: “Mobile is a pervasive infrastructure that is accelerating economic and social development across the globe. With more than 5bn connections, mobile is the only platform that can be leveraged to achieve broad ﬁnancial inclusion. As the GSMA and Citi partnership demonstrates, mobile money is a win-win for banks and mobile operators; working collectively, we can all capitalise on the signiﬁcant opportunity before us.” Citi relates that the forum was also attended by industry participants including key mobile network operators, CEOs from major utility and large public sector entities, as well as NGOs active in promoting ﬁnancial inclusion including CGAP and the Gates Foundation.
The GSMA represents the interests of the worldwide mobile communications industry. Spanning 219 countries, the GSMA unites nearly 800 of the world's mobile operators, as well as more than 200 companies in the broader mobile ecosystem, including handset makers, software companies, equipment providers, Internet companies, and media and entertainment organisations.
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Caceis
Uncovering the hidden beneﬁts of outsourcing
Since the ﬁnancial crisis broke, investment managers and their clients have come to realise the added value in terms of security and peace of mind that the engagement of an independent third-party administrator brings. Pierre Oger, head of business engineering at CACEIS Bank Luxembourg, looks at how attitudes toward service providers’ roles have changed over time
Handling high-volume services
An asset servicing company was traditionally brought on board by investment managers to handle labour-intensive, administrative tasks such as net asset value calculation and fund accounting. By outsourcing such tasks, investment managers also beneﬁted indirectly by being freed from internal infrastructure burdens associated with the recruitment of qualiﬁed staff and IT-related matters such as system maintenance and upgrading, backup plans and adoption of standards associated with automation initiatives. terms of investment transparency legitimacy and protection concerns was demonstrated by the Swiss fund of fund administrator UBP, which took the decision to accept only those sub-funds serviced by a third-party administrator.
InvestorServices
Protecting managers' businesses
However, the indirect beneﬁts of engaging an administrator go beyond answering the transparency concerns of the investor. During the recent ﬁnancial crisis, asset servicing companies were able to demonstrate their commitment to a partnership approach by working in very close collaboration with manager clients, to ﬁnd practicable solutions to arising problems. For instance, as administrators' compliance departments constantly monitor counterparty risk, they could notify investment managers the instant counterparty risk issues were detected at Lehman Brothers, and by being at the source of data, were able to identify impacted portfolios, enabling managers to rapidly reduce their exposure prior to the group's failure. Also, close relationships with many prime brokers permitted the administrator to assist manager clients using Lehman's prime broker services to identify a suitable replacement. However, it was during the alternative liquidity crisis that clients with a ﬁnancially strong administrator and afﬁliated custodian beneﬁted most. Many were able to leverage their administrator's considerable ﬁnancial resources to assist them in negotiating the wave of withdrawals by investors, so that they could remain liquid and importantly, in business.
Moving up the value chain
However, the services proposed by the asset servicing industry have greatly evolved since these more humble beginnings, today encompassing more complex matters such as cross-border distribution support, risk management and performance measurement as well as more sensitive areas of the investment manager's business, with the advent of outsourcing of functions typically associated with manager's middle ofﬁce. These services not only permit the manager to concentrate on the core business of asset management, but combined with comprehensive online reporting tools to answer increasing calls from investors for transparency in many aspects of the manager's business.
An indicator of investment security
In the current marketplace, the service provider has developed from being an anonymous outsourcing company to being a more visible extension of the investment manager's company. Indeed, the security and peace of mind provided by the engagement of a third-party administrator has seen end-investors now actively seek information on the administrator as part of their internal due diligence process and the presence of a strong administrator, carrying out constant market and regulatory monitoring, can prove to be another indirect beneﬁt. Managers have realised this, and there is a growing trend among those using the services of an independent administrator and custodian to utilise the service provider as one of the selling points for their fund. The rising importance of the administrator in 56 | Fundamentals
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Relationship management is key
CACEIS is a strong ﬁnancial player and a leading global provider of asset services. Despite our size, we still score highly on the human side of our business as measured by client service and relationship management in leading industry surveys based on client feedback. This is thanks to the expertise and dedication of our staff, who are committed to supporting their clients, developing initial relationships into dependable business partnerships.
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FinTuition is an international training company based in London specialising in the securities ﬁnance business: securities lending, equity ﬁnance, hedge funds, prime brokerage, repo and collateral management.
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Outlook2011
Missy Seidel, securities lending global product head, Brown Brothers Harriman
There are many forces at work that will inﬂuence supply and demand in the securities lending market, most notably our current regulatory environment. Regulators in all jurisdictions have been drafting rules designed to promote transparency and control, while not unduly impacting the way our markets function. The US has enacted changes already via Dodd Frank, with much subject to additional rule making over the next two years; European regulators are ﬁnalising Basel III and AIFMD with changes expected to take effect around 2013; and while we seem close to resolution on the EU short selling proposal, there is still ambiguity as to how the rules will ultimately impact lending. The overall uncertainty has produced a lack of conviction on the borrowing side, and ultimately subdued demand. As we move into 2011, the industry is cautiously optimistic that demand will return once the regulatory environment stabilises and the economy continues to improve. A rebound in hedge fund assets and M&A activity have been positive signs - as we see leverage and stock M&A deals return, we expect to see more opportunities for beneﬁcial owners. We also anticipate that more hedge funds will implement active trading strategies, which would translate to an uptick in demand. Flexibility and transparency remain front and centre for beneﬁcial owners - many have been through a review of their programme and providers,
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and are re-engaging with more knowledge. They are correctly demanding speciﬁc and customised collateral and programme parameters, meaning the ability for a lending provider to be ﬂexible and provide a customised programme is more important than ever. The most nimble providers will be well positioned to gain market share in the coming year. Lending agents are increasingly selected based on their merits as agents, rather than because of custodial or other relationships.
Jonathan Lombardo, executive director, sales, SecFinex
The securities lending industry will face its greatest challenges adjusting to new regulatory changes. EMIR’s possible decision to mandate SBL transactions to be viewed as OTC instruments resulting in trading via CCPs will change the SBL landscape going forward. In addition Basel III and Solvency II initiatives will impact capital requirements for all participants in the SBL space, resulting in bi-lateral transactions becoming more capital-intensive and forcing businesses to rethink trading strategies to retain proﬁtability and maximise return on capital. Business streams that are capital intensive will be required to ﬁnd alternative routes to reduce capital requirements or inevitably might face smaller lines to trade. These changes will bring SBL in line with the ﬁnancial community as a whole and validate an often misunderstood market.
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Outlook 2011
David Little, director, strategy & business development, Calypso
Collateral management of OTCs is being rewritten by the CCP initiative. The biggest impacts are on the margining process, because the CCP has to hold the margin from both sides. It is bringing some people into collateralisation who haven’t traditionally been exposed to it before (buy-side – prime brokerage and AMs), and it changes the rules for collateralisation for others. As a result of this, people are reviewing what they are doing with collateral management, so this is possibly going to form the stimulus for a trend that was happening anyway across the trading desks. Traditionally collateral management was done in the silos of equities, ﬁxed income and OTC derivatives but there is now a trend towards installing a single collateral desk that takes on the responsibility for all of these, and driving out some synergies and economies of scale. In regulation, Dodd Frank will shift the playing ﬁeld in the favour of the smaller players. This runs counter to the trend currently playing in the securities ﬁnancing market which is favouring the larger tier-1 players. We therefore expect to see more, smaller, members. This will mean more relationships, meaning a greater overhead to manage and will act as a driver to improved systems, higher STP rates and need for overall efﬁciency. Basel III will impact the Sec Fin market though the requirement to set aside capital and liquidity buffers. By collateralising and demonstrating that you have good control over your collateral, you can reduce the amount of capital you have to set aside. Capital is going to become the limiting factor in the market, thus becoming a strong driver.
the marketplace for securities ﬁnance
Since 2001, SecFinex has been a leading force for continuing market innovation, providing alternatives to OTC trading. SecFinex introduced centrally cleared services for stock borrowing and lending on the SecFinex Order Market in 2009. Access to an exchange-based marketplace eliminates multi-entity counterparty risk, increases capital efﬁciency and introduces market standards and efﬁciencies that will be increasingly beneﬁcial to the evolution of the securities ﬁnance business.
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SECFINEX LIMITED IS AUTHORISED AND REGULATED BY THE FINANCIAL SERVICES AUTHORITY
ETFs: The underlying lending
ETFs: The underlying lending
Following on from last quarter’s article on securities lending in ETFs, Cherry Reynard takes a deeper look at both the physically-backed and synthetically-replicated product offerings
ecurities lending is widely employed by ETF providers. With the larger ETFs running into billions, they are often a signiﬁcant part of the wider securities lending programmes of asset managers and investment banks. Theoretically, there should be signiﬁcant beneﬁts to the client as well, who should see a reduced total expense ratio and lower tracking error as a result. But are these programmes sufﬁciently transparent? And are investors aware of the risks they present? Both physically-backed ETFs and synthetically replicated ETFs will have securities lending programmes. For synthetic ETFs, the risk is borne by the swap provider (usually an investment bank). It is therefore simply rolled up into the ultimate swap rate and investors will never see the impact. For physically backed ETFs, it will create variation in the total expense ratio depending on how much revenue can be generated via securities lending for assets in the portfolio. Demand for securities held by ETFs is largely market-driven. Stefan Kaiser, a vice president of global securities lending at BlackRock, says: “Securities lending is an integral part of the portfolio management value chain and investors should beneﬁt from this type of programme. We try to add all funds to our lending programme, but there is different demand and supply for different assets. There is less demand for FTSE 100, for example, and more demand for the MSCI Turkey.” In general, securities lending is done to reduce tracking error as all ETFs will incur costs of some kind. Vin Bhattacharjee, senior managing director and head of EMEA Intermediary Business at State Street Global Advisors (SSGA), says: “We see securities lending as a way of offsetting the expense ratio on the fund. Physically-backed funds have expenses such as custodian fees or withholding tax and this is a way of mitigating that. We don’t necessarily earn a ﬁxed amount. It is part of managing a portfolio efﬁciently.” Christos Costandinides, an ETF Strategist for the Global Markets Research team at Deutsche Bank points out that securities lending happens with all mutual funds, but people talk about it a lot more with ETFs. He adds: “If you look at any large asset manager, there will be a big line for securities lending.” In general, the uses of borrowed stock from ETFs are as wide as those of any securities lending programme and may include short-selling, M&A, risk arbitrage or the hedging of convertible bond issuance. In physically replicated ETFs, around 50% of the income from securities lending will ﬂow back into the fund. The remainder is split between the ETF provider and the custodian. As securities lending agreements are customised, there are no limits, but Costandinides says that this is the market norm. It is impossible to say the extent to which securities lending reduces costs for derivative-backed ETFs because it is priced into the swap rate. The income available from securities lending will vary quite substantially. Nick Thomas, global head of specialised sales for HSBC Securities Services says: “Securities lending generally brings in incremental revenue for the ETF provider. Depending on the nature of the ETF, this can vary quite substantially. The revenue raised from lending out a security can vary between a couple of basis points and a couple of per cent. The larger a stock, the less the probability that short-selling would inﬂuence the share price.” For the larger groups, such as State Street and HSBC, the ETF securities lending programme will form part of the group’s wider lending programme and will be managed centrally. SSGA has around $2 trillion under management and therefore has a lot of stock that can be lent out of which ETFs are just one part. Securities lending programmes within ETFs have created some controversy because of the counterparty and collateral risks that can be generated. For example, if an asset manager lends out a stock and the counterparty goes bust, it will receive whatever collateral has been put in place. This collateral may bear no resemblance to the original stock. Historically this has not been a problem, but became an issue during the credit crunch when stock lending transactions were collateralised with bonds that became extremely illiquid. As it was, no European ETFs were affected. In the US some ETF Securities exchange-traded commodities were backed by collateral posted by AIG. Before AIG was rescued, this became a signiﬁcant problem. Liquidity in one of the ETFs disappeared because market makers would not trade it. This was a temporary phenomenon and ETF Securities has now changed its collateral requirements. Other ETF providers, unnerved by its
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ETFs: The underlying lending
experience, have also tightened up. Kaiser says: “We meaningful additional risk. never have unsecured counterparty risk. With swap However, Costandinides says that investors still agreements, in theory, it is possible to have unsecured have to do some due diligence. He believes it is counterparty risk. We over-collateralise at 110-112% worth examining the underlying securities lending for equity against equity loans to avoid unsecured agreement; how collateral is held and how quickly counterparty exposure.” can it be accessed. Different rules apply to the US and Thomas says: “With a large securities lending Europe, for example. In the US, if a counterparty fails programme, when you consider how much is being to return securities, they are served with a letter and borrowed, the risk is very small because the loans after three days if the securities are not returned the are collateralised and marked to market daily. There collateral passes to the counterparty. have been some securities lending defaults, but European repo and securities lending is more compared to the aggregate amount being lent in the market the losses have been complicated. Collateral may sit in a very small. The losses have occurred different jurisdiction to the fund. Those when lending clients have lent jurisdictions will have different legal The types of assets stock against cash collateral and regimes and it may take anything reinvested the cash in weaker that will be lent will from a few days to a few months to instruments. We will always depend on the state recover the collateral. receive more collateral than of the market. This is For Costandinides, transparency the amount being borrowed.” is by far the greater issue for why it is often difﬁcult Also, ETF providers securities lending programmes to get to what the fund running securities lending on ETFs. He says: “There are no programmes are likely to is doing. Of, say, 500 have a lot of counterparties. regulatory guidelines as to the stocks held, not all will If one goes bust, it may be percentage of assets that are lent problematic, but investors be lent out. out. You can look at the annual are unlikely to lose their shirts. reports, but disclosure is poor and They will simply see a short-term should be better.” Annual reports are, widening in tracking error. by their nature, infrequent and it can Counterparty risk is more of a problem be difﬁcult to get at the amount derived from for derivative-backed ETFs rather than securities lending. Certainly, the majority do not physically-backed ETFs running securities lending reveal the type of stocks lent out or how much is programmes. Synthetic ETFs will generally only made from individual positions. have one counterparty – the investment bank - and therefore the collateral problem is more pressing if it This is not simply a division between synthetic goes wrong. Rather than just losing a few percent in and physically-backed ETFs. In synthetic ETFs, the one or two stocks, investors risk losing the whole of investors will never see how much is made from their investment. Any risks from securities lending securities lending because it is rolled up into the should be set in this context. swap rate. It is clearer in physically-based ETFs, but it will depend on the individual providers. For Costandinides agrees that securities lending is example, Kaiser argues that BlackRock has focused generally a low-risk practice, despite some hysteria on transparency and it is clear how its securities during the ﬁnancial crisis about counterparty risk. It lending programme adds value: “The difference introduces an element of risk, but it is not signiﬁcant. between swaps and physically-based – in swap-based Markets have been through the most signiﬁcant crisis securities lending, it happens outside the fund and in their history and these issues have only posed a it is not seen. With our funds, if the TER is 35 basis problem for a handful of ETFs. It is difﬁcult to make points and securities lending has generated 40 basis the case that securities lending programmes create
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ETFs: The underlying lending
points, the investor knows about it. We show clients provide synthetic replication, while asset managers what we are deducting and what we are generating use physical ETFs. In synthetic replication, the in securities lending. We are transparent about costs investment bank will provide access to a total return and the same is true of securities lending.” swap at zero cost. It is therefore more cost effective to construct the asset. Tracking error has also tended However, part of the problem with ETF providers to be better for synthetic replication. As securities giving complete transparency on costs is the relative lending creates variation in tracking error, it could be unpredictability of securities lending. Because it is seen as adding to the case for synthetic replication. driven by the market, it is difﬁcult to know at any one time how many stocks will be being lent out and There again, as in most cases it reduces tracking error, it could be seen as mitigating some of the for how much. Often asset managers will give their problems of physical replication. securities lending team a mandate enabling Having historically gone for one them to lend out securities on demand side or the other, providers are up to a certain level. This could increasingly offering both types, be as high as 60% or 70% of the We show clients depending on the asset class portfolio, but may be nothing if being replicated. iShares what we are there is no market demand for has always had physicallythe assets. deducting and what based ETFs, but has recently Costandinides says: “The we are generating in launched a synthetic ETF. types of assets that will be lent securities lending. Credit Suisse has done the will depend on the state of the We are transparent opposite. Kaiser says: “We market. This is why it is often about costs and tend to use swap-based ETFs difﬁcult to get to what the fund where physical replication the same is true of is doing. Of, say, 500 stocks held, poses challenges, such as foreign not all will be lent out.” securities lending investor restrictions.” Bhattacharjee says: “Securities Costandinides says that there is lending is a market-driven lots of debate as to which is the best phenomenon. You only lend if there is an approach, and this has largely been propagated economic return for doing so. The counterparties by the providers: “Both have pluses and minuses – don’t have much control over the securities that are in demand. Usually lending rates will rise if there are you have to look at it in the context of the product. There was a lot of talk about counterparty risk during large numbers of people interested in going short. the credit crisis, but not a single ETF suffered losses Rates are not stable – it varies day by day.” Kaiser says that theoretically most physically-based because of counterparty risk. Investors lost a lot more money from not understanding the type of asset in ETFs could generate an income from securities which they were invested.” lending, but they have to take account of demand Certainly the presence or absence of a securities patterns. At the moment, he says that there is more lending programme does not swing the balance demand for borrowing government debt and less for in favour of one approach or another. It does not borrowing corporate debt. It depends on the asset increase risk materially to create a problem for class and market environment. physically-based ETFs and it does not reduce cost With this in mind, does the presence or lack of a sufﬁciently to make a case against synthetic ETFs. securities lending programme add to the arguments The difference made by the securities lending for physical or synthetic replication? Costandinides programme will depend on the asset class and the says that the market is now around 50/50 physical group providing the programme. and synthetic ETFs. In general, investment banks
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Be Prepared
Be Prepared
Tim Smith, executive vice president of SunGard Securities Finance looks forward to securities lending in 2011 - Ready?
he motto of the Boy Scouts - “Be Prepared” is also relevant to securities lending in 2011. While today’s world usually resembles that of yesterday, and it’s only the rare black swan that takes us by surprise, the securities lending markets and the entire capital markets are standing presently in an uneasy state of readiness. Never before have securities ﬁnance professionals been so utterly uncertain as to what is going to happen next. And we do not even know where the unknown occurrence will happen. Will it be BRIC? North America? Europe? Asia? Everywhere? Therefore, it’s important that we continually remind ourselves of the Boy Scout motto in order to best protect ourselves and thrive in the changing environment. In addition to any regulatory diktats, which may vary from region to region and country to country, there will be new operational memoranda issued by the industry associations. These will address regulatory concerns and attempt to head off any unnecessary and overly burdensome impositions. However, securities lending booking systems will need to be as ﬂexible and as integrated as possible to ensure not only the ability to comply, but to do so without having to employ a vast army of manual workers. The latter would be ﬁne in normal circumstances, but the time constraints will be far too great to allow for manual intervention in the normal course of business. It will have to be automated. One of the major themes for 2010 was the expansion of the number of ways of doing business including central counterparties, single stock futures, and prime custody services. The new methodologies will co-exist because providers have established realistic assumptions in terms of market penetration. Nevertheless, they will still require support, monitoring and the ability to integrate the activity without disturbing legacy processes. As the whole proposition grows in complexity, banks, brokers, beneﬁcial owners and hedge funds will realise that to be prepared means one of two things: either devote more resources to deal with non-core IT infrastructure and data processing, or concentrate on bread and butter businesses and use experts to cope with the systems and the necessary regulatory compliance. Qualitative controls and benchmarking will be another major push for 2011 in terms of both risk and performance. The problem with risk for securities lending businesses is that the business side looks at it from a different perspective than the corporate side. To cover it well, there is a need to satisfy both business and corporate, but most offerings out there usually concentrate on one or the other. Similarly, for the performance benchmarking technology, it will be important to provide all required users with easier access using familiar tools like Excel so that information can be shared internally more quickly. Ask anyone about the current main area of focus and, chances are, you will receive the reply: ‘collateral management.’ Although a standard deﬁnition of collateral management eludes many people (and it can mean different things to different people), the common thread is efﬁciency, compliance, transparency, and managing balance sheets well for every business that touches trading. To this end, it will be necessary for serious players to adopt an across-the-board approach that will necessitate vast resource commitment. And maintaining it in an uncertain world will require an ongoing commitment. The above may all sound very similar to what has happened in the past. However, this would be a mistaken impression. Securities ﬁnance is no longer a stand-alone business. There are too many variables and connections with other areas of banks to allow a piecemeal approach. There is also too much uncertainty as to the regulators’ next steps in applying new forms of control and reporting. There are also too many opportunities arising from different markets and products. Consequently, it is certainly wise to work with both internal and external service providers to ‘be prepared’ for any eventuality.
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Off Centre
Off Centre
Roy Zimmerhansl gauges industry opinion on why central counterparties – deemed “inevitable” by many – have not yet fully taken off in the securities lending world
Four Reasons Why CCPs Haven’t Had More Impact on Securities Lending
A substantial amount of editorial space has been devoted to the topic of central counterparties (CCP) for securities lending. Launched in 2009 in both the US and Europe, CCPs have been a controversial subject from the start. It’s no surprise as to why the subject is of interest to market participants. Any new development - whether technology-based, the result of regulatory imposition, or a change to best practice –has the potential to fundamentally change the economic dynamics for lenders, borrowers and intermediaries. Let’s recap the supportive arguments for implementation before turning to the questions that remain. substantial use of CCP is commonplace. Yet, even with this weight of intellectual argument, the impact of CCP remains negligible in the grand scheme of securities lending today. So let’s turn the discussion to the reasons why activity remains muted and enthusiasm comes mostly from those with vested interests. I should mention that several very thoughtful commentators gave me insights as to their views on the issues outlined below. Most were restricted from making credited statements, so I thought it best to capture their cumulative views for readers’ consideration and anonymise everyone’s comments. Interestingly, virtually all of those individuals describing the mineﬁeld of issues we discuss below, believe CCPs are in fact inevitable. (Few were willing to guess when though …)
There are several compelling arguments for CCP usage.
• Beneﬁcial owners, ultimately the lenders of stock, are generally risk averse, so surely the credit risk of a CCP borrower rated AAA must be an attractive proposition. Agent lenders using a CCP might be in a position to increase distribution to a large community of borrowers, some of whom are outside its bilateral approved list. CCP clearly brings huge value to the prime broker and proprietary trading borrowing side of the business. Regulators give substantial reduction in balance sheet usage and capital allocation for participants in CCP-cleared trading businesses, and securities lending would equally beneﬁt. Access to supply is increased as Agent Lender Disclosure (“ALD”) requirements are removed for CCP-traded positions. Hedge funds – the end demand in most cases, should beneﬁt in several ways. As noted, prime brokers’ access to stock is increased and the efﬁcient use of resources at PBs should indirectly beneﬁt hedge funds from a product pricing point of view. Regulators around the world have been encouraging the use of CCP for over-the-counter trading activity. They point to the risk reduction beneﬁts best exempliﬁed by the very successful unwind of Lehman trading positions across multiple products in numerous markets around the world. The scale of the unwind dwarfs the relatively small securities lending market position that Lehman carried.
Reason One - Margin
The most often discussed issues revolve around margin. Remember that excess margin held by agent lenders on behalf of beneﬁcial owners is the bedrock safety net that underpins this marketplace. Investors that lend securities are protected from losses arising from borrower defaults primarily by the excess collateral value that they take from borrowers. Anything changing this core principle threatens the very basis of the decision to lend. Under conventional CCP arrangements for other ﬁnancial products, both the buyer and seller provide margin to the CCP with subsequent margin movements based on proﬁtability or underlying value changes. This represents a radical change from the current securities lending business in at least four ways. First, “lenders” (used in this article to mean either the agent or beneﬁcial owner) receive excess collateral, they don’t give it. Second, the beneﬁcial owner is the owner of the collateral. Third, lenders decide which collateral is acceptable and the extent of excess margin taken from borrowers. Fourth, lenders determine where and how the collateral is held. Solutions for many of these issues exist. Investors that trade derivatives already have to post margin, so conceptually it is possible to get over that hurdle. Agents having to post collateral could in theory provide other long positions as collateral or have custodial arrangements whereby CCPs could call on margin in the event of a default. Alternatively the borrower or even the General Clearing Member acting for the lender could post the collateral on its behalf. In many ways, collateral is just a cost calculation that needs to be added in. Or it may be possible to restructure the CCP arrangements so that the lender does not have to provide collateral in the ﬁrst instance. In any case, it is clear that without an answer to
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Given all of these positives, it is not surprising that many use the word “inevitable” to describe a future where
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Off Centre
these collateral issues, it is unlikely substantial progress will be made. Some (in fact, many) investors are legally restricted from lending securities without taking collateral - so their own regulatory requirements bar them from using the current conﬁguration of the CCPs. It may be possible to get clients to change their governing documentation or push for regulatory changes that require them to hold collateral at least equal to the value of securities on loan. But don’t hold your breath – that’s a long-haul approach that would have little appeal to beneﬁcial owners or their regulators. be reduced, streamlining operational ﬂows. And it’s hard to dispute that having fewer breaks would be good. CCPs generate greater beneﬁts the more they are used, so in the highest volume markets they bring substantial hard-money value to large-scale users. But, like all new products, CCPs have started with relatively low market penetration and low volumes. Also, the securities lending CCPs rightly concentrate on many of the highest volume securities lending markets – US, France and Germany for instance. Yet these markets are already amongst the most efﬁcient, and with sparse volumes, CCP use adds to the operational workload rather than reducing it. Low volumes of trades requiring new processes, practices and procedures are the reward for the earliest users. More complex and cumbersome markets will remain outside the scope of CCPs. Eventually this too shall pass, and as with other fundamental processing innovations at some point critical mass will be achieved and the value will become accessible to all. These high-volume markets tend to be GC markets and anything that can help reduce overall costs for dealing in these securities helps product proﬁtability. Better that operations people beneﬁt from straight through processing for low-margin markets and concentrate their time and effort on complex, difﬁcult settlement countries.
Reason Two – Credit Exposure
Agent lenders each have individual lists of approved borrowers in their programme s. Beneﬁcial owners usually have the option of reducing the list further, even if the agent offers those clients indemniﬁcations. The agents have a surprisingly wide variation of borrowers on their approved lists. In addition to their individual credit assessments, other factors including relationships and business opportunities also shape these lists. Having invested time and effort into selecting borrowers that suit their needs, agents want to trade bilaterally with those entities. Currently the primary way to access the existing CCPs is via anonymous trading platforms. The argument in favour of the trading platform entry point is improved distribution to a wider audience through the enhanced ﬁlter of CCPs as risk managers. Through the CCP credit assessment of individual members, the activity-based margin provision by those entities, further guarantees that are required to gain membership, and the mutuality of credit risk amongst CCP members, regulators consider CCPs as a superior risk. Even for those that accept the AAA-rated risk assessment of CCPs as counterparties, it fundamentally changes the risk relationship. Rather than choosing the counterparty you are willing to take risk on, trades are automatically completed with any qualifying member. This hands over the credit assessment process to CCPs and some doubt whether they can in fact legally delegate the decision making process to any third party. Questions also arise on counterparty risk where the agent lender is not a clearing member itself – does the risk transfer to the clearing member? While this would insulate the agent from CCP default, it would concentrate risk into the clearing member. Finally, many critics of CCPs in the wider ﬁnancial markets point to the concentration of credit risk into CCPs and away from diverse counterparty credit exposure.
Reason Four – Cost
To paraphrase: “It’s the economics of CCP, stupid”.The use of CCP entails new costs. At the very least, CCPs are new additional counterparties for borrowers and lenders. There are new processes that apply to collateral, margin, reconciliation and entitlement processing that will add to costs. The additional CCP charges are entirely new. And don’t forget, under the current product structures, the only access point is via trading platforms that carry their own costs. And of course, all of this needs to be planned, organised and implemented – costs of change that can’t be underestimated. All of this against a background where revenues have taken a signiﬁcant nosedive in 2010. A formidable challenge at the best of times, let alone the current conditions.
Summary
So the battle rages on. Four very real and tangible barriers to success for CCPs. Nevertheless, there are solutions to each of these obstacles, either through adaption or innovation from existing CCPs, trading platforms and market participants – or new market entrants in one or more of those categories. Success will come for those that can walk the ﬁne line of bringing change to the market, listening to the borrowers’ and lenders’ needs, making adjustments where necessary, bringing new practices to the business without disenfranchising the very ﬁrms that are expected to implement change. While the barriers are real, the beneﬁts are compelling and for the business to survive in the long term, must prevail. For securities lending as a whole to return to peak levels and exceed them, more efﬁcient resource utilisation is a prerequisite. CCP usage is a critical piece of that brave new world. Inevitable? Yes. When? Now that’s a different question entirely. 2011 | Fundamentals | 65
Reason Three – Operational Impact
CCPs have two roles at the core of their existence. One is as risk manager described above. The second concentrates on their position of having the “Golden Data”. Rather than two bilateral counterparties needing to reconcile and agree pending and outstanding transactions, billing and entitlements, the CCP becomes the dictator of the data. All users must accept the CCPs information as correct. The upshot of trades cleared through CCPs is that disagreements between counterparties or “breaks” should
Quadriserv update
Quadriserv Primed to Extend Automation
John Sandman catches up with the latest Quadriserv developments in New York
he regulatory climate for securities lending is still subject to the winds of change, but industry insiders are beginning to plan for the inevitable: the cost of doing business in this market is likely to go up across the board—to the custodian, the borrower and every other link in the securities lending supply chain. As a result automated solutions are going to become more critical, not only as part of a strategy that can more efﬁciently deliver borrowed securities and meet compliance demands, but as an alternative to expensive and risky manual processing. The current state of affairs, as well as what the future will hold, was a topic for discussion at an afterhours event held at the Noodle Bar East in Lower Manhattan, not normally a place where staff from the International Securities Exchange and securities lending vendor Quadriserv meet to discuss the industry’s prospects. Quadriserv is a vendor of market data for the securities lending, developers of the AQS market data service, which provides reliable real-time data , leveraging its relationship with the Chicagobased Options Clearing Corporation, providing a centralized market for securities lending in the US. Plans are in the works to expand into the European market through it relationship with Eurex clearing. Greg DePetris, co-founder and chief strategic ofﬁcer of Quadriserv said the two year launch phase of the company and integration stage of AQS had gone as planned. “We’re excited to see lots of borrowers and lenders coming into a centralised market and that it is resulting in better pricing. Our focus is to build out synergised products.” AQS extended its reach further when it became integrated with SunGard’s Loanet, a securities lending platform that enables broker dealers, custodian banks and agent lenders to support the securities lending transaction life cycle from loan initiation to ﬁnal return. DePetris identiﬁed Loanet as a critical part of this enterprise. “We concluded that we would either have to ﬁnd a way to build something like Loanet or partner with them,” DePetris said. “It wasn’t until we started working with them that we realised how similar their vision was to ours. It was only later that we decided to adopt similar strategy.” With Loanet, he said: “We are rolling out technology to the entire industry that will be like having a single order management system.” DePetris said that Quadriserv’s subscribers to AQS market data “can view real-time securities lending delivered through a variety of delivery mechanisms, including SunGard’s Astec Analytics platform.” The expansion of AQS has extended the securities lending products it supports to equity, index and ADRs (American Depository Receipts) and has been helped by relatively new products such as exchange traded funds. The $34 million preferred stock investment in AQS last March led by the International Stock Exchange is evidence of AQS’ reach. “There’s a holistic synergy between ISE and Quadriserv,” said Gary Katz, CEO of the International Securities Exchange, speaking at the event. “Our customers are natural consumers of the data that AQS supplies and some of our biggest customers are stock lenders. “ “Quadriserv began using technology in the securities lending market at a time when it was more opaque than it is now,” Katz noted. “There were many similarities with the options market when we started ISE and to that extent when we look at them, they remind us of ourselves when we were at a similar stage. What Quadriserv is doing will alter the market by making it more liquid and transparent.”
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– I am missing corporate actions that impact the profitability of a trade – I have to work very long hours to sort our billing discrepancies – I can’t take risks when choosing the supplier for my mission critical solutions - I don’t have truly real time globa global
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Hedging the props
Danny Caplan Head of prime ﬁnance sales, Deutsche Bank
Hedging the props – The prime broker angle
As reports indicate that many proprietary traders are looking to set up their own hedge funds, Fundamentals talks to prime brokers about the new landscape
their original ﬁrm then this is seen by investors as conﬁrmation that they had a very positive record of running money internally. Pinnock: Whilst our view is ﬁrst day seeding and track record are important requirements when setting up, we don’t believe it’s impossible to do so without either. This may be dependent on whether managers choose to launch on their own or join an existing manager. Additionally, we believe there may be examples where people are allowed to keep performance history and their reputations should also play a part in this. Suber: Managers with a repeatable process, deﬁnable edge, proven risk management and an ability to generate alpha on longs and shorts continue to attract capital from seeders, family ofﬁces, the managed account platforms and other mid-size institutional investors.
Ron Suber Senior partner and head of global sales & marketing, Merlin Securities
Matthew Pinnock European head of prime services and global head of prime sales, Nomura
SecuritiesLending
Is there a real move for prop trading desks to ‘go it alone’ as hedge funds? Caplan: This has certainly been the central theme
in the hedge fund industry for 2010. It is difﬁcult to think of an institutional prop team that we have not had a discussion with. Pinnock: Assuming desks want to continue to be autonomous and transact on a proprietary basis, the forthcoming changes certainly provide few alternatives to do so without setting up funds on their own. We do not believe they necessarily need to go it alone as there are also opportunities to join existing managers in this space. This enables managers to beneﬁt from existing infrastructure, marketing and expertise. Suber: Yes, to raise institutional capital and in response to recent regulation- numerous managers have moved off the prop trading structure to create independent asset management and hedge fund businesses.
Can they compete without the low cost and easily accessible balance sheet and funding that they have/had as banks? Caplan: This very much depends on the strategy
they are running. Event or equity long/short managers are unlikely to ﬁnd this an issue but it may be more difﬁcult for prop desks that focus on index or quant strategies. The process of devising a comparable hedge fund track record, which takes into account the low relative cost of bank capital, should help them to ascertain this before they decide to spin out. Pinnock: Existing managers already have a proven track record where they can compete without the backing of a larger institution or bank. The role of the prime broker in this regard will help facilitate this and should not necessarily hinder success. Investors are very cognisant of the differences of trading outside the environs of an investment bank and are quick to identify any potential threat to the hedge fund business model. These key differences can include corporate access, risk oversight, accounting of capital usage, technology, execution, disaster recovery etc. Suber: Deﬁnitely, funds can compete given the
Will they get funding without an independent track record? Caplan: Prop teams that leave an institution with a
marketable track record will deﬁnitely have a head start, as this is a key requirement for most investors. At Deutsche Bank we have particular expertise in this space, as the key principals running our prime brokerage business were closely involved in the spin-out of all our internal teams. If a team are able to leave with a signiﬁcant investment from 68 | Fundamentals
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Hedging the props
oversupply of prime brokers, under utilisation of balance sheet offered and excess securities lending supply - funding costs remain relatively low. In addition, with the recent entrance of three massive global banks offering prime brokerage, aggressive bids are accelerating.
Caplan: They key difference with a prop desk
starting a hedge fund is that they will have a signiﬁcant number of years’ expertise from running a high revenue business at an investment bank. This leads them to choose their ﬁnance counterparties with more technical expertise around leverage, risk and multi-asset capabilities. Capital introduction is deﬁnitely a key factor, and we have regularly had to arrange global roadshows to see the top investor groups before the ofﬁcial launch. Our consulting offering has also been in high demand, as the infrastructure needed for day one is more sophisticated and costly than for the average hedge fund start up. Pinnock: The 2008 crisis forced the hedge fund industry to revisit the way that it looks at the hedge fund model. Some may argue there was less focus on the structure of the fund and its key terms, for example gates, and this caused funds in the industry to close due to redemptions, not poor performance. Prop traders will need assistance in the key area of establishing a robust business structure which previously has had less attention due to the higher focus on performance of the portfolio. This is clearly dependant on the strategy. However, we would typically expect funds to require services from leverage, execution, research, corporate access, structuring, ﬁnancing, technology, risk management, consulting and capital introductions. We have deﬁnitely experienced increased appetite for capital raising, primarily due to an increase in investor due diligence and historic redemptions. Suber: These ﬁrms are looking for a full suite of global execution solutions (DMA, OMS, EMS, Dark Pool and Algo Access), real-time P&L across multiple custodians and accounts, securities lending consultation, advanced analytics to satisfy investor demands, risk management and trade allocation tools as well as support in capital development.
Are there some hedge fund strategies that are better suited to switching to a hedge fund structure? For instance, are index arbitrage traders who depend on thin margins and cheap funding less likely to form funds than other strategies? Caplan: Answered in previous question. Pinnock: We don’t view this to be any different to
other managers starting new funds.
The spread made by PB/Equity Finance groups is higher on external clients than for internal prop trading desks. Will these new hedge funds become the new “darling” clients of prime brokers, as sources of potentially high revenues? Caplan: Most prop groups are run as independent
businesses and are using external swap providers for access to speciﬁc markets and stock loan availability. Therefore, they already have similar pricing to an external hedge fund . The key difference will be the more formal use of external prime brokers. Pinnock: As with any spin out historically, there is deﬁnite desire for prime brokers to partner with the high calibre managers. We believe a high percentage of funds will naturally transact more with the providers they are closer to or are major supporters of them. This is typically the ﬁrm they span out from in addition to other primes. Prop desks are often more trading oriented, which may lead to a higher turnover and greater execution revenue. Suber: Clients of prime brokers who borrow money on margin, short securities, execute with the prime and utilize other products including repo, swap, CFD, derivatives, capital markets, research, futures, FX and more remain "darlings" as they feed numerous revenue streams throughout the ﬁrm.
What types of services are these ﬁrms likely to want? Is capital introduction particularly important at this stage, or something else?
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centres, cash and derivative trading and the ALM. Furthermore we receive an increasing demand for balance sheet-driven trade queries from a wide variety of clients which often require creative and tailor made solutions. Lastly, from a risk management perspective we are seeing stricter controls regarding subjects like underlying liquidity of collateral, haircuts and dynamic margining. Overall the securities ﬁnancing industry has evolved into a sophisticated and well respected business which over the last couple of years has attracted a high proﬁle amongst various market participants. Personally I am very pleased to see the industry moving in this direction as it is in line with how I view securities ﬁnancing within ABN Amro. As it stands we have identiﬁed securities ﬁnancing as a key growth activity and therefore we are globally present in the three major time zones offering the full range of securities ﬁnancing products. In addition, on the risk and operational side we are continuously investing in systems in order to achieve sustainable business. Although we are still in the process of rebuilding parts of the business we had lost due to the separation with Belgium, I am convinced that we are on the right track. We are deliberately not as large as before and also not as large as the usual prime brokers but we still possess key securities ﬁnancing intellect which is always able to put forward creative solutions. Taking everything into account this reafﬁrms that we are fully committed to the securities lending industry.
Describe your history in the securities ﬁnancing business:
In 1996 I started working for Commerz Financial Products (CFP) at the collateral management desk in Frankfurt. Afterwards I moved to the front ofﬁce where I got involved in securities lending trading. Within one year the team moved to London to work for the Japanese broker Nikko Securities. One and a half years later Nikko Securities was acquired by Citibank. Following this I decided to return to my Dutch roots by joining MeesPierson Securities in London for one and a half years, before I moved back to Amsterdam. MeesPierson Securities eventually became part of Fortis. In 2005 I became globally responsible for Securities Financing within Fortis. During the credit turmoil in October 2008 the Dutch state acquired the Dutch operations of Fortis (including Fortis Bank Netherlands N.V. and ABN Amro Netherlands N.V.). When Fortis Bank Netherlands N.V. and ABN Amro Netherlands N.V. merged in July 2008, I became global head of markets trading at the new ABN Amro. Nowadays, as global head of trading within ABN Amro markets, I have to equally divide my attention between other products as well. However, securities ﬁnancing will always have a special meaning for me as it is where I started my journey. I have passed on the sales side of securities ﬁnancing to Cassander Jupijn while the trading side of the business has been passed on to Dave Chang.
SecuritiesLending
Has the ﬁnancial crisis helped develop this move away from the back ofﬁce?
The move away from the back ofﬁce actually started a long time before the ﬁnancial crisis. The crisis merely accelerated the industry’s awareness within its surrounding areas and emphasised the importance of this business within the ﬁnancial system. The ﬁnancial crisis also stressed the importance of collateral and its crucial link to the balance sheet, in particular, the link to liquidity management. Many market participants recognised the urge to have treasury centres, balance sheet management, collateral management and securities ﬁnancing working closely together in order to achieve sound liquidity management.
How has the industry changed during this time?
I have seen a number of signiﬁcant industry changes during my career. First, I have seen securities ﬁnancing move from a semi back-ofﬁce activity to a fully ﬂedged integrated front ofﬁce trading unit. Nowadays securities ﬁnancing is an integral part of the dealing room functioning in very near proximity to treasury
What lessons should the securities lending industry learn from the last few years?
It is important to make a clear distinction between securities lending itself and reinvestment programmes funded with the cash collateral. Although we never offered cash reinvestment programmes, it seems most losses were suffered on opaque reinvestment programmes while losses from securities lending itself were limited. As a result the responsibility for
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Bas Cohen
monitoring the reinvestments fell on the reinvestment agents or the beneﬁcial owners themselves. Due to the lack of transparency of the reinvestment products and consequently lack of adequate risk management, the underlying risks associated with these reinvestment programmes were clearly underestimated. To answer your question in short, there are two “quick” wins: First, provide more transparency in complex reinvestment products and secondly, strengthen risk management infrastructure.
Should beneﬁcial owners take some of the blame for the losses they saw?
There are several causes that lead to these losses. On a macro level, 10 to 20 years of oversupply of liquidity resulted in excess demand for ﬁnancial assets, which lead to the credit spread tightening. Business plans and whole industries were built on the ability to reﬁnance liabilities and even losses cheaply due to this inexpensive and abundant liquidity. Consequently credit risk was virtually non-existent and the concept of real delinquencies seemed remote, however the true credit risks did not change as we learned. On a micro level, structured products like securitisation and SIVs were developed further to enhance yield for investors in the tight credit spread environment. Due to competition and search for yield, this drew in participants to whom these structures were not core products or the underlying was not allowed under their own investment policies. So was it the central bankers and governments who initiated the monetary easing, the sellers and structures of leveraged products or the buyers in search for yield who did not always understand them. The answer lies in the middle; every link in the chain is partly responsible. With respect to your question about the reinvestment programme losses, i.e. the last two, in my view a seller should always provide full transparency of the risks in its products and a buyer should stick to its own investment policies and with its own risk management capabilities.
What other lessons can the securities lending industry learn?
If I compare the equity lending market with the repo market I still see a substantial difference between the levels of maturity in the different markets. The repo market has succeeded in transforming into a highly liquid mature market, while securities lending is exactly in the midst of that transition. Electronic platforms on the repo side are currently more liquid and advanced when compared to stock loan. Finally there is the subject of central counterparties, where I see a very attractive opportunity in which the securities lending market can develop.
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Talking collateral
Talking collateral
Fundamentals spoke with Jo Van de Velde, Managing Director and Head of Product Management at Euroclear, about the latest trends in secured ﬁnancing, particularly after the recent ﬁnancial crisis.
What do you believe are the most prominent trends we will see in the area of collateral management? Jo Van de Velde: The ﬁnancial crisis intensiﬁed the need for ﬁrms to collateralise exposures across all market segments. It has been common market practice to fully collateralise some types of transactions, such as repos, central bank credit and securities lending, but others were not, such as OTC derivatives and many money market transactions. A meaningful and prominent trend we expect is the move towards complete collateralisation of all exposures arising from any type of transaction. We also expect the regulators to have great inﬂuence in making sure this happens. Their objective is to prevent banks from relying too heavily on short-term funding, while requiring banks to better mitigate their operational risks. The regulatory measures we expect to see worldwide will establish a closer link between collateralised transactions and the cost of funding for banks. This will increase the need for more operational efﬁciency in the movement of collateral, particularly as the markets become more global, while the location of useful collateral remains highly fragmented. As a result of these trends, we believe the role of triparty collateral management agents, like Euroclear Bank, will grow in importance. How are these trends different from what you see today and saw ﬁve years ago? Jo Van de Velde: The most pronounced difference compared with ﬁve years ago is the fundamental change in the sources, ﬂows and means of access to liquidity within the interbank market. Five years ago, liquidity was abundant and always readily available, at a good price. From a collateral management perspective, ﬁve years ago the market’s focus was on collateral usage. By this I mean that discussions between collateral givers and takers were more about expanding the range of assets to be used as collateral, including a variety of structured securities, whereas today’s risk-conscious behaviour dictates a shift to the use of only high-quality collateral, at least in the interbank market. Are you noticing any new regional or geographic patterns emerging? Jo Van de Velde: The massive intermediary role of the central banks in Europe during the crisis has clearly pushed a large portion of the ﬁnancing business to the domestic markets. It is understandable that the objective for banks is to be as close as possible to their primary source of liquidity, i.e. their national central bank. On the other hand, recently released ﬁgures from the European Repo Survey conducted by ICMA and the European Repo Council demonstrate an easing of tensions within the secured interbank lending market across Europe. Outstanding repo volumes rose above pre-crisis levels, of which 57% consisted of cross-border repo transactions. In addition, ﬁgures from the Bank for International Settlements show that banks boosted lending activity beyond their national borders by more than 500 billion euros in the ﬁrst quarter of 2010. These are signs that the trend is gradually moving away from central bank sources of liquidity. How will the exit strategy of central banks easing liquidity impact the collateral landscape? Jo Van de Velde: The ﬁrst point to consider is the timing of their exit strategy. In Europe, the ill ﬁnancial health of some EU nations is demonstrating that segments of the euro zone are still extremely fragile. The European Central Bank has, however, already decided to implement several adjustments to its collateral framework. Over the past two years, banks have signiﬁcantly increased the amount – to more than 2 trillion euros - of collateral deposited with central banks to meet both their routine and contingency liquidity needs. It is worth noting that the composition of collateral
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held within the Eurosystem has changed dramatically, where government debt represents only around 11%. In comparison, in the European interbank repo market, about 78% of European securities used as collateral are government debt. Therefore, if it implies additional changes to their collateral framework, the exit strategy of central banks will have an impact on the collateral landscape in Europe, as banks alter their models to optimise their use of available collateral. How has Euroclear Bank’s triparty collateral management service portfolio changed as a result of the ﬁnancial crisis? Jo Van de Velde: All of the market infrastructure service providers were tested during the crisis and all performed well. Euroclear Bank’s triparty collateral management services were no exception. Taking on board the lessons learned from the crisis and by request from our clients, we have implemented several triparty service upgrades at Euroclear Bank. We have taken into consideration the growing importance of easing access to central bank credit and have complemented our portfolio with new services to automate the collateralisation process for clients to obtain this form of credit. One of our continuing key objectives is to provide a risk-controlled and scalable environment to help our clients optimise use of their assets as collateral. What collateral management services do the Euroclear group CSDs offer for their clients? Jo Van de Velde: Today, some national CSDs provide auto-collateralisation mechanisms that primarily support the delivery-versus-payment settlement processes that CSDs operate in central bank money. Euroclear UK & Ireland, for example, offers collateral management services, called Delivery-By-Value services (DBVs) that support collateralised transactions between banks using baskets of eligible securities as collateral. In 2011, we will introduce term DBVs to the UK market, where settlement banks will be better able to manage their liquidity needs with the Bank of England. Other
collateral management enhancements are planned for other Euroclear CSDs, such as the Belgian, Dutch and French CSDs that today operate on a single settlement platform. Are you seeing different types of ﬁrms engaging in collateral management activity than before the ﬁnancial crisis? Has your client based changed since the crisis? Jo Van de Velde: Indeed, we have seen new types of ﬁrms using our triparty services to collateralise previously unsecured exposures or to beneﬁt from the double-name risk management features we offer for their cash investments in triparty repo. An increasing number of money market funds, corporates and supranationals are using our services. Also worth noting is that more intermediaries (agent banks and custodians) are accessing our triparty environment for the beneﬁt of their underlying clients. Why does a ﬁrm outsource collateral management to a third-party service provider like Euroclear Bank? Jo Van de Velde: Euroclear Bank offers a unique value proposition. We help clients access a very large pool of collateral comprising a wide range of securities, which is fully integrated with the transaction settlement and custody processing services we perform for clients. As a result, we are able to optimise their use of collateral and manage term ﬁnancing business in a seamless manner, identifying and substituting collateral using automated processes. Real-time reporting keeps clients informed of these movements at all times. The recent ﬁnancial crisis has proven Euroclear’s expertise in this area, which is supported by a solid legal and operational environment. By outsourcing their collateral management obligations to a triparty agent like Euroclear Bank, clients can collateralise all types of exposures arising with a wide range of counterparties, or through a central counterparty (CCP), but all of the back-ofﬁce administration is done by us on an end-toend STP basis.
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What kinds of ﬁrms are using your services? Jo Van de Velde: As mentioned earlier, many types of ﬁrms are using our triparty services. They are working with us to collateralise transactions for their own account, as well as acting as intermediaries to collateralise exposures for their underlying clients. While many central banks were already using our services to manage their reserves or their own investment activity, central banks in Europe and beyond are also using our services for their monetary policy operations, ranging from routine collateral operations to arranging contingency liquidity facilities. In addition, more CCPs are becoming active users to manage their core margining processes and for their new General Collateral products. How will collateral management support a recovery in the securities lending market? Jo Van de Velde: The securities lending market was severely hit by the crisis, as there was a 50% drop in securities on loan. Many lenders and beneﬁcial owners withdrew from the market due to serious risk-related concerns. We believe triparty securities lending is helping the market to build conﬁdence and regain lost ground. In fact, volumes in our triparty securities lending service are now back to pre-crisis levels. However, securities lenders have modiﬁed their risk proﬁles and have revised many of their risk assessment benchmarks. Do you expect an impact on your collateral management business as a result of new or pending regulation? Jo Van de Velde: Most deﬁnitely, and in a positive sense. New regulation will provide incentives, in the form of reduced capital requirements, for ﬁrms to pursue longer-term funding arrangements and greater operational efﬁciency. As our triparty environment has been designed to support term business in a very efﬁcient way, we expect more business ﬂows. Fully automated processing of collateral substitutions, margin calls, custody operations and more make a compelling business case for ﬁrms to outsource these responsibilities to a neutral agent like Euroclear Bank. Moreover, our fully integrated collateral re-use feature alleviates liquidity constraints that are inherent to term cash investments. As more and more regulatory focus is on OTC derivatives, and the use of CCPs in this market segment, we expect our triparty services will be helpful in managing the systemic risks arising from even more CCP and collateral fragmentation. In this regard, Euroclear Bank’s services will complement the risk mitigation objectives of CCPs and extend a high degree of collateral management efﬁciency along the whole post-trade processing chain. And, as CCP interoperability becomes a reality in the future, our services can also be of assistance in this context. What are the biggest changes in collateral composition that you believe collateral takers will demand in the future? Jo Van de Velde: Fully in line with general market trends, we saw a ‘ﬂight-to-quality’ in collateral taker demand within our triparty environment, i.e., a move towards high quality and highly liquid government debt. The evolution in collateral composition worldwide will depend on the exit strategies of central banks, which are currently accepting and receiving pools of lower-quality collateral for which liquidity has not been ﬁrmly re-established within the interbank market. What opportunities do you see for Euroclear in the area of collateral management? Jo Van de Velde: The main opportunities for Euroclear reside in expanding the pool of assets to be used as collateral that are held within the different entities of the Euroclear group. With collateral becoming an increasingly scarce resource, our priority will be to ease the sourcing and mobilisation of assets held within the group for collateral management purposes. Our goal is to be the market’s ﬁrst choice to optimise their collateral usage, no matter the type of transaction, location of their counterparty or where their assets are held within the Euroclear group.
SecuritiesLending
Euroclear makes an important contribution to the efﬁcient use and movement of collateral to reduce risks and exposures for market participants, administering more than 500 billion euros of collateral everyday.
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Market Movements
Market Movements
Sunil Daswani, international head of client relations for securities lending at Northern Trust, looks back at market developments of recent months, in which the continued corporate recovery and emergence of more positive economic data resulted in increased overall lending activity, and outlines the factors that are driving this trend.
he third quarter of 2010 witnessed a seasonallyadjusted increase in securities lending trading activity, with corporate events acting as a catalyst for increased demand for equities globally. Fixed-income activity, on the other hand, varied from market to market although, at time of writing, uncertainty over several European nations’ ability to service their sovereign debt continues to be a dominant theme.
eurozone region and a continuing increase in demand for German Government bonds in particular.
North America
A continued recovery in the US meant that the equity markets ended back in positive territory for the quarter, although as I write, concerns over European sovereign debt are overshadowing positive domestic news, leading US stock markets to close slightly down at the end of November. Investors were generally buoyed by good earnings from corporations, slightly more positive economic data and the prospect of additional US Federal Reserve asset purchases. This contributed to a 31% decrease in stock market volatility as measured by the Chicago Board Options Exchange Market Volatility Index (VIX Index) – good news that may encourage more market participation in lending, as investors are potentially reassured by greater levels of stability. As in Europe an increased number of corporate events took place, and mergers and acquisitions in particular, although the latter did not generate the levels of lending activity that would usually be anticipated. The strongest lending demand for corporate equities came from securities in the consumer durables, automotives, and hardware and equipment industries. On the ﬁxed-income front, the Federal Reserve maintained its policies to speed up the economic recovery, particularly its decision to reinvest proceeds from maturing agency debt and mortgage-backed securities into US Treasuries to maintain a stable Fed balance sheet. Additionally, the Fed conducted its ﬁrst Treasury buyback since October 2009 and by the end of the quarter over US$42 billion in Treasuries had been purchased. Corporate bond issuers took advantage of lower yields, selling US$364 billion of new debt in the third quarter, an increase of 86% more than during the second quarter. US high-yield issuance was US$80 billion, a 63% increase over the second quarter. Tight credit spreads and low yields contributed to the rush
Europe
European equity markets enjoyed a rally during the third quarter as positive corporate news outweighed mixed economic data. In the eurozone there was a notable difference between many countries’ third quarter growth ﬁgures, with Germany’s GDP increase of 2.2% contrasting with Spain and Portugal’s more modest increases of 0.2%. As expected, lending volumes declined compared to the second quarter, due to less yield enhancement trading activity caused by fewer companies distributing dividends. Hedge fund demand also remained constrained as investors’ cautious approach of recent months persisted. On a more positive note, the quarter saw a modest increase in the volume of corporate activity, such as mergers and acquisitions, stock market offerings and fundraisings. Activity largely centred on the construction and banking sectors, and acted as a spur for increases in lending volume as borrowers sought to beneﬁt from the arbitrage opportunities created by these events. European ﬁxed-income markets continued to experience volatility, particularly in the European sovereign sector. While August had brought a level of stability to the market, September and later months were marked by continually rising bondyield premiums culminating in the agreement of an internationally-funded support package for the Irish Republic. In the securities lending market, we noted two major trends: on the one hand, we experienced high levels of demand to borrow bonds issued by Greece, Italy, Ireland, Portugal and Spain. On the other, uncertainty continued to support a "ﬂight to quality" in the
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Market Movements to issue new debt as ﬁrms replaced short-dated higher yield debt with longer-dated lower yield funding. In terms of demand for ﬁxed income securities, media sector securities saw a noteworthy rise in popularity, with an increase in demand of almost 25% during the quarter. Demand increased in the electrical and telecommunications industries, and fell in the banking sector. of lending activity – continued to exhibit a mainly cautious and risk-averse trading approach. However, capital-raising activity continued to be robust, predominantly in both Hong Kong and Japan’s ﬁnancial sector. Lending volumes in the latter moved higher towards the end of September due to short-term borrowing demand for the securities of many of Japan’s corporations.
Global lending activity: a steady upturn
Writing at the beginning of December, some positive signs continue to emerge that demand for securities lending will continue to rise in 2011. While concerns over how the eurozone debt crisis can be stabilised are likely to persist in the near-term, increases in corporate activity and greater levels of market stability are assisting a steady upturn in global lending activity at the present time.
Asia
Asian equity markets moved broadly higher during the third quarter of 2010, as investors sought better returns in the region's stock markets over those of Europe and the US. Again, better-thanexpected economic data and corporate earnings also provided a boost for equity markets here. Against this backdrop, securities lending activity increased modestly as hedge funds – one of the key drivers
Sunil Daswani can be contacted at sunil_daswani@ntrs.com
Author Proﬁle
How did your career in securities lending start?
After completing a degree in accounting and ﬁnance at the London School of Economics and Political Science in 1993, I started a graduate internship in the operations team at Swiss Bank Corporation, now known as UBS. Roles in operations are a great foundation for careers in this industry, as you really do get to see what happens ‘behind the scenes’ of individual products. This provides strong knowledge of technical practices and processes, whatever role you move into later in your career. After two years at UBS, I moved to Citibank, continuing in operations but specialising in treasury, cash management and foreign exchange. Here, I moved to the front ofﬁce taking on the role of product manager for global custody, where I was introduced to the securities lending business. After seven years, I moved to Northern Trust in 2002 to specialise in securities lending. I have been here for eight years now in various front ofﬁce roles, including leading product management and development, and managing the business for the Asia-Paciﬁc region, including the trading desk in Hong Kong. I currently head up client sales and relationship management for securities lending globally outside of North America.
Stephanie Baxter talks to Sunil Daswani about his career and the continued evolution of the industry
moved to the region when the Asian markets were booming and even now it is the region in which demand for lending remains particularly robust. I was fortunate to have this experience of being located in an exceptionally dynamic region. It also proved essential when I came back to London to take on my current role, as it provided the practical understanding that client needs vary enormously from country to country.
SecuritiesLending
Shortly after arriving in Hong Kong you became chairman of the PASLA. How did that come about?
When arriving in Hong Kong, my predecessor at Northern Trust was the chairman of PASLA [the PanAsia Securities Lending Association]. When he left the industry, many people encouraged me to take on the role. Being a board member of securities lending associations allows you to work with the industry to develop the product, which is something Northern Trust has supported for many years globally.
Did you ﬁnd it challenging to take on a demanding role in an unfamiliar market?
It was a good way to get involved with what was going on in the industry and refreshing to be taking on such an important role whilst new to the market. I had enormous support from the executive board and had strong knowledge of Asia as Northern Trust had already been among the foremost lenders in establishing itself in the Chinese, Korean &
How did the Asian market differ to Europe?
I was born in Hong Kong and have family there, so I settled in very quickly. I was lucky in that I 76 | Fundamentals
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Sunil Daswani Taiwanese markets. Therefore, I was familiar with market practice and it was nice to ‘get out there’ and effectively bring some new direction to the role. It was an exciting time: I had the opportunity to meet more regulators; we rebranded PASLA and built a new website among other things. Ultimately, by generating more interest, we became recognised as the one regional ‘voice’ of the industry. It is also important that regulators and key market inﬂuencers are educated regarding securities lending. The core function of industry associations should be to ensure that key policy or regulatory decision makers know how ﬁnancial products within the markets operate and what ramiﬁcations their decisions may have. Their decisions, for example, may achieve a desired outcome in one place but a negative one in another.
Did you ﬁnd it difﬁcult to re-adapt to the UK market when you returned to London?
The market was certainly presenting a fresh set of challenges. I moved back to the UK in the midst of the ﬁnancial crisis in February 2008, when the initial tremors began in the securities lending market. Before that there was little visibility how lending was to be affected; there were looming issues in the ﬁnancial markets but the securities lending business had yet to feel the ramiﬁcations. It all started when Bear Stearns experienced problems and was ultimately taken over, coupled with the additional and growing issues in the credit markets.
Do you see much coordination between the regulators and trade associations to help improve the securities lending market?
Regulators within Asia are talking to each other but I still do not see that necessarily happening across all other regions. Asia-Paciﬁc seems to have led the industry in terms of communication and close collaboration between regulators. Leading executives have continuously been discussing issues, challenges and potential solutions, and have always reached out to industry experts and associations for feedback and opinions. This is how all regulators within our industry globally should operate. Communication is a strength of the Asian regulators, and bodies have been good at using simple methods to communicate effectively – promptly publishing white papers on their websites, for example. It was refreshing to see that during my time at PASLA, and it continues today. I am still in contact with PASLA’s executive members and the current chairman, Larry Komo, who has done a fantastic job of leading PASLA and taking it forward since my departure.
What’s happening in the Hong Kong market at the moment?
The market has always been cyclical but is starting to look quite bullish at the moment. The stock and property markets have been long-standing indictors and both are rising at dramatic rates. The government has tried applying the brakes through methods such as the introduction of new taxes, to slow down the speed and growth of the property market. We continue to watch the market closely, have lots of clients in the region and are looking to further expand our client servicing teams in Asia-Paciﬁc as a whole.
Can the industry return to its former glory?
There has been lots of negative noise from the media, so my aim at the moment is to emphasise the wider picture and look at things from a long-term perspective. I think a lot has been learned by all market participants and we have emerged two years on after the credit crunch as a much stronger industry. The majority of my meetings with clients continue to be very positive. Of course, there are some clients that have left programmes and not rejoined but it is good that these have reviewed their position regarding the ‘risk versus reward’ equation and come to a decision that is right for their individual circumstances. That said, clients are generally ‘in to stay’ for the long haul, and people are generally looking towards the future in terms of generating incremental returns via lending, and moving this part of their business forward.
What do you think has been the biggest change in securities lending during your time?
The key words that spring to mind are education, risk and transparency. Educating clients about risk is very important and needs to be continuous within the industry. For clients, an element of risk obviously needs to be taken in order to generate return, but understanding it and knowing how much to take on is absolutely key. Client education was also crucial during and after the crisis. We sought to lead our clients through the crisis, to work closely with them to establish any potential impact, and then review their lending programmes with them to reach decisions about the future. Securities lending can be as simple or complex as clients want, but the more you reﬁne, change or customise it, the more complex it can get. The key is to ensure you remain transparent with your clients throughout.
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Recruitment
Finding a way back in
While jobseekers at senior level report difﬁculties in securing roles in securities lending, junior roles are increasing as ﬁrms cut back on beneﬁts and big pay packages. By Stephanie Baxter
After huge cuts to the ﬁnance industry following the recession, hiring seemed to be on the cards again in 2010 with pockets of activity across the sector and evidence of strong recovery in the UK, US and Asia. According to head hunters, the industry has moved on from the disaster year of 2009 where hiring fell to all-time low. Morgan McKinley, a London-based recruitment ﬁrm, claims that the industry is now somewhere in between that year and the “dizzy heights” of 2005 and 2006, prior to the credit crisis. While recent global ﬁgures published by eFinancialCareers show that investment banking and capital markets are among the strongest performers on the hiring league table, securities lending is proving to be more difﬁcult. Securities lending is experiencing more sporadic hiring than other sectors, says James Bennett, managing director of eFinancialCareers. Banking giants such Barclays Capital, J.P. Morgan, Citi and Nomura have been hiring, but there does not seem to have been a signiﬁcant rise across the industry, the recruitment website added. Several job seekers with senior level experience in securities lending say they are ﬁnding it difﬁcult to ﬁnd a suitable role. The sector has previously been criticised for being too specialised, but this does not seem to be the problem here. Head hunters and job seekers talk about a growing trend where junior level professionals are ﬁnding it easier to enter the sector than those with years of experience behind them. Many graduates start off in global custody which can give them a broad understanding of the industry with the opportunity to move into securities lending at a later time. According to Emma Rowe, manager of investment banking operations at Morgan McKinley, although senior candidates are not necessarily conﬁned to a speciﬁc role, there is more ﬂexibility for junior-level professionals. This does seem to be the case when talking to executive-level professionals who have been at the forefront of job cuts and are struggling to ﬁnd a way back into a similar role. Michael Mooney, who spent most of his career at Investors Bank & Trust prior to their purchase by State Street, has been looking to secure his next role since he left Brown Brother Harriman (BBH) in November 2009 after nearly two years as a senior trader. Despite a 13-year career in securities lending, Mooney says the last year has been an “uphill struggle” as he tries to ﬁnd a suitable role in his home town, Boston. “From the agency side of lending, banks have seen more compression on hiring than on broker dealers,” he says. He adds that some cities such as Boston have seen very limited hiring with news of mergers and job cuts. In the last three to four years Boston has lost some of its major players, including the securities lending ofﬁce of UBS, which has inevitably added to the pressure on hiring. “People are willing to speak to me and there are a few roles in the area, but it’s about ﬁnding a role that’s suitable,” he says. The opportunities are in New York, says Mooney, but moving there isn’t always an option. However, he says he is now widening his job search to New York and elsewhere in North America. Another Boston-based job seeker, who did not wish to be named, has almost 20 years’ experience in the securities lending industry, mainly prime brokerage. He says that it is essential to avoid conﬁning yourself to a speciﬁc role when job hunting. “Job seekers have to be prepared to recreate themselves. Although it seems daunting at ﬁrst, it is not actually all that difﬁcult to move into a different role.” He adds that at a junior level, most candidates are looking at relationship management roles rather than trading roles because they are easier to walk into. As reporting requirements become increasingly important, ﬁrms are likely to create more junior roles to increase the number of people working on client accounts. Even New York can present a struggle for job seekers, as another jobseeker who wanted to remain anonymous discovered. She has 15 years of securities lending experience behind her, but feels that a desire for young, inexperienced minds in many ﬁrms is taking precedence over the hiring of experienced middle managers. “There is a gap in between the junior and senior levels. You need a middle manager to ﬁll that gap
SecuritiesLending
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Recruitment
to help bring everything together.” She says that ﬁrms should be taking more risks to ﬁnd someone with strong securities lending experience rather than concentrating on hiring younger people who can be moulded easily into the ﬁrm’s culture. Commenting upon this emerging trend, eFinancialCareer’s Bennett says: “There was a huge jump in the number of apprenticeships offered in 2010, which seems to be a continuing trend. Somehow the sector has managed to bounce back.” The jobseeker also regrets moving away from the trading desk, a move that she claims has “hurt” her career. It is a very difﬁcult time for female professionals in particular, she says. Back in the 1990s female executives were abundant, but now many have had to take up roles in other services, she adds. “I need a job badly. I have a family to provide for and it’s very expensive to travel back and forth to New York to meet people for future job possibilities.” According to many job seekers, networking is the only way to get back into the industry. Some are getting in touch with previous bosses while others are attending industry events to ‘get in’ with the right people. The majority of top jobs are ﬁlled by word of mouth or by a recommendation rather than through job posting sites. Some ﬁrms already have a candidate in mind before they post the vacancy, claims Kate*, who says that she has rarely received feedback from HR departments after applying for a role. But there are still opportunities in securities lending with the emergence of new products, and blossoming markets in the Asia-Paciﬁc, according to head hunters. Exchange-traded funds (ETFs) are an example of a new product that requires a new set of skills. Few professionals have extensive experience in specialising in ETFs, which opens a window for those looking to adapt their skills to the new product. Although some ﬁrms have a tendency to send a batch of juniors to emerging Asian markets such as Hong Kong and Singapore, it is becoming increasingly important to have experienced professionals who have local knowledge as regulators impose more rules on the securities lending market. Being able to communicate in or learn another language can be a great asset here. More is expected of you now, says the ﬁrst jobseeker. “You need broader skills than before, for example a better understanding about macroeconomics and the ability to do training across different areas.”
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The China angle
The China angle
With Michael Mooney
There has recently been excitement and a spike in overall interest in emerging Asia and prime brokers, beneﬁcial owners, hedge funds and agency lenders have all been growing their Far East infrastructure. This call to arms is necessary as ﬁrms look for additional opportunities to enhance their programmes. With over 200 Chinese Depository Receipts trading in the US markets, according to J.P.Morgan’s ADR.com, and currently no active securities lending trading on the Chinese mainland, the securities lending industry has found a very fertile uncharted territory and many fresh opportunities. One broker was quoted as saying that currently: “China is a very large percentage of borrower needs.” On the bank side, agent lenders have seen a signiﬁcant spike in demand for Chinese ADRs as of late. A few Chinacentric ETFs have also been of interest and there are expectations of a continued increase of the issuance of Chinese shares. According to Ernst & Young LLP, third quarter results on global IPO activity by region and capital raised show that $40.4 billion was raised in China and Hong Kong, representing 76.6% of total global IPO capital raised. The Chinese securities lending industry has been slow to move forward due to the lack of regulation or a regulatory body. Changes do appear to be taking place however, following an early August 2010 meeting between government supervisors and fund companies where many issues were addressed. In addition, Caixin Media Company, a Beijingbased ﬁnancial media group, believes that the securities lending market may be approved in mainland China within the coming months. In addition, the China Securities Regulatory Commission (CSRC) is researching all issues with relation to a viable local Chinese lending market. Until this happens, ADRs will continue to be the primary point of entry to the short side in China. Currently ADRs and ETFs are the best way for US investors to gain exposure to the Chinese markets. In fact, foreign investors are unable to make a market in any Chinese mainland “A” shares. The only route to market other than the ETFs and ADRs are Chinese securities known as “Red Chips” that maintain their ﬁling and reporting requirements on the Hong Kong Exchange. These are additional fungible Chinese listings that are in addition to the “A” shares. They should not be confused however as they do not trade in parallel to the mainland shares. With regard to ETFs, currently the only truly liquid player in the securities lending world is the iShares FTSE/XinhuaCina 25 Index Fund. FXI’s membership consists of the top 25 Chinese companies by total market cap and consists of both H or “Red Chip” shares. The street wide utilisation of FXI shares rallied at around 80% as stated by a prime brokerage contact in October of 2010, with extremely heavy demand. Following some questioning regarding Chinese shares, the securities lending manager at a major beneﬁcial owner stated that, while he is not an expert on Chinese ADRs or their lending, its thirdparty lending agent said: “We are lending Chinese ADRs for our clients. The demand is not necessarily a result of their being Chinese, as much as the sectors that they represent (such as alternative energy, technology, etc.), and the fact that certain securities in those sectors are viewed as attractive to borrow based upon concerns around overvaluation.”
SecuritiesLending
The question is: Are other beneﬁcial owners and asset managers actually taking ownership and engaging their lenders and consultants with regard to such issues - and asking questions?
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PASLA preview
The Pan Asia Securities Lending Association (PASLA) will hold its eighth annual conference jointly with The Risk Management Association (RMA) on 1st–3rd March 2011 at the Ritz-Carlton in Singapore. The programme is designed by securities lending professionals and will cover current issues in the Asian securities lending markets. For the ﬁrst time, a high-level roundtable will focus on operational issues in the current markets. Regulators and market professionals will discuss challenges in the Asian markets, best practices from established markets, methods to mitigate risk, and their applications to emerging markets and developing market workﬂows. The roundtable will be hosted by the co-chairs of the PASLA Operations Group. Regionally focused topics will include market updates for Korea, Taiwan, Hong Kong, and Malaysia. Regulators and industry experts will discuss developments, conditions, lending prospects, and legal and regulatory issues in these markets. In addition, separate panels will discuss the Indian and Singaporean markets. Representatives from the Indian exchanges, regulators, and market participants will discuss the demand for securities in India and the future of securities lending. The Singapore panel will explore demand for securities in the marketplace, market and operational challenges, and securities lending in that market, including the effects of the merger between the Singaporean and Australian exchanges. Among other regional topics to be discussed will be current and future issues facing the hedge fund industry. Industry participants, including members of three regional hedge funds, will question the effects of the ﬁnancial crisis on the hedge fund industry across the region and provide an in-depth view of potential regulatory reform. Panellists also will debate hedge funds issues with the equity ﬁnance world and the relationships between central clearing counterparty,
prime brokerage houses, and agent lenders. In addition, a panel on the lending and borrowing of ﬁxed income in the Asia Paciﬁc region will review those lending markets and discuss the outlook for 2011 from the product and participant perspective, including funding strategies, collateral developments, and risk tolerance. The impacts of new tax, regulatory, and capital reforms affecting securities lending will be discussed by legal and tax experts in this area. Topics addressed will include the Dodd-Frank Act and Basel III, along with other issues being contemplated abroad. Another panel will discuss alternative access and sources of inventory in the market. Topics will include non-traditional SBL routes to market and how ADRs, GDRs, and ETFs have increased the supply of securities for loan. The panel will discuss how this has changed the market through recent events, what it means to the market, and the outlook for both the supply and demand sides of the market. Among other topics to be addressed will be central counterparty clearing, including the requirements for a central counterparty in the securities lending market given the changes in regulations and how the Brazilian, Korean, and Taiwanese models are working and the introduction of central counterparty in India. What do these markets do differently and what do central counterparty providers have for the securities lending market and will there be conformity across Asian markets? Continuing last year’s discussions at the PASLA/RMA Conference in Hong Kong, global securities lending and borrowing association chairs will explore trends in the regional and global markets and the regulatory environment and its impact. Information, registration and hotel reservations for the conference will be available soon at www. paslaonline.com or www.rmahq.org/RMA/ SecuritiesLending. This is a secure site and all information provided is protected against outside intrusion.
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The Fundamentals Glossary
AFME Association of Financial Markets Europe APJ Asia-Pacific & Japan ASIC Australian Securities and Investments Commission ASLA Australian Securities Lending Association Asset management The professional management of investments such as stocks, bonds and real estate. Basel Committee on Banking Supervision Provides a forum for regular cooperation on banking supervisory matters, aiming to improve the quality of banking supervision around the globe. Basel III An update to the Basel Accords (recommendations on banking laws and regulations in the G20 countries) which are currently under development. Under the new rules, banks will have to increase their core tier-one capital ratio Beneﬁcial owner The actual owner of the asset, but that does not mean they are necessarily the legal owner. The beneficial owner enjoys the benefits of ownership even though the asset is under another name. Broker-dealer An agent that trades securities for its own account or on behalf of its customers. Buy-side ﬁrms This refers to firms that invest money or ‘buy’ securities. Capital requirements A bank regulation which tells banks and depositories how they must handle their capital. They are put in place to ensure that institutions are not holding investments that increase default risk and that they have enough capital to cover operating losses. Cash collateral Negotiable securities such as certificates of deposit and gilt-edged securities that are accepted as collateral by lenders because of their low risk and ability to be converted into liquidity. Cash reinvestment Where the service provider reinvests cash collateral under the terms agreed with the client. CASLA Canadian Securities Lending Association Collateral management A process of dealing with collateral transactions, where its main function is reducing credit risk in unsecured financial transactions. Collateral pools Cash collateral provided by the borrowing party in a securities-lending transaction, which is then pooled and invested in shortterm securities to generate return. Contract for difference (CFD) A contract between two parties where the issuer agrees to pay the buyer the difference between the asset’s current value and its value at time contract was made. The buyer pays the issuer if the difference is negative. Corporate actions An action which is part of a process that brings change to a company’s stock, such as stock splits, mergers, dividends and acquisitions. Some corporate actions have a direct or indirect impact on the shareholders, while others do not impact them at all. Covered short selling The opposite of naked short-selling (see below) where the short seller has a binding stock lending agreement in place. Custodial agent An agent, bank or trust which looks after an individual’s mutual funds or an investment firm’s assets. Custodian bank Financial institutions that look after the financial assets of an individual or firm. Dodd-Frank Wall Street Reform and Consumer Protection Act A US federal statute that was signed into law in July 2010 to promote the financial stability of the US and to put an end to the bailing-out of the banks. Exchange-traded fund (ETF) A security that tracks like a stock on an exchange instead of having its net asset value evaluated every day like a mutual fund. It tracks an index, commodity or pool of assets like an index fund. Fed Federal Reserve (US) FSA Financial Services Authority (UK) Hedge fund A largely unregulated portfolio of investments that are catered for sophisticated investors. These funds are often partnerships or mutual funds that aim to make high returns by taking advantage of ups and downs in the markets. IOSCO International Organisation of Securities Commission (US) IRS Internal Revenue Service (US) ISDA International Swaps and Derivatives Association (US) ISLA International Securities Lending Association Liquidity The more liquid an asset, the easier it is to convert it into cash. Liquidity is also known as marketability. Margin collection In securities trading, it’s the difference between the loan amount advanced by a stockbroker to a speculator. Market maker A broker-dealer firm that creates a market for financial obligation. They hold a certain number of shares of a particular security to ease up trading in that asset. Market makers therefore help to keep the financial markets running efficiently. Naked short-selling A practice that is illegal in many countries, where the short seller does not borrow the security in the first place or does not ensure that it can be borrowed. It allows manipulators to drive down stock prices, ignoring normal stock supply and demand patterns. NAPF National Association of Pension Funds (UK) NY Fed Federal Reserve Bank of New York OCC Options Clearing Corporation PASLA Pan-Asia Securities Lending Association Prime broker A broker who provides a special group of services to clients such as securities lending, leveraged trade executions and cash management. Prime custodian A custodian who takes responsibility for managing a client’s custody relationships when they have several global custodians across a number of portfolios. Private equity Equity capital that is not put on the public exchange, where investors and funds make direct investments into private firms or buy out public companies that results in a delisting of private equity. Proprietary desk/trader A trader who deals with a securities firm’s transactions that affect the firm’s accounts but not the accounts of its clients. The bank uses its own balance sheet to take positions in shares, bonds or commodities. Proxy voting Where someone acts on behalf of a company member at a company meeting where at least one vote is taken. Repo A repurchase agreement which is the sale of securities tied to an agreement to buy the securities back at a later point. Request for proposal (RFP) A document used by many organisations to receive offers of services from potential suppliers. It enables organisations to receive the right information to make good business decisions. RG 196 Australian short selling regulation that was introduced by the Australian Securities and Investments Commission in April 2010. Risk mitigationTaking efforts to reduce the exposure to risk. Also called risk reduction. Risk versus return The balance between the risk of loss and the potential return. Usually, the higher the risk of loss, the greater the potential return, while the lower the risk of loss, the lower the potential return. RMA Risk Management Association (US) SAS70 audits Standards that an auditor must use to assess the contracted internal controls of a service organisation. SEC Securities and Exchange Commission (US) Securities lending The lending of securities from one party to another in return for a fee. The borrower is obliged to return them either on demand or at the end of the agreement. Sell-side ﬁrms Investment banks that provide buy-side firms with services and products. SFC Securities and Futures Commission (US) Short selling An advanced trading strategy in securities lending where the short seller hopes to capitalise from a fall in the asset price. ‘Going short’ is the opposite of ‘going long’. SIFMA Securities Industry and Financial Markets Association (US) Single stock future (SSF) A futures contract with the underlying asset being one particular stock. It gives investors more capabilities to leverage themselves in the market. Swap-based ETF ETFs that use swap arrangements to replicate markets where there may be difficult access or poor liquidity. Unlike standard ETFs, swap-based ETFs hold a pool of securities which may have no relation at all to the index being tracked. Third-party lender A firm specialising in securities lending which is not the custodian of the beneficial owner’s assets. Triparty collateral managers These provide a centralised service to manage, clear and hypothecate collateral among different OTC counterparties in the market. Workﬂow management Managing and defining a series of tasks within an organisation to produce a final outcome.
BackOfﬁce
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AP Information Services Ltd. Tel: +44 (0)20-7566 8255 Tel: +44 (0)20-8349 9988 AP Information Services AP InformationServices Ltd. Tel: +44 (0)20-7566 8255 2nd Floor Fax: +44 (0)20-7324 2343 2nd Floor Fax: +44 (0)20-7608 1163 2nd Floor Fax: +44 (0)20-7608 1163 6-14 Underwood Street Street Email: info @apinfo.co.uk 6-14 Underwood Email: data@apinfo.co.uk 6-14 Underwood Street Email: data@apinfo.co.uk London N1 7JQ, UK Web: www.apinfo.co.uk London N1 7JQ, UK Web: www.apinfo.co.uk London N1 7JQ, UK Web: www.wlrstore.com/apinfo
Directory of services
Securities Lending
Deutsche Bank’s Global Transaction Banking division, offers its clients access to a growing domestic custody and clearing network which currently covers more than 30 securities markets globally. We are dedicated to providing cross-border custody services, fund administration, securities clearing and agency securities lending consistently in all markets to exceptional standards as part of our commitment to support our clients’ success. Through ofﬁces in London, New York and Frankfurt, Deutsche Bank’s Agency Securities Lending team operates one of the world’s largest non-custodial agency securities lending programs offering institutional clients a comprehensive and efﬁcient service for generating additional return on their ﬁxed income and equity portfolios in a low risk environment. Deutsche Bank has been recognized in Global Custodian’s Securities Lending Survey 2010 achieving “Top-rated” status in a number of categories. It was also the highest scoring regional provider in Europe, the highest scoring provider in the Multi-Provider category and obtained 34 Best in Class awards. eSecLending is a leading global securities lending agent servicing sophisticated institutional investors worldwide. The company’s approach has introduced investment management practices to the securities lending industry, offering beneﬁcial owners an alternative to the custodial lending model. Their philosophy is focused on providing clients with complete program customization, optimal intrinsic returns, high touch client service and comprehensive risk management. Their process is to begin each client’s program with a competitive auction to determine the optimal route to market for their portfolios or asset classes whether it is via agency exclusives or traditional agency lending. This differentiated approach achieves best execution while delivering their clients with greater transparency and control, allowing them to more effectively monitor and mitigate risks. Additional information about eSecLending is available on the company’s website - www.eseclending.com. Contact: Tim Smollen Deutsche Bank Managing Director, Global Head of Agency Securities Lending Tel: +1 212 250 4611 Email: tim.smollen@db.com www.tss.db.com tss.info@db.com
Contact: Christopher Jaynes, Co-CEO Tel: US +1 617 204 4500 Address: 175 Federal Street 11th Floor, Boston, MA 02110, USA Tel: UK +44 (0) 20 7469 6000 Address: 1st Floor, 10 King William Street, London, EC4N 7TW, UK Email: info@eseclending.com Web: www.eseclending.com
Northern Trust Corporation (Nasdaq: NTRS) is a global leader in delivering innovative and customized Securities Lending programs to clients whose assets are custodied at Northern Trust and elsewhere. Northern Trust Global Securities Lending is a leader in the industry, operating trading centers throughout the United States, Europe, Canada and Asia to take advantage of markets throughout the world 24-hours a day. Northern Trust’s Securities Lending program is consistently recognized as a top lender; continuously outperforms the RMA’s Aggregate Composite; holds top positions at industry organizations; provides superior relationship management and technology; and maintains a strong 28-year track record.
Chris Doell Senior Vice President Head of North American Securities Lending Client Service +1 312 444 7177 Sunil Daswani Senior Vice President Head of International Securities Lending Client Service +44 (0)20 7982 3850
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J.P. Morgan Worldwide Securities Services (WSS) is a premier securities servicing provider that helps institutional investors, alternative asset managers, broker dealers and equity issuers optimize efﬁciency, mitigate risk and enhance revenue. A division of JPMorgan Chase Bank, N.A., WSS leverages the ﬁrm’s unparalleled scale, leading technology and deep industry expertise to service investments around the world. It has $15.3 trillion in assets under custody and $6.5 trillion in funds under administration. J.P. Morgan offers a complete fund accounting solution, servicing a wide array of investment vehicles and fund structures with customized, full-service back-ofﬁce support. We service a broad array of investment products, including mutual funds, private equities, partnerships and commingled trusts, offering full support for high volumes of derivatives and complex instruments, including meticulous distinction between GAAP and tax.
Visit www.jpmorgan.com/visit/wss or contact: J.P. Morgan Worldwide Securities Services Francis Jackson, francis.j.jackson@ jpmorgan.com or 44-207-3253742 Huw Williams, huw.c.williams@ jpmorgan or 44-207-7775434
Custody & Clearing
Société Générale Securities Services offers institutional investors, asset managers and ﬁnancial intermediaries a comprehensive range of ﬁnancial securities services: custody, clearing & trustee services, fund administration, asset servicing and transfer agency. SGSS currently ranks 3rd European custodian and 9th worldwide custodian (Source: Globalcustody.net) with EUR 2,580* billion in assets held and valuates 4,354* funds representing assets of EUR 405* billion (as of June 2007). Sébastien Danloy Global Head of Sales, Investor Services Société Générale Securities Services T: +33 (0)1 41 42 98 65 E: sebastien.danloy@socgen.com W: www.sg-securities-services.com
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Custody & Clearing (cont)
T: +47 22 94 92 95 F: +47 22 48 28 46 Contact: Bente I. Hoem, Head of Global Relations & Network E: bente.hoem@dnbnor.no W:www.dnbnor.com DnB NOR is the leading provider of Custody, Clearing and Remote Member Service in Norway. DnB NOR offers a full range of securities settlement, Corporate Action and cash management services for both foreign and domestic institutional clients. The bank has a strong commitment to the Custody business in Norway and the staff is highly knowledgeable and experienced. In addition, DnB NOR provides a wide range of value-added services for foreign clients such as Securities Lending, Income Collection, Proxy Voting, Tax Reclaim, and MIS reporting. As the largest commercial bank in Norway, DnB NOR offers clients full services in securities trading, registration, foreign exchange and Money Market. Banking Securities Services provides award winning local and regional custody services for investment professionals. We are proud to be the largest custodian provider in terms of assets and number of foreign clients in Central & Eastern Europe. ING has been providing Securities Services in CEE since 1994 and we will continue our ongoing pursuit of excellence through new technology. Innovation and client focus are the key drivers to service our clients the best way. Other activities of ING Wholesale Banking Securities Services are Paying Agency Services and web-based management of employee stock option & share plans. ING is your local partner in: Belgium, Bulgaria, Czech Republic, Hungary, Poland, Romania, Russia, Slovak Republic and Ukraine. Nordea is the leading ﬁnancial services group in the Nordic and Baltic region and operates through three business areas: Nordic Banking, Private Banking and Institutional & International Banking. Nordea is the leading custody services provider in the region. Nordea provides high quality, tailor-made custody services for local and foreign investors dealing with Nordic and Baltic securities. Due to the unique history of being formed from four established banks, Nordea is the only Nordic custody provider with strong local presence and expertise in all four markets. Nordea combines Nordic competence with local expertise, and has proven ability to deliver high quality services that meet both clients’ and each local market’s requirements. • Leading Nordic custodian: • Critical mass and resources available; • deep local experience and active involvement in each Nordic market; • Complete operational capabilities and best-ﬁt systems developed in each Nordic market; • Proven ability to deliver high-quality service in all Nordic markets; Excellent connection with key players in all Nordic Markets; • Extensive product and service offering; • Your single point of entry to the whole Nordic region. RBC Dexia Investor Services offers a complete range of investor services to institutions worldwide. Our unique offshore and onshore solutions, combined with the expertise of our 5,300 professionals in 16 markets, help clients grow their business and sustain enhanced performance through efﬁciency improvements and robust risk management practices. Equally owned by RBC and Dexia, the company ranks among the world’s top 10 global custodians with USD 2.5 trillion in client assets under administration. RBC Dexia’s innovative solutions include global custody, fund and pension administration, shareholder services, distribution support, securities lending and borrowing, reconciliation services, compliance monitoring and reporting, investment analytics, and treasury services.
For further information please contact Lilla Juranyi, Global Head Custody at + 31 20 7979 435 or contact her by email: Lilla.Juranyi@mail.ing.nl
Contact: Nina Groth Head of Sub-custody and Clearing Tel: +45 3333 6124 E-mail: nina.groth@nordea.com
71 Queen Victoria Street London EC4V 4DE, UK C: Tony Johnson T: +44 (0) 20 7653 4096 E: antony.johnson@rbcdexia.com W: http://www.rbcdexia.com
T: Europe: (34) 91 2893932 / 28 T: USA: (1212) 350 39 02 W: santanderglobal.com E: globalsecurities@ gruposantander.com
Banco Santander is a retail and commercial bank, based in Spain, with presence in 10 main markets. At the end of 2009, Santander was the largest bank in the euro zone by market capitalization and fourth in the world by proﬁt. Founded in 1857, Santander had EUR 1,245 billion in managed funds at the end of 2009. Santander has 90 million customers, 13,660 branches and 170,000 employees. It is the largest ﬁnancial group in Spain and Latin America. In 2009, Santander registered 8,943 million in net attributable proﬁt.
C: Goran Fors T: +46 8 763 5770 E: goran.fors@seb.se W: http://www.seb.se
SEB is the leading provider of securities services in the Nordic and Baltic area. We are committed to custody and clearing processes for the wholesale market. We hold securities worth over EUR 500 bn and provide services in more that 80 markets, 11 of them under the SEB name (Sweden, Norway, Finland, Denmark, Luxembourg, Germany, Estonia, Latvia, Lithuania, Russia and Ukraine). We offer a full range of securities services including corporate action and information services, securities lending and services to remote members of the Nordic and Baltic stock exchanges. We are also General Clearing Member on all CCP´s covering Nordic securities. We continuously develop new products in connection with clients and partners to ensure we deliver the high-quality products our clients demand. We always strive to make the processes more efﬁcient. With a history of 150 years in the securities industry; we know the market and our clients well.
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? ?? Fund Administration
With more than 35 years’ industry experience, Capita Financial Group provides fund managers with fast and cost effective third-party administration services, enabling you to free up your day to focus on growing your funds and business. Our main focus is to provide a ‘Best in Class’ administration service, we work in partnership with you to innovate, increase efﬁciency and provide the high level of customer service that you and your clients expect. With our UK and offshore centres (Jersey, Guernsey, Ireland and Gibraltar), we offer a bespoke service to our clients and each area’s unique regulatory environment. Société Générale Securities Services offers institutional investors, asset managers and ﬁnancial intermediaries a comprehensive range of ﬁnancial securities services: Clearing, Liquidity Management, Custody and Trustee, Fund Administration, Asset Servicing, Fund Distribution Services and Issuer Services. SGSS currently ranks 3rd European custodian and 7th worldwide custodian (Source: Globalcustody.net) with EUR 2,731* billion in assets held and valuates 5,158* funds representing assets of EUR 499* billion (at end March 2008). Leah Cox +44 (0) 207 954 9559 leah.cox@capitaﬁnancial.com www.capitaﬁnancial.com.
Sébastien Danloy Global Head of Sales Société Générale Securities Services T: +33 (0)1 41 42 98 65 E: sebastien.danloy@socgen.com W: www.sg-securities-services.com
Hedge Fund Administration
Apex Fund Services Ltd is a global hedge fund administration solution for hedge funds and private equity clients located in 12 separate jurisdictions across the globe. The company uses the software solution, PFS PAXUS, which is a fully integrated hedge fund accounting system combined with web-based reporting to allow clients and investors to access their information 24/7 securely online. We will tailor all solutions to meet your needs and our continuing focus on the quality of service and the relationship with each and individual client ensures that we retain our ethos of providing a personalized service rather than a generic solution. Highly qualiﬁed and experienced staff, mirrored with top tier technology and competitive fee structures make Apex Fund Services Ltd the clear choice for your fund administration needs.
C: Peter Hughes Group Managing Director T: +1 441-292-2739 F:+1 441-292-1884 E: peter@apex.bm John Bohan Group Manager of Operations T: +353 21 4633366 F: +353 21 4633377 E: John@apexfunds.ie
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Custom House Global Fund Services Ltd. (“CHGFS”), the Malta based parent company of the Custom House Group of Companies (“Custom House”), was established when Equity Trust’s fund services division was merged into Custom House in September 2008. CHGFS is recognised as a fund administrator and licensed under a Category 4 license as a Custodian for Funds of Funds and is also an authorised Trustee for Trusts. Custom House offers a full 24/5, “round the world”, “round the clock” administration service out of its ofﬁces in Amsterdam, Chicago, Dublin, Guernsey, Luxembourg, Malta and Singapore. This service, which enables Custom House to offer daily dealing NAVs covers all aspects of day to day operations, including maintaining the fund’s books and records, carrying out the valuations, calculating the NAV and handling all subscriptions and redemptions, as well as over-seeing payment of the fund’s expenses. Custom House uses the PFS-PAXUS fully integrated fund administration system. Reporting is effected through CHARIOT, Custom House’s secure web-reporting platform for managers and investors. Custom House is fully SAS70 compliant and the Dublin ofﬁce was the only hedge fund administrator in the world ever to be awarded a Moody’s Management Quality Rating. CHGFS and its subsidiaries are fully regulated, as required, by the relevant authorities in their jurisdiction.
Custom House Global Fund Services Limited Head Ofﬁce Address: Tigne Towers Suite 33 Tigne Street Sliema 3172 Malta www.customhousegroup.com Contacts: Dermot S. L. Butler, Chairman dermot.butler@customhousegroup. com T: +353 1 878 0807 Albert Cilia, Managing Director albert.cilia@mt.customhousegroup. com T: +356 2702 2799
Consultancy
With annual revenue of USD5 billion, SunGard is a global leader in software and processing solutions for ﬁnancial services, higher education and the public sector. SunGard also helps information-dependent enterprises of all types to ensure the continuity of their business. SunGard serves more than 25,000 customers in more than 50 countries, including the world’s 50 largest ﬁnancial services companies. Visit SunGard at www.sungard.com
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Technology
C: Judith McKelvey T: +44 (0) 207 043 8319 E: judith.mckelvey@4sight.com C: Jason Hayes T: +1 416 548 7922 E:jason.hayes@4sight.com C: Peter Sanders T: +61 (0) 2 90378416 E: peter.sanders@4sight.com W: www.4sight.com
4sight Financial Software is a leading supplier of innovative software solutions to the Securities Finance, Settlement & Connectivity markets with ofﬁces and clients worldwide. 4sight Securities Finance (4SF) is a ﬂexible modular solution that empowers ﬁnancial institutions of all sizes, from the smallest direct lender to the global custodian, broker or intermediary on an agency or principal basis. 4SF contains market leading functionality that provides greater automation, faster trading, improved risk management, and enhanced relationships with clients and counterparties. It supports borrowing, lending, repo, swaps and collateral management across the equity and ﬁxed-income markets and provides 24 hour continuous operation, inter desk trading, a ‘global book’, real-time value dated position keeping and a powerful web reporting module, allowing full front to back ofﬁce processing. With annual revenue of USD5 billion, SunGard is a global leader in software and processing solutions for ﬁnancial services, higher education and the public sector. SunGard also helps information-dependent enterprises of all types to ensure the continuity of their business. SunGard serves more than 25,000 customers in more than 50 countries, including the world’s 50 largest ﬁnancial services companies.
Visit SunGard at www.sungard.com
T: +41 (0)44 298 92 00 F: +41 (0)44 298 93 00 A: COMIT AG, Pﬂanzschulstrasse 7, CH-8004 Zürich, Switzerland W: www.ﬁnacesolution.com www.comit.ch
Finace is currently the only fully integrated solution which supports the future business model within the areas of Securities Lending, Repo and OTC Derivatives Collateral Management. The architecture of Finace is based on a stable, leading edge technology platform, which was developed with performance and robustness as the focus of design. With ﬂexibility at its core, customer-driven extensions and modiﬁcations can be quickly and easily applied to the standard component set.
For more information about Broadridge, please visit www.broadridge.com.
Broadridge Financial Solutions, Inc., with over $2.1 billion in revenues in ﬁscal year 2009 and more than 40 years of experience, is a leading global provider of technology-based solutions to the ﬁnancial services industry. Our systems and services include investor communication, securities processing, and clearing and outsourcing solutions. We offer advanced, integrated systems and services that are dependable, scalable and cost-efﬁcient. Our systems help reduce the need for clients to make signiﬁcant capital investments in operations infrastructure, thereby allowing them to increase their focus on core business activities.Proxy Edge - our comprehensive solution for institutional global proxy voting management.Gloss - our leading international STP system which automates the trade processing lifecycle from trade capture through conﬁrmation, clearing agency reporting and settlement. Tarot - a UK retail and private client stockbroking, custody and fund management solution. Securities Data Management outsourced data services for securities operations.
Eagle Investment Systems LLC The Bank of New York Mellon Financial Centre 160 Queen Victoria Street, London UNITED KINGDOM EC4V 4LA Phone Number: 44 (0)20 7163 5700 E: sales@eagleinvsys.com W: www.eagleinvsys.com
Eagle Investment Systems LLC is a global provider of ﬁnancial services technology serving the world’s leading ﬁnancial institutions. Eagle provides enterprisewide, leading-edge technology and professional services for data management, investment accounting and performance measurement. Eagle’s Web-based solutions support the complex requirements of ﬁrms of any size including institutional investment managers, mutual funds, hedge funds, brokers, public funds, plan sponsors and insurance companies. Eagle’s product suite is offered as an installed application or can be hosted via Eagle ACCESSSM, Eagle’s ASP offering. Eagle Investment Systems LLC is a subsidiary of The Bank of New York Mellon Corporation. To learn more about Eagle’s solutions, contact sales@ eagleinvsys.com or visit www.eagleinvsys.com.
C: Mr Ras Sipko T: +1-201-291-7747 E: ras@kogerusa.com W: http://www.kogerusa.com
KOGER is a leading provider of technology solutions to the fund administration industry. KOGER products are used by some of the largest and most respected institutions in the industry. KOGER has ofﬁces in each of the USA, Ireland, Slovakia and Australia and provides comprehensive 24/5 technical support. NTAS (New Generation Transfer Agency System) is the premier shareholder register and transfer agency system in the market. NTAS modules include an extensive range of incentive fee calculation methods as well as an extensive list of capabilities such as dividend processing, cash ﬂow management, anti-money laundering, blacklist, taxation and fee management. NTAS supports a wide variety of fund structures including master-feeder, fund of funds, series, limited partnerships, private equity and side pockets. Reports are fully customizable and worldwide replication is available. KOGER’s GRID (Global Reach Interface Daemon) is a middleware interface that integrates NTAS with any third-party system.
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National service: Think of the bonuses
National service : Think of the bonuses
Or how public outrage at bankers’ pay can strengthen regulators
uilders talking about short selling, school kids waxing lyrical about credit default swaps, barbers talking about, well, haircuts – the ﬁnancial crisis ensured many new phrases entered the public discourse, but probably nothing got the average man on the street quite so riled as the issue of bankers’ pay. And it is ongoing - moves to cap bonuses or put greater tax burdens on them are afoot across the globe. Everyone knows bankers are well remunerated, always have been and probably always will be. It is one of the reasons (or the only?) why people get into it in the ﬁrst place. It is why the top economics graduates and ﬁnancial minds choose banking as a career path, as opposed to something dull – say, being a regulator. Poaching pays better than game-keeping. Of course, regulators did not get off lightly either, although exactly what they had done wrong is still a matter of debate: they were under-qualiﬁed and not as smart as the people they were regulating or they were too academic and not real-world savvy; they were over burdened or they did not have enough responsibilities; they were too chummy with the industry or were too distant. So what can be done? The answer is simple – a form of national service. When a top ﬁgure at a bank wants to retire with his cushy pension and bonuses, he gets taxed at, say, 75%, for the sake of argument. Public happy, government purse strings happy – but banker unhappy. However, he can win his money back – he will only be taxed at, say 25%, if he works for two years at a regulator. That way, regulators get the experience of people who have worked at the top level in the real world, have no vested interest in returning to the private sector and have a good idea of what loopholes need to be closed (safe in the knowledge that as they are soon to retire, said closed loopholes will not affect them - anymore). It would even be simple to put in some KPIs – identify a certain amount of dubious practices or fraudulent practices a year to get the full tax break. There must be enough bad blood between some top
B
level ﬁgures to know they would be happy ratting one another out – all for the public good of course. But why stop at banking? There are plenty of other applications – one that particularly springs to mind is politicians. In the UK, pensions secretary Iain Duncan Smith has called for the long-term unemployed to do community work in order to receive their full beneﬁts. Why not ask politicians to do the same upon retiring from ofﬁce? Finding out whether they would smile as much while helping clean grafﬁti off walls or sweep up streets as they do in new policy publicity shots would be an interesting experiment. Of course, following that line would mean that the policy should be applied across the board – so journalists would have to spend a couple of years working at the Press Complaints Commission. Luckily, journalists do not get bonuses, so any tax hike would not affect us; the minimum retirement age will soon be above average life expectancy so pensions are a moot point; and most importantly, no one ever listens to journalists so this policy will never be enacted anyway. See you next quarter...
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Flexibility for a world in motion
trade services, need them
A reliable service provider like Euroclear can help you meet your short-term needs, especially during these challenging times of changing market conditions, tighter regulation and scarce liquidity.
ENHANCE YOUR RETURNS
In the current market environment it takes more than good fortune to enhance your portfolio’s returns while managing risks. In order to make strategic decisions, you need expertise, ﬂexibility and sound recommendations when one borrows, lends and repo domestic and international securities. You can rely on our team to provide you with an innovative approach and support. • • • • • • Enhanced Returns above your current Securities Lending Activities Tailor Made Securities Finance Solutions Customized Collateral Programs Global Infrastructure Principal Borrower An Exclusive Relationship with Fixed Commitment Capability
• Structured Product Suite For more information please contact our Securities Finance team in; Amsterdam: Cassander Jupijn, Global Head Sales Securities Financing
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Tel. +31 20 383 662 London: New York: Justin Head, Director Sales Securities Financing Tel. +44 203 192 9250 Barbara Eelens, Director Sales Securities Financing* Tel. +1 917 284 6702 Hong Kong: Gene Lim, Executive Director Sales Securities Financing Tel. +852 3472 1714
This information is intended for institutional investors only, and not the general public. *ABN AMRO Securities (USA) LLC, a wholly owned subsidiary of ABN AMRO Bank N.V.

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